<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A)
OF THE SECURITIES EXCHANGE ACT OF 1934
Filed by the Registrant [X]
Filed by a Party other than the Registrant [_]
[_] Confidential, For Use of the Commission
Only (as permitted by Rule 14a-6(e)(2))
Check the appropriate box:
[X] Preliminary Proxy Statement
[_] Definitive Proxy Statement
[_] Soliciting Materials Pursuant to (S) 240.14a-11(c) or (S) 240.14a-12
CHOICE HOTELS INTERNATIONAL, INC.
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(NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CHOICE HOTELS INTERNATIONAL, INC.
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(NAME OF PERSON(S) FILING PROXY STATEMENT)
Payment of Filing Fee (Check the appropriate box):
[_] $125 per Exchange Act Rules 0-11(c)(1)(ii), 14a-(6)(i)(1) or 14a6(j)(2).
[_] $500 per each party to the controversy pursuant to Exchange Act Rule 14a-
6(i)(3).
[X] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
(1) Title of each class of securities to which transaction applies:
Common Stock, par value, $.01 per share.
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(2) Aggregate number of securities to which transaction applies:
61,068,547
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(3) Per unit price or other underlying value of transaction computed to
Exchange Act Rule 0-11:/1/
-
$.70
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/1/ Book value of securities to be distributed ($43,045,000),
-
calculated pursuant to Exchange Act Rule 0-11(a)(4).
(4) Proposed maximum aggregate value of transaction:
$43,045,000
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Book value of securities to be distributed calculated pursuant to
Exchange. Act Rule 0-11(a)(4).
(5) Total fee paid:
$8,609
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[_] Fee paid previously with preliminary materials:
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[_] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
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(2) Form Schedule or Registration Statement No.:
----------------------------------------------------------------------
(3) Date Filed:
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(4) Date Filed:
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[CHOICE LOGO]
, 1997
Dear Stockholder:
You are cordially invited to attend the 1997 Annual Meeting of
Stockholders (the "Annual Meeting") of Choice Hotels International, Inc.
("Choice" or the "Company") to be held on September 16, 1997 at 9:00 a.m.
(E.S.T.) in the auditorium located at 11555 Darnestown Road, Gaithersburg,
Maryland. I urge you to be present in person or represented by proxy at this
important Annual Meeting at which stockholders will be asked to ratify a major
transaction that will separate Choice into two publicly-traded companies.
You are being asked to consider and vote upon a group of related
proposals (the "Distribution Proposals") which will provide for the distribution
(the "Distribution") to stockholders, on a share-for-share basis, of all
outstanding shares of common stock of a wholly owned subsidiary of the Company,
Choice Hotels Franchising, Inc. ("Franchising"). The Distribution will separate
the Company's hotel franchising business from its hotel ownership and management
business. Upon the Distribution, the Company will change its corporate name (as
renamed, "Realco") and will continue to own and operate hotel properties in the
United States (the "Hotel Business"). After the Distribution, Franchising will
change its name to Choice Hotels International, Inc. and will engage in the
business of franchising hotels under the Clarion, Quality, Comfort, Sleep Inn,
Rodeway, Econo Lodge and MainStay brands (the "Franchising Business") and will
own and operate 14 hotel properties in France, Germany, and the United Kingdom.
The Board of Directors believes that the proposed Distribution will
remove the existing impediments to the growth of the Company's Hotel Business
and, at the same time, reduce or eliminate the substantial recurring conflicts
between the Hotel Business and the Franchising Business. The Distribution will
also enable the Hotel Business to attract, retain and effectively incentivize
skilled real estate professionals and will facilitate a better understanding by
the investment community of the Company's two distinct businesses.
Details of the Distribution Proposals and the other proposals to be
considered at the Annual Meeting, as well as important information relating to
the Distribution, including a description of the business, directors and
management of Realco and Franchising, are set forth in the accompanying Proxy
Statement and should be considered carefully.
I am excited about the future prospects for both Realco and
Franchising as separate public companies. The Board of Directors believes that
the Distribution is in the best interests of stockholders and unanimously
recommends that stockholders vote to approve the Distribution Proposals.
WHETHER OR NOT YOU EXPECT TO ATTEND THE ANNUAL MEETING, IT IS
IMPORTANT THAT YOUR SHARES BE REPRESENTED. PLEASE COMPLETE, SIGN AND DATE THE
ENCLOSED PROXY CARD AND RETURN IT PROMPTLY IN THE ACCOMPANYING ENVELOPE. If you
attend the Annual Meeting, you may vote in person if you wish even though you
previously have returned your proxy card.
Sincerely,
[signature]
William R. Floyd
Vice Chairman and Chief Executive Officer
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CHOICE HOTELS INTERNATIONAL, INC.
10750 COLUMBIA PIKE
SILVER SPRING, MARYLAND 20901
_________________
NOTICE OF ANNUAL MEETING
TO BE HELD SEPTEMBER 16, 1997
_________________
TO THE STOCKHOLDERS OF
CHOICE HOTELS INTERNATIONAL, INC.
Notice is Hereby Given that the Annual Meeting of Stockholders (the
"Annual Meeting") of Choice Hotels International, Inc., a Delaware corporation
(the "Company"), will be held in the auditorium located at 11555 Darnestown
Road, Gaithersburg, Maryland at 9:00 a.m. (E.S.T.) for the following purposes:
1. To consider and to vote upon four related proposals (collectively, the
"Distribution Proposals") described in the accompanying Proxy
Statement, which provide for:
(i) Proposal One: Ratification of a special dividend, consisting
of the distribution (the "Distribution") to the holders of the
Company's outstanding shares of common stock, par value $.01
per share ("Company Common Stock"), on a share-for-share basis,
of all outstanding shares of common stock, par value $ $.01 per
share ("Franchising Common Stock"), of the Company's wholly
owned subsidiary, Choice Hotels Franchising, Inc., a Delaware
corporation ("Franchising") and the related arrangements
between the Company and Franchising, and the policies to be
adopted by such companies, in connection therewith;
(ii) Proposal Two: Approval of the amendment of the Restated
Certificate of Incorporation of the Company to (i) change the
name of the Company to ; (ii) decrease the
number of authorized shares of Company Common Stock from
160,000,000 to 60,000,000; and (iii) to effect a one-for-three
reverse stock split of Company Common Stock whereby every three
shares of Company Common Stock would be aggregated into one
share of Company Common Stock (the "Reverse Stock Split");
(iii) Proposal Three: Ratification of the election by the Company,
as sole stockholder of Franchising, of 9 directors of
Franchising specified in the Proxy Statement, who will be
divided into three classes, the initial terms of which will
expire in 1998, 1999 and 2000; and
(iv) Proposal Four: Ratification of adoption by Franchising of the
Franchising Stock Incentive Plan and the Franchising Employee
Stock Purchase Plan.
2. To consider and to vote upon the following additional proposal (the
"Additional Proposal") described in the accompanying Proxy Statement,
which provides for:
(i) Proposal Five: Election of three directors to hold office
until the 2000 Annual Meeting of Stockholders and until their
successors are elected and qualified.
3. To transact such other business as may properly come before the Annual
Meeting.
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The Board of Directors of the Company has fixed the close of business
on , 1997 as the record date (the "Record Date") for the determination
of stockholders entitled to notice of, and to vote at, the Annual Meeting or any
adjournment(s) or postponement(s) thereof. Only stockholders of record at the
close of business on the Record Date are entitled to notice of, and to vote at,
the Annual Meeting and any adjournment(s) or postponement(s) thereof. 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.
[signature]
Edward A. Kubis
Secretary
, 1997
Silver Spring, Maryland
TO VOTE YOUR SHARES, PLEASE SIGN, DATE AND COMPLETE THE ENCLOSED PROXY
AND MAIL IT PROMPTLY IN THE ENCLOSED RETURN ENVELOPE.
<PAGE>
CHOICE HOTELS INTERNATIONAL, INC.
10750 COLUMBIA PIKE
SILVER SPRING, MARYLAND 20901
_____________
PROXY STATEMENT
ANNUAL MEETING OF STOCKHOLDERS
SEPTEMBER 16, 1997
_____________
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 (the "Company"), for use at the 1997 Annual Meeting of
Stockholders of the Company to be held at 9:00 a.m. (E.S.T.) on September 16,
1997, in the auditorium located at 11555 Darnestown Road, Gaithersburg, Maryland
and at any adjournment(s) or postponement(s) thereof (the "Annual Meeting"). It
is anticipated that this Proxy Statement together with the proxy and the 1997
Annual Report to Stockholders, will first be mailed to the Company's
stockholders on or about August 1, 1997.
At the Annual Meeting, holders of shares of Company Common Stock will
be asked to consider and to vote upon the following related proposals,
denominated Proposals One through Four (collectively, the "Distribution
Proposals"):
(i) Proposal One: Ratification of a special dividend, consisting
of the distribution (the "Distribution") to the holders of
the Company's outstanding shares of common stock, par value
$.01 per share ("Company Common Stock"), on a share-for-
share basis, of all outstanding shares of common stock, par
value $ $.01 per share ("Franchising Common Stock"), of the
Company's wholly owned subsidiary, Choice Hotels
Franchising, Inc., a Delaware corporation ("Franchising")
and the related arrangements between the Company and
Franchising, and the policies to be adopted by such
companies, in connection therewith;
(ii) Proposal Two: Approval of the amendment of the Restated
Certificate of Incorporation of the Company to (i) change
the name of the Company to ; (ii) decrease the
number of authorized shares of Company Common Stock from
160,000,000 to 60,000,000; and (iii) to effect a one-for-
three reverse stock split of Company Common Stock whereby
every three shares of Company Common Stock would be
aggregated into one share of Company Common Stock (the
"Reverse Stock Split");
(iii) Proposal Three: Ratification of the election by the Company,
as sole stockholder of Franchising, of 9 directors of
Franchising specified in the Proxy Statement, who will be
divided into three classes, the initial terms of which will
expire in 1998, 1999 and 2000; and
(iv) Proposal Four: Ratification of adoption by Franchising of
the Franchising Stock Incentive Plan and the Franchising
Employee Stock Purchase Plan.
THE EFFECTIVENESS OF EACH OF THE DISTRIBUTION PROPOSALS IS CONDITIONED
UPON THE APPROVAL OF ALL OF THE DISTRIBUTION PROPOSALS. ACCORDINGLY, FAILURE OF
THE STOCKHOLDERS TO APPROVE ANY ONE OR MORE OF THE DISTRIBUTION PROPOSALS WILL
RESULT IN THE INEFFECTIVENESS OF ALL OF THE DISTRIBUTION PROPOSALS.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT THE STOCKHOLDERS
VOTE FOR ALL OF THE DISTRIBUTION PROPOSALS.
Although the Company does not believe that stockholder approval of the
Distribution is required under applicable law, the Board of Directors has made
stockholder ratification of the Distribution (along with stockholder
ratification or approval, as the case may be, of each of the other Distribution
Proposals, as set forth above) a
<PAGE>
condition to the Distribution because of importance of the Distribution to the
Company and its stockholders. For a description of the reasons for the
Distribution, see "The Distribution Proposals--The Distribution." The Board of
Directors has retained discretion, even if stockholder approval of the
Distribution Proposals is obtained, to abandon, defer or modify the Distribution
or any other element contained in the Distribution Proposals, provided that,
following stockholder approval, the Board of Directors will not make any changes
in the terms of the Distribution or the other elements of the Distribution
Proposals unless the Board determines that such changes would not be materially
adverse to the Company's stockholders.
In addition, holders of shares of Company Common Stock will also be
asked to consider and to vote upon the following proposal (the "Additional
Proposal"):
(i) Proposal Five: Election of three directors to hold office
until the 2000 Annual Meeting of Stockholders and until
their successors are elected and qualified.
THE EFFECTIVENESS OF THE ADDITIONAL PROPOSAL IS NOT CONDITIONED ON THE
APPROVAL OF ANY DISTRIBUTION PROPOSAL.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT STOCKHOLDER VOTE
FOR THE ADDITIONAL PROPOSAL.
The close of business on , 1997 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 shares of Company Common Stock. The presence, either in
person or by proxy, of persons entitled to cast a majority of such votes
constitutes a quorum for the transaction of business at the Annual Meeting.
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. Abstentions and broker non-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. Each proposal is
tabulated separately. Abstentions are counted in tabulations of the votes cast
on proposals presented to the stockholders, whereas brokers non-votes are not
counted for purposes of determining whether a proposal has been approved.
The affirmative vote of the holders of at least a majority of the
outstanding shares of Company Common Stock is required to approve each
Distribution Proposal. 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 pursuant to Proposal Five.
"Plurality" means that the individual who receives 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 trusts
established by members of the Bainum family) in the aggregate have the right to
vote approximately 33.53% 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 with respect to the Distribution Proposals and the
Additional Proposal. See "Proposals Relating to the Annual Meeting--Security
Ownership of Principal Stockholders and Management.".
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 in such proxies. If no instructions are indicated for a
Distribution Proposal or Additional Proposal, such proxies will be voted in
accordance with the Board of Directors' recommendations as set forth herein with
respect to such proposal(s).
<PAGE>
In the event that a quorum is not present at the time the Annual
Meeting is convened, or if, for any other reason, the Company believes that
additional time should be allowed for the solicitation of proxies, the Company
may adjourn the Annual Meeting with or without a vote of the stockholders. If
the Company proposes to adjourn the Annual Meeting by a vote of the
stockholders, the persons named in the enclosed form of proxy will vote all
shares of Company Common Stock for which they have voting authority in favor of
such adjournment.
Any proxy given pursuant to this solicitation may be revoked by the
person giving it at any time before it is voted. Proxies may be revoked by (i)
filing with 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) duly executing a subsequent
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 .
The Company will bear the cost of the solicitation. In addition to
solicitation by mail, the Company will request banks, brokers and other
custodian nominees and fiduciaries to supply proxy material to the beneficial
owners of Company Common Stock of whom they have knowledge, and will reimburse
them for their expenses in so doing; and certain directors, officers and other
employees of the Company, not specially employed for the purpose, may solicit
proxies, without additional remuneration therefor, by personal interview, mail,
telephone or telegraph. In addition, the Company has retained to
assist in the solicitation for a fee of $ plus expenses.
Stockholders of the Company will not be entitled to appraisal rights
under Delaware law in connection with the Distribution Proposals or the
Additional Proposal.
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TABLE OF CONTENTS
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PAGE
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Proxy Statement Summary...................................................................... 1
The Distribution Proposals................................................................... 8
The Distribution............................................................................ 8
Risk Factors................................................................................ 13
Relationship Between the Company and Franchising After the Distribution..................... 18
Accounting Treatment........................................................................ 21
Post Distribution Dividend Policy........................................................... 21
Certain Information Concerning Franchising.................................................. 22
Selected Historical Financial Data of Franchising.......................................... 24
Management's Discussion and Analysis of Financial Condition and Results of Operations...... 26
Business and Properties.................................................................... 30
Legal Proceedings.......................................................................... 45
Management................................................................................. 45
Certain Relationships and Related Transaction.............................................. 53
Security Ownership......................................................................... 53
Description of Capital Stock of Franchising................................................ 55
Purposes and Antitakeover Effects of Certain Provisions of the Franchising Certificate
and Bylaws................................................................................ 56
Franchising Certificate and Bylaws......................................................... 56
Liability and Indemnification of Officers and Directors.................................... 59
Certain Information Concerning Realco....................................................... 61
Pro Forma Financial Data of Realco........................................................ 61
Business and Properties................................................................... 65
Management................................................................................ 71
Other Proposal Relating to the Annual Meeting................................................ 74
Proposal Five: Election Of Directors....................................................... 74
Stockholders Proposals For 1998.............................................................. 86
General...................................................................................... 86
Index To Financial Statements................................................................ F-1
Annex A: Opinion Letter of American Appraisal Associates.................................... A-1
Annex B: Form of Amended and Restated of Certificate of Incorporation of Choice Hotels
International Inc (formerly known as Choice Hotels Franchising, Inc.)........................ B-1
Annex C: Form of Bylaws of Choice Hotels International Inc. (formerly known as
Choice Hotels Franchising, Inc.)............................................................. C-1
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PROXY STATEMENT SUMMARY
The following summarizes certain information contained elsewhere in
this Proxy Statement, including the appendices hereto (the "Proxy Statement").
Reference is made to, and this summary is qualified in its entirety by, the more
detailed information set forth in this Proxy Statement, which should be read in
its entirety. Unless the context otherwise requires, all references herein to
the Company and to Franchising shall include their respective subsidiaries and
all references herein to Franchising prior to the Distribution Date shall refer
to the Franchising Business (as defined herein) as operated by the Company.
Unless otherwise indicated, all statistical information and data relating to the
hotel industry in this Proxy Statement are derived from information provided by
Smith Travel Research. Smith Travel Research has not consented to the use of
the hotel industry data presented herein or provided any form of consultation,
advice, or counsel regarding any aspects of, and is in no way whatsoever
associated with, the proposed transaction.
THE ANNUAL MEETING
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DATE, TIME AND PLACE OF ANNUAL
MEETING......................... The Annual Meeting of Stockholders (the
"Annual Meeting") of Choice Hotels
International, Inc., a Delaware Corporation
(the "Company") will be held 9:00 a.m.
(E.S.T.) in the auditorium located at 11555
Darnestown Road, Gaithersburg, Maryland on
September 16, 1997.
MATTERS FOR CONSIDERATION
AT THE ANNUAL MEETING........... At the Annual Meeting, holders of shares of
Company Common Stock will be asked to
consider and to vote upon the following
related proposals, denominated Proposals One
through Four (collectively, the "Distribution
Proposals"): (i) Proposal One: Ratification
of a special dividend, consisting of the
distribution (the "Distribution") to the
holders of the Company's outstanding shares
of common stock, par value $.01 per share
("Company Common Stock"), on a share-for-
share basis, of all outstanding shares of
common stock, par value $ $.01 per share
("Franchising Common Stock"), of the
Company's wholly owned subsidiary, Choice
Hotels Franchising, Inc., a Delaware
corporation ("Franchising") and the related
arrangements between the Company and
Franchising, and the policies to be adopted
by such companies, in connection therewith;
(ii) Proposal Two: Approval of the amendment
of the Restated Certificate of Incorporation
of the Company to (a) change the name of the
Company to , (b) decrease the number of
authorized shares of Company Common Stock
from 160,000,000 to 60,000,000, and (c) to
effect a one-for-three reverse stock split of
Company Common Stock whereby every three
shares of Company Common Stock would be
aggregated into one share of Company Common
Stock (the "Reverse Stock Split"); (iii)
Proposal Three: Ratification of the election
by the Company, as sole stockholder of
Franchising, of 9 directors of Franchising
specified herein, who will be divided into
three classes, the initial terms of which
will expire in 1998, 1999 and 2000; and (iv)
Proposal Four: Ratification of adoption by
Franchising of the Franchising Stock
Incentive Plan and the
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Franchising Employee Stock Purchase Plan.
THE EFFECTIVENESS OF EACH OF THE DISTRIBUTION
PROPOSALS IS CONDITIONED UPON THE APPROVAL OF
ALL OF THE DISTRIBUTION PROPOSALS.
ACCORDINGLY, FAILURE OF THE STOCKHOLDERS TO
APPROVE ANY ONE OR MORE OF THE DISTRIBUTION
PROPOSALS WILL RESULT IN THE INEFFECTIVENESS
OF ALL OF THE DISTRIBUTION PROPOSALS. THE
BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS
THAT THE STOCKHOLDERS VOTE FOR ALL OF THE
DISTRIBUTION PROPOSALS.
In addition, holders of shares of Company
Common Stock will also be asked to consider
and to vote upon the following proposal (the
"Additional Proposal"): (i) Proposal Five:
The election of three directors to hold
office until the 2000 Annual Meeting of
Stockholders and until their successors are
elected and qualified.
THE EFFECTIVENESS OF THE ADDITIONAL PROPOSAL
IS NOT CONDITIONED ON THE APPROVAL OF ANY
DISTRIBUTION PROPOSAL. THE BOARD OF DIRECTORS
UNANIMOUSLY RECOMMENDS THAT STOCKHOLDER VOTE
FOR PROPOSALS ONE THROUGH FIVE.
ANNUAL MEETING RECORD DATE...... , 1997 ("Annual Meeting Record Date").
VOTING.......................... Each stockholder of record as of the Annual
Meeting Record Date is entitled at the Annual
Meeting to one vote for each share held. The
affirmative vote of the holders of at least a
majority of the outstanding shares of Company
Common Stock is required to approve each of
the Distribution Proposals. The affirmative
vote of the holders of at least a majority of
the shares of Company Common Stock present in
person or represented by proxy at the Annual
Meeting is required to approve the Additional
Proposal. As of May 1, 1997, there were
61,068,547 shares of Company Common Stock
outstanding and entitled to vote at the
Annual Meeting. Certain members of the Bainum
family (including various trusts established
by members of the Bainum family) in the
aggregate have the right to vote
approximately 33.53% 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 with respect to the Distribution
Proposals and the Additional Proposal.
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THE DISTRIBUTION
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DISTRIBUTED COMPANY............. Choice Hotels Franchising, Inc.
("Franchising"), a Delaware corporation and a
wholly owned subsidiary of the Company, will,
on the Distribution Date, own all of the
business and assets of, and be responsible
for all of the liabilities associated with,
the business of franchising hotels under the
Clarion/(R)/, Quality/(R)/, Comfort/(R)/,
Sleep Inn/(R)/, Rodeway/(R)/, Econo
Lodge/(R)/ and MainStay Suites/SM/ brands
currently conducted by Franchising and
certain of its subsidiaries (the "Franchising
Business"), as well as all European real
estate assets currently held by the Company.
After the Distribution, Franchising will
change its corporate name to Choice Hotels
International, Inc.
DISTRIBUTING COMPANY............ Choice Hotels International, Inc., a Delaware
corporation (the "Company"). After the
Distribution, the Company will continue to
own and operate hotel properties in US (the
"Hotel Business") and will change its
corporate name upon the Distribution (as
renamed, "Realco").
SECURITIES TO BE DISTRIBUTED.... Approximately 61,068,547 shares (the
"Shares") of Franchising Common Stock based
on 61,068,547 shares of Company Common
outstanding as of May 1, 1997.
REASONS FOR THE DISTRIBUTION.... The Company's Board of Directors and
management believe that the separation of the
Company's Franchising Business and Hotel
Business into two public companies via the
Distribution will remove the existing
impediments to the growth of the Company's
Hotel Business and, at the same time, reduce
or eliminate substantial recurring conflicts
between the Hotel Business and the
Franchising Business. The Distribution will
also enable the Hotel Business to attract,
retain and effectively incentivize skilled
real estate professionals and will facilitate
a better understanding by the investment
community of the Company's distinct
businesses. See "The Distribution Proposals--
The Distribution--Background and Reasons for
the Distribution."
CONDITIONS TO THE DISTRIBUTION.. The Distribution is conditioned upon, among
other things, stockholder approval of the
Distribution Proposals at the Annual Meeting.
Even if all conditions are satisfied, the
Board has reserved the right to abandon,
defer or modify the Distribution or the other
elements of the Distribution Proposals at any
time prior to the Distribution Date. The
Board will not, however, waive any of the
conditions to the Distribution or make any
changes in the terms of the Distribution or
the other elements of the Distribution
Proposals after the Distribution Proposals
are approved by the Company's Stockholders
unless the Board determines that such changes
would not be materially adverse to the
Company's stockholders. In determining
whether any such
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3
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changes would be materially adverse to the
Company's stockholders, the Board will
consider, as appropriate, advice from its
outside financial and legal advisors as well
as the recommendation of management as to the
potential impact of such changes on the
Company and the Company's Stockholders. See
"The Distribution Proposals--The
Distribution--Conditions; Termination."
DISTRIBUTION RATIO.............. One share of Franchising Common Stock for
each share of Company Common Stock.
TAX CONSEQUENCES................ The Company has conditioned the Distribution
on receipt of a ruling from the Internal
Revenue Service to the effect that, among
other things, that receipt of shares of
Franchising Common Stock by the Company
stockholders will be tax free. However, the
Board has reserved the right to waive the
receipt of such ruling as a condition to
consummation of the Distribution. The Board
will not provide stockholders with notice if
receipt of the tax ruling is waived as a
condition to consummation of the
Distribution; however, (i) the Board will
waive such condition only if the Board
believes that the receipt of the Franchising
Shares will be tax free and (ii) the Company
will notify stockholders if the Company
either receives an unfavorable ruling from
the Internal Revenue Service, or withdraws
its request for such ruling prior to the
Annual Meeting. See "The Distribution--
Federal Income Tax Aspects of the
Distribution."
RISK FACTORS.................... Stockholders should carefully consider all of
the information contained in this Proxy
Statement, including the matters described
under "Risk Factors."
RELATIONSHIP BETWEEN THE COMPANY
AND FRANCHISING AFTER THE
DISTRIBUTION.................... For purposes of governing the ongoing
relationships between the Company and
Franchising after the Distribution Date and
in order to provide for an orderly transfer
of the Franchising Business to Franchising
and facilitate the transition to two separate
publicly traded companies, the Company and
Franchising have entered into a Distribution
Agreement, a Strategic Alliance Agreement and
various other agreements with respect to,
among other things, intercompany debt, tax
matters, employee benefits, risk management
and corporate and administrative services.
See "Relationship Between the Company and
Franchising After the Distribution." The
relationship between the Company and
Franchising may be subject to certain
potential conflicts of interest. See "Risk
Factors--Potential Conflicts."
ACCOUNTING TREATMENT............ The historical combined financial statements
of Franchising present its financial
position, results of operations and cash
flows as if it were a separate entity for all
periods presented. The Company's historical
basis in the assets and liabilities of
Franchising has been carried over. See "The
Distribution Proposals--Accounting Treatment"
and the combined
</TABLE>
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4
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<TABLE>
<S> <C>
financial statements of Choice Hotels
Franchising, Inc., contained elsewhere
herein.
LISTING AND TRADING MARKET...... There is currently no public market for
Franchising Common Stock. The Company intends
to list the Franchising Common Stock on the
New York Stock Exchange. See "The
Distribution Proposals--Risk Factors--No
Current Market for Franchising Common Stock."
RECORD DATE..................... Close of business on , 1997
(the "Distribution Date").
DISTRIBUTION DATE............... As of , 1997. On the
Distribution Date, the Company will deliver
the Shares to the Distribution Agent. As soon
as practicable thereafter, the Distribution
Agent will mail certificates representing the
appropriate number of Shares to the Company's
stockholders entitled thereto. See "The
Distribution--Manner of Effecting the
Distribution."
DISTRIBUTION AGENT.............. the transfer agent for the Company.
REVERSE STOCK SPLIT............. The Company shall effect a one-for-three
reverse stock split of the Company Common
Stock whereby every three shares of Company
Common Stock will be aggregated into one
share of Company Common Stock.
</TABLE>
CHOICE HOTELS FRANCHISING, INC.
<TABLE>
<S> <C>
BUSINESS........................ Franchising is presently a wholly owned
subsidiary of the Company. Following the
Distribution, Franchising will conduct the
Franchising Business as now conducted by
Franchising, the Company and certain other
subsidiaries of the Company. Franchising will
be one of the world's largest franchisors of
hotels with 3,280 properties open and
operating in 33 countries at February 28,
1997. As a franchisor, Franchising will
license hotel operators to use Franchising's
brand names: Comfort/(R)/, Quality/(R)/,
Clarion/(R)/, Sleep/(R)/, Rodeway/(R)/, Econo
Lodge/(R)/ and MainStay Suites/SM/
(collectively, the "Choice Brands"), and will
provide to these hotel operators products and
services designed to increase their revenues
and profitability. Following the
Distribution, Franchising will also conduct
the Company's European hotel operations,
including the Company's indirect investment
in Friendly Hotels, PLC.
BOARD OF DIRECTORS.............. Effective as of the Distribution Date, the
Board of Directors of Franchising is expected
to consist of nine persons: Stewart Bainum,
Jr., Stewart Bainum, Barbara Bainum, William
R. Floyd, Paul R. Gould, Robert C. Hazard,
Jr., Gerald W. Petitt, Jerry E. Robertson,
Ph.D and Frederic V. Malek.
POST-DISTRIBUTION DIVIDEND
POLICY.......................... The dividend policy of Franchising will be
determined by Franchising's Board of
Directors following the Distribution.
</TABLE>
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5
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<TABLE>
<S> <C>
CERTAIN RESTATED CERTIFICATE OF
INCORPORATION AND BYLAW
PROVISIONS...................... The Restated Certificate of Incorporation
(the "Franchising Certificate") and the
Bylaws of Franchising (the "Franchising
Bylaws) are substantially identical to the
Company's Restated Certificate of
Incorporation and Bylaws. Certain provisions
of the Franchising Certificate and the
Franchising Bylaws have the effect of
delaying or making more difficult an
acquisition of control of Franchising in a
transaction not approved by its Board of
Directors. These provisions have been
designed to enable Franchising, especially in
its initial years, to develop its businesses
and foster its long-term growth without
disruptions caused by the threat of a
takeover not deemed by its Board of Directors
to be in the best interest of Franchising.
See "Purposes and Effects of Certain
Provisions of the Franchising Certificate and
Bylaws." The Franchising Certificate would
eliminate certain liabilities of directors in
connection with the performance of their
duties. See "Liability and Indemnification of
Officers and Directors--Elimination of
Liability in Certain Circumstances."
PRINCIPAL OFFICE................ 10750 Columbia Pike, Silver Spring, Maryland
20901. Its telephone number is (301) 979-
5000.
[REALCO]
BUSINESS........................ Following the Distribution, Realco will
retain the Company's Hotel Business and will
own and manage 71 hotels in 25 states,
primarily under Franchising's brands.
BOARD OF DIRECTORS.............. Effective as of the Distribution Date, the
Board of Directors of Realco is expected to
consist of seven persons; Stewart Bainum,
Jr., Stewart Bainum, William R. Floyd, and
four additional directors to be elected at a
later time.
POST-DISTRIBUTION DIVIDEND
POLICY.......................... The dividend policy of Realco will be
determined by Realco's Board of Directors
following the Distribution.
LISTING AND TRADING MARKET...... The Realco Common Stock (formerly Company
Common Stock) is expected to continue to be
listed on the New York Stock Exchange
following the Distribution. The trading price
of Realco Common Stock will be substantially
affected by the Distribution.
PRINCIPAL OFFICE................ 10770 Columbia Pike, Silver Spring, Maryland
20901. Its telephone number is (301) 979-
3800.
</TABLE>
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6
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CHOICE HOTELS FRANCHISING, INC.
SUMMARY FINANCIAL INFORMATION
The following table summarizes certain selected historical financial
data of Franchising for the three fiscal years ended May 31, 1996 and the
thirty-six weeks ended February 28, 1997 and February 29, 1996. The information
set forth below should be read in conjunction with "Certain Information
Concerning Franchising--Selected Historical Financial Data--Management's
Discussion and Analysis of Financial Conditions and Results of Operations," and
the Combined Financial Statements of Franchising contained elsewhere herein. Per
share data is not presented because Franchising was not a publicly-held company
during the periods presented below.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
------------------ ------------ ------------
1994 1995 1996(1) 1996 1997
---- ---- ---- ---- ----
(Unaudited) (Unaudited)
(Dollars in thousands)
----------------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA
Revenues....................................... $184,866 $212,672 $246,316 $187,897 $205,947
Operating expense.............................. 156,743 170,706 213,793 144,861 155,020
Operating income............................... 28,123 41,966 32,523 43,036 50,927
Net income..................................... 8,601 16,228 11,664 19,867 25,109
OTHER DATA
EBITDA (2)(3).................................. $ 37,472 $ 51,534 $ 67,590 $ 50,945 $ 58,684
Cash flows from operating activities........... 32,357 37,851 32,394 27,144 44,526
Cash flows from investing activities........... (12,864) (7,733) (78,499) (55,126) (4,448)
Cash flows from financing activities........... (17,774) (31,261) 48,513 29,907 (41,708)
Number of franchised
properties (Unaudited)...................... 2,713 2,835 3,052 2,978 3,280
Number of rooms (Unaudited).................... 239,744 245,669 261,456 255,545 278,364
Average royalty rate (Unaudited)............... 3.1% 3.2% 3.5% 3.4% 3.4%
BALANCE SHEET DATA
Working capital (Unaudited).................... $ 1,525 $(29,423) $ 3,956 $(11,843) $(11,800)
Total assets................................... 173,646 $189,087 214,158 206,994 205,461
Notes payable to Parent........................ 78,700 78,700 78,700 78,700 78,700
Total debt..................................... 126,294 128,205 145,148 126,572 124,923
Total Investment and advances from
(to) Parent................................. 13,275 (3,833) 39,398 47,738 43,045
</TABLE>
______________________
(1) 1996 includes a pre-tax charge of $24.8 million for impairment of certain
long lived assets associated with Franchising's European operations.
(2) EBITDA consists of the sum of net income (loss), interest expense, income
taxes, depreciation and amortization and non-cash asset writedowns. EBITDA
is presented because such data is used by certain investors to determine
Franchising's ability to meet debt service, fund capital expenditures and
expand its business. Franchising considers EBITDA to be an indicative
measure of operating performance particularly due to the large amount of
goodwill and franchise rights amortization. Such information should not be
considered an alternative to net income, operating income, cash flow from
operations or any other operating or liquidity performance measure
prescribed by GAAP. Cash expenditures for various long-term assets,
interest expense and income taxes have been, and will be, incurred which
are not reflected in the EBITDA presentation.
(3) 1996 excludes a pre-tax charge of $24.8 million for impairment of certain
long lived assets associated with Franchising's European operations in
1996.
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7
<PAGE>
THE DISTRIBUTION PROPOSALS
THE DISTRIBUTION
BACKGROUND AND REASONS FOR THE DISTRIBUTION
The Company's Board of Directors and management have determined, for
the reasons set forth below, among others, to separate the Company's Franchising
Business from its Hotel Business. On April 28, 1997, the Company's Board of
Directors announced its intention to distribute to holders of Company Common
Stock all of the outstanding Shares. On April 28, 1997, the high and low sales
prices of Company Common Stock as reported on the New York Stock Exchange
Composite Tape were $12 1/4 and $12 3/4, respectively. Following the
Distribution, the Company will not own any Franchising Shares or other capital
stock of Franchising, but will have certain contractual relationships with
Franchising. See "Relationship Between the Company and Franchising After the
Distribution."
Prior to November 1, 1996, the Company and Franchising were wholly
owned subsidiaries of Manor Care, Inc., a Delaware corporation ("Manor Care").
On November 1, 1996, Manor Care contributed all of the stock of Franchising to
the Company and then distributed to Manor Care stockholders, on a pro rata
basis, all of the stock of the Company (the "Manor Care Spin-off"). Prior to the
Manor Care Spin-off, Manor Care was generally engaged, directly and through
subsidiaries, in the Franchising Business, the Hotel Business and the health
care business. Thus, the Manor Care Spin-off effected the separation of Manor
Care's Franchising Business and Hotel Business from its health care business.
The Board of Directors believes that the proposed Distribution will
remove existing impediments to the growth of the Company's Hotel Business and,
at the same time, reduce or eliminate substantial recurring conflicts between
the Hotel Business and the Franchising Business. The Distribution will also
enable the Hotel Business to attract, retain and effectively incentivize skilled
real estate professionals and will facilitate a better understanding by the
investment community of the Company's two distinct businesses.
The Company currently owns and operates hotels for its account and
also enters into franchise relationships with unrelated franchisees who own and
operate hotels for their account. As a result, business conflicts between the
Hotel Business and the Franchising Business are inevitable, as are franchisee
perceptions that the Hotel Business "competes" with the Company's franchisees.
Moreover, the potential for conflict is exacerbated due to the large size of the
Company's franchise system, and the territorial protections provided by the
Company to its franchisees. As a result of these conflicts, the Hotel Business
has been forced, on numerous occasions, to relinquish attractive hotel
acquisition and development opportunities because of franchisee complaints to
Company management that a proposed site and brand posed a competitive threat.
Numerous other transactions have not been pursued by the Hotel Business because
of concerns raised by management of the Franchising Business regarding potential
adverse franchisee reaction. The Company believes that the Distribution will
resolve such conflicts.
The Distribution, by separating the Company's two distinct
businesses--hotel franchising and hotel ownership and management--should also
facilitate better understanding of these business by the investment community.
The Company believes that the consolidation of its service-oriented Franchise
Business and capital intensive, ownership-oriented Hotel Business has resulted
in confusion and misperception in the investor community about the nature and
growth opportunities of the Company's various operations.
Additionally, the Board of Directors believes that, as part of an
independent company with enhanced growth opportunities, the Hotel Business will
be better able to attract, retain and effectively motivate skilled professionals
in the real estate development area who are compensated in large part based on
successfully completing real estate development and acquisition transactions.
As an independent company freed of the conflicts which have hindered its growth,
the Hotel Business will be able to provide meaningful incentive compensation
arrangements that will permit it to attract, motivate and retain key personnel
in the real estate development area.
8
<PAGE>
These factors led the Board to initiate consideration in November
1996, in connection with efforts to monetize the Company's owned real estate, of
a possible separation of the Franchising Business and the Hotel Business. In
February 1997, the Board directed management to prepare for its consideration a
recommendation concerning the possible separation of the Franchising Business
and the Hotel Business. In April 1997, management discussed with the Company's
Board of Directors the results of its study to date, and the proposal to effect
the Distribution, as ultimately developed by management of the Company with
advice from its advisors, was presented to and approved by the Company's Board
of Directors.
Stockholders of the Company with inquiries relating to the
Distribution should contact the Company's Investor Relations Department at (301)
979-3800. After the Distribution Date, stockholders of the Franchising should
contact the Franchising Investor Relations Department at (301) 979-5000.
REVERSE STOCK SPLIT
In order to enable Realco to maintain an acceptable trading range for
Realco Common Stock after the Distribution, while also retaining sufficient
liquidity for Realco Common Stock, the Company has proposed that, in connection
with the Distribution, the Company's Certificate of Incorporation be amended to
effect a one-for-three reverse stock split pursuant to which each three shares
of Common Stock will be exchanged for one share of Common Stock. As of May 1,
1997, the Company had outstanding 61,068,547 shares of Company Common Stock (not
including shares issuable upon exercise of options to purchase Company Common
Stock) and had reserved for issuance under the 1996 Stock Incentive Plan
7,100,000 shares of Company Common Stock. After giving effect to the Reverse
Stock Split, such numbers would be 20,356,182 and 2,366,667, respectively.
This Amendment will not be implemented if the Distribution is not
completed.
SOLVENCY OPINION
The Board of Directors has retained American Appraisal Associates,
Inc. ("American Appraisal") a financial advisory firm, to provide advice as to
certain solvency matters relating to the Distribution. In a written opinion to
the Board of Directors dated , 1997, American Appraisal stated that,
based upon the considerations set forth therein and on other factors it deemed
relevant, it was of the opinion that, assuming the Distribution is consummated
as proposed: (i) with respect to each of the Company and Franchising,
immediately after giving effect to the Distribution (a) the fair value of such
company's aggregate assets would exceed such company's total liabilities
(including contingent liabilities); (b) the present fair saleable value of such
company's aggregate assets would be greater than such company's probable
liabilities on its debts as such debts become absolute and mature; (c) such
company would be able to pay its debts and other liabilities (including
contingent liabilities) as they mature; and (d) the capital remaining in such
company after the Distribution would not be unreasonably small for the business
in which such company is engaged, as management has indicated it is now
conducted and is proposed to be conducted following consummation of the
Distribution; and (ii) the excess of the value of aggregate assets of the
Company, before a consummation of the Distribution, over the total identified
liabilities (including contingent liabilities) of the Company. The full text of
American Appraisal's opinion is set forth in Annex A, and this summary is
qualified in its entirety by reference to the text of such opinion. It is a
condition to the consummation of the Distribution that American Appraisal
deliver an updated opinion to the Board, to be dated as of the Distribution
Date, in substantially the same form as the opinion set forth in Annex A. See
"The Distribution--Conditions; Termination").
In preparing its opinion, American Appraisal relied on the accuracy
and completeness of all information supplied or otherwise made available to it
by the Company, and did not independently verify such information or undertake
any physical inspection or independent appraisal of the assets or liabilities of
the Company or Franchising. Such opinion was based on business, economic, market
and other conditions existing on the date such opinion was rendered.
American Appraisal's opinion is also based on, among other things, its
review of the agreements relating to the Distribution, historical and pro forma
financial information and certain business information relating to the
9
<PAGE>
Company and Franchising, including that contained in this Proxy Statement, as
well as certain financial forecasts and other data provided by the Company
relating to the businesses and prospects of the Company and Franchising.
