CHOICE HOTELS INTERNATIONAL INC /DE, 424B1, 1998-10-19

CHOICE HOTELS INTERNATIONAL INC /DE
424B1, 1998-10-19
HOTELS & MOTELS

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Filed Pursuant to Rule 424(b)(1)
Registration No. 333-62543

PROSPECTUS
OFFER TO EXCHANGE

7.125% SENIOR NOTES DUE 2008 FOR ALL OUTSTANDING
7.125% SENIOR NOTES DUE 2008
OF
CHOICE HOTELS INTERNATIONAL, INC.

THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME ON
NOVEMBER 19, 1998, UNLESS EXTENDED.
Choice Hotels International, Inc., a Delaware corporation (the "Company" or
"Choice") hereby offers (the "Exchange Offer"), upon the terms and subject to
the conditions set forth in this Prospectus and the accompanying Letter of
Transmittal (the "Letter of Transmittal"), to exchange its outstanding 7.125%
Senior Notes due 2008 (the "Original Notes"), of which an aggregate of
$100,000,000 in principal amount is outstanding as of the date hereof, for an
equal principal amount of newly issued 7.125% Senior Notes due 2008 (the
"Exchange Notes"), which exchange has been registered under the Securities Act
of 1933, as amended (the "Securities Act") pursuant to a registration
statement of which this Prospectus is a part (the "Registration Statement").
The form and terms of the Exchange Notes will be the same as the form and
terms of the Original Notes except that (i) the Exchange Notes will be
registered under the Securities Act and hence will not bear legends
restricting the transfer thereof, and (ii) the holders of Exchange Notes will
not be entitled to certain rights of holders of Original Notes under the
Registration Agreement (as defined) which rights will terminate upon the
consummation of the Exchange Offer. The Exchange Notes will evidence the same
debt as the Original Notes (which they replace) and will be entitled to the
benefits of an indenture dated as of May 4, 1998 by and among Choice, Quality
Hotels Europe, Inc. ("QHE"), a wholly owned subsidiary of the Company, QH
Europe Partnership ("QHE Partnership"), a general partnership whose
partnership interests are held by the Company and QHE, and Marine Midland
Bank, as trustee (the "Trustee") governing the Original Notes and the Exchange
Notes (the "Indenture"). The Indenture provides for the issuance of both the
Exchange Notes and the Original Notes. The Exchange Notes and the Original
Notes are sometimes referred to herein collectively as the "Notes." See "The
Exchange Offer" and "Description of Exchange Notes."

The Exchange Notes will mature on May 1, 2008 and will bear interest at the
rate of 7.125% per annum from their date of issuance. Interest on the Exchange
Notes will be payable semiannually on May 1 and November 1 of each year,
commencing November 1, 1998. Interest on the Original Notes accepted for
exchange will cease to accrue upon issuance of the Exchange Notes. Interest
accrued on the exchanged Original Notes from the most recent date to which
interest has been paid or duly provided for on such Original Notes or, if no
interest has been paid or duly provided for, from May 4, 1998, through, but
not including the Rate the Exchange Notes are issued, will be paid with the
first interest payment on the Exchange Notes. The Exchange Notes may be
redeemed at any time at the option of the Company, in whole or in part at any
time or from time to time, at a price equal to 100% of the principal amount
thereof plus accrued interest to the date of redemption plus a Make-Whole
Premium (as defined), if any, relating to the then-prevailing Treasury Yield
(as defined) and the remaining life of the Exchange Notes. The Original Notes
were issued by Choice in an offering (the "Offering") of the Original Notes,
consummated on May 4, 1998.

The Original Notes are, and the Exchange Notes will be, senior unsecured
obligations of the Company, ranking pari passu with all existing and future
senior debt of the Company and senior in right of payment to all future
subordinated debt of the Company. The Original Notes are, and the Exchange
Notes will be, guaranteed on a senior unsecured basis by QHE, QHE Partnership,
and, under certain circumstances, by other subsidiaries of the Company
(collectively, the "Subsidiary Guarantors"). The Indenture contains no limits
on the amount of debt that may be incurred by the Company and its
subsidiaries.
(continued on next page)
----------
SEE "RISK FACTORS" BEGINNING ON PAGE 14 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED IN CONNECTION WITH THE EXCHANGE OFFER AND AN
INVESTMENT IN THE EXCHANGE NOTES.

----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.

----------
The date of this Prospectus is October 19, 1998.
<PAGE>

(continued from previous page)

The Company will accept for exchange any and all validly tendered Original
Notes not withdrawn on or prior to 5:00 p.m., New York City time, on November
19, 1998, unless the Exchange Offer is extended by the Company in its sole
discretion (if and as extended, the "Expiration Date"). Tenders of Original
Notes may be withdrawn at any time prior to 5:00 p.m., New York City time, on
the Expiration Date. The Exchange Offer is not conditioned upon any minimum
principal amount of Original Notes being tendered for exchange. The Original
Notes may be tendered only in integral multiples of $1,000. In the event the
Company terminates the Exchange Offer and does not accept for exchange any
Original Notes, the Company will promptly return all previously tendered
Original Notes to the Holders thereof. The Exchange Offer is subject to
customary conditions. See "The Exchange Offer--Conditions."

Based upon an interpretation by the staff of the Commission set forth in
certain no-action letters issued to third parties, the Company believes that a
holder (other than (i) a broker-dealer who purchases Exchange Notes directly
from the Company to resell pursuant to Rule 144A or any other available
exemption under the Securities Act or (ii) any such holder that is an
"affiliate" of the Company within the meaning of Rule 405 under the Securities
Act) who exchanges Original Notes for Exchange Notes in the ordinary course of
business and who is not participating, does not intend to participate, and has
no arrangement with any person to participate, in a distribution of the
Exchange Notes, will be allowed to resell Exchange Notes to the public without
further registration under the Securities Act and without delivering the
purchasers of the Exchange Notes a prospectus that satisfies the requirements
of Section 10 of the Securities Act. However, if any holder acquires Exchange
Notes in the Exchange Offer for the purpose of distributing or participating
in the distribution of the Exchange Notes or is a broker-dealer, such holder
cannot rely on the position of the staff of the Commission enumerated in
certain no-action letters issued to third parties and must comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with any resale transaction, unless an exemption from registration
is otherwise available. Each broker-dealer that receives Exchange Notes for
its own account pursuant to the Registered Exchange Offer, must acknowledge
that it will deliver a prospectus in connection with any resale of such
Exchange Notes. The Letter of Transmittal states that by so acknowledging and
by delivering a prospectus, a broker-dealer will not be deemed to admit that
it is an "underwriter" within the meaning of the Securities Act. This
Prospectus, as it may be amended or supplemented from time to time, may be
used by a broker-dealer in connection with resales of Exchange Notes received
in exchange for Original Notes where such Exchange Notes were acquired by such
broker-dealer as a result of market-making or other trading activities.
Pursuant to the Registration Agreement, the Company and the Subsidiary
Guarantors have agreed to make this Prospectus, as it may be amended or
supplemented from time to time, available to broker-dealers for use in
connection with any resale starting on the date hereof and ending on the close
of business on the earlier to occur of (i) the date on which all Exchange
Notes held by broker-dealers eligible to use the Prospectus to satisfy their
prospectus delivery obligations under the Securities Act have been sold and
(ii) the date 180 days after the Expiration Date. See "Plan of Distribution."

Prior to the Exchange Offer, there has been no public market for the
Exchange Notes. There can be no assurance as to the liquidity of any market
that may develop for the Exchange Notes, the ability of holders to sell the
Exchange Notes or the price at which holders would be able to sell the
Exchange Notes. The Company does not intend to list the Exchange Notes for
trading on any national securities exchange or over-the-counter market system.
Future trading prices of the Exchange Notes will depend on many factors,
including among other things, prevailing interest rates, the Company's
operating results and the market for similar securities. See "Risk Factors--
Lack of Public Market."

Any Original Notes not tendered and accepted in the Exchange Offer will
remain outstanding and will be entitled to all the rights and will be subject
to the limitations applicable thereto under the Indenture. Following
consummation of the Exchange Offer, the holders of Original Notes will
continue to be subject to the existing restrictions upon transfer thereof and
the Company will have no further obligation to such holders to provide for
registration under the Securities Act of the Original Notes held by them. To
the extent that Original Notes are tendered and accepted in the Exchange
Offer, a holder's ability to sell untendered Original Notes could be adversely
affected. See "Risk Factors--Consequences of Failure to Exchange" and
"Exchange Offer--Procedures for Tendering."

The Exchange Notes will be available initially only in book-entry form. The
Company expects that the Exchange Notes issued pursuant to this Exchange Offer
will be issued in the form of one or more Global Notes

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(as defined herein), which will be deposited with, or on behalf of, The
Depository Trust Company (the "Depositary") and registered in its name or in
the name of its nominee. Beneficial interests in a Global Note representing
the Exchange Notes will be shown on, and transfers thereof will be effected
through, records maintained by the Depositary and its participants. After the
initial issuance of the Global Notes, Exchange Notes in certificated form will
be issued in exchange for a Global Note only on the terms set forth in the
Indenture. See "Description of Exchange Notes--Book Entry, Delivery and Form."

The Company will not receive any cash proceeds from the issuance of the
Exchange Notes offered hereby. No dealer-manager is being used in connection
with this Exchange Offer. The Company will pay all expenses incurred by it
incident to the Exchange Offer. See "Use of Proceeds" and "Plan of
Distribution."

NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER, OR A
SOLICITATION IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS, NOR ANY DISTRIBUTION OF SECURITIES MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS NOT BEEN ANY CHANGE IN
THE FACTS SET FORTH IN THIS PROSPECTUS OR IN THE AFFAIRS OF THE COMPANY SINCE
THE DATE HEREOF.

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TABLE OF CONTENTS

<TABLE>
<S> <C>
Prospectus Summary........................................................ 1
Risk Factors.............................................................. 14
Use of Proceeds........................................................... 17
Capitalization............................................................ 18
Pro Forma Financial Information........................................... 18
The Exchange Offer........................................................ 19
Selected Historical Consolidated Financial Data........................... 27
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 30
Business.................................................................. 38
Management................................................................ 54
Security Ownership of Certain Beneficial Owners and Management............ 64
Certain Relationships and Related Transactions............................ 67
Relationship Between The Company and Sunburst............................. 67
Description of Certain Indebtedness....................................... 72
Description of Exchange Notes............................................. 73
Certain United States Federal Tax Consequences............................ 87
Plan of Distribution...................................................... 89
Legal Matters............................................................. 90
Experts................................................................... 90
Index to Financial Statements............................................. F-1
</TABLE>

AVAILABLE INFORMATION

The Company and the Subsidiary Guarantor has filed with the Securities and
Exchange Commission (the "Commission") a registration statement on Form S-4
(the "Registration Statement", which term shall include all amendments,
exhibits, annexes and schedules thereto) pursuant to the Securities Act, and
the rules and regulations promulgated thereunder, covering the Exchange Notes
being offered hereby. This Prospectus does not contain all the information set
forth in the Registration Statement, certain parts of which are omitted in
accordance with the rules and regulations of the Commission. Copies of such
material can be obtained from the Company upon request.

The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended, and the rules and regulations promulgated
thereunder (the "Exchange Act") and, in accordance therewith, file reports,
proxy statements and other information with the Commission. All such
information filed by the Company with the Commission may be inspected at the
public reference facilities maintained by the Commission at Room 1024, 450
Fifth Street, N.W., Washington, D.C. 20549, or at its regional offices located
at the Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661 and 7 World Trade Center, 13th Floor, New York, New York 10007. The
Commission maintains a Web site that contains reports, proxy and information
statements and other information regarding registrants that file
electronically with the Commission. Such Web site is located at
http://www.sec.gov. While any Exchange Notes remain outstanding, the Company
will make available, upon request, to any holder of the Exchange Notes, the
information required pursuant to Rule 144A(d)(4) under the Securities Act
during any period in which the Company is not subject to Section 13 or 15(d)
of the Exchange Act. Any such request should be directed to the General
Counsel of the Company at 10750 Columbia Pike, Silver Spring, Maryland 20901.

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FORWARD-LOOKING INFORMATION

Certain statements contained in this Prospectus under the captions
"Prospectus Summary," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Business" and elsewhere constitute
estimates of future performance or other forward-looking statements within the
meaning of Section 27A of the Securities Act. Forward-looking statements
include statements regarding the intent, belief or current expectations of the
Company, primarily with respect to the future operating performance of the
Company or related industry developments. When used in this Prospectus, terms
such as "anticipate," "believe," "estimate," "expect," "intend," "may be,"
"objective," "plan," "predict" and "will be" are intended to identify such
statements. Any such forward-looking statements are not guarantees of future
performance and involve known and unknown risks, uncertainties and other
important factors that could cause the actual results, performance or
achievements of the Company to differ materially from any future results,
performance or achievements expressed or implied by such forward-looking
statements. Such risks, uncertainties and other important factors include,
among other things: the Company's plans to market new brands and products; the
Company's success in implementing its business strategies, including its
success in arranging financing where required; the balance between supply of
and demand for hotel rooms; the Company's ability to develop and maintain
positive relations with current and potential franchisees; the Company's plans
to expand its international franchise operations; competition; government
regulation; general economic and business conditions; and other factors
referenced in this Prospectus. These forward-looking statements speak only as
of the date of this Prospectus. The Company expressly disclaims 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 expectations
with regard thereto or any change in events, conditions or circumstances on
which any statement is based.

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PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read in
conjunction with, the more detailed information (including financial
information and the related notes thereto) included elsewhere in this
Prospectus. Choice Hotels International, Inc. and its subsidiaries are
collectively referred to herein as "Choice" or the "Company" unless otherwise
indicated or the context otherwise requires. Unless otherwise indicated, all
statistical information and data relating to the hotel industry in this
Prospectus are derived from information provided by Smith Travel Research.
Smith Travel Research has neither consented to the use of the hotel industry
data presented herein nor has it provided any form of consultation, advice or
counsel regarding any aspects of, nor is it in any way whatsoever associated
with, the Offering. During 1997, the Company changed its fiscal year from a May
31 year-end to a December 31 year-end.

THE COMPANY

OVERVIEW

Choice Hotels International, Inc. is the world's second largest franchisor of
hotel properties with 3,567 franchised properties open and 870 franchised
properties under development at June 30, 1998, representing 297,396 rooms open
and 76,523 rooms under development in 33 countries. The Company franchises
lodging properties under its proprietary brand names (the "Choice Brands"):
Comfort(R), Quality(R), Clarion(R), Sleep(R), Rodeway(R), Econo Lodge(R) and
MainStay (R). The Company has over 2,100 franchisees in its domestic franchise
system, the largest of which, Sunburst Hospitality Corporation, accounted for
approximately 5% of the Company's royalty fees for the six-months ended June
30, 1998. The Company franchises hotels in all 50 states and the District of
Columbia and 32 additional countries, with 94% of its franchising revenue
generated from hotels franchised in the United States. With recognized brands
and a diverse and growing franchisee base, the Company believes it has
established a strong foundation for continued growth.

The Company is a "pure-play" lodging franchisor with limited real estate
exposure and low capital expenditure requirements. With a focus on hotel
franchising versus ownership, the Company benefits from the economies of scale
inherent in the franchising business. The fee and cost structures of the
Company's business provide significant opportunities to increase profits by
increasing the number of franchised properties. The Company derives
substantially all of its revenues from franchise fees which consist of an
initial fee and ongoing royalty fees which are based on a percentage of the
franchisees' gross room revenues. The principal factors that affect the
Company's operating results are: (i) growth in the number of hotels under
franchise, (ii) occupancy and room rates achieved by the hotels under
franchise, (iii) the number and relative mix of franchised hotels and (iv) the
Company's ability to manage costs. The number of rooms at franchised properties
and occupancy and room rates at those properties significantly affect the
Company's results because royalty fees are based upon room revenues at
franchised hotels. The variable overhead costs associated with franchise system
growth are substantially less than incremental royalty fees generated from new
franchisees, therefore the Company is able to capture a significant portion of
these royalty fees as operating income.

The Company believes that the continued growth of its franchise business
should enable it to capture increasing benefits from the operating leverage in
place and thereby continue to improve operating margins. The Company's
operating margins have improved from 47.1% for the year ended May 31, 1995 to
55.0% for the year ended May 31, 1997. Furthermore, the Company has generated
steady royalty fee income from its increasing franchisee base growing from
$51.0 million for the year ended May 31, 1992 to $97.2 million for the year
ended May 31, 1997, representing a compounded annual growth rate of 13.8%.
Earnings before interest expense, income taxes (EBITDA), depreciation and
amortization have grown at a compounded annual growth rate of 20.5% from $32.2
million for the year ended May 31, 1992 to $81.7 million for the year ended May
31, 1997. Operating margins have improved from 40% for the six month period
ended June 30, 1997 to 49% for the six

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month period ended June 30, 1998. Similarly, EBITDA has increased from $39.0
million for the six month period ended June 30, 1997 to $51.6 million for the
six month period ended June 30, 1998.

Service is a distinguishing characteristic in the lodging industry.
Generally, the Company believes there are three levels of service: full-service
hotels (which typically offer food and beverage services, meeting rooms, room
service and similar guest services); limited-service hotels (which typically
offer amenities such as swimming pools and continental breakfast or similar
services); and all-suites hotels (which typically have limited public areas,
but offer guests two rooms or one room with distinct areas, and which may or
may not offer food and beverage services). The Company's Econo Lodge, Rodeway
and Sleep brands compete primarily in the limited-service economy category and
its Comfort and Quality brands compete primarily in the limited-service middle-
market category. The Company's MainStay brand competes primarily in the all-
suites middle-market category and its Clarion brand competes primarily in the
full-service upscale category.

The following table provides an overview by brand of hotels open and under
development as of June 30, 1998 for the Company's U.S. franchise system:

<TABLE>
<CAPTION>
HOTELS UNDER
BRAND HOTELS OPEN DEVELOPMENT
----- ------------------ -----------------
PROPERTIES ROOMS PROPERTIES ROOMS
---------- ------- ---------- ------
<S> <C> <C> <C> <C>
Comfort...................... 1,351 108,270 307 26,907
Quality...................... 427 50,258 106 10,795
Econo Lodge.................. 693 44,675 111 8,281
Clarion...................... 97 16,240 32 5,387
Rodeway...................... 197 12,340 49 3,401
Sleep ....................... 171 12,785 146 11,505
MainStay .................... 15 1,380 25 2,276
----- ------- --- ------
Total....................... 2,951 245,948 776 68,552
===== ======= === ======
</TABLE>

BUSINESS STRATEGY

The Company's strategy is to create an organization that is focused on: (i)
serving franchisee and consumer needs, (ii) optimizing its brands, (iii)
strategically growing the franchise system, (iv) improving margins through
increased productivity, (v) growing profitably internationally and (vi)
pursuing complementary business opportunities.

. Serving Franchisee and Consumer Needs. The Company has created an
organizational structure that focuses on consumers, serves franchisees
and leverages the franchise system.

--Consumer Focus: Brand management, new product development and
traditional marketing and advertising are all combined under the
Company's marketing department to create consumer focus and to drive
demand for the Company's brand products. New product development is
based on consumer needs determined through consumer research. The
Company believes that this focus leads to greater demand for its
products, which in turn results in higher revenue from the Company's
franchise system.

--Franchisee Service: The Company has established five regional
operating teams that are responsible for franchisee service and sales
in their respective regions. This structure provides each franchisee
with one primary contact who is responsible for assessing and
responding to each hotel's specialized needs. Led by seasoned
executives averaging over 20 years' experience in the lodging and
franchising industries, the Company believes it is positioned to
strategically develop new hotel franchises and enhance the operating
performance of its existing hotels.

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--Leveraging the Franchise System: Strategic partnerships, purchasing
and other functions that leverage the scale of the franchise system
are combined under the Company's partner services group. The Company
believes there is significant opportunity to leverage the franchise
system by entering into joint marketing arrangements with national and
multi-national companies that want to gain exposure to the millions of
guests who patronize the Company's franchised hotels each year. In the
past, these arrangements have added to the Company's and its
franchisees' revenues and profits by attracting business to its
franchised hotels.

. Optimizing its Brands. The Company believes that each of its brands has
particular attributes and strengths. The Company's strategy is to
leverage the strengths of each brand for profit growth and for
identifying new niches into which the Company may expand. This strategy
is effected by raising the Company's brand standards which are strictly
enforced through a consumer-driven quality assurance program.

. Strategically Growing the Franchise System. The Company is taking
advantage of its regional structure to analyze key markets in the U.S.
and, in conjunction with its franchisees, identify the best opportunities
for new development or conversion to one of the Company's brands.

. Improving Margins Through Increased Productivity. The Company enhances
the competitiveness of its own and its franchisees' profitability by
initiating revenue generating programs and implementing cost reduction
programs. A key component of this strategy is the implementation of the
Company's proprietary property and yield management system "Profit
Manager by Choice," which the Company believes will improve the operating
performance of its franchisees. This system has been supplemented by
continued enforcement of the Company's contracts (including franchisee
audits) and an aggressive focus on strategic partnership opportunities.

. Growing Profitably Internationally. As of June 30, 1998, the Company's
international franchise system had 616 properties with 51,448 rooms. The
Company's international franchise system includes hotels in 32 countries
outside the United States. The Company plans to continue to grow
profitably its brands internationally by strategically pursuing joint
ventures, master franchising agreements and brand-specific development
agreements for certain geographic areas.

. Pursuing Complementary Business Opportunities. The separation of the
Company from Former Choice (as defined below) allows the Company to focus
solely on franchising, including acquisition opportunities that are
complementary to the Company's core business and unique operating skills.
The Company's acquisition strategy includes the potential purchase of
lodging brands that would enhance the spectrum of brands and services the
Company currently offers its franchisees and hotel consumers.

COMPANY HISTORY

Prior to becoming a separate, publicly-held company on October 15, 1997
pursuant to the Company Spin-Off (as defined below), the Company was known as
Choice Hotels Franchising, Inc. and was a wholly-owned subsidiary of Choice
Hotels International, Inc. ("Former Choice"). On October 15, 1997, Former
Choice distributed to its stockholders its business of franchising hotels under
the Choice Brands (which had been conducted primarily by the Company) and its
European hotel ownership and franchising business pursuant to a pro rata
distribution to its stockholders of all the stock of the Company (the "Company
Spin-Off"). At the time of the Company Spin-Off, the Company changed its name
to "Choice Hotels International, Inc." and Former Choice changed its name to
"Sunburst Hospitality Corporation." For purposes of this Prospectus, references
to the Company's former parent corporation prior to the Company Spin-Off are to
"Former Choice," and references to such corporation after the Company Spin-Off
are to "Sunburst."

Prior to November 1996, the Company and Former Choice were each subsidiaries
of Manor Care, Inc. ("Manor Care") which, directly and through its
subsidiaries, engaged in the hotel franchising business currently

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conducted by the Company as well as in the business of owning and managing
hotels under the Choice Brands (together with the hotel franchising business,
the "Lodging Business") and the health care business. On November 1, 1996,
Manor Care separated the Lodging Business from its health care business through
a pro rata distribution to the holders of Manor Care's common stock of all the
stock of Former Choice (the "Former Choice Spin-Off"). In connection with the
Former Choice Spin-Off, the Company became a wholly-owned subsidiary of Former
Choice and remained as such until consummation of the Company Spin-Off.

The Company's common stock, $.01 par value per share, is listed on the New
York Stock Exchange under the trading symbol "CHH."

The Company is a Delaware corporation and its principal executive offices are
located at 10750 Columbia Pike, Silver Spring, Maryland 20901. The Company's
telephone number is (301) 592-5000.

THE OFFERING

On May 4, 1998, the Company consummated the Offering. The Company used
approximately $99 million of the net proceeds from the Offering to repay
amounts outstanding under the revolving portion of the Credit Facility (as
defined below).

The Original Notes were sold by the Company on May 4, 1998 to Salomon
Brothers Inc., Bear, Stearns & Co. Inc. and Lehman Brothers Inc. (the "Initial
Purchasers") pursuant to a Purchase Agreement dated April 28, 1998 (the
"Purchase Agreement"). The Initial Purchasers subsequently resold the Original
Notes to qualified institutional buyers pursuant to Rule 144A under the
Securities Act. Pursuant to the Purchase Agreement, the Company and the Initial
Purchasers entered into the registration rights agreement dated April 28, 1998
(the "Registration Agreement"), which grants the holders of the Original Notes
certain exchange and registration rights. The Exchange Offer is intended to
satisfy certain obligations of the Company under the Registration Agreement.

RECENT DEVELOPMENTS

In June 1998, William R. Floyd, the Company's Chief Executive Officer and
President, resigned from the Company and from the Board of Directors for
personal reasons. In August 1998, Charles A. Ledsinger was named as the new
Chief Executive Officer and President and was appointed to the Board of
Directors. Donald Dempsey, the Company's Executive Vice President and Chief
Financial Officer resigned in July 1998 for personal reasons unrelated to the
departure of Mr. Floyd. Two members of the Board of Directors, Stewart Bainum,
age 78, and Robert C. Hazard, age 62, retired from the Board of Directors in
July and August 1998, respectively. The Company is currently seeking candidates
to fill these positions.

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THE EXCHANGE OFFER

Securities Offered...... $100,000,000 aggregate principal amount of 7.125%
Senior Notes due 2008 (the "Exchange Notes").

The Exchange Offer...... The Company is offering to exchange up to $100
million principal amount of the Exchange Notes for a
like principal amount of Original Notes. The Exchange
Note may be exchanged only in multiples of $1,000
principal amount. The Company will issue the Exchange
Notes on or promptly after the Expiration Date. See
"The Exchange Offer."

Based upon an interpretation by the staff of the
Commission set forth in certain no-action letters
issued to third parties, the Company believes that a
holder (other than (i) a broker-dealer who purchases
such Exchange Notes directly from the Company to
resell pursuant to Rule 144A or any other available
exemption under the Securities Act or (ii) any such
holder that is an "affiliate" of the Company within
the meaning of Rule 405 under the Securities Act) who
exchanges Original Notes for Exchange Notes in the
ordinary course of business and who is not
participating, does not intend to participate, and
has no arrangement with any person to participate, in
a distribution of the Exchange Notes, will be allowed
to resell Exchange Notes to the public without
further registration under the Securities Act and
without delivering the purchasers of the Exchange
Notes a prospectus that satisfies the requirements of
Section 10 of the Securities Act. However, if any
holder acquires Exchange Notes in the Exchange Offer
for the purpose of distributing or participating in
the distribution of the Exchange Notes or is a
broker-dealer, such holder cannot rely on the
position of the staff of the Commission enumerated in
certain no-action letters issued to third parties and
must comply with the registration and prospectus
delivery requirements of the Securities Act in
connection with any resale transaction, unless an
exemption from registration is otherwise available.
Each broker-dealer that receives Exchange Notes for
its own account in exchange for Original Notes, where
such Original Notes were acquired by such broker-
dealer as a result of market-making activities or
other trading activities, must acknowledge that it
will deliver a prospectus in connection with any
resale of such Exchange Notes. The Letter of
Transmittal states that by so acknowledging and by
delivering a prospectus, a broker-dealer will not be
deemed to admit that it is an "underwriter" within
the meaning of the Securities Act. This Prospectus,
as it may be amended or supplemented from time to
time, may be used by a broker-dealer in connection
with resales of Exchange Notes received in exchange
for Original Notes where such Original Notes were
acquired by such broker-dealer as a result of market-
making or other trading activities. Pursuant to the
Registration Agreement, the Company has agreed to
make this Prospectus, as it may be amended or
supplemented from time to time, available to broker-
dealers for use in connection with any resale
starting on the date hereof and ending on the close
of business on the earlier to occur of (i) the date
on which all Exchange Notes held by broker-dealers
eligible to use the Prospectus to satisfy their
prospectus delivery obligations under the

5
<PAGE>

Securities Act have been sold and (ii) the date 180
days after the Expiration Date. See "Plan of
Distribution."

Any holder who tenders in the Exchange Offer with the
intention to participate, or for the purpose of
participating, in a distribution of the Exchange
Notes should not rely on the position of the Staff of
the Commission enunciated in no-action letters and,
in the absence of an exemption therefrom, must comply
with the registration and prospectus delivery
requirements of the Securities Act in connection with
any resale transaction. Failure to comply with such
requirements in such instance may result in such
holder incurring liability under the Securities Act
for which the holder is not indemnified by the
Company. See "Plan of Distribution."

To comply with the securities laws of certain
jurisdictions, it may be necessary to qualify for
sale or register the Exchange Notes prior to offering
or selling such Exchanges Notes. If a holder of
Original Notes does not exchange such Original Notes
for the Exchange Notes pursuant to the Exchange
Offer, such Original Notes will continue to be
subject to the restrictions on transfer contained in
the legend thereon. In general, Original Notes may
not be offered or sold, unless registered under the
Securities Act, except pursuant to an exception from,
or in a transaction not subject to the Securities Act
and applicable state securities laws. See "Risk
Factors--Consequences of Failure to Exchange" and
"Description of Exchange Notes."

Expiration Date......... The Exchange Offer will expire at 5:00 p.m., New York
City time, on November 19, 1998, unless extended, in
which case the term "Expiration Date" shall mean the
latest date and time to which the Exchange Offer is
so extended.

Accrued Interest on the
Exchange Notes and the
Original Notes......... Each Exchange Note will bear interest at the rate of
7.125% per annum from their date of issuance.
Interest on the Exchange Notes will be payable semi-
annually on each May 1 and November 1, commencing on
November 1, 1998. Interest on the Original Notes
accepted for exchange will cease to accrue upon
issuance of the Exchange Notes. Interest accrued on
exchanged Original Notes from the most recent date to
which interest has been paid or duly provided for on
such Original Notes or, if no interest has been paid
or duly provided for, from May 4, 1998, through, but
not including the date the Exchange Notes are issued,
will be paid with the first interest payment on the
Exchange Notes.

Conditions to the
Exchange Offer......... The Exchange Offer is subject to certain customary
conditions, which may be waived by the Company in
whole or in part and from time to time in its sole
discretion. See "The Exchange Offer--Conditions." The
Exchange Offer is not conditioned upon any minimum
aggregate principal amount of Original Notes being
tendered for exchange.

6
<PAGE>

Procedures for
Tendering the Original
Notes.................. Each holder of Original Notes wishing to accept the
Exchange Offer must complete, sign and date the
Letter of Transmittal, or a facsimile thereof, in
accordance with the instructions contained herein and
therein, and mail or otherwise deliver such Letter of
Transmittal, or such facsimile, together with such
Original Notes and any other required documentation,
to the Exchange Agent (as defined) at the address set
forth herein. By executing the Letter of Transmittal,
each holder of the Original Notes will represent to
the Company that, among other things, (i) the
Exchange Notes to be acquired by such holder of
Original Notes in connection with the Exchange Offer
are being acquired by such holder in the ordinary
course of its business, (ii) if such holder is not a
broker-dealer, such holder is not currently
participating in, does not intend to participate in,
and has no arrangement or understanding with any
person to participate in a distribution of the
Exchange Notes, (iii) such holder is a broker-dealer
registered under the Exchange Act or is participating
in the Exchange Offer for the purposes of
distributing the Exchange Notes, such holder will
comply with the registration and prospectus delivery
requirements of the Securities Act in connection with
a secondary resale transaction of the Exchange Notes
acquired by such person and cannot rely on the
position of the staff of the Commission set forth in
no-action letters, (iv) such holder understands that
a secondary resale transaction described in clause
(iii) above and any resales of Exchange Notes
obtained by such holder in exchange for Original
Notes acquired by such holder directly from the
Company should be covered by an effective
registration statement containing the selling
securityholder information required by Item 507 or
Item 508, as applicable, of Regulation S-K of the
Commission and (v) such holder is an "affiliate," (as
defined in Rule 405 under the Securities Act) of the
Company. Any Original Notes not accepted for exchange
for any reason will be returned without expense to
the tendering holder thereof as promptly as
practicable after the expiration or termination of
the Exchange Offer. See "The Exchange Offer--
Procedures for Tendering."

Untendered Original
Notes................... Following the consummation of the Exchange Offer,
holders of Original Notes eligible to participate but
who do not tender their Original Notes will not have
any further exchange rights and such Original Notes
will continue to be subject to certain restrictions
on transfer. Accordingly, the liquidity of the market
for such Original Notes could be adversely affected.

Special Procedures for
Beneficial Holders..... Any beneficial holder whose Original Notes are
registered in the name of a broker, dealer,
commercial bank, trust company or other nominee and
who wishes to tender should contact such registered
holder promptly and instruct such registered holder
to tender on such beneficial owner's behalf. If such
beneficial holder wishes to tender on its own behalf,
such beneficial holder must, prior to completing and
executing the Letter of Transmittal and delivering
its Original Notes, either make appropriate
arrangements to register ownership of the Original
Notes in such holder's

7
<PAGE>

name or obtain a properly completed bond power from
the registered holder. The transfer of registered
ownership may take considerable time and may not be
able to be completed prior to the Expiration Date.
See "The Exchange Offer--Procedures for Tendering."

Shelf Registration
Statement............... In the event that (i) any changes in law or
applicable interpretations of the staff of the
Commission do not permit the Company to effect the
Exchange Offer, (ii) for any other reason the
registration statement of which this Prospectus is a
part is not declared effective within 180 days of the
issuance date of the Original Notes or the Exchange
Offer is not consummated within 210 days, (iii) the
Initial Purchasers so request with respect to
Original Notes not eligible to be exchanged for
Exchange Notes in the Exchange Offer or (iv) any
holder of Original Notes (other than an Initial
Purchaser) is not eligible to participate in the
Exchange Offer or does not receive freely tradeable
Exchange Notes in the Exchange Offer other than by
reason of such holder being an affiliate of the
Company (it being understood that the requirement
that a broker-dealer deliver this prospectus in
connection with sales of Exchange Notes shall not
result in such Exchange Notes being not freely
tradeable), the Company will, at its cost, (a) as
promptly as practicable, file a resale "Shelf"
Registration Statement (the "Shelf Registration
Statement") covering resales of the Original Notes or
the Exchange Notes, as the case may be, (b) cause the
Shelf Registration Statement to be declared effective
under the Securities Act and (c) use its best efforts
to keep the Shelf Registration Statement effective
until two years after its effective date.

Guaranteed Delivery
Procedures.............. Holders of the Original Notes who wish to tender
their Original Notes and whose Original Notes are not
immediately available or who cannot deliver their
Original Notes or any other documents required by the
Letter of Transmittal to the Exchange Agent prior to
the Expiration Date, must tender their Original Notes
according to the guaranteed delivery procedures set
forth in "The Exchange Offer--Guaranteed Delivery
Procedures."

Withdrawal Rights....... Tenders of Original Notes may be withdrawn at any
time prior to 5:00 p.m., New York City time, on the
Expiration Date. For a withdrawal to be effective, a
written or facsimile notice of withdrawal must be
received by the Exchange Agent at its address set
forth herein. Such notice must (i) specify the name
of the person having tendered the Original Notes to
be withdrawn; (ii) identify the Original Notes to be
withdrawn (including the serial number or numbers and
principal amount of Original Notes to be withdrawn);
(iii) be signed by the holder in the same manner as
the original signature on the Letter of Transmittal
by which such Original Notes were tendered; and (iv)
specify the name in which the Original Notes are to
be registered, if different from that of the
withdrawing holder. See "The Exchange Offer--
Withdrawal of Tenders."

Acceptance of Original
Notes and Delivery of
Exchange Notes......... The Company will accept for exchange any and all
Original Notes which are properly tendered in the
Exchange Offer and not withdrawn prior to 5:00 p.m.,
New York City time, on the Expiration Date. The
Exchange

8
<PAGE>

Notes issued pursuant to the Exchange Offer will be
delivered promptly following the Expiration Date. See
"The Exchange Offer--Terms of the Exchange Offer."

Consequences of Failure
to Exchange............ Holders of Original Notes who do not exchange their
Original Notes for the Exchange Notes pursuant to the
Exchange Offer will continue to be subject to the
restrictions on transfer of such Original Notes as
set forth in the legend thereon. In general, the
Original Notes that are not exchanged pursuant to the
Exchange Offer may not be offered or sold except
pursuant to a registration statement under the
Securities Act or an exemption from registration
thereunder and in compliance with applicable state
securities laws. In the event the Company completes
the Exchange Offer, the interest rate on Original
Notes will remain as stated thereon and holders of
Original Notes will have no further rights under the
Registration Agreement.

Certain Tax
Considerations.......... Latham & Watkins, counsel to the Company, has advised
the Company that because the Exchange Notes should
not be considered to differ materially from the
Original Notes, the exchange of the Original Notes
for Exchange Notes should not result in any material
federal income tax consequences to holders exchanging
the Original Notes for the Exchange Notes. For a full
description of the basis of, and limitations on, this
opinion, see "Certain United States Federal Tax
Consequences."

Registration Rights
Agreement............... Pursuant to a registration rights agreement (the
"Registration Agreement") among the Company and the
Initial Purchasers, the Company has agreed (i) to
file a registration statement with respect to an
offer to exchange the Original Notes for a like
principal amount of Exchange Notes and (ii) to use
their reasonable best efforts to cause such
registration statement to become effective under the
Securities Act. This Exchange Offer is intended to
satisfy the rights of holders of Original Notes under
the Registration Agreement, which rights terminate
upon consummation of the Exchange Offer. The holders
of the Exchange Notes are not entitled to any
exchange or registration rights with respect to the
Exchange Notes.

Exchange Agent.......... Marine Midland Bank is the Exchange Agent. The
address and telephone number of the Exchange Agent
are set forth in "The Exchange Offer--Exchange
Agent."

Use of Proceeds......... There will be no cash proceeds to the Company from
the exchange pursuant to the Exchange Offer.

9
<PAGE>

THE EXCHANGE NOTES

The Exchange Offer applies to $100 million aggregate principal amount of the
Original Notes. The form and terms of the Exchange Notes are the same as the
form and terms of the Original Notes (which they replace) except that (i) the
Exchange Notes have been registered under the Securities Act and, therefore,
will not bear legends restricting the transfer thereof, and (ii) the holders of
Exchange Notes will not be entitled to certain rights under the Registration
Agreement, including the provisions providing for an increase in the interest
rate on the Original Notes in certain circumstances relating to the timing of
the Exchange Offer, which rights will terminate when the Exchange Offer is
consummated. See "The Exchange Offer--Purpose and Effect of the Exchange
Offer." The Exchange Notes will evidence the same debt as the Original Notes
and the Notes will be entitled to the benefits of the Indenture and treated as
a single class of debt securities thereunder. See "Description of Exchange
Notes."

Issuer.................. Choice Hotels International, Inc., a Delaware
corporation.

Exchange Notes
Offered................ $100,000,000 aggregate principal amount of 7.125%
Senior Notes Due 2008.

Maturity Date........... May 1, 2008.

Interest Payment
Dates.................. May 1 and November 1 of each year, commencing
November 1, 1998.

Sinking Fund............ None.

Ranking................. The Exchange Notes will be senior unsecured
obligations of the Company, ranking pari passu with
all existing and future senior debt of the Company
and senior in right of payment to all future
subordinated debt of the Company. The Original Notes
are, and the Exchange Notes will be, unconditionally
guaranteed, jointly and severally on a senior
unsecured basis by QHE, QHE Partnership and, under
certain circumstances, by other subsidiaries of the
Company (collectively, the "Subsidiary Guarantors").
The Exchange Notes will be effectively subordinated
to all existing and future debt and other liabilities
of the Company's subsidiaries which are not
Subsidiary Guarantors. The Exchange Notes will also
be effectively subordinated to all secured debt and
other obligations of the Company to the extent of the
value of the assets securing such debt and other
obligations. As of June 30, 1998, the Company has on
a consolidated basis, approximately $293.7 million of
debt outstanding (excluding outstanding letters of
credit, purchase money security obligations and trade
payables incurred in the normal course of business),
including approximately $171.0 million outstanding
under the Credit Facility (as defined below) and $8.2
million under a separate working capital credit
facility with which the Exchange Notes would rank
pari passu and approximately $1.5 million of debt
secured by a lien on assets of the Company. As of
June 30, 1998, the total debt of the Company's
subsidiaries was approximately $15.1 million. The
Indenture contains no limits on the amount of debt
that may be incurred by the Company and its
subsidiaries. The terms of the Company's Credit
Facility limit the amount of additional debt that the
Company and its subsidiaries may incur; however, the
Credit Facility may be repaid or its terms may be
amended without the consent of the holders of the
Exchange Notes. See "Capitalization," "Description of
Exchange Notes" and "Description of Certain
Indebtedness."

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<PAGE>

Optional Redemption..... The Exchange Notes may be redeemed at the option of
the Company, in whole or in part at any time or from
time to time, at a price equal to 100% of the
principal amount thereof plus accrued interest to the
date of redemption plus a Make-Whole Premium (as
defined below), if any, relating to the then-
prevailing Treasury Yield (as defined below) and the
remaining life of the Exchange Notes. See
"Description of Exchange Notes--Optional Redemption."

Certain Covenants....... The Indenture contains limitations on the ability of
the Company and its subsidiaries to: (i) Incur Liens
(as defined below), (ii) engage in Sale and Leaseback
Transactions (as defined below) and (iii) in the case
of the Company, enter into mergers or consolidations
or transfer substantially all its assets. The
covenants are subject to numerous significant
exceptions and qualifications. See "Description of
Exchange Notes--Certain Covenants."

RISK FACTORS

For a discussion of certain risk factors that should be considered by holders
of Original Notes in evaluating a tender of Original Notes for Exchange Notes
pursuant to the Exchange Offer, see "Risk Factors."

11
<PAGE>

SUMMARY HISTORICAL CONSOLIDATED FINANCIAL DATA

The following table summarizes certain historical consolidated financial data
of the Company as of and for the six-month periods ended June 30, 1998 and
1997, the seven-month periods ended December 31, 1997 and 1996 and the three
fiscal years ended May 31, 1997, 1996 and 1995. During September 1997, the
Company changed its fiscal year from a May 31 year-end to a December 31 year-
end. The summary historical consolidated financial data as of and for the seven
months ended December 31, 1997 and the three fiscal years ended May 31, 1997,
1996 and 1995 are derived from the audited consolidated financial statements of
the Company. The summary historical consolidated financial data for the six-
month periods ended June 30, 1998 and 1997, and the seven-month period ended
December 31, 1996 are derived from the Company's unaudited consolidated
financial statements which, in the opinion of management, include all material
adjustments necessary at such dates and for such periods. The summary
historical consolidated financial data presented herein for all periods are
presented as if the Company were a separate entity. See the "Basis of
Presentation" note to the Company's Consolidated Financial Statements. The
Company's historical net income and cash flows as a wholly-owned subsidiary of
Manor Care or Former Choice (all periods prior to October 15, 1997) are not
necessarily indicative of the net income and cash flows the Company might have
realized as an independent entity. The data set forth below should be read in
conjunction with "Selected Historical Consolidated Financial Data,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's Consolidated Financial Statements and related
notes thereto contained elsewhere herein.

