US FRANCHISE SYSTEMS INC/, 10-Q, 2000-08-14

US FRANCHISE SYSTEMS INC/
10-Q, 2000-08-14
HOTELS & MOTELS

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
------------------------

FORM 10-Q

<TABLE>
<C> <S>
(MARK ONE)
/X/ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2000
OR

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from to
</TABLE>

Commission file number 0-23941

------------------------

U.S. FRANCHISE SYSTEMS, INC.

(Exact Name of Registrant as Specified in its Charter)

<TABLE>
<CAPTION>
DELAWARE 58-2361501
<S> <C>
(State or other jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

13 CORPORATE SQUARE, SUITE 250 30329
Atlanta, Georgia(Address of Principal Executive Offices) (Zip Code)
</TABLE>

Registrant's telephone number, including area code: (404) 321-4045

------------------------

Indicate by check mark whether the registrant: (1) has filed all reports
required by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /

There were 17,245,834 shares of the registrant's Class A Common Stock and
2,707,919 shares of the registrant's Class B Common Stock outstanding as of
August 1, 2000.

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<PAGE>
U.S. FRANCHISE SYSTEMS, INC.
INDEX

<TABLE>
<CAPTION>
PAGE
--------
<S> <C> <C>
PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Consolidated Statements of Financial Position at June 30,
2000 (Unaudited) and December 31, 1999...................... 3

Consolidated Statements of Operations for the three and six
months ended June 30, 2000 and June 30, 1999 (Unaudited).... 4

Consolidated Statements of Cash Flows for the six months
ended June 30, 2000 and June 30, 1999 (Unaudited)........... 5

Notes to Consolidated Financial Statements (Unaudited)...... 6

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................... 10

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK................................................. 24

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS........................................... 24

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS................... 25

ITEM 3. DEFAULTS UPON SENIOR SECURITIES............................. 25

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 25

ITEM 5. OTHER INFORMATION........................................... 25

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................ 25

SIGNATURES.................................................. 27

EXHIBIT INDEX............................................... 28
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (UNAUDITED)

<TABLE>
<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
------------- -----------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and temporary cash investments....................... $ 2,418,000 $ 6,332,000
Accounts receivable....................................... 3,025,000 2,084,000
Deposits and prepaid expenses............................. 214,000 522,000
Promissory notes receivable............................... 1,612,000 1,898,000
Net current asset from discontinued operation............. -- 135,000
Deferred commissions...................................... 3,099,000 2,564,000
----------- -----------
TOTAL CURRENT ASSETS.................................... 10,368,000 13,535,000

PROMISSORY NOTES RECEIVABLE................................. 12,136,000 12,259,000
PROPERTY AND EQUIPMENT-Net.................................. 1,991,000 1,864,000
FRANCHISE RIGHTS-Net........................................ 24,235,000 24,691,000
DEFERRED COMMISSIONS........................................ 6,088,000 6,525,000
DEVELOPMENT SUBSIDIES....................................... 12,462,000 10,837,000
NET LONG-TERM ASSET FROM DISCONTINUED OPERATIONS............ -- 393,000
OTHER ASSETS-Net............................................ 1,322,000 491,000
----------- -----------
TOTAL ASSETS............................................ $68,602,000 $70,595,000
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 483,000 $ 218,000
Commissions payable....................................... 655,000 1,516,000
Deferred application fees................................. 3,203,000 3,686,000
Accrued expenses.......................................... 3,380,000 1,767,000
Net current liability from discontinued operations........ 163,000 --
----------- -----------
TOTAL CURRENT LIABILITIES............................... 7,884,000 7,187,000
DEFERRED APPLICATION FEES................................... 6,852,000 6,570,000
----------- -----------
TOTAL LIABILITIES....................................... 14,736,000 13,757,000

REDEEMABLE STOCK:
Common shares, par value $0.01 per share; issued and
outstanding 3,128,473 (net of 58,807 shares in Treasury at
June 30, 2000 and December 31, 1999) entitled to
redemption under certain circumstances at $324,000 (net of
$6,000 in Treasury) as of June 30, 2000 and December 31,
1999...................................................... 324,000 324,000
STOCKHOLDERS' EQUITY:
Common shares, par value $0.01 per share; authorized
30,000,000 shares of Class A Common Stock and 5,000,000
shares of Class B Common Stock; issued and outstanding
14,117,361 Class A shares and 2,707,919 Class B shares at
June 30, 2000; issued and outstanding 14,063,496 Class A
shares and 2,707,919 Class B shares at December 31,
1999...................................................... 167,000 167,000
Change in unrealized loss on equity securities............ (27,000)
Capital in excess of par.................................. 90,854,000 90,293,000
Accumulated deficit....................................... (37,452,000) (33,946,000)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY................................ 53,542,000 56,514,000
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................. $68,602,000 $70,595,000
=========== ===========
</TABLE>

See notes to consolidated financial statements.

2
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

<TABLE>
<CAPTION>
THREE THREE
MONTHS MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2000 JUNE 30, 1999 JUNE 30, 2000 JUNE 30, 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Royalty and other fee income............. $ 4,762,000 $2,908,000 $ 8,269,000 $5,015,000
Franchise application fees............... 1,519,000 1,362,000 2,437,000 1,978,000
----------- ---------- ----------- ----------
6,281,000 4,270,000 10,706,000 6,993,000
EXPENSES:
General and administrative............... 5,874,000 2,081,000 9,186,000 4,196,000
Franchise sales commissions.............. 1,457,000 1,204,000 2,261,000 1,863,000
Depreciation and amortization............ 751,000 349,000 1,170,000 673,000
Interest income.......................... (195,000) (788,000) (401,000) (1,534,000)
----------- ---------- ----------- ----------
INCOME (LOSS)FROM CONTINUING OPERATIONS
BEFORE TAXES............................. (1,606,000) 1,424,000 (1,510,000) 1,795,000
Income taxes............................. 19,000 86,000 19,000 86,000
----------- ---------- ----------- ----------
INCOME (LOSS) FROM CONTINUING OPERATIONS... (1,625,000) 1,338,000 (1,529,000) 1,709,000
DISCONTINUED OPERATIONS(NOTE 10):
Income (loss) from operations of
discontinued management services (less
income taxes of $1,000)................ (828,000) 175,000 (1,279,000) 309,000
Loss on disposal (less income taxes of
$0).................................... (698,000) 0 (698,000) 0
----------- ---------- ----------- ----------
Net income after taxes..................... $(3,151,000) $1,513,000 $(3,506,000) $2,018,000
=========== ========== =========== ==========
Weighted average number of common shares
outstanding.............................. 19,953,753 19,880,326 19,944,162 19,877,719
=========== ========== =========== ==========
Weighted average number of common shares
outstanding, assuming dilution........... 20,044,600 20,041,993
Earnings (loss) per share from continuing
operations--Basic........................ $ (0.08) $ 0.07 $ (0.08) $ 0.09
Earnings (loss) per share from discontinued
operations--Basic........................ $ (0.08) $ 0.01 $ (0.10) $ 0.01
----------- ---------- ----------- ----------
Net Earnings (loss) per share--Basic....... $ (0.16) $ 0.08 $ (0.18) $ 0.10
Earnings per share from continuing
operations--Diluted...................... $ 0.07 $ 0.09
Earnings per share from discontinued
operations--Diluted...................... $ 0.01 $ 0.01
---------- ----------
Net Earnings per share--Diluted............ $ 0.08 $ 0.10
</TABLE>

See Notes to Consolidated Financial Statements.

3
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 2000 JUNE 30, 1999
------------- -------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income/(loss) after tax............................... $(3,506,000) $ 2,018,000
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization........................... 1,170,000 673,000
Deferred compensation amortization...................... 293,000 236,000
Changes in assets and liabilities:
Increase in accounts receivable, prepaid expenses &
deposits.............................................. (633,000) (913,000)
Decrease/(increase) in promissory notes receivable...... 409,000 (3,043,000)
Increase in deferred commissions........................ (98,000) (1,157,000)
Decrease/(increase) in other assets..................... (748,000) 141,000
Increase in accounts payable............................ 265,000 110,000
Increase in accrued expenses............................ 1,613,000 2,000
Decrease in commissions payable......................... (861,000) (382,000)
(Decrease)/increase in deferred application fees........ (201,000) 575,000
Gain on sale of land.................................... -- (155,000)
(Decrease)/increase from discontinued operations........ 597,000 (269,000)
----------- -----------
NET CASH USED IN OPERATING ACTIVITIES................... (1,700,000) (2,164,000)
----------- -----------
INVESTING ACTIVITIES:
Acquisition of property and equipment..................... (292,000) (93,000)
Issuance of development subsidies......................... (1,947,000) (8,894,000)
Proceeds from sale of property............................ -- 809,000
Acquisition of franchise rights........................... -- (2,000)
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES................... (2,239,000) (8,180,000)
FINANCING ACTIVITIES:
Exercise of stock options................................. 25,000 154,000
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALANTS................... (3,914,000) (10,190,000)
CASH AND TEMPORARY INVESTMENTS
Beginning of period....................................... 6,332,000 15,642,000
----------- -----------
End of period............................................. $ 2,418,000 $ 5,452,000
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASHFLOW INFORMATION:
Non-cash activities:
Issuance of 48,290 shares of common stock as a form of
development subsidy....................................... $ (220,000)
Receipt of stock in exchange for master license agreement... $ 220,000
Unrealized loss on securities held for sale................. $ (27,000)
</TABLE>

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

4
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying unaudited financial statements have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission for
reporting on Form 10-Q. Accordingly, certain information and footnotes required
by generally accepted accounting principles for complete financial statements
have been omitted. In the opinion of management, all adjustments, consisting of
normal recurring adjustments, which are necessary for a fair presentation of
financial position and results of operations, have been made. These interim
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto presented in the U.S. Franchise
Systems, Inc. ("USFS" or the "Company") Annual Report on Form 10-K as amended by
Form 10 K/A filed April 28, 2000 for the year ended December 31, 1999, filed
with the Securities and Exchange Commission. The results of operations for the
six months ended June 30, 2000 are not necessarily indicative of results that
may be expected for the full year.