American Appraisal also conducted discussions with the Company's management with
respect to the businesses and prospects of the Company and Franchising and
conducted such financial studies, analyses and investigations as it deemed
appropriate in rendering its opinion.
The Company will pay American Appraisal a fee of $70,000 for services
rendered in connection with the Distribution, including services it has
conducted to render its opinion.
MANNER OF EFFECTING THE DISTRIBUTION
The general terms and conditions of the Distribution are set forth in
the Distribution Agreement (the "Distribution Agreement") to be entered into by
the Company and Franchising prior to the Distribution.
If the Company's stockholders approve the Distribution Proposals and
all other conditions thereto are satisfied (or waived by the Board), the
Distribution will be made on a date to be established by the Board of Directors
following the Annual Meeting (the "Distribution Date") to stockholders of record
of the Company as of the Distribution Date (such date, the "Distribution Record
Date"). The Distribution Record Date will be established by the Board of
Directors following the Annual Meeting. On the Distribution Date, all of the
Shares will be delivered by the Company to , as the Distribution Agent
(the "Distribution Agent"). As soon thereafter as practicable, certificates
therefor will be mailed by the Distribution Agent to holders of Company Common
Stock as of the Distribution Record Date on the basis of one share of
Franchising Common Stock for every share of Company Common Stock held on such
date. All shares will be fully paid and non-assessable and the holders thereof
will not be entitled to preemptive rights.
No holder of Company Common Stock will be required to pay any cash or
other consideration for the shares of Franchising Common Stock received in the
Distribution or to surrender or exchange shares of Company Common Stock in order
to receive Franchising Common Stock.
FEDERAL INCOME TAX ASPECTS OF THE DISTRIBUTION
The Company has conditioned the Distribution on the receipt of a
ruling from the Internal Revenue Service to the effect, among other things,
that, for federal income tax purposes, the Distribution will qualify as a tax-
free spin-off under Section 355 of the Internal Revenue Code of 1986, as
amended, and that:
(1) No gain or loss will be recognized by (and no amount will be
included in the income of) holders of Company Common Stock upon the receipt of
Shares of Franchising Common Stock in the Distribution;
(2) Provided that on the Distribution Date a holder of Company
Common Stock holds such stock as a capital asset, the holding period for the
Shares of Franchising Common Stock to be received in the Distribution will
include the period during which Company Common Stock was held;
(3) A holder's basis in Company Common Stock held immediately
before the Distribution will be allocated, based upon relative fair market
values at the time of the Distribution, between such Company Common Stock and
the Shares of Franchising Common Stock received by the stockholder in the
Distribution; and
(4) No gain or loss will be recognized by the Company or
Franchising upon the Distribution.
Application has been made to the Internal Revenue Service for a ruling
to the foregoing effect. As of the date hereof, the Internal Revenue Service has
not yet issued the ruling requested. The Company believes and has been advised
by its outside tax advisors that the positions asserted by the Company in
requesting the ruling are consistent with the Code and the rules and regulations
promulgated thereunder. However, there is no certainty that the Internal Revenue
Service will issue a favorable ruling. If such ruling is not obtained, the
Board's present intention is not to proceed with the Distribution. However, the
Board has reserved the right to waive the receipt of
10
<PAGE>
such a ruling as a condition to consummation of the Distribution. The Board will
not provide stockholders with notice if receipt of the tax ruling is waived as a
condition to consummation of the Distribution; however, (i) the board will waive
such condition only if the board believes that the receipt of shares of
Franchising Common Stock will be tax free and (ii) the Company will notify
stockholders if the Company either receives an unfavorable ruling from the
Internal Revenue Service, or withdraws its request for such ruling, prior to the
Annual Meeting. See "Background and Reasons for the Distribution--Conditions;
Termination." For a description of the consequences to the Company, Franchising
and the stockholders if the Distribution were not to qualify as tax free, see
"Risk Factors--Certain Tax Considerations."
THE FOREGOING IS ONLY A SUMMARY OF CERTAIN FEDERAL INCOME TAX
CONSEQUENCES OF THE DISTRIBUTION UNDER CURRENT LAW AND DOES NOT PURPORT TO COVER
ALL FEDERAL INCOME TAX CONSEQUENCES THAT MAY APPLY TO ALL CATEGORIES OF
STOCKHOLDERS AND IS INTENDED FOR GENERAL INFORMATION ONLY. EACH STOCKHOLDER
SHOULD CONSULT HIS OR HER OWN TAX ADVISOR AS TO THE PARTICULAR CONSEQUENCES OF
THE DISTRIBUTION TO SUCH STOCKHOLDER, INCLUDING THE APPLICATION OF STATE, LOCAL
AND FOREIGN TAX LAWS, AND THE EFFECT OF POSSIBLE CHANGES IN TAX LAWS THAT MAY
AFFECT THE TAX CONSEQUENCES DESCRIBED ABOVE.
LISTING AND TRADING OF FRANCHISING COMMON STOCK
There is not currently a public market for Franchising Common Stock.
Prices at which Franchising Common Stock may trade prior to the Distribution on
a "when-issued" basis or after the Distribution cannot be predicted. Until the
Franchising Common Stock is fully distributed and an orderly market develops,
the prices at which trading in such stock occurs may fluctuate significantly.
The prices at which Franchising Common Stock trades will be determined by the
marketplace and may be influenced by many factors, including, among others, the
depth and liquidity of the market for Franchising Common Stock, investor
perception of Franchising and the industries in which Franchising participates,
Franchising's dividend policy and general economic and market conditions. Such
prices may also be affected by certain provisions of the Franchising Certificate
and Franchising Bylaws, as each will be in effect following the Distribution,
which will have an antitakeover effect. See "Risk Factors--Dividend Policies"
and "Purposes and Antitakeover Effects of Certain Provisions of the Franchising
Certificate and Bylaws."
Franchising intends to list the Franchising Common Stock on the New
York Stock Exchange. Franchising initially will have approximately 4,406
stockholders of record based upon the number of stockholders of record of the
Company as of May 1, 1997. For certain information regarding options to purchase
Franchising Common Stock that will be outstanding after the Distribution, see
"Relationship Between the Company and Franchising after the Distribution --
Employee Benefits Allocation Agreement."
The Company filed a request for no-action letter with the Securities
and Exchange Commission on , 1997, setting forth, among other things,
the Company's view that the distribution of Franchising Common Stock does not
require registration under the Securities Act of 1933, as amended (the
"Securities Act"). Accordingly, the effect of obtaining such no-action letter
will be that the distribution of the Franchising Shares need not be registered
under the Securities Act and shares of Franchising Common Stock distributed to
the Company's stockholders in the Distribution will be freely transferable,
except for securities received by persons who may be deemed to be "affiliates"
of the Company within the meaning of Rule 144 under the Securities Act. Persons
who are affiliates of Franchising within the meaning of Rule 144 may not
publicly offer or sell the Franchising Common Stock received in connection with
the Distribution except pursuant to a registration statement under the
Securities Act or pursuant to Rule 144.
LISTING AND TRADING OF REALCO COMMON STOCK
It is expected that the Realco Common Stock (formerly Company Common
Stock) will continue to be listed and traded on the New York Stock Exchange
after the Distribution. Following the Distribution, Realco's financial results
will no longer be consolidated with those of the Company's Franchising Business,
and Realco's revenues, income and other results of operations will be
substantially below those of the Company prior to the Distribution.
Accordingly, as a result of the Distribution, the trading price range of the
Realco Common Stock
11
<PAGE>
immediately after the Distribution is expected to be significantly lower than
the trading price range of Company Common Stock, and the combined trading prices
of Realco Common Stock and Franchising Common Stock held by stockholders after
the Distribution may be less than, equal to or greater than the trading price of
Company Common Stock, prior to the Distribution. The prices at which Realco
Common Stock trades after the Distribution will be determined by the marketplace
and may be influenced by many factors, including, among others, the continuing
depth and liquidity of the market for Realco Common Stock, investor perception
of the Realco's Hotel Business, dividend policy and general economic and market
conditions.
CONDITIONS; TERMINATION
The Board has conditioned the Distribution upon, among other things,
(i) the Internal Revenue Service having issued a ruling in response to the
Company's request in form and substance satisfactory to the Board; (ii) approval
of each of the Distribution Proposals by the Company's stockholders; (iii) the
Franchising Common Stock having been approved for listing on the New York Stock
Exchange subject to official notice of issuance; (iv) the taking of all actions
with respect to the Distribution required or advisable under the Securities Act
and the Exchange Act and the rules and regulations promulgated thereto,
including the Registration Statement on Form 10 with respect to the Franchising
Common Stock (the "Form 10 Registration Statement") having become effective
under the Exchange Act; (v) any third-party consents to the transactions
contemplated by the Distribution Proposals having been obtained, except for
those the failure of which to obtain would not have a material adverse effect on
the Company or Franchising; and (vi) American Appraisal having delivered an
updated opinion to the Board, dated as of the Declaration Date, in substantially
the same form as the opinion attached hereto as Annex A see, "The Distribution--
Opinion of Financial Advisor"). Any of these conditions, except for approval of
the Distribution Proposals by the Company's stockholders, may be waived in the
discretion of the Board. Even if all the above conditions are satisfied, the
Board has reserved the right to abandon, defer or modify the Distribution or the
other elements of the Distribution Proposals at any time prior to the
Distribution Date; however, the Board will not waive any of the conditions to
the Distribution or make any changes in the terms of the Distribution or the
other elements of the Distribution Proposals after the Distribution Proposals
are approved by the stockholders unless the Board determines that such changes
would not be materially adverse to the Company's stockholders. In determining
whether any such changes would be materially adverse to the Company's
stockholders, the Board of Directors will consider, as appropriate, advice from
its outside financial and legal advisors as well as the recommendation of
management as to the potential impact of such changes on the Company and the
Company's stockholders. See "Relationship Between the Company and Franchising
after the Distribution--Distribution Agreement."
12
<PAGE>
RISK FACTORS
CERTAIN FINANCIAL AND OPERATING CONDITIONS
While the Hotel Business and the Franchising Business have substantial
operating histories, Realco and Franchising do not have operating histories as
separate stand-alone companies. Prior to the Distribution, each of the two
businesses had access to the cash flow generated by the other and the Company's
credit, which was based on the combined assets of the Hotel Business and the
Franchising Business. Subsequent to the Distribution, Realco will not have the
benefit of either the cash flow generated by, or the assets of, the Franchising
Business, and Franchising will not have the benefit of either the cash flow
generated by or the assets of, the Hotel Business.
Subsequent to the Distribution, each of Realco and Franchising will be
a smaller and less diversified company than the Company prior to the
Distribution. In addition, the division of the Company may result in some
temporary dislocation and inefficiencies to the business operations, as well as
the organization and personnel structure, of each company. Nevertheless, the
Company's Board of Directors believes that separation of the two companies will
also result in long-term operating efficiencies by allowing the companies to
focus on their respective businesses.
SUBSTANTIAL LEVERAGE AT REALCO
On April 23, 1997, the Company, through its wholly-owned subsidiary
First Choice Properties, completed an offering of $117.5 million Multiclass
Mortgage Pass-Through Certificates (collectively, the "Mortgage Securities").
The Mortgage Securities carry a blended weighted average interest rate of 7.8%
and have a final maturity of May 1, 2012. The Mortgage Securities are non-
recourse and collateralized by 36 hotels owned by Realco. The offerings' net
proceeds of $110 million have been used to prepay a portion of the Note Payable
to MNR Finance Corp., a subsidiary of Manor Care. A total yield maintenance
payment of approximately $1.9 million will be made to Manor Care by Realco as a
result of the prepayment.
As of May 31, 1997, it is expected that Realco will have a long-term
debt of approximately $241 million. The $241 million will include the $117.5 of
mortgage securities plus $86 million of bank debt and $37.5 million of debt
remaining to MNR Finance Corp. It is anticipated that Realco will incur
additional debt prior to the Distribution. As a result, Realco will have
significant interest expense and principal repayment obligations. This
significant degree of leverage could have a potential negative impact on the
ability of Realco to incur additional debt to fund future expansion. While
Realco expects that its operating cash flow will be sufficient to cover its
expenses, including interest costs, Realco may be required to supplement
operating cash flow with asset sales, refinancing proceeds, a secondary equity
offering or capital spending reductions to meet principal repayment obligations
in later years. There can be no assurance that any asset sales or refinancing
could be successfully concluded, although Realco has no plans for such asset
sales. Any resort to alternative sources of funds may impair Realco's
competitive position and reduce its cash flow.
The ability of Realco to satisfy its obligations, to reduce its debt
and to increase equity will also be dependent upon its respective future
performance, which will be subject to prevailing economic conditions and to
financial, business and other factors, including factors beyond the control of
Realco, affecting the business operations of Realco.
CERTAIN TAX CONSIDERATIONS
The Company has conditioned the Distribution on the receipt of a
favorable ruling from the Internal Revenue Service (although the Board has
reserved the right to waive receipt of the ruling as a condition to consummation
of the Distribution). The Board of Directors will not provide stockholders with
notice if receipt of the tax ruling is waived as a condition to consummation of
the Distribution; however, (i) the Board of Directors will waive such condition
only if the Board of Directors believes that the receipt of shares of
Franchising Common Stock will be tax free and (ii) the Company will notify
stockholders if the Company either receives an unfavorable ruling from the
Internal Revenue Service, or withdraws its request for such ruling, prior to the
Annual Meeting. See
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<PAGE>
"The Distribution--Federal Income Tax Aspects of the Distribution." Such
rulings, while generally binding upon the Internal Revenue Service, are subject
to certain factual representations and assumptions. If such factual
representations and assumptions were incorrect in a material respect, such
ruling would be jeopardized. The Company is not aware of any facts or
circumstances which would cause such representations and assumptions to be
untrue. The Company and Franchising have agreed to certain restrictions on their
future actions to provide further assurances that the Distribution will qualify
as tax free. See "Relationship Between The Company and Franchising After the
Distribution--Distribution Agreement."
If the Distribution were not to qualify under Section 355 of the Code,
then in general a corporate tax would be payable by the consolidated group of
which the Company is the common parent based upon the difference between (x) the
fair market value of the Franchising Common Stock and (y) the adjusted basis of
the Franchising Common Stock immediately prior to the Distribution. The
corporate level tax would be payable by the Company and could be substantial.
See "Relationship Between the Company and Franchising after the Distribution--
Tax Sharing Agreement." In addition, under the consolidated return rules, each
member of the consolidated group (including Franchising) is severally liable for
such tax liability.
Furthermore, each holder of Company Common Stock who receives shares
of Franchising Common Stock in the Distribution would be treated as if such
stockholder received a taxable distribution in an amount equal to the fair
market value of the Franchising Common Stock received, which would result in (x)
a dividend to the extent of such stockholder's pro rata share of the Company's
current and accumulated earnings and profits, (y) a reduction in such
stockholder's basis in Company Common Stock to the extent the amount received
exceed such stockholder's share of earnings and profits and (z) gain from the
exchange of Company Common Stock to the extent the amount received exceeds both
such stockholder's share of earnings and profits and such stockholder's basis in
Company Common Stock.
NO CURRENT PUBLIC MARKET FOR FRANCHISING COMMON STOCK
There is not currently a public market for Franchising Common Stock
and there can be no assurances as to the prices at which trading in Franchising
Common Stock will occur after the Distribution. Until Franchising Common Stock
is fully distributed and an orderly market develops, the prices at which trading
in such stock occurs may fluctuate significantly. Franchising intends to list
the Franchising Common Stock on the New York Stock Exchange. See "The
Distribution--Listing and Trading of Franchising Common Stock."
CHANGES IN TRADING PRICES OF REALCO COMMON STOCK
It is expected that Realco Common Stock will continue to be listed and
traded on the New York Stock Exchange after the Distribution. As a result of the
Distribution, the trading price range of Realco Common Stock is expected to be
significantly lower than the trading price range of Company Common Stock prior
to the Distribution. The combined trading prices of Realco Common Stock and
Franchising Common Stock held by stockholders after the Distribution may be less
than, equal to or greater than the trading prices of Company Common Stock prior
to the Distribution. See "Distribution--Listing and Trading of Realco Common
Stock."
CERTAIN ANTITAKEOVER FEATURES
If the Distribution Proposals are approved and the Distribution is
consummated, the Franchising Certificate and Franchising Bylaws will contain
several provisions, many of which are now in effect with respect to the Company
and will continue to be in effect with respect to Realco, that may make the
acquisition of control of Franchising difficult or expensive, or increase the
likelihood that incumbent management will retain their positions, and of
depriving stockholders of opportunities to receive premiums over market value
for their shares. See "Purposes and Antitakeover Effects of Certain Provisions
of the Franchising Certificate and Bylaws."
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<PAGE>
POTENTIAL CONFLICTS
Subsequent to the Distribution, the interests of Realco and
Franchising may potentially conflict due to the ongoing relationships between
the companies. Such sources of conflict include the fact that after the
Distribution, (i) Realco and Franchising will enter into a Strategic Alliance
Agreement pursuant to which Realco will grant to Franchising a right of first
refusal to franchise lodging properties developed or acquired by Realco that
Realco intends to franchise; Franchising will grant to Realco a conditional
option to purchase the MainStay Suites hotel system; each of the parties will
continue to cooperate with respect to matters of mutual interest, including new
product and concept testing for Franchising in hotels owned by Realco, and
Realco will authorize Franchising, in certain circumstances, to negotiate with
third party vendors on Realco's behalf and (ii) Realco and Franchising will be
parties to agreements pursuant to which Franchising will provide to Realco
certain administrative services after the Distribution. See "Relationship
Between the Company and Franchising After the Distribution." With respect to
these items, 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. will serve as Chairman of the Board of Directors of Realco
and Franchising and Stewart Bainum will serve as Director of Realco and
Franchising. Additionally William R. Floyd will serve as a director of each of
Realco and Franchising. Messrs. Bainum, Jr. Bainum and William R. Floyd as well
as certain other officers and directors of Realco and Franchising will also own
shares (and/or options or other rights to acquire shares) in both companies
following the Distribution. Appropriate policies and procedures will be followed
by the boards of directors of each company to limit the involvement of the
overlapping director (and if appropriate, relevant officers of such companies)
in conflict situations, including requiring them to abstain from voting as
directors of either Realco or Franchising on certain matters which present a
conflict between the two companies.
FRAUDULENT TRANSFER CONSIDERATIONS; LEGAL DIVIDEND REQUIREMENTS
It is a condition to the consummation of the Distribution that the
Board of Directors of the Company shall have received a satisfactory opinion
regarding the solvency of the Company and the permissibility of the Distribution
under Section 170 of the Delaware General Corporation Law. See "The
Distribution--Opinions of Financial Advisors--Solvency Opinion." The Company's
Board of Directors does not intend to consummate the Distribution unless it is
satisfied regarding the solvency of the Company, Franchising and the
permissibility of the Distribution under Section 170 of the Delaware General
Corporation Law ("DGCL"). There is no certainty, however, that a court would not
find that at the time the Company effected the Distribution of Franchising, the
Company or Franchising, as the case may be, (i) was insolvent, (ii) was rendered
insolvent by reason of the Distribution, (iii) was engaged in a business or
transaction for which the Company's or Franchising's remaining assets, as the
case may be, constituted unreasonably small capital, or (iv) intended to incur,
or believed it would incur, debts beyond its ability to pay as such debts
matured, such court may be asked to void the Distribution (in whole or in part)
as a fraudulent conveyance and require that the stockholders return the special
dividend (in whole or in part) to the Company, or require the Company or
Franchising, as the case may be, to fund certain liabilities of the other
company for the benefit of creditors. The measure of insolvency for purposes of
the foregoing will vary depending upon the jurisdiction whose law is being
applied. Generally, however, the Company, Franchising or their stock, as the
case may be, would be considered insolvent if the fair value of their respective
assets were less than the amount of their respective liabilities or if they
incurred debt beyond their ability to repay such debt as it matures. In
addition, under Section 170 of the DGCL (which is applicable to the Company in
the Distribution) a corporation generally may make distributions to its
stockholders only out of its surplus (net assets minus capital)and not out of
capital.
The Company's Board of Directors and management believe that, in
accordance with the solvency opinion rendered in connection with the
Distribution, (i) Realco and Franchising each will be solvent at the time of the
Distribution (in accordance with the foregoing definitions), will be able to
repay its debts as they mature following the Distribution and will have
sufficient capital to carry on its businesses, and (ii) the Distribution will be
made entirely out of surplus, as provided under Section 170 of the DGCL.
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<PAGE>
SIGNIFICANT BAINUM FAMILY INTEREST
Upon completion of the Distribution, Stewart Bainum, Stewart Bainum,
Jr., and Barbara Bainum are expected to beneficially own approximately 17.45%,
26.19% and 9.04%, respectively, of Company Common Stock, and Franchising Common
Stock, in each case including shares with respect to which voting power is
shared with other individuals or entities. See "Security Ownership of Principal
Stockholders and Management." In addition, Mr. Bainum and Mr. Bainum, Jr. will
be directors of Realco and Mr. Bainum, Mr. Bainum, Jr. and Ms. Bainum will be
directors of Franchising. As a result, the Bainum family may be in a position to
significantly influence the affairs of each of Realco and Franchising, including
the election of directors.
DIVIDEND POLICIES
The dividend policies of Realco and Franchising will be determined by
their respective Boards of Directors following the Distribution. The declaration
and payment of dividends by Realco will be at the discretion of the Realco Board
of Directors. The declaration and payment of dividends by Franchising will be at
the discretion of the Franchising Board of Directors. The Realco Board of
Directors and the Franchising Board of Directors intend to re-evaluate their
respective dividend policies in the future in light of their respective
companies' results of operations, financial conditions, cash requirements,
future prospects and other factors deemed relevant by the respective boards of
directors. There can be no assurance that any dividends will be paid in the
future.
IMPACT OF INFLATION AND OTHER EXTERNAL FACTORS
Franchising's principal sources of revenues are franchise fees.
Franchise fees and revenues from owned and managed hotels can be impacted by two
external factors: the supply of hotel rooms within the lodging industry relative
to the demand for rooms by travelers, and inflation.
Although industry-wide supply and demand for hotel rooms recently has
been fairly balanced, any excess in supply that might develop in the future
could have an unfavorable impact on room revenues at Franchising's franchised
hotels either by reducing the number of rooms reserved at Franchising's
properties or by restricting the rates hotel operators can charge for their
rooms. In addition, an excess supply of hotel rooms may discourage potential
franchisees from opening new hotels, unfavorably impacting the franchise fees
received by Franchising.
Although Franchising believes that increases in the rate of inflation
will generally result in comparable increases in hotel room rates, severe
inflation could contribute to a slowing of the national economy, which could
result in reduced travel by both business and leisure travelers. That could lead
to less demand for hotel rooms, which could result in a temporary reduction in
room rates and fewer room reservations, negatively impacting revenues received
by Franchising. A weak economy could also reduce demand for new hotels,
negatively impacting the franchise fees received by Franchising.
Among the other unpredictable external factors which may affect
Franchising's fee stream are wars, airline strikes and severe weather.
FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY
Certain statements contained in this Proxy Statement under the
captions "Proxy Statement Summary," "Risks Factors," "Management's Discussion
and Analysis of Financial Condition and Results of Operations," "Choice Hotels
Franchising, Inc.--Business and Properties," "Realco--Business and Properties"
and elsewhere constitute "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve known and unknown risks, uncertainties and other important
factors that could cause the actual results, performance or achievements of the
Company or Franchising for industry results to differ materially from any future
results, performance or achievements express or implied by such forward-looking
statements. Such risks, uncertainties and other important factors include, among
other things: Realco's substantial leverage after the Distribution, and its
plans to realize cash proceeds through leveraging its remaining assets; Realco's
plans to make selected strategic investments and acquisitions and develop new
hotels; Franchising's plans
16
<PAGE>
to expand its international franchise operations; Franchising's plans to market
new brands and products; Realco's and Franchising's success in implementing
their respective business strategies, including their success in arranging
financing where required; competition; government regulation; general economic
and business conditions; and other factors referenced in this Proxy Statement.
See "Risk Factors." These forward-looking statements speak only as of the date
of this Proxy Statement. The Company and Franchising expressly disclaim any
obligation or undertaking to disseminate any updates or revisions to any
forward-looking statement contained herein to reflect any change in the
Company's or Franchising's expectations with regard thereto or any change in
events, conditions or circumstances on which any such statement is based.
17
<PAGE>
RELATIONSHIP BETWEEN THE COMPANY
AND FRANCHISING AFTER THE DISTRIBUTION
For purposes of governing the ongoing relationships between the
Company and Franchising after the Distribution Date, and in order to facilitate
the transition to two separate publicly-traded companies, the Company and
Franchising will enter into various agreements setting forth the Company's and
Franchising's on-going responsibilities regarding various matters outlined
below. The agreements summarized in this section are included as exhibits to
Franchising's Registration Statement on Form 10.
DISTRIBUTION AGREEMENT
On or prior to the Distribution Date, the Company and Franchising will
enter into a Distribution Agreement which provides for, among other things, the
principal corporate transactions required to effect the Distribution, the
assumption by Franchising of all liabilities relating to the Franchise Business
and the allocation between the Company and Franchising of certain other
liabilities, certain indemnification obligations of the Company and Franchising
and certain other agreements governing the relationship between the Company and
Franchising with respect to or in consequence of the Distribution. The
Distribution Agreement provides that the Distribution is subject to the prior
satisfaction of certain conditions including, among other things, the execution
of all ancillary agreements to the Distribution Agreement, certain of which are
described below, and the formal approval of the Distribution by the Company
Board of Directors.
Subject to certain exceptions, Franchising has agreed to indemnify the
Company and its subsidiaries against any loss, liability or expense incurred or
suffered by the Company or its subsidiaries arising out of or related to the
failure by Franchising to perform or otherwise discharge liabilities allocated
to and assumed by Franchising under the Distribution Agreement, and the Company
has agreed to indemnify Franchising against any loss, liability or expense
incurred or suffered by Franchising arising out of or related to the failure by
the Company to perform or otherwise discharge the liabilities retained by the
Company 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. The Distribution Agreement also
includes procedures for notice and payment of indemnification claims and
provides that the indemnifying party may assume the defense of a claim or suit
brought by a third party.
The Distribution Agreement also provides that by the Distribution
Date, Franchising's Amended and Restated Certificate of Incorporation and Bylaws
shall be in the forms attached hereto as Annexes B and C, respectively, and that
Franchising and the Company will take all actions which may be required to elect
or otherwise appoint, as directors of Franchising, the nine persons indicated
herein. See "Description of Franchising Capital Stock," "Purposes and
Antitakeover Effects of Certain Provisions of the Franchising Certificate and
Bylaws" and "Management of Franchising--Directors of Franchising."
The Distribution Agreement also provides that each of the Company and
Franchising will be granted access to certain records and information in the
possession of the other, and requires the retention by such information in its
possession, 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 Franchising to obtain
the consent of the other prior to waiving any shared privilege.
The Distribution Agreement provides that except as otherwise
specifically provided, all costs and expenses incurred in connection with the
preparation, execution, delivery and implementation of the Distribution
Agreement and with the consummation of the transactions contemplated by the
Distribution Agreement (including transfer taxes and the fees and expenses of
all counsel, accountants and financial and other advisors) shall be paid by the
party incurring such cost or expense. Notwithstanding the foregoing, the Company
shall be obligated to pay the legal, filing, accounting, printing and other
accountable and out-of-pocket expenditures in connection with the preparation,
printing and filing of the Registration Statement on Form 10 and obtaining
financing.
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<PAGE>
STRATEGIC ALLIANCE AGREEMENT
On or prior to the Distribution Date, the Company and Franchising will
enter into a Strategic Alliance Agreement pursuant to which: (i) the Company
will grant a right of first refusal to Franchising to franchise any lodging
property that the Company develops or acquires and intends to franchise; (ii)
the Company will, barring a material change in market conditions, continue to
develop Sleep Inns and MainStay Suite Hotels so that it will have opened a total
of 14 Sleep Inns and 15 MainStay Suite Hotels within 48 months of the
Distribution Date; (iii) Franchising will grant to the Company 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 Franchising will continue to cooperate with respect to matters
of material interest, including new product and concept testing for Franchising
in hotels owned by the Company; and (v) the Company will authorize Franchising
to negotiate with third party vendors on the Company's behalf for the purchase
of certain items. The Strategic Alliance Agreement extends for a term of 20
years with a mutual termination provision on the fifth, tenth and fifteenth
anniversaries.
TAX SHARING AGREEMENT
The Company and Franchising will enter into the Tax Sharing Agreement
for purposes of allocating pre-Distribution tax liabilities among the Company
and Franchising and their respective subsidiaries. In general, the Company will
be responsible for (i) filing consolidated federal income tax returns for the
Company affiliated group and combined or consolidated state tax returns for any
group that includes a member of the Company affiliated group, including in each
case Franchising 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) remitted by the Company and
Franchising, respectively. Franchising will reimburse the Company for the
portion of such taxes that relates to Franchising and its subsidiaries, as
determined based on their hypothetical separate company income tax liabilities.
The Company and Franchising 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 AND ADMINISTRATION AGREEMENT
The Company anticipates that it will amend the existing Choice Hotels
International Inc. Retirement Savings and Investment Plan ("401(k) Plan") and
Choice Hotels International, Inc. Non-Qualified Retirement Savings and
Investment Plan ("Non-Qualified Savings Plan") to make each plan a multiple
employer plan in which both Franchising and Realco will participate. The Company
will enter into an Employee Benefits and Other Employment Matters Allocation and
Administration Agreement (the "Employee Benefits Allocation and Administration
Agreement") which will provide for (i) administration of the 401(k) Plan and
Non-Qualified Plan and (ii) the allocation subsequent to the Distribution of
other employee benefits, as they relate to employees who remain employed by the
Company or its subsidiaries (the "Company Employees") after the Distribution and
employees who are employed by Franchising after the Distribution ("Franchising
Employees"). The Employee Benefits Allocation and Administration Agreement will
provide that, effective as of the Distribution Date, Franchising will, or will
cause one or more of its subsidiaries to assume or retain, as the case may be,
all liabilities of the Company, to the extent unpaid as of the Distribution
Date, under employee benefit plans, policies, arrangements, contracts and
agreements, including under collective bargaining agreements, with respect to
Franchising Employees. The Employee Benefits Allocation and Administration
Agreement will also provide that Realco generally will assume or retain, as the
case may be, all other liabilities under employee benefit plans maintained by
the Company, or any of its subsidiaries with respect to employees of the Company
or any of its retained subsidiaries after the Distribution. Pursuant to the
Employee Benefits Allocation and Administration Agreement, Realco will continue
sponsorship of the various Company profit sharing plans, stock plans and health
and welfare plans with respect to the Company Employees. Franchising will
establish a number of plans (other than the 401(k) Plan and Non-Qualified
Savings Plan) which will allow Franchising to provide to its employees
substantially the same benefits currently provided to them as employees of the
Company. With respect to each Company profit sharing and retirement plan, the
Company shall transfer to Franchising on or before , 1998, an amount
representing the present value of the full accrued benefit of all Franchising
Employees who had earned a benefit under any such
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<PAGE>
Company plan. The Employee Benefits Allocation Agreement provides for cross-
guarantees between the Company and Franchising with respect to the payment of
benefits under certain plans and for cross-indemnification with respect to pre-
Distribution employment-related claims.
The Employee Benefits Allocation and Administration Agreement also
provides for the adjustment of outstanding options to purchase shares of Company
Common Stock held by Company Employees, Franchising Employees and employees of
Manor Care who hold such shares as a result of the Manor Care Spin-off. On the
Distribution Date, each Company Employee and Franchising Employee holding an
incentive stock option to purchase Company Common Stock will receive, for each
such option, a conversion award consisting of an incentive stock option to
purchase the common stock of such employee's employer after the Distribution
(i.e., Franchising Common Stock for Franchising Employees and Company Common
Stock for Company Employees), with the number of shares that may be acquired and
the option price adjusted pursuant to a formula designed to preserve the
financial value of the options. Each Company Employee and Franchising Employee
holding a non-qualified option to purchase Company Common Stock that has vested
on or prior to the Distribution Date, may make a one-time election to choose a
conversion consisting of any percentage combination of Company Common Stock and
Franchising Common Stock with the number of shares and the exercise price
adjusted so as to preserve the financial value of the outstanding options. Each
Company Employee and Franchising Employee holding a non-qualified option to
purchase Company Common Stock that has not vested on or prior to such date, will
receive a conversion award of which one-half of the financial value of which
will comprise shares of common stock of such employee's employer after the
Distribution, and one-half of the financial value of which will comprise a pro
rata combination of shares of Realco Common Stock and Franchising Common Stock.
On the Distribution Date, each employee of Manor Care holding vested
non-qualified options to purchase shares of Company Common Stock may make a one-
time election to choose a conversion consisting of any percentage combination of
Company Common Stock and Franchising Common Stock with the number of shares and
the exercise price adjusted so as to preserve the financial value of the
outstanding options. Manor Care employees holding unvested non-qualified options
to purchase shares of Company Common Stock will receive a conversion award
consisting of an option to purchase shares of Realco Common Stock and an option
to purchase shares of Franchising Common Stock, whereby the number of shares
that may be acquired under, and the option price of, each conversion award will
be set pursuant to a formula designed to allocate the financial value of the
outstanding option based on the relative stock values immediately following the
Distribution.
LEASE AGREEMENTS
On or prior to the Distribution Date, the Company and Franchising will
enter into a agreement with Manor Care amending the terms of the Silver Spring
Lease and the Gaithersburg Lease to allocate the Company's rights and
responsibilities thereunder between Franchising and Realco. It is currently
expected that the Company and Franchising will allocate the Company's rights and
responsibilities under the Silver Spring Lease such that Franchising will have
the obligation to lease from Manor Care approximately % of the office space
available under the Silver Spring Lease with financial terms approximately equal
(on a square foot basis) to the terms of the Silver Spring Lease, with liability
for payment allocated proportionally. See "Relationship Between the Company and
Manor Care--Lease Agreements."
TRANSITIONAL SERVICE AGREEMENTS
On or prior to the Distribution Date, the Company and Franchising will
enter into a number of agreements pursuant to which Franchising will provide
certain continuing services to the Company for a transitional period. Such
services will be provided on market terms and conditions. Subject to the
termination provisions of the specific agreements, the Company 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.
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<PAGE>
Pursuant to the Employee Benefits Administration Agreement,
Franchising will provide 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, Franchising will provide certain sales,
use, occupancy, real and personal property tax return administration, audit and
appeals services for the Company. Pursuant to the Vehicle Lease Agreement,
Franchising will provide the use of certain vehicles to the Company.
OTHER AGREEMENTS
On or prior to the Distribution Date, the Company and Franchising will
enter into certain other agreements that will, as of 12:00 midnight on the
Distribution Date, fix the respective responsibilities of the Company and
Franchising with respect to the following: the provision by Manor Care of
certain corporate services (including administrative and accounting systems),
the provision of management services, and the procurement by Manor Care of
certain products and supplies used by the Company and Franchising in their
respective businesses and other miscellaneous matters. None of these agreements
extends for a period greater then 18 months from the Distribution Date and they
are not, either alone or in the aggregate, expected to materially affect the
Company or its results of operations.
AMENDMENT TO AGREEMENTS WITH MANOR CARE
Prior to November 1, 1996, the Company and Franchising were wholly-
owned subsidiaries of Manor Care. On November 1, 1996, Manor Care effected the
Manor Care Spin-off. In connection with the Manor Care Spin-off the Company and
Manor Care entered into various agreements setting forth the Company's and Manor
Care's on-going responsibilities regarding various matters. In connection with
the Distribution, certain of these agreements will be amended to allocate
certain of the Company's rights and responsibilities thereunder between
Franchising and Realco.
ACCOUNTING TREATMENT
The historical combined financial statements of Franchising present
its financial position, results of operations and cash flows as if it were a
separate entity for all periods presented. The Company's historical basis in the
assets and liabilities of Franchising has been carried over.
POST DISTRIBUTION DIVIDEND POLICY
The dividend policies of Realco and Franchising will be determined by
their respective Boards of Directors following the Distribution.
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<PAGE>
CERTAIN INFORMATION CONCERNING FRANCHISING
PRO FORMA FINANCIAL DATA
The following unaudited pro forma combined statements of income of
Franchising give effect to (i) the Manor Care Distribution and related
transactions and (ii) the Distribution and related transactions as if the
foregoing had occurred on June 1, 1995. The pro forma financial data are
provided for information purposes only and do not purport to be indicative of
the results that actually would have been obtained if the Manor Care
Distribution and related transactions and the Distribution and related
transactions had been effected on the dates indicated or of those results that
may be obtained in the future. The pro forma combined statement of income are
based on preliminary estimates. The actual recording of the transactions will
be based on actual costs. Accordingly, the actual recording of the Manor Care
Distribution and related transactions and the Distribution and related
transactions can be expected to differ from those pro forma financial
statements. There were no adjustments required to the Statement of Income for
the year ended May 31, 1996 as a result of the Distribution. No pro forma
Statement of Income is presented for the nine months ended February 28, 1997,
and no pro forma balance sheet is presented as of February 28, 1997 as there
were no pro forma adjustments to the financial statements for those periods.
PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED MAY 31, 1996
<TABLE>
<CAPTION>
Manor Care
Distribution
Historical Adjustments(a) Pro Forma
----------- ----------------- ----------
<S> <C> <C> <C>
REVENUES
Royalty fees........................................... $ 89,182 $ 89,182
Marketing and reservation fees......................... 93,237 93,237
European hotel operations.............................. 19,609 19,609
Product sales and rentals.............................. 26,693 26,693
Initial franchise fees................................. 12,253 12,253
Other revenue.......................................... 5,342 5,342
-------- --------
Total revenues....................................... 246,316 246,316
-------- --------
OPERATING EXPENSES
Payroll and benefits................................... 57,056 57,056
Other administrative expenses.......................... 38,200 38,200
European hotel operations.............................. 19,545 19,545
Product sales and rentals.............................. 20,709 20,709
Advertising and marketing.............................. 41,684 41,684
Depreciation and amortization.......................... 11,839 11,839
Provision for asset impairment......................... 24,760 24,760
-------- --------
Total operating expenses............................. 213,793 $ 4,100(b) 217,893
-------- ------- --------
Operating income..................................... 32,523 (4,100) 28,423
-------- ------- --------
OTHER INCOME AND EXPENSES
Minority interest...................................... 1,532 (1,532)(c) --
Interest on Notes payable to Manor Care................ 7,083 ------- 7,083
Interest and other 2,931 2,931
-------- ------- --------
Total other expenses................................. 11,546 (1,532) 10,014
-------- ------- --------
Income before income taxes............................. 20,977 (2,568) 18,409
Income taxes........................................... (9,313) 1,623(d) (7,690)
-------- ------- --------
Net income............................................. $ 11,664 $ (945) $ 10,719
======== ======= ========
Net income per share................................... $ 0.17(e)
========
</TABLE>
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____________________
(a) Reflects the effect of the Manor Care Distribution and related
transactions.
(b) Reflects the net additional costs associated with staffing of accounting,
finance, cash management, risk management, human resources and legal
personnel, directors' costs, incremental rental costs and the payment of
certain consulting fees to Manor Care.
(c) Reflects the elimination of minority interest associated with the purchase
of minority equity.
(d) Represents the income tax impact of pro forma adjustments at statutory
rates.
(e) Pro forma income per share is computed by dividing pro forma net income by
the pro forma weighted average number of outstanding common shares,
aggregating 62.6 million in fiscal year 1996. The pro forma weighted
average number of outstanding common shares is based on Manor Care's
weighted average number of outstanding common shares at May 31, 1996.
23
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA OF FRANCHISING
The following table presents selected historical combined financial
data of Franchising for the five fiscal years ended May 31, 1996, 1995, 1994,
1993, 1992 and the thirty six weeks ended February 28, 1997 and February 29,
1996.
The combined financial statements of Franchising include the assets
and liabilities, revenues and expenses of the Franchising Business and the
ownership and operation of 14 hotel properties in France, Germany and the United
Kingdom. The Franchising combined financial statements include certain
allocations of the overhead expenses incurred by the Company, and prior to
November 1, 1996 incurred by Manor Care, that support all of the Franchising
Business. In management's opinion, these allocations were made on a reasonable
basis, however, such allocations may not be indicative of the level of expenses
which will be incurred by Franchising after the Distribution. The expenses were
generally allocated based upon specific identification and estimates of the
relative time devoted to supporting Franchising.
