<PAGE>
 
  AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 19, 1997
                                                      REGISTRATION NO. 333-
 
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ----------------
 
                                   FORM S-1
 
                            REGISTRATION STATEMENT
                                     UNDER
                          THE SECURITIES ACT OF 1933
 
                               ----------------
 
                        CHOICE HOTELS FRANCHISING, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
                               ----------------
 
         DELAWARE                    8999                    52-1209792
     (STATE OR OTHER         (PRIMARY INDUSTRIAL           (IRS EMPLOYER
     JURISDICTION OF          CLASSIFICATIONCODE       IDENTIFICATION NUMBER)
     INCORPORATION OR              NUMBER)
      ORGANIZATION)
                              10750 COLUMBIA PIKE
                         SILVER SPRING, MARYLAND 20901
                                (301) 979-5000
  (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
                   REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

                              MICHAEL J. DESANTIS
                              10750 COLUMBIA PIKE
                         SILVER SPRING, MARYLAND 20901
                                (301) 979-5000
 (NAME, ADDRESS, INCLUDING ZIP CODE, TELEPHONE NUMBER, INCLUDING AREA CODE, OF
                              AGENT FOR SERVICE)
 
                   PLEASE SEND COPIES OF COMMUNICATIONS TO:
                              BRUCE E. ROSENBLUM
                               LATHAM & WATKINS
                   1001 PENNSYLVANIA AVE., N.W., SUITE 1300
                          WASHINGTON, D.C. 20004-2505
 
                               ----------------
 
  Approximate date of commencement of proposed sale to the public: AS SOON AS
PRACTICABLE AFTER THE EFFECT DATE OF THIS REGISTRATION STATEMENT.
 
  IF ANY OF THE SECURITIES BEING REGISTERED ON THIS FORM ARE TO BE OFFERED ON
A DELAYED OR CONTINUOUS BASIS PURSUANT TO RULE 415 UNDER THE SECURITIES ACT OF
1933, CHECK THE FOLLOWING BOX. [X]
 
  IF THIS FORM IS FILED TO REGISTER ADDITIONAL SECURITIES FOR AN OFFERING
PURSUANT TO RULE 462(B) UNDER THE SECURITIES ACT, PLEASE CHECK THE FOLLOWING
BOX AND LIST THE SECURITIES ACT REGISTRATION STATEMENT NUMBER OF THE EARLIER
EFFECTIVE REGISTRATION STATEMENT FOR THE SAME OFFER. [_]
 
  IF THIS FORM IS A POST-EFFECTIVE AMENDMENT FILED PURSUANT TO RULE 462(C)
UNDER THE SECURITIES ACT, CHECK THE FOLLOWING BOX AND LIST THE SECURITIES ACT
REGISTRATION STATEMENT NUMBER OF THE EARLIER EFFECTIVE REGISTRATION STATEMENT
FOR THE SAME OFFERING. [_]
 
  IF DELIVERY OF THE PROSPECTUS IS EXPECTED TO BE MADE PURSUANT TO RULE 434,
PLEASE CHECK THE FOLLOWING BOX. [_]
 
                               ----------------
 
                        CALCULATION OF REGISTRATION FEE
<TABLE> 
<CAPTION>
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--------------------------------------------------------------------------------------------
                                                    PROPOSED        PROPOSED                      
                                     AMOUNT         MAXIMUM         MAXIMUM      AMOUNT OF       
     TITLE OF EACH CLASS OF          TO BE       OFFERING PRICE    AGGREGATE    REGISTRATION     
   SECURITIES TO BE REGISTERED     REGISTERED       PER UNIT     OFFERING PRICE     FEE      
--------------------------------------------------------------------------------------------
<S>                                <C>            <C>            <C>            <C>
Common Stock, $.01 par value
 ("Common Stock")................    1,193,571       $.70(1)        $835,500      $253.18(1)
<CAPTION> 
--------------------------------------------------------------------------------------------
<S>                                <C>            <C>            <C>            <C>
Options to Purchase Shares of
 Common Stock, $.01 par value....    1,193,571         *(1)            *              *
<CAPTION> 
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
</TABLE> 
*   Not Applicable.
(1) The registration fee has been calculated pursuant to Rule 457(h)(1) under
    the Securities Act of 19933 on the basis of a book value of $.70 per share
    for the maximum number of shares of Common Stock to be received upon
    exercise of options to purchase Common Stock. The exercise price of such
    options will not be determined until their issuance as described in this
    Registration Statement.
 
                               ----------------
 
  THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
 
-------------------------------------------------------------------------------
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
                             CROSS REFERENCE SHEET
                     PURSUANT TO ITEM 501 OF REGULATION S-K
 
<TABLE>
<CAPTION>
           S-1 ITEM NUMBER AND HEADING                        LOCATION IN PROSPECTUS
           ---------------------------                        ----------------------
 <S> <C>                                           <C>
  1. Forepart of the Registration Statement and    
      Outside Front Cover Page of Prospectus.....  Facing Page; Cross Reference Sheet; Outside 
                                                    Front Cover Page                           
  2. Inside Front and Outside Back Cover Pages
      of Prospectus..............................  Inside Front Cover Page; Table of Contents
  3. Summary Information, Risk Factors and Ratio
      of Earnings to Fixed Charges...............  Prospectus Summary; Risk Factors
  4. Use of Proceeds.............................  Use of Proceeds
  5. Determination of Offering Price.............  Outside Front Cover Page; Plan of
                                                   Distribution
  6. Dilution....................................  Not Applicable
  7. Selling Securitiy Holders...................  Not Applicable
  8. Plan of Distribution........................  Outside Front Cover Page; Plan of
                                                    Distribution
  9. Description of Securities to be               
     Registered..................................  The Distribution--Description of Capital    
                                                   Stock; The Offering                       
 10. Interests of Named Experts and Counsel......  Legal Matters; Experts
 11. Information with Respect to Registrant......  Certain Information Concerning Franchising--Selected Historical Financial Data;
                                                    --Pro Forma Financial Data;--Management's Discussion and Analysis of Financial
                                                    Condition and Results of Operations;--Business and Properties;--Management;
                                                    Certain Relationships and Related Transactions; Security Ownership
 12. Disclosure of Commission Position on
      Indemnification for Securities Act
      Liabilities................................  Not Applicable
</TABLE>
<PAGE>
 
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+                                                                              +
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A         +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE   +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY  +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT        +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR   +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE      +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE    +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF  +
+ANY SUCH STATE.                                                               +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
 
                SUBJECT TO COMPLETION, DATED SEPTEMBER 19, 1997
 
PROSPECTUS
 
                        CHOICE HOTELS FRANCHISING, INC.
              (TO BE RENAMED "CHOICE HOTELS INTERNATIONAL, INC.")
 
                   1,193,571 OPTIONS TO PURCHASE COMMON STOCK
 
                        1,193,571 SHARES OF COMMON STOCK
 
                                  -----------
 
  This Prospectus relates to the issuance by Choice Hotels Franchising, Inc.
("Franchising") of options ("Franchising Options") to purchase up to 1,193,571
shares of common stock of Franchising, par value $0.01 per share ("Franchising
Common Stock") to thirty-three employees of Manor Care, Inc., a Delaware
corporation ("Manor Care" and such employees, the "Manor Care Employees") as
part of the equitable adjustments to outstanding options to purchase shares of
common stock ("Choice Common Stock") of Choice Hotels International, Inc.
("Choice"), as described below, and (ii) up to 1,193,571 shares of Franchising
Common Stock issuable upon exercise of the Franchising Options.
 
  Franchising is currently a wholly owned subsidiary of Choice. On or about
October 15, 1997, (the "Distribution Date"), Choice intends to make a special
dividend, consisting of the distribution (the "Distribution") to holders of
outstanding shares of Choice Common Stock at the close of business on October
7, 1997 (the "Distribution Record Date"), on a share for share basis, of all
outstanding shares of Franchising Common Stock. This Distribution will separate
Choice's hotel franchising business from its hotel ownership and management
business. Upon the Distribution, Choice will change its corporate name to
Sunburst Hospitality Corporation (as renamed after the Distribution,
"Sunburst") and will continue to own and operate hotel properties in the United
States (the "Hotel Business"). Upon the Distribution, Franchising will change
its name to Choice Hotels International, Inc. and will engage in the business
of franchising hotels under the Clarion, Quality, Comfort, Sleep Inn, Rodeway,
Econo Lodge and Mainstay brands and will own and operate 14 hotel properties in
France, Germany and the United Kingdom (together, the "Franchising Business").
The Distribution is described in more detail herein.
 
  As of the date hereof, the thirty-three Manor Care Employees, in the
aggregate, held options (the "Choice Options") to purchase up to 1,193,571
shares of Choice Common Stock issued by Choice in November 1996 as part of the
Manor Care Spin-off (as defined herein) pursuant to the Choice Hotels
International, Inc. 1996 Long-Term Incentive Plan (the "Choice Plan"). Under
the Choice Plan, each outstanding Choice Option will be adjusted as a result of
the Distribution in a manner described herein in order to preserve the
financial values of such Choice Options prior to the Distribution. On or prior
to the Distribution Date, each Manor Care Employee holding nonqualified Choice
Options may make a one-time election to choose a conversion award consisting of
any percentage combination of an option to acquire Franchising Common Stock and
an adjusted Choice Option, with the number of shares and the exercise price of
each option adjusted so as to preserve the financial value of the outstanding
Choice Options. The Franchising Options issuable to Manor Care Employees as
part of the aforementioned adjustment to Choice Options and the shares of
Franchising Common Stock issuable upon exercise of such Franchising Options
will be issued pursuant to the Registration Statement of which this Prospectus
is part.
 
  SEE "RISK FACTORS" BEGINNING ON PAGE 9 FOR A DISCUSSION OF CERTAIN RISKS
ASSOCIATED WITH AN INVESTMENT IN THE FRANCHISING OPTIONS AND THE FRANCHISING
COMMON STOCK OFFERED HEREBY.
 
                                  -----------
 
THESE SECURITIES  HAVE NOT BEEN APPROVED  OR DISAPPROVED BY THE  SECURITIES AND
 EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
 AND  EXCHANGE COMMISSION  OR ANY  STATE SECURITIES COMMISSION  PASSED ON  THE
  ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
  IS A CRIMINAL OFFENSE.
 
 
                 The date of this Prospectus is          , 1997
<PAGE>
 
  NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE SECURITIES REGISTERED HEREBY, AND IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY FRANCHISING. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY OF THE SECURITIES OFFERED
HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS NOT LAWFUL TO MAKE ANY
SUCH OFFER OR SOLICITATION IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY ISSUANCE OF SECURITIES HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF FRANCHISING SINCE THE DATE HEREOF OR THAT THE INFORMATION HEREIN IS
CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
 
                             AVAILABLE INFORMATION
 
  Franchising has filed a Registration Statement on Form S-1 (the
"Registration Statement") with the Securities and Exchange Commission (the
"Commission") under the Securities Act of 1933, as amended (the "Securities
Act"), with respect to the securities offered hereby. As permitted by the
rules and regulations of the Commission, this Prospectus omits certain
information, exhibits and undertakings contained in the Registration
Statement. Such additional information, exhibits and undertakings can be
inspected at and obtained from the Commission in the manner set forth below.
For further information with respect to the securities offered hereby and
Franchising, reference is made to the Registration Statement and the financial
schedules and exhibits filed as part thereof. Statements contained in this
Prospects as to the terms of any contract or other document are not
necessarily complete, and, in each case, reference is made to the copy of each
such contract or other document that has been filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference.
 
  Franchising Common Stock has been approved to submit an application for
listing on the New York Stock Exchange. In connection with such approval,
Franchising will become subject to informational and reporting requirements of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and be
required to file periodic reports and other information with the Commission.
Such reports and other information (when filed with the Commission), as well
as the Registration Statement, can be inspected and copied at the public
reference facilities of the Commission at 450 Fifth Street, N.W., Washington,
D.C. 20549, and at the Commission's regional offices located at 7 World Trade
Center, New York, New York 10048 and at Northwestern Atrium Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. Such reports and other
information can also be inspected (when filed) at the office of the New York
Stock Exchange, 20 Broad Street, New York, New York 10005. Such material may
also be accessed electronically by means of the Commission's home page on the
Internet at http://www.sec.gov.
 
  The aforementioned documents are also available upon request from Michael J.
DeSantis, Senior Vice President, General Counsel and Secretary, Choice Hotels
Franchising, Inc., 10750 Columbia Pike, Silver Spring, Maryland 20901, (301)
979-5000.
<PAGE>
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
PROSPECTUS SUMMARY........................................................   1
RISK FACTORS..............................................................   9
USE OF PROCEEDS...........................................................  13
PLAN OF DISTRIBUTION......................................................  13
LEGAL MATTERS.............................................................  13
EXPERTS...................................................................  13
THE DISTRIBUTION..........................................................  14
  Manner of Effecting the Distribution....................................  14
  Federal Income Tax Aspects of the Distribution..........................  14
  Listing and Trading of Franchising Common Stock.........................  15
  Listing and Trading of Sunburst Common Stock............................  15
  Conditions; Termination.................................................  16
  Interest of Certain Persons in the Distribution.........................  16
RELATIONSHIP BETWEEN CHOICE AND FRANCHISING AFTER THE DISTRIBUTION........  18
FINANCING.................................................................  23
ACCOUNTING TREATMENT......................................................  24
POST-DISTRIBUTION DIVIDEND POLICY.........................................  25
CERTAIN INFORMATION CONCERNING FRANCHISING................................  25
  Pro Forma Financial Data................................................  25
  Selected Historical Financial Data......................................  27
  Management's Discussion and Analysis of Financial Condition and Results
   of Operations..........................................................  29
  Business And Properties.................................................  32
  Management..............................................................  47
  Employment Agreements...................................................  54
  Retirement Plans........................................................  55
  Certain Relationships and Related Transactions..........................  56
  Security Ownership......................................................  57
  Description of Franchising Capital Stock................................  59
  Purposes and Antitakeover Effects of Certain Provisions of the
   Franchising Certificate and Bylaws.....................................  60
  Liability and Indemnification of Officers and Directors.................  63
CERTAIN INFORMATION CONCERNING SUNBURST...................................  65
  Pro Forma Financial Data................................................  65
  Management's Discussion and Analysis of Sunburst Pro Forma Financial
   Condition and Results of Operations....................................  67
  Business and Properties.................................................  69
  Management..............................................................  76
AMENDMENTS TO THE CHOICE RESTATED CERTIFICATE OF INCORPORATION............  80
FRANCHISING BENEFIT PLAN..................................................  82
</TABLE>
 
 
 
                                       i
<PAGE>
 
<TABLE>
<CAPTION>
                                                                          PAGE
                                                                          ----
<S>                                                                       <C>
INDEX TO FINANCIAL STATEMENTS............................................ F-1
ANNEX A: FORM OF RESTATED CERTIFICATE OF INCORPORATION OF CHOICE HOTELS
          FRANCHISING, INC............................................... A-1
ANNEX B: FORM OF AMENDED AND RESTATED BYLAWS OF CHOICE HOTELS
          INTERNATIONAL, INC............................................. B-1
ANNEX C: CHOICE HOTELS FRANCHISING, INC. 1997 LONG-TERM INCENTIVE PLAN... C-1
</TABLE>
 
 
                                       ii
<PAGE>
 
                               PROSPECTUS SUMMARY
 
  The following summarizes certain information contained elsewhere in this
Prospectus, including the appendices hereto (the "Prospectus"). Reference is
made to, and this summary is qualified in its entirety by, the more detailed
information set forth in this Prospectus, which should be read in its entirety.
Unless the context otherwise requires, all references herein to Choice and to
Franchising shall include their respective subsidiaries and all references
herein to Franchising prior to the Distribution Date (as defined herein) shall
refer to the Franchising Business (as defined herein) as operated by Choice.
Unless otherwise indicated, all statistical information and data relating to
the hotel industry in this Prospectus are derived from information provided by
Smith Travel Research. Smith Travel Research has not consented to the use of
the hotel industry data presented herein or provided any form of consultation,
advice, or counsel regarding any aspects of, and is in no way whatsoever
associated with, the proposed transaction.
 
                                   BACKGROUND
 
  Franchising is currently a wholly owned subsidiary of Choice. On or about
October 15, 1997 (the "Distribution Date"), Choice intends to make a special
dividend, consisting of the distribution (the "Distribution") to holders of
outstanding shares of Choice Common Stock at the close of business on October
7, 1997 (the "Distribution Record Date"), on a share for share basis, of all
outstanding shares of Franchising Common Stock.
 
  This Distribution will separate Choice's hotel franchising business from its
hotel ownership and management business. Upon the Distribution, Choice will
change its corporate name to Sunburst Hospitality Corporation (as renamed after
the Distribution, "Sunburst") and will continue to own and operate hotel
properties in the United States (the "Hotel Business"). Upon the Distribution,
Franchising will change its name to Choice Hotels International, Inc. and will
engage in the business of franchising hotels under the Clarion, Quality,
Comfort, Sleep Inn, Rodeway, Econo Lodge and Mainstay brands and will own and
operate 14 hotel properties in France, Germany and the United Kingdom
(together, the "Franchising Business"). The Distribution is described in more
detail herein.
 
  As of the date hereof, the thirty-three Manor Care Employees held options
(the "Choice Options") to purchase up to 1,193,571 shares of Choice Common
Stock issued in November 1996 as part of the Manor Care Spin-off (as defined
herein) pursuant to the Choice Hotels International, Inc. 1996 Long-Term
Incentive Plan (the "Choice Plan"). Under the Choice Plan, each outstanding
Choice Option will be adjusted as a result of the Distribution in a manner
described herein in order to preserve the financial value of such Choice
Options prior to the Distribution. On or prior to the Distribution Date, each
Manor Care Employee holding nonqualifed Choice Options may make a one-time
election to choose a conversion award consisting of any percentage combination
of an option to acquire Franchising Common Stock and an adjusted Choice Option,
with the number of shares and the exercise price of each option adjusted so as
to preserve the financial value of the outstanding Choice Options. The
Franchising Options issuable to Manor Care Employees as part of the
aforementioned adjustment to Choice Options and the shares of Franchising
Common Stock issuable upon exercise of such Franchising Options will be issued
pursuant to the Registration Statement of which this Prospectus is a part.
 
 
                                       1
<PAGE>
 
                                  THE COMPANY
 
  Franchising is a Delaware corporation and a wholly owned subsidiary of
Choice, formed in 1981. Franchising currently conducts a significant portion of
the Franchising Business. Immediately prior to the Distribution, Franchising
will succeed to that portion of the Franchising Business currently conducted by
Choice or Choice's other subsidiaries. Franchising is one of the world's
largest franchisors of hotels with 3,344 properties open and operating in 33
countries at May 31, 1997. These properties operate under one of Franchising's
brand names: Comfort, Quality, Clarion, Sleep, Rodeway, Econo Lodge and
Mainstay Suites. At May 31, 1997, another 820 franchise properties with a total
of 72,093 rooms were under development.
 
  The principal executive offices of Franchising are located at 10750 Columbia
Pike, Silver Spring, Maryland 20901. Its telephone number is (301) 797-5000.
For additional information with respect to Franchising and the Franchising
Business expected to be conducted by Franchising after the Distribution, see
"Certain Information Concerning Franchising."
 
                                  THE OFFERING
 
Securities Offered............  (i) options (the "Franchising Options") to
                                purchase up to 1,193,571 shares of Franchising
                                Common Stock, and (ii) up to 1,193,571 shares
                                of Franchising Common Stock issuable upon
                                exercise of the Franchising Options.
Franchising Common Stock        
Outstanding...................  Franchising is currently a wholly owned
                                subsidiary of Choice. Based on the number of
                                shares of Choice Common Stock outstanding on
                                August 5, 1997, it is expected that
                                approximately 60,200,784 shares of Franchising
                                Common Stock will be issued in the
                                Distribution.
 
Use of Proceeds...............  The Franchising Options will be issued as part
                                of the adjustments of outstanding Choice
                                Options and Franchising will receive no
                                proceeds from such issuance. The proceeds to
                                Franchising to be received from exercise of the
                                Franchising Options will be used for working
                                capital and other general corporate purposes.
 
Proposed NYSE Symbol..........  CCH.
 
                                       2
<PAGE>
 
  The following portion of the Prospectus Summary presents a summary of the
Distribution, Franchising (as its expected to be constituted after the
Distribution), and Sunburst.
 
                                THE DISTRIBUTION
 
Distributed Company...........  Choice Hotels Franchising, Inc.
                                ("Franchising"), a Delaware corporation and a
                                wholly owned subsidiary of Choice Hotels
                                International, Inc., a Delaware corporation
                                (the "Choice"), will, on the Distribution Date,
                                own all of the business and assets of, and be
                                responsible for all of the liabilities
                                associated with, the business of franchising
                                hotels under the Clarion(R), Quality(R),
                                Comfort(R), Sleep Inn(R), Rodeway(R), Econo
                                Lodge(R) and MainStay SuitesSM brands currently
                                conducted by Franchising and certain of its
                                subsidiaries as well as all European real
                                estate assets currently held by Choice (the
                                "Franchising Business"). Upon the Distribution,
                                Franchising will change its corporate name to
                                Choice Hotels International, Inc.
 
Distributing Company..........  Choice Hotels International, Inc., a Delaware
                                corporation ("Choice"). Upon the Distribution,
                                Choice will continue to own and operate hotel
                                properties in the U.S. (the "Hotel Business")
                                and will change its corporate name upon the
                                Distribution to Sunburst Hospitality
                                Corporation (as renamed after the Distribution,
                                "Sunburst").

Securities to Be 
  Distributed.................. Approximately 60,200,784 shares of Franchising
                                Common Stock based on 60,200,784 shares of
                                Company Common outstanding as of August 5, 1997
                                (the "Annual Meeting Record Date").

Conditions to the 
  Distribution................. Choice's stockholders approved the Distribution
                                at Choice's Annual Meeting of Stockholders on
                                September 16, 1997; however, the Choice Board
                                of Directors has conditioned the effectiveness
                                of the Distribution on satisfaction of certain
                                conditions prior to the Distribution Record
                                Date. The Board of Directors will not waive any
                                of the conditions to the Distribution or make
                                any changes in the terms of the Distribution
                                unless the Board of Directors determines that
                                such changes would not be materially adverse to
                                Choice's stockholders. In determining whether
                                any such changes would be materially adverse to
                                Choice's stockholders, the Board of Directors
                                will consider, as appropriate, advice from its
                                outside advisors as well as the recommendation
                                of management as to the potential impact of
                                such changes on the Company and the Company's
                                Stockholders. See "The Distribution--
                                Conditions; Termination."
 
Distribution Ratio............  One share of Franchising Common Stock for each
                                share of Choice Common Stock.
 
                                       3
<PAGE>
 
 
Tax Consequences..............  Choice has conditioned the Distribution on
                                receipt of a ruling from the Internal Revenue
                                Service to the effect that, among other things,
                                for federal income tax purposes, receipt of
                                shares of Franchising Common Stock by Choice
                                stockholders will be tax free. On September 12,
                                1997, Choice received such a ruling from the
                                Internal Revenue Service.
 
                                For a discussion of the effects on Choice and
                                Franchising if the Distribution were not to
                                qualify as tax free for federal income tax
                                purposes, see "Risk Factors--Certain Tax
                                Considerations."
 
Risk Factors..................  Manor Care Employees should carefully consider
                                all of the information contained in this Proxy
                                Statement, including the matters described
                                under "Risk Factors."
 
Relationship between Choice
 and Franchising after the
 Distribution.................  For purposes of governing the ongoing          
                                relationships between Choice and Franchising    
                                after the Distribution Date and in order to     
                                provide for an orderly transfer of the          
                                Franchising Business to Franchising and         
                                facilitate the transition to two separate       
                                publicly traded companies, Choice and           
                                Franchising will enter into a Distribution      
                                Agreement, a Strategic Alliance Agreement,      
                                Franchising Agreements and various other        
                                agreements with respect to, among other things, 
                                intercompany debt, tax matters, employee        
                                benefits, risk management and corporate and     
                                administrative services. See "Relationship      
                                Between Choice and Franchising After the        
                                Distribution." Choice and Franchising may be    
                                subject to certain potential conflicts of       
                                interest. See "Risk Factors--Potential          
                                Conflicts."                                     
                                                                                
 
Accounting Treatment..........  The historical combined financial statements of
                                Franchising present its financial position,
                                results of operations and cash flows as if it
                                were a separate entity for all periods
                                presented. Choice's historical basis in the
                                assets and liabilities of Franchising has been
                                carried over. See "Accounting Treatment," and
                                the combined financial statements of Choice
                                Hotels Franchising, Inc., contained elsewhere
                                herein.
 
Listing and Trading Market....  There is currently no public market for
                                Franchising Common Stock. Choice has been
                                approved to submit an application for listing
                                the Franchising Common Stock on the New York
                                Stock Exchange, subject to satisfaction of
                                certain conditions; however, there can be no
                                assurance that the Franchising Common Stock
                                will ultimately be accepted for listing on the
                                New York Stock Exchange or any other national
                                stock exchange or market. Choice expects that
                                no "when issued" trading market will exist
                                prior to the time that Franchising's
                                Registration Statement on Form 10 is declared
                                effective by the Commission. See "Risk
                                Factors--No Current Market for Franchising
                                Common Stock; and --The Distribution--Listing
                                and Trading of Franchising Common Stock."
 
                                       4
<PAGE>
 
 
Record Date...................  The Choice Board of Directors set the record
                                date for the Distribution referred to herein as
                                October 7, 1997 (the "Distribution Record
                                Date") provided, however, that the Distribution
                                remains subject to satisfaction of certain
                                conditions prior to the Distribution Record
                                Date.
 
Distribution Date.............  The Choice Board of Directors set the
                                Distribution Date, as October 15, 1997. On the
                                Distribution Date, Choice will deliver all
                                outstanding shares of Franchising Common Stock
                                to the Distribution Agent. As soon as
                                practicable thereafter, the Distribution Agent
                                will mail account statements reflecting
                                ownership of the appropriate number of shares
                                of Franchising Common Stock to Choice's
                                stockholders entitled thereto. See "The
                                Distribution--Manner of Effecting the
                                Distribution."
 
Distribution Agent............  ChaseMellon Shareholder Services, L.L.C., the
                                transfer agent for the Company.
 
Reverse Stock Split...........  In connection with the Distribution, Choice
                                shall effect a one-for-three reverse stock
                                split of Choice Common Stock whereby every
                                three shares of Choice Common Stock will be
                                aggregated into one share of Choice Common
                                Stock. See "Amendments to the Restated
                                Certification of Incorporation of Choice--
                                Reverse Stock Split."
 
                                       5
<PAGE>
 
 
                        CHOICE HOTELS FRANCHISING, INC.
 
Business......................  Franchising is presently a wholly owned
                                subsidiary of Choice. Following the
                                Distribution, Franchising will conduct the
                                Franchising Business as now conducted by
                                Franchising, Choice and certain other
                                subsidiaries of Choice. Franchising will be one
                                of the world's largest franchisors of hotels
                                with 3,344 properties open and operating in 33
                                countries at May 31, 1997. As a franchisor,
                                Franchising will license hotel operators to use
                                Franchising's brand names: Comfort(R),
                                Quality(R), Clarion(R), Sleep(R), Rodeway(R),
                                Econo Lodge(R) and MainStay SuitesSM
                                (collectively, the "Choice Brands"), and will
                                provide to these hotel operators products and
                                services designed to increase their revenues
                                and profitability. Following the Distribution,
                                Franchising will also conduct Choice's European
                                hotel operations, including Choice's indirect
                                investment in Friendly Hotels, PLC.
 
Board of Directors............  Effective as of the Distribution Date, the
                                Board of Directors of Franchising is expected
                                to consist of nine persons: Stewart Bainum,
                                Jr., Stewart Bainum, Barbara Bainum, William R.
                                Floyd, James H. Rempe, Robert C. Hazard, Jr.,
                                Gerald W. Petitt, Jerry E. Robertson, Ph.D and
                                Frederic V. Malek.

Post-Distribution Dividend    
 Policy.......................  The dividend policy of Franchising will be
                                determined by Franchising's Board of Directors
                                following the Distribution. It is expected that
                                the Franchising Credit Facility (as defined
                                below) will restrict Franchising's ability to
                                pay dividends. See "Financing."
 
Certain Restated Certificate  
 of Incorporation and Bylaw   
 Provisions...................  The Restated Certificate of Incorporation (the
                                "Franchising Certificate") and the Bylaws (the
                                "Franchising Bylaws") of Franchising are
                                substantially identical to, and contain no
                                material differences from, the Choice Restated
                                Certificate of Incorporation and Bylaws.
                                Certain provisions of the Franchising
                                Certificate and the Franchising Bylaws have the
                                effect of delaying or making more difficult an
                                acquisition of control of Franchising in a
                                transaction not approved by its Board of
                                Directors. These provisions have been designed
                                to enable Franchising, especially in its
                                initial years, to develop its businesses and
                                foster its long-term growth without disruptions
                                caused by the threat of a takeover not deemed
                                by its Board of Directors to be in the best
                                interests of Franchising. Such provisions
                                could, however, deter an offer for Franchising
                                Common Stock at a substantial premium to the
                                then current market price or hinder a potential
                                transaction that may be attractive to
                                stockholders. See "Certain Information
                                Concerning Franchising--Purposes and Effects of
                                Certain Provisions of the Franchising
                                Certificate and Bylaws." The Franchising
                                Certificate would eliminate certain liabilities
                                of directors in connection with the performance
                                of their duties. See "Certain Information
                                Concerning Franchising--Liability and
                                Indemnification of Officers and Directors--
                                Elimination of Liability in Certain
                                Circumstances."
 
Principal Office..............  10750 Columbia Pike, Silver Spring, Maryland
                                20901. Its telephone number is (301) 979-5000.
 
 
                                       6
<PAGE>
 
                        SUNBURST HOSPITALITY CORPORATION
 
Business......................  Following the Distribution, Sunburst will
                                retain Choice's Hotel Business and will own and
                                manage 71 hotels in 25 states, primarily under
                                Franchising's brands, and will be Franchising's
                                largest franchisee.
 
Board of Directors............  Effective as of the Distribution Date, the
                                Board of Directors of Sunburst is expected to
                                consist of seven persons; Stewart Bainum, Jr.,
                                Stewart Bainum, Donald J. Landry, Frederic V.
                                Malek, Paul R. Gould, Carole Y. Prest and one
                                additional director to be selected by the
                                Company's Board of Directors prior to the
                                Distribution. The remaining vacancy will be
                                filled by a person who is not a Sunburst
                                employee or employee or director of
                                Franchising.
Post-Distribution Dividend      
 Policy.......................  The dividend policy of Sunburst will be
                                determined by its Board of Directors following
                                the Distribution. Choice currently is
                                prohibited from paying dividends pursuant to
                                the terms of its loan agreement with MNR
                                Finance Corp. It is expected that the Sunburst
                                Credit Facility will restrict Sunburst's
                                ability to pay dividends. See "Financing."
 
Listing and Trading Market....  The Sunburst Common Stock (formerly Choice
                                Common Stock) is expected to continue to be
                                listed on the New York Stock Exchange following
                                the Distribution. Following the Distribution,
                                Sunburst's financial results will no longer be
                                consolidated with those of Choice's Franchising
                                Business, and Sunburst's revenues, income and
                                other results of operations will be
                                substantially below those of Choice prior to
                                the Distribution. Accordingly, as a result of
                                the Distribution, the trading price range of
                                Sunburst Common Stock immediately after the
                                Distribution (prior to the effect of the
                                Reverse Stock Split) is expected to be
                                significantly lower than the trading range of
                                Choice Common Stock. See "--The Distribution--
                                Listing and Trading of Sunburst Common Stock;
                                and --Risk Factors--Changes in Trading Prices
                                of Sunburst Common Stock."
 
Principal Office..............  10750 Columbia Pike, Silver Spring, Maryland
                                20901. Its telephone number is (301) 979-3800.
 
                                       7
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
                         SUMMARY FINANCIAL INFORMATION
 
  The following table summarizes certain selected historical financial data of
Franchising for the three fiscal years ended May 31, 1997. The information set
forth below should be read in conjunction with "Certain Information Concerning
Franchising--Selected Historical Financial Data; and --Management's Discussion
and Analysis of Financial Condition and Results of Operations," and the
Combined Financial Statements of Franchising contained elsewhere herein.
 
<TABLE>
<CAPTION>
                                                      YEAR ENDED MAY 31,
                                                  ----------------------------
                                                    1997      1996      1995
                                                  --------  --------  --------
                                                    (DOLLARS IN THOUSANDS)
<S>                                               <C>       <C>       <C>
Statement of Income Data
  Revenues....................................... $272,255  $250,654  $212,672
  Operating expense..............................  201,893   216,271   170,706
  Operating income...............................   70,362    34,383    41,966
  Net income.....................................   34,730    11,664    16,228
  Pro forma earnings per share(4)................ $   0.55  $   0.19  $   0.26
Other Data
  EBITDA(2)(3)................................... $ 80,800  $ 69,450  $ 51,534
  Cash flows from operating activities...........   46,448    32,742    37,851
  Cash flows from investing activities...........  (17,871)  (78,499)   (7,733)
  Cash flows from financing activities...........  (28,222)   48,513   (31,261)
  Number of franchised properties (unaudited)....    3,344     3,052     2,835
  Number of rooms (unaudited)....................  335,127   261,456   245,669
  Average royalty rate (unaudited)...............      3.4%      3.3%      3.2%
Balance Sheet Data
  Working capital (unaudited).................... $ (1,359) $ (3,927) $(29,423)
  Total assets...................................  221,473   212,803   189,087
  Notes payable to Parent........................   78,700    78,700    78,700
  Total debt.....................................  125,163   145,315   128,205
  Total investment and advances from (to)
   Parent........................................   57,193    30,532   (12,699)
</TABLE>
--------
(1) 1996 includes a pre-tax charge of $24.8 million for impairment of certain
    long lived assets associated with Franchising's European operations.
(2) EBITDA consists of the sum of net income (loss), interest expense, income
    taxes, depreciation and amortization and non-cash asset writedowns. EBITDA
    is presented because such data is used by certain investors to determine
    Franchising's ability to meet debt service, fund capital expenditures and
    expand its business. Franchising considers EBITDA to be an indicative
    measure of operating performance particularly due to the large amount of
    goodwill and franchise rights amortization. Such information should not be
    considered an alternative to net income, operating income, cash flow from
    operations or any other operating or liquidity performance measure
    prescribed by GAAP. Cash expenditures (including nondiscretionary
    expenditures) for various long-term assets, interest expense and income
    taxes have been, and will be, incurred which are not reflected in the
    EBITDA presentation and therefore EBITDA does not represent funds available
    for management's discretionary use. EBITDA presented by Franchising may not
    be comparable to EBITDA defined and presented by other companies.
(3) 1996 EBITDA excludes a pre-tax charge of $24.8 million for impairment of
    certain long lived assets associated with Franchising's European
    operations.
(4) Pro forma earnings per share has been calculated based on the weighted
    average shares outstanding of its parent Manor Care, Inc. for fiscal year
    1995 and fiscal year 1996 of 62,480,000 and 62,628,000, respectively, and
    its parent Choice Hotels International, Inc. for fiscal year 1997 of
    62,680,000.
 
                                       8
<PAGE>
 
                                 RISK FACTORS
 
CERTAIN FINANCIAL AND OPERATING CONDITIONS
 
  While the Hotel Business and the Franchising Business have substantial
operating histories, Sunburst and Franchising do not have operating histories
as separate stand-alone companies. Prior to the Distribution, each of the two
businesses had access to the cash flow generated by the other and Choice's
credit, which was based on the combined assets of the Hotel Business and the
Franchising Business. Subsequent to the Distribution, Sunburst will not have
the benefit of either the cash flow generated by, or the assets of, the
Franchising Business, and Franchising will not have the benefit of either the
cash flow generated by, or the assets of, the Hotel Business.
 
  Subsequent to the Distribution, each of Sunburst and Franchising will be a
smaller and less diversified company than Choice prior to the Distribution. In
addition, the division of Choice may result in some temporary dislocation and
inefficiencies to the business operations, as well as the organization and
personnel structure, of each company. Nevertheless, Choice's Board of
Directors believes that separation of the two companies will also result in
long-term operating efficiencies by allowing the companies to focus on their
respective businesses.
 
SUBSTANTIAL LEVERAGE AT SUNBURST
 
  After the Distribution, Sunburst will be a highly leveraged corporation.
Assuming that the Distribution had been consummated on May 31, 1997, Sunburst
would have had, on a pro forma basis, total long-term indebtedness of
approximately $246.8 million (representing approximately 78.6% of its total
capitalization) and total stockholders' equity of $67.3 million, compared with
Choice's actual long-term indebtedness as of May 31, 1997, before allocation
of indebtedness to Franchising of $372.0 million (representing approximately
74.9% of its total capitalization) and total stockholder's equity of $124.5
million.
 
  Sunburst's Hotel Business is a capital-intensive business and Sunburst will
continue to have significant capital requirements in the future. As a highly
leveraged corporation, any new financing and refinancing by Sunburst of its
existing indebtedness may be at higher interest rates and on less advantageous
terms than may have been the case had the Distribution not taken place. For a
discussion of the financing for Sunburst expected to be implemented in
connection with the Distribution, see "Financing." This significant degree of
leverage could have a potential negative impact on the ability of Sunburst to
incur additional debt to fund future expansion. While Sunburst's operating
cash flow is expected to be sufficient to cover its expenses, including
interest costs, Sunburst may be required to supplement operating cash flow
with asset sales, refinancing proceeds, equity offerings or capital spending
reductions to meet principal repayment obligations in later years. There can
be no assurance that any refinancing or equity offering could be successfully
concluded. Any resort to alternative sources of funds may impair Sunburst's
competitive position and reduce its cash flow.
 
  The ability of Sunburst to satisfy its obligations, to reduce its debt and
to increase equity will also be dependent upon its future performance, which
will be subject to prevailing economic conditions and to financial, business
and other factors, including factors beyond the control of Sunburst, affecting
the business operations of Sunburst.
 
CERTAIN TAX CONSIDERATIONS
 
  Choice has conditioned the Distribution on the receipt of a favorable ruling
from the Internal Revenue Service. On September 12, 1997, Choice received such
a ruling from the Internal Revenue Service.
 
  Such rulings, while generally binding upon the Internal Revenue Service, are
subject to certain factual representations and assumptions. If such factual
representations and assumptions were incorrect in a material respect, such
ruling would be jeopardized. Choice is not aware of any facts or circumstances
which would cause such representations and assumptions to be untrue. Choice
and Franchising will agree to comply in all material respects with each
representation and statement made to a taxing authority in connection with the
Distribution to provide further assurances that the Distribution will qualify
as tax free. See "--Relationship Between Choice and Franchising After the
Distribution--Distribution Agreement."
 
                                       9
<PAGE>
 
  If the Distribution were not to qualify under Section 355 of the Code, then
in general a corporate tax would be payable by the consolidated group of which
Choice is the common parent based upon the difference between (x) the fair
market value of the Franchising Common Stock and (y) the adjusted basis of the
Franchising Common Stock immediately prior to the Distribution. The corporate
level tax would be payable by Choice and could be substantial. Under the
consolidated return rules, each member of the consolidated group (including
Franchising) is severally liable for such tax liability.
 
  Furthermore, each holder of Choice Common Stock who receives shares of
Franchising Common Stock in the Distribution would be treated as if such
stockholder received a taxable distribution in an amount equal to the fair
market value of the Franchising Common Stock received, which would result in
(x) a dividend to the extent of such stockholder's pro rata share of Choice's
current and accumulated earnings and profits, (y) a reduction in such
stockholder's basis in Choice Common Stock to the extent the amount received
exceeds such stockholder's share of earnings and profits and (z) gain from the
exchange of Choice Common Stock to the extent the amount received exceeds both
such stockholder's share of earnings and profits and such stockholder's basis
in Choice Common Stock.
 
NO CURRENT PUBLIC MARKET FOR FRANCHISING COMMON STOCK
 
  Currently, there is no public market for Franchising Common Stock and there
can be no assurances as to the prices at which trading in Franchising Common
Stock will occur after the Distribution. Until Franchising Common Stock is
fully distributed and an orderly market develops, the prices at which trading
in such stock occurs may fluctuate significantly. The prices at which
Franchising Common Stock trades will be determined by the marketplace and may
be influenced by many factors, including, among others, the depth and
liquidity of the market for Franchising Common Stock, investor perception of
Franchising and the industry in which Franchising participates, Franchising's
dividend policy and general economic and market conditions. The Franchising
Common Stock has been approved to submit an application for listing on the New
York Stock Exchange subject to certain conditions. See "The Distribution--
Listing and Trading of Franchising Common Stock."
 
CHANGES IN TRADING PRICES OF SUNBURST COMMON STOCK
 
  It is expected that Sunburst Common Stock (formerly Choice Common Stock)
will continue to be listed and traded on the New York Stock Exchange after the
Distribution. Following the Distribution, Sunburst's financial results will no
longer be consolidated with those of Choice's Franchising Business, and
Sunburst's revenues, income and other results of operations will be
substantially below those of Choice prior to the Distribution. Accordingly, as
a result of the Distribution, the trading price range of Sunburst Common Stock
immediately after the Distribution (prior to giving effect to the Reverse
Stock Split) is expected to be significantly lower than the trading price
range of Choice Common Stock. Additionally, the combined trading prices of
Sunburst Common Stock and Franchising Common Stock held by stockholders after
the Distribution may be less than, equal to or greater than the trading price
of Choice Common Stock prior to the Distribution. See "The Distribution--
Listing and Trading of Sunburst Common Stock."
 
  For a description of the Reverse Stock Split to be undertaken by Choice as
part of the Distribution and its anticipated impact on the trading price range
of Sunburst Common Stock, see "Amendments to the Restated Certificate of
Incorporation of Choice."
 
CERTAIN ANTITAKEOVER FEATURES
 
  If the Distribution is consummated, the Franchising Certificate and
Franchising Bylaws will contain several provisions, which are now in effect
with respect to Choice and will continue to be in effect with respect to
Sunburst, that may make the acquisition of control of Franchising difficult or
expensive, or increase the likelihood that incumbent management will retain
their positions or hinder a transaction that may be attractive to
stockholders. See "The Distribution--Certain Information Concerning
Franchising--Purposes and Antitakeover Effects of Certain Provisions of the
Franchising Certificate and Bylaws."
 
 
                                      10
<PAGE>
 
POTENTIAL CONFLICTS
 
  Subsequent to the Distribution, the ongoing relationship between Sunburst
and Franchising may potentially give rise to conflicts of interests. In
connection with the Distribution, (i) Sunburst and Franchising will enter into
a Strategic Alliance Agreement pursuant to which Sunburst will grant to
Franchising a right of first refusal to franchise lodging properties developed
or acquired by Sunburst that Sunburst intends to operate under franchise;
Franchising will grant to Sunburst a conditional option to purchase the
MainStay Suites hotel system; each of the parties will continue to cooperate
with respect to matters of mutual interest, including new product and concept
testing for Franchising in hotels owned by Sunburst, and Sunburst will
authorize Franchising, in certain circumstances, to negotiate with third party
vendors on Sunburst's behalf; (ii) Sunburst and Franchising will be parties to
agreements pursuant to which Franchising will provide to Sunburst certain
administrative services after the Distribution and (iii) Sunburst, pursuant to
certain franchising agreements, will be the largest franchisee of Franchising.
See "Relationship Between Choice and Franchising After the Distribution." With
respect to these matters, the potential exists for disagreements as to the
quality of the services provided by the parties and as to contract compliance.
Nevertheless, Choice believes that there will be sufficient mutuality of
interest between the two companies to result in a mutually productive
relationship. In addition, Stewart Bainum, Jr. will serve as Chairman of the
Board of Directors of both Sunburst and Franchising. Stewart Bainum and
Frederick V. Malek will each serve as a director of each of Sunburst and
Franchising. Messrs. Bainum, Jr., Bainum and Malek as well as certain other
officers and directors of Sunburst and Franchising will also own shares
(and/or options or other rights to acquire shares) in both companies following
the Distribution. Appropriate policies and procedures will be followed by the
boards of directors of each company to limit the involvement of the
overlapping directors (and if appropriate, relevant officers of such
companies) in conflict situations, including requiring them to abstain from
voting as directors of either Sunburst or Franchising on certain matters which
present a conflict between the two companies.
 
FRAUDULENT TRANSFER CONSIDERATIONS; LEGAL DIVIDEND REQUIREMENTS
 
  Choice's Board of Directors does not intend to consummate the Distribution
unless it is satisfied regarding the solvency of Choice, Franchising and the
permissibility of the Distribution under Section 170 of the (DGCL). There is
no certainty, however, that a court would reach the same conclusion. If a
court (for example, in a lawsuit by an unpaid creditor or representatives of
creditors) were to find that, at the time the Company effected the
Distribution of Franchising, Choice or Franchising, as the case may be, (i)
was insolvent, (ii) was rendered insolvent by reason of the Distribution,
(iii) was engaged in a business or transaction for which Choice's or
Franchising's remaining assets, as the case may be, constituted unreasonably
small capital, or (iv) intended to incur, or believed it would incur, debts
beyond its ability to pay as such debts matured, such court may be asked to
void the Distribution (in whole or in part) as a fraudulent conveyance and
require that the stockholders return the special dividend (in whole or in
part) to Choice, or require Choice or Franchising, as the case may be, to fund
certain liabilities of the other company for the benefit of creditors. The
measure of insolvency for purposes of the foregoing will vary depending upon
the jurisdiction whose law is being applied. Generally, however, Choice,
Franchising, as the case may be, would be considered insolvent if the fair
value of their respective assets were less than the amount of their respective
liabilities or if they incurred debt beyond their ability to repay such debt
as it matures. In addition, under Section 170 of the DGCL (which is applicable
to Choice in the Distribution) a corporation generally may make distributions
to its stockholders only out of its surplus (net assets minus capital) and not
out of capital.
 
SIGNIFICANT BAINUM FAMILY INTEREST
 
  Upon completion of the Distribution, certain members of the Bainum family
(including various trusts established by members of the Bainum family) in the
aggregate will have the right to vote approximately 34.43% of the outstanding
shares of Franchising Common Stock and Sunburst Common Stock. See "--Certain
Information Concerning Franchising--Security Ownership." In addition, Mr.
Bainum and Mr. Bainum, Jr. each will be a director of Sunburst and Mr. Bainum,
Mr. Bainum, Jr. and Ms. Bainum each will be a director of Franchising. As a
result, the Bainum family may be in a position to significantly influence the
affairs of each of Sunburst and Franchising, including the election of
directors.
 
                                      11
<PAGE>
 
DIVIDEND POLICIES
 
  The dividend policies of Sunburst and Franchising will be determined by
their respective Boards of Directors following the Distribution. The
declaration and payment of dividends by Sunburst will be at the discretion of
the Sunburst Board of Directors. The declaration and payment of dividends by
Franchising will be at the discretion of the Franchising Board of Directors.
The Sunburst Board of Directors and the Franchising Board of Directors intend
to re-evaluate their respective dividend policies from time to time in light
of their respective companies' results of operations, financial condition,
cash requirements, future prospects and other factors deemed relevant. There
can be no assurance that any dividends will be paid by either company in the
future. Choice currently is prohibited from paying dividends pursuant to the
terms of its loan agreement with MNR Finance Corp. It is expected that the
Franchising Credit Facility (defined below) and the Sunburst Credit Facility
(defined below) will restrict Franchising and Sunburst's ability to pay
dividends. See "Financing."
 
IMPACT OF INFLATION AND OTHER EXTERNAL FACTORS
 
  Franchising's principal sources of revenues are franchise fees. Franchise
fees and revenues from owned and managed hotels can be impacted by two
external factors: the supply of hotel rooms within the lodging industry
relative to the demand for rooms by travelers, and inflation.
 
  Although industry-wide supply and demand for hotel rooms recently has been
fairly balanced, any excess in supply that might develop in the future could
have an unfavorable impact on room revenues at Franchising's franchised hotels
either by reducing the number of rooms reserved at Franchising's properties or
by restricting the rates hotel operators can charge for their rooms. In
addition, an excess supply of hotel rooms may discourage potential franchisees
from opening new hotels, unfavorably impacting the franchise fees received by
Franchising.
 
  Although Franchising believes that increases in the rate of inflation will
generally result in comparable increases in hotel room rates, severe inflation
could contribute to a slowing of the national economy, which could result in
reduced travel by both business and leisure travelers. That could lead to less
demand for hotel rooms, which could result in a temporary reduction in room
rates and fewer room reservations, negatively impacting revenues received by
Franchising. A weak economy could also reduce demand for new hotels,
negatively impacting the franchise fees received by Franchising.
 
  Among the other unpredictable external factors which may affect
Franchising's fee revenue stream are wars, airline strikes and severe weather.
 
FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY
 
  Certain statements contained in this Prospectus under the captions
"Prospectus Summary; Risks Factors; Certain Information Concerning
Franchising--Management's Discussion and Analysis of Financial Condition and
Results of Operations; Business and Properties; Certain Information Concerning
Sunburst--Management's Discussion and Analysis of Sunburst Pro Forma Financial
Condition and Results of Operations; and Business and Properties" and
elsewhere constitute estimates of future performance or other forward-looking
statements. Such forward-looking statements involve known and unknown risks,
uncertainties and other important factors that could cause the actual results,
performance or achievements of Choice or Franchising for industry results to
differ materially from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such risks,
uncertainties and other important factors include, among other things:
Sunburst's substantial leverage after the Distribution, and its plans to
realize cash proceeds through leveraging its remaining assets; Sunburst's
plans to make selected strategic investments and acquisitions and develop new
hotels; Franchising's plans to expand its international franchise operations;
Franchising's plans to market new brands and products; Sunburst's and
Franchising's success in implementing their respective business strategies,
including their success in arranging financing where required; competition;
government regulation; general economic and business conditions; and other
factors referenced in this Proxy Statement. These forward-looking statements
speak only as of the date of this Prospectus. Choice and Franchising expressly
disclaim any obligation or undertaking to disseminate any updates or revisions
to any forward-looking statement contained herein to reflect any change in
Choice's or Franchising's expectations with regard thereto or any change in
events, conditions or circumstances on which any such statement is based.
 
                                      12
<PAGE>
 
                                USE OF PROCEEDS
 
  The Franchising Options will be issued as part of the adjustments to
outstanding Choice Options and Franchising will receive no proceeds from such
issuance. The proceeds to Franchising, if any, to be received from exercise of
the Franchising Options will be used for working capital and other general
corporate purposes.
 
  The number of Franchising Options issued to any Manor Care Employee and the
aggregate exercise price thereof will be set so that the number of shares of
Franchising Common Stock subject to the Franchising Options and the aggregate
exercise price thereof, when combined with the adjusted number of shares
under, and aggregate exercise price of, the Choice Options held by such Manor
Care Employees will preserve the aggregate exercise price and aggregate
financial value of the Choice Options held by such Manor Care Employee prior
to the adjustment.
 
                             PLAN OF DISTRIBUTION
 
  As of the date hereof, the thirty-three Manor Care Employees hold options
(the "Choice Options") to purchase up to 1,193,571 shares of Choice Common
Stock issued by Choice in November 1996 as part of the Manor Care Spin-off (as
defined herein) pursuant to the Choice Hotels International, Inc. 1996 Long-
Term Incentive Plan (the "Choice Plan"). Under the Choice Plan, each
outstanding Choice Option will be adjusted as a result of the Distribution in
the manner described herein in order to preserve the financial value of such
Choice Options prior to the Distribution.
 
  On or prior to the Distribution Date, each Manor Care Employee holding
nonqualified Choice Options may make a one-time election to choose a
conversion award consisting of any percentage combination of an option to
acquire any Franchising Common Stock and an adjusted Choice Option, with the
number of shares and the exercise price of each option adjusted so as to
preserve the financial value of the outstanding Choice Options. The
Franchising Options issuable to Manor Care Employees as part of the
aforementioned adjustment to Choice Options and the Shares of Franchising
Common Stock issuable upon exercise of such Franchising Options will be issued
pursuant to the Registration Statement of which this Prospectus is a part.
 