2. RECLASSIFICATIONS

Certain amounts in the June 30, 2000 Statement of Financial Position,
Statement of Operations and Consolidated Statement of Cash Flows have been
reclassified to conform to current year classifications.

3. ACCOUNTING CHANGES

In 1999, the Securities and Exchange Commission's staff issued Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Instruments." SAB No. 101 provides guidance on revenue recognition. The Company
is currently evaluating the impact of SAB 101 on current revenue recognition
policies.

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement, which is effective for the
year beginning January 1, 2001, establishes accounting and reporting standards
for derivative instruments and for hedging activities. SFAS No. 133 requires a
company to recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair market
value. Management is evaluating the impact this statement may have on the
Company's financial statements.

4. EARNINGS PER SHARE

Basic earnings per common share are computed using the weighted average
number of common shares outstanding during the period. A diluted earnings per
common share incorporates the incremental shares issuable upon the assumed
exercise of stock options.

5
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

5. STOCK OPTION PLANS

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions:

<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
30-JUNE-00 30-JUNE-99 30-JUNE-00 30-JUNE-99
------------ ------------ ---------- ----------
<S> <C> <C> <C> <C>
NEW STOCK OPTION GRANTS
Expected life(years)........................... 4.3 4.3 4.0 3.6
Expected volatility............................ 44.3% 36.6% 44% 34.8%
Risk free interest rate........................ 6% 6% 6% 5.9%
Dividend yield................................. 0% 0% 0% 0%
Number of options granted...................... 18,000 73,550 189,450 277,100
Weighted average exercise price................ 4.55 19.25 4.78 11.77
FORFEITURES AND EXERCISES:
Number of options forfeited.................... 11,250 24,175 32,225 38,675
Number of options exercised.................... 0 15,625 5,575 15,625
Stock option expense........................... $142,000 $87,000 $235,000 $175,000
</TABLE>

6. SEGMENT REPORTING

The Company owns three hotel brands primarily in the United States.
Other/Corporate represents overhead and assets not specifically allocable to the
brands. Revenues, expenses and capital expenditures directly attributable to
each business segment are reflected as such and are shown below. Common expenses
and common capital expenditures are classified in Other/Corporate. The Best
franchising business segment Net income (loss) from operations for the three and
six months ended June 30, 2000 include a contract termination payment of
$2,405,000 for the release of certain obligations of the Company to a multi-unit
franchisee unrelated to franchise agreements. The results of operations from the
discontinued management services business have been excluded from the segment
report.

THREE MONTHS ENDED JUNE 30, 2000

<TABLE>
<CAPTION>
MICROTEL HAWTHORN BEST OTHER/ CORPORATE CONSOLIDATED
---------- ---------- ----------- ---------------- ------------
<S> <C> <C> <C> <C> <C>
REVENUE
June 30, 2000................. $1,682,000 $3,313,000 $ 1,286,000 $ 0 $ 6,281,000
June 30, 1999................. 1,820,000 1,595,000 855,000 0 4,270,000
NET INCOME (LOSS) FROM
OPERATIONS
June 30, 2000................. $ 879,000 $2,308,000 $(1,973,000) $(2,839,000) $(1,625,000)
June 30, 1999................. 1,229,000 1,186,000 1,045,000 (2,122,000) 1,338,000
CAPITAL EXPENDITURES
June 30, 2000................. $ 0 $ 0 $ 196,000 $ 64,000 $ 260,000
June 30, 1999................. 10,000 0 0 57,000 67,000
</TABLE>

6
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

6. SEGMENT REPORTING (CONTINUED)
SIX MONTHS ENDED JUNE 30, 2000

<TABLE>
<CAPTION>
MICROTEL HAWTHORN BEST OTHER/ CORPORATE CONSOLIDATED
---------- ---------- ----------- ---------------- ------------
<S> <C> <C> <C> <C> <C>
REVENUE
June 30, 2000................. $3,180,000 $5,353,000 $ 2,173,000 $ 0 $10,706,000
June 30, 1999................. 2,918,000 2,644,000 1,431,000 0 6,993,000
NET INCOME (LOSS) FROM
OPERATIONS
June 30, 2000................. $2,161,000 $3,849,000 $(1,389,000) $(6,150,000) $(1,529,000)
June 30, 1999................. 1,999,000 2,052,000 1,860,000 (4,202,000) 1,709,000
CAPITAL EXPENDITURES
June 30, 2000................. $ 2,000 $ 1,000 $ 198,000 $ 91,000 $ 292,000
June 30, 1999................. 10,000 0 0 83,000 93,000
</TABLE>

7. COMMITMENTS AND CONTINGENCIES

The Company is currently in litigation with respect to certain financing
programs with Nomura Asset Capital Corporation under which the Company retained
an ongoing participation. Management has accrued and reserved approximately
$800,000 with respect to the termination of the loan program as of both
June 30, 2000 and December 31, 1999.

On April 11, 2000, the Company and certain subsidiaries settled a lawsuit
brought by the owner of nine Best Inn properties for alleged mismanagement under
management agreements that the Company assumed in connection with its 1998
acquisition of the Best Inns brand. USFS Management, Inc., a subsidiary of the
Company, had also filed a counterclaim alleging fraudulent conduct by the owner
and certain of his affiliates, which was also settled. In connection with the
settlement, during the second quarter of 2000 the Company paid approximately
$500,000 in settlement payments and related legal costs. Approximately $510,000
was accrued for such payments during the first quarter of 2000. The franchise
agreements with the owner of the properties remain in effect.

On May 18, 2000, a purported class action lawsuit, FORREST P. GUNTHER V.
U.S. FRANCHISE SYSTEMS, INC., MICHAEL A. LEVEN, NEAL K. ARONSON AND RICHARD D.
GOLDSTEIN, CASE NO. 00-CV-1244 (the "Class Action Lawsuit"), was brought in the
United States District Court for the Northern District of Georgia, Atlanta
Division. The named plaintiff in this lawsuit claims to represent all purchasers
of the Class A Common Stock during the period from May 6, 1999 through
October 29, 1999 and seeks unspecified damages on their behalf. The named
plaintiff alleges, among other things, that the Company and the individual
defendants violated federal securities laws by concealing adverse material
information about the business, business practices, performance, operations and
future prospects of the Company. The Company believes that the allegations are
without merit and intends to defend this action vigorously.

On June 29, 2000, the Company and certain subsidiaries settled a lawsuit
relating to its management company operations, which was brought by two former
employees alleging wrongful termination. The Company and certain of its
subsidiaries had also filed a counterclaim in this action which was also
settled. In connection with the settlement in the second quarter of 2000, the
Company made aggregate settlement payments of $215,000 to its two former
employees (including reimbursement of legal fees), without any admission of
wrongdoing.

7
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

7. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In addition, the Company is subject to litigation in the ordinary course of
its business. In the opinion of management, the outcome of such litigation will
not have a material impact of the earnings, financial position or cash flow of
the Company.

8. RECAPITALIZATION AGREEMENT

On June 2, 2000, the Company entered into a Recapitalization Agreement (the
"Recapitalization Agreement") with SDI, Inc. ("SDI" and together with its
affiliated designees, the "Investors"), Meridian Associates, L.P. ("Meridian")
and HSA Properties, Inc. ("HSA"). Under the Recapitalization Agreement USFS has
agreed to issue and sell to the Investors (1) 65,000 shares of its Series A 8.5%
Cumulative Redeemable Preferred Stock (the "A Preferred Stock") and (2) 10,000
shares of its Series B 6.0% Cumulative Redeemable Convertible/Exchangeable
Preferred Stock (the "B Preferred Stock" and together with the A Preferred Stock
collectively, the "Preferred Stock") for an aggregate purchase price of
$75,000,000 (the "Investment"). The Investors, Meridian and HSA, all of which
are parties to the Recapitalization Agreement, are controlled by Pritzker family
business interests.

Under the terms of the Recapitalization Agreement, USFS will use up to
$65,000,000 of the gross proceeds from the issuance and sale of the Preferred
Stock to complete an offer to purchase up to an aggregate of 8,666,666, but not
less than 3,000,000, shares of its Class A Common Stock, par value $0.01 per
share (the "Class A Common Stock") and Class B Common Stock, $0.01 par value per
share (the "Class B Common Stock" and collectively with the Class A Common
Stock, the "Common Stock"), at a purchase price of $7.50 per share (the
"Offer"). Of the remaining $10,000,000 of gross proceeds, the Company estimates
that approximately $6,308,000 will be used to pay various expenses relating to
the Offer, the Investment and related matters.