The combined income statement data for 1992 and 1993, the balance
sheet data for 1992 through 1994 and the financial data as of and for the nine
months ended February 29, 1996 and February 28, 1997 have been derived from
unaudited combined financial statements of Franchising which in the opinion of
management include all material adjustments necessary for those periods and were
prepared as if Franchising were a separate entity for all periods presented. The
historical combined financial data is not necessarily indicative of
Franchising's future results of operations or financial condition. The data set
forth below should be read in conjunction with the Unaudited Pro Forma Financial
Data and the notes thereto of Franchising and the audited Combined Financial
Statements of Franchising and the notes thereto and the Management's Discussion
and Analysis of Historical Financial Condition and Results of Operations of
Franchising included elsewhere in this Proxy Statement. For a discussion of the
basis of presentation of the Franchising Combined Financial Statements, see Note
1 of the Notes to the Franchising Combined Financial Statements.
24
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
SELECTED HISTORICAL FINANCIAL DATA
<TABLE>
<CAPTION>
(IN THOUSANDS) NINE-MONTHS ENDED
--------------------------------------------------- ------------------------------
YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
---------------------------------------------------
1992 1993 1994 1995 1996 1996 1997
---- ---- ---- ---- ---- ---- ----
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA
Revenues.............................. $128,024 $143,054 $184,866 $212,672 $ 246,316 $187,897 $205,947
Operating expenses:
Payroll and benefits.............. 35,700 36,950 42,773 49,252 57,056 43,010 49,490
Other administrative expenses..... 31,030 37,651 48,149 40,227 38,200 30,349 36,293
European hotel operations......... -- -- 9,004 17,922 19,545 13,995 12,122
Product sales and rentals......... 6,433 7,365 12,014 13,882 20,709 13,825 17,490
Advertising and marketing......... 24,224 28,851 33,978 37,655 41,684 34,624 31,868
Depreciation and amortization..... 8,076 9,182 10,825 11,768 11,839 9,058 7,757
Provision for asset impairment.... -- -- -- -- 24,760(1) -- --
-------- -------- -------- -------- --------- -------- --------
Total operating expenses....... 105,463 119,999 156,743 170,706 213,793 144,861 155,020
-------- -------- -------- -------- --------- -------- --------
Operating income...................... 22,561 23,055 28,123 41,966 32,523 43,036 50,927
-------- -------- -------- -------- --------- -------- --------
OTHER INCOME AND EXPENSES
Interest expense on Notes
payable to Manor Care........... 7,083 7,083 7,083 7,083 7,083 5,312 5,312
Minority interest................. -- 900 1,476 2,200 1,532 1,149 --
Interest and other................ 176 145 3,591 3,672 2,931 2,258 2,928
-------- -------- -------- -------- --------- -------- --------
Total other income and expenses 7,259 8,128 12,150 12,955 11,546 8,719 8,240
-------- -------- -------- -------- --------- -------- --------
Income before income taxes........ 15,302 14,927 15,973 29,011 20,977 34,317 42,687
Income taxes...................... (6,180) (6,422) (7,372) (12,783) (9,313) (14,450) (17,578)
-------- -------- -------- -------- --------- -------- --------
Net income........................ $ 9,122 $ 8,505 $ 8,601 $ 16,228 $ 11,664 $ 19,867 $ 25,109
======== ======== ======== ======== ========= ======== ========
BALANCE SHEET DATA
Total assets...................... $139,121 $170,815 $173,646 $189,087 $ 214,158 $206,994 $205,461
Notes payable to Manor Care....... $ 78,700 $ 78,700 $ 78,700 $ 78,700 $ 78,700 $ 78,700 $ 78,700
Total debt........................ $ 87,632 $122,909 $126,294 $128,205 $ 145,148 $126,572 $124,923
Total liabilities................. $111,537 $144,982 $160,371 $192,860 $ 174,760 $159,256 $162,416
Total investments and
advances from (to) Parent.... $ 27,584 $ 25,833 $ 13,275 $ (3,833) $ 39,398 $ 47,738 $ 43,045
</TABLE>
__________________
(1) In 1996 Franchising recorded a pre-tax charge of $24.8 million for
impairment of long lived assets associated with Franchising's European
operations.
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The principal factors that affect Franchising's results are: growth in
the number of hotels; occupancies and room rates achieved by Franchising's
brands; the number and relative mix of franchised hotels; and Franchising's
ability to manage costs. The number of rooms at franchised properties and
occupancies and room rates significantly affect Franchising's results because
franchise royalty fees are based upon room revenues at franchised hotels.
Increases in franchise fee revenues have a disproportionate impact on
Franchising's operating margin due to the lower incremental costs associated
with these revenues.
COMPARISON OF RESULTS OF OPERATION
THE NINE MONTHS ENDED FEBRUARY 28, 1997 AND FEBRUARY 29, 1996. Net
income was $25.1 million for the nine months ended February 28, 1997, an
increase of $5.2 million, or 26.4%, compared to the same period in fiscal year
1996.
Royalty fees charged to franchisees are generally calculated based on
a percentage of franchised hotels total revenues. Marketing fees charged to
franchisees are generally calculated based on a percentage of franchised hotels
total revenues plus, in many cases, a fixed amount per franchised room.
Reservation fees charged to franchisees are also generally calculated based on a
percentage of franchised hotels total revenues but may also be based upon
reservation call volume. Royalty fees increase $7.3 million, or 11.0% during the
nine months ended February 28, 1997 compared to the nine months ended February
29, 1996 and marketing and reservation fees increased $3.7 million, or 5.4%.
These increases were primarily the result of the increase in the number of
domestic franchised properties and the operating performance at those
properties. Franchising's domestic franchise hotels increased by 287 properties,
or 11.8% to 2,718 properties at February 28, 1997, from 2,431 properties as of
February 29, 1996. Average daily room rates of domestic franchise hotels
increased by approximately 4.8% for the nine months ended February 28, 1997
compared to the same period of the prior fiscal year. Average occupancies of
domestic franchise hotels were 63.1% and 64.2% for the nine months ended
February 28, 1997 and February 29, 1996, respectively.
At February 28, 1997, Franchising owned and managed 14 European hotels
in Germany, France and Great Britain. Revenues from European hotel operations
decreased 9.2% during the nine months ended February 28, 1997 compared to the
same period of the prior year. The decrease is as a result of exchange rate
fluctuations as well significantly decreased revenue at a German hotel resulting
from low occupancy in an increasingly competitive market.
Product sales and rentals consists, primarily, of sales made to
franchisees under Franchising's group purchasing program for franchisees but
also consists of rental and sales of equipment and software used to support
Franchising's reservation system. Product sales and rentals increased $3.7
million, or 20.6%, for the nine months ended February 28, 1997 compared to the
nine months ended February 29, 1996, primarily due to increases in group
purchasing program sales associated with the sale of furniture and fixtures for
newly constructed Comfort Inns and Sleep Inns.
Initial franchise fees are one time fees charged to new licensees for
the use of proprietary marks and systems. Initial franchise fees increased $1.2
million, or 13.1%, for the nine months ended February 28, 1997 compared to the
same period of the prior fiscal year. The increase is the result of an increase
in the number of new properties added to the system as well as increased fees on
certain brands.
Other revenue primarily consists of relicensing fees charged to
transfer ownership of a Choice branded property to a new owner, convention
revenues, partnership income, and fees for the use of global distribution
systems, among others. Other revenue increased approximately $3.5 million, or
30.9%, for the nine months ended February 28, 1997 compared to the same period
of the prior fiscal year.
Payroll and benefits increased $6.5 million, or 15.1%, for the nine
months ended February 28, 1997 compared to the nine months ended February 29,
1996. The increase primarily relates to the increased costs of
26
<PAGE>
supporting Franchising's domestic reservation systems and of the increased costs
of supporting Franchising's domestic marketing programs. The remainder of the
increase is associated with additional personnel added to support company
growth, new company initiatives and the personnel added as a result of the Manor
Care Spin-off.
Other administrative expenses increased $5.9 million, or 19.6%, for
the nine months ended February 28, 1997 compared to the nine months ended
February 29, 1996. The increase is due primarily to increased overhead
associated with increased personnel, increased global distribution system costs,
increased convention costs and miscellaneous other cost increases.
Hotel operations expense decreased $1.9 million, or 13.4%, for the
nine months ended February 28, 1997 compared to the same period of the prior
fiscal. The decreased costs are consistent with the decrease in revenues.
Gross margins on product sales and rentals were 18.7% and 22.5% during
the nine months ended February 28, 1997 and February 29, 1996, respectively. The
decrease is due to the change in the relative mix of product sales. Product
sales made to franchisees under Franchising's group purchasing program for
franchisees increased $3.7 million and represented 84.0% and 80.0% respectively,
of total product sales. These sales are made at average margins of less than
10%.
Advertising and marketing costs decreased $2.8 million, or 8.0%,
during the nine months ended February 28, 1997 compared to the same period of
the prior fiscal year, principally due to the timing of advertising campaigns.
COMPARISON OF FISCAL YEAR RESULTS. Net income was $11.7 million for
fiscal year 1996, a decrease of $4.6 million, or 28.1%, compared to fiscal year
1995. In fiscal year 1995, net income increased $7.6 million, or 88.7% compared
to fiscal year 1994. Net income in fiscal year 1996 includes a pre-tax charge of
$24.8 million related to asset impairment charges. Excluding the impact of the
asset impairment charges, net income in fiscal 1996 would have increased $10.4
million, or 64.1%.
Royalty fees in fiscal 1996, 1995 and 1994 increased $10.4 million, or
13.2%, $4.8 million, or 6.5%, and $16.1 million, or 27.7%, respectively.
Marketing and reservation fees in fiscal 1996, 1995 and 1994 increased $12.7
million, or 15.8%, $8.5 million, or 11.8%, and $10.8 million, or 17.7%,
respectively. These increases were primarily the result of the increase in the
number of domestic franchised properties, the operating performance at those
properties and the rates charged to domestic franchised properties. At the end
of fiscal 1996, 1995 and 1994 Franchising had 214,613, 200,792, and 203,019
franchised domestic rooms, respectively. Average daily room rates at franchised
properties were $49.49, $47.13, and $45.63 in fiscal 1996, 1995 and 1994,
respectively, while average occupancies were 63.8%, 63.8% and 62.2%,
respectively. Average royalty rates at franchised properties were 3.5%, 3.2%
and 3.1% for fiscal years 1996, 1995 and 1994, respectively.
At May 31, 1996, Franchising owned and managed 14 European hotels in
Germany, France and Great Britain. Revenues from hotel operations increased 5.2%
in fiscal 1996 over the prior year and 157.5% in fiscal 1995 over the prior
year. The increase in fiscal 1996 is primarily due to improved performance of
newly completed owned and managed hotels. The increase in fiscal 1995 is due
primarily to the addition of owned or managed hotels associated with the
Resthotel Primevere acquisition.
Product sales and rentals increased 30.1% and 10.6% in fiscal years
1996 and 1995 from the prior years, respectively. The entire increase in fiscal
1996 and 92.4% of the increase in fiscal 1995 was due to increases in group
purchasing program sales associated with the sale of furniture and fixtures for
new construction Comfort Inns and Sleep Inns.
Initial franchises fees increased $2.9 million, or 31.7%, and
$730,000, or 8.5%, in fiscal 1996 and fiscal 1995, respectively. The increase is
the result of an increase in the number of new properties added to the system as
well as increased fees on certain brands.
27
<PAGE>
Payroll and benefits increased $7.8 million, or 15.8%, and $6.5
million, or 15.1%, in fiscal years 1996 and 1995 respectively. In fiscal 1996
and fiscal 1995, the increases primarily relate to the increased costs of
supporting Franchising's domestic reservation systems and of the increased costs
of supporting Franchising's domestic marketing programs. The remainder of the
increase is associated with additional personnel added to support company growth
and new company initiatives.
Other administrative expenses decreased $2.0 million, or 5.0%, and
$7.9 million, or 16.5%, in fiscal years 1996 and 1995, respectively. In fiscal
1996 the decrease is due to primarily to decrease overhead costs of European
franchise operations while in fiscal 1994 the decrease is due to reduced
European overhead costs, significantly lower travel and entertainment
expenditures and a decreased reserve for bad debts.
In fiscal 1996, hotel operations expense increased $1.6 million, or
9.1%, over the prior fiscal year. In fiscal 1995, hotel operations costs
increased $8.9 million. The increases in hotel operating expenses is driven
primarily by the increase in hotel operations revenue.
Gross margins on product sales and rentals were 22%, 32% and 35% in
fiscal years 1996, 1995, and 1994, respectively. The decrease is due to the
change in the relative mix of product sales. Product sales made to franchisees
under Franchising's group purchasing program for franchisees increased $7.1
million and $1.9 million in fiscal 1996 and 1995, respectively, and represented
80.8% and 70.5%, respectively, of total product sales. These sales are made at
average margins of less than 10%.
Advertising and marketing costs increased $4.0 million, or 10.7%, and
$3.7 million, or 10.8%, in fiscal 1996 and fiscal 1995, respectively,
principally due to general increases in advertising costs. These increases were
offset by corresponding increases in marketing fees charged to Franchising's
franchised hotels.
Depreciation and amortization expense increased 0.6% in fiscal 1996
and 8.7% in fiscal 1995. The increase is primarily due to depreciation on
additional computer hardware used to support Franchising's reservation systems.
In fiscal year 1996, Franchising recorded a pre-tax charge against
earnings of $24.8 million related to impairment of certain long-lived assets
associated with Franchising's European operations. During fiscal year 1996, in
connection with Franchising's equity investment in Friendly Hotels, PLC,
Franchising restructured its European operations to focus more specifically on
selected geographic markets. Franchising performed a review of its European
operations and determined that certain assets associated with these operations
were impaired. These assets relate primarily to European properties opened or
acquired in fiscal years 1993 and 1994. Franchising's experience shows that
newly opened or acquired properties require up to three-years to reach
stabilized operating levels. Operating results at the affected properties have
not improved as expected over the three year period. The amount of the
impairment charge was measured in accordance with Franchising's policy. See the
Combined Financial Statements and related notes included elsewhere herein.
LIQUIDITY AND CAPITAL RESOURCES
Historically all cash received by Franchising has been deposited in or
combined with its Parent's corporate funds as part of its Parent's cash
management system. Subsequent to the Distribution, Franchising will maintain
its own cash balances and implement its own internal cash management system.
The Company has $225.7 million payable to Manor Care as of May 31,
1996 assumed as part of the Manor Care Distribution. The portion of this
indebtedness related to acquisitions made by Franchising has been pushed down to
Franchising, and, as of February 28, 1997 and May 31, 1996, Notes payable to
Manor Care by Franchising totaling $78.7 million were outstanding. Interest on
the amount of the loan is payable quarterly at a rate of 9% per annum. The loan
will mature on November 1, 1999 and may be prepaid in whole or in part, together
with accrued interest, at Franchising's option. If the loan is repaid prior to
November, 1, 1997, Franchising will be required to reimburse Manor Care on
demand for any actual loss incurred or to be incurred by Manor Care (for the
period up to
28
<PAGE>
and including November 1, 1997) in the redeployment of the funds released by any
prepayment of the loan. The Notes Payable to Manor Care are expected to be
repaid from operating cash flow or from third party financing.
During fiscal 1996 and through November 1, 1996, the Company was a co-
guarantor with Manor Care and other affiliates for a $250 million competitive
advance and multi-currency revolving credit facility. On October 30, 1996 the
Company entered into a $100.0 million competitive advance and multi-currency
revolving credit facility provided by a group of seven banks. During November
1996 the Company repaid its portion of the Manor Care multi-currency credit
facility, $50.1 million, with an advance from the Company's newly acquired
Credit Facility. As of February 28, 1997, Franchising had $31.0 million in
advances against the multi-currency portion of the newly acquired credit
facility outstanding. Franchising expects to have access to a revolving credit
facility prior to the Distribution and will repay its portion of borrowings
under the Company's existing credit facility.
Management believes cash flows from operations and third party
financing sources will be adequate to support on-going operations, capital
expenditures and meet debt service requirements for the foreseeable future. If
necessary, Franchising will need to secure additional sources of financing to
repay the Notes Payable to Manor Care on November 1, 1999.
Net cash provided by operating activities for the nine months ended
February 28, 1997 was $44.5 million compared to $27.1 million for the same
period of the prior fiscal year. Improved cash flow resulted primarily from
improved net income and a reduced change in deferred taxes.
Franchising's working capital ratio at February 28, 1997 and May 31,
1996 was .68 and 1.14, respectively. Franchising attempts to minimize its
investments in net current assets. Franchising utilizes the Credit Facility to
meet seasonal fluctuations in working capital requirements. The change in the
working capital ratio primarily results from an increase in accounts payable.
Cash used in investing activities was $12.9 million, $7.7 million, and
$78.5 million in fiscal 1994, 1995 and 1996, respectively. During 1994,
Franchising acquired the Resthotel Primevere hotel chain operating primarily in
France for $10.4 million. During 1995, Franchising repurchased one-half of the
11% interest held by its management in Choice Hotels Franchising, Inc.
Approximately $19.8 million was allocated to goodwill; the purchase cost of
$27.4 million was paid in June and July 1995. On May 31, 1996, Franchising
repurchased the remaining 5.5% minority interest in Choice Hotels Franchising,
Inc. for $27.9 million. Approximately $26.4 million was allocated to goodwill.
During 1996, Franchising purchased a 5% common stock interest and a preferred
stock interest in Friendly Hotels, PLC, a U.K. hotel company, 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 nine months ended February 28, 1997, capital expenditures totaled
$3.1 million and related primarily to the development of a new property
management system and the installation of new financial systems. Capital
expenditures in prior years include amounts for computer hardware, reservation
systems and European hotel capital improvements.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
Franchising is required to adopt SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," no
later than fiscal year 1997. Franchising's current policy is to regularly
review the recoverability of the net carrying value of its long-lived assets and
make adjustments accordingly. The adoption of SFAS No. 121 did not have a
material impact on Franchising's financial statements.
Franchising is required to adopt SFAS No. 123, "Accounting for Stock-
Based Compensation," no later than fiscal year 1997. Management expects to adopt
SFAS No. 123 utilizing the method which provides for disclosure of the impact of
stock-based compensation grants. Franchising is required to adopt SFAS No. 128,
"Earnings Per Share," and SFAS No. 129, "Disclosure of Information about Capital
Structure," no later than fiscal year 1998. The adoption of these pronouncements
will not materially affect Franchising's financial statements.
29
<PAGE>
BUSINESS AND PROPERTIES
GENERAL
Franchising is a wholly owned subsidiary of the Company and currently
conducts a significant portion of the Franchising Business. Immediately prior
to the Distribution, Franchising will succeed to that portion of the Franchising
Business currently conducted directly by the Company and certain other
subsidiaries of the Company. The following description summarizes the current
business of Franchising, as well as the business to be transferred to
Franchising prior to the Distribution.
Franchising is one of the world's largest franchisors of hotels with
3,280 properties open and operating in 33 countries at February 28, 1997. These
properties principally operate under one of Franchising's brand names:
Comfort/(R)/, Quality/(R)/, Clarion/(R)/, Sleep/(R)/, Rodeway/(R)/, Econo
Lodge/(R)/ and MainStay Suites/SM/. At February 28, 1997, another 797 franchise
properties with a total of 71,616 rooms were under development. As a franchisor,
Franchising licenses hotel operators to use Franchising's brand names and
provides to these hotel operators products and services designed to increase
their revenues and profitability. Key products and services provided include
nationally recognized marketing and advertising programs, access to a
reservation system that delivers business to the franchisees' hotels, access to
innovative products and services developed by Franchising and other support
services such as training programs, purchasing discounts, operating manuals,
quality standards and inspections. In return for the use of Franchising's brand
names and access to Franchising's products and services, franchisees pay to
Franchising fees that are generally based on a percentage of the franchise
hotels' gross room revenues. Franchising's franchise operations have experienced
significant growth in revenues and profitability over the last few years.
Franchising's compound annual growth rate from fiscal year 1992 to fiscal year
1996 was 17.8% for revenues and 30.8% for net income before unusual items. For
the nine months ended February 28, 1997 total revenues and net income were
$205.9 million and $25.1 million, respectively. Excluding unusual items net
income for fiscal year 1996 was $26.7 million.
THE LODGING INDUSTRY
As of December 1996, there are approximately 3.4 million hotel rooms
in the United States in hotels/motels containing twenty or more rooms. Of those
rooms, approximately 1.2 million rooms are not affiliated with a national or
regional brand, while the remaining approximately 2.2 million rooms are
affiliated with a brand either through franchise or the ownership/management of
a national or regional chain.
During the late 1980s, the industry added approximately 500,000 hotel
rooms to its inventory due largely to a favorable hotel lending environment, the
ability of hotel operators to regularly increase room rates and the
deductibility of passive tax losses, which encouraged hotel development. As a
result, the lodging industry saw an oversupply of rooms and a decrease in
industry performance.
The lodging industry in recent years has demonstrated a recovery,
based on year-to-year increases in room revenues, occupancy rates, revenue per
available room ("RevPAR"), and lodging industry profitability. RevPAR is
calculated by multiplying the percentage of occupied rooms by the average daily
room rate charged. Since 1993, the lodging industry has been able to increase
its average daily rate ("ADR") at a pace faster than the increase in the
Consumer Price Index ("CPI"), a common measure of inflation published by the US
Department of Labor. Smith Travel Research's estimates indicate that occupancy
rates in 1996 increased to 65.2% from 65.1% in 1995, in part because of
increases in room demand attributable to the 1996 Summer Olympics, the 1996
national political campaigns and conventions, and a continued improvement in the
national economy. The following chart demonstrates the recent trends:
30
<PAGE>
THE US LODGING INDUSTRY'S GROWTH TRENDS SINCE 1991
<TABLE>
<CAPTION>
INCREASE IN AVERAGE
ROOM DAILY INCREASE INCREASE REVENUE PER
REVENUE (ROOM) IN ADR IN CPI AVAILABLE NEW
VERSUS OCCUPANCY RATES VERSUS VERSUS ROOM PROFITS ROOMS
YEAR PRIOR YEAR RATES (ADR) PRIOR YEAR PRIOR YEAR (REVPAR) (IN BILLIONS) ADDED
- - ------ ------------ ---------- -------- ----------- ----------- ------------ ------------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1992.............. N/A 62.6% $58.91 1.4% 2.9% $36.87 break-even 36,000
1993.............. 6.3% 63.5% $60.53 2.7% 2.7% $38.42 $ 2.4 40,000
1994.............. 8.6% 64.7% $62.86 3.8% 2.7% $40.70 $ 5.5 45,000
1995.............. 7.0% 65.1% $65.81 4.7% 2.9% $42.83 $ 8.5 64,000
1996.............. N/A 65.2% $69.66 5.9% 2.9% $45.47 $11.5 91,000
</TABLE>
_________________
Source: Smith Travel Research
Franchising believes the lodging industry can be divided into three
categories: luxury or upscale, middle-market and economy. Franchising believes
the luxury category generally has room rates above $70 per night, the middle-
market category generally has room rates between $46 and $70 per night and the
economy category generally has room rates less than $46 per night.
Service is a distinguishing characteristic in the lodging industry.
Generally there are three levels of service: full-service hotels (which offer
food and beverage services, meeting rooms, room service and similar guest
services); limited-service hotels (which offer amenities such as swimming pools,
continental breakfast, or similar services); and all-suites hotels (which
usually have limited public areas, but offer guests two rooms or one room with
distinct areas, and which may or may not offer food and beverage services).
Franchising's Econo Lodge, Rodeway and Sleep brands compete primarily
in the limited-service economy market; Franchising's Comfort and Quality brands
compete primarily in the limited-service middle-market; Franchising's Clarion
brand competes primarily in the full-service upscale market; and Franchising's
MainStay Suites brand competes primarily in the all-suites middle-market.
New hotels opened in recent years typically have been limited service
hotels, as limited-service hotels are less costly to develop, enjoy higher gross
margins, and tend to have better access to financing. These hotels typically
operate in the economy and middle-market categories and are located in suburban
or highway locations. From 1991 to 1996, the average room count in new hotels
declined from 122 to 87, primarily because hotel developers found it difficult
to obtain financing of more than $3 million from their primary lending sources
(local banks and Small Business Administration guaranteed loan programs).
In recent years, operators of hotels not owned or managed by major
lodging companies have increasingly joined national hotel franchise chains as a
means of remaining competitive with hotels owned by or affiliated with national
lodging companies. Because hotels typically operate with high fixed costs,
increases in revenues generated by affiliation with a franchise lodging chain
can improve a hotel's financial performance. Of approximately 933 hotel
properties that changed their affiliation in 1995, 77% converted from
independent status to affiliation with a chain or converted from one chain to
another, while only 23% canceled or were required to cancel their chain
affiliation. The share of US hotel rooms affiliated with a chain was
approximately 63% in 1995.
The shift to chain membership has been most pronounced among hotels in
the same categories as Franchising, i.e., the economy and middle-market
categories. In 1995, 53% of all conversions to a chain from independent status
or from another chain were in the economy category, 37% were in the middle-
market category, and 10% were in the upscale category. Often by affiliating with
a middle-market or economy brand, a hotel operator can reposition the hotel
property in the price category best suited to its market.
The large franchise chains, including Franchising, 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. Franchising believes that national
franchise chains with a larger
31
<PAGE>
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.
Franchising 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
Franchising's franchise business provides significant opportunities for
Franchising to increase profits by increasing the number of franchised
properties. Hotel franchisors such as Franchising derive substantially all of
their revenue from franchise fees. Franchise fees are comprised of an initial
fee and ongoing royalty and marketing and reservation fees charged by the
franchisor as a percentage of the franchisee's gross room revenues. The royalty
portion of the franchise fee is intended to cover the operating expenses of the
franchisor, such as expenses incurred in quality assurance, administrative
support and other franchise services and to provide the franchisor with
operating profits. The marketing and reservation portion of the franchise fee
is intended to reimburse the franchisor for the expenses associated with
providing such franchise services as the central reservation system and national
marketing and media advertising.
Much of the variable costs associated with Franchising's activities
are reimbursed by the franchisees through the marketing and reservation fees.
Franchising's existing base of franchises more than covers the fixed cost of the
business at its current level so that the variable costs of overhead--in such
areas as quality assurance, franchise development, franchise services and
administration, finance and legal--represent the bulk of incremental costs
associated with the addition of franchisees. Because the variable overhead costs
associated with incremental franchise system growth are substantially less than
the incremental royalty fees, Franchising is able to capture a significant
portion of these incremental royalty fees as operating profit.
STRATEGY. Franchising's franchise strategy is based on expanding,
enhancing and maximizing--revenue of its franchise system by providing hotel
operators with products and services that increase their revenues and
profitability, capitalizing on its franchising and marketing expertise through
joint marketing programs with preferred vendors and engaging in strategic
acquisitions in the lodging, travel-related and other franchise industries. Key
components of Franchising's franchise strategy include:
. GROWTH OF FRANCHISING'S DOMESTIC FRANCHISE SYSTEM. Franchising's
existing franchisees form a pool of potential buyers and builders
of new hotels that may affiliate with one of Franchising's
brands. Approximately 40% of new franchises sold by Franchising
in the nine months ended February 28, 1997 were sold to existing
franchisees. Franchising believes that its focus on improving the
revenues and profitability of its franchisees will allow it to
retain these current franchisees and attract new franchisees.
During the ten fiscal years ended May 31, 1996, the number of
properties in Franchising's domestic franchise system increased
through acquisition and internal growth to 2,495 properties with
214,613 rooms, from 599 properties with 69,187 rooms. As of
February 28, 1997 there were 2,718 properties with 230,561 rooms
in the United States. Franchising believes that its operating
structure and the services it provides to its franchisees will
enable Franchising to attract new hotels to its franchise system.
The following are the principal components of Franchising's
franchising system and services:
RESERVATION SYSTEM--Franchising maintains a reservations
system that delivers customers to franchisees and produces
incremental revenues for both franchisees and Franchising.
ADVERTISING CAMPAIGNS--Franchising promotes its brand
awareness through nationally recognized advertising
campaigns including the long running "celebrity in a
suitcase" campaign.
32
<PAGE>
PRE-OPENING AND ONGOING SUPPORT--Franchising supports
franchisees by providing assistance in opening hotels and
assisting franchisees in ongoing operational problems and
improving franchisee profitability through revenue
management assistance and direct sales.
PRODUCTS AND SERVICES--Franchising provides its franchisees
with access to Franchising's products and services. Many of
these products and services are tested and developed by
Franchising in its owned hotels before being adapted to the
franchise system. For example, Franchising's franchised
hotels may offer customized rooms designed to meet the needs
of niche markets, such as senior citizens and business
travelers. Franchising also offers its franchisees
innovative food delivery concepts such as Choice Picks food
court and K-Minus/SM/ Banqueting Kitchens.
APPROACH TO FRANCHISING--Franchising's franchising system
structure and internal performance measures have been
developed to appeal to current and potential franchisees.
-- Territorial Protection. Competition from same-brand
franchisees within a specific geographic area is
limited in order to protect the investments of current
and potential franchisees.
-- Brand Segmentation. Franchising is able to meet the
needs of current and potential franchisees across a
wide range of market segments by maintaining an array
of distinct brands, each with its own marketing and
operating strategy. In addition, Franchising plans to
continue to develop new brands to target high-growth
segments of the lodging industry. Brand segmentation
enables Franchising to franchise multiple properties--
each under a different franchise brand--in a given
geographic area.
-- RevPAR Focus. Revenue per available room per day, or
RevPAR, is calculated by multiplying the percentage of
occupied rooms by the average daily room rate charged.
Franchising believes that franchisees view RevPAR as
the single most important measure of the operational
success of their properties. Accordingly, Franchising
has adopted overall systemwide RevPAR improvement as
the key internal measure of performance for Franchising
and its management in order to better align the goals
and objectives of Franchising with those of its
customers.
. INCREASES IN AVERAGE ACTUAL ROYALTY RATES. Franchising's average
actual royalty rate is determined by analyzing the revenues and
royalty rates of individual properties. Each property's royalty
rates vary based upon the brand and the age of the contract (with
newer contracts generally having higher royalty rates).
Franchising has increased its average actual royalty rate each
year since 1992, and Franchising expects to continue to increase
its average actual royalty rate as franchise agreements with low
royalty fees expire, terminate or are amended.
. STRATEGIC DEVELOPMENT OF THE INTERNATIONAL FRANCHISE SYSTEM.
During the ten fiscal years ended May 31, 1996, the number of
properties in Franchising's international franchise system
increased to 557 properties with 46,843 rooms, from 46 properties
with 4,505 rooms. As of February 28, 1997 there were 562
properties with 47,803 rooms in 32 International Countries.
Franchising anticipates further development in its existing
international markets in order to increase the number of Choice
hotels and to allow for more efficient use of existing financial,
marketing and human resources. In other parts of the world,
Franchising intends to expand in gateway cities which attract
international travelers who are familiar with Franchising's hotel
brands. International development of Franchising's brands may be
structured in a variety of ways, including development by
Franchising directly, by master franchisees or by joint ventures.
. EXPANSION OF PREFERRED VENDOR PROGRAMS. Franchising believes
there is significant opportunity to leverage its size and
marketing expertise by entering into joint marketing arrangements
with national
33
<PAGE>
and multinational companies that want to gain exposure to the
millions of guests who patronize Franchising's franchise hotels
each year. In the past, these arrangements have added to
Franchising's and franchisees' revenues and profits by attracting
business to its franchise hotels. Franchising has also sought to
structure these arrangements to include direct payments to
Franchising from preferred vendors who wish to capitalize on
Franchising's marketing reach. Firms that have entered into
marketing arrangements with Franchising on such terms include
AT&T, Pizza Hut, Nortel (formerly Northern Telecom), Alamo Rent-A
Car and CUC Travel.
. PURSUIT OF SELECTED STRATEGIC INVESTMENTS AND ACQUISITIONS.
Franchising intends to pursue strategic investments and
acquisitions, both in the United States and abroad, of lodging,
travel-related and other franchise businesses. Franchising
believes that such opportunities are significant and that
Franchising has financial capability sufficient to pursue such
opportunities.
FRANCHISE SYSTEM
Franchising's franchise hotels principally operate under one of
Franchising's brand names: Comfort, Quality, Clarion, Sleep, Rodeway, Econo
Lodge and MainStay Suites. The following table presents key statistics relative
to Franchising's domestic franchise system over the three fiscal years ended May
31, 1996.
COMBINED DOMESTIC FRANCHISE SYSTEM
<TABLE>
<CAPTION>
AS OF AND FOR THE
NINE MONTHS ENDED
------------------
AS OF AND FOR THE YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
------------------------------------ ------------ -----------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Number of properties, end of period.......... 2,283 2,311 2,495 2,431 2,718
Number of rooms, end of period............... 203,019 200,792 214,613 209,047 230,561
Average royalty rate......................... 3.1% 3.2% 3.5% 3.4% 3.4%
Average occupancy percentage................. 62.2% 63.8% 63.8% 64.2% 63.1%
Average daily (room) rate (ADR).............. $ 45.63 $ 47.13 $ 49.49 $ 49.44 $ 51.81
RevPAR*...................................... $ 28.40 $ 30.08 $ 31.60 $ 31.74 $ 32.69
Royalty fees ($000s)......................... $ 62,590 $ 71,665 $ 82,239 $ 61,566 $ 69,362
</TABLE>
_______________________
* Franchising's RevPAR figure for each fiscal year is an average of the RevPAR
calculated for each month in the fiscal year. Franchising calculates RevPAR
each month based on information actually reported by franchisees on a timely
basis to Franchising. In contrast, Smith Travel Research's monthly RevPAR
calculations are periodically updated to reflect information reported after
Franchising's deadline for the receipt of monthly information. Smith Travel
Research's RevPAR calculations also reflect information reported by
franchisees directly to Smith Travel Research but not to Franchising and
Smith Travel Research's estimates of RevPAR for properties that did not
report to either Franchising or Smith Travel Research at all or for the whole
period. Smith Travel Research's calculations of Franchising's domestic RevPAR
for fiscal years 1994, 1995 and 1996 and the nine months ended February 28,
1996 and 1997 were $28.87, $30.56, $32.30, $31.92 and $32.91 respectively.
No master franchisee or other franchisee accounted for 10% or more of
Franchising's total revenues or revenues related to franchise operations during
the last three fiscal years.
BRAND POSITIONING
Franchising'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).
34
<PAGE>
COMFORT. Comfort Inns and Comfort Suites hotels offer rooms in the
limited-service, middle market category. Comfort Inns and Comfort Suites are
targeted to traditional business and leisure travelers. Principal competitor
brands include Days Inn, Fairfield Inn, Hampton Inn, Holiday Express and
LaQuinta. At February 28, 1997, there were 1,421 Comfort Inn properties and 109
Comfort Suite properties with a total of 112,421 and 9,009 rooms, respectively,
open and operating worldwide. An additional 196 Comfort Inn properties and 117
Comfort Suite properties with a total of 18,538 and 9,543 rooms, respectively,
were under development.
Comfort properties are located in the United States and in Australia,
the Bahamas, Belgium, Canada, France, Germany, India, Indonesia, Ireland, Italy,
Jamaica, Mexico, Norway, Portugal, Puerto Rico, Sweden, Switzerland, Thailand,
the United Kingdom and United Arab Emirates. The following chart summarizes the
Comfort system in the United States:
COMFORT DOMESTIC SYSTEM
<TABLE>
<CAPTION>
AS OF AND FOR THE
NINE MONTHS ENDED
-------------------
AS OF AND FOR THE YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
------------------------------------ ------------ ------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Number of properties, end of period.... 935 1,015 1,129 1,100 1,227
Number of rooms, end of period......... 82,479 87,551 94,160 92,510 100,711
Royalty fees ($000s)................... $31,187 $37,635 $44,657 $33,495 $ 38,442
</TABLE>
QUALITY. Certain Quality Inns and Quality Suites hotels compete in the
limited service, middle market category while others compete in the full
service, middle market category. Quality Inns and Quality Suites are targeted to
traditional business and leisure travelers. Principal competitor brands include
Best Western, Holiday Inn, Howard Johnson, Ramada Inn and Days Inn. At February
28, 1997, there were 578 Quality Inn properties with a total of 67,570 rooms,
and 27 Quality Suites properties with a total of 3,980 rooms open worldwide. An
additional 105 Quality Inn properties and 33 Quality Suites properties with a
total of 11,382 rooms and 3,290 rooms, respectively, were under development.
Quality properties are located in the United States and in Argentina,
Australia, Canada, Chile, Costa Rica, the Czech Republic, Denmark, France,
Germany, India, Indonesia, Ireland, Italy, Jamaica, Mexico, New Zealand, Norway,
Portugal, Russia, Spain, Thailand, the United Kingdom and the United Arab
Emirates.
35
<PAGE>
The following chart summarizes the Quality system in the United States:
QUALITY DOMESTIC SYSTEM
<TABLE>
<CAPTION>
AS OF AND FOR THE
NINE MONTHS ENDED
-------------------
AS OF AND FOR THE YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
------------------------------------ ------------ ------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Number of properties, end of period.. 358 341 362 357 392
Number of rooms, end of period....... 45,032 43,281 45,967 44,688 48,583
Royalty fees ($000s)................. $14,890 $15,632 $16,606 $12,414 $13,379
</TABLE>
ECONO LODGE. Econo Lodge hotels operate in the limited-service,
economy category of the lodging industry. Econo Lodges are targeted to the
senior travel market and rely to a large extent on strong roadside name
recognition. Principal competitor brands include Days Inn, Ho-Jo Inn, Motel 6,
Ramada Limited, Red Carpet Inn, Red Roof Inn, Super 8 and Travelodge.
At February 28, 1997, there were 699 Econo Lodge properties with a
total of 45,590 rooms open and operating in the United States and Canada, and an
additional 114 properties with a total of 7,901 rooms under development in those
two countries. The following chart summarizes the Econo Lodge system in the
United States:
ECONO LODGE DOMESTIC SYSTEM
<TABLE>
<CAPTION>
AS OF AND FOR THE
NINE MONTHS ENDED
-----------------
AS OF AND FOR THE YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
------------------------------------ ------------ ------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Number of properties, end of period.... 677 633 641 634 677
Number of rooms, end of period......... 46,570 42,801 42,726 42,394 44,512
Royalty fees ($000s)................... $11,231 $12,021 $12,760 $9,692 $10,267
</TABLE>
CLARION. Clarion Inns, Clarion Hotels, Clarion Resorts and Clarion
Suites hotels are full-service properties which operate in the upscale category.
Clarion hotels are targeted to traditional business and leisure travelers.
Principal competitor brands include Holiday Inn, Holiday Select, Crowne Plaza,
Four Points by Sheraton, Radisson, Courtyard by Marriott and Doubletree.
At February 28, 1997, there were 104 Clarion properties with a total
of 16,802 rooms open and operating worldwide and an additional 32 properties
with a total of 5,921 rooms under development. The properties are located in the
United States, the Bahamas, Canada, France, Guatemala, Indonesia, Ireland,
Japan, Mexico, Norway, Russia, Thailand and Uruguay. The following chart
summarizes the Clarion system in the United States:
CLARION DOMESTIC SYSTEM
<TABLE>
<CAPTION>
AS OF AND FOR THE
NINE MONTHS ENDED
-----------------
AS OF AND FOR THE YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
------------------------------------ ------------ ------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Number of properties, end of period... 65 63 75 69 87
Number of rooms, end of period........ 12,211 10,420 12,817 11,908 14,309
Royalty fees ($000s).................. $2,735 $2,995 $3,602 $2,576 $2,767
</TABLE>
RODEWAY. The Rodeway brand competes in the limited-service, economy
category and is targeted to the senior travel market. Principal competitor
brands include Ho-Jo Inn, Ramada Limited, Red Roof Inn, Budgetel, Shoney's Inn,
Super 8 and Motel 6. At February 28, 1997, there were 219 Rodeway Inn
properties with a total of 13,819 rooms, open and operating in the United States
and Canada, and an additional 40 properties with a total of 2,705 rooms under
development in those two countries. The following chart summarizes the Rodeway
system in the United States:
36
<PAGE>
RODEWAY DOMESTIC SYSTEM(1)
<TABLE>
<CAPTION>
AS OF AND FOR THE
NINE MONTHS ENDED
-------------------
AS OF AND FOR THE YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
------------------------------------ ------------ ------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Number of properties, end of period... 214 208 201 196 214
Number of rooms, end of period........ 13,806 13,067 12,547 12,085 13,444
Royalty fees ($000s).................. $1,941 $2,302 $2,506 $1,862 $2,053
</TABLE>
__________________________
(1) Includes data pertaining to the Friendship Inn system, which is being
combined with the Rodeway Inn system.