                                 LEGAL MATTERS
 
  The validity of the Franchising Common Stock and Franchising Options will be
passed upon for Franchising by Michael J. DeSantis, Senior Vice President,
General Counsel and Secretary of Franchising.
 
                                    EXPERTS
 
  The combined financial statements of Choice Hotels Franchising included in
this Registration Statement have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their reports with respect
thereto and have been included herein in reliance upon the authority of said
firm as experts in giving said reports.
 
                                      13
<PAGE>
 
                               THE DISTRIBUTION
 
MANNER OF EFFECTING THE DISTRIBUTION
 
  The general terms and conditions of the Distribution will be set forth in a
Distribution Agreement (the "Distribution Agreement") to be entered into by
Choice and Franchising prior to the Distribution.
 
  If all conditions to the Distribution are satisfied (or waived by the Board
of Directors), the Distribution will be made on the Distribution Date to
stockholders of record of Choice as of the Record Date. On the Distribution
Date, the Franchising Common Stock will be delivered by Choice to ChaseMellon
Shareholder Services, L.L.C., as the distribution agent (the "Distribution
Agent"). As soon thereafter as practicable, account statements reflecting
ownership of shares of Choice Common Stock and Franchising Common Stock will
be mailed by the Distribution Agent to holders of Choice Common Stock as of
the Distribution Record Date to reflect the distribution of one share of
Franchising Common Stock for every share of Choice Common Stock held on such
date. All shares will be fully paid and non-assessable and the holders thereof
will not be entitled to preemptive rights.
 
  No holder of Choice Common Stock will be required to pay any cash or other
consideration for the shares of Franchising Common Stock received in the
Distribution or to surrender or exchange shares of Choice Common Stock in
order to receive Franchising Common Stock.
 
FEDERAL INCOME TAX ASPECTS OF THE DISTRIBUTION
 
  Choice has conditioned the Distribution on the receipt of a ruling from the
Internal Revenue Service to the effect that, among other things, for federal
income tax purposes, the Distribution will qualify as a tax-free spin-off
under Section 355 of the Internal Revenue Code of 1986 (the "Code"), as
amended, and that:
 
    (1) No gain or loss will be recognized by (and no amount will be included
  in the income of) holders of Choice Common Stock upon the receipt of shares
  of Franchising Common Stock in the Distribution;
 
    (2) Provided that on the Distribution Date a holder of Choice Common
  Stock holds such stock as a capital asset, the holding period for the
  shares of Franchising Common Stock to be received in the Distribution will
  include the holding period of Choice Common Stock with respect to which the
  Distribution was made;
 
    (3) A holder's basis in Choice Common Stock held immediately before the
  Distribution will be allocated, based upon relative fair market values at
  the time of the Distribution, between such Choice Common Stock and the
  shares of Franchising Common Stock received by the stockholder in the
  Distribution; and
 
    (4) No gain or loss will be recognized by Choice or Franchising upon the
  Distribution.
 
  On September 12, 1997, Choice received from the Internal Revenue Service a
ruling to the foregoing effect. For a description of the consequences to
Choice, Franchising and the stockholders if the Distribution were not to
qualify as tax free, see "--Risk Factors--Certain Tax Considerations."
 
                                      14
<PAGE>
 
  The foregoing summary of material federal income tax consequences of the
Distribution does not purport to cover all federal income tax consequences
that may apply to all categories of stockholders. Each stockholder should
consult its own tax advisor as to the particular consequences of the
Distribution to such stockholder, including the application of state, local
and foreign tax laws, and the effect of possible changes in tax laws that may
affect the tax consequences described above.
 
LISTING AND TRADING OF FRANCHISING COMMON STOCK
 
  Currently, there is no public market for Franchising Common Stock. It is
Choice's intention that no "when-issued" trading market for Franchising Common
Stock will exist prior to the time Franchising's Registration Statement on
Form 10 with respect to the Franchising Common Stock (the "Franchising Form
10") is declared effective by the Commission. Prices at which Franchising
Common Stock may trade prior to the Distribution (on a "when-issued" basis) or
after the Distribution cannot be predicted. Until the Franchising Common Stock
is fully distributed and an orderly market develops, the prices at which
trading in such stock occurs may fluctuate significantly. The prices at which
Franchising Common Stock trades will be determined by the marketplace and may
be influenced by many factors, including, among others, the depth and
liquidity of the market for Franchising Common Stock, investor perception of
Franchising and the industry in which Franchising participates, Franchising's
dividend policy and general economic and market conditions. Such prices may
also be affected by certain provisions of the Franchising Certificate and
Franchising Bylaws, as each will be in effect following the Distribution,
which may have an antitakeover effect. See "Risk Factors--Dividend Policies;
and--Certain Information Concerning Franchising--Purposes and Antitakeover
Effects of Certain Provisions of the Franchising Certificate and Bylaws."
 
  Franchising has received approval to submit an application to list the
Franchising Common Stock on the New York Stock Exchange. However, there can be
no assurance that the Franchising Common Stock will be accepted for listing on
the New York Stock Exchange or any other national stock exchange or market.
Franchising initially will have approximately 4,550 stockholders of record
based upon the number of stockholders of record of Choice as of August 5,
1997. For certain information regarding options to purchase Franchising Common
Stock that will be outstanding after the Distribution, see "Relationship
Between the Company and Franchising After the Distribution--Employee Benefits
Allocation Agreement."
 
  The distribution of the Franchising Common Stock need not be registered
under the Securities Act of 1933, as amended (the "Securities Act") and shares
of Franchising Common Stock distributed to Choice's stockholders in the
Distribution will be freely transferable, except for securities received by
persons who may be deemed to be "affiliates" of Choice within the meaning of
Rule 144 under the Securities Act. Persons who are affiliates of Franchising
within the meaning of Rule 144 may not publicly offer or sell the Franchising
Common Stock received in connection with the Distribution except pursuant to a
registration statement under the Securities Act or pursuant to Rule 144.
 
LISTING AND TRADING OF SUNBURST COMMON STOCK
 
  It is expected that the Sunburst Common Stock (formerly Choice Common Stock)
will continue to be listed and traded on the New York Stock Exchange after the
Distribution. Following the Distribution, Sunburst's financial results will no
longer be consolidated with those of Choice's Franchising Business, and
Sunburst's revenues, income and other results of operations will be
substantially below those of Choice prior to the Distribution. Accordingly, as
a result of the Distribution, the trading price range of Sunburst Common Stock
immediately after the Distribution (prior to the effect of the Reverse Stock
Split) is expected to be significantly lower than the trading price range of
Choice Common Stock, and the combined trading prices of Sunburst Common Stock
and Franchising Common Stock held by stockholders after the Distribution may
be less than, equal to or greater than the trading price of Choice Common
Stock, prior to the Distribution. The prices at which Sunburst Common Stock
trades after the Distribution will be determined by the marketplace and may be
influenced by many factors, including, among others, the continuing depth and
liquidity of the market for Sunburst Common Stock, investor perception of the
Hotel Business, Sunburst's dividend policy and general economic and market
conditions.
 
                                      15
<PAGE>
 
CONDITIONS; TERMINATION
 
  Choice's stockholders approved the Distribution at the Choice Annual Meeting
of Stockholders on September 16, 1997, however, the Board of Directors has
conditioned the Distribution upon, among other things, satisfaction of the
following conditions prior to the Distribution Record Date: (i) the Internal
Revenue Service having issued a ruling in response to Choice's request in form
and substance satisfactory to the Board of Directors (which ruling has been
obtained by Choice); (ii) the Franchising Common Stock having been approved
for listing on the New York Stock Exchange subject to official notice of
issuance; (iii) the taking of all actions with respect to the Distribution
required or advisable under the Securities Act and the Exchange Act and the
rules and regulations promulgated thereto, including the Franchising Form 10
having become effective under the Exchange Act; (iv) any third-party consents
to the transactions contemplated by the Distribution Proposals having been
obtained, except for those the failure of which to obtain would not have a
material adverse effect on Choice or Franchising; and (v) the financing
arrangements described below in "--Financing" have been entered into. Any of
these conditions, may be waived in the discretion of the Board of Directors at
any time prior to the Distribution Date. The Board of Directors will not waive
any of the conditions to the Distribution or make any changes in the terms of
the Distribution unless the Board of Directors determines that such changes
would not be materially adverse to Choice's stockholders. In determining
whether any such changes would be materially adverse to the Choice's
stockholders, the Board of Directors will consider, as appropriate, advice
from its outside advisors as well as the recommendation of management as to
the potential impact of such changes on Choice and Choice's stockholders. See
"Relationship Between Choice and Franchising after the Distribution--
Distribution Agreement."
 
INTEREST OF CERTAIN PERSONS IN THE DISTRIBUTION
 
 Franchising
 
  It is anticipated that upon the Distribution, all of the current members of
Choice's Board of Directors except for Paul R. Gould will be appointed to the
Board of Directors of Franchising. Additionally, Stewart Bainum, Jr. will
serve as Chairman of the Boards of Directors of Choice and Franchising and
Stewart Bainum and Frederic V. Malek will be members of the Boards of
Directors of Choice and Franchising. Messrs. Bainum and Bainum, Jr., Ms.
Bainum and Messrs. Hazard, Jr., Malek, Petitt and Robertson will each receive
from Franchising compensation for serving as a director of Franchising that is
substantially the same as the compensation currently received by such persons
as directors of Choice.
 
  It is further anticipated that upon the Distribution, William R. Floyd will
become Vice Chairman and Chief Executive Officer of Franchising; James A.
MacCutcheon will become Executive Vice President, Chief Financial Officer and
Treasurer of Franchising; Thomas Mirgon will become Senior Vice President,
Human Resources of Franchising; Barry L. Smith will become Senior Vice
President--Marketing of Franchising; Michael J. DeSantis will become Senior
Vice President, General Counsel and Secretary of Franchising; and Joseph M.
Squeri will become Vice President--Finance and Controller of Franchising.
 
  Effective upon the Distribution Date, Franchising is expected to enter into
a series of employment agreements with current members of Choice's management
as follows. It is expected that Franchising will enter into an employment
agreement with Stewart Bainum, Jr., providing for Mr. Bainum, Jr.'s employment
as Chairman of the Board of Franchising. Either Franchising or Mr. Bainum may
terminate the agreement upon 30 days' prior written notice on the first and
second anniversary dates of the agreement. The agreement will provide that Mr.
Bainum, Jr. will devote 12.5% of his professional time to the affairs of
Franchising, 12.5% of his professional time to the affairs of Choice and the
remaining 75% of his professional time to the affairs of Manor Care. The
agreement provides for a base salary of $82,044 per annum for services to
Franchising and a maximum bonus of 60% of Mr. Bainum, Jr.'s base compensation
based upon the performance of Franchising.
 
  Effective upon the Distribution Date, Franchising is expected to assume
employment agreements between Choice and William R. Floyd, James A.
MacCutcheon and Thomas Mirgon, respectively. For additional discussion of
employment agreements between Franchising and its management, see "Certain
Information Concerning Franchising--Employment Agreements."
 
                                      16
<PAGE>
 
 Sunburst
 
  Sunburst has entered into an employment agreement with Donald J. Landry,
which will become effective upon the Distribution Date, providing for Mr.
Landry's employment as Chief Executive Officer of Sunburst.
 
 Outstanding Stock Options
 
  In connection with the Distribution, directors and officers of Choice will
have the opportunity to receive options to purchase Franchising Common Stock
and/or to retain Choice Common Stock as an adjustment to preserve the
financial value of their outstanding options to purchase Choice Common Stock.
For a discussion of the treatment of outstanding options to purchase Choice
Common Stock in connection with the Distribution, see "Relationship Between
Choice and Franchising After the Distribution--Employee Benefits Allocations
Agreement."
 
                                      17
<PAGE>
 
                          RELATIONSHIP BETWEEN CHOICE
                    AND FRANCHISING AFTER THE DISTRIBUTION
 
  For purposes of governing the ongoing relationships between Choice and
Franchising after the Distribution Date, and in order to facilitate the
transition to two separate publicly-traded companies, Choice and Franchising
will enter into agreements setting forth Choice's and Franchising's on-going
responsibilities regarding the matters outlined below. The material terms of
such agreements are described below and the agreements summarized in this
section are included as exhibits to the Registration Statement of which this
Prospectus is a part.
 
DISTRIBUTION AGREEMENT
 
  On or prior to the Distribution Date, Choice and Franchising will enter into
a Distribution Agreement which provides for, among other things, the principal
corporate transactions required to effect the Distribution, the assumption by
Franchising of all liabilities relating to the Franchising Business and the
allocation between the Company and Franchising of certain other liabilities,
certain indemnification obligations of Choice and Franchising and certain
other agreements governing the relationship between Choice and Franchising
with respect to or in consequence of the Distribution. The Distribution
Agreement provides that the Distribution is subject to the prior satisfaction
of certain conditions including, among other things, the execution of all
ancillary agreements to the Distribution Agreement, certain of which are
described below, and the declaration of the Distribution by the Choice Board
of Directors.
 
  Subject to certain exceptions, Franchising has agreed to indemnify Choice
and its subsidiaries against any loss, liability or expense incurred or
suffered by Choice or its subsidiaries arising out of or related to the
failure by Franchising to perform or otherwise discharge liabilities allocated
to and assumed by Franchising under the Distribution Agreement, and Choice has
agreed to indemnify Franchising against any loss, liability or expense
incurred or suffered by Franchising arising out of or related to the failure
by Choice to perform or otherwise discharge the liabilities retained by Choice
under the Distribution Agreement. The foregoing cross-indemnities do not apply
to indemnification for tax claims and liabilities, which are addressed in the
Tax Sharing Agreement described below. The Distribution Agreement also
includes procedures for notice and payment of indemnification claims and
provides that the indemnifying party may assume the defense of a claim or suit
brought by a third party.
 
  To avoid adversely affecting the intended tax consequences of the
Distribution, the Distribution Agreement provides that each of Choice and
Franchising will agree to comply in all material respects with each
representation and statement made to any taxing authority in connection with
the IRS tax ruling or any other tax ruling obtained by Choice and Franchising
in connection with the Distribution.
 
  The Distribution Agreement also provides that by the Distribution Date,
Franchising's Amended and Restated Certificate of Incorporation and Bylaws
shall be in the forms attached hereto as Annexes A and B, respectively, and
that Franchising and Choice will take all actions which may be required to
elect or otherwise appoint, as directors of Franchising, the nine persons
indicated herein. See "Certain Information Concerning Franchising--Description
of Franchising Capital Stock; Purposes and Antitakeover Effects of Certain
Provisions of the Franchising Certificate and Bylaws; and Management."
 
  The Distribution Agreement also provides that each of Choice and Franchising
will be granted access to certain records and information in the possession of
the other, and requires the retention of such information in its possession
for specified periods and thereafter requires that each party give the other
prior notice of its intention to dispose of such information. In addition, the
Distribution Agreement provides for the allocation of shared privileges with
respect to certain information and requires each of Choice and Franchising to
obtain the consent of the other prior to waiving any shared privilege.
 
  The Distribution Agreement provides that except as otherwise specifically
provided, all costs and expenses incurred in connection with the preparation,
execution, delivery and implementation of the Distribution
 
                                      18
<PAGE>
 
Agreement and with the consummation of the transactions contemplated by the
Distribution Agreement (including transfer taxes and the fees and expenses of
all counsel, accountants and other advisors) shall be paid by the party
incurring such cost or expense. Notwithstanding the foregoing, Choice shall be
obligated to pay the legal, filing, accounting, printing and other out-of-
pocket expenditures in connection with the preparation, printing and filing of
the Franchising Form 10 Registration Statement.
 
STRATEGIC ALLIANCE AGREEMENT
 
  On or prior to the Distribution Date, Choice and Franchising will enter into
a Strategic Alliance Agreement pursuant to which: (i) Choice will grant a
right of first refusal to Franchising to franchise any lodging property that
Sunburst develops or acquires and intends to operate under franchise; (ii)
Sunburst will, barring a material change in market conditions, continue to
develop Sleep Inns and MainStay Suites hotels so that it will have opened a
total of 14 Sleep Inns and 15 MainStay Suites hotels within 48 months of the
Distribution Date; (iii) Franchising will grant to Sunburst an option,
exercisable under certain circumstances, to purchase the brand names, marks,
franchise agreements and other assets of the MainStay Suites hotel system;
(iv) Sunburst and Franchising will continue to cooperate with respect to
matters of mutual interest, including new product and concept testing for
Franchising in hotels owned by Sunburst; and (v) Sunburst will authorize
Franchising to negotiate with third party vendors on Sunburst's behalf for the
purchase of certain items. The Strategic Alliance Agreement extends for a term
of 20 years with rights of mutual termination on the fifth, tenth and
fifteenth anniversaries.
 
TAX SHARING AGREEMENT
 
  Choice and Franchising will enter into the Tax Sharing Agreement for
purposes of allocating pre-Distribution tax liabilities among Sunburst and
Franchising and their respective subsidiaries. In general, Sunburst will be
responsible for (i) filing consolidated federal income tax returns for the
Sunburst affiliated group and combined or consolidated state tax returns for
any group that includes a member of the Sunburst affiliated group, including
in each case Franchising and its subsidiaries for the periods of time that
such companies were members of the applicable group and (ii) paying the taxes
relating to such tax returns to the applicable taxing authorities (including
any subsequent adjustments resulting from the redetermination of such tax
liabilities by the applicable taxing authorities). Franchising will reimburse
Sunburst for the portion of such taxes that relates to Franchising and its
subsidiaries, as determined based on their hypothetical separate company
income tax liabilities. Sunburst and Franchising have agreed to cooperate with
each other, and to share information, in preparing such tax returns and in
dealing with other tax matters.
 
EMPLOYEE BENEFITS ALLOCATION AGREEMENT
 
  On or prior to the Distribution Date, Choice and Franchising will enter into
an Employee Benefits and Other Employment Matters Allocation Agreement (the
"Employee Benefits Allocation Agreement"). The Employee Benefits Allocation
Agreement provides for the allocation subsequent to the Distribution of
employee benefits, as they relate to employees who remain employed by Sunburst
or its subsidiaries ("Sunburst Employees") after the Distribution and
employees who are employed by Franchising or its subsidiaries after the
Distribution ("Franchising Employees"). During the period beginning on the
Distribution Date and ending on December 31, 1997, Franchising shall pay to
Sunburst, on a monthly basis, a payment equal to 1.9% of the payroll for all
Franchising Employees. In consideration thereof, during such period, Sunburst
will assume all responsibility for all funding obligations and current plan
year matching contributions attributable to certain retirement and savings
plans specified in the Employee Benefits Allocation Agreement. During the same
period, Franchising will also pay to Sunburst a monthly fee of $216 for each
Franchising Employee receiving services and benefits under a Sunburst medical
plan. Sunburst shall be responsible for all liabilities and obligations
related to claims incurred through December 31, 1997 in respect of Sunburst
Employees and Franchising Employees (whether such claims are assessed before
or after December 31, 1997) under any Sunburst welfare plan and, with respect
to pre-tax medical and dependent care programs, will retain any funds
remaining on January 1, 1998. Pursuant to the Employee Benefits Allocation
Agreement, Sunburst will continue sponsorship of the various Choice profit
 
                                      19
<PAGE>
 
sharing plans, stock plans and health and welfare plans with respect to
Sunburst Employees. Franchising will establish a number of plans which will
allow Franchising to provide to its employees substantially the same benefits
currently provided to them as employees of Choice. With respect to each Choice
profit sharing and retirement plan, Sunburst shall transfer to Franchising on
or before January 1, 1998, an amount representing the present value of the
full accrued benefit of all Franchising Employees who had earned a benefit
under any such Choice plan. The Employee Benefits Allocation Agreement
provides for cross-guarantees between Sunburst and Franchising with respect to
the payment of benefits under certain plans and for cross-indemnification with
respect to pre-Distribution employment-related claims.
 
  The Employee Benefits Allocation Agreement also provides for the adjustment
of outstanding options to purchase shares of Choice Common Stock held by
Choice Employees, Franchising Employees and employees of Manor Care (the
"Manor Care Employees") who hold such options as a result of the Manor Care
Spin-off. On the Distribution Date, each Choice Employee and Franchising
Employee holding an incentive stock option to purchase Choice Common Stock
will receive, for each such option, a conversion award consisting of an
incentive stock option to purchase the common stock of such employee's
employer after the Distribution (i.e., Franchising Common Stock for
Franchising Employees and Sunburst Common Stock for Sunburst Employees), with
the number of shares that may be acquired and the option price adjusted
pursuant to a formula designed to preserve the financial value of the options.
Each Sunburst Employee and Franchising Employee holding a non-qualified option
to purchase Choice Common Stock that has vested on or prior to the
Distribution Date may make a one-time election to choose a conversion award
consisting of an option to acquire any percentage combination of Sunburst
Common Stock and Franchising Common Stock with the number of shares and the
exercise price adjusted so as to preserve the financial value of the
outstanding option. Each Sunburst Employee and Franchising Employee holding a
non-qualified option to purchase Choice Common Stock that has not vested on or
prior to such date will receive a conversion award of which one-half of the
financial value of which will comprise an option to acquire shares of common
stock of such employee's employer after the Distribution, and one-half of the
financial value of which will comprise an option to acquire a pro rata
combination of shares of Sunburst Common Stock and Franchising Common Stock.
 
  On the Distribution Date, each Manor Care Employee holding nonqualified
options to purchase shares of Choice Common Stock may make a one-time election
to choose a conversion award consisting of any percentage combination of an
option to acquire Franchising Common Stock and an adjusted Choice Option with
the number of shares and the exercise price of each option adjusted so as to
preserve the financial value of the outstanding Choice Options.
 
LEASE AGREEMENTS
 
  On or prior to the Distribution Date, Choice and Franchising will enter into
a agreement with Manor Care amending the terms of the Gaithersburg Lease to
add Franchising as a guarantor of Sunburst's obligations under the
Gaithersburg Lease. Also on or prior to the Distribution Date, Choice and
Franchising will enter into a sublease agreement with respect to the Silver
Spring Lease. It is currently expected that Franchising will sublease
approximately 54.3% of the office space available under the Silver Spring
Lease with financial terms approximately equal (on a square foot basis) to the
terms of the Silver Spring Lease.
 
TRANSITIONAL SERVICE AGREEMENTS
 
  On or prior to the Distribution Date, Choice and Franchising will enter into
a number of agreements pursuant to which Franchising will provide certain
continuing services to Sunburst for a transitional period. Such services will
be provided on market terms and conditions. Subject to the termination
provisions of the specific agreements, Sunburst will be free to procure such
services from outside vendors or may develop an in-house
 
                                      20
<PAGE>
 
capability in order to provide such services internally. Management believes
that these agreements are based on commercially reasonable terms including
pricing and payment terms. The primary transitional services agreements are
summarized below.
 
  Pursuant to the Employee Benefits Administration Agreement, Franchising will
provide certain benefits, compensation and other services. Such other services
may include benefit plan administration and accounting, COBRA administration,
regulatory compliance and certain fiduciary services. Pursuant to the Tax
Administration Agreement, Franchising will provide certain sales, use,
occupancy, real and personal property tax return administration, audit and
appeals services for Sunburst. Pursuant to the Vehicle Lease Agreement,
Franchising will provide the use of certain vehicles to Sunburst.
 
AMENDMENT TO AGREEMENTS WITH MANOR CARE
 
  Prior to November 1, 1996, Choice and Franchising were wholly owned
subsidiaries of Manor Care. On November 1, 1996, Manor Care effected the Manor
Care Spin-off. In connection with the Manor Care Spin-off Choice and Manor
Care entered into various agreements setting forth Choice's and Manor Care's
on-going responsibilities regarding various matters. In connection with the
Distribution, certain of these agreements will be amended to allocate certain
of Choice's rights and responsibilities thereunder between Franchising and
Sunburst.
 
FRANCHISE AGREEMENTS
 
  The Clarion, Comfort, Econo Lodge, Sleep Inn, Quality, MainStay Suites and
Rodeway marks are each owned by Franchising. Each property currently owned by
Choice is subject to a franchise agreement between Franchising and Choice, as
franchisee (the "Franchise Agreements"). Such agreements (the material terms
of which are described below) will remain in place between Sunburst and
Franchising after the Distribution.
 
  Term. Each Franchise Agreement has an initial term of 20 years, except the
agreement for Tempe, Arizona which is a year to year agreement. The Franchise
Agreements have varying original dates, from 1982 through 1996. Certain
Franchise Agreements allow for unilateral termination by either party on the
5th, 10th, or 15th anniversary of the Franchise Agreement.
 
  Termination by Sunburst. Sunburst (except with respect to one property as
described below) may terminate a Franchise Agreement if Franchising defaults
on its material obligations under such Franchise Agreement and fails to cure
such defaults within 30 days following written notice. The Franchise Agreement
with respect to the Quality Hotel--Arlington (the "Non-Standard Franchise
Agreement") does not allow Sunburst to terminate such Franchise Agreement.
 
  Termination by Franchising. Franchising (except with respect to the Non-
Standard Franchise Agreement) may suspend or terminate a Franchise Agreement
at any time, if, among other things, Sunburst (a) fails to submit reports when
due; (b) fails to pay amounts due under such Franchise Agreement; (c) fails to
pay its debts generally as they become due; or (d) receives two or more
notices of default for similar reasons for any 12 month period. Franchising
(except with respect to the Non-Standard Franchise Agreement) may terminate a
Franchise Agreement immediately upon notice to Sunburst if, among other
things, (a) certain bankruptcy events occur with respect to Sunburst; (b)
Sunburst loses possession or the right to possession of the Property; (c)
Sunburst breaches transfer restrictions in the related Franchise Agreement;
(d) any action is taken to dissolve or liquidate Sunburst; or (e) there is a
threat or danger to the public health and safety in the continued operation of
the Property. If a Franchise Agreement is terminated by Franchising for any of
the reasons discussed in the immediately preceding two sentences, Sunburst is
required to pay liquidated damages equal to the product of (i) the average
monthly gross room revenue for the preceding 12 months, multiplied by (ii) the
royalty fee percentage (more fully described below), multiplied by (iii) the
number of months unexpired under the term of the related Franchise Agreement
(in no event less than $21-$50 multiplied by the specified room count).
 
                                      21
<PAGE>
 
  The Non-Standard Franchise Agreement has termination provisions similar to
those in the other Franchise Agreements. Franchising may terminate the Non-
Standard Franchise Agreement immediately upon notice to Sunburst if, among
other things, (a) certain bankruptcy events occur with respect to Sunburst;
(b) certain breaches of the related agreements are not remedied; (c) any
action is taken to dissolve or liquidate Sunburst; or (d) legal proceedings
against Sunburst are not dismissed within a certain period of time. Upon
termination, the Franchise Agreement for the Rodeway Inn-Phoenix (Tempe) calls
for liquidated damages of the greater of (i) $50,000 and (ii) the sum of the
previous two years of fees paid by the licensee.
 
  Fees. The Franchise Agreements require the payment of certain fees and
charges, including the following: (a) a royalty fee of between 1.93% to 5.0%
of monthly gross room revenues; (b) a marketing fee of between 0.7% and 2.5%
plus $0.28 per day multiplied by the specified room count; and (c) a
reservation fee of 0.88% to 1.75% of monthly gross room revenues (or 1% of
monthly gross room revenues plus $1.00 per room confirmed through Choice's
reservation system). The marketing fee and the reservation fee are subject to
reasonable increases during the term of the franchise if Franchising raises
such fees uniformly among all its franchisees, generally. Late payments (i)
will be a breach of the Franchise Agreement and (ii) will accrue interest from
the date of delinquency at a rate of 1.5% per month or portion thereof.
 
  Certain Covenants. The Franchise Agreements impose certain affirmative
obligations upon Franchising including: (a) to lend the Franchisor an
operations manual; (b) to utilize money collected from marketing and
reservation fees to promote those aspects of the franchise business; and (c)
to periodically inspect the Property. The Franchise Agreements also impose
affirmative obligations upon Sunburst including: (a) to participate in a
specified reservation system; (b) to keep and comply with the up-to-date
version of Franchising's rules and regulations for properly running the
specified franchise; (c) to prepare monthly financial and other records; (d)
to not interfere with the franchised mark(s) and Franchising's rights thereto;
and (e) to maintain certain specified insurance policies.
 
  Assignments. Sunburst is prohibited from directly or indirectly selling,
assigning, transferring, conveying, pledging or mortgaging its interest in the
Franchise Agreement, or any equity interest in such franchise interests
without the consent of Franchising except that, among other things, certain
percentages of ownership interests in Sunburst may be transferred without
Franchising's consent. Franchising's consent to such transfers, will not be
given unless, among other things: (a) all monetary obligations due under the
Franchise Agreement are paid to Franchising; (b) no defaults under the
Franchise Agreement remain uncured; (c) the transferee agrees in writing to
upgrade the related Property to the then-current standards; and (d) the
transferee agrees to remain liable for all obligations under the Franchise
Agreement so transferred.
 
  Franchising is permitted to assign all or any part of its rights or
obligations under the Franchise Agreements. However, the Franchise Agreements
(with the exception of the Non-Standard Franchise Agreement) do not permit
Franchising to absolve itself from the obligations that it transfers under the
Franchise Agreement. Upon the assignment of Franchising's obligations under
the Non-Standard Franchise Agreement, Franchising will no longer be liable
with respect to the obligations it so transfers.
 
NONCOMPETITION AGREEMENT
 
  Choice and Franchising will enter into a noncompetition agreement that
defines the rights and obligations with respect to certain businesses to be
operated by Sunburst and Franchising. Under the noncompetition agreement, for
a period of five years from the Distribution (subject to extentions in the
event that the Strategic Alliance Agreement remains in effect), subject to the
exceptions set forth below, Sunburst will be prohibited from conducting any
business that competes with the Franchising Business. Sunburst will also be
prohibited from acquiring any entity conducting a business that competes with
the Franchising Business, with certain exceptions outlined below, unless,
prior to such acquisition, Sunburst offers to sell such competing business to
Franchising on substantially the same terms and conditions; provided, however,
that Sunburst will not be required to make such an offer to Franchising where
the competing business is not readily divisible from other businesses
permitted to be held or acquired by Sunburst and the gross sales from such
competing business for the 12 months prior to such acquisition do not exceed
the greater of $1,000,000 (as adjusted for increases to the Consumer Price
 
                                      22
<PAGE>
 
Index during the term) or 5% of gross sales of the businesses to be acquired.
Subject to the foregoing, however, the noncompetition agreement will not
prohibit Sunburst from engaging in the following activities: (i) the continued
operation and development of any business operated as of the Distribution Date
by Choice; (ii) any activities otherwise permitted under the Strategic
Alliance Agreement; (iii) the ownership of up to 5% of the equity interests of
a publicly-traded entity that competes with the Franchising Business; and (iv)
the ownership of equity interests of any entity that competes with the
Franchising Business, if (A) the competing business does not comprise such
entity's primary business, (B) the gross sales of such entity for the prior 12
months attributable to such competing business does not exceed 20% of such
entity's consolidated gross sales, and (C) neither the fair market value of,
nor the value, if any, attributed by the acquisition agreement to, the
competing business is in excess of $5,000,000 (as adjusted for increases to
the Consumer Price Index during the term).
 
  During the term of the noncompetition agreement, subject to the exceptions
set forth below, Franchising will be prohibited from conducting any business
that competes with the Hotel Business. Franchising will also be prohibited
from acquiring any entity conducting a business that competes with the Hotel
Business, with certain exceptions outlined below, unless, prior to such
acquisition, Franchising offers to sell such competing business to Sunburst on
substantially the same terms and conditions; provided, however, that
Franchising will not be required to make such an offer to Sunburst where the
competing business is not readily divisible from other business permitted to
be held or acquired by Franchising and the gross revenues from such competing
business for the 12 months prior to such acquisition do not exceed the greater
of $1,000,000 (as adjusted for increases to the Consumer Price Index during
the term) or 5% of gross sales of the businesses to be acquired. Subject to
the foregoing, however, the noncompetition agreement will not prohibit
Franchising from the following activities: (i) continued operation and
development of any business operated as of the Distribution Date by
Franchising, (ii) any activities otherwise permitted under the Strategic
Alliance Agreement, (iii) the ownership of up to 5% of the equity interests of
a publicly-traded entity that competes with the Hotel Business, (iv) the
ownership of equity interests of any entity that competes with the Hotel
Business, if (A) the competing business does not comprise such entity's
primary business, (B) the gross revenue of such entity for the prior 12 months
attributable to such competing business does not exceed 20% of such entity's
consolidated gross sales, and (C) neither the fair market value of, nor the
value, if any, attributed by the acquisition agreement to, the competing
business is in excess of $5,000,000 (as adjusted for increases to the Consumer
Price Index during the term).
 
                                   FINANCING
 
SUNBURST
 
  As part of the Distribution, it is estimated that Sunburst will be allocated
approximately $250.0 million of long-term indebtedness, including (i)
approximately $117.0 million of commercial mortgage backed securities, with
respect to which an affiliate of Sunburst is the obligor and (ii) a
Subordinated Term Note in the amount of $115.0 million to Franchising (the
"Term Note"). The Term Note will not have any prepayment penalties. It is also
expected that on or prior to the Distribution Date, Sunburst will enter into a
revolving credit facility (the "Sunburst Credit Facility").
 
  Sunburst currently is negotiating a commitment from a bank lender pursuant
to which such lender, together with other financial institutions, will, from
and after the Distribution Date, provide Sunburst with a senior secured
revolving credit facility in an aggregate principal amount of up to $75.0
million with availability subject to a borrowing base formula. The Sunburst
Credit Facility will have a maturity of three years. Depending on the type of
loan requested by Sunburst and upon certain specified financial ratios,
interest on the loans will accrue at a rate based on LIBOR, certificate of
deposit rates, prime rates or federal funds rates. A portion of the Sunburst
Credit Facility not in excess of a specified percentage of the maximum
borrowing base shall be available for the issuance of letters of credit. The
Sunburst Credit Facility will be secured by a first priority pledge of certain
of the capital stock held by Sunburst and/or any of its subsidiaries. Upon
consummation of the Distribution, approximately $18.0 million will be drawn by
Sunburst under such facility, and together with the $115.0 million of proceeds
realized under the Term Note, will be used to repay $96.0 million in bank debt
and the $37.0 million
 
                                      23
<PAGE>
 
of Sunburst's allocable portion of the debt outstanding to an affiliate of
Manor Care (the "Manor Care Note"). The remaining availability under the
Sunburst Credit Facility will be used for working capital, including capital
expenditures and acquisitions.
 
  The Sunburst Credit Facility is expected to contain customary covenants that
will, among other things, restrict the ability of Sunburst and its
subsidiaries to make certain investments, incur debt, change its line of
business, dispose of assets, create liens, enter into transactions with
affiliates and otherwise restrict certain corporate activities. In addition,
the Sunburst Credit Facility will contain, among other financial covenants,
requirements that Sunburst maintain specified financial ratios, including
minimum net worth, maximum leverage and minimum interest coverage. The
Sunburst Credit Facility is also expected to contain representations and
warranties of Sunburst and its subsidiaries and contain conditions to funding
customary in credit facilities of this type.
 
  It is expected that the Term Note will have a maturity of five years, and
will accrue interest at a rate equal to 500 basis points above the interest
rate on a 5-year U.S. Treasury Note. The Term Note will contain restrictive
covenants substantially equivalent to those contained in the Sunburst Credit
Facility and will also contain subordination provisions.
 
FRANCHISING
 
  As part of the Distribution, Franchising will be allocated $125.0 million of
Choice's long-term indebtedness, including approximately (i) $78.7 million of
indebtedness under the Manor Care Note and (ii) $32.9 million related to
foreign borrowings and other bank debt. It is expected that Franchising will
repay this indebtedness, as of the Distribution, with proceeds available under
a credit facility which Franchising intends to enter into on or prior to the
Distribution Date (the "Franchising Credit Facility").
 
  Franchising currently is negotiating a commitment from a bank lender
pursuant to which such lender, together with other financial institutions,
will, from and after the Distribution Date, provide Franchising with a senior
term loan and a senior competitive advance and multicurrency revolving credit
facility in an aggregate principal amount of up to $300.0 million. The
Franchising Credit Facility will have a maturity of five years. The term loan
portion of the Franchising Credit Facility will amortize on a quarterly basis
in specified annual amounts until maturity. Depending on the type of loan
requested by Franchising and on certain specified financial ratios, interest
on the loans will accrue at a rate based on LIBOR, certificate of deposit
rates, prime rates or federal fund rates. A portion of the revolving credit
facility not in excess of $10.0 million shall be available for the issuance of
letters of credit. Upon consummation of the Distribution, approximately $226.6
million will be drawn under the Franchising Credit Facility, representing
$115.0 million disbursed to Sunburst under the Term Note plus $111.6 million
to refinance obligations allocated to Franchising. The remaining availability
under the Credit Facility will be used for working capital and general
corporate purposes.
 
  The Franchising Credit Facility is expected to contain customary covenants
that will, among other things, restrict the ability of Franchising and its
subsidiaries to make certain investments, incur debt, change its line of
business, dispose of assets, create liens, enter into transactions with
affiliates and otherwise restrict certain corporate activities. In addition,
the Franchising Credit Facility will contain, among other financial covenants,
requirements that Franchising maintain specified financial ratios, including
minimum net worth, maximum leverage and minimum interest coverage. The
Franchising Credit Facility is also expected to contain representations and
warranties of Franchising and its subsidiaries and contain conditions to
funding customary in credit facilities of this type.
 
                             ACCOUNTING TREATMENT
 
  The historical combined financial statements of Franchising present its
financial position, results of operations and cash flows as if it were a
separate entity owning and operating the Franchising Business for all periods
presented. Choice's historical basis in the assets and liabilities of
Franchising has been carried over.
 
                                      24
<PAGE>
 
                       POST-DISTRIBUTION DIVIDEND POLICY
 
  The dividend policies of Sunburst and Franchising will be determined by
their respective Boards of Directors following the Distribution. Choice
currently is prohibited from paying dividends pursuant to the terms of its
loan agreement with MNR Finance Corp. It is expected that the Sunburst Credit
Facility and the Franchising Credit Facility will restrict the ability of
Sunburst and Franchising, respectively, to pay dividends. See "Financing."
 
                  CERTAIN INFORMATION CONCERNING FRANCHISING
 
PRO FORMA FINANCIAL DATA
 
  The following unaudited Pro Forma Combined Statement of Income of
Franchising gives effect to (i) the Manor Care Distribution and related
transactions and (ii) the Distribution and related transactions as if the
foregoing had occurred on June 1, 1996. The pro forma financial data is
provided for information purposes only and does not purport to be indicative
of the results that actually would have been obtained if the Manor Care
Distribution and related transactions and the Distribution and related
transactions had been effected on the date indicated or of those results that
may be obtained in the future. There were no adjustments required to the Pro
Forma Combined Statements as of May 31, 1997 as a result of the Distribution.
 
 
                                      25
<PAGE>
 
                    PRO FORMA COMBINED STATEMENT OF INCOME
                        FOR THE YEAR ENDED MAY 31, 1997
 
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                      MANOR CARE
                                                     DISTRIBUTION
                                         HISTORICAL ADJUSTMENTS(A)  PRO FORMA
                                         ---------- --------------  ---------
<S>                                      <C>        <C>             <C>
Revenues
  Royalty fees..........................  $95,157                    $95,157
  Marketing and reservation fees........  104,216                    104,216
  Product sales.........................   23,643                     23,643
  European hotel operations.............   17,737                     17,737
  Initial franchise fees................   14,250                     14,250
  Other.................................   17,252                     17,252
                                          -------      -------       -------
    Total revenues......................  272,255                    272,255
                                          -------      -------       -------
Operating Expenses
  Marketing and reservation.............  101,421                    101,421
  Selling, general and administrative...   51,102                     51,102
  Product cost of sales.................   22,766                     22,766
  European hotel operations.............   16,166                     16,166
  Depreciation and amortization.........   10,438                     10,438
                                          -------      -------       -------
    Total operating expenses............  201,893      $ 3,400 (b)   205,293
                                          -------      -------       -------
    Operating income....................   70,362       (3,400)       66,962
                                          -------      -------       -------
OTHER
  Interest on notes payable to Manor
   Care.................................    7,083                      7,083
  Interest and other, net...............    3,704                      3,704
                                          -------      -------       -------
    Total other expenses................   10,787                     10,787
                                          -------      -------       -------
  Income before income taxes............   59,575       (3,400)       56,175
  Income taxes..........................  (24,845)       1,343 (c)   (23,502)
                                          -------      -------       -------
  Net income............................  $34,730      $(2,057)      $32,673
                                          =======      =======       =======
  Net income per share..................                             $  0.52 (d)
                                                                     =======
</TABLE>
--------
(a) Reflects the effect of the Manor Care Distribution and related
    transactions.
(b) Reflects the net additional costs associated with staffing of accounting,
    finance, cash management, risk management, human resources and legal
    personnel, incremental rental costs and the payment of certain consulting
    fees to Manor Care.
(c) Represents the income tax impact of pro forma adjustments at statutory
    rates.
(d) Pro forma income per share is computed by dividing pro forma net income by
    the pro forma weighted average number of outstanding common shares,
    aggregating 62.7 million in fiscal year 1997. The pro forma weighted
    average number of outstanding common shares is based on Manor Care's
    weighted average number of outstanding common shares for the period June
    1, 1996 through October 31, 1996 and Choice's weighted average number of
    shares for the period November 1, 1996 through May 31, 1997.
 
                                      26
<PAGE>
 
SELECTED HISTORICAL FINANCIAL DATA
 
  The following table presents selected historical combined financial data of
Franchising for the five fiscal years ended May 31, 1997.
 
  The combined financial statements of Franchising include the assets and
liabilities, revenues and expenses of the Franchising Business, including the
ownership and operation of 14 hotel properties in France, Germany and the
United Kingdom. The Franchising combined financial statements include certain
allocations of overhead expenses incurred by Choice, and prior to November 1,
1996 incurred by Manor Care, that support the Franchising Business. In
management's opinion, these allocations were made on a reasonable basis,
however, such allocations may not be indicative of the level of expenses which
will be incurred by Franchising after the Distribution. The expenses were
generally allocated based upon specific identification and estimates of the
relative time devoted to supporting Franchising.
 
  The combined income statement data for 1993 and the balance sheet data for
1993 and 1994 have been derived from unaudited combined financial statements
of Franchising which, in the opinion of management, include all material
adjustments necessary for those periods and were prepared as if Franchising
were a separate entity for all periods presented. The historical combined
financial data is not necessarily indicative of Franchising's future results
of operations or financial condition. The data set forth below should be read
in conjunction with the unaudited Pro Forma Financial Data and the notes
thereto of Franchising; the audited Combined Financial Statements of
Franchising and the notes thereto; and Management's Discussion and Analysis of
Financial Condition and Results of Operations of Franchising included
elsewhere in this Proxy Statement. For a discussion of the basis of
presentation of the Franchising Combined Financial Statements, see the "Basis
of Presentation" in the Notes to the Franchising Combined Financial
Statements.
 
                                      27
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
                      SELECTED HISTORICAL FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                        YEAR ENDED MAY 31,
                          -----------------------------------------------------
                            1997      1996        1995      1994       1993
                          --------  --------    --------  --------  -----------
                                          (IN THOUSANDS)
                                                                    (UNAUDITED)
<S>                       <C>       <C>         <C>       <C>       <C>
Statement of Income Data
 Revenues................ $272,255  $250,654    $212,672  $184,866   $143,054
 Operating expenses:
  Marketing and
   reservation...........  101,421    96,246      81,545    74,149     57,631
  Selling, general and
   administrative........   51,102    45,196      45,589    49,529     46,187
  Product cost of sales..   22,766    20,709      13,882    11,977      6,999
  European hotel
   operations............   16,166    17,521      17,922    10,263        --
  Depreciation and
   amortization..........   10,438    11,839      11,768    10,825      9,182
  Provision for asset
   impairment............      --     24,760(1)      --        --         --
                          --------  --------    --------  --------   --------
   Total operating
    expenses.............  201,893   216,271     170,706   156,743    119,999
                          --------  --------    --------  --------   --------
 Operating income........   70,362    34,383      41,966    28,123     23,055
                          --------  --------    --------  --------   --------
Other
 Interest expense on
  notes payable to Manor
  Care...................    7,083     7,083       7,083     7,083      7,083
 Minority interest
  expense................      --      1,532       2,200     1,476        900
 Interest and other,
  net....................    3,704     4,791       3,672     3,591        145
                          --------  --------    --------  --------   --------
   Total other expenses..   10,787    13,406      12,955    12,150      8,128
                          --------  --------    --------  --------   --------
Income before income
 taxes...................   59,575    20,977      29,011    15,973     14,927
Income taxes.............  (24,845)   (9,313)    (12,783)   (7,372)    (6,422)
                          --------  --------    --------  --------   --------
Net Income............... $ 34,730  $ 11,664    $ 16,228  $  8,601   $  8,505
                          ========  ========    ========  ========   ========
Pro forma earnings per
 share................... $   0.55  $   0.19    $   0.26  $   0.14   $   0.15
                          ========  ========    ========  ========   ========
Balance Sheet Data
 Total assets............ $221,473  $212,803    $189,087  $173,646   $170,815
 Notes payable to Manor
  Care................... $ 78,700  $ 78,700    $ 78,700  $ 78,700   $ 78,700
 Total debt.............. $125,163  $145,315    $128,205  $126,294   $122,909
 Total liabilities....... $164,280  $182,271    $201,786  $169,237   $144,982
 Total investments and
  advances from (to)
  Parent................. $ 57,193  $ 30,532    $(12,699) $  4,409   $ 25,833
</TABLE>
--------
(1) In 1996 Franchising recorded a pre-tax charge of $24.8 million for
    impairment of long lived assets associated with Franchising's European
    operations.
(2) Pro forma earnings per share has been calculated based on the weighted
    average shares outstanding of its parent Choice Hotels International, Inc.
    for fiscal year 1997 of 62,680,000 and its parent Manor Care, Inc. for
    fiscal years 1996, 1995, 1994 and 1993 of 62,628,000, 62,480,000,
    60,524,000 and 57,316,000, respectively.
 
                                      28
<PAGE>
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 
  Franchising is one of the largest hotel franchisors in the world with 3,344
hotels open and 820 under development representing 355,127 rooms in 33
countries. Franchising franchises hotels under the Comfort, Quality, Econo
Lodge, Sleep, Clarion, Rodeway and MainStay Suites brand names.
 
  The principal factors that affect Franchising's results are: growth in the
number of hotels under franchise; occupancies and room rates achieved by
Franchising's brands; the number and relative mix of franchised hotels; and
Franchising's ability to manage costs. The number of rooms at franchised
properties and occupancies and room rates at those properties significantly
affect Franchising's results because franchise royalty fees are based upon
room revenues at franchised hotels. Increases in franchise fee revenues have a
disproportionate impact on Franchising's operating margin due to the lower
incremental costs associated with these revenues.
 
 Comparison of Fiscal Year 1997 Operating Results and Fiscal Year 1996
Operating Results
 
  Franchising recorded net income of $34.7 million for the year ended May 31,
1997 ("fiscal 1997"), an increase of $23.0 million, compared to net income of
$11.7 million for the year ended May 31, 1996 ("fiscal 1996"). Fiscal 1996
results include a $24.8 million asset impairment charge related to
Franchising's European hotel operations. Exclusive of this charge, fiscal 1996
net income was $26.7 million. The increase in net income for fiscal 1997 was
primarily attributable to an increase in franchise revenue as a direct result
of the addition of new licensees to the franchise system and improvements in
the operating performance of franchised hotels.
 
  Combined revenues increased $21.6 million (or 8.6%) to $272.3 million in
fiscal 1997 from $250.7 million in fiscal 1996.
 
  Franchise Operating Revenues. In operating the franchise business,
Franchising collects marketing and reservation fees and assessments from its
franchisees. Franchising is contractually obligated to disburse these fees for
marketing and reservation activities to be provided on behalf of its
franchisees. Management, therefore, analyzes its franchise business based on
revenues net of marketing and reservation fees ("net franchise revenue") and
expenses net of marketing and reservation expenses ("net franchise expenses").
 
  Net franchise revenues include base royalty fees, initial fees earned on
contracts signed and other revenues, including strategic vendor fees. Net
franchise revenues are dependent upon growth in the number of franchised
properties as well as the underlying performance of franchised hotels for
continued growth. The key industry standard for measuring hotel operating
performance is RevPAR, which is calculated by multiplying the percentage of
occupied rooms by the average daily room rate realized.
 
  Net franchise revenues were $126.7 million for fiscal 1997 and $110.6
million for fiscal 1996. Royalties increased $9.0 million to $95.2 million
from $86.2 million in fiscal 1996, an increase of 10.4%. The increase in
royalties is attributable to a net increase of 292 franchisees during the
period representing an additional 21,578 rooms added to the system, an
improvement in domestic RevPAR of 2.9% and an increase in the effective
royalty rate of the domestic hotel system to 3.43% from 3.34%. Domestic
initial fee revenue generated from franchise contracts signed increased 14.8%
to $14.0 million from $12.2 million in fiscal 1996. Total franchise agreements
signed in fiscal 1997 were 495, up 13.5% from the total contracts signed in
fiscal 1996 of 436. Revenues generated from strategic vendor relationships
increased to $6.1 million from $1.8 million in fiscal 1996. This revenue
relates to agreements that provide preferred vendors access to Franchising's
licensees.
 
  Franchise Operating Expenses. The cost to operate the franchising business
is reflected in selling, general and administrative expenses. Combined
selling, general and administrative expenses were $51.1 million in fiscal
1997, an increase of $5.9 million from the fiscal 1996 total of $45.2 million.
$4.8 million of the increase was directly attributable to additional costs of
operating as an independent company apart from Manor Care. These additional
costs are primarily additional staffing, incremental rental expenses, and
consulting fees as Franchising assumed certain administrative tasks previously
provided by Manor Care. The remaining increases in selling, general and
administrative expenses were primarily due to additional personnel to support
company growth and new company initiatives. Exclusive of the $4.8 million
increase resulting from the Manor Care Spin-off, as a
 
                                      29
<PAGE>
 
percentage of net franchise revenues, selling, general and administrative
expenses declined to 36.5% in fiscal 1997 from 40.9% in fiscal 1996. The
improvement in the franchising margins relates to the economies of scale
generated from operating a larger franchisee base and improvements in
franchised hotel performance.
 
  Product Sales. Sales made to franchisees through Franchising's group
purchasing program increased $2.1 million to $23.6 million in fiscal 1997 from
$21.6 million in fiscal 1996. The group purchasing program utilizes bulk
purchases to obtain favorable pricing from third party vendors for franchisees
ordering similar products. Franchising acts as a "clearing-house" between the
franchisee and the vendor, and orders are shipped directly to the franchisee.
 
  Similarly, product cost of sales increased $2.1 million (or 9.9%) in fiscal
1997. The product services margins decreased in fiscal 1997 to 3.7% from 4.0%
in fiscal 1996. This purchasing program is provided to the franchisees as a
service and is not expected to be a major component of Franchising's
profitability.
 
  European Hotel Operations. Franchising owns or operates 14 hotels in
Germany, France and Great Britain. Total revenues at Franchising's owned hotel
operations in Europe declined to $17.7 million in fiscal 1997 from $19.6
million in fiscal 1996. Operating margins at the hotels declined to 8.9% in
fiscal 1997 from 10.6% in fiscal 1996. The decline in revenue and operating
performance reflects the difficult economic and competitive climates in which
a number of the European hotels operate. Franchising is pursuing strategies
with the objective of improving the profitability of the hotels including,
among others, divestiture, strategic alliances and joint ventures.
 
  Other Expenses. Depreciation and amortization decreased $1.4 million (or
11.9%) to $10.4 million in fiscal 1997 from $11.8 million in fiscal 1996. The
decrease was primarily due to an asset impairment charge against European
fixed assets which reduced the asset base upon which depreciation is
determined.
 