The completion of the Investment is subject to a number of conditions,
including without limitation, (1) approval by the Company's stockholders of the
Company's issuance and sale of the Preferred Stock and the Company's issuance of
Class A Common Stock upon the potential conversion/exchange of the B Preferred
Stock and certain amendments to the Company's Certificate of Incorporation and
(2) the consummation of the Offer. If the stockholders do not approve these
matters, or if the other conditions are not satisfied, the Company will be
unable to consummate the Offer or the Investment. The Company would be obligated
to reimburse the Investors under certain circumstances for their reasonable
legal and other fees, not to exceed $1,000,000. Also, if the Company were to
enter into an agreement for a Superior Proposal (as defined in the
Recapitalization Agreement), it would be obligated to pay the Investors
$3,000,000.

8
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

9. MARKETABLE EQUITY INVESTMENTS

The Company classifies its marketable equity securities as
available-for-sale in accordance with the provisions of SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." Marketable
equity securities classified as available-for-sale are carried at fair market
value, with the unrealized gains and losses, net of tax, reported in
shareholders equity.

Available-for-sale investments as of June 30, 2000 had an original cost of
$220,000, with unrealized holding loss of $27,000 determined on the specific
identification method. There were no available-for-sale investments as of
December 31, 1999.

10. DISCONTINUED OPERATIONS

In the second quarter of 2000, the Company determined to cease providing
management services to hotel properties except with respect to one hotel. The
Company's twenty other remaining management contracts were terminated in June
with management of the majority of the properties ceasing as of June 2, 2000.
The management services operations have been classified as discontinued
operations for the three and six months ended June 30, 2000 and prior periods
have been restated in the Consolidated Statement of Operations.

Loss on disposal of discontinued operations reflects management's best
estimates of the amounts expected to be incurred in connection with
discontinuing the management services business. The actual amounts that the
Company will incur could materially differ from the estimated amounts reflected
in the loss on disposal of the discontinued operations.

Revenues, income/(loss) from discontinued operations, and loss on disposal
are as follows:

<TABLE>
<CAPTION>
THREE THREE
MONTHS MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2000 JUNE 30, 1999 JUNE 30, 2000 JUNE 30, 1999
------------- ------------- ------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Management services revenues............... $ 137,000 $ 480,000 $ 504,000 $933,000
Operating income........................... (827,000) 176,000 (1,278,000) 310,000
Income tax expense......................... 1,000 1,000 1,000 1,000
--------- --------- ----------- --------
Income (loss) from discontinued
operations............................... $(828,000) $175,0000 $(1,279,000) $309,000
========= ========= =========== ========
Loss on disposal........................... $(698,000) $ 0 $ (698,000) $ 0
========= ========= =========== ========
</TABLE>

11. OTHER SIGNIFICANT EVENTS

On June 2, 2000, the Company entered into certain agreements terminating the
management agreement and certain of the Company's related obligations (but not
the franchise agreements) relating to the 17 Best Inn properties owned by a
subsidiary of Alpine Hospitality Ventures LLC. In connection with these
termination agreements, the Company agreed to make a $2.5 million payment, one
half of which was paid in cash and the other half of which is to be paid through
the issuance of a 5% promissory note that matures on the earlier of October 2,
2000 or the closing of the recapitalization transactions.

9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

GENERAL

This "Management's Discussion and Analysis of Financial Condition and
Results of Operations" should be read in conjunction with the consolidated
financial statements included herein of the Company and its subsidiaries.
Certain statements under this caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" constitute "forward-looking
statements" under the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"). Certain, but not necessarily all, of such forward-looking
statements can be identified by the use of forward-looking terminology such as
"believes," "expects," "may," "will," "should," or "anticipates" or the negative
thereof or other variations thereon or comparable terminology, or by discussions
of strategy that involve risks and uncertainties. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
which may cause the actual results, performance or achievements of the Company
and its subsidiaries to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements. Such factors include, but are not limited to, the following: general
economic and business conditions; aggressive competition in the lodging and
franchising industries; success of acquisitions and operating initiatives;
management of growth; risks relating to the Company's loans to and other
investments in franchisees; dependence on senior management; brand awareness;
general risks of the lodging and franchising industries; development risk and
construction; risk relating to the availability of financing for franchisees;
the existence or absence of adverse publicity; changes in business strategy or
development plan; availability, terms and deployment of capital; business
abilities and judgment of personnel; availability of qualified personnel; labor
and employee benefit costs; changes in, or failure to comply with, government
regulations; construction schedules; the outcome of a purported class action
lawsuit pending against the Company; and the costs and other effects of legal
and administrative proceedings and other factors referenced below under the
sub-heading "Risk Factors" in this Form 10-Q. The Company will not undertake and
specifically declines any obligation to publicly release the results of any
revisions which may be made to any forward-looking statement to reflect events
or circumstances after the date of such statements or to reflect the occurrence
of anticipated or unanticipated events. In addition, there can be no assurance
that the transactions under the Recapitalization Agreement described below will
be completed on the terms contemplated or at all, or if completed, that the
Company will experience the benefits that it expects from its relationship with
the Pritzker family business interests. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations--Risk Factors".

The Company was formed to acquire, market and service well-positioned brands
with potential for rapid unit growth through franchising. The Company's brands,
which are in the lodging industry, are Microtel Inn & Suites, Hawthorn and Best
Inn & Suites. The Company acquired the rights to these brands because of their
potential for significant growth, which reflects, among other things, their
potential profitability for franchisees at the property level and their
positions in attractive segments of the lodging industry. Microtel primarily
competes in the budget and economy segments, Hawthorn primarily in the upscale
and mid-market segments, and Best primarily in the mid-market and economy
segments of the lodging industry. Until June 2000, the Company operated a
management services business that managed certain properties on behalf of
franchisees (although the Company continues to manage one hotel property).

As a franchisor, the Company licenses the use of its brand names to
independent hotel owners and operators (i.e. franchisees). The Company provides
its franchisees with a variety of benefits and services designed to
(i) decrease development costs, (ii) shorten the time frame and reduce the
complexity of the construction process and (iii) increase the occupancy rates,
revenues and profitability of the franchised properties. The Company offers
prospective franchisees a business format, design and construction assistance
(including architectural plans), quality standards, training programs, national
reservations systems, national and local advertising and promotional campaigns
and volume purchasing discounts.

10
<PAGE>
The Company expects that its future revenues will consist primarily of
(i) franchise royalty fees, (ii) franchise application fees, and (iii) payments
made by vendors who supply the Company's franchisees with various products and
services. The Company recognizes franchise application fees as revenue only upon
the opening of the underlying hotels.

The Company's predecessor was incorporated in Delaware in August 1995. The
Company was incorporated in Delaware on November 26, 1997 and merged with its
predecessor on March 12, 1998 with the Company as the surviving corporation. The
Company's executive offices are located at 13 Corporate Square, Suite 250,
Atlanta, Georgia 30329 and its telephone number is (404) 321-4045.

RECAPITALIZATION TRANSACTIONS

On June 2, 2000, the Company entered into a Recapitalization Agreement (the
"Recapitalization Agreement") with SDI, Inc. ("SDI" and together with its
affiliated designees, the "Investors"); Meridian Associates, L.P. ("Meridian")
and HSA Properties, Inc. ("HSA"). Under the Recapitalization Agreement USFS has
agreed to issue and sell to the Investors (1) 65,000 shares of its Series A 8.5%
Cumulative Redeemable Preferred Stock (the "A Preferred Stock") and (2) 10,000
shares of its Series B 6.0% Cumulative Redeemable Convertible/Exchangeable
Preferred Stock (the "B Preferred Stock" and together with the A Preferred Stock
collectively, the "Preferred Stock") for an aggregate purchase price of
$75,000,000 (the "Investment"). The Investors, Meridian and HSA, all of which
are parties to the Recapitalization Agreement, are controlled by Pritzker family
business interests. Pritzker family business interests include, among other
ventures, Hyatt Corporation and Hyatt International Corporation, and have
significant experience in the hospitality industry. However, there can be no
assurance that the personnel assets or assets of these or other Pritzker family
business interests will be available to the Company.

Immediately following completion of the transactions contemplated by the
Recapitalization Agreement, and assuming 8,666,666 shares of Common Stock are
purchased in the Offer, the Investors, Meridian and HSA would own approximately
42.9% of the voting power of the Company's capital stock. In connection with the
Recapitalization Agreement, Michael Leven, the Company's Chairman and Chief
Executive Officer, and his family, and Steven Romaniello, the Company's
President and Chief Operating Officer, have entered into a Stockholders
Agreement with the Investors, Meridian and HSA. Under the Stockholders
Agreement, the Investors will be entitled to designate a majority of the
Company's Board of Directors. This ability to control the Board of Directors and
the Investors' voting power will give the Investors the ability to control the
business, corporate actions and management of the Company. This could
(1) result in the Investors taking actions with respect to the Company with
which other stockholders disagree, and/or (2) delay, defer or prevent tender
offers or takeover attempts that other stockholders of the Company consider to
be in their best interest and adversely affect the price that investors might be
willing to pay in the future for shares of Class A Common Stock.