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
traditional business and leisure traveler. Principal competitor brands include
Days Inn, Fairfield Inn, Holiday Express, LaQuinta Inn, Ho-Jo Inn and Ramada
Inn.
At February 28, 1997, there were 122 Sleep Inn properties with a total
of 9,077 rooms open and operating worldwide. An additional 146 properties with a
total of 10,952 rooms were under development. The properties are located in the
United States, Canada and the Cayman Islands. The following chart summarizes the
Sleep system in the United States:
SLEEP DOMESTIC SYSTEM
<TABLE>
<CAPTION>
AS OF AND FOR THE
NINE MONTHS ENDED
-------------------
AS OF AND FOR THE YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
------------------------------------ ------------ ------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Number of properties, end of period.... 34 51 87 75 120
Number of rooms, end of period......... 2,921 3,672 6,396 5,462 8,906
Royalty fees ($000s)................... $ 605 $1,080 $2,108 $1,527 $2,454
</TABLE>
MAINSTAY SUITES. MainStay Suites, Franchising's newest hotel brand,
is a middle market, extended-stay lodging product targeted to travelers who book
hotel rooms for five or more consecutive nights. The first MainStay Suites
hotel, which Realco owns and manages, opened in Plano, Texas, in November 1996.
An additional 14 properties with 1,384 rooms were under development as of
February 28, 1997.
The MainStay Suites brand is designed to fill the gap between existing
upscale and economy extended-stay lodging products. Principal competitors for
the brand include Candlewood hotels, TownPlace Suites, as well as competition
from all-suite hotel properties and traditional extended stay operators in both
the upscale market (Residence Inn, Homewood Suites, Hawthorne Suites and
Summerfield Suites) and the economy market (Extended Stay America, Studio Plus
and Oakwood).
INTERNATIONAL FRANCHISE OPERATIONS
Franchising's international franchise operations have traditionally
been operated as a division separate from its domestic franchise operations. In
some cases, international master franchisees are not required to separately
report royalty results by brand, making brand results on a worldwide basis
unavailable. In the past fiscal year, Franchising entered into arrangements to
enter eight new international markets. At February 28, 1997, Choice had 562
franchise hotels open in 32 countries outside the United States. The following
table illustrates the growth of Franchising's international franchise system
over the three fiscal years ended May 31, 1996; and the nine months ended
February 29/28, 1996 and 1997.
37
<PAGE>
COMBINED INTERNATIONAL FRANCHISE SYSTEM
<TABLE>
<CAPTION>
AS OF AND FOR THE
NINE MONTHS ENDED
-------------------
AS OF AND FOR THE YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
------------------------------------ ------------ ------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Number of properties, end of period... 430 524 557 547 562
Number of rooms, end of period........ 36,725 44,877 46,843 46,498 47,803
Royalty fees ($000s).................. $1,667 $ 1,998 $1,586 $1,143 $ 1,350
</TABLE>
EUROPE. Choice is the second-largest international
franchised hotel chain in Europe, with 272 hotels open in 14 countries
at February 28, 1997. In a move to realign and streamline its
European operations, in May 1996 Franchising, through its subsidiary,
Manor Care Hotels (France) S.A., consummated a transaction with
Friendly Hotels, PLC ("Friendly") whereby Franchising purchased an
equity interest for approximately $17 million in Friendly to finance
the development of ten new Comfort Inn or Quality Inn hotels in the
United Kingdom and Ireland. Additionally, Friendly purchased from
Franchising a master franchise for the United Kingdom and Ireland.
Franchising closed its London office as a result of the transaction.
Franchising's French and German operations were consolidated into
Franchising's Paris, France office, which directly operates
Franchising's business in most of Europe. There is also a master
franchise arrangement in Scandinavia.
THE MIDDLE EAST. In August 1995, Franchising signed a master
franchise for Israel. Franchising opened its first franchised property
in Dubai, United Arab Emirates, in December 1995. At February 28,
1997, there were two properties open in this region.
ASIA/PACIFIC. During fiscal year 1996, Company franchisees opened
seven hotels in Australia, two in New Zealand, two in India, two in
Thailand and four in Indonesia, bringing the total number of
properties open in the Asia/Pacific region at February 28, 1997 to 59.
CARIBBEAN. Franchising's master franchisee had 6 properties open
in 4 Caribbean countries at February 28, 1997.
CENTRAL AND SOUTH AMERICA. Franchising recently signed master
franchise agreements covering Brazil, Uruguay, Paraguay and Argentina.
Franchising also has master franchisees operating in Guatemala, Costa
Rica, Chile and Mexico. In total there were 19 open properties in this
region at February 28, 1997.
CANADA. Choice Hotels Canada (a joint venture with Journey's End
Corporation of Belleville, Ontario, Canada ("Journey's End")) is
Canada's largest lodging organization with 204 properties open at
February 28, 1997. The joint venture, owned 50% by Franchising and 50%
by Journey's End, was formed in 1993 when Journey's End converted
substantially all of its controlled hotels to Franchising's brands and
Franchising contributed its operations in Canada to form Choice Hotels
Canada.
FRANCHISE SALES
Franchising markets franchises principally to: (i) developers of
hotels, (ii) owners of independent hotels and motels, (iii) owners of hotels
affiliated with other franchisors' brands, (iv) its own franchisees, who may
own, buy or build other hotels which can be converted to Franchising's brands,
and (iv) contractors who construct any of the foregoing. In fiscal year 1996,
existing franchisees accounted for approximately one-half of Franchising's new
franchise agreements. In considering hotels for conversion to one of
Franchising's brands, or sites for development of new hotels, Franchising seeks
properties in locations which are in close proximity to major highways,
airports, tourist attractions and business centers that attract travelers.
At February 28, 1997, Franchising 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
38
<PAGE>
one of Franchising's well-known brand names, Franchising's commitment to
improving RevPAR, Franchising's "celebrity in a suitcase" television advertising
campaign (formerly used for the entire Choice family of brands and now used
principally for its three largest brands, Comfort, Quality and Econo Lodge),
Franchising's reservation system, Franchising's training and support systems,
and Franchising's history of growth and profitability. Because it offers brands
covering a broad spectrum of the lodging marketplace, Franchising is able to
offer each prospective franchisee a brand that fits its needs, lessening the
chances that the prospective franchisee would need to consider a competing
franchise system.
Because retention of existing franchisees is important to
Franchising'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.
Franchising believes that it is the only major franchise company to routinely
offer such territorial protection to its franchisees.
During the nine months ended February 28, 1997, Franchising received
788 franchise applications, approved 655 applications, signed 546 franchise
agreements and placed 300 new properties into operation in the United States
under Franchising's brands. Of those placed into operation, 147 were newly
constructed hotels. By comparison, during the nine months ended February 29,
1996, Franchising received 610 franchise applications, approved 497
applications, signed 305 franchise agreements and had 201 new U.S. properties
come on line. Applications may not result in signed franchise agreements either
because an applicant is unable to obtain financing or because Franchising and
the applicant are unable to agree on the financial terms of the franchise
agreement.
FRANCHISE AGREEMENTS
A franchise agreement grants a franchisee the right to non-exclusive
use of Franchising'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 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 Franchising's brands
and the master franchisee generally must manage the delivery of necessary
services (such as quality assurance, reservations and marketing) to support the
franchised hotels in the master franchise area. The master franchisee collects
the fees paid by the local franchisee and remits an agreed share to Franchising.
Master franchise agreements generally have a term of at least 10 years.
Franchise agreements, other than master franchise agreements, can be
terminated by either party prior to the conclusion of their term under certain
circumstances, such as at certain anniversaries of the agreement or if a
franchisee fails to bring properties into compliance with contractual quality
standards within specified periods of time. Early termination options give
Franchising 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 Franchising
to terminate the agreement for failure to meet a specified development schedule.
Franchise fees vary among Franchising's different brands, but
generally are competitive with or slightly below the industry average within
their market group. Franchise fees usually have four components: an initial, one
time affiliation fee; a royalty fee; a marketing fee; and a reservation fee.
Proceeds from the marketing fee and reservation fee are used exclusively to fund
marketing programs and Franchising's central reservation system, respectively.
Most marketing fees support brand-specific marketing programs, although
Franchising occasionally contributes a portion of such fees to marketing
programs designed to support all of Franchising's brands. Royalty fees and
affiliation fees are the principal source of profits for Franchising.
Under the terms of the standard franchise agreements, Franchising's
franchisees are typically required to pay the following initial fees and on-
going fees as a percentage of gross room revenues:
39
<PAGE>
QUOTED FEES BY BRAND
<TABLE>
<CAPTION>
INITIAL FEE
PER ROOM/ ON-GOING FEES AS A PERCENTAGE OF GROSS ROOM REVENUES
----------------------------------------------------
BRAND MINIMUM ROYALTY FEES MARKETING FEES RESERVATION FEES
- - ----- ------- ------------ -------------- ----------------
<S> <C> <C> <C> <C>
Comfort Inn $300/$45,000 5.25% 2.1% 1.75%
Comfort Suites $300/$50,000 5.0% 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 2.75% 1.0% 1.25%
Econo Lodge $250/$25,000 4.0% 3.5%(1) --
MainStay Suites $300/$30,000 4.5% 2.5%(1) --
Rodeway
Year 1 $250/$25,000 3.5% 1.25% 1.25%
Year 2 -- 3.0% 1.25% 1.25%
Year 3 -- 3.0% 1.00% 1.00%
</TABLE>
_____________________
(1) Fee includes both Marketing and Reservations
Franchising has increased its average actual royalty rate since FY93,
primarily by raising the royalty fee for Comfort franchisees to 5.25% of annual
gross room revenues ("GRR") from 4.0% of GRR in 1993, and by raising the royalty
rate for franchisees in the former Friendship franchise system to 3.0% of GRR
from 2.0% of GRR in 1991. For the nine months ended February 28, 1997,
Franchising's average actual royalty rate was 3.4%. Franchising believes that
its average actual royalty rate will continue to increase as older franchise
agreements expire, terminate or are amended.
At February 28, 1997, Franchising had 2,718 franchise agreements in
effect in the United States and 562 franchise agreements in effect in other
countries. The average age of the franchise agreements was 4 years. One hundred
thirteen of the franchise agreements are scheduled to expire during the five
year period beginning February 28, 1997; however, franchise agreements generally
contain early termination provisions.
FRANCHISE OPERATIONS
Franchising's operations are designed to improve RevPAR for
Franchising's franchisees, as this is the measure of performance that most
directly impacts franchisee profitability. It is Franchising's belief that by
helping its franchisees to become more profitable it will enhance its ability to
retain its existing franchisees and attract new franchisees. The key aspects of
Franchising's franchise operations are:
CENTRAL RESERVATION SYSTEM. On average, approximately 22% of the room
nights booked at franchisees' properties are reserved through the toll-free
telephone reservation system operated by Franchising. Franchising'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 Franchising or its master franchisees. The CHOICE 2001 system is
designed to allow trained operators to match each caller with a the Company-
branded hotel meeting the caller's needs. It provides an instant data link to
Franchising's franchised properties as well as to the Amadeus, Galileo, SABRE
and Worldspan airline reservation systems thereby facilitating the reservation
process for travel agents.
To more sharply define the market and image for each of its brands,
Franchising began advertising separate toll-free reservation numbers for all of
its brands in fiscal year 1995. Franchising allows its reservation agents to
cross-sell Franchising's hotel brands. If a room in the Choice hotel brand
requested by a customer is not available in the location or price range that the
customer desires, the agent may offer the customer a room in another Choice
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<PAGE>
brand hotel that meets the customer's needs. Franchising believes that cross-
selling enables Franchising 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, Franchising
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. Franchising also markets to its franchisees a property management
product. Such products are designed to manage the financial and operations
information of an individual hotel and improve its efficiency.
BRAND NAME MARKETING AND ADVERTISING. Franchising's marketing and
advertising programs are designed to heighten consumer awareness of
Franchising's brands. Marketing and advertising efforts are focused primarily
in the United States and include national television and radio advertising,
print advertising in consumer and trade media and promotional events, including
joint marketing promotions with vendors and corporate partners.
Franchising is recognized for its "celebrity in a suitcase" television
advertisements. In fiscal year 1996, Franchising began using brand-specific
marketing and largely discontinued the strategy of advertising its multiple
brands under the Choice umbrella, although it continues to use its "suitcase"
ads for its three largest brands, Comfort, Quality and Econo Lodge. The
marketing fees generated by these brands are used, in part, to fund a national
network television advertising campaign. Franchising's smaller hotel brands
conduct advertising campaigns that also include cable television, radio and
print.
Franchising 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 Franchising's
Marketing Department, which utilize the services of independent advertising
agencies. Franchising 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 Franchising's franchised hotels are
located, the motor coach market, and meeting planners. Most of these sales
personnel sell reservations and services for all of Franchising's brands, but
four are responsible exclusively for the Clarion brand.
Franchising's regional sales directors work with franchisees to
maximize RevPAR. These directors advise franchisees on topics such as how to
market their hotels and how to maximize the benefits offered by Franchising's
reservations system.
QUALITY ASSURANCE PROGRAMS. Consistent quality standards are critical
to the success of a hotel franchise. Franchising has established quality
standards for all of its franchised brands which cover housekeeping,
maintenance, brand identification and level of services offered. Franchising
inspects properties for compliance with its quality standards when application
is made for admission to the franchise system. The compliance of existing
franchisees with quality standards is monitored through scheduled and
unannounced Quality Assurance Reviews conducted at least once per year at each
property. Properties which fail to maintain a minimum score are reinspected on a
more frequent basis until deficiencies are cured, or until such properties are
terminated .
To encourage compliance with quality standards, Franchising offers
various brand-specific incentives to franchisees who maintain consistent quality
standards. Franchisees who fail to meet minimum quality standards may be subject
to consequences ranging from written warnings to termination of the franchisee's
franchise agreement.
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<PAGE>
TRAINING. Franchising maintains a training department which conducts
mandatory training programs for all franchisees and their employees. Franchising
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 Franchising's reservation system and marketing programs,
and fundamental hotel operations such as housekeeping, maintenance, and
inventory yield management.
Training is conducted by a variety of methods, including group
instruction seminars and video programs. Franchising 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 Franchising.
RESEARCH AND DEVELOPMENT. Franchising seeks to enhance RevPAR by
providing to franchisees systems and products that will reduce costs and/or
improve their operations. Research and development activity resulted in the
launch of three new franchise products in fiscal year 1996, Choice Picks food
court, MainStay Suites hotels and K-Minus food service.
In January 1996, Franchising introduced its MainStay Suites franchise
hotel brand, an extended-stay product targeted to travelers who book hotel rooms
for five or more consecutive nights. See "-- MainStay Suites."
In November 1995, Franchising introduced Choice Picks food court, a
customized, modular food-service system tailored to the needs of middle-market
hotels. Choice Picks food courts offer hotel guests a "choice pick" of
nationally known branded food items, such as Nathan's Famous hot dogs,
sandwiches made with Healthy Choice/(R)/ deli meats, Pizzeria Uno/(R)/ pizza and
calzone, Nestle Toll House/(R)/ cookies and muffins, I Can't Believe It's
Yogurt/(R)/ desserts, and Coca-Cola/(R)/ beverages. The typical Choice Picks
food court can be operated by as few as two employees, thus providing the
properties with lower operating costs than properties with conventional
restaurants. Franchisees pay Franchising a one-time affiliation fee and monthly
royalty fees equal to a percentage of gross revenues on Choice Picks food court
sales. Franchisees must buy equipment and food service modules necessary to set
up a Choice Picks food court. Franchising intends to market Choice Picks food
court to larger hotel operators and other potential customers outside of
Franchising's franchise system.
In November 1995, Franchising also began to offer to its franchisees
the K-Minus food service system, which eliminates expensive banquet kitchens by
outsourcing food preparation and limiting on-site work to assembly and
rethermalization. Compared with a traditional banquet operation, the K-Minus
food service system saves labor costs and energy. Franchisees who wish to
implement the K-Minus system are given design and technical assistance by
Franchising. Franchising receives a one-time technical assistance fee for the
provision of these services based on the scope of the project.
PURCHASING. Franchising's product services department negotiates
volume purchases of various products needed by franchisees to run their hotels,
including such items as furniture, fixtures, carpets and bathroom amenities. The
department also helps to ensure consistency in such products across its
exclusively new-construction brands, Sleep Inn and MainStay Suites brands. Sales
to franchisees by Franchising were $18.1 million during the nine months ended
February 28, 1997, up from $14.3 million for the same period the prior year.
DESIGN AND CONSTRUCTION. Franchising 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 Franchising's brand specifications by
providing technical expertise and cost-savings suggestions.
FINANCIAL ASSISTANCE PROGRAMS. Franchising has established programs or
helped franchisees obtain financing through (i) a wholly owned subsidiary; (ii)
strategic partnerships with hotel lenders and/or (iii) by referral to hotel
lenders for hotel refinancing, acquisition, renovation and development. Some of
the specific programs include:
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<PAGE>
(a) Second mortgage financing for the development and construction of
Quality Inn, Quality Suites, Quality Inn & Suites, Comfort Inn, Comfort Suites,
Comfort Inn & Suites, MainStays and Sleep Inns. The terms of the financing will
depend on each franchisees credit worthiness, the amount of the proposed loan
and the current economic conditions. Generally not more than 25% of the project
will be financed. Total debt cannot exceed 75% of the fair market value.
(b) Econo Lodge exterior renovation program. Loans up to an amount of
$17,500 per property are given to franchisees for standardized exterior
renovation. Franchisee participation requires, among other things, extension of
the franchise agreement. The loan is forgiven at the expiration of the extended
franchise agreement, assuming no defaults have occurred thereunder.
(c) Solomon Brothers in conjunction with Suburban Capital Markets Inc.
is offering a $100 million construction to permanent financing program to
qualified franchisees. All Choice brands are included in this program. The
construction loan will be issued for a term up to three years at a floating rate
of 355 basis points over the 30-day LIBOR. The loan amount will not exceed 75%
of loan to cost. The franchisee will be responsible for cost of all third party
reports and fees in the amount of 2.75% of the loan amount. A stabilized debt
service coverage ratio of at least 1.4:1 is required for the permanent loans,
which are issued for a 10 year term with amortization up to 25 years and a fixed
interest rate of 260 basis points over the 10 year U.S. Treasury interest rate
on the day of closing. The permanent loan will require a fee of 1% of the loan
amount.
COMPETITION
Competition among franchise lodging chains is intense, both in
attracting potential franchisees to the system and in generating reservations
for franchisees. In addition, hotel chains and independent hotels compete
intensely for guests and for meeting and banquet business.
Franchising's principal competitor brands at the national and
international level in the economy category of the lodging industry are
LaQuinta, Ho-Jo Inn, Ramada Inn, Motel 6, Ramada Limited, Red Carpet Inn, Red
Roof Inn, Budgetel, Hampton Inn, Fairfield Inn, Holiday Express, Shoney's Inn,
Super 8, Days Inn, and Travelodge. Franchising's principal competitor brands at
the national and international level in the middle market category of the
lodging industry are Days Inn, Fairfield Inn, Hampton Inn, Holiday Express,
LaQuinta, Holiday Inn, Best Western, Howard Johnson and Ramada Inns.
Franchising's principal competitor brands at the national and international
level in the upscale category are Holiday Inn, Holiday Select, Crowne Plaza,
Four Points by Sheraton, Radisson, Courtyard by Marriott and Doubletree.
Franchising believes that hotel operators choose lodging franchisors
based primarily on the perceived value and quality of each franchisor's brand
and services, and the extent to which affiliation with that franchisor may
increase the franchisee's reservations and profits. Hotel operators may also
select a franchisor in part based on the franchisor's reputation among other
franchisees, and the success of its existing franchisees.
Choice is the second largest hotel franchiser in the world. The
largest, HFS, Inc., has over 4,600 franchised hotels. Holiday Inn Worldwide has
1,240, Promus Hotel Corp. has 597, Marriott International has 394 and Carlson
Hospitality Worldwide has 248./*/
Franchising's prospects for growth are largely dependent upon the
ability of its franchisees to compete in the lodging market, since Franchising's
franchise system revenues are based on franchisees' gross room revenues (but not
directly on franchisees' profitability).
___________________
/*/ The figures in this paragraph are with respect to U.S. hotel properties as
indicated in the August 1996 issue of Lodging Hospitality.
-------------------
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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
economic conditions on Franchising's results is substantially reduced by the
geographic diversity of Franchising's franchised properties, which are located
in all 50 states and in 33 countries, as well as its range of products and room
rates.
SERVICE MARKS AND OTHER INTELLECTUAL PROPERTY
The service marks Quality Inn, Quality Suites, Comfort Inn, Comfort
Suites, Clarion Hotel, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites and
related logos are material to the Franchising Business. Franchising, directly
and through its franchisees, actively uses these marks. All of the material
marks are registered with the United States Patent and Trademark Office, except
for MainStay Suites and K-Minus, which are the subject of pending applications.
In addition, Franchising has registered certain of its marks with the
appropriate governmental agencies in over 100 countries where it is doing
business or anticipates doing business in the foreseeable future. Franchising
seeks to protect its brands and marks throughout the world, although the
strength of legal protection available varies from country to country.
NON-HOTEL PROPERTIES
The principal executive offices of Franchising are located at 10750
Columbia Pike, Silver Spring, Maryland, 20901. On the Distribution Date,
Franchising and Manor Care will execute leases relating to such offices and to
certain other real estate being made available to Franchising by Manor Care.
See "Relationship Between Manor Care and Franchising After the Distribution."
Franchising owns its reservation system offices in Phoenix, AZ and Minot, ND.
Franchising leases two additional reservation system offices in Grand Junction,
CO, pursuant to leases that expire in 1999 and 2000, and occupies additional
space in Toronto, Canada, on a month-to-month basis. In addition, Franchising
leases 12 sales offices across the United States. Franchising's European
headquarters, which Franchising leases pursuant to a lease that expires on
December 31, 1997, is located in Paris, France. Franchising also leases one
international sales offices in France pursuant to a lease that terminates in
June 1998. 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 Franchising.
SEASONALITY
Franchising's principal sources of revenues are franchise fees based
on the gross room revenues of its franchise properties and revenues generated by
its owned and managed hotels. Franchising experiences seasonal revenue patterns
similar to those of the lodging industry in general. This seasonality can be
expected to cause quarterly fluctuations in the revenues, profit margins and net
income of Franchising.
REGULATION
Franchising'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 a hotel owner's relationship with employees,
including minimum wage requirements, overtime, working conditions and work
permit requirements. The failure to obtain or retain liquor licenses or an
increase in the minimum wage rate, employee benefit costs or other costs
associated with employees could adversely affect Franchising's owned hotels.
Both at the federal and state level, there are proposals under consideration to
increase the minimum wage and introduce a system of mandated health insurance.
Under the Americans with Disabilities Act of 1990 (the "ADA"), all public
accommodations are required to meet certain federal requirements related to
access and use by disabled persons. A determination that Franchising is not in
compliance with the ADA could result in the imposition of fines or an award of
damages to private litigants. These and other initiatives could adversely
affect Franchising as well as the lodging industry in general.
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The Federal Trade Commission (the "FTC") and certain other
jurisdictions (including France, Province of Alberta, Canada, and Mexico and
various states) regulate the sale of franchises. The FTC requires franchisors to
make extensive disclosure to prospective franchisees but does not require
registration. A number of states require registration or disclosure in
connection with franchise offers and sales. In addition, several states have
"franchise relationship laws" or "business opportunity laws" that limit the
ability of the franchisor to terminate franchise agreements or to withhold
consent to the renewal or transfer of these agreements. While Franchising's
franchising operations have not been materially adversely affected by such
regulation, Franchising cannot predict the effect of future regulation or
legislation.
IMPACT OF INFLATION AND OTHER EXTERNAL FACTORS
Franchising's principal sources of revenues are franchise fees.
Franchise fees and revenues from owned and managed hotels can be impacted by two
external factors: the supply of hotel rooms within the lodging industry relative
to the demand for rooms by travelers, and inflation.
Although industry-wide supply and demand for hotel rooms recently has
been fairly balanced, any excess in supply that might develop in the future
could have an unfavorable impact on room revenues at Franchising's franchised
hotels either by reducing the number of rooms reserved at Franchising's
properties or by restricting the rates hotel operators can charge for their
rooms. In addition, an excess supply of hotel rooms may discourage potential
franchisees from opening new hotels, unfavorably impacting the franchise fees
received by Franchising.
Although Franchising believes that increases in the rate of inflation
will generally result in comparable increases in hotel room rates, severe
inflation could contribute to a slowing of the national economy, which could
result in reduced travel by both business and leisure travelers. That could lead
to less demand for hotel rooms, which could result in a temporary reduction in
room rates and fewer room reservations, negatively impacting revenues received
by Franchising. A weak economy could also reduce demand for new hotels,
negatively impacting the franchise fees received by Franchising.
Among the other unpredictable external factors which may affect
Franchising's fee stream are wars, airline strikes and severe weather.
EMPLOYEES
Franchising employed 2,243 people full-time at February 28, 1997.
Less than 5% of Franchising's employees are represented by unions. Such union
contracts expire between August 1997 and August 1999. Franchising considers its
relations with its employees to be satisfactory.
LEGAL PROCEEDINGS
Neither the Company nor Franchising is a party to any litigation,
other than routine litigation incidental to the Franchising 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
Franchising.
MANAGEMENT
BOARD OF DIRECTORS OF FRANCHISING
The current directors of Franchising are William R. Floyd, Donald J.
Landry and James A MacCutcheon. Prior to the Distribution Date, the Company, as
sole stockholder of Franchising, plans to elect a total of nine persons to the
Board of Franchising so that the persons will constitute the entire Franchising
Board of Directors effective as of the Distribution Date. From and after the
Distribution Date, Franchising's Board of Directors will be classified into
three classes, designated Class I, Class II and Class III, each class to be as
nearly equal in number of directors as possible. The term of the initial Class
I directors will terminate on the date of the 1998 annual meeting of
Franchising's stockholders; the term of the initial Class II directors will
terminate on the date of the 1999 annual
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<PAGE>
meeting of Franchising's stockholders; and the term of the initial Class III
directors will terminate on the date of the 2000 annual meeting of Franchising's
stockholders. At each annual meeting of Franchising's stockholders, successors
to the class of directors whose term expires at that annual meeting will be
elected for a three-year term.
The name, age, proposed class of directorship upon consummation of the
Distribution and business background (other than executive officers who are
directors) of the nine persons who are expected to be the directors of
Franchising from and after the Distribution Date are set forth below.
<TABLE>
<CAPTION>
NAME AGE CLASS OF DIRECTOR
---- --- -----------------
<S> <C> <C>
Stewart Bainum, Jr................ 50 Class
Stewart Bainum.................... 77 Class
Barbara Bainum.................... 52 Class
William R. Floyd.................. 52 Class
Paul R. Gould..................... 50 Class
Robert C. Hazard, Jr.............. 61 Class
Frederic V. Malek................. 59 Class
Gerald W. Petitt.................. 50 Class
Jerry E. Robertson, Ph.D.......... 63 Class
</TABLE>
BACKGROUND OF DIRECTORS
For biographical information with respect to the persons listed above,
see "Other Proposals Relating to the Annual Meeting--Proposal Five: Election of
Directors."
THE BOARD OF DIRECTORS AND COMMITTEES OF THE BOARD
Upon consummation of the Distribution, the Franchising Board of
Directors is expected to consist of nine members. It is expected that the Board
of Directors will hold five meetings during the fiscal year and that the
standing committees of the Board will include the Audit Committee, the Finance
Committee, the Compensation/Key Executive Stock Option Plan Committee and the
Nominating Committee. The members of the committees have not yet been
determined.
The Compensation/Key Executive Stock Option Plan Committee will
administer the Franchising stock option plans and grant stock options
thereunder, will review compensation of officers and key management employees,
will recommend development programs for employees such as training, bonus and
incentive plans, pensions and retirement, and will review other employee fringe
benefit programs.
The Finance Committee will review the financial affairs of Franchising
and will recommend financial objectives, goals and programs to the Board of
Directors and to management.
The Audit Committee will review the scope and results of the annual
audit, will review and approve the services and related fees of Franchising's
independent public accountants, will review Franchising's internal accounting
controls and will review it's Internal Audit Department and its activities.
The Nominating Committee will recommend to the Board of Directors the
members to serve on the Board of Directors during the ensuing year. The
Committee will not consider nominees recommended by stockholders.
COMPENSATION OF DIRECTORS
Prior to the Distribution, it is expected that Franchising will adopt
the Choice Hotels Franchising, Inc. Non-Employee Director Stock Option and
Deferred Compensation Stock Purchase Plan. Part A of the Plan will provide that
eligible non-employee directors will be granted options to purchase 5,000 shares
of Franchise Common
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Stock on their date of election and will be granted options to purchase 1,000
shares on their date of election in subsequent calendar years. Part B of the
Plan will provide that eligible non-employee directors may elect, prior to May
31 of each year, to defer a minimum of 25% of committee fees earned during the
ensuing fiscal year. The fees which are so deferred will be used to purchase
Franchise Common Stock on the open market within 15 days after December 1,
February 28 and May 31 of such fiscal year. Pending such purchases, the funds
will be credited to an Interest Deferred Account, which will be interest
bearing. Stock which is so purchased will be deposited in a Stock Deferred
Account pending distribution in accordance with the Plan.
Directors who will be employees of Franchising will receive no
separate remuneration for their services as directors. Pursuant to the Non-
Employee Director Stock Compensation Plan to be adopted by Franchising prior to
the Distribution, eligible non-employee directors will receive annually, in lieu
of cash, restricted stock of Franchising, the fair market value of which at the
time of grant will be equal to $30,000, which will represent the Board retainer
and meeting fees. In addition, all non-employee directors will receive $1,610
per diem for Committee meetings attended, except where the Committee meeting is
on the same day as a Board meeting, and will be reimbursed for travel expenses
and other out-of-pocket costs incurred in attending meetings.
EXECUTIVE OFFICERS OF FRANCHISING
The name, age, proposed title upon consummation of the Distribution
and business background of each of the persons who are expected to become on the
Distribution Date the executive officers of Franchising are set forth below. The
Company is currently seeking a candidate for the position of Senior Vice
President, General Counsel and Secretary. The business address of each
prospective executive officer is 10750 Columbia Pike, Silver Spring, Maryland
20901, unless otherwise indicated.
<TABLE>
<CAPTION>
NAME AGE POSITION
- - ---- --- --------
<S> <C> <C>
Stewart Bainum, Jr...... 50 Chairman of the Board
William R. Floyd........ 52 Vice Chairman and Chief Executive Officer
James A. MacCutcheon.... 44 Executive Vice President, Chief Financial Officer
and Treasurer
Donald J. Landry........ 48 President
Thomas Mirgon........... 41 Senior Vice President, Human Resources
Barry L. Smith.......... 54 Senior Vice President - Marketing
Joseph M. Squeri........ 31 Vice President - Finance and Controller
</TABLE>
James A. MacCutcheon. Executive Vice President, Chief Financial
Officer and Treasurer of the Company since November 1996; Senior Vice President,
Chief Financial Officer and Treasurer of the Company's predecessor (together
with the Company, "Choice Hotels") since September 1993; Senior Vice President,
Chief Financial Officer and Treasurer of Manor Care from September 1993 to
November 1996; Senior Vice President - Finance and Treasurer of Manor Care from
October 1987 to September 1993; Treasurer of Vitalink from September 1992 to
January 1997 and a Director since September 1994.
Donald J. Landry. President of Choice Hotels since January 1995;
President of Manor Care Hotel Division ("MCHD") since March 1992; various
executive positions with Richfield Hotel Management, Inc. and its predecessors
for more than 20 years, including President of MHM Corporation.
Thomas Mirgon. Senior Vice President, Human Resources of the Company
since March 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 Treasures from February 1992
to August 1993.
Barry L. Smith. Senior Vice President - Marketing of Choice Hotels
since February 1989.
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Joseph M. Squeri. Vice President - Finance and Controller of the
Company since March 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.
For biographical information with respect to the other persons listed
above, see "Other Proposals Relating to the Annual Meeting--Proposal Five:
Election of Directors."
COMPENSATION OF EXECUTIVE OFFICERS
SUMMARY COMPENSATION. The following tables set forth certain
information concerning the annual and long term compensation of those persons
who, following the Distribution, will serve as the chairman of the board and the
three other most highly compensated executive officers of Franchising (the
"Named Officers"). No information is presented for Messrs. Floyd and Mirgon,
who will serve as Chief Executive Officer and Senior Vice President - Human
Resources, respectively, following the Distribution, as they were not employed
by either the Company or Manor Care as of the end of last fiscal year.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
------------
FISCAL ANNUAL COMPENSATION STOCK OPTION ALL OTHER
-------------------
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OTHER SHARES(#)(1) COMPENSATION (2)
- - --------------------------- ------ ------ ----- ----- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Stewart Bainum,(3)................... 1996 $625,102 $337,555 (4) 60,000 $33,543
Chairman 1995 572,308 343,385 (4) -- 9,000
1994 457,867(5) 274,720 (4) 40,000 14,150
James A. MacCutcheon (6)............. 1996 301,517 135,682 (4) 25,000 13,176
Senior Vice President, 1995 273,199 136,600 (4) -- 13,176
Chief Financial Officer and 1994 258,360 129,150 (4) 15,000 6,750
Treasurer
Donald L. Landry..................... 1996 366,702 201,686 (4) -- 5,000
President 1995 311,635 171,399 (4) 40,000 2,250
1995 275,712 144,059 (4) 25,000 3,537
Barry L. Smith....................... 1996 233,640 116,820 (4) 5,000 10,427
Sr. Vice President, Marketing 1995 221,668 104,561 (4) -- 6,750
1994 209,151 98,642 (4) 5,000 3,072
</TABLE>
(1) Represents options to purchase shares of Manor Care Common Stock. In
connection with the Manor Care Spin-off, the options to purchase Manor Care
Common Stock were converted, in some cases 100%, to options to purchase
Company 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 Manor Care Spin-off. In the Distribution, the options will be
adjusted and converted into options to purchase Franchising Common Stock.
(2) Represents amounts contributed by Manor Care or the Company for fiscal years
1996, 1995 and 1994 under the Manor Care 401(k) Plan and the Non-Qualified
Savings Plan, which provide retirement and other benefits to eligible
employees, including the Named Officers. Amounts contributed in cash or
stock by the Company during fiscal year 1996 under the Manor Care 401(k)
Plan for the Named Offices were as follows: Mr. Bainum, Jr., $49,000; Mr.
MacCutcheon, $4,410; Mr. Landry, $1,752 and Mr. Smith, $3,489. Amounts
contributed in cash or stock of Manor Care during fiscal year 1995 under the
Manor Care Non-Qualified Saving Plan for the Named Officers were as follows:
Mr. Bainum, Jr., $24,543; Mr. MacCutcheon, $8,766; Mr. Landry, $3,498 and
Mr. Smith $6,938.
(3) As of the end of the fiscal year 1996, Mr. Bainum, Jr. was the Chairman and
Chief Executive Officer of Manor Care and Choice Hotels. The compensation
reflected here is the total compensation received for services rendered to
both Manor Care and Choice Hotels.
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<PAGE>
(4) 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.
(5) Mr. Bainum, Jr. took an unpaid leave of absence during April and May 1994.
(6) As of the end of the fiscal year 1996, Mr. MacCutcheon was Senior Vice
President, Chief Financial Officer and Treasurer of Manor Care and Choice
Hotels. On November 1, 1996, Mr. MacCutcheon resigned from his position at
Manor Care and assumed the position of Executive Vice President and Chief
Financial Officer of the Company. The compensation reflected here is total
compensation received for services rendered to both Manor Care and Choice
Hotels.
STOCK OPTIONS. The following tables set forth certain information at
May 31, 1996 and for the fiscal year then ended concerning options to purchase
Manor Care Common Stock granted to the Named Officers. All Common Stock figures
and exercise prices have been adjusted to reflect stock dividends and stock
splits effective in prior fiscal years. In connection with the Manor Care Spin-
off, existing Manor Care stock options, which are shown here, were subject to
certain adjustments or conversion into options to purchase Company Common Stock.
MANOR CARE STOCK OPTION GRANTS IN FISCAL 1996
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
----------------------------------------------
PERCENTAGE OF
TOTAL OPTIONS POTENTIAL REALIZABLE VALUE OF ASSUMED
NUMBER OF GRANTED TO ALL EXERCISE RATE OF STOCK PRICE APPRECIATION FOR
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION OPTION TERM(2)
-------------------------------------------
NAME GRANTED(1) FISCAL YEAR 1996 PER SHARE DATE 5%(3) 10%(4)
---- --------- ---------------- --------- ---- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Stewart Bainum, Jr.(5).... 60,000 10.5% $30.31 6/21/2005 $1,143,600 2,898,606
James A. MacCutcheon(5)... 25,000 4.4% $30.31 6/21/2005 $ 476,500 1,207,750
Donald J. Landry(5)....... -- -- -- -- -- --
Barry L. Smith(5)......... 5,000 0.9% $30.31 6/21/2005 $ 95,300 241,550
</TABLE>
_____________________
(1) In connection with the Manor Care Spin-off, the options to purchase Manor
Care Common Stock, which are shown here, were converted, in some cases 100%,
to options to purchase Company 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 Manor Care Spin-off. On the Distribution
Date, the options will be adjusted and converted into options to purchase
Franchising Common Stock.
(2) The dollar amounts under these columns are the result of calculations at the
5% and 10% rates set by the Securities and Exchange Commission and therefore
are not intended to forecast future possible appreciation, if any, of the
stock price. Since options are granted at market price, a zero percent gain
in the stock price will result in no realizable value to the optionees.
(3) A 5% per year appreciation in stock price from $30.31 per share yields
$49.37.
(4) A 10% per year appreciation in stock price from $30.31 per share yields
$78.62.
(5) The options granted to the officers vest at the rate of 20% per year on the
first through the fifth anniversary of the date of the stock option grant.
49
<PAGE>
AGGREGATE OPTION EXERCISES IN FISCAL 1996
AND YEAR-END OPTION VALUES(1)
<TABLE>
<CAPTION>
SHARES NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
ACQUIRED ON OPTIONS AT MAY 31, 1996 IN-THE-MONEY OPTIONS AT
----------------------------
EXERCISE VALUE REALIZED EXERCISABLE UNEXERCISABLE MAY 31, 1996 (2)
----------------------------
NAME # $ # # EXERCISABLE UNEXERCISABLE
- - ---- --------- -------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Stewart Bainum, Jr. -- -- 635,500 229,500 $17,236,482 $4,684,465
Donald J. Landry -- -- 37,000 148,000 810,190 2,668,992
James A. MacCutcheon 16,500 $510,180 84,250 118,250 2,399,197 3,359,956
Barry L. Smith 12,600 334,880 -- 54,100 -- 1,334,179
</TABLE>
________________
(1) Represents options to purchase Manor Care Common Stock. In connection
with the Manor Care Spin-off, the options to purchase Manor Care
Common Stock, which are shown here, were converted, in some cases
100%, to options to purchase Company 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 Company
Spin-off. Upon the Distribution, the options will be adjusted and
converted into options to purchase Franchising Common Stock.
(2) The closing price of Manor Care Common Stock as reported by the New
York Stock Exchange on May 31, 1996 was $39.00. The value is
calculated on the basis of the difference between the option exercise
price and such closing price multiplied by the number of shares of
Manor Care Common Stock underlying the option.
EMPLOYMENT AGREEMENTS
Effective upon the Distribution Date, Franchising is expected to enter
into an employment agreement with Stewart Bainum, Jr., providing for Mr. Bainum,
Jr.'s employment as Chairman of the Board of Franchising. The agreement will
have a term of three years. Either Franchising or Mr. Bainum may terminate the
agreement upon 30 days' prior written notice on the first and second anniversary
dates of the agreement. The agreement will provide that Mr. Bainum, Jr. will
devote 12.5% of his professional time to the affairs of Franchising, 12.5% of
his professional time to the affairs of the Company and the remaining 75% of his
professional time to the affairs of Manor Care. The agreement provides for a
base salary of $82,044 per annum for services to Franchising and a maximum bonus
of 60% of Mr. Bainum, Jr.'s base compensation based upon the performance of
Franchising.