  In fiscal 1996, Franchising recorded a charge against earnings of $24.8
million relating to impairment of certain long-lived assets related to
Franchising's European hotel operations.
 
  In fiscal 1997, Franchising recognized $943,000 in dividend income from its
investment in Friendly Hotels, PLC.
 
 Comparison of Fiscal Year 1996 Operating Results and Fiscal Year 1995
Operating Results
 
  Net income for the fiscal year ended May 31, 1996 was $11.7 million, a
decrease of $4.5 million (or 27.8%) compared to net income of $16.2 million
for the fiscal year ended May 31, 1995 ("fiscal 1995"). Net income in fiscal
1996 includes a one time charge of $24.8 million relating to asset impairment.
Exclusive of the $24.8 million charge, net income increased to $26.7 million
in fiscal 1996, a 64.8% increase over fiscal 1995.
 
  Combined revenues increased $38.0 million (or 17.9%) to $250.7 million in
fiscal 1996 from $212.7 million in fiscal 1995.
 
  Franchise Operating Revenues. Net franchise revenues were $110.6 million for
fiscal 1996 and $95.9 million for fiscal 1995. Royalties increased $10.8
million to $86.2 million from $75.4 million in fiscal 1996, an increase of
14.3%. The increase in royalties is attributable to a net increase of 217
domestic franchisees during the period, representing an additional 15,787
rooms added to the system, an improvement in RevPAR of 5.1% and an increase in
the effective royalty rate of the domestic hotel system to 3.34% from 3.20%.
Initial fee revenue generated from franchising contracts signed increased
37.8% to $13.5 million from $9.8 million in fiscal 1996. Total franchise
agreements signed in fiscal 1996 were 436, up 21.4% from the total contracts
signed in fiscal 1995 of 359.
 
  Franchise Operating Expenses. The cost to operate the franchising business
is reflected in selling, general and administrative expenses. Combined
selling, general and administrative costs declined to $45.2 million in fiscal
1996 from $45.6 million in fiscal 1995.
 
                                      30
<PAGE>
 
  Selling, general and administrative expenses as a percentage of net
franchise revenues declined to 40.9% in fiscal 1996 from 47.7% in fiscal 1995.
The improvement in the franchising margins relates to the economies of scale
generated from operating a larger franchisee base and improved operating
performance of the franchised hotels.
 
  Product Sales. Sales made to franchisees through Franchising's group
purchasing program increased $7.1 million to $21.6 million in fiscal 1996 from
$14.5 million in fiscal 1995.
 
  Similarly, product cost of sales increased $6.8 million (or 49.2%) in fiscal
1996. The product services margins were 4.0% in fiscal 1996 and fiscal 1995.
This purchasing program is provided to the franchisees as a service and is not
expected to be a major component of Franchising's profitability.
 
  European Hotel Operations. Revenues from hotel operations increased 5.2% in
fiscal 1996. Operating margins increased to 10.6% in fiscal 1996 from 3.8% in
fiscal 1995. The increase in fiscal 1996 is primarily due to improved
performance of newly completed owned and managed hotels.
 
  Other Expenses. In fiscal 1996, Franchising recorded a charge against
earnings of $24.8 million relating to impairment of certain long-lived assets
associated with Franchising's European hotel operations.
 
 Liquidity and Capital Resources
 
  Historically, cash received by Franchising has been deposited in or combined
with its parent's corporate funds as part of its parent's cash management
system. Subsequent to the Distribution, Franchising will maintain its own cash
balances and implement its own internal cash management system.
 
  Choice had $225.7 million of indebtedness payable to Manor Care as of May
31, 1996, assumed as part of the Manor Care Spin-off. The portion of this
indebtedness related to acquisitions made by Franchising has been pushed down
to Franchising. As of May 31, 1997 and May 31, 1996, notes payable to Manor
Care by Franchising totaling $78.7 million were outstanding. Interest on the
amount of the loan is payable quarterly at a rate of 9% per annum. The loan
will mature on November 1, 1999 and may be prepaid in whole or in part,
together with accrued interest, at Franchising's option. If the loan is repaid
prior to November, 1, 1997, Franchising will be required to reimburse Manor
Care on demand for any actual loss incurred or to be incurred by Manor Care
(for the period up to and including November 1, 1997) in the redeployment of
the funds released by any prepayment of the loan. The notes payable to Manor
Care are expected to be repaid from operating cash flow or from third party
financing.
 
  During fiscal 1996 and through November 1, 1996, the Choice was a co-
guarantor with Manor Care and other affiliates for a $250 million competitive
advance and multi-currency revolving credit facility. On October 30, 1996
Choice entered into a $100.0 million competitive advance and multi-currency
revolving credit facility provided by a group of seven banks (the "Credit
Facility"). During November 1996 Choice repaid its portion of the Manor Care
multi-currency credit facility, $50.1 million, with an advance from the
Choice's newly acquired Credit Facility. On May 5, 1997, Choice increased the
size of the Credit Facility to $125 million. As of May 31, 1997, Franchising
had $31.1 million in advances against the multi-currency portion of the Credit
Facility outstanding. Franchising expects to obtain a new revolving credit
facility prior to the Distribution to repay its portion of borrowings under
Choice's Credit Facility. See "--Financing."
 
  Management believes cash flows from operations and third party financing
sources will be adequate to support on-going operations, capital expenditures
and meet debt service requirements for the foreseeable future. Franchising
expects to secure a revolving credit facility prior to the Distribution
sufficient to refinance its existing obligations, loan amounts to Sunburst
sufficient to support its refinancing requirements and meet working capital
and business development needs.
 
  Net cash provided by operating activities for the fiscal year ended May 31,
1997 was $46.4 million compared to $32.7 million for the same period of the
prior fiscal year. Improved cash flow resulted primarily from improved net
income.
 
                                      31
<PAGE>
 
  Franchising's working capital ratio at May 31, 1997 and May 31, 1996 was .99
and .89, respectively. Franchising attempts to minimize its investments in net
current assets, utilizing the Credit Facility to meet seasonal fluctuations in
working capital requirements.
 
  Cash used in investing activities was $17.9 million, $78.5 million, and $7.7
million in fiscal years 1997, 1996 and 1995, respectively. During fiscal 1995,
Franchising repurchased one-half of the 11% interest held by its management in
Choice Hotels Franchising, Inc. Approximately $19.8 million was allocated to
goodwill; the purchase cost of $27.4 million was paid in June and July 1995.
On May 31, 1996, Franchising repurchased the remaining 5.5% minority interest
in Choice Hotels Franchising, Inc. for $27.9 million. Approximately $26.4
million was allocated to goodwill. During fiscal 1996, Franchising purchased a
5% common stock interest and a preferred stock interest in Friendly Hotels,
PLC, a U.K. hotel company, for approximately $17 million.
 
  Investment in property and equipment includes computer hardware as well as
new developments and enhancements of reservation and finance systems. During
the fiscal year ended May 31, 1997, capital expenditures totaled $10.6 million
and related primarily to the development of a new property management system
and the installation of new financial systems. Capital expenditures in prior
years include amounts for computer hardware, reservation systems and European
hotel capital improvements.
 
 Impact of Recently Issued Accounting Standards
 
  Franchising has adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." The adoption
of SFAS No. 121 did not have a material impact on Franchising's financial
statements.
 
  Franchising plans to utilize the method under SFAS No. 123, "Accounting for
Stock-Based Compensation," which provides for disclosure of the impact of
stock-based compensation grants.
 
  Franchising is required to adopt SFAS No. 128, "Earnings Per Share," and
SFAS No. 129, "Disclosure of Information about Capital Structure," no later
than fiscal year 1998. The adoption of these pronouncements will not
materially affect Franchising's financial statements.
 
  Franchising is required to adopt SFAS No. 130, "Reporting Comprehensive
Income," and SFAS No. 131, "Disclosures About Segments of an Enterprise and
Related Information," no later than fiscal 1999. Management is still
evaluating the impact that these pronouncements will have on Franchising's
financial statements.
 
BUSINESS AND PROPERTIES
 
 General
 
  Franchising is a wholly owned subsidiary of Choice and currently conducts a
significant portion of the Franchising Business. Immediately prior to the
Distribution, Franchising will succeed to that portion of the Franchising
Business currently conducted directly by Choice and certain other subsidiaries
of Choice. The following description summarizes the current business of
Franchising, as well as the business to be transferred to Franchising prior to
the Distribution.
 
  Franchising is one of the world's largest franchisors of hotels with 3,344
properties open and operating in 33 countries at May 31, 1997. These
properties principally operate under one of Franchising's brand names:
Comfort(R), Quality(R), Clarion(R), Sleep(R), Rodeway(R), Econo Lodge(R) and
MainStay SuitesSM. At May 31, 1997, another 820 franchise properties with a
total of 72,093 rooms were under development. As a franchisor, Franchising
licenses hotel operators to use Franchising's brand names and provides to
these hotel operators products and services designed to increase their
revenues and profitability. Key products and services provided include
nationally recognized marketing and advertising programs, access to a
reservation system that delivers
 
                                      32
<PAGE>
 
business to the franchisees' hotels, access to innovative products and
services developed by Franchising and other support services such as training
programs, purchasing discounts, operating manuals, quality standards and
inspections. In return for the use of Franchising's brand names and access to
Franchising's products and services, franchisees pay to Franchising fees that
are generally based on a percentage of the franchise hotels' gross room
revenues. Franchising's franchise operations have experienced significant
growth in revenues and profitability over the last few years. Franchising's
compound annual growth rate from fiscal year 1993 to fiscal year 1997 was
17.5% for revenues and 42.2% for net income.
 
 The Lodging Industry
 
  As of December 1996, there were approximately 3.4 million hotel rooms in the
United States in hotels/motels containing twenty or more rooms. Of those
rooms, approximately 1.2 million rooms were not affiliated with a national or
regional brand, while the remaining approximately 2.2 million rooms were
affiliated with a brand either through franchise or the ownership/management
of a national or regional chain.
 
  During the late 1980s, the industry added approximately 500,000 hotel rooms
to its inventory due largely to a favorable hotel lending environment, the
ability of hotel operators to regularly increase room rates and the
deductibility of passive tax losses, which encouraged hotel development. As a
result, the lodging industry saw an oversupply of rooms and a decrease in
industry performance.
 
  The lodging industry in recent years has demonstrated a recovery, based on
year-to-year increases in room revenues, occupancy rates, revenue per
available room ("RevPAR"), and lodging industry profitability. RevPAR is
calculated by multiplying the percentage of occupied rooms by the average
daily room rate charged. Since 1993, the lodging industry has been able to
increase its average daily rate ("ADR") at a pace faster than the increase in
the Consumer Price Index ("CPI"), a common measure of inflation published by
the US Department of Labor. Smith Travel Research's estimates indicate that
occupancy rates in 1996 increased to 65.2% from 65.1% in 1995, in part because
of increases in room demand attributable to the 1996 Summer Olympics, the 1996
national political campaigns and conventions, and a continued improvement in
the national economy. The following chart demonstrates the recent trends:
 
THE US LODGING INDUSTRY'S GROWTH TRENDS SINCE 1991
 
<TABLE>
<CAPTION>
                         INCREASE IN           AVERAGE
                            ROOM                DAILY   INCREASE   INCREASE  REVENUE PER
                           REVENUE             (ROOM)    IN ADR     IN CPI    AVAILABLE                 NEW
                           VERSUS    OCCUPANCY  RATES    VERSUS     VERSUS      ROOM        PROFITS    ROOMS
YEAR                     PRIOR YEAR    RATES    (ADR)  PRIOR YEAR PRIOR YEAR  (REVPAR)   (IN BILLIONS) ADDED
----                     ----------- --------- ------- ---------- ---------- ----------- ------------- ------
<S>                      <C>         <C>       <C>     <C>        <C>        <C>         <C>           <C>
1992....................     N/A       62.6%   $58.91     1.4%       2.9%      $36.87     break-even   36,000
1993....................    6.3%       63.5%   $60.53     2.7%       2.7%      $38.42        $ 2.4     40,000
1994....................    8.6%       64.7%   $62.86     3.8%       2.7%      $40.70        $ 5.5     45,000
1995....................    7.0%       65.1%   $65.81     4.7%       2.9%      $42.83        $ 8.5     64,000
1996....................     N/A       65.2%   $69.66     5.9%       2.9%      $45.47        $11.5     91,000
</TABLE>
--------
Source: Smith Travel Research
 
  Franchising believes the lodging industry can be divided into three
categories: luxury or upscale, middle-market and economy. Franchising believes
the luxury category generally has room rates above $70 per night, the middle-
market category generally has room rates between $46 and $70 per night and the
economy category generally has room rates less than $46 per night.
 
  Service is a distinguishing characteristic in the lodging industry.
Generally there are three levels of service: full-service hotels (which offer
food and beverage services, meeting rooms, room service and similar guest
services); limited-service hotels (which offer amenities such as swimming
pools, continental breakfast, or similar services); and all-suites hotels
(which usually have limited public areas, but offer guests two rooms or one
room with distinct areas, and which may or may not offer food and beverage
services).
 
                                      33
<PAGE>
 
  Franchising's Econo Lodge, Rodeway and Sleep brands compete primarily in the
limited-service economy market; Franchising's Comfort and Quality brands
compete primarily in the limited-service middle-market; Franchising's Clarion
brand competes primarily in the full-service upscale market; and Franchising's
MainStay Suites brand competes primarily in the all-suites middle-market.
 
  New hotels opened in recent years typically have been limited service
hotels, as limited-service hotels are less costly to develop, enjoy higher
gross margins, and tend to have better access to financing. These hotels
typically operate in the economy and middle-market categories and are located
in suburban or highway locations. From 1991 to 1996, the average room count in
new hotels declined from 122 to 87, primarily because hotel developers found
it difficult to obtain financing of more than $3 million from their primary
lending sources (local banks and Small Business Administration guaranteed loan
programs).
 
  In recent years, operators of hotels not owned or managed by major lodging
companies have increasingly joined national hotel franchise chains as a means
of remaining competitive with hotels owned by or affiliated with national
lodging companies. Because hotels typically operate with high fixed costs,
increases in revenues generated by affiliation with a franchise lodging chain
can improve a hotel's financial performance. Of approximately 933 hotel
properties that changed their affiliation in 1995, 77% converted from
independent status to affiliation with a chain or converted from one chain to
another, while only 23% canceled or were required to cancel their chain
affiliation. The share of US hotel rooms affiliated with a chain was
approximately 63% in 1995.
 
  The shift to chain membership has been most pronounced among hotels in the
same categories as Franchising, i.e., the economy and middle-market
categories. In 1995, 53% of all conversions to a chain from independent status
or from another chain were in the economy category, 37% were in the middle-
market category, and 10% were in the upscale category. Often by affiliating
with a middle-market or economy brand, a hotel operator can reposition the
hotel property in the price category best suited to its market.
 
  The large franchise chains, including Franchising, provide a number of
services to hotel operators to improve the financial performance of their
properties, including national reservation systems, marketing and advertising
programs and direct sales programs. Franchising believes that national
franchise chains with a larger number of hotels enjoy greater brand awareness
among potential guests than those with fewer numbers of hotels, and that
greater brand awareness can increase the desirability of a hotel to its
potential guests.
 
  Franchising believes that hotel operators choose lodging franchisors based
primarily on the perceived value and quality of each franchisor's brand and
its services, and the extent to which affiliation with that franchisor may
increase the franchisee's reservations and profits.
 
 Franchise Business
 
  Economics of Franchise Business. The fee and cost structure of Franchising's
franchise business provides significant opportunities for Franchising to
increase profits by increasing the number of franchised properties. Hotel
franchisors such as Franchising derive substantially all of their revenue from
franchise fees. Franchise fees are comprised of an initial fee and ongoing
royalty and marketing and reservation fees charged by the franchisor as a
percentage of the franchisee's gross room revenues. The royalty portion of the
franchise fee is intended to cover the operating expenses of the franchisor,
such as expenses incurred in quality assurance, administrative support and
other franchise services and to provide the franchisor with operating profits.
The marketing and reservation portion of the franchise fee is intended to
reimburse the franchisor for the expenses associated with providing such
franchise services as the central reservation system and national marketing
and media advertising.
 
  Much of the variable costs associated with Franchising's activities are
reimbursed by the franchisees through the marketing and reservation fees.
Franchising's existing base of franchises more than covers the fixed cost of
the business at its current level so that the variable costs of overhead--in
such areas as quality assurance, franchise development, franchise services and
administration, finance and legal--represent the bulk of
 
                                      34
<PAGE>
 
incremental costs associated with the addition of franchisees. Because the
variable overhead costs associated with incremental franchise system growth
are substantially less than the incremental royalty fees, Franchising is able
to capture a significant portion of these incremental royalty fees as
operating profit.
 
  Strategy. Franchising's strategy is based on creating an organization that
is focused on consumer and franchisee needs, optimizing the portfolio of
brands, strategically growing the franchise system, improving its and its
franchisees' margins, growing profitability internationally, and leveraging
its separation from Choice. Key components of Franchising's strategy include:
 
  .  Organize for Success. Franchising has created an organizational
     structure to focus on consumers, serve franchisees and leverage the
     franchise system.
 
     Consumer Focus--Brand management, new product development and
     traditional marketing and advertising are all combined under
     Franchising's Marketing Department to create consumer focus and to
     drive demand for Franchising's brand products. New product development
     will be based on consumer needs determined through consumer research.
     Franchising believes that a consumer focus will lead to greater demand
     for Franchising's products, which in turn will result in higher revenue
     from Franchising's franchise system.
 
     Franchisee Service--Franchise service and sales are consolidated under
     a regional structure made up of five regional operating teams. This
     structure provides each licensee one primary contact who is responsible
     for assessing and responding to each hotel's specialized needs.
     Franchising believes that its regional operating structure and the
     services it provides to franchisees will allow it to attract new hotels
     to the franchising system.
 
     Leveraging the Franchise System--Strategic partnerships, purchasing and
     other functions that leverage the scale of the franchise system are
     combined under the Partner Services Group. Franchising believes there
     is significant opportunity to leverage its size by entering into joint
     marketing arrangements with national and multi-national companies that
     want to gain exposure to the millions of guests who patronize
     Franchising's franchise hotels each year. In the past, these
     arrangements have added to Franchising's and its franchisees' revenues
     and profits by attracting business to its franchise hotels.
 
  .  Optimize the Brand Portfolio. Franchising believes that each of its
     brands has particular attributes and strengths. Franchising's strategy
     is to leverage the strengths of each brand for profit growth and for
     identifying new niches into which the company may expand.
 
  .  Increase Market Penetration on a Strategic Basis. Franchising will take
     advantage of its regional structure to analyze key markets in the U.S.
     and, in conjunction with its franchisees, identify the best
     opportunities for new development or conversion to one of Franchising's
     brands.
 
  .  Improve Margins Through Increased Productivity. Franchising addresses
     the competitiveness of its own and its franchisees' profitability by
     initiating revenue generating programs and improving cost productivity.
     A key component of this strategy is the roll out of Franchising's
     proprietary property and yield management system "Profit Manager by
     Choice," which Franchising believes will improve the RevPAR of its
     franchisees.
 
  .  Profitably Grow Internationally. During the ten fiscal years ended May
     31, 1997, the number of properties in Franchising's international
     franchise system increased to 563 properties with 47,603 rooms, from 81
     properties with 8,330 rooms. Franchising's international franchise
     system includes hotels in 32 countries outside the United States.
     Franchising plans to continue to profitably grow its brands
     internationally through a strategic pursuit of joint ventures, master
     franchising agreements and brand specific area development agreements.
 
  .  Leverage Spin-Off From Sunburst. The separation of Franchising from
     Sunburst will allow a pure focus on franchising, including the potential
     pursuit of acquisition opportunities complementary to Franchising's core
     business.
 
                                      35
<PAGE>
 
 Franchise System
 
  Franchising's franchise hotels principally operate under one of
Franchising's brand names: Comfort, Quality, Clarion, Sleep, Rodeway, Econo
Lodge and MainStay Suites. The following table presents key statistics
relative to Franchising's domestic franchise system over the four fiscal years
ended May 31, 1997.
 
                      COMBINED DOMESTIC FRANCHISE SYSTEM
 
<TABLE>
<CAPTION>
                                    AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
<S>                                <C>        <C>        <C>        <C>
Number of properties, end of
 period...........................     2,283      2,311      2,495      2,781
Number of rooms, end of period....   203,019    200,792    214,613    235,431
Average Royalty Rate..............       3.1%       3.2%       3.3%       3.4%
Average occupancy percentage......      62.2%      63.8%      63.8%      62.6%
Average daily room rate (ADR).....  $  45.63   $  47.13   $  49.49   $  51.92
RevPAR............................ *$  28.40   $  30.08   $  31.60   $  32.52
Royalty fees ($000s)..............  $ 62,590   $ 71,665   $ 82,239   $ 91,724
</TABLE>
--------
* Franchising's RevPAR figure for each fiscal year is an average of the
  RevPAR calculated for each month in the fiscal year. Franchising calculates
  RevPAR each month based on information actually reported by franchisees on
  a timely basis to Franchising.
 
  No master franchisee or other franchisee accounted for 10% or more of
Franchising's total revenues or revenues related to franchise operations
during the last three fiscal years. Following the Distribution, Sunburst will
be Franchising's largest franchisee.
 
 Brand Positioning
 
  Franchising's hotels are primarily limited-service hotels (offering
amenities such as swimming pools and continental breakfast) or limited-to-full
service (offering amenities such as food and beverage services, meeting rooms
and room service).
 
  Comfort. Comfort Inns and Comfort Suites hotels offer rooms in the limited-
service, middle market category. Comfort Inns and Comfort Suites are targeted
to traditional business and leisure travelers. Principal competitor brands
include Days Inn, Fairfield Inn, Hampton Inn, Holiday Express and LaQuinta. At
May 31, 1997, there were 1,441 Comfort Inn properties and 120 Comfort Suite
properties with a total of 113,729 and 9,935 rooms, respectively, open and
operating worldwide. An additional 193 Comfort Inn properties and 119 Comfort
Suite properties with a total of 17,550 and 9,671 rooms, respectively, were
under development.
 
                                      36
<PAGE>
 
  Comfort properties are located in the United States and in Australia, the
Bahamas, Belgium, Canada, France, Germany, India, Indonesia, Ireland, Italy,
Jamaica, Mexico, Norway, Portugal, Puerto Rico, Sweden, Switzerland, Thailand,
the United Kingdom and the United Arab Emirates. The following chart
summarizes the Comfort system in the United States:
 
                            COMFORT DOMESTIC SYSTEM
 
<TABLE>
<CAPTION>
                                    AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
<S>                                <C>        <C>        <C>        <C>
Number of properties, end of
 period...........................       935      1,015      1,129      1,255
Number of rooms, end of period....    82,479     87,551     94,160    102,722
Royalty fees ($000s).............. $  31,187  $  37,635  $  44,657  $  50,758
Average occupancy percentage......      68.0%      69.5%      68.7%      67.2%
Average daily room rate (ADR)..... $   46.46  $   48.24  $   51.13  $   54.17
RevPAR............................ $   31.57  $   33.54  $   35.11  $   36.39
</TABLE>
 
  Quality. Certain Quality Inns and Quality Suites hotels compete in the
limited service, middle market category while others compete in the full
service, middle market category. Quality Inns and Quality Suites are targeted
to traditional business and leisure travelers. Principal competitor brands
include Best Western, Holiday Inn, Howard Johnson, Ramada Inn and Days Inn. At
May 31, 1997, there were 583 Quality Inn properties with a total of 67,995
rooms, and 36 Quality Suites properties with a total of 4,999 rooms open
worldwide. An additional 105 Quality Inn properties and 34 Quality Suites
properties with a total of 11,173 rooms and 3,315 rooms, respectively, were
under development.
 
  Quality properties are located in the United States and in Argentina,
Australia, Canada, Chile, Costa Rica, the Czech Republic, Denmark, France,
Germany, India, Indonesia, Ireland, Italy, Jamaica, Mexico, New Zealand,
Norway, Portugal, Russia, Spain, Thailand, the United Kingdom and the United
Arab Emirates.
 
  The following chart summarizes the Quality system in the United States:
 
                            QUALITY DOMESTIC SYSTEM
 
<TABLE>
<CAPTION>
                                    AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
<S>                                <C>        <C>        <C>        <C>
Number of properties, end of
 period...........................       358        341        362        409
Number of rooms, end of period....    45,032     43,281     45,967     50,487
Royalty fees ($000s).............. $  14,890  $  15,632  $  16,606  $  17,623
Average occupancy percentage......      61.6%      63.1%      62.5%      61.3%
Average daily room rate (ADR)..... $   50.07  $   50.94  $   52.90  $   54.61
RevPAR............................ $   30.83  $   32.16  $   33.08  $   33.46
</TABLE>
 
  Econo Lodge. Econo Lodge hotels operate in the limited-service, economy
category of the lodging industry. Econo Lodges are targeted to the senior
travel market and rely to a large extent on strong roadside name recognition.
Principal competitor brands include Days Inn, Ho-Jo Inn, Motel 6, Ramada
Limited, Red Carpet Inn, Red Roof Inn, Super 8 and Travelodge.
 
                                      37
<PAGE>
 
  At May 31, 1997, there were 704 Econo Lodge properties with a total of
45,718 rooms open and operating in the United States and Canada, and an
additional 116 properties with a total of 8,330 rooms under development in
those two countries. The following chart summarizes the Econo Lodge system in
the United States:
 
                          ECONO LODGE DOMESTIC SYSTEM
 
<TABLE>
<CAPTION>
                                    AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
<S>                                <C>        <C>        <C>        <C>
Number of properties, end of
 period...........................       677        633        641        682
Number of rooms, end of period....    46,570     42,801     42,726     44,636
Royalty fees ($000s).............. $  11,231  $  12,021  $  12,760  $  13,288
Average occupancy percentage......      56.7%      57.5%      58.0%      56.4%
Average daily room rate (ADR)..... $   37.27  $   38.31  $   39.97  $   41.33
RevPAR............................ $   21.14  $   22.04  $   23.17  $   23.30
</TABLE>
 
  Clarion. Clarion Inns, Clarion Hotels, Clarion Resorts and Clarion Suites
hotels are full-service properties which operate in the upscale category.
Clarion hotels are targeted to traditional business and leisure travelers.
Principal competitor brands include Holiday Inn, Holiday Select, Crowne Plaza,
Four Points by Sheraton, Radisson, Courtyard by Marriott and Doubletree.
 
  At May 31, 1997, there were 110 Clarion properties with a total of 17,249
rooms open and operating worldwide and an additional 32 properties with a
total of 5,022 rooms under development. The properties are located in the
United States, the Bahamas, Canada, France, Guatemala, Indonesia, Ireland,
Japan, Mexico, Norway, Russia, Thailand and Uruguay. The following chart
summarizes the Clarion system in the United States:
 
                            CLARION DOMESTIC SYSTEM
 
<TABLE>
<CAPTION>
                                    AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
<S>                                <C>        <C>        <C>        <C>
Number of properties, end of
 period...........................        65         63         75         92
Number of rooms, end of period....    12,211     10,420     12,817     14,721
Royalty fees ($000s).............. $   2,735  $   2,995  $   3,602  $   4,081
Average occupancy percentage......      62.0%      63.7%      63.3%      63.3%
Average daily room rate (ADR)..... $   62.47  $   63.71  $   64.36  $   67.76
RevPAR............................ $   38.75  $   40.58  $   40.74  $   42.86
</TABLE>
 
  Rodeway. The Rodeway brand competes in the limited-service, economy category
and is targeted to the senior travel market. Principal competitor brands
include Ho-Jo Inn, Ramada Limited, Red Roof Inn, Budgetel, Shoney's Inn, Super
8 and Motel 6. At May 31, 1997, there were 216 Rodeway Inn properties with a
total of 13,509 rooms, open and operating in the United States and Canada, and
an additional 50 properties with a total of 3,481 rooms under development in
those two countries. The following chart summarizes the Rodeway system in the
United States:
 
                          RODEWAY DOMESTIC SYSTEM(1)
 
<TABLE>
<CAPTION>
                                    AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
<S>                                <C>        <C>        <C>        <C>
Number of properties, end of
 period...........................       214        208        201        216
Number of rooms, end of period....    13,806     13,067     12,547     13,509
Royalty fees ($000s).............. $   1,941  $   2,302  $   2,506  $   2,631
Average occupancy percentage......      51.4%      50.5%      52.7%      52.7%
Average daily room rate (ADR)..... $   36.89  $   38.93  $   40.66  $   41.15
RevPAR............................ $   19.00  $   19.64  $   21.48  $   21.68
</TABLE>
--------
(1) Includes data pertaining to the Friendship Inn system, which is being
    combined with the Rodeway Inn system.
 
                                      38
<PAGE>
 
  Sleep Inn. Established in 1988, Sleep Inn is a new-construction hotel brand
in the limited-service, economy category. Sleep Inns are targeted to the
traditional business and leisure traveler. Principal competitor brands include
Days Inn, Fairfield Inn, Holiday Express, LaQuinta Inn, Ho-Jo Inn and Ramada
Inn.
 
  At May 31, 1997, there were 133 Sleep Inn properties with a total of 9,806
rooms open and operating worldwide. An additional 150 properties with a total
of 11,497 rooms were under development. The properties are located in the
United States, Canada and the Cayman Islands. The following chart summarizes
the Sleep system in the United States:
 
                             SLEEP DOMESTIC SYSTEM
 
<TABLE>
<CAPTION>
                                    AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
<S>                                <C>        <C>        <C>        <C>
Number of properties, end of
 period...........................        34         51         87        131
Number of rooms, end of period....     2,921      3,672      6,396      9,635
Royalty fees ($000s).............. $     605  $   1,080  $   2,108  $   3,343
Average occupancy percentage......      64.6%      65.3%      65.5%      63.9%
Average daily room rate (ADR)..... $   39.11  $   41.89  $   45.11  $   48.11
RevPAR............................ $   25.28  $   27.37  $   29.56  $   30.75
</TABLE>
 
  MainStay Suites. MainStay Suites, Franchising's newest hotel brand, is a
middle market, extended-stay lodging product targeted to travelers who book
hotel rooms for five or more consecutive nights. The first MainStay Suites
hotel, which Sunburst owns and manages, opened in Plano, Texas, in November
1996. An additional 21 properties with 2,054 rooms were under development as
of May 31, 1997.
 
  The MainStay Suites brand is designed to fill the gap between existing
upscale and economy extended-stay lodging products. Principal competitors for
the brand include Candlewood hotels, TownPlace Suites, as well as competition
from all-suite hotel properties and traditional extended stay operators in
both the upscale market (Residence Inn, Homewood Suites, Hawthorne Suites and
Summerfield Suites) and the economy market (Extended Stay America, Studio Plus
and Oakwood).
 
 International Franchise Operations
 
  Franchising's international franchise operations have traditionally been
operated as a division separate from its domestic franchise operations. In
some cases, international master franchisees are not required to separately
report royalty results by brand, making brand results on a worldwide basis
unavailable. In the past fiscal year, Franchising entered into arrangements to
enter four new international markets. At May 31, 1997, Choice had 563
franchise hotels open in 32 countries outside the United States. The following
table illustrates the growth of Franchising's international franchise system
over the four fiscal years ended May 31, 1997. Choice does not track ADR,
RevPAR or occupancy rates for international properties.
 
                    COMBINED INTERNATIONAL FRANCHISE SYSTEM
 
<TABLE>
<CAPTION>
                                         AS OF AND FOR THE YEAR ENDED MAY 31,
                                        ---------------------------------------
                                          1994      1995      1996      1997
                                        --------- --------- --------- ---------
<S>                                     <C>       <C>       <C>       <C>
Number of properties, end of period....       430       524       557       563
Number of rooms, end of period.........    36,725    44,877    46,843    47,603
Royalty fees ($000s)................... $   1,667 $   1,998 $   1,586 $   1,672
</TABLE>
 
  Europe. Choice is the second-largest international franchised hotel chain in
Europe, with 270 hotels open in 14 countries at May 31, 1997. In a move to
realign and streamline its European operations, in May 1996 Franchising,
through its subsidiary, Manor Care Hotels (France) S.A., consummated a
transaction with Friendly Hotels, PLC ("Friendly") whereby Franchising
purchased an equity interest for approximately $17 million in
 
                                      39
<PAGE>
 
Friendly to finance the development of ten new Comfort Inn or Quality Inn
hotels in the United Kingdom and Ireland. Additionally, Friendly purchased
from Franchising a master franchise for the United Kingdom and Ireland.
Franchising closed its London office as a result of the transaction.
Franchising's French and German operations were consolidated into
Franchising's Paris, France office, which directly operates Franchising's
business in most of Europe. There is also a master franchise arrangement in
Scandinavia.
 
  The Middle East. In August 1995, Franchising signed a master franchise for
Israel. Franchising opened its first franchised property in Dubai, United Arab
Emirates, in December 1995. At May 31, 1997, there were two properties open in
this region.
 
  Asia/Pacific. During fiscal year 1997, Choice franchisees opened four hotels
in Australia, four in New Zealand, three in India, one in Thailand and two in
Indonesia, bringing the total number of properties open in the Asia/Pacific
region at May 31, 1997 to 61.
 
  Caribbean. Franchising's master franchisee had 6 properties open in 4
Caribbean countries at May 31, 1997.
 
  Central and South America. Franchising recently signed master franchise
agreements covering Brazil, Uruguay, Paraguay and Argentina. Franchising also
has master franchisees operating in Guatemala, Costa Rica, Chile and Mexico.
In total there were 19 open properties in this region at May 31, 1997.
 
  Canada. Choice Hotels Canada (a joint venture with Journey's End Corporation
of Belleville, Ontario, Canada ("Journey's End")) is Canada's largest lodging
organization with 205 properties open at May 31, 1997. The joint venture,
owned 50% by Franchising and 50% by Journey's End, was formed in 1993 when
Journey's End converted substantially all of its controlled hotels to
Franchising's brands and Franchising contributed its operations in Canada to
form Choice Hotels Canada.
 
 Owned and Operated International Hotels
 
  After the Distribution, Franchising, through its wholly-owned subsidiary,
Quality Hotels Europe, Inc. and its affiliates, will own and operate hotels in
the United Kingdom, France and Germany. These hotels are located in:
Kensington, England; Troisdorf, Peine and Jena, Germany; and Moulins,
Perpignan, Lormont, Montlucon, Paris, Ponte-a-Mousson, Vierzon, St. Catherine,
Reims and Cherbourg, France.
 
 Franchise Sales
 
  Franchising markets franchises principally to: (i) developers of hotels,
(ii) owners of independent hotels and motels, (iii) owners of hotels
affiliated with other franchisors' brands, (iv) its own franchisees, who may
own, buy or build other hotels which can be converted to Franchising's brands,
and (iv) contractors who construct any of the foregoing. In fiscal year 1996,
existing franchisees accounted for approximately one-half of Franchising's new
franchise agreements. In considering hotels for conversion to one of
Franchising's brands, or sites for development of new hotels, Franchising
seeks properties in locations which are in close proximity to major highways,
airports, tourist attractions and business centers that attract travelers.
 
  At May 31, 1997, Franchising employed approximately 40 sales directors, each
of whom is responsible for a particular region or geographic area. Sales
directors contact potential franchisees directly and receive compensation
based on sales generated. Franchise sales efforts emphasize the benefits of
affiliating with one of Franchising's well-known brand names, Franchising's
commitment to improving RevPAR, Franchising's "celebrity in a suitcase"
television advertising campaign (formerly used for the entire Choice family of
brands and now used principally for its three largest brands, Comfort, Quality
and Econo Lodge), Franchising's reservation system, Franchising's training and
support systems, and Franchising's history of growth and profitability.
Because it offers brands covering a broad spectrum of the lodging marketplace,
Franchising is able to offer each prospective franchisee a brand that fits its
needs, lessening the chances that the prospective franchisee would need to
consider a competing franchise system.
 
 
                                      40
<PAGE>
 
  Because retention of existing franchisees is important to Franchising's
growth strategy, existing franchisees are offered the right to object to a
same-brand property within 15 miles, and are protected from the opening of a
same-brand property within a specific distance, generally two to five miles,
depending upon the size of the property and the market size. Franchising
believes that it is the only major franchise company to routinely offer such
territorial protection to its franchisees.
 
  During the fiscal year ended May 31, 1997, Franchising received 1,078
franchise applications, approved 874 applications, signed 715 franchise
agreements and placed 390 new properties into operation in the United States
under Franchising's brands. Of those placed into operation, 203 were newly
constructed hotels. By comparison, during the fiscal year ended May 31, 1996,
Franchising received 993 franchise applications, approved 862 applications,
signed 665 franchise agreements and had 284 new U.S. properties come on line.
Applications may not result in signed franchise agreements either because an
applicant is unable to obtain financing or because Franchising and the
applicant are unable to agree on the financial terms of the franchise
agreement.
 
 Franchise Agreements
 
  A franchise agreement grants a franchisee the right to non-exclusive use of
Franchising's franchise system in the operation of a single hotel at a
specified location, typically for a period of 20 years, with certain rights to
each of the franchisor and franchisee to terminate before the twentieth year.
When the responsibility for development is sold to a master franchisee, that
party has the responsibility to sell to local franchisees Franchising's brands
and the master franchisee generally must manage the delivery of necessary
services (such as quality assurance, reservations and marketing) to support
the franchised hotels in the master franchise area. The master franchisee
collects the fees paid by the local franchisee and remits an agreed share to
Franchising. Master franchise agreements generally have a term of at least 10
years.
 
  Franchise agreements, other than master franchise agreements, can be
terminated by either party prior to the conclusion of their term under certain
circumstances, such as at certain anniversaries of the agreement or if a
franchisee fails to bring properties into compliance with contractual quality
standards within specified periods of time. Early termination options give
Franchising flexibility in eliminating or re-branding properties which become
weak performers for reasons other than contractual failure by the franchisee.
Master franchise agreements typically contain provisions permitting
Franchising to terminate the agreement for failure to meet a specified
development schedule.
 
  Franchise fees vary among Franchising's different brands, but generally are
competitive with the industry average within their market group. Franchise
fees usually have four components: an initial, one-time affiliation fee; a
royalty fee; a marketing fee; and a reservation fee. Proceeds from the
marketing fee and reservation fee are used exclusively to fund marketing
programs and Franchising's central reservation system, respectively. Most
marketing fees support brand-specific marketing programs, although Franchising
occasionally contributes a portion of such fees to marketing programs designed
to support all of Franchising's brands. Royalty fees and affiliation fees are
the principal source of profits for Franchising.
 
                                      41
<PAGE>
 
  Under the terms of the standard franchise agreements, Franchising's
franchisees are typically required to pay the following initial fees and on-
going fees as a percentage of gross room revenues:
 
                             QUOTED FEES BY BRAND
 
<TABLE>
<CAPTION>
                         INITIAL FEE         ON-GOING FEES AS A PERCENTAGE OF GROSS ROOM REVENUES
                          PER ROOM/   ---------------------------------------------------------------------
         BRAND             MINIMUM     ROYALTY FEES           MARKETING FEES             RESERVATION FEES
         -----           ------------ -----------------      -----------------          -------------------
<S>                      <C>          <C>                    <C>                        <C>
Comfort Inn............. $300/$45,000      5.25%                    2.1%                       1.75%
Comfort Suites.......... $300/$50,000       5.0%                    2.1%                       1.75%
Quality Inn............. $300/$35,000       4.0%                    2.1%                       1.75%
Quality Suites.......... $300/$50,000       4.0%                    2.1%                       1.25%
Sleep Inn............... $300/$40,000       4.5%                    2.1%                       1.75%
Clarion................. $300/$40,000      2.75%                    1.0%                       1.25%
Econo Lodge............. $250/$25,000       4.0%                    3.5%(1)                     --
MainStay Suites......... $300/$30,000       4.5%                    2.5%(1)                     --
Rodeway.................                   
  Year 1................ $250/$25,000       3.5%                   1.25%                       1.25%
  Year 2................          --        3.0%                   1.25%                       1.25%
  Year 3................          --        3.0%                   1.00%                       1.00%
</TABLE>
--------
(1) Fee includes both Marketing and Reservations
 
  For a description of the Franchising Agreements between Choice and
Franchising which will remain in effect after the Distribution between
Sunburst and Franchising, see "--Relationship Between Choice and Franchising
After the Distribution--Franchise Agreements."
 
  Franchising has increased its actual royalty rate since FY 93, primarily by
raising the royalty fee for Comfort franchisees to 5.25% of annual gross room
revenues ("GRR") from 4.0% of GRR in 1993, and by raising the royalty rate for
franchisees in the former Friendship franchise system to 3.0% of GRR from 2.0%
of GRR in 1991. For the fiscal year ended May 31, 1997, Franchising's average
actual royalty rate was 3.4%. Franchising believes that its average actual
royalty rate will continue to increase as older franchise agreements expire,
terminate or are amended.
 
  At May 31, 1997, Franchising had 2,781 franchise agreements in effect in the
United States and 563 franchise agreements in effect in other countries. The
average age of the franchise agreements was 4 years. One hundred nineteen of
the franchise agreements are scheduled to expire during the five year period
beginning May 31, 1997; however, franchise agreements generally contain early
termination provisions.
 
 Franchise Operations
 
  Franchising's operations are designed to improve RevPAR for Franchising's
franchisees, as this is the measure of performance that most directly impacts
franchisee profitability. It is Franchising's belief that by helping its
franchisees to become more profitable it will enhance its ability to retain
its existing franchisees and attract new franchisees. The key aspects of
Franchising's franchise operations are:
 
  Central Reservation System. On average, approximately 22% of the room nights
booked at franchisees' properties are reserved through the toll-free telephone
reservation system operated by Franchising. Franchising's reservation system
consists of a computer reservation system known as CHOICE 2001, five
reservation centers in North America and several international reservation
centers run by Franchising or its master franchisees. The CHOICE 2001 system
is designed to allow trained operators to match each caller with a Choice-
branded hotel meeting the caller's needs. It provides an instant data link to
Franchising's franchised properties as well as to the Amadeus, Galileo, SABRE
and Worldspan airline reservation systems thereby facilitating the reservation
process for travel agents.
 
                                      42
<PAGE>
 
  To more sharply define the market and image for each of its brands,
Franchising began advertising separate toll-free reservation numbers for all
of its brands in fiscal year 1995. Franchising allows its reservation agents
to cross-sell Franchising's hotel brands. If a room in the Choice hotel brand
requested by a customer is not available in the location or price range that
the customer desires, the agent may offer the customer a room in another
Choice brand hotel that meets the customer's needs. Franchising believes that
cross-selling enables Franchising and its franchisees to capture additional
business.
 
  On-line reports generated by the CHOICE 2001 system enable franchisees to
analyze their reservation patterns over time. In addition, Franchising
provides and is currently improving a yield management product for its
franchisees to allow them to improve the management of their mix of rates and
occupancy based on current and forecasted demand on a property by property
basis. Franchising also markets to its franchisees a property management
product. Such products are designed to manage the financial and operations
information of an individual hotel and improve its efficiency.
 
  Brand Name Marketing and Advertising. Franchising's marketing and
advertising programs are designed to heighten consumer awareness of
Franchising's brands. Marketing and advertising efforts are focused primarily
in the United States and include national television and radio advertising,
print advertising in consumer and trade media and promotional events,
including joint marketing promotions with vendors and corporate partners.
 
  Franchising is recognized for its "celebrity in a suitcase" television
advertisements. In fiscal year 1996, Franchising began using brand-specific
marketing and largely discontinued the strategy of advertising its multiple
brands under the Choice umbrella, although it continues to use its "suitcase"
ads for its three largest brands, Comfort, Quality and Econo Lodge. The
marketing fees generated by these brands are used, in part, to fund a national
network television advertising campaign. Franchising's smaller hotel brands
conduct advertising campaigns that also include cable television, radio and
print.
 
  Franchising conducts numerous marketing programs targeting specific groups,
including senior citizens, motorist club members, families, government and
military employees, and meeting planners. Other marketing efforts include
telemarketing and telesales campaigns, domestic and international trade show
programs, publication of group and tour rate directories, direct-mail
programs, discounts to holders of preferred credit cards, centralized
commissions for travel agents, fly-drive programs in conjunction with major
airlines, and twice yearly publication of a Travel and Vacation Directory.
 
  Marketing and advertising programs are directed by Franchising's Marketing
Department, which utilize the services of independent advertising agencies.
Franchising also employs sales personnel at its Silver Spring, Maryland,
headquarters and in its Phoenix, Arizona, office. These sales personnel use
telemarketing to target specific customer groups, such as potential corporate
clients in areas where Franchising's franchised hotels are located, the motor
coach market, and meeting planners. Most of these sales personnel sell
reservations and services for all of Franchising's brands, but four are
responsible exclusively for the Clarion brand.
 
  Franchising's regional sales directors work with franchisees to maximize
RevPAR. These directors advise franchisees on topics such as how to market
their hotels and how to maximize the benefits offered by Franchising's
reservations system.
 
  Quality Assurance Programs. Consistent quality standards are critical to the
success of a hotel franchise. Franchising has established quality standards
for all of its franchised brands which cover housekeeping, maintenance, brand
identification and level of services offered. Franchising inspects properties
for compliance with its quality standards when application is made for
admission to the franchise system. The compliance of existing franchisees with
quality standards is monitored through scheduled and unannounced Quality
Assurance Reviews conducted at least once per year at each property.
Properties which fail to maintain a minimum score are reinspected on a more
frequent basis until deficiencies are cured, or until such properties are
terminated.
 
  To encourage compliance with quality standards, Franchising offers various
brand-specific incentives to franchisees who maintain consistent quality
standards. Franchisees who fail to meet minimum quality standards
 
                                      43
<PAGE>
 
may be subject to consequences ranging from written warnings to termination of
the franchisee's franchise agreement. During fiscal year 1997, Franchising
terminated forty-nine properties for failure to maintain minimum quality
assurance scores.
 
  Training. Franchising maintains a training department which conducts
mandatory training programs for all franchisees and their employees.
Franchising also conducts regularly scheduled regional and national training
meetings for both property-level staff and managers. Training programs teach
franchisees how to take advantage of Franchising's reservation system and
marketing programs, and fundamental hotel operations such as housekeeping,
maintenance, and inventory yield management.
 
  Training is conducted by a variety of methods, including group instruction
seminars and video programs. Franchising is developing an interactive
computer-based training system that will train hotel employees at their own
pace. Franchisees will be required to purchase hardware to operate the
training system, and will use software developed by Franchising.
 
  Research and Development. Franchising seeks to enhance RevPAR by providing
to franchisees systems and products that will reduce costs and/or improve
their operations. Research and development activity resulted in the launch of
three new franchise products in fiscal year 1996, Choice Picks food court,
MainStay Suites hotels and K-Minus food service.
 
  In January 1996, Franchising introduced its MainStay Suites franchise hotel
brand, an extended-stay product targeted to travelers who book hotel rooms for
five or more consecutive nights. See "--MainStay Suites."
 
  In November 1995, Franchising introduced Choice Picks food court, a
customized, modular food-service system tailored to the needs of middle-market
hotels. Choice Picks food courts offer hotel guests a "choice pick" of
nationally known branded food items, such as Nathan's Famous hot dogs,
sandwiches made with Healthy Choice(R) deli meats, Pizzeria Uno(R) pizza and
calzone, Nestle Toll House(R) cookies and muffins, I Can't Believe It's
Yogurt(R) desserts, and Coca-Cola(R) beverages. The typical Choice Picks food
court can be operated by as few as two employees, thus providing the
properties with lower operating costs than properties with conventional
restaurants. Franchisees pay Franchising a one-time affiliation fee and
monthly royalty fees equal to a percentage of gross revenues on Choice Picks
food court sales. Franchisees must buy equipment and food service modules
necessary to set up a Choice Picks food court. Franchising intends to market
Choice Picks food court to larger hotel operators and other potential
customers outside of Franchising's franchise system.
 
  In November 1995, Franchising also began to offer to its franchisees the K-
Minus food service system, which eliminates expensive banquet kitchens by
outsourcing food preparation and limiting on-site work to assembly and
rethermalization. Compared with a traditional banquet operation, the K-Minus
food service system saves labor costs and energy. Franchisees who wish to
implement the K-Minus system are given design and technical assistance by
Franchising. Franchising receives a one-time technical assistance fee for the
provision of these services based on the scope of the project.
 
  Purchasing. Franchising's product services department negotiates volume
purchases of various products needed by franchisees to run their hotels,
including such items as furniture, fixtures, carpets and bathroom amenities.
The department also helps to ensure consistency in such products across its
exclusively new-construction brands, Sleep Inn and MainStay Suites brands.
 
  Design and Construction. Franchising maintains a design and construction
department to assist franchisees in refurbishing, renovating, or constructing
their properties prior to or after joining the system. Department personnel
assist franchisees in meeting Franchising's brand specifications by providing
technical expertise and cost-savings suggestions.
 
                                      44
<PAGE>
 
  Financial Assistance Programs. Franchising has established programs or
helped franchisees obtain financing through (i) a wholly owned subsidiary;
(ii) strategic partnerships with hotel lenders and/or (iii) by referral to
hotel lenders for hotel refinancing, acquisition, renovation and development.
Some of the specific programs include:
 
    (a) Second mortgage financing for the development and construction of
  Quality Inn, Quality Suites, Quality Inn & Suites, MainStay Suites and
  Sleep Inns. The terms of the financing will depend on each franchisee's
  credit worthiness, the amount of the proposed loan and the current economic
  conditions. Generally not more than 25% of the project will be financed.
  Total debt cannot exceed 75% of the fair market value.
 
    (b) Econo Lodge exterior renovation program. Loans up to an amount of
  $17,500 per property are given to qualified franchisees for standardized
  exterior renovation. Franchisee participation requires, among other things,
  extension of the franchise agreement. The loan is forgiven at the
  expiration of the extended franchise agreement, assuming no defaults have
  occurred thereunder.
 
    (c) Salomon Brothers in conjunction with Suburban Capital Markets Inc. is
  offering a $100 million construction to permanent financing program to
  qualified franchisees. All Choice brands are included in this program. The
  construction loan will be issued for a term up to three years at a floating
  rate of 355 basis points over the 30-day LIBOR. The loan amount will not
  exceed 75% of cost. The franchisee will be responsible for cost of all
  third party reports and fees in the amount of 2.75% of the loan amount. A
  stabilized debt service coverage ratio of at least 1.4:1 is required for
  the permanent loans, which are issued for a 10 year term with amortization
  up to 25 years and a fixed interest rate of 260 basis points over the 10
  year U.S. Treasury interest rate on the day of closing. The permanent loan
  will require a fee of 1% of the loan amount.
 
 Competition
 
  Competition among franchise lodging chains is intense, both in attracting
potential franchisees to the system and in generating reservations for
franchisees. In addition, hotel chains and independent hotels compete
intensely for guests and for meeting and banquet business.
 
  Franchising's principal competitor brands at the national and international
level in the economy category of the lodging industry are LaQuinta, Ho-Jo Inn,
Ramada Inn, Motel 6, Ramada Limited, Red Carpet Inn, Red Roof Inn, Budgetel,
Hampton Inn, Fairfield Inn, Holiday Express, Shoney's Inn, Super 8, Days Inn,
and Travelodge. Franchising's principal competitor brands at the national and
international level in the middle market category of the lodging industry are
Days Inn, Fairfield Inn, Hampton Inn, Holiday Express, LaQuinta, Holiday Inn,
Best Western, Howard Johnson and Ramada Inns. Franchising's principal
competitor brands at the national and international level in the upscale
category are Holiday Inn, Holiday Select, Crowne Plaza, Four Points by
Sheraton, Radisson, Courtyard by Marriott and Doubletree.
 
  Franchising believes that hotel operators choose lodging franchisors based
primarily on the perceived value and quality of each franchisor's brand and
services, and the extent to which affiliation with that franchisor may
increase the franchisee's reservations and profits. Hotel operators may also
select a franchisor in part based on the franchisor's reputation among other
franchisees, and the success of its existing franchisees.
 