The Company expects to complete the recapitalization transactions in the
third or fourth quarter of 2000. The completion of the Investment, however, is
subject to a number of conditions, including without limitation, (1) approval by
the Company's stockholders of the Company's issuance and sale of the Preferred
Stock and the Company's issuance of Class A Common Stock upon the potential
conversion/ exchange of the B Preferred Stock and certain amendments to the
Company's Certificate of Incorporation

11
<PAGE>
and (2) the consummation of the Offer. If the stockholders do not approve these
matters, or if the other conditions are not satisfied, the Company will be
unable to consummate the Offer or the Investment. In that event, the Company
will attempt to seek other alternatives to maximize stockholder value. However,
such alternatives have not been identified and may not be available. The Company
would also be obligated, under certain circumstances, to reimburse the Investors
for their reasonable legal and other fees, not to exceed $1,000,000. Also, if
the Company were to enter into an agreement for a Superior Proposal (as defined
in the Recapitalization Agreement), it would be obligated to pay the Investors
$3,000,000.

OTHER RECENT DEVELOPMENTS

In the second quarter of 2000, the Company determined to cease providing
management services to hotel properties except with respect to one hotel. On
June 2, 2000, the Company entered into certain agreements terminating the
management agreement and certain of the Company's related obligations (but not
the franchise agreements) relating to the 17 Best Inn properties owned by a
subsidiary of Alpine Hospitality Ventures LLC. In connection with these
termination agreements, the Company agreed to make a $2.5 million payment, one
half of which was paid in cash and the other half of which is to be paid through
the issuance of a 5% promissory note that matures on the earlier of October 2,
2000 or the closing of the recapitalization transactions. In addition, during
the second quarter the Company terminated three of its other management
contracts (leaving the Company with one remaining management contract).

RESULTS OF OPERATIONS

The Company believes that it continues to feel the effects of the more
difficult and competitive environment in the hotel franchising business, as well
as of the effects of the disruption to the Company's business caused by the
Company's assessment of strategic alternatives and its decision to complete the
recapitalization transactions. For the three and six months ended June 30, 2000
as compared to the same periods in 1999, accepted applications, executed
contracts and hotel openings have declined. In addition, the number of
terminations of open hotels and the number of executed but not open hotels have
increased and the Company's overall blended royalty rate ramp up has not
occurred as quickly as expected. To the extent that the difficult environment
being encountered by the Company continues through 2000, the Company's revenues
and profitability could be adversely affected and all or a portion of the
Company's remaining loan portfolio to the franchisees and the marketing funds
could become impaired.

Comparisons have been made between the three and six months ended June 30,
2000 and the three and six months ended June 30, 1999 for the purposes of the
following discussion.

FRANCHISE SALES DATA --During the first half of 2000, the Company
implemented a comprehensive franchisee compliance program and restructured its
sales force. The initiatives were undertaken to enable the company to more
effectively evaluate and, if necessary, terminate the license agreements of
non-complying hotels, thereby "opening up" the related territory to new
prospective franchisees. The program evaluates hotels in development and open
hotels to ensure such hotels conform to the license agreements in terms of
opening milestones, quality standards, and financial obligations. Additionally,
the Company has begun to more stringently monitor the progress of franchisees
converting accepted applications into executed license agreements and has more
aggressively terminated accepted applications that have not progressed as
required. In part as a result of the adoption of these stricter measures, the
number of hotels in development (including the number of accepted applications)
at June 30, 2000 may not be directly comparable to prior year numbers.

12
<PAGE>
The Company has realized Microtel franchise sales as follows:

FRANCHISE SALES DATA

<TABLE>
<CAPTION>
AS OF JUNE 30,
-----------------------
MICROTEL FRANCHISE DATA 2000 1999
----------------------- -------- --------
<S> <C> <C>
Properties open(1)........................................ 196 159
Executed agreements and under construction................ 58 53
Executed franchise agreements but not under
construction............................................ 237 262
Accepted applications..................................... 26 86
--- ---
Total in development and accepted applications(2)........... 321 401
--- ---
OPEN PLUS IN DEVELOPMENT AND ACCEPTED APPLICATIONS.......... 517 560
=== ===
</TABLE>

------------------------

(1) The Company does not receive royalties from 27 hotels open as of June 30,
2000. During the three months ended June 30, 2000, three previously opened
hotels ceased operating as a Microtel.

(2) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels. Since the
Microtel brand was acquired by the Company, approximately 37% of accepted
applications did not become executed agreements and approximately 41% of
executed agreements terminated before resulting in open hotels. See "Risk
Factors-Dependence on, and Obstacles to, Hotel Openings."

During the second quarter 2000, for Microtel hotels open one year or more,
average daily rate, occupancy and revenue per available room ("Rev Par") were
$47.68, 63% and $30.03 compared to $45.61, 62.6%, and $28.56 in the second
quarter 1999.

The Company has realized Hawthorn Suites franchise sales as follows:

<TABLE>
<CAPTION>
AS OF JUNE 30,
-----------------------
HAWTHORN SUITES FRANCHISE DATA 2000 1999
------------------------------ -------- --------
<S> <C> <C>
Properties open(1)........................................ 126 63
Executed agreements and under construction................ 32 39
Executed franchise agreements but not under
construction............................................ 125 126
Accepted applications..................................... 46 65
--- ---
Total in development and accepted applications(2)........... 203 230
--- ---
OPEN PLUS IN DEVELOPMENT AND ACCEPTED APPLICATIONS.......... 329 293
=== ===
</TABLE>

------------------------

(1) The Company does not receive royalties from 1 hotel open as of June 30,
2000. During the three months ended June 30, 2000, two previously opened
hotels ceased operating as a Hawthorn. Additionally, the franchisee of
multiple Hawthorn Suites properties has advised the Company that six of its
Hawthorn Suites properties are currently being held for sale. If these
properties are sold, it is possible that they may cease operating as
Hawthorn Suites properties.

(2) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels. Since the
Hawthorn brand was acquired by the Company, approximately 35% of accepted
applications did not become executed agreements and approximately 21% of
executed agreements terminated before resulting in open hotels. See "Risk
Factors-Dependence on, and Obstacles to, Hotel Openings."

13
<PAGE>
During the second quarter 2000, for properties in the Hawthorn system one
year or more, average daily rate, occupancy and Rev Par were $86.62, 73% and
$63.24 compared to $85.07, 66%, and $56.11 in second quarter 1999.

The Company has realized Best Inns franchise sales as follows:

<TABLE>
<CAPTION>
AS OF JUNE 30,
-----------------------
BEST INNS FRANCHISE DATA 2000 1999
------------------------ -------- --------
<S> <C> <C>
Properties open(1)........................................ 142 80
Executed agreements and under construction................ 26 24
Executed franchise agreements but not under
construction............................................ 28 36
Accepted applications..................................... 53 108
--- ---
Total in development and accepted applications(2)........... 107 168
--- ---
OPEN PLUS IN DEVELOPMENT AND ACCEPTED APPLICATIONS.......... 249 248
=== ===
</TABLE>

------------------------

(1) During the three months ended June 30, 2000, three previously opened hotels
ceased operating as a Best Inns. The franchisee of multiple Best Inns
properties has advised the Company that two of its Best Inns properties are
currently being held for sale. If these properties are sold, it is possible
that they may cease operating as Best Inns properties.

(2) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels. Since the Best
brand was acquired by the Company, approximately 66% of accepted
applications did not become executed agreements and approximately 5% of
executed agreements terminated before resulting in open hotels. See "Risk
Factors- Dependence on, and Obstacles to, Hotel Openings."

During the second quarter 2000, for properties in the Best Inns system one
year or more, average daily rate, occupancy and Rev Par were $51.78, 65.1% and
$33.71 compared to $50.24 65.8%, and $33.04 in second quarter 1999.

REVENUE--The Company has derived revenues from the following sources:

THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE MONTHS ENDED JUNE 30, 1999

Royalty and other fee income increased approximately $1,854,000 for the
three months ended June 30, 2000 as compared to the prior year's comparable
period. The increase is primarily attributable to (i) the increase in royalty
paying hotels from 273 to 436 ($1,837,000) and (ii) signing of an international
master license agreement ($220,000). The revenue increase was offset by a
$125,000 scheduled reduction (from $250,000 to $125,000) in the management fees
received from a development fund that is managed by the Company and was formed
to provide financing for franchisees (the "Constellation Development Fund").

Franchise application fees increased approximately $157,000 for the three
months ended June 30, 2000 as compared to the prior year's comparable period
primarily due to an increase in the number of

14
<PAGE>
license agreements terminated during the second quarter ($312,000), offset by a
decline in application fees on open hotels ($155,000).

SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999

Royalty and other fee income increased approximately $3,254,000 for the six
months ended June 30, 2000 as compared to the prior year's comparable period.
The increase is primarily attributable to (i) the increase in royalty paying
hotels from 273 to 476 ($3,211,000) and (ii) signings of international master
license agreements ($320,000). The revenue increase was offset by a $250,000
scheduled reduction (from $500,000 to $250,000) in the management fees received
from Constellation Development Fund.