12
<PAGE>

and for fiscal year 1997 based on the weighted average shares outstanding of
the Company's former parent Former Choice of 62,680,000. Basic earnings per
share have been calculated for the seven-month period ended December 31,
1996 based on the weighted average shares outstanding of Manor Care from
June 1, 1996 through November 1, 1996 and of Former Choice from November 2,
1996 through December 31, 1996 of 63,063,146, for the seven-month period
ended December 31, 1997 based on the weighted average shares outstanding of
Former Choice from June 1, 1997 through October 15, 1997 and of the Company
from October 16, 1997 through December 31, 1997 of 59,798,000, and for the
six-month period ended June 30, 1998 based on the weighted average shares
outstanding from January 1, 1998 through June 30, 1998.
(3) EBITDA consists of the sum of net income, 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 the
Company's ability to meet debt service obligations, fund capital
expenditures and expand its business. The Company 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
(including nondiscretionary 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 and therefore EBITDA does not
represent funds available for management's discretionary use. EBITDA
presented by the Company may not be comparable to EBITDA defined and
presented by other companies.
(4) Fiscal year 1996 EBITDA excludes a non-cash, pre-tax charge of $24.8
million for impairment of certain long-lived assets associated with the
Company's European operations.
(5) Earnings used in computing the ratio of earnings to fixed charges consist
of income before income taxes and fixed charges. Fixed charges consist of
interest expense and the amortization of deferred financing fees and that
portion of rental expense representative of interest.
(6) Represents domestic royalty fees as a percentage of aggregate gross room
revenues of all domestic Choice Brand franchised hotels.
(7) Includes the Term Note (as defined below) in an aggregate principal amount
of $115.0 million plus accrued interest thereon as of December 31, 1997
and June 30, 1998 of $2.4 million and $4.9 million, respectively and a
receivable from Sunburst as of December 31, 1997 and June 30, 1998 of
$25.1 million and $19.9 million, respectively. See "Risk Factors--
Significant Receivables from Sunburst."
(8) Includes a note payable to Manor Care in the amount of $78.7 million, as
of December 31, 1996 and as of May 31, 1997, 1996 and 1995.
(9) During the second quarter of 1998, the Company changed its presentation of
marketing and reservation fees such that the fees collected and associated
expenses are reported on a net basis. All periods have been restated to
conform to this presentation.
(10)Depreciation and amortization related to the marketing and reservation
funds included in EBITDA was $2.2 million for the six month period ended
June 30, 1998, $1.2 million for the six months ended June 30, 1997, $2.2
million for the seven-month period ended December 31, 1997 and $2.8
million, $2.7 million and $2.1 million for the fiscal years ended May 31,
1997, May 31, 1996 and May 31, 1995, respectively.

13
<PAGE>

RISK FACTORS

Holders of Original Notes should carefully consider the following risk
factors in addition to the other information contained in this Prospectus in
evaluating the Company and its business in connection with the Exchange Offer.

INHERENT RISKS OF THE LODGING INDUSTRY; COMPETITION

The Company derives a significant portion of its revenues from fees based
upon room revenues at hotels franchised under one of the Choice Brands. As
such, the Company's business is subject, directly or through its franchisees,
to the risks inherent in the lodging industry. These risks include, among
other things, adverse effects of general and local economic conditions,
changes in local market conditions, oversupply of hotel space, a reduction in
local demand for hotel rooms, changes in travel patterns, changes in
governmental regulations that influence or determine wages, prices or
construction costs, changes in interest rates, the availability of credit and
changes in real estate taxes and other operating expenses. Due in part to the
strong correlation between the lodging industry's performance and economic
conditions, the lodging industry is subject to cyclical changes in revenues
and profits. Downturns or prolonged adverse conditions in real estate or
capital markets or the economy as a whole that affect the Company's franchised
hotels will have a material impact on the Company. During the 1980s,
construction of lodging facilities in the United States resulted in an excess
supply of available rooms. This oversupply had an adverse effect on occupancy
levels and room rates in the industry.

The lodging industry is highly competitive. Competitive factors in the
industry include reasonableness of room rates, quality of accommodations,
brand recognition, service levels and convenience of locations. The Company's
franchised hotels generally operate in areas that contain numerous other
competitors. The Company believes that hotel operators choose lodging
franchisors based primarily on the perceived value and quality of each
franchisor's brand and services, and the extent to which affiliation with that
franchisor may increase the franchisee's reservations and profits.
Demographic, economic or other changes in markets may adversely affect the
convenience or desirability of the Choice Brands and, correspondingly, the
number of hotels franchised under the Choice Brands. The Company primarily
franchises hotels that operate in the limited-service segment of the domestic
lodging industry, which has experienced a significant amount of new hotel
construction. There can be no assurance that, in the markets in which the
Company's franchised hotels operate, competing hotels will not pose greater
competition for guests than presently exists, or that new hotels will not
enter such locales. In addition, an excess supply of hotel rooms may
discourage potential franchisees from opening new hotels, thereby limiting a
source of growth of the franchise fees received by the Company. Such excess
supply of hotel rooms may also lead to lower room rates at the Company's
franchised hotels and, correspondingly, a reduction in the franchise fees
received by the Company.

ADVERSE IMPACT OF EXTERNAL FACTORS

The Company's principal sources of revenues are franchise fees which can be
negatively impacted by inflation and other external factors. Increases in
costs due to inflation may not be able to be totally offset by increases in
hotel room rates. Moreover, significant increases in inflation could
contribute to a slowing of the national economy. Such a slowdown would likely
result in reduced travel by both business and leisure travelers, less demand
for hotel rooms, a reduction in room rates and fewer room reservations,
negatively impacting the Company's revenues. A weak economy could also reduce
demand for new hotels, negatively impacting the amount of franchise fees
received by the Company.

The Company's revenues may also be negatively impacted by certain other
unpredictable external factors which would have an especially significant
impact on the travel and lodging industries. These factors include airline
strikes, gasoline price increases and severe weather, which would likely
result in reduced travel by both business and leisure travelers.

14
<PAGE>

POTENTIAL CONFLICT WITH SUNBURST

The ongoing relationship between the Company and Sunburst resulting from the
agreements and arrangements described under "Relationship Between the Company
and Sunburst" may give rise to a conflict of interest between the Company and
Sunburst. With respect to the agreements between the parties, the potential
exists for disagreements as to the quality of the services provided by the
parties and as to contract compliance. Nevertheless, the Company believes that
there will be sufficient mutuality of interest between the two companies to
result in a continued productive relationship.

In addition, Frederic V. Malek serves as a director of both the Company and
Sunburst. As a result of the Company Spin-Off, Mr. Malek, as well as certain
other officers and directors of the Company and of Sunburst, own shares and/or
options or other rights to acquire shares in each of the Company and Sunburst.
Stewart Bainum, Jr. is the chairman of the Board of Directors of the Company
and his sister, Barbara Bainum, is also a director. Their father, Stewart
Bainum, is the chairman of the Board of Directors of Sunburst and the Bainum
family has a significant ownership interest in both the Company and Sunburst.
Policies and procedures are followed by the Boards of Directors of the Company
and Sunburst to limit the involvement of the overlapping directors (and, if
appropriate, relevant officers of such companies) in conflict situations,
including requiring them to abstain from voting as directors of either the
Company or Sunburst on certain matters which present a conflict between the
two companies.

SIGNIFICANT RECEIVABLES FROM SUNBURST

At June 30, 1998, the Term Note (as defined below) and receivables from
Sunburst totaled $142.2 million. In connection with the Company Spin-Off,
Sunburst issued to the Company a note in an aggregate principal amount of
$115.0 million (the "Term Note"). The Term Note matures on October 15, 2002,
is subordinated to all senior indebtedness of Sunburst and restricts
Sunburst's ability to merge or consolidate or dispose of all or substantially
all of its assets. Simple interest accrues at an annual rate of 11%
(representing an effective annual rate of 8.8%), all of which is payable on
maturity. Total interest accrued on the Term Note through June 30, 1998 was
approximately $7.3 million. Additionally, Sunburst is the obligor on
receivables totaling approximately $19.9 million at June 30, 1998. This amount
is payable in cash or Sunburst common stock (or a combination thereof) no
later than December 31, 1998. In addition, in connection with the Company
Spin-Off, the Company guaranteed certain lease and other payment obligations
owed by Sunburst to Manor Care. See "Certain Relationships and Related
Transactions" and "Relationship Between the Company and Sunburst."

Sunburst is a highly leveraged company whose business is subject to many of
the risks of the lodging industry outlined in this section. Sunburst, the
Company's largest franchisee, owned 85 hotels franchised under the Choice
Brands as of June 30, 1998. A material adverse change in Sunburst's business
would adversely affect its ability to repay its obligations to the Company,
which in turn could have a material adverse effect on the Company.

REGULATION

The Federal Trade Commission (the "FTC"), various states and certain foreign
jurisdictions (including France, the Province of Alberta, Canada and Mexico)
regulate the sale of franchises. The FTC requires franchisors to make
extensive disclosure to prospective franchisees but does not require
registration. A number of states in which the Company's franchisees operate
require registration or disclosure in connection with franchise offers and
sales. In addition, several states in which the Company's franchisees operate
have "franchise relationship laws" or "business opportunity laws" that limit
the ability of the franchisor to terminate franchise agreements or to withhold
consent to the renewal or transfer of these agreements. While the Company's
business has not been materially adversely affected by such regulation, there
can be no assurance that this will continue or that future regulation or
legislation will not have such an effect.

15
<PAGE>

FRAUDULENT TRANSFER

The Company's obligations under the Original Notes are, and under the
Exchange Notes will be, guaranteed by the Subsidiary Guarantors. The
guarantees may be subject to review under state or federal fraudulent transfer
laws in the event of the bankruptcy or other financial difficulty of a
Subsidiary Guarantor. Under those laws, if a court in a lawsuit by an unpaid
creditor or representative of creditors of a Subsidiary Guarantor, such as a
trustee in bankruptcy or a Subsidiary Guarantor as debtor in possession, were
to find that at the time the Subsidiary Guarantor issued its guarantee, it
either (i) was insolvent, (ii) was rendered insolvent, (iii) was engaged in a
business or transaction for which its remaining unencumbered assets
constituted unreasonably small capital or (iv) intended to incur or believed
that it would incur debts beyond its ability to pay as such debts matured,
such court could avoid the guarantee and the Subsidiary Guarantor's
obligations thereunder, and direct the return of any amounts paid thereunder
to the Company or to a fund for the benefit of its creditors. Moreover,
regardless of the factors identified in the foregoing clauses (i) through
(iv), the court could avoid the guarantee and direct such repayment if it
found that the guarantee was issued with actual intent to hinder, delay, or
defraud the Subsidiary Guarantor's creditors.

The measure of insolvency for purposes of the foregoing will vary depending
on the law of the jurisdiction being applied. Generally, however, an entity
would be considered insolvent if the sum of its debts (including contingent or
unliquidated debts) is greater than all of its property at a fair valuation or
if the present fair salable value of its assets is less than the amount that
will be required to pay its probable liability on its existing debts as they
become absolute and matured.

LACK OF PUBLIC MARKET

Prior to the Exchange Offer, there has not been any public market for the
Notes. The Original Notes have not been registered under the Securities Act or
any state securities laws and will be subject to restrictions on
transferability to the extent that they are not exchanged for Exchange Notes
by holders who are eligible to participate in the Exchange Offer. The Exchange
Notes will constitute a new issue of securities with no established trading
market and will not be listed on any national securities exchange or for
quotation of the Exchange Notes on an automated dealer quotation system.

Although the Initial Purchasers in the Offering have each informed the
Company that they currently intend to make a market in the Exchange Notes,
they are not obligated to do so, and any such market-making, if initiated, may
be discontinued at any time without notice. The liquidity of any market for
Exchange Notes will depend upon the number of holders of the Exchange Notes,
the interest of securities dealers in making a market in the Exchange Notes
and other factors. Accordingly, there can be no assurance as to the
development or liquidity of any market for the Exchange Notes. If an active
trading market for the Exchange Notes does not develop, the market price and
liquidity of the Exchange Notes may be adversely affected. If the Exchange
Notes are traded, they may trade at a discount from their face value,
depending upon prevailing interest rates, the market for similar securities,
the performance of the Company and certain other factors.

CONSEQUENCES OF FAILURE TO EXCHANGE

Holders of Original Notes who do not exchange their Original Notes for
Exchange Notes pursuant to the Exchange Offer will continue to be subject to
the restrictions on transfer of such Original Notes as set forth in the legend
thereon as a consequence of the issuance of the Original Notes pursuant to
exemptions from, or in transactions not subject to, the registration
requirements of the Securities Act and applicable state securities laws. In
general, the Original Notes may not be offered or sold, unless registered
under the Securities Act and applicable state securities laws, or pursuant to
an exemption therefrom. The Company does not intend to register the Original
Notes under the Securities Act. In addition, any holder of Original Notes who
tenders in the Exchange Offer for the purpose of participating in a
distribution of the Exchange Notes may be deemed to have received restricted
securities and, if so, will be required to comply with the registration and
prospectus delivery requirements of the Securities Act in connection with any
resale transaction. Each broker-dealer that receives

16
<PAGE>

Exchange Notes for its own account in exchange for Original Notes, where such
Original Notes were acquired by such broker-dealer as a result of market-
making activities or any other trading activities, must acknowledge that it
will deliver a prospectus meeting the requirements of the Securities Act in
connection with any resale of such Exchange Notes. Any broker-dealer that
resells Exchange Notes that were received by it for its own account pursuant
to the Exchange Offer may be deemed to be an "underwriter" within the meaning
of the Securities Act. To the extent that Original Notes are tendered and
accepted in the Exchange Offer, the trading market for untendered and tendered
but unaccepted Original Notes could be adversely affected due to the limited
amount, or "float," of the Original Notes that are expected to remain
outstanding following the Exchange Offer. Generally, a lower "float" of a
security could result in less demand to purchase such security and could,
therefore, result in lower prices for such security. For the same reason, to
the extent that a large amount of Original Notes are not tendered or are
tendered and not accepted in the Exchange Offer, the trading market for the
Exchange Notes could be adversely affected. See "Plan of Distribution" and
"The Exchange Offer."

CONSEQUENCES OF FAILURE TO PROPERLY TENDER THE ORIGINAL NOTES IN THE EXCHANGE

Issuance of the Exchange Notes in exchange for the Original Notes pursuant
to the Exchange Offer will be made only after timely receipt by the Exchange
Agent of such Original Notes, a properly completed and duly executed Letter of
Transmittal and all other required documents. Therefore, holders of the
Original Notes desiring to tender such Original Notes in exchange for Exchange
Notes should allow sufficient time to ensure timely delivery. Neither the
Exchange Agent nor the Company is under any duty to give notification of
defects or irregularities with respect to tenders of Original Notes for
exchange. Original Notes that are not tendered or that are tendered but not
accepted by the Company for exchange, will, following consummation of the
Exchange Offer, continue to be subject to the existing restrictions upon
transfer thereof under the Securities Act and, upon consummation of the
Exchange Offer, certain registration rights under the Registration Agreement
will terminate.

USE OF PROCEEDS

The Company will not receive any cash proceeds from the issuance of the
Exchange Notes offered hereby. The Exchange Offer is intended to satisfy
certain of the Company's obligations under the Registration Agreement. In
consideration for issuing the Exchange Notes as contemplated in this
Prospectus, the Company will receive in exchange, Original Notes in like
principal amount, the terms of which are identical to the Exchange Notes. The
Original Notes surrendered in exchange for the Exchange Notes will not result
in any increase in the indebtedness of the Company.

The net proceeds to the Company from the Offering (after deducting the
Initial Purchasers' discounts and expenses payable by the Company in
connection with the Offering), of approximately $99 million were used to repay
amounts outstanding under the revolving portion of the Credit Facility. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" and "Description of Certain
Indebtedness" for a description of the interest rate and maturity date under
the Credit Facility and of the use of proceeds borrowed thereunder.

17
<PAGE>

CAPITALIZATION

The following table sets forth the historical capitalization of the Company
as of June 30, 1998. This information should be read in conjunction with "Use
of Proceeds," "Selected Historical Consolidated Financial Data," "Pro Forma
Financial Information," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Description of Certain Indebtedness,"
"Description of Notes" and the Company's Consolidated Financial Statements and
related notes thereto included elsewhere in this Offering Memorandum.

<TABLE>
<CAPTION>
AS OF
JUNE 30,
1998
--------
<S> <C>
Cash and cash equivalents........................................... $ 6,365
========
Debt:
Credit Facility(1) and working capital line........................ $179,200
7.125% Senior Notes Due 2008....................................... 99,436(2)
Other Long-term Debt............................................... 15,083
--------
Total Debt...................................................... 293,719
Shareholders' equity................................................ 57,187
--------
Total Capitalization............................................ $350,906
========
</TABLE>
- --------
(1) Includes the current portion of long-term debt in the amount of
approximately $10.04 million.
(2) Net of discount in connection with the issuance of the Original Notes.

PRO FORMA FINANCIAL INFORMATION

The purpose of the Offering is to refinance certain of the Company's
existing short-term bank borrowings under the Credit Facility, with long-term
debt to be represented by the Notes issued in the Offering at a rate of
7.125%. The impact of the Offering and the application of the estimated
proceeds therefrom on the Company's interest expense and income from
continuing operations for the six-month period ended June 30, 1998 assuming
the refinancing occurred as of the beginning of the period would be to
increase interest expense by $270,000 and to decrease income from continuing
operations by $157,000. The impact of the Offering on interest expense and
income from continuing operations of the Company and its subsidiaries for the
seven-month period ended December 31, 1997 assuming the refinancing occurred
as of the beginning of the period would be to decrease interest expense by
$65,000 and to increase income from continuing operations by $38,000. The
impact of the Offering on interest expense and income from continuing
operations of the Company and its subsidiaries for the fiscal year ended May
31, 1997 would be to decrease interest expense by $597,000 and increase income
from continuing operations by $348,000. The offering will have no impact on
the Company's June 30, 1998 balance sheet. This pro forma financial
information is provided for informational purposes only and does not purport
to be indicative of the results of operations and financial position of the
Company and its subsidiaries that actually would have been obtained if the
Offering had been effected on the dates indicated or of those results that may
be obtained in the future.

18
<PAGE>

THE EXCHANGE OFFER

PURPOSE AND EFFECT OF THE EXCHANGE OFFER

The Original Notes were originally sold by the Company on May 4, 1998 to the
Initial Purchasers pursuant to the Purchase Agreement. The Initial Purchasers
subsequently resold the Original Notes to qualified institutional buyers in
reliance on Rule 144A under the Securities Act. As a condition to the
completion of the Offering, the Company entered into the Registration
Agreement with the Initial Purchasers pursuant to which the Company agreed to
file with the Commission the Registration Statement on the appropriate form
under the Securities Act with respect to an offer to exchange the Original
Notes for Exchange Notes. The Exchange Notes will be substantially identical
to the Original Notes, except that the Exchange Notes will have been
registered under the Securities Act and, therefore, will not contain terms
with respect to transfer restrictions (other than those that might be imposed
by state securities laws). In the event that (i) any changes in law or
applicable interpretations of the Staff of the Commission do not permit the
Company to effect the Exchange Offer, (ii) for any other reason the
registration statement of which this Prospectus is a part is not declared
effective within 180 days of the issuance date of the Original Notes or the
Exchange Offer is not consummated within 210 days, (iii) the Initial
Purchasers so request with respect to Original Notes not eligible to be
exchanged for Exchange Notes in the Exchange Offer or (iv) any holder of
Original Notes (other than an Initial Purchaser) is not eligible to
participate in the Exchange Offer or does not receive freely tradeable
Exchange Notes in the Exchange Offer other than by reason of such holder being
an affiliate of the Company (it being understood that the requirement that a
broker-dealer deliver this prospectus in connection with sales of Exchange
Notes shall not result in such Exchange Notes being not freely tradeable), the
Company will, at its cost, (a) as promptly as practicable, file a Shelf
Registration Statement covering resales of the Original Notes or the Exchange
Notes, as the case may be, (b) cause the Shelf Registration Statement to be
declared effective under the Securities Act and (c) use its best efforts to
keep the Shelf Registration Statement effective until two years after its
effective date.

Based upon an interpretation by the staff of the Commission set forth in
certain no-action letters issued to third parties, the Company believes that a
holder (other than (i) a broker-dealer who purchases such Exchange Notes
directly from the Company to resell pursuant to Rule 144A or any other
available exemption under the Securities Act or (ii) any such holder that is
an "affiliate" of the Company within the meaning of Rule 405 under the
Securities Act) who exchanges Original Notes for Exchange Notes in the
ordinary course of business and who is not participating, does not intend to
participate, and has no arrangement with any person to participate, in a
distribution of the Exchange Notes, will be allowed to resell Exchange Notes
to the public without further registration under the Securities Act and
without delivering the purchasers of the Exchange Notes a prospectus that
satisfies the requirements of Section 10 the Securities Act. However, if any
holder acquires Exchange Notes in the Exchange Offer for the purpose of
distributing or participating in the distribution of the Exchange Notes or is
a broker-dealer, such holder cannot rely on the position of the staff of the
Commission enumerated in certain no-action letters issued to third parties and
must comply with the registration and prospectus delivery requirements of the
Securities Act in connection with any resale transaction, unless an exemption
from registration is otherwise available. Each broker-dealer that receives
Exchange Notes for its own account in exchange for Original Notes, where such
Original Notes were acquired by such broker-dealer as a result of market-
making activities or other trading activities, must acknowledge that it will
deliver a prospectus in connection with any resale of such Exchange Notes. The
Letter of Transmittal states that by so acknowledging and by delivering a
prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act. This Prospectus, as it
may be amended or supplemented from time to time, may be used by a broker-
dealer in connection with resales of Exchange Notes received in exchange for
Original Notes where such Original Notes were acquired by such broker-dealer
as a result of market-making or other trading activities. Pursuant to the
Registration Agreement, the Company has agreed to make this Prospectus, as it
may be amended or supplemented from time to time, available to broker-dealer
for use in connection with any resale starting on the date hereof and ending
on the close of business on the earlier to occur of (i) the date on which all
Exchange Notes held by broker-dealers eligible to use the Prospectus to
satisfy their prospectus delivery obligations under the Securities Act have
been sold and (ii) the date 180 days after the Expiration Date. See "Plan of
Distribution."

19
<PAGE>

Each holder who wishes to exchange such Original Notes for Exchange Notes in
the Exchange Offer will be required to make certain representations, including
representations that (i) the Exchange Notes to be acquired by such holder of
Original Notes in connection with the Exchange Offer are being acquired by
such holder in the ordinary course of its business, (ii) if such holder is not
a broker-dealer, such holder is not currently participating in, does not
intend to participate in, and has no arrangement or understanding with any
person to participate in a distribution of the Exchange Notes, (iii) if such
holder is a broker-dealer registered under the Exchange Act or is
participating in the Exchange Offer for the purposes of distributing the
Exchange Notes, such holder will comply with the registration and prospectus
delivery requirements of the Securities Act in connection with a secondary
resale transaction of the Exchange Notes acquired by such person and cannot
rely on the position of the staff of the Commission set forth in no-action
letters, (iv) such holder understands that a secondary resale transaction
described in clause (iii) above and any resales of Exchange Notes obtained by
such holder in exchange for Original Notes acquired by such holder directly
from the Company should be covered by an effective registration statement
containing the selling securityholder information required by Item 507 or Item
508, as applicable, of Regulation S-K of the Commission and (v) it is not an
affiliate (as defined in Rule 405 under the Securities Act) of the Company.

The summary herein of certain provisions of the Registration Agreement does
not purport to be complete and is subject to, and is qualified in its entirety
by, all the provisions of the Registration Agreement, a copy of which is filed
as an exhibit to the Exchange Offer Registration Statement of which this
Prospectus is a part.

Following the consummation of the Exchange Offer, holders of the Original
Notes who were eligible to participate in the Exchange Offer but who did not
tender their Original Notes will not have any further registration rights and
such Original Notes will continue to be subject to certain restrictions on
transfer. Accordingly, the liquidity of the market for such Original Notes
could be adversely affected.

TERMS OF THE EXCHANGE OFFER

Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal, the Company will accept any and all Original
Notes validly tendered and not withdrawn prior to 5:00 p.m., New York City
time, on the Expiration Date. The Company will issue $1,000 principal amount
of Exchange Notes in exchange for each $1,000 principal amount of outstanding
Original Notes accepted in the Exchange Offer. Holders may tender some or all
of their Original Notes pursuant to the Exchange Offer. However, Original
Notes may be tendered only in integral multiples of $1,000.

The form and terms of the Exchange Notes are the same as the form and terms
of the Original Notes except that (i) the Exchange Notes have been registered
under the Securities Act and hence will not bear legends restricting the
transfer thereof and (ii) the holders of the Exchange Notes will not be
entitled to certain rights under the Registration Agreement, including the
provisions providing for an increase in the interest rate on the Original
Notes in certain circumstances relating to the timing of the Exchange Offer,
all of which rights generally will terminate when the Exchange Offer is
terminated. The Exchange Notes will evidence the same debt as the Original
Notes and will be entitled to the benefits of the Indenture.

The Exchange Offer is not conditioned upon any minimum number of Original
Notes being tendered. As of the date of this Prospectus, $100,000,000
aggregate principal amount of Original Notes were outstanding.

Holders of Original Notes do not have any appraisal or dissenters rights
under the General Corporation Law of Delaware or the Indenture in connection
with the Exchange Offer. The Company intends to conduct the Exchange Offer in
accordance with the applicable requirements of the Exchange Act and the rules
and regulations of the Commission thereunder.

The Company shall be deemed to have accepted validly tendered Original Notes
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as agent for the tendering holders
for the purpose of receiving the Exchange Notes from the Company.

20
<PAGE>

If any tendered Original Notes are not accepted for exchange because of an
invalid tender, the occurrence of certain other events set forth herein or
otherwise, the certificates for any such unaccepted Original Notes will be
returned, without expense, to the tendering holder thereof as promptly as
practicable after the Expiration Date. See "--Procedure for Tendering," "--
Book-Entry Transfer," "--Guaranteed Delivery Procedures" and "--Conditions."

Holders whose Original Notes are not tendered or are tendered but not
accepted in the Exchange Offer will continue to hold such Original Notes and
will be entitled to all the rights and preferences and subject to the
limitations applicable thereto under the Indenture. Following consummation of
the Exchange Offer, the holders will continue to be subject to the existing
restrictions upon transfer thereon and the Company will have no further
obligation to such holders to provide for the registration under the
Securities Act of the Original Notes held by them. To the extent that Original
Notes are tendered and accepted in the Exchange Offer, the trading market for
untendered and tendered but unaccepted Original Notes could be adversely
affected. See "Risk Factors--Consequences of Failure to Exchange."

Holders who tender Original Notes in the Exchange Offer will not be required
to pay brokerage commissions or fees or, subject to the instructions in the
Letter of Transmittal, transfer taxes with respect to the exchange of Original
Notes pursuant to the Exchange Offer. The Company will pay all charges and
expenses, other than transfer taxes in certain circumstances, in connection
with the Exchange Offer. See "--Fees and Expenses."

EXPIRATION DATE; EXTENSION; AMENDMENTS

The term "Expiration Date" shall mean 5:00 p.m., New York City time, on
November 19, 1998, unless the Company, in its sole discretion, extends the
Exchange Offer, in which case the term "Expiration Date" shall mean the latest
date and time to which the Exchange offer is extended.

In order to extend the Exchange Offer, the Company will notify the Exchange
Agent of any extension by oral or written notice prior to 9:00 a.m., New York
City time, on the next business day after the previously scheduled expiration
date.

The Company reserves the right, in its sole discretion, (i) to delay
accepting any Original Notes, to extend the Exchange Offer or to terminate the
Exchange Offer if any of the conditions set forth below under "--Conditions"
shall not have been satisfied, by giving oral or written notice of such delay,
extension or termination to the Exchange Agent or (ii) to amend the terms of
the Exchange Offer in any manner. Any such delay in acceptance, extension,
termination or amendment will be followed as promptly as practicable by oral
or written notice thereof to the registered holders.

INTEREST ON THE EXCHANGE NOTES

The Exchange Notes will bear interest at the rate of 7.125% per annum from
their date of issuance. Interest on the Exchange Notes will be payable semi-
annually on May 1 and November 1 of each year, commencing November 1, 1998.
Interest on the Original Notes accepted for exchange will cease to accrue upon
issuance of the Exchange Notes. Interest accrued on the Original Notes so
accepted for exchange from the most recent date to which interest has been
paid or duly provided for on such Original Notes or, if no interest has been
paid or duly provided for, from May 4, 1998, through, but not including, the
date that the Exchange Notes are issued, will be paid with the first interest
payment on the Exchange Notes.

PROCEDURES FOR TENDERING

For a holder of Original Notes to tender Original Notes validly pursuant to
the Exchange Offer, a properly completed and duly executed Letter of
Transmittal (or facsimile thereof), with any required signature guarantee, or
(in the case of a book-entry transfer) an Agent's Message (as defined below)
in lieu of the Letter of Transmittal, and any other required documents, must
be received by the Exchange Agent at the address set forth in the Letter of
Transmittal prior to 5:00 p.m., New York City time, on the Expiration Date. In
addition, prior to

21
<PAGE>

5:00 p.m., New York City time, on the Expiration Date, either (a) certificates
for tendered Original Notes must be received by the Exchange Agent at such
address or (b) such Original Notes must be transferred pursuant to the
procedures for book-entry transfer described below (and a confirmation of such
tender received by the Exchange Agent, including an Agent's Message if the
tendering holder has not delivered a Letter of Transmittal).

The term "Agent's Message" means a message transmitted by the Depositary,
received by the Exchange Agent and forming part of the confirmation of a book-
entry transfer, which states that the Depositary has received an express
acknowledgment from the participant in the Depositary tendering Original Notes
which are the subject of such book-entry confirmation that such participant
has received and agrees to be bound by the terms of the Letter of Transmittal
and that the Company may enforce such agreement against such participant. In
the case of an Agent's Message relating to guaranteed delivery, the term means
a message transmitted by the Depositary and received by the Exchange Agent,
which states that the Depositary has received an express acknowledgment from
the participant in the Depositary tendering Original Notes that such
participant has received and agrees to be bound by the Notice of Guaranteed
Delivery.

By tendering Original Notes pursuant to the procedures set forth above, each
holder will make to the Company the representations set forth above in the
third paragraph under the heading "--Purpose and Effect of the Exchange
Offer."

The tender by a holder and the acceptance thereof by the Company will
constitute agreement between such holder and the Company in accordance with
the terms and subject to the conditions set forth herein and in the Letter of
Transmittal. THE METHOD OF DELIVERY OF ORIGINAL NOTES AND THE LETTER OF
TRANSMITTAL AND ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE
ELECTION AND SOLE RISK OF THE HOLDER. AS AN ALTERNATIVE TO DELIVERY BY MAIL,
HOLDERS MAY WISH TO CONSIDER OVERNIGHT OR HAND DELIVERY SERVICE. IN ALL CASES,
SUFFICIENT TIME SHOULD BE ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT
BEFORE THE EXPIRATION DATE. NO LETTER OF TRANSMITTAL OR ORIGINAL NOTES SHOULD
BE SENT TO THE COMPANY. HOLDERS MAY REQUEST THEIR RESPECTIVE BROKERS, DEALERS,
COMMERCIAL BANKS, TRUST COMPANIES OR NOMINEES TO EFFECT THE ABOVE TRANSACTIONS
FOR SUCH HOLDERS.

Any beneficial owner whose Original Notes are registered in the name of a
broker, dealer, commercial bank, trust company or other nominee and who wishes
to tender should contact the registered holder promptly and instruct such
registered holder to tender on such beneficial owner's behalf. If such
beneficial owner wishes to tender such Original Notes, such beneficial owner
must, prior to completing and executing the Letter of Transmittal and
delivering such Original Notes in such beneficial owner's name, either make
appropriate arrangements to register ownership of the Original Notes in such
beneficial owner's name or obtain a properly completed bond power from the
registered holder of the Original Notes. The transfer of registered ownership
may take considerable time and may not be able to be completed prior to the
Expiration Date.

Signatures on a Letter of Transmittal or a notice of withdrawal, as the case
may be, must be guaranteed by an Eligible Institution (as defined below)
unless the Original Notes tendered pursuant thereto are tendered (i) by a
registered holder who has not completed the box entitled "Special Registration
Instructions" or "Special Delivery Instructions" on the Letter of Transmittal
or (ii) for the account of an Eligible Institution (as defined below). In the
event that signatures on a Letter of Transmittal or a notice of withdrawal, as
the case may be, are required to be guaranteed, such guarantee must be by a
member firm of a recognized signature guarantee medallion program within the
meaning of Rule 17Ad-15 of the Exchange Act (an "Eligible Institution").

If the Letter of Transmittal is signed by a person other than the registered
holder of any Original Notes listed therein, such Original Notes must be
endorsed or accompanied by a properly completed bond power, signed by such
registered holder as such registered holder's name appears on such Original
Notes with the signature thereon guaranteed by an Eligible Institution.

22
<PAGE>

If the Letter of Transmittal or any Original Notes or bond powers are signed
by trustees, executors, administrators, guardians, attorneys-in-fact, offices
of corporations or others acting in a fiduciary or representative capacity,
such persons should so indicate when signing, and evidence satisfactory to the
Company of their authority to so act must be submitted with the Letter of
Transmittal.

The Exchange Agent and the Depositary have confirmed that the Exchange Offer
is eligible for DTC's Automated Tender Offer Program ("ATOP"). Accordingly,
DTC participants may electronically transmit their acceptance of the Exchange
Offer by causing DTC as the Depositary to transfer Original Notes to the
Exchange Agent in accordance with DTC's ATOP procedures for transfer. The
Depositary will then send an Agent's Message to the Exchange Agent.

All questions as to the validity, form, eligibility (including time of
receipt), acceptance of tendered Original Notes and withdrawal of tendered
Original Notes will be determined by the Company in its sole discretion, which
determination will be final and binding. The Company reserves the absolute
right to reject any and all Original Notes not properly tendered or any
Original Notes the Company's acceptance of which would, in the opinion of
counsel for the Company, be unlawful. The Company also reserves the right in
its sole discretion to waive any defects, irregularities or conditions of
tender as to particular Original Notes. The Company's interpretation of the
terms and conditions of the Exchange Offer (including the instructions in the
Letter of Transmittal) will be final and binding on all parties. Unless
waived, any defects or irregularities in connection with tenders of Original
Notes must be cured within such time as the Company shall determine. Although
the Company intends to notify holders of defects or irregularities with
respect to tenders of Original Notes, neither the Company, the Exchange Agent
nor any other person shall incur any liability for failure to give such
notification. Tenders of Original Notes will not be deemed to have been made
until such defects or irregularities have been cured or waived. Any Original
Notes received by the Exchange Agent that are not properly tendered and as to
which the defects or irregularities have not been cured or waived will be
returned by the Exchange Agent to the tendering holders, unless otherwise
provided in the Letter of Transmittal, as soon as practicable following the
Expiration Date.

BOOK-ENTRY TRANSFER

The Company understands that the Exchange Agent will make a request promptly
after the date of this Prospectus to establish accounts with respect to the
Original Notes at the Depositary for the purpose of facilitating the Exchange
Offer, and subject to the establishment thereof, any financial institution
that is a participant in the Depositary's system may make book-entry delivery
of Original Notes by causing the Depositary to transfer such Original Notes
into the Exchange Agent's account with respect to the Original Notes in
accordance with the Depositary's procedures for such transfer. Although
delivery of the Original Notes may be effected through book-entry transfer
into the Exchange Agent's account at the Depositary, an appropriate Letter of
Transmittal properly completed and duly executed with any required signature
guarantee, or, in the case of a book-entry transfer, an Agent's Message in
lieu of the Letter of Transmittal and all other required documents must in
each case be transmitted to and received or confirmed by the Exchange Agent at
its address set forth in the Letter of Transmittal on or prior to the
Expiration Date, or, if the guaranteed delivery procedures described below are
complied with, within the time period provided under such procedures. Delivery
of documents to the Depositary does not constitute delivery to the Exchange
Agent.

Unless an exemption applies under the applicable law and regulations
concerning "backup withholding" of federal income tax, the Exchange Agent will
be required to withhold, and will withhold, 31% of the gross proceeds
otherwise payable to a holder pursuant to the Exchange Offer if the holder
does not provide its taxpayer identification number (social security number or
employer identification number) and certify that such number is correct. Each
tendering holder should complete and sign the main signature form and the
Substitute Form W-9 included as part of the Letter of Transmittal, so as to
provide the information and certification necessary to avoid backup
withholding, unless an applicable exemption exists and is proved in a manner
satisfactory to the Company and the Exchange Agent.

23
<PAGE>

GUARANTEED DELIVERY PROCEDURES

Holders who wish to tender their Original Notes and (i) whose Original Notes
are not immediately available, (ii) who cannot deliver their Original Notes,
the Letter of Transmittal or any other required documents to the Exchange
Agent or (iii) who cannot complete the procedures for book-entry transfer,
prior to the Expiration Date, may effect a tender if: (a) the tender is made
through an Eligible Institution; (b) prior to the Expiration Date, the
Exchange Agent receives from such Eligible Institution a properly completed
and duly executed Notice of Guaranteed Delivery (by facsimile transmission,
mail or hand delivery) setting forth the name and address of the holder, the
certificate number(s) of such Original Notes and the principal amount of
Original Notes tendered, stating that the tender is being made thereby and
guaranteeing that, within three business days after the date of execution of
the Notice of Guaranteed Delivery, the Letter of Transmittal (or facsimile
thereof) together with the certificate(s) representing the Original Notes (or
a confirmation of book-entry transfer of such Original Notes into the Exchange
Agent's account at the Depositary), and any other documents required by the
Letter of Transmittal will be deposited by the Eligible Institution with the
Exchange Agent or, alternatively, the Holder shall have complied with the
Depositary's ATOP procedures; and (c) such properly completed and executed
Letter of Transmittal (or facsimile thereof), as well as the certificates
representing all tendered Original Notes in proper form for transfer (or a
confirmation of book-entry transfer of such Original Notes into the Exchange
Agent's account at the Depositary), and all other documents required by the
Letter of Transmittal are received by the Exchange Agent within three business
days after the date of execution of the Notice of Guaranteed Delivery.

Upon request to the Exchange Agent, a Notice of Guaranteed Delivery will be
sent to holders who wish to tender their Original Notes according to the
guaranteed delivery procedures set forth above.

WITHDRAWAL OF TENDERS

Except as otherwise provided herein, tenders of Original Notes may be
withdrawn at any time prior to 5:00 p.m., New York City time, on the
Expiration Date.

To withdraw a tender of Original Notes in the Exchange Offer, a written or
facsimile notice of withdrawal must be received by the Exchange Agent at its
address set forth in the Letter of Transmittal prior to 5:00 p.m., New York
City time, on the Expiration Date. Any such notice of withdrawal must (i)
specify the name of the person having deposited the Original Notes to be
withdrawn (the "Depositor"), (ii) identify the Original Notes to be withdrawn
(including the certificate number(s) and principal amount of such Original
Notes, or, in the case of Original Notes transferred by book-entry transfer,
the name and number of the account at the Depositary to be credited), (iii) be
signed by the holder in the same manner as the original signature on the
Letter of Transmittal by which such Original Notes were tendered (including
any required signature guarantees) or be accompanied by documents of transfer
sufficient to have the Trustee with respect to the Original Notes register the
transfer of such Original Notes into the name of the person withdrawing the
tender and (iv) specify the name in which any such Original Notes are to be
registered, if different from that of the Depositor. All questions as to the
validity, form and eligibility (including time of receipt) of such notices
will be determined by the Company, whose determination shall be final and
binding on all parties. Any Original Notes so withdrawn will be deemed not to
have been validly tendered for purposes of the Exchange Offer and no Exchange
Notes will be issued with respect thereto unless the Original Notes so
withdrawn are validly retendered. Any Original Notes which have been tendered
but which are not accepted for exchange will be returned to the holder thereof
without cost to such holder as soon as practicable after withdrawal, rejection
of tender or termination of the Exchange Offer. Properly withdrawn Original
Notes may be retendered by following one of the procedures described above
under "--Procedures for Tendering" at any time prior to the Expiration Date.

CONDITIONS

Notwithstanding any other term of the Exchange Offer, the Company shall not
be required to accept for exchange, or exchange Notes for, any Original Notes,
and may terminate or amend the Exchange Offer as provided herein before the
acceptance of such Original Notes, if:

(a) any action or proceeding is instituted or threatened in any court or
by or before any governmental agency with respect to the Exchange Offer
which, in the Company's reasonable discretion, might materially

24
<PAGE>

impair the ability of the Company to proceed with the Exchange Offer or any
material adverse development has occurred in any existing action or
proceeding with respect to the Company or any of its subsidiaries; or

(b) any law, statute, rule, regulation or interpretation by the Staff of
the Commission is proposed, adopted or enacted, which, in the Company's
reasonable discretion, might materially impair the ability of the Company
to proceed with the Exchange Offer or materially impair the contemplated
benefits of the Exchange Offer to the Company; or

(c) any governmental approval has not been obtained, which approval the
Company shall, in the Company's reasonable discretion, deem necessary for
the consummation of the Exchange Offer as contemplated hereby.

If the Company determines in its reasonable discretion that any of the
conditions are not satisfied, the Company may (i) refuse to accept any
Original Notes and return all tendered Original Notes to the tendering
holders, (ii) extend the Exchange Offer and retain all Original Notes tendered
prior to the expiration of the Exchange Offer, subject, however, to the rights
of holders to withdraw such Original Notes (see "--Withdrawal of Tenders"), or
(iii) waive such unsatisfied conditions with respect to the Exchange Offer and
accept all properly tendered Original Notes which have not been withdrawn.

The foregoing conditions are solely for the benefit of the Company and may
be asserted by the Company in good faith regardless of the circumstances
giving rise to such conditions or may be waived by the Company in whole or in
part at any time and from time to time in its discretion. The failure by the
Company at any time to exercise the foregoing rights shall not be deemed a
waiver of any such right and each such right shall be deemed an ongoing right
which may be asserted at any time and from time to time. In addition, the
Company has reserved the right, notwithstanding the satisfaction of each of
the foregoing, to terminate or amend the Exchange Offer.

EXCHANGE AGENT

Marine Midland Bank (the "Exchange Agent") has been appointed as Exchange
Agent for the Exchange Offer. Questions and requests for assistance, requests
for additional copies of this Prospectus or of the Letter of Transmittal and
requests for Notice of Guaranteed Delivery should be directed to the Exchange
Agent addressed as follows:

By Registered or Certified Mail; By Overnight Courier; or By Hand:

Marine Midland Bank
140 Broadway
Level A
New York, New York 10005-1180
Attention: Corporate Trust Services
(212) 658-5931

By Facsimile:

(212) 658-2292
Attention: Corporate Trust Services

DELIVERY TO AN ADDRESS OTHER THAN AS SET FORTH ABOVE OR TRANSMISSION OF
INSTRUCTIONS VIA FACSIMILE OTHER THAN AS SET FORTH ABOVE DOES NOT CONSTITUTE A
VALID DELIVERY.

FEES AND EXPENSES

The expenses of soliciting tenders will be borne by the Company. The
principal solicitation is being made by mail; however, additional solicitation
may be made by telegraph, telecopy, telephone or in person by officers and
regular employees of the Company and its affiliates.

25
<PAGE>

The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers, dealers, or others
soliciting acceptances of the Exchange Offer. The Company, however, will pay
the Exchange Agent reasonable and customary fees for its services and will
reimburse it for its reasonable out-of-pocket expenses in connection
therewith.

The cash expenses to be incurred in connection with the Exchange Offer will
be paid by the Company. Such expenses include fees and expenses of the
Exchange Agent and Trustee, accounting and legal fees and printing costs,
among others.

ACCOUNTING TREATMENT

The Exchange Notes will be recorded at the same carrying value as the
Original Notes, which is face value, net of original issue discount, as
reflected in the Company's accounting records on the date of exchange.
Accordingly, no gain or loss for accounting purposes will be recognized by the
Company. The expenses of the Exchange Offer will be expensed over the term of
the Exchange Notes.

CONSEQUENCES OF FAILURE TO EXCHANGE

Holders of Original Notes who do not exchange their Original Notes for
Exchange Notes pursuant to the Exchange Offer will continue to be subject to
the restrictions on transfer of such Original Notes as set forth in the legend
thereon. In general, the Original Notes may not be offered or sold, unless
registered under the Securities Act, except pursuant to an exemption from, or
in a transaction not subject to, the Securities Act and applicable state
securities laws. The Company does not intend to register the Original Notes
under the Securities Act.

FEDERAL INCOME TAX CONSEQUENCES

The exchange of Original Notes for Exchange Notes by holders will not be a
taxable exchange for federal income tax purposes, and holders should not
recognize any taxable gain or loss or any interest income as a result of such
exchange.

OTHER

Participation in the Exchange Offer is voluntary and holders should
carefully consider whether to accept. Holders of the Original Notes are urged
to consult their financial and tax advisors in making their own decisions on
what action to take.