  Choice is the second largest hotel franchiser in the world. The largest,
HFS, Inc., has over 4,600 franchised hotels. Holiday Inn Worldwide has 1,240,
Promus Hotel Corp. has 597, Marriott International has 394 and Carlson
Hospitality Worldwide has 248.*
--------
* The figures in this paragraph are with respect to U.S. hotel properties as
  indicated in the August 1996 issue of Lodging Hospitality.
 
                                      45
<PAGE>
 
  Franchising's prospects for growth are largely dependent upon the ability of
its franchisees to compete in the lodging market, since Franchising's
franchise system revenues are based on franchisees' gross room revenues (but
not directly on franchisees' profitability).
 
  The ability of a hotel to compete may be affected by a number of factors,
including the location and quality of its property, the number and quality of
competing properties nearby, its affiliation with a recognized name brand, and
general regional and local economic conditions. The effect of economic
conditions on Franchising's results is substantially reduced by the geographic
diversity of Franchising's franchised properties, which are located in all 50
states and in 33 countries, as well as its range of products and room rates.
 
 Service Marks and Other Intellectual Property
 
  The service marks Quality Inn, Quality Suites, Comfort Inn, Comfort Suites,
Clarion Hotel, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites and
related logos are material to the Franchising Business. Franchising, directly
and through its franchisees, actively uses these marks. All of the material
marks are registered with the United States Patent and Trademark Office,
except for MainStay Suites and K-Minus, which are the subject of pending
applications. In addition, Franchising has registered certain of its marks
with the appropriate governmental agencies in over 100 countries where it is
doing business or anticipates doing business in the foreseeable future.
Franchising seeks to protect its brands and marks throughout the world,
although the strength of legal protection available varies from country to
country.
 
 Non-Hotel Properties
 
  The principal executive offices of Franchising are located at 10750 Columbia
Pike, Silver Spring, Maryland, 20901. These offices are leased from Manor Care
pursuant to the Silver Spring Lease. For a description of the Silver Spring
Lease and the effect of the Distribution on the Silver Spring Lease, see "--
Relationship Between the Company of Franchising after the Distribution," and
"Proposal Five: Election of Directors--Certain Relationships and
Transactions." Franchising owns its reservation system offices in Phoenix, AZ
and Minot, ND. Franchising leases two additional reservation system offices in
Grand Junction, CO, pursuant to leases that expire in 1999 and 2000, and
occupies additional space in Toronto, Canada, on a month-to-month basis. In
addition, Franchising leases 12 sales offices across the United States.
Franchising's European headquarters, which Franchising leases pursuant to a
lease that expires on December 31, 1997, is located in Paris, France.
Franchising also leases one international sales offices in France pursuant to
a lease that terminates in June 1998. Management believes that its executive,
reservation systems and sales offices are sufficient to meet its present needs
and does not anticipate any difficulty in securing additional or alternative
space, as needed, on terms acceptable to Franchising.
 
 Seasonality
 
  Franchising's principal sources of revenues are franchise fees based on the
gross room revenues of its franchise properties and revenues generated by its
owned and managed hotels. Franchising experiences seasonal revenue patterns
similar to those of the lodging industry in general. This seasonality can be
expected to cause quarterly fluctuations in the revenues, profit margins and
net income of Franchising.
 
 Regulation
 
  Franchising's franchisees are responsible for compliance with all laws and
government regulations applicable to the hotels they own or operate. The
lodging industry is subject to numerous federal, state and local government
regulations, including those relating to the preparation and sale of food and
beverage (such as health and liquor license laws), building and zoning
requirements and laws governing a hotel owner's relationship with employees,
including minimum wage requirements, overtime, working conditions and work
permit requirements. The failure to obtain or retain liquor licenses or an
increase in the minimum wage rate, employee benefit costs or other costs
associated with employees could adversely affect Franchising's owned hotels.
Under the Americans
 
                                      46
<PAGE>
 
with Disabilities Act of 1990 (the "ADA"), all public accommodations are
required to meet certain federal requirements related to access and use by
disabled persons. A determination that Franchising is not in compliance with
the ADA could result in the imposition of fines or an award of damages to
private litigants. These and other initiatives could adversely affect
Franchising as well as the lodging industry in general.
 
  The Federal Trade Commission (the "FTC") and certain other jurisdictions
(including France, Province of Alberta, Canada, and Mexico and various states)
regulate the sale of franchises. The FTC requires franchisors to make
extensive disclosure to prospective franchisees but does not require
registration. A number of states require registration or disclosure in
connection with franchise offers and sales. In addition, several states have
"franchise relationship laws" or "business opportunity laws" that limit the
ability of the franchisor to terminate franchise agreements or to withhold
consent to the renewal or transfer of these agreements. While Franchising's
franchising operations have not been materially adversely affected by such
regulation, Franchising cannot predict the effect of future regulation or
legislation.
 
 Impact of Inflation and Other External Factors
 
  Franchising's principal sources of revenues are franchise fees. Franchise
fees and revenues from owned and managed hotels can be impacted by two
external factors: the supply of hotel rooms within the lodging industry
relative to the demand for rooms by travelers, and inflation.
 
  Although industry-wide supply and demand for hotel rooms recently has been
fairly balanced, any excess in supply that might develop in the future could
have an unfavorable impact on room revenues at Franchising's franchised hotels
either by reducing the number of rooms reserved at Franchising's properties or
by restricting the rates hotel operators can charge for their rooms. In
addition, an excess supply of hotel rooms may discourage potential franchisees
from opening new hotels, unfavorably impacting the franchise fees received by
Franchising.
 
  Although Franchising believes that increases in the rate of inflation will
generally result in comparable increases in hotel room rates, severe inflation
could contribute to a slowing of the national economy, which could result in
reduced travel by both business and leisure travelers. That could lead to less
demand for hotel rooms, which could result in a temporary reduction in room
rates and fewer room reservations, negatively impacting revenues received by
Franchising. A weak economy could also reduce demand for new hotels,
negatively impacting the franchise fees received by Franchising.
 
  Among the other unpredictable external factors which may affect
Franchising's fee stream are wars, airline strikes, gasoline shortages and
severe weather.
 
 Legal Proceedings
 
  Neither Choice nor Franchising is a party to any litigation, other than
routine litigation incidental to the Franchising Business. None of such
litigation, either individually or in the aggregate, is expected to be
material to the business, financial condition or results of operations of
Franchising.
 
 Employees
 
  Franchising employed 2,070 people as of June 30, 1997. None of Franchising's
employees are represented by unions or covered by collective bargaining
agreements. Franchising considers its relations with its employees to be
satisfactory.
 
MANAGEMENT
 
 Board of Directors
 
  The current directors of Franchising are William R. Floyd, Donald J. Landry
and James A MacCutcheon. In connection with the Distribution, it is expected
that Messrs. Landry and MacCutcheon will resign as directors of Franchising
and that, prior to the Distribution Date, Choice, as sole stockholder of
Franchising, will expand
 
                                      47
<PAGE>
 
the Franchising board of directors to a total of nine persons and appoint
seven persons to the resulting vacancies so that the persons listed below will
constitute the entire Franchising Board of Directors effective as of the
Distribution Date. From and after the Distribution Date, Franchising's Board
of Directors will be classified into three classes, designated Class I, Class
II and Class III, each class to be as nearly equal in number of directors as
possible. The term of the initial Class I directors will terminate on the date
of the 1998 annual meeting of Franchising's stockholders; the term of the
initial Class II directors will terminate on the date of the 1999 annual
meeting of Franchising's stockholders; and the term of the initial Class III
directors will terminate on the date of the 2000 annual meeting of
Franchising's stockholders. At each annual meeting of Franchising's
stockholders, successors to the class of directors whose term expires at that
annual meeting will be elected for a three-year term.
 
  The name, age and proposed class of directorship upon consummation of the
Distribution of the nine persons who are expected to be the directors of
Franchising from and after the Distribution Date are set forth below.
 
<TABLE>
<CAPTION>
      NAME                                                 AGE CLASS OF DIRECTOR
      ----                                                 --- -----------------
   <S>                                                     <C> <C>
   Stewart Bainum, Jr. ...................................  51     Class II
   Stewart Bainum.........................................  78     Class I
   Barbara Bainum.........................................  53     Class III
   William R. Floyd.......................................  52     Class II
   James H. Rempe.........................................  67     Class II
   Robert C. Hazard, Jr. .................................  62     Class III
   Frederic V. Malek......................................  60     Class III
   Gerald W. Petitt.......................................  51     Class I
   Jerry E. Robertson, Ph.D...............................  64     Class I
</TABLE>
 
 Background of Directors
 
  Stewart Bainum Jr. Chairman of the Board of Choice since November 1996;
Chairman of the Board of Choice Hotels from March 1987 to June 1990; Chairman
of the Board and Chief Executive Officer of Manor Care and Manor Care Health
Services, Inc. ("MCHS") since March 1987; Chief Executive Officer of Manor
Care since March 1987 and President since June 1989; Vice Chairman of the
Board of Vitalink Pharmacy Services, Inc. ("Vitalink") since December 1994;
Vice Chairman of the Board of Manor Care and subsidiaries from June 1982 to
March 1987; Director of Manor Care since August 1981, of Vitalink since
September 1991, of MCHS since 1976 and of Choice Hotels since 1977; Chief
Executive Officer of MCHS since June 1989 and President from May 1990 to May
1991; Chairman of the Board and Chief Executive Officer of Vitalink from
September 1991 to February 1995 and President and Chief Executive Officer from
March 1987 to September 1991.
 
  Stewart Bainum. Vice Chairman of the Board of Manor Care and subsidiaries
since March 1987; Chairman of the Board of Manor Care from August 1981 to
March 1987, Chief Executive Officer from July 1985 to March 1987, President
from May 1982 to July 1985; Chairman of the Board of MCHS from 1968 to March
1987 and a Director since 1968; Director of Vitalink from September 1991 to
September 1994; Chairman of the Board of Choice Hotels from 1972 to March 1987
and a Director since 1963; Chairman of the Board of Realty Investment Company,
Inc. since 1965.
 
  Barbara Bainum. President, Secretary and Director of the Commonwealth
Foundation since December 1990, December 1984 and December 1994, respectively;
Secretary and Director of Realty Investment Company, Inc. since July 1989 and
March 1982, respectively; Family Services Agency, Gaithersburg, Maryland,
Clinical Social Work since September 1994; Department of Social Services,
Rockville, Maryland, Social Work Case Management from September 1992 to May
1993; member of the Boards of Trustees of Columbia Union College (September
1987 to May 1991) and Atlantic Union College (September 1985 to May 1987).
 
                                      48
<PAGE>
 
  William R. Floyd. Chief Executive Officer of Choice since October 1996;
Chief Operating Officer of Taco Bell Corp., (a subsidiary of PepsiCo) from
July 1995 to October 1996, Chief Operating Officer of KFC (a subsidiary of
PepsiCo) from August 1994 to July 1995; National Vice President of Taco Bell
Company Operations from July 1992 to August 1994, Vice President of Taco Bell
Eastern Operations from December 1990 to January 1992; Director, Friendly
Hotels PLC since 1996.
 
  Robert C. Hazard, Jr. Hotel Developer. Co-Chairman of Choice Hotels from
January 1995 to November 1996 and a Director since December 1980; Chairman
from June 1990 to January 1995 and Chief Executive Officer from December 1980
to January 1995; President from December 1980 to June 1990. Advisory Board
Outrigger Hotels.
 
  Frederic V. Malek. Chairman of Thayer Capital Partners since March 1993, Co-
Chairman of CB Commercial Real Estate Group, Inc. from April 1989 to October
1996; Campaign Manager for Bush-Quayle 92 from January 1992 to November 1992;
Vice Chairman of NWA, Inc. (airlines), July 1990 to December 1991; Director:
Manor Care, Inc., American Management Systems, Inc., Automatic Data Processing
Corp., CB Commercial Real Estate Group, Inc., FPL Group, Inc. (an affiliate of
Florida Power and Light--power company); Northwest Airlines and various Paine
Webber mutual funds.
 
  Gerald W. Petitt. Hotel Developer, Co-Chairman of Choice Hotels from January
1995 to November 1996 and a Director since December 1980; President from June
1990 to January 1995 and Chief Operating Officer from December 1980 to January
1995.
 
  Jerry E. Robertson, Ph.D. Retired; Executive Vice President, 3M Life
Sciences Sector and Corporate Services from November 1986 to March 1994;
Director: Manor Care, Inc., Allianz Life Insurance Company of North America,
Cardinal Health, Inc., Coherent, Inc., Haemonetics Corporation, Medwave, Inc.,
Project Hope and Steris Corporation.
 
  James H. Rempe. Senior Vice President, General Counsel and Secretary of
Manor Care since August 1981 and of Franchising from February 1981 to November
1996. Director, In Home Health Inc. and Vitalink Pharmacy Services, Inc.
 
 The Board of Directors and Committees of the Board
 
  Upon consummation of the Distribution, the Franchising Board of Directors is
expected to consist of nine members. It is expected that the Board of
Directors will hold five meetings during the fiscal year and that the standing
committees of the Board of Directors will include the Audit Committee, the
Finance Committee, the Compensation/Key Executive Stock Option Plan Committee
and the Nominating Committee. The members of the committees are expected to be
the same members of Choice's current Committees.
 
  The Compensation/Key Executive Stock Option Plan Committee will administer
the Franchising stock option plans and grant stock options thereunder, will
review compensation of officers and key management employees, will recommend
development programs for employees such as training, bonus and incentive
plans, pensions and retirement, and will review other employee fringe benefit
programs.
 
  The Finance Committee will review the financial affairs of Franchising and
will recommend financial objectives, goals and programs to the Board of
Directors and to management.
 
  The Audit Committee will review the scope and results of the annual audit,
will review and approve the services and related fees of Franchising's
independent public accountants, will review Franchising's internal accounting
controls and will review Franchising's Internal Audit Department and its
activities.
 
  The Nominating Committee will recommend to the Board of Directors the
members to serve on the Board of Directors during the ensuing year. The
Committee will not consider nominees recommended by stockholders.
 
                                      49
<PAGE>
 
 Compensation of Directors
 
  Prior to the Distribution, it is expected that Franchising will adopt the
Choice Hotels Franchising, Inc. Non-Employee Director Stock Option and Deferred
Compensation Stock Purchase Plan. Part A of the Plan will provide that eligible
non-employee directors will be granted options to purchase 5,000 shares of
Franchise Common Stock on their first date of election and will be granted
options to purchase 1,000 shares on their date of election in subsequent
calendar years. Part B of the Plan will provide that eligible non-employee
directors may elect, prior to May 31 of each year, to defer a minimum of 25% of
committee fees earned during the ensuing fiscal year. The fees which are so
deferred will be used to purchase Franchise Common Stock on the open market
within 15 days after December 1, February 28 and May 31 of such fiscal year.
Pending such purchases, the funds will be credited to an Interest Deferred
Account, which will be interest bearing. Stock which is so purchased will be
deposited in a Stock Deferred Account pending distribution in accordance with
the Plan.
 
  Directors who will be employees of Franchising will receive no separate
remuneration for their services as directors. Pursuant to the Non-Employee
Director Stock Compensation Plan to be adopted by Franchising prior to the
Distribution, eligible non-employee directors will receive annually, in lieu of
cash, restricted stock of Franchising, the fair market value of which at the
time of grant will be equal to $30,000, which will represent the Board of
Directors retainer and meeting fees. In addition, all non-employee directors
will receive $1,610 per diem for Committee meetings attended, except where the
Committee meeting is on the same day as a Board meeting, and will be reimbursed
for travel expenses and other out-of-pocket costs incurred in attending
meetings.
 
 Executive Officers
 
  The name, age, proposed title upon consummation of the Distribution and
business background of each of the persons who are expected to become on the
Distribution Date the executive officers of Franchising are set forth below.
The business address of each prospective executive officer is 10750 Columbia
Pike, Silver Spring, Maryland 20901, unless otherwise indicated.
 
<TABLE>
<CAPTION>
      NAME               AGE                            POSITION
      ----               ---                            --------
<S>                      <C> <C>
Stewart Bainum, Jr......  51 Chairman of the Board of Directors
William R. Floyd........  52 Vice Chairman and Chief Executive Officer
James A. MacCutcheon....  45 Executive Vice President, Chief Financial Officer and Treasurer
Thomas Mirgon...........  41 Senior Vice President, Human Resources
Barry L. Smith..........  55 Senior Vice President, Marketing
Michael J. DeSantis.....  38 Senior Vice President, General Counsel and Secretary
Joseph M. Squeri........  32 Vice President, Finance and Controller
Rodney Sibley...........  48 Senior Vice President, Franchise Operations
</TABLE>
 
  James A. MacCutcheon. Executive Vice President, Chief Financial Officer and
Treasurer of Choice since November 1996; Senior Vice President, Chief Financial
Officer and Treasurer of Choice's predecessor (together with Choice, "Choice
Hotels") since September 1993; Senior Vice President, Chief Financial Officer
and Treasurer of Manor Care from September 1993 to November 1996; Senior Vice
President--Finance and Treasurer of Manor Care from October 1987 to September
1993; Treasurer of Vitalink from September 1992 to January 1997 and a Director
since September 1994.
 
  Thomas Mirgon. Senior Vice President, Human Resources of Choice since March
1997; Vice President, Administration of Interim Services from August 1993 to
February 1997; employed by Taco Bell Corp. from January 1986 to August 1993,
last serving as Senior Director, Field Human Treasures from February 1992 to
August 1993.
 
                                       50
<PAGE>
 
  Barry L. Smith. Senior Vice President--Marketing of Choice Hotels since
February 1989.
 
  Michael J. DeSantis. Senior Vice President, General Counsel and Secretary of
the Company since June 1997; Senior Attorney for the Company from November
1996 to June 1997; Senior Attorney for Manor Care from January 1996 to October
1996; Vice President, Associate General Counsel and Assistant Secretary for
Caterair International Corporation from April 1994 to December 1995; Assistant
General Counsel of Caterair International from May 1990 to March 1994.
 
  Rodney Sibley. Senior Vice President, Franchise Operations of Choice since
June 1997; Senior Vice President, Development for the Company from June 1996
to June 1997; Regional Vice President of Choice from 1992 to June 1996.
 
 
  For biographical information with respect to the other persons listed above,
see "Certain Information Concerning Franchising--Management--Board of
Directors."
 
 Compensation of Executive Officers
 
  Summary Compensation. The following tables set forth certain information
concerning the annual and long term compensation of those persons who,
following the Distribution, will serve as the chairman of the board, the chief
executive officer and the four other most highly compensated executive
officers of Franchising (the "Franchising Named Officers").
 
                          SUMMARY COMPENSATION TABLE
 
<TABLE>
<CAPTION>
                                                  ANNUAL          LONG-TERM COMPENSATION
                                               COMPENSATION             RESTRICTED
                                             -----------------    -----------------------
                             FISCAL                                 STOCK    STOCK OPTION      ALL OTHER
NAME AND PRINCIPAL POSITION   YEAR   SALARY   BONUS    OTHER      AWARDS($)  SHARES(#)(1)   COMPENSATION(2)
---------------------------  ------ -------- -------- --------    ---------- ------------   ---------------
<S>                          <C>    <C>      <C>      <C>         <C>        <C>            <C>
Stewart Bainum, Jr.(3)..      1997  $656,357 $388,520      (4)           --     60,000(5)           --
 Chairman                     1996   625,102  337,555      (4)           --     60,000(5)       $33,543
                              1995   572,308  343,385      (4)           --        --             9,000
William R. Floyd(6).....      1997   270,373  146,001 $107,831(7) $1,250,000   307,693              --
 Vice Chairman and            1996       --       --       --            --        --               --
 Chief Executive Officer      1995       --       --       --            --        --               --
James A.
 MacCutcheon(8).........      1997   313,578  155,953      (4)           --     67,500(9)        18,682
 Executive Vice President,    1996   301,517  135,682      (4)           --     25,000(10)       13,176
 Chief Financial Officer      1995   273,199  136,600      (4)           --        --            13,176  
  and Treasurer               
Barry L. Smith..........      1997   240,000  108,000      (4)           --     25,000(11)       11,086
 Sr. Vice President,          1996   233,640  116,820      (4)           --     5,000(12)        10,427          
  Marketing                   1995   221,668  104,561      (4)           --        --             6,750 
Thomas Mirgon(13).......      1997    58,477   26,315      (4)           --     40,000              --
 Senior Vice President,       1996       --       --                     --        --               --
 Human Resources              1995       --       --                     --        --               --
Rodney Sibley(14).......      1997   309,123  139,105      (4)           --     30,000(15)       27,329
 Senior Vice President,       1996   423,858      --       (4)           --        --            27,329
 Franchise Operations         1995   478,355      --       (4)           --        --            21,349
</TABLE>
--------
 (1) For Messrs. Bainum, Jr., MacCutcheon, Smith and Sibley, represents
     options to purchase shares of Manor Care Common Stock granted in fiscal
     years 1997, 1996 and 1995. In connection with the Manor Care Spin-off,
     the options to purchase Manor Care Common Stock were converted, in some
     cases 100%, to options to purchase Choice Common Stock. In all cases,
     however, the exercise prices were adjusted to maintain the same financial
     value to the option holder before and after the Manor Care Spin-off.
 (2) Represents amounts contributed by Manor Care for fiscal years 1996 and
     1995 and Choice for fiscal year 1997 under their respective 401(k) Plan
     and Non-Qualified Savings Plan, which provide retirement and other
     benefits to eligible employees, including the Franchising Named Officers.
     The value of the amounts contributed in stock by Choice during fiscal
     year 1997 under the 401(k) Plan for the Franchising Named Offices were as
     follows: Mr. MacCutcheon, $6,240; Mr. Smith, $3,696 and Mr. Sibley,
     $9,000. The value of the amounts contributed in stock of Choice during
     fiscal year 1997 under the Non-Qualified Saving Plan for the Franchising
     Named Officers were as follows: Mr. MacCutcheon, $12,443; Mr. Smith
     $7,390 and Mr. Sibley $18,329.
 
                                      51
<PAGE>
 
 (3) For part of fiscal year 1997 and all of fiscal years 1996 and 1995, Mr.
     Bainum, Jr. was the Chairman and Chief Executive Officer of Manor Care
     and Choice. In November, 1996, he resigned as Chief Executive Officer of
     Choice. The compensation reflected here is the total compensation
     received for services rendered to both Manor Care and Choice. For the
     period of fiscal year 1997 after the Manor Care Spin-off, the amount of
     compensation paid solely by Choice was $88,302 for base salary and
     $47,683 for bonus.
 (4) The value of perquisites and other compensation does not exceed the
     lesser of $50,000 or 10% of the amount of annual salary and bonus paid as
     to any of the Franchising Named Officers.
 (5) In connection with the Manor Care Spin-off, these options were converted
     on a pro rata basis into options to purchase Manor Care Common Stock and
     options to purchase Choice Common Stock.
 (6) Mr. Floyd's employment as Chief Executive Officer of Choice commenced
     October 16, 1996.
 (7) Consists of relocation expenses.
 (8) For fiscal years 1996 and 1995 and part of fiscal year 1997, Mr.
     MacCutcheon was Senior Vice President, Chief Financial Officer and
     Treasurer of Manor Care and Choice. On November 1, 1996, Mr. MacCutcheon
     resigned from his position at Manor Care and assumed the position of
     Executive Vice President and Chief Financial Officer of Choice. The
     compensation reflected here is total compensation received for services
     rendered to both Manor Care and Choice. For the period of fiscal year
     1997 after the Manor Care Spin-off, the amount of compensation paid
     solely by Choice was $209,052 for base salary and $103,690 for bonus.
 (9) In connection with the Manor Care Spin-off, these options were converted
     into options to purchase 6,563 shares of Manor Care Common Stock at an
     adjusted exercise price of $25.0505, 36,387 options and 136,326 options
     to purchase Choice Common Stock at adjusted exercise prices of $14.5095
     and $13.8933, respectively.
(10) In connection with the Manor Care Spin-off, these options were converted
     into options to purchase 50,102 shares of Choice Common Stock at an
     adjusted exercise price of $11.1168 and 10,462 shares of Manor Care
     Common Stock at an adjusted exercise price of $19.1932.
(11) In connection with the Manor Care Spin-off, these options were converted
     into options to purchase 68,182 shares of Choice Common Stock at an
     adjusted exercise price of $14.5095.
(12) In connection with the Manor Care Spin-off, these options were converted
     into options to purchase 13,633 shares of Choice Common Stock at an
     adjusted exercise price of $11.1168.
(13) Mr. Mirgon's employment with Choice commenced March 3, 1997.
(14) Prior to fiscal year 1997, Mr. Sibley's compensation was based on
     commissions.
(15) In connection with the Manor Care Spin-off, such options were converted
     into options to purchase 81,818 shares of Choice Common Stock at an
     adjusted exercise price of $14.5095.
 
  Stock Options. The following tables set forth certain information at May 31,
1997 and for the fiscal year then ended concerning options to purchase Choice
Common Stock granted to the Franchising Named Officers. All common stock
figures and exercise prices have been adjusted to reflect stock dividends and
stock splits effective in prior fiscal years. In connection with the Manor
Care Spin-off, existing Manor Care stock options were subject to certain
adjustments or conversion into options to purchase Choice Common Stock.
 
                                      52
<PAGE>
 
                      STOCK OPTION GRANTS IN FISCAL 1997
 
                               INDIVIDUAL GRANTS
 
<TABLE>
<CAPTION>
                                               PERCENTAGE OF                             POTENTIAL REALIZABLE
                                               TOTAL OPTIONS                           VALUE OF ASSUMED RATE OF
                                               GRANTED TO ALL                          STOCK PRICE APPRECIATION
                                    NUMBER OF   EMPLOYEES IN  EXERCISE BASE               FOR OPTION TERM(2)
                                     OPTIONS    FISCAL YEAR       PRICE     EXPIRATION ------------------------
          NAME             COMPANY* GRANTED(1)      1997        PER SHARE      DATE       5%(3)       10%(4)
          ----             -------- ---------- -------------- ------------- ---------- ----------- ------------
<S>                        <C>      <C>        <C>            <C>           <C>        <C>         <C>
Stewart Bainum, Jr.(5)...   CHI       60,000        (6)         $14.5095     07/01/06  $   547,494 $  1,387,464
                            MNR       60,000        (6)         $25.0505     07/01/06      945,246    2,395,440
                                     -------                                           ----------- ------------
                            Total    120,000                                             1,492,740    3,782,904

William R. Floyd(5)......   CHI      307,693        (6)         $ 14.625     11/04/06    2,830,037    7,171,862
                            MNR            0        --               --           --           --           --
                                     -------                                           ----------- ------------
                            Total    307,693                                             2,830,087    7,171,862

James A. MacCutcheon(5)..   CHI       36,387        (6)         $14.5095     07/01/06      332,028      841,428
                            CHI      136,326        (6)         $13.8933     09/30/06    1,191,135    3,018,571
                            MNR        6,563        (6)         $25.0505     07/01/06      103,394      262,021
                                     -------                                           ----------- ------------
                            Total    179,276                                             1,626,557    4,122,020

Barry L. Smith(5)........   CHI       68,182        (6)         $14.5095     07/01/06      622,154    1,576,668
                            MNR            0        --               --           --           --           --
                                     -------                                           ----------- ------------
                            Total     68,182                                               622,154    1,576,668

Thomas Mirgon(5).........   CHI       40,000        (6)         $ 15.625     02/25/07      393,060      996,088
                            MNR            0        --               --           --           --           --
                                     -------                                           ----------- ------------
                            Total     40,000                                               393,060      996,088

Rodney Sibley(5).........   CHI       81,818        (6)         $14.5095     07/01/06      746,581    1,891,992
                            MNR            0        --               --           --           --           --
                                     -------                                           ----------- ------------
                            Total     81,818                                               746,581    1,891,992
</TABLE>
--------
 *  References to "CHI" are to Choice and "MNR" are to Manor Care.
(1) Options granted to Messrs. Bainum, Jr., MacCutcheon, Smith and Sibley were
    granted prior to the Manor Care Spin-off and were thus granted as options
    to purchase Manor Care Common Stock. In connection with the Manor Care
    Spin-off, these options to purchase Manor Care Common Stock were
    converted, in some cases 100%, and in some cases partially to options to
    purchase Choice Common Stock. In all cases, however, the exercise prices
    were adjusted to maintain the same financial value to the option holder
    before and after the Manor Care Spin-off. The number of options set forth
    in the table represent the number of Choice and Manor Care options and the
    adjusted exercise prices after the conversion.
(2) The dollar amounts under these columns are the result of calculations at
    the 5% and 10% rates set by the Securities and Exchange Commission and
    therefore are not intended to forecast future possible appreciation, if
    any, of the stock price. Since options are granted at market price, a zero
    percent gain in the stock price will result in no realizable value to the
    optionees.
(3) A 5% per year appreciation in stock price from $13.8933 per share yields
    $22.6307, from $14.5095 per share yields $23.6344, from $14.625 per share
    yields $23.8226, from $25.0505 per share yields $40.8046, and from $15.625
    per share yields $25.4515.
(4) A 10% per year appreciation in stock price from $13.8933 per share yields
    $36.0356, from $14.5095 per share yields $37.6339, from $14.625 per share
    yields $37.9335, from $25.0505 per share yields $64.9745, and from $15.625
    per share yields $40.5272.
(5) The options granted to the officers vest at the rate of 20% per year on
    the first through the fifth anniversaries of the date of the stock option
    grant.
(6) Information with respect to the total options granted to all Manor Care
    employees is unavailable. With respect to the Company, the only options
    granted by Choice during the fiscal year were the grants to Messrs. Floyd
    and Mirgon as identified in the table and grants aggregating 25,000
    options to purchase Choice Common Stock to two additional new employees.
    All other options to purchase Choice Common Stock issued to employees were
    issued as a result of the conversion of Manor Care options in the Manor
    Care Spin-off.
 
                                      53
<PAGE>
 
                   AGGREGATE OPTION EXERCISES IN FISCAL 1997
                         AND YEAR-END OPTION VALUES(1)
 
<TABLE>
<CAPTION>
                                                                                      VALUE OF UNEXERCISED
                                                           NUMBER OF UNEXERCISED          IN-THE-MONEY
                                    SHARES                OPTIONS AS MAY 31, 1997  OPTIONS AT MAY 31, 1997(2)
                                  ACQUIRED ON   VALUE    ------------------------- -----------------------------
          NAME           COMPANY*  EXERCISE#  REALIZED$  EXERCISABLE UNEXERCISABLE EXERCISABLE    UNEXERCISABLE
          ----           -------- ----------- ---------- ----------- ------------- -------------  --------------
<S>                      <C>      <C>         <C>        <C>         <C>           <C>            <C>
Stewart Bainum, Jr......   CHI      465,000   $3,105,452   239,000      221,000       $2,758,324      $1,334,863
                           MNR      293,791    2,318,180   174,000      221,000        3,633,404       2,749,771

William R. Floyd........   CHI          --           --          0      307,693              --          346,154
                           MNR          --           --          0            0              --              --

James A. MacCutcheon....   CHI          --           --    162,639      335,408        1,858,096       1,708,638
                           MNR          --           --     91,362       46,563        1,962,041         704,946
 
Barry L. Smith..........   CHI       39,537      156,324     9,815      166,336          117,676       1,000,544
                           MNR          --           --          0            0              --              --

Thomas Mirgon...........   CHI          --           --          0       40,000              --            5,000
                           MNR          --           --          0            0

Rodney Sibley...........   CHI          --           --     13,633       81,818          108,466         101,495
                           MNR          --           --          0            0              --              --
</TABLE>
--------
*   References to "CHI" are to Choice and "MNR" are to Manor Care.
(1) Options granted to Messrs. Bainum, Jr., MacCutcheon, Smith and Sibley were
    granted prior to the Manor Care Spin-off and were thus granted as options
    to purchase Manor Care Common Stock. In connection with the Manor Care
    Spin-off, these options to purchase Manor Care Common Stock, were
    converted, in some cases 100%, to options to purchase Choice Common Stock.
    In all cases, however, the exercise prices were adjusted to maintain the
    same financial value to the option holder before and after the Manor Care
    Spin-off. The number of options set forth in the table represent the
    number of Choice and Manor Care options and the adjusted exercise prices
    after the conversion.
(2) The closing prices of Choice Common Stock and Manor Care Common Stock as
    reported by the New York Stock Exchange on May 30, 1997 were $15.75, and
    $28.625, respectively. The value is calculated on the basis of the
    difference between the option exercise price and such closing price
    multiplied by the number of shares of Choice Common Stock or Manor Care
    Common Stock underlying the option.
 
EMPLOYMENT AGREEMENTS
 
  Effective upon the Distribution Date, Franchising is expected to enter into
an employment agreement with Stewart Bainum, Jr., providing for Mr. Bainum,
Jr.'s employment as Chairman of the Board of Franchising. The agreement will
have a term of three years. Either Franchising or Mr. Bainum may terminate the
agreement upon 30 days' prior written notice on the first and second
anniversary dates of the agreement. The agreement will provide that Mr.
Bainum, Jr. will devote 12.5% of his professional time to the affairs of
Franchising, 12.5% of his professional time to the affairs of Choice and the
remaining 75% of his professional time to the affairs of Manor Care. The
agreement provides for a base salary of $82,044 per annum for services to
Franchising and a maximum bonus of 60% of Mr. Bainum, Jr.'s base compensation
based upon the performance of Franchising.
 
  Effective upon the Distribution Date, Franchising is expected to assume an
employment agreement between Choice and William R. Floyd. The agreement has a
term of five years from October 21, 1996 and provides for a base salary of
$425,000 per annum, subject to annual adjustments and an annual bonus of up to
60% of his base compensation, based on performance (including a customer
satisfaction component). Pursuant to the employment agreement, Choice granted
to Mr. Floyd 85,470 shares of restricted Choice Common Stock and options to
purchase 307,693 shares of Choice Common Stock, of which 34,188 of the options
are incentive stock options granted under the Choice 1997 Long Term Incentive
Plan. The remainder of the options are non-qualified stock options. Upon
assumption of the Employment Agreements by Franchising, such restricted stock
and options will be adjusted and converted into Franchising Common Stock and
options. See "Relationship Between
 
                                      54
<PAGE>
 
Choice and Franchising after the Distribution--Employee Benefits Allocation
Agreement." Mr. Floyd's employment agreement further provides that, with
respect to Mr. Floyd's participation in the Choice Hotels International, Inc.
Supplemental Executive Retirement Plan (the "SERP"), (i) Mr. Floyd's normal
retirement age will be 62 and (ii) no minimum years of services for benefit
eligibility will be applicable.
 
  Effective upon the Distribution Date, Franchising is expected to assume an
employment agreement between Choice and Mr. MacCutcheon. The agreement has a
term of five years from November 1, 1996 and provides for a base salary of
$313,576 per annum, subject to annual adjustments and an annual bonus of up to
55% of his base compensation, based on Choice's performance (including a
customer satisfaction component).
 
  Effective upon the Distribution Date, Franchising is expected to assume an
employment agreement between Choice and Thomas Mirgon. The agreement has a
term of five years from March 3,1997 and provides for a base salary of
$230,000 per annum, subject to annual adjustments and an annual bonus of up to
50% of his base compensation, based on the Franchising's performance. The
agreement also provides for (i) a one-time cash payment of $50,000, payable in
two equal installments: the first within 30 days of March 3, 1997 and the
second within 30 days of March 3, 1998; and (ii) a grant of 30,000 non-
qualified options and 10,000 incentive stock options.
 
RETIREMENT PLANS
 
  Franchising will adopt the SERP. Participants are selected by the Board of
Directors or any designated committee and must be at the level of Senior Vice
President or above.
 
  Participants in the SERP receive a monthly benefit for life based upon final
average salary and years of service. Final average salary is the average of
the monthly base salary, excluding bonuses or commissions, earned in a 60
month period which produces the highest average out of the 120 months of
employment, prior to the first occurring of the early retirement date or the
normal retirement date. The normal retirement age is 65, and participants must
have a minimum of 15 years of service. Participants may retire at age 60 and
may elect to receive reduced benefits commencing prior to age 65, subject to
Board approval. All of the Named Officers who will be participants are age 55
or younger, so that none of their compensation reported above would be
included in the final average salary calculation. See "--Employment
Agreements" for a discussion of the terms applicable to Mr. Floyd's
participation in the SERP.
 
  Assuming that the following officers continue to be employed by Franchising
until they reach age 65, their credited years of service would be as follows:
 
<TABLE>
<CAPTION>
                                                  CURRENT YEARS YEARS OF SERVICE
    NAME OF INDIVIDUAL                             OF SERVICE      AT AGE 65
    ------------------                            ------------- ----------------
   <S>                                            <C>           <C>
   Stewart Bainum, Jr.,..........................     22.5             38
   James A. MacCutcheon..........................        9             30
   Thomas Mirgon.................................        0             24
   Barry L. Smith................................        7             18
</TABLE>
 
                                      55
<PAGE>
 
  The table below sets forth estimated annual benefits payable upon retirement
to persons in specified compensation and years of service classifications.
These benefits are straight life annuity amounts, although participants have
the option of selecting a joint and 50% survivor annuity or ten-year certain
payments. The benefits are not subject to offset for social security and other
amounts.
 
                          YEARS OF SERVICE/BENEFIT AS
                      PERCENTAGE OF FINAL AVERAGE SALARY
 
<TABLE>
<CAPTION>
                                                                         25 OR
   REMUNERATION                                        15/15%  20/22.5% MORE/30%
   ------------                                        ------- -------- --------
   <S>                                                 <C>     <C>      <C>
   $300,000........................................... $45,000 $ 67,500 $ 90,000
    350,000...........................................  52,500   78,750  105,000
    400,000...........................................  60,000   90,000  120,000
    450,000...........................................  67,500  101,250  135,000
    500,000...........................................  75,000  112,500  150,000
    600,000...........................................  90,000  135,000  180,000
</TABLE>
 
  It is expected that upon the Distribution, Franchising will establish the
Choice Hotels Franchising, Inc. Retirement Savings and Investment Plan (the
"Franchising 401(k) Plan"). The Franchising 401(k) Plan will be a defined
contribution retirement, savings and investment plan qualified under Section
401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), and will
include a cash or deferred arrangement under Section 401(k) of the Code. All
employees age 21 or over and who have worked for Franchising (or Choice) for a
twelve month period during which such employee completed at least 1,000 hours
will be eligible to participate. Subject to certain non-discrimination
requirements, each employee will be able to contribute an amount to the
Franchising 401(k) Plan on a pre-tax basis up to 15% of the employee's salary,
but not more than the current federal limit of $9,500. Franchising will match
contributions made by its employees subject to certain limitations. The amount
of the match will be equal to a percentage of the amount of salary reduction
contribution made on behalf of a participant during the plan year based upon a
formula that involves the profits of Franchising (or, prior to the
Distribution, Choice) for the year and the number of years of service of the
participant. Amounts contributed by Choice pursuant to its 401(k) Plan for the
Franchising Named Officers are included in the Summary Compensation Table
under the column headed "All Other Compensation."
 
  It is expected that upon the Distribution, Franchising will adopt the Choice
Hotels Franchising, Inc. Non-Qualified Retirement Savings and Investment Plan
("Franchising Non-Qualified Savings Plan"). Certain select highly compensated
members of management of Franchising will be eligible to participate in the
Franchising Non-Qualified Savings Plan. The Franchising Non-Qualified Savings
Plan is structured so as to provide the participants with a pre-tax savings
vehicle to the extent that pre-tax savings are limited under the 401(k) Plan
as a result of various governmental regulations, such as non-discrimination
testing. Amounts contributed by Choice under its Non-Qualified Savings Plan
for fiscal year 1997 for the Franchising Named Officers are included in the
Summary Compensation Table under the column headed "All Other Compensation."
 
  The Franchising match under the Franchising 401(k) Plan and the Franchising
Non-Qualified Savings Plan will be limited to a maximum aggregate of 6% of the
annual salary of a participant. Likewise, participant contributions under the
two plans will not exceed the aggregate of 15% of the annual salary of a
participant.
 
  For a discussion of the Franchising Incentive Plan and Franchising Stock
Purchase Plans, see "Franchising Benefit Plans."
 
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  Upon consummation of the Distribution, certain management employees of
Franchising and of Choice will hold options to purchase shares of Choice
Common Stock. See "Relationship Between Choice and Franchising After the
Distribution--Employee Benefits Allocation Agreement."
 
                                      56
<PAGE>
 
  For a discussion of certain contracts to be executed between Choice and
Franchising as of the Distribution Date, see "Relationship Between Choice and
Franchising After the Distribution." For a discussion of the historical
financial relationship between Choice and Franchising, see "--Management's
Discussion and Analysis of Financial Condition and Results of Operation--
Liquidity and Capital Resources."
 
SECURITY OWNERSHIP
 
  The following table sets forth the amount of Franchising Common Stock
expected to be beneficially owned by (i) each director and director nominee of
Franchising, (ii) the chief executive officer of Franchising and the other
Franchising Named Officers, (iii) all officers and directors of Franchising as
a group and (iv) all persons who are expected to own beneficially more than 5%
of Franchising Common Stock, based on Choice Common Stock beneficially owned
by such persons on the Annual Meeting Record Date. Unless otherwise specified,
the address for each of them is 10750 Columbia Pike, Silver Spring, Maryland
20901. On the Distribution Date, the holders of Choice Common Stock as of the
Distribution Record Date will be entitled to receive one share of Franchising
Common Stock for each share of Choice Common Stock. For purposes of the
following table, it is assumed that all options to purchase shares of Choice
Common Stock held by the persons specified will be converted into options to
purchase Franchising Common Stock. For a discussion of the treatment of
outstanding options to purchase Choice Common Stock in connection with the
Distribution, see "Relationship Between Choice and Franchising After the
Distribution--Employee Benefits Allocation Agreement."
 
<TABLE>
<CAPTION>
                                   TOTAL SHARES OF     PERCENT OF SHARES
                                 CHOICE COMMON STOCK      OUTSTANDING
                                   EXPECTED TO BE        EXPECTED TO BE
    NAME OF BENEFICIAL OWNER     BENEFICIALLY OWNED  BENEFICIALLY OWNED (1)
    ------------------------     ------------------- ----------------------
<S>                              <C>                 <C>
Stewart Bainum, Jr..............     16,003,408(2)           26.58%
Stewart Bainum..................     10,325,997(3)           17.15%
Barbara Bainum..................      5,520,867(4)            9.17%
William R. Floyd................         85,570(5)               *
Robert C. Hazard, Jr............         40,756(6)               *
James A. MacCutcheon............        181,910(7)               *
Frederic V. Malek...............          5,510(8)               *
Thomas Mirgon...................              0                  *
Gerald W. Petitt................         86,281(9)               *
James H. Rempe..................         67,527(10)              *
Jerry E. Robertson, Ph.D........         20,824(11)              *
Barry L. Smith..................        244,292(12)              *
Rodney Sibley...................         38,234(13)              *
All Directors and Officers as a
 Group (15 persons).............     21,592,499(14)          35.87%
Bruce Bainum....................      5,512,302(15)           9.16%
Ronald Baron....................     15,790,713(16)          26.23%
</TABLE>
--------
*    Less than 1% of class.
 (1) Percentages are based on 60,200,784 shares outstanding on August 5, 1997
     (the "Annual Meeting Record Date") plus, for each person, the shares
     which would be issued assuming that such person exercises all options it
     holds which are exercisable on such date or become exercisable within 60
     days thereafter.
 (2) Includes 549,152 shares owned directly by the Stewart Bainum, Jr.
     Declaration of Trust dated March 13, 1996, the sole trustee and
     beneficiary of which is the reporting person. Also includes 5,417,761
     shares owned by Bainum Associates Limited Partnership ("Bainum
     Associates") and 4,415,250 shares owned by MC Investments Limited
     Partnership ("MC Investments"), in both of which Mr. Bainum, Jr. is
     managing general partner with the sole right to dispose of the shares;
     3,567,869 shares held directly by Realty Investment Company, Inc.
     ("Realty"), a real estate management and investment company in which Mr.
     Bainum, Jr. has shared voting authority; 1,779,628 shares owned by Mid
     Pines Associates Limited Partnership ("Mid Pines"), in which Mr. Bainum,
     Jr. is managing general partner and has shared voting
 
                                      57
<PAGE>
 
     authority and 10,600 shares owned by the Foundation for Maryland's Future,
     in which Mr. Bainum, Jr. is the sole director. Also includes 263,000
     shares which Mr. Bainum, Jr. has the right to acquire pursuant to stock
     options which are presently exercisable or which become exercisable within
     60 days after the Annual Meeting Record Date, and 148 shares which Mr.
     Bainum, Jr. has the right to receive upon termination of his employment
     with Choice pursuant to the terms of the Choice Hotels International, Inc.
     Non-Qualified Retirement Savings and Investment Plan ("Non- Qualified
     Savings Plan").
 (3) Includes 3,906,278 shares held directly by the Stewart Bainum Declaration
     of Trust, of which Mr. Bainum is the sole trustee and beneficiary, his
     joint interest in 895,466 shares owned by Bainum Associates and 1,082,857
     shares owned by MC Investments, each of which is a limited partnership in
     which Mr. Bainum has joint ownership with his wife as a limited partner
     and as such has the right to acquire at any time a number of shares equal
     in value to the liquidation preference of their limited partnership
     interests; 3,567,869 shares held directly by Realty, in which Mr. Bainum
     and his wife have shared voting authority; and 70,305 shares held by the
     Commonweal Foundation of which Mr. Bainum is Chairman of the Board of
     Directors and has shared voting authority. Also includes 798,711 shares
     held by the Jane L. Bainum Declaration of Trust, the sole trustee and
     beneficiary of which is Mr. Bainum's wife, and 1,667 shares which Mr.
     Bainum has the right to acquire pursuant to stock options which are
     presently exercisable or which become exercisable within 60 days after
     the Annual Meeting Record Date. Also includes 2,844 shares of restricted
     stock granted by the issuer to Mr. Bainum which are not vested but which
     Mr. Bainum has the right to vote.
 (4) Includes 101,013 shares owned directly by Ms. Bainum. Also includes
     1,779,628 shares owned by Mid Pines, in which Ms. Bainum's trust is a
     general partner and has shared voting authority, 3,567,869 shares owned
     by Realty, in which Ms. Bainum's trust has voting stock and shares voting
     authority and 70,305 shares owned by the Commonweal Foundation, in which
     Ms. Bainum is President and Director and has shared voting authority.
     Also includes 2,052 shares of restricted stock issued to Ms. Bainum under
     the Choice Hotels International, Inc. Non-Employee Director Stock
     Compensation Plan (the "Non-Employee Director Stock Compensation Plan")
     which shares are not vested, but which Ms. Bainum has the right to vote.
 (5) Consists of restricted shares granted pursuant to Mr. Floyd's employment
     agreement which are not yet vested, but which Mr. Floyd has the right to
     vote.
 (6) Includes 37,304 shares owned directly by Mr. Hazard; 2,844 restricted
     shares granted under the Non-Employee Director Stock Compensation Plan,
     which are not yet vested, but which Mr. Hazard has the right to vote, and
     113 shares and 415 shares, respectively, which Mr. Hazard has the right
     to receive upon termination of his employment pursuant to the terms of
     the Choice Hotels International, Inc. Retirement Savings and Investment
     Plan ("401(k) Plan") and Non-Qualified Savings Plan.
 (7) Includes 180,311 shares which Mr. MacCutcheon has the right to acquire
     pursuant to stock options which are presently exercisable or exercisable
     within 60 days of the Annual Meeting Record Date and 664 and 935 shares,
     respectively, which Mr. MacCutcheon has the right to receive upon
     termination of his employment with Choice pursuant to the terms of the
     401(k) Plan and Non-Qualified Savings Plan.
 (8) Includes 1,666 shares which Mr. Malek has the right to acquire pursuant
     to stock options which are presently exercisable and 2,844 restricted
     shares granted under the Non-Employer Director Stock Compensation Plan
     which are not vested, but which Mr. Malek has the right to vote.
 (9) Includes 74,776 shares held directly by Mr. Petitt and 8,661 shares held
     in trust for minor children for which Mr. Petitt is trustee. Beneficial
     ownership of such shares is disclaimed. Also includes 2,844 restricted
     shares granted under the Non-Employee Director Stock Compensation Plan
     which are not yet vested, but which Mr. Petitt has the right to vote.
(10) Includes 59,624 shares which Mr. Rempe has the right to acquire pursuant
     to stock options which are presently exercisable or exercisable within 60
     days of the Annual Meeting Record Date.
(11) Includes 15,500 shares owned by the JJ Robertson Limited Partnership, of
     which Mr. Robertson and his wife are the general partners with shared
     voting authority and 2,844 restricted shares granted under the Non-
     Employee Director Stock Compensation Plan which are not yet vested, but
     which Mr. Robertson has the right to vote. Also includes 1,666 shares
     which Mr. Robertson has the right to acquire pursuant to stock options
     which are presently exercisable and 814 shares acquired pursuant to the
     Choice Hotels International, Inc. Non-Employee Director Stock Option and
     Deferred Compensation Stock Purchase Plan.
 
                                      58
<PAGE>
 
(12) Includes 243,483 shares which Mr. Smith has the right to acquire pursuant
     to stock options which are presently exercisable or exercisable within 60
     days of the Annual Meeting Record Date and 254 shares and 555 shares,
     respectively, which Mr. Smith has the right to receive upon termination
     of his employment pursuant to the terms of the 401(k) Plan and the Non-
     Qualified Savings Plan.
(13) Includes 5,800 shares held directly by Mr. Sibley, 29,996 shares which
     Mr. Sibley has the right to acquire pursuant to stock options which are
     presently exercisable or exercisable within 60 days of the Annual Meeting
     Record Date, and 963 and 1,475 shares, respectively, which Mr. Sibley has
     the right to receive upon termination of his employment pursuant to the
     terms of the 401(k) Plan and Nonqualified Savings Plan.
(14) Includes a total of 721,789 shares which the officers and directors
     included in the group have the right to acquire pursuant to stock options
     which are presently exercisable, or exercisable within 60 days of the
     Annual Meeting Record Date, and a total of 1,994 shares and 3,528 shares,
     respectively, which such directors and officers have the right to receive
     upon termination of their employment with Choice pursuant to the terms of
     the 401(k) Plan and the Non-Qualified Savings Plan.
(15) Includes 94,500 shares owned directly by Mr. Bainum. Also includes
     1,779,628 shares owned by Mid Pines, in which Mr. Bainum is a general
     partner and has shared voting authority, 3,568,869 shares owned by Realty
     in which Mr. Bainum's trust has voting stock and shares voting authority
     and 70,305 shares owned by the Commonwealth Foundation, in which Mr.
     Bainum is a Director and has shared voting authority. Mr. Bainum's
     address is 8737 Colesville Road, Suite 800, Silver Spring, Maryland,
     20910.
(16) As of July 31, 1997 based on a Schedule 13-D, as amended, filed by Mr.
     Baron with the Securities and Exchange Commission (the "Commission"). Mr.
     Baron's address is 450 Park Avenue, Suite 2800, New York, New York 10022.
 
DESCRIPTION OF FRANCHISING CAPITAL STOCK
 
  Under the Restated Certificate of Incorporation of Franchising (the
"Franchising Certificate"), which is attached as Annex A to this Prospectus,
the total number of shares of capital stock that Franchising has authority to
issue is 165,000,000, consisting of 160,000,000 shares of common stock, par
value $.01 per share, and 5,000,000 shares of preferred stock (the "Preferred
Stock"), par value $.01 per share.
 
  Based on the number of shares of Choice Common Stock outstanding on the
Annual Meeting Record Date, it is expected that approximately 60,200,784
shares of Franchising Common Stock will be issued to stockholders of Choice in
the Distribution. All of the shares Franchising Common Stock to be distributed
to Choice stockholders in the Distribution and to Manor Care Employees upon
exercise of the Franchising Options will be fully paid and non-assessable.
 