Franchise application fees increased approximately $459,000 for the six
months ended June 30, 2000 as compared to the prior year's comparable period
primarily due to an increase in the average application fee on openings for the
year (resulting in incremental revenues of $164,000) and an increase in the
number of license agreements terminated ($295,000).

EXPENSES--The Company's expenses were as summarized below:

THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE MONTHS ENDED JUNE 30, 1999

General and administrative expenses increased by approximately $3,793,000
including charges totaling $2,320,000 for the three months ended June 30, 2000
as compared to the prior year's comparable period. The $2,320,000 charge
reflected in the three months ended June 30, 2000 primarily pertains to (i) a
portion of the termination payments made to an affiliate of Alpine Hospitality
Ventures LLC ($2,405,000), (ii) reversal of a $250,000 charge reflected in the
three months ended March 31, 2000 for amounts previously expensed relating to
costs incurred in connection with the Recapitalization Agreement that have now
been deferred, and (iii) write-offs for loans made to franchisees of $158,000.

Excluding such charges, general and administrative expenses increased
$1,473,000 primarily related to (i) an increase in personnel and associated
costs due to more open hotels ($427,000); (ii) increased professional fees
($272,000); (iii) increased bad debt expense ($171,000); (iv) gain on sale of
land reflected in 1999 but not in 2000 ($155,000); (v) increased deferred
expense in 2000 due to more terminated and fewer executed franchise agreements
($152,000); and (vi) increases in other operating expenses associated with more
open hotels ($296,000).

Of the $171,000 increase in bad debt reserve, $128,000 relates to reserves
taken against accrued royalty fees owed by the franchisee of 12 open Best Inn
properties and 22 open Hawthorn Suites properties that collectively had accrued
royalty fees owing to the Company of approximately $664,000 as of June 30, 2000,
a substantial portion of which (approximately 40%) had been owing more than
120 days. In addition, as of June 30, 2000, that franchisee owed approximately
$300,000 in marketing and reservation fees, a substantial portion of which
(approximately 45%) had been owing more than 120 days. Furthermore, as of
June 30, 2000, that franchisee owed the Company approximately $100,000 in
initial application fees for five franchises open or under construction. Such
marketing and reservation fees and initial application fees have not been
included in the operating results of the company as of June 30, 2000.

15
<PAGE>
Franchise sales commissions increased $253,000 for the three months ended
June 30, 2000 as compared to the comparable prior year's period primarily due to
(i) an increase in the number of license agreements terminated during the
quarter ($192,000), (ii) higher average commission expense on properties that
opened during the quarter ($25,000), and (iii) higher commissions on
international licensing arrangements ($36,000).

Depreciation and amortization expense increased $402,000 primarily due to
additional amortization related to development subsidies. This increase includes
$315,000 related to certain development subsidies that were written off in the
three months ended June 30, 2000.

Interest income, resulting primarily from promissory notes receivable and
investments in cash and marketable securities, decreased $593,000 primarily
because the Company recorded no interest income during the second quarter of
2000 related to a $15 million loan made to Alpine Hospitality Ventures LLC and a
reduced amount of cash available for investments in marketable securities. The
Company does not expect to recognize pay-in-kind interest on this loan in 2000
or for the foreseeable future.

SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999

General and administrative expenses increased by approximately $4,990,000
including charges totaling $2,570,000 related to contract termination and bad
debt expenses for the six months ended June 30, 2000 as compared to the prior
year's comparable period. The $2,570,000 charge reflected in the six months
ended June 30, 2000 primarily pertains to (i) contract termination costs of
$2,405,000, and (ii) write-offs for loans made to franchisees of $158,000.

Excluding such charges, general and administrative expenses increased
$2,420,000 primarily related to (i) an increase in personnel and associated
costs due to more open hotels ($709,000); (ii) increased professional fees
($541,000); (iii) increased bad debt expense ($187,000); (iv) gain on sale of
land reflected in 1999 but not in 2000 ($155,000); (v) less deferred expense in
2000 due to more terminated and fewer executed franchise agreements ($244,000);
(vi) less deferred commission expense resulting from less covered draws
($122,000) and (vii) increases in other operating expenses associated with more
open hotels ($462,000).

Of the $187,000 increase in bad debt reserve, $128,000 relates to reserves
taken against accrued royalty fees owed by the multi-unit franchisee referred to
above.

Franchise sales commissions increased $398,000 for the six months ended
June 30, 2000 as compared to the comparable prior year's period primarily due to
(1) an increase in the number of license agreements terminated ($93,000), and
(ii) higher average commission expense on properties that opened ($208,000), and
(iii) higher commission expense related to international licensing arrangements
($97,000).

Depreciation and amortization expense increased $497,000 primarily due to
additional amortization related to development subsidies. The increase includes
$315,000 related to certain development subsidies that were written off in the
six months ended June 30, 2000.

Interest income, resulting primarily from promissory notes receivable and
investments in cash and marketable securities, decreased $1,133,000 because the
Company recorded no interest income during the first six months of 2000 related
to a $15 million loan made to Alpine Hospitality Ventures LLC and had a reduced
amount of cash available for investments in marketable securities. The Company
does not expect to recognize pay-in-kind interest on this loan in 2000 or for
the foreseeable future.

16
<PAGE>
DISCONTINUED OPERATIONS--

The Company has recognized income/(loss) from discontinued operations of its
management services business:

<TABLE>
<CAPTION>
THREE THREE
MONTHS MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2000 JUNE 30, 1999 JUNE 30, 2000 JUNE 30, 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Income/(loss) from operations of
discontinued management services
business................................. $ (828,000) $175,000 $(1,279,000) $309,000
Loss on disposal of management services
business................................. (698,000) 0 (698,000) 0
----------- -------- ----------- --------
TOTAL...................................... $(1,526,000) $175,000 $(1,977,000) $309,000
</TABLE>

Effective June 2000, the Company discontinued providing management services
except with respect to one hotel property. The Company's twenty remaining
management contracts were terminated in June with management of the properties
ceasing on or before June 30, 2000. The management services operations have been
classified as discontinued operations for the three and six months ended
June 30, 2000 and prior periods have been restated in the Consolidated Statement
of Operations.

THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE MONTHS ENDED JUNE 30, 1999

The loss from discontinued operations for the three months ended June 30,
2000 was $828,000 compared to income of $175,000 for the same period in 1999, a
decrease in income of $1,003,000. The $1,003,000 decrease in income includes
reserves for unpaid management fees under certain management contracts of
$520,000, a reduction in management fee revenues of approximately $343,000 as a
result of fewer properties under the Company's management in the 2000 period,
offset by a reduction in operating expenses due to fewer managed properties.

The estimated loss on disposal of $698,000 includes (i) severance payments
of approximately $260,000 to former employees who provided management services,
(ii) write-off or reductions of certain franchisee loans to managed properties
of approximately $319,000, (iii) payment related to the termination of the
management agreement with Alpine Hospitality Ventures LLC and certain of its
affiliates of $100,000 and (iv) other expenses associated with disposal of the
management services business.

SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999

The loss from discontinued operations for the six months ended June 30, 2000
was $1,279,000 compared to income of $309,000 for the same period in 1999, a
decrease in income of $1,588,000. The $1,588,000 decrease in income includes
reserves for unpaid management fees under certain management contracts of
$520,000, a reduction in revenues of approximately $429,000, settlement and
associated legal fees with certain managed properties of $518,000 as a result of
fewer properties under the Company's management in the 2000 period, and
settlement and associated legal fees with certain prior employees of the
management company of $213,000, offset by a reduction in operating expenses due
to fewer managed properties.

The estimated loss on disposal of $698,000 includes (i) severance payments
of approximately $260,000 to former employees who provided management services,
(ii) write-offs or reductions of certain franchisee loans to managed properties
of approximately $319,000, (iii) payment related to the termination of the
management agreement for Alpine Hospitality Ventures LLC and certain of its
affiliates of $100,000 and (iv) other expenses associated with disposal of the
management services business.

17
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES

The Company had approximately $2.4 million in cash or cash equivalents as of
June 30, 2000. The Company recently has incurred and expects to further incur
significant costs and expenses in connection with (i) the Company's
consideration of strategic alternatives, including legal and investment banking
fees (a substantial portion of which are payable regardless of whether the
recapitalization transactions are completed), (ii) the completion of the
proposed recapitalization transactions, (iii) defense of a pending class action
lawsuit, and (iv) the discontinuation of the Company's management services
business including the termination of the Company's management contracts and
related obligations in respect of the 17 Best Inns properties owned by a
subsidiary of Alpine Hospitality Ventures LLC. Management of the Company
believes that if the Company is unsuccessful in completing the recapitalization
transactions under the Recapitalization Agreement in a timely manner, the
Company may be required to seek other sources of capital to fund its operations;
however, there can be no assurance that the Company would be successful in
finding such sources of additional funding on acceptable terms if the
recapitalization transactions are not completed in a timely manner. The Company
currently has no lines of credit in place to meet its cash requirements.

For the six months ended June 30, 2000, the Company had a net loss of
$3,506,000. Net cash used in operating activities was $1,700,000 and the primary
operating adjustments to net income was (i) an increase in accrued expenses
($1,613,000), (ii) depreciation and amortization ($1,170,000), (iii) decrease of
commissions payable ($861,000), (iv) increase in accounts receivable and prepaid
expenses ($633,000) and (v) an increase from discontinued operations ($597,000).