As a result of the making of, and upon acceptance for exchange of all
validly tendered Original Notes pursuant to the terms of this Exchange Offer,
the Company will have fulfilled a covenant contained in the terms of the
Original Notes and the Registration Agreement. Holders of the Original Notes
who do not tender their certificates in the Exchange Offer will continue to
hold such certificates and will be entitled to all the rights, and limitations
applicable thereto, under the Indenture, except for any such rights under the
Registration Agreement which by their terms terminate or cease to have further
effect as a result of the making of this Exchange Offer. See "Description of
Exchange Notes." All untendered Original Notes will continue to be subject to
the restriction on transfer set forth in the Indenture. To the extent that
Original Notes are tendered and accepted in the Exchange Offer, the trading
market, if any, for the Original Notes could be adversely affected. See "Risk
Factors--Consequences of Failure to Exchange."

The Company may in the future seek to acquire untendered Original Notes in
open market or privately negotiated transactions, through subsequent exchange
offers or otherwise. The Company has no present plan to acquire any Original
Notes which are not tendered in the Exchange Offer.

26
<PAGE>

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

The following table presents selected historical consolidated financial data
of the Company as of and for the six-months period ended June 30, 1998 and
1997, the seven-month periods ended December 31, 1997 and 1996 and the five
fiscal years ended May 31, 1997, 1996, 1995, 1994 and 1993. During September
1997, the Company changed its fiscal year from a May 31 year-end to a December
31 year-end.

The selected historical consolidated financial data as of and for the seven
months ended December 31, 1997 and the four fiscal years ended May 31, 1997,
1996, 1995 and 1994 (with respect to income statement data only) are derived
from the audited consolidated financial statements of the Company. The
selected historical consolidated financial data for the six-month periods
ended June 30, 1998 and 1997, the seven-month period ended December 31, 1996
and the fiscal year ended May 31, 1993 and the selected historical
consolidated balance sheet data and certain other data as of May 31, 1994 are
derived from the Company's unaudited consolidated financial statements which,
in the opinion of management, include all material adjustments necessary at
such dates and for such periods. The selected historical consolidated
financial data presented herein for all periods are presented as if the
Company were a separate entity. See the "Basis of Presentation" note to the
Company's Consolidated Financial Statements. The Company's historical net
income and cash flows as a wholly-owned subsidiary of Manor Care or Former
Choice (all periods prior to October 15, 1997) are not necessarily indicative
of the net income and cash flows the Company might have realized as an
independent entity. The data set forth below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Company's Consolidated Financial Statements and related
notes thereto contained elsewhere herein.

27
<PAGE>

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA

<TABLE>
<CAPTION>
SIX-MONTH SIX-MONTH
PERIOD ENDED PERIOD ENDED SEVEN-MONTH PERIOD
JUNE 30, JUNE 30, ENDED DECEMBER 31, YEAR ENDED MAY 31,
------------ ------------ ------------------------- -------------------------------------------
1998 1997 1997 1996 1997 1996 1995 1994(1)
------------ ------------ --------- ----------- -------- -------- -------- --------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AND STATISTICAL DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME
DATA:
Revenues(13)...... $ 77,606 $81,688 $ 107,839 $99,978 $168,039 $151,748 $129,027 $112,829
Operating
expenses(13)..... 39,955 49,178 55,665 54,511 97,677 117,365(2) 87,061 84,706
-------- ------- --------- ------- -------- -------- -------- --------
Operating income.. 37,651 32,510 52,174 45,467 70,362 34,383 41,966 28,123
-------- ------- --------- ------- -------- -------- -------- --------
Interest on notes
payable to Manor
Care............. -- -- -- -- 7,083 7,083 7,083 7,083
Minority interest
expense.......... -- -- -- -- -- 1,532 2,200 1,476
Interest and
other, net....... 1,433(12) 5,008 5,791(3) 5,784 3,704(4) 4,791 3,672 3,591
-------- ------- --------- ------- -------- -------- -------- --------
Total other
expenses....... 1,433 5,008 5,791 5,784 10,787 13,406 12,955 12,150
-------- ------- --------- ------- -------- -------- -------- --------
Income before
income taxes...... 36,218 27,502 46,383 39,683 59,575 20,977 29,011 15,973
Income taxes....... (15,085) (11,455) (19,096) (16,338) (24,845) (9,313) (12,783) (7,372)
-------- ------- --------- ------- -------- -------- -------- --------
Net income......... $ 21,133 $16,047 $ 27,287 $23,345 $ 34,730 $ 11,664 $ 16,228 $ 8,601
-------- ------- --------- ------- -------- -------- -------- --------
Basic earnings per
share(5).......... $ 0.36 $ 0.26 $ 0.46 $ 0.37 $ 0.55 $ 0.19 $ 0.26 $ 0.14
======== ======= ========= ======= ======== ======== ======== ========
Diluted earnings
per share......... $ 0.35 $ 0.26 $ 0.45 $ 0.37 $ 0.55 $ 0.19 $ 0.26 $ 0.14
======== ======= ========= ======= ======== ======== ======== ========
OTHER DATA:
EBITDA
(unaudited)(6)(14).. $ 51,551 $38,972 $ 61,330 $51,514 $ 81,743 $ 69,450(7) $ 51,534 $ 37,472
Cash flows from
operating
activities....... 17,054 29,816 33,607 25,153 45,505 32,742 37,851 N/A
Cash flows from
investing
activities....... (8,700) (6,515) (149,739) (7,523) (16,928) (78,499) (7,733) N/A
Cash flows from
financing
activities....... (12,271) (22,820) 122,247 (17,442) (28,222) 48,513 (31,261) N/A
Ratio of earnings
to fixed charges
(unaudited)(8) .. 4.59x 5.99x 5.69x 7.05x 5.56x 2.42x 3.03x 2.18x
Number of
franchised
properties
(unaudited)...... 3,567 3,397 3,484 3,220 3,344 3,052 2,835 2,713
Number of rooms
(unaudited)...... 297,396 287,444 292,733 272,819 283,034 261,456 245,669 239,744
Average royalty
rate
(unaudited)(9)... 3.50% 3.40% 3.51% 3.43% 3.43% 3.34% 3.20% 3.10%
BALANCE SHEET DATA
(AT PERIOD END):
Working capital
(unaudited)...... $ 8,384 -- $ 5,397 $ 500 $ (416) $ (3,927) $(29,423) N/A
Total assets...... 408,344(10) -- 386,395(10) 217,870 221,473 212,803 189,087 $173,646
Total debt(11).... 293,719 -- 282,821 133,700 125,163 145,315 128,205 126,294
Total
liabilities...... 351,157 -- 337,137 168,700 164,280 182,271 201,786 169,237
Total investments
and advances from
(to) Parent...... -- -- -- 49,170 57,193 30,532 (12,699) 4,409
Total
shareholders'
equity........... 57,187 -- 49,258 -- -- -- -- --
<CAPTION>
1993
-----------
(UNAUDITED)
<S> <C>
STATEMENT OF INCOME
DATA:
Revenues(13)...... $ 80,545
Operating
expenses(13)..... 57,490
-----------
Operating income.. 23,055
-----------
Interest on notes
payable to Manor
Care............. 7,083
Minority interest
expense.......... 900
Interest and
other, net....... 145
-----------
Total other
expenses....... 8,128
-----------
Income before
income taxes...... 14,927
Income taxes....... (6,422)
-----------
Net income......... $ 8,505
-----------
Basic earnings per
share(5).......... $ 0.15
===========
Diluted earnings
per share......... $ 0.15
===========
OTHER DATA:
EBITDA
(unaudited)(6)(14).. $ 31,337
Cash flows from
operating
activities....... N/A
Cash flows from
investing
activities....... N/A
Cash flows from
financing
activities....... N/A
Ratio of earnings
to fixed charges
(unaudited)(8) .. 2.58x
Number of
franchised
properties
(unaudited)...... 2,381
Number of rooms
(unaudited)...... 216,990
Average royalty
rate
(unaudited)(9)... N/A
BALANCE SHEET DATA
(AT PERIOD END):
Working capital
(unaudited)...... N/A
Total assets...... $170,815
Total debt(11).... 122,909
Total
liabilities...... 144,982
Total investments
and advances from
(to) Parent...... 25,833
Total
shareholders'
equity........... --
</TABLE>
- -------
(1) The selected historical consolidated income statement data for the fiscal
year ended May 31, 1994 are derived from the audited consolidated
financial statements of the Company. The selected historical consolidated
balance sheet data and certain other data as of May 31, 1994 are derived
from unaudited consolidated financial statements of the Company.
(2) Fiscal year 1996 operating expenses include a non-cash, pre-tax charge of
$24.8 million for impairment of certain long-lived assets associated with
the Company's European operations.
(3) Includes interest expense and other for the seven-month period ended
December 31, 1997 of $8.79 million offset by approximately $2.4 million
of accrued interest income on the Term Note (see note 10 below) and
approximately $550,000 in dividend income from the Company's investment
in Friendly Hotels, PLC ("Friendly").

28
<PAGE>

(4)Includes interest expense and other for fiscal year 1997 of approximately
$4.65 million offset by approximately $943,000 in dividend income from the
Company's investment in Friendly.
(5) Basic earnings per share have been calculated for fiscal years 1993,
1994, 1995 and 1996 based on the weighted average shares outstanding of
the Company's former parent Manor Care of 57,316,000, 60,524,000,
62,480,000 and 62,628,000, respectively, and for fiscal year 1997 based
on the weighted average shares outstanding of the Company's former parent
Former Choice of 62,680,000. Basic earnings per share have been
calculated for the six-month period ended June 30, 1998 based on the
weighted average shares outstanding from January 1, 1998 through June 30,
1998, for the seven-month period ended December 31, 1996 based on the
weighted average shares outstanding of Manor Care from June 1, 1996
through November 1, 1996 and of Former Choice from November 2, 1996
through December 31, 1996 of 63,063,146 and for the seven-month period
ended December 31, 1997 based on the weighted average shares outstanding
of Former Choice from June 1, 1997 through October 15, 1997 and of the
Company from October 16, 1997 through December 31, 1997 of 59,798,000.
(6) EBITDA consists of the sum of net income, 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 the
Company's ability to meet debt service obligations, fund capital
expenditures and expand its business. The Company 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
(including nondiscretionary 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 and therefore EBITDA does
not represent funds available for management's discretionary use. EBITDA
presented by the Company may not be comparable to EBITDA defined and
presented by other companies.
(7) Fiscal year 1996 EBITDA excludes a non-cash, pre-tax charge of $24.8
million for impairment of certain long-lived assets associated with the
Company's European operations.
(8) Earnings used in computing the ratio of earnings to fixed charges consist
of income before income taxes and fixed charges. Fixed charges consist of
interest expense and the amortization of deferred financing fees and that
portion of rental expense representative of interest.
(9) Represents domestic royalty fees as a percentage of aggregate gross room
revenues of all domestic Choice Brand franchised hotels.
(10) Includes the Term Note in an aggregate principal amount of $115.0 million
plus accrued interest thereon as of December 31, 1997 and June 30, 1998
of $2.4 million and 4.9 million, respectively and a receivable from
Sunburst as of December 31, 1997 and June 30, 1998 of $25.1 million and
$19.9 million, respectively. See "Risk Factors--Significant Receivables
from Sunburst."
(11) Includes a note payable to Manor Care in the amount of $78.7 million, as
of December 31, 1996 and as of May 31, 1997, 1996, 1995, 1994 and 1993.
(12) Includes interest expense and other for the six-month period ended
June 30, 1998 of $9.6 million offset by approximately $4.9 million of
accrued interest income on the Term Note (see note 10 above),
approximately $1.0 million in dividend income from the Company's
investment in Friendly Hotels PLC ("Friendly") and approximately
$2.2 million of gain recognized from the sale of certain investments.
(13) During the second quarter of 1998, the Company changed its presentation
of marketing and reservation fees such that the fees collected and
associated expenses are reported on a net basis. All periods have been
restated to conform to this presentation.
(14) Depreciation and amortization related to the marketing and reservation
funds included in EBITDA was $2.2 million for the six month period ended
June 30, 1998, $1.2 million for the six months ended June 30, 1997, $2.2
million for the seven-month period ended December 31, 1997 and $2.8
million, $2.7 million and $2.1 million for the fiscal years ended May 31,
1997, May 31, 1996 and May 31, 1995, respectively.

29
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

The Company is the world's second largest franchisor of hotel properties
with 3,567 franchised properties open and 870 franchised properties under
development at June 30, 1998, representing 297,396 rooms open and 76,523 rooms
under development in 33 countries. The Company franchises lodging properties
under the Choice Brands: Comfort, Quality, Clarion, Sleep, Rodeway, Econo
Lodge and MainStay. The Company has over 2,100 franchisees in its domestic
franchise system, the largest of which, Sunburst, accounted for approximately
5% of the Company's royalty fees for the six months ended June 30, 1998. The
Company franchises hotels in all 50 states and the District of Columbia and 32
additional countries, with 94% of its franchising revenue generated from
hotels franchised in the United States. Accordingly, management's discussion
of its franchise operating results focuses on the performance of the domestic
system.

The principal factors that affect the Company's operating results are: (i)
growth in the number of hotels under franchise, (ii) occupancy and room rates
achieved by the hotels under franchise, (iii) the number and relative mix of
franchised hotels and (iv) the Company's ability to manage costs. The number
of rooms at franchised properties and occupancy and room rates at those
properties significantly affect the Company's results because franchise
royalty fees are based upon room revenues at franchised hotels. The variable
overhead costs associated with franchise system growth are substantially less
than incremental royalty fees generated from new franchisees, therefore the
Company is able to capture a significant portion of those royalty fees as
operating income.

During September 1997, the Company changed its fiscal year from a May 31
year-end to a December 31 year-end. Accordingly, the following discussion
includes a discussion of the unaudited results of the six months ended June
30, 1998 as compared to unaudited results from the comparable six month period
in 1997 as well as the audited results of the seven months ended December 31,
1997, as compared to unaudited results from the comparable seven-month period
in 1996.

Comparison of Six Month Period Ended June 30, 1998 Operating Results and Six
Month Period Ended June 30, 1997 Operating Results

The Company reported net income of $21.1 million, or $0.35 per diluted
share, for the six months ended June 30, 1998, compared to net income for the
same period of 1997 of $16.0 million, or $0.26 per diluted share. The $0.35
per share includes approximately $0.02 resulting from a sale of certain
investments held by the Company. Exclusive of this gain, diluted earnings per
share increased 26.9% to $0.33 per share from $0.26 per share. The increase in
net income for the period is primarily attributable to an increase in
franchise revenue as a direct result of the addition of new licensees to the
franchise system, improvements in the operating performance of franchised
hotels and the control of the Company's selling, general and administrative
costs.

30
<PAGE>

Franchise Revenues

In operating the franchise business, the Company collects marketing and
reservation fees and assessments from its franchisees. The Company is
contractually obligated to disburse these fees for marketing and reservation
activities to be provided on behalf of its franchisees. Management, therefore,
analyzes its franchise business based on revenues net of marketing and
reservation fees ("net franchise revenue") and franchise operating expenses
which are reflected as selling, general and administrative expenses.

Net franchise revenues include royalty fees, initial franchise fees and
relicensing fees earned on contracts signed and other revenues, including
partner service revenue. Net franchise revenues are dependent upon growth in
the number of franchised properties as well as the underlying performance of
franchised hotels for continued growth. The key industry standard for
measuring hotel operating performance is revenue per available room
("RevPAR"), which is calculated by multiplying the percentage of occupied
rooms by the average daily room rate realized.

The Company's net franchise revenues were $64.1 million for the six months
ended June 30, 1998 and $61.2 million for the six months ended June 30, 1997.

Total net franchise revenues are computed as follows:

<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1998 1997
-------- --------
(IN MILLIONS)
<S> <C> <C>
Total franchise revenues...................................... $ 76.5 $ 73.1
Product sales................................................. (12.4) (11.9)
------ ------
Total net franchise revenues.................................. $ 64.1 $ 61.2
====== ======
</TABLE>

Royalties increased $5.0 million to $50.1 million in 1998 from $45.1 million
in 1997, an increase of 11.1%. The increase in royalties is attributable to a
net increase of 157 franchisees during the period representing an additional
12,077 rooms added to the system, an improvement in domestic RevPAR of 1.4%
and an increase in the effective royalty rate of the domestic hotel system to
3.50% from 3.40%. Also, foreign fees increased $1.6 million for the six months
ended June 30, 1998 from the six months ended June 30, 1997. Initial fee and
relicensing fee revenue generated from domestic franchise contracts signed
decreased to $7.6 million from $8.8 million in 1997. However, total franchise
agreements signed in the six months ended June 30, 1998 were 368, as compared
to 324 for the six months ended June 30, 1997. The decline in initial and
relicensing fee revenue is attributable to certain incentives offered related
to the Company's Sleep Inn brand. The total number of hotels open and under
development increased to 4,437 from 4,191, an increase of 5.9% for the period
ending June 30, 1998. This represents an increase in the number of rooms open
and under development of 4.6% from 357,451 as of June 30, 1997 to 373,919 as
of June 30, 1998.

Franchise Expenses

Selling, general and administrative expenses declined approximately $1
million between years. As a percentage of total net franchising revenues,
total franchising selling, general and administrative expenses declined to
36.9% for the six months ended June 30, 1998 as compared to 40.4% for 1997.
The improvement in the franchising margins relates to the economies of scale
generated from operating a larger franchisee base, cost control initiatives
and improvements in franchised hotel performance.

Product Sales

Sales made to franchisees through the Company's group purchasing program
increased $500,000 (or 4.2%) to $12.4 million for the six months ended June
30, 1998 from $11.9 million at June 30, 1997. The group purchasing program
utilizes bulk purchases to obtain favorable pricing from third party vendors
for franchisees ordering similar products. The Company acts as a "clearing-
house" between the franchisee and the vendor, and orders are shipped directly
to the franchisee.

31
<PAGE>

Similarly, product cost of sales increased approximately $300,000 (or 2.7%)
for the six months ended June 30, 1998. The product services margins increased
for the six months ended June 30, 1998 to 6.2% from 4.7% at June 30, 1997.
This purchasing program is provided to the franchisees as a service and is not
expected to be a major component of the Company's profitability.

Other

For the six months ended June 30, 1998, the Company recognized approximately
$1.0 million in dividend income from its investment in Friendly and
approximately $4.9 million of interest income from its subordinated term note
to Sunburst Hospitality, Inc. For the six months ended June 30, 1998, the
Company recognized a gain of approximately $2.2 million from the sale of
certain investments.

Comparison of Seven-Month Period Ended December 31, 1997 Operating Results
and Seven-Month Period Ended December 31, 1996 Operating Results

The Company recorded net income of $27.3 million for the seven-month period
ended December 31, 1997 ("December 1997"), an increase of $4.0 million,
compared to net income of $23.3 million for the seven-month period ended
December 31, 1996 ("December 1996"). The increase in net income for December
1997 was primarily attributable to an increase in royalty fee revenue as a
direct result of the addition of new franchisees to the system and
improvements in the operating performance of franchised hotels.

Summarized financial results for December 1997 and December 1996 are as
follows:

<TABLE>
<CAPTION>
SEVEN MONTHS ENDED
DECEMBER 31,
--------------------
1997 1996
-------- -----------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
REVENUES:
Royalty fees............................................. $ 70,308 $ 61,821
Marketing and reservation fees........................... 72,284 66,273
Product sales............................................ 13,524 14,717
Initial franchise fees and relicensing fees.............. 8,597 9,304
Other, including partner service revenue................. 4,869 3,161
European hotel operations................................ 10,541 10,975
-------- --------
Total revenue.......................................... 180,123 166,251
OPERATING EXPENSES:
Marketing and reservation................................ 70,102 63,379
European hotel operations................................ 9,203 9,745
Selling, general and administrative...................... 29,454 28,132
Product services cost of sales........................... 13,031 13,481
Depreciation and amortization............................ 6,159 6,047
-------- --------
Total operating expenses............................... 127,949 120,784
Operating income........................................... 52,174 45,467
Interest expense and other, net............................ 5,791 5,784
-------- --------
Income before income taxes................................. 46,383 39,683
Income taxes............................................... 19,096 16,338
-------- --------
Net income................................................. $ 27,287 $ 23,345
======== ========
</TABLE>

Net franchise revenues were $83.8 million for December 1997 and $74.3
million for December 1996. Royalties increased $8.5 million to $70.3 million
from $61.8 million in December 1996, an increase of 13.8%. The increase in
royalties is attributable to a net increase of 264 franchised properties from
December 31, 1996 to

32
<PAGE>

December 31, 1997 representing an additional 19,914 rooms added to the system,
an improvement in domestic RevPAR of 2.4% and an increase in the effective
royalty rate of the domestic hotel system to 3.51% from 3.43%. Initial and
relicensing fee revenue generated from franchise contracts signed declined
7.5% to $8.6 million from $9.3 million in December 1996. Total franchise
agreements signed in December 1997 were 368, down 14% from the total contracts
signed in December 1996 of 428. The decline in initial fees is primarily a
result of the Company's sales force reorganization and the resulting temporary
displacement of the sales force. The reorganization of the regional market
management sales and support force was completed in September 1997. Revenues
generated from strategic partnership relationships increased to $3.4 million
from $1.5 million in December 1996. This revenue relates to agreements that
provide preferred vendors access to the Company's franchisees.

Franchise Expenses. The cost to operate the franchising business is
reflected in selling, general and administrative expenses. Selling, general
and administrative expenses were $29.5 million for December 1997, an increase
of $1.4 million from the December 1996 total of $28.1 million. The increases
in selling, general and administrative expenses were primarily due to
additional personnel to support company growth and new company initiatives.
Selling, general and administrative expenses declined to 35.2% of net
franchise revenues in December 1997 from 37.8% in December 1996. The
improvement in the franchising margins relates to the economies of scale
generated from operating a larger franchisee base, cost control initiatives
and improvements in franchised hotel performance.

Product Sales. Sales made to franchisees through the Company's group
purchasing program declined $1.2 million to $13.5 million in December 1997
from $14.7 million in December 1996. The group purchasing program utilizes
bulk purchases to obtain favorable pricing from third party vendors for
franchisees ordering similar products. The Company acts as a "clearing-house"
between the franchisee and the vendor, and orders are shipped directly to the
franchisee.

Similarly, product cost of sales decreased $0.45 million (or 3.3%) in
December 1997. The product services margins decreased in December 1997 to 3.6%
from 8.4% in December 1996. This purchasing program is provided to the
franchisees as a service and is not expected to be a major component of the
Company's profitability.

European Hotel Operations. In January 1998, the Company and Friendly Hotels,
PLC ("Friendly") consummated a transaction in which Friendly acquired from the
Company the master franchise rights for the Comfort, Quality and Clarion
brands for all of Europe with the exception of Scandinavia for a period of ten
years, for a payment of $8.0 million payable in eight equal annual
installments. As part of the transaction, Friendly acquired from the Company
ten hotels in France, two in Germany and one in the United Kingdom in exchange
for $22.2 million in 5.75% convertible preferred shares in Friendly. In
addition, Friendly will pay the Company deferred compensation of $4.0 million
in cash, payable by the fifth anniversary of the transaction or sooner
depending on the level of future profits of the hotels acquired.

Depreciation and Amortization. Depreciation and amortization increased to
$6.2 million in December 1997 from $6.0 million in December 1996. The increase
was primarily due to recent capital improvements to the Company's financial
and billing information systems.

Interest expense and other, net. Interest expense and other for December
1997 was $8.8 million offset by approximately $2.4 million of accrued interest
income on the Term Note and approximately $0.55 million in dividend income
from the Company's investment in Friendly. The increase in interest expense
results from additional debt incurred in connection with the Company Spin-Off.

Comparison of Fiscal Year 1997 Operating Results and Fiscal Year 1996
Operating Results

The Company recorded net income of $34.7 million for the fiscal year ended
May 31, 1997 ("fiscal 1997"), an increase of $23.0 million, compared to net
income of $11.7 million for the fiscal year ended May 31, 1996

33
<PAGE>

("fiscal 1996"). Fiscal 1996 results include a non-cash, pre-tax $24.8 million
asset impairment charge related to the Company's European hotel operations.
Exclusive of this charge, fiscal 1996 net income was $26.7 million. The
increase in net income for fiscal 1997 was primarily attributable to an
increase in royalty fee revenue as a direct result of the addition of new
franchisees to the franchise system and improvements in the operating
performance of franchised hotels.

Franchise Revenues. Net franchise revenues were $126.7 million for fiscal
1997 and $110.6 million for fiscal 1996. Royalties increased $9.2 million to
$97.2 million from $88.0 million in fiscal 1996, an increase of 10.5%. The
increase in royalties is attributable to a net increase of 292 franchised
properties during the period representing an additional 21,578 rooms added to
the system, an improvement in domestic RevPAR of 2.9% and an increase in the
effective royalty rate of the domestic hotel system to 3.43% from 3.34%.
Initial franchising and relicensing fees increased 7.9% to $16.8 million from
$15.6 million in fiscal 1996. Total franchise agreements signed in fiscal 1997
were 495, up 13.5% from the total contracts signed in fiscal 1996 of 436.
Revenues generated from strategic vendor relationships increased to $6.1
million from $1.8 million in fiscal 1996. This revenue relates to agreements
that provide preferred vendors access to the Company's franchisees.

Franchise Expenses. Selling, general and administrative expenses were $51.1
million in fiscal 1997, an increase of $5.9 million from the fiscal 1996 total
of $45.2 million. $4.8 million of the increase was directly attributable to
additional costs of operating as an independent company apart from Manor Care.
These additional costs are primarily additional staffing, incremental rental
expenses, and consulting fees as the Company assumed certain administrative
tasks previously provided by Manor Care. The remaining increases in selling,
general and administrative expenses were primarily due to additional personnel
to support company growth and new company initiatives.

Franchising selling, general and administrative expenses were 40.3% of net
franchising revenues in fiscal year 1997 and 40.9% of net franchising revenues
in fiscal 1996. Exclusive of the $4.8 million increase resulting from the
Former Choice Spin-Off, as a percentage of net franchising revenues, selling,
general and administrative expenses declined to 36.5% in fiscal 1997 from
40.9% in fiscal year 1996. The improvement in the franchising margins
primarily relates to the economies of scale generated from operating a larger
franchisee base.

Product Sales. Sales made to franchisees through the Company's group
purchasing program increased $2.0 million to $23.6 million in fiscal 1997 from
$21.6 million in fiscal 1996.

Similarly, product cost of sales increased $2.1 million (or 9.9%) in fiscal
1997. The product services margins decreased in fiscal 1997 to 3.7% from 4.0%
in fiscal 1996. This purchasing program is provided to the franchisees as a
service and is not expected to be a major component of the Company's
profitability.

European Hotel Operations. Total revenues at the Company's owned hotel
operations in Europe declined to $17.7 million in fiscal 1997 from $19.6
million in fiscal 1996. Operating margins at the hotels declined to 8.9% in
fiscal 1997 from 10.6% in fiscal 1996. The decline in revenue and operating
performance reflects the difficult economic and competitive climates in which
a number of the European hotels operated.

Depreciation and Amortization. Depreciation and amortization decreased $1.4
million (or 11.9%) to $10.4 million in fiscal 1997 from $11.8 million in
fiscal 1996. The decrease was primarily due to the asset impairment charge
against European fixed assets which reduced the asset base upon which
depreciation is determined.

Provision for Asset Impairment. In fiscal 1996, the Company recorded a non-
cash, pre-tax charge against earnings of $24.8 million relating to impairment
of certain long-lived assets related to the Company's European hotel
operations.

Other. In fiscal 1997, the Company recognized $0.94 million in dividend
income from its investment in Friendly.

34
<PAGE>

Comparison of Fiscal Year 1996 Operating Results and Fiscal Year 1995
Operating Results

Net income for fiscal 1996 was $11.7 million, a decrease of $4.5 million (or
27.8%) compared to net income of $16.2 million for the fiscal year ended May
31, 1995 ("fiscal 1995"). Net income in fiscal 1996 includes a one-time non-
cash, pre-tax $24.8 million asset impairment charge relating to the Company's
European hotel operations. Exclusive of the $24.8 million charge, net income
increased to $26.7 million in fiscal 1996, a 64.8% increase over fiscal 1995.

Franchise Revenues. Net franchise revenues were $110.6 million for fiscal
1996 and $95.9 million for fiscal 1995. Royalties increased $9.9 million to
$88.0 million in fiscal 1996 from $78.1 million, an increase of 12.7%. The
increase in royalties is attributable to a net increase of 217 franchised
properties during the period, representing an additional 15,787 rooms added to
the system, an improvement in domestic RevPAR of 5.1% and an increase in the
effective royalty rate of the domestic hotel system to 3.34% from 3.20%.
Initial franchising and relicensing fees increased 33.3% to $15.6 million in
fiscal 1996 from $11.7 million in fiscal 1995. Total franchise agreements
signed in fiscal 1996 were 436, up 21.4% from the total contracts signed in
fiscal 1995 of 359.

Franchise Expenses. Selling, general and administrative costs declined to
$45.2 million in fiscal 1996 from $45.6 million in fiscal 1995.

Selling, general and administrative expenses as a percentage of net
franchise revenues declined to 40.9% in fiscal 1996 from 47.5% in fiscal 1995.
The improvement in the franchising margins relates to the economies of scale
generated from operating a larger franchisee base and improved operating
performance of the franchised hotels.

Product Sales. Sales made to franchisees through the Company's group
purchasing program increased $7.1 million to $21.6 million in fiscal 1996 from
$14.5 million in fiscal 1995.

Similarly, product cost of sales increased $6.8 million (or 49.2%) in fiscal
1996. The product services margins were 4.0% in fiscal 1996 and fiscal 1995.
This purchasing program is provided to the franchisees as a service and is not
expected to be a major component of the Company's profitability.

European Hotel Operations. Revenues from European hotel operations increased
5.2% in fiscal 1996. Operating margins increased to 10.6% in fiscal 1996 from
3.8% in fiscal 1995. The increase in fiscal 1996 was primarily due to improved
performance of newly completed owned and managed hotels.

Other Expenses. In fiscal 1996, the Company recorded a non-cash, pre-tax
charge against earnings of $24.8 million relating to impairment of certain
long-lived assets associated with the Company's European hotel operations.

Liquidity and Capital Resources

Net cash provided by operating activities was $33.6 million for December
1997, an increase of $8.4 million from $25.2 million for December 1996. At
December 31, 1997, the total debt outstanding for the Company was $282.8
million.

Net cash provided by operating activities was $17.1 million for the six
months ended June 30, 1998, a decrease of approximately $12.7 million from
$29.8 million for 1997. As June 30, 1998, the total long-term debt outstanding
for the Company was $293.7 million.

In May 1998, the Company consummated the Offering of the Original Notes with
an aggregated payment amount of $100,000,000. The Original Notes bear a coupon
rate of 7.125% and will mature on May 1, 2008, with interest to be paid semi-
annually. The Company used the net proceeds from the offering of approximately
$99 million to repay amounts outstanding under the Company's $300 million
revolving credit facility. In connection with the Company Spin-Off on October
15, 1997, the Company was issued a $115.0 million 5-year 11% Subordinated Term
Note from Sunburst (referred to elsewhere as the "Term Note"). The note is
payable in full, along with accrued interest on October 15, 2002. Total
interest accrued at June 30, 1998 was $7.3 million. As of June 30, 1998,
approximately $19.9 million of receivables are due to the Company from
Sunburst, which are included in current assets. These receivables relate to a
net worth guarantee relating to the allocation of Former Choice liabilities
between the Company and Sunburst as provided for under the terms of the
Distribution Agreement and the reimbursement of various expenses paid by the
Company subsequent to the date of the Company Spin-Off. See "Relationship
Between the Company and Sunburst--Distribution Agreement."

35
<PAGE>

During fiscal 1995, prior to the Former Choice Spin-Off, the Company
repurchased one-half of the 11% interest held by its management for $27.4
million. Approximately $19.8 million was allocated to goodwill. On May 31,
1996, the Company repurchased the remaining 5.5% minority interest in the
Company for $27.9 million. Approximately $26.4 million was allocated to
goodwill. During fiscal 1996, the Company purchased a 5% common stock interest
and a preferred stock interest in Friendly for approximately $17.1 million.

Investment in property and equipment includes computer hardware as well as
new developments and enhancements of reservation and finance systems. During
the six month period ended June 30, 1998, December 1997 and fiscal 1997,
capital expenditures totaled $5.6 million, $7.3 million and $10.6 million,
respectively, and related primarily to the development of a new property
management system and the installation of new financial systems. Capital
expenditures in prior years included amounts for computer hardware,
reservation systems and European hotel capital improvements.

On October 15, 1997, the Company entered into a five-year $300 million
competitive advance and multi-currency credit facility. The credit facility
provides for a term loan of $150 million and a revolving credit facility of
$150 million, $50 million of which is available in foreign currency
borrowings. At the time of the Distribution, the Company borrowed $150 million
under the term loan and $89.5 million under the revolving credit facility, the
proceeds of which were used to fund the Term Note and to refinance existing
indebtedness. As of December 31, 1997, the Company had $150 million of term
loans outstanding, $86.6 million of revolving loans and $31 million of multi-
currency borrowings. The term loan is payable over five years, $15 million of
which is due in 1998. The Credit Facility includes customary financial and
other covenants that require the maintenance of certain ratios including
maximum leverage, minimum net worth and interest coverage and restrict the
Company's ability to make certain investments, repurchase stock, incur debt,
and dispose of assets. At the Company's option, the interest rate may be based
on LIBOR, a certificate of deposit rate or an alternate base rate (as defined
therein), plus a facility fee percentage. The rate is determined based on the
Company's consolidated leverage ratio at time of borrowing. Interest on
current borrowings is based on one of several rates including LIBOR. The
average interest rate of the borrowings under the Credit Facility at December
31, 1997 was 6.60%.

During the six months ended June 30, 1998, the Company repurchased
approximately 1.8 million shares at a total cost of $26.8 million. Subsequent
to June 30, 1998, the Company has repurchased 1.2 million shares of its common
stock at a total cost of $14.4 million. The Company has authorization from its
Board of Directors to repurchase up to an additional 5.8 million shares.

The Company believes that cash flow from operations and available financing
capacity is adequate to meet the expected operating, investing, financing and
debt service requirements for the business for the immediate future.

The Company has entered into interest rate swap agreements with a notional
amount of $115 million at June 30, 1998, to fix certain of its variable rate
debt in order to reduce the Company's exposure to fluctuations in interest
rates. The interest rate differential to be paid or received on interest rate
swap agreements is accrued as interest rates change and is recognized as an
adjustment to interest expense. On average, the interest rate swap agreements
have a life of three and one-half years with a fixed rate of 6.68% and a
variable rate at December 31, 1997 of 6.39%. As of June 30, 1998, the interest
rate swap agreements have a fair market valuation of approximately ($1.9)
million.

Impact of Recently Issued Accounting Standards

The Company has adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." The adoption
of SFAS No. 121 did not have a material impact on the Company's financial
statements.

The Company has adopted SFAS No. 130 "Reporting Comprehensive Income," in
the first quarter of 1998. The impact of adoption was not material to the
financial statements.

The Company is required to adopt SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information," no later than fiscal 1999.
Management is evaluating the impact this pronouncement will have on the
Company's financial statements.

36
<PAGE>

YEAR 2000 COMPLIANCE

The Company is engaged in an ongoing effort to evaluate and remediate the
Year 2000 computer problem shared by virtually all companies and businesses.
As part of this effort, a cross-functional Year 2000 Compliance Committee was
established to manage and supervise the efforts to become compliant and a Year
2000 action plan has been developed. The Company has completed the first two
phases of the plan, which include (i) making the Company's internal
organizations aware of the Year 2000 issue and assigning responsibility
internally, and (ii) inventorying and initial testing of its proprietary
software. The remaining phases include: (i) assessing the risk form third
party vendors and franchisees and (ii) inventorying and testing secondary
internal systems (e.g. employee PC's). Throughout the process, remedial
actions have been or will be taken as warranted.

The Company's exposure to potential Year 2000 problems exists in two general
areas: technological operations in the sole control of the Company, and
technological operations dependent in some way on one or more third parties.
With respect to the Company's internal systems, it has conducted Year 2000
compliance testing on all of its proprietary software, including its
reservations and reservations support systems, its franchise support system
and its franchisee property management support systems. The tests have
indicated that the proprietary software is year 2000 compliant. The Company
has also been in the process of replacing its hardware platforms for these
systems and a number of smaller support systems and has kept them updated so
that by the end of 1998, all of the Company's large system computers will be
no more than eighteen months old. Based on manufacturer's specifications, the
Company believes that these new hardware platforms are year 2000 compliant.

The Company is also in the process of conducting an inventory of third party
software, including PC operating systems and word processing and other
commercial software. The Company anticipates that it will need to upgrade
approximately 80% of its employee workstation PC's. The Company has not
quantified the costs of such upgrades to its PC based systems, but the Company
does not currently expect such costs to be material.

The Year 2000 Compliance Committee is currently identifying third party
vendors and service providers whose non-compliant systems could have a
material impact on the Company and undertaking an assessment as to such
parties' compliant status. These parties include franchisees, airline global
distribution systems ("GDS"), utility providers, telephone service providers,
banks and data processing services. The GDS companies, which provide databases
through which travel agents can book hotel rooms, have assured the Company in
writing that they are making the necessary changes in their system to become
compliant and the Company expects to conduct tests with the GDS companies in
September and October 1998. The Year 2000 Compliance Committee is in the
process of assessing other third parties as to their compliance and the
consequences in the event they are not compliant. The Committee expects that
such assessment will be completed by the fourth quarter of 1998.

Costs of addressing potential Year 2000 problems have not been material to
date and, based upon preliminary information gathered to date, are not
currently expected to have a material adverse impact on the Company's
financial position, results of operations or cash flows. However, if the
Company, its vendors or franchisees are unable to resolve such Year 2000
issues in a timely manner, it could result in a material financial risk,
including loss of revenue, substantial unanticipated costs and service
interruptions.

FORWARD-LOOKING STATEMENTS

The statements contained in this document that are not historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995.

A number of important factors could cause the Company's actual results for
future periods to differ materially from those expressed in any forward-
looking statements made by, or on behalf of the Company.

Certain statements contained in this Form 10-Q, including those in the
section entitled "Management's Discussion and Analysis of Operating Results
and Financial Condition," contain forward-looking information that involves
risk and uncertainties. Actual future results and trends may differ materially
depending on a variety of factors discussed in the "Risk Factors" section
included in the Company's SEC filings, including the nature and extent of
future competition, and political, economic and demographic developments in
countries where the Company does business or in the future may do business.

Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. The Company undertakes no
obligation to revise or update these forward-looking statements.

37
<PAGE>

BUSINESS

Overview

Choice Hotels International, Inc. is the world's second largest franchisor
of hotel properties with 3,567 franchised properties open and 870 franchised
properties under development at June 30, 1998, representing 297,396 rooms open
and 76,523 rooms under development in 33 countries. The Company franchises
lodging properties under the Choice Brands: Comfort, Quality, Clarion, Sleep,
Rodeway, Econo Lodge and MainStay. The Company has over 2,100 franchisees in
its domestic franchise system, the largest of which, Sunburst, accounts for
approximately 5% of the Company's royalty fees for the six- months ended June
30, 1998. The Company franchises hotels in all 50 states and the District of
Columbia and 32 additional countries, with 94% of its franchising revenue
generated from hotels franchised in the United States. With recognized brands
and a diverse and growing franchisee base, the Company believes it has
established a strong foundation for continued growth.

The Company is a "pure-play" lodging franchisor with limited real estate
exposure and low capital expenditure requirements. With a focus on hotel
franchising versus ownership, the Company benefits from the economies of scale
inherent in the franchising business. The fee and cost structures of the
Company's business provide significant opportunities to increase profits by
increasing the number of franchised properties. The Company derives
substantially all of its revenues from franchise fees which consist of an
initial fee and ongoing royalty, marketing, and reservation fees which are
based on a percentage of the franchisees' gross room revenues. The principal
factors that affect the Company's operating results are: (i) growth in the
number of hotels under franchise, (ii) occupancy and room rates achieved by
the hotels under franchise, (iii) the number and relative mix of franchised
hotels and (iv) the Company's ability to manage costs. The number of rooms at
franchised properties and occupancy and room rates at those properties
significantly affect the Company's results because royalty fees are based upon
room revenues at franchised hotels. The variable overhead costs associated
with franchise system growth are substantially less than incremental royalty
fees generated from new franchisees, therefore the Company is able to capture
a significant portion of these royalty fees as operating income.

The Company believes that the continued growth of its franchise business
should enable it to capture increasing benefits from the operating leverage in
place and thereby continue to improve operating margins. The Company's
operating margins have improved from 47.1% for the year ended May 31, 1995 to
55.0% for the year ended May 31, 1997. Furthermore, the Company has generated
steady royalty fee income from its increasing franchisee base growing from
$51.0 million for the year ended May 31, 1992 to $97.2 million for the year
ended May 31, 1997, representing a compounded annual growth rate of 13.8%.
Earnings before interest expense, income taxes, depreciation and amortization
have grown at a compounded annual growth rate of 20.5% from $32.2 million for
the year ended May 31, 1992 to $81.7 million for the year ended May 31, 1997.
Similarly, EBITDA has increased from $39.0 million for the six month period
ended June 30, 1997 to $51.6 million for the six month period ended June 30,
1998. Operating margins have improved from 40% for the six month period ended
June 30, 1997 to 49% for the six month period ended June 30, 1998.

The Lodging Industry

As of December 31, 1997, there were approximately 3.5 million hotel rooms in
the United States in hotels/motels containing twenty or more rooms. Of those
rooms, approximately 1.0 million rooms were not affiliated with a national or
regional brand, while the remaining approximately 2.5 million rooms were
affiliated with a brand either through the 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.

38
<PAGE>

The lodging industry in recent years has demonstrated strong performance,
based on year-to-year increases in room revenues, average daily rates, revenue
per available room ("RevPAR"), and lodging industry profitability. RevPAR is
calculated by multiplying the percentage of occupied rooms by the average
daily room rate realized. Since 1993, the lodging industry has been able to
increase its average daily rate ("ADR") at a rate faster than the increase in
the Consumer Price Index ("CPI"), a common measure of inflation published by
the US Department of Labor. The following chart demonstrates the recent
trends:

THE US LODGING INDUSTRY'S GROWTH TRENDS SINCE 1991

<TABLE>
<CAPTION>
AVERAGE
INCREASES IN DAILY INCREASE INCREASE REVENUE PER
ROOM 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.................... 3.5% 62.6% $58.91 1.4% 2.9% $36.87 break-even 36,000
1993.................... 4.6% 63.5% $60.53 2.7% 2.7% $38.42 $ 2.4 40,000
1994.................... 7.1% 64.7% $62.86 3.8% 2.7% $40.70 $ 5.5 45,000
1995.................... 6.7% 65.1% $65.81 4.7% 2.9% $42.83 $ 8.5 64,000
1996.................... 8.9% 65.0% $70.81 7.6% 2.9% $46.06 $12.5 101,000
1997.................... 8.8% 64.5% $75.16 6.1% 1.9% $48.50 $14.5 123,000
</TABLE>
- --------
Source: Smith Travel Research

The Company believes the lodging industry can be divided into three
categories: luxury or upscale, middle-market and economy. The Company believes
the luxury category generally has room rates above $70 per night, the middle-
market category generally has room rates between $46 and $70 per night and the
economy category generally has room rates less than $46 per night.

The Company's Econo Lodge, Rodeway and Sleep brands compete primarily in the
limited-service economy market and its Comfort and Quality brands compete
primarily in the limited-service middle-market. The Company's MainStay brand
competes primarily in the all-suites middle-market and its Clarion brand
competes primarily in the full-service upscale market.

New hotels opened in recent years typically have been limited-service
hotels, as limited-service hotels are less costly to develop, enjoy higher
gross margins, and tend to have better access to financing. These hotels
typically operate in the economy and middle-market categories and are located
in suburban or highway locations. From 1991 through 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 the costs of owning and operating a hotel are
generally fixed, increases in revenues generated by affiliation with a
franchise lodging chain can improve a hotel's financial performance. Of
approximately 2,198 hotel properties that changed their affiliation in 1996,
88% converted from independent status to affiliation with a chain or converted
from one chain to another, while only 12% canceled or were required to cancel
their chain affiliation. A total of 466 independent properties switched to a
franchise chain in 1996, the second largest number in the past ten years.