 Common Stock
 
  The Franchising Certificate authorizes common stock consisting of
160,000,000 shares. Holders of Franchising Common Stock are entitled to
receive, subject to preferences that may be applicable from time to time with
respect to any outstanding Preferred Stock, such dividends as are declared by
the Board of Directors of Franchising, one vote for each share at all meetings
of stockholders, and, subject to preferences that may be applicable from time
to time with respect to any outstanding Preferred Stock, the remaining assets
of Franchising upon liquidation, dissolution or winding up of Franchising.
Franchising may issue additional shares of common stock without further
stockholder approval, up to the maximum authorized number of shares, except as
may be otherwise required by applicable law or stock exchange regulations.
 
  Shares of common stock may be issued from time to time in one or more
classes or series. With respect to the issuance of common shares of any class
or series, the Board of Directors of Franchising is authorized to determine,
without any further action by the holders of Franchising's Common Stock, among
other things, the dividend rights, dividend rate, conversion rights, voting
rights and rights and terms of redemption, as well as the number of shares
constituting such class or series. Should the Board of Directors of
Franchising elect to exercise its authority, the rights and privileges of
holders of Franchising's Common Stock could be made subject to rights
 
                                      59
<PAGE>
 
and privileges of any such other series of common stock. Choice has no present
plans to issue any common stock of a class or series other than Franchising's
Common Stock.
 
  See "Post-Distribution Dividend Policy" for a description of the dividend
policy of Franchising after the Distribution.
 
 Preferred Stock
 
  Franchising's Board of Directors is authorized to issue up to 5,000,000
shares of Preferred Stock without further stockholder approval (except as may
be required by applicable law or stock exchange regulations) and to fix from
time to time, by resolution or resolutions, the relative powers, preferences
and rights and the qualifications, limitations or restrictions of any class or
series of Preferred Stock, as well as the number of shares constituting such
class or series and the designation thereof.
 
 Preemptive Rights
 
  Holders of shares of Franchising Common Stock have no preemptive rights.
 
PURPOSES AND ANTITAKEOVER EFFECTS OF CERTAIN PROVISIONS OF THE FRANCHISING
CERTIFICATE AND BYLAWS
 
  Prior to the Distribution Date, the Franchising Certificate and the Bylaws
of Franchising (the "Franchising Bylaws") will be amended by Choice as sole
stockholder of Franchising to make the Franchising Certificate and the
Franchising Bylaws substantially similar to Choice Certificate and Choice
Bylaws as currently in effect. Such amendment to the Franchising Certificate
and Franchising Bylaws may have an antitakeover effect with respect to
Franchising, deter an offer with a substantial premium to the then-current
trading price of Franchising Common Stock or hinder a potential transaction
that may be attractive to stockholders.
 
 Franchising Certificate and Bylaws
 
  The Franchising Certificate contains several provisions that will make
difficult an acquisition of control of Franchising, by means of a tender
offer, open market purchase, a proxy fight or otherwise, that is not approved
by the Franchising Board of Directors. The Franchising Bylaws also contain
provisions that could have an antitakeover effect.
 
  The purposes of the relevant provisions of the Franchising Certificate and
the Franchising Bylaws are to discourage certain types of transactions,
described below, which may involve an actual or threatened change of control
of Franchising and to encourage persons seeking to acquire control of
Franchising to consult first with the Board of Directors to negotiate the
terms of any proposed business combination or offer. The provisions are
designed to reduce the vulnerability of Franchising to an unsolicited proposal
for a takeover that does not contemplate the acquisition of all outstanding
shares or is otherwise unfair to stockholders of Franchising or an unsolicited
proposal for the restructuring or sale of all or part of Franchising. Choice
and Franchising believe that, as a general rule, such proposals would not be
in the best interests of Franchising and its stockholders.
 
  There has been a history of the accumulation of substantial stock positions
in public companies by third parties as a prelude to proposing a takeover or a
restructuring or sale of all or part of the company or another similar
extraordinary corporate action. Such actions are often undertaken by the
third-party without advance notice to, or consultation with, the management or
board of directors of the target company. In many cases, the purchaser seeks
representation on the company's board of directors in order to increase the
likelihood that its proposal will be implemented by the target company. If the
company resists the efforts of the purchaser to obtain representation on the
company's board, the purchaser may commence a proxy contest to have its
nominees elected to the board in place of certain directors or the entire
board. In some cases, the purchaser may not truly be interested in taking over
the company, but may use the threat of a proxy fight and/or a bid to take over
the company as a means of forcing the company to repurchase its equity
position at a substantial premium over market price.
 
                                      60
<PAGE>
 
  Choice and Franchising believe that the imminent threat of removal of
Franchising's management or Board of Directors in such situations would
severely curtail the ability of management or the board of directors to
negotiate effectively with such purchasers. The management or the Franchising
Board of Directors would be deprived of the time and information necessary to
evaluate the takeover proposal, to study alternative proposals and to help
ensure that the best price is obtained in any transaction involving
Franchising which may ultimately be undertaken. If the real purpose of a
takeover bid were to force Franchising to repurchase an accumulated stock
interest at a premium price, management or the Board of Directors would face
the risk that, if it did not repurchase the purchaser's stock interest,
Franchising's business and Franchising's management would be disrupted,
perhaps irreparably.
 
  Certain provisions of the Franchising Certificate and Bylaws, in the view of
Choice and Franchising, will help ensure that the Franchising Board of
Directors, if confronted by a surprise proposal from a third-party which has
acquired a block of stock, will have sufficient time to review the proposal
and appropriate alternatives to the proposal and to act in what it believes to
be the best interests of the stockholders. In addition, certain other
provisions of the Franchising Certificate are designed to prevent a purchaser
from utilizing two-tier pricing and similar inequitable tactics in the event
of an attempt to take over Franchising.
 
  These provisions, individually and collectively, will make difficult and may
discourage a merger, tender offer or proxy fight, even if such transaction or
occurrence may be favorable to the interests of the stockholders, and may
delay or frustrate the assumption of control by a holder of a large block of
Franchising Common Stock and the removal of incumbent management, even if such
removal might be beneficial to the stockholders. Furthermore, these provisions
may deter or could be utilized to frustrate a future takeover attempt which is
not approved by the incumbent Board of Directors, but which the holders of a
majority of the Franchising Common Stock may deem to be in their best
interests or in which stockholders may receive a substantial premium for their
stock over prevailing market prices of such stock. By discouraging takeover
attempts, these provisions may have the incidental effect of inhibiting
certain changes in management (some or all of the members of which might be
replaced in the course of a change of control) and also the temporary
fluctuations in the market price of the stock which often result from actual
or rumored takeover attempts.
 
  Set forth below is a description of all such material provisions in the
Franchising Certificate and Bylaws. Such description is intended as a summary
only and is qualified in its entirety by reference to the Franchising
Certificate and Bylaws, the forms of which are attached to this Prospectus as
Annexes A and B, respectively.
 
  Classified Board of Directors. The Franchising Certificate provides for the
Franchising Board of Directors to be divided into three classes serving
staggered terms so that directors' initial terms will expire either at the
1998, 1999 or 2000 annual meeting of stockholders. Starting with the 1998
annual meeting of Franchising stockholders, one class of directors will be
elected each year for three-year terms. See "--Management--Board of
Directors."
 
  The classification of directors will have the effect of making it more
difficult for stockholders to change the composition of the Franchising Board
of Directors in a relatively short period of time. At least two annual
meetings of stockholders, instead of one, will generally be required to effect
a change in a majority of the Franchising Board of Directors. Such a delay may
help ensure that the Franchising Board of Directors, if confronted by a holder
attempting to force a stock repurchase at a premium above market prices, a
proxy contest or an extraordinary corporate transaction, will have sufficient
time to review the proposal and appropriate alternatives to the proposal and
to act in what it believes are the best interests of the stockholders.
 
  The classified board provision could have the effect of discouraging a
third-party from making a tender offer or otherwise attempting to obtain
control of Franchising, even though such an attempt might be beneficial to
Franchising and its stockholders. The classified board provision could thus
increase the likelihood that incumbent directors will retain their positions.
In addition, since the classified board provision is designed to discourage
accumulations of large blocks of Franchising stock by purchasers whose
objective is to have such stock repurchased by Franchising at a premium, the
classified board provision could tend to reduce the temporary
 
                                      61
<PAGE>
 
fluctuations in the market price of Franchising's stock that could be caused
by accumulations of large blocks of such stock. Accordingly, stockholders
could be deprived of certain opportunities to sell their stock at a
temporarily higher market price.
 
  Choice and Franchising believe that a classified board of directors will
help to assure the continuity and stability of the Franchising Board of
Directors and Franchising's business strategies and policies as determined by
the Board of Directors, because generally a majority of the directors at any
given time will have had prior experience as directors of Franchising. The
classified board provision will also help assure that the Franchising Board of
Directors, if confronted with an unsolicited proposal from a third-party that
has acquired a block of the voting stock of Franchising, will have sufficient
time to review the proposal and appropriate alternatives and to seek the best
available result for all stockholders.
 
  Removal; Filling Vacancies. The Franchising Certificate provides that only a
majority of the Board of Directors then in office shall have the authority to
fill any vacancies on the Board of Directors, including vacancies created by
an increase in the number of directors. In addition, the Franchising
Certificate provides that a new director elected to fill a vacancy on the
Board of Directors will serve for the remainder of the full term of his or her
class and that no decrease in the number of directors shall shorten the term
of an incumbent. These provisions relating to removal and filling of vacancies
on the Board of Directors will preclude stockholders from enlarging the Board
of Directors or removing incumbent directors and filling the vacancies with
their own nominees.
 
  Limitations on Stockholder Action By Written Consent; Special Meetings. The
Franchising Certificate and Bylaws provide that stockholder action can be
taken only at an annual or special meeting of stockholders and prohibit
stockholder action by written consent in lieu of a meeting. The Franchising
Certificate and Bylaws provide that special meetings of stockholders can be
called only by the Chairman or Vice Chairman of Franchising's Board of
Directors or by the Secretary of Franchising within 10 calendar days after
receipt of the written request of a majority of the total number of directors
Franchising would have if there were no vacancies. Stockholders are not
permitted to call a special meeting or to require that the Board of Directors
call a special meeting of stockholders. Moreover, the business permitted to be
conducted at any special meeting of stockholders is limited to the business
brought before the meeting by or at the direction of the Board of Directors.
 
  The provisions of the Franchising Certificate and Bylaws restricting
stockholder action by written consent may have the effect of delaying
consideration of a stockholder proposal until the next annual meeting unless a
special meeting is called by a majority of the entire Board of Directors.
These provisions would also prevent the holders of a majority of the voting
power of the voting stock from using the written consent procedure to take
stockholder action and from taking action by consent without giving all the
stockholders of Franchising entitled to vote on a proposed action the
opportunity to participate in determining such proposed action. Moreover, a
stockholder could not force stockholder consideration of a proposal over the
opposition of the Franchising Board of Directors by calling a special meeting
of stockholders prior to the time the Board of Directors believed such
consideration to be appropriate.
 
  Choice and Franchising believe that such limitations on stockholder action
will help to assure the continuity and stability of the Franchising Board of
Directors and Franchising's business strategies and policies as determined by
the Board of Directors, to the benefit of all of Franchising's stockholders.
If confronted with an unsolicited proposal from stockholders of Franchising,
the Board of Directors will have sufficient time to review such proposal and
to seek the best available result for all stockholders, before such proposal
is approved by such stockholders by written consent in lieu of a meeting or
through a special meeting of stockholders.
 
  Nominations of Directors and Stockholder Proposals. The Franchising Bylaws
establish an advance notice procedure with regard to the nomination other than
by or at the direction of the Board of Directors of candidates for election as
directors and with regard to stockholder proposals to be brought before an
annual meeting of stockholders. Specifically, Franchising's Bylaws require
that stockholders desiring to bring any business, including nominations for
directors, before an annual meeting of stockholders deliver advance written
notice
 
                                      62
<PAGE>
 
thereof to the Secretary of Franchising. The Bylaws further require that the
notice by the stockholder set forth a description of the business to be
brought before the meeting and information concerning the stockholder
proposing such business and the beneficial owner, if any, on whose behalf the
proposal is made, including their names and addresses, the class and number of
shares of Franchising that are owned beneficially and of record by each of
them, and any material interest of either of them in the business proposed to
be brought before the meeting.
 
  The purpose of the advance notice provision is to provide the Franchising
Board of Directors the opportunity to inform stockholders, prior to an annual
meeting of stockholders, of any business propose to be conducted at such
meeting (including any recommendation as to the Board's position with respect
to any action to be taken). In the case of the advance notice nomination
procedures, the Franchising Board of Directors is afforded a meaningful
opportunity to consider and inform directors and stockholders of the
qualifications of the proposed nominees.
 
  Although the Franchising Bylaws do not give the Board of Directors any power
to approve or disapprove stockholder nominations for the election of directors
or any other proposal submitted by stockholders, the Franchising Bylaws may
have the effect of precluding a nomination for the election of directors or
precluding the conducting of business at a particular stockholder meeting if
the proper procedures are not followed, and may discourage or deter a third-
party from conducting a solicitation of proxies to elect its own slate of
directors or otherwise attempting to obtain control of Franchising, even if
the conduct of such solicitation or such attempt might be beneficial to
Franchising and its stockholders.
 
  Supermajority Vote for Business Combinations. The affirmative vote of
holders of shares representing not less than two-thirds of the voting power of
the Franchising is required for the approval of any proposal to merge or
consolidate with any other entity (other than an entity 90% owned by
Franchising) or sell, lease or exchange all or substantially all of
Franchising's assets. Likewise, the Franchising Certificate and Bylaws provide
that any change or repeal of this provision requires the same vote of shares
representing two-thirds of the voting power of Franchising. Although an
effective impediment to unwanted takeovers, these provisions may also make
desired alliances with other business more difficult and time consuming to
implement.
 
  Issuance of Preferred Stock. The Franchising Board of Directors is
authorized to issue up to 5,000,000 shares of preferred stock without
stockholder approval and to fix by resolution the relative powers, preferences
and rights and the qualifications, limitations or restrictions of any class or
series of preferred stock. Such action by the Franchising Board of Directors
could effectively dilute the voting power of any potential suitor of
Franchising, making a takeover substantially more difficult.
 
LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS
 
  Elimination of Liability in Certain Circumstances. Pursuant to authority
conferred by Delaware General Corporation Law Section 102, the Franchising
Certificate provides that no director of Franchising shall be liable to
Franchising or its stockholders for monetary damages for breach of fiduciary
duty as a director except for breach of the director's duty of loyalty to
Franchising or the stockholders, for acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, for
unlawful payment of dividends, unlawful stock redemptions or repurchases and
for any transaction from which the director derived an improper personal
benefit. This provision is intended to eliminate the risk that a director
might incur personal liability to Franchising or its stockholders for breach
of the duty of care. The Franchising Certificate also provides that if
Delaware law is amended to further limit the liability of directors, then the
liability of a director of Franchising shall be further limited to the fullest
extent permitted by Delaware law as so amended.
 
  Indemnification and Insurance. Delaware General Corporation Law Section 145
contains provisions permitting and, in some situations, requiring Delaware
corporations, such as Franchising, to provide indemnification to their
officers and directors for losses and litigation expense incurred in
connection with their service to the corporation in those capacities. The
Restated Certificate contains provisions requiring
 
                                      63
<PAGE>
 
indemnification by Franchising of its directors and officers to the fullest
extent permitted by law. Among other things, the Franchising Certificate
provides indemnification for officers and directors against liabilities for
judgments in and settlements of lawsuits and other proceedings and for the
advancement and payment of fees and expenses reasonably incurred by the
director or officer in defense of any such lawsuit or proceeding.
 
                                       64
<PAGE>
 
                    CERTAIN INFORMATION CONCERNING SUNBURST
 
PRO FORMA FINANCIAL DATA
 
  The following unaudited pro forma combined statement of income illustrates
the estimated effects on Sunburst of the Distribution and related
transactions. The pro forma balance sheet is based on the May 31, 1997 balance
sheet of Choice and assumes that the Distribution was consummated on that
date. The pro forma income statement is based on the income statement of
Choice for the fiscal year ended May 31, 1997, and assumes that the
Distribution was consummated on June 1, 1996. The pro forma financial data are
provided for informational purposes only and do not purport to be indicative
of the results that actually would have been obtained if the Distribution and
related transactions had been effected on the dates indicated or of those
results that may be obtained in the future.
 
                       SUNBURST HOSPITALITY CORPORATION
 
                  PRO FORMA CONDENSED COMBINED BALANCE SHEET
                              AS OF MAY 31, 1997
 
<TABLE>
<CAPTION>
                                     CHOICE HOTELS     DISTRIBUTION  PRO FORMA
                                  INTERNATIONAL, INC. ADJUSTMENTS(A) SUNBURST
                                  ------------------- -------------- ---------
<S>                               <C>                 <C>            <C>
             ASSETS
Current Assets
  Cash and cash equivalents......      $  10,825        $   (4,167)  $   6,658
  Receivables (net of allowance
   for doubtful accounts)........         31,981           (24,472)      7,509
  Deferred taxes receivable......          1,219               --        1,219
  Other current assets...........         10,579            (5,676)      4,903
                                       ---------        ----------   ---------
    Total current assets.........         54,604           (34,315)     20,289
Property and equipment, at cost,
 net of accumulated
 depreciation....................        370,244           (43,377)    326,867
Lodging franchise rights, net of
 accumulated amortization........         50,503           (50,503)        --
Goodwill, net of accumulated
 amortization....................         69,939           (69,939)        --
  Other long term assets.........         29,044           (23,339)      5,705
                                       ---------        ----------   ---------
                                       $ 574,334        $ (221,473)  $ 352,861
                                       =========        ==========   =========
     LIABILITIES AND EQUITY
Current liabilities
  Current portion of mortgages
   and long-term debt............      $  27,955        $      (36)  $  27,919
  Accounts payable...............         42,489           (20,412)     22,077
  Accrued expenses...............         26,932           (10,965)     15,967
  Income tax payable.............          3,318            (3,318)        --
                                       ---------        ----------   ---------
    Total current liabilities....        100,694           (34,731)     65,963
                                       ---------        ----------   ---------
Mortgages and other long-term
 debt............................        228,325           (46,427)    181,898
Notes payable to Manor Care......        115,723           (78,700)     37,023
Deferred income taxes and other
 liabilities.....................          5,105            (4,422)        683
Equity...........................        124,487           (57,193)     67,294
                                       ---------        ----------   ---------
                                       $ 574,334        $ (221,473)  $ 352,861
                                       =========        ==========   =========
</TABLE>
 
 
                                      65
<PAGE>
 
                       SUNBURST HOSPITALITY CORPORATION
 
               PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
                    FOR THE FISCAL YEAR ENDED MAY 31, 1997
 
<TABLE>
<CAPTION>
                            CHOICE HOTELS     DISTRIBUTION     OTHER       PRO FORMA
                         INTERNATIONAL, INC. ADJUSTMENTS(A) ADJUSTMENTS    SUNBURST
                         ------------------- -------------- -----------    ---------
<S>                      <C>                 <C>            <C>            <C>
REVENUES
  Franchise.............      $244,176         $(254,518)    $ 10,342 (B)  $    --
  Hotel operations......       185,753           (17,737)         --        168,016
                              --------         ---------     --------      --------
    Total revenues......       429,929          (272,255)      10,342       168,016
                              --------         ---------     --------      --------
OPERATING EXPENSES
  Franchise.............       183,769          (183,769)         --            --
  Hotel operations......       148,250           (18,124)      10,342 (B)   140,468
                                   --                --         3,955 (C)     3,955
                              --------         ---------     --------      --------
    Total operating
     expenses...........       332,019          (201,893)      14,297       144,423
                              --------         ---------     --------      --------
INCOME BEFORE OTHER
 EXPENSES AND INCOME
 TAXES..................        97,910           (70,362)      (3,955)(C)    23,593
OTHER EXPENSES
  Interest expense on
   Notes payable to
   Manor Care...........        18,568            (7,083)      (8,815)(D)     2,670
  Other interest and
   other expenses, net..         7,118            (3,704)       8,309 (D)    11,723
                              --------         ---------     --------      --------
    Total other
     expenses...........        25,686           (10,787)        (506)       14,393
                              --------         ---------     --------      --------
Income before income
 taxes..................        72,224           (59,575)      (3,449)        9,200
                              --------         ---------     --------      --------
Income taxes............       (30,200)           24,845        1,380 (E)    (3,975)
                              --------         ---------     --------      --------
Net income before
 extraordinary item.....      $ 42,024         $ (34,730)    $ (2,069)     $  5,225
                              ========         =========     ========      ========
Pro forma earnings per
 share..................                                                        .25(F)
                                                                           ========
</TABLE>
 
                                   SUNBURST
 
          NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS
 
A. Represents adjustment to reflect the Distribution.
 
B. Represents the adjustment to record franchise fee revenue, franchise fee
   expense, and intercompany product sales on Sunburst-owned hotels previously
   eliminated in consolidation.
 
C. Represents the net additional costs associated with staffing of accounting,
   finance, cash management, risk management, human resources and legal
   personnel and directors' costs to operate Sunburst on a stand alone basis.
 
D. Represents incremental interest expense in deferred financing amortization
   relating to Sunburst's refinancing of $110 million of notes payable to
   Manor Care with $117.5 million of commercial backed mortgage securities in
   April 1997.
 
E. Represents the income tax impact of pro forma adjustments at statutory
   rates.
 
F. Represents pro forma earnings per share based on pro forma Sunburst Net
   Income divided by the pro forma weighted average share of Choice of 62,680
   adjusted for the proposed one-for-three stock split.
 
 
                                      66
<PAGE>
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF SUNBURST PRO FORMA FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
  Sunburst is a leading national hotel company with a portfolio of 71 hotels
containing 10,330 rooms located in 25 states as of May 31, 1997. Each hotel is
branded with one of the Choice franchise brands.
 
  Sunburst's strategy is to (i) optimize the operating performance and value
of its existing portfolio of hotels through the consistent application of high
quality sales, marketing and operating programs; (ii) capitalize on the under-
served, high growth, mid-priced, extended-stay all-suite segment with the
development of 20 MainStay Suite hotels; (iii) develop other high quality,
consumer focused hotels such as Sleep Inns; and (iv) pursue the opportunistic
acquisition of existing hotels whereby substantial value can be created.
 
  The following discussion should be read in conjunction with the preceding
Pro Forma Condensed Combined Balance Sheet and the Pro Forma Condensed
Combined Statement of Income.
 
 Comparison of Fiscal Year 1997 Pro Forma Operating Results and Pro Forma
 Fiscal Year 1996 Operating Results
 
  Sunburst's hotel operations revenue consists principally of guest room
revenue, meeting room revenue and food-and-beverage revenue from owned and
operated hotels. The pro forma revenues for Sunburst are derived from Choice's
audited financial statements as follows:
 
<TABLE>
<CAPTION>
                                              FISCAL YEAR 1997 FISCAL YEAR 1996
                                              ---------------- ----------------
                                               (IN MILLIONS)    (IN MILLIONS)
   <S>                                        <C>              <C>
   Choice reported hotel operations
    revenue.................................      $185,753         $154,625
   Less: European hotel operations revenue..       (17,737)         (19,609)
                                                  --------         --------
   Total Sunburst pro-forma hotel operations
    revenue.................................      $168,016         $135,016
                                                  ========         ========
</TABLE>
 
  Sunburst's revenues were $168.0 million for fiscal year 1997, up 24.4% from
$135.0 million for fiscal year 1996. The increases in revenue were primarily
the result of additional rooms achieved through hotel acquisitions and the
construction of new hotels. Overall average daily room rates increased 6.5%
from fiscal year 1996 to fiscal year 1997, and occupancy increased 3.2% over
the corresponding period. Revenue per available room, or RevPAR, increased to
$40.96 from $37.28, an improvement of 9.9%. Increases in food-and-beverage
sales of $2.2 million in fiscal year 1997 also contributed to revenue growth.
 
  Sunburst's hotel operating expenses are derived from Choice's audited
financial statements as follows:
 
<TABLE>
<CAPTION>
                                              FISCAL YEAR 1997 FISCAL YEAR 1996
                                              ---------------- ----------------
                                               (IN MILLIONS)    (IN MILLIONS)
   <S>                                        <C>              <C>
   Choice reported hotel operations
    expense.................................      $127,599         $116,481
   Less: European hotel operations expense..       (16,166)         (17,521)
   Add: Franchise fees paid to Franchising..        10,342            7,500
     Pro-forma "spin-off" costs.............         3,955            3,955
     Allocable depreciation and
      amortization..........................        18,693           14,223
                                                  --------         --------
   Total Sunburst pro-forma hotel operations
    expense.................................      $144,423         $124,638
                                                  ========         ========
</TABLE>
 
  Hotel operations expenses increased $19.8 million or 15.9% in fiscal year
1997 resulting primarily from the addition of six hotels during the year and
to a lesser extent a $1.3 million increase in food-and-beverage costs. Pro
forma fiscal year 1996 expense excludes an $8.6 million one time charge for
restructuring costs associated with the Manor Care Spin-off. The increase in
franchise fees paid to Franchising results from the increase in hotel
operations revenue. Franchise fees paid are determined based on total revenues
multiplied by franchise fee rates. These rates vary based on the type of hotel
franchised. Depreciation expense increased 31.4% in fiscal
 
                                      67
<PAGE>
 
year 1997 as a result of the addition of new hotels and renovations of
existing hotel properties during fiscal years 1997 and 1996.
 
  Hotel operating margins (before depreciation and amortization) increased to
25.2% in fiscal year 1997 from 18.2% in fiscal year 1996 due primarily to a
9.9% increase in RevPAR.
 
 Other Expenses
 
  Interest expense for Choice increased $2.3 million or 9.6% in fiscal year
1997 as a result of increased borrowings to support the stock repurchase
program. Pro forma interest expense for Sunburst was $15.3 million in fiscal
year 1997, an increase of $2.9 million from pro forma interest expense of
$12.4 million in fiscal year 1996. The increase in interest expense relates to
additional borrowings under Choice's credit facility for stock repurchases.
Certain amounts related to the incremental borrowings incurred to finance the
stock repurchase program have been allocated to Sunburst. See "--Liquidity and
Capital Resources."
 
 Liquidity and Capital Resources
 
  Sunburst is currently considering options, including entering into a new
credit facility, to secure long-term financing to meet the debt requirements
in fiscal 1998 as well as working capital and business development needs. See
"Financing." Management expects to have adequate financing secured prior to
the distribution date to finance Choice's near-term financing requirements and
development objectives.
 
  On a pro-forma basis, Sunburst has $246.8 million of long-term debt, $27.9
million of which is payable in fiscal year 1998. Pro-forma earnings before
interest, taxes, depreciation and amortization and non-cash asset writedowns
("EBITDA") was $43.2 million in fiscal year 1997. This represents an increase
of 75.6% from the $24.6 million of pro-forma EBITDA in fiscal year 1996.
EBITDA, while not a term defined by generally accepted accounting principles,
is often used by investors and other users of financial statements, to
determine Sunburst's ability to meet debt service, fund capital expenditures
and expand its business. Cash expenditures (including nondiscretionary
expenditures) for various long-term assets, interest expense and income taxes
have been and will be incurred which are not reflected in EBITDA and therefore
EBITDA does not represent funds available for Sunburst's discretionary use.
 
  On April 23, 1997, Choice, through its indirect subsidiary, First Choice
Properties, completed an offering of $117.5 million multi-class mortgage pass-
through certificates, which are non-recourse and collateralized by 36 hotel
properties with a net book value of $146.7 million owned by Choice. The
certificates bear a 7.8% interest rate, and have a final maturity of May 5,
2012. Choice used the proceeds to repay $110.0 million of the $225.7 million
9% long-term note payable to Manor Care. The mortgage pass-through
certificates have been allocated to Sunburst and are reflected on the
accompanying pro-forma balance sheet of Sunburst.
 
  On October 30, 1996, Choice entered into a $100.0 million competitive
advance and multi-currency revolving credit facility provided by a group of
seven banks. This facility provides that up to $75.0 million is available for
borrowings in foreign currencies. On May 5, 1997, Choice increased the size of
this facility from $100.0 million to $125.0 million. Borrowings under the
additional $25.0 million are due on December 31, 1997, and accordingly $25
million is classified as current on Choice's consolidated balance sheet.
Choice has $121.6 million drawn at May 31, 1997 under the facility. Sunburst
has been allocated $90.5 million of this bank debt.
 
  Total pro-forma capital expenditures for Sunburst were $79.7 million in
fiscal year 1997 versus $96.6 million in fiscal year 1996. The number of hotel
properties brought on-line in fiscal year 1997 was six versus 17 in fiscal
year 1996. Choice plans capital expenditures for development of Sleep Inn and
MainStay Suites hotels of $69.0 million and $32.0 million in fiscal years 1998
and 1999, respectively. These amounts include expected capital expenditures
relating to the construction of seven Sleep Inn hotels and 19 MainStay Suites
hotels over the next two fiscal years. Planned capital expenditures for
routine maintenance and renovation of existing properties are $13.5 million
and $14.4 million for fiscal years 1998 and 1999, respectively. Sunburst's
management will also pursue additional acquisitions of significantly under-
valued hotel properties.
 
                                      68
<PAGE>
 
BUSINESS AND PROPERTIES
 
  Sunburst will operate the Hotel Business as previously operated by Choice.
 
  Sunburst will be a leading national hotel company with a portfolio of 71
hotels containing 10,330 rooms located in 25 States as of May 31, 1997. Each
hotel is branded with one of the Choice franchise brands and Sunburst will be
Franchising's largest franchisee. Sunburst's hotels operate in one of three
principal segments of the lodging industry: all-suite, full service and
limited service. The majority of Sunburst's hotels have been acquired by
Choice since 1992 at prices below their replacement cost. All of these hotels
have benefited from the investment of capital to improve the renovated hotels.
Since June 1992, Choice has spent $260.4 million to buy and renovate 54 hotel
properties. More recently, Choice shifted its development efforts to the
construction of Sleep Inn hotels and MainStay Suite hotels.
 
  Sunburst's strategy is to: (i) optimize the operating performance and value
of its existing portfolio of hotels through the consistent application of high
quality sales, marketing and operating programs; (ii) capitalize on the under-
served, high growth, mid-priced, extended-stay all-suite segment with the
development of 20 MainStay Suite hotels; (iii) develop other high quality,
consumer focused hotels such as Sleep Inns; and (iv) pursue the opportunistic
acquisition of existing hotels whereby substantial value can be created.
 
  Choice's performance is a beneficiary of the operating leverage inherent in
the lodging industry and is further supported by the substantial discount to
replacement cost of its existing portfolio. The 54 hotels acquired since 1992
have an investment basis of approximately 55.3% of current estimated
replacement cost. In addition to the initial renovation of acquired hotels,
Sunburst has spent approximately 5% of revenue for ongoing improvements to the
hotels, thereby maintaining the physical assets to optimize competitive
advantages in each local market.
 
  Sunburst's strategy to build 20 MainStay Suites hotels is intended to
provide it with hotels positioned to benefit from the demand/supply imbalance
in the mid-priced, extended stay all-suite segment which should produce higher
than average return on investment.
 
  Sunburst's historical existing hotel acquisition program and the current
MainStay Suite hotel development program are illustrative of management's
capabilities to timely ascertain market trends, conceive of strategies and to
implement those strategies.
 
 Historical Acquisition Strategy
 
  The primary focus of Sunburst from 1992 through 1995 was the acquisition of
existing hotels at prices below their replacement cost with the intent to
increase their value through (i) the investment of capital to improve the
hotels and (ii) the installation of professional management and marketing
teams to operate the renovated hotels. Since June 1992, Sunburst has spent
$260.4 million to buy and renovate 54 hotels containing 7,809 rooms. In fiscal
year 1997, Sunburst acquired two hotels and is in the process of renovating
them, one of which (located in Charlotte, NC) Sunburst is in the process of
converting to a Clarion Hotel from a senior assisted living facility.
 
  In addition to the acquired hotels, Sunburst owns and operates 8 hotels
developed or acquired prior to 1992, 7 Sleep Inn hotels and 1 MainStay Suites
hotel developed by Sunburst since 1994.
 
<TABLE>
<CAPTION>
                                        SUNBURST EXISTING HOTEL ACQUISITIONS
                                       ---------------------------------------
                                                     FISCAL YEAR
                                       ---------------------------------------
                                        1993    1994    1995    1996    1996
                                       ------- ------- ------- ------- -------
<S>                                    <C>     <C>     <C>     <C>     <C>
Total acquisitions....................       7      13      16      16       2
Total number of rooms acquired........   1,276   1,933   2,336   1,940     324
Total cost of acquisitions (in
 millions) (including initial
 improvements)........................ $  30.9 $  55.8 $  83.3 $  71.8 $  17.9
Average cost per room................. $24,216 $28,867 $35,659 $37,010 $55,246
</TABLE>
 
                                      69
<PAGE>
 
  Net operating income for the seven hotels purchased in fiscal year 1993
increased from $8.0 million in fiscal 1996 to $9.4 million in fiscal 1997, a
17% improvement. For the 13 hotels purchased in fiscal year 1994, net
operating income increased 14.4% to $11.5 million in fiscal year 1997 from
$10.0 million in fiscal year 1996. Net operating income for the 16 hotels
acquired in fiscal year 1995 was $12.8 million in fiscal year 1996, a 91%
increase over the $6.7 million achieved in fiscal year 1996. The following
chart summarizes occupancy improvements for original portfolio hotels, and
fiscal 1993, 1994, 1995, 1996 and 1997 acquisitions. Occupancy rates for the
year acquired reflect only the period during which the properties were owned
by Choice. Because many of the recently acquired and developed hotels have not
yet reached stabilized levels of operating performance, Choice believes that
revenues and gross profit at these hotels will continue to grow.
 
<TABLE>
<CAPTION>
                                                SUNBURST HOTELS OCCUPANCY
                                              ---------------------------------
                                                       FISCAL YEAR
                                              ---------------------------------
                                              1993   1994   1995   1996   1997
                                              -----  -----  -----  -----  -----
<S>                                           <C>    <C>    <C>    <C>    <C>
Original Domestic Portfolio.................. 62.27% 64.16% 67.19% 68.02% 71.63%
Fiscal 1993 Acquisitions..................... 56.17  63.20  73.68  76.17  75.02
Fiscal 1994 Acquisitions.....................   --   66.09  70.71  73.76  73.68
Fiscal 1995 Acquisitions.....................   --     --   48.96  58.49  66.27
Fiscal 1996 Acquisitions.....................   --     --     --   53.23  61.16
Fiscal 1997 Acquisitions.....................   --     --     --     --   54.65
</TABLE>
 
 The Hotel Properties
 
  Sunburst's hotel properties serve three primary segments of the lodging
industry; all-suites, full service and limited service. Each hotel, except for
one hotel in Miami Beach which is under physical renovation, is branded with
one of the Choice franchise flags.
 
  All-Suites Hotels. Sunburst has 6 hotels in the all-suite segment open and
13 hotels under construction or in the development process. Sunburst's all-
suite hotel properties compete in the moderate and upscale price segments. The
table below identifies Sunburst's all-suite hotels by brand and price segment.
 
                               ALL-SUITE HOTELS
 
<TABLE>
<CAPTION>
                                                     NUMBER    NUMBER    PRICE
BRAND                                               OF HOTELS OF ROOMS  SEGMENT
-----                                               --------- -------- ---------
<S>                                                 <C>       <C>      <C>
Quality Suites.....................................      3      345      upscale
Comfort Suites.....................................      2      232    mid-price
MainStay Suites....................................      1       96    mid-price
</TABLE>
 
  As of May 31, 1997, Sunburst had an additional 10 MainStay Suites hotels
under construction with 970 rooms.
 
  Full-Service Hotels. Sunburst has 16 hotels in the full service segment.
Sunburst's full service hotels compete in the mid-price and upscale price
segments. The table below identifies Sunburst's full service hotels by brand
and price segment.
 
                              FULL SERVICE HOTELS
 
<TABLE>
<CAPTION>
                                               NUMBER    NUMBER       PRICE
                    BRAND                     OF HOTELS OF ROOMS     SEGMENT
                    -----                     --------- -------- ---------------
<S>                                           <C>       <C>      <C>
Clarion Hotels & Inns........................     11     2,114   upper mid-price
Quality Hotel & Inns.........................      5     1,327         mid-price
</TABLE>
 
                                      70
<PAGE>
 
  Limited Service Hotels. Sunburst has 49 hotels in the limited service
segment open and six hotels under construction or in the development process.
Sunburst's limited service hotel properties compete in the mid-price and
economy price segments. The table below identifies Sunburst's limited service
hotels by brand and price segment.
 
                            LIMITED SERVICE HOTELS
 
<TABLE>
<CAPTION>
                                                     NUMBER    NUMBER    PRICE
                       BRAND                        OF HOTELS OF ROOMS  SEGMENT
                       -----                        --------- -------- ---------
<S>                                                 <C>       <C>      <C>
Comfort Inn........................................     31     4,074   mid-price
Quality Inns.......................................      8     1,014   mid-price
Sleep Inns.........................................      7       757   mid-price
Econo Lodge........................................      1       120     economy
Rodeway Inns.......................................      1       101     economy
Independent........................................      1       150     economy
</TABLE>
 
  As of May 31, 1997, Sunburst had an additional 4 Sleep Inns under
construction with 453 rooms.
 
 External Development
 
  Sunburst's focus on external development is geared to (i) capitalize on the
under-served, high-growth, mid-priced extended stay all-suite segment, and
(ii) the development of other high-quality, consumer-focused hotels.
 
  To effect these strategies, Sunburst maintains a Real Estate Development and
Construction Department staff. This staff effects the identification of target
markets, specific site identification, negotiation, due diligence, planning,
zoning and other approval requirements, design and construction of new hotels.
The Real Estate Development staff have served in the past as the focal point
to effect Sunburst's historical acquisition strategy. This dual capacity to
acquire existing hotels or build new hotels allows Sunburst to be responsive
to changing market conditions.
 
  The following is a list of the new hotels developed by Sunburst since 1994
or currently under development:
 
<TABLE>
<CAPTION>
                                                                    CALENDAR
                        MARKET                           HOTEL   YEAR OF OPENING
                        ------                          -------- ---------------
<S>                                                     <C>      <C>
Dallas/Plano, TX....................................... Sleep         1994
San Antonio, TX........................................ Sleep         1995
Baton Rouge, LA........................................ Sleep         1996
Houston/Airport, TX.................................... Sleep         1996
Austin/Round Rock, TX.................................. Sleep         1996
Dallas/Plano, TX....................................... MainStay      1996
Raleigh, NC............................................ Sleep         1997
Dallas/Arlington, TX................................... Sleep         1997
Kansas City/Airport, MO(1)............................. Sleep         1997
Charlotte, NC(1)....................................... Sleep         1997
Rockville, MD(1)....................................... Sleep         1997
Providence/Airport, RI(1).............................. MainStay      1997
Cincinnati/Blue Ash, OH(1)............................. MainStay      1997
Kansas City/Airport, MO(1)............................. MainStay      1997
Indianapolis, IN(1).................................... MainStay      1997
Louisville, KY(1)...................................... MainStay      1997
Denver/Tech Center, CO(1).............................. MainStay      1998
Orlando/Lake Mary, FL(1)............................... MainStay      1998
Jacksonville, FL(1).................................... MainStay      1998
</TABLE>
 
                                      71
<PAGE>
 
<TABLE>
<CAPTION>
                                                                    CALENDAR
                        MARKET                           HOTEL   YEAR OF OPENING
                        ------                          -------- ---------------
<S>                                                     <C>      <C>
Greenville, SC(1)...................................... MainStay      1998
Nashville/Brentwood, TN(1)............................. MainStay      1998
Miami/Airport, FL(2)................................... MainStay      1998
Denver/Airport, CO(1).................................. Sleep         1998
Miami/Airport, FL(2)................................... Sleep         1998
Ft. Lauderdale/Cypress Creek, FL(2).................... MainStay      1998
Pittsburgh/Airport, PA(2).............................. MainStay      1998
Fishkill/Poughkeepsie, NY(2)........................... MainStay      1998
</TABLE>
--------
(1) Hotel under construction
(2) Sunburst has acquired the land and is in final planning stages prior to
    start of construction.
 
  Sunburst's focus on the development of MainStay Suites is based on the
sector-wide demand/supply imbalance as evidenced by numerous industry studies.
According to various industry studies, demand for extended stay lodging far
exceeds supply. Demand in the mid-price market is very high, yet supply
additions have been minimal. The extended stay, all-suite segment, defined as
stays of five or more nights, consists of 228 million room nights annually, or
27% of total U.S. industry demand, according to industry sources. Only 1.5% of
total room supply is dedicated extended stay rooms. Sunburst believes that it
can utilize its real estate development expertise to locate attractive markets
for and build MainStay extended stay hotels. Sunburst also believes that it
can successfully operate these hotels based on its experience operating other
limited services hotels.
 
  MainStay Suites has been created by Choice with a unique product design and
service package which enhances property level appeal, productivity and
profitability. Two of these unique features of the MainStay product are the
use of an automatic check-in kiosk (which allows guests to check in without
assistance) and optional daily light touch housekeeping with full housekeeping
every five days. These features allow a MainStay Suites hotel to operate with
fewer full time equivalent employees than a similar size limited service hotel
that has 24-hour front desk coverage and provides full housekeeping daily.
Sunburst believes that MainStay Suites projects will produce a stabilized
unleveraged pre-tax property level return on investment of 15% or higher. This
return is supported by the experiences at the first MainStay Suites opened by
Sunburst in Plano, Texas and by projections for the MainStay Suites under
development which are based on rate and occupancy generated internally by
Sunburst and by external feasibility consultants, internal operating
guidelines, land cost and projected construction cost. However, there can be
no assurance that the projected return will be achieved or that actual results
will not differ materially. See "Risk Factors--Forward Looking Information is
Subject to Risk and Uncertainty."
 
  Sunburst's initial development of 20 MainStay Suites combined with
Franchising's efforts to franchise MainStay Suites is intended to result in a
brand with national recognition.
 
  Sunburst's MainStay Suites hotel properties will average approximately 100
suites and be developed on 2.5 to 3.0 acres of land in suburban office parks
or locations proximate to major employers, restaurants and retail amenities.
MainStay Suites feature high quality, interior corridor building construction
with amenities and features demanded by consumers. All suites feature a
bedroom area, living room area with a pull-out couch or recliner, private
bathroom and fully furnished kitchen. The kitchen area includes a full-size
refrigerator, dishwasher, microwave, stove, coffee maker, toaster and all
cooking and serving utensils. Each suite features an over-sized counter
serving as an eating or working center, along with two ergonomic chairs. Suite
alternatives include a studio suite or one-bedroom suite. Each suite includes
two direct dial phone lines, voice mail and other automated phone services.
 
  Sunburst and Franchising have developed a state-of-the-art automated check-
in/out property management system which enables guests with reservations to
obtain their key from the kiosk unassisted. This feature allows transaction
time to be shortened and provides operating efficiencies while enhancing guest
satisfaction.
 
                                      72
<PAGE>
 
  Based on experience from the first MainStay Suites opened by Sunburst in
Plano, Texas, guest satisfaction is very high. Financial results to-date have
met or exceeded Sunburst's expectations.
 
 Operations
 
  Each of Sunburst's owned and managed hotels operates under one of the Choice
brand names. The following table illustrates the growth of Sunburst over the
four fiscal years ended May 31, 1997.
 
<TABLE>
<CAPTION>
                                                   FISCAL YEAR
                                        --------------------------------------
                                         1993    1994    1995    1996    1997
                                        ------  ------  ------  ------  ------
<S>                                     <C>     <C>     <C>     <C>     <C>
Number of properties, end of period....     19      32      48      65      71
Number of rooms, end of period.........  3,686   5,605   7,941   9,713  10,330
Average occupancy percentage...........  61.36%  64.18%  67.10%  66.61%  68.70%
Average daily room rate (ADR).......... $49.53  $49.15  $51.28  $55.97  $59.62
RevPAR................................. $30.39  $31.54  $34.40  $37.28  $40.96
</TABLE>
 
  Operating Systems and Procedures. Sunburst's hotels take advantage of the
same systems and services available to franchisees with respect to a
particular brand. The hotels participate in the central reservation system,
marketing and advertising efforts and volume purchasing discounts and are
subject to the same quality assurance program. In addition, Sunburst has
instituted the following systems in each of the hotels it operates.
 
  .  Yield Management. An automated yield management program has been
     installed at hotels which allows the local management to take advantage
     of the supply and demand conditions in their marketplace. The system is
     automated to the point that it performs calculations and suggests
     pricing strategies to the local hotel management. The program continues
     to update information based on the availability of room supply and
     reservation volume within each hotel.
 
  .  Training. Sunburst has developed a training system for all guest
     services representatives that teaches the basic sales techniques. A
     computerized guest comment system was developed to solicit the comments
     of guests and the experiences they had at the hotel while providing
     management with immediate guest feedback.
 
  .  Accounting Systems. Each of the Sunburst-operated hotels has a
     computerized front desk and accounting system. This system allows key
     financial indicators (such as daily occupancy and revenue) to be
     immediately gathered from each hotel and electronically transmitted to
     the key operating officers and managers of Sunburst. This instant access
     to information allows management to quickly spot trends and make
     corrections and changes where necessary. The system is completely
     computerized and allows for cost savings in the accounting and
     bookkeeping departments of each hotel. In addition, control over
     operational and capital expenditures is provided by a dedicated group of
     financial controllers in the corporate office. This group works with the
     hotel operations group to maintain expense standards as well as
     established operating procedures.
 
  .  Time and Attendance System. Each hotel maintains an automated time and
     attendance system that is tied into a central payroll system at the
     corporate headquarters. This computerized method of tracking time allows
     management to make quick decisions on controlling labor costs and
     provides immediate information on projected costs.
 
  .  Food and Beverage. The food and beverage efforts are headed by a vice
     president of food and beverage. The department is responsible for the
     daily food and beverage activities of the various hotels, as well as the
     development of new food concepts. This group was responsible for the
     development, testing and implementation of the Choice Picks food court
     concept. Recently, Sunburst opened a new food and beverage concept
     called "Classic Sports Food, Drink and Memories" in its Richardson,
     Texas hotel. A sports theme restaurant, this concept has been developed
     jointly with the Classic Sports Network, a national cable television
     service. This agreement allows for the use of certain trademarks at
     Sunburst's locations. Additional "Classic Sports Food, Drink and
     Memories" are planned for three other Sunburst hotels.
 
                                      73
<PAGE>
 
  .  Annual Business Planning Process. Each hotel prepares a zero-based
     annual business plan which incorporates historical performance and
     market conditions. The plan, which is reviewed and approved by senior
     management, provides detailed strategies in the key operating areas of
     marketing, guest services and food and beverage. The plan also includes
     a comprehensive capital expenditures process which serves to maintain
     the physical plant in optimal condition based on market conditions and
     operating strategies. The annual plan serves as a fundamental
     measurement of management's performance.
 
 Properties
 
  The following chart lists by market segment Sunburst's hotels at May 31,
1997:
 
<TABLE>
<CAPTION>
                                                                       YEAR
                                                                   CONSTRUCTED/
                                                            NO. OF  LAST MAJOR
    HOTEL                               MARKET              ROOMS   RENOVATION
    -----                               ------              ------ ------------
<S>                        <C>                              <C>    <C>
ALL SUITE
  Upscale
  Quality Suites
   Deerfield.............. Fort Lauderdale, Florida          107    1991/1995
  Quality Suites.......... Raleigh, North Carolina           114    1988/1994
  Quality Suites Shady
   Grove.................. Rockville, Maryland               124    1978/1996
  Mid-Price
  Comfort Suites
   Haverhill.............. Boston, Massachusetts             131    1989/1997
  Comfort Suites
   Deerfield.............. Fort Lauderdale, Florida          101    1991/1995
  MainStay Suites
   Plano(6)............... Dallas, Texas                      96         1996
  MainStay Suites
   Warwick(1)............. Providence, Rhode Island           94         1997
  MainStay Suites Blue
   Ash(1)................. Cincinnati, Ohio                  100         1997
  MainStay Suites
   Airport(1)............. Kansas City, Missouri              88         1998
  MainStay Suites
   Northwest(1)........... Indianapolis, Indiana              88         1997
  MainStay Suites(1)...... Louisville, Kentucky              100         1998
  MainStay Suites Tech
   Center(1).............. Denver, Colorado                  100         1998
  MainStay Suites Lake
   Mary(1)................ Orlando, Florida                  100         1998
  MainStay Suites South
   Pointe(1).............. Jacksonville, Florida             100         1998
  MainStay Suites(1)...... Greenville, South Carolina        100         1998
  MainStay Suites
   Brentwood(1)........... Nashville, Tennessee              100         1998
FULL SERVICE
  Upscale
  Clarion Hotel
   Baltimore.............. Baltimore, Maryland               103    1927/1996
  Clarion Hotel
   Worthington............ Columbus, Ohio                    232    1975/1996
  Clarion Hotel
   Richardson............. Dallas, Texas                     296    1982/1995
  Clarion on the Lake..... Hot Springs, Arkansas             151    1965/1997
  Clarion Hotel Miami
   Airport................ Miami, Florida                    103    1970/1996
  Clarion Hotel Hollywood
   Beach.................. Miami-Ft. Lauderdale, Florida     309    1972/1996
  Clarion Hotel........... Mobile, Alabama                   250    1979/1994
  Clarion Hotel Virginia
   Beach.................. Norfolk-Virginia Beach, Virginia  149    1985/1995
  Clarion Hotel Roanoke... Roanoke, Virginia                 148    1981/1997
  Clarion Hotel
   Springfield............ Springfield, Missouri             199    1974/1997
  Clarion Hotel(2)........ Charlotte, North Carolina         174    1974/1997
  Mid-Price
  Quality Inn South
   Point.................. Jacksonville, Florida             184    1988/1994
  Quality Hotel Airport... Los Angeles, California           278    1971/1994
  Quality Hotel Maingate
   Anaheim(4)............. Los Angeles, California           284    1970/1995
  Quality Inn & Suites
   Hampton................ Norfolk-Virginia Beach, Virginia  190    1972/1995
  Quality Hotel
   Arlington.............. Washington, DC                    391    1962/1997
</TABLE>
 
                                      74
<PAGE>
 
<TABLE>
<CAPTION>
                                                                       YEAR
                                                                   CONSTRUCTED/
                                                            NO. OF  LAST MAJOR
    HOTEL                                 MARKET            ROOMS   RENOVATION
    -----                                 ------            ------ ------------
<S>                             <C>                         <C>    <C>
LIMITED SERVICE
  Mid-Price
  Comfort Inn Albuquerque...... Albuquerque, New Mexico      114    1985/1996
  Quality Inn Anderson......... Anderson, South Carolina     121    1988/1995
  Comfort Inn Norcross......... Atlanta, Georgia             110    1987/1996
  Comfort Inn N.W.
   Pikesville(5)............... Baltimore, Maryland          186    1964/1994
  Comfort Inn University....... Baton Rouge, Louisiana       150    1972/1994
  Comfort Inn Danvers(6)....... Boston, Massachusetts        136    1972/1997
  Comfort Inn Brooklyn......... Brooklyn, New York            67    1926/1997
  Comfort Inn Canton........... Canton, Ohio                 124    1989/1994
  Comfort Inn Airport.......... Charleston, South Carolina   122    1986/1994
  Comfort Inn Charlotte(6)..... Charlotte, North Carolina    150    1985/1996
  Quality Inn & Suites--Crown
   Point....................... Charlotte, North Carolina    100    1988/1996
  Comfort Inn.................. Cincinnati, Ohio             117    1984/1996
  Comfort Inn Middleburg
   Heights..................... Cleveland, Ohio              136         1989
  Comfort Inn College Station.. College Station, Texas       114    1984/1995
  Comfort Inn Columbia......... Columbia, South Carolina      98    1987/1996
  Comfort Inn DFW Airport...... Dallas-Fort Worth, Texas     152    1986/1995
  Quality Inn Plymouth......... Detroit, Michigan            123    1989/1996
  Comfort Inn Deerfield Beach.. Fort Lauderdale, Florida      69    1975/1997
  Comfort Inn Hershey.......... Hershey, Pennsylvania        125    1990/1997
  Comfort Inn Hilton Head...... Hilton Head, South Carolina  150    1988/1996
  Quality Inn & Suites
   Indianapolis................ Indianapolis, Indiana        116    1982/1996
  Quality Inn Lincoln.......... Lincoln, Nebraska            108    1969/1996
  Quality Inn & Suites
   Lumberton................... Lumberton, North Carolina    120    1974/1996
  Comfort Inn Collierville..... Memphis, Tennessee            94    1984/1996
  Comfort Inn & Suites, Miami
   Springs..................... Miami, Florida               165    1970/1996
  Comfort Inn Miami Springs.... Miami, Florida               110    1986/1996
  Miami Beach Hotel(3)(6)...... Miami, Florida               150    1952/1997
  Comfort Inn--Lee Road........ Orlando, Florida             145    1985/1994
  Comfort Inn--Turf Paradise... Phoenix, Arizona             155    1981/1995
  Comfort Inn--North........... Phoenix, Arizona             153    1986/1997
  Comfort Inn Portland......... Portland, Maine              126    1984/1996
  Quality Inn Richmond......... Richmond, Virginia           194    1985/1997
  Quality Inn Midvalley........ Salt Lake City, Utah         132    1972/1995
  Comfort Inn by the Bay....... San Francisco, California    135    1971/1996
  Comfort Inn Westport......... St. Louis, Missouri          170    1971/1995
  Comfort Inn Sturgis.......... Sturgis, Michigan             83    1965/1997
  Comfort Inn Traverse City.... Traverse City, Michigan       96    1989/1996
  Comfort Inn Tyson's.......... Washington, D.C              250    1982/1995
  Comfort Inn West Palm Beach.. West Palm Beach, Florida     158    1974/1995
  Comfort Inn Wichita.......... Wichita, Kansas              114    1985/1997
  Sleep Inn Round Rock(6)...... Austin, Texas                107         1996
  Sleep Inn Six Flags(6)....... Dallas-Fort Worth, Texas     124         1997
  Sleep Inn Baton Rouge........ Baton Rouge, Louisiana       101         1996
  Sleep Inn Plano.............. Dallas, Texas                104         1994
  Sleep Inn Intercontinental... Houston, Texas               107         1996
  Econo Lodge Tolleson......... Phoenix, Arizona             120    1988/1997
  Rodeway Inn Tempe............ Phoenix, Arizona             101         1989
</TABLE>
 
                                       75
<PAGE>
 
<TABLE>
<CAPTION>
                                                                        YEAR
                                                                    CONSTRUCTED/
                                                             NO. OF  LAST MAJOR
    HOTEL                                   MARKET           ROOMS   RENOVATION
    -----                                   ------           ------ ------------
<S>                                <C>                       <C>    <C>
  Sleep Inn Raleigh(6)............ Raleigh, North Carolina    107       1996
  Sleep Inn San Antonio........... San Antonio, Texas         107       1995
  Sleep Inn University(1)......... Charlotte, North Carolina  120       1997
  Sleep Inn Airport(1)............ Denver, Colorado           119       1997
  Sleep Inn Airport(1)............ Kansas City, Missouri      107       1998
  Sleep Inn Rockville(1).......... Washington, D.C.           107       1997
</TABLE>
--------
(1) Hotel under construction
(2) Hotel closed for renovation
(3) Hotel under renovation
(4) Leased property
(5) Hotel on leased land
(6) Partial year results only
 
  The following chart shows operating statistics for all of Sunburst's owned
and managed hotels presented by market segment for the five fiscal years ended
May 30, 1997.
 