For the six months ended June 30, 2000, net cash used in investing
activities was $2,239,000 with the primary investments being development
subsidies issued to franchisees ($1,947,000), and acquisition of property and
equipment ($292,000).

For the six months ended June 30, 2000, net cash provided by financing
activities was $25,000 resulting from the exercise of stock options by certain
current and former employees.

As of June 30, 2000, the Company had loans outstanding of approximately
$4.3 million in the aggregate to Constellation Equity Corp. ("Constellation").
Due to uncertainties surrounding ultimate recoverability of these loans, the
Company is accounting for them on the cost recovery basis, where interest income
is recorded only after recovery of principal.

As of June 30, 2000, the Company had made a $15 million unsecured
subordinated loan to Alpine Hospitality Ventures LLC. In the fourth quarter of
2000, the Company took a $15.5 million reserve against this loan and accrued
interest thereon.

YEAR 2000 COMPUTER MATTER

The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. The Company has experienced no
material disruptions or adverse effects due to Year 2000 issues, but there can
be no guarantee that the systems of other companies on which the Company's
operations and systems rely will not experience disruptions that could have an
adverse effect on the Company's systems or results of operations.

SEASONALITY

Royalties generated by gross room revenues of franchised properties are
expected to be the largest source of revenue for the Company for the immediate
future. The Company expects to experience seasonal revenue patterns similar to
those experienced by the lodging industry generally. The summer months, because
of increase in leisure travel, are expected to produce higher revenues for the
Company than other periods. Accordingly, the Company may experience lower
revenues and profits in the first and fourth quarters and higher revenues and
profits in the second and third quarters.

18
<PAGE>
RISK FACTORS

In evaluating the Company and its business, the following risks should be
considered. These are not the only risks the Company faces. Some risks are not
yet known to the Company and others that the Company does not consider material
but could later turn out to be so. All of these risks could adversely affect the
Company's business:

MANAGEMENT OF GROWTH

The Company has experienced rapid growth in the number of its employees and
the scope of its operations since its inception. This growth has resulted in,
and is expected to continue to create, new and increased responsibilities for
management personnel, as well as added demands on the Company's operating and
financial systems. The Company's success will depend on its ability to manage
this growth while implementing its strategy. The efforts of key management
personnel and the Company's ability to attract or develop new management
personnel and to integrate these new employees into its overall operations will
be crucial to continued growth. The recent aggressive competition in the hotel
franchise business has made it more difficult and more costly to attract
qualified personnel. If the Company is unable to manage growth effectively, the
Company's business and results of operations could be materially and adversely
affected.

DEPENDENCE ON, AND OBSTACLES TO, HOTEL OPENINGS

The Company expects that in the future its principal source of revenue will
be franchise fees received from its franchisees. Accordingly, future revenues
will be highly dependent on the timing and the number of open hotels and their
gross room revenues. There are numerous factors beyond the control of the
Company which affect the probability and timing of a hotel opening and the
ability or desire for a hotel to stay in the Company's franchise system. These
factors include, but are not limited to, the ability of a potential hotel owner
to (i) secure adequate financing or satisfy financing payments during the
construction period; (ii) locate an appropriate site of a hotel; (iii) obtain
all necessary state and local construction, occupancy or other permits and
approvals; (iv) obtain necessary construction materials; and (v) reach a
satisfactory level of profitability at the hotel. Under industry and general
economic conditions that prevailed in 1999, the first half of 2000 and that are
expected to continue in 2000, hotel developers have had and may continue to have
difficulty accessing needed capital and attaining satisfactory levels of
profitability. As a result, the number and timing of franchised hotel openings,
and accordingly the Company's franchise fees, could be adversely affected if
current conditions do not improve. Additionally, there can be no assurance that
accepted franchise applications will result in executed franchise agreements or
that executed franchise agreements will result in open properties. Deteriorating
conditions in the lodging industry can be expected to adversely affect the
likelihood that properties in development will open on a timely basis or at all.

LIMITED OPERATING HISTORY; NET LOSSES; OUR RESULTS FLUCTUATE AND THESE
FLUCTUATIONS CAN BE UNPREDICTABLE

The Company began operating in October 1995 and therefore has a limited
operating history upon which investors can evaluate its performance. While the
Company was profitable during the first three quarters of 1999, the Company
incurred significant charges in the fourth quarter of 1999 that resulted in a
net loss for the year and recorded a net loss for the first and second quarters
of 2000. There can be no assurance that the Company will be profitable in the
future. Additionally, events outside our control, including those set forth in
other risk factors, may cause the Company to experience fluctuations in revenues
and operating results. As a result, the Company's future results may be below
market expectations, including the expectations of financial analysts and
investors. A failure to meet such expectations may adversely affect the trading
price of the Company's Class A Common Stock.

19
<PAGE>
MANAGEMENT, BY VIRTUE OF OWNERSHIP OF SUPERVOTING CLASS B COMMON STOCK, CONTROLS
THE COMPANY

Holders of Class A Common Stock are entitled to one vote per share and
holders of Class B Common Stock are entitled to ten votes per share. Each share
of Class B Common Stock is convertible at any time into one share of the
Class A Common Stock and, with limited exceptions, will convert automatically
upon any transfer thereof. Michael A. Leven, Chairman and Chief Executive
Officer, and Neal K. Aronson, Executive Vice President and Chief Financial
Officer, have the right to vote all of the outstanding shares of Class B Common
Stock, which, together with shares of Class A Common Stock which they
beneficially own (including stock held by other members of management),
represent approximately 65% of the combined voting power of the Company's
outstanding Common Stock. By reason of their right to vote the Class B Common
Stock, Messrs. Leven and Aronson will be able to (i) elect all of the Company's
directors (except as otherwise contractually provided), (ii) amend the Charter
with respect to most matters, (iii) effect a merger, sale or other major
corporate transaction, (iv) defeat any unsolicited takeover attempt and
(v) generally direct the affairs of the Company (including in a manner that may
benefit themselves disproportionately relative to other shareholders).

SUCCESSFUL COMPLETION AND INTEGRATION OF ACQUISITIONS

One element of the Company's business strategy is to continuously evaluate
acquisitions and business combinations. These acquisitions may be of brands in
the lodging industry or in other industries, or of businesses that the Company
does not expect to franchise, which would require the Company to develop
expertise in areas that it does not currently operate. There can be no assurance
that the Company will identify and complete suitable acquisitions or if
completed, that such acquisitions will be successfully integrated. The Company
did not engage in any such transaction in 1999 or in the first half of 2000, and
unless the recapitalization transactions are completed, does not expect to
complete any acquisitions in 2000. Acquisitions involve numerous risks,
including difficulties assimilating new operations and brands. There can be no
assurance that any acquisitions would result in long-term benefits to the
Company or that management would be able to manage effectively the resulting
business.

DEPENDENCE ON SENIOR MANAGEMENT

The success of the Company is largely dependent on the efforts and abilities
of its senior management and certain other key personnel, particularly
Messrs. Michael Leven, Chairman, and Steve Romaniello, President. The Company's
success will depend in large part on its ability to retain these individuals and
other current members of its senior management team and to attract and retain
qualified personnel in the future. The loss of members of senior management or
of certain other key employees or the Company's inability to retain and attract
other qualified employees could have an adverse impact on the Company's business
and results of operations. Certain franchise agreements have stipulations which
allow franchisees to exit without penalty if certain members of management are
no longer affiliated with the Company. The Company does not maintain key person
life insurance on behalf of the lives of any of its officers or employees.
Additionally, Neal K. Aronson, the Company's Executive Vice President and Chief
Financial Officer and co-founder, expects to leave the Company shortly after the
completion of the recapitalization transactions and the Company will be required
to find a replacement for Mr. Aronson.

COMPETITION FOR NEW FRANCHISE PROPERTIES AND HOTEL GUESTS

Competition among national brand franchisers and smaller chains in the
lodging industry to grow their franchise systems is fierce and intensified
during 1999 and during the first half of 2000. The Company believes there has
been a marked increase in franchise sales personnel throughout the lodging
industry and more aggressive financial incentives are being offered to hotel
owners and developers. Many of the Company's competitors are affiliated with
larger chains with substantially more properties, greater marketing budgets and
greater brand identity than the Company and its brands. There can be no
assurance

20
<PAGE>
that the Company can franchise a sufficient number of properties to generate
operating efficiencies that will enable it to compete with these larger chains.

GENERAL RISKS OF THE LODGING INDUSTRY

The Company is exposed to general risks of the lodging industry in a number
of ways. First, as a franchisor and manager, the Company's franchise royalty fee
revenues vary directly with its franchisees' gross room revenues. As a result,
the Company's franchise business is, and will be, affected by risks experienced
by hotel operators generally. Second, to the extent the Company directly or
indirectly makes equity or debt investments in hotel properties, those
investments will be subject to the risks experienced by the underlying
properties. Third, the Company may directly acquire ownership interests in its
branded hotel properties in order to promote the brand or for other reasons. To
the extent that the Company owns or leases hotel properties, it will be
subjected to the risks of a hotel operator.