39
<PAGE>

The large franchise lodging chains, including the Company, generally provide
a number of services to hotel operators to improve the financial performance
of their properties, including national reservation systems, marketing and
advertising programs and direct sales programs. The Company believes that
national franchise chains with a larger number of hotels enjoy greater brand
awareness among potential guests than those with fewer numbers of hotels, and
that greater brand awareness can increase the desirability of a hotel to its
potential guests. The Company believes that hotel operators choose lodging
franchisors based primarily on the perceived value and quality of each
franchisor's brand and its services, and the extent to which affiliation with
that franchisor may increase the franchisee's reservations and profits.

Franchise Business

Economics of Franchise Business. The Company's fee and cost structures
provide significant opportunities for the Company to increase profits by
increasing the number of franchised properties. The Company derives
substantially all of its revenue from franchise fees which consist of an
initial fee and ongoing royalty fees which are based on a percentage of the
franchisees' gross room revenues. The royalty portion of the franchise fee is
intended to provide operating profits and cover the Company's operating
expenses, such as expenses incurred in quality assurance, administrative
support and other franchise services and to provide the Company with operating
profits. The Company also collects marketing and reservation fees from its
franchisees. The marketing and reservation fees are intended to reimburse the
Company for the expenses associated with providing such franchise services as
the central reservation system and national marketing and media advertising.

Much of the variable costs associated with the Company's activities are
reimbursed by the franchisees through the initial fees. The royalty fees
generated from franchisees more than cover the fixed costs of the business at
its current level. The variable overhead costs associated with franchise
system growth are substantially less than incremental royalty fees generated
from new franchisees, therefore the Company is able to capture a significant
portion of these royalty fees as operating income.

Strategy. The Company's strategy is to create an organization that is
focused on: (i) serving franchisee and consumer needs, (ii) optimizing its
brands, (iii) strategically growing the franchise system, (iv) improving
margins through increased productivity, (v) growing profitably internationally
and (vi) pursuing complementary business opportunities.

. Serving Franchisee and Consumer Needs. The Company has created an
organizational structure that focuses on consumers, serves franchisees
and leverages the franchise system.

-- Consumer Focus: Brand management, new product development and
traditional marketing and advertising are all combined under the
Company's marketing department to create consumer focus and to drive
demand for the Company's brand products. New product development is
based on consumer needs determined through consumer research. The
Company believes that this focus leads to greater demand for its
products, which in turn results in higher revenue from the Company's
franchise system.

-- Franchisee Service: The Company has established five regional
operating teams that are responsible for franchisee service and
sales in their respective regions. This structure provides each
franchisee with one primary contact who is responsible for assessing
and responding to each hotel's specialized needs. Led by seasoned
executives averaging over 20 years' experience in the lodging and
franchising industries, the Company believes it is positioned to
strategically develop new hotel franchises and enhance the operating
performance of its existing hotels.

-- Leveraging the Franchise System: Strategic partnerships, purchasing
and other functions that leverage the scale of the franchise system
are combined under the Company's partner services group. The Company
believes there is significant opportunity to leverage the franchise
system by entering into joint marketing arrangements with national
and multi-national companies that want to gain exposure to the
millions of guests who patronize the Company's franchised hotels
each year. In the past, these arrangements have added to the
Company's and its franchisees' revenues and profits by attracting
business to its franchised hotels.

40
<PAGE>

. Strategically Growing the Franchise System. The Company is taking
advantage of its regional structure to analyze key markets in the U.S.
and, in conjunction with its franchisees, identify the best
opportunities for new development or conversion to one of the Company's
brands.

. Improving Margins Through Increased Productivity. The Company enhances
the competitiveness of its own and its franchisees' profitability by
initiating revenue generating programs and implementing cost reduction
programs. A key component of this strategy is the implementation of the
Company's proprietary property and yield management system "Profit
Manager by Choice," which the Company believes will improve the
operating performance of its franchisees. This system has been
supplemented by continued enforcement of the Company's contracts
(including franchisee audits) and an aggressive focus on strategic
partnership opportunities.

. Pursuing Complementary Business Opportunities. The separation of the
Company from Former Choice allows the Company to focus solely on
franchising, including acquisition opportunities that are complementary
to the Company's core business and unique operating skills. The
Company's acquisition strategy includes the potential purchase of
lodging brands that would enhance the spectrum of brands and services
the Company currently offers its franchisees and hotel consumers.

Franchise System

The Company's franchised hotels operate under one of the Choice Brands:
Comfort, Quality, Clarion, Sleep, Rodeway, Econo Lodge and MainStay. The
following table presents key statistics relative to the Company's domestic
franchise system over the four fiscal years ended May 31, 1994, 1995, 1996 and
1997, for the seven-month periods ended December 31, 1996 and 1997, and for
the six-month periods ended June 30, 1997 and 1998.

COMBINED DOMESTIC FRANCHISE SYSTEM

<TABLE>
<CAPTION>
AS OF AND AS OF AND
FOR THE SEVEN FOR THE SIX
MONTHS ENDED MONTHS ENDED
AS OF AND FOR THE YEAR ENDED MAY 31, DECEMBER 31, JUNE 30,
------------------------------------------ ---------------- ----------------
1994 1995 1996 1997 1996 1997 1997 1998
--------- --------- --------- --------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Number of properties,
end of period.......... 2,283 2,311 2,495 2,781 2,672 2,879 2,814 2,951
Number of rooms, end of
period................. 203,019 200,792 214,613 235,431 226,346 242,094 238,136 245,948
Average Royalty
Rate(1)................ 3.10% 3.20% 3.34% 3.43% 3.43% 3.51% 3.4% 3.50%
Average occupancy
percentage............. 62.2% 63.8% 63.8% 62.6% 67.7% 66.2% 57.6% 56.0%
Average daily room rate
(ADR).................. $ 45.63 $ 47.13 $ 49.49 $ 51.92 $ 52.50 $ 54.97 $ 51.78 $ 53.94
RevPAR(2)............... $ 28.40 $ 30.08 $ 31.60 $ 32.52 $ 35.54 $ 36.39 $ 29.81 $ 30.23
Royalty fees ($000s).... $ 62,590 $ 71,665 $ 82,238 $ 91,724 $58,025 $65,271 $42,277 $46,394
</TABLE>
- --------
(1) Represents domestic royalty fees as a percentage of aggregate gross room
revenues of all of the domestic Choice Brand franchised hotels.
(2) RevPAR figures for the Company's combined domestic franchise system and
for each brand for each fiscal year or seven-month period are averages of
the RevPAR calculated for each month in the fiscal year or seven-month
period. The Company calculates RevPAR each month based on information
reported by franchisees on a timely basis to the Company.

41
<PAGE>

The Company has over 2,100 domestic franchisees and operates in all 50
states and the District of Columbia. Approximately 94% of the total royalty
income is generated from domestic franchise operations. Consequently, the
Company's analysis of its franchise system is focused on the domestic
operations. Sunburst is the Company's largest franchisee with a portfolio of
85 hotels containing 11,796 rooms located in 28 states as of June 30, 1998.

Brand Positioning

The Company's hotels are primarily limited-service hotels that offer
amenities such as swimming pools and continental breakfast or similar services
or limited-to-full service hotels that offer amenities such as food and
beverage services, meeting rooms, room service and similar guest services.

Comfort. The Comfort brand is the Company's largest brand. Comfort Inns and
Comfort Suites hotels offer rooms in the limited-service, middle-market
category. Comfort Inns and Comfort Suites are targeted to business and leisure
travelers. Principal competitor brands include Days Inn, Fairfield Inn,
Hampton Inn, Holiday Express and LaQuinta Inn. At June 30, 1998, there were
1,492 Comfort Inn properties and 174 Comfort Suites properties with a total of
115,318 and 14,312 rooms, respectively, open and operating worldwide. An
additional 185 Comfort Inn properties and 153 Comfort Suites properties with a
total of 17,263 and 11,788 rooms, respectively, were under development.

Comfort properties are located in the United States and in Australia, the
Bahamas, Belgium, Canada, France, Germany, India, Ireland, Italy, Jamaica,
Mexico, Norway, Portugal, Puerto Rico, Sweden, Switzerland, Thailand, the
United Kingdom and the United Arab Emirates.

The following chart summarizes the Comfort system in the United States:

COMFORT DOMESTIC SYSTEM

Sleep. Established in 1988, Sleep is an exclusively new-construction hotel
brand in the limited-service, economy category. Sleep Inns are targeted to the
business and leisure traveler. Principal competitor brands include Days Inn,
Fairfield Inn, Holiday Express, LaQuinta Inn, Ho-Jo Inn and Ramada Inn.

At June 30, 1998, there were 174 Sleep Inn properties with a total of 13,075
rooms open and operating worldwide. An additional 152 properties with a total
of 11,901 rooms were under development. The properties are located in the
United States, Canada, the Cayman Islands and Thailand.

42
<PAGE>

The following chart summarizes the Sleep system in the United States:

SLEEP DOMESTIC SYSTEM

Quality. Certain Quality Inns and Quality Suites hotels compete in the
limited-service, middle-market category while others compete in the full-
service, middle-market category. Quality Inns and Quality Suites are targeted
to business and leisure travelers. Principal competitor brands include Best
Western, Holiday Inn, Howard Johnson, Ramada Inn and Days Inn. At June 30,
1998, there were 583 Quality Inn properties with a total of 65,692 rooms, and
91 Quality Suites properties with a total of 10,163 rooms open worldwide. An
additional 97 Quality Inn properties and 47 Quality Suites properties with a
total of 11,598 rooms and 2,811 rooms, respectively, were under development.

Quality properties are located in the United States and in Australia,
Canada, Chile, Costa Rica, the Czech Republic, Denmark, France, Germany,
Guatemala, India, Indonesia, Ireland, Italy, Jamaica, Malaysia, Mexico, New
Zealand, Norway, Portugal, Russia, Spain, Sweden, Thailand, the United Kingdom
and the United Arab Emirates.

The following chart summarizes the Quality system in the United States:

QUALITY DOMESTIC SYSTEM

Clarion. Clarion Inns, Clarion Hotels, Clarion Resorts and Clarion Suites
hotels are full-service properties which operate in the upscale category.
Clarion properties are targeted to business and leisure travelers. Principal
competitor brands include Holiday Inn, Holiday Select, Crowne Plaza, Four
Points by Sheraton, Radisson, Courtyard by Marriott and Doubletree.

At June 30, 1998, there were 117 Clarion properties with a total of 18,779
rooms open and operating worldwide and an additional 40 properties with a
total of 6,746 rooms under development. The properties are located in the
United States, Canada, Chile, France, Indonesia, Ireland, Japan, Mexico,
Norway, Russia and Uruguay.

43
<PAGE>

The following chart summarizes the Clarion system in the United States:

CLARION DOMESTIC SYSTEM

<TABLE>
<CAPTION>
AS OF AND
FOR THE AS OF AND
SEVEN FOR THE SIX
MONTHS ENDED MONTHS ENDED
AS OF AND FOR THE YEAR ENDED MAY 31, DECEMBER 31, JUNE 30,
------------------------------------------ -------------- --------------
1994 1995 1996 1997 1996 1997 1997 1998
--------- --------- --------- --------- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Number of properties,
end of period.......... 65 63 75 92 79 96 93 97
Number of rooms, end of
period................. 12,211 10,420 12,817 14,721 13,101 16,161 14,850 16,240
Royalty fees ($000s).... $ 2,735 $ 2,995 $ 3,602 $ 4,081 $2,168 $2,957 $2,342 $2,521
Average occupancy
percentage............. 62.0% 63.7% 63.3% 63.3% 67.1% 64.7% 59.7% 56.3%
Average daily room rate
(ADR).................. $ 62.47 $ 63.71 $ 64.36 $ 67.76 $66.96 $71.53 $69.76 $71.09
RevPAR.................. $ 38.75 $ 40.58 $ 40.74 $ 42.86 $44.94 $46.29 $41.64 $40.03
</TABLE>

Econo Lodge. Econo Lodge hotels operate in the limited-service, economy
category. Econo Lodges are primarily targeted to senior citizens and rely to a
large extent on strong roadside name recognition. Principal competitor brands
include Days Inn, Ho-Jo Inn, Motel 6, Ramada Limited, Red Carpet Inn, Red Roof
Inn, Super 8 and Travelodge. At June 30, 1998, there were 718 Econo Lodge
properties with a total of 45,907 rooms open and operating in the United
States and Canada, and an additional 120 properties with a total of 8,535
rooms under development in those two countries.

The following chart summarizes the Econo Lodge system in the United States:

ECONO LODGE DOMESTIC SYSTEM

Rodeway. The Rodeway brand competes in the limited-service, economy category
and is primarily targeted to senior citizens. Principal competitor brands
include Ho-Jo Inn, Ramada Limited, Red Carpet Inn, Red Roof Inn, Budgetel,
Shoney's Inn, Super 8, Motel 6 and Travelodge. At June 30, 1998, there were
202 Rodeway Inn properties with a total of 12,752 rooms open and operating in
the United States and Canada, and an additional 50 properties with a total of
3,495 rooms under development in those two countries.

The following chart summarizes the Rodeway system in the United States:

RODEWAY DOMESTIC SYSTEM

<TABLE>
<CAPTION>
AS OF AND AS OF AND
FOR THE SEVEN FOR THE SIX
AS OF AND MONTHS ENDED MONTHS ENDED
FOR THE YEAR ENDED MAY 31, DECEMBER 31, JUNE 30,
------------------------------ -------------- --------------
1994 1995 1996 1997 1996 1997 1997 1998
------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Number of properties,
end of period.......... 214 208 201 216 214 208 211 197
Number of rooms, end of
period................. 13,806 13,067 12,547 13,509 13,248 12,940 13,163 12,340
Royalty fees ($000s).... $1,941 $2,302 $2,506 $2,631 $1,711 $1,756 $1,160 $1,094
Average occupancy
percentage............. 51.4% 50.5% 52.7% 52.7% 57.0% 54.7% 47.8% 46.0%
Average daily room rate
(ADR).................. $36.89 $38.93 $40.66 $41.15 $42.07 $44.11 $41.26 $41.23
RevPAR.................. $19.00 $19.64 $21.48 $21.68 $23.99 $24.13 $19.73 $18.97
</TABLE>

44
<PAGE>

MainStay. MainStay, the Company's newest hotel brand, is an exclusively new-
construction middle-market, extended-stay lodging product targeted to
travelers who book hotel rooms for five nights or more. The first MainStay
Suites hotel, which Sunburst owns and manages, opened in Plano, Texas in
November 1996. As of June 30, 1998, there were 15 open hotels with 1,380 rooms
and an additional 26 properties with 2,386 rooms under development.

The MainStay brand is designed to fill the gap in the middle-market category
between existing upscale and economy extended-stay lodging products.
MainStay's principal competitors are all-suite hotel properties and
traditional extended stay operators in the middle market (including Candlewood
Hotels, TownePlace Suites and Studio Plus), the upscale market (including
Hawthorne Suites, Homewood Suites, Residence Inns and Summerfield Suites) and
the economy market (including Extended Stay America and Oakwood). The Company
has granted to Sunburst an option exercisable under certain circumstances at
January 1, 2000, to purchase the brand names, marks, franchise agreements and
other assets of the MainStay system. See "Relationship Between the Company and
Sunburst--Strategic Alliance Agreement."

International Franchise Operations

The Company's international franchise operations are conducted through
master franchise arrangements. These agreements provide the master franchisee
the right to develop Choice-branded hotels in a specific geographic region,
usually for a fee. The agreements govern the relationship between the Company
and the master franchisee, who share the royalties generated by the underlying
franchised hotels. At June 30, 1998, the Company had 616 franchise hotels open
in 32 countries outside the United States.

The following table illustrates the growth of the Company's international
franchise system over the four fiscal years ended May 31, 1994, 1995, 1996 and
1997, for the seven-month periods ended December 31, 1996 and 1997 and for the
six-month period ended June 30, 1998 and 1997.

COMBINED INTERNATIONAL FRANCHISE SYSTEM(1)

Europe. The Company is the second-largest international franchised hotel
chain in Europe, with 261 hotels open in 15 countries at June 30, 1998.

In order to realign and streamline its European operations, in May 1996, the
Company, through its subsidiary, ManorCare Hotels (France) S.A., acquired
750,000 ordinary (common) shares and 10,000,000 convertible preferred shares
of Friendly for approximately $17.1 million. The proceeds from this investment
have been and will be used by Friendly to finance the development of ten new
Comfort Inn or Quality Inn hotels in the United Kingdom and Ireland.
Additionally, the Company granted to Friendly a master franchise for the
United Kingdom and Ireland in exchange for an additional 333,333 Friendly
ordinary shares. Each 5.75% convertible preferred share is immediately
convertible into one Friendly ordinary share for every 150p nominal value of
the 5.75% convertible preferred shares.

45
<PAGE>

In January 1998, the Company and Friendly consummated a second transaction
in which Friendly acquired from the Company the master franchise rights for
the Comfort, Quality and Clarion brands for all of Europe with the exception
of Scandinavia for a period of ten years, for a payment of $8 million, payable
in eight equal annual installments. As part of the transaction, Friendly
acquired from the Company ten hotels in France, two in Germany and one in the
United Kingdom in exchange for 13,624,742 additional 5.75% convertible
preferred shares with a value of $22.2 million. Each such 5.75% convertible
preferred share is convertible on or after the announcement by Friendly of its
1998 financial results (which is expected to occur in April 1999) into one
Friendly ordinary share for each 150p nominal value of the 5.75% convertible
preferred shares. In addition, Friendly will pay the Company deferred
compensation of $4 million in cash, payable by the fifth anniversary of the
transaction or sooner depending on the level of future profits of the hotels
acquired. After consummation of this transaction (and the receipt of
additional ordinary shares resulting from the payment of dividends in ordinary
shares), the Company holds 1,139,881 Friendly ordinary shares and 23,624,742
5.75% convertible preferred shares of Friendly (convertible into 15,749,828
Friendly ordinary shares). Assuming conversion to Friendly ordinary shares of
all Friendly convertible preferred shares held by the Company, the Company
would hold approximately 45% of the outstanding Friendly ordinary shares.
Under the terms of its investment, the Company currently has the right to
appoint three of the ten directors to the Friendly board.

There is also a master franchise arrangement in Scandinavia that has 56 open
properties as of June 30, 1998.

Canada. Choice Hotels Canada is Canada's largest lodging organization with
213 properties open at June 30, 1998. Choice Hotels Canada is a joint venture,
owned 50% by the Company and 50% by Journey's End Corporation ("Journey's
End"), which was formed in 1993 when Journey's End converted substantially all
of its controlled hotels to Choice's brands and Choice contributed its
operations in Canada to form Choice Hotels Canada.

Australia. In July, 1998 the Company and Flag International Limited,
Australia's largest lodging chain, agreed to form Flag Choice Hotels Limited.
Effective July 1, 1998, Flag Choice Hotels Limited will franchise
approximately 500 properties representing 26,000 rooms across Australia, New
Zealand, Fiji and Papua New Guinea. Through the agreement, Flag Choice Hotels
will operate as the Company's master franchisee under a 20-year Australian
master franchise agreement to use the Choice brands of Clarion, Quality and
Comfort. The agreement also provides the Company the opportunity to acquire,
within the first four years of the agreement, up to 30 percent of the equity
of Flag Choice Hotels.

Other International Relationships. The Company has master franchise
arrangements with developers in various countries, including Australia, New
Zealand, Mexico and Brazil. At June 30, 1998, 86 hotels were open and
operating under these master franchise arrangements, generating annual royalty
fees to the Company of over $1.8 million.

Franchise Sales

The Company has identified key market areas for hotel development based on
supply/demand relationships and strategic objectives. Development
opportunities are first offered to existing franchisees and then to: (i)
developers of hotels, (ii) owners of independent hotels and motels, (iii)
owners of hotels affiliated with other franchisors' brands and (iv)
contractors who construct any of the foregoing. In the six-months ended June
30, 1998, existing franchisees accounted for approximately 64% of the
Company's new franchise agreements. In considering hotels for conversion to
one of the Choice Brands, or sites for development of new hotels, the Company
considers locations which are close to major highways, airports, tourist
attractions and business centers that attract travelers.

At June 30, 1998, the Company employed approximately 36 sales directors,
each of whom is responsible for a particular region or geographic area. Sales
directors contact potential franchisees directly and receive compensation
based on sales generated. Franchise sales efforts emphasize the benefits of
affiliating with one of the Choice Brands, the Company's commitment to
improving RevPAR, the Company's "celebrity in a suitcase"

46
<PAGE>

television advertising campaign (formerly used for the entire family of Choice
Brands and now used principally for its three largest brands, Comfort, Quality
and Econo Lodge), the Choice reservation system, the Company's training and
support systems, and the Company's history of growth and profitability.
Because the Choice Brands cover a broad spectrum of the lodging marketplace,
the Company is able to offer each prospective franchisee a brand that fits its
needs, reducing the chances that the prospective franchisee would need to
consider a competing franchise system.

Because retention of existing franchisees is important to the Company's
growth strategy, existing franchisees are offered the right to object to a
same-brand property within 15 miles, and are protected from the opening of a
same-brand property within a specific distance, generally two to five miles,
depending upon the size of the property and the market size. The Company
believes that it is the only major franchise company to routinely offer such
territorial protection to its franchisees.

For the six months ended June 30, 1998, the Company received 452
applications, approved 382 applications, signed 368 franchise agreements and
placed 157 properties into operation in the U.S. Of those placed into
operation, 137 were newly constructed hotels. During fiscal 1997, the Company
received 1,078 franchise applications, approved 874 applications, signed 715
franchise agreements and placed 390 new properties into operation in the
United States. Of those placed into operation, 203 were newly constructed
hotels. By comparison, during the fiscal year ended May 31, 1996, the Company
received 993 franchise applications, approved 862 applications, signed 665
franchise agreements and had 284 new U.S. properties operating. Of those
placed into operation, 150 were newly constructed. Applications may not result
in signed franchise agreements either because an applicant is unable to obtain
financing or because the Company and the applicant are unable to agree on the
financial terms of the franchise agreement. Nonetheless, the Company believes
that increased applications lead to an increased number of hotels entering the
Company's franchise system.

Franchise Agreements

The Company's standard franchise agreement grants a franchisee the right to
non-exclusive use of the Company's franchise system in the operation of a
single hotel at a specified location, typically for a period of 20 years, with
certain rights to each of the franchisor and franchisee to terminate the
franchise agreement before the twentieth year. When the responsibility for
development is sold to a master franchisee, that party has the responsibility
to sell to local franchisees the Choice Brands and the master franchisee
generally must manage the delivery of necessary services (such as quality
assurance, reservations and marketing) to support the franchised hotels in the
master franchise area. The master franchisee collects the fees paid by the
local franchisee and remits an agreed share to the Company. Master franchise
agreements generally have a term of at least 10 years. The Company has only
entered into master franchise agreements with respect to franchise hotels
outside the United States.

Either party to a franchise agreement, other than master franchise
agreements, can terminate a franchise agreement prior to the conclusion of its
term under certain circumstances, such as at certain anniversaries of the
agreement or if a franchisee fails to bring properties into compliance with
contractual quality standards within specified periods of time. Early
termination options give the Company flexibility in eliminating or re-branding
properties which become weak performers for reasons other than contractual
failure by the franchisee. Master franchise agreements typically contain
provisions permitting the Company to terminate the agreement for failure to
meet a specified development schedule.

Franchise fees vary among the different Choice Brands, but generally are
competitive with the industry average within their market group. Franchise
fees usually have four components: an initial, one-time affiliation fee; a
royalty fee; a marketing fee; and a reservation fee. Proceeds from the
marketing fee and reservation fee are used exclusively to fund marketing
programs and the Company's central reservation system, respectively. Most
marketing fees support brand-specific marketing programs, although the Company
occasionally contributes a portion of such fees to marketing programs designed
to support all of the Choice Brands. Royalty fees and affiliation fees are the
principal sources of profits for the Company.

47
<PAGE>

The standard franchise agreements typically require the Company's
franchisees to pay the following fees:

QUOTED FEES BY PRODUCT

<TABLE>
<CAPTION>
INITIAL FEE ONGOING FEES AS A PERCENTAGE OF GROSS ROOM REVENUES
PER ROOM/ -------------------------------------------------------------------
PRODUCT 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 5.00% 2.1% 1.75%
Quality Inn............. $300/$35,000 4.0% 2.1% 1.75%
Quality Suites.......... $300/$50,000 4.0% 2.1% 1.25%
Sleep Inn............... $300/$40,000 4.5% 2.1% 1.75%
Clarion................. $300/$40,000 3.75% 1.0% 1.25%
Econo Lodge............. $250/$25,000 4.0% 3.5%(1) --
MainStay Suites......... $300/$30,000 4.5% 2.5%(1) --
Rodeway................. $250/$25,000 3.5% 1.25% 1.25%
</TABLE>
- --------
(1) Fee includes both Marketing and Reservation Fees.

For a description of the franchising agreements between the Company and
Sunburst, see "Relationship Between the Company and Sunburst--Franchise
Agreements."

The Company has increased its average royalty rate since fiscal year 1993,
primarily by raising the quoted royalty fee for Comfort Inn franchisees to
5.25% of annual gross room revenues ("GRR") from 4.0% of GRR in 1993, and by
increasing the number of franchise agreements providing for royalty fees that
are higher than the Company's average royalty fees. The Company has increased
its average royalty rate for all Choice Brands from 3.10% from fiscal year
1994 to 3.43% for fiscal year 1997. The Company believes that its average
royalty rate will continue to increase as new franchisees are added and as
older franchise agreements expire, terminate or are amended.

At June 30, 1998, the Company had 2,951 franchise agreements in effect in
the United States and 616 franchise agreements in effect in other countries.
The average age of the franchise agreements was 4.6 years. Ninety-four of the
franchise agreements are scheduled to expire during the five-year period
beginning June 30, 1998.

Franchise Operations

The Company's operations are designed to improve RevPAR for its franchisees,
as this is the measure of performance that most directly impacts franchisee
profitability. The Company believes that by helping its franchisees to become
more profitable it will enhance its ability to both retain its existing
franchisees and attract new franchisees. The key aspects of the Company's
franchise operations are:

Central Reservation System. On average, approximately 30.0% of the room
nights booked at franchisees' properties are reserved through the toll-free
telephone reservation system operated by the Company. The Company's
reservation system consists of a computer reservation system known as CHOICE
2001, five reservation centers in North America and several international
reservation centers run by the Company or its master franchisees. Operators
trained on the CHOICE 2001 system can match each caller with a Choice-branded
hotel meeting the caller's needs. The CHOICE 2001 system provides an instant
data link to the Company's franchised properties as well as to the Amadeus,
Galileo, SABRE and Worldspan airline reservation systems that facilitate the
reservation process for travel agents.

To define more sharply the market and image for each of its brands, the
Company began advertising separate toll-free reservation numbers for all of
its brands in fiscal year 1995, although the Company allows its

48
<PAGE>

reservation agents to cross-sell the Choice Brands. If a room in the Choice-
branded hotel requested by a customer is not available in the location or
price range that the customer desires, the agent may offer the customer a room
in another Choice-branded hotel that meets the customer's needs. The Company
believes that cross-selling enables the Company and its franchisees to capture
additional business.

On-line reports generated by the CHOICE 2001 system enable franchisees to
analyze their reservation patterns over time. In addition, the Company
provides and is currently improving a yield management product for its
franchisees to allow them to improve the management of their mix of rates and
occupancy based on current and forecasted demand on a property-by-property
basis. The Company also markets to its franchisees a property management
product. Such products are designed to manage the financial and operations
information of an individual hotel and improve its efficiency.

Brand Name Marketing and Advertising. The Company's marketing and
advertising programs are designed to heighten consumer awareness of the Choice
Brands. Marketing and advertising efforts are focused primarily in the United
States and include national television and radio advertising, print
advertising in consumer and trade media and promotional events, including
joint marketing promotions, with vendors and corporate partners.

The Company is recognized for its "celebrity in a suitcase" television
advertisements. In fiscal year 1996, the Company began using brand-specific
marketing and largely discontinued the strategy of advertising its multiple
brands under the Choice umbrella. The marketing fees generated by these brands
are used, in part, to fund a national network television advertising campaign.
The smaller Choice Brands conduct advertising campaigns that also include
cable television, radio and print.

The Company conducts numerous marketing programs targeting specific groups,
including senior citizens, motorist club members, families, government and
military employees, and meeting planners. Other marketing efforts include
telemarketing and telesales campaigns, domestic and international trade show
programs, publication of group and tour rate directories, direct-mail
programs, discounts to holders of preferred credit cards, centralized
commissions for travel agents, fly-drive programs in conjunction with major
airlines, and twice-yearly publication of a Travel and Vacation Directory.

Marketing and advertising programs are directed by the Company's marketing
department, which utilizes the services of independent advertising agencies.
The Company also employs sales personnel at its Silver Spring, Maryland,
headquarters and at its Phoenix, Arizona office. These sales personnel use
telemarketing to target specific customer groups, such as potential corporate
clients in areas where the Company's franchised hotels are located, the motor
coach market and meeting planners. Most of these sales personnel sell
reservations and services for all of the Choice Brands.

The Company's regional sales directors work with franchisees to maximize
RevPAR. These directors advise franchisees on topics such as marketing their
hotels and maximizing the benefits offered by the Choice reservations system.

Quality Assurance Programs. Consistent quality standards are critical to the
success of a hotel franchise. The Company has established quality standards
for all of its franchised brands which cover housekeeping, maintenance, brand
identification and level of services offered. The Company inspects properties
for compliance with its quality standards when application is made for
admission to the franchise system. The compliance of existing franchisees with
quality standards is monitored through scheduled and unannounced Quality
Assurance Reviews conducted at least once per year at each property.
Properties which fail to maintain a minimum score are reinspected on a more
frequent basis until deficiencies are cured, or until such properties are
terminated.

To encourage compliance with quality standards, the Company offers various
brand-specific incentives to franchisees who maintain consistent quality
standards. The Company identifies franchisees whose properties

49
<PAGE>

operate below minimum quality standards and assists them in complying with
brand specifications. Franchisees who fail to improve on identified quality
matters may be subject to consequences ranging from written warnings to
termination of the franchisee's franchise agreement. During the six-months
ended June 30, 1998, the seven-months ended December 1997, fiscal year 1997
and fiscal year 1996, the Company terminated 90, 20, 49 and 48 properties,
respectively, for failure to maintain minimum quality assurance scores.

Training. The Company maintains a training department which conducts
mandatory training programs for all franchisees and their employees. The
Company also conducts regularly scheduled regional and national training
meetings for both property-level staff and managers. Training programs teach
franchisees how to take advantage of the Company's reservation system and
marketing programs, and fundamental hotel operations such as housekeeping,
maintenance, and inventory yield management.

Training is conducted by a variety of methods, including group instruction
seminars and video programs. The Company is developing an interactive
computer-based training system that will train hotel employees at their own
pace. Franchisees will be required to purchase hardware to operate the
training system, and will use software developed by the Company.

Purchasing. The Company's product services department negotiates volume
purchases of various products needed by franchisees to run their hotels,
including furniture, fixtures, carpets and bathroom amenities. The department
also helps to ensure consistency in such products across its exclusively new-
construction brands, Sleep and MainStay. The Company utilizes its group
purchasing program to obtain favorable pricing from third-party vendors for
franchisees ordering similar products. The Company acts as a clearinghouse
between the franchisee and the vendor, and most orders are shipped directly to
the franchisee.

Design and Construction. The Company maintains a design and construction
department to assist franchisees in refurbishing, renovating, or constructing
their properties prior to or after joining the system. Department personnel
assist franchisees in meeting the Company's brand specifications by providing
technical expertise and cost-savings suggestions.

Financial Assistance Programs. The Company has established programs or
helped franchisees obtain financing through: (i) a wholly-owned subsidiary;
(ii) strategic partnerships with hotel lenders; and (iii) by referral to hotel
lenders for hotel refinancing, acquisition, renovation and development. Some
of the specific programs include:

(a) "Construction to Permanent Financing" program to qualified
franchisees. Salomon Smith Barney is offering $100 million in "Construction
to Permanent Financing" per year to qualified franchisees. All Choice
Brands are included in this program. The construction loan is issued for a
term up to three years at a floating rate of 355 basis points over the 30-
day LIBOR. The loan amount will not exceed 75% of cost. The franchisee is
responsible for cost of all third party reports and fees in the amount of
2.75% of the loan amount. A stabilized debt service coverage ratio of at
least 1.4:1 is required for the permanent loans, which are issued for a 10-
year term with amortization up to 25 years with the balance payable at
maturity and a fixed interest rate of 225 basis points over the 10-year
U.S. Treasury interest rate on the day of closing. The permanent loan
requires a fee of 1% of the loan amount. The Company's guarantee is based
on loans outstanding with a maximum guarantee amount of $10 million. At
June 30, 1998, loans under the program totaled $12.5 million and the
Company's guarantee covered $6.3 million in loans.

(b) Econo Lodge exterior renovation program. Under this program, loans up
to an amount of $17,500 per property are granted to qualified Econo Lodge
franchisees for standardized exterior renovation. Franchisee participation
requires, among other things, extension of the franchise agreement. The
loan is forgiven at the expiration of the extended franchise agreement,
assuming no defaults have occurred thereunder. At June 30, 1998, the
Company had loans of $2.4 million outstanding under this program.

50
<PAGE>

(c) Second Mortgage Financing. The Company previously offered second
mortgage financing for the development and construction of Quality Inns,
Quality Suites, Quality Inn and Suites, MainStay Suites and Sleep Inns. The
financing program ceased issuing Loan Commitments in March of 1997. At June
30, 1998, loans outstanding under the program were $1.5 million, with two
unfunded commitments totaling $4.7 million.

Competition

Competition among franchise lodging chains is intense, both in attracting
potential franchisees to the system and in generating reservations for
franchisees. The Company believes that hotel operators choose lodging
franchisors based primarily on the perceived value and quality of each
franchisor's brand and services, and the extent to which affiliation with that
franchisor may increase the franchisee's reservations and profits. The Company
believes that hotel operators select a franchisor in part based on the
franchisor's reputation among other franchisees, and the success of its
existing franchisees.

The Company is the second largest hotel franchisor in the world. The
largest, Cendant Corporation (formerly HFS, Inc.), has over 5,300 franchised
hotels. Accor SA has 2,465, Holiday Corporation has 2,260, Marriott
International, Inc. has 1,268, Promus Hotel Corporation has 1,136, Societe de
Louvre has 511, Carlson Radisson/SAS has 437, ITT Corporation has 413 and
Hilton Hotels Corporation has 245. The figures in this paragraph are with
respect to U.S. hotel properties as indicated in the July 1997 issue of Hotels
Magazine.

The Company's prospects for growth are largely dependent upon the ability of
its franchisees to compete in the lodging market, since the Company's
franchise system revenues are based on franchisees' gross room revenues. The
ability of a hotel to compete may be affected by a number of factors,
including the location and quality of its property, the number and quality of
competing properties nearby, its affiliation with a recognized name brand, and
general regional and local economic conditions. The effect of local economic
conditions on the Company's results is substantially reduced by the geographic
diversity of the Company's franchised properties, which are located in all 50
states and in 32 other countries, as well as its range of products and room
rates. See "Risk Factors--Inherent Risks of the Lodging Industry;
Competition."

Service Marks and Other Intellectual Property

The service marks Quality, Comfort, Clarion, Sleep, Econo Lodge, Rodeway,
MainStay and related logos are material to the Company's business. The
Company, directly and through its franchisees, actively uses these marks. All
of the material marks are registered with the United States Patent and
Trademark Office. In addition, the Company has registered certain of its marks
with the appropriate governmental agencies in over 100 countries where it is
doing business or anticipates doing business in the foreseeable future. The
Company seeks to protect its brands and marks throughout the world, although
the strength of legal protection available varies from country to country.

Headquarters and Office Facilities

The Company's principal executive offices are located at 10750 Columbia
Pike, Silver Spring, Maryland, 20901. Its telephone number is (301) 592-5000.
These offices are leased from Manor Care pursuant to the Silver Spring Lease
(as defined in "Relationship Between Company and Sunburst"). For a description
of the Silver Spring Lease and the sublease entered into by the Company,
Sunburst and Manor Care, see "Relationship Between the Company and Sunburst--
Lease Agreements." The Company owns its reservation system offices in Phoenix,
Arizona and Minot, North Dakota and leases two additional reservation system
offices in Grand Junction, Colorado, pursuant to leases that expire in 1999
and 2000, and occupies additional space in Toronto, Canada, on a month-to-
month basis. In addition, the Company leases 12 sales offices across the
United States. Management believes that its executive, reservation systems and
sales offices are sufficient to meet its present needs and does not anticipate
any difficulty in securing additional or alternative space, as needed, on
terms acceptable to the Company.

51
<PAGE>

Seasonality

The Company's principal sources of revenues are franchise fees based on the
gross room revenues of its franchised properties. The Company experiences
seasonal revenue patterns similar to those of the lodging industry in general.
This seasonality can be expected to cause quarterly fluctuations in the
Company's revenues, profit margins and net income.

Regulation

The Company's franchisees are responsible for compliance with all laws and
government regulations applicable to the hotels they own or operate. The
lodging industry is subject to numerous federal, state and local government
regulations, including those relating to the preparation and sale of food and
beverage (such as health and liquor license laws), building and zoning
requirements and laws governing with employee relations, including minimum
wage requirements, overtime, working conditions and work permit requirements.

The FTC, various states and certain foreign jurisdictions (including France,
the Province of Alberta, Canada and Mexico) regulate the sale of franchises.
The FTC requires franchisors to make extensive disclosure to prospective
franchisees but does not require registration. A number of states in which the
Company's franchisees operate require registration or disclosure in connection
with franchise offers and sales. In addition, several states in which the
Company's franchisees operate have "franchise relationship laws" or "business
opportunity laws" that limit the ability of the franchisor to terminate
franchise agreements or to withhold consent to the renewal or transfer of
these agreements. While the Company's business has not been materially
adversely affected by such regulation, there can be no assurance that this
will continue or that future regulation or legislation will not have such an
effect.

Year 2000 Compliance

As is the case with most other companies using computers in their
operations, the Company is faced with the task of addressing the year 2000
problem during the next two years. This problem results from the past practice
in the computer industry of using two digits rather than four to designate the
calendar year. This practice will result in incorrect results when the
computer software programs perform arithmetic operations, comparisons of data
field sorting involving years later than 1999.

The Company's reservations systems, its current software products offered
for license to franchisees as well as its internal financial systems are being
analyzed for year 2000 compliance. Although the testing of these systems is
not yet complete, the Company does not believe any of the above elements will
have a material impact on the Company's results of operations or financial
condition.

Legal Proceedings

The Company is, from time to time the subject of, or involved in,
litigation. None of such litigation currently involving the Company, either
individually or in the aggregate, is expected to be material to the Company's
business, financial condition or results of operations.

Employees

The Company employed approximately 2,268 people as of June 30, 1998. None of
the Company's employees are represented by unions or covered by collective
bargaining agreements. The Company considers its relations with its employees
to be satisfactory.

Company History

Prior to becoming a separate, publicly-held company on October 15, 1997
pursuant to the Company Spin-Off, the Company was known as Choice Hotels
Franchising, Inc. and was a wholly-owned subsidiary of Former

52
<PAGE>

Choice. On October 15, 1997, Former Choice distributed to its stockholders its
business of franchising hotels under the Choice Brands (which had been
conducted primarily by the Company) and its European hotel ownership and
franchising business pursuant to the Company Spin-Off. At the time of the
Company Spin-Off, the Company changed its name to "Choice Hotels
International, Inc.," and Former Choice changed its name to "Sunburst
Hospitality Corporation."

Prior to November 1996, Former Choice was a subsidiary of Manor Care which,
directly and through its subsidiaries, engaged in the Lodging Business and the
health care business. On November 1, 1996, Manor Care separated the Lodging
Business from its health care business pursuant to the Former Choice Spin-Off.
In connection with the Former Choice Spin-Off, the Company became a wholly-
owned subsidiary of Former Choice and remained as such until consummation of
the Company Spin-Off.

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<PAGE>

MANAGEMENT

Board of Directors

The Company's Board of Directors is divided into three classes, designated
Class I, Class II and Class III, each as nearly equal in number of directors
as possible. The terms of the Class I directors will terminate on the date of
the 2001 annual meeting of the Company's stockholders; the terms of the Class
II directors will terminate on the date of the 1999 annual meeting of the
Company's stockholders; and the terms of the Class III directors will
terminate on the date of the 2000 annual meeting of the Company's
stockholders. At each annual meeting of the Company's stockholders, successors
to the class of directors whose terms expire at that annual meeting will be
elected for a three-year term. For a discussion of recent changes in the
Company's board of directors, see "Prospectus Summary -- Recent Developments."

The name, age and class of directorship of each of the seven persons who are
the directors of the Company are set forth below:

<TABLE>
<CAPTION>
CLASS OF
NAME AGE DIRECTOR
---- --- ---------
<S> <C> <C>
Stewart Bainum, Jr. ......................................... 52 Class II
Barbara Bainum............................................... 53 Class III
Charles A. Ledsinger, Jr. ................................... 48 Class II
Frederic V. Malek............................................ 61 Class III
Gerald W. Petitt............................................. 52 Class I
James H. Rempe............................................... 67 Class II
Jerry E. Robertson, Ph.D..................................... 65 Class I
</TABLE>
--------
Stewart Bainum, Jr. is the brother of Barbara Bainum.

Background of Directors

Stewart Bainum, Jr. Chairman of the Board of the Company from March 1987 to
June 1990 and since October 1997; Chairman of the Board of Former
Choice/Sunburst from November 1996 to July 1998; Chairman of the Board and
Chief Executive Officer of Manor Care and ManorCare Health Services, Inc.
("MCHS") since March 1987; Chief Executive Officer of Manor Care since March
1987 and President since June 1989; Vice Chairman of the Board of Vitalink
Pharmacy Services, Inc. ("Vitalink") since December 1994; Vice Chairman of the
Board of Manor Care and subsidiaries from June 1982 to March 1987; Director of
Manor Care since August 1981, of Vitalink since September 1991, of MCHS since
1976 and of the Company since 1977; Chief Executive Officer of MCHS since June
1989 and President from May 1990 to May 1991; Chairman of the Board and Chief
Executive Officer of Vitalink from September 1991 to February 1995 and
President and Chief Executive Officer from March 1987 to September 1991.

Barbara Bainum. President, Secretary and Director of the Commonweal
Foundation since December 1990, December 1984 and December 1994, respectively;
Secretary and Director of Realty Investment Company, Inc. since July 1989 and
March 1982, respectively; Family Services Agency, Gaithersburg, Maryland,
Clinical Social Work since September 1994; Department of Social Services,
Rockville, Maryland, Social Work Case Management from September 1992 to May
1993; member of the Boards of Trustees of Columbia Union College (September
1987 to May 1991) and Atlantic Union College (September 1985 to May 1987);
Director of the Company since October 1997 and of Former Choice from November
1996 to October 1997.

Charles A. Ledsinger, Jr. Chief Executive Officer, President and Director of
the Company since July 1998; President and Chief Operating Officer of St. Joe
Company from February 1998 to July 1998; Senior Vice President and Chief
Financial Officer of St. Joe Company from May 1997 to February 1998; Senior
Vice President and Chief Financial Officer of Harrah's Entertainment/The
Promus Companies from 1990 to 1997, where he served as Treasurer from 1988 to
1990 and as Vice President, Project Finance in the Embassy Suites Division
from 1983 to 1986; Senior Vice President and Treasurer of Harrah's Jazz
Finance Company from

54
<PAGE>

December 1993 to April 1997; various management positions with Holiday Inns
from 1978 to 1993; Director: TBC Corporation, Perkins Management Company, Inc.
and Friendly Ice Cream Corporation.