Effective upon the Distribution Date, Franchising is expected to
assume an employment agreement between the Company and William R. Floyd. The
agreement has a term of five years from October 21, 1996 and provides 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, the
Company granted to Mr. Floyd 85,470 shares of restricted Company Common Stock
and options to purchase 307,693 shares of Company Common Stock, of which 34,188
of the options are incentive stock options granted under the Company 1997 Long
Term Incentive Plan. The remainder of the options are Non-Qualified stock
options. Upon assumption of the Employment Agreements by Franchising, such
restricted stock and options will be adjusted and converted into Franchising
Common Stock and options. See "Relationship Between the Company and Franchising
after the Distribution--Employee Benefits Allocation and Administration
Agreement." Mr. Floyd's employment agreement further provides that, with respect
to Mr. Floyd's participation in the Choice Hotels International, Inc.
Supplemental Executive Retirement Plan (the "SERP"), (i) Mr. Floyd's normal
retirement age will be 62 and (ii) no minimum years of services for benefit
eligibility will be applicable. Effective upon the Distribution Date, the
Company is expected to assign its rights under that employment agreement to
Franchising.
50
<PAGE>
Effective upon the Distribution Date, Franchising is expected to
assume an employment agreement between the Company and Mr. MacCutcheon. The
agreement has a term of five years from November 1, 1996 and provides for a base
salary of $313,576 per annum, subject to annual adjustments and an annual bonus
of up to 55% of his base compensation, based on the Company's performance
(including a customer satisfaction component). Effective upon the Distribution
Date, the Company is expected to assign its rights under that employment
agreement to Franchising.
Effective upon the Distribution Date, Franchising is expected to
assume an employment agreement between the Company and Mr. Landry. Under the
terms of the agreement, Mr. Landry's annual salary is presently $404,250 with
annual cost-of-living increases. The agreement extends through November 30,
1999. The agreement provides for an annual bonus of up to 55% of his base
compensation based in part on the performance of the Company. Following the
Distribution, Mr. Landry's annual bonus will be based on the performance of
Franchising. Effective upon the Distribution Date, the Company is expected to
assign its rights under that employment agreement to Franchising.
Effective upon the Distribution Date, Franchising is expected to
assume an employment agreement between the Company 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 Franchising'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. Effective upon the Distribution
Date, the Company is expected to assign its rights under that employment
agreement to Franchising.
RETIREMENT PLANS
Franchising will adopt the SERP. Participants are selected by the
Board or any designated committee and must be at the level of Senior Vice
President or above.
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 out of the 120 months of employment which produces the highest
average, prior to the first occurring of the early retirement date or the normal
retirement date. The normal retirement age is 65, and participants must have a
minimum of 15 years of service. Participants may retire at age 60 and may elect
to receive reduced benefits commencing prior to age 65, subject to Board
approval. All of the Named Officers who will be participants are age 55 or
younger, so that none of their compensation reported above would be included in
the final average salary calculation. See "Certain Information Concerning
Franchising--Employment Agreements" for a discussion of the terms applicable to
Mr. Floyd's participation in the SERP.
Assuming that the following officers continue to be employed by
Franchising until they reach age 65, their credited years of service would be as
follows:
<TABLE>
<CAPTION>
CURRENT YEARS YEARS OF SERVICE
NAME OF INDIVIDUAL OF SERVICE AT AGE 65
- - ---------------------------------- ----------------------------- ----------------------------
<S> <C> <C>
Stewart Bainum, Jr., ........... 22.5 38
James A. MacCutcheon ........... 9 30
Donald J. Landry ............... 4 22
Thomas Mirgon .................. 0 24
Barry L. Smith ................. 7 18
</TABLE>
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
51
<PAGE>
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
<TABLE>
<CAPTION>
25 OR
REMUNERATION 15/15% 20/22.5% MORE/30%
------------ ------------- ------------- ----------------
<S> <C> <C> <C>
$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
</TABLE>
It is expected that upon the Distribution, the existing 401(k) plan
will be amended to provide for a multiple employer plan in which both
Franchising and Realco will participate. 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 Franchising (or 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 $9,500. Franchising 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 Franchising (or, prior to the Distribution, the Company) for the
year and the number of years of service of the participant. Amounts contributed
by Franchising or the Company pursuant to the 401(k) Plan for the Named Officers
are included in the Summary Compensation Table under the column headed "All
Other Compensation."
It is expected that upon the Distribution, the existing Non-Qualified
Savings Plan will also be amended to provide for a multiple employer plan in
which both Franchising and Realco will participate. Certain select highly
compensated members of management of Franchising 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 Franchising or the Company under the Non-Qualified Savings Plan
for fiscal year 1997 for the Named Officers are included in the Summary
Compensation Table under the column headed "All Other Compensation."
The Franchising match under the 401(k) Plan and the Non-Qualified
Savings Plan will be limited to a maximum aggregate of 6% of the annual salary
of a participant. Likewise, participant contributions under the two plans will
not exceed the aggregate of 15% of the annual salary of a participant.
OPTION AND STOCK PURCHASE PLANS
Prior to the Distribution, it is expected that Franchising will adopt
the Franchising Employee Stock Purchase Plan (the "Franchising Stock Purchase
Plan"). Under the Franchising Stock Purchase Plan, all employees who have
completed one year of service are eligible to participate. Eligible employees
may purchase stock of Franchising in an amount of no less than 2% nor more than
10% of compensation (as defined in the Stock Purchase Plan), subject to an
overall maximum purchase per employee per calendar year of $25,000. At the end
of each quarterly offering period, Franchising will contribute cash equal to 10%
of the purchase price of the common stock so purchased. Franchising will pay the
administrative costs for the purchase of the Company common stock.
Prior to the Distribution, it is expected that Franchising will adopt
the Franchising 1997 Long-Term Incentive Plan (the "Franchising Incentive
Plan"), pursuant to which key employees of Franchising and its
52
<PAGE>
subsidiaries are eligible to be granted awards under the Franchising Incentive
Plan. The types of awards that may be granted under the Incentive Plan are
restricted shares, incentive stock options, Non-Qualified stock options, stock
appreciation rights and performance shares.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTION
Upon consummation of the Distribution, certain management employees of
Franchising and of the Company will hold options to purchase shares of Company
Common Stock. See "Relationship Between Franchising and the Company After the
Distribution--Employee Benefits Allocation Agreement."
For a discussion of certain contracts to be executed between the
Company and Franchising as of the Distribution Date, see "Relationship Between
Franchising and the Company After the Distribution." For a discussion of the
historical financial relationship between the Company and Franchising, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operation--Liquidity and Capital Resources."
SECURITY OWNERSHIP
The following table sets forth the amount of Franchising Common Stock
expected to be beneficially owned by (i) each director and director nominee of
Franchising, (ii) the chief executive officer of Franchising and the Named
Officers, (iii) all officers and directors of Franchising as a group and (iv)
all persons who are expected to own beneficially more than 5% of Franchising
Common Stock, based on Company Common Stock beneficially owned by such persons
on May 1, 1997. Unless otherwise specified, the address for each of them is
10750 Columbia Pike, Silver Spring, Maryland 20901. On the Distribution Date,
the holders of Company Common Stock as of the Record Date will be entitled to
receive one share of Franchising Common Stock for each share of Company Common
Stock. For purposes of the following table, it is assumed that all options to
purchase shares of Company Common Stock held by the persons specified will be
converted into options to purchase Franchising Common Stock. For a discussion of
the treatment of outstanding options to purchase Company Common Stock in
connection with the Distribution, see "Relationship Between the Company and
Franchising." "After the Distribution--Employee Benefits Allocation Agreement."
<TABLE>
<CAPTION>
TOTAL SHARES OF PERCENT OF SHARES
COMPANY COMMON STOCK OUTSTANDING
EXPECTED TO BE EXPECTED TO BE
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED BENEFICIALLY OWNED (1)
- - ---------------------------------------------- -------------------------------- --------------------------------
<S> <C> <C> <C>
Stewart Bainum, Jr.......................... 15,993,471 (2) 26.19%
Stewart Bainum.............................. 10,657,122 (3) 17.45%
Barbara Bainum.............................. 5,520,867 (4) 9.04%
William R. Floyd............................ 85,570 (5) *
Paul A. Gould............................... 2,844 (6) *
Robert C. Hazard, Jr........................ 40,756 (7) *
Donald J. Landry............................ 207,756 (8) *
James A. MacCutcheon........................ 180,545 (9) *
Frederic V. Malek........................... 5,510 (10) *
Thomas Mirgon............................... 0 *
Gerald W. Petitt............................ 86,281 (11) *
Jerry E. Robertson, Ph.D.................... 20,824 (12) *
Barry L. Smith.............................. 243,734 (13) *
All Directors and Officers as a Group
(15 persons)................................ 33,045,280 (14) 54.12%
Bruce Bainum................................ 5,512,302 (15) 9.03%
Ronald Baron................................ 11,708,883 (16) 19.18%
</TABLE>
______________
*Less than 1% of class.
(1) Percentages are based on 61,068,547 shares outstanding on May 1, 1997
plus, for each person, the shares which would be issued assuming that
such person exercises all options it holds which are exercisable
within 60 days thereafter.
53
<PAGE>
(2) Includes 549,152 shares owned directly by the Stewart Bainum, Jr.
Declaration of Trust dated March 13, 1996, the sole trustee and
beneficiary of which is the reporting person. Also includes 5,417,761
shares owned by Bainum Associates Limited Partnership ("Bainum
Associates") and 4,415,250 shares owned by MC Investments Limited
Partnership ("MC Investments"), in both of which Mr. Bainum, Jr. is
managing general partner with the sole right to dispose of the shares;
3,567,869 shares held directly by Realty Investment Company, Inc.
("Realty"), a real estate management and investment company in which
Mr. Bainum, Jr. has shared voting authority; 1,779,628 shares owned by
Mid Pines Associates Limited Partnership ("Mid Pines"), in which Mr.
Bainum, Jr. is managing general partner and has shared voting
authority and 10,600 shares owned by the Foundation for Maryland's
Future, in which Mr. Bainum, Jr. is the sole director. Also includes
251,000 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 May 1, 1997, and 1,504 and 707
shares, respectively, which Mr. Bainum, Jr. has the right to receive
upon termination of his employment with the Company pursuant to the
terms of the Choice Hotels International, Inc. Retirement Savings and
Investment Plan ("401(k) Plan") and the Choice Hotels International,
Inc. Non-Qualified Retirement Savings and Investment Plan ("Non-
Qualified Savings Plan").
(3) Includes 3,906,278 shares held directly by the Stewart Bainum
Declaration of Trust, of which Mr. Bainum is the sole trustee and
beneficiary, his joint interest in 1,013,167 shares owned by Bainum
Associates and 1,296,281 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 1,667 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 December
31, 1996. Also includes 2,844 shares of restricted stock granted by
the issuer to Mr. Bainum which is not vested but which Mr. Bainum has
the right to vote.
(4) Includes 101,013 shares owned directly by Ms. Bainum. Also includes
1,779,628 shares owned by Mid Pines, in which Ms. Bainum's trust is a
general partner and has shared voting authority, 3,567,869 shares
owned by Realty, in which Ms. Bainum's trust has voting stock and
shares voting authority and 70,305 shares owned by Commonweal
Foundation, in which Ms. Bainum is President and Director and has
shared voting authority. Also includes 2,052 shares of restricted
stock issued to Ms. Bainum under the Choice Hotels International, Inc.
Non-Employee Director Stock Compensation Plan (the "Non-Employee
Director Stock Compensation Plan") which shares are not vested, but
which Ms. Bainum has the right to vote.
(5) Consists of restricted shares granted pursuant to Mr. Floyd's
employment agreement which are not yet vested, but which Mr. Floyd has
the right to vote.
(6) Consists of restricted shares granted pursuant to the Non-Employee
Director Stock Compensation Plan which shares are not vested, but
which Mr. Gould has the right to vote.
(7) Includes 32,384 shares owned directly by Mr. Hazard; 2,844 restricted
shares granted under the Non-Employee Director Stock Compensation
Plan, which are not yet vested, but which Mr. Hazard has the right to
vote. Also includes 5,000 shares which Mr. Hazard has the right to
acquire pursuant to stock options which are presently exercisable and
113 shares and 415 shares, respectively, which Mr. Hazard has the
right to receive upon termination of his employment pursuant to the
terms of the 401(k) Plan and the Non-Qualified Savings Plan.
(8) Includes 205,866 shares which Mr. Landry has the right to acquire
pursuant to stock options which are presently exercisable or
exercisable within 60 days of May 1, 1997 and 108 shares and 170
shares, respectively, which Mr. Landry has the right to receive upon
termination of his employment pursuant to the terms of the 401(k) Plan
and the Non-Qualified Savings Plan.
54
<PAGE>
(9) Includes 180,311 shares which Mr. MacCutcheon has the right to acquire
pursuant to stock options which are presently exercisable or
exercisable within 60 days of May 1, 1997 and 234 shares which Mr.
MacCutcheon has the right to receive upon termination of his
employment with the Company pursuant to the terms of the 401(k) Plan.
(10) Includes 1,666 shares which Mr. Malek has the right to acquire
pursuant to stock options which are presently exercisable and 2,844
restricted shares granted under the Non-Employer Director Stock
Compensation Plan which are not vested, but which Mr. Malek has the
right to vote.
(11) Includes 69,776 shares held directly by Mr. Petitt and 8,661 shares
held in trust for minor children for which Mr. Petitt is trustee.
Beneficial ownership of such shares is disclaimed. Also includes 2,844
restricted shares granted under the Company Non-Employee Director
Stock Compensation Plan which are not yet vested, but which Mr. Petitt
has the right to vote. Also includes 5,000 shares which Mr. Petitt has
the right to acquire pursuant to stock options which are presently
exercisable.
(12) Includes 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, 2,844 restricted shares granted under the
Non-Employer Director Stock Compensation Plan which are not yet
vested, but which Mr. Robertson has the right to vote. Also includes
1,666 shares which Mr. Robertson has the right to acquire pursuant to
stock options which are presently exercisable and 814 shares acquired
pursuant to the Choice Hotels International, Inc. Non-Employee
Director Stock Option and Deferred Compensation Stock Purchase Plan.
(13) Includes 243,483 shares which Mr. Smith has the right to acquire
pursuant to stock options which are presently exercisable or
exercisable within 60 days of May 1, 1997 and 86 shares and 165
shares, respectively, which Mr. Smith has the right to receive upon
termination of his employment pursuant to the terms of the 401(k) Plan
and the Non-Qualified Savings Plan.
(14) Includes a total of 895,659 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 May 1, 1997, and a total of 2,045 shares and 1,457 shares,
respectively, which such directors and officers have the right to
receive upon termination of their employment with the Company pursuant
to the terms of the 401(k) Plan and the Non-Qualified Savings Plan.
(15) 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, 3,568,869 shares owned by
Realty in which Mr. Bainum's trust has voting stock and shares voting
authority and 70,305 shares owned by the 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.
(16) As of May 13, 1997, 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.
DESCRIPTION OF CAPITAL STOCK OF FRANCHISING
Under the Restated Certificate of Franchising, which is attached as
Annex B to this Proxy Statement, the total number of shares of capital stock
that Franchising has authority to issue is 165,000,000, consisting of
160,000,000 shares of common stock, par value $.01 per share, and 5,000,000
shares of preferred stock (the "Preferred Stock"), par value $.01 per share.
Based on the number of shares of Company Common Stock outstanding on
May 1, 1997, it is expected that approximately 61,068,547 shares of
Franchising's Common Stock will be issued to stockholders of the Company in the
Distribution. All of the shares Franchising's Common Stock to be distributed to
the Company stockholders in the Distribution will be fully paid and non-
assessable.
55
<PAGE>
COMMON STOCK
The Franchising Certificate designates common stock consisting of
160,000,000 shares. Holders of Franchising Common Stock are entitled to receive,
subject to preferences that may be applicable from time to time with respect to
any outstanding Preferred Stock, such dividends as are declared by the Board of
Directors of Franchising, one vote for each share at all meetings of
stockholders, and, subject to preferences that may be applicable from time to
time with respect to any outstanding Preferred Stock, the remaining assets of
Franchising upon liquidation, dissolution or winding up of Franchising.
Franchising is authorized to issue additional shares of common stock without
further stockholder approval (except as may be required by applicable law or
stock exchange regulations).
With respect to the issuance of common shares of any additional
series, the Board of Directors of Franchising is authorized to determine,
without any further action by the holders of Franchising's Common Stock, among
other things, the dividend rights, dividend rate, conversion rights, voting
rights and rights and terms of redemption, as well as the number of shares
constituting such series and the designation thereof. Should the Board of
Directors of Franchising elect to exercise its authority, the rights and
privileges of holders of Franchising's Common Stock could be made subject to
rights and privileges of any such other series of common stock. the Company has
no present plans to issue any common stock of a series other than Franchising's
Common Stock.
See "Post-Distribution Dividend Policy" for a description of the
dividend policy of the Company after the Distribution.
PREFERRED STOCK
The Franchising's Board of Directors is authorized to issue up to
5,000,000 shares of Preferred Stock without further stockholder approval (except
as may be required by applicable law or stock exchange regulations) and to fix
from time to time, by resolution or resolutions, the relative powers,
preferences and rights and the qualifications, limitations or restrictions of
any series of Preferred Stock, as well as the number of shares constituting such
series and the designation thereof.
PREEMPTIVE RIGHTS
Holders of shares of Company Common Stock have no preemptive rights.
PURPOSES AND ANTITAKEOVER EFFECTS OF CERTAIN PROVISIONS OF THE FRANCHISING
CERTIFICATE AND BYLAWS
Prior to the Distribution Date, the Franchising Certificate and Bylaws
of Franchising (the "Franchising Bylaws") will be amended by the Company as sole
stockholder of Franchising to make the Franchising Certificate and Franchising
Bylaws substantially similar to the Company Certificate and the Company Bylaws
as currently in effect. Such amendment to the Franchising Certificate and
Franchising Bylaws may have an antitakeover effect with respect to Franchising.
FRANCHISING CERTIFICATE AND BYLAWS
The Franchising Certificate contains several provisions that will make
difficult an acquisition of control of Franchising, by means of a tender offer,
open market purchase, a proxy fight or otherwise, that is not approved by the
Franchising Board. The Franchising Bylaws also contain provisions that could
have an antitakeover effect.
The purposes of the relevant provisions of the Franchising Certificate
and the Franchising Bylaws are to discourage certain types of transactions,
described below, which may involve an actual or threatened change of control of
Franchising and to encourage persons seeking to acquire control of Franchising
to consult first with the Board of Directors to negotiate the terms of any
proposed business combination or offer. The provisions are designed to reduce
the vulnerability of Franchising to an unsolicited proposal for a takeover that
does not contemplate the acquisition of all outstanding shares or is otherwise
unfair to stockholders of Franchising or an
56
<PAGE>
unsolicited proposal for the restructuring or sale of all or part of
Franchising. The Company and Franchising believe that, as a general rule, such
proposals would not be in the best interests of Franchising and its
stockholders.
There has been a history of the accumulation of substantial stock
positions in public companies by third parties as a prelude to proposing a
takeover or a restructuring or sale of all or part of the Company or another
similar extraordinary corporate action. Such actions are often undertaken by the
third-party without advance notice to, or consultation with, the management or
board of directors of the target company. In many cases, the purchaser seeks
representation on the Company's board of directors in order to increase the
likelihood that its proposal will be implemented by the Company. If the Company
resists the efforts of the purchaser to obtain representation on the Company's
board, the purchaser may commence a proxy contest to have its nominees elected
to the board in place of certain directors or the entire board. In some cases,
the purchaser may not truly be interested in taking over the Company, but may
use the threat of a proxy fight and/or a bid to take over the Company as a means
of forcing the Company to repurchase its equity position at a substantial
premium over market price.
The Company and Franchising believe that the imminent threat of
removal of Franchising's management or Board in such situations would severely
curtail the ability of management or the Board to negotiate effectively with
such purchasers. The management or the Board of Franchising would be deprived of
the time and information necessary to evaluate the takeover proposal, to study
alternative proposals and to help ensure that the best price is obtained in any
transaction involving Franchising which may ultimately be undertaken. If the
real purpose of a takeover bid were to force Franchising to repurchase an
accumulated stock interest at a premium price, management or the Board would
face the risk that, if it did not repurchase the purchaser's stock interest,
Franchising's business and Franchising's management would be disrupted, perhaps
irreparably.
Certain provisions of the Franchising Certificate and Bylaws, in the
view of the Company and Franchising, will help ensure that the Franchising
Board, if confronted by a surprise proposal from a third-party which has
acquired a block of stock, will have sufficient time to review the proposal and
appropriate alternatives to the proposal and to act in what it believes to be
the best interests of the stockholders. In addition, certain other provisions of
the Franchising Certificate are designed to prevent a purchaser from utilizing
two-tier pricing and similar inequitable tactics in the event of an attempt to
take over Franchising.
These provisions, individually and collectively, will make difficult
and may discourage a merger, tender offer or proxy fight, even if such
transaction or occurrence may be favorable to the interests of the stockholders,
and may delay or frustrate the assumption of control by a holder of a large
block of Franchising and the removal of incumbent management, even if such
removal might be beneficial to the stockholders. Furthermore, these provisions
may deter or could be utilized to frustrate a future takeover attempt which is
not approved by the incumbent Board of Directors, but which the holders of a
majority of may deem to be in their best interests or in which stockholders may
receive a substantial premium for their stock over prevailing market prices of
such stock. By discouraging takeover attempts, these provisions may have the
incidental effect of inhibiting certain changes in management (some or all of
the members of which might be replaced in the course of a change of control) and
also the temporary fluctuations in the market price of the stock which often
result from actual or rumored takeover attempts.
Set forth below is a description of such provisions in the Franchising
Certificate and Bylaws. Such description is intended as a summary only and is
qualified in its entirety by reference to the Franchising Certificate and
Bylaws, the form of which is attached to this Proxy Statement as Annexes B and
C, respectively.
CLASSIFIED BOARD OF DIRECTORS. The Franchising Certificate provides
for the Franchising Board to be divided into three classes serving staggered
terms so that directors' initial terms will expire either at the 1998, 1999 or
2000 annual meeting of stockholders. Starting with the 1998 annual meeting of
Franchising stockholders, one class of directors will be elected each year for
three-year terms. See "Management of Franchising--Board of Directors of
Franchising."
The classification of directors will have the effect of making it more
difficult for stockholders to change the composition of the Franchising Board in
a relatively short period of time. At least two annual meetings of
57
<PAGE>
stockholders, instead of one, will generally be required to effect a change in a
majority of the Franchising Board. Such a delay may help ensure that the
Franchising Board, if confronted by a holder attempting to force a stock
repurchase at a premium above market prices, a proxy contest or an extraordinary
corporate transaction, will have sufficient time to review the proposal and
appropriate alternatives to the proposal and to act in what it believes are the
best interests of the stockholders.
The classified board provision could have the effect of discouraging a
third-party from making a tender offer or otherwise attempting to obtain control
of Franchising, even though such an attempt might be beneficial to Franchising
and its stockholders. The classified board provision could thus increase the
likelihood that incumbent directors will retain their positions. In addition,
since the classified board provision is designed to discourage accumulations of
large blocks of Franchising stock by purchasers whose objective is to have such
stock repurchased by Franchising at a premium, the classified board provision
could tend to reduce the temporary fluctuations in the market price of
Franchising's stock that could be caused by accumulations of large blocks of
such stock. Accordingly, stockholders could be deprived of certain opportunities
to sell their stock at a temporarily higher market price.
The Company and Franchising believe that a classified board of
directors will help to assure the continuity and stability of the Franchising
Board and Franchising's business strategies and policies as determined by the
Board, because generally a majority of the directors at any given time will have
had prior experience as directors of Franchising. The classified board provision
will also help assure that the Franchising Board, if confronted with an
unsolicited proposal from a third-party that has acquired a block of the voting
stock of Franchising, will have sufficient time to review the proposal and
appropriate alternatives and to seek the best available result for all
stockholders.
REMOVAL; FILLING VACANCIES. The Franchising Certificate provides that
only a majority of the Board then in office shall have the authority to fill any
vacancies on the Board, including vacancies created by an increase in the number
of directors. In addition, the Franchising Certificate provides that a new
director elected to fill a vacancy on the Board will serve for the remainder of
the full term of his or her class and that no decrease in the number of
directors shall shorten the term of an incumbent. These provisions relating to
removal and filling of vacancies on the Board will preclude stockholders from
enlarging the Board or removing incumbent directors and filling the vacancies
with their own nominees.
LIMITATIONS ON STOCKHOLDER ACTION BY WRITTEN CONSENT; SPECIAL
MEETINGS. The Franchising Certificate and Bylaws provide that stockholder action
can be taken only at an annual meeting of stockholders and prohibit stockholder
action by written consent in lieu of a meeting. The Franchising Certificate and
Bylaws provide that, special meetings of stockholders can be called only by the
Chairman or Vice Chairman of Franchising's Board or by the Secretary of
Franchising within 10 calendar days after receipt of the written request of a
majority of the total number of directors Franchising would have if there were
no vacancies or, if there are no directors in office, by a majority of the
stockholders. Stockholders are not permitted to call a special meeting or to
require that the Board call a special meeting of stockholders. Moreover, the
business permitted to be conducted at any special meeting of stockholders is
limited to the business brought before the meeting by or at the direction of the
Board.
The provisions of the Franchising Certificate and Bylaws restricting
stockholder action by written consent may have the effect of delaying
consideration of a stockholder proposal until the next annual meeting unless a
special meeting is called by a majority of the entire Board. These provisions
would also prevent the holders of a majority of the voting power of the voting
stock from using the written consent procedure to take stockholder action and
from taking action by consent without giving all the stockholders of Franchising
entitled to vote on a proposed action the opportunity to participate in
determining such proposed action. Moreover, a stockholder could not force a
stockholder consideration of a proposal over the opposition of the Franchising
Board by calling a special meeting of stockholders prior to the time the Board
believed such consideration to be appropriate.
The Company and Franchising believe that such limitations on
stockholder action will help to assure the continuity and stability of the
Franchising Board and Franchising's business strategies and policies as
determined by the Board, to the benefit of all of Franchising's stockholders. If
confronted with an unsolicited proposal from
58
<PAGE>
stockholders in Franchising, the Board will have sufficient time to review such
proposal and to seek the best available result for all stockholders, before such
proposal is approved by such stockholders by written consent in lieu of a
meeting or through a special meeting of stockholders.
NOMINATIONS OF DIRECTORS AND STOCKHOLDER PROPOSALS. The Franchising
Bylaws establish an advance notice procedure with regard to the nomination other
than by or at the direction of the Board of candidates for election as directors
and with regard to stockholder proposals to be brought before an annual or
special meeting of stockholders. Specifically, Franchising's Bylaws require that
stockholders desiring to bring any business, including nominations for
directors, before an annual meeting of stockholders, deliver advance written
notice thereof to the Secretary of the Company. The Bylaws further require that
the notice by the stockholder set forth a description of the business to be
brought concerning the stockholder proposing such business and the beneficial
owner, if any, on whose behalf the proposal is made, including their names an
addressees, the class and number of shares of the Company that are owned
beneficially and of record by each of them, and any material interest of either
of them in the business proposed to be brought before the meeting.
The purpose of the advance notice provision is to provide the
Company's board the opportunity to inform stockholders, prior to an annual
meeting of stockholders, of any business propose to be conducted at such meeting
(including any recommendation as to the board's position with respect to any
action to be taken). In the case of the advance notice nomination procedures,
the Company's board is afforded a meaningful opportunity to consider and inform
directors and stockholders of the qualifications of the proposed nominees.
Although the Franchising Bylaws do not give the Board any power to
approve or disapprove stockholder nominations for the election of directors or
of any other proposal submitted by stockholders, the Franchising Bylaws may have
the effect of precluding a nomination for the election of directors or
precluding the conducting of business at a particular stockholder meeting if the
proper procedures are not followed, and may discourage or deter a third-party
from conducting a solicitation of proxies to elect its own slate of directors or
otherwise attempting to obtain control of the Company, even if the conduct of
such solicitation or such attempt might be beneficial to the Company and its
stockholders.
SUPERMAJORITY VOTE FOR BUSINESS COMBINATIONS. The affirmative vote of
holders of shares representing not less than two-thirds of the voting power of
the Franchising is required for the approval of any proposal to merge or
consolidate with any other entity (other than an entity 90% owned by
Franchising) or sell, lease or exchange all or substantially all of the
Franchising's assets. Likewise, the Franchising Certificate and Bylaws provide
that any change or repeal of this provision requires the same vote of shares
representing two-thirds of the voting power of Franchising. Although an
effective impediment to unwanted takeovers, it is important to note and these
provisions may also make desired alliances with other business more difficult
and time consuming to implement.
ISSUANCE OF PREFERRED STOCK. The Franchising Board of Directors is
authorized to issue up to 5,000,000 shares of preferred stock without
stockholder approval and to fix by resolution the relative powers, preferences
and rights and the qualifications, limitations or series and its specific
designation. Such action by the Franchising Board would effectively dilute the
voting power of any potential suitor of Franchising, making a takeover
substantially more difficult.
LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS
ELIMINATION OF LIABILITY IN CERTAIN CIRCUMSTANCES
Pursuant to authority conferred by Delaware General Corporation Law
Section 102, the Restated Certificate provides that no director of the Company
shall be liable to the Company or its stockholders for monetary damages for
breach of fiduciary duty as a director except for breach of the director's duty
of loyalty to the Company or the stockholders, for acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of law, for
unlawful payment of dividends, unlawful stock redemptions or repurchases and for
any transaction from which the director derived an improper personal benefit.
This provision is intended to eliminate the risk that a director might incur
personal liability to the Company or its stockholders for breach of the duty of
59
<PAGE>
care. The Restated Certificate also provides that if Delaware law is amended to
further limit the liability of directors, then the liability of a director of
the Company shall be further limited to the fullest extent permitted by Delaware
law as so amended.
INDEMNIFICATION AND INSURANCE
Delaware General Corporation Law Section 145 contains provisions
permitting and, in some situations, requiring Delaware corporations, such as
Franchising, to provide indemnification to their officers and directors for
losses and litigation expense incurred in connection with their service to the
corporation in those capacities. The Restated Certificate contains provisions
requiring indemnification by Franchising of its directors and officers to the
fullest extent permitted by law. Among other things, the Restated Certificate
provides indemnification for officers and directors against liabilities for
judgments in and settlements of lawsuits and other proceedings and for the
advance and payment of fees and expenses reasonably incurred by the director or
officer in defense of any such lawsuit or proceeding.
60
<PAGE>
CERTAIN INFORMATION CONCERNING REALCO
PRO FORMA FINANCIAL DATA OF REALCO
The following unaudited pro forma combined statements of income
illustrate the estimated effects on Realco of the Distribution and related
transactions. The pro forma balance sheet is based on the February 28, 1997
balance sheet of Realco and assumes that the Distribution was consummated on
that date. The Pro Forma income statement is based on the income statement of
Realco for the thirty six weeks ended February 28, 1997 and the fiscal year
ended May 31, 1996 and assumes that the Distribution was consummated at the
beginning of each such period. The pro forma financial data are provided for
information purposes only and do not purport to be indicative of the results
that actually would have been obtained if the Distribution and related
transactions had been effected on the dates indicated or of those results that
may be obtained in the future. The pro forma combined statements of income are
based on preliminary estimates. The actual recording of the transactions will
be based on actual costs. Accordingly, the actual recording of the Distribution
and related transactions can be expected to differ from these pro forma
financial statements.
REALCO
PRO FORMA CONDENSED COMBINED BALANCE SHEET
AS OF FEBRUARY 28, 1997
<TABLE>
<CAPTION>
FRANCHISE
CHOICE HOTELS DISTRIBUTION OTHER PRO FORMA
INTERNATIONAL, INC. ADJUSTMENTS(A) ADJUSTMENTS REALCO
-------------------- -------------- ----------- ---------
<S> <C> <C> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents.................. $ 3,331 $ (1,834) $ -- $ 1,497
Receivables (net of allowance for
doubtful accounts)....................... 27,491 (19,838) -- 7,653
Other current assets....................... 5,918 (3,613) -- 2,305
-------- --------- ---------- --------
Total current assets..................... 36,740 (25,285) -- 11,455
Property and equipment, at cost, net of
accumulated depreciation................. 339,800 (26,151) -- 313,649
Lodging franchise rights, net of accumulated
amortization............................. 56,509 (56,509) -- --
Goodwill, net of accumulated amortization..... 61,137 (61,137) -- --
Other assets.................................. 42,297 (36,379) 5,610(D) 11,528
-------- --------- ---------- --------
TOTAL ASSETS.................................. $536,483 $(205,461) $ 5,610 $336,632
======== --------- ========== ========
LIABILITIES AND EQUITY
Current liabilities
Current portion of mortgages and $ 595 $ (146) $ -- $ 449
long-term debt..............................
Accounts payable............................ 37,928 (30,914) -- 7,014
Accrued expenses............................ 12,607 (6,025) -- 6,582
-------- --------- ---------- ---------
Total current liabilities............. 51,130 (37,085) -- 14,045
-------- --------- ---------- ---------
Mortgages and other long-term debt............ 95,727 (46,223) 117,500(D) 167,004
Notes payable to Manor Care................... 225,723 (78,700) (110,000)(D) 37,023
Deferred income taxes and other liabilities... 1,718 (408) -- 1,310
Equity........................................ 162,185 (43,045) (1,890)(D) 117,250
-------- --------- ---------- --------
TOTAL LIABILITIES AND EQUITY.................. $536,483 $(205,461) $ $5,610 $336,632
======== ========= ========== ========
</TABLE>
61
<PAGE>
REALCO
PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
FOR THE NINE MONTHS ENDED FEBRUARY 28, 1997
<TABLE>
<CAPTION>
CHOICE HOTELS DISTRIBUTION OTHER PRO FORMA
INTERNATIONAL, INC. ADJUSTMENTS(A) ADJUSTMENTS REALCO
------------------- -------------- ----------- ---------
<S> <C> <C> <C> <C>
REVENUES
Franchise................................... $185,206 $(192,692) $7,486(B) $ --
Hotel operations............................ 134,306 (13,255) 121,051
-------- --------- --------- ---------
Total revenues............................ 319,512 (205,947) 7,486 121,051
-------- --------- --------- ---------
OPERATING EXPENSES
Franchise................................... 142,898 (142,898) -- --
Hotel operations............................ 107,948 (12,122) 7,486(B) 103,312
-- -- 2,966(C) 2,966
-------- --------- ------ --------
Total operating expenses.................. 250,846 (155,020) 10,452 106,278
-------- --------- ------ --------
INCOME BEFORE OTHER EXPENSES AND
INCOME TAXES.................................. 68,666 50,927 (2,966)(C) 14,773
-------- --------- ------ --------
OTHER EXPENSES
Interest expense on Notes payable to Manor
Care.................................... 15,236 (5,312) (7,425)(D) 2,499
Minority interest........................... -- -- -- --
Other interest and other expenses, net...... 3,370 (2,928) 6,955(D) 7,397
-------- --------- ------- -------
Total other expenses..................... 18,606 (8,240) (470) 9,896
-------- --------- ------- -------
Income before income taxes.................... 50,060 (42,687) (2,496) 4,877
-------- --------- ------- -------
Income taxes.................................. 20,600 (17,578) (1,013)(F) (2,009)
-------- --------- ------- -------
Net income.................................... $ 29,460 $ (25,109) $ 1,483 $ 2,868
======== ========= ======= =======
</TABLE>
62
<PAGE>
REALCO
PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED MAY 31, 1996
<TABLE>
<CAPTION>
CHOICE HOTELS DISTRIBUTION OTHER PRO FORMA
INTERNATIONAL, INC. ADJUSTMENTS(A) ADJUSTMENTS REALCO
------------------- -------------- ----------- ---------
<S> <C> <C> <C> <C>
REVENUES
Franchise............................................. $219,164 $(226,707) $ 7,543(B) $
Hotel operations...................................... 155,709 (19,609) 12,946(E) 149,046
-------- --------- ------- --------
Total revenues.................................... 374,873 (246,316) 20,489 149,046
-------- --------- ------- --------
OPERATING EXPENSES
Franchise............................................. 194,248 (194,248) -- --
Hotel operations...................................... 139,835 (19,545) 7,543(B) 127,833
11,688(E) 11,688
-- -- 3,955(C) 3,955
-------- --------- ------- --------
Total operating expenses......................... 334,083 (213,793) 23,186 143,476
-------- --------- ------- --------
INCOME BEFORE OTHER EXPENSES AND
INCOME TAXES............................................. 40,790 (32,523) (2,697) 5,570
-------- --------- ------- --------
OTHER EXPENSES
Interest expense on notes payable to Manor Care.. 19,673 (7,083) (9,900)(D) 2,690
-- -- 666(E) 666
Minority interest................................ 1,532 (1,532) -- --
Other interest and other expenses, net........... 3,727 (2,931) 9,300(D) 10,096
-------- --------- ------- --------
Total other expenses............................. 24,932 (11,546) 66 13,452
-------- --------- ------- --------
Income before income taxes............................... 15,858 (20,977) (2,763) (7,882)
-------- --------- ------- --------
Income taxes............................................. 7,400 (9,313) (1,091)(F) (3,004)
-------- --------- ------- --------
Net Income............................................... $ 8,458 $ (11,664) $(1,672) $ (4,878)
======== ========= ======= ========
</TABLE>
63
<PAGE>
REALCO
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS
A. Represents adjustment to reflect the Distribution.
B. Represents the adjustment to record franchise fee revenue and franchise fee
expense on Realco owned hotels previously eliminated in consolidation.
C. Represents the net additional costs associated with staffing of accounting,
finance, cash management, risk management, human resources and legal
personnel and directors' costs to operate Realco on a stand alone basis.
D. Represents the following relating to Realco's refinancing of $110 million
of notes payable to Manor Care with $117.5 million of commercial backed
mortgage securities in April 1997:
. Record $117.5 million of commercial backed mortgage securities and
repayment of $110 million of Manor Care notes payable.
. Record prepayment penalty of $1.9 million relating to Manor Care notes
payable. The extraordinary loss related to the $1.9 million prepayment
penalty is not reflected in the accompanying pro forma combined income
statements.
. Record escrow reserves for furniture and equipment and taxes in other
assets of $3.0 million.
. Record deferred financing costs of $2.6 million.
. Record incremental interest expense and deferred financing
amortization related to the commercial backed mortgage securities.
E. Represents the adjustment to record the revenue, operating costs and
incremental interest expense related to the acquisition of 16 hotels in
1996.
F. Represents the income tax impact of pro forma adjustments at statutory
rates.
64
<PAGE>
BUSINESS AND PROPERTIES
Realco will operate the Hotel Business as previously operated by the
Company.
Realco will be a leading national hotel Company with a portfolio of 71
hotels containing 10,330 rooms located in 25 States as of February 28, 1997.
Each hotel is branded with one of the Choice franchise brands. Realco's hotels
operate in one of three principal segments of the lodging industry: all-suite,
full service and limited service. The majority of Realco's hotels have been
acquired by the Company since 1992 at prices below their replacement cost. All
of these hotels have benefited from the investment of capital to improve the
renovated hotels. Since June 1992, the Company has spent $260.4 to buy and
renovate 54 hotel properties. More recently, the Company shifted its
development efforts to the construction of Sleep Inn hotels and MainStay Suite
hotels.
Realco's strategy is to: (i) optimize the operating performance and
value of its existing portfolio of hotels through the consistent application of
high quality sales, marketing and operating programs; (ii) capitalize on the
under-served, high growth, mid-priced, extended-stay all-suite segment with the
development of 20 MainStay Suite hotels; (iii) develop other high quality,
consumer focused hotels such as Sleep Inns; and (iv) pursue the opportunistic
acquisition of existing hotels whereby substantial value can be created.
The Company's performance is a beneficiary of the operating leverage
inherent in the lodging industry and is further supported by the substantial
discount to replacement cost of its existing portfolio. The 54 hotels acquired
since 1992 have an investment basis of approximately 55.3% of current estimated
replacement cost. In addition to the initial renovation of acquired hotels,
Realco has spent approximately 5% of revenue for ongoing improvements to the
hotels, thereby maintaining the physical assets to optimize competitive
advantages in each local market.
Realco's strategy to build 20 MainStay Suites hotels is intended to
provide the Company with hotels positioned to benefit from the demand/supply
imbalance in the mid-priced, extended stay all-suite segment which will produce
higher than average return on investment.
Realco's historical existing hotel acquisition program and the current
MainStay Suite hotel development program are illustrative of management's
capabilities to timely ascertain market trends, conceive of strategies and to
implement those strategies.