The segments in which hotels franchised under the Company's brands currently
operate or plan to operate, may be adversely affected by changes in national or
local economic conditions and other local market conditions, such as an
oversupply of or a reduction in demand for lodging or a scarcity of potential
sites in a geographic area, changes in travel patterns, extreme weather
conditions, changes in governmental regulations that influence or determine
wages, prices, construction costs or methods of operation, changes in interest
rates, the availability of financing, and changes in real estate tax rates and
other operating expenses. In addition, 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. In fact, the
Company believes that hotel operators were negatively affected during 1999 and
during the first half of 2000 by increased room supply, weaker room demand and
higher interest rates, among other things. These risks may have been exacerbated
by the relatively illiquid nature of real estate holdings.

Downturns or prolonged adverse conditions in real estate or capital markets
or in national or local economies could have a material adverse impact on the
Company's ability to locate new franchisees, the timing of new hotel openings,
the number of rooms at newly-opened hotels, and the amount of royalty fee income
earned by the Company, and could result in the cancellation of the Company's
franchise agreements and increase risks of impairment on loans or other
investments made by the Company directly or indirectly to or in franchisees and
developers and potential deferral or loss of the interest income associated with
such potential write-offs. In addition to the aforementioned risks, the
Company's current and potential future investments in or ownership of hotel
properties creates a risk of decreased earnings due to losses related to
start-up expenses or ongoing losses due to shortfalls in expected performance of
a hotel. In addition, any guaranty required to secure construction or permanent
financing could adversely affect the Company's financial condition.

The Company expects to experience seasonal revenue patterns similar to those
experienced by participants in the lodging industry generally. Accordingly, the
summer months, because of increases in leisure travel, are expected to produce
higher revenues for the Company than other periods during the year.

DEVELOPMENT AND OWNERSHIP RISK

The Company's success depends upon the development or conversion and opening
of hotels. As a result, it is subject to risks experienced by hotel developers.
These risks, which are applicable to Microtels as new construction properties,
and to Hawthorn and Best Inns as both new construction and conversion
properties, include delays in the commencement or completion of construction,
failure to obtain all necessary zoning and construction permits, discovery of
environmental hazards, unavailability of financing on favorable terms, if at
all, the failure of developed properties to achieve desired revenue or
profitability levels once opened, competition for suitable development sites
from competing franchise chains, the risk of incurring substantial costs in the
event a development project must be abandoned prior to completion,

21
<PAGE>
changes in governmental rules, regulations and interpretations and general
economic and business conditions. The Company's revenues may also be adversely
affected by increases in interest rates, which could increase the costs of
financing new hotel construction or the conversion of existing hotels. Any one
of these risks could discourage or prohibit potential franchisees from beginning
or completing hotel projects or harm the profitability of an open hotel, which
could result in the termination of franchise agreements.

If the Company leases and/or owns hotel properties or makes, directly or
indirectly, equity or debt investments in hotel properties, it would be subject
to risks experienced by hotel operators generally. During 1999, the Company
incurred costs of approximately $0.5 million in connection with its abandoned
purchase of a Hawthorn Suites property, representing a portion of a forfeited
deposit and transaction costs.

RISKS RELATING TO THE FINANCING OF FRANCHISEES

The Company participates, from time to time, in construction loans, equity
investments, and long-term mortgage loans made to franchisees. In particular,
the Company has committed to lend up to $10 million to Constellation to be
invested by Constellation in Constellation Development Fund, LLC (the
"Development Fund") and to be used by the Development Fund to provide debt and
equity financing to selected developers. As of June 30, 2000, the Company has
loaned approximately $4.3 million in the aggregate to Constellation. The loan to
Constellation is subordinated to certain target returns of the other members of
the Development Fund. If such returns are not met, this loan could be
jeopardized. Due to the uncertainty surrounding the ultimate recoverability of
the subordinated loan, the Company is accounting for them on a cost-recovery
basis, where interest income is recorded only after recovery of principal. As of
June 30, 2000, the Development Fund has invested in seven Microtels and two
Hawthorn Suites hotels which are in different stages of development. As of
August 8, 2000, the managers of the Development Fund agreed not to commence any
new projects in the future.

In addition, the Company made a $15 million unsecured subordinated loan to
Alpine Hospitality Ventures LLC ("Ventures") in connection with the Best Inns
acquisition at an interest rate of 12% per annum, interest on which will be paid
in cash to the extent available and otherwise to be paid in-kind. The loan is
subordinated to a guaranty provided by Ventures in connection with a third party
senior loan in the principal amount of approximately $65 million to its
subsidiary that acquired 17 Best Inns hotels in the Best Inns transaction and is
structurally subordinated to such third party loan. Each of Ventures and
Constellation is a highly leveraged entity and there can be no assurances that
any loans to Ventures or Constellation will be repaid. In the fourth quarter
1999, the Company was advised by Ventures that the senior lender to its
operating subsidiary planned to institute a "lock-box" arrangement because of
the deteriorating financial condition of the operating subsidiary. In
March 2000, the lock-box agreement was executed. The lock-box arrangement
effectively precludes the payment of cash interest to the Company while such
arrangement is in place. The Company will continue to receive interest in-kind
payments but will not include such in-kind payments in income. Recognition of
such in-kind payments as income is dependent upon the amount of underlying
property values of the borrower, relative to other lenders and shareholders.
There can be no assurance that those values will continue to be sufficient to
permit the Company to continue to record such interest income and, in fact, no
such income was recognized by the Company in the fourth quarter 1999 or the
first or second quarters of 2000 and the Company does not currently expect to
record income for the foreseeable future. In fact, the Company has taken a
reserve of approximately $15.5 million associated with the principal and accrued
interest of the loan.

The Company has also made various loans and advances to individual
franchisees, the reservation and marketing funds for the Microtel and Best Inns
brands, and loan participations in a financing program with Nomura Asset Capital
Corp. See "Legal Proceedings" for a discussion of a pending litigation
concerning these loan participations. The Company is subject to the risks
experienced by lenders generally, including risks of franchisee/borrower
defaults and bankruptcies. Among other things, the ability of the borrowers to

22
<PAGE>
repay these loans will be affected by the factors discussed under "General Risks
of the Lodging Industry" and "Development and Ownership Risk." The failure of a
borrower to pay interest could have a material adverse effect on the Company's
results of operations. In the event of default under such loans, the Company, as
a lender, would bear the risk of loss of principal to the extent the value of
the collateral was not sufficient to pay lenders, which may be more senior in
the capital structure. As of June 30, 2000, the Company had outstanding loans to
individual franchisees of approximately $3.6 million aggregate principal amount
(with associated reserves of approximately $716,000), and loans to the
reservation and marketing funds of $3.3 million aggregate principal amount (with
associated reserves of approximately $436,000). If the financial condition of
the borrowers of these loans were to worsen, the loans could be deemed to be
impaired, which could result in a significant charge to the Company and future
interest income related to these loans could be deferred or eliminated which
could have a materially adverse effect on future income. In connection with
equity investments, the Company would be subject to risks as an equity investor.
See "Business--Regulation."

REGULATION

The sale of franchises is regulated by various state laws, as well as by the
United States Federal Trade Commission. To the extent that the Company manages,
owns or leases hotel properties, it will be subject to additional governmental
regulations. For example, owners and operators of hotels are subject to numerous
federal, state and local government regulations, including those relating to the
preparation and sale of food and beverages (such as health and liquor license
laws) and building and zoning requirements. Under the Americans with
Disabilities Act of 1990 (the "ADA"), all public accommodations are required to
meet certain federal requirements related to access and use by disabled persons.
The determination that hotels owned, managed or leased by the Company are not in
compliance with the ADA could result in the imposition of fines, and award of
damages to private litigants or significant expense to the Company in bringing
these hotels into compliance. Additionally, various national, state and local
laws and regulations may affect activities undertaken by the Company in
connection with providing financing to franchisees. In particular, the Company
may be required to obtain a license or to register in certain states in order to
arrange loans to be made to franchisees. See "Business--Regulation."

DEPENDENCE ON SPIRIT RESERVATION SYSTEM

Franchisees of the Hawthorn brand open one year or greater derived
approximately 21% of their reservations through the Spirit Reservation System,
which is operated under contract with Hyatt Hotels Corporation by CSC
Outsourcing, Inc. ("CSC") and Sabre Technology Solutions ("Sabre"). There can be
no assurance that CSC and Sabre will continue to service Hawthorn Suites'
reservations needs in the future.

ABSENCE OF DIVIDENDS

The Company has not paid a dividend on its Common Stock since its inception.
The Company intends to retain any earnings to finance its growth and for general
corporate purposes and therefore does not anticipate paying any cash dividends
in the foreseeable future. In addition, future financing agreements may contain
limitations on the payment of cash dividends or other distributions of assets to
the holders of Common Stock.