Frederic V. Malek. Director of the Company from 1990 to November 1996 and
since October 1997; Chairman of Thayer Capital Partners since March 1993; Co-
Chairman of CB Commercial Real Estate Group, Inc. from April 1989 to October
1996; Campaign Manager for Bush-Quayle '92 from January 1992 to November 1992;
Vice Chairman of NWA, Inc. (airlines), July 1990 to December 1991; Director:
Manor Care, Sunburst, American Management Systems, Inc., Automatic Data
Processing Corp., CB Commercial Real Estate Group, Inc., FPL Group, Inc. (an
affiliate of Florida Power and Light-power company), Northwest Airlines and
various Paine Webber mutual funds.

Gerald W. Petitt. President and Chief Executive Officer of Creative Hotel
since November 1996; Co-Chairman of the Company from January 1995 to November
1996 and a Director from December 1980 to November 1996 and since October
1997; President of the Company from June 1990 to January 1995 and Chief
Operating Officer from December 1980 to January 1995; Director of Former
Choice from November 1996 to October 1997; Director: Old Westbury Private
Coastal Fund LLC.

James H. Rempe. Senior Vice President, General Counsel and Secretary of
Manor Care since August 1981 and of the Company from February 1981 to November
1996; Director of the Company since October 1997; Director: In Home Health
Inc. and Vitalink.

Jerry E. Robertson, Ph.D. Retired; Executive Vice President, 3M Life
Sciences Sector and Corporate Services from November 1986 to March 1994;
Director of the Company from 1989 to October 1996 and since October 1997;
Director: Manor Care, Allianz Life Insurance Company of North America,
Cardinal, Inc., Coherent, Inc., Haemonetics Corporation, Medwave, Inc.,
Project Hope and Steris Corporation.

Compensation of Directors

The Company has adopted the Choice Hotels International, Inc. Non-Employee
Director Stock Option and Deferred Compensation Stock Purchase Plan. Part A of
the Plan provides that eligible non-employee directors are granted options to
purchase 5,000 shares of the Company's common stock on their first date of
election and are granted options to purchase 1,000 shares on their date of
election in subsequent calendar years. Part B of the Plan provides that
eligible non-employee directors may elect, prior to May 31 of each year, to
defer a minimum of 25% of committee fees earned during the ensuing fiscal
year. The fees which are so deferred will be used to purchase the Company's
common stock on the open market within 15 days after December 1, February 28
and May 31 of such fiscal year. Pending such purchases, the funds will be
credited to an Interest Deferred Account, which will be interest bearing.
Stock which is so purchased will be deposited in a Stock Deferred Account
pending distribution in accordance with the Plan.

Directors who are employees of the Company receive no separate remuneration
for their services as directors. Pursuant to the Non-Employee Director Stock
Compensation Plan adopted by the Company, eligible non-employee directors will
receive annually, in lieu of cash, restricted shares of the Company's common
stock, the fair market value of which at the time of grant will be equal to
$30,000, which will represent the Board of Directors retainer and meeting
fees. In addition, all non-employee directors receive $1,610 per diem for
Committee meetings attended and are reimbursed for travel expenses and other
out-of-pocket costs incurred in attending meetings.

55
<PAGE>

Executive Officers

The name, age, title and business background of each executive officer of
the Company are set forth below. The business address of each executive
officer is 10750 Columbia Pike, Silver Spring, Maryland 20901. For a
discussion of recent changes in the Company's executive officers, see
"Prospectus Summary -- Recent Developments."

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Stewart Bainum, Jr. ........... 52 Chairman of the Board of Directors
Charles A. Ledsinger, Jr. ..... 48 Chief Executive Officer and President
Thomas Mirgon.................. 41 Senior Vice President, Administration
Mark C. Wells.................. 48 Senior Vice President, Marketing
Michael J. DeSantis............ 39 Senior Vice President, General Counsel
and Secretary
Joseph M. Squeri............... 33 Vice President, Treasurer and Controller
</TABLE>

Background of Executive Officers

Stewart Bainum, Jr. See--"Management--Background of Directors."

Charles A. Ledsinger, Jr. See--"Management--Background of Directors."

Michael J. DeSantis. Senior Vice President, General Counsel and Secretary of
the Company since June 1997 and of Former Choice from June 1997 to October
1997; Senior Attorney for Former Choice from November 1996 to June 1997;
Senior Attorney for Manor Care from January 1996 to October 1996; Vice
President, Associate General Counsel and Assistant Secretary for Caterair
International Corporation from April 1994 to December 1995; Assistant General
Counsel of Caterair International from May 1990 to March 1994.

Thomas Mirgon. Senior Vice President, Administration of the Company since
April 1998; Senior Vice President, Human Resources of the Company from March
1997 to April 1998 and of Former Choice from March 1997 to October 1997;
Senior Vice President, Partner Services of the Company from October 1997 to ;
Vice President, Administration of Interim Services from August 1993 to
February 1997; employed by Taco Bell Corp. from January 1986 to August 1993,
last serving as Senior Director, Field Human Resources from February 1992 to
August 1993.

Mark C. Wells. Senior Vice President, Marketing of the Company since April
1998; Senior Vice President, Franchise Services of Promus Hotel Corp. from
January 1996 to April 1998; Senior Vice President, Marketing of Promus Hotel
Corp. from August 1993 to January 1996; Senior Vice President, Embassy Suites,
Inc. from January 1992 to August 1993; Vice President, Marketing of Hampton
Inns, Inc. from September 1986 to January 1992; Vice President, Marketing of
Days Inn, Inc. from July 1982 to September 1986; Vice President, Operations
and Marketing of Holiday Clubs International from April 1980 to July 1982.
Director: Pegasus Systems, Inc.

Joseph M. Squeri. Vice President, Treasurer and Controller of the Company
since April 1998; Vice President, Finance and Controller of the Company since
March 1997 and of Former Choice from March 1997 to October 1997; Director of
Investment Funds, The Carlyle Group, from November 1994 to February 1997;
various positions with Arthur Andersen LLP from July 1987 to November 1994,
most recently as Manager.

Compensation of Executive Officers

Summary Compensation. The following tables set forth certain information
concerning the annual and long-term compensation of the chief executive
officer, the four other most highly compensated executive officers of the
Company, all of whom were serving in such capacity at the end of the last
fiscal year, and one former executive officer of the Company who otherwise
would have been one of the four other most highly compensated executive
officers (the "Named Officers"). Messrs. Ledsinger and Wells were not employed
by the Company at the end of the last fiscal year.

56
<PAGE>

Compensation received by the Named Officers prior to consummation of the
Former Choice Spin-Off was paid by Manor Care. Compensation received by the
Named Officers after the Former Choice Spin-Off, but prior to the Company
Spin-Off, was paid by Former Choice. Compensation received by the Named
Officers after the Company Spin-Off was paid by the Company.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
ANNUAL LONG-TERM COMPENSATION
COMPENSATION(1) RESTRICTED
-------------------------- ---------------------------
FISCAL STOCK STOCK OPTION ALL OTHER
NAME AND PRINCIPAL POSITION YEAR(1) SALARY BONUS OTHER AWARDS($) SHARES(#)(2) COMPENSATION(3)
- --------------------------- ------- -------- -------- -------- ---------- ------------ ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Stewart Bainum, Jr.
(4).................... 1997A $164,089 $ 47,683 (5) -- -- --
Chairman 1997B 656,357 388,520 (5) -- 60,000 (6) --
1996 625,102 337,555 (5) -- 60,000 (7) $ 33,543
William R. Floyd (8).... 1997A 437,260 267,233 $139,403 (9) -- 65,000(10) --
Former Chief Executive 1997B 278,754 -- 107,831(11) $1,250,000(12) 307,693(13) --
Officer and President 1996 -- -- -- -- -- --
Barry L. Smith (14)..... 1997A 254,231 108,000 (5) -- 37,900(15) 11,086
Former Senior Vice 1997B 239,914 108,000 (5) -- 25,000(16) 11,086
President, Marketing 1996 233,728 110,834 (5) -- 5,000(17) 10,427
Thomas Mirgon (18)...... 1997A 188,423 51,315 169,626(19) -- 7,100(20)
Senior Vice President, 1997B 56,718 51,315 (5) -- 40,000(21) --
Administration 1996 -- -- -- -- --
Michael J. DeSantis
(22)................... 1997A 122,870 19,204 (5) 40,000(23) --
Senior Vice President, 1997B 99,516 3,477 -- -- --
General Counsel &
Secretary 1996 35,656 -- -- -- --
Rodney Sibley (24)...... 1997A 307,446 139,105 31,382(25) -- 47,400(26) 177,329(27)
Former Senior Vice
President, 1997B 309,123 139,105 (5) -- 30,000(28) 27,329
Franchise Operations 1996 423,858 -- (5) -- -- 27,329
</TABLE>
- --------
(1) On September 16, 1997, the Company changed its fiscal year end from May
31 to December 31. Accordingly, the summary compensation information
presented is for the twelve months ended December 31, 1997 ("1997A"), the
fiscal year ended May 31, 1997 ("1997B") and the fiscal year ended May
31, 1996 ("1996"). Summary compensation data paid to the Named Officers
during the period between January 1, 1997 and May 31, 1997 are reflected
in each of the 1997A and 1997B periods.
(2) For Messrs. Bainum, Jr., Smith and Sibley, the grants in fiscal years
1997B and 1996 represent options to purchase shares of Manor Care common
stock. In connection with the Former Choice Spin-Off, the options to
purchase Manor Care common stock were converted, in some cases 100%, to
options to purchase Former Choice common stock. For Messrs. Floyd and
Mirgon with respect to grants in 1997B and for all of the Named Officers
with respect to grants in 1997A, each grant represents options to acquire
shares of Former Choice common stock. In connection with the Company
Spin-Off, the options to purchase Former Choice common stock were
converted to successor options to purchase Company common stock and
Sunburst common stock. In all cases, however, the exercise prices were
adjusted to maintain the same financial value to the option holder before
and after the Former Choice Spin-Off and the Company Spin-Off.
(3) Represents amounts contributed by Manor Care for 1996, Former Choice for
1997B and Former Choice/Sunburst for 1997A under their respective 401(k)
Plan and Non-Qualified Savings Plan, which provide retirement and other
benefits to eligible employees, including the Named Officers. The value
of the amounts contributed in stock by Former Choice during 1997B and
1997A under the 401(k) Plan and Non-qualified Savings Plan, respectively,
for the Named Offices were as follows: Mr. Smith, $3,696 and $7,390 and
Mr. Sibley, $9,000 and $18,329.
(4) For part of 1997B and all of 1996, Mr. Bainum, Jr. was the Chairman and
Chief Executive Officer of Manor Care and Former Choice. In November,
1996, he resigned as Chief Executive Officer of Former Choice. The
compensation reflected for 1997B and 1996 is the total compensation
received for services

57
<PAGE>

rendered to both Manor Care and Former Choice. For the period between
January 1, 1997 and October 15, 1997, the amount of compensation paid
solely by Former Choice was $132,533 for base salary and $47,683 for
bonus. From October 15, 1997 to December 31, 1997, the amount of
compensation paid solely by the Company was $15,777 for the period between
October 16, 1997 and December 31, 1997.
(5) The value of perquisites and other compensation does not exceed the
lesser of $50,000 or 10% of the amount of annual salary and bonus paid.
(6) In connection with the Company Spin-Off, these options were converted
into options to acquire 60,000 shares of Company common stock at an
exercise price of $12.1130 and 20,000 shares of Sunburst common stock at
an exercise price of $7.1894.
(7) In connection with the Company Spin-Off, these options were converted
into options to acquire 60,000 shares of Company common stock at an
exercise price of $9.2807 and 20,000 shares of Sunburst common stock at
an exercise price of $5.5083.
(8) Mr. Floyd's employment as Chief Executive Officer of Former Choice and
the Company commenced October 21, 1996 and terminated on June 15, 1998.
(9) Consists of $127,703 in relocation expenses (including $107,831 reported
under 1997B) and $11,700 in automobile allowance.
(10) In connection with the Company Spin-Off, these options were converted
into options to purchase 71,631 shares of Company common stock at an
exercise price of $16.488 and 10,833 shares of Sunburst common stock at
an exercise price of $9.786.
(11) Consists of relocation expenses.
(12) Represents a grant of 85,470 restricted shares of Former Choice common
stock granted on November 4, 1996. The shares vest in three equal annual
installments beginning on November 4, 1997. The restricted shares are
entitled to dividends and in connection with the Company Spin-Off, Mr.
Floyd received 85,470 shares of Company common stock as a dividend on
such shares of Former Choice common stock, of which 56,980 remain
unvested. Pursuant to a Severance Agreement, 42,375 of the unvested
shares of the Company common stock and 14,246 shares of the Sunburst
common stock were cancelled.
(13) In connection with the Company Spin-Off, these options were converted
into options to purchase 341,515 shares of Company common stock at an
exercise price of $12.2095 and 45,584 shares of Sunburst common stock at
an exercise price of $7.2466.
(14) Mr. Smith retired from the Company in April 1998.
(15) In connection with the Company Spin-Off, these options were converted
into options to purchase 42,586 shares of Company common stock at an
exercise price of $13.2008 and 4,738 shares of Sunburst common stock at
an exercise price of $7.835.
(16) In connection with the Former Choice Spin-Off and the Company Spin-Off,
these options were converted into options to acquire 77,624 shares of
Company common stock at an exercise price of $12.113 and 6,819 shares of
Sunburst common stock at an exercise price of $7.1894.
(17) In connection with the Former Choice Spin-Off, these options were
converted into options to acquire 15,183 shares of Company common stock
at an exercise price of $9.2807 and 1,023 shares of Sunburst common stock
at an exercise price of $5.5083.
(18) Mr. Mirgon's employment with the Company and Former Choice commenced
March 3, 1997.
(19) Consists of $160,995 in relocation expenses and $8,631 in automobile
allowance.
(20) In connection with the Company Spin-Off, these options were converted
into options to purchase 7,978 shares of Company common stock at an
exercise price of $13.2008 and 888 shares of Sunburst common stock at an
exercise price of $7.835.
(21) In connection with the Company Spin-Off, these options were converted
into options to purchase 44,946 shares of Company common stock at an
exercise price of $13.0443 and 5,000 shares of Sunburst common stock at
an exercise price of $7.7421.
(22) Mr. DeSantis' employment with Manor Care commenced in January 1996. Mr.
DeSantis' employment with Former Choice commenced in November 1996. He
was appointed Senior Vice President, General Counsel and Secretary of
Former Choice and the Company in June 1997.
(23) In connection with the Company Spin-Off, these options were converted
into options to purchase 44,946 shares of Company common stock at an
exercise price of $13.2008 and 5,000 shares of Sunburst common stock at
an exercise price of $7.835.

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<PAGE>

(24) Prior to 1997A, Mr. Sibley's compensation was based on commissions. Mr.
Sibley's employment was terminated in November 1997.
(25) Consists of $29,029 in relocation expenses and $2,353 in automobile
allowance.
(26) In connection with the Company Spin-Off, these options were converted
into options to purchase 53,261 shares of Company common stock at an
exercise price of $13.2008 and 5,925 shares of Sunburst common stock at
an exercise price of $7.835.
(27) In connection with his resignation, Mr. Sibley was paid a severance
payment of $150,000.
(28) In connection with the Former Choice Spin-Off and the Company Spin-Off,
these options were converted into options to acquire 93,149 shares of
Company common stock at an exercise price of $12.113 and 8,182 shares of
Sunburst common stock at an exercise price of $7.1894.

59
<PAGE>

Stock Options. The following tables set forth certain information at
December 31, 1997 and for the twelve months then ended concerning options to
purchase Company common stock granted to Named Officers. All common stock
figures and exercise prices have been adjusted to reflect stock dividends and
stock splits effective in prior fiscal years. Upon consummation of the Company
Spin-Off, existing Former Choice stock options were subject to certain
adjustments or conversions into options to purchase Company common stock and
Sunburst common stock.

STOCK OPTION GRANTS IN 1997

INDIVIDUAL GRANTS

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
PERCENTAGE OF VALUE OF ASSUMED
TOTAL OPTIONS RATE OF STOCK PRICE
GRANTED TO ALL APPRECIATION
NUMBER OF EMPLOYEES IN EXERCISE BASE FOR OPTION TERM(2)
OPTIONS FISCAL YEAR PRICE EXPIRATION ---------------------
NAME COMPANY* GRANTED (1) 1997 PER SHARE DATE 5%(3) 10%(4)
---- -------- ----------- -------------- ------------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Stewart Bainum, Jr...... CHH 0 -- -- -- -- --
SNB 0 -- -- -- -- --
------
Total 0 -- -- -- -- --
William R. Floyd(5)..... CHH 71,431 (6) $ 16.488 9/16/07 $ 740,682 $ 1,877,035
SNB 10,833 (7) $ 9.786 9/16/07 66,670 168,955
------ --------- -----------
Total 82,264 807,352 2,045,990
Barry L. Smith(5)....... CHH 42,586 (6) $13.2008 6/24/07 353,544 895,954
SNB 4,738 (7) $ 7.8350 6/24/07 23,346 59,163
------ --------- -----------
Total 47,324 376,890 955,117
Thomas Mirgon(5)........ CHH 44,946 (6) $13.0443 2/25/07 368,714 934,395
CHH 7,978 (6) $13.2008 6/24/07 66,232 167,846
SNB 5,000 (7) $ 7.7421 2/25/07 24,345 61,694
SNB 888 (7) $ 7.8350 6/24/07 4,375 11,088
------ --------- -----------
Total 58,812 463,666 1,175,023
Michael J. DeSantis(5).. CHH 44,946 (6) $13.2008 6/24/07 373,137 945,605
SNB 5,000 (7) $ 7.8350 6/24/07 24,637 62,435
------ --------- -----------
Total 49,946 397,774 1,008,040
Rodney Sibley(5)........ CHH 53,261 (6) $13.2008 6/24/07(8) 442,167 1,120,542
SNB 5,925 (7) $ 7.8350 6/24/07(8) 29,194 73,985
------ --------- -----------
Total 59,186 471,361 1,194,527
</TABLE>
- --------
* References to "CHH" are to the Company and "SNB" are to Sunburst.
(1) Options granted to the Named Officers were granted prior to the Company
Spin-Off and were thus granted as options to purchase Former Choice common
stock. In connection with the Company Spin-Off, these options to purchase
Former Choice common stock were converted to options to purchase Company
common stock and Sunburst common stock. In all cases, however, the
exercise prices were adjusted to maintain the same financial value to the
option holder before and after the Company Spin-Off. The number of options
set forth in the table represent the number of Company and Sunburst
options and the adjusted exercise prices after the conversion.
(2) The dollar amounts under these columns are the result of calculations at
the 5% and 10% rates set by the 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 for the option term from $16.488
per share yields $10.3692, from $9.786 per share yields $6.1544, from
$13.2008 per share yields $8.3019, from $7.835 per share yields $4.9274,
from $13.0443 per share yields $8.2035 and from $7.7421 per share yields
$4.8690.

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<PAGE>

(4) A 10% per year appreciation in stock price for the option term from
$16.488 per share yields $26.2776, from $9.786 per share yields $15.5964,
from $13.2008 per share yields $21.0387, from $7.835 per share yields
$12.4970, from $13.0443 per share yields $20.7893 and from $7.7421 per
share yields $12.3389.
(5) The options granted to the officers vest at the rate of 20% per year on
the first through the fifth anniversaries of the date of the stock option
grant.
(6) In the twelve months ended December 31, 1997, the Company only granted
options to two individuals for a total of 50,000 options granted. All
other outstanding Company options (including those listed in this table)
were issued in connection with the conversion of Former Choice options in
the Company Spin-Off.
(7) The options presented in this table are presented post-conversion from the
Company Spin-Off. Since the option grants presented in the table were
granted prior to the Company Spin-Off conversion, the percentage is not
presented since it would not be equivalent to the percentage if calculated
on a pre-Company Spin-Off basis.
(8) In connection with Mr. Sibley's termination, the expiration date of these
options was changed to 7/5/01.

AGGREGATE OPTION EXERCISES IN 1997 AND YEAR-END OPTION VALUES(1)

<TABLE>
<CAPTION>
NUMBER OF VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
SHARES AT DECEMBER 31, 1997 AT DECEMBER 31, 1997(2)
ACQUIRED ON VALUE ------------------------- -------------------------
NAME COMPANY* EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- -------- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Stewart Bainum, Jr...... CHH -- -- 303,000 157,000 $3,602,207 $1,188,693
SNB 465,000(3) $3,105,452 101,000 52,334 750,906 254,990
William R. Floyd........ CHH -- -- 68,303 344,643 258,902 1,000,752
SNB -- -- 9,117 47,300 23,963 96,814
Barry L. Smith.......... CHH -- -- 68,539 168,500 727,316 1,036,330
SNB 39,537(3) 156,324 6,135 20,988 48,467 91,205
Thomas Mirgon........... CHH -- -- 0 52,924 0 155,178
SNB -- -- 0 5,888 0 12,476
Michael J. DeSantis..... CHH -- -- 0 44,946 0 125,812
SNB -- -- 0 5,000 0 10,200
Rodney Sibley........... CHH -- -- 35,933 126,808 231,229 434,965
SNB -- -- 0 14,107 0 34,060
</TABLE>
- --------
* References to "CHH" are to the Company, and "SNB" are to Sunburst.
(1) Options granted to the Named Officers were granted prior to the Company
Spin-Off and were thus granted as options to purchase Former Choice common
stock. In connection with the Company Spin-Off, these options to purchase
Former Choice common stock were converted to options to purchase Company
common stock and Sunburst common stock. In all cases, however, the
exercise prices were adjusted to maintain the same financial value to the
option holder before and after the Company Spin-Off. The number of options
set forth in the table represent the number of Company and Sunburst
options and the adjusted exercise prices after the conversion.
(2) The closing prices of Company common stock and Sunburst common stock as
reported by the New York Stock Exchange on December 31, 1997 were $16.00
and $9.875, respectively. 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 or Sunburst
common stock underlying the option.
(3) These exercises occurred prior to the Company Spin-Off and therefore
involved the exercise of Former Choice options.

EMPLOYMENT AGREEMENTS

The Company entered into an employment agreement with Stewart Bainum, Jr.,
providing for Mr. Bainum, Jr.'s employment as Chairman of the Company's Board
of Directors. The agreement has a term of three years from October 15, 1997.
Either Choice or Mr. Bainum may terminate the agreement upon 30 days' prior
written

61
<PAGE>

notice on the first and second anniversary dates of the agreement. The
agreement provides that Mr. Bainum, Jr. devote 12.5% of his professional time
to the Company's affairs, 12.5% of his professional time to the affairs of
Sunburst and the remaining 75% of his professional time to the affairs of
Manor Care. The agreement provides for a base salary of $82,702 per annum,
subject to annual adjustments, 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. In July 1995, the agreement was amended to provide that Mr.
Bainum, Jr. would devote 25% of his professional time to Choice for an annual
base salary of $165,404.

The Company entered into an Employment Agreement with Charles A. Ledsinger,
Jr. providing for Mr. Ledsinger's employment and Chief Executive Officer and
President. The agreement has a term of five years from July 31, 1998 and
provides for a base salary of $500,000 per annum, subject to annual
adjustments, and an annual bonus of up to 60% of his base compensation, based
upon the Company's performance. The agreement also provides for an award of
$825,000 worth of restricted Company common stock, which vests in three equal
annual installments beginning one year from the grant date and options to
acquire Company common stock at a value of $7.5 million, which vests in five
equal annual installments beginning one year form the grant date. The
agreement provides that for a period of two years after the termination of his
employment, Mr. Ledsinger will not disclose confidential information or
solicit Company employees. The agreement also provides that if Mr. Ledsinger
is terminated within twelve months of a change of control of the Company, then
he shall receive a severance payment equal to 200% of his base salary plus 75%
of the amount of any bonus awarded in the previous fiscal year.

The Company assumed an employment agreement between Former Choice and Thomas
Mirgon. The agreement has a term of five years from March 3, 1997 and provides
for a base salary of $230,000 per annum, subject to annual adjustments and an
annual bonus of up to 50% of his base compensation, based on the Company's
performance. The agreement also provides for (i) a one-time cash payment of
$50,000, payable in two equal installments: the first within 30 days of March
3, 1997 and the second within 30 days of March 3, 1998; and (ii) a grant of
30,000 non-qualified options and 10,000 incentive stock options of Former
Choice.

The Company entered into an Employment Agreement with Mark Wells dated April
13, 1998. The agreement has a five-year term and provides for a base salary of
$275,000 per annum, subject to annual adjustments, and an annual bonus of up
to 50% of his base compensation, based upon the Company's performance. The
agreement also provides for an award of 18,750 restricted shares of the
Company's common stock and options to acquire 65,000 shares of the Company's
common stock, both granted on May 18, 1998. The restricted stock and stock
options each vest in five equal annual installments beginning on May 18, 1999.

The Company entered into an Employment Agreement with Michael J. DeSantis
dated April 29, 1998. The agreement has a five-year term and provides for a
base salary of $170,000 per annum, subject to annual adjustments, and an
annual bonus of up to 50% of his base compensation, based upon the Company's
performance.

On June 15, 1998, the Company and William R. Floyd entered into an agreement
relating to Mr. Floyd's resignation which provides for a severance payment
equal to one year of Mr. Floyd's base salary and for the continued vesting of
previously granted stock options for one year. The agreement also provides
that Mr. Floyd shall be entitled to one-half of the amount of restricted
shares of the Company and Sunburst common stock which vest on November 4,
1999. The other one-half as well as the portion which vests in 2000 are
canceled. Mr. Floyd has agreed to keep confidential any business information
of the Company and for one year not to solicit for employment any Company
employees.

On December 18, 1997, the Company entered into a Consulting Agreement with
Barry L. Smith under which Mr. Smith will provide consulting services to the
Company upon his retirement. Mr. Smith will retire as Senior Vice President,
Marketing upon 45 days of a successor being appointed, but in no event later
than December 15, 1998. The initial term of the agreement shall commence on
Mr. Smith's retirement and end on December 15, 1998. At the mutual election of
the parties, the agreement shall be extended for successive one-

62
<PAGE>

year periods. For the initial term, Mr. Smith shall receive a pro rata portion
of an annual fee of $265,000, depending upon the commencement of the initial
term. During any extension period, Mr. Smith shall be paid at a rate of $200
per hour. Mr. Smith agrees that during the term of the agreement (and any
extensions), he will not compete with the Company.

On December 16, 1997, the Company and Mr. Sibley entered into an agreement
which was effective upon Mr. Sibley's resignation from the Company on November
20, 1997. The agreement provides for a payment to Mr. Sibley in the aggregate
amount of $150,000. The agreement also provides that Mr. Sibley's stock
options will continue to vest through July 5, 2001 and that Mr. Sibley agrees
not to compete with the Company during that period.

RETIREMENT PLANS

The Company has adopted the Choice Hotels International, Inc. Supplemental
Executive Retirement Plan (the "SERP"). Participants are Senior Vice
Presidents and other officers who report directly to the CEO.

Participants in the SERP receive a monthly benefit for life based upon final
average salary and years of service. Final average salary is the average of
the monthly base salary, excluding bonuses or commissions, earned in a 60-
month period which produces the highest average out of the 120 months of
employment, prior to the first occurring of the early retirement date or the
normal retirement date. The nominal retirement age is 65, and participants
must have a minimum of 15 years of service. Participants may retire at age 60
and may elect to receive reduced benefits commencing prior to age 65, subject
to Board approval. All of the Named Officers who are participants, except for
Mr. Smith, are age 55 or younger, so that none of their compensation reported
above would be included in the final average salary calculation.

Assuming that the following officers continue to be employed by the Company
until they reach age 65, their credited years of service are as follows:

<TABLE>
<CAPTION>
CURRENT YEARS YEARS OF SERVICE
NAME OF INDIVIDUAL OF SERVICE AT AGE 65
------------------ ------------- ----------------
<S> <C> <C>
Stewart Bainum, Jr. ........................ 22 38
Charles A. Ledsinger, Jr. .................. 0 17
Thomas Mirgon............................... 2 24
Michael J. DeSantis......................... 3 28
Mark C. Wells............................... 0 [17]
</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 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
RENUMERATION 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>

In October 1997, the Company established the Choice Hotels International,
Inc. Retirement Savings and Investment Plan (the "401(k) Plan"). The 401(k)
Plan is a defined contribution retirement, savings and

63
<PAGE>

investment plan qualified under Section 401(a) of the Internal Revenue Code of
1986, as amended (the "Code"), and includes a cash or deferred arrangement
under Section 401(k) of the Code. All employees age 21 or over and who have
worked for the Company for a twelve-month period during which such employee
completed at least 1,000 hours will be eligible to participate. Subject to
certain non-discrimination requirements, each employee will be able to
contribute an amount to the 401(k) Plan on a pre-tax basis up to 15% of the
employee's salary, but not more than the current Federal limit of $10,000. The
Company will match contributions made by its employees subject to certain
limitations. The amount of the match will be equal to a percentage of the
amount of salary reduction contribution made on behalf of a participant during
the plan year based upon a formula that involves the profits of the Company
for the year and the number of years of service of the participant. Amounts
contributed by the Company pursuant to its 401(k) Plan for Named Officers are
included in the Summary Compensation Table under the column headed "All Other
Compensation."

The Company also adopted the Choice Hotels International, Inc. Non-Qualified
Retirement Savings and Investment Plan ("Non-Qualified Savings Plan"). Certain
select highly-compensated members of management of the Company will be
eligible to participate in the Non-Qualified Savings Plan. The Non-Qualified
Savings Plan is structured so as to provide the participants with a pre-tax
savings vehicle to the extent that pre-tax savings are limited under the
401(k) Plan as a result of various governmental regulations, such as non-
discrimination testing. Amounts contributed by the Company under its Non-
Qualified Savings Plan for fiscal year 1997 for the Named Officers are
included in the Summary Compensation Table under the column headed "All Other
Compensation."

The Company match under the 401(k) Plan and the Non-Qualified Savings Plan
is limited to a maximum aggregate of 6% of the annual salary of a participant.
Likewise, participant contributions under the two plans will not exceed the
aggregate of 15% of the annual salary of a participant.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth the amount of the Company's common stock
beneficially owned by (i) each director of the Company, (ii) the Company's
chief executive officer and the other Named Officers, (iii) all officers and
directors of the Company as a group and (iv) all persons who are expected to
own beneficially more than 5% of the Company's common stock, each as of August
15, 1998. Unless otherwise specified, the address for each of them is 10750
Columbia Pike, Silver Spring, Maryland 20901.

<TABLE>
<CAPTION>
SHARES OF
COMMON STOCK PERCENT OF SHARES
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED OUTSTANDING(1)
------------------------ ------------------ -----------------
<S> <C> <C>
Stewart Bainum, Jr. ................. 16,336,908 (2) 27.74%
Barbara Bainum....................... 5,596,769 (3) 9.55%
Michael J. DeSantis.................. 9,890 (4) *
William R. Floyd (5)................. 153,873 (6) *
Charles A. Ledsinger, Jr. ........... 65,842 (7) *
Frederic V. Malek.................... 14,118 (8) *
Thomas Mirgon........................ 10,585 (9) *
Gerald W. Petitt..................... 89,055(10) *
James H. Rempe....................... 136,337(11) *
Jerry E. Robertson, Ph.D............. 26,850(12) *
Barry L. Smith....................... 16,131(13) *
Rodney Sibley(14).................... 70,771(15) *
All Directors and Officers as a Group
(13 persons)........................ 17,106,432(16) 29.20%
Stewart Bainum....................... 10,350,628 (17) 17.67%
Bruce Bainum......................... 5,585,502(18) 9.53%
Ronald Baron......................... 19,712,033(19) 33.65%
</TABLE>
- --------
* Less than 1% of class.

64
<PAGE>

(1) Percentages are based on 58,573,529 shares outstanding on August 15, 1998
(the "Measurement Date") plus, for each person, the shares which would be
issued assuming that such person exercises all options it holds which are
exercisable on such date or become exercisable within 60 days thereafter.
(2) Includes 502,252 shares owned directly by Mr. Bainum, Jr. Also includes
5,417,761 shares owned by Bainum Associates Limited Partnership ("Bainum
Associates") and 4,415,250 shares owned by MC Investments Limited
Partnership ("MC Investments"), in both of which Mr. Bainum, Jr. is
managing general partner with the sole right to dispose of the shares;
3,567,869 shares held directly by Realty Investment Company, Inc.
("Realty"), a real estate management and investment company in which Mr.
Bainum, Jr. has shared voting authority; 1,779,628 shares owned by Mid
Pines Associates Limited Partnership ("Mid Pines"), in which Mr. Bainum,
Jr. is managing general partner and has shared voting authority; 73,200
shares owned by Vintage, L.P. in which Mr. Bainum is a general partner
and has shared voting authority and 300 shares owned by the Foundation
for Maryland's Future, in which Mr. Bainum, Jr. is the sole director.
Also includes 327,000 shares which Mr. Bainum, Jr. has the right to
acquire pursuant to stock options which are presently exercisable or
which become exercisable within 60 days after the Measurement Date, and
148 shares which Mr. Bainum, Jr. has the right to receive upon
termination of his employment with the Company pursuant to the terms of
the Choice Hotels International, Inc. Non-Qualified Retirement Savings
and Investment Plan ("Non-Qualified Savings Plan").
(3) Includes 101,697 shares owned directly by Ms. Bainum. Also includes
1,779,628 shares owned by Mid Pines, in which Ms. Bainum's trust is a
general partner and has shared voting authority, 3,567,869 shares owned
by Realty, in which Ms. Bainum's trust has voting stock and shares voting
authority; 73,200 shares owned by Vintage, L.P. in which Ms. Bainum is a
general partner and has shared voting authority, and 70,305 shares owned
by the Commonweal Foundation, in which Ms. Bainum is President and
Director and has shared voting authority. Also includes 4,070 shares of
restricted stock issued to Ms. Bainum under the Non-Employee Director
Stock Compensation Plan which shares are not vested, but which Ms. Bainum
has the right to vote.
(4) Includes 900 shares owned directly and 8,990 shares which Mr. Desantis
has the right to acquire pursuant to stock options which are currently
exercisable or become exercisable within 60 days of the measurement date.
(5) Mr. Floyd resigned from the Company on June 15, 1998.
(6) Includes 28,590 shares held directly and 28,490 shares of restricted
shares which are not yet vested, but which Mr. Floyd has the right to
vote. Also includes 82,589 shares which Mr. Floyd has the right to
acquire pursuant to stock options which are currently exercisable or
become exercisable within 60 days of the Measurement Date.
(7) Consists of restricted shares which are not yet vested, but which Mr.
Ledsinger has the right to vote.
(8) Includes 1,948 shares owned directly by Mr. Malek; 5,999 shares which Mr.
Malek has the right to acquire pursuant to stock options which are
presently exercisable, 5,591 restricted shares granted under the Non-
Employee Director Stock Compensation Plan which are not vested, but which
Mr. Malek has the right to vote and 580 shares held in a Rabbi Trust
pursuant to the Choice Hotels International, Inc. Non-Employee Director
Stock Option and Deferred Compensation Stock Purchase Plan (the "Deferred
Compensation and Stock Purchase Plan").
(9) Consists of shares which Mr. Mirgon has the right to acquire pursuant to
stock options which are currently exercisable or exercisable within 60
days of the Measurement Date.
(10) Includes 76,324 shares held directly by Mr. Petitt and 8,661 shares held
in trust for minor children for which Mr. Petitt is trustee. Beneficial
ownership of such shares is disclaimed. Also includes 4,070 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.
(11) Includes 49,678 shares owned directly by Mr. Rempe and 83,851 shares
which Mr. Rempe has the right to acquire pursuant to stock options which
are presently exercisable or exercisable within 60 days of the
Measurement Date. Also includes 2,808 restricted shares granted under the
Non-Employee Director Stock Compensation Plan which are not yet vested,
but which Mr. Rempe has the right to vote.
(12) Includes 2,710 shares held directly by Mr. Robertson and 15,500 shares
owned by the JJ Robertson Limited Partnership, of which Mr. Robertson and
his wife are the general partners with shared voting

65
<PAGE>

authority and 4,598 restricted shares granted under the Non-Employee
Director Stock Compensation Plan which are not yet vested, but which Mr.
Robertson has the right to vote. Also includes 2,564 shares which Mr.
Robertson has the right to acquire pursuant to stock options which are
presently exercisable and 1,478 shares acquired pursuant to the Deferred
Compensation Stock Purchase Plan.
(13) Includes 15,322 shares which Mr. Smith has the right to acquire pursuant
to stock options which are presently exercisable or exercisable within 60
days of the Measurement Date and 254 shares and 555 shares, respectively,
which Mr. Smith has the right to receive upon termination of his
employment pursuant to the terms of the Choice Hotels International, Inc.
Retirement Savings and Investment Plan ("401(k) Plan") and the Non-
Qualified Savings Plan.
(14) Mr. Sibley's employment with the Company was terminated in November 1997.
(15) Includes 27,031 shares held directly by Mr. Sibley, and 43,740 shares
which Mr. Sibley has the right to acquire pursuant to stock options which
are presently exercisable or exercisable within 60 days of the
Measurement Date.
(16) Includes a total of 575,720 shares which the officers and directors
included in the group have the right to acquire pursuant to stock options
which are presently exercisable, or exercisable within 60 days of the
Measurement Date, and a total of 1,994 shares and 3,528 shares,
respectively, which such directors and officers have the right to receive
upon termination of their employment with the Company pursuant to the
terms of the 401(k) Plan and the Non-Qualified Savings Plan.
(17) Includes 3,906,542 shares held directly by the Stewart Bainum Declaration
of Trust, of which Mr. Bainum is the sole trustee and beneficiary, his
joint interest in 905,421 shares owned by Bainum Associates and 1,099,190
shares owned by MC Investments, each of which is a limited partnership in
which Mr. Bainum has joint ownership with his wife as a limited partner
and as such has the right to acquire at any time a number of shares equal
in value to the liquidation preference of their limited partnership
interests; 3,567,869 shares held directly by Realty, in which Mr. Bainum
and his wife have shared voting authority; and 70,305 shares held by the
Commonwealth Foundation of which Mr. Bainum is Chairman of the Board of
Directors and has shared voting authority. Also includes 798,711 shares
held by the Jane L. Bainum Declaration of Trust, the sole trustee and
beneficiary of which is Mr. Bainum's wife, and 5,999 shares which Mr.
Bainum has the right to acquire pursuant to stock options which are
presently exercisable or which become exercisable within 60 days after
the Measurement Date. Also includes 5,591 shares of restricted stock
granted by the Company to Mr. Bainum under the Choice Hotels
International, Inc. Non-Employee Director Stock Compensation Plan (the
"Non-Employee Director Stock Compensation Plan") which are not vested but
which Mr. Bainum has the right to vote.
(18) Includes 94,500 shares owned directly by Mr. Bainum. Also includes
1,779,628 shares owned by Mid Pines and 73,200 shares owned by Vintage,
L.P., in each of which Mr. Bainum is a general partner and has shared
voting authority, 3,567,869 shares owned by Realty in which Mr. Bainum's
trust has voting stock and shares voting authority and 70,305 shares
owned by the Commonwealth Foundation, in which Mr. Bainum is a Director
and has shared voting authority. Mr. Bainum's address is 8737 Colesville
Road, Suite 800, Silver Spring, Maryland, 20910.
(19) As of February 3, 1998 based on a Schedule 13-D, as amended, filed by Mr.
Baron with the Commission. Mr. Baron's address is 450 Park Avenue, Suite
2800, New York, New York 10022. Pursuant to a letter agreement dated
February 4, 1998 between the Company, Mr. Baron and entities under the
control of Mr. Baron (together with Mr. Baron, the "Baron Entities"),
each Baron Entity covenanted not to (i) acquire any additional shares of
stock or security convertible into stock of the Company; (ii) take any
action or participate in any transaction which may constitute an event of
default under the Credit Facility; or (iii) seek representation on the
Board of Directors of the Company.

66
<PAGE>

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Relationship with Manor Care. Stewart Bainum, Jr. is the Chairman of the
Company's Board of Directors and is also the Chairman of the Board of
Directors of Manor Care. James Rempe is a Director of the Company and Senior
Vice President and General Counsel of Manor Care. Additionally, Messrs.
Bainum, Bainum, Jr. and Rempe, as well as certain other officers and directors
of the Company and of Manor Care own shares and/or options or other rights to
acquire shares of each of the Company and Manor Care.

In connection with the Company Spin-Off, the Company, Sunburst and Manor
Care entered into an Omnibus Amendment and Guaranty Agreement (the "Amendment
and Guaranty") pursuant to which the Company (i) became a party to certain
agreements entered into between Manor Care and Former Choice at the time of
the Former Choice Spin-Off, (ii) guaranteed Sunburst's payment obligations
under certain leases (which have since been terminated) and (iii) guaranteed
Sunburst's payment obligations to Manor Care under an agreement pursuant to
which Manor Care provided to Former Choice/Sunburst certain consulting
services.

Relationship with Sunburst. For a discussion of the relationship between the
Company and Sunburst resulting from the Company Spin-Off, see "Relationship
Between the Company and Sunburst."

Other Relationships. Creative Hotel is a franchisee of the Company which
owns Sleep Inns in Ormond Beach, Florida and Albuquerque, New Mexico and a
Comfort Inn and Suites in Carbondale, Colorado. Gerald W. Petitt is a director
of the Company and the President and Chief Executive Officer of Creative
Hotel. Robert C. Hazard, Jr., who resigned as a director of the Company in
July 1998, is Chairman of Creative Hotel. Total payments to the Company in the
six months ended June 30, 1998 were $47,579.

RELATIONSHIP BETWEEN THE COMPANY AND SUNBURST

In connection with the Company Spin-Off, the Company and Sunburst entered
into certain agreements intended to govern the relationship between the
parties after the Company Spin-Off. The material terms of certain of these
agreements and other arrangements, entered into between the Company and
Sunburst, including the franchise agreements with respect to Sunburst's
hotels, are described below.

DISTRIBUTION AGREEMENT

In connection with the Company Spin-Off, the Company and Sunburst entered
into a Distribution Agreement which provided for, among other things, the
principal corporate transactions required to effect the Company Spin-Off, the
assumption by the Company of all liabilities relating to its business and the
allocation between the Company and Sunburst of certain other liabilities,
certain indemnification obligations of Sunburst and the Company and certain
other agreements governing the relationship between the Company and Sunburst
with respect to or in consequence of the Company Spin-Off.

Subject to certain exceptions, the Company has agreed to indemnify Sunburst
and its subsidiaries against any loss, liability or expense incurred or
suffered by Sunburst or its subsidiaries arising out of or related to the
failure by the Company to perform or otherwise discharge liabilities allocated
to and assumed by the Company under the Distribution Agreement, and Sunburst
has agreed to indemnify the Company against any loss, liability or expense
incurred or suffered by the Company arising out of or related to the failure
by Sunburst to perform or otherwise discharge the liabilities retained by
Sunburst under the Distribution Agreement. The foregoing cross-indemnities do
not apply to indemnification for tax claims and liabilities, which are
addressed in the Tax Sharing Agreement described below.

To avoid adverse tax consequences of the Company Spin-Off, each of the
Company and Sunburst has agreed to comply in all material respects with each
representation and statement made to any taxing authority in

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connection with the IRS tax ruling or any other tax ruling obtained by the
Company and Sunburst in connection with the Company Spin-Off.

Under the Distribution Agreement, each of the Company and Sunburst will be
granted access to certain records and information in the possession of the
other, and requires the retention of such information in its possession for
specified periods and thereafter requires that each party give the other prior
notice of its intention to dispose of such information. In addition, the
Distribution Agreement provides for the allocation of shared privileges with
respect to certain information and requires each of the Company and Sunburst
to obtain the consent of the other prior to waiving any shared privilege.