HISTORICAL ACQUISITION STRATEGY
The primary focus of Realco from 1992 through 1995 was the acquisition
of existing hotels at prices below their replacement cost with the intent to
increase their value through (i) the investment of capital to improve the hotels
and (ii) the installation of professional management and marketing teams to
operate the renovated hotels. Since June 1992, the Company has spent $260.4
million to buy and renovate 54 hotels containing 7,809 rooms. In fiscal year
1997, the Company acquired two hotels and is in the process of renovating them.
Additionally, the Company is in the process of renovating and converting a
facility in Charlotte, NC to a Clarion Hotel from a senior assisted living
facility which the Company acquired in 1994.
In addition to the acquired hotels, Realco owns and operates 8 hotels
developed or acquired prior to 1992, 7 Sleep Inn hotels and 1 MainStay Suites
hotel developed by the Company since 1994.
65
<PAGE>
<TABLE>
<CAPTION>
REALCO EXISTING HOTEL ACQUISITIONS
------------------------------------------------------------------------------------
AS OF AND FOR THE
NINE MONTHS ENDED
-----------------
FISCAL YEAR FEBRUARY 29, FEBRUARY 28,
----------------------------------------------------- ------------ ------------
1993 1994 1995 1996 1996 1997
----------------------------------------------------- ----------------------------
<S> <C> <C> <C> <C> <C> <C>
Total acquisitions.......................... 7 13 16 16 15 2
Total number of rooms acquired.............. 1,276 1,933 2,336 1,940 1,873 324
Total cost of acquisitions (in millions)
(including initial improvements)........... $ 30.9 $ 55.8 $ 83.3 $ 71.8 $ 67.5 $ 17.9
Average cost per room....................... $24,216 $28,867 $35,659 $37,010 $36,038 $55,246
</TABLE>
Net operating income for the seven hotels purchased in fiscal year 1993
increased from $6.6 million in fiscal 1995 to $8.0 million in fiscal 1996, a 22%
improvement. For the 13 hotels purchased in fiscal year 1994, net operating
income increased 38% to $10.0 million in fiscal year 1996 from $7.2 million in
fiscal year 1995. Net operating income for the 16 hotels acquired in fiscal
year 1995 was $6.7 million in fiscal year 1996, a 268% increase over the $1.8
million achieved in fiscal year 1995. The following chart summarizes occupancy
improvements for original portfolio hotels, and fiscal 1993, 1994, 1995 and 1996
acquisitions. Occupancy rates for the year acquired reflect only the period
during which the properties were owned by the Company. Because many of the
recently acquired and developed hotels have not yet reached stabilized levels of
operating performance, the Company believes that revenues and gross profit at
these hotels will continue to grow.
<TABLE>
<CAPTION>
REALCO HOTELS OCCUPANCY
---------------------------------------------------------------------------------
AS OF AND FOR THE
NINE MONTHS ENDED
-----------------
FISCAL YEAR FEBRUARY 29, FEBRUARY 28,
------------------------------------------------ ------------------------------
1993 1994 1995 1996 1996 1997
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Original Domestic Portfolio.................. 62.27% 64.16% 67.19% 68.02% 66.36% 69.80%
Fiscal 1993 Acquisitions..................... 56.17 63.20 73.68 76.17 74.22 73.05
Fiscal 1994 Acquisitions..................... -- 66.09 70.71 73.76 72.06 72.98
Fiscal 1995 Acquisitions..................... -- -- 48.96 58.49 54.64 65.19
Fiscal 1996 Acquisitions..................... -- -- -- 53.23 49.53 59.24
</TABLE>
THE HOTEL PROPERTIES
Realco's hotel properties serve three primary segments of the lodging
industry; all-suites, full service and limited service. Each hotel, except Miami
Beach, which is under physical renovation, is branded with one of the Choice
franchise flags.
ALL-SUITES HOTELS. Realco has 6 hotels in the all-suite segment open and 13
hotels under construction or in the development process. Realco's all-suite
hotel properties compete in the moderate and upscale price segments. The table
below identifies Realco's all-suite hotels by brand and price segment.
<TABLE>
<CAPTION>
ALL-SUITE HOTELS
NUMBER NUMBER PRICE
BRAND OF HOTELS OF ROOMS SEGMENT
----- --------- -------- -------
<S> <C> <C> <C>
Quality Suites............................................ 3 345 upscale
Comfort Suites............................................ 2 232 mid-price
MainStay Suites........................................... 1 96 mid-price
</TABLE>
Realco, as of May 31, 1997, had an additional 10 MainStay Suites hotels
under construction with 970 rooms.
FULL-SERVICE HOTELS. Realco has 16 hotels in the full service segment.
Realco's full service hotels compete in the mid-price and upscale price
segments. The table below identifies Realco's full service hotels by brand and
price segment.
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<PAGE>
FULL SERVICE HOTELS
<TABLE>
<CAPTION>
NUMBER NUMBER PRICE
BRAND OF HOTELS OF ROOMS SEGMENT
----- --------- -------- ---------
<S> <C> <C> <C>
Clarion Hotels & Inns................... 11 2,114 upscale
Quality Hotel & Inns.................... 5 1,327 mid-price
</TABLE>
LIMITED SERVICE HOTELS. Realco has 49 hotels in the limited service
segment open and six hotels under construction or in the development process.
Realco's limited service hotels properties compete in the mid-price and economy
price segments. The table below identifies Realco's limited service hotels by
brand and price segment.
LIMITED SERVICE HOTELS
<TABLE>
<CAPTION>
NUMBER NUMBER PRICE
BRAND OF HOTELS OF ROOMS SEGMENT
----- --------- -------- -------
<S> <C> <C> <C>
Comfort Inn............................ 31 4,074 mid-price
Quality Inns........................... 8 1,014 mid-price
Sleep Inns............................. 7 757 mid-price
Econo Lodge............................ 1 120 economy
Rodeway Inns........................... 1 101 economy
Independent............................ 1 150 economy
</TABLE>
EXTERNAL DEVELOPMENT
Realco's focus on external development is geared to (i) capitalize on the
under-served, high-growth, mid-priced extended stay all-suite segment, and (ii)
the development of other high-quality, consumer-focused hotels.
To effect these strategies, Realco maintains a Real Estate Development and
Construction Department staff. This staff effects the identification of target
markets, specific site identification, negotiation, due diligence, planning,
zoning and other approval requirements, design and construction of new hotels.
The Real Estate Development staff have served in the past as the focal point to
effect the Company's historical acquisition strategy. This dual capacity to
acquire existing hotels or build new hotels allows the Company to be responsive
to changing market conditions.
The following is a list of the new hotels developed by the Company since
1994 or currently under development:
<TABLE>
<CAPTION>
CALENDAR
MARKET HOTEL YEAR OF OPENING
------ ----- ---------------
<S> <C> <C>
Dallas/Plano, TX......................................... Sleep 1994
San Antonio, TX.......................................... Sleep 1995
Baton Rouge, LA.......................................... Sleep 1996
Houston/Airport, TX...................................... Sleep 1996
Austin/Round Rock, TX.................................... Sleep 1996
Dallas/Plano, TX......................................... MainStay 1996
Raleigh, NC.............................................. Sleep 1997
Dallas/Arlington, TX..................................... Sleep 1997
Kansas City/Airport, MO(1)............................... Sleep 1997
Charlotte, NC(1)......................................... Sleep 1997
Rockville, MD(1)......................................... Sleep 1997
Providence/Airport, RI(1)................................ MainStay 1997
Cincinnati/Blue Ash, OH(1)............................... MainStay 1997
Kansas City/Airport, MO(1)............................... MainStay 1997
Indianapolis, IN(1)...................................... MainStay 1997
Louisville, KY(1)........................................ MainStay 1997
Denver/Tech Center, CO(1)................................ MainStay 1998
Orlando/Lake Mary, FL(1)................................. MainStay 1998
Jacksonville, FL(1)...................................... MainStay 1998
Greenville, SC(1)........................................ MainStay 1998
</TABLE>
67
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Nashville/Brentwood, TN(1)........................... MainStay 1998
Miami/Airport, FL(2)................................. MainStay 1998
Denver/Airport, CO(1)................................ Sleep 1998
Miami/Airport, FL(2)................................. Sleep 1998
Ft. Lauderdale/Cypress Creek, FL(2).................. Sleep 1998
Pittsburgh/Airport, PA(2)............................ MainStay 1998
Fishkill/Poughkeepsie, NY(2)......................... MainStay 1998
</TABLE>
(1) Hotel under construction
(2) The Company has acquired the land and is in final planning stages prior to
start of construction.
Realco's focus on the development of MainStay Suites is based on the
sector-wide demand/supply imbalance as evidenced by numerous industry studies.
According to industry studies, demand for extended stay lodging far exceeds
supply. Demand in the mid-price market is very high, yet supply additions have
been minimal. The extended stay, all-suite segment, defined as stays of five or
more nights, consists of 228 million room nights annually, or 27% of total U.S.
industry demand, according to industry sources. Only 1.5% of total room supply
is dedicated extended stay rooms. Realco's capacities in both Real Estate
Development and Hotel Operations are leveraged to capitalize on this
opportunity.
MainStay Suites has been created by the Company with a unique product
design and service package which enhances property level appeal, productivity
and profitability. Realco believes that MainStay Suites projects will produce a
stabilized unleveraged pre-tax property level return on investment of 15% or
higher.
Realco's initial development of 20 MainStay Suites combined with
Choice Franchising other franchised MainStay Suites is intended to result in a
brand with national recognition.
Realco's MainStay Suites hotel properties will average approximately
100 suites and be developed on 2.5 to 3.0 acres of land in suburban office parks
or locations proximate to major employers, restaurants and retail amenities.
MainStay Suites feature high quality, interior corridor building construction
with amenities and features demanded by consumers. All suites feature a bedroom
area, living room area with a pull-out couch or recliner, private bathroom and
fully furnished kitchen. The kitchen area includes a full-size refrigerator,
dishwasher, microwave, stove, coffee maker, toaster and all cooking and serving
utensils. Each suite features an over-sized counter serving as an eating or
working center, along with two ergonomic chairs. Suite alternatives include a
studio suite or one-bedroom suite. Each suite includes two direct dial phone
lines, voice mail and other automated phone services.
The Company and Franchising have developed a state-of-the-art
automated checkin/out property management system which enables guests with
reservations to obtain their key from the kiosk unassisted. This feature allows
transaction time to be shortened and provides operating efficiencies while
enhancing guest satisfaction.
Based on experience from the first MainStay Suites opened by Realco in
Plano, Texas, guest satisfaction is very high. Financial results to-date have
met or exceeded the Company's expectations.
OPERATIONS
Each of Realco's owned and managed hotels operates under one of Choice
Franchise brand names. The following table illustrates the growth of Realco
over the four fiscal years ended May 31, 1996 and for the nine months ended
February 28, 1997.
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<PAGE>
<TABLE>
<CAPTION>
AS OF AND FOR THE
NINE MONTHS ENDED
FISCAL YEAR FEBRUARY 29, FEBRUARY 28,
---------------------------------------------- ------------ ------------
1993 1994 1995 1996 1996 1997
---------------------------------------------- ------------------------------
<S> <C> <C> <C> <C> <C> <C>
Number of properties, end of period 19 32 48 65 63 71
Number of rooms, end of period 3,686 5,605 7,941 9,713 9,687 10,330
Average occupancy percentage 61.36% 64.18% 67.10% 66.61% 65.09% 67.36%
Average daily (room) rate (ADR) $49.53 $49.15 $51.28 $55.97 $55.46 $59.16
RevPAR $30.39 $31.54 $34.40 $37.28 $36.10 $39.85
</TABLE>
OPERATING SYSTEMS AND PROCEDURES. Realco's hotels take advantage of the
same systems and services available to franchisees with respect to a particular
brand. The hotels participate in the central reservation system, marketing and
advertising efforts and volume purchasing discounts and are subject to the same
quality assurance program. In addition, Realco has instituted the following
systems in each of the hotels it operates.
. YIELD MANAGEMENT. An automated yield management program has been
installed at hotels which allows the local management to take
advantage of the supply and demand conditions in their marketplace.
The system is automated to the point that it performs calculations and
suggests pricing strategies to the local hotel management. The program
continues to update information based on the availability of room
supply and reservation volume within each hotel.
. TRAINING. Realco has developed a training system for all guest
services representatives that teaches the basic sales techniques. A
computerized guest comment system was developed to solicit the
comments of guests and the experiences they had at the hotel while
providing management with immediate guest feedback.
. ACCOUNTING SYSTEMS. Each of the Realco-operated hotels has a
computerized front desk and accounting system. This system allows key
financial indicators (such as daily occupancy and revenue) to be
immediately gathered from each hotel and electronically transmitted to
the key operating officers and managers of Realco. This instant access
to information allows management to quickly spot trends and make
corrections and changes where necessary. The system is completely
computerized and allows for cost savings in the accounting and
bookkeeping departments of each hotel. In addition, control over
operational and capital expenditures is provided by a dedicated group
of financial controllers in the corporate office. This group works
with the hotel operations group to maintain expense standards as well
as established operating procedures.
. TIME AND ATTENDANCE SYSTEM. Each hotel maintains an automated time and
attendance system that is tied into a central payroll system at the
corporate headquarters. This computerized method of tracking time
allows management to make quick decisions on controlling labor costs
and provides immediate information on projected costs.
. FOOD AND BEVERAGE. The food and beverage efforts are headed by a vice
president of food and beverage. The department is responsible for the
daily food and beverage activities of the various hotels, as well as
the development of new food concepts. This group was responsible for
the development, testing and implementation of the Choice Picks food
court concept. Recently, the Company opened a new food and beverage
concept called "Classic Sports Food, Drink and Memories" in its
Richardson, Texas hotel. A sports theme restaurant, this concept has
been developed jointly with the Classic Sports Network, a national
cable television service. This agreement allows for the use of
certain trademarks at Realco's locations. Additional "Classic Sports
Food, Drink and Memories" are planned for three other Realco hotels.
. ANNUAL BUSINESS PLANNING PROCESS. Each hotel prepares a zero-based
annual business plan which incorporates historical performance and
market conditions. The plan which is reviewed and
69
<PAGE>
approved by senior management, provides detailed strategies in the key
operating areas of marketing, guest services and food and beverage. The
plan also includes a comprehensive capital expenditures process which
serves to maintain the physical plant in optimal condition based on market
conditions and operating strategies. The annual plan serves as a
fundamental measurement of management's performance.
PROPERTIES
The following chart lists by market segment Realco's hotels at
February 28, 1997:
<TABLE>
<CAPTION>
HOTEL MARKET NUMBER OF ROOMS
----- ------ ---------------
<S> <C> <C>
ALL SUITE
---------
Upscale
-------
Quality Suites Deerfield...................... Ft. Lauderdale, Florida 107
Quality Suites................................ Raleigh, North Carolina 114
Quality Suites Shady Grove.................... Rockville, Maryland 124
Mid-Price
---------
Comfort Suites Haverhill...................... Boston, Massachusetts 131
Comfort Suites Deerfield...................... Ft. Lauderdale, Florida 101
MainStay Suites Plano......................... Dallas, Texas 96
MainStay Suites Warwick(1).................... Providence, Rhode Island 94
MainStay Suites Blue Ash(1)................... Cincinnati, Ohio 100
MainStay Suites Airport(1).................... Kansas City, Missouri 88
MainStay Suites Northwest(1).................. Indianapolis, Indiana 88
MainStay Suites(1)............................ Louisville, Kentucky 100
MainStay Suites Tech Center(1)................ Denver, Colorado 100
MainStay Suites Lake Mary(1).................. Orlando, Florida 100
MainStay Suites South Pointe(1)............... Jacksonville, Florida 100
MainStay Suites(1)............................ Greenville, South Carolina 100
MainStay Suites Brentwood(1).................. Nashville, Tennessee 100
FULL SERVICE
------------
Upscale
-------
Clarion Hotel Baltimore....................... Baltimore, Maryland 103
Clarion Hotel Worthington..................... Columbus, Ohio 232
Clarion Hotel Richardson...................... Dallas, Texas 296
Clarion on the Lake........................... Hot Springs, Arkansas 151
Clarion Hotel Miami Airport................... Miami, Florida 103
Clarion Hotel Hollywood Beach................. Miami-Ft. Lauderdale, Florida 309
Clarion Hotel................................. Mobile, Alabama 250
Clarion Hotel Virginia Beach.................. Norfolk-Virginia Beach, Virginia 149
Clarion Hotel Roanoke......................... Roanoke, Virginia 148
Clarion Hotel Springfield..................... Springfield, Missouri 199
Clarion Hotel(2).............................. Charlotte, North Carolina 174
Mid Price
---------
Quality Inn South Point....................... Jacksonville, Florida 184
Quality Hotel Airport......................... Los Angeles, California 278
Quality Hotel Maingate Anaheim(4)............. Los Angeles, California 284
Quality Inn & Suites Hampton.................. Norfolk-Virginia Beach, Virginia 190
Quality Hotel Arlington....................... Washington, DC 391
LIMITED SERVICE
---------------
Mid-Price
---------
Comfort Inn Albuquerque....................... Albuquerque, New Mexico 114
Quality Inn Anderson.......................... Anderson, South Carolina 121
Comfort Inn Norcross.......................... Atlanta, Georgia 110
Comfort Inn Pikesville(5)..................... Baltimore, Maryland 186
Comfort Inn University........................ Baton Rouge, Louisiana 150
Comfort Inn Danvers........................... Boston, Massachusetts 136
Comfort Inn Brooklyn.......................... Brooklyn, New York 67
Comfort Inn Canton............................ Canton, Ohio 124
Comfort Inn Airport........................... Charleston, South Carolina 122
</TABLE>
70
<PAGE>
<TABLE>
<CAPTION>
HOTEL MARKET NUMBER OF ROOMS
----- ------ ---------------
<S> <C> <C>
Comfort Inn Charlotte......................... Charlotte, North Carolina 150
Quality Inn & Suites - Crown Point............ Charlotte, North Carolina 100
Comfort Inn................................... Cincinnati, Ohio 117
Comfort Inn Middleburg Heights................ Cleveland, Ohio 136
Comfort Inn College Station................... College Station, Texas 114
Comfort Inn Columbia.......................... Columbia, South Carolina 98
Comfort Inn DFW Airport....................... Dallas-Fort Worth, Texas 152
Quality Inn Plymouth.......................... Detroit, Michigan 123
Comfort Inn Deerfield East.................... Ft. Lauderdale, Florida 69
Comfort Inn Hershey........................... Harrisburg, Pennsylvania 125
Comfort Inn Hilton Head....................... Hilton Head Island, South Carolina 150
Quality Inn & Suites Indianapolis............. Indianapolis, Indiana 116
Quality Inn Lincoln........................... Lincoln, Nebraska 108
Quality Inn & Suites Lumberton................ Lumberton, North Carolina 120
Comfort Inn Collierville...................... Memphis, Tennessee 94
Comfort Inn & Suites, Miami Springs........... Miami, Florida 165
Comfort Inn Miami Springs..................... Miami, Florida 110
Miami Beach Hotel(3).......................... Miami, Florida 150
Comfort Inn - Lee Road........................ Orlando, Florida 145
Comfort Inn - Turf Paradise................... Phoenix, Arizona 155
Comfort Inn - North........................... Phoenix, Arizona 153
Comfort Inn Portland.......................... Portland, Maine 126
Quality Inn Richmond.......................... Richmond, Virginia 194
Quality Inn Midvalley......................... Salt Lake City, Utah 132
Comfort Inn by the Bay(4)..................... San Francisco, California 135
Comfort Inn Westport.......................... St. Louis, Missouri 170
Comfort Inn Sturgis........................... Sturgis, Michigan 83
Comfort Inn Traverse City..................... Traverse City, Michigan 96
Comfort Inn Tyson's........................... Washington, D.C. 250
Comfort Inn West Palm Beach................... West Palm Beach, Florida 158
Comfort Inn Wichita........................... Wichita, Kansas 114
Economy
-------
Sleep Inn Round Rock.......................... Austin, Texas 107
Sleep Inn Six Flags........................... Dallas-Ft. Worth, Texas 124
Sleep Inn Baton Rouge......................... Baton Rouge, Louisiana 101
Sleep Inn Plano............................... Dallas, Texas 104
Sleep Inn Intercontinental.................... Houston, Texas 107
Econo Lodge Tolleson.......................... Phoenix, Arizona 120
Rodeway Inn Tempe............................. Phoenix, Arizona 101
Sleep Inn Raleigh............................. Raleigh, North Carolina 107
Sleep Inn San Antonio......................... San Antonio, Texas 107
Sleep Inn University City(1).................. Charlotte, North Carolina 120
Sleep Inn Airport(1).......................... Denver, Colorado 119
Sleep Inn Airport(1).......................... Kansas City, Missouri 107
Sleep Inn Rockville(1)........................ Washington, D.C. 107
</TABLE>
____________________
(1) Hotel under construction.
(2) Hotel closed for renovation.
(3) Hotel under renovation.
(4) Leased property.
(5) Hotel on leased land.
MANAGEMENT
BOARD OF DIRECTORS OF REALCO
Immediately prior to the Distribution, six of the nine current member of
the Company's Board of Directors will resign. After the Distribution, the Realco
Board of Directors will consist of seven directors.
71
<PAGE>
The name, age, proposed class of directorship upon consummation of the
Distribution and business background (other than executive officers who are
directors) of three of the seven persons who are expected to become on the
Distribution Date the directors of Realco are set forth below. The Company's
Board of Director will select candidates for the remaining directorships prior
to the Distribution.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Stewart Bainum, Jr................... 50 Class
Stewart Bainum....................... 77 Class
William R. Floyd..................... 52 Class
</TABLE>
For biographical information with respect to the other persons listed
above, see "Other Proposals Relating to the Annual Meeting--Proposal Five
Election of Directors."
THE BOARD OF DIRECTORS AND COMMITTEES OF THE BOARD
It is expected that the Realco Board of Directors will hold five meetings
during the fiscal year and that the standing committees of the Realco Board of
Directors will include the Audit Committee, the Finance Committee, the
Compensation/Key Executive Stock Option Plan Committee and the Nominating
Committee.
The Compensation/Key Executive Stock Option Plan Committee administers
Realco's stock option plans and grants 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.
The Finance Committee reviews the financial affairs of Realco and
recommends financial objectives, goals and programs to the Board of Directors
and to management.
The Audit Committee reviews the scope and results of the annual audit, will
review and approve the services and related fees of Realco's does independent
public accountants, will review Realco's internal accounting controls and
reviews Realco's Internal Audit Department and its activities.
The Nominating Committee recommends to the Board of Directors the members
to serve on the Board of Directors during the ensuing year. The Committee does
not consider nominees recommended by stockholders.
COMPENSATION OF DIRECTORS
The Company has previously adopted the Choice Hotels International, Inc.
Non-Employee Director Stock Option and Deferred Compensation Stock Purchase
Plan. Part A of the Plan provides that eligible non-employee directors will be
granted options to purchase 5,000 shares of Realco Common Stock on their date of
election and will be granted options to purchase 1,000 shares on their date of
election in subsequent calendar years. Part B of the Plan provides that eligible
non-employee directors may elect, prior to May 31 of each year, to defer a
minimum of 25% of committee fees earned during the ensuing fiscal year. The fees
which are so deferred will be used to purchase Realco Common Stock on the open
market within 15 days after December 1, February 28 and May 31 of such fiscal
year. Pending such purchases, the funds will be credited to an Interest Deferred
Account, which will be interest bearing. Stock which is so purchased will be
deposited in a Stock Deferred Account pending distribution in accordance with
the Plan.
Directors who will be employees of Realco will receive no separate
remuneration for their services as directors. Pursuant to the Non-Employee
Director Stock Compensation Plan to be adopted by Realco prior to the
Distribution, eligible non-employee directors will receive annually, in lieu of
cash, restricted stock of Realco, the fair market value of which at the time of
grant will be equal to $30,000, which will represent the Board retainer and
meeting fees. In addition, all non-employee directors will receive $1,610 per
diem for Committee meetings
72
<PAGE>
attended, except where the Committee meeting is on the same day as a Board
meeting, and will be reimbursed for travel expenses and other out-of-pocket
costs incurred in attending meetings.
EXECUTIVE OFFICERS OF REALCO
The name, age, proposed title upon consummation of the Distribution and
business background of each of the persons who are expected to become on the
Distribution Date the executive officers of Realco are set forth below. The
Company is currently seeking candidates for the positions of Senior Vice
President, Chief Financial Officer and Treasurer and Vice President-Finance and
Controller. The business address of each prospective executive officer is 10750
Columbia Pike, Silver Spring, Maryland 20901, unless otherwise indicated.
<TABLE>
<CAPTION>
NAME AGE POSITION
- - ---- --- --------
<S> <C> <C>
Stewart Bainum, Jr................. 50 Chairman of the Board
Antonio DiRico..................... 44 President and Chief Operating Officer
Weldon Humphries................... 59 Senior Vice President, Asset Management
Kevin P. Hanley.................... 39 Senior Vice President, Real Estate and Development
Edward A. Kubis.................... 38 Senior Vice President, General Counsel and Secretary
</TABLE>
Antonio DiRico. Senior Vice President, Hotel Operations of the Company
since November 1996; Senior Vice President, Hotel Operations of MCHD from May
1992 to November 1996; Senior Vice President of Richfield Hotel Management, Inc.
and its predecessor, MHM Corporation, from May 1975 to May 1992.
Weldon Humphries. Senior Vice President, Real Estate and Development of
the Company since February 1981; Senior Vice President, Real Estate and
Development of Manor Care from August 1981 to November 1996.
Kevin P. Hanley. Vice President, Real Estate and Development of the
Company since December 1994; Executive Vice President of Hospitality Investment
Trust from September 1994 to November 1994; Senior Vice President, Development
and Acquisitions of Motel 6, L.P. from May 1992 to September 1994; various other
positions with Motel 6, L.P. since January 1987.
Edward A. Kubis. Senior Vice President, General Counsel and Secretary of
Choice since November 1996; Assistant General Counsel and Assistant Secretary,
Manor Care from December 1993 to November 1996; Senior Attorney, Real Estate,
from December 1990 to December 1993; Staff Attorney, Real Estate from June 1987
to December 1990.
For biographical information with respect to the other persons listed
above, see "Other Proposals Relating to the Annual Meeting--Proposal Five
Election of Directors."
73
<PAGE>
OTHER PROPOSAL RELATING TO THE ANNUAL MEETING
PROPOSAL FIVE: ELECTION OF DIRECTORS
ELECTION OF DIRECTORS AT THE ANNUAL MEETING
At the Annual Meeting, stockholders will elect three directors to hold
office until the 2000 Annual Meeting of stockholders and until their successors
are elected and qualified.
The names of the nominees for election as directors at the Annual Meeting
and the present directors whose terms of office do not expire in 1996 are set
forth in the following table. The Company has no reason to believe that any
nominee for election will not be able to serve as a director. However, should
any nominee become unavailable to serve, the proxies solicited hereby may be
voted for election of such other person as may be nominated by the Board of
Directors.
It is expected that in connection with the consummation of the
Distribution, Barbara Bainum, Robert C. Hazard, Jr., Gerald W. Petitt, Jerry B.
Robertson, Ph.D. and Paul A. Gould will each resign as director of the Company
effective as of the Distribution Date and become directors of Franchising. For
a discussion of the board of Directors of the Company after the Distribution,
see "The Distribution Proposals--Realco--Management of Realco." For a
discussion of the Board of Directors of Franchising after the Distribution, see
"The Distribution Proposals--Management of Franchising--Board of Directors of
Realco."
PRESENT BOARD OF DIRECTORS INCLUDING NOMINEES FOR RE-ELECTION:
<TABLE>
<CAPTION>
TERM TO DIRECTOR OF
NAME AGE POSITION EXPIRE CHOICE HOTELS SINCE
---- --- -------- ------ -------------------
<S> <C> <C> <C> <C>
NOMINEES FOR TERMS EXPIRING IN 2000:
Barbara Bainum........................................ 52 Director 2000 1996
Robert C. Hazard, Jr.................................. 61 Director 2000 1980
Frederic V. Malek..................................... 59 Director 2000 1990
DIRECTORS WHOSE TERMS EXPIRE AFTER 1997 AND WHO
ARE NOT CURRENTLY NOMINEES FOR RE-ELECTION:
Stewart Bainum........................................ 77 Director 1998 1963
Gerald W. Petitt...................................... 50 Director 1998 1981
Jerry E. Robertson, Ph.D.............................. 63 Director 1998 1989
Stewart Bainum, Jr.................................... 50 Chairman of the Board 1999 1977
and Director
William R. Floyd...................................... 52 Director 1999 1996
Paul A. Gould......................................... 50 Director 1999 1996
</TABLE>
Stewart Bainum, Jr., Chairman of the Board of the Company since November
1996; Chairman of the Board of Choice Hotels from March 1987 to June 1990;
Chairman of the Board and Chief Executive Officer of Manor Care and Manor Care
Health Services, Inc. ("MCHS") since March 1987; Chief Executive Officer of
Manor Care since March 1987 and President since June 1989; Vice Chairman of the
Board of Vitalink Pharmacy Services, Inc. ("Vitalink") since December 1994; Vice
Chairman of the Board of Manor Care and subsidiaries from June 1982 to March
1987; Director of Manor Care since August 1981, of Vitalink since September
1991, of MCHS since 1976 and of Choice Hotels since 1977; Chief Executive
Officer of MCHS since June 1989 and President from May 1990 to May 1991;
Chairman of the Board and Chief Executive Officer of Vitalink from September
1991 to February 1995 and President and Chief Executive Officer from March 1987
to September 1991.
74
<PAGE>
Stewart Bainum. Vice Chairman of the Board of Manor Care and
subsidiaries since March 1987; Chairman of the Board of Manor Care from August
1981 to March 1987, Chief Executive Officer from July 1985 to March 1987,
President from May 1982 to July 1985; Chairman of the Board of MCHS from 1968 to
March 1987 and a Director since 1968; Director of Vitalink from September 1991
to September 1994; Chairman of the Board of Choice Hotels from 1972 to March
1987 and a Director since 1963; Chairman of the Board of Realty Investment
Company, Inc. since 1965.
Barbara Bainum. President, Secretary and Director of the Commonwealth
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).
William R. Floyd. Chief Executive Officer of the Company since
October 1996; Chief Operating Officer of Taco Bell Corp., (a subsidiary of
PepsiCo) from July 1995 to October 1996, Chief Operating Officer of KFC (a
subsidiary of PepsiCo) from August 1994 to July 1995; National Vice President of
Taco Bell Company Operations from July 1992 to August 1994, Vice President of
Taco Bell Eastern Operations from December 1990 to January 1992.
Paul Gould. Managing Director of Allen & Company Incorporated
(investment banking firm) for more than five years and other positions at Allen
& Company Incorporated since 1973. Director: Telecommunications International,
Inc., United Video Satellite Group, Inc. and National Patent Development
Corporation; Board of Trustees: The New School, The Hackley School and The
Holderness School.
Robert C. Hazard, Jr. Hotel Developer. Co-Chairman of Choice Hotels
from January 1995 to November 1996 and a Director since December 1980; Chairman
from June 1990 to January 1995 and Chief Executive Officer from December 1980 to
January 1995; President from December 1980 to June 1990. Advisory Board
Outrigger Hotels.
Frederic V. Malek. Director of Manor Care since 1990; Director of
MCHS from 1990 to February 1997; Co-Chairman of CB Commercial Real Estate Group,
since April 1989; Chairman of Thayer Capital Partners since March 1993; Campaign
Manager for Bush-Quayle '92 from January 1992 to November 1992; Vice Chairman of
NWA, Inc. (airlines), July 1990 to December 1991; Director: American Management
Systems, Inc., Automatic Data Processing Corp., FPL Group, Inc. (an affiliate of
Florida Power and Light--power company), ICF Kaiser International, Inc., Intrav,
Inc. (travel and leisure services), National Education Corporation, Northwest
Airlines and various Paine Webber mutual funds.
Gerald W. Petitt. Hotel Developer, Co-Chairman of Choice Hotels from
January 1995 to November 1996 and a Director since December 1980; President from
June 1990 to January 1995 and Chief Operating Officer from December 1980 to
January 1995.
Jerry E. Robertson, Ph.D. Director of Manor Care since 1989; Director
of MCHS from 1989 to February 1997; Retired; Executive Vice President, 3M Life
Sciences Sector and Corporate Services from November 1986 to March 1994;
Director: Allianz Life Insurance Company of North America, Cardinal Health,
Inc., Coherent, Inc., Haemonetics Corporation, Life Technologies, Inc., Medwave,
Inc., Project Hope and Steris Corporation.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE ELECTION OF ALL THE
NOMINEES NAMED HEREIN.
BOARD OF DIRECTORS AND COMMITTEES OF THE BOARD
From November 1, 1996 (the date the Manor Care Spin-off was
consummated), the Board of Directors has consisted of nine directors, four whom
were not officers or employees of the Company. for the fiscal year ended
75
<PAGE>
May 31, 1997, each of the directors attended at least 75% of the aggregate
number of meetings of the Board of Directors and all committees of the Board of
Directors on which such director served.
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.
The Finance Committee reviews the financial affairs of the Company and
recommends financial objectives, goals and programs to the Board of Directors
and to management.
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 Nominating Committee recommends to the Board of Directors the
members to serve on the Board of Directors during the ensuing year. The
Committee will not consider nominees recommended by stockholders.
COMPENSATION OF DIRECTORS
In connection with the Manor Care Spin-off, the Company adopted the
Choice Hotels International, Inc. Non-Employee Director Stock Option and
Deferred Compensation Stock Purchase Plan. Part A of the Plan provides that
eligible non-employee directors will be granted options to purchase 5,000 shares
of Common Stock on their date of election and will be granted options to
purchase 1,000 shares on their date of election in subsequent calendar years.
Part B of the Plan provides that eligible non-employee directors may elect,
prior to May 31 of each year, to defer a minimum of 25% of committee fees earned
during the ensuing fiscal year. The fees which are so deferred will be used to
purchase Common Stock on the open market within 15 days after December 1,
February 28 and May 31 of such fiscal year. Pending such purchases, the funds
will be credited to an Interest Deferred Account, which will be interest
bearing. Stock which is so purchased will be deposited in a Stock Deferred
Account pending distribution in accordance with the Plan.
Directors who are employees of the Company will receive no separate
remuneration for their services as directors. Pursuant to the Non-Employee
Director Stock Compensation Plan, eligible non-employee directors will receive
annually, in lieu of cash, restricted stock of the Company, the fair market
value of which at the time of grant will be equal to $30,000, which will
represent the Board retainer and meeting fees. In addition, all non-employee
directors will receive $1,610 per diem for Committee meetings attended, except
where the Committee meeting is on the same day as a Board meeting, and will be
reimbursed for travel expenses and other out-of-pocket costs incurred in
attending meetings.
COMPENSATION OF EXECUTIVE OFFICERS
The following tables set forth certain information concerning the
annual and long term compensation of the chairman of the board and the four
other most highly compensated executive officers of the Company (the "Named
Officers") who were employed by Manor Care or the predecessor of the Company at
May 31, 1996. In addition, information is presented with respect to certain
persons who no longer serve as officers of the Company. No information is
presented for William R. Floyd, Chief Executive Officer, or Thomas Mirgon,
Senior Vice President - Human Resources, as neither were employed by Manor Care,
the Company or its predecessor at May 31, 1996.
76
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
------------
FISCAL ANNUAL COMPENSATION STOCK OPTION ALL OTHER
-------------------
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OTHER SHARES(#)(1) COMPENSATION(2)
- - --------------------------- ---- ------ ----- ----- ------------ ---------------
<S> <C> <C> <C> <C> <C>
Stewart Bainum, Jr.(3).............. 1996 $625,102 $337,555 (5) 60,000 $33,543
Chairman and-Chief Executive
Officer 1995 572,308 343,385 (5) -- 9,000
1994 457,867(4) 274,720 (5) 40,000 14,150
Richard P. Kaden(6)................. 1996 196,603 88,471 (5) 8,000 2,925
Sr. Vice President, Franchise 1995 187,007 59,971 (5) -- 2,458
Operations 1994 133,270 0 (5) 10,000 1,868
James A. MacCutcheon(7)............. 1996 301,517 135,682 (5) 25,000 13,176
Senior Vice President, 1995 273,199 136,600 (5) -- 13,176
Chief Financial Officer and 1994 258,360 129,150 (5) 15,000 6,750
Treasurer
Donald L. Landry.................... 1996 366,702 201,686 (5) -- 5,000
President 1995 311,635 171,399 (4) 40,000 2,250
1995 275,712 144,059 (4) 25,000 3,537
Barry L. Smith...................... 1996 233,640 116,820 (5) 5,000 10,427
Sr. Vice President, Marketing 1995 221,668 104,561 (5) -- 6,750
1994 209,151 98,642 (5) 5,000 3,072
Robert C. Hazard, Jr.(8)............ 1996 403,489 201,745 (5) -- 20,932
Co-Chairman 1995 373,709 186,855 (5) -- 9,000
Choice Hotels International, Inc. 1994 346,124 173,062 (5) -- 14,150
Gerald W. Petitt(8)................. 1996 330,129 165,065 (5) -- 18,770
Co-Chairman 1995 323,553 161,776 (5) -- 9,000
Choice Hotels International, Inc. 1994 283,193 141,596 (5) -- 14,150
</TABLE>
____________________
(1) Represents options to purchase shares of Manor Care Common Stock. In
connection with the Manor Care Spin-off, options to purchase Manor
Care Common Stock were converted, in some cases 100%, to options to
purchase Company 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 Manor Care Spin-off. In the
Distribution, the options will be adjusted.
(2) Represents amounts contributed by Manor Care for fiscal years 1996,
1995 and 1994 under the Manor Care 401(k) Plan and the Non-Qualified
Savings Plan, which provide retirement and other benefits to eligible
employees, including the Named Officers. Amounts contributed in cash
or stock by Manor Care during fiscal year 1996 under the Manor Care
401(k) Plan for the Named Officers were as follows: Mr. Bainum, Jr.,
$9,000; Mr. Landry, $1,752; Mr. Kaden, $977; Mr. MacCutcheon, $4,410;
and Mr. Smith, $3,489. Amounts contributed in cash or stock by Manor
Care during fiscal year 1996 under the Manor Care Non-Qualified
Savings Plan for the Named Officers were as follows: Mr. Bainum, Jr.,
$24,543; Mr. Landry, $3,498; Mr. Kaden, $1,948; Mr. MacCutcheon,
$8,766; and Mr. Smith, $6,938.
(3) As of the end of the fiscal year 1996, Mr. Bainum, Jr. was Chairman
and Chief Executive Officer of Manor Care and Choice Hotels. On
November 1, 1997, Mr. Bainum, Jr. resigned as Chief Executive Officer
of Choice Hotels. The compensation received for services rendered to
both Choice Hotels and Manor Care.
(4) Mr. Bainum, Jr. took an unpaid leave of absence during April and May
1994.
(5) The value of perquisites and other compensation does not exceed the
lesser of $50,000 or 10% of the amount of annual salary and bonus paid
as to any of the Named Officers.
(6) Mr. Kaden resigned from the Company on November 29, 1996.
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(7) As of the end of the fiscal year 1996, Mr. MacCutcheon was Senior Vice
President, Chief Financial Officer and Treasurer of Manor Care and
Choice Hotels. On November 1, 1996, Mr. MacCutcheon resigned from his
position at Manor Care and assumed the position of Executive Vice
President and Chief Financial Officer of the Company. The compensation
reflected here is total compensation received for services rendered to
both Choice Hotels and Manor Care.
(8) Mr. Hazard and Mr. Petitt served as Co-Chairmen of Choice Hotels from
January 1995 to May 31, 1996. Prior to January 1, 1995, Mr. Hazard
served as Chairman and Chief Executive Officer of Choice Hotels and
Mr. Petitt served as President and Chief Operating Officer of Choice
Hotels. Neither Mr. Hazard nor Mr. Petitt continue to serve as
executive officers of the Company.
The following tables set forth certain information at May 31, 1996 and
for the fiscal year then ended concerning options to purchase Manor Care Common
Stock granted to the Named Officers. All Common Stock figures and exercise
prices have been adjusted to reflect stock dividends and stock splits effective
in prior fiscal years. In connection with the Manor Care Spin-off, existing
Manor Care stock options, which are shown here, were converted, in some cases
100%, to options to purchase Company Common Stock.