<TABLE>
<CAPTION>
                                  FY 1993                 FY 1994                 FY 1995
                          ----------------------- ----------------------- -----------------------
                           ADR   OCCUPANCY REVPAR  ADR   OCCUPANCY REVPAR  ADR   OCCUPANCY REVPAR
                          ------ --------- ------ ------ --------- ------ ------ --------- ------
<S>                       <C>    <C>       <C>    <C>    <C>       <C>    <C>    <C>       <C>
All Suite Hotels........  $   --      --%  $   -- $60.62   71.58%  $43.39 $58.74   61.34%  $36.03
Full Service Hotels.....   54.06   61.42    33.20  54.37   60.74    33.02  54.04   65.43    35.36
Limited Service Hotels..   44.59   61.30    27.34  45.09   66.71    30.08  48.39   69.15    33.46
All Hotels..............   49.53   61.36    30.39  49.15   64.16    31.54  51.28   67.10    34.40
</TABLE>
 
<TABLE>
<CAPTION>
                                        FY 1996                 FY 1997
                                ----------------------- -----------------------
                                 ADR   OCCUPANCY REVPAR  ADR   OCCUPANCY REVPAR
                                ------ --------- ------ ------ --------- ------
<S>                             <C>    <C>       <C>    <C>    <C>       <C>
All Suite Hotels............... $64.70   69.00%  $44.65 $69.48   72.73%  $50.53
Full Service Hotels............  58.85   65.41    38.49  63.25   67.05    42.41
Limited Service Hotels.........  53.36   67.11    35.81  56.38   69.25    39.04
All Hotels.....................  55.97   66.61    37.28  59.60   68.70    40.94
</TABLE>
 
EMPLOYEES
 
  Assuming the Distribution had occurred on June 30, 1997, Sunburst employed
approximately 3,380 people full-time. Less than 5% of Sunburst's employees are
represented by unions. All of Sunburst's employees covered by collective
bargaining agreements are employed at Comfort Inn by the Bay, San Francisco,
California which has four collective bargaining agreements covering laundry
workers, front desk workers, housekeeping and food service and maintenance
workers. Such agreements expire between August 1997 and December 1997.
Sunburst considers its relations with its employee to be satisfactory.
 
MANAGEMENT
 
 Board of Directors
 
  Immediately prior to the Distribution, five of the nine current members of
Choice's Board of Directors will resign and Donald J. Landry, the Chief
Executive Officer of Sunburst, and Carole Y. Prest are expected to be
appointed to fill two vacancies on the Sunburst Board of Directors.
 
                                      76
<PAGE>
 
  At the time of the Distribution, the Sunburst Board of Directors will
consist of up to seven directors. The name, age and proposed class of six of
the persons who are expected to be directors of Sunburst as of the
Distribution Date are set forth below. Choice's Board of Directors will select
a candidate to fill the remaining vacancy on the Sunburst Board of Directors.
The remaining vacancy will be filled by a person who is not a Sunburst
employee or a director or employee of Franchising.
 
<TABLE>
<CAPTION>
      NAME                                                         AGE POSITION
      ----                                                         --- ---------
      <S>                                                          <C> <C>
      Stewart Bainum, Jr..........................................  50 Class II
      Stewart Bainum..............................................  78 Class I
      Donald J. Landry............................................  48 Class III
      Frederic V. Malek...........................................  60 Class III
      Paul A. Gould...............................................  50 Class II
      Carole Y. Prest.............................................  46 Class I
</TABLE>
 
  Donald J. Landry. President of Choice since January 1995; President of Manor
Care Hotel Division ("MCHD") since March 1992; various executive positions
with Richfield Hotel Management, Inc. and its predecessors for more than 20
years, including President of MHM Corporation; Director, Friendly Hotels PLC,
since 1996.
 
  Paul A. Gould. Managing Director of Allen & Company Incorporated (investment
banking firm) for more than five years and other positions at Allen & Company
Incorporated since 1973. Director: Telecommunication International, Inc.,
United Video Satellite Group, Inc. and National Patent Development
Corporation; Board of Trustees: The New School, The Hackley School and The
Holderness School.
 
  Carole Y. Prest. Vice President, Corporate Strategic Planning of Manor Care
since September 1995; Vice President and General Manager and various other
positions at Gen Rad, Inc. from May 1985 to 1994.
 
  For biographical information with respect to the other persons listed above,
see "Certain Information Concerning Franchising--Management--Background of
Directors."
 
 The Board of Directors and Committees of the Board
 
  It is expected that the Sunburst Board of Directors will hold five meetings
during the fiscal year and will retain the standing committees of the
Company's Board of Directors which will include the Audit Committee, the
Finance Committee, the Compensation/Key Executive Stock Option Plan Committee
and the Nominating Committee.
 
  The Compensation/Key Executive Stock Option Plan Committee administers
Sunburst's stock option plans and grants stock options thereunder, reviews
compensation of officers and key management employees, recommends development
programs for employees such as training, bonus and incentive plans, pensions
and retirement, and reviews other employee fringe benefit programs.
 
  The Finance Committee reviews the financial affairs of Sunburst and
recommends financial objectives, goals and programs to the Board of Directors
and to management.
 
  The Audit Committee reviews the scope and results of the annual audit, will
review and approve the services and related fees of Sunburst's independent
public accountants, review Sunburst's internal accounting controls and review
Sunburst's Internal Audit Department and its activities.
 
  The Nominating Committee recommends to the Board of Directors the members to
serve on the Board of Directors during the ensuing year. The Committee does
not consider nominees recommended by stockholders.
 
                                      77
<PAGE>
 
 Compensation of Directors
 
  Choice has previously adopted the Choice Hotels International, Inc. Non-
Employee Director Stock Option and Deferred Compensation Stock Purchase Plan.
Part A of the Plan provides that eligible non-employee directors will be
granted options to purchase 5,000 shares of Sunburst Common Stock on their
first date of election and will be granted options to purchase 1,000 shares on
their date of election in subsequent calendar years. Part B of the Plan
provides that eligible non-employee directors may elect, prior to May 31 of
each year, to defer a minimum of 25% of committee fees earned during the
ensuing fiscal year. The fees which are so deferred will be used to purchase
Sunburst Common Stock on the open market within 15 days after December 1,
February 28 and May 31 of such fiscal year. Pending such purchases, the funds
will be credited to an Interest Deferred Account, which will be interest
bearing. Stock which is so purchased will be deposited in a Stock Deferred
Account pending distribution in accordance with the Plan.
 
  Directors who will be employees of Sunburst will receive no separate
remuneration for their services as directors. Pursuant to the Non-Employee
Director Stock Compensation Plan to be adopted by Sunburst prior to the
Distribution, eligible non-employee directors will receive annually, in lieu
of cash, restricted stock of Sunburst, the fair market value of which at the
time of grant will be equal to $30,000, which will represent the Board of
Directors retainer and meeting fees. In addition, all non-employee directors
will receive $1,610 per diem for Committee meetings attended, except where the
Committee meeting is on the same day as a Board of Directors meeting, and will
be reimbursed for travel expenses and other out-of-pocket costs incurred in
attending meetings.
 
 Executive Officers
 
  The name, age, proposed title upon consummation of the Distribution and
business background of each of the persons who are expected on the
Distribution Date to be the executive officers of Sunburst are set forth
below. Choice is currently seeking candidates for the positions of Senior Vice
President, Chief Financial Officer and Treasurer and Vice President- Finance
and Controller. The business address of each prospective executive officer is
10750 Columbia Pike, Silver Spring, Maryland 20901, unless otherwise
indicated.
 
<TABLE>
<CAPTION>
  NAME                 AGE                       POSITION
  ----                 ---                       --------
<S>                    <C> <C>
Stewart Bainum, Jr....  51 Chairman of the Board of Directors
Donald J. Landry......  48 Vice Chairman and Chief Executive Officer
Antonio DiRico........  44 President and Chief Operating Officer
Kevin P. Hanley.......  39 Senior Vice President, Real Estate and Development
Edward A. Kubis.......  38 Senior Vice President, General Counsel and Secretary
</TABLE>
 
  Joseph M. Squeri. Vice President, Finance and Controller of the Company
since March 1997; Director of Investment Funds, The Carlyle Group, from
November 1994 to February 1997; various positions with Arthur Andersen LLP
from July 1987 to November 1994, most recently as Manager.
 
  Antonio DiRico. Senior Vice President, Hotel Operations of the Company since
November 1996; Senior Vice President, Hotel Operations of MCHD from May 1992
to November 1996; Senior Vice President of Richfield Hotel Management, Inc.,
and its predecessor, MHM Corporation; Director, Friendly Hotels PLC, since
1996.
 
  Kevin P. Hanley. Vice President, Real Estate and Development of Choice since
December 1994; Vice President, Real Estate and Development of MCHD from
December 1994 to November 1996; Executive Vice President of Hospitality
Investment Trust from September 1994 to November 1994; Senior Vice President,
Development and Acquisitions of Motel 6, L.P. from May 1992 to September 1994;
various other positions with Motel 6, L.P. since January 1987.
 
  Edward A. Kubis. Senior Vice President and General Counsel of Choice
Management and Realty Services, a division of Choice, since June 1997; Senior
Vice President, General Counsel and Secretary of Choice from
 
                                      78
<PAGE>
 
November 1996 to June 1997; Assistant General Counsel and Assistant Secretary,
Manor Care from December 1993 to November 1996; Senior Attorney, Real Estate,
from December 1990 to December 1993; Staff Attorney, Real Estate from June
1987 to December 1990.
 
  For biographical information with respect to the other persons listed above,
see "Certain Information Concerning Franchising--Management--Background of
Directors; and Certain Information Concerning Sunburst--Management--Background
of Directors."
 
                                      79
<PAGE>
 
                 AMENDMENTS TO THE CHOICE RESTATED CERTIFICATE
                               OF INCORPORATION
 
  In connection with the Distribution, Choice intends to implement certain
amendments to the Restated Certificate of Incorporation of Choice to (i)
change the name of Choice to Sunburst Hospitality Corporation, (ii) decrease
the number of authorized shares of Choice Common Stock from 160,000,000 to
60,000,000 and (iii) effect a one-for-three reverse stock split of Choice
Common Stock whereby every three shares of Choice Common Stock would be
aggregated into one share of Sunburst Common Stock. Under the DGCL, the
amendments to the Choice Restated Certificate of Incorporation described
herein require the approval of a majority of the outstanding Company Common
Stock, which approval has been obtained.
 
NAME CHANGE
 
  The purpose and principal effect of the proposed amendment to the Restated
Certificate of Incorporation of Choice to change the name of Choice to
Sunburst Hospitality Corporation is to permit Franchising to adopt the name
Choice Hotels International, Inc. after the Distribution, to minimize
confusion to the public and to investors and to reflect that the principal
business of Choice after the Distribution will emphasize the ownership of
hotels and other lodging-related properties. This amendment should not have
any adverse effect on Choice shareholders.
 
REVERSE STOCK SPLIT AND REDUCTION IN NUMBER OF AUTHORIZED SHARES
 
  Purposes of the Reverse Stock Split. In order to enable Sunburst to maintain
an acceptable trading range for Sunburst Common Stock after the Distribution
while also retaining sufficient liquidity for Sunburst Common Stock, Choice
has proposed that, following the Distribution, the Choice Restated Certificate
of Incorporation be amended to effect a one-for-three reverse stock split
pursuant to which each three shares of Choice Common Stock will be exchanged
for one share of Sunburst Common Stock (i.e. common stock of Choice following
the Distribution). As of the Annual Meeting Record Date, Choice had
outstanding 60,200,784 shares of Choice Common Stock (not including shares
issuable upon exercise of options to purchase Choice Common Stock) and had
reserved for issuance under the 1996 Incentive Plan 6,732,307 shares of Choice
Common Stock. After giving effect to the Reverse Stock Split, such numbers
would be 20,054,432 and 2,244,102 respectively.
 
  Purposes of the Reverse Stock Split. The Board of Directors, after
considering the effects of the Distribution on the price per share of Choice
Common Stock, believes that the Reverse Stock Split is advisable and in the
best interests of Choice and its stockholders as a means of enhancing the
liquidity and marketability of Choice Common Stock. The reduction in the
number of issued and outstanding shares of Choice Common Stock as a result of
the Reverse Stock Split is expected to increase the market price of Choice
Common Stock, thereby reducing any negative attributes traditionally
associated with a low per share market price.
 
  A low per share market price often adversely effects the marketability of a
stock. Certain institutional investors have internal policies preventing the
purchase of low-priced stocks and many brokerage houses do not permit low-
priced stock to be used as collateral for margin accounts or to be purchased
on margin. Further, certain brokerage houses have adopted time-consuming
practices and procedures which act to discourage individual brokers from
dealing in low-priced stocks because such practices and procedures make the
handling of low-priced stocks economically unattractive. A low stock price
also has the effect of increasing the amount and percentage of transaction
costs paid by individual investors. Because brokers' commission on low-priced
stocks generally represent a higher percentage of the stock price than
commissions on higher priced stocks, a low stock price can result in
individual stockholders paying transaction costs (commissions, markups or
markdowns) which are a higher percentage of their total share value than would
be the case with stock with a higher share price. The Board of Directors
believes that the expected increase in the share price of Choice Common Stock
resulting from the Reverse Stock Split should reduce the effect of these
negative attributes traditionally associated with a low per share price,
thereby enhancing the acceptability of Choice Common Stock with the financial
community and investing public and resulting in a broader market for Choice
Common Stock than currently exists.
 
                                      80
<PAGE>
 
  There can be no assurance that the Reverse Stock Split will increase the
current market price per share, or that any increase in market price of Choice
Common Stock after the Reverse Stock Split will be maintained. The Reverse
Stock Split could result in an increase in the market price for Choice Common
Stock which is proportionately less than the decease in the number of shares
outstanding. Additionally, there can be no assurances that any of the effects
described above will be achieved.
 
  Certain Effects of the Reverse Stock Split. A holder of Choice Common Stock
will be entitled to receive a whole number of shares plus a fraction of a
share if the number of shares of Choice Common Stock held by him prior to the
Reverse Stock Split is not evenly divisable by three. However, no certificate
or scrip representing fractional shares of Choice Common Stock will be issued.
In lieu of fractional shares, the Transfer Agent of the Choice Common Stock on
behalf of all persons otherwise entitled to receive fractional shares
(including individual beneficial owners of shares held by a nominee holder)
will, promptly following the effective time of the Reverse Stock Split,
aggregate such fractional shares and sell the resulting whole shares of Choice
Common Stock for the accounts of those persons in open market transactions on
the NYSE. Those persons will thereafter be entitled to receive their allocable
portion of the net proceeds of the sale thereof upon surrender of their Choice
Common Stock certificates as described below.
 
  The Reverse Stock Split may result in some stockholders owning "odd-lots" of
less than 100 shares of Choice Common Stock. Brokerage commissions and other
costs of transactions in odd-lots are generally higher than the costs of
transactions in "round-lots" of even multiples of 100 shares.
 
  Choice Common Stock is currently registered under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), and as a result, Choice is
subject to the periodic reporting and other requirements of the Exchange Act.
The proposed Reverse Stock Split will not affect the registration of the
Choice Common Stock under the Exchange Act.
 
  Exchange of Stock Certificates. If the Reverse Stock Split is approved as
part of the Distribution Proposals, Choice will, after consummation of the
Distribution, file an amendment to the Choice's Restated Certificate of
Incorporation with the Secretary of State of the State of Delaware. Choice
will notify holders of Choice Common Stock of the effectiveness of the Reverse
Stock Split and will furnish the holders of record of shares of Choice Common
Stock at the close of business on such effective date with a letter of
transmittal for use in exchanging certificates. The holders of Choice Common
Stock will be required to promptly mail their certificates representing shares
of Choice Common Stock to the transfer agent, in order that new certificates
giving effect to the Reverse Stock Split may be issued and the proceeds of any
fractional shares may be distributed. Commencing with the effective date of
the Reverse Stock Split, previously outstanding certificates representing
shares of Choice Common Stock will be deemed for all purposes to represent
one-third of the number of shares previously represented thereby.
 
  Decreased Number of Authorized Shares. Choice has authorized 160,000,000
shares of Choice Common Stock, of which approximately 60,200,784 are issued
and outstanding as of the Annual Meeting Record Date. In connection with the
Reverse Stock Split, the outstanding shares of Choice Common Stock will be
reduced to approximately 20,066,928. To reflect this reduction in the number
of shares outstanding, it is proposed to amend the Choice's Restated
Certificate of Incorporation to decrease the total number of shares of Choice
Common Stock authorized by Choice from 160,000,000 to 60,000,000.
 
                                      81
<PAGE>
 
                           FRANCHISING BENEFIT PLAN
 
  The Franchising Options to be issued to Manor Care Employees in the manner
set forth herein shall be issued pursuant to the Choice Hotels Franchising,
Inc. 1997 Long-Term Incentive Plan (the "Franchising Incentive Plan"). Set
forth below is a summary of the material terms of the Franchising Incentive
Plan, which is attached hereto as Exhibit C.
 
FRANCHISING INCENTIVE PLAN
 
  General. The continuing growth and development and financial success of
Franchising and its subsidiaries are dependent upon ensuring the best possible
management. The Franchising Board of Directors believes the Franchising
Incentive Plan will be an important aid to Franchising in attracting and
retaining individuals of outstanding abilities and in rewarding them for the
continued profitable performance of Franchising and its subsidiaries.
 
  The types of awards that may be granted under the Franchising Incentive Plan
are restricted shares, incentive stock options, nonqualified stock options,
stock appreciation rights and performance shares. The Franchising Incentive
Plan provides that over the next ten years restricted shares, incentive stock
options, nonqualified stock options, stock appreciation rights, and/or
performance shares involving up to six million shares (subject to adjustment
for stock splits and similar capital changes) of Franchising Common Stock may
be granted. Franchising Common Stock issued under the Franchising Incentive
Plan may be authorized and unissued stock, treasury stock or stock purchased
on the open market (including in private transactions). To the extent that an
award lapses or the rights of a participant to whom it was granted terminate,
any shares of Franchising Common Stock subject to the award will again be
available for awards under the Franchising Incentive Plan.
 
  Administration. The Franchising Incentive Plan provides that it will be
administered by one or more Key Executive Stock Option Plan Committee(s) of
the Board of Directors (the "Committee"), which establishes the conditions of
each grant made under the Franchising Incentive Plan and determines which key
employees will receive awards as well as the type and amount of each award.
 
  Eligibility. Key employees of Franchising and its subsidiaries (including
employees who are members of the Franchising Board of Directors, but excluding
directors who are not employees) who, in the opinion of the Committee, are
mainly responsible for the continued growth and development and financial
success of the business of Franchising or one of its subsidiaries are eligible
to be granted awards under the Franchising Incentive Plan. Subject to the
provisions of the Franchising Incentive Plan, the Committee shall from time to
time select from such eligible persons those to whom awards shall be granted
and determine the number of shares to be granted. Because eligibility is
determined by these subjective criteria, it is not possible at this time to
determine either the number of employees eligible to participate in the
Franchising Incentive Plan or the amount of awards which will be made.
 
  In connection with the Distribution, options to purchase Choice Common Stock
held by Choice employees will be converted into options to purchase
Franchising Common Stock and Sunburst Common Stock. Such converted options to
purchase Franchising Common Stock will be deemed to be governed by the
Franchising Incentive Plan but are not deemed to be issued under the
Franchising Incentive Plan. All of such awards will vest at the rate of twenty
percent per year for the first five years, and expire ten years after the date
of the award.
 
  Restricted Shares. Restricted share awards are shares of Franchising Common
Stock bearing restrictive legends prohibiting their sale, transfer, pledge or
hypothecation until the expiration of a restriction period of not more than
ten years set at the time of grant. In addition or in lieu of a restriction
period, the Committee may establish a performance goal which must be achieved
as a condition to retention of the award. The recipient of an award is
entitled to receive dividends and vote the restricted shares, unless
forfeited.
 
  Stock Options. Options granted under the Franchising Incentive Plan may be
either Incentive Stock Options, as defined in the Internal Revenue Code, as
amended, or options which do not so qualify ("nonqualified
 
                                      82
<PAGE>
 
options"). At the time an option is granted, the Committee determines the
number of shares of Franchising Common Stock subject to each stock option, the
manner and time of exercise, and the vesting schedule. No options granted
under the Franchising Incentive Plan may be exercised more than 10 years after
date of grant; however, Incentive Stock Options granted to a Ten Percent
Shareholder (as defined) may not be exercised more than 5 years after the date
of grant. The option price per share for stock options will be set in the
grant, but will be equal to or greater than the fair market value of a share
of Franchising Common Stock on the date of grant, except with respect to an
Incentive Stock Option granted to a Ten Percent Shareholder (as defined) shall
be at least 110% of the fair market value on the date of grant. The option
exercise price may be paid with cash and/or shares of Franchising Common
Stock. Options will be evidenced by stock option agreements in a form approved
by the Committee and are not transferable except by will or the laws of
descent and distribution. Under the Franchising Incentive Plan, no Covered
Employee (as defined in Section 162(m)(3) of the Internal Revenue Code) may be
granted stock options for more than 100,000 shares during any calendar year.
With respect to Incentive Stock Options granted to any employee, the aggregate
fair market value determined on the date of grant with respect to which any
Incentive Stock Option is first exercisable shall not exceed $100,000.
 
  The granting of an option does not entitle the participant to any dividends,
voting or other rights of a stockholder, unless and until the participant
receives stock upon exercise of the option. The Committee may limit an option
by restricting its exercise in whole or in part for specified periods.
 
  Stock Appreciation Rights. An SAR is the right to receive payment for the
appreciation in value of one share of Franchising Common Stock over a
specified price. An SAR may be granted either in tandem with a stock option
award or independently. If the SAR is granted in tandem with a stock option
award, the payment is measured by the excess of the fair market value of
Franchising Common Stock at the time of exercise over the option price (which
cannot be less than the fair market value of the stock at the time of grant).
If the SAR is granted independent of a stock option, the Committee will
specify whether the award is a "regular" SAR or whether the award is a "book
value" SAR. If the award is a "regular" SAR, the payment is measured by the
excess of the fair market value of the stock at the time of exercise over the
fair market value at the time of grant. If the award is a "book value" SAR,
the payment is measured by the excess of the book value of Franchising Common
Stock at the time of exercise over the book value of Franchising Common Stock
at the time of grant.
 
  Stock appreciation payments, at the election of the participant, may be made
in cash or Franchising Common Stock or a combination of both. The Committee
must approve any election to receive cash.
 
  An SAR issued pursuant to an option cannot be exercised less than six months
after the grant; an SAR issued independently is subject to the terms and
conditions established on grant. SARs are deemed to be exercised on the last
day of the Exercise Period, if not previously exercised, which may not extend
more than ten years beyond the date of grant. The Committee may impose such
restrictions on transferability of SARs as it may determine.
 
  The granting of an SAR does not entitle the participant to any dividend,
voting or other rights of a stockholder, unless and until the participant
receives stock upon the exercise of an SAR. SARs which are not exercisable
immediately upon being granted may be made immediately exercisable upon the
occurrence of retirement or disability, as determined by the Committee in its
sole discretion. Under the Franchising Incentive Plan, no Covered Employee (as
defined in Section 162(m)(3) of the Internal Revenue Code) may be granted more
than 100,000 SARs during any calendar year.
 
  Performance Shares. A performance share award involves the grant of a right
to receive a specified number of shares of Franchising Common Stock upon
satisfaction of certain performance-related objectives specified in the
granting instrument. The performance-related objectives may relate to the
individual, Franchising, a department or a division of Franchising and/or a
group or class of participants. The measuring period used to establish the
performance criteria will be specified by the Committee at the time of grant
and may be subsequently waived or reduced, or the performance criteria may be
adjusted, upon the occurrence of events determined by the Committee in its
sole discretion to justify such waiver, reduction or adjustment. Under the
 
                                      83
<PAGE>
 
Franchising Incentive Plan, no Covered Employee (as defined in Section
162(m)(3) of the Internal Revenue Code) may be granted more than 100,000
Performance Shares during any calendar year.
 
  Retirement or Disability. The Committee may, in its discretion, waive the
forfeiture, termination or lapse of an award in the event of retirement or
disability of the participant.
 
  Income Tax Consequences. The Federal income tax consequences of an award
under the Franchising Incentive Plan depend on the type of award, as discussed
below. The grant of a restricted share award or a performance share award does
not immediately produce taxable income to a recipient or a tax deduction to
Franchising. However, at the time the restrictions expire or the performance
objectives have been achieved, as the case may be, a recipient will recognize
taxable ordinary income in an amount equal to the fair market value of the
stock on the date the restrictions expire or the performance criteria are
achieved and Franchising will be entitled to a corresponding income tax
deduction. In the case of a restricted share award, during the restriction
period, a recipient will be taxed on the dividends received from the
restricted shares as additional compensation, and Franchising will be entitled
to a corresponding compensation deduction.
 
  Generally, a recipient of an incentive stock option will not recognize
taxable income at the time of grant or exercise and Franchising will not be
entitled to an income tax deduction. Provided the minimum holding periods are
satisfied, any gain on a disposition of stock acquired through an incentive
stock option will be taxable to a recipient as long-term capital gain. If the
minimum holding periods are not satisfied, a recipient will recognize ordinary
income in the amount of the excess of the fair market value of the stock on
the date the option is exercised over the option price, and Franchising will
be entitled to a corresponding income tax deduction.
 
  The grant of a nonqualified stock option does not result in taxable income
to a recipient or a tax deduction for Franchising. Upon exercise, a recipient
will recognize taxable ordinary income in an amount equal to the excess of the
fair market value of the stock on the date of exercise over the option price,
and Franchising will be entitled to a corresponding income tax deduction.
 
  A recipient of a stock appreciation right will not recognize taxable income
at the time the right is granted, and Franchising will not be entitled to a
tax deduction. However, ordinary taxable income will be recognized by a
recipient and a corresponding deduction will be taken by Franchising, at the
time of exercise, in an amount equal to the cash and the fair market value of
the stock received.
 
  Amendment and Termination. The Franchising Board of Directors may at any
time and from time to time alter, amend, suspend or terminate the Franchising
Incentive Plan in whole or in part, except (i) any such action affecting
options granted or to be granted under the Franchising Incentive Plan which
are intended to qualify as Incentive Stock Options shall be subject to
stockholder approval to the extent such stockholder approval is required
pursuant to Section 422 of the Internal Revenue Code and (ii) without the
consent of the participant to whom any award has been granted, no such action
may be taken which adversely affects the rights of such participant concerning
such award, except as such termination or amendment of the Franchising
Incentive Plan is required by statute, or rules and regulations promulgated
thereunder.
 
  The Franchising Incentive Plan terminates in October, 2007. Awards may be
granted under the Franchising Incentive Plan at any time and from time to time
prior to the termination of the Franchising Incentive Plan. Any award
outstanding at the time the Franchising Incentive Plan is terminated shall
remain in effect until said award is exercised or expires.
 
                                      84
<PAGE>
 
                         INDEX TO FINANCIAL STATEMENTS
 
  Choice Hotels Franchising, Inc.
 
<TABLE>
<S>                                                                         <C>
Report of Independent Public Accountants................................... F-2
Combined Balance Sheets as of May 31, 1997 and May 31, 1996................ F-3
Combined Statements of Income for the fiscal years ended May 31, 1997, May
 31, 1996 and May 31, 1995................................................. F-4
Combined Statements of Cash Flows for the fiscal years ended May 31, 1997,
 May 31, 1996 and May 31, 1995............................................. F-5
Notes to Combined Financial Statements..................................... F-6
</TABLE>
 


                                      F-1
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To Choice Hotels Franchising, Inc.:
 
  We have audited the accompanying combined balance sheets of Choice Hotels
Franchising, Inc., as defined under "Basis of Presentation" in the Notes to
Combined Financial Statements, as of May 31, 1997 and 1996, and the related
combined statements of income and cash flows for each of the three years in
the period ended May 31, 1997. These combined financial statements are the
responsibility of Franchising's management. Our responsibility is to express
an opinion on these combined financial statements based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the financial statements referred to above present fairly,
in all material respects, the combined financial position of Choice Hotels
Franchising, Inc. as of May 31, 1997 and 1996, and the combined results of
their operations and their combined cash flows for each of the three years in
the period ended May 31, 1997, in conformity with generally accepted
accounting principles.
 
                                          Arthur Andersen LLP
 
Washington, D.C.,
June 24, 1997
 
                                      F-2
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
                          (SEE BASIS OF PRESENTATION)
 
                            COMBINED BALANCE SHEETS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                   MAY 31,
                                                              -----------------
                                                                1997     1996
                                                              -------- --------
<S>                                                           <C>      <C>
                           ASSETS
CURRENT ASSETS
  Cash and cash equivalents.................................. $  4,167 $  3,812
  Receivables (net of allowance for doubtful accounts of
   $6,159 and $4,515, respectively)..........................   24,472   21,875
  Prepaid expenses...........................................      599    2,793
  Other......................................................    5,077    3,429
                                                              -------- --------
    Total current assets.....................................   34,315   31,909
                                                              -------- --------
PROPERTY AND EQUIPMENT, AT COST, NET OF ACCUMULATED
 DEPRECIATION................................................   43,377   38,305
                                                              -------- --------
GOODWILL, NET OF ACCUMULATED AMORTIZATION....................   69,939   65,377
                                                              -------- --------
FRANCHISE RIGHTS, NET OF ACCUMULATED AMORTIZATION............   50,503   53,138
                                                              -------- --------
INVESTMENT IN FRIENDLY HOTELS, PLC...........................   17,161   17,069
                                                              -------- --------
OTHER ASSETS.................................................    6,178    7,005
                                                              -------- --------
                                                              $221,473 $212,803
                                                              ======== ========
                   LIABILITIES AND EQUITY
CURRENT LIABILITIES
  Current portion of long term debt.......................... $     36 $     57
  Accounts payable...........................................   20,412   18,338
  Accrued expenses...........................................   10,965   15,184
  Income taxes payable.......................................    3,318    2,257
                                                              -------- --------
    Total current liabilities................................   34,731   35,836
                                                              -------- --------
LONG TERM DEBT...............................................   46,427   66,558
                                                              -------- --------
NOTES PAYABLE TO MANOR CARE..................................   78,700   78,700
                                                              -------- --------
DEFERRED INCOME TAXES ($3,498 AND $427, RESPECTIVELY) AND
 OTHER LIABILITIES...........................................    4,422    1,177
                                                              -------- --------
INVESTMENTS AND ADVANCES FROM PARENT.........................   57,193   30,532
                                                              -------- --------
                                                              $221,473 $212,803
                                                              ======== ========
</TABLE>
 
 
 The accompanying notes are an integral part of these combined balance sheets.
 
 
                                      F-3
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
                          (SEE BASIS OF PRESENTATION)
 
                         COMBINED STATEMENTS OF INCOME
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                      YEAR ENDED MAY 31,
                                                  ----------------------------
                                                    1997      1996      1995
                                                  --------  --------  --------
<S>                                               <C>       <C>       <C>
REVENUES
  Royalty fees................................... $ 95,157  $ 86,173  $ 75,402
  Marketing and reservation fees.................  104,216    98,906    83,645
  Product sales..................................   23,643    21,570    14,461
  European hotel operations......................   17,737    19,609    18,638
  Initial franchise fees.........................   14,250    13,520     9,837
  Other..........................................   17,252    10,876    10,689
                                                  --------  --------  --------
    Total revenues...............................  272,255   250,654   212,672
                                                  --------  --------  --------
OPERATING EXPENSES
  Marketing and reservation......................  101,421    96,246    81,545
  Selling, general and administrative............   51,102    45,196    45,589
  Product cost of sales..........................   22,766    20,709    13,882
  European hotel operations......................   16,166    17,521    17,922
  Depreciation and amortization..................   10,438    11,839    11,768
  Provision for asset impairment.................      --     24,760       --
                                                  --------  --------  --------
    Total operating expenses.....................  201,893   216,271   170,706
                                                  --------  --------  --------
    Operating income.............................   70,362    34,383    41,966
                                                  --------  --------  --------
OTHER
  Minority interest expense......................      --      1,532     2,200
  Interest on notes payable to Manor Care........    7,083     7,083     7,083
  Interest and other, net........................    3,704     4,791     3,672
                                                  --------  --------  --------
    Total other expenses.........................   10,787    13,406    12,955
                                                  --------  --------  --------
Income before income taxes.......................   59,575    20,977    29,011
Income taxes.....................................  (24,845)   (9,313)  (12,783)
                                                  --------  --------  --------
NET INCOME....................................... $ 34,730  $ 11,664  $ 16,228
                                                  ========  ========  ========
Pro forma weighted average shares outstanding....   62,680    62,628    62,480
                                                  ========  ========  ========
Pro forma earnings per share..................... $   0.55  $   0.19  $   0.26
                                                  ========  ========  ========
</TABLE>
 
 
  The accompanying notes are an integral part of these combined statements of
                                    income.
 
 
                                      F-4
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
                          (SEE BASIS OF PRESENTATION)
 
                       COMBINED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                      YEAR ENDED MAY 31,
                                                  ----------------------------
                                                    1997      1996      1995
                                                  --------  --------  --------
<S>                                               <C>       <C>       <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income....................................... $ 34,730  $ 11,664  $ 16,228
  Reconciliation of net income to net cash pro-
   vided by operating activities:
    Depreciation and amortization................   10,438    11,839    11,768
    Provision for bad debts......................    2,238       685       692
    Increase (decrease) in deferred taxes........    3,171   (13,527)       68
    Provision for asset impairment...............      --     24,760       --
    Change in assets and liabilities:
      Change in receivables......................   (4,835)   (7,533)   (3,000)
      Change in prepaid expenses and other cur-
       rent assets...............................    1,615      (990)    1,524
      Change in current liabilities..............   (2,145)    4,050     3,694
      Change in income taxes payable.............    1,061      (265)      158
      Change in other liabilities................      175     2,059     6,719
                                                  --------  --------  --------
      NET CASH PROVIDED BY OPERATING ACTIVITIES..   46,448    32,742    37,851
                                                  --------  --------  --------
CASH FLOWS FROM INVESTING ACTIVITIES
  Investment in property and equipment...........  (10,630)   (6,506)  (13,611)
  Purchase of minority interest..................   (2,494)  (55,269)      --
  Investment in Friendly Hotels, PLC.............      --    (17,069)      --
  Other items, net...............................   (4,747)      345     5,878
                                                  --------  --------  --------
NET CASH UTILIZED IN INVESTING ACTIVITIES........  (17,871)  (78,499)   (7,733)
                                                  --------  --------  --------
CASH FLOWS FROM FINANCING ACTIVITIES
  Proceeds from mortgages and other long-term
   debt..........................................   31,107    17,296    15,567
  Principal payments of debt.....................  (51,260)     (350)  (13,492)
  Cash transfers (to) from Parent, net...........   (8,069)   31,567   (33,336)
                                                  --------  --------  --------
      NET CASH (UTILIZED IN) PROVIDED BY
       FINANCING ACTIVITIES......................  (28,222)   48,513   (31,261)
                                                  --------  --------  --------
Net change in cash and cash equivalents..........      355     2,756    (1,143)
Cash and cash equivalents at beginning of peri-
 od..............................................    3,812     1,056     2,199
                                                  --------  --------  --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD....... $  4,167  $  3,812  $  1,056
                                                  ========  ========  ========
</TABLE>
 
 
  The accompanying notes are an integral part of these combined statements of
                                  cash flows.
 
 
                                      F-5
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
                    NOTES TO COMBINED FINANCIAL STATEMENTS
 
                  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
BASIS OF PRESENTATION
 
  On March 7, 1996, Manor Care, Inc. ("Manor Care") announced its intention to
proceed with the separation of its lodging business ("Choice Hotels
International, Inc." or the "Company") from its health care business through a
spin-off of its lodging business (the "Manor Care Distribution"). On September
30, 1996 the Board of Directors of Manor Care declared a special dividend to
its shareholders of one share of common stock of the Company for each share of
Manor Care stock, and the Board of Directors set the Record Date and the
Distribution Date. The Manor Care Distribution was made on November 1, 1996 to
holders of record of Manor Care's Common Stock on October 10, 1996.
 
  The Manor Care Distribution separated the lodging and health care businesses
of Manor Care into two public corporations. The operations of the Company
consist principally of the hotel franchise operations and the owned and
managed hotel operations formerly conducted by Manor Care directly or through
its subsidiaries (the "Lodging Business").
 
  On November 1, 1996, concurrent with the Manor Care Distribution, the
Company changed its name from Choice Hotels Holdings, Inc. to Choice Hotels
International, Inc., and the Company's franchising subsidiary, formerly named
Choice Hotels International, Inc., changed its name to Choice Hotels
Franchising, Inc.
 
  On April 29, 1997, Choice Hotels International, Inc. announced its intention
to proceed with the separation of its domestic lodging business from its
franchising and European hotel business through a spin-off of its franchising
business (the "Distribution"). The Company's Board of Directors voted to
approve, in principle, the Distribution subject to receipt of other approvals
and consents and satisfactory implementation of the arrangements for the
Distribution. The Company intends to consummate the Distribution in the second
quarter of fiscal year 1998 through a special dividend to its stockholders of
one share of common stock of Choice Hotels Franchising, Inc. ("Franchising")
for each share of Company common stock. The Distribution is conditional upon
certain matters, including declaration of the special dividend by the
Company's Board of Directors, receipt of a ruling from the Internal Revenue
Service that the Distribution will be tax-free and approval by the Company's
shareholders of the special dividend and of the proposed reverse stock split
of the Company post-Distribution. It is anticipated that upon the
Distribution, the Company will change its corporate name to Sunburst
Hospitality Corporation ("Sunburst") and Choice Hotels Franchising, Inc. will
change its name to Choice Hotels International, Inc.
 
  As of May 31, 1997, Franchising had franchise agreements with 3,344 hotels
operating in 33 countries under the following brand names: Comfort, Clarion,
Sleep, Quality, Rodeway, Econo Lodge and MainStay Suites. Franchising also
owns or manages 14 hotels in Germany, France and England. The operations of
Franchising will consist principally of the hotel franchise operations and the
hotel operations in Europe formerly conducted by the Company.
 
  The combined financial statements present the financial position, results of
operations and cash flows of Franchising as if it were formed as a separate
entity of Manor Care which conducted the hotel franchising business and
European hotel operations of Manor Care through November 1, 1996 and as if
Franchising were a separate company for all periods presented. Manor Care's
and the Company's historical basis in the assets and liabilities of
Franchising has been carried over to the combined financial statements. All
material intercompany transactions and balances between Franchising and its
subsidiaries have been eliminated. Changes in the Investments and advances
from Parent represent the net income of Franchising plus the net change in
cash transferred between Franchising and Manor Care through November 1, 1996
and the Company through May 31, 1997.
 
 
                                      F-6
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  An analysis of the activity in the "Investments and advances from Parent"
account for the three years ended May 31, 1997 is as follows:
 
<TABLE>
<CAPTION>
                                                                  (IN THOUSANDS)
                                                                  --------------
   <S>                                                            <C>
   Balance, May 31, 1994.........................................    $  4,409
   Cash transfers to Parent, net.................................     (33,336)
   Net income....................................................      16,228
                                                                     --------
   Balance, May 31, 1995.........................................     (12,699)
   Cash transfers from Parent, net...............................      31,567
   Net income....................................................      11,664
                                                                     --------
   Balance, May 31, 1996.........................................      30,532
   Cash transfers to Parent, net.................................      (8,069)
   Net income....................................................      34,730
                                                                     --------
   Balance, May 31, 1997.........................................    $ 57,193
                                                                     ========
</TABLE>
 
  The average balance of the Investments and advances from Parent was $43.9
million, $8.9 million and ($4.1) million for fiscal years 1997, 1996 and 1995,
respectively.
 
RECLASSIFICATIONS
 
  Certain reclassifications have been made to the prior year combined
financial statements to conform to the current year presentation.
 
PRO FORMA INCOME PER SHARE (UNAUDITED)
 
  The pro forma income per common share is computed by dividing net income by
the pro forma weighted average number of outstanding common shares,
aggregating 62.7 million, 62.6 million and 62.5 million in fiscal years 1997,
1996 and 1995, respectively. The pro forma weighted average number of
outstanding common shares is based on the Company's weighted average number of
outstanding common shares for the period November 1, 1996 through May 31, 1997
and Manor Care's weighted average number of outstanding common shares for the
period June 1, 1996 through October 31, 1996 and for fiscal years 1996 and
1995.
 
CASH AND CASH EQUIVALENTS
 
  Franchising considers all highly liquid investments purchased with a
maturity of three months or less at the date of purchase to be cash
equivalents.
 
 
PROPERTY AND EQUIPMENT
 
  The components of property and equipment in the combined balance sheets
were:
 
<TABLE>
<CAPTION>
                                                                  MAY 31,
                                                              -----------------
                                                               1997      1996
                                                              -------  --------
                                                               (IN THOUSANDS)
   <S>                                                        <C>      <C>
   Land...................................................... $ 3,033  $  3,124
   Building and improvements.................................  27,409    29,274
   Furniture, fixtures and equipment.........................  30,526    25,181
                                                              -------  --------
                                                               60,968    57,579
   Less: Accumulated depreciation............................ (17,591)  (19,274)
                                                              -------  --------
                                                              $43,377  $ 38,305
                                                              =======  ========
</TABLE>
 
 
                                      F-7
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
  Depreciation has been computed for financial reporting purposes using the
straight-line method. A summary of the ranges of estimated useful lives upon
which depreciation rates have been based follows:
 
<TABLE>
   <S>                                                               <C>
   Building and improvements........................................ 10-40 years
   Furniture, fixtures and equipment................................  3-20 years
</TABLE>
 
MINORITY INTEREST
 
  Prior to May 31, 1996, certain former members of the Company's management
had a minority ownership interest in Choice Hotels Franchising, Inc., a
majority owned subsidiary. Amounts reflected as minority interest represent
the minority owners' share of income in Choice Hotels Franchising, Inc. As of
May 31, 1997, the Company had repurchased all of the outstanding minority
ownership interest.
 
GOODWILL
 
  Goodwill primarily represents an allocation of the excess purchase price of
the stock of Choice Hotels Franchising, Inc. over the recorded minority
interest. Goodwill is being amortized on a straight-line basis over 40 years.
Such amortization amounted to $1.9 million in the year ended May 31, 1997,
$1.1 million in the year ended May 31, 1996, and $598,000 in the year ended
May 31, 1995. Goodwill is net of accumulated amortization of $5.0 million and
$3.1 million at May 31, 1997 and 1996, respectively.
 
FRANCHISE RIGHTS
 
  Franchise rights are an intangible asset and represent an allocation in
purchase accounting for the value of long-term franchise contracts. The
majority of the balance resulted from the Econo Lodge and Rodeway acquisitions
made in fiscal year 1991. Franchise rights acquired are amortized over an
average life of twenty-six years. Amortization expense for the fiscal years
ended May 31, 1997, 1996 and 1995 amounted to $2.9 million, $2.6 million and
$2.6 million, respectively. Franchise rights are net of accumulated
amortization of $14.0 million and $11.1 million at May 31, 1997 and 1996,
respectively.
 
SELF-INSURANCE PROGRAM
 
  Subsequent to the Manor Care Distribution, Franchising maintained its own
self-insurance program for certain levels of general and professional
liability, automobile liability and workers' compensation coverage. The
estimated costs of these programs are accrued at present values based on
actuarial projections for known and anticipated claims.
 
  Prior to the Manor Care Distribution, Franchising participated in Manor
Care's self-insurance program for certain levels of general and professional
liability, automobile liability and workers' compensation coverage. The
estimated costs of these programs are accrued at present values based on
actuarial projections for known and anticipated claims. All accrued self-
insurance costs through November 1, 1996 were assumed by Manor Care and have
been treated as paid to Manor Care, and as such, amounts paid to Manor Care up
to November 1, 1996 have been charged directly to Investments and advances
from Parent.
 
REVENUE RECOGNITION
 
  Franchising enters into numerous franchise agreements committing to provide
licensees with various marketing services, a centralized reservation system
and limited rights to utilize Franchising's registered tradenames. These
agreements are typically for a period of twenty years, with certain rights to
the franchisee to terminate after 5, 10 or 15 years.
 
  Initial franchise fees are recognized upon sale, because the initial
franchise fee is non-refundable and Franchising has no continuing obligations
related to the franchisee.
 
                                      F-8
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Royalty fees, primarily based on gross room revenues of each franchisee, are
recorded when earned. Reserves for uncollectible accounts are charged to bad
debt expense and included in selling, general and administrative expenses in
the accompanying combined statements of income.
 
  Franchising assesses franchisees monthly fees related to marketing and
reservations which are expended for national advertising, marketing, and
selling activities and the operation of a centralized reservation system.
 
IMPAIRMENT POLICY
 
  Franchising evaluates the recoverability of long lived assets, including
franchise rights and goodwill, whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Recoverability is measured based on net, undiscounted expected cash flows.
Assets are considered to be impaired if the net, undiscounted expected cash
flows are less than the carrying amount of the assets. Impairment charges are
recorded based upon the difference between the carrying value of the asset and
the expected net cash flows, discounted at an appropriate interest rate.
 
CAPITALIZATION POLICIES
 
  Major renovations and replacements are capitalized to appropriate property
and equipment accounts. Upon sale or retirement of property, the cost and
related accumulated depreciation are eliminated from the accounts and the
related gain or loss is taken into income. Maintenance, repairs and minor
replacements are charged to expense.
 
FOREIGN OPERATIONS
 
  Franchising accounts for foreign currency translation in accordance with
SFAS No. 52, "Foreign Currency Translation." Revenues generated by foreign
operations for the fiscal years ended May 31, 1997, 1996 and 1995 were $27.5
million, $29.9 million and $29.2 million, respectively. Losses were generated
by foreign operations for the fiscal years ended May 31, 1997, 1996 and 1995
of $1.8 million, $19.4 million and $5.7 million, respectively. Losses
generated by foreign operations for fiscal year 1996 include a $15.0 million
net of tax charge relating to a provision for asset impairment. The majority
of the revenues and losses of foreign operations relate to Franchising's
European business operations. Total assets relating to foreign operations were
$48.8 million and $56.8 million at May 31, 1997 and 1996, respectively.
Translation gains and losses are recorded in the cumulative translation
adjustment account included in Investments and advances from Parent in the
accompanying combined balance sheets as follows:
 
<TABLE>
<CAPTION>
                                                                 (IN THOUSANDS)
                                                                 --------------
   <S>                                                           <C>
   Balance, May 31, 1994........................................    $    (31)
   Net adjustments..............................................         740
                                                                    --------
   Balance, May 31, 1995........................................         709
   Net adjustments..............................................      (2,459)
                                                                    --------
   Balance, May 31, 1996........................................      (1,750)
   Net adjustments..............................................      (5,268)
                                                                    --------
   Balance, May 31, 1997........................................    $ (7,018)
                                                                    ========
</TABLE>
 
USE OF ESTIMATES
 
  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
 
                                      F-9
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
 
                                 INCOME TAXES
 
  Franchising is included in the consolidated federal income tax returns of
Manor Care and the Company. The income tax provision included in these
combined financial statements reflects the historical income tax provision and
temporary differences attributable to the operations of Franchising on a
separate return basis. Deferred taxes are recorded for the tax effect of
temporary differences between book and tax income.
 
  Income before income taxes for the fiscal years ended May 31, 1997, 1996 and
1995 were derived from the following:
 
<TABLE>
<CAPTION>
                                                       1997     1996     1995
                                                      -------  -------  -------
                                                          (IN THOUSANDS)
   <S>                                                <C>      <C>      <C>
   Income before income taxes
     Domestic operations............................. $62,641  $52,801  $38,385
     Foreign operations..............................  (3,066) (31,824)  (9,374)
                                                      -------  -------  -------
   Combined income before income taxes............... $59,575  $20,977  $29,011
                                                      =======  =======  =======
</TABLE>
 
  Income before income taxes for domestic operations and foreign operations
for fiscal year 1996 includes a pretax provision of $24.8 million for asset
impairment.
 