STRATEGIC ALLIANCE AGREEMENT

At the time of the Company Spin-Off, the Company and Sunburst entered into a
Strategic Alliance Agreement pursuant to which: (i) Sunburst granted a right
of first refusal, subject to certain exceptions, to the Company to franchise
any lodging property that Sunburst develops or acquires and intends to operate
under franchise; (ii) Sunburst agreed, barring a material change in market
conditions, to continue to develop Sleep Inns and MainStay Suites hotels so
that it will have opened a total of 14 Sleep Inns and 15 MainStay Suites
hotels by October 15, 2001 (48 months from the date of the Company Spin-Off);
(iii) the Company has granted to Sunburst an option (exercisable only in the
event that there are not 100 MainStay Suites open or under construction by
January 1, 2000), to purchase the brand names, marks, franchise agreements and
other assets of the MainStay Suites hotel system; (iv) the Company and
Sunburst have agreed to continue to cooperate with respect to matters of
mutual interest, including new product and concept testing for the Company in
hotels owned by Sunburst; and (v) Sunburst has authorized the Company to
negotiate with third party vendors on Sunburst's behalf for the purchase of
certain items. The Strategic Alliance Agreement extends for a term of 20 years
with rights of mutual termination on the fifth, tenth and fifteenth
anniversaries of the Company Spin-Off.

Under the Strategic Alliance Agreement, each new hotel property owned by
Sunburst and franchised under a Choice Brand after the Company Spin-Off is
subject to the Company's standard franchise agreement, except that the initial
fee and royalty, reservation and marketing fees payable thereunder by Sunburst
are commensurate with such fees paid by other multi-unit franchisees of the
Company.

AMENDMENT AND GUARANTY

In connection with the Company Spin-Off, the Company, Manor Care and
Sunburst entered into the Amendment and Guaranty for the purpose of adding the
Company as a party to certain agreements entered into between Former Choice
and Manor Care in connection with the Former Choice Spin-Off and adding the
Company as a guarantor of certain payment obligations of Sunburst to Manor
Care pursuant to agreements between Former Choice and Manor Care. For a
discussion of the Amendment and Guaranty, see "Certain Relationships and
Transactions--Relationship with Manor Care" and "--Lease Agreements."

TERM NOTE; ACCOUNTS RECEIVABLE

In connection with the Company Spin-Off, the Company loaned to Sunburst
approximately $115 million which was used by Sunburst to repay approximately
$91 million outstanding under Former Choice's credit facility and to repay
that portion of the Former Choice indebtedness to an affiliate of Manor Care
allocated to Sunburst in connection with the Company Spin-Off (approximately
$37 million).

This loan is represented by a term note in an aggregate principal amount of
$115.0 million (the "Term Note"). The Term Note matures on October 15, 2002
and accrues simple interest monthly at an annual rate equal to 11% with an
annual effective rate through maturity of 8.8%. The Term Note is subordinated
to all senior debt of Sunburst and restricts Sunburst's ability to merge or
consolidate or dispose of all or substantially all of its assets. Total
interest accrued on the Term Note through June 30, 1998 was $7.3 million. All
interest on the Term Note is payable at maturity. Sunburst is also the obligor
to the Company on accounts receivable totaling $19.9

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million. This amount will be paid in cash or Sunburst stock. Subsequent to
year-end, Sunburst paid $7.5 million of the receivable and reached an
understanding with the Company whereby Sunburst will pay the balance of the
amount in cash or Sunburst common stock (or a combination thereof) no later
than December 31, 1998. See "Risk Factors--Significant Receivables from
Sunburst."

TAX SHARING AGREEMENT

The Company and Sunburst have entered into a Tax Sharing Agreement for
purposes of allocating tax liabilities of Former Choice from before the
Company Spin-Off among the Company and Sunburst and their respective
subsidiaries. In general, Sunburst will be responsible for (i) filing
consolidated federal income tax returns for the Sunburst affiliated group and
combined or consolidated state tax returns for any group that includes a
member of the Sunburst affiliated group, including in each case the Company
and its subsidiaries for the periods of time that such companies were members
of the applicable group, and (ii) paying the taxes relating to such tax
returns to the applicable taxing authorities (including any subsequent
adjustments resulting from the redetermination of such tax liabilities by the
applicable taxing authorities). The Company will reimburse Sunburst for the
portion of such taxes that relates to the Company and its subsidiaries, as
determined based on their hypothetical separate company income tax
liabilities. The Company and Sunburst have agreed to cooperate with each
other, and to share information, in preparing such tax returns and in dealing
with other tax matters.

EMPLOYEE BENEFITS ALLOCATION AGREEMENT

In connection with the Company Spin-Off, the Company and Sunburst entered
into an Employee Benefits and Other Employment Matters Allocation Agreement
(the "Employee Benefits Allocation Agreement"). The Employee Benefits
Allocation Agreement provides for the allocation subsequent to the Company
Spin-Off of employee benefits, as they relate to employees who remained
employed by Sunburst or its subsidiaries ("Sunburst Employees") after the
Company Spin-Off and employees who are employed by the Company or its
subsidiaries after the Company Spin-Off ("Choice Employees"). Pursuant to the
Employee Benefits Allocation Agreement, Sunburst will continue sponsorship of
the various Sunburst profit sharing plans, stock plans and health and welfare
plans with respect to Sunburst Employees. The Company has established a number
of plans which allow it to provide to its employees substantially the same
benefits previously provided to them as employees of Former Choice. The
Employee Benefits Allocation Agreement provides for cross-guarantees between
the Company and Sunburst with respect to the payment of benefits under certain
plans and for cross-indemnification with respect to employment-related claims
relating to prior to the Company Spin-Off.

The Employee Benefits Allocation Agreement also provided for the adjustment
of outstanding options to purchase shares of Sunburst common stock held by
Sunburst Employees, Choice Employees and employees of Manor Care who hold such
options as a result of the Former Choice Spin-Off. As a result of these
adjustments, the Company granted options to purchase approximately 5.2 million
shares of Company common stock to Choice Employees, Sunburst Employees and
employees of Manor Care.

LEASE AGREEMENTS

Sunburst and the Company entered into a sublease agreement (the "Silver
Spring Sublease") with respect to the Company's principal executive offices at
10750 Columbia Pike, Silver Spring, Maryland, 20901. The sublease was
terminated on May 31, 1998. For the six months ended June 30, 1998, the
Company paid to Sunburst approximately $952,000 under the sublease.

TRANSITIONAL SERVICE AGREEMENTS

The Company and Sunburst have entered into a number of agreements pursuant
to which the Company provides, or will provide, certain continuing services to
Sunburst for a transitional period. Such services will be provided on market
terms and conditions. Subject to the termination provisions of the specific
agreements, Sunburst will be free to procure such services from outside
vendors or may develop an in-house capability in

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order to provide such services internally. Management believes that these
agreements are based on commercially reasonable terms including pricing and
payment terms. The primary transitional services agreements are summarized
below.

Pursuant to the Employee Benefits Administration Agreement, the Company
provides certain benefits, compensation and other services. Such other
services may include benefit plan administration and accounting, COBRA
administration, regulatory compliance and certain fiduciary services. Pursuant
to the Tax Administration Agreement, the Company provides certain sales, use,
occupancy, real and personal property tax return administration, audit and
appeals services for Sunburst. Pursuant to the Vehicle Lease Agreement, the
Company provides the use of certain vehicles to Sunburst.

FRANCHISE AGREEMENTS

Each of the 76 hotel properties owned by Sunburst at the time of the Company
Spin-Off is subject to a franchise agreement between the Company and Sunburst,
as franchisee, and except as otherwise described herein, such franchise
agreement is substantially identical to the franchise agreements with the
Company's other franchisees. The material terms of such agreements are
described below.

Although most of the Company franchise agreements have an initial term of 20
years, the agreement for the Rodeway Inn owned by Sunburst in Tempe, Arizona
(the "Rodeway Inn-Phoenix (Tempe)") is a year-to-year agreement.

Typically, a franchisee may terminate a franchise agreement if the Company
defaults on its material obligations under such franchise agreement and fails
to cure such defaults within 30 days following written notice. However, the
franchise agreement with respect to the Quality Hotel in Arlington, Virginia
owned by Sunburst (the "Non-Standard Franchise Agreement") does not allow
Sunburst to terminate such Franchise Agreement. The Non-Standard Franchise
Agreement otherwise has termination provisions similar to those in the other
Franchise Agreements. The Company may terminate the Non-Standard Franchise
Agreement immediately upon notice to Sunburst if, among other things, (a)
certain bankruptcy events occur with respect to Sunburst; (b) certain breaches
of the related agreements are not remedied; (c) any action is taken to
dissolve or liquidate Sunburst; or (d) certain legal proceedings against
Sunburst are not dismissed within a certain period of time. Upon termination,
the franchise agreement for the Rodeway Inn-Phoenix (Tempe) calls for special
interest of the greater of (i) $50,000 and (ii) the sum of the previous two
years of fees paid by the licensee.

Fees. The franchise agreements require the payment of certain fees and
charges, including the following: (a) a royalty fee of between 1.93% to 5.0%
of monthly gross room revenues; (b) a marketing fee of between 0.7% and 2.5%
of monthly gross room revenues plus $0.28 per day multiplied by the specified
room count; and (c) a reservation fee of 0.88% to 1.75% of monthly gross room
revenues (or 1% of monthly gross room revenues plus $1.00 per room confirmed
through Choice's reservation system). The marketing and reservation fees are
generally subject to reasonable increases during the term of the franchise if
the Company raises such fees uniformly among all its franchisees. Late
payments (i) will be a breach of the franchise agreement and (ii) will accrue
interest from the date of delinquency at a rate of 1.5% per month or portion
thereof.

New Hotels. Each new hotel property owned by Sunburst and franchised under a
Choice Brand after the Company Spin-Off is subject to the Company's standard
franchise agreement described above except that the initial fee and the
royalty, reservation and marketing fees payable thereunder by Sunburst are
commensurate with such fees paid by other multi-unit franchisees of the
Company.

NONCOMPETITION AGREEMENT

The Company and Sunburst have entered into a noncompetition agreement that
defines the rights and obligations with respect to certain businesses to be
operated by the Company and Sunburst. Under the noncompetition agreement, for
a period of five years from the date of the Company Spin-Off, subject to the

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exceptions set forth below, Sunburst will be prohibited from conducting any
business that competes with the business operated by Former Choice transferred
to the Company as part of the Company Spin-Off ("the Choice Business").
Sunburst will also be prohibited from acquiring any entity conducting a
business that competes with the Choice Business, with certain exceptions
outlined below, unless, prior to such acquisition, Sunburst offers to sell
such competing business to the Company on substantially the same terms and
conditions; provided, however, that Sunburst will not be required to make such
an offer to the Company where the competing business is not readily divisible
from other businesses permitted to be held or acquired by Sunburst and the
gross sales from such competing business for the 12 months prior to such
acquisition do not exceed the greater of $1,000,000 (as adjusted for increases
to the Consumer Price Index during the term) or 5% of gross sales of the
businesses to be acquired. Subject to the foregoing, however, the
noncompetition agreement does not prohibit Sunburst from engaging in the
following activities: (i) the continued operation and development of any
business operated as of the date of the Company Spin-Off by Former Choice and
retained by Sunburst; (ii) any activities otherwise permitted under the
Strategic Alliance Agreement; (iii) the ownership of up to 5% of the equity
interests of a publicly-traded entity that competes with the Company's
business; and (iv) the ownership of equity interests of any entity that
competes with the Company's business, if (A) the competing business does not
comprise such entity's primary business, (B) the gross sales of such entity
for the prior 12 months attributable to such competing business does not
exceed 20% of such entity's consolidated gross sales, and (C) neither the fair
market value of, nor the value, if any, attributed by the acquisition
agreement to, the competing business is in excess of $5,000,000 (as adjusted
for increases to the Consumer Price Index during the term).

During the term of the noncompetition agreement, subject to the exceptions
set forth below, the Company will be prohibited from conducting any business
that competes with the business of owning and operating hotel properties (the
"Hotel Business"). The Company is also prohibited from acquiring any entity
conducting a business that competes with the Hotel Business, with certain
exceptions outlined below, unless, prior to such acquisition, the Company
offers to sell such competing business to Sunburst on substantially the same
terms and conditions; provided, however, that the Company will not be required
to make such an offer to Sunburst where the competing business is not readily
divisible from other business permitted to be held or acquired by the Company
and the gross revenues from such competing business for the 12 months prior to
such acquisition do not exceed the greater of $1,000,000 (as adjusted for
increases to the Consumer Price Index during the term) or 5% of gross sales of
the businesses to be acquired. Subject to the foregoing, however, the
noncompetition agreement will not prohibit the Company from the following
activities: (i) continued operation and development of any business operated
as of the date of the Company Spin-Off by the Company, (ii) any activities
otherwise permitted under the Strategic Alliance Agreement, (iii) the
ownership of up to 5% of the equity interests of a publicly-traded entity that
competes with the Hotel Business, or (iv) the ownership of equity interests of
any entity that competes with the Hotel Business, or if (A) the competing
business does not comprise such entity's primary business, (B) the gross
revenue of such entity for the prior 12 months attributable to such competing
business does not exceed 20% of such entity's consolidated gross sales, and
(C) neither the fair market value of, nor the value, if any, attributed by the
acquisition agreement to, the competing business is in excess of $5,000,000
(as adjusted for increases to the Consumer Price Index during the term).

POTENTIAL CONFLICT

The ongoing relationship between the Company and Sunburst resulting from the
agreements and arrangements described above may give rise to a conflict of
interest between the Company and Sunburst. With respect to the agreements
between the parties, the potential exists for disagreements as to the quality
of the services provided by the parties and as to contract compliance.
Nevertheless, the Company believes that there will be sufficient mutuality of
interest between the two companies to result in a mutually productive
relationship.

In addition, Frederic V. Malek serves as a director of each of the Company
and Sunburst. As a result of the Company Spin-Off, Mr. Malek, as well as
certain other officers and directors of the Company and of Sunburst, also own
shares and/or options or other rights to acquire shares in each of the Company
and Sunburst. Additionally, Stewart Bainum, Jr. is the chairman of the Company
and his sister, Barbara Bainum, is also a director. Their father, Stewart
Bainum, is the Chairman of Sunburst and the Bainum family has a significant

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ownership interest in both companies. Policies and procedures are followed by
the Boards of Directors of the Company and Sunburst to limit the involvement
of the overlapping directors (and, if appropriate, relevant officers of such
companies) in conflict situations, including requiring them to abstain from
voting as directors of either the Company or Sunburst on certain matters which
present a conflict between the two companies. See "Risk Factors--Potential
Conflict with Sunburst" and "--Significant Receivables from Sunburst."

DESCRIPTION OF CERTAIN INDEBTEDNESS

The Company is the borrower under a $300 million Competitive Advance and
Multi-Currency Credit Facilities Agreement (the "Credit Facility") provided by
a group of 14 commercial banks. The Credit Facility has a term of five years
and provides for (a) a term loan of $150 million and (b) a revolving credit
loan of $150 million, $50 million of which is available in foreign currency
borrowings. 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 Credit Facility. The Credit Facility will terminate on October
15, 2002. As of June 30, 1998, the Company had $145 million of term loans and
$26 million of multi-currency borrowings outstanding. In connection with the
Company Spin-Off, the Company borrowed $150 million under the Credit Facility
term loan and $89.5 million under the Credit Facility revolving loan in order
to fund the Term Note and to refinance existing indebtedness (including $78.7
million to repay indebtedness of Former Choice to Manor Care which was
allocated to the Company in connection with the Company Spin-Off). At the
Company's option, the interest rate may be based on LIBOR, a certificate of
deposit rate or an alternate base rate, plus facility fee percentage. The rate
is determined based on the Company's consolidated leverage ratio at a time of
borrowing with interest on current borrowings based on one of several rates
including LIBOR. The average interest rate on all borrowings under the Credit
Facility was 6.7% at June 30, 1998.

The Credit Facility includes customary financial and other covenants that
require the maintenance of certain ratios with respect to maximum leverage,
minimum net worth and interest coverage and restrict the Company's ability to
make certain investments, repurchase stock, incur debt, create liens and
dispose of assets.

The term loan under the Credit Facility began to amortize pursuant to
quarterly payments commencing on May 31, 1998.

The Company maintains a separate uncommitted $15 million working capital
line of credit with a commercial bank which expires on April 30, 1999. Total
borrowings under this line were $8.2 million as of June 30, 1998.

Additionally, the Company's payment obligations under the Credit Facility
are jointly and severally guaranteed by QHE, a wholly-owned subsidiary of the
Company, and QHE Partnership, a general partnership whose partnership
interests are held by the Company and QHE. Under the terms of the Credit
Facility, if any other subsidiary of the Company has or acquires assets
greater than or equal to 10% of the Company's Consolidated Total Assets (as
defined in the Credit Facility), then such subsidiary will also be required to
guarantee the Company's obligations thereunder.

The Company used approximately $99 million of net proceeds of the Offering
to repay amounts outstanding under the revolving portion of the Credit
Facility. See "Use of Proceeds."

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DESCRIPTION OF EXCHANGE NOTES

The Original Notes were issued and the Exchange Notes will be issued
pursuant to the Indenture dated as of May 4, 1998 (the "Indenture"), among the
Company, the Subsidiary Guarantors and Marine Midland Bank, as Trustee (the
"Trustee"). The Exchange Notes will evidence the same indebtedness as the
Original Notes (which they replace) and will be entitled to the benefits of
the Indenture. The form and terms of the Exchange Notes are the same as the
form and terms of the Original Notes except that (i) the Exchange Notes will
have been registered under the Securities Act, and, therefore, the Exchange
Notes will not bear legends restricting the transfer thereof and (ii) holders
of the Exchange Notes will not be entitled to certain rights of holders of
Original Notes under the Registration Agreement, which rights will terminate
upon the consummation of the Exchange Offer. The terms of the Exchange Notes
include those stated in the Indenture and those made part of the Indenture by
reference to the Trust Indenture Act of 1939 (the "TIA") as in effect on the
date of the Indenture. The following summary of certain terms and provisions
of the Indenture does not purport to be complete and is subject, and is
qualified in its entirety by reference, to the TIA and to all the provisions
of the Notes and the Indenture, including the definitions therein of certain
terms.

For purposes of this Section, references to the "Company" shall mean Choice
Hotels International, Inc., excluding its subsidiaries. Capitalized terms used
in this Section and not otherwise defined below have the respective meanings
assigned to them in the Indenture.

GENERAL

The Exchange Notes will be unsecured senior obligations of the Company,
limited to $100 million aggregate principal amount, and will mature on May 1,
2008. The Exchange Notes will be guaranteed on a senior unsecured basis by QHE
and QHE Partnership and, under certain circumstances, by other subsidiaries of
the Company. See "Certain Covenants--Future Subsidiary Guarantors." The
Exchange Notes will bear interest at the rate per annum shown on the cover
page hereof from the date of issuance or from the most recent date to which
interest has been paid, payable semiannually in arrears on May 1 and November
1 of each year, commencing November 1, 1998, to Holders of record at the close
of business on the April 15 or October 15 immediately preceding the interest
payment date. Interest is computed on the basis of a 360-day year comprised of
twelve 30-day months.

Principal of and interest on the Exchange Notes are payable, and the
Exchange Notes are exchangeable and transferable, at an office or agency of
the Company, one of which shall be maintained for such purpose in The City of
New York (which initially will be the corporate trust office of the Trustee);
provided, however, that payment of interest may be made at the option of the
Company by check mailed to the Person entitled thereto as shown on the
Security Register.

The Exchange Notes will be issued in fully registered form, without coupons,
in denominations of $1,000 or integral multiples thereof. No service charge is
be made for any registration of transfer or exchange of Notes, but the Company
may require payment of a sum sufficient to cover any transfer tax or other
similar governmental charge payable in connection therewith.

OPTIONAL REDEMPTION

The Notes are redeemable, at the option of the Company, in whole or in part
at any time or from time to time, upon not less than 30 and not more than 60
days' notice as provided in the Indenture, on any date prior to maturity (the
"Redemption Date") at a redemption price equal to 100% of the principal amount
of the Notes to be redeemed plus accrued interest to the Redemption Date
(subject to the right of Holders of record on the relevant record date to
receive interest due on an interest payment date that is on or prior to the
Redemption Date) plus a Make-Whole Premium, if any (the "Redemption Price").
In no event will the Redemption Price ever be less than 100% of the principal
amount of the Notes plus accrued interest to the Redemption Date.

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The amount of the Make-Whole Premium with respect to any Note (or portion
thereof) to be redeemed will be equal to the excess, if any, of:

(1) the sum of the present values, calculated as of the Redemption Date,
of:

(a) each interest payment that, but for such redemption, would have
been payable on the Note (or portion thereof) being redeemed on each
interest payment date occurring after the Redemption Date (excluding
any accrued interest for the period prior to the Redemption Date); and

(b) the principal amount that, but for such redemption, would have
been payable at the final maturity of the Note (or portion thereof)
being redeemed;

over

(2) the principal amount of the Note (or portion thereof) being redeemed.

The present values of interest and principal payments referred to in clause
(1) above will be determined in accordance with generally accepted principles
of financial analysis. Such present values will be calculated by discounting
the amount of each payment of interest or principal from the date that each
such payment would have been payable, but for the redemption, to the
Redemption Date at a discount rate equal to the Treasury Yield (as defined
below) plus 25 basis points.

The Make-Whole Premium will be calculated by an independent investment
banking institution of national standing appointed by the Company; provided,
that if the Company fails to make such appointment at least 30 calendar days
prior to the Redemption Date, or if the institution so appointed is unwilling
or unable to make such calculation, such calculation will be made by Salomon
Smith Barney Holdings Inc, or an affiliate thereof, or, if such firm is
unwilling or unable to make such calculation, by an independent investment
banking institution of national standing appointed by the Trustee (in any such
case, an "Independent Investment Banker").

For purposes of determining the Make-Whole Premium, "Treasury Yield" means a
rate of interest per annum equal to the weekly average yield to maturity of
United States Treasury Notes that have a constant maturity that corresponds to
the remaining term to maturity of the Notes, calculated to the nearest 1/12th
of a year (the "Remaining Term"). The Treasury Yield will be determined as of
the third business day immediately preceding the applicable Redemption Date.

The weekly average yields of United States Treasury Notes will be determined
by reference to the most recent statistical release published by the Federal
Reserve Bank of New York and designated "H.15(519) Selected Interest Rates" or
any successor release (the "H.15 Statistical Release"). If the H.15
Statistical Release sets forth a weekly average yield for United States
Treasury Notes having a constant maturity that is the same as the Remaining
Term, then the Treasury Yield will be equal to such weekly average yield. In
all other cases, the Treasury Yield will be calculated by interpolation, on a
straight-line basis, between the weekly average yields on the United States
Treasury Notes that have a constant maturity closest to and greater than the
Remaining Term and the United States Treasury Notes that have a constant
maturity closest to and less than the Remaining Term (in each case as set
forth in the H.15 Statistical Release). Any weekly average yields so
calculated by interpolation will be rounded to the nearest 1/100th of 1%, with
any figure of 1/200th of 1% or above being rounded upward. If weekly average
yields for United States Treasury Notes are not available in the H.15
Statistical Release or otherwise, then the Treasury Yield will be calculated
by interpolation of comparable rates selected by the Independent Investment
Banker.

Any notice to the Holders of Notes of such a redemption need not set forth
the redemption price of such Notes but need only set forth the calculation
thereof as described in the immediately preceding paragraph. The redemption
price, calculated as aforesaid, shall be set forth in an Officers' Certificate
delivered to the Trustee no later than two business days prior to the
Redemption Date.

In the case of any partial redemption, selection of the Notes for redemption
will be made by the Trustee on a pro rata basis, by lot or by such other
method as the Trustee in its sole discretion shall deem to be fair and

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appropriate, although no Note of $1,000 in original principal amount or less
shall be redeemed in part. If any Note is to be redeemed in part only, the
notice of redemption relating to such Note shall state the portion of the
principal amount thereof to be redeemed. A new Note in principal amount equal
to the unredeemed portion thereof will be issued in the name of the Holder
thereof upon cancellation of the original Note.

RANKING

The Original Notes are, and the Exchange Notes will be senior unsecured
obligations of the Company, rank pari passu in right of payment with all
existing and future senior debt of the Company and senior in right of payments
to all future subordinated debt of the Company. As a result of the Offering
and the application of the net proceeds therefrom, as of June 30, 1998, the
Company had, on a consolidated basis, $293.7 million of debt outstanding
(excluding outstanding letters of credit, purchase money security obligations
and trade payables incurred in the normal course of business), including
$171.0 million outstanding under the Credit Facility and $8.2 million under a
separate working capital credit facility, with which the Notes rank pari
passu. None of the Company's debt as of such date, after giving such effect,
would have been subordinated to the Notes.

All existing and future debt and other liabilities of the Company's
Subsidiaries, including the claims of trade creditors and claims of preferred
stockholders, if any, of such Subsidiaries, are effectively senior to the
Notes. As of June 30, 1998, the total debt of the Company's Subsidiaries was
approximately $15.2 million. The Company and its Subsidiaries have other
liabilities, including contingent liabilities, which may be significant. The
Original Notes are, and the Exchange Notes will be effectively subordinated to
any secured debt of the Company, to the extent of the value of the assets
securing such debt. The Company had secured debt as of June 30, 1998 of
approximately $1.5 million.

BOOK-ENTRY, DELIVERY AND FORM

Except as described below, the Exchange Notes will initially be represented
one or more Global Notes. The Global Notes will be deposited with, or on
behalf of, the Depository and registered in the name of the Depository or its
nominee. Except as set forth below, the Global Notes may be transferred, in
whole and not in part, only to the Depository or another nominee of the
Depository. Investors may hold their beneficial interests in the Global Notes
directly through the Depository if they have an account with the Depository or
indirectly through organizations which have accounts with the Depository.

Upon the transfer of an Exchange Note in definitive form, such Exchange Note
will, unless the Global Notes have previously been exchanged for Exchange
Notes in definitive form, be exchanged for an interest in the Global Notes
representing the principal amount of Exchange Notes being transferred.

The Depositary has advised the Company as follows: The Depositary is a
limited-purpose trust company and organized under the laws of the State of New
York, a member of the Federal Reserve System, a "clearing corporation" within
the meaning of the New York Uniform Commercial Code, and "a clearing agency"
registered pursuant to the provisions of Section 17A of the Exchange Act. The
Depositary was created to hold securities of institutions that have accounts
with the Depositary ("participants") and to facilitate the clearance and
settlement of securities transactions among its participants in such
securities through electronic book-entry changes in accounts of the
participants, thereby eliminating the need for physical movement of securities
certificates. The Depositary's participants include securities brokers and
dealers (which may include the Initial Purchasers), banks, trust companies,
clearing corporations and certain other organizations. Access to the
Depository's book-entry system is also available to others such as banks,
brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a participant, whether directly or indirectly
(collectively, the "indirect participants"). Holders who are not participants
may own securities held by or on behalf of the Depositary only through
participants or indirect participants.

Upon the issuance of the Global Notes, the Depositary will credit, on its
book-entry registration and transfer system, the principal amount of the Notes
represented by such Global Notes to the accounts of participants.

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Ownership of beneficial interests in the Global Notes will be limited to
participants or persons that may hold interests through participants. Any
person acquiring an interest in a Global Note through an offshore transaction
in reliance on Regulation S may hold such interest through Euroclear or Cedel.
Ownership of beneficial interests in the Global Notes will be shown on, and
the transfer of those ownership interests will be effected only through,
records maintained by the Depository (with respect to participants' interest)
and such participants (with respect to the owners of beneficial interests in
the Global Notes other than participants). The laws of some jurisdictions may
require that certain purchasers of securities take physical delivery of such
securities in definitive form. Such limits and laws may impair the ability to
transfer or pledge beneficial interests in the Global Notes.

So long as the Depositary, or its nominee, is the registered holder and
owner of the Global Notes, the Depositary or such nominee, as the case may be,
will be considered the sole legal owner and holder of the related Exchange
Notes for all purposes of such Exchange Notes and the Indenture. Except as set
forth below, owners of beneficial interests in the Global Notes will not be
entitled to have the Exchange Notes represented by the Global Notes registered
in their names, will not receive or be entitled to receive physical delivery
of certificated Notes in definitive form and will not be considered to be the
owners or holders of any Exchange Notes under the Global Notes. The Company
understands that under existing industry practice, in the event an owner of a
beneficial interest in the Global Notes desires to take any action that the
Depositary, as the holder of the Global Note, is entitled to take, the
Depositary would authorize the participants to take such action, and that the
participants would authorize beneficial owners owning through such
participants to take such action or would otherwise act upon the instructions
of beneficial owners owning through them.

Payment of principal of and interest on Exchange Notes represented by the
Global Notes registered in the name of and held by the Depository or its
nominee will be made to the Depositary or its nominee, as the case may be, as
the registered owner and holder of the Global Notes.

The Company expects that the Depositary or its nominee, upon receipt of any
payment of principal of or interest on the Global Notes, will credit
participants' accounts with payments in amounts proportionate to their
respective beneficial interests in the principal amount of the Global Notes as
shown on the records of the Depository or its nominee. The Company also
expects that payments by participants to owners of beneficial interests in the
Global Notes held through such participants will be governed by standing
instructions and customary practices and will be the responsibility of such
participants. The Company will not have any responsibility or liability for
any aspect of the records relating to, or payments made on account of,
beneficial ownership interests in the Global Notes for any Exchange Note or
for maintaining, supervising or reviewing any records relating to such
beneficial ownership interests or for any other aspect of the relationship
between the Depositary and its participants or the relationship between such
participants and the owners of beneficial interests in the Global Notes owning
through such participants.

Unless and until it is exchanged in whole or in part for certificated
Exchange Notes in definitive form, the Global Notes may not be transferred
except as a whole by the Depositary to a nominee of such Depositary or by a
nominee of such Depositary to such Depositary or another nominee of such
Depositary.

Although the Depositary has agreed to the foregoing procedures in order to
facilitate transfers of interests in the Global Notes among participants of
the Depositary, it is under no obligation to perform or continue to perform
such procedures, and such procedures may be discontinued at any time. Neither
the Trustee nor the Company will have any responsibility for the performance
by the Depositary or its participants or indirect participants of their
respective obligations under the rules and procedures governing their
operations.

CERTIFICATED NOTES

The Exchange Notes represented by the Global Notes are exchangeable for
certificated Exchange Notes in definitive form of like tenor as such Exchange
Notes in denominations of U.S. $1,000 and integral multiples thereof if (i)
the Depositary notifies the Company that it is unwilling or unable to continue
as Depositary for the Global Notes or if at any time the Depositary ceases to
be a clearing agency registered under the Exchange Act

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and a successor Depositary is not appointed by the Company within 90 days,
(ii) the Company in its discretion at any time determines not to have all of
the Exchange Notes represented by the Global Notes or (iii) an Event of
Default has occurred and is continuing. Any Exchange Note that is exchangeable
pursuant to the preceding sentence is exchangeable for certificated Exchange
Notes issuable in authorized denominations and registered in such names as the
Depositary shall direct. Subject to the foregoing, the Global Notes are not
exchangeable, except for Global Notes of the same aggregate denomination to be
registered in the name of the Depositary or its nominee.

SAME-DAY PAYMENT

The Indenture requires that payments in respect of Notes (including
principal, premium and interest) be made by wire transfer of immediately
available funds to the accounts specified by the Holders thereof or, if no
such account is specified, by mailing a check to each such Holder's registered
address. The Notes will clear in the Depositary's Same-Day Funds Settlement
System until maturity, and secondary market trading activity in the Notes that
is effected through the Depository will therefore be required by the
Depository to settle in immediately available funds.

SUBSIDIARY GUARANTIES

The obligations of the Company under the Indenture are fully and
unconditionally guaranteed, jointly and severally, on a senior unsecured basis
by the Subsidiary Guarantors. As of June 30, 1998, after giving effect to the
Offering and the application of the net proceeds therefrom, the assets of
Subsidiaries of the Company not giving Subsidiary Guaranties represented
approximately 1.1% of the Company's consolidated total assets. For the six-
month period then ended, such Subsidiaries generated approximately 0.7% of the
Company's consolidated total revenues.

Upon the sale or other disposition of a Subsidiary Guarantor, the sale or
disposition of all or substantially all the assets of a Subsidiary Guarantor
(in each case other than to the Company or an Affiliate of the Company)
permitted by the Indenture, or the release or termination of any guarantee
provided by a Subsidiary Guarantor under the Credit Facility, such Subsidiary
Guarantor will be released from all its obligations under its Subsidiary
Guarantee.

Each of the Company and the Subsidiary Guarantors will agree to contribute
to any other Subsidiary Guarantor which makes payments pursuant to its
Subsidiary Guarantee an amount equal to the Company's or such Subsidiary
Guarantor's proportionate share of such payment, based on the net worth of the
Company or such Subsidiary Guarantor relative to the aggregate net worth of
the Company and the Subsidiary Guarantors.

CERTAIN COVENANTS

The Indenture does not limit the amount of indebtedness or other obligations
that may be incurred by the Company and its Subsidiaries and does not contain
provisions which would give Holders of Notes the right to require the Company
to repurchase their Notes in the event of a decline in the credit rating of
the Company's debt securities or a change of control of the Company. The
Indenture does contain the following covenants, among others:

Limitation on Liens. The Indenture provides that the Company will not, and
will not permit any of its Subsidiaries to, directly or indirectly, create,
Incur or otherwise cause or suffer to exist or become effective any Liens of
any kind upon any Principal Property or any Capital Stock or Debt of any
Subsidiary which owns or leases Principal Property (whether such Principal
Property, Capital Stock or Debt are now owned or hereafter acquired), or any
interest therein or any increase or profits therefrom, unless all payments due
under the Indenture and the Notes are secured on an equal and ratable basis
with (or prior to) the obligations so secured until such time as such
obligation is no longer secured by a Lien, except in the case of Permitted
Liens or as provided under "--Exempted Debt" below.

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Limitation on Sale and Leaseback Transactions. The Indenture provides that,
except as provided under "--Exempted Debt" below, the Company will not, and
will not permit any Subsidiaries to, enter into any Sale and Leaseback
Transaction with respect to any Principal Property unless either (a) the
Company or such Subsidiary would be entitled, pursuant to the provisions of
the Indenture, to Incur Debt secured by a Lien on the Property to be leased in
an amount equal to the Attributable Debt with respect to such transaction
without equally and ratably securing the Notes, or (b) the Company, within 180
days after the effective date of such transaction, applies to the voluntary
retirement of its Funded Debt an amount equal to the value of such
transaction, defined as the greater of the net proceeds of the sale of the
Principal Property leased in such transaction or the fair value, in the
opinion of the Company's Board of Directors, of the leased Principal Property
at the time such transaction was entered into.

Exempted Debt. Notwithstanding the foregoing limitations on Liens and Sale
and Leaseback Transactions, the Company and its Subsidiaries may create, Incur
or otherwise cause to suffer to exist or become effective Liens without
securing the Notes or enter into a Sale and Leaseback Transaction without
retiring Funded Debt, or enter into a combination of such transactions,
provided that, at the time of such event, and after giving effect thereto and
to the retirement of any other such Debt which is concurrently being repaid,
the sum of (x) the principal amount of such Debt secured by such Liens or the
Attributable Debt in respect of such Sale and Leaseback Transaction, as the
case may be, and (y) the principal amount of all other such Debt secured by
such Liens (not including Liens permitted under "--Limitations on Liens") and
all other Attributable Debt in respect of Sale and Leaseback Transactions then
outstanding (not including Sale and Leaseback Transactions permitted under "--
Sale and Leaseback Transactions"), measured, in each case, at the time any
such Lien is Incurred or any such Sale and Leaseback Transaction is entered
into, does not exceed the greater of (i) $25 million or (ii) 15% of the
Consolidated Net Tangible Assets of the Company and its consolidated
Subsidiaries.

Future Subsidiary Guarantors. The Indenture provides that the Company will
cause each Person that provides a guarantee under the Credit Facility or any
extension, revision, refinancing or any replacement thereof by a lender or a
group of lenders following the Issue Date to execute and deliver to the
Trustee a Subsidiary Guarantee at the time such Person executes such guarantee
under the Credit Facility.

Merger and Consolidation. The Indenture provides that the Company may
consolidate or amalgamate with or merge into any other Person or convey,
transfer, lease or otherwise dispose of its Property substantially as an
entirety to any Person or may permit any Person to consolidate or amalgamate
with or merge into, or convey, transfer, lease or otherwise dispose of its
Property substantially as an entirety to, the Company; provided, however, that
(a) the successor, transferee or lessee is organized under the laws of any
United States jurisdiction; (b) the successor, transferee or lessee, if other
than the Company, expressly assumes the Company's obligations under the
Indenture and the Notes by means of a supplemental indenture entered into with
the Trustee; (c) immediately before and after giving effect to the transaction
on a pro forma basis, no Default shall have occurred and be continuing; and
(d) certain other conditions are met.

Under any consolidation or amalgamation by the Company with, or merger by
the Company into, any other Person or any conveyance, transfer, lease or other
disposition of the Property of the Company substantially as an entirety as
described in the preceding paragraphs, the successor resulting from such
consolidation or amalgamation or into which the Company is merged or the
transferee or lessee to which such conveyance, transfer, lease or disposition
is made, will succeed to, and be substituted for, and may exercise every right
and power of, the Company under the Indenture, and thereafter, except in the
case of a conveyance, transfer, lease or disposition, the predecessor (if
still in existence) will be released from its obligations and covenants under
the Indenture and the Notes.

EVENTS OF DEFAULT

An Event of Default is defined in the Indenture to be (i) failure to pay any
interest upon any of the Notes for 30 days or more after such payment is due,
(ii) failure to pay the principal of and premium, if any, on any of the Notes
when due, (iii) failure to comply with any other covenants in the Indenture
which will not have been

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remedied by the end of a period of 30 days after written notice to the Company
by the Trustee or to the Company and the Trustee by the Holders of at least
25% in principal amount of the outstanding Notes, (iv) acceleration of, or
failure by the Company or any Subsidiary to pay when due, the principal of any
Debt for money borrowed of the Company or any Subsidiary having an aggregate
principal amount at the time in excess of the greater of $15 million and 5% of
Consolidated Net Worth or its foreign currency equivalent at such time, if
such acceleration is not annulled, or such Debt is not discharged, by the end
of a period of 20 days after written notice to the Company by the Trustee or
to the Company and the Trustee by the Holders of at least 25% in principal
amount of the outstanding Notes (the "cross acceleration provision"), (v)
certain events of bankruptcy, insolvency or reorganization of the Company or a
Significant Subsidiary (the "bankruptcy provisions") or (vi) any Subsidiary
Guarantee ceases to be in full force and effect (other than in accordance with
the terms of the Indenture or such Subsidiary Guarantee) or any Subsidiary
Guarantor denies or disaffirms its obligations under its Subsidiary Guarantee
(the "guarantee provisions").

The Indenture provides that if an Event of Default (other than of a type
referred to in clause (v) of the preceding paragraph with respect to the
Company) shall have occurred and is continuing, either the Trustee or the
Holders of at least 25% in principal amount of the outstanding Notes by notice
in writing to the Company (and to the Trustee if given by the Holder of the
Notes) may declare the principal amount of all Notes to be immediately due and
payable. Such declaration may be rescinded if certain conditions are
satisfied. If an Event of Default of the type referred to in clause (v) of the
preceding paragraph shall have occurred with respect to the Company, the
principal amount of the outstanding Notes shall automatically become
immediately due and payable.

The Indenture also provides that the Holders of not less than a majority in
principal amount of the outstanding Notes may direct the time, method and
place of conducting any proceedings for any remedy available to the Trustee,
or exercising any trust or power conferred on the Trustee, provided that such
direction is not in conflict with any rule of law or with the Indenture. The
Trustee may take any other action deemed proper by the Trustee which is not
inconsistent with such direction.

The Indenture contains provisions entitling the Trustee, subject to the duty
of the Trustee during the continuance of an Event of Default to act with the
required standard of care, to be indemnified by the Holders of Notes before
proceeding to exercise any right or power under the Indenture at the request
of the Holders of Notes.

No Holder of any Note will have any right to institute any proceeding with
respect to the Indenture or for any remedy thereunder, unless (i) such Holder
shall have previously given to the Trustee written notice of a continuing
Event of Default, (ii) the Holders of at least 25% in aggregate principal
amount of the outstanding Notes shall have made written request, and offered
reasonable indemnity, to the Trustee to institute such proceeding as Trustee
and (iii) the Trustee shall not have received from the Holders of a majority
in aggregate principal amount of the outstanding Notes a direction
inconsistent with such request and shall have failed to institute such
proceeding within 60 days. However, such limitations do not apply to a suit
instituted by a Holder of a Note for enforcement of payment of the principal
of and premium, if any, or interest on such Note on or after the respective
due dates expressed in such Note.

The Indenture requires the Company to file annually with the Trustee a
certificate, executed by a designated officer of the Company, stating to the
best of such officer's knowledge that the Company is not in default under the
terms, provisions and conditions of the Indenture or, if such officer has
knowledge that the Company is in such default, specifying such default.

AMENDMENTS AND WAIVERS

Subject to certain exceptions, the Indenture may be amended with the consent
of the Holders of a majority in principal amount of the Notes then outstanding
(including consents obtained in connection with a tender offer or exchange for
the Notes) and any past default or compliance with any provisions may also be
waived with the consent of the Holders of a majority in principal amount of
the Notes then outstanding. However, without the

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consent of each Holder of an outstanding Note affected thereby, no amendment
may (i) reduce the amount of Notes whose Holders must consent to an amendment
or waiver, (ii) reduce the rate of or extend the time for payment of interest
on any Note, (iii) reduce the principal of or extend the Stated Maturity of
any Note, (iv) reduce the amount payable upon the redemption of any Note or
change the time at which any Note may be redeemed as described under "--
Optional Redemption" above, (v) make any Note payable in a place or in money
other than that stated in the Note, (vi) impair the right of any Holder of the
Notes to receive payment of principal of and interest on such Holder's Notes
on or after the due dates therefor or to institute suit for the enforcement of
any payment on or with respect to such Holder's Notes or any Subsidiary
Guarantee, (vii) make any change in the amendment or waiver provisions which
require each Holder's consent or (viii) make any change in any Subsidiary
Guarantee that would adversely affect the holders of the Notes.

Without the consent of any Holder of the Notes, the Company and the Trustee
may amend the Indenture to cure any ambiguity, omission, defect or
inconsistency, to provide for the assumption by a successor corporation of the
obligations of the Company under the Indenture, to provide for uncertificated
Notes in addition to or in place of certificated Notes (provided that the
uncertificated Notes are issued in registered form for purposes of Section
163(f) of the Code, or in a manner such that the uncertificated Notes are
described in Section 163(f)(2)(B) of the Code), to add additional guarantees
with respect to the Notes or to release Subsidiary Guarantors from Subsidiary
Guarantees as provided by the terms of the Indenture, to secure the Notes, to
add to the covenants of the Company for the benefit of the Holders of the
Notes or to surrender any right or power conferred upon the Company, to make
any change that does not adversely affect the rights of any Holder of the
Notes or to comply with any requirement of the Commission in connection with
the qualification of the Indenture under the Trust Indenture Act.

The consent of the Holders of the Notes is not necessary under the Indenture
to approve the particular form of any proposed amendment. It is sufficient if
such consent approves the substance of the proposed amendment.

After an amendment under the Indenture becomes effective, the Company is
required to mail to Holders of the Notes a notice briefly describing such
amendment. However, the failure to give such notice to all Holders of the
Notes, or any defect therein, will not impair or affect the validity of the
amendment.

TRANSFER

The Notes are issued in registered form and are transferable only upon the
surrender of the Notes being transferred for registration of transfer. The
Company may require payment of a sum sufficient to cover any tax, assessment
or other governmental charge payable in connection with certain transfers and
exchanges.

DEFEASANCE

The Company at any time may terminate all its obligations under the Notes
and the Indenture ("legal defeasance"), except for certain obligations,
including those respecting the defeasance trust and obligations to register
the transfer or exchange of the Notes, to replace mutilated, destroyed, lost
or stolen Notes and to maintain a registrar and paying agent in respect of the
Notes. The Company at any time may terminate its obligations under the
covenants described under "--Certain Covenants" (other than the covenant
described under "--Certain Covenants--Merger and Consolidation"), the
operation of the cross acceleration provision, the bankruptcy provisions with
respect to Significant Subsidiaries and the guarantee provisions described
under "--Events of Default" above and the limitations contained in clauses (c)
and (d) under the first paragraph of "--Certain Covenants--Merger and
Consolidation" above ("covenant defeasance").