MANOR CARE STOCK OPTION GRANTS IN FISCAL 1996
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
----------------------------------------------
PERCENTAGE OF POTENTIAL REALIZABLE VALUE OF
TOTAL OPTIONS ASSUMED RATE OF STOCK PRICE
NUMBER OF GRANTED TO ALL EXERCISE BASE APPRECIATION FOR OPTION TERM(2)
OPTIONS EMPLOYEES IN PRICE EXPIRATION
NAME GRANTED(1) FISCAL YEAR 1996 PER SHARE DATE 5%(3) 10%(4)
---- ---------- ---------------- --------- ---- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Stewart Bainum, Jr.(5)..... 60,000 10.5% $30.31 6/21/2005 $1,143,600 2,898,606
Richard P. Kaden (5)....... 8,000 1.4% 30.31 6/21/2005 152,480 386,480
Donald J. Landry........... ___ ___ ___ ___ ___ ___
James A. MacCutcheon(5).... 25,000 4.4% 30.31 6/21/2005 476,500 1,207,750
Barry Smith(5)............. 5,000 0.9% 30.31 6/21/2005 95,300 241,550
Robert C. Hazard, Jr....... ___ ___ ___ ___ ___ ___
Gerald W. Petitt........... ___ ___ ___ ___ ___ ___
</TABLE>
__________________
(1) In connection with the Manor Care Spin-off, the options to purchase
Manor Care Common Stock, which are shown here, were converted, in some
cases 100%, to options to purchase Company 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 Manor Care
Spin-off. In the Distribution, the options will be adjusted.
(2) The dollar amounts under these columns are the result of calculations
at the 5% and 10% rates set by the Securities and Exchange Commission
and therefore are not intended to forecast future possible
appreciation, if any, of the stock price. Since options are granted at
market price, a zero percent gain in the stock price will result in no
realizable value to the optionees.
(3) A 5% per year appreciation in stock price from $30.31 per share yields
$49.37.
(4) A 10% per year appreciation in stock price from $30.31 per share
yields $78.62.
(5) The options granted to the officers vest at the rate of 20% per year
on the first through the fifth anniversary of the date of the stock
option grant.
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AGGREGATE OPTION EXERCISES IN FISCAL 1996
AND YEAR-END OPTION VALUES(1)
<TABLE>
<CAPTION>
SHARES NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
ACQUIRED ON OPTIONS AT MAY 31, 1996 IN-THE-MONEY OPTIONS AT
------------------------------
EXERCISE VALUE REALIZED EXERCISABLE UNEXERCISABLE MAY 31, 1996 (2)
----------------------------
NAME # $ # # EXERCISABLE UNEXERCISABLE
---- -------- -------------- ---------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Stewart Bainum, Jr............ -- -- 635,500 229,500 $17,236,482 $ 4,684,465
Richard P, Kaden.............. -- -- 2,166 15,834 39,659 212,949
Donald J. Landry.............. -- -- 37,000 148,000 810,190 2,668,992
James A. MacCutcheon.......... 16,500 $510,180 84,250 118,250 2,399,197 3,359,956
Barry Smith................... 12,600 334,880 -- 54,100 -- 1,334,179
Robert C. Hazard, Jr.......... -- -- 78,000 34,500 2,281,721 1,034,130
Gerald W. Petitt.............. 18,300 536,119 39,500 34,500 1,184,330 10,034,130
</TABLE>
(1) Represents options to purchase shares of Manor Care Common Stock. In
connection with the Manor Care Spin-off, the options to purchase Manor
Care Common Stock, which are shown here, were converted, in some cases
100%, to options to purchase Company 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 Manor Care
Spin-off. In the Distribution, the options will be adjusted.
(2) The closing price of Manor Care's Common Stock as reported by the New
York Stock Exchange on May 31, 1996 was $39.00. The value is
calculated on the basis of the difference between the option exercise
price and such closing price multiplied by the number of shares of
Company Common Stock underlying- the option.
EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement with Stewart
Bainum, Jr., effective November 1, 1996, providing for Mr. Bainum, Jr.'s
employment as Chairman of the Board of the Company. The agreement has a term of
three years. Either the Company or Mr. Bainum may terminate the agreement upon
thirty days' prior written notice on the first and second anniversary dates of
the agreement. The agreement provides that Mr. Bainum, Jr. will devote 25% of
his professional time to the affairs of the Company, and the remaining 75% of
his professional time to the affairs of Manor Care. The agreement provides for
a base salary of $164,088 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.
For a description of employment agreements for Messrs. Floyd,
MacCutcheon, Landry and Mirgon, see "Choice Hotels Franchising, Inc.--
Management--Employment Agreements."
CERTAIN RELATIONSHIPS AND TRANSACTIONS
In connection with the Manor Care Spin-off, the Company entered into
certain agreements with Manor Care, of which Mr. Bainum, Jr. is Chairman of the
Board and Chief Executive Officer and beneficially owns approximately 24.25% of
the outstanding Manor Care Common Stock.
MANOR CARE LEASE AGREEMENTS. The Company and Manor Care entered into
a lease agreement with respect to the complex in Silver Spring, Maryland at
which the Company's principal executive offices are located (the "Silver Spring
Lease"). Pursuant to the Silver Spring Lease, the Company leases from Manor Care
for a period of 30 months certain office space (approximately 30% of the complex
initially, with provisions to allow the Company to use additional square footage
as needed) at a monthly rental rate equal to one-twelfth of the operating
expenses (as defined therein) of the complex net of third party rental income
paid to Manor Care by other tenants of the complex, less a pro rata portion of
the operating expenses attributable to the space occupied by Manor Care
(initially approximately 29% of the complex). At the beginning of each fiscal
year following the November 1 ( the
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date of the Manor Care distribution) date, Manor Care's occupancy percentage is
redetermined. Operating expenses include all of the costs associated with
operating and maintaining the complex including, without limitation, supplies
and materials used to maintain the complex, wages and salaries of employees who
operate the complex, insurance for the complex, costs of repairs and capital
improvements to the complex, the fees of the property manager (which may be
Manor Care), costs and expenses associated with leasing space at the complex and
renovating space rented to tenants, costs of environmental inspection, testing
or cleanup, principal and interest payable on indebtedness secured by mortgages
against the complex, or any portion thereof, and charges for utilities, taxes
and facilities services. The Company and Manor Care also entered into (i) a
sublease agreement with respect to certain office space in Gaithersburg,
Maryland (the "Gaithersburg Lease") pursuant to which the Company is obligated
to rent from Manor Care, on terms similar to the Silver Spring Lease, certain
additional space as such space becomes available during the 30 month period
following the date of the Manor Care Spin-off and (ii) a sublease agreement with
respect to the Comfort Inn N.W., Pikesville, Maryland, pursuant to which the
Company subleases the property from Manor Care on the same terms and conditions
that govern Manor Care's rights and interests under the lease relating to such
property.
THE MANOR CARE LOAN AGREEMENT. On November 1, 1996, the Company and
a subsidiary of Manor Care entered into a loan agreement (the "Loan Agreement"),
governing the repayment by the Company of an Aggregate of $225.7 million
previously advanced to the Company by Manor Care. The Loan Agreement contains a
number of covenants that, among other things, restrict the ability of the
Company and its subsidiaries to make certain investments, incur debt, change its
line of business, dispose of assets, create liens, enter into transactions with
affiliates and otherwise restrict certain corporate activities. The Loan
Agreement also restricts the Company's ability to pay dividends. In addition,
the Loan Agreement contains, among other financial covenants, requirements that
the Company maintain specified financial ratios, including minimum net worth,
maximum leverage and minimum interest coverage. Interest on the amount of the
loan is payable semiannually at a rate of 9% per annum. The loan will mature on
November 1, 1999 and may be prepaid in whole or in part, together with accrued
interest, at the option of the Company. If prepayment is made on or before
November 1, 1997, the Company will pay a penalty equal to the difference between
the stated interest rate and the annualized interest rate on a U.S. Treasury
Note or Bill for a relevant period until November 1, 1997. If prepayment is made
after November 1, 1997, there is no penalty. The Company will be required to
repay the loan with the proceeds from the monetization of Company-owned hotels.
On April 23, 1997, the Company, through its wholly-owned subsidiary
First Choice Properties, completed an offering of the Mortgage Securities. The
net proceeds of $110 million from the offering were used to prepay a portion of
the loan from Manor Care. A total yield maintenance payment of $1.9 million will
be made to Manor Care as a result of the prepayment.
CORPORATE SERVICES AGREEMENT. The Company and Manor Care entered
into the Corporate Services Agreement (the "Corporate Services Agreement") which
provides for the provision, by Manor Care, of certain corporate services,
including administrative, accounting, systems and, for a fixed annual fee of
$1.0 million, certain consulting services.
TIME SHARING AGREEMENT. On October 10, 1996, the Company entered into
a Time Sharing Agreement with Manor Care under which the Company has the right
to lease from time to time a Cessna Citation VI owned by Wilderness Investment
Company, Inc., a corporation which is solely owned by Stewart Bainum at the rate
of $1,150 per flight hour. During the 1996 fiscal year, the Company incurred a
total of $100,631 for aircraft usage pursuant to the Lease.
In the opinion of management, the foregoing transactions were on terms
at least as advantageous to the Company as could have been obtained from non-
affiliated persons.
SECURITY OWNERSHIP OF PRINCIPAL STOCKHOLDERS AND MANAGEMENT
The following table sets forth the amount of Company Common Stock
beneficially owned by (i) each director of the Company , (ii) the chief
executive officer of the Company and the Named Officers, (iii) all officers and
directors of the Company as a group and (iv) all persons who own beneficially
more than 5% of the Company Common Stock. Unless otherwise specified, the
address for each of them is 10750 Columbia Pike, Silver Spring, Maryland 20901.
On the Distribution Date, the holders of Company Common Stock as of the Record
Date will be entitled to receive one share of Franchising Common Stock for each
share of Company Common Stock.
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<TABLE>
<CAPTION>
TOTAL SHARES OF PERCENT OF SHARES
COMPANY COMMON OUTSTANDING
STOCK EXPECTED TO BE EXPECTED TO BE
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED BENEFICIALLY OWNED
- - ------------------------ ------------------ ------------------
<S> <C> <C>
Stewart Bainum, Jr......................... 15,993,471(2) 26.19%
Stewart Bainum............................. 10,657,122(3) 17.45%
Barbara Bainum.............................. 5,520,867(4) 9.04%
William R. Floyd............................ 85,570(5) *
Paul A. Gould............................... 2,844(6) *
Robert C. Hazard, Jr........................ 40,756(7) *
Donald J. Landry............................ 207,756(8) *
James A. MacCutcheon........................ 180,545(9) *
Frederic V. Malek........................... 5,510(10) *
Thomas Mirgon............................... 0 *
Gerald W. Petitt............................ 86,281(11) *
Jerry E. Robertson, Ph.D.................... 20,824(12) *
Barry L. Smith.............................. 243,734(13) *
All Directors and Officers as a Group *
(17 persons)................................ 33,072,267(14) 54.12%
Bruce Bainum................................ 5,512,302(15) 9.03%
Ronald Baron................................ 11,708,883(16) 19.18%
</TABLE>
____________________
(1) Percentages are based on 61,068,547 shares outstanding on May 1, 1997 plus,
for each person, the shares which would be issued assuming, that such
person exercises all options it holds which are exercisable at May 1, 1997
or become exercisable within 60 days thereafter.
(2) Includes 549,152 shares owned directly by the Stewart Bainum, Jr.
Declaration of Trust dated March 13, 1996, the sole trustee and beneficiary
of which is the reporting person. Also includes 5,417,761 shares owned by
Bainum Associates Limited Partnership ("Bainum Associates") and 4,415,250
shares owned by MC Investments Limited Partnership ("MC Investments"), in
both of which Mr. Bainum, Jr. is managing general partner with the sole
right to dispose of the shares; 3,567,869 shares held directly by Realty
Investment Company, Inc. ("Realty"), a real estate management and
investment company in which Mr. Bainum, Jr. has shared voting authority;
1,779,628 shares owned by Mid Pines Associates Limited Partnership ("Mid
Pines"), in which Mr. Bainum, Jr. is managing general partner and has
shared voting authority and 10,600 shares owned by the Foundation for
Maryland's Future, in which Mr. Bainum, Jr. is the sole director. Also
includes 251,000 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 May 1, 1997, and 1,504 and 707 shares,
respectively, which Mr. Bainum, Jr. has the right to receive upon
termination of his employment with the Company pursuant to the terms of the
Choice Hotels International, Inc. Retirement Savings and Investment Plan
("401(k) Plan") and the Choice Hotels International, Inc. Non-Qualified
Retirement Savings and Investment Plan ("Non-Qualified Savings Plan").
(3) Includes 3,906,278 shares held directly by the Stewart Bainum Declaration
of Trust, of which Mr. Bainum is the sole trustee and beneficiary, his
joint interest in 1,013,167 shares owned by Bainum Associates and 1,296,281
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 1,667 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 December 31, 1996. Also includes
2,844 shares of restricted stock granted by the issuer to Mr. Bainum which
is not vested but which Mr. Bainum has the right to vote.
(4) Includes 101,013 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
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owned by Realty, in which Ms. Bainum's trust has voting stock and shares
voting authority and 70,305 shares owned by Commonweal Foundation, in which
Ms. Bainum is President and Director and has shared voting authority. Also
includes 2,052 shares of restricted stock issued to Ms. Bainum under the
Choice Hotels International, Inc. Non-Employee Director Stock Compensation
Plan ("Non-Employee Director Stock Compensation Plan") which shares are not
vested, but which Ms. Bainum has the right to vote.
(5) Consists of restricted shares granted pursuant to Mr. Floyd's employment
agreement which are not vested, but which Mr. Floyd has the right to vote.
(6) Consists of restricted shares granted pursuant to the Non-Employee Director
Stock Compensation Plan, which are not yet vested, but which Mr. Gould has
the right to vote.
(7) Includes 32,304 shares owned directly by Mr. Hazard, 2,844 restricted
shares granted under the Company Non-Employee Director Stock Compensation
Plan which are not yet vested, but which Mr. Hazard has the right to vote,
5,000 shares which Mr. Hazard has the right to acquire pursuant to stock
options which are presently exercisable and 113 shares and 415 shares,
respectively, which Mr. Hazard has the right to receive upon termination of
his employment pursuant to the terms of the 401(k) Plan and the Non-
Qualified Savings Plan.
(8) Includes 205,866 shares which Mr. Landry has the right to acquire pursuant
to stock options which are presently exercisable or become exercisable
within 60 days of May 1, 1997 and 108 shares and 170 shares, respectively,
which Mr. Landry has the right to receive upon termination of his
employment pursuant to the terms of the 401(k) Plan and the Non-Qualified
Savings Plan.
(9) Includes 180,311 shares which Mr. MacCutcheon has the right to acquire
pursuant to stock options which are presently exercisable or become
exercisable within 60 days of May 1, 1997 and 234 shares which Mr.
MacCutcheon has the right to receive upon termination of his employment
with the Company pursuant to the terms of the 401(k) Plan.
(10) Includes 1,666 shares which Mr. Malek has the right to acquire pursuant to
stock options which are presently exercisable and 2,844 restricted shares
granted under the Non-Employee Director Stock Compensation Plan which are
not yet vested, but which Mr. Malek has the right to vote.
(11) Includes 69,776 shares held directly by Mr. Petitt, 8,661 shares held in
trust for minor children for which Mr. Petitt is trustee. Beneficial
ownership of such shares is disclaimed. Also includes 2,844 restricted
shares granted under the Non-Employee Director Stock Compensation Plan
which are not yet vested, but which Mr. Petitt has the right to vote. Also
includes, 5,000 shares which Mr. Petitt has the right to acquire pursuant
to stock options which are presently exercisable.
(12) Includes 15,500 shares owned by the JJ Robertson Limited Partnership, of
which Mr. Robertson and his wife are general partners with shared voting
authority, 2,844 restricted shares granted under the Non-Employee Director
Stock Plan, 1,666 shares which Mr. Robertson has the right to acquire
pursuant to stock options which are presently exercisable and 814 shares
acquired pursuant to the Non-Employee Director Stock Option and Deferred
Compensation Stock Purchase Plan.
(13) Includes 243,483 shares which Mr. Smith has the right to acquire pursuant
to stock options which are presently exercisable or become exercisable
within 60 days of May 1, 1997 and 86 shares and 165 shares, respectively,
which Mr. Smith has the right to receive upon termination of his employment
with the Company pursuant to the terms of the 401(k) Plan and the Non-
Qualified Savings Plan.
(14) Includes a total of 936,066 shares which the officers and directors
included in the group have the right to acquire pursuant to stock options
which are presently exercisable or which become exercisable within 60 days
of May 1, 1997 and a total of 2,238 shares and 1,673 shares, respectively,
which such directors and officers have the right to receive upon
termination of their employment with the Company pursuant to the terms of
the 401(k) Plan and the Non-Qualified Savings Plan.
(15) 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, 3,568,869 shares owned by Realty
in which Mr. Bainum's trust has voting stock and shares voting authority
and 70,305 shares
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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.
(16) As of May 13, 1997, 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.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Section 16(a) of the Exchange Act requires the Company's directors,
executive officers and holders of more than 10% of the Company's Common Stock to
file with the Commission initial reports of ownership and reports of changes in
ownership of any equity securities of the Company. The Company believes that
during the year ended May 31, 1996, its executive officers, directors and
holders of more than 10% of the Company's Common Stock complied with all Section
16(a) filing requirements.
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.
REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS
The compensation philosophy of the Company is to be competitive with the
leading service companies and selected direct competitors in the marketplace, to
attract, retain and motivate a highly qualified workforce, and to provide career
opportunities. The Company uses various compensation surveys, primarily
conducted and evaluated by independent consultants, to provide data to support
the development of competitive compensation plans which reinforce this
philosophy. Summary data on service companies of similar size participating in
each survey are utilized as the basis for the evaluations. This is the same
philosophy applied by the Compensation/Key Executive Stock Option Plan Committee
and the Compensation/Key Executive Stock Option Plan Committee No. 2 ("Committee
No. 2") of the Board of Directors (collectively, the "Committee") in determining
compensation for the CEO and executive officers. In evaluating the CEO's
performance, the Committee, in addition to financial performance, considers
factors important to the Company such as ethical business conduct, progress
against the Company's strategic plan objectives, management succession planning,
customer service satisfaction and the general overall, perception of the Company
by financial leaders and customers.
The Committee is responsible for setting and administering the policies
which govern executive compensation and the stock based programs of the Company.
The members of the Committee are Messrs. Robertson (Chairman), Bainum (not a
member of Committee No. 2), and Malek. Mr. Bainum served as Chairman and CEO
prior to March 1987.
Compensation of the Company's officers is reviewed annually by the
Committee. Changes proposed for these employees are evaluated and approved by
the Committee on an individual basis.
There are three components in the Company's executive compensation program:
1. Base salary;
2. Cash bonus; and
3. Long-term incentive compensation.
The Committee continues to believe that compensation for the CEO and other
executive officers should be weighted in favor of more "pay at risk" or
"variable pay."
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BASE SALARY
Base salary is the only component that is not variable. Scope and
complexity of the position as well as external market factors are used to
determine base salary levels. Salary changes are based on guidelines established
for all employees using individual performance to determine the change. Mr.
Bainum, Jr.'s base salary paid in fiscal 1996 is shown under the heading
"Salary" in the Summary Compensation Table.
CASH BONUS
A cash bonus based on return on beginning equity or business unit profit
and on customer satisfaction surveys of the business unit is used to focus
management's attention on profits and the effective use of Company assets.
LONG-TERM INCENTIVE COMPENSATION
Long-term compensation has been established to:
a. Focus attention on the Company's and stockholders' long term goals;
and
b. Increase ownership and retention in the Company's stock.
The Company 1996 Long-Term Incentive Plan ("Long-Term Incentive Plan")
provides the Committee with the discretion to grant Restricted Shares, Incentive
Stock Options, Non-Qualified Stock Options, Stock Appreciation Rights of
Performance Shares as it may determine to be desirable in order to recruit and
retain management and to focus the optionees on the long term goals of the
Company to be more closely aligned with the interest of stockholders.
The Committee believes the Company has an overall compensation plan which
fulfills current Company philosophy and, in addition, promotes increased
stockholder value through performance-based competition.
IMPACT OF INTERNAL REVENUE CODE SECTION 162(M)
The Omnibus Budget Reconciliation Act of 1993 disallows, effective January
1, 1994, a federal income tax deduction for compensation, other than certain
performance-based compensation, in excess of $1 million annually paid by the
Company to any currently serving Named Officer identified in the Summary
Compensation Table. With respect to the 1996 Long-Term Incentive Plan,
appropriate steps have been and will continue to be taken to qualify awards made
thereunder as performance-based compensation and thus be exempt from
consideration for purposes of calculating the one million dollar limit. Except
for William R. Floyd, no individual named in the Summary Compensation Table is
likely to receive compensation, not including performance-based compensation, in
fiscal 1997 which would be in excess of $1 million. In connection with his
employment agreement, Mr. Floyd was granted 85,470 non-performance based
restricted shares of Company Common Stock which vest in three equal annual
installments beginning November 4, 1997. Additionally, the employment agreement
provides for options to purchase 207,693 shares of Company Common Stock which
were granted outside of Long-Term Incentive Plan and which vest in five equal
annual installments beginning November 4, 1997. Upon the exercise of such
options by Mr. Floyd during any fiscal year, his gain (the difference between
the fair market value on the date of exercise and the exercise price) will be
included in calculating the compensation for that fiscal year for which the
federal income tax deduction is disallowed. The Committee intends to monitor the
Company's compensation programs with respect to such laws.
84
<PAGE>
COMPENSATION/KEY EXECUTIVE STOCK OPTION PLAN COMMITTEE
Jerry E. Robertson, Ph.D., Chairman
Stewart Bainum
Frederic V. Malek
PERFORMANCE GRAPH
The following performance graph compares the performance of the
Company Common Stock with the performance of the Standard & Poor's 500 Composite
Stock Price Index ("S&P 500 Index") and a peer group index (the "Peer Group
Index") by measuring the changes in common stock prices from November 1, 1996,
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 in
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 engage in lines of business similar to the
Company. The common stock of the following companies have been included in the
Peer Group Index:
The graph assumes that $100 was invested on November 1, 1996, in each
of Company Common Stock, the S&P 500 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 market capitalization, measured at
the beginning of each relevant time period.
COMPANY, S&P INDEX, PEER GROUP INDEX
COMPARISON OF CUMULATIVE TOTAL RETURNS
--------------------------------------
[TO BE ADDED.]
85
<PAGE>
STOCKHOLDERS PROPOSALS FOR 1998
Under the rules of the Commission, any stockholder proposal intended
for inclusion in the proxy material for the annual meeting of stockholders to be
held in 1998 must be received by the Company by , 1998 to be eligible
for inclusion in such proxy material. Proposals should be addressed to Edward A.
Kubis, Secretary, Choice Hotels International, Inc., 10750 Columbia Pike, Silver
Spring, Maryland 20901. Proposals must comply with the proxy rules of the
Commission relating to stockholder proposals in order to be included in the
proxy materials.
GENERAL
The Company's Annual Report for 1997, including consolidated financial
statements and other information (the "the Company 1997 Annual Report"),
accompanies copies of this Proxy Statement being mailed to The Company
stockholders but does not form a part of the proxy soliciting materials. A
complete list of the stockholders entitled to vote at the Company Annual Meeting
will be open and available for examination by any stockholder, for any purpose
germane to the Company Annual Meeting, between 9:00 a.m. and 5:00 p.m. at the
Company's offices at 10750 Columbia Pike, Silver Spring, Maryland 20901 from
September 5, 1997 through September 15, 1997 and at the time and the place of
the Company annual meeting.
THE COMPANY WILL PROVIDE EACH OF THE STOCKHOLDERS, WITHOUT CHARGE,
UPON THE WRITTEN REQUEST OF ANY SUCH PERSON, A COPY OF THE COMPANY'S ANNUAL
REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED MAY 31, 1996 (THE "THE COMPANY
1996 10-K"), INCLUDING THE FINANCIAL STATEMENTS AND THE FINANCIAL STATEMENT
SCHEDULES REQUIRED TO BE FILED WITH THE COMMISSION PURSUANT TO THE RULES
PROMULGATED UNDER THE EXCHANGE ACT. EXHIBITS TO THE COMPANY 1996 10-K WILL NOT
BE SUPPLIED UNLESS SPECIFICALLY REQUESTED, FOR WHICH THERE MAY BE A REASONABLE
CHARGE. THOSE STOCKHOLDERS WISHING TO OBTAIN A COPY OF THE COMPANY 1996 FORM
10-K SHOULD SUBMIT A WRITTEN REQUEST TO EDWARD A. KUBIS, SECRETARY, CHOICE
HOTELS INTERNATIONAL, INC., 10750 COLUMBIA PIKE, SILVER SPRING, MARYLAND 20901.
In addition to solicitation by mail, proxies may be solicited in
person, or by telephone or telegraph, by directors and by officers and other
regular employees of the Company. The Company has also retained to act as
solicitation agent on behalf of the Company for a fee not to exceed .
All expenses in connection with the preparation of proxy material and the
solicitation of proxies will be borne by the Company.
86
<PAGE>
INDEX TO FINANCIAL STATEMENTS
CHOICE HOTELS FRANCHISING, INC.
<TABLE>
<S> <C>
Report of Independent Public Accountants.......................................................F-2
Combined Balance Sheets as of May 31, 1995 and May 31, 1996 and February
28, 1997 (Unaudited)..........................................................................F-3
Combined Statements of Income for the fiscal years ended May 31, 1994,
May 31, 1995 and May 31, 1996, and for the nine-month periods ended
February 29, 1996 (Unaudited) and February 28, 1997 (Unaudited)...............................F-4
Combined Statements of Cash Flows for the fiscal years ended May 31, 1994,
May 31, 1995 and May 31, 1996, and for the nine-month periods ended
February 29, 1996 (Unaudited) and February 28, 1997 (Unaudited)...............................F-5
Notes to Combined Financial Statements.........................................................F-6
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Choice Hotels Franchising, Inc.:
We have audited the accompanying combined balance sheets of Choice
Hotels Franchising, Inc., as defined under "Basis of Presentation" in the Notes
to Combined Financial Statements, as of May 31, 1995 and 1996, and the related
combined statements of income and cash flows for each of the three years in the
period ended May 31, 1996. These combined financial statements are the
responsibility of Franchising's management. Our responsibility is to express an
opinion on these combined 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 combined financial position of Choice
Hotels Franchising, Inc. as of May 31, 1996 and 1995, and the combined results
of their operations and their combined cash flows for each of the three years in
the period ended May 31, 1996, in conformity with generally accepted accounting
principles.
Arthur Andersen LLP
Washington, D.C.,
May 23, 1997
F-2
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
(SEE BASIS OF PRESENTATION)
COMBINED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
MAY 31, FEBRUARY 28,
---------------------------
1995 1996 1997
---- ---- ----
(UNAUDITED)
ASSETS
<S> <C> <C> <C>
CURRENT ASSETS
Cash and cash equivalents.................................................. $ 1,056 $ 3,464 $ 1,834
Receivables (net of allowance for doubtful accounts of $3,976
$4,515, and $6,586, respectively)........................................ 17,815 25,011 19,838
Prepaid expenses........................................................... 2,153 2,912 2,125
Other...................................................................... 982 1,213 1,488
-------- -------- --------
Total current assets.................................................. 22,006 32,600 25,285
-------- -------- --------
PROPERTY AND EQUIPMENT, AT COST, NET OF ACCUMULATED DEPRECIATION.............. 62,692 31,457 30,321
-------- -------- --------
LODGING FRANCHISE RIGHTS, NET OF ACCUMULATED AMORTIZATION..................... 61,565 58,676 56,509
-------- -------- --------
INVESTMENT IN FRIENDLY HOTELS, PLC............................................ -- 17,069 16,596
-------- -------- --------
GOODWILL, NET OF ACCUMULATED AMORTIZATION..................................... 32,128 59,839 61,137
-------- -------- --------
OTHER ASSETS.................................................................. 10,636 14,517 15,613
-------- -------- --------
$189,027 $214,158 $205,461
======== ======== ========
LIABILITIES AND EQUITY
CURRENT LIABILITIES
Current portion of mortgages and long-term debt........................... $ 164 $ 167 $ 146
Accounts payable.......................................................... 40,312 15,245 30,914
Accrued expenses.......................................................... 10,688 13,232 2,159
Income taxes payable...................................................... 265 -- 3,866
-------- -------- --------
Total current liabilities............................................. 51,429 28,644 37,085
-------- -------- --------
MORTGAGES AND OTHER LONG TERM DEBT............................................ 49,505 66,448 46,223
-------- -------- --------
NOTES PAYABLE TO MANOR CARE................................................... 78,700 78,700 78,700
-------- -------- --------
DEFERRED INCOME TAXES ($12,785, $0 AND $0,
RESPECTIVELY) AND OTHER LIABILITIES......................................... 13,226 968 408
-------- -------- --------
INVESTMENTS AND ADVANCES (TO) FROM PARENT..................................... (3,833) 39,398 43,045
-------- -------- --------
$189,027 $214,158 $205,461
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these combined balance sheets.
F-3
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
(SEE BASIS OF PRESENTATION)
COMBINED STATEMENTS OF INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
----------------------------
YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
-------------------------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES
Royalty fees......................................... $ 73,961 $ 78,775 $ 89,182 $ 66,114 $ 73,367
Marketing and reservation fees....................... 72,037 80,534 93,237 68,885 72,624
European hotel operations............................ 7,237 18,638 19,609 14,594 13,255
Product sales and rentals............................ 18,554 20,520 26,693 17,837 21,507
Initial franchise fees............................... 8,571 9,301 12,253 8,994 10,176
Other................................................ 4,506 4,904 5,342 11,473 15,018
-------- -------- -------- -------- --------
Total revenues................................... 184,866 212,672 246,316 187,897 205,947
-------- -------- -------- -------- --------
OPERATING EXPENSES
Payroll and benefits................................. 42,773 49,252 57,056 43,010 49,490
Other administrative................................. 48,149 40,227 38,200 30,349 36,293
European hotel operations............................ 9,004 17,922 19,545 13,995 12,122
Product sales and rentals............................ 12,014 13,882 20,709 13,825 17,490
Advertising and marketing............................ 33,978 37,655 41,684 34,624 31,868
Depreciation and amortization........................ 10,825 11,768 11,839 9,058 7,757
Provision for asset impairment....................... -- -- 24,760 -- --
-------- -------- -------- -------- --------
Total operating expenses......................... 156,743 170,706 213,793 144,861 155,020
-------- -------- -------- -------- --------
Operating income................................. 28,123 41,966 32,523 43,036 50,927
-------- -------- -------- -------- --------
OTHER EXPENSES
Minority interest.................................... 1,476 2,200 1,532 1,149 --
Interest on Notes payable to Manor Care.............. 7,083 7,083 7,083 5,312 5,312
Interest and other................................... 3,591 3,672 2,931 2,258 2,928
-------- -------- -------- -------- --------
Total other expenses............................. 12,150 12,955 11,546 8,719 8,240
-------- -------- -------- -------- --------
Income before income taxes.............................. 15,973 29,011 20,977 34,317 42,687
Income taxes............................................ (7,372) (12,783) (9,313) (14,450) (17,578)
-------- -------- -------- -------- --------
Net income.............................................. $ 8,601 $ 16,228 $ 11,664 $ 19,867 $ 25,109
======== ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these combined statements of
income.
F-4
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
(SEE BASIS OF PRESENTATION)
COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
------------------------------
YEAR ENDED MAY 31, FEBRUARY 29, FEBRUARY 28,
----------------------------------
1994 1995 1996 1996 1997
---- ---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................................. $ 8,601 $ 16,228 $ 11,664 $ 19,867 $ 25,109
Reconciliation of net income to net cash
provided by operating activities:
Depreciation and amortization.......................... 10,825 11,768 11,839 9,058 7,757
Provision for bad debts................................ 3,192 692 685 1,715 2,457
Increase (decrease) in deferred taxes.................. 4,820 68 (13,527) (3,055) (1,927)
Provision for asset impairment......................... -- -- 24,760 -- --
Change in assets and liabilities-
Change in receivables................................. 1,750 (3,000) (7,881) 1,013 2,716
Change in prepaid expenses and other current assets... (1,448) 1,524 (990) 725 512
Change in current liabilities......................... 3,270 3,694 4,050 6,188 4,596
Change in income taxes payable........................ 107 158 (265) 1,441 3,866
Change in other liabilities........................... 1,240 6,719 2,059 (9,808) (560)
-------- -------- -------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES............. 32,357 37,851 32,394 27,144 44,526
-------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property and equipment..................... (95) (13,611) (693) (2,703) (3,060)
Acquisition of a hotel chain............................. (10,400) -- -- -- --
Purchase of minority interest............................ -- -- (55,269) (52,423) (2,494)
Investment in Friendly Hotels, PLC....................... -- -- (17,069) -- --
Other items, net......................................... (2,369) 5,878 (5,468) -- 1,106
-------- -------- -------- -------- --------
NET CASH UTILIZED IN INVESTING
ACTIVITIES............................................ (12,864) (7,733) (78,499) (55,126) (4,448)
-------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from mortgages and other long-term debt......... 5,079 15,567 17,296 -- 28,602
Principal payments of debt............................... (1,694) (13,492) (350) (1,797) (48,848)
Cash transfers (to) from Manor Care, net................. (21,159) (33,336) 31,567 31,704 (21,462)
-------- -------- -------- -------- --------
NET CASH (UTILIZED IN) PROVIDED BY
FINANCING ACTIVITIES.................................. (17,774) (31,261) 48,513 29,907 (41,708)
-------- -------- -------- -------- --------
Net change in cash and cash equivalents.................... 1,719 (1,143) 2,408 1,925 (1,630)
Cash and cash equivalents at beginning of period........... 480 2,199 1,056 1,056 3,464
-------- -------- -------- -------- --------
Cash and cash equivalents at end of period................. $ 2,199 $ 1,056 $ 3,464 $ 2,981 $ 1,834
======== ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these combined statements of cash
flows.
F-5
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
On March 7, 1996, Manor Care, Inc. ("Manor Care") announced its intention
to proceed with the separation of its lodging business from its health care
business via a spin-off of its lodging business (the "Manor Care Distribution").
On September 30, 1996 the Board of Directors of Manor Care declared a special
dividend to its shareholders of one share of common stock of the Company for
each share of Manor Care stock, and the Board set the Record Date and the
Distribution Date. The Stock Distribution was made on November 1, 1996 to
holders of record of Manor Care's Common Stock on October 10, 1996.
The Manor Care Distribution separated the lodging and health care
businesses of Manor Care into two public corporations. The operations of the
Company consist principally of the hotel franchise operations and the owned and
managed hotel operations formerly conducted by Manor Care directly or through
its subsidiaries (the "Lodging Business").
On November 1, 1996, concurrent with the Manor Care Distribution, the
Company changed its name from Choice Hotels Holdings, Inc. to Choice Hotels
International, Inc. and the Company's franchising subsidiary, formerly named
Choice Hotels International, Inc., changed its name to Choice Hotels
Franchising, Inc.
On April 29, 1997, Choice Hotels International, Inc., (the "Company")
announced its intention to proceed with the separation of its domestic lodging
business from its franchising and European hotel business via a spin-off of its
franchising business (the "Distribution"). The Company's Board of Directors
voted to approve, in principle, the Distribution subject to receipt of other
approvals and consents and satisfactory implementation of the arrangements for
the Distribution. The Company intends to consummate the Distribution in the
second quarter of fiscal year 1998 through a special dividend to its
stockholders of one share of common stock of Choice Hotels Franchising, Inc.
("Franchising") for each share of Company common stock. The Distribution is
conditional upon certain matters, including declaration of the special dividend
by the Company's Board of Directors, receipt of a ruling from the Internal
Revenue Service that the Distribution will be tax-free and approval by the
Company's shareholders of the special dividend and of the proposed reverse stock
split of the Company post-Distribution. It is anticipated that upon the
Distribution, the Company will change its corporate name (not as yet renamed,
but for purposes of these financial statements, "Realco") and Choice Hotels
Franchising, Inc. will change its name to Choice Hotels International, Inc.
As of May 31, 1996, Franchising had franchise agreements with 3,052 hotels
operating in 30 countries under the following brand names: Comfort, Clarion,
Sleep, Quality, Rodeway and Econo Lodge. Franchising also owns or manages 14
hotels in Germany, France and England. The operations of Franchising will
consist principally of the hotel franchise operations and the hotel operations
in Europe formerly conducted by the Company.
The combined financial statements present the financial position, results
of operations and cash flows of Franchising as if it were formed as a separate
entity of Manor Care which conducted the Lodging Business through November 1,
1996 and as if the Distribution of Franchising had been completed for all
periods presented. Manor Care's and the Company's historical basis in the assets
and liabilities of Franchising has been carried over to the combined financial
statements. All material intercompany transactions and balances between
Franchising and its subsidiaries have been eliminated. Changes in the
investments and advances from Parent represent the net income of the Company
plus the net change in cash transferred between the Company and Manor Care
through November 1, 1996 and the Company through February 28, 1997. The
financial statements and pro forma income per share calculations do not include
any adjustment for the effect of the proposed reverse stock split.
F-6
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
An analysis of the activity in the "Investments and advances from
Parent" account for the three years ended May 31, 1996 and the nine months ended
February 28, 1997 is as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Balance, May 31, 1993................................... $ 25,833
Cash transfers to Parent, net........................... (21,159)
Net income.............................................. 8,601
--------
Balance, May 31, 1994................................... 13,275
Cash transfers to Parent, net........................... (33,336)
Net income.............................................. 16,228
--------
Balance, May 31, 1995................................... (3,833)
Cash transfers from Parent, net......................... 31,567
Net income.............................................. 11,664
--------
Balance, May 31, 1996................................... 39,398
Cash transfers to Parent, net........................... (21,462)
Net income.............................................. 25,109
--------
Balance, February 28, 1997 (Unaudited).................. $ 43,045
========
</TABLE>
The average balance of the Investments and advances from Parent was
$19.6 million, $4.7 million, $17.8 million and $41.2 million (unaudited) for
fiscal years 1994, 1995, 1996, and the nine months ended February 28, 1997,
respectively.
PRO FORMA INCOME PER SHARE (UNAUDITED)
Per share data is not presented on a historical basis because
Franchising was not a publicly-held company during the periods presented. Pro
forma income per share for both fiscal year 1996, and the nine months ended
February 28, 1997 after giving effect to the transactions described in the pro
forma combined financial statements, would have been $0.16. The pro forma
income per common share is computed by dividing pro forma net income by the pro
forma weighted average number of outstanding common shares, aggregating 62.6
million and 62.8 million in fiscal year 1996 and the nine months ended February
28, 1997, respectively. The pro forma weighted average number of outstanding
common shares is based on the Company's weighted average number of outstanding
common shares.
CASH AND CASH EQUIVALENTS
Franchising considers all highly liquid investments 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 combined balance
sheets were:
<TABLE>
<CAPTION>
MAY 31,
--------------------
1995 1996
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Land................................................. $ 3,043 $ 3,124
Building and improvements............................ 49,145 21,907
Furniture, fixtures and equipment.................... 31,722 25,700
-------- --------
83,910 50,731
Less: Accumulated depreciation....................... (21,218) (19,274)
-------- --------
$ 62,692 $ 31,457
======== ========
</TABLE>
F-7
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
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:
<TABLE>
<S> <C>
Building and improvements........................................ 10-40 years
Furniture, fixtures and equipment................................ 3-20 years
</TABLE>
MINORITY INTEREST
Prior to May 31, 1996, certain former members of the Company's
management had a minority ownership interest in Choice Hotels Franchising, Inc.,
a majority owned subsidiary. Amounts reflected as minority interest represent
the minority owners' share of income in Choice Hotels Franchising, Inc. As of
May 31, 1996, the Company had repurchased all of the outstanding minority
ownership interest.
GOODWILL
Goodwill primarily represents an allocation of the excess purchase
price of the stock of Choice Hotels Franchising, Inc. over the recorded minority
interest. Goodwill is being amortized on a straight-line basis over 40 years.
Such amortization amounted to $343,000 in each of the years ended May 31, 1994
and 1995 and $854,000 in the year ended May 31, 1996. Goodwill is net of
accumulated amortization of $1.9 million and $2.8 million at May 31, 1995 and
1996, respectively.