  The provisions for income taxes follows for the fiscal years ended May 31:
 
<TABLE>
<CAPTION>
                                                       1997     1996     1995
                                                      -------  -------  -------
                                                          (IN THOUSANDS)
   <S>                                                <C>      <C>      <C>
   Current tax (benefit) expense
     Federal......................................... $19,421  $20,097  $14,169
     Federal benefit of foreign operations...........  (1,213)  (2,792)  (3,703)
     State...........................................   3,950    3,754    2,292
   Deferred tax (benefit) expense
     Federal.........................................   2,293      125       58
     Federal benefit of foreign operations...........     --    (9,778)     --
     State...........................................     394   (2,093)     (33)
                                                      -------  -------  -------
                                                      $24,845  $ 9,313  $12,783
                                                      =======  =======  =======
</TABLE>
 
  Deferred tax assets (liabilities) are comprised of the following at May 31:
 
<TABLE>
<CAPTION>
                                                      1997     1996      1995
                                                     -------  -------  --------
                                                          (IN THOUSANDS)
   <S>                                               <C>      <C>      <C>
   Depreciation and amortization.................... $(5,145) $(1,637) $(12,755)
   Prepaid expenses.................................    (856)  (1,550)   (1,386)
   Other............................................  (2,799)  (1,542)   (2,165)
                                                     -------  -------  --------
   Gross deferred tax liabilities...................  (8,800)  (4,729)  (16,306)
                                                     -------  -------  --------
   Foreign operations...............................   2,271    1,931     1,086
   Accrued expenses.................................   3,181    2,065     1,343
   Net operating loss...............................     609      820     1,031
   Other............................................     310      655        61
                                                     -------  -------  --------
   Gross deferred tax assets........................   6,371    5,471     3,521
                                                     -------  -------  --------
   Net deferred tax (liability) asset............... $(2,429) $   742  $(12,785)
                                                     =======  =======  ========
</TABLE>
 
                                     F-10
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  A reconciliation of income tax expense at the statutory rate to income tax
expense included in the accompanying combined statements of income follows:
 
<TABLE>
<CAPTION>
                                                    1997     1996      1995
                                                  --------  -------- --------
                                                    (IN THOUSANDS, EXCEPT
                                                  FEDERAL INCOME TAX RATE)
   <S>                                            <C>       <C>      <C>
   Federal income tax rate.......................       35%      35%       35%
   Federal taxes at statutory rate...............  $20,853   $7,345   $10,154
   State income taxes, net of Federal tax bene-
    fit..........................................    2,824    1,080     1,468
   Minority interest.............................      --       536       770
   Other.........................................    1,168      352       391
                                                  --------  -------  --------
   Income tax expense............................ $ 24,845  $ 9,313  $ 12,783
                                                  ========  =======  ========
</TABLE>
 
  Cash paid for state income taxes was $1.3 million, $1.4 million and $549,000
for the years ended May 31, 1997, 1996 and 1995, respectively. Federal income
taxes were paid by Manor Care for the years ended May 31, 1995 and May 31,
1996 and the period from June 1, 1996 through October 31, 1996. Federal income
taxes were paid by the Company for the short period beginning November 1, 1996
and ending May 31, 1997.
 
  Consistent with the existing Company tax sharing policy, all current Federal
provision amounts have been treated as paid to, or received from, the Company,
and as such, there are no current tax provision balances due to the Company at
May 31, 1997 or to Manor Care at May 31, 1996. Differences between amounts
paid to or received from Manor Care and the Company have been charged or
credited directly to Investments and advances from Parent.
 
                               ACCRUED EXPENSES
 
  Accrued expenses at May 31, 1997 and 1996 were as follows:
 
<TABLE>
<CAPTION>
                                                              1997    1996
                                                             ------- -------
                                                               (IN THOUSANDS)
   <S>                                                       <C>     <C>     <C>
   Payroll.................................................. $ 7,950 $ 7,041
   Other....................................................   3,015   8,143
                                                             ------- -------
                                                             $10,965 $15,184
                                                             ======= =======
</TABLE>
 
                       LONG TERM DEBT AND NOTES PAYABLE
 
  Debt consisted of the following at May 31, 1997 and 1996:
 
<TABLE>
<CAPTION>
                                                                 1997     1996
                                                               -------- --------
                                                                (IN THOUSANDS)
   <S>                                                         <C>      <C>
   $250 million competitive advance and multi-currency
    revolving credit facility with an average rate of 5.69%
    at May 31, 1996..........................................  $     -- $ 50,557
   $125 million competitive advance and multi-currency
    revolving credit facility with an average rate of 6.28%
    at May 31, 1997..........................................    31,107      --
   Notes payable to Manor Care, Inc. with a rate of 9% at May
    31, 1997 and 1996, respectively..........................    78,700   78,700
   Capital lease obligations.................................    13,531   13,951
   Other notes with an average rate of 5.94% and 6.33% at May
    31, 1997 and 1996, respectively..........................     1,825    2,107
                                                               -------- --------
   Total indebtedness........................................  $125,163 $145,315
                                                               ======== ========
</TABLE>
 
 
                                     F-11
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
  Maturities of debt at May 31, 1997 were as follows:
 
<TABLE>
<CAPTION>
   FISCAL YEAR                                                    (IN THOUSANDS)
   -----------                                                    --------------
   <S>                                                            <C>
   1998..........................................................    $     36
   1999..........................................................          87
   2000..........................................................     110,012
   2001..........................................................         210
   2002..........................................................         215
   Thereafter....................................................      14,603
                                                                     --------
                                                                     $125,163
                                                                     ========
</TABLE>
 
  During fiscal year 1996 and through November 1, 1996, the Company was a co-
guarantor with Manor Care and other affiliates for a $250 million competitive
advance and multi-currency revolving credit facility. The facility provided
that up to $75.0 million was available in foreign currency borrowings under
the foreign currency portion of the facility. Franchising's borrowings under
this facility amounted to $50.6 million at May 31, 1996. Franchising was
charged interest for amounts borrowed under the foreign currency portion of
the facility at one of several interest rates, including LIBOR plus 26.25
basis points. Subsequent to the Manor Care Distribution, the Company utilized
its new credit facility, as described below, to repay Franchising's portion of
borrowings under Manor Care's foreign currency portion of the facility, and
the Company was released from all liabilities and guarantees relating to the
Manor Care credit facility.
 
  On October 30, 1996, the Company entered into a $100.0 million competitive
advance and multi-currency revolving credit facility provided by a group of
seven banks. As a subsidiary of the Company, Franchising's cash requirements
and related borrowings were provided by the Company. This facility provides
that up to $75.0 million is available for borrowings in foreign currencies.
Borrowings under the facility are, at the option of the borrower, at one of
several rates including LIBOR plus from 20.0 to 62.5 basis points, based upon
a defined financial ratio and the loan type. In addition, the Company has the
option to request participating banks to bid on loan participation at lower
rates than those contractually provided by the facility. The facility
presently requires the Company to pay annual fees of 1/10 of 1% to 1/4 of 1%,
based upon a defined financial ratio, of the total loan commitment. The
facility will terminate on October 30, 1999. On May 5, 1997, the Company
increased the size of the facility from $100 million to $125 million. The
Company has $121.6 million outstanding under the facility at May 31, 1997 of
which $31.1 million has been allocated to Franchising. In connection with the
Distribution, Franchising intends to secure financing to repay its portion of
borrowings under the Company's foreign currency portion of the facility as
well as to provide for seasonal cash requirements.
 
  The Company has $115.7 million payable to Manor Care as of May 31, 1997
assumed as part of the Manor Care Distribution. The portion of this
indebtedness related to Franchising acquisitions has been pushed down to
Franchising and is reflected as Notes payable to Manor Care in the
accompanying combined balance sheets totaling $78.7 million at May 31, 1997
and 1996, respectively. The loan will mature on November 1, 1999 and may be
prepaid in whole or in part, together with accrued interest, at the Company's
option. If the loan is prepaid prior to November 1, 1997, the Company will be
required to reimburse Manor Care on demand for any actual loss incurred or to
be incurred by Manor Care (for the period up to and including November 1,
1997) in the redeployment of the funds released by a prepayment of the loan.
The Notes payable to Manor Care are expected to be repaid with the proceeds
from operating cash flow or with third-party financing. Interest expense on
those notes for each of the years ended May 31, 1997, 1996 and 1995 was $7.1
million. Interest on the amount of the loan is payable quarterly at an annual
rate of 9%.
 
  Cash paid for interest was $11.6 million, $11.8 million and $10.8 million
for fiscal years 1997, 1996 and 1995, respectively.
 
                                     F-12
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
                                    LEASES
 
  Franchising operates certain property and equipment under operating leases
that expire at various dates through 2001. Future minimum lease payments total
approximately $280,000. Rental expense under non-cancellable operating leases
was $171,000 in 1997, $231,000 in 1996 and $400,000 in 1995. No amounts have
been included in minimum lease payments for office rent because Franchising is
not subject to a rental agreement. Franchising paid office rent of $4.0
million to the Company in 1997 based on the portion of total space occupied by
Franchising. Subsequent to the Distribution, Franchising will sublease office
space from Sunburst.
 
                         ACQUISITIONS AND DIVESTITURES
 
  On May 31, 1995, Franchising repurchased one-half of the 11% interest held
by its management in Choice Hotels Franchising, Inc. Approximately $19.8
million was allocated to goodwill; the purchase cost of $27.4 million was paid
in June and July 1995. On May 31, 1996, Franchising repurchased the remaining
5.5% minority interest in Choice Hotels Franchising, Inc. for $27.9 million.
Approximately $26.4 million was allocated to goodwill.
 
  On May 31, 1996, Franchising invested approximately $17.1 million in the
capital stock of Friendly Hotels, PLC ("Friendly"). In exchange for the $17.1
million investment, Franchising received 750,000 shares of common stock and
10,000,000 newly issued immediately convertible preferred shares. In addition,
Franchising granted to Friendly a Master Franchise Agreement for the United
Kingdom and Ireland in exchange for 333,333 additional shares of common stock.
At May 31, 1997, Franchising owned approximately 5% of the outstanding shares
of Friendly which would increase to approximately 27% if Franchising's
preferred stock were converted. The preferred shares carry a 5.75% dividend
payable in cash or in stock, at the Company's option. The dividend accrues
annually with the first dividend paid on the earlier of the third anniversary
of completion or on a conversion date. The proceeds of the investment received
by Friendly are to be used to support the construction of 10 Quality or
Comfort hotels. As a condition to the investment, Franchising has the right to
appoint two directors to the board of Friendly. Franchising is accounting for
the common stock investment under the equity method.
 
  Franchising recognized $943,000 in preferred dividend income from the
Friendly investment during 1997.
 
                          TRANSACTIONS WITH SUNBURST
 
  Franchising participates in a cash concentration system with the Company and
as such maintains no significant cash balances or banking relationships.
Substantially all cash received by Franchising has been immediately deposited
in and combined with the Company's corporate funds through its cash management
system. Similarly, operating expenses, capital expenditures and other cash
requirements of Franchising have been paid by the Company and charged to
Franchising. The net result of all of these intercompany transactions are
reflected in Investments and advances from Parent.
 
  Since the Manor Care Distribution, Franchising has provided certain services
to the Company including, among others, executive management, human resources,
legal, accounting, tax, information systems and certain administrative
services, as required. Also since the Manor Care Distribution, the Company has
provided services to Franchising, either directly or through the Corporate
Services Agreement with Manor Care, including, among others, cash management,
payroll and payables processing, employee benefits plans, insurance,
accounting and certain administrative services, as required. Costs associated
with the Manor Care Corporate Services Agreement as well as costs of services
provided by the Company to Franchising or provided by Franchising to the
Company
 
                                     F-13
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
have been allocated between the entity providing the services and the entity
receiving the services in the accompanying financial statements. As a result,
future administrative and corporate expenses are expected to vary from
historical results. However, Franchising has estimated that general and
administrative expenses incurred annually will not materially change after the
Distribution.
 
  For purposes of providing an orderly transition after the Distribution, the
Company and Franchising will enter into various agreements, including, among
others, a Distribution Agreement, Tax Sharing Agreement, Corporate Services
Agreement and Employee Benefits Allocation Agreement. Effective at the
Distribution, these agreements will provide, among other things, that
Franchising (i) will receive and/or provide certain corporate and support
services, such as accounting, tax and computer systems support, (ii) will
establish pension, profit sharing and incentive plans similar to those in
place at the Company, (iii) will receive certain risk management services and
other miscellaneous administrative services and (iv) will adjust outstanding
options to purchase shares of Company Common Stock held by Company employees,
Franchising employees and employees of Manor Care. These agreements will
extend for a maximum period of 30 months from the Distribution date or until
such time as Franchising and the Company have arranged to provide such
services in-house or through another unrelated provider of such services.
 
  On or prior to the Distribution date, the Company and Franchising will enter
into a strategic alliance agreement. Among other things, the agreement will
provide for (i) a right of first refusal to Franchising to franchise lodging
properties to be acquired or developed by the Company, (ii) certain
commitments by the Company for the development of Sleep Inns and MainStay
Suites hotels, (iii) continued cooperation of both parties with respect to
matters of mutual interest, such as new product and concept testing, (iv)
continued cooperation with respect to third party vendor arrangements and (v)
certain limitations on competition in each others' line of business. The
strategic alliance agreement extends for a term of 20 years with mutual rights
of termination on the 5th, 10th and 15th anniversaries.
 
  During the periods presented, Sunburst operated substantially all of its
hotels pursuant to franchise agreements with Franchising. Total fees paid to
Franchising included in the accompanying financial statements for franchising
royalty, marketing and reservation fees were $9.5 million, $7.5 million, and
$5.3 million for the years ended May 31, 1997, 1996 and 1995, respectively.
 
                         COMMITMENTS AND CONTINGENCIES
 
  Franchising is a defendant in a number of lawsuits arising in the ordinary
course of business. In the opinion of management and general counsel to
Franchising, the ultimate outcome of such litigation will not have a material
adverse effect on Franchising's business, financial position or results of
operations.
 
                  PENSION, PROFIT SHARING AND INCENTIVE PLANS
 
  Bonuses accrued for key executives of Franchising under incentive
compensation plans were $1.4 million in 1997, $1.1 million in 1996 and $1.4
million in 1995.
 
  Employees of Franchising participate in retirement plans sponsored by the
Company, and prior to the Manor Care Distribution employees participated in
retirement plans sponsored by Manor Care. Costs allocated to Franchising are
based on the size of its payroll relative to the sponsor's payroll. Costs
allocated to Franchising were approximately $1.4 million in 1997, $817,000 in
1996 and $776,000 in 1995.
 
                                     F-14
<PAGE>
 
                        CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
 
                      FAIR VALUE OF FINANCIAL INSTRUMENTS
 
  Franchising is required to disclose the fair value of its financial
instruments in accordance with Statement of Financial Accounting Standards No.
107, "Disclosures about Fair Value of Financial Instruments." Fair values of
material balances were determined by using market rates currently available.
 
  The balance sheet carrying amount of cash, cash equivalents and receivables
approximate fair value due to the short term nature of these items. Long term
debt consist of bank loans and Notes payable to Manor Care. Interest rates on
bank loans adjust frequently based on current market rates; accordingly, the
carrying amount of bank loans is equivalent to fair value. The carrying
amounts for long-term debt approximate fair market values.
 
                        PROVISION FOR ASSET IMPAIRMENT
 
  During fiscal year 1996, Franchising began restructuring its European
operations. This restructuring effort included the purchase of an equity
interest in Friendly Hotels, PLC and a reevaluation of key geographic markets
in Europe. In connection with this restructuring, Franchising performed a
review of its European operations and in May 1996 recognized a $15.0 million
non-cash charge (net of a $9.8 million income tax benefit) against earnings
related to the impairment of assets associated with certain European hotel
operations.
 
                IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
 
  Franchising has adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The adoption
of SFAS No. 121 did not have a material impact on Franchising's financial
statements.
 
  Franchising plans to utilize the method under SFAS No. 123, "Accounting for
Stock-Based Compensation," which provides for disclosure of the impact of
stock-based compensation grants.
 
  Franchising is required to adopt SFAS No. 128, "Earnings Per Share," and
SFAS No. 129, "Disclosure of Information about Capital Structure," no later
than fiscal year 1998. The adoption of these pronouncements will not
materially affect Franchising's financial statements. Franchising is required
to adopt SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information," no
later than fiscal 1999. Management is still evaluating the impact that these
pronouncements will have on Franchising's financial statements.
 
 
                                     F-15
<PAGE>
 
                                                                        ANNEX A
 
                                    FORM OF
 
                     RESTATED CERTIFICATE OF INCORPORATION
 
                                      OF
 
                        CHOICE HOTELS FRANCHISING, INC.
 
  Choice Hotels Franchising, Inc. (the "Corporation"), a corporation
incorporated on December 12, 1980 and existing under and by virtue of the
General Corporation Law of the State of Delaware (the "GCL"), hereby certifies
as follows:
 
  FIRST: The board of directors of the Corporation (the "Board of Directors")
adopted a resolution proposing and declaring advisable the following
amendments to and restatement of the Certificate of Incorporation of the
Corporation.
 
  SECOND: This Restated Certificate of Incorporation was duly adopted by the
sole stockholder of the Corporation in accordance with the provisions of
Sections 228, 242 and 245 of the GCL.
 
  THIRD: The text of the Certificate of Incorporation is hereby amended and
restated as herein set forth in full:
 
    1. The name of the Corporation is CHOICE HOTELS INTERNATIONAL, INC. (the
  "Corporation").
 
    2. The address of the Corporation's registered office in the State of
  Delaware is 100 West Tenth Street, in the City of Wilmington, County of New
  Castle. The name of its registered agent at such address is The Corporation
  Trust Company.
 
    3. The purpose of the Corporation is to engage in any lawful act or
  activity for which corporations may be organized under the GCL.
 
    4. The total number of shares of capital stock of all classifications
  which the Corporation shall have authority to issue is One Hundred Sixty-
  Five Million (165,000,000), of which One Hundred Sixty Million
  (160,000,000) shares having a par value of One Cent ($.01) per share shall
  be common stock, and Five Million (5,000,000) shares having a par value of
  One Cent ($.01) per share shall be preferred stock.
 
  Shares of common stock of the Corporation may be issued from time to time in
one or more classes or series, each of which class or series shall have such
distinctive designation or title as shall be fixed by the Board of Directors
prior to the issuance of any shares thereof. Each such class or series of
common stock shall have such voting powers (full or limited) or no voting
powers, such preferences and relative participating, optional or other special
rights, relative ranking and such qualifications, limitations or restrictions,
as shall be stated in such resolution or resolutions providing for the issue
of such class or series of common stock as may be adopted from time to time by
the Board of Directors prior to the issuance of any shares thereof pursuant to
the authority hereby expressly vested in it, all in accordance with the laws
of the State of Delaware.
 
  Without limiting the generality of the foregoing, shares of a series of
common stock consisting of Seventy Five Million (75,000,000) shares, or such
larger number of shares as the Board of Directors shall from time to time fix
by resolution or resolutions, may be issued from time to time by the Board of
Directors. Shares of this series shall be designated, and are hereinafter
called "Common Stock."
 
  The holders of record of the Common Stock shall be entitled to the following
rights:
 
    (a) subject to the rights of any holders of any class or series of
  capital stock as specified in the resolution providing for such class or
  series of capital stock, to vote at all meetings of stockholders of the
 
                                      A-1
<PAGE>
 
  Corporation, and at all such meetings such holders shall have one vote in
  respect of each share of Common Stock held of record by them;
 
    (b) subject to the rights of any holders of any class or series of
  capital stock having a preference with respect to dividends, to receive
  when, if and as declared by the Board of Directors out of the assets of the
  Corporation legally available therefor, such dividends as may be declared
  by the Corporation from time to time to holders of Common Stock; and
 
    (c) subject to the rights of any holders of any class or series of
  capital stock having a preference with respect to distribution of assets
  upon liquidation or dissolution, to receive the remaining assets of the
  Corporation upon liquidation, dissolution or winding-up.
 
  Shares of preferred stock of the Corporation may be issued from time to time
in one or more classes or series, each of which class or series shall have
such distinctive designation or title as shall be fixed by the Board of
Directors prior to the issuance of any shares thereof. Each such class or
series of preferred stock shall have such voting powers (full or limited) or
no voting powers, such preferences and relative participating, optional or
other special rights, relative ranking and such qualifications, limitations or
restrictions, as shall be stated in such resolution or resolutions providing
for the issue of such class or series of preferred stock as may be adopted
from time to time by the Board of Directors prior to the issuance of any
shares thereof pursuant to the authority hereby expressly vested in it, all in
accordance with the laws of the State of Delaware.
 
  Subject to the rights of any holders of any class or series of capital
stock, as specified in the resolution providing for such class or series of
capital stock, the holders of Common Stock are expressly denied the preemptive
right to subscribe to any or all additional shares of capital stock of the
Corporation or any or all classes or series thereof.
 
    5. The Corporation expressly elects not to be governed by Section 203 of
  the GCL.
 
    6. Subject to the rights of any holders of any class or series of capital
  stock as specified in the resolution providing for such class or series of
  capital stock, any action required to be taken by the stockholders of the
  Corporation must be effected at a duly called annual or special meeting of
  stockholders of the Corporation and may not be effected by any consent in
  writing of such stockholders in lieu of a meeting.
 
  Special meetings of the stockholders of the Corporation may be called only
by (i) the Chairman or Vice Chairman of the Board of Directors or (ii) the
Secretary of the Corporation within 10 calendar days after receipt of the
written request of a majority of the total number of directors which the
Corporation would have if there were no vacancies (the "Whole Board").
 
  Meetings of stockholders may be held within or without the State of
Delaware, as the Bylaws may provide. The books of the Corporation may be kept
outside the State of Delaware at such place or places as may be designated
from time to time by the Board of Directors or in the Bylaws.
 
    7. A. Subject to the rights of any holders of any class or series of
  capital stock as specified in the resolution providing for such class or
  series of capital stock, the business and affairs of the Corporation shall
  be managed by or under the direction of the Board of Directors consisting
  of not less than 3 nor more than 12 directors, the exact number of
  directors to be determined from time to time solely by resolution adopted
  by the affirmative vote of a majority of the Whole Board. The directors
  shall be divided into three classes, designated Class I, Class II and Class
  III. Each Class of directors shall consist, as nearly as may be possible,
  of one-third of the total number of directors constituting the Whole Board.
  The initial term of the Class I directors shall expire upon the election
  and qualification of their successors at the 1998 annual meeting of
  stockholders; the initial term of the Class II directors shall expire upon
  the election and qualification of their successors at the 1999 annual
  meeting of stockholders; and the initial term of the Class III directors
  shall expire upon the election and qualification of their successors at the
  2000 annual meeting of stockholders. At each annual meeting of stockholders
  beginning with the 1998 annual meeting, successors to the Class of
  directors whose term expires at that annual meeting shall be elected for a
  three-year term and shall hold office until the annual meeting for the year
  in which his or her term expires and
 
                                      A-2
<PAGE>
 
  until his or her successor shall be elected and shall qualify, subject,
  however, to prior death, resignation, retirement, disqualification or
  removal from office.
 
    B. Subject to the rights of any holders of any class or series of capital
  stock as specified in the resolution providing for such class or series of
  capital stock, newly created directorships resulting from any increase in
  the number of directors and any vacancies on the Board of Directors
  resulting from death, resignation, retirement, disqualification, removal or
  other cause will be filled solely by the affirmative vote of a majority of
  the remaining directors then in office, even though less than a quorum of
  the Board of Directors. Increases or decreases in the number of directors
  shall be apportioned among the Classes so as to maintain the number of
  directors in each Class as nearly equal as possible, and any additional
  director of any Class elected to fill a vacancy resulting from an increase
  in such Class shall hold office for a term that shall coincide with the
  remaining term of that Class, but in no case will a decrease in the number
  of directors shorten the term of any incumbent director.
 
    C. The election of directors need not be by written ballot unless the
  Bylaws shall so provide.
 
    D. Notwithstanding the foregoing, whenever the holders of any one or more
  class or series of capital stock shall have the right, voting separately as
  a class or series, to elect directors, the election, removal, term of
  office, filling of vacancies and other features of such directorships shall
  be governed by the terms of this Restated Certificate of Incorporation
  applicable thereto, and such directors so elected shall not be divided into
  classes pursuant to Article 6, Section A, unless expressly provided by such
  terms.
 
    8. The affirmative vote of the holders of the outstanding shares of
  capital stock representing not less than two-thirds of the Voting Power (as
  defined) of the Corporation shall be required for the approval of any
  proposal for the Corporation to dissolve, liquidate, merge, or consolidate
  with any other entity (other than an entity 90% of the Voting Power of
  which is owned by the Corporation), or sell, lease or exchange all or
  substantially all of its property and assets, including its goodwill and
  its corporate franchises. "Voting Power" means the total number of votes
  that may be cast by holders of capital stock in the election of directors.
 
    9. The Corporation reserves the right to amend, alter, change or repeal
  any provision contained in this Restated Certificate of Incorporation, in
  the manner now or hereafter prescribed by statute, and all rights conferred
  upon stockholders herein are granted subject to this reservation.
  Notwithstanding anything contained in this Restated Certificate of
  Incorporation to the contrary, the affirmative vote of the holders of the
  outstanding shares of capital stock representing not less than two-thirds
  of the Voting Power of the Corporation shall be required to amend, alter,
  change or repeal, or to adopt any provision inconsistent with, Article 8 of
  this Restated Certificate of Incorporation. The Board of Directors shall
  have the power to make, adopt, alter, amend, change or repeal the Bylaws by
  resolution adopted by the affirmative vote of a majority of the Whole
  Board. Stockholders may not make, adopt, alter, amend, change or repeal the
  Bylaws except upon the affirmative vote of the holders of the outstanding
  shares of capital stock representing not less than two-thirds of the Voting
  Power of the Corporation and no Bylaws hereafter adopted by the
  stockholders or otherwise shall invalidate any prior act of the directors
  which would have been valid if such Bylaws had not been adopted.
 
    10. A. No director of the Corporation shall be liable to the Corporation
  or its stockholders for monetary damages for breach of fiduciary duty as a
  director, except for liability (i) for any breach of the director's duty of
  loyalty to the Corporation or its stockholders, (ii) for acts or omissions
  not in good faith or which involve intentional misconduct or a knowing
  violation of law, (iii) under Section 174 of the GCL, or (iv) for any
  transaction from which the director derived an improper personal benefit.
  No amendment to or repeal of this Article 10 shall apply to or have any
  effect on the liability or alleged liability of any director of the
  Corporation for or with respect to any acts or omissions of such director
  occurring prior to such amendment or repeal. If the GCL is amended
  hereafter to further limit the liability of a director, then the liability
  of a director of the Corporation shall be further limited to the fullest
  extent permitted by the GCL, as so amended.
 
    B. The Corporation shall indemnify each person who is or was or has
  agreed to become a director or officer of the Corporation, and may
  indemnify other employees and agents of the Corporation, to the fullest
 
                                      A-3
<PAGE>
 
  extent permitted by Section 145 of the GCL, as the same may be amended or
  supplemented, against all expenses and liabilities (including, but not
  limited to, counsel fees) reasonably incurred by or imposed upon such
  person in connection with any proceeding to which he or she may be made a
  party, or in which he or she may become involved, by reason of his or her
  being or having been a director, officer, employee or agent of the
  Corporation, or any settlement thereof, whether or not he or she is a
  director, officer, employee or agent at the time such expenses are incurred
  or liability incurred, except in such cases where the director, officer,
  employee or agent is adjudged guilty of willful misfeasance or malfeasance
  in the performance of his or her duties; provided that in the event of a
  settlement the indemnification herein shall apply only when the Board of
  Directors approves such settlement and reimbursement as being for the best
  interests of the Corporation. Without limiting the generality or the effect
  of the foregoing, the Corporation may adopt Bylaws, or enter into one or
  more agreements with any person, which provide for indemnification greater
  or different than that provided in this Article 10 or the GCL and the
  foregoing right of indemnification shall be in addition to and not
  exclusive of all other rights to which such director, officer, employee or
  agent may be entitled.
 
    C. The Corporation may purchase insurance on behalf of any person who is
  a director, officer, employee or agent of the Corporation, or is or was
  serving at the request of the Corporation as a director, officer, employee
  or agent of another corporation, partnership, joint venture, trust or other
  enterprise against any liability asserted by him or her and incurred by him
  or her in any such capacity, or arising out of his or her status as such,
  whether or not the Corporation would have the power or the obligation to
  indemnify him or her against such liability under the provisions of this
  Article 10.
 
    11. The Board of Directors, each committee of the Board of Directors and
  each individual director, in discharging their respective duties under
  applicable law and this Restated Certificate of Incorporation and in
  determining what they each believe to be in the best interests of the
  Corporation and its stockholders, may consider the effects, both short-term
  and long-term, of any action or proposed action taken or to be taken by the
  Corporation, the Board of Directors or any committee of the Board of
  Directors on the interests of (i) the employees, franchisees, licensees,
  customers, suppliers and/or creditors of the Corporation and its
  subsidiaries and (ii) the communities in which the Corporation and its
  subsidiaries own or lease property or conduct business, all to the extent
  that the Board of Directors, any committee of the Board of Directors or any
  individual director deems pertinent under the circumstances; provided,
  however, that the provisions of this Article 11 shall not limit in any way
  the right of the Board of Directors to consider any other lawful factors in
  making its determinations, including, without limitation, the effects, both
  short-term and long-term, or any action or proposed action on the
  Corporation or its stockholders directly; and provided further that this
  Article 11 shall be deemed solely to grant discretionary authority to the
  Board of Directors, each committee of the Board of Directors and each
  individual director and shall not be deemed to provide to any specific
  constituency any right to be considered.
 
    12. Whenever a compromise or arrangement is proposed between this
  Corporation and its creditors or any class of them and/or between this
  Corporation and its stockholders or any class of them, any court of
  equitable jurisdiction within the State of Delaware may, on the application
  in a summary way of this Corporation or of any creditor or stockholder
  thereof or on the application of any receiver or receivers appointed for
  this Corporation under the provisions of Section 291 of the GCL or on the
  application of trustees in dissolution or of any receiver or receivers
  appointed for this Corporation under the provisions of Section 279 of the
  GCL, order a meeting of the creditors or class of creditors, and/or of the
  stockholders or class of stockholders of this Corporation, as the case may
  be, to be summoned in such manner as the said court directs. If a majority
  in number representing three-fourths in value of the creditors or class of
  creditors, and/or of the stockholders or class of stockholders of this
  Corporation, as the case may be, agree to any compromise or arrangement and
  to any reorganization of this Corporation as consequence of such compromise
  or arrangement, the said compromise or arrangement and the said
  reorganization shall, if sanctioned by the court to which the said
  application has been made, be binding on all the creditors or class of
  creditors, and/or on all the stockholders or class of stockholders, of this
  Corporation, as the case may be, and also on this Corporation.
 
 
                                      A-4
<PAGE>
 
  IN WITNESS WHEREOF, the Corporation has caused this Restated Certificate of
Incorporation to be duly executed in its corporate name.
 
Dated:     , 1997
 
                                          -------------------------------------
                                          Name:   Stewart Bainum, Jr.
                                                  Chairman
 
 
                                      A-5
<PAGE>
 
                                                                        ANNEX B
 
                                    FORM OF
 
                             AMENDED AND RESTATED
 
                                   BYLAWS OF
 
                       CHOICE HOTELS INTERNATIONAL, INC.
             (FORMERLY KNOWN AS "CHOICE HOTELS FRANCHISING, INC."
               AND HEREINAFTER REFERRED TO AS THE "CORPORATION")
 
                      AS AMENDED AND RESTATED,       1997
 
                                   ARTICLE I
 
                                    OFFICES
 
  Section 1. Office. The registered office of the Corporation shall be in the
City of Wilmington, County of New Castle, State of Delaware.
 
  Section 2. Additional Offices. The Corporation may also have offices at such
other places, both within and without the State of Delaware, as the Board of
Directors may from time to time determine or as the business of the
Corporation may require.
 
                                  ARTICLE II
 
                           MEETINGS OF STOCKHOLDERS
 
  Section 1. Time and Place. Meetings of stockholders for any purpose may be
held at such time and place, within or without the State of Delaware, as the
Board of Directors may fix from time to time and as shall be stated in the
notice of the meeting or in a duly executed waiver of notice thereof.
 
  Section 2. Annual Meeting. Annual meetings of stockholders shall be held on
any date in the month of September or October in each year at 9:00 a.m. or at
such other [time and such] date and time as shall be designated, from time to
time, by the Board of Directors and stated in the notice of the meeting. At
such annual meeting, the stockholders shall elect directors and transact such
other business as may properly be brought before the meeting in accordance
with Section 7 of this Article II.
 
  Section 3. Notice of Annual Meeting. Written notice of the annual meeting
stating the place, date and time thereof shall be given to each stockholder
entitled to vote at such meeting not less than 10 nor more than 60 days prior
to the meeting.
 
  Section 4. List of Stockholders. The officer in charge of the stock ledger
of the Corporation or the transfer agent shall prepare and make, at least 10
days before every meeting of stockholders, a complete list of the stockholders
entitled to vote at the meeting, arranged in alphabetical order, and showing
the address of each stockholder and the number of shares registered in the
name of each stockholder. Such list shall be open to the examination of any
stockholder for any purpose germane to the meeting, during ordinary business
hours, for a period of at least 10 days prior to the meeting either at a place
within the city where the meeting is to be held (other than the place of the
meeting), which place shall be specified in the notice of the meeting, or, if
not so specified, at the place where the meeting is to be held. The list shall
also be produced and kept at the time and place of the meeting during the
whole time thereof, and may be inspected by any stockholder who is present.
 
  Section 5. Notice of Special Meeting. Written notice of a special meeting
stating the place, date and time thereof and the purpose or purposes for which
the meeting is called, shall be given to each stockholder entitled to vote at
such meeting not less than 10 nor more than 60 days prior to the meeting.
 
                                      B-1
<PAGE>
 
  Section 6. Stockholder Proposals. To be properly brought before an annual
meeting, business must be (1) specified in the notice of meeting (or any
supplement thereto) given by or at the direction of the Board of Directors,
(2) otherwise properly brought before the meeting by or at the direction of
the Board of Directors or (3) otherwise properly brought before the meeting by
a stockholder entitled to vote thereon. For business to be properly brought
before an annual meeting by a stockholder, the stockholder must have given
timely notice thereof in writing to the Secretary of the Corporation. To be
timely, a stockholder's notice must be received not less than sixty days nor
more than ninety days prior to the first anniversary of the preceding year's
annual meeting; provided, however, that in the event that the date of the
annual meeting is advanced by more than thirty days or delayed by more than
sixty days from such anniversary, notice by the stockholder to be timely must
be so received not earlier than the ninetieth day prior to such annual meeting
and not later than the close of business on the later of (1) the sixtieth day
prior to such annual meeting or (2) the tenth day following the date on which
notice of the date of the annual meeting was mailed or public disclosure
thereof was made by the Corporation, whichever first occurs. For purposes of
calculating the first such notice period following adoption of this Restated
Certificate of Incorporation. the first anniversary of the 1997 annual meeting
shall be deemed to be    , 1998. Each such notice shall set forth as to each
matter the stockholder proposes to bring before the annual meeting: (a) a
brief description of the business desired to be brought before the annual
meeting and the reasons for conducting such business at the meeting, (b) the
name and address, as they appear on the Corporation's books, of the
stockholder proposing such business and the name and address of the beneficial
owner on whose behalf the proposal is being made, (c) the class, series and
number of shares of the Corporation which are beneficially owned by the
stockholder or by the beneficial owner on whose behalf the proposal is being
made, (d) any material interest of the stockholder, or the beneficial owner on
whose behalf the proposal is being made, in such business, (e) a
representation that the stockholder is a holder of record of stock of the
Corporation entitled to vote at such meeting and intends to appear in person
or by proxy at the meeting, and (f) a description of all arrangements or
understandings between the stockholder, the beneficial owner on whose behalf
the proposal is being made, or any other person or persons (naming such person
or persons) relating to the matter being proposed.
 
  To be properly brought before a special meeting, business must be (1)
specified in the notice of meeting (or any supplement thereto) given by or at
the direction of the Board of Directors or (ii) otherwise properly brought
before the meeting by or at the direction of the Board of Directors,
 
  No business shall be conducted at any meeting of the stockholders except in
accordance with the procedures set forth in this Article II, Section 6. The
presiding officer of the meeting shall, if the facts warrant, determine and
declare to the meeting that business was not properly brought before the
meeting and in accordance with the provisions of this Article II, Section 6
and if he or she should so determine, any such business not properly brought
before the meeting shall not be transacted. Nothing herein shall be deemed to
affect any rights of stockholders to request inclusion of proposals in the
Corporation's proxy statement pursuant to Rule 14a-8 under the Securities
Exchange Act of 1934, as amended (the "Exchange Act").
 
  Section 7. Presiding Officer. Meetings of stockholders shall be presided
over by the Chairman of the Board, or, if he is not present, by the Vice
Chairman, or, if he is not present, by the Chief Executive Officer, or if he
is not present, by the President or, if he is not present, by such person who
may have been chosen by the Board of Directors or, if none of such persons is
present, by a chairman to be chosen by the stockholders owning a majority of
the shares of capital stock of the Corporation issued and outstanding and
entitled to vote at the meeting and who are present in person or by proxy. The
Secretary of the Corporation or, if he is not present, an Assistant Secretary
or, if he is not present, such person who may have been chosen by the Board of
Directors, shall act as secretary of meetings of stockholders, but if none of
such persons is present the stockholders owning a majority of the Voting Power
of the Corporation and who are present in person or by proxy shall choose any
person present to act as secretary of the meeting. "Voting Power" means the
total number of votes that may be cast by holders of capital stock in the
election of directors.
 
  Section 8. Quorum. The holders of a majority of the Voting Power of the
Corporation, present in person or represented by proxy, shall be necessary to,
and shall constitute a quorum for, the transaction of business at
 
                                      B-2
<PAGE>
 
all meetings of stockholders, except as otherwise provided by statute or by
the Certificate of Incorporation. If, however, a quorum shall not be present
in person or by proxy at any meeting of the stockholders, the stockholders
entitled to vote thereat, present in person or represented by proxy, shall
have the power to adjourn the meeting from time to time, without notice of the
adjourned meeting if the time and place thereof are announced at the meeting
at which the adjournment is taken, until a quorum shall be present in person
or by proxy. At any meeting of the stockholders, the stockholders entitled to
vote thereat, present in person or represented by proxy, shall have the power
to adjourn the meeting from time to time for good cause, without notice of the
adjourned meeting if the time and place thereof are announced at the meeting
at which the adjournment is taken. until a date which is not more than 30 days
after the date of the original meeting. At such adjourned meeting, at which a
quorum shall be present in person or by proxy, any business may be transacted
which might have been transacted at the meeting as originally called. If the
adjournment is for more than 30 days, or if after the adjournment a new record
date is fixed for the adjourned meeting, a notice of the adjourned meeting
shall be given to each stockholder of record entitled to vote at the meeting.
 
  Section 9. Voting.
 
    (a) At any meeting of stockholders, every stockholder having the right to
  vote shall be entitled to vote in person or by proxy. Except as otherwise
  provided by law or the Certificate of Incorporation or a resolution of the
  Board of Directors creating a series or class of capital stock of the
  Corporation, each stockholder of record shall be entitled to one vote for
  each share of capital stock registered in his name on the books of the
  Corporation.
 
    (b) All elections shall be determined by a plurality vote, and except as
  otherwise provided by law or the Certificate of Incorporation, all other
  matters shall be determined by a vote of a majority of the Voting Power
  present in person or by proxy and voting, on such other matters.
 
                                  ARTICLE III
 
                                   DIRECTORS
 
  Section 1. General Powers: Number: Tenure. The business of the Corporation
shall be managed by its Board of Directors, which may exercise all powers of
the Corporation and perform all lawful acts and things as are not by law, the
Certificate of Incorporation or these Bylaws directed or required to be
exercised or performed by the stockholders. The number of directors
constituting the whole Board of Directors shall be not less than 3 nor more
than 12. The first Board of Directors shall consist of 9 directors.
Thereafter, within the limits above specified, the number of directors shall
be determined by the Board of Directors. The directors shall be elected and
shall hold office as specified in the Certificate of Incorporation. Directors
need not be stockholders. Directors, other than Stewart Bainum, Sr., shall
retire from the Board of Directors as of the annual meeting of stockholders
next following the date they attain the age of seventy (70) years.
 
  Section 2. Nomination of Directors. Any stockholder entitled to vote in the
election of directors generally may nominate one or more persons for election
as directors at an annual meeting only pursuant to the Corporation's notice of
such meeting or if written notice of such stockholder's intent to make such
nomination or nominations has been received by the Secretary of the
Corporation not less than sixty nor more than ninety days prior to the first
anniversary of the preceding year's annual meeting; provided, however, that in
the event that the date of the annual meeting is advanced by more than thirty
days or delayed by more than sixty days from such anniversary, notice by the
stockholder to be timely must be so received not earlier than the ninetieth
day prior to such annual meeting and not later than the close of business on
the later of (1) the sixtieth day prior to such annual meeting or (2) the
tenth day following the day on which notice of the date of the annual meeting
was mailed or public disclosure thereof was made by the Corporation, whichever
first occurs. For purposes of calculating the first such notice period
following adoption of this Restated Certificate of Incorporation, the first
anniversary of the 1997 annual meeting, shall be deemed to be      1998. Each
such notice shall set forth: (a) the name and address of the stockholder who
intends to make the nomination and the name, age, business
 
                                      B-3
<PAGE>
 
address, residence address and principal occupation of the person or persons
to be nominated; (b) a representation that the stockholder is a holder of
record of stock of the Corporation entitled to vote at such meeting and
intends to appear in person or by proxy at the meeting to nominate the person
or persons specified in the notice; (c) a description of all arrangements or
understandings between the stockholder and each nominee and any other person
or persons (naming, such person or persons) relating to the nomination or
nominations; (d) the class and number of shares of the Corporation which are
beneficially owned by such stockholder and the person to be nominated as of
the date of such stockholder's notice and by any other stockholders known by
such stockholder to be supporting such nominees as of the date of such
stockholder's notice; (e) such other information regarding each nominee
proposed by such stockholder as would be required to be included in a proxy
statement filed pursuant to the proxy rules of the Securities and Exchange
Commission: and (f) the consent of each nominee to serve as a director of the
Corporation if so elected.
 
  In addition, in the event the Corporation calls a special meeting of
stockholders for the purpose of electing one or more directors, any
stockholder entitled to vote in the election of directors generally may
nominate one or more persons for election as directors at a special meeting
only pursuant to the Corporation's notice of meeting or if written notice of
such stockholder's intent to make such nomination or nominations, setting
forth the information and complying with the form described in the immediately
preceding paragraph, has been received by the Secretary of the Corporation not
earlier than the ninetieth day prior to such special meeting and not later
than the close of business on the later of (i) the sixtieth day prior to such
special meeting or (ii) the tenth day following the day on which notice of the
date of the special meeting was mailed or public disclosure thereof was made
by the Corporation, whichever comes first.
 
  No person shall be eligible for election as a director of the Corporation
unless nominated in accordance with the procedures set forth in this Article
III, Section 2. The presiding officer of the meeting shall, if the facts
warrant, determine and declare to the meeting that a nomination was not made
in accordance with the procedures prescribed by this Article III, Section 2;
and if he or she should so determine, the defective nomination shall be
disregarded.
 
  Section 3. Vacancies: Resignations.
 
    (a) If any vacancies occur in the Board of Directors, or if any new
  directorships are created, they shall be filled solely by a majority of the
  directors then in office, whether or not less than a quorum. Each director
  so chosen shall hold office until the expiration of the term of the class
  into which such director was elected and until his successor is duly
  elected and qualified. If there are no directors in office a special
  meeting of stockholders shall be called in accordance with the provisions
  of the Certificate of Incorporation or these Bylaws, at which meeting such
  vacancies shall be filled.
 
    (b) Any director may resign at any time by giving written notice to the
  Board of Directors, the Chairman of the Board, the Chief Executive Officer,
  the President or the Secretary of the Corporation. Unless otherwise
  specified in such written notice, a resignation shall take effect upon
  delivery thereof to the Board of Directors or the designated officer. It
  shall not be necessary for a resignation to be accepted before it becomes
  effective.
 
  Section 4. Place of Meeting. The Board of Directors may hold meetings, both
regular and special, either within or without the State of Delaware.
 
  Section 5. First Meeting. The first regular meeting of each newly elected
Board of Directors shall be held immediately following the annual meeting of
stockholders and no notice of such meeting shall be necessary to the newly
elected directors in order legally to constitute the meeting, provided a
quorum shall be present.
 
  Section 6. Regular Meetings. Additional regular meetings of the Board of
Directors may be held without notice, at such time and place as may from time
to time be determined by the Board of Directors.
 
  Section 7. Special Meetings. Special meetings of the Board of Directors may
be called by the Chairman of the Board of Directors or, in the event of his
disability, by the Vice Chairman, on 2 days' notice to each
 
                                      B-4
<PAGE>
 
director in accordance with Article V. Special meetings shall be called by the
Chairman of the Board, Vice Chairman, Chief Executive Officer, President or
Secretary in like manner and on like notice on the written request of 4
directors or one-half (1/2) of the number of directors. whichever is less.
 
  Section 8. Quorum. At all meetings of the Board of Directors one-half (1/2)
of the number of directors then in office, or such greater number as equals
one-third (1/3) of the total number of directors shall constitute a quorum
for the transaction of business and the act of a majority of the directors
present at any meeting at which there is a quorum shall be the act of the
Board of Directors, except as may be otherwise specifically provided by law or
the Certificate of Incorporation. If a quorum is not present at any meeting of
the Board of Directors, the directors present may adjourn the meeting, from
time to time, without notice other than announcement at the meeting, until a
quorum shall be present.
 
  Section 9. Compensation. Directors shall be entitled to such compensation
for their services as directors and to such reimbursement for any reasonable
expenses incurred in attending directors' meetings as may from time to time be
fixed by the Board of Directors. The compensation of directors may be on such
basis as is determined by the Board of Directors. Any director may waive
compensation for any meeting. Any director receiving compensation under these
provisions shall not be barred from serving the Corporation in any other
capacity and receiving reasonable compensation for such other services.
 
  Section 10. Action by Consent. Any action required or permitted to be taken
at any meeting of the Board of Directors may be taken without a meeting if a
written consent to such action is signed by all members of the Board of
Directors and such written consent is filed with the minutes of its
proceedings.
 
                                  ARTICLE IV
 
                                  COMMITTEES
 
  Section 1. Executive Committee. The Board of Directors may appoint Executive
Committee consisting of not less than    directors, one of whom shall be
designated as Chairman of the Executive Committee.
 
  Section 2. Powers. The Executive Committee shall have and may exercise those
powers of the Board of Directors as may from time to time be granted to it by
the Board of Directors.
 
  Section 3. Procedure, Meetings. The Executive Committee shall fix its own
rules of procedure and shall meet at such times and at such place or places as
may be provided by such rules. The Executive Committee shall keep regular
minutes of its meetings and deliver such minutes to the Board of Directors.
 
  The Chairman of the Executive Committee, or, in his absence, a member of the
Executive Committee chosen by a majority of the members present, shall preside
at meetings of the Executive Committee and another member thereof chosen by
the Executive Committee shall act as Secretary of the Executive Committee.
 
  Section 4. Quorum. A majority of the Executive Committee shall constitute a
quorum for the transaction of business, and the affirmative vote of a majority
of the members thereof shall be required for any action of the Executive
Committee.
 
  Section 5. Other Committees. The Board of Directors may appoint such other
committee or committees as it shall deem advisable and with such functions and
duties as the Board of Directors shall prescribe.
 
  Section 6. Vacancies: Changes: Discharge. The Board of Directors shall have
the power at any time to fill vacancies in, to change the membership of, and
to discharge, any such committee.
 
  Section 7. Compensation. Members of any committee shall be entitled to such
compensation for their services as members of any such committee and to such
reimbursement for any reasonable expenses incurred in attending committee
meetings as may from time to time be fixed by the Board of Directors. Any
member may waive compensation for any meeting.
 
                                      B-5
<PAGE>
 
  Section 8. Action by Consent. Any action required or permitted to be taken
at any meeting of any committee of the Board of Directors may be taken without
a meeting, if written consent to such action is signed by all members of the
committee and such written consent is filed with the minutes of its
proceedings.
 
                                   ARTICLE V
 
                                    NOTICES
 
  Section 1. Form; Delivery. Whenever, under the provisions of law, the
Certificate of Incorporation or these Bylaws, notice is required to be given
to any director or stockholder, it shall not be construed to mean personal
notice unless otherwise specifically provided, but such notice may be given by
regular or overnight mail, addressed to such director or stockholder at his or
her address as it appears on the records of the Corporation, with postage
thereon prepaid. Notices given by regular mail shall be deemed to be given at
the time they are deposited in the United States mail. Notice to a director
may also be given personally, by telegram sent to his address as it appears on
the records of the Corporation, by facsimile (with a machine generated
confirmation) or by telephone.
 
  Section 2. Waiver. Whenever any notice is required to be given under the
provisions of law, the Certificate of Incorporation or these Bylaws, a written
waiver thereof signed by the person or persons entitled to said notice,
whether before or after the time stated therein, shall be deemed to be
equivalent to such notice. In addition, any stockholder who attends a meeting
of stockholders in person, or is represented at such meeting by proxy, without
protesting prior to the conclusion of the meeting the lack of notice thereof
to him, or any director who attends a meeting of the Board of Directors
without protesting, prior to the commencement of the meeting such lack of
notice, shall be conclusively deemed to have waived notice of such meeting.
 
                                  ARTICLE VI
 
                                   OFFICERS
 
  Section 1. Designations. The officers of the Corporation shall be chosen by
the Board of Directors and shall be a Chairman of the Board, Vice Chairman of
the Board, a Chief Executive Officer, a President, a Secretary and a
Treasurer. The Board of Directors may also choose one or more Executive or
Senior Vice Presidents, one or more additional vice presidents, one or more
assistant secretaries and assistant treasurers, and such other officers and
agents as it shall deem necessary. All officers of the Corporation shall hold
their offices for such terms and shall exercise such powers and perform such
duties as shall from time to time be determined by the Board of Directors. Any
number of offices may be held by the same person, unless the Certificate of
Incorporation or these Bylaws otherwise provide.
 
  Section 2. Term of Office, Removal. The Board of Directors at its first
meeting after each annual meeting of stockholders shall choose a Chairman, a
Vice Chairman, a Chief Executive Officer, a President, a Secretary and a
Treasurer and such other officers as the Board of Directors shall deem
appropriate. The officers of the Corporation shall hold office until their
successors are chosen and shall qualify. Any officer elected or appointed by
the Board of Directors may be removed, with or without cause, at any time by
the affirmative vote of a majority of the directors then in office. Such
removal shall not prejudice the contract rights, if any, of the person so
removed. Any vacancy occurring in any office of the Corporation may be filled
by the Board of Directors.
 
  Section 3. Compensation. The salaries of all officers of the Corporation
shall be fixed by the Board of Directors.
 
  Section 4. The Chairman of the Board.
 
    (a) The Chairman of the Board shall have general direction of the
  business affairs of the Corporation, subject to the control of the Board of
  Directors. The Chairman shall preside at all meetings of stockholders
 
                                      B-6
<PAGE>
 
  and the Board of Directors which he shall attend. Except where, by law, the
  signature of the President is required, the Chairman shall possess the same
  power as the President to execute all certificates, contracts, bonds,
  mortgages and other instruments of the Corporation.
 
    (b) Unless otherwise prescribed by the Board of Directors, the Chairman
  shall have full power and authority on behalf of the Corporation to attend,
  act and vote at any meeting of security holders of other corporations in
  which the Corporation may hold securities. At such meeting, the Chairman
  shall possess and may exercise any and all rights and powers incident to
  the ownership of such securities which the Corporation might have possessed
  and exercised if it had been present. The Board of Directors may from time
  to time confer like powers upon any other person or persons.
 