The Company may exercise its legal defeasance option notwithstanding its
prior exercise of its covenant defeasance option. If the Company exercises its
legal defeasance option, payment of the Notes may not be accelerated because
of an Event of Default with respect thereto. If the Company exercises its
covenant defeasance option, payment of the Notes may not be accelerated
because of an Event of Default specified in clause (iii), (iv), (v) or (vi)
under "--Events of Default" above or because of the failure of the Company to

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comply with clause (c) or (d) under the first paragraph of "--Certain
Covenants--Merger and Consolidation" above. If the Company exercises either
its legal defeasance option or its covenant defeasance option, each Subsidiary
Guarantor will be released from all its obligations under its Subsidiary
Guarantee.

In order to exercise either defeasance option, the Company must irrevocably
deposit in trust (the "defeasance trust") with the Trustee money or U.S.
Government Obligations for the payment of principal and interest on the Notes
to redemption or maturity, as the case may be, and must comply with certain
other conditions, including delivery to the Trustee of an Opinion of Counsel
to the effect that Holders of the Notes will not recognize income, gain or
loss for federal income tax purposes as a result of such deposit and
defeasance and will be subject to federal income tax on the same amounts and
in the same manner and at the same times as would have been the case if such
deposit and defeasance had not occurred (and, in the case of legal defeasance
only, such Opinion of Counsel must be based on a ruling of the Internal
Revenue Service or other change in applicable Federal income tax law).

CONCERNING THE TRUSTEE

Marine Midland Bank is the Trustee under the Indenture and has been
appointed by the Company as Registrar and Paying Agent with regard to the
Notes.

The Holders of a majority in principal amount of the outstanding Notes have
the right to direct the time, method and place of conducting any proceeding
for exercising any remedy available to the Trustee, subject to certain
exceptions. The Indenture provides that if an Event of Default occurs (and is
not cured), the Trustee will be required, in the exercise of its power, to use
the degree of care of a prudent man in the conduct of his own affairs. Subject
to such provisions, the Trustee will be under no obligation to exercise any of
its rights or powers under the Indenture at the request of any Holder of
Notes, unless such Holder shall have offered to the Trustee security and
indemnity satisfactory to it against any loss, liability or expense and then
only to the extent required by the terms of the Indenture.

GOVERNING LAW

The Indenture provides that it and the Notes will be governed by, and
construed in accordance with, the laws of the State of New York without
reference to principles of conflicts of law to the extent that the application
of the law of another jurisdiction would be required thereby.

CERTAIN DEFINITIONS

"Affiliate" means, with respect to any Person, a Person (i) which directly
or indirectly through one or more intermediaries controls, or is controlled
by, or is under common control with, such Person, (ii) which directly or
indirectly through one or more intermediaries beneficially owns or holds 10%
or more of any class of the Voting Stock of such Person (or a 10% or greater
equity interest in a Person which is not a corporation) or (iii) of which 10%
or more of any class of the Voting Stock (or, in the case of a Person which is
not a corporation, 10% or more of the equity interest) is beneficially owned
or held directly or indirectly through one or more intermediaries by such
Person. The term "control" means the possession, directly or indirectly, of
the power to direct or cause the direction of the management and policies of a
Person, whether through the ownership of voting securities, by contract or
otherwise.

"Attributable Debt" in respect of a Sale and Leaseback Transaction means, at
any date of determination, (a) if such Sale and Leaseback Transaction is a
Capital Lease Obligation, the amount of Debt represented thereby according to
the definition of "Capital Lease Obligation" and (b) in all other instances,
the present value of the total obligations of the lessee for rental payments
during the remaining term of the lease included in such Sale and Leaseback
Transaction (including any period for which such lease has been extended)
determined in accordance with GAAP, discounted at a rate that at the inception
of the lease the lessee would have incurred to borrow over a similar term the
funds necessary to purchase the leased assets.

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"Business Day" means each day which is not a Legal Holiday.

"Capital Lease Obligation" means any obligation that is required to be
classified and accounted for as a capitalized lease for financial reporting
purposes in accordance with GAAP and the amount of Debt represented by such
obligation shall be the capitalized amount of such obligation determined in
accordance with GAAP, and the Stated Maturity thereof shall be the date of the
last payment of rent or any other amount due under such lease prior to the
first date upon which such lease may be terminated by the lessee without
payment of a penalty. For purposes of "--Certain Covenants--Limitation on
Liens," a Capital Lease Obligation shall be deemed secured by a Lien on the
Property being leased.

"Capital Stock" of any Person means any and all shares, interests, rights to
purchase, warrants, options, participations or other equivalents of or
interests in (however designated) equity of such Person, including any
Preferred Stock, but excluding any debt securities convertible or exchangeable
into such equity interest.

"Code" means the Internal Revenue Code of 1986, as amended.

"Commission" means the Securities and Exchange Commission.

"Consolidated Net Tangible Assets" means, as of any date of determination,
the total amount of assets (less applicable reserves and other properly
deductible items) after deducting (1) all current liabilities (excluding the
amount of those which are by their terms extendable or renewable at the option
of the obligor to a date more than 12 months after the date as of which the
amount is being determined and excluding all intercompany items between the
Company and any Subsidiary or between Subsidiaries) and (2) all goodwill,
tradenames, trademarks, patents, unamortized debt discount and expense and
other like intangible assets, all as determined in accordance with GAAP.

"Consolidated Net Worth" means the excess of assets over liabilities of the
Company and its consolidated Subsidiaries, plus Minority Interests, as
determined from time to time in accordance with GAAP.

"Currency Agreement" means, in respect of any Person, any foreign exchange
contract, currency swap agreement, currency option or other similar agreement
or arrangement designed to protect such Person against fluctuations in
currency exchange rates.

"Debt" means, with respect to any Person on any date of determination
(without duplication), (a) the principal of and premium (if any) in respect of
(i) debt of such Person for money borrowed and (ii) debt evidenced by notes,
debentures, bonds or other similar instruments for the payment of which such
Person is responsible or liable; (b) all Capital Lease Obligations of such
Person and all Attributable Debt in respect of Sale and Leaseback Transactions
entered into by such Person; (c) all obligations of such Person issued or
assumed as the deferred purchase price of Property, all conditional sale
obligations of such Person and all obligations of such Person under any title
retention agreement (but excluding trade accounts payable arising in the
ordinary course of business); (d) all obligations of such Person for the
reimbursement of any obligor on any letter of credit, banker's acceptance or
similar credit transaction (other than obligations with respect to letters of
credit securing obligations (other than obligations described in (a) through
(c) above) entered into in the ordinary course of business of such Person to
the extent such letters of credit are not drawn upon or, if and to the extent
drawn upon, such drawing is reimbursed no later than the third Business Day
following receipt by such Person of a demand for reimbursement following
payment on the letter of credit); (e) the amount of all obligations of such
Person with respect to the redemption, repayment or other repurchase of any
Disqualified Stock or, with respect to any Subsidiary of such Person, any
Preferred Stock (but excluding, in each case, any accrued dividends); (f) all
obligations of the type referred to in clauses (a) through (e) of other
Persons and all dividends of other Persons for the payment of which, in either
case, such Person is responsible or liable, directly or indirectly, as
obligor, guarantor or otherwise, including by means of any Guarantee; (g) all
obligations of the type referred to in clauses (a) through (f) of other
Persons secured by any Lien on any Property of such Person (whether or not
such obligation is assumed by such Person), the amount of such obligation
being deemed to be

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the lesser of the value of such Property or the amount of the obligation so
secured; and (h) to the extent not otherwise included in this definition,
Hedging Obligations of such Person. The amount of Debt of any Person at any
date shall be the outstanding balance at such date of all unconditional
obligations as described above and the maximum liability, upon the occurrence
of the contingency giving rise to the obligation, of any contingent
obligations at such date.

"Default" means any event which is, or after notice or passage of time or
both would be, an Event of Default.

"Disqualified Stock" means, with respect to any Person, Redeemable Stock of
such Person as to which (i) the maturity, (ii) mandatory redemption or (iii)
redemption, conversion or exchange at the option of the holder thereof occurs,
or may occur, on or prior to the first anniversary of the Stated Maturity of
the Notes; provided, however, that Redeemable Stock of such Person that would
not otherwise be characterized as Disqualified Stock under this definition
shall not constitute Disqualified Stock if such Redeemable Stock is
convertible or exchangeable into Debt solely at the option of the issuer
thereof.

"Exchange Act" means the Securities Exchange Act of 1934.

"Funded Debt" means all Debt of the Company and its Subsidiaries with a
Stated Maturity more than one year after, or which is renewable or extendable
at the option of the Company for a period ending more than one year after, the
date as of which Funded Debt is being determined.

"GAAP" means generally accepted accounting principles in the United States
of America as in effect as of the Issue Date, including those set forth in (i)
the opinions and pronouncements of the Accounting Principles Board of the
American Institute of Certified Public Accountants, (ii) statements and
pronouncements of the Financial Accounting Standards Board and (iii) the rules
and regulations of the Commission governing the inclusion of financial
statements (including pro forma financial statements) in periodic reports
required to be filed pursuant to Section 13 of the Exchange Act, including
opinions and pronouncements in staff accounting bulletins and similar written
statements from the accounting staff of the Commission.

"Guarantee" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Debt of any other Person and any
obligation, direct or indirect, contingent or otherwise, of such Person (a) to
purchase or pay (or advance or supply funds for the purchase or payment of)
such Debt of such other Person (whether arising by virtue of partnership
arrangements, or by agreements to keep-well, to purchase assets, goods,
securities or services, to take-or-pay or to maintain financial statement
conditions or otherwise) or (b) entered into for the purpose of assuring in
any other manner the obligee against loss in respect thereof (in whole or in
part); provided, however, that the term "Guarantee" shall not include
endorsements for collection or deposit in the ordinary course of business. The
term "Guarantee" used as a verb has a corresponding meaning. The term
"Guarantor" shall mean any Person Guaranteeing any obligation.

"Hedging Obligation" of any Person means any obligation of such Person
pursuant to any Interest Rate Agreement, Currency Agreement or any other
similar agreement or arrangement.

"Holder" or "Noteholder" means the Person in whose name a Note is registered
on the Registrar's books.

"Incur" means, with respect to any Debt or other obligation of any Person,
to create, issue, incur (by merger, conversion, exchange or otherwise),
extend, assume, Guarantee or become liable in respect of such Debt or other
obligation or the recording, as required pursuant to GAAP or otherwise, of any
such Debt or obligation on the balance sheet of such Person (and "Incurrence"
and "Incurred" shall have meanings correlative to the foregoing); provided,
however, that a change in GAAP that results in an obligation of such Person
that exists at such time, and is not theretofore classified as Debt, becoming
Debt shall not be deemed an Incurrence of such Debt.

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<PAGE>

"Interest Rate Agreement" means, for any Person, any interest rate swap
agreement, interest rate cap agreement, interest rate collar agreement or
other similar agreement or arrangement designed to protect such Person against
fluctuations in interest rates.

"Issue Date" means the date on which the Notes are originally issued.

"Joint Venture" means (i) with respect to properties located in the United
States, any partnership, corporation or other entity, in which up to and
including 50% of the partnership interests, outstanding voting stock or other
equity interest is owned, directly or indirectly, by the Company and/or one or
more Subsidiaries, and (ii) with respect to properties located outside the
United States, any partnership, corporation or other entity, in which up to
and including 60% of the partnership interests, outstanding voting stock or
other equity interests is owned, directly or indirectly, by the Company and/or
one or more Subsidiaries.

"Legal Holiday" is a Saturday, a Sunday or a day on which banking
institutions are not required to be open in the State of New York.

"Lien" means, with respect to any Property of any Person, any mortgage or
deed of trust, pledge, security interest, encumbrance, hypothecation,
assignment, deposit arrangement, lien, charge or adverse claim affecting title
or resulting in an encumbrance against Property (including any Capital Lease
Obligation, conditional sale or other title retention agreement or lease in
the nature thereof or any filing or agreement to file a financing statement as
debtor under the Uniform Commercial Code or any similar statute other than to
reflect ownership by another Person of Property leased to such Person under a
lease that is not in the nature of a Capital Lease Obligation, conditional
sale or title retention agreement).

"Minority Interest" means any Capital Stock of a Subsidiary of the Company
that is not owned by the Company or another such Subsidiary.

"Permitted Liens" means:

(a) Liens for taxes, assessments or governmental charges or levies on the
Property of the Company or any Subsidiary if the same shall not at the time
be delinquent or thereafter can be paid without penalty, or are being
contested in good faith and by appropriate proceedings, provided that any
reserve or other appropriate provision that shall be required in conformity
with GAAP shall have been made therefor;

(b) Liens imposed by law, such as carriers', warehousemen's and
mechanics' Liens on the Property of the Company or any Subsidiary arising
in the ordinary course of business and securing payment of obligations
which are not more than 60 days past due or are being contested in good
faith and by appropriate proceedings;

(c) Liens on the Property of the Company or any Subsidiary Incurred in
the ordinary course of business to secure performance of obligations with
respect to statutory or regulatory requirements, performance or return-of-
money bonds, surety bonds or other obligations of a like nature, in each
case which are not incurred in connection with the borrowing of money, the
obtaining of advances or credit or the payment of the deferred purchase
price of Property and which do not in the aggregate impair in any material
respect the use of Property in the operation of the business of the Company
and the Subsidiaries taken as a whole;

(d) Liens on Property at the time the Company or any Subsidiary acquired
such Property, including any acquisition by means of a merger or
consolidation with or into the Company or any Subsidiary; provided,
however, that any such Lien may not extend to any other Property of the
Company or any Subsidiary except as otherwise provided herein;

(e) Liens on the Property or securing the Debt or Capital Stock of a
Person at the time such Person becomes a Subsidiary; provided, however,
that any such Lien may not extend to any other Property of the Company or
any other Subsidiary which is not a direct Subsidiary of such Person except
as otherwise provided herein;

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<PAGE>

(f) pledges or deposits by the Company or any Subsidiary under workmen's
compensation laws, unemployment insurance laws or similar legislation, or
good faith deposits in connection with bids, tenders, contracts (other than
for the payment of Debt) or leases to which the Company or any Subsidiary
is party, or deposits to secure public or statutory obligations of the
Company, or deposits for the payment of rent, in each case Incurred in the
ordinary course of business;

(g) Liens on the stock, partnership or other equity interest of the
Company or any Subsidiary in any Joint Venture or any Subsidiary which owns
an equity interest in such Joint Venture to secure Debt, provided the
amount of such Debt is contributed and or advanced solely to such Joint
Venture;

(h) Liens on Property to secure Debt Incurred for the purpose of
financing all or any part of the cost of acquisition, construction,
improvement, development or expansion of any such Property; provided such
Debt is Incurred and related Liens are created within 24 months of the
completion of acquisition, construction, improvement, development or
expansion and commencement of full operation, whichever is later, and such
Debt does not exceed the aggregate amount of the cost thereof;

(i) utility easements, building restrictions and such other encumbrances
or charges against real Property as are of a nature generally existing with
respect to properties of a similar character;

(j) Liens on franchise agreements of the Company or any Subsidiary
securing Debt in an aggregate principal amount not to exceed the greater of
(i) $25 million or (ii) two percent of Consolidated Net Tangible Assets;

(k) Liens existing on the Issue Date not otherwise described in clauses
(a) through (j) above; or

(l) Liens on the Property of the Company or any Subsidiary to secure any
Refinancing, in whole or in part, of any Debt secured by Liens referred to
in clause (b), (d), (e), (g), (h) or (k) above; provided, however, that any
such Lien shall be limited to all or part of the same Property that secured
the original Lien (together with improvements and accessions to such
Property) and the aggregate principal amount of Debt that is secured by
such Lien shall not be increased to an amount greater than the sum of (i)
the outstanding principal amount, or, if greater, the committed amount, of
the Debt secured by Liens described under clause (b), (d), (e), (g), (h) or
(k) above, as the case may be, at the time of such Refinancing and (ii) an
amount necessary to pay any premiums, fees and other expenses incurred by
the Company in connection with such Refinancing.

"Person" means any individual, corporation, partnership, company (including
any limited liability company), joint venture, trust, unincorporated
organization, government or any agency or political subdivision thereof or any
other entity.

"Preferred Stock", as applied to the Capital Stock of any Person, means
Capital Stock of any class or classes (however designated) which is preferred
as to the payment of dividends or distributions, or as to the distribution of
assets upon any voluntary or involuntary liquidation or dissolution of such
Person, over shares of Capital Stock of any other class of such Person.

"principal" of the Notes means the principal amount of the Notes plus the
premium, if any, on the Notes.

"Principal Property" means any Property owned or leased by the Company or
any Subsidiary of the Company, the net book value of which exceeds the greater
of (i) $5 million or (ii) two percent of Consolidated Net Tangible Assets and
any franchise agreement of the Company or any Subsidiary.

"Property" means, with respect to any Person, all types of real, personal,
tangible, intangible or mixed property owned by such Person whether or not
included in the most recent consolidated balance sheet of such Person and its
Subsidiaries under GAAP.

"Redeemable Stock" means, with respect to any Person, any Capital Stock that
by its terms (or by the terms of any security into which it is convertible or
for which it is exchangeable) or otherwise (a) matures or is mandatorily
redeemable pursuant to a sinking fund obligation or otherwise, (b) is or may
become redeemable or

85
<PAGE>

repurchaseable at the option of the holder thereof, in whole or in part, or
(c) is convertible or exchangeable for Debt or Disqualified Stock.

"Refinance" means, in respect of any Debt, to refinance, extend, renew,
refund, repay, prepay, redeem, defease or retire, or to issue other Debt, in
exchange or replacement for, such Debt. "Refinanced" and "Refinancing" shall
have correlative meanings.

"Sale and Leaseback Transaction" means any arrangement with any Person
(other than the Company or any Subsidiary) providing for the leasing by the
Company or a Subsidiary of any Principal Property owned by the Company or such
Subsidiary (except for leases for a term of not more than three years), which
property has been or is to be sold or transferred by the Company or such
Subsidiary to such Person on the security of such Principal Property more than
365 days after the acquisition thereof or the completion of construction and
commencement of full operation thereof.

"Significant Subsidiary" means any Subsidiary that would be a "Significant
Subsidiary" of the Company within the meaning of Rule 1-02 under Regulation S-
X promulgated by the Commission.

"Stated Maturity" means, with respect to any security or any installment of
interest thereon, the date specified in such security as the fixed date on
which the principal of such security or such installment of interest is due
and payable.

"Subsidiary", in respect of any Person, means (i) any Person of which more
than 50% of the total voting power of shares of Capital Stock entitled
(without regard to the occurrence of any contingency) to vote in the election
of directors, managers or trustees thereof is at the time owned or controlled,
directly or indirectly, by any Person or one or more of the Subsidiaries of
that Person or a combination thereof, and (ii) any partnership, joint venture
or other Person in which such Person or one or more of the Subsidiaries of
that Person or a combination thereof has the power to control by contract or
otherwise the board of directors or equivalent governing body or otherwise
controls such entity.

"Subsidiary Guarantor" means, unless released from their Subsidiary
Guaranties as permitted by the Indenture, QHE, QHE Partnership and any other
Person that becomes a Subsidiary Guarantor pursuant to the covenant described
under "--Certain Covenants--Future Subsidiary Guarantors".

"Subsidiary Guarantee" means a Guarantee on the terms set forth in the
Indenture by a Subsidiary Guarantor of the Company's obligations with respect
to the Notes.

"U.S. Government Obligations" means direct obligations (or certificates
representing an ownership interest in such obligations) of the United States
of America (including any agency or instrumentality thereof) for the payment
of which the full faith and credit of the United States of America is pledged
and which are not callable at the issuer's option.

"Voting Stock" of a corporation means all classes of Capital Stock of such
corporation then outstanding and normally entitled (without regard to the
occurrence of any contingency) to vote in the election of directors, managers
or trustees thereof.

"Wholly Owned Subsidiary" means, at any time, a Subsidiary all the Voting
Stock of which (other than directors' qualifying shares) is at such time owned
by the Company or one or more other Wholly Owned Subsidiaries.

86
<PAGE>

CERTAIN UNITED STATES FEDERAL TAX CONSIDERATIONS

The following is a general discussion of certain United States federal
income and estate tax consequences relevant to the exchange of Original Notes
for Exchange Notes and the ownership and disposition of Exchange Notes by an
initial beneficial owner of Original Notes. This discussion is based upon the
United States federal tax law now in effect, which is subject to change,
possibly retroactively. The tax treatment of the holders of the Notes may vary
depending upon their particular situations. Certain holders (including
insurance companies, tax exempt organizations, financial institutions,
subsequent purchasers of Notes and broker-dealers) may be subject to special
rules not discussed below. In addition, this discussion does not describe any
tax consequences arising under the laws of any state, locality or taxing
jurisdiction other than the United States federal government. In general, the
discussion assumes that a holder acquires a Note at original issuance and
holds such Notes as a capital asset and not as part of a "hedge," "straddle,"
"conversion transaction," "synthetic security" or other integrated investment.
Prospective investors are urged to consult their tax advisors regarding the
United States federal tax consequences of acquiring, holding and disposing of
Notes, as well as any tax consequences that may arise under the laws of any
foreign, state, local or other taxing jurisdiction.

As used herein, the term "United States Holder" means a beneficial owner of
a Note that is, for United States federal income tax purposes, a citizen or
resident (as defined in Section 7701 (b)(1) of the Code) of the United States,
a corporation, partnership or other entity created or organized in the United
States or under the law of the United States or of any political subdivision
thereof, an estate whose income is includible in gross income for United
States federal income tax purposes regardless of its source or a trust, if a
U.S. court is able to exercise primary supervision over the administration of
the trust and one or more U.S. persons have the authority to control all
substantial decisions of the trust.

UNITED STATES HOLDERS

Stated Interest. Stated interest on a Note will be taxable to a United
States Holder as ordinary interest income at the time that such interest
accrues or is received, in accordance with the United States Holder's regular
method of accounting for federal income tax purposes.

EXCHANGE OFFER

An exchange of Exchange Notes for Original Notes pursuant to the Exchange
Offer should not be treated as an exchange or other taxable event for United
States federal income tax purposes because the Exchange Notes should not be
considered to differ materially in kind or extent from the Notes. As a result,
holders who exchange Exchange Notes for Original Notes pursuant to the
Exchange Offer should not recognize any income, gain or loss for federal
income tax purposes at the time of the exchange and any such holder should
have the same adjusted tax basis and holding period in the Exchange Notes as
it had in the Original Notes immediately before the exchange.

Sales, Exchange or Retirement of the Notes. Upon the sale, exchange,
redemption, retirement at maturity or other disposition of a Note, a United
States Holder will generally recognize taxable gain or loss equal to the
difference between the sum of cash plus the fair market value of all other
property received on such disposition (except to the extent such cash or
property is attributable to accrued interest which will be taxable as ordinary
income) and such holder's adjusted tax basis in the Note. A United States
Holder's adjusted tax basis in the Notes will equal the holder's purchase
price for such Notes. Gain or loss recognized on the disposition of a Note
generally will be capital gain or loss and will be long term capital gain or
loss if the Holders' holding period in the Notes was longer than one year.

Backup Withholding and Information Reporting. In general, a United States
Holder of a Note will be subject to backup withholding at the rate of 31% with
respect to interest, principal and premium, if any, paid on a Note, unless the
holder (a) is an entity (including corporations, tax-exempt organizations and
certain qualified nominees) that is exempt from withholding and, when
required, demonstrates this fact, or (b) provides the

87
<PAGE>

Company with its Taxpayer Identification Number ("TIN") (which, for an
individual would be the holder's Social Security number), certifies that the
TIN provided to the Company is correct and that the holder has not been
notified by the IRS that it is subject to backup withholding due to
underreporting of interest or dividends, and otherwise complies with
applicable requirements of the backup withholding rules. In addition, such
payments of interest, principal and premium to United States Holders that are
not corporations, tax-exempt organizations or qualified nominees will
generally be subject to information reporting requirements.

The amount of any backup withholding from a payment to a United States
Holder will be allowed as a credit against such holder's federal income tax
liability and may entitle such holder to a refund, provided that the required
information is furnished to the IRS.

NON-UNITED STATES HOLDERS

Stated Interest. Interest paid by the Company to any beneficial owner of a
Note that is not a United States Holder ("Non-United States Holder") will not
be subject to United States federal income or withholding tax if such interest
is not effectively connected with the conduct of a trade or business within
the United States by such Non-United States Holder and (a) such Non-United
States Holder (i) does not actually or constructively own 10% or more of the
total combined voting power of all classes of stock of the Company; (ii) is
not a controlled foreign corporation with respect to which the Company is a
"related person" within the meaning of the Code; and (iii) satisfies certain
certification requirements or (b) such Non-United States Holder is entitled to
the benefits of an income tax treaty under which the interest is exempt from
United States withholding tax, and such Non-United States Holder provides a
properly executed IRS Form 1001 claiming the exemption (or, after December 31,
1999, IRS Form W-8, which may require obtaining a Taxpayer Identification
Number and making certain certifications).

Sale, Exchange or Retirement of the Notes. A Non-United States Holder will
generally not be subject to United States federal income tax on gain
recognized on a sale, redemption, retirement at maturity or other disposition
of a Note unless (i) the gain is effectively connected with the conduct of a
trade or business within the United States by the Non-United States Holder or
(ii) in the case of a Non-United States Holder who is a nonresident alien
individual and holds the Note or Debenture as a capital asset, such holder is
present in the United States for 183 or more days in the taxable year and
certain other requirements are met.

Federal Estate Taxes. If interest on the Notes is exempt from withholding of
United States federal income tax under clause (a) of the rules described under
"Stated Interest," the Notes will not be included in the estate of a deceased
Non-United States Holder for United States federal estate tax purposes.

Backup Withholding and Information Reporting. The Company will, where
required, report to the holders of Notes and the Internal Revenue Service the
amount of any interest paid on the Notes in each calendar year and the amounts
of tax withheld, if any, with respect to such payments.

In the case of payments of interest to Non-United States Holders, Treasury
Regulations provide that the 31% backup withholding tax and certain
information reporting will not apply to such payment with respect to which
either the requisite certification has been received or an exemption has
otherwise been established; provided that neither the Company nor its payment
agent has actual knowledge that the holder is a United States person or that
the conditions of any other exemption are not in fact satisfied. Under the
Treasury Regulations, these information reporting and backup withholding
requirements will apply, however, to the gross proceeds paid to a Non-United
States Holder on the disposition of the Notes by or through a United States
office of a United States or foreign broker, unless certain certification
requirements are met or the holder otherwise establishes an exemption.
Information reporting requirements, but not backup withholding, will also
apply to a payment of the proceeds of a disposition of the Notes by or through
a foreign office of a United States broker or foreign brokers with certain
types of relationships to the United States unless the holder is an exempt
recipient (as demonstrated through appropriate certification) or such broker
has documentary evidence in its file that the holder of the Notes is not a
United States person and has no actual knowledge to the contrary and certain
other conditions are met.

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<PAGE>

Neither information reporting nor backup withholding generally will apply to a
payment of the proceeds of a disposition of the Notes by or through a foreign
office of a foreign broker not subject to the preceding sentence.

Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules may be refunded or credited against the Non-United
States Holder's United States federal income tax liability, provided that the
required information is furnished to the IRS. Non-United States Holders are
urged to consult their tax advisors with respect to the application of these
final regulations.

Recently, the Treasury Department has promulgated final regulations
regarding the withholding and information reporting rules discussed above. In
general, the proposed regulations do not significantly alter the substantive
withholding and information reporting requirements but unify current
certification procedures and forms and clarify reliance standards. Under the
final regulations, special rules apply which permit the shifting of primary
responsibility for withholding to certain financial intermediaries acting on
behalf of beneficial owners. The final regulations would generally be
effective for payments made after December 31, 1999, subject to certain
transition rules.

PLAN OF DISTRIBUTION

Each broker-dealer that receives Exchange Notes for its own account in
connection with the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with any resale of such Exchange Notes. This
Prospectus, as it may be amended or supplemented from time to time, may be
used by broker-dealers during the period referred to below in connection with
resales of Exchange Notes received in exchange for Original Notes where such
Original Notes were acquired by such broker-dealers for their own accounts as
a result of market-making activities or other trading activities. The Company
and the Subsidiary Guarantors have agreed that they will make this Prospectus,
as it may be amended or supplemented from time to time, available to any
broker-dealer for use in connection with resales of such Exchange Notes for a
period starting on the date hereof and ending on the close of business on the
earlier to occur of (i) the date on which all Exchange Notes held by broker-
dealers eligible to use the Prospectus to satisfy their prospectus delivery
obligations under the Securities Act have been sold and (ii) the date 180 days
after the consummation of the Exchange Offer. In addition, until January 18,
1999, all dealers effecting transactions in the Exchange Securities may be
required to deliver a prospectus. However, a broker-dealer who intends to use
this Prospectus in connection with the resale of Exchange Notes received in
exchange for Original Notes pursuant to the Exchange Offer must notify the
Company, or cause the Company to be notified, on or prior to the Expiration
Date, that it is a broker-dealer. Such notice may be given in the space
provided for that purpose in the Letter of Transmittal or may be delivered to
the Exchange Agent at one of the addresses set forth in the Letter of
Transmittal. See "The Exchange Offer--Resales of Exchange Notes."

Neither the Company nor any Subsidiary Guarantor will receive any proceeds
from any sale of Exchange Notes by broker-dealers. Exchange Notes received by
broker-dealers for their own accounts in connection with the Exchange Offer
may be sold from time to time in one or more transactions in the over-the-
counter market, in negotiated transactions, through the writing of options on
the Exchange Notes or a combination of such methods of resale, at market
prices prevailing at the time of resale, at prices related to such prevailing
market prices or at negotiated prices. Any such resale may be made directly to
purchasers or to or through brokers or dealers who may receive compensation in
the form of commissions or concessions from any such broker-dealer and/or the
purchasers of any such Exchange Notes. Any broker-dealer that resells Exchange
Notes that were received by it for its own account in connection with the
Exchange Offer and any broker or dealer that participates in a distribution of
such Exchange Notes may be deemed to be an "underwriter" within the meaning of
the Securities Act, and any profit on any such resale of Exchange Notes and
any commissions or concessions received by any such persons may be deemed to
be underwriting compensation under the Securities Act. The Letter of
Transmittal states that by acknowledging that it will deliver and by
delivering a prospectus, a broker-dealer will not be deemed to admit that it
is an "underwriter" within the meaning of the Securities Act.

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<PAGE>

For a period commencing on the date on which the Exchange Offer Registration
Statement is declared effective and ending on the close of business on the
earlier to occur of (i) the date on which all Exchange Notes held by broker-
dealers eligible to use the Prospectus to satisfy their prospectus delivery
obligation under the Securities Act have been sold and (ii) the date 180 days
after the consummation of the Exchange Offer, the Company will promptly send
additional copies of this Prospectus and any amendment or supplement to this
Prospectus to any broker-dealer that requests such documents in the Letter of
Transmittal. The Company and the Subsidiary Guarantors have jointly and
severally agreed to pay all expenses incident to the Exchange Offer (including
the expenses of one counsel for the holders of the Notes) other than
commissions or concessions of any brokers or dealers and will indemnify the
holders of the Notes (including any broker-dealers) against certain
liabilities, including liabilities under the Securities Act.

LEGAL MATTERS

The validity of the Exchange Notes will be passed upon for the Company by
Michael J. DeSantis.

EXPERTS

The financial statements and schedule included in this prospectus and
elsewhere in the registration statement have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their reports with
respect thereto, and are included herein in reliance upon the authority of
said firm as experts in giving said reports.

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INDEX TO FINANCIAL STATEMENTS

<TABLE>
<S> <C>
CHOICE HOTELS INTERNATIONAL, INC.
Report of Independent Public Accountants................................. F-2
Consolidated Balance Sheets as of December 31, 1997 and May 31, 1997..... F-3
Consolidated Statements of Income for the seven months ended December 31,
1997 and for the fiscal years ended May 31, 1997, May 31, 1996 and May
31, 1995................................................................ F-4
Consolidated Statements of Cash Flows for the seven months ended December
31, 1997 and for the fiscal years ended May 31, 1997, May 31, 1996 and
May 31, 1995............................................................ F-5
Consolidated Statement of Shareholders' Equity for the period October 15,
1997 through December 31, 1997.......................................... F-6
Notes to Consolidated Financial Statements............................... F-7
Consolidated Balance Sheets as of June 30, 1998 (unaudited) and December
31, 1997................................................................ F-21
Consolidated Statements of Income for the six months ended June 30, 1998
and June 30, 1997 (unaudited)........................................... F-23
Consolidated Statements of Cash Flows for the six months ended June 30,
1998 and June 30, 1997.................................................. F-24
Notes to Consolidated Financial Statements (unaudited) .................. F-25
Management's Discussion and Analysis of Results of Operations and
Financial Condition .................................................... F-27
</TABLE>

F-1
<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Choice Hotels International, Inc.:

We have audited the accompanying consolidated balance sheets of Choice
Hotels International, Inc., as defined under "Basis of Presentation" in the
Notes to Consolidated Financial Statements, as of December 31, 1997 and May
31, 1997, and the related consolidated statements of income and cash flows for
the seven months ended December 31, 1997 and for each of the three fiscal
years in the period ended May 31, 1997, and the statement of shareholders'
equity for the period from October 15, 1997 (inception) to December 31, 1997.
These consolidated financial statements are the responsibility of Choice
Hotels International, Inc.'s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Choice Hotels
International, Inc. as of December 31, 1997 and May 31, 1997, and the
consolidated results of their operations and their consolidated cash flows for
the seven months ended December 31, 1997, and each of the three fiscal years
in the period ended May 31, 1997, and the statement of shareholders' equity
for the period from October 15, 1997 (inception) to December 31, 1997, in
conformity with generally accepted accounting principles.

Arthur Andersen LLP

Washington, D.C.,
January 27, 1998

F-2
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.
(SEE BASIS OF PRESENTATION)

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31, MAY 31,
1997 1997
------------ --------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents.............................. $ 10,282 $ 4,167
Receivables (net of allowance for doubtful accounts of
$7,608 and $6,159, respectively)...................... 28,347 24,472
Other.................................................. 9,904 5,676
Receivable from Sunburst Hospitality................... 25,066 --
-------- --------
Total current assets................................. 73,599 34,315
Property and equipment, at cost, net of accumulated
depreciation............................................ 37,040 43,377
Goodwill, net of accumulated amortization................ 68,792 69,939
Franchise rights, net of accumulated amortization........ 48,819 50,503
Investment in Friendly Hotels, PLC....................... 17,011 17,161
Assets held for sale..................................... 12,935 --
Other assets............................................. 10,752 6,178
Note receivable from Sunburst Hospitality................ 117,447 --
-------- --------
Total assets......................................... $386,395 $221,473
======== ========
LIABILITIES AND EQUITY
Current liabilities
Current portion of long-term debt...................... $ 15,041 $ 36
Accounts payable....................................... 26,452 20,412
Accrued expenses....................................... 20,702 10,965
Income taxes payable................................... 6,007 3,318
-------- --------
Total current liabilities............................ 68,202 34,731
-------- --------
Long-term debt........................................... 267,780 46,427
Notes payable to Manor Care, Inc. ....................... -- 78,700
Deferred income taxes ($0 and $3,498, respectively) and
other liabilities....................................... 1,155 4,422
-------- --------
Total liabilities.................................... 337,137 164,280
-------- --------
Shareholders' Equity
Common Stock, $.01 par value, 160,000,000 shares
authorized and 59,828,878 shares issued and
outstanding........................................... 598 --
Additional paid-in capital............................. 47,907 --
Cumulative translation adjustment...................... (8,316) --
Treasury stock......................................... (189) --
Retained earnings...................................... 9,258 --
Investments and advances from Parent................... -- 57,193
-------- --------
Total shareholders' equity........................... 49,258 57,193
-------- --------
Total liabilities and shareholders' equity........... $386,395 $221,473
======== ========
</TABLE>

The accompanying notes are an integral part of these consolidated balance
sheets.

F-3
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.
(SEE BASIS OF PRESENTATION)

CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
SEVEN MONTHS
ENDED YEAR ENDED MAY 31,
DECEMBER 31, ----------------------------
1997 1997 1996 1995
------------ -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues
Royalty fees...................... $ 70,308 $ 97,215 $ 87,994 $ 78,092
Product sales..................... 13,524 23,643 21,570 14,461
European hotel operations......... 10,541 17,737 19,609 18,638
Initial franchise fees and
relicensing fees................. 8,597 16,802 15,578 11,656
Other, including partner services
revenue.......................... 4,869 12,642 6,997 6,180
-------- -------- -------- --------
Total revenues.................. 107,839 168,039 151,748 129,027
-------- -------- -------- --------
Operating expenses
Selling, general and
administrative................... 29,454 51,102 45,196 45,589
Product cost of sales............. 13,031 22,766 20,709 13,882
European hotel operations......... 9,203 16,166 17,521 17,922
Depreciation and amortization..... 3,977 7,643 9,179 9,668
Provision for asset impairment.... -- -- 24,760 --
-------- -------- -------- --------
Total operating expenses........ 55,665 97,677 117,365 87,061
-------- -------- -------- --------
Operating income.................... 52,174 70,362 34,383 41,966
-------- -------- -------- --------
Other
Minority interest expense......... -- -- 1,532 2,200
Interest on notes payable to Manor
Care............................. -- 7,083 7,083 7,083
Interest expense and other........ 8,788 4,647 4,791 3,672
Interest and dividend income
(including interest income on the
Sunburst Note of $2.4 million for
December 31, 1997)............... (2,997) (943) -- --
-------- -------- -------- --------
Total other expenses............ 5,791 10,787 13,406 12,955
-------- -------- -------- --------
Income before income taxes.......... 46,383 59,575 20,977 29,011
Income taxes........................ (19,096) (24,845) (9,313) (12,783)
-------- -------- -------- --------
Net income.......................... $ 27,287 $ 34,730 $ 11,664 $ 16,228
======== ======== ======== ========
Weighted average shares
outstanding........................ 59,798 62,680 62,628 62,480
======== ======== ======== ========
Basic earnings per share............ $ 0.46 $ 0.55 $ 0.19 $ 0.26
======== ======== ======== ========
Diluted earnings per share.......... $ 0.45 $ 0.55 $ 0.19 $ 0.26
======== ======== ======== ========
</TABLE>

The accompanying notes are an integral part of these consolidated statements of
income.

F-4
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.
(SEE BASIS OF PRESENTATION)

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
SEVEN MONTHS ENDED YEAR ENDED MAY 31,
DECEMBER 31, ----------------------------
1997 1997 1996 1995
------------------ -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Cash flows from operating
activities
Net income.................... $ 27,287 $ 34,730 $ 11,664 $ 16,228
Reconciliation of net income
to net cash provided by
operating activities:
Depreciation and
amortization............... 6,159 10,438 11,839 11,768
Provision for bad debt...... 2,274 2,238 685 692
Increase (decrease) in
deferred taxes............. (4,828) 3,171 (13,527) 68
Non-cash interest and
dividend income............ (2,997) (943) -- --
Provision for asset
impairment................. -- -- 24,760 --
Change in assets and
liabilities:
Change in receivables....... (10,606) (4,835) (7,533) (3,000)
Change in prepaid expenses
and other current assets... 2,403 1,615 (990) 1,524
Change in current
liabilities................ 11,226 (2,145) 4,050 3,694
Change in income taxes
payable.................... 2,689 1,061 (265) 158
Change in other
liabilities................ -- 175 2,059 6,719
--------- -------- -------- --------
Net cash provided by
operating activities....... 33,607 45,505 32,742 37,851
--------- -------- -------- --------
Cash flows from investing
activities
Investment in property and
equipment.................. (7,329) (10,630) (6,506) (13,611)
Purchase of minority
interest................... -- (2,494) (55,269) --
Investment in Friendly
Hotels, PLC................ -- -- (17,069) --
Advances to Sunburst
Hospitality................ (25,066) -- -- --
Note receivable from
Sunburst Hospitality....... (115,000) -- -- --
Other items, net............ (2,344) (3,804) 345 5,878
--------- -------- -------- --------
Net cash utilized in
investing activities....... (149,739) (16,928) (78,499) (7,733)
--------- -------- -------- --------
Cash flows from financing
activities
Proceeds from mortgages and
other long-term debts...... 236,509 31,107 17,296 15,567
Principal payments of debt.. (78,851) (51,260) (350) (13,492)
Purchase of treasury stock.. (189) -- -- --
Cash transfers (to) from
Parent, net................ (35,222) (8,069) 31,567 (33,336)
--------- -------- -------- --------
Net cash provided by
(utilized in) financing
activities................. 122,247 (28,222) 48,513 (31,261)
--------- -------- -------- --------
Net change in cash and cash
equivalents.................. 6,115 355 2,756 (1,143)
Cash and cash equivalents at
beginning of period.......... 4,167 3,812 1,056 2,199
--------- -------- -------- --------
Cash and cash equivalents at
end of period................ $ 10,282 $ 4,167 $ 3,812 $ 1,056
========= ======== ======== ========
</TABLE>

The accompanying notes are an integral part of these consolidated statements of
cash flows.

F-5
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.
(SEE BASIS OF PRESENTATION)

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
------------------ PAID-IN- TRANSLATION TREASURY RETAINED
SHARES AMOUNT CAPITAL ADJUSTMENT STOCK EARNINGS
---------- ------ ---------- ----------- -------- --------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
Initial capitalization-
October 15, 1997....... 59,767,716 $598 $48,064 $(8,662) $ -- $ --
Net income.............. -- -- -- -- -- 27,287
Exercise of stock
options/grants, net.... 71,876 -- (157) -- -- --
Translation adjustment.. -- -- -- 346 -- --
Treasury purchases...... (10,714) -- -- -- (189) --
Transfers of net income
to Sunburst prior to
the distribution....... -- -- -- -- -- (18,029)
---------- ---- ------- ------- ----- --------
Balance as of December
31, 1997............... 59,828,878 $598 $47,907 $(8,316) $(189) $ 9,258
========== ==== ======= ======= ===== ========
</TABLE>

The accompanying notes are an integral part of this consolidated statement of
shareholders' equity.

F-6
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED 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 ("Choice Hotels Holdings,
Inc." or "Holdings") from its health care business via a Spin-Off of its
lodging business (the "Manor Care Distribution"). On September 30, 1996 the
Board of Directors of Manor Care declared a special dividend to its
shareholders of one share of common stock of Holdings for each share of Manor
Care stock, and the Board set the record date and the distribution date. The
Manor Care Distribution was made on November 1, 1996 to holders of record of
Manor Care's common stock on October 10, 1996.

The Manor Care Distribution separated the lodging and health care businesses
of Manor Care into two public corporations. The operations of Holdings
consisted principally of the hotel franchise operations and the owned and
managed hotel operations formerly conducted by Manor Care directly or through
its subsidiaries (the "Lodging Business").

On November 1, 1996, concurrent with the Manor Care Distribution, Holdings
changed its name from Choice Hotels Holdings, Inc. to Choice Hotels
International, Inc. ("CHI") and CHI's franchising subsidiary, formerly named
Choice Hotels International, Inc., changed its name to Choice Hotels
Franchising, Inc. ("Franchising").

On April 29, 1997, CHI's Board of Directors announced its intention to
separate CHI's franchising business from its owned hotel business (hereinafter
referred to as the "Sunburst Distribution"). On September 16, 1997 the Board
of Directors and shareholders of CHI approved the separation of the business
via a Spin-Off of the franchising business, along with CHI's European hotel
and franchising operations, to its shareholders. The Board set October 15,
1997 as the date of distribution and on that date, CHI shareholders received
one share in Franchising (renamed "Choice Hotels International, Inc." and
referred to hereafter as the "Company") for every share of CHI stock held on
October 7, 1997 (the date of record). Concurrent with the October 15, 1997
distribution date, CHI changed its name to Sunburst Hospitality Corporation
(referred to hereafter as "Sunburst") and effected a one-for-three reverse
stock split of its common stock.

The Company is in the business of hotel franchising. As of December 31,
1997, the Company had franchise agreements with 3,484 hotels operating in 33
countries under the following brand names: Comfort, Clarion, Sleep, Quality,
Rodeway, Econo Lodge and MainStay.