FRANCHISE RIGHTS
Franchise rights are an intangible asset and represent an allocation
in purchase accounting for the value of long-term franchise contracts. The
majority of the balance resulted from the Econo Lodge and Rodeway acquisitions
made in fiscal year 1991. Franchise rights acquired are amortized over an
average life of twenty-six years. Amortization expense amounted to $2.9 million
for each of the years ended May 31, 1994, 1995 and 1996. Franchise rights are
net of accumulated amortization of $8.5 million and $11.4 million at May 31,
1995 and 1996, respectively.
SELF-INSURANCE PROGRAM
Prior to the Distribution, Franchising participated in the Company's
self-insurance program for certain levels of general and professional liability,
automobile liability and workers' compensation coverage. The estimated costs of
these programs are accrued at present values based on actuarial projections for
known and anticipated claims. All accrued self-insurance costs have been
treated as paid to the Company, and as such, amounts paid to the Company have
been charged directly to Investments and advances from Parent. Subsequent to the
Distribution, Franchising will establish and maintain its own insurance program.
Prior to the Manor Care Distribution, Franchising 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 have been treated as paid to Manor
Care, and as such, amounts paid to Manor Care have been charged directly to
Investments and advances from Parent.
FRANCHISE REVENUES
Franchising enters into numerous franchise agreements committing to
provide licensees with various marketing services, a centralized reservation
system and limited rights to utilize Franchising's registered
F-8
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
tradenames. These agreements are typically for a period of twenty years, with
certain rights to the franchisee to terminate after 10 or 15 years.
Initial franchise fees are recognized upon sale because the initial
franchise fee is non-refundable and Franchising has no continuing obligations
related to the franchisee.
Royalty fees, based on gross room revenues of each franchisee, are
recorded when earned. Reserves for uncollectible accounts are charged to bad
debt expense and included in other administrative expense in the accompanying
combined statements of income.
Franchising assesses franchisees monthly fees related to marketing and
reservations which are expended for national advertising, marketing, and selling
activities and the operation of a centralized reservation system.
IMPAIRMENT POLICY
Franchising 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.
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.
FOREIGN OPERATIONS
Franchising accounts for foreign currency translation in accordance
with SFAS No. 52, "Foreign Currency Translation." Revenues generated by foreign
operations for the fiscal years ended May 31, 1994, 1995 and 1996 were $21.2
million, $29.2 million and $29.9 million, respectively. Losses were generated
by foreign operations for the fiscal years ended May 31, 1994, 1995 and 1996 of
$5.5 million, $5.7 million and $19.3 million, respectively. Losses generated
by foreign operations for fiscal year 1996 include $15.0 million relating to a
provision for asset impairment and restructuring. The majority of the revenues
and losses of foreign operations relate to Franchising's European business
operations. Total assets relating to foreign operations were $62.6 million and
$50.9 million at May 31, 1995 and 1996, respectively. Translation gains and
losses are recorded in the cumulative translation adjustment account included in
Investments and advances (to) from Parent in the accompanying combined balance
sheets as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Balance, May 31, 1993................................... $ 352
Net adjustments......................................... (383)
-------
Balance, May 31, 1994................................... (31)
Net adjustments......................................... 740
-------
Balance, May 31, 1995................................... 709
Net adjustments......................................... (2,459)
-------
Balance, May 31, 1996................................... $(1,750)
=======
</TABLE>
F-9
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
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.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The accompanying combined balance sheet as of February 28, 1997 and
the combined statements of income and cash flows for the nine month periods
ended February 29, 1996 and February 28, 1997 have been prepared by Franchising
without audit. Certain information and footnote disclosures normally included
in financial statements presented in accordance with generally accepted
accounting principles have been omitted. Franchising believes the disclosures
made are adequate to make the information presented not misleading. In the
opinion of Franchising, the accompanying unaudited combined financial statements
reflect all adjustments, including only normal recurring adjustments, necessary
to present fairly the financial position of Franchising at February 28, 1997 and
the results of operations and cash flows for the nine months ended February 29,
1996 and February 28, 1997. Interim results are not necessarily indicative of
fiscal year performance because of the impact of seasonal variations.
INCOME TAXES
Franchising is included in the consolidated federal income tax returns
of Manor Care and the Company. The income tax provision included in the combined
financial statements reflects the historical income tax provision and temporary
differences attributable to the operations of Franchising on a separate return
basis. Deferred taxes are recorded for the tax effect of temporary differences
between book and tax income.
Income before income taxes for the fiscal years ended May 31, 1994,
1995 and 1996 were derived from the following:
<TABLE>
<CAPTION>
1994 1995 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Income before income taxes
Domestic operations.......................... $25,107 $38,385 $ 52,801
Foreign operations........................... (9,134) (9,374) (31,824)
------- ------- --------
Combined income before income taxes............ $15,973 $29,011 $ 20,977
======= ======= ========
</TABLE>
Income before income taxes for domestic operations and foreign
operations for fiscal year 1996 includes a provision of $24.7 million for asset
impairment.
The income tax provisions for fiscal years 1994, 1995 and 1996 were
accounted for under Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes." The provisions for income taxes follows for the
fiscal years ended May 31:
F-10
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
<TABLE>
<CAPTION>
1994 1995 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Current tax (benefit) expense
Federal.................................................. $ 6,659 $14,169 $20,097
Federal benefit of foreign operations.................... (3,608) (3,703) (2,792)
State.................................................... 710 2,292 3,754
Deferred tax (benefit) expense
Federal.................................................. 3,041 58 125
Federal benefit of foreign operations.................... -- -- (9,778)
State.................................................... 570 (33) (2,093)
------- ------- -------
$ 7,372 $12,783 $ 9,313
======= ======= =======
</TABLE>
Included in the 1994 tax provision is a charge of $182,000 due to the
impact of the change in the tax rates on prior periods.
Deferred tax assets (liabilities) are comprised of the following at
May 31:
<TABLE>
<CAPTION>
1994 1995 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Depreciation and amortization......................... $(13,262) $(12,755) $(1,637)
Prepaid expenses...................................... (1,412) (1,386) (1,550)
Foreign operations.................................... (710) -- --
Other................................................. (2,043) (2,165) (1,542)
-------- -------- -------
Gross deferred tax liabilities........................ (17,427) (16,306) (4,729)
-------- -------- -------
Foreign operations.................................... -- 1,086 1,931
Accrued expenses...................................... 2,854 1,343 2,065
Net operating loss.................................... 1,242 1,031 820
Other................................................. 614 61 655
-------- -------- -------
Gross deferred tax assets............................. 4,710 3,521 5,471
-------- -------- -------
Net deferred tax (liability) asset.................... $(12,717) $(12,785) $ 742
======== ======== =======
</TABLE>
A reconciliation of income tax expense at the statutory rate to income
tax expense included in the accompanying combined statements of income follows:
<TABLE>
<CAPTION>
1994 1995 1996
---- ---- ----
(IN THOUSANDS, EXCEPT FEDERAL INCOME TAX RATE)
<S> <C> <C> <C>
Federal income tax rate.......................... 35% 35% 35%
====== ======= ======
Federal taxes at statutory rate.................. $5,591 $10,154 $7,345
State income taxes, net of Federal tax benefit... 831 1,468 1,080
Minority interest................................ 517 770 536
Other............................................ 433 391 352
------ ------- ------
Income tax expense............................... $7,372 $12,783 $9,313
====== ======= ======
</TABLE>
Cash paid for state income taxes was $615,000, $549,000 and $1,421,000
for the years ended May 31, 1994, 1995 and 1996, respectively.
Consistent with the existing Company tax sharing policy, all current
Federal provision amounts have been treated as paid to, or received from, the
Company, and as such, there are no current tax provision balances due to the
Company at May 31, 1995 and 1996. Differences between amounts paid to or
received from Manor Care and the Company have been charged or credited directly
to Investments and advances from Parent.
F-11
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
ACCRUED EXPENSES
Accrued expenses at May 31, 1995 and 1996 were as follows:
<TABLE>
<CAPTION>
1995 1996
---- ----
(IN THOUSANDS)
<S> <C> <C>
Payroll............................................... $ 4,314 $ 5,665
Taxes, other than income.............................. 174 74
Other................................................. 6,200 7,493
------- -------
$10,688 $13,232
======= =======
</TABLE>
LONG TERM DEBT AND NOTES PAYABLE
Debt consisted of the following at May 31, 1995, 1996 and February 28,
1997:
<TABLE>
<CAPTION>
1995 1996 FEBRUARY 28, 1997
---- ---- ------------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C>
$250 million competitive advance and multi-
currency revolving credit facility with an average rate
of 6.12% and 5.69% at May 31, 1995 and 1996, respectively................... $ 33,262 $ 50,557 --
$100 million competitive advance and multi-
currency revolving credit facility with an average rate
of 5.54% at February 28, 1997............................................... -- -- $ 30,977
Notes payable to Manor Care, Inc. with a
rate of 9% at May 31, 1995 and 1996, respectively........................... 78,700 78,700 78,700
Capital lease obligations................................................... 14,136 13,951 13,531
Other notes with an average rate of 5.57% and 6.33%
at May 31, 1995 and 1996, respectively and 6.08% at
February 28, 1997........................................................... 2,270 2,107 1,861
------- ------- -------
Total indebtedness.......................................................... $128,368 $145,315 $125,069
======== ======== ========
</TABLE>
Maturities of debt at May 31, 1996 and February 28, 1997 were as
follows:
<TABLE>
<CAPTION>
FISCAL YEAR 1996 FEBRUARY 28, 1997
- - ----------- ---- -----------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
1997......................................................................... $ 167 $ 146
1998......................................................................... 59 36
1999......................................................................... 78,811 109,764
2000......................................................................... 232 205
2001......................................................................... 240 210
Thereafter................................................................... 65,806 14,708
-------- --------
$145,315 125,069
======== ========
</TABLE>
F-12
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
During fiscal year 1996 and through November 1, 1996, the Company was
a co-guarantor with Manor Care and other affiliates for a $250 million
competitive advance and multi-currency revolving credit facility. The facility
provided that up to $75.0 million was available in foreign currency borrowings
under the foreign currency portion of the facility. Franchising's borrowings
under this facility amounted to $50.6 million at May 31, 1996. Franchising was
charged interest for amounts borrowed under the foreign currency portion of the
facility at one of several interest rates, including LIBOR plus 26.25 basis
points. Subsequent to the Manor Care Distribution, the Company utilized its new
credit facility, as described below, to repay Franchising's portion of
borrowings under Manor Care's foreign currency portion of the facility and the
Company was released from all liabilities and guarantees relating to the Manor
Care credit facility.
On October 30, 1996, the Company entered into a $100.0 million
competitive advance and multi-currency revolving credit facility provided by a
group of seven banks. As a subsidiary of the Company, Franchising's cash
requirements and related borrowings were provided by the Company. This facility
provides that up to $75.0 million is available for borrowings in foreign
currencies. Borrowings under the facility are, at the option of the borrower,
at one of several rates including LIBOR plus from 20.0 to 62.5 basis points,
based upon a defined financial ratio and the loan type. 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 facility presently requires the Company to pay annual fees of 1/10 of 1% to
1/4 of 1%, based upon a defined financial ratio, of the total loan commitment.
The facility will terminate on October 30, 1999. On May 5, 1997, the Company
obtained additional credit from its lenders which increased the size of the
facility from $100 million to $125 million. In connection with the
Distribution, Franchising intends to secure financing to repay its portion of
borrowings under the Company's foreign currency portion of the facility as well
as to provide for seasonal cash requirements.
The Company has $225.7 million payable to Manor Care as of May 31,
1996 assumed as part of the Manor Care Distribution. The portion of this
indebtedness related to Franchise acquisitions has been pushed down to
Franchising and is reflected as Notes payable to Manor Care in the accompanying
combined balance sheets totaling $78.7 million at May 31, 1995 and 1996,
respectively. The loan will mature on November 1, 1999 and may be prepaid in
whole or in part, together with accrued interest, at the Company's option. If
the loan is prepaid prior to November 1, 1997, the Company will be required to
reimburse Manor Care on demand for any actual loss incurred or to be incurred by
Manor Care (for the period up to and including November 1, 1997) in the
redeployment of the funds released by a prepayment of the loan. The Notes
payable to Manor Care are expected to be repaid with the proceeds from operating
cash flow or with third-party financing. Interest expense on those notes for
each of the years ended May 31, 1994, 1995 and 1996 was $7.1 million. Interest
on the amount of the loan is payable quarterly at an annual rate of 9%.
Cash paid for interest was $10.7 million, $10.8 million, and $10.0
million for fiscal years 1994, 1995 and 1996, respectively.
At May 31, 1996, owned property with a net book value of $9.9 million
was pledged or mortgaged as collateral.
F-13
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
LEASES
Franchising operates certain property and equipment under leases that
expire at various dates through 2001. Future minimum lease payments are as
follows:
<TABLE>
<CAPTION>
OPERATING
LEASES
------
(IN THOUSANDS)
<S> <C>
1997........................................................................................ $209
1998........................................................................................ 173
1999........................................................................................ 144
2000........................................................................................ 34
2001........................................................................................ 20
----
Total minimum lease payments.............................................................. $580
====
</TABLE>
Rental expense under non-cancellable operating leases was $423,000 in
1994, $400,000 in 1995 and $231,000 in 1996.
ACQUISITIONS AND DIVESTITURES
On May 31, 1995, Franchising repurchased one-half of the 11% interest
held by its management in Choice Hotels Franchising, Inc. Approximately $19.8
million was allocated to goodwill; the purchase cost of $27.4 million was paid
in June and July 1995. On May 31, 1996, Franchising repurchased the remaining
5.5% minority interest in Choice Hotels Franchising, Inc. for $27.9 million.
Approximately $26.4 million was allocated to goodwill.
On May 31, 1996, the Company invested approximately $17 million in the
capital stock of Friendly Hotels, PLC ("Friendly"). In exchange for the $17
million investment, the Company received 750,000 shares of common stock and
10,000,000 newly issued immediately convertible preferred shares. In addition,
the Company granted to Friendly a Master Franchise Agreement for the United
Kingdom and Ireland in exchange for 333,333 additional shares of common stock.
At May 31, 1996, the Company owned approximately 5% of the outstanding shares of
Friendly. The preferred shares carry a 5.75% dividend payable in cash or in
stock, at the Company's option. The dividend accrues annually with the first
dividend paid on the earlier of the third anniversary of completion or on a
conversion date. The proceeds of the investment received by Friendly are to be
used to support the construction of 10 Quality or Comfort hotels. As a
condition to the investment, Choice has the right to appoint two directors to
the board of Friendly. The Company is accounting for the common stock
investment under the equity method due to its representation on Friendly's board
of directors.
TRANSACTIONS WITH REALCO
Franchising participates in a cash concentration system with the
Company and as such maintains no significant cash balances or banking
relationships. Substantially all cash received by Franchising has been
immediately deposited in and combined with the Company's corporate funds through
its cash management system. Similarly, operating expenses, capital expenditures
and other cash requirements of Franchising have been paid by the Company and
charged to Franchising. The net result of all of these intercompany
transactions are reflected in Investments and advances (to) from Parent.
Since the Manor Care Distribution, Franchising has provided certain
services to the Company including, among others, executive management, human
resources, legal, accounting, tax, information systems and certain
administrative services, as required. Also since the Manor Care Distribution,
the Company has provided services to Franchising, either directly or through the
Corporate Services Agreement with Manor Care, including, among others, cash
management, payroll and payables processing, employee benefits plans, insurance,
accounting and certain administrative services, as required. Costs associated
with the Manor Care Corporate Services Agreement as
F-14
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
well as costs of services provided by the Company to Franchising or provided by
Franchising to the Company 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, Franchising has estimated
that general and administrative expenses incurred annually will not materially
change after the Distribution.
For purposes of providing an orderly transition after the
Distribution, the Company and Franchising will enter into various agreements,
including, among others, a Distribution Agreement, Tax Sharing Agreement,
Corporate Services Agreement and Employee Benefits Allocation Agreement.
Effective at the Distribution, these agreements will provide, among other
things, that Franchising (i) will receive and/or provide certain corporate and
support services, such as accounting, tax and computer systems support, (ii)
will establish pension, profit sharing and incentive plans similar to those in
place at the Company and (iii) will receive certain risk management services and
other miscellaneous administrative services. These agreements will extend for a
maximum period of 30 months from the Distribution date or until such time as
Franchising and the Company have arranged to provide such services in-house or
through another unrelated provider of such services.
On or prior to the Distribution date, the Company and Franchising will
enter into a Strategic Alliance Agreement pursuant to which: (i) the Company
will grant a right of first refusal to Franchising to franchise any lodging
property that the Company develops or acquires and intends to franchise; (ii)
the Company will, barring a material change in market conditions, develop or
acquire 11 Sleep Inns and 15 MainStay Suite hotels within 48 months of the
Distribution Date; (iii) the Company will grant an option to Franchising to
purchase any new concepts or brands developed or acquired by the Company; (iv)
Franchising will grant to the Company an option, exercisable under certain
circumstances, to purchase the brand names, marks, franchise agreements and
other assets of the MainStay suites hotel system; (v) the Company and
Franchising will continue to cooperate with respect to matters of material
interest, including new product and concept testing for Franchising in hotels
owned by the Company; and (vi) the Company will authorize Franchising to
negotiate with third party vendors on the Company's behalf for the purchase of
certain products and services.
During the periods presented, Realco franchised substantially all of
its hotels through franchise agreements with Franchising. Total fees paid to
Franchising included in the accompanying financial statement for franchising
royalty, marketing and reservation fees were $3.3 million, $5.3 million, and
$7.5 million for the years ended May 31, 1994, 1995 and 1996, respectively.
COMMITMENTS AND CONTINGENCIES
Franchising is a defendant in a number of lawsuits arising in the
ordinary course of business. In the opinion of management and general counsel
to Franchising, the ultimate outcome of such litigation will not have a material
adverse effect on Franchising's business, financial position or results of
operations.
PENSION, PROFIT SHARING AND INCENTIVE PLANS
Bonuses accrued for key executives of Franchising under incentive
compensation plans were $2.3 million in 1994, $1.4 million in 1995 and $1.1
million in 1996.
Employees of Franchising participate in retirement plans sponsored by
the Company, and prior to the Manor Care Distribution employees participated in
retirement plans sponsored by Manor Care. Costs allocated to Franchising are
based on the size of its payroll relative to the sponsor's payroll. Costs
allocated to Franchising were approximately $776,000 in 1994, $776,000 in 1995
and $817,000 in 1996.
F-15
<PAGE>
CHOICE HOTELS FRANCHISING, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
Franchising is required to disclose the fair value of its financial
instruments in accordance with Statement of Financial Accounting Standards No.
107, "Disclosures about Fair Value of Financial Instruments." Fair values of
material balances were determined by using market rates currently available.
The balance sheet carrying amount of cash, cash equivalents and
receivables approximate fair value due to the short term nature of these items.
Mortgages and other long term debt consist of bank loans and mortgages. Interest
rates on bank loans adjust frequently based on current market rates;
accordingly, the carrying amount of bank loans is equivalent to fair value. The
carrying amounts for mortgages and Notes payable to Manor Care approximate fair
market values.
PROVISION FOR ASSET IMPAIRMENT
During fiscal year 1996, Franchising began restructuring its European
operations. This restructuring effort included the purchase of an equity
interest in Friendly Hotels, PLC and a reevaluation of key geographic markets in
Europe. In connection with this restructuring, Franchising performed a review
of its European operations and in May 1996 recognized a $15.0 million non-cash
charge (net of an $9.7 million income tax benefit) against earnings related
primarily to the impairment of assets associated with certain European hotel
operations.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
Franchising is required to adopt SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," no
later than fiscal year 1997. Franchising's current policy is to regularly
review the recoverability of the net carrying value of its long-lived assets and
make adjustments accordingly. The adoption of SFAS No. 121 did not have a
material impact on Franchising's financial statements.
Franchising is required to adopt SFAS No. 123, "Accounting for Stock-
Based Compensation," no later than fiscal year 1997. Management expects to adopt
SFAS No. 123 utilizing the method which provides for disclosure of the impact of
stock-based compensation grants. Franchising is required to adopt SFAS No. 128,
"Earnings Per Share," and SFAS No. 129, "Disclosure of Information about Capital
Structure," no later than fiscal year 1998. The adoption of these pronouncements
will not materially affect Franchising's financial statements.
F-16
<PAGE>
ANNEX A
OPINION OF AMERICAN APPRAISAL ASSOCIATES
A-1
<PAGE>
ANNEX B
FORM OF
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
OF
CHOICE HOTELS FRANCHISING, INC.
Choice Hotels Franchising, Inc. (the "Corporation"), a corporation
incorporated on June 27, 1996 and existing under and by virtue of the General
Corporation Law of the State of Delaware (the "GCL"), hereby certifies as
follows:
FIRST: The board of directors of the Corporation (the "Board of
Directors") adopted a resolution proposing and declaring advisable the following
amendments to and restatement of the Certificate of Incorporation of the
Corporation.
SECOND: This Restated Certificate of Incorporation was duly adopted
by the sole stockholder of the Corporation in accordance with the provisions of
Sections 228, 242 and 245 of the GCL.
THIRD: The text of the Certificate of Incorporation is hereby amended
and restated as herein set forth in full:
1. The name of the corporation is CHOICE HOTELS INTERNATIONAL, INC.
(the "Corporation").
2. The address of the Corporation's registered office in the State
of Delaware is 100 West Tenth Street, in the City of Wilmington, County of New
Castle. The name of its registered agent at such address is The Corporation
Trust Company.
3. The purpose of the Corporation is to engage in any lawful act or
activity for which corporations may be organized under the GCL.
4. The total number of shares of capital stock of all
classifications which the Corporation shall have authority to issue is One
Hundred Sixty-Five Million (165,000,000), of which One Hundred Sixty Million
(160,000,000) shares having a par value of One Cent ($.01) per share shall be
common stock, and Five Million (5,000,000) shares having a par value of One Cent
($.01) per share shall be preferred stock.
Shares of common stock of the Corporation may be issued from time to
time in one or more classes or series, each of which class or series shall have
such distinctive designation or title as shall be fixed by the Board of
Directors prior to the issuance of any shares thereof. Each such class or series
of common stock shall have such voting powers (full or limited) or no voting
powers, such preferences and relative participating, optional or other special
rights, relative ranking and such qualifications, limitations or restrictions,
as shall be stated in such resolution or resolutions providing for the issue of
such class or series of common stock as may be adopted from time to time by the
Board of Directors prior to the issuance of any shares thereof pursuant to the
authority hereby expressly vested in it, all in accordance with the laws of the
State of Delaware.
Without limiting the generality of the foregoing, shares of a series
of common stock consisting of Seventy Five Million (75,000,000) shares, or such
larger number of shares as the Board of Directors shall from time to time fix by
resolution or resolutions, may be issued from time to time by the Board of
Directors. Shares of this series shall be designated, and are hereinafter called
"Common Stock."
The holders of record of the Common Stock shall be entitled to the
following rights:
B-1
<PAGE>
(d) subject to the rights of any holders of any class or series
of capital stock as specified in the resolution providing for such class or
series of capital stock, to vote at all meetings of stockholders of the
Corporation, and at all such meetings such holders shall have one vote in
respect of each share of Common Stock held of record by them;
(e) subject to the rights of any holders of any class or series
of capital stock having a preference with respect to dividends, to receive when,
if and as declared by the Board of Directors out of the assets of the
Corporation legally available therefor, such dividends as may be declared by the
Corporation from time to time to holders of Common Stock; and
(f) subject to the rights of any holders of any class or series
of capital stock having a preference with respect to distribution of assets upon
liquidation or dissolution, to receive the remaining assets of the Corporation
upon liquidation, dissolution or winding-up.
Shares of preferred stock of the Corporation may be issued from time
to time in one or more classes or series, each of which class or series shall
have such distinctive designation or title as shall be fixed by the Board of
Directors prior to the issuance of any shares thereof. Each such class or
series of preferred stock shall have such voting powers (full or limited) or no
voting powers, such preferences and relative participating, optional or other
special rights, relative ranking and such qualifications, limitations or
restrictions, as shall be stated in such resolution or resolutions providing for
the issue of such class or series of preferred stock as may be adopted from time
to time by the Board of Directors prior to the issuance of any shares thereof
pursuant to the authority hereby expressly vested in it, all in accordance with
the laws of the State of Delaware.
Subject to the rights of any holders of any class or series of capital
stock, as specified in the resolution providing for such class or series of
capital stock, the holders of Common Stock are expressly denied the preemptive
right to subscribe to any or all additional shares of capital stock of the
Corporation or any or all classes or series thereof.
Upon this Restated Certificate of Incorporation becoming effective
pursuant to the GCL (the "Effective Time"), each share of the Corporation's
common stock, par value $.01 per share (the "Old Common Stock"), issued and
outstanding immediately prior to the Effective Time, will be automatically
reclassified as and converted into one share of Common Stock. Any stock
certificate that, immediately prior to the Effective Time, represents shares of
the Old Common Stock will, from and after the Effective Time, automatically and
without the necessity of presenting the same for exchange, represent the number
of shares of Common Stock as equals the sum obtained by multiplying the number
of shares of Old Common Stock represented by such certificate immediately prior
to the Effective Time by one.
5. The Corporation expressly elects not to be governed by Section 203
of the GCL.
6. Subject to the rights of any holders of any class or series of
capital stock as specified in the resolution providing for such class or series
of capital stock, any action required to be taken by the stockholders of the
Corporation must be effected at a duly called annual or special meeting of
stockholders of the Corporation and may not be effected by any consent in
writing of such stockholders in lieu of a meeting.
Special meetings of the stockholders of the Corporation may be called
only by (i) the Chairman or Vice Chairman of the Board of Directors or (ii) the
Secretary of the Corporation within 10 calendar days after receipt of the
written request of a majority of the total number of directors which the
Corporation would have if there were no vacancies (the "Whole Board").
Meetings of stockholders may be held within or without the State of
Delaware, as the Bylaws may provide. The books of the Corporation may be kept
outside the State of Delaware at such place or places as may be designated from
time to time by the Board of Directors or in the Bylaws.
B-2
<PAGE>
7. A. Subject to the rights of any holders of any class or series
of capital stock as specified in the resolution providing for such class or
series of capital stock, the business and affairs of the Corporation shall be
managed by or under the direction of the Board of Directors consisting of not
less than 3 nor more than 12 directors, the exact number of directors to be
determined from time to time solely by resolution adopted by the affirmative
vote of a majority of the Whole Board. The directors shall be divided into three
classes, designated Class I, Class II and Class III. Each Class of directors
shall consist, as nearly as may be possible, of one-third of the total number of
directors constituting the Whole Board. The initial term of the Class I
directors shall expire upon the election and qualification of their successors
at the 1997 annual meeting of stockholders; the initial term of the Class II
directors shall expire upon the election and qualification of their successors
at the 1998 annual meeting of stockholders; and the initial term of the Class
III directors shall expire upon the election and qualification of their
successors at the 1999 annual meeting of stockholders. At each annual meeting of
stockholders beginning with the 1997 annual meeting, successors to the Class of
directors whose term expires at that annual meeting shall be elected for a
three-year term and shall hold office until the annual meeting for the year in
which his or her term expires and until his or her successor shall be elected
and shall qualify, subject, however, to prior death, resignation, retirement,
disqualification or removal from office.
B. Subject to the rights of any holders of any class or series
of capital stock as specified in the resolution providing for such class or
series of capital stock, newly created directorships resulting from any increase
in the number of directors and any vacancies on the Board of Directors resulting
from death, resignation, retirement, disqualification, removal or other cause
will be filled solely by the affirmative vote of a majority of the remaining
directors then in office, even though less than a quorum of the Board of
Directors. Increases or decreases in the number of directors shall be
apportioned among the Classes so as to maintain the number of directors in each
Class as nearly equal as possible, and any additional director of any Class
elected to fill a vacancy resulting from an increase in such Class shall hold
office for a term that shall coincide with the remaining term of that Class, but
in no case will a decrease in the number of directors shorten the term of any
incumbent director.
C. The election of directors need not be by written ballot
unless the Bylaws shall so provide.
D. Notwithstanding the foregoing, whenever the holders of any
one or more series of capital stock shall have the right, voting separately as a
class or series, to elect directors, the election, removal, term of office,
filling of vacancies and other features of such directorships shall be governed
by the terms of this Restated Certificate of Incorporation applicable thereto,
and such directors so elected shall not be divided into classes pursuant to
Article 6, Section A, unless expressly provided by such terms.
8. The affirmative vote of the holders of the outstanding shares of
capital stock representing not less than two-thirds of the Voting Power (as
defined) of the Corporation shall be required for the approval of any proposal
for the Corporation to dissolve, liquidate, merge, or consolidate with any other
entity (other than an entity 90% of the Voting Power of which is owned by the
Corporation), or sell, lease or exchange all or substantially all of its
property and assets, including its goodwill and its corporate franchises.
"Voting Power" means the total number of votes that may be cast by holders of
capital stock in the election of directors.
9. The Corporation reserves the right to amend, alter, change or
repeal any provision contained in this Restated Certificate of Incorporation, in
the manner now or hereafter prescribed by statute, and all rights conferred upon
stockholders herein are granted subject to this reservation. Notwithstanding
anything contained in this Restated Certificate of Incorporation to the
contrary, the affirmative vote of the holders of the outstanding shares of
capital stock representing not less than two-thirds of the Voting Power of the
Corporation shall be required to amend, alter, change or repeal, or to adopt any
provision inconsistent with, Article 8 of this Restated Certificate of
Incorporation. The Board of Directors shall have the power to make, adopt,
alter, amend, change or repeal the Bylaws by resolution adopted by the
affirmative vote of a majority of the Whole Board. Stockholders may not make,
adopt, alter, amend, change or repeal the Bylaws except upon the affirmative
vote of the holders of the outstanding shares of capital stock representing not
less than two-thirds of the Voting Power of the Corporation and no Bylaws
hereafter adopted by the stockholders or otherwise shall invalidate any prior
act of the directors which would have been valid if such Bylaws had not been
adopted.
B-3
<PAGE>
10. A. No director of the Corporation shall be liable to the
Corporation or its stockholders for monetary damages for breach of fiduciary
duty as a director, except for liability (i) for any breach of the director's
duty of loyalty to the Corporation or its stockholders, (ii) for acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law, (iii) under Section 174 of the GCL, or (iv) for any
transaction from which the director derived an improper personal benefit. No
amendment to or repeal of this Article 10 shall apply to or have any effect on
the liability or alleged liability of any director of the Corporation for or
with respect to any acts or omissions of such director occurring prior to such
amendment or repeal. If the GCL is amended hereafter to further limit the
liability of a director, then the liability of a director of the Corporation
shall be further limited to the fullest extent permitted by the GCL, as so
amended.
B. The Corporation shall indemnify each person who is or was or
has agreed to become a director or officer of the Corporation, and may indemnify
other employees and agents of the Corporation, to the fullest extent permitted
by Section 145 of the GCL, as the same may be amended or supplemented, against
all expenses and liabilities (including, but not limited to, counsel fees)
reasonably incurred by or imposed upon such person in connection with any
proceeding to which he or she may be made a party, or in which he or she may
become involved, by reason of his or her being or having been a director,
officer, employee or agent of the Corporation, or any settlement thereof,
whether or not he or she is a director, officer, employee or agent at the time
such expenses are incurred or liability incurred, except in such cases where the
director, officer, employee or agent is adjudged guilty of willful misfeasance
or malfeasance in the performance of his or her duties; provided that in the
event of a settlement the indemnification herein shall apply only when the Board
of Directors approves such settlement and reimbursement as being for the best
interests of the Corporation. Without limiting the generality or the effect of
the foregoing, the Corporation may adopt Bylaws, or enter into one or more
agreements with any person, which provide for indemnification greater or
different than that provided in this Article 10 or the GCL and the foregoing
right of indemnification shall be in addition to and not exclusive of all other
rights to which such director, officer, employee or agent may be entitled.
C. The Corporation may purchase insurance on behalf of any
person who is a director, officer, employee or agent of the Corporation, or
is or was serving at the request of the Corporation as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise against any liability asserted by him or her and incurred by
him or her in any such capacity, or arising out of his or her status as such,
whether or not the Corporation would have the power or the obligation to
indemnify him or her against such liability under the provisions of this Article
10.
11. The Board of Directors, each committee of the Board of Directors
and each individual director, in discharging their respective duties under
applicable law and this Restated Certificate of Incorporation and in determining
what they each believe to be in the best interests of the Corporation and its
stockholders, may consider the effects, both short-term and long-term, of any
action or proposed action taken or to be taken by the Corporation, the Board of
Directors or any committee of the Board of Directors on the interests of (i) the
employees, franchisees, licensees, customers, suppliers and/or creditors of the
Corporation and its subsidiaries and (ii) the communities in which the
Corporation and its subsidiaries own or lease property or conduct business, all
to the extent that the Board of Directors, any committee of the Board of
Directors or any individual director deems pertinent under the circumstances;
provided, however, that the provisions of this Article 11 shall not limit in any
way the right of the Board of Directors to consider any other lawful factors in
making its determinations, including, without limitation, the effects, both
short-term and long-term, or any action or proposed action on the Corporation or
its stockholders directly; and provided further that this Article 11 shall be
deemed solely to grant discretionary authority to the Board of Directors, each
committee of the Board of Directors and each individual director and shall not
be deemed to provide to any specific constituency any right to be considered.
12. Whenever a compromise or arrangement is proposed between this
Corporation and its creditors or any class of them and/or between this
Corporation and its stockholders or any class of them, any court of equitable
jurisdiction within the State of Delaware may, on the application in a summary
way of this Corporation or of any creditor or stockholder thereof or on the
application of any receiver or receivers appointed for this Corporation under
the provisions of Section 291 of the GCL or on the application of trustees in
dissolution or of any receiver or receivers appointed for this Corporation under
the provisions of Section 279 of the GCL, order a meeting of the
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<PAGE>
creditors or class of creditors, and/or of the stockholders or class of
stockholders of this Corporation, as the case may be, to be summoned in such
manner as the said court directs. If a majority in number representing three-
fourths in value of the creditors or class of creditors, and/or of the
stockholders or class of stockholders of this Corporation, as the case may be,
agree to any compromise or arrangement and to any reorganization of this
Corporation as consequence of such compromise or arrangement, the said
compromise or arrangement and the said reorganization shall, if sanctioned by
the court to which the said application has been made, be binding on all the
creditors or class of creditors, and/or on all the stockholders or class of
stockholders, of this Corporation, as the case may be, and also on this
Corporation.
IN WITNESS WHEREOF, the Corporation has caused this Restated
Certificate of Incorporation to be duly executed in its corporate name.
Dated: , 1997
________________________________________
Name: Stewart Bainum, Jr.
Chairman
B-5
<PAGE>
ANNEX C
FORM OF
BYLAWS OF
CHOICE HOTELS FRANCHISING, INC.
C-1
<PAGE>
CHOICE HOTELS INTERNATIONAL, INC.
PROXY SOLICITED BY THE BOARD OF DIRECTORS
FOR ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD SEPTEMBER 16, 1997
The undersigned hereby appoints William R. Floyd Jr. and James A.
MacCutcheon, and each of them, his or her attorneys and agents, with full power
or substitution to vote as proxy for the undersigned, as herein stated, at the
Annual Meeting of Shareholders of Choice Hotels International, Inc. (the
"Company") to be held on September 16, 1997 at 9:00 a.m. in the auditorium
located at 11555 Darnestown Road, Gaithersburg, Maryland and at any adjournment
thereof, according to the number of votes the undersigned would be entitled to
vote if personally present on the proposals set forth below and in accordance
with their discretion on any other matters that may properly come before the
meeting or any adjournment thereof.
DISTRIBUTION PROPOSALS:
- - --------------------------------------------------------------------------------
PROPOSALS ONE THROUGH FOUR LISTED BELOW CONSTITUTE THE "DISTRIBUTION PROPOSALS."
THE EFFECTIVENESS OF EACH OF THE DISTRIBUTION PROPOSALS IS CONDITIONED UPON THE
APPROVAL OF ALL OF THE DISTRIBUTION PROPOSALS. ACCORDINGLY, FAILURE OF THE
SHAREHOLDERS TO APPROVE ANY ONE OR MORE OF THE DISTRIBUTION PROPOSALS WILL
RESULT IN THE INEFFECTIVENESS OF ALL OF THE DISTRIBUTION PROPOSALS.
- - --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT SHAREHOLDERS VOTE
FOR ALL OF THE DISTRIBUTION PROPOSALS.
(INSTRUCTION: Shareholders may vote on the Distribution Proposals
either as a group or for each Distribution Proposal separately. To vote on the
Distribution Proposals separately, mark the appropriate box set forth under each
numbered Distribution Proposal One through Four. To vote on the Distribution
Proposals as a group, mark the appropriate box set forth immediately below.)
FOR all Distribution Proposals [_] AGAINST all Distribution Proposals [_]
ABSTAIN [_]
(INSTRUCTION: If you have elected to vote on the Distribution
Proposals as a group by checking the appropriate box set forth above, you need
not (and should not) vote on the Distribution Proposals separately and may
proceed directly to the section of the Proxy Card captioned "Additional
Proposals." All proxies in which a shareholder has elected to vote on the
Distribution Proposals as a group will be voted in accordance with such vote,
whether or not Distribution Proposals as a group will be voted in accordance
with such vote, whether or not votes are registered for each Distribution
Proposal separately.)
PLEASE SIGN AND DATE ON PAGE 3
<PAGE>
1. PROPOSAL ONE: Ratification of a special dividend, consisting of the
distribution (the "Distribution") to the holders of the Company's outstanding
shares of common stock, par value $.01 per share (the "Company Common
Stock"), on a share-for-share basis of all outstanding shares of common
stock, par value $.01 per share (the "Franchising Common Stock"), of the
Company's wholly-owned subsidiary, Choice Hotels Franchising, Inc.
("Franchising"), and the related arrangements between the Company and
Franchising, and the policies to be adopted by such companies, in connection
therewith.
FOR [_] AGAINST [_] ABSTAIN [_]
2. PROPOSAL TWO: Approval of the amendment of the Certificate of Incorporation
of the Company to (i) change the name of the Company to , (ii)
decrease the number of authorized shares of Company Common Stock from
160,000,00 to 60,000,000, and (iii) to effect a one-for-three reverse stock
split of Company Common Stock whereby every three shares of Company Common
Stock would be aggregated into one share of Company Common Stock (the
"Reverse Stock Split").
FOR [_] AGAINST [_] ABSTAIN [_]
3. PROPOSAL THREE: Ratification of the election by the Company, as sole
stockholder of Franchising, of 9 directors of Franchising specified in the
Proxy Statement, who will be divided into three classes, the initial terms of
which will expire in 1998, 1999 and 2000.
FOR [_] AGAINST [_] ABSTAIN [_]
4. PROPOSAL FOUR: Ratification of adoption by Franchising of the Franchising
Stock Incentive Plan and the Franchising Employee Stock Purchase Plan.
FOR [_] AGAINST [_] ABSTAIN [_]
ADDITIONAL PROPOSAL:
- - --------------------------------------------------------------------------------
PROPOSAL FIVE LISTED BELOW CONSTITUTES THE "ADDITIONAL PROPOSAL." THE
EFFECTIVENESS OF THE ADDITIONAL PROPOSAL IS NOT CONDITIONED ON THE APPROVAL
OF THE DISTRIBUTION PROPOSALS.
- - --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT SHAREHOLDERS VOTE FOR
PROPOSAL FIVE.
5. PROPOSAL FIVE: The election of three directors to hold office until the 2000
Annual Meeting of Stockholders and until their successors are elected and
qualified.
FOR all nominees listed below WITHHOLD AUTHORITY
(except as marked to the contrary) [_] to vote for all nominees listed
below [_]
Nominees: Barbara Bainum; Robert C. Hazard, Jr.; and Frederic V. Malek
(INSTRUCTION: To withhold your vote for any individual nominee, write that
nominee's name in the space provided 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 a
Distribution Proposal, or Proposal
2
<PAGE>
Five, such proxies will be voted in accordance with the Boar of Directors'
recommendations as set forth herein with respect to such proposal(s).
If you plan to attend the Annual Meeting of Shareholders, please mark the
following box and promptly return this Proxy Card. [_]
PLEASE FILL IN DATE, SIGN AND RETURN
THIS PROXY IN THE ACCOMPANYING
ENVELOPE
Dated: , 1997
Signature___________________________
Signature___________________________
Signatures of shareholders should
correspond exactly with the names
shown on the Proxy Card. Attorneys,
trustees, executors, administrators,
guardians and others signing in a
representative capacity should
designate their full titles. If a
corporation, please sign in full
corporate name by President or other
authorized officer. If a
partnership, please sign in
partnership names by authorized
persons.
3