  Section 5. Vice Chairman. The Vice Chairman shall, in the absence of the
Chairman of the Board or in the event of his disability, preside at all
meetings of the Board of Directors and stockholders and perform the duties and
exercise the powers of the Chairman of the Board and shall perform such other
duties and have such other powers as may from time to time be prescribed by
the Board of Directors.
 
  Section 6. Chief Executive Officer. The Chief Executive Officer shall be the
chief administrator of the Corporation and shall have general direction of
administration of the business affairs of the Corporation, subject to the
direction of the Board of Directors, and shall perform such other duties and
have such other powers as may from time to time be prescribed by the Board of
Directors.
 
  Section 7. The President. The President shall be the chief operations
officer of the Corporation and shall have general direction of the operation
of the Corporation, subject to the direction of the Chief Executive Officer
and the Board of Directors, and shall perform such other duties and shall have
such other powers as may from time to time be prescribed by the Board of
Directors.
 
  Section 8. The Vice Presidents. The Vice President (or in the event there by
more than one, the Vice Presidents in the order designated, or in the absence
of any designation, then in order of their election) shall, in the absence of
the President or in the event of his disability, perform the duties and
exercise the powers of the President and shall generally assist the President
and perform such other duties and have such other powers as may from time to
time be prescribed by the Board of Directors.
 
  Section 9. The Secretary. The Secretary shall attend all meetings of the
Board of Directors and all meetings of stockholders and record all votes and
the proceedings of the meetings in a book to be kept for that purpose and
shall perform like duties for the Executive Committee or other committees, if
required. He shall give, or cause to be given, notice of all meetings of
stockholders and special meetings of the Board of Directors, and shall perform
such other duties as may from time to time be prescribed by the Board of
Directors, the Chairman of the Board or the President, under whose supervision
he shall act. He shall have custody of the seal of the Corporation and he, or
an Assistant Secretary, shall have authority to affix the same to any
instrument requiring it and, when so affixed, the seal may be attested by his
signature or by the signature of such Assistant Secretary. The Board of
Directors may give general authority to any other officer to affix the seal of
the Corporation and to attest the affixing thereof by his signature.
 
  Section 10. The Assistant Secretary. The Assistant Secretary (or in the
event there be more than one, the Assistant Secretaries in the order
designated, or in the absence of any designation, then in the order of their
election) shall, in the absence of the Secretary or in the event of his
disability, perform the duties and exercise the powers of the Secretary and
shall perform such other duties and have such other powers as may from time to
time be prescribed by the Board of Directors.
 
  Section 11. The Treasurer. The Treasurer shall have the custody of the
corporate funds and other valuable effects, including securities, and shall
keep full and accurate accounts of receipts and disbursements in books
belonging to the Corporation and shall deposit all moneys and other valuable
effects in the name and to the credit of the Corporation in such depositories
as may from time to time be designated by the Board of Directors. He shall
disburse the funds of the Corporation as may be ordered by the Board of
Directors, taking
 
                                      B-7
<PAGE>
 
proper vouchers for such disbursements, and shall render to the Chairman of
the Board or the President, and the Board of Directors at regular meetings of
the Board, or whenever they may require it, an account of all of his
transactions as Treasurer and of the financial condition of the Corporation.
 
  Section 12. The Assistant Treasurer. The Assistant Treasurer (or in the
event there be more than one, the Assistant Treasurers in the order
designated, or in the absence of any designation, then in the order of their
election) shall, in the absence of the Treasurer or in the event of his
disability, perform the duties and exercise the powers of the Treasurer and
shall perform such other duties and have such other powers as may from time to
time be prescribed by the Board of Directors.
 
                                  ARTICLE VII
 
         INDEMNIFICATION OF OFFICERS, DIRECTORS, EMPLOYEES AND AGENTS
 
  Section 1. Action Other Than by or in the Right of the Corporation. The
Corporation shall indemnify any person who was or is a party or is threatened
to be made a party, to any threatened, pending or completed action, suit or
proceeding or investigation, whether civil, criminal or administrative, and
whether external or internal to the Corporation (other than a judicial action
or suit brought by or in the right of the Corporation) by reason of the fact
that he is or was a director, officer, employee or agent of the Corporation,
or that, being or having been such a director, officer, employee or agent, he
is or was serving at the request of the Corporation as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise (all such persons being referred to hereafter as an "Agent"),
against expenses (including attorneys' fees), judgments, fines and amounts
paid in settlement actually and reasonably incurred by him or her in
connection with such action, suit or proceeding, or any appeal thereof, if he
or she acted in good faith and in a manner he or she reasonably believed to be
in or not opposed to the best interests of the Corporation, and with respect
to any criminal action or proceeding, had no reasonable cause to believe his
or her conduct was unlawful. The termination of any action, suit or
proceeding--whether by judgment, order, settlement, conviction, or upon a plea
of nolo contendere or its equivalent -- shall not, of itself, create a
presumption that the person did not act in good faith and in manner which he
or she reasonably believed to be in or not opposed to the best interests of
the Corporation, or, with respect to any criminal action or proceeding, that
he or she had reasonable cause to believe that his or her conduct was
unlawful.
 
  Section 2. Action by or in the Right of the Corporation. The Corporation
shall indemnify any person who was or is a party or is threatened to be made a
party to any threatened, pending or completed juridical action or suit brought
by or in the right of the Corporation to procure a judgment in its favor by
reason of the fact that he or she is or was an Agent (as defined above)
against expenses (including attorneys' fees) actually and reasonably incurred
by him or her in connection with the defense, settlement or appeal of such
action or suit if he or she acted in good faith and in a manner he or she
reasonably believed to be in or not opposed to the best interests of the
Corporation, except that no indemnification shall be made in respect of any
claim, issue or matter as to which such person shall have been adjudged to be
liable for gross negligence or misconduct in the performance of his or her
duty to the Corporation unless and only to extent that the Court of Chancery
or the court in which such action or suit was brought shall have determined
upon application that, despite the adjudication of liability but in view of
all the circumstances of the case, such person is fairly and reasonably
entitled to indemnity for such expenses which the Court of Chancery or other
such court shall deem proper.
 
  Section 3. Determination of Right of Indemnification. No indemnification
under Section 1 or 2 of this Article VII (unless ordered by a court) shall be
made by the Corporation if a determination is reasonably and promptly made (i)
by the Board of Directors by a majority vote consisting of directors who were
not parties to such action, suit or proceeding, even though less than a quorum
or (ii) if there are no such directors or if such directors so direct, by
independent legal counsel in a written opinion, or (iii) by the stockholders.
that such person did not act in good faith and in a manner that such person
reasonably believed to be in or not opposed to the best interests of the
Corporation, or, with respect to any criminal proceeding, that such person
believed or had reasonable cause to believe that his or her conduct was
unlawful.
 
 
                                      B-8
<PAGE>
 
  Section 4. Indemnification Against Expenses of Successful
Party. Notwithstanding the other provisions of this Article, to the extent
that an Agent has been successful on the merits or otherwise, including the
dismissal of an action without prejudice or the settlement of an action
without admission of liability, in defense of any action, suit or proceeding
or in defense of any, claim, issue or matter therein, or on appeal from any
such proceeding, action, claim or matter, such Agent shall be indemnified
against all expenses actually and reasonably incurred in connection therewith.
 
  Section 5. Advances of Expenses. Except as limited by Section 6 of this
Article, expenses incurred in defending any civil, criminal, administrative or
investigative action, suit or proceeding or investigation or any appeal
therein shall be paid by the Corporation in advance of the final disposition
of such matter, if the Agent shall undertake to repay such amount in the event
that it is ultimately determined, as provided herein, that such person is not
entitled to indemnification. Notwithstanding the foregoing, no advance shall
be made by the Corporation if a determination is reasonably and promptly made
by the Board of Directors by a majority vote of disinterested directors, or
(if there are no such directors or such directors so direct) by independent
legal counsel in a written opinion, that, based upon the facts known to the
Board or counsel at the time such determination is made, such person did not
act in good faith and in a manner that such person believed to be in or not
opposed to the best interests of the Corporation, or, with respect to any
criminal proceeding, that such person believed or had reasonable cause to
believe his or her conduct was unlawful. In no event shall any advance be made
in instances where the Board of Directors or independent legal counsel
reasonably determines that such person deliberately breached his duty to the
Corporation or its shareholders.
 
  Section 6. Right of Agent to Indemnification Upon Application; Procedure
Upon Application. Any indemnification under Sections 1, 2, or 4. or advance
under Section 5 of this Article, shall be made promptly, and in any event
within ninety days, upon the written request of the Agent, unless with respect
to applications under Sections 1, 2 or 5, a determination is reasonably and
promptly be made by the Board of Directors by a majority vote of disinterested
directors that such Agent acted in a manner set forth in such Sections as to
justify the Corporation's not indemnifying or making an advance to the Agent.
In the event there are no such disinterested directors, the Board of Directors
shall promptly direct that independent legal counsel shall decide whether the
Agent acted in the manner set forth in such Sections as to justify the
Corporation's not indemnifying or making an advance to the Agent. The right to
indemnification or advances as granted by this Article shall be enforceable by
the Agent in any court of competent jurisdiction, if the Board or independent
legal counsel denies the claim, in whole or in part, or if no disposition of
such claim is made within ninety days. The Agent's expenses incurred in
connection with successfully establishing his right to indemnification, in
whole or in part, in any such proceeding shall also be indemnified by the
Corporation.
 
  Section 7. Contribution. In order to provide for just and equitable
contribution in circumstances in which the indemnification provided for in
this Article is held by a court of competent jurisdiction to be unavailable to
an indemnitee in whole or part, the Corporation, shall, in such an event,
after taking into account, among other things, contributions by other
directors and officers of the Corporation pursuant to indemnification
agreements or otherwise, and in the absence of personal enrichment, acts of
intentional fraud or dishonesty or criminal conduct on the part of the Agent,
contribute to the payment of Agent's losses to the extent that, after other
contributions are taken into account, such losses exceed: (i) in the case of a
director of the Corporation or any of its subsidiaries who is not an officer
of the Corporation or any of such subsidiaries, the amount of fees paid to him
or her for serving as a director during the 12 months preceding the
commencement of the suit, proceeding, or investigation; or (ii) in the case of
a director of the Corporation or any of its subsidiaries who is also an
officer of the Corporation or any of such Subsidiaries, the amount set forth
in clause (i) plus 5% of the aggregate cash compensation paid to said director
for such office(s) during the 12 months preceding the commencement of the
suit, proceeding, or investigation; or (iii) in the case of an officer of the
Corporation or any of its subsidiaries, 5% of the aggregate cash compensation
paid to such officer for service in such office(s) during the 12 months
preceding the commencement of such suit, proceeding or investigation.
 
  Section 8. Other Rights and Remedies. The indemnification provided by this
Article shall not be deemed exclusive of, and shall not affect, any other
rights to which an Agent seeking indemnification may be
 
                                      B-9
<PAGE>
 
entitled under any Bylaws, agreement, vote of stockholders or disinterested
directors or otherwise, both as to action in his official capacity and as to
action in another capacity while holding such office, and shall continue as to
a person who has ceased to be an Agent and shall inure to the benefit of the
heirs, executors and administrators of such a person. All rights to
indemnification under this Article shall be deemed to be provided by a
contract between the Corporation and the Agent who serves in such capacity, at
any time while these Bylaws and other relevant provisions of the General
Corporation Law and other applicable law, if any, are in effect. Any repeal or
modification thereof shall not affect any rights or obligations then existing.
 
  Section 9. Insurance. Upon resolution passed by the Board, the Corporation
may purchase and maintain insurance on behalf of any person who is or was an
Agent against any liability asserted against him and incurred by him in any
such capacity, or arising out of his status as such, whether or not the
Corporation would have the power to indemnify him against such liability under
the provisions of this Article. The Corporation may create a trust fund, grant
a security interest or use other means (including, without limitation, a
letter of credit) to ensure the payment of such sums as may become necessary
to effect indemnification as provided herein.
 
  Section 10. Constituent Corporations. For the purposes of this Article,
references to "the Corporation" include all constituent corporations absorbed
in a consolidation or merger as well as the resulting or surviving
corporation, so that any person who is or was a director, officer, employee,
or trustee of such a constituent corporation or who, being or having been such
a director, officer, employee or trustee, is or was serving at the request of
such constituent corporation as a director, officer, employee, trustee of
another corporation, partnership, joint venture, trust or other enterprise
shall stand in the same position under the provisions of this Article with
respect to the resulting or surviving corporation as he would if he had served
the resulting or surviving corporation in the same capacity.
 
  Section 11. Other Enterprises, Fines, and Serving at Corporation's
Request. References to "other enterprises" in Sections 1, 7 and 10 shall
include employee benefit plans; references to "fines" shall include any excise
taxes assessed on a person with respect to any employee benefit plan; and
references to "serving at the request of the Corporation" shall include any
service by Agent as director, officer, employee, trustee or agent of the
Corporation which imposes duties on, or involves services by, such Agent with
respect to any employee benefit plan, its participants, or beneficiaries; and
a person who acted in good faith and in a manner he reasonably believed to be
in the interests of the participants and beneficiaries of an employee benefit
plan shall be deemed to have acted in a manner "not opposed to the best
interests of the Corporation" as referred to in this Article.
 
  Section 12. Savings Clause. If this Article or any portion thereof shall be
invalidated on any ground by any court of competent jurisdiction, then the
Corporation shall nevertheless indemnify each Agent as to expenses (including
attorneys' fees), judgments, fines and amounts paid in settlement with respect
to any action, suit, appeal, proceeding or investigation, whether civil,
criminal or administrative, and whether internal or external, including a
grand jury proceeding and an action or suit brought by or in the right of the
Corporation, to the full extent permitted by any applicable portion of this
Article that shall not have been invalidated, or by any other applicable law.
 
                                 ARTICLE VIII
 
                              STOCK CERTIFICATES
 
  Section 1. Form: Signatures.
 
    (a) Every holder of stock in the Corporation shall be entitled to have a
  certificate, signed by the Chairman of the Board or the Chief Executive
  Officer and the Treasurer or an Assistant Treasurer or the Secretary or an
  Assistant Secretary of the Corporation, exhibiting the number, and class
  (and series, if any), of shares owned by him, and bearing the seal of the
  Corporation. Such seal may be a facsimile. Where a certificate is manually
  signed (i) by a transfer agent other than the Corporation or its employee
  or (ii) by a registrar other than the Corporation or its employee, the
  signature of any such officer may be a facsimile. In case any officer who
  has signed, or whose facsimile signature was placed on, a certificate shall
  have ceased to be such officer before such certificate is issued, it may
  nevertheless be issued by the Corporation with the same effect as if he
  were such officer at the date of its issue.
 
                                     B-10
<PAGE>
 
    (b) All stock certificates representing shares of capital stock which are
  subject to restrictions on transfer or to other restrictions, may have
  imprinted thereon a notation to such effect, as shall be determined by the
  Board of Directors.
 
  Section 2. Registration of Transfer. Upon surrender to the Corporation or
any transfer agent of the Corporation of a certificate for shares duly
endorsed or accompanied by proper evidence of succession, assignment or
authority to transfer, it shall be the duty of the Corporation or its transfer
agent to issue a new certificate to the person entitled thereto, to cancel the
old certificate and to record the transaction upon its books.
 
  Section 3. Registered Stockholders.
 
    (a) Except as otherwise provided by law, the Corporation shall be
  entitled to recognize the exclusive right of a person who is registered on
  its books as the owner of shares of capital stock to receive dividends or
  other distributions and to vote as such owner, and to hold liable for calls
  and assessments a person who is registered on its books as the owner of
  shares of its capital stock. The Corporation shall not be bound to
  recognize any equitable or legal claim to or interest in such shares on the
  part of any other person.
 
    (b) Stockholders are responsible for giving written notice to the
  Corporation or the transfer agent and registrar, if any, of any change of
  name or address, and failure to do so shall relieve the Corporation, its
  directors, officers and agents, and its transfer agent and registrar, if
  any, of liability for failure to send notices or pay dividends or other
  distributions to a name or address other than the name or address appearing
  on the stock ledger maintained by the Corporation or by the transfer agent
  and registrar, if any.
 
  Section 4. Lost, Stolen or Destroyed Certificates. The Board of Directors
may direct a new certificate to be issued in place of any certificate
theretofore issued by the Corporation which is claimed to have been lost,
stolen or destroyed, upon the making of an affidavit of that fact by the
person claiming the certificate of stock to be lost, stolen or destroyed. When
authorizing such issue of a new certificate, the Board of Directors may, in
its discretion and as a condition precedent to the issuance thereof, require
the owner of such lost. stolen or destroyed certificate. or his legal
representative, to advertise the same in such manner as it shall require
and/or to give the Corporation a bond in such sum as it may direct as
indemnity against any claim that may be made against the Corporation with
respect to the certificate claimed to have been lost, stolen or destroyed.
 
                                  ARTICLE IX
 
                              GENERAL PROVISIONS
 
  Section 1. Dividends. Subject to the provisions of the Certificate of
Incorporation, dividends upon the outstanding capital stock of the Corporation
may be declared by the Board of Directors at any regular or special meeting,
pursuant to law, and may be paid in cash, in property, or in shares of the
Corporation's capital stock.
 
  Section 2. Reserves. The Board of Directors shall have full power, subject
to the provisions of law and the Certificate of Incorporation, to determine
whether any, and, if so, what part, of the funds legally available for the
payment of dividends shall be declared as dividends and paid to the
stockholders of the Corporation. The Board of Directors may fix a sum which
may be set aside or reserved over and above the paid-in capital of the
Corporation for working capital or as a reserve for any proper purpose, and
may, from time to time, increase or diminish any such fund in its absolute
judgment and discretion.
 
  Section 3. Fiscal Year. The fiscal year of the Corporation shall begin on
January 1 in each calendar year and end on December 31 in that calendar year.
 
  Section 4. Seal. The corporate seal shall have inscribed thereon the name of
the Corporation, the year of its incorporation and the words "Corporate Seal,
Delaware."
 
                                     B-11
<PAGE>
 
                                                                        ANNEX C
 
                        CHOICE HOTELS FRANCHISING, INC.
 
                         1997 LONG-TERM INCENTIVE PLAN
 
                                  SECTION ONE
 
                        Designation and Purpose of Plan
 
  The purpose of the Choice Hotels Franchising, Inc. 1997 Long-Term Incentive
Plan (the "Plan") is to increase the ownership of Company Stock by those
officers, professional staff and other key employees who are mainly
responsible for the continued growth and development and financial success of
the Company and its subsidiaries. Such stock ownership gives such employees a
proprietary interest in the Company which induces them to continue in its
employ. The Plan also enables the Company to attract and retain such employees
and reward them for the continued profitable performance of Choice Hotels
Franchising, Inc.
 
                                  SECTION TWO
 
                                  Definitions
 
  The following definitions are applicable herein:
 
  A. "Award"--Individually or collectively, Options, Stock Appreciation
Rights, Performance Shares or Restricted Stock granted hereunder.
 
  B. "Award Period"--the period of time during which a Stock Appreciation
Right which has not been granted pursuant to an Option may be exercised. The
Award Period shall be set forth in the document issuing the Stock Appreciation
Right to the selected Eligible Employee.
 
  C. "Board"--the Board of Directors of the Company.
 
  D. "Book Value"--the book value of a share of Stock determined in accordance
with the Company's regular accounting practices as of the last business day of
the month immediately preceding the month in which a Stock Appreciation Right
is exercised as provided in Section Nine D.
 
  E. "Code"--the Internal Revenue Code of 1986, as amended. Reference in the
Plan to any section of the Code shall be deemed to include any amendments or
successor provisions to such section and any regulations promulgated
thereunder.
 
  F. "Committee"--the Key Executive Stock Option Plan Committee appointed to
administer the Plan pursuant to Section Four. "If two or more Key Executive
Stock Option Plan Committees are appointed with the power to grant Awards to
different classes of employees, references in this Plan to the "Committee'
shall refer to the Key Executive Stock Option Plan Committee administering the
portion of the Plan pertaining to Awards to the applicable class of
employees."
 
  G. "Company"--Choice Hotels Franchising, Inc., including any present or
future "subsidiary corporation" as such term is defined in Section 424(f) of
the 1986 Internal Revenue Code, as amended.
 
  H. "Covered Employee"--an individual described in Section 162(m)(3) of the
Code.
 
  I. "Date of Grant"--the date on which the granting of an Award is authorized
by the Committee or such later date as may be specified by the Committee in
such authorization.
 
  J. "Eligible Employee"--any person employed by the Company or a Subsidiary
on a regularly scheduled basis who satisfies all of the requirements of
Section Six.
 
                                      C-1
<PAGE>
 
  K. "Exercise Period"--the period or periods during which a Stock
Appreciation Right is exercisable as described in Section Nine B.
 
  L. "Fair Market Value"--the fair market value of the Stock as determined in
accordance with Section Eight D.
 
  M. "Incentive Stock Option"--an incentive stock option within the meaning of
Section 422 of the Code.
 
  N. "Option" or "Stock Option"--either a nonqualified stock option or an
Incentive Stock Option granted under Section Eight. It also means any Option
which remains after a Participant has exercised his Option with respect to
part of the shares covered by a Stock Option Agreement as described in Section
Eight B.
 
  O. "Option Period" or "Option Periods"--the period or periods during which
an Option is exercisable as described in Section Eight E.
 
  P. "Option Price"--the price, expressed on a per share basis, for which the
Company Stock can be acquired by the holder of an Option pursuant to the
exercise of such Option.
 
  Q. "Participant"--an Eligible Employee of the Company or a Subsidiary who
has been granted an Option, a Stock Appreciation Right, a Performance Share
Award or a Restricted Stock Award under this Plan.
 
  R. "Performance Share"--an Award granted under Section Ten.
 
  S. "Restricted Stock"--an Award granted under Section Seven.
 
  T. "Stock" and "Company Stock"--the common stock of the Company.
 
  U. "Stock Appreciation Right"--an Award granted under Section Nine.
 
  V. "Subsidiary"--any corporation of which fifty percent (50%) or more of its
outstanding voting stock or voting power is beneficially owned, directly or
indirectly, by the Company.
 
  W. "Ten Percent Shareholder"--a Participant who, at the Date of Grant, owns
directly or indirectly (within the meaning of Section 424(d) of the Internal
Revenue Code) stock possessing more then ten percent (10%) of the total
combined voting power of all classes of stock of the Company or a subsidiary
thereof.
 
  X. Wherever appropriate, words used in this Plan in the singular may mean
the plural, the plural may mean the singular and the masculine may mean the
feminine.
 
                                 SECTION THREE
 
               Effective Date, Duration and Stockholder Approval
 
  A. Effective Date and Stockholder Approval. Subject to the approval of the
Plan by a majority of the outstanding shares of Stock, the Plan shall be
effective as of [   ], 1997.
 
  B. Period for Grant of Awards. Awards may be made as provided herein for a
period of ten (10) years after [   ],1997.
 
                                 SECTION FOUR
 
                                Administration
 
  A. Appointment of Committee. The Board of Directors shall appoint one or
more Key Executive Stock Option Plan Committees which shall consist of not
less than two (2) members of such Board of Directors and
 
 
                                      C-2
<PAGE>
 
which members shall be Non-Employee Directors as defined in Rule 16b-3 under
the Securities Exchange Act of 1934, as amended (or such greater number of
members which may be required by said Rule 16b-3). In addition, such Board of
Directors shall designate a member of the Committee to act as Chairman of the
Committee, and such Board of Directors may remove any member of the Committee
at any time and appoint any director to fill any vacancy on the Committee.
 
  B. Committee Meetings. The Committee shall hold its meetings at such times
and places as specified by the Committee Chairman. A majority of the Committee
shall constitute a quorum. All actions of the Committee shall be taken by all
of the members of the meeting duly called by its Chairman; provided, however,
any action taken by a written document signed by a majority of the members of
the Committee shall be as effective as action taken by the Committee at a
meeting duly called and held.
 
  C. Committee Powers. Subject to the provisions of this Plan, the Committee
shall have full authority in its discretion to (i) designate the Participants
to whom Awards shall be granted, (ii) determine the number of shares to be
made available under each such Award, (iii) determine the period or periods in
which the Participant may exercise such Award, (iv) determine the date when
such Award expires, (v) determine the price for Stock under such Award, and
(vi) determine the grounds of forfeiture of an Award. The Committee shall have
all powers necessary to administer the Plan in accordance with its terms,
including the power to interpret this Plan and resolve all questions arising
thereunder. The Committee may prescribe such rules and regulations for
administering this Plan as the Committee deems appropriate.
 
                                 SECTION FIVE
 
                              Grant of Awards and
                Limitation of Number of Shares Subject to Award
 
  The Committee may, from time to time, grant Awards to one or more Eligible
Employees, provided that (i) subject to any adjustment pursuant to Section
Eleven, the aggregate number of shares of Stock subject to Stock Options,
Stock Appreciation Rights, Performance Share Awards or Restricted Stock Awards
under this Plan may not exceed 7,100,000 shares; (ii) to the extent that a
Stock Option, Stock Appreciation Right, Performance Share Award or Restricted
Stock Award lapses or the rights of the Participant to whom it was granted
terminate, expire or are cancelled for any other reason, in whole or in part,
shares of Stock (or remaining shares) subject to such Award shall again be
available for the grant of an Award under the Plan; and (iii) Shares delivered
by the Company under the Plan may be authorized and unissued Stock, Stock held
in the treasury of the Company or Stock purchased on the open market
(including private purchases) in accordance with applicable securities laws.
In determining the size of Awards, the Committee shall take into account the
responsibility level, performance, potential, and cash compensation level of a
Participant, and the Fair Market Value of the Stock at the time of Awards, as
well as such other considerations it deems appropriate.
 
                                  SECTION SIX
 
                                  Eligibility
 
  Key employees of the Company and its Subsidiaries (including employees who
are members of the Board, but excluding directors who are not employees) who,
in the opinion of the Committee, are mainly responsible for the continued
growth and development and financial success of the business of the Company or
one or more of its Subsidiaries shall be eligible to be granted Awards under
the Plan. Subject to the provisions of the Plan, the Committee may from time
to time select from such eligible persons those to whom Awards shall be
granted and determine the nature and amount of each Award. No employee of the
Company or its Subsidiaries shall have any right to be granted an Award under
this Plan. A member of the Committee shall not be eligible for any Award
hereunder.
 
                                      C-3
<PAGE>
 
  Notwithstanding any provision to the contrary contained herein, Options
shall be granted under this Plan to persons, including without limitation,
employees of Manor Care, Inc., its subsidiaries, and affiliated companies in
substitution for prior Options under plans of Manor Care, Inc. in accordance
with the terms of the Employee Benefits and other Employee Matters Allocation
Agreement between Manor Care, Inc. and the Company.
 
                                 SECTION SEVEN
 
                            Restricted Stock Awards
 
  A. Grants of Shares of Restricted Stock. An Award made pursuant to this
Section Seven shall be granted in the form of shares of Stock, restricted as
provided in this Section Seven. Shares of the Restricted Stock shall be issued
to the Participant without the payment of consideration by the Participant.
The shares of Restricted Stock shall be issued in the name of the Participant
and shall bear a restrictive legend prohibiting sale, transfer, pledge or
hypothecation of the shares of Restricted Stock until the expiration of the
restriction period.
 
  The Committee may also impose such other restrictions and conditions on the
shares of Restricted Stock as it deems appropriate.
 
  B. Restriction Period. At the time a Restricted Stock Award is made, the
Committee may establish a restriction period applicable to such Award which
shall not be more than ten (10) years. Each Restricted Stock Award may have a
different restriction period, at the discretion of the Committee. In addition
to or in lieu of a restriction period, the Committee may establish a
performance goal which must be achieved as a condition to the retention of the
Restricted Stock. The performance goal may be based on the attainment of
specified types of performance measurement criteria, which may differ as to
various Participants or classes or categories of Participants. Such criteria
may include, without limitation, the attainment of certain performance levels
by the individual Participant, the Company, a department or division of the
Company and/or a group or class of participants. Any such performance goals,
together with the ranges of Restricted Stock Awards for which the Participants
may be eligible shall be set from time to time by the Committee and shall be
timely communicated to the Eligible Employees in advance of the commencement
of the performance of services to which such performance goals relate. The
total number of shares of Restricted Stock which may be granted to any single
Covered Employee under this Plan during any calendar year shall be limited to
100,000.
 
  C. Forfeiture or Payout of Award. In the event a Participant ceases
employment during a restriction period, or in the event performance goals
attributable to a Restricted Stock Award are not achieved, subject to the
terms of each particular Restricted Stock Award, and subject to discretionary
action by the Committee as set forth below in Section Thirteen, a Restricted
Stock Award is subject to forfeiture of the shares of stock which had not
previously been removed from restriction under the terms of the Award.
 
  Any shares of Restricted Stock which are forfeited will be transferred to
the Company.
 
  Upon completion of the restriction period and satisfaction of any
performance-goal criteria, all restrictions upon the Award will expire and new
certificates representing the Award will be issued without the restrictive
legend described in Section Seven A. As a condition precedent to receipt of
the new certificates, the Participant (or the designated beneficiary or
personal representative of the Participant) will agree to make payment to the
Company in the amount of any taxes, payable by the Participant, which are
required to be withheld with respect to such shares of Stock.
 
                                 SECTION EIGHT
 
                                 Stock Options
 
  A. Grant of Option. One or more Options may be granted to any Eligible
Employee. Upon the grant of an Option to an Employee, the Committee shall
specify whether the Option is intended to constitute a non-
 
                                      C-4
<PAGE>
 
qualified stock option or an Incentive Stock Option. The total number of
shares of Stock subject to Options which may be granted to any single Covered
Employee under this Plan during any calendar year shall be limited to 100,000.
 
  B. Stock Option Agreement. Each Option granted under the Plan shall be
evidenced by a written "Stock Option Agreement" between the Company and the
Participant containing such terms and conditions as the Committee determines,
including, without limitation, provisions to qualify Incentive Stock Options
as such under Section 422 of the Code. Such agreements shall incorporate the
provisions of this Plan by reference. The date of granting an Option is the
date specified in the written Stock Option Agreement which is signed by the
Participant and the Company.
 
  C. Determination of Option Price. The Option price for Stock shall be not
less than 100% of the fair market value of the Stock on the date of grant.
Notwithstanding the foregoing, in the case of an Option which is designed to
qualify as an Incentive Stock Option (as defined in Section 422 of the Code)
which is granted to a Ten Percent Shareholder, the Option Price shall not be
less than 110% of such fair market value.
 
  D. Determination of Fair Market Value. The fair market value of the Stock on
the date of granting an Option shall be the mean of the high and low prices at
which the Stock was sold on the market on such date. In the event no such
sales of Stock occurred on such date, the fair market value of the Stock shall
be determined by the Committee in accordance with applicable Regulations of
the Internal Revenue Service.
 
  E. Term of Option. The term of an Option may vary within the Committee's
discretion; provided, however, that the term of an Option shall not exceed ten
(10) years from the date of granting the Option to the Participant, and, to
this end, all Options granted pursuant to this Plan must provide that each
such Option cannot be exercised after the expiration of ten (10) years from
the date each such Option is granted. Notwithstanding the foregoing, in the
case of any Option which is designed to qualify as an Incentive Stock Option
(as defined in Section 422 of the Code) which is granted to a Ten Percent
Shareholder, the term of such Option may not exceed five (5) years from the
date of grant of such Option.
 
  F. Limitation on Exercise of Option. The Committee may limit an Option by
restricting its exercise in whole or in part for specified periods.
 
  G. Method of Exercising an Option. Subject to the terms of a particular
Option, a Participant may exercise it in whole or in part by written notice to
the Secretary of the Company stating in such written notice the number of
shares of Stock such Participant elects to purchase under his Option.
 
  H. No Obligation to Exercise Option. A Participant is under no obligation to
exercise an Option or any part thereof.
 
  I. Payment for Option Stock. Stock purchased pursuant to an Option shall be
paid in full at the time of purchase. Payment may be made (a) in cash, (b)
with the approval of the Committee, by delivery to the Company of shares of
Stock having an aggregate fair market value equal to the exercise price, or
(c) a combination of (a) and (b). Payment may also be made, in the discretion
of the Committee, by delivery (including by facsimile transmission) to the
Company or its designated agent of an executed irrevocable Option exercise
form together with irrevocable instructions to a broker-dealer to sell (or
margin) a sufficient portion of the shares and deliver the sale (or margin
loan) proceeds directly to the Company to pay for the exercise price. Upon
receipt of payment and subject to paragraph J of this Section Eight, the
Company shall, without transfer or issue tax to the Participant or other
person entitled to exercise the Option, deliver to the Participant (or other
person entitled to exercise the Option) a certificate or certificates for such
shares.
 
  J. Delivery of Stock to Participant. The Company shall undertake and follow
all necessary procedures to make prompt delivery of the number of shares of
Stock which the Participant elects to purchase upon exercise of an Option
granted under this Plan. Such delivery, however, may be postponed, at the sole
discretion of the Company, to enable the Company to comply with any applicable
procedures, regulations or listing requirements of any government agency,
stock exchange or regulatory authority.
 
                                      C-5
<PAGE>
 
  K. Failure to Accept Delivery of Stock. If a Participant refuses to pay for
Stock which he has elected to purchase under his Option, in accordance with
the terms of payment, which had previously been agreed upon, his Option shall
thereupon, at the sole discretion of the Committee, terminate, and such funds
previously paid for unissued Stock shall be refunded. Stock which has been
previously issued to the Participant and been fully paid for shall remain the
property of the Participant and shall be unaffected by such termination.
 
  L. Non-Transferability of Options. During the lifetime of a Participant, an
Incentive Stock Option granted to him may be exercised only by him. It may not
be sold, assigned, pledged or otherwise transferred except by will or by the
laws of descent and distribution. In the case of Options which are not
Incentive Stock Options, the Committee may impose such restrictions on
transferability, if any, as it may in its sole discretion determine.
 
  M. Purchase for Investment
 
    (a) Written Agreement by Participants. Unless a registration statement
  under the Securities Act of 1933 is then in effect with respect to the
  Stock a Participant receives upon exercise of his Option, a Participant
  shall acquire the Stock he receives upon exercise of his Option for
  investment and not for resale or distribution and he shall furnish the
  Company with a written statement to that effect when he exercises his
  Option and a reference to such investment warranty shall be inscribed on
  the Stock certificate(s).
 
    (b) Registration Requirement. Each Option shall be subject to the
  requirement that, if at any time the Board determines that the listing,
  registration or qualification of the shares subject to the Option upon any
  securities exchange or under any state or Federal law is necessary or
  desirable as a condition of, or in connection with, the issuance of shares
  thereunder, the Option may not be exercised in whole or in part unless such
  listing, registration or qualification shall have been effected or obtained
  (and the same shall have been free of any conditions not acceptable to the
  Board).
 
  N. Special Limitations on Exercise of Incentive Stock Options. The aggregate
fair market value (determined at the time the Incentive Stock Option is
granted) of the Stock with respect to which any Incentive Stock Option is
first exercisable during any calendar year shall not exceed $100,000.
 
                                 SECTION NINE
 
                           Stock Appreciation Rights
 
  A. Grant of Stock Appreciation Rights. Stock Appreciation Rights may be
granted under the Plan in conjunction with an Option either at the time of
grant or by amendment or may be separately awarded. Stock Appreciation Rights
shall be subject to such terms and conditions not inconsistent with the Plan
as the Committee shall impose. However, the total number of Stock Appreciation
Rights which may be granted to a single Covered Employee under this Plan
during any calendar year shall be limited to 100,000.
 
  B. Right to Exercise; Exercise Period. A Stock Appreciation Right issued
pursuant to an Option shall be exercisable to the extent the Option is
exercisable. A Stock Appreciation Right issued independent of an Option shall
be exercisable pursuant to such terms and conditions established in the grant.
 
  C. Automatic Redemption of Unexercised Stock Appreciation Rights. If on the
last day of the Option Period, in the case of a Stock Appreciation Right
granted pursuant to an Option, or the specified Award Period, in the case of a
Stock Appreciation Right issued independent of an Option, the Participant has
not exercised such Stock Appreciation Right, then such Stock Appreciation
Right shall be automatically redeemed by the Company for an amount equal to
the payment that would otherwise have been made to the Participant if the
Participant had chosen to exercise the Stock Appreciation Right on the last
day of the Option Period or the specified Award Period, as the case may be.
 
 
                                      C-6
<PAGE>
 
  D. Rights Upon Exercise. An exercisable Stock Appreciation Right granted
pursuant to an Option shall entitle the Participant to surrender unexercised
the Option or any portion thereof to which the Stock Appreciation Right is
attached, and to receive in exchange for the Stock Appreciation Right a
payment (in cash or Stock or a combination thereof as described below) equal
to the Fair Market Value of one share of Stock at the date of exercise minus
the Option Price times the number of shares called for by the Stock
Appreciation Right (or portion thereof) which is so exercised. With respect to
the issuance of Stock Appreciation Rights which are not granted pursuant to an
Option, the Committee shall specify upon the Date of the Grant of the Stock
Appreciation Right whether the Stock Appreciation Right is a "regular" Stock
Appreciation Right or a "book value" Stock Appreciation Right. Upon the
exercise of a regular Stock Appreciation Right, the Participant will receive a
payment equal to the Fair Market Value of one share of Stock at the date of
exercise minus the Fair Market Value of one share of Stock as of the Date of
Grant of the Stock Appreciation Right times the number of shares called for by
the Stock Appreciation Right (or portion thereof) which is so exercised. Upon
the exercise of a book value Stock Appreciation Right, the Participant will
receive a payment equal to the Book Value of one share of Stock at the date of
exercise minus the Book Value of one share of Stock as of the Date of the
Grant of the Stock Appreciation Right times the number of shares called for by
the Stock Appreciation Right (or portion thereof) which is so exercised.
 
  The value of any Stock to be received upon exercise of a Stock Appreciation
Right shall be the Fair Market Value of the Stock on such date of exercise. To
the extent that a Stock Appreciation Right issued pursuant to an Option is
exercised, such Option shall be deemed to have been exercised, and shall not
be deemed to have lapsed.
 
  E. Transferability. The Committee may impose such restrictions on
transferability of Stock Appreciation Rights, if any, as it may in its sole
discretion determine.
 
                                  SECTION TEN
 
                              Performance Shares
 
  A. Grant of Performance Share Units. Awards made pursuant to this Section
Ten shall be granted in the form of Performance Shares, subject to such terms
and conditions not inconsistent with the Plan as the Committee shall impose.
Performance Shares shall be issued to the Participant without the payment of
consideration by the Participant. Awards shall be based on the attainment of
specified types and combination of performance measurement criteria, which may
differ as to various Participants or classes or categories of Participants.
Such criteria may include, without limitation, the attainment of certain
performance levels by the individual Participant, the Company, a department or
division of the Company and/or a group or class of Participants. Such
criteria, together with the ranges of Performance Shares from which employees
may be eligible shall be set from time to time by the Committee and shall be
communicated to the Eligible Employees. The total number of Performance Shares
which may be granted to any single Covered Employee under this Plan during any
calendar year shall be limited to 100,000.
 
  B. Performance Period. The measuring period to establish the performance
criteria set forth in a Performance Share Award shall be determined by the
Committee. A Performance Share Award may initially provide, or the Committee
may at any time thereafter, but no more frequently than once in any six (6)
month period, amend it to provide, for waiver or reduction of the measuring
period and, if appropriate, for adjustment of the performance criteria set
forth in the Performance Share Award, upon the occurrence of events determined
by the Committee in its sole discretion to justify such waiver, reduction or
adjustment.
 
  C. Form of Payment. Upon the completion of the applicable measuring period,
a determination shall be made by the Committee in accordance with the Award as
to the number of shares of Stock to be awarded to the Participant. The
appropriate number of shares of Stock shall thereupon be issued to the
Participant in accordance with the Award in satisfaction of such Performance
Share Award.
 
                                      C-7
<PAGE>
 
                                SECTION ELEVEN
 
                    Changes in Capital Structure or Shares
 
  In the event any reorganization, merger, consolidation, recapitalization,
liquidation, reclassification, stock dividend, stock split, combination of
shares, rights offering, or extraordinary dividend or divestiture (including a
spin-off), or any other change in the capital structure or shares of the
Company, the Committee shall make adjustments, determined by the Committee in
its discretion to be appropriate, as to the number and kind of securities
subject to this Plan and specified in Section Five of this Plan and as to the
number and kind of securities covered by each outstanding Award and, where
applicable, the price per share thereunder; provided, however, that with
respect to Incentive Stock Options, such adjustments shall be made in
accordance with Section 424(h) of the Code unless the Committee determines
otherwise.
 
                                SECTION TWELVE
 
                    Corporate Reorganization or Dissolution
 
  A. Discontinuation of the Plan. The Plan shall be discontinued in the event
of the dissolution or liquidation of the Company or in the event of a
Reorganization (as hereinafter defined) in which the Company is not the
surviving or acquiring company, or in which the Company is or becomes a
wholly-owned subsidiary of another company after the effective date of the
Reorganization and no plan or agreement respecting the Reorganization is
established which specifically provides for the continuation of the Plan and
the change, conversion, or exchange of the stock relating to existing Awards
under this Plan for securities of another corporation. Upon the dissolution of
the Plan in connection with an event described in this Paragraph A, all Awards
shall become fully vested and all outstanding Options and Stock Appreciation
Rights shall become immediately exercisable by the holder thereof. Any Options
or Stock Appreciation Rights granted under the Plan may be terminated as of a
date fixed by the Committee, provided that no less than fifteen (15) days
written notice of the date so fixed shall be given to each Participant and
each such Participant shall have the right during such period to exercise all
or any portion of such Options or Stock Appreciation Rights. Any Stock
Appreciation Rights not so exercised shall be redeemed.
 
  B. Continuation of the Plan Upon a Reorganization. In the event of a
Reorganization (as hereinafter defined) (i) in which the Company is not the
surviving or acquiring company, or in which the Company is or becomes a
wholly-owned subsidiary of another company after the effective date of the
Reorganization, and (ii) with respect to which there is a reorganization
agreement which undertakes to continue the Plan and to provide for the change,
conversion or exchange of the Stock attributable to outstanding Awards for
securities of another corporation, then the Plan shall continue and the
Committee shall adjust the shares under such outstanding Awards (and shall
adjust the shares remaining under the Plan which are then to be available for
the grant of additional Awards under the Plan, if the reorganization agreement
makes specific provisions therefor), in a manner not inconsistent with the
provisions of the reorganization agreement and this Plan for the adjustment,
change, conversion or exchange of such Awards.
 
  The term "Reorganization" as used in this Section Twelve shall mean any
statutory merger, statutory consolidation, sale of all or substantially all of
the assets of the Company, or sale, pursuant to an agreement with the Company,
of securities of the Company pursuant to which the Company is or becomes a
wholly-owned subsidiary of another company after the effective date of the
Reorganization.
 
  C. Adjustments and Determinations. Adjustments and determinations under this
Section Twelve shall be made by the Committee, whose decisions as to what
adjustments or determinations shall be made, and the extent thereof, shall be
final, binding, and conclusive.
 
 
                                      C-8
<PAGE>
 
                               SECTION THIRTEEN
 
                           Retirement and Disability
 
  The Committee may, in its discretion, waive the forfeiture, termination, or
lapse of an Award in the event of retirement or disability of a Participant
(each as determined by the Committee, in its discretion). Exercise of such
discretion by the Committee in any individual case, however, shall not be
deemed to require, or to establish a precedent suggesting such exercise in any
other case.
 
                               SECTION FOURTEEN
 
                           Miscellaneous Provisions
 
  A. Nontransferability. The Committee may impose such restrictions on the
transferability of an Award, if any, as it may in its sole discretion
determine.
 
  B. No Employment Right. Neither this Plan nor any action taken hereunder
shall be construed as giving any right to be retained as an officer or
employee of the Company or any of its Subsidiaries.
 
  C. Tax Withholding. Either the Company or a Subsidiary, as appropriate,
shall have the right to deduct from all Awards paid in cash any federal, state
or local taxes as it deems to be required by law to be withheld with respect
to such cash payments. In the case of Awards paid in Stock, the employee or
other person entitled to receiving such Stock shall be required to satisfy any
tax withholding obligations in connection with such Awards in any of the
following ways, as elected by such employee or other person: (i) by paying in
cash to the Company or a Subsidiary, as appropriate, the amount of any
federal, state or local taxes required to be withheld (as determined by the
Company or a Subsidiary, as appropriate), (ii) by having the Company retain a
sufficient number of shares of Stock otherwise payable under the Award to
cover any federal, state or local taxes required to be withheld (as determined
by the Company or a Subsidiary, as appropriate), provided, however, that
management shall assure that the amount of such stock withholding does not
cause the Company to incur additional compensation expense, or (iii) by a
combination of (i) and (ii). The number of shares of Stock to be retained for
this purpose shall be determined on the basis of the Fair Market Value of the
Stock on the date of exercise.
 
  D. Fractional Shares. Any fractional shares concerning Awards shall be
eliminated at the time of payment by rounding down for fractions of less than
one-half and rounding up for fractions of equal to or more than one-half. No
cash settlements shall be made with respect to fractional shares eliminated by
rounding.
 
  E. Government and Other Regulations. The obligation of the Company to make
payment of Awards in Stock or otherwise shall be subject to all applicable
laws, rules, and regulations, and to such approvals by any government agencies
as may be required. The Company shall be under no obligation to register under
the Securities Act of 1933, as amended ("Act"), any of the shares of Stock
issued, delivered or paid in settlement under the Plan. If Stock awarded under
the Plan may in certain circumstances be exempt from registration under the
Act, the Company may restrict its transfer in such manner as it deems
advisable to ensure such exempt status.
 
  F. Severance. Subject to the provision of Paragraph B of this Section
Fourteen, in the event a Participant's employment with the Company terminates,
his rights under any Award which constitutes an Option or a Stock Appreciation
Right terminate one (1) month from the date of such termination of employment.
Such rights shall be exercisable only to the extent the Participant was
entitled to exercise such rights under the Award on the date of such
termination of employment.
 
  G. Death. If a Participant dies prior to the full exercise of his Option
and/or Stock Appreciation Right, his Option to purchase Stock under such
Option and/or Stock Appreciation Right may be exercised to the extent, if any,
that Participant would be entitled to exercise it at the date of the death of
the Participant by the person to whom the Option and/or Stock Appreciation
Right shall pass by will or by the laws of descent and distribution within
twelve (12) months of the death of the Participant or the expiration of the
term of the Option and/or Stock Appreciation Right whichever date is sooner.
 
  H. Limitation. In no event may an Option be exercised by anyone after the
expiration date provided for in Section Eight of the Plan.
 
                                      C-9
<PAGE>
 
  I. Limits on Discretion. Anything in this Plan to the contrary
notwithstanding, if the Award so provides, the Committee shall not have any
discretion to increase the amount of compensation payable under the Award to
the extent such discretion would cause the Award to lose its qualification as
performance-based compensation for purposes of Section 162(m)(4)(C) of the
Code and the regulations thereunder.
 
  J. Governing Law. All matters relating to the Plan or to Awards granted
hereunder shall be governed by the laws of the State of Maryland, without
regard to its principles of conflict of laws.
 
  K. Titles and Headings. The titles and headings of the sections in the Plan
are for convenience of reference only, and in the event of any conflict, the
text of the Plan, rather than such titles and headings, shall control.
 
                                SECTION FIFTEEN
 
                               Amendment of Plan
 
  A. Discretion of the Board. The Board may at any time and from time to time
alter, amend, suspend or terminate the Plan in whole or in part, except (i)
any such action affecting Options granted or to be granted under this Plan
which are intended to qualify as Incentive Stock Options shall be subject to
stockholder approval to the extent such stockholder approval is required
pursuant to Section 422 of the Internal Revenue Code and (ii) no such action
may be taken without the consent of the Participant to whom any Award shall
theretofore have been granted, which adversely affects the rights of such
Participant concerning such Award, except as such termination or amendment of
the Plan is required by statute, or rules and regulations promulgated
thereunder.
 
  B. Automatic Termination. This Plan shall terminate on [   ], 2007. Awards
may be granted under this Plan at any time and from time to time prior to the
termination of the Plan. Any Award outstanding at the time the Plan is
terminated shall remain in effect until said Award is exercised or expires.
 
 
                                     C-10
<PAGE>
 
                    INFORMATION NOT REQUIRED ON PROSPECTUS
 
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
 
  The following is an itemized statement of all expenses in connection with
the issuance and distribution of the securities registered hereby. The
information is subject to future contingencies.
 
<TABLE>
      <S>                                                               <C>
      Registration Fee................................................. $  253
      Blue Sky Fees and Expenses....................................... $    0
      Legal Fees....................................................... $2,500*
      Accounting Fees.................................................. $1,500*
      Miscellaneous.................................................... $3,000*
                                                                        ------
      Total............................................................ $7,253
                                                                        ======
      * Estimate
</TABLE>
 
ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS
 
  See the section of the Prospectus entitled "Certain Information Concerning
Franchising--Liability and Indemnification of Officers and Directors."
 
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
 
  None.
 
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
  (a) Exhibits
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                DESCRIPTION
 -------                               -----------
 <C>     <S>
  *2.01  --Form of Distribution Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
  *3.01  --Form of Restated Certificate of Incorporation of Choice Hotels
           Franchising, Inc.
  *3.02  --Form of Amended and Restated Bylaws of Choice Hotels International,
           Inc.
  *4.01  --Form of Common Stock Certificate
   5.01  --Opinion of Michael J. DeSantis regarding the validity of Franchising
           Options and Franchising Common Stock
 *10.01  --Form of Strategic Alliance Agreement between Choice Hotels
           Franchising, Inc. and Choice Hotels International, Inc.
 *10.02  --Form of Employee Benefits and Other Employment Matters Allocation
           Agreement between Choice Hotels Franchising, Inc. and Choice Hotels
           International, Inc.
 *10.03  --Form of Employee Benefits Administration Agreement between Choice
           Hotels Franchising, Inc. and Choice Hotels International, Inc.
 *10.04  --Form of Tax Administration Agreement between Choice Hotel
           Franchising, Inc. and Choice Hotels International, Inc.
 *10.05  --Form of Tax Sharing Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
 *10.06  --Form of Amendment to Corporate Services Agreement among Manor Care,
           Inc., Choice Hotels Franchising, Inc. and Choice Hotels
           International, Inc.
 *10.07  --Form of Amendment to Risk Management Consulting Services Agreement
           among Manor Care, Inc., Choice Hotels Franchising, Inc. and Choice
           Hotels International, Inc.
</TABLE>
 
                                     II-1
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                DESCRIPTION
 -------                               -----------
 <C>     <S>
 *10.08  --Form of Office Sublease Agreement between Choice Hotels Franchising,
           Inc and Choice Hotels International, Inc.
 *10.09  --Form of Noncompetition Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
 *10.10  --Form of Guarantee by Choice Hotels Franchising, Inc. to Manor Care,
           Inc.
 *21.01  --Subsidiaries of Choice Hotels Franchising, Inc.
  23.01  --Consent of Arthur Anderson LLP
  23.02  --Consent of Michael J. DeSantis (included in the opinion filed as
           Exhibit 5.01 hereto)
  24.01  --Power of Attorney (contained on page II-3 hereof)
</TABLE>
--------
*  Incorporated by reference to the identically numbered exhibit to the
   Registration Statement on Form 10 filed with the Securities and Exchange
   Commission by Franchising on September 19, 1997.
 
  (b) Financial Statements Schedules
 
  Schedule II -- Valuation and Qualifying Accounts
 
  All other schedules are omitted because they are not applicable or the
required information is included in the combined financial statements or notes
thereto.
 
ITEM 17. UNDERTAKINGS
 
  The undersigned registrant hereby undertakes:
 
  (1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this Registration Statement:
 
    (i) To include any prospectus required by Section 10(a)(3) of the
  Securities Act of 1933;
 
    (ii) To reflect in the prospectus any facts or events arising after the
  effective date of the registration statement (or the most recent post-
  effective amendment thereof) which, individually or in the aggregate,
  represent a fundamental change in the information set forth in