23
<PAGE>
ANTI-TAKEOVER DEVICES

Certain provisions of the Certificate of Incorporation and the By-laws of
the Company may be deemed to have anti-takeover effects and may delay, deter or
prevent a change in control of the Company that stockholders might otherwise
consider in their best interests. These provisions (i) allow only the Board of
Directors, the Chairman of the Board of Directors or the Chief Executive Officer
of the Company to call special meetings of the stockholders, (ii) eliminate the
ability of stockholders to take any action without a meeting, (iii) establish
certain advance notice procedures for nomination of candidates for election as
directors and for stockholder proposals to be considered at stockholders'
meeting, (iv) generally authorize the issuance of one or more classes of "blank
check" preferred stock, with such designations, rights and preferences as may be
determined from time to time by the Board of Directors, (v) require approval of
holders of 75% of the outstanding Class B Common Stock for the Board of
Directors to create a series of Preferred Stock with general voting rights or
with the right to elect a majority of directors under any circumstances and
(vi) require approval of holders of 75% of the outstanding voting power to amend
or repeal items (i), (ii) or (v) above or this item (vi).

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.

Not Applicable.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is and may become party to claims and litigations that arise in
its normal course of business, including but not limited to those listed below.
In management's opinion, except for certain of the matters described below, the
outcome of any currently pending matters is not expected to have a material
adverse effect on the Company's consolidated financial statements.

On April 11, 2000, the Company and certain subsidiaries settled a lawsuit
brought relating to its management company operations by the owner of nine Best
Inn properties for alleged mismanagement under management agreements that the
Company assumed in connection with its 1998 acquisition of the Best Inns brand.
USFS Management, Inc., a subsidiary of the Company, had also filed a
counterclaim alleging fraudulent conduct by the owner and certain of his
affiliates, which was also settled. In connection with the settlement, during
the second quarter of 2000 the Company paid approximately $500,000 in settlement
payments and related legal costs. Approximately $510,000 was accrued for such
payments during the first quarter of 2000. The franchise agreements with the
owner of the properties remain in effect.

On June 29, 2000, the Company and certain subsidiaries settled a lawsuit,
relating to its management company operations which was brought by two former
employees alleging wrongful termination. The Company and certain of its
subsidiaries had also filed a counterclaim in this action which was also
settled. In connection with the settlement in the second quarter of 2000, the
Company made aggregate settlement payments of $215,000 to its two former
employees (including reimbursement of legal fees), without any admission of
wrongdoing.

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<PAGE>
On August 3, 2000, a former employee of a hotel previously managed by the
Company's management company subsidiary filed a lawsuit against certain of the
Company's subsidiaries and other defendants (CARRIE CHAPO V. MICROTEL INN &
SUITES, RICHARD CLASBY, DENNIS WHEELER, UNITED STATES FRANCHISE MANAGEMENT
SYSTEMS AND DOES 1-10; SUPERIOR COURT OF CALIFORNIA; COUNTY OF PLACER; CASE NO.
S CV 10349), alleging sexual harassment, assault and false imprisonment by the
former general manager of the hotel. The Company believes that it has
meritorious defenses and will vigorously defend this action, although the
outcome cannot be predicted.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders during the
quarter.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits:

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
--------------------- -----------
<C> <S>
10.1 Recapitalization Agreement, dated as of June 2, 2000, by and
among U.S. Franchise Systems, Inc., SDI, Inc., Meridian
Associates, L.P. and HSA Properties, Inc. (incorporated by
reference to Exhibit 2.1 to the Current Report on Form 8-K
of the Company filed with the Commission on June 6, 2000).

10.2 Employment Agreement, dated as of June 30, 2000, by and
between U.S. Franchise Systems, Inc. and Michael A. Leven,
entered into in connection with the Recapitalization
Agreement, dated as of June 2, 2000, and effective only upon
completion of the transactions thereunder.

10.3 Employment Agreement, dated as of June 30, 2000, by and
between U.S. Franchise Systems, Inc. and Steven Romaniello,
entered into in connection with the Recapitalization
Agreement, dated as of June 2, 2000, and effective only upon
completion of the transactions thereunder.

10.4 Separation Agreement, dated as of June 2, 2000, by and
between U.S. Franchise Systems, Inc. and Neal K. Aronson,
entered into in connection with the Recapitalization
Agreement, dated as of June 2, 2000, and effective only upon
completion of the transactions thereunder (the form of which
was previously included as an exhibit to the
Recapitalization Agreement that was previously filed as an
Exhibit to the Form 8-K of the Company filed with the
Commission on June 6, 2000).
</TABLE>

25
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
--------------------- -----------
<C> <S>
10.5 Stockholders Agreement, dated as of June 2, 2000, by and
among Meridian Associates, L.P., SDI, Inc., HSA Properties,
Inc., Michael A. Leven, Andrea Leven, Jonathan Leven, Robert
Leven, Adam Leven and Steven Romaniello, entered into in
connection with the Recapitalization Agreement, dated as of
June 2, 2000, and effective only upon completion of the
transactions thereunder (the form of which was previously
included as an exhibit to the Recapitalization Agreement
that was previously filed as an Exhibit to the Form 8-K of
the Company filed with the Commission on June 6, 2000).

10.6 Registration Rights Agreement, dated as of June 2, 2000, by
and among U.S. Franchise Systems, Inc., SDI, Inc., Meridian
Associates, L.P., HSA Properties, Inc. and Neal K. Aronson,
entered into in connection with the Recapitalization
Agreement, dated as of June 2, 2000, and effective only upon
completion of the transactions thereunder (the form of which
was previously included as an exhibit to the
Recapitalization Agreement that was previously filed as an
Exhibit to the Form 8-K of the Company filed with the
Commission on June 6, 2000).

10.7 Voluntary Termination and Mutual Release Agreement,
effective as of June 2, 2000, by and among RSVP-BI OPCO,
LLC, RSVP-ABI REALCO, LLC, Alpine Hospitality Ventures LLC,
USFS Management, Inc and U.S. Franchise Systems, Inc.

10.8 Letter Agreement, dated as of June 2, 2000, among U.S.
Franchise Systems, Inc., USFS Management, Inc. and Best
Franchising, Inc., and Alpine Hospitality Holdings LLC,
RSVP-BI OPCO, LLC, RSVP-ABI REALCO, LLC and Alpine
Hospitality Ventures LLC.

10.9 Consent to Termination of Hotel Management Agreement and
Manager's Consent and Subordination Agreement, effective as
of June 2, 2000, among USFS Management, Inc., Alpine
Hospitality Ventures LLC, RSVP-BI OPCO, LLC, RSVP-ABI
REALCO, LLC, PW Real Estate Investments, Inc. and Best
Franchising, Inc.

10.10 Promissory Note, dated June 2, 2000, of the Company in favor
of Alpine Hospitality Holdings LLC in the principal amount
of $1,250,000.

27.1 Financial Data Schedule.

99.1 Leven Agreement, dated as of June 2, 2000, between Meridian
Associates, L.P. and Michael A. Leven and Andrea Leven,
entered into in connection with the Recapitalization
Agreement, dated as of June 2, 2000 (the form of which was
previously included as an exhibit to the Recapitalization
Agreement that was previously filed as an exhibit to the
Form 8-K of the Company filed with the Commission on June 6,
2000).

99.2 Aronson Agreement, dated as of June 2, 2000, between
Meridian Associates, L.P. and Neal K. Aronson, entered into
in connection with the Recapitalization Agreement, dated as
of June 2, 2000 (the form of which was previously included
as an exhibit to the Recapitalization Agreement that was
previously filed as an exhibit to the Form 8-K of the
Company filed with the Commission on June 6, 2000).
</TABLE>

(b) Reports on Form 8-K:

During the quarter for which this report is filed, the following reports on
Form 8-K were filed by the Company, each reporting information under Form 8-K,
Item 5:

--On June 1, 2000, the Company reported the filing of a class action
lawsuit against it and certain of its officers and directors.

--On June 6, 2000, the Company reported that it had entered into the
Recapitalization Agreement, pursuant to which it will commence a self-tender
for 8.66 million shares of Class A Common Stock and Class B Common Stock at
a price of $7.50 per share, and that business interests of the Pritzker
family of Chicago will invest $75 million in the Company in exchange for the
issuance and sale to them by the Company of shares of two new classes of
preferred stock.

26
<PAGE>
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

<TABLE>
<S> <C> <C> <C>
U.S. FRANCHISE SYSTEMS, INC.

BY /S/ MICHAEL A. LEVEN By /s/ NEAL K. ARONSON
---------------------------------------- ----------------------------------------
Michael A. Leven Neal K. Aronson
CHAIRMAN OF THE BOARD EXECUTIVE VICE PRESIDENT AND CHIEF
AND CHIEF EXECUTIVE OFFICER FINANCIAL OFFICER
</TABLE>

Dated: August 14, 2000

27
<PAGE>
EXHIBIT INDEX

10.5 Stockholders Agreement, dated as of June 2, 2000, by and
among Meridian Associates, L.P., SDI, Inc., HSA Properties,
Inc., Michael A. Leven, Andrea Leven, Jonathan Leven, Robert
Leven, Adam Leven and Steven Romaniello, entered into in
connection with the Recapitalization Agreement, dated as of
June 2, 2000, and effective only upon completion of the
transactions thereunder (the form of which was previously
included as an exhibit to the Recapitalization Agreement
that was previously filed as an Exhibit to the Form 8-K of
the Company filed with the Commission on June 6, 2000).

10.10 Promissory Note, dated June 2, 2000, of the Company in favor
of Alpine Hospitality Holdings LLC in the principal amount
of $1,250,000.
</TABLE>

28
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
--------------------- -----------
<C> <S>
27.1 Financial Data Schedule.