The consolidated financial statements present the financial position,
results of operations, cash flows and equity of the Company as if it were
formed as a separate entity of its parent (Manor Care prior to the Manor Care
Distribution and Sunburst prior to the Sunburst Distribution, in each case,
the "Parent") which conducted the hotel franchising business and European
hotel operations and as if the Company were a separate company for all periods
presented. The Parent's historical basis in the assets and liabilities of the
Company has been carried over to the consolidated financial statements. All
material intercompany transactions and balances between the Company and its
subsidiaries have been eliminated. Changes in the Investments and advances
from Parent represent the net income of the Company plus the net change in
transfers between the Company and Manor Care through November 1, 1996 and
Sunburst through October 15, 1997.

F-7
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

An analysis of the activity in the "Investments and advances from Parent"
account for the three years ended May 31, 1997 and the seven months ended
December 31, 1997 is as follows:

<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
Balance, May 31, 1994......................................... $ 4,409
Transfers to Parent, net...................................... (33,336)
Net income.................................................... 16,228
--------
Balance, May 31, 1995......................................... (12,699)
Transfers from Parent, net.................................... 31,567
Net income.................................................... 11,664
--------
Balance, May 31, 1996......................................... 30,532
Transfers to Parent, net...................................... (8,069)
Net income.................................................... 34,730
--------
Balance, May 31, 1997......................................... 57,193
Net income from June 1, 1997 through October 15, 1997......... 18,029
Transfers to Parent, net through October 15, 1997............. (35,222)
Initial capitalization........................................ (40,000)
--------
Balance, October 15, 1997..................................... $ 0
========
</TABLE>

The average balance of the Investments and advances from Parent was $43.9
million, $8.9 million and ($4.1) million for fiscal years 1997, 1996 and 1995,
respectively and $48.6 million for the period June 1, 1997 through October 15,
1997.

RECLASSIFICATIONS

Certain reclassifications have been made to the prior year financial
statements to conform to the current year presentation. The Company revised
its presentation of marketing and reservation fees. All years presented have
been restated to conform to the current presentation. See Significant
Accounting Policies -- Revenue Recognition.

SIGNIFICANT ACCOUNTING POLICIES

FISCAL YEAR

Prior to December 1997, the Company's fiscal year was the twelve-month
period ended May 31. During September 1997, the Company changed its fiscal
year from a May 31 year-end to December 31 year-end.

ASSETS HELD FOR SALE

Assets held for sale by the Company are stated at the lower of cost or
estimated net realizable value.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments purchased with a
maturity of three months or less at the date of purchase to be cash
equivalents.

F-8
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

PROPERTY AND EQUIPMENT

The components of property and equipment in the consolidated balance sheets
were:

<TABLE>
<CAPTION>
DECEMBER 31, MAY 31,
1997 1997
-------------- --------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C>
Land........................................... $ 996 $ 3,033
Buildings and improvements..................... 18,238 27,409
Furniture, fixtures and equipment.............. 31,228 30,526
-------- --------
50,462 60,968
Less: accumulated depreciation................. (13,422) (17,591)
-------- --------
$ 37,040 $ 43,377
======== ========
</TABLE>

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 the Company. Amounts reflected as
minority interest represent the minority owners' share of income in the
Company. The Company repurchased all of the outstanding minority ownership
interest in fiscal years 1995 and 1996.

GOODWILL

Goodwill primarily represents an allocation of the excess purchase price of
the stock of the Company over the recorded minority interest. Goodwill is
being amortized on a straight-line basis over 40 years. Such amortization
amounted to $1.1 million in the period ended December 31, 1997 and $1.9
million, $1.1 million, and $598,000 in the fiscal years ended May 31, 1997,
1996 and 1995, respectively. Goodwill is net of accumulated amortization of
$6.1 million and $5.0 million at December 31, 1997 and May 31, 1997,
respectively.

FRANCHISE RIGHTS

Franchise rights are an intangible asset and represent an allocation in
purchase accounting for the value of long-term franchise contracts. The
majority of the balance resulted from the Econo Lodge and Rodeway acquisitions
made in fiscal year 1991. Franchise rights acquired are amortized over an
average life of 26 years. Amortization expense for the periods ended December
31, 1997, May 31, 1997, 1996 and 1995 amounted to $1.7 million, $2.9 million,
$2.6 million and $2.6 million, respectively. Franchise rights are net of
accumulated amortization of $15.7 million and $14.0 million at December 31,
1997 and May 31, 1997, respectively.

SELF-INSURANCE PROGRAM

Subsequent to the Manor Care Distribution, the Company maintained its own
self-insurance program for certain levels of general and professional
liability, automobile liability and workers' compensation coverage. The
estimated costs of these programs were accrued at present values based on
actuarial projections for known and anticipated claims. As of June 1, 1997,
the Company was no longer self-insured.

F-9
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Prior to the Manor Care Distribution, the Company participated in Manor
Care's self-insurance program for certain levels of general and professional
liability, automobile liability and workers' compensation coverage. The
estimated costs of these programs are accrued at present values based on
actuarial projections for known and anticipated claims. All accrued self-
insurance costs through November 1, 1996 were assumed by Manor Care and have
been treated as paid to Manor Care, and as such, amounts paid to Manor Care up
to November 1, 1996 have been charged directly to Investments and advances
from Parent.

REVENUE RECOGNITION

The Company enters into numerous franchise agreements committing to provide
franchisees with various marketing services, a centralized reservation system
and limited rights to utilize the Company's registered trade names. These
agreements are typically for a period of twenty years, with certain rights to
the franchisee to terminate after five, 10 or 15 years.

Initial franchise fees are recognized upon sale, because the initial
franchise fee is non-refundable and the Company has no continuing obligations
related to the franchisee.

Royalty fees, primarily based on gross room revenues of each franchisee, are
recorded when earned. Reserves for uncollectible accounts are charged to bad
debt expense and included in selling, general and administrative expenses in
the accompanying consolidated statements of income.

The Company's franchise agreements require the payment of franchise fees
which include marketing and reservation fees. These fees, which are based on a
percentage of the franchisees' gross room revenues, are used exclusively to
reimburse the Company for expenses associated with providing such franchise
services as central reservation systems, national marketing, and media
advertising. The Company is contractually obligated to expend the reservation
and marketing fees it collects from franchisees in accordance with the
franchise agreements; as such no income or loss to the Company is generated.
Amounts charged and expended under these programs are recorded on a net basis

IMPAIRMENT POLICY

The Company has adopted the Statement of Financial Accounting Standards
("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of" in fiscal year 1997. Accordingly, the
Company evaluates the recoverability of long-lived assets, including franchise
rights and goodwill, whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Recoverability is
measured based on net, undiscounted expected cash flows. Assets are considered
to be impaired if the net, undiscounted expected cash flows are less than the
carrying amount of the assets. Impairment charges are recorded based upon the
difference between the carrying value of the asset and the expected net cash
flows, discounted at an appropriate interest rate. The adoption of SFAS No.
121 did not have a material impact on the Company's financial statements.

CAPITALIZATION POLICIES

Major renovations and replacements are capitalized to appropriate property
and equipment accounts. Upon sale or retirement of property, the cost and
related accumulated depreciation are eliminated from the accounts and the
related gain or loss is taken into income. Maintenance, repairs and minor
replacements are charged to expense.

INTEREST RATE HEDGES

The Company has entered into interest rate swap agreements with a notional
amount of $115 million at December 31, 1997 to fix certain of its variable
rate debt in order to reduce the Company's exposure to fluctuations in
interest rates. The interest rate differential to be paid or received on
interest rate swap agreements is accrued as interest rates change and is
recognized as an adjustment to interest expense. On average, the interest rate
swap agreements have a life of three and one-half years with a fixed rate of
6.68% and a variable rate of

F-10
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

6.39%. As of December 31, 1997, the interest rate swap agreements have a fair
market valuation of approximately ($496,000).

FOREIGN OPERATIONS

The Company accounts for foreign currency translation in accordance with
SFAS No. 52, "Foreign Currency Translation." Revenues generated by foreign
operations for the seven months ended December 31, 1997 and the fiscal years
ended May 31, 1997, 1996 and 1995 were $16.2 million, $27.5 million, $29.9
million and $29.2 million, respectively. The Company's foreign operations had
net income of $313,000 for the seven months ended December 31, 1997. Net
losses were generated by foreign operations for the years ended May 31, 1997,
1996 and 1995 of $1.8 million, $19.4 million and $5.7 million, respectively.
Net losses generated by foreign operations for fiscal year 1996 include a
$15.0 million net of tax charge relating to a provision for asset impairment.
Total assets relating to foreign operations were $34.3 million and $48.8
million at December 31, 1997 and May 31, 1997, respectively. The majority of
the revenues and assets of foreign operations relate to the Company's European
business operations (See "Acquisitions and Divestitures"). Translation gains
and losses are recorded in the cumulative translation adjustment account
included in Investments and advances from Parent in the accompanying
consolidated balance sheets prior to October 15, 1997 and are shown separately
in shareholders' equity after October 15, 1997 as follows:

<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
Balance, May 31, 1994......................................... $ (31)
Net adjustments............................................... 740
-------
Balance, May 31, 1995......................................... 709
Net adjustments............................................... (2,459)
-------
Balance, May 31, 1996......................................... (1,750)
Net adjustments............................................... (5,268)
-------
Balance, May 31, 1997......................................... (7,018)
Net Adjustments............................................... (1,298)
-------
Balance, December 31, 1997.................................... $(8,316)
=======
</TABLE>

The cumulative translation adjustment included in the December 31, 1997
balance sheet relating to assets held for sale was $(6.6) million.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.

F-11
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

EARNINGS PER SHARE

The Company adopted SFAS 128, "Earnings Per Share" in 1997. The following
table illustrates the reconciliation of the earnings and number of shares used
in the basic and diluted earnings per share calculations (in millions, except
per share amounts).

<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
Computation of Basic Earnings Per Share
Net Income.................................................... $27.3
Weighted average shares outstanding........................... 59.8
-----
Basic Earnings Per Share.................................... $0.46
=====
Computation of Diluted Earnings Per Share
Net income for diluted earnings per share..................... $27.3
Weighted average shares outstanding........................... 59.8
Effect of Dilutive Securities--
Employee stock option plan.................................... 1.5
-----
Shares for diluted earnings per share......................... 61.3
-----
Diluted Earnings Per Share.................................. $0.45
=====
</TABLE>
The effect of dilutive securities is computed using the treasury stock
method and average market prices during the period. The Company does not have
any options outstanding that were excluded from the computation of diluted
earnings per share. The Company had no shares outstanding to the public or
material dilutive securities prior to the Sunburst Distribution and therefore,
no reconciliation has been provided for periods prior to December 31, 1997.

The weighted average number of common shares outstanding is based on the
Company's weighted average number of outstanding common shares for the period
October 15, 1997 through December 31, 1997, Sunburst's weighted average number
of outstanding common shares for the period November 1, 1996 through October
15, 1997 and Manor Care's weighted average number of outstanding common shares
prior to November 1, 1996.

INCOME TAXES

The Company was included in the consolidated federal income tax returns of
Manor Care and Sunburst prior to October 15, 1997. Subsequent to October 15,
1997, the Company is required to make its own filings. The income tax
provision included in these consolidated financial statements reflects the
historical income tax provision and temporary differences attributable to the
operations of the Company on a separate return basis. Deferred taxes are
recorded for the tax effect of temporary differences between book and tax
income.

Income before income taxes for the seven months ended December 31, 1997 and
the fiscal years ended May 31, 1997, 1996 and 1995 were derived from the
following:

<TABLE>
<CAPTION>
MAY 31,
DECEMBER 31, -------------------------
1997 1997 1996 1995
------------ ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Income before income taxes
Domestic operations................ $45,866 $62,641 $52,801 $38,385
Foreign operations................. 517 (3,066) (31,824) (9,374)
------- ------- ------- -------
Income before income taxes........... $46,383 $59,575 $20,977 $29,011
======= ======= ======= =======
</TABLE>

F-12
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Income before income taxes for domestic operations and foreign operations
for fiscal year 1996 includes a pre-tax provision of $24.8 million for asset
impairment.

The provisions for income taxes follows for the period ended December 31,
1997 and for the fiscal years ended May 31, 1997, 1996 and 1995:

<TABLE>
<CAPTION>
MAY 31,
DECEMBER 31, -------------------------
1997 1997 1996 1995
------------ ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Current tax (benefit) expense
Federal.......................... $15,742 $19,421 $20,097 $14,169
Federal benefit of foreign
operations...................... 204 (1,213) (2,792) (3,703)
State............................ 3,475 3,950 3,754 2,292
Deferred tax (benefit) expense
Federal.......................... (223) 2,293 125 58
Federal benefit of foreign
operations...................... -- -- (9,778) --
State............................ (102) 394 (2,093) (33)
------- ------- ------- -------
$19,096 $24,845 $ 9,313 $12,783
======= ======= ======= =======
</TABLE>

Deferred tax assets (liabilities) are comprised of the following at December
31, 1997 and May 31, 1997:

<TABLE>
<CAPTION>
DECEMBER 31, MAY 31,
1997 1997
------------ -------
<S> <C> <C>
Depreciation and amortization...................... $(3,184) $(5,145)
Prepaid expenses................................... (1,484) (856)
Other.............................................. (2,458) (2,799)
------- -------
Gross deferred tax liabilities..................... (7,126) (8,800)
------- -------
Foreign operations................................. 2,843 2,271
Accrued expenses................................... 5,283 3,181
Net operating loss................................. 398 609
Other.............................................. 1,001 310
------- -------
Gross deferred tax assets.......................... 9,525 6,371
------- -------
Net deferred tax asset (liability)................. $ 2,399 $(2,429)
======= =======
</TABLE>

A reconciliation of income tax expense at the statutory rate to income tax
expense included in the accompanying consolidated statements of income
follows:

<TABLE>
<CAPTION>
MAY 31,
DECEMBER 31, ------------------------
1997 1997 1996 1995
-------------- ------- ------ -------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C>
Federal income tax rate........... 35% 35% 35% 35%
Federal taxes at statutory rate... $16,234 $20,853 $7,345 $10,154
State income taxes, net of Federal
tax benefit...................... 2,192 2,824 1,080 1,468
Minority interest................. -- -- 536 770
Other............................. 670 1,168 352 391
------- ------- ------ -------
Income tax expense................ $19,096 $24,845 $9,313 $12,783
======= ======= ====== =======
</TABLE>

F-13
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Cash paid for state income taxes was $197,000, $1.3 million, $1.4 million
and $549,000 for the period ended December 31, 1997 and the fiscal years ended
May 31, 1997, 1996 and 1995, respectively. Federal income taxes were paid by
Manor Care for the years ended May 31, 1995 and May 31, 1996 and the period
ending October 31, 1996. Federal income taxes were paid by Sunburst for the
period beginning November 1, 1996 through May 31, 1997. The Company paid $9.1
million for the period June 1, 1997 to December 31, 1997.

Consistent with the existing Company tax-sharing policy, all current Federal
provision amounts have been treated as paid to, or received from, the Company,
and as such, there are no current tax provision balances due to Sunburst at
May 31, 1997. Differences between amounts paid to or received from Manor Care
and Sunburst and the Company have been charged or credited directly to
Investments and advances from Parent. As part of the tax sharing agreement,
the current taxes payable as of October 15, 1997 were assumed by Sunburst.

ACCRUED EXPENSES

Accrued expenses were as follows:

<TABLE>
<CAPTION>
DECEMBER 31, MAY 31,
1997 1997
-------------- --------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C>
Payroll........................................ $ 8,729 $ 7,950
Other.......................................... 11,973 3,015
------- -------
$20,702 $10,965
======= =======
</TABLE>

LONG TERM DEBT AND NOTES PAYABLE

Debt consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31, MAY 31,
1997 1997
-------------- --------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C>
$300 million competitive advance and multi-
currency revolving credit facility with an
average rate of 6.60% at December 31, 1997.. $267,600 $ --
$125 million competitive advance and multi-
currency revolving credit facility with an
average rate of 6.28% at May 31, 1997....... -- 31,107
Notes payable to Manor Care, Inc. with a rate
of 9% at May 31, 1997....................... -- 78,700
Capital lease obligations.................... 13,469 13,531
Other notes with an average rate of 5.95% and
5.94% at December 31, 1997 and May 31,
1997........................................ 1,752 1,825
-------- --------
Total indebtedness........................... $282,821 $125,163
======== ========
</TABLE>

Maturities of debt at December 31, 1997 were as follows:

<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
1998.......................................................... $ 15,041
1999.......................................................... 22,679
2000.......................................................... 32,726
2001.......................................................... 42,769
2002.......................................................... 155,471
Thereafter.................................................... 14,135
--------
$282,821
========
</TABLE>

F-14
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED 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 $250.0 million
competitive advance and multi-currency revolving credit facility. The facility
provided that up to $75.0 million was available in foreign currency borrowings
under the foreign currency portion of the facility. The Company was charged
interest for amounts borrowed under the foreign currency portion of the
facility at one of several interest rates, including LIBOR plus 26.25 basis
points. Subsequent to the Manor Care Distribution, the Company utilized its
new credit facility, as described below, to repay the Company's portion of
borrowings under Manor Care's foreign currency portion of the facility, and
the Company was released from all liabilities and guarantees relating to the
Manor Care credit facility.

On October 30, 1996, the Company entered into a $100.0 million competitive
advance and multi-currency revolving credit facility provided by a group of
seven banks. Borrowings under the facility were, at the option of the
borrower, at one of several rates including LIBOR plus from 20.0 to 62.5 basis
points, based upon a defined financial ratio and the loan type. The Company
had $31.1 million outstanding under the facility at May 31, 1997. In
connection with the Sunburst Distribution, all outstanding amounts were
repaid.

The Company's portion of the payable to Manor Care was $78.7 million as of
May 31, 1997 and 1996, which was pushed down as part of the Manor Care
Distribution and is reflected as notes payable to Manor Care in the
accompanying consolidated balance sheets. Interest on the amount of the loan
was payable quarterly at an annual rate of 9%. Interest expense on those notes
for the seven months ended December 31, 1997 was $2.7 million and $7.1 million
for the fiscal years ended May 31, 1997, 1996 and 1995. The Company repaid the
note at the Sunburst Distribution.

On October 15, 1997, the Company entered into a $300 million competitive
advance and multi-currency revolving credit facility (the "Credit Facility")
provided by a group of 14 banks. The Credit Facility provides for a term loan
of $150 million and a revolving credit facility of $150 million, $50 million
of which is available for borrowings in foreign currencies. The credit
facility includes customary financial and other covenants that require the
maintenance of certain ratios including maximum leverage, minimum net worth
and interest coverage and restrict the Company's ability to make certain
investments, repurchase stock, incur debt and dispose of assets. The term loan
is payable over five years, $15 million of which is due in 1998. Borrowings
under the facility are, at the option of the borrower, at one of several rates
including LIBOR plus from 20.0 to 87.5 basis points, based upon a defined
financial ratio and the loan type. In addition, the Company has the option to
request participating banks to bid on loan participation at lower rates than
those contractually provided by the facility. The Credit Facility requires the
Company to pay annual fees of 1/10 of 1% to 1/3 of 1%, based upon a defined
financial ratio of the total loan commitment. The Credit Facility will
terminate on October 15, 2002.

In connection with the Sunburst Distribution, the Company borrowed $115
million under its Credit Facility in order to fund a subordinated term note to
Sunburst. The Subordinated Term Note of $115 million accrues interest monthly
at 11% with an effective rate through maturity of 8.8%, and is due on October
15, 2002. No interest is payable until maturity. Total interest accrued at
December 31, 1997 was $2.4 million.

Cash paid for interest was $7.9 million, $11.6 million, $11.8 million and
$10.8 million for December 31, 1997, and May 31, 1997, 1996 and 1995,
respectively.

LEASES

Rental expense under non-cancelable operating leases was $181,000, $171,000,
$231,000 and $400,000 for the seven months ended December 31, 1997 and fiscal
years ended May 31, 1997, 1996 and 1995, respectively.

F-15
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The Company paid office rent of $1.1 million and $4.0 million to Sunburst for
the seven months ended December 31, 1997 and the year ended May 31, 1997 based
on the portion of total space occupied by the Company.

In addition, the Company operates certain property and equipment under
leases that expire in 2014. Future minimum lease payments are as follows:

<TABLE>
<CAPTION>
OPERATING CAPITALIZED
LEASES LEASE
--------- -----------
(IN THOUSANDS)
<S> <C> <C>
1998................................................... $2,058 $ 811
1999................................................... 699 939
2000................................................... 223 950
2001................................................... 189 950
2002................................................... 146 950
Thereafter............................................. -- 20,553
------ --------
Total minimum lease payments........................... $3,315 25,153
======
Less: interest......................................... (11,684)
--------
Present value of lease payment......................... $ 13,469
========
</TABLE>

In accordance with the Manor Care Lease Amendment and Guaranty, the Company,
Sunburst and Manor Care have added the Company as a guarantor of Sunburst's
obligations under the Gaithersburg Lease and the Silver Spring Lease.
Additionally, Sunburst and Choice have entered into a sublease agreement with
respect to the Silver Spring Lease for the Company's principal executive
offices. The Company subleases approximately 54.3% of the office space
available under the Silver Spring Lease with financial terms approximately
equal (on a square foot basis) to the terms of the Silver Spring Lease. The
lease expires April 1, 1999.

ACQUISITIONS AND DIVESTITURES

On May 31, 1995, the Company repurchased one-half of the 11% interest held
by its management in the Company. Approximately $19.8 million was allocated to
goodwill; the purchase cost of $27.4 million was paid in June and July 1995.
On May 31, 1996, the Company repurchased the remaining 5.5% minority interest
in the Company for $27.9 million. Approximately $26.4 million was allocated to
goodwill.

On May 31, 1996, the Company invested approximately $17.1 million in the
capital stock of Friendly Hotels, PLC ("Friendly"). In exchange for the $17.1
million investment, the Company received 750,000 shares of common stock and 10
million newly issued immediately convertible preferred shares. In addition,
the Company granted to Friendly a Master Franchise Agreement for the United
Kingdom and Ireland in exchange for 333,333 additional shares of common stock.
At May 31, 1997, the Company owned approximately 5% of the outstanding shares
of Friendly which would increase to approximately 27% if the Company's
preferred stock were converted. The preferred shares carry a 5.75% dividend
payable in cash or in stock, at the Company's option. The dividend accrues
annually with the first dividend paid on the earlier of the third anniversary
of completion or on a conversion date. The proceeds of the investment received
by Friendly are to be used to support the construction of 10 Quality or
Comfort hotels. As a condition to the investment, the Company has the right to
appoint three directors to the board of Friendly. The Company is accounting
for the common stock investment under the equity method.

The Company recognized $550,083 and $943,000 in preferred dividend income
from the Friendly investment for the period ended December 31, 1997 and May
31, 1997.

F-16
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

In January 1998, the Company completed a transaction with Friendly in which
Friendly would assume the master franchise rights for Choice's Comfort,
Quality and Clarion brand hotels throughout Europe (with the exception of
Scandinavia) for the next 10 years. In exchange, the Company will receive from
Friendly $8.0 million, payable in eight equal annual installments.

As part of the transaction, Friendly acquired European hotels currently
owned by the Company for a total consideration of approximately $26.2 million
in convertible preferred shares and cash. In exchange for 10 hotels in France,
two in Germany and one in the United Kingdom, the Company will receive $22.2
million in new unlisted 5.75 percent convertible preferred shares in Friendly
at par, convertible for one new Friendly ordinary share for every 150p nominal
of the preferred convertible shares. In addition, Friendly will pay the
Company deferred compensation of $4.0 million in cash, payable by the fifth
anniversary of completion or sooner dependent on the level of future profits
of the hotels acquired. The European hotels included in this transaction have
a carrying value, which includes a cumulative translation adjustment of $(6.6)
million, totaling approximately $17.3 million. The Company has reflected the
net assets subject to this transaction as assets held for sale in the December
31, 1997 accompanying consolidated balance sheet.

TRANSACTIONS WITH SUNBURST

Subsequent to the Manor Care Distribution, the Company participated in a
cash concentration system with Sunburst and as such maintained no significant
cash balances or banking relationships. Substantially all cash received by the
Company was immediately deposited in and combined with Sunburst's corporate
funds through its cash management system. Similarly, operating expenses,
capital expenditures and other cash requirements of the Company have been paid
by Sunburst and charged to the Company. The net result of all these
intercompany transactions is reflected in Investments and advances from
Parent.

Since the Manor Care Distribution, the Company has provided certain services
to Sunburst including, among others, executive management, human resources,
legal, accounting, tax, information systems and certain administrative
services, as required. Also since the Manor Care Distribution, Sunburst has
provided services to the Company, either directly or through the Corporate
Services Agreement with Manor Care, including, among others, cash management,
payroll and payables processing, employee benefits plans, insurance,
accounting and certain administrative services as required. Costs associated
with the Manor Care Corporate Services Agreement as well as costs of services
provided by Sunburst to the Company or provided by the Company to Sunburst
have been allocated between the entity providing the services and the entity
receiving the services in the accompanying financial statements. As a result,
future administrative and corporate expenses are expected to vary from
historical results. However, the Company has estimated that general and
administrative expenses incurred annually will not materially change after the
Distribution.

As part of the Sunburst Distribution, Sunburst and the Company have entered
into a strategic alliance agreement. Among other things, the agreement
provides for: (i) a right of first refusal to the Company to franchise any
lodging properties to be acquired or developed by Sunburst, (ii) certain
commitments by Sunburst for the development of Sleep Inns and MainStay Suites
hotels, (iii) continued cooperation of both parties with respect to matters of
mutual interest, such as new product and concept testing, (iv) continued
cooperation with respect to third party vendor arrangements; and (v) certain
limitations on competition in each others' line of business. The strategic
alliance agreement extends for a term of 20 years with mutual rights of
termination on the fifth, 10th and 15th anniversaries of the Sunburst
Distribution.

For purposes of providing an orderly transition after the Sunburst
Distribution, Sunburst and the Company entered into various agreements,
including, among others, a Distribution Agreement, a Tax Sharing Agreement, a
Corporate Services Agreement and an Employee Benefits Allocation Agreement.
Effective as of October 15,

F-17
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

1997, these agreements provide, among other things, that Sunburst (i) will
receive and/or provide certain corporate and support services, such as
accounting, tax and computer systems support, (ii) will adjust outstanding
options to purchase shares of Company common stock held by Company employees,
Sunburst employees, and employees of Manor Care, (iii) is responsible for
filing and paying the related taxes on consolidated federal tax returns and
consolidated or combined state tax returns for itself and any of its
affiliates (including the Company) for the periods of time that the affiliates
were members of the consolidated group, (iv) will be reimbursed by the Company
for the portion of income taxes paid that relate to the Company and its
subsidiaries, and (v) guarantees that the Company will, at the date of
distribution, have a specified minimum level of net worth. These agreements
will extend for a maximum period of 30 months from the distribution date or
until such time as the Company and Sunburst have arranged to provide such
services in-house or through another unrelated provider of such services.

During the periods presented, Sunburst operated substantially all of its
hotels pursuant to franchise agreements with the Company. Total fees paid to
the Company included in the accompanying financial statements for franchising
royalty, marketing and reservation fees were $6.2 for the seven months ended
December 31, 1997 and $9.5 million, $7.5 million, and $5.3 million for the
years ended May 31, 1997, 1996 and 1995, respectively.

In accordance with the Sunburst Distribution Agreement, the Company agreed
to assume and pay certain liabilities of Sunburst, subject to the Company
maintaining a minimum net worth of $40 million, at the date of Distribution.
As of December 31, 1997, approximately $25 million is due to the Company from
Sunburst, which is included in other current assets. This receivable relates
to the net worth guarantee and the reimbursement of various expenses paid by
the Company, subsequent to the Sunburst Distribution. Subsequent to year-end,
Sunburst paid $7.5 million of the outstanding balance.

COMMITMENTS AND CONTINGENCIES

The Company is a defendant in a number of lawsuits arising in the ordinary
course of business. In the opinion of management and general counsel to the
Company, the ultimate outcome of such litigation will not have a material
adverse effect on the Company's business, financial position or results of
operations.

PENSION, PROFIT SHARING AND INCENTIVE PLANS

Bonuses accrued for key executives of the Company under incentive
compensation plans were $520,000 for the seven months ended December 31, 1997,
$1.4 million in 1997, $1.1 million in 1996, and $1.4 million in 1995.

Employees of the Company participate in retirement plans sponsored by the
Company, and prior to the Manor Care Distribution and Sunburst Distribution,
employees participated in retirement plans sponsored by Manor Care and
Sunburst. Costs allocated to the Company are based on the size of its payroll
relative to the sponsor's payroll. Costs allocated to the Company were
approximately $817,000 for the seven months ended December 31, 1997, $1.4
million in 1997, $817,000 in 1996 and $776,000 in 1995.

F-18
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

CAPITAL STOCK

Since the Sunburst Distribution, the Company repurchased 10,714 shares of
its common stock at a total cost of $189,000. Subsequent to December 31, 1997,
the Company has repurchased 490,214 shares of its common stock at a total cost
of $7.9 million. The Company has authorization from its Board of Directors to
repurchase up to an additional 1.27 million shares. In fiscal year 1997, the
Company granted a key executive 85,470 restricted shares of common stock with
a value of $1.25 million on the grant date. The restricted stock vests over a
three-year period.

The Company has stock option plans for which it is authorized to grant
options to purchase up to 7.1 million shares of the Company's common stock.
Stock options may be granted to officers, key employees and non-employee
directors with an exercise price not less than the fair market value of the
common stock on the date of grant. In connection with the Sunburst
Distribution, the outstanding options held by current and former employees of
the Company were redenominated in the stock of the newly separated companies
and the number and exercise prices of the options were adjusted based on the
relative trading prices of the common stock of the two companies in order to
retain the intrinsic value of the options.

Option activity under the above plans is as follows:

<TABLE>
<CAPTION>
NUMBER WEIGHTED
OF SHARES OPTION PRICE
---------- -------------
<S> <C> <C>
Outstanding at October 15, 1997.................... 4,689,515 $ 8.71
Granted............................................ 15,000 17.63
Exercised.......................................... (28,550) 3.32
Canceled........................................... (508,920) 10.05
--------- ------
Outstanding at December 31, 1997................... 4,167,045 $ 8.62
========= ======
</TABLE>

At December 31, 1997, options with a weighted average remaining life of 4.2
years covering 1,845,642 shares were exercisable at $2.64 to $12.21 per share
with a weighted average of $5.80 per share.

SFAS No. 123, "Accounting for Stock-Based Compensation," requires companies
to provide additional note disclosures about employee stock-based compensation
plans based on a fair value based method of accounting. As permitted by this
accounting standard, the Company continues to account for these plans under
APB Opinion 25, under which no compensation cost has been recognized.

Compensation cost for the Company's stock option plan was determined based
on the fair value at the grant dates for awards under those plans consistent
with the method of SFAS No. 123. The fair value of each option grant has been
estimated on the date of the grant using an option-pricing model with the
following weighted average assumptions used for grants in 1997: risk-free
interest rate of 5.65% and volatility of 23.6%, expected lives of 10 years and
0% dividend yield. The weighted average fair value per option granted during
fiscal year 1997 was $8.79. If options had been reported as compensation
expense based on their fair value pro forma, net income would have been $27.3
million for 1997, and pro forma earnings per share would have been $0.46.

Since this methodology has not been applied to options granted prior to the
Sunburst Distribution date, the resulting pro forma compensation cost is not
likely to be representative of that to be expected in future years.

F-19
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FAIR VALUE OF FINANCIAL INSTRUMENTS

The balance sheet carrying amount of cash and cash equivalents and
receivables approximate fair value due to the short-term nature of these
items. Long-term debt consists of bank loans and notes payable to Manor Care.
Interest rates on bank loans adjust frequently based on current market rates;
accordingly, the carrying amount of bank loans is equivalent to fair value.
The carrying amounts for long-term debt approximate fair market values.

The Note Receivable from Sunburst approximates fair value based on its
current yield to maturity, which is equivalent to those investments of similar
quality and terms.

PROVISION FOR ASSET IMPAIRMENT

During fiscal year 1996, the Company began restructuring its European
operations. This restructuring effort included the purchase of an equity
interest in Friendly and a reevaluation of key geographic markets in Europe.
In connection with this restructuring, the Company performed a review of its
European operations and in May 1996 recognized a $15.0 million non-cash charge
(net of a $9.8 million income tax benefit) against earnings related to the
impairment of assets associated with certain European hotel operations.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

The Company adopted SFAS No. 128, "Earnings Per Share," and SFAS No. 129,
"Disclosure of Information about Capital Structure," during 1997. The adoption
of these pronouncements did not materially affect the Company's financial
statements. The Company is required to adopt SFAS No. 130, "Reporting
Comprehensive Income," and SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information," no later than 1998. Management is
evaluating the impact that these pronouncements will have on the Company's
financial statements.

SUBSEQUENT EVENTS (UNAUDITED)

On February 19, 1998, the Board of Directors adopted a shareholder rights
plan under which a dividend of one preferred stock purchase right was
distributed for each outstanding share of the Company's common stock to
shareholders of record on April 3, 1998. Each right will entitle the holder to
buy 1/100th of a share of a newly issued series of junior participating
preferred stock of the Company at an exercise price of $75 per share. The
rights will be exercisable, subject to certain exceptions, 10 days after a
person or group acquires beneficial ownership of 10% or more of the Company's
common stock. Shares owned by a person or group on February 19, 1998, and held
continuously thereafter are exempt for purposes of determining beneficial
ownership under the rights plan. The rights will be non-voting and will expire
on January 31, 2008, unless exercised or previously redeemed by the Company
for $.001 each. If the Company is involved in a merger or certain other
business combinations not approved by the Board of Directors, each right will
entitle its holder, other than the acquiring person or group, to purchase
common stock of either the Company or the acquiror having a value of twice the
exercise price of the right.

F-20
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents........................... $ 6,365 $ 10,282
Receivables (net of allowance for doubtful accounts
of $5,394 and $7,608, respectively)................ 26,868 28,347
Other............................................... 12,476 9,904
Receivable from Sunburst Hospitality................ 19,921 25,066
-------- --------
Total current assets.............................. 65,630 73,599
Property and equipment, at cost, net of accumulated
depreciation......................................... 39,146 37,040
Goodwill, net of accumulated amortization............. 67,866 68,792
Franchise rights, net of accumulated amortization..... 47,578 48,819
Investment in Friendly Hotels, PLC, net............... 41,552 17,011
Other assets.......................................... 24,204 12,935
Assets held for sale.................................. -- 10,752
Note receivable from Sunburst Hospitality............. 122,368 117,447
-------- --------
Total assets...................................... $408,344 $386,395
======== ========
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities
Current portion of long-term debt................... $ 10,041 $ 15,041
Accounts payable.................................... 24,149 26,452
Accrued expenses.................................... 16,302 20,702
Income taxes payable................................ 6,754 6,007
-------- --------
Total current liabilities......................... 57,246 68,202
-------- --------
Long-term debt........................................ 283,678 267,780
Deferred income taxes and other....................... 10,233 1,155
-------- --------
Total liabilities................................. 351,157 337,137
Shareholders' Equity
Common stock, $.01 par value........................ 604 598
Additional paid-in capital.......................... 51,561 47,907
Accumulated other comprehensive income.............. 1,660 (8,316)
Treasury stock...................................... (27,029) (189)
Retained earnings................................... 30,391 9,258
-------- --------
Total shareholders' equity........................ 57,187 49,258
-------- --------
Total liabilities & shareholders' equity.......... $408,344 $386,395
======== ========
</TABLE>

The accompanying notes are an integral part of these consolidated balance
sheets.

F-21
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
------------------
1998 1997
-------- --------
(UNAUDITED)
<S> <C> <C>
Revenues
Royalty fees.............................................. $ 50,058 $ 45,171
Product sales............................................. 12,374 11,900
Initial franchise fees and relicensing fees............... 7,649 8,831
Other, including partner service revenue.................. 6,427 7,198
European hotel operations................................. 1,098 8,588
-------- --------
Total revenues.......................................... 77,606 81,688
-------- --------
Operating expenses
Selling, general and administrative....................... 23,664 24,681
Product cost of sales..................................... 11,608 11,346
Depreciation and amortization............................. 3,550 5,262
European hotel operations................................. 1,133 7,889
-------- --------
Total operating expenses................................ 39,955 49,178
-------- --------
Operating Income............................................ 37,651 32,510
Other
Interest expense.......................................... 9,583 5,008
Interest and dividend income.............................. (5,960) --
Gain from sale of investments............................. (2,190) --
-------- --------
Total other............................................. 1,433 5,008
-------- --------
Income before income taxes.................................. 36,218 27,502
Income taxes................................................ 15,085 11,455
-------- --------
Net income.................................................. $ 21,133 $ 16,047
======== ========
Weighted average shares outstanding......................... 59,522 62,674
======== ========
Diluted shares outstanding.................................. 60,757 62,674
======== ========
Basic earnings per share.................................... $ 0.36 $ 0.26
======== ========
Diluted earnings per share.................................. $ 0.35 $ 0.26
======== ========
</TABLE>

The accompanying notes are an integral part of these consolidated statements of
income.

F-22
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
-------------------
JUNE 30, JUNE 30,
1998 1997
--------- --------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 21,133 $ 16,047
Reconciliation of net income to net cash provided by
operating activities:
Depreciation and amortization........................... 5,653 5,262
Provision for bad debts................................. 553 486
Increase in deferred taxes and other.................... 2,211 3,179
Non cash interest and dividend income................... (5,943) --
Changes in assets and liabilities:
Change in receivables................................... 926 3,700
Change in inventories and other current assets.......... (1,713) 542
Change in current liabilities........................... (6,513) (1,414)
Change in income taxes payable.......................... 747 2,014
--------- --------
Net cash provided by operating activities............... 17,054 29,816
--------- --------
Cash flow from investing activities:
Investment in property and equipment.................... (5,593) (6,515)
Repayments of Sunburst Hospitality advances, net........ 5,286 --
Other items, net........................................ (8,393) --
--------- --------
Net cash utilized by investing activities............... (8,700) (6,515)
--------- --------
Cash flow from financing activities:
Proceeds from long-term debt............................ 118,959 --
Repayment of long-term debt............................. (108,061) (21,775)
Purchase of treasury stock.............................. (26,840) --
Proceeds from issuance of common stock.................. 3,671 --
Transfers to Parent, net................................ -- (1,045)
--------- --------
Net cash utilized by financing activities............... (12,271) (22,820)
--------- --------
Net change in cash and cash equivalents................... (3,917) 481
Cash and cash equivalents, beginning of period............ 10,282 2,973
--------- --------
Cash and cash equivalents, end of period.................. $ 6,365 $ 3,454
========= ========
</TABLE>

The accompanying notes are an integral part of these consolidated statements of
cash flows.

F-23
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. The accompanying consolidated financial statements of Choice Hotels
International, Inc. (the "Company") and subsidiaries have been prepared by the
Company without audit. Certain information and footnote disclosures normally
included in financial statements presented in accordance with generally
accepted accounting principles have been condensed or omitted. The Company
believes the disclosures made are adequate to make the information presented
not misleading. The consolidated financial statements should be read in
conjunction with the consolidated financial statements for the stub year ended
December 31, 1997 and notes thereto included in the Company's Form 10-K, dated
March 31, 1998. In the opinion of management, all adjustments (which include
any normal recurring adjustments) considered necessary for a fair presentation
have been included. Interim results are not necessarily indicative of fiscal
year performance because of seasonal and short-term variations. All
intercompany transactions and balances between Choice Hotels International,
Inc. and its subsidiaries have been eliminated. Certain reclassifications have
been made to the prior year amounts to conform to current period presentation.

2. In January 1998, the Company completed a transaction with Friendly
Hotels, PLC ("Friendly") in which Friendly assumed the master franchise rights
for Choice's Comfort, Quality and Clarion brand hotels throughout Europe (with
the exception of Scandinavia) for the next 10 years. In exchange, the Company
will receive from Friendly $8.0 million, payable in eight equal annual
installments.

As part of the transaction, Friendly acquired European hotels currently
owned by the Company for a total consideration of approximately $26.2 million
in convertible preferred shares and cash. In exchange for 10 hotels in France,
two in Germany and one in the United Kingdom, the Company received $22.2
million in new unlisted 5.75 percent convertible preferred shares in Friendly
at par, convertible into one new Friendly ordinary share for every 150p
nominal of the preferred convertible shares. In addition, Friendly will pay
the Company deferred compensation of $4.0 million in cash, payable by the
fifth anniversary of completion or sooner dependent on the level of future
profits of the hotels acquired. The European hotels included in this
transaction have a carrying value, which includes a cumulative translation
adjustment of $(6.6) million, totaling approximately $19.9 million. The
Company had a gain on the sale of $2.0 million which has been deferred and is
presented net of the Investment in Friendly Hotels, PLC in the accompanying
consolidated balance sheets.

3. In May 1998, the Company consummated a $100 million senior unsecured note
offering (the "Notes"), bearing a coupon rate of 7.125%. The Notes will mature
on May 1, 2008, with interest on the Notes to be paid semi-annually. The
Company has used the net proceeds from the offering of approximately $99
million to repay amounts outstanding under the Company's $300 million
revolving credit facility.

4. During the six months ended June 30, 1998, the Company's comprehensive
income (consisting of net income plus foreign currency translation
adjustments) exceeded net income by approximately $3 million.

5. During the second quarter of 1998, the Company changed its presentation
of marketing and reservation fees such that the fees collected and associated
expenses are reported on a net basis. The Company's franchise agreements
require the payment of franchise fees which include marketing and reservation
fees. These fees, which are based on a percentage of the franchisees' gross
room revenues, are used exclusively to reimburse the Company for expenses
associated with providing such franchise services as central reservation
systems, national marketing, and media advertising. The Company is
contractually obligated to expend the reservation and marketing fees it
collects from franchisees in accordance with the franchise agreements; as such
no income or loss to the Company is generated. All prior periods have been
restated to conform to the new presentation.

The total marketing and reservation fees received by the Company (previously
reported as revenue) were $56.7 million and $43.8 million for the six months
ended June 30, 1998 and June 30, 1997, respectively.

F-24
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Depreciation and amortization charged to reservation and marketing expenses
was $2.2 million and $1.2 million for the six months ending June 30, 1998 and
June 30, 1997, respectively. Reservation fees and marketing fees not expended
in the current year are carried over to the next fiscal year and expended in
accordance with the franchise agreements. Shortfall amounts are similarly
recovered in subsequent years. Excess or shortfall amounts from the operation
of these programs are recorded as a payable or receivable from the particular
fund. The shortfall amount recorded as a current receivable in other assets on
the Company's balance sheet was $7.2 million and $1.7 million at June 30, 1998
and December 31, 1997, respectively.

F-25
<PAGE>

CHOICE HOTELS INTERNATIONAL, INC.

Until January 18, 1999, all dealers that effect transactions in these
securities, whether or not participating in this offering, may be required to
deliver a prospectus. This is in addition to the dealers' obligation to
deliver a prospectus when acting as underwriters and with respect to their
unsold allotments or other subscriptions. All tendered Original Notes,
executed Letters of Transmittal, and other related documents should be
directed to the Exchange Agent. Requests for assistance and for additional
copies of the Prospectus, the Letter of Transmittal and other related
documents should be directed to the Exchange Agent.

THE EXCHANGE AGENT FOR THE EXCHANGE OFFER IS

MARINE MIDLAND BANK

by Facsimile:
(212) 658-2292
Attention: Corporate Trust Services

Confirm by telephone
(212) 658-5931

By Registered or Certified Mail:
Marine Midland Bank
140 Broadway
Level A
New York, New York 10005-1180
Attention: Corporate Trust Services

By Hand
Marine Midland Bank
140 Broadway
Level A
New York, New York 10005-1180
Attention: Corporate Trust Services

By Overnight Courier:
Marine Midland Bank
140 Broadway
Level A
New York, New York 10005-1180
Attention: Corporate Trust Services
(212) 658-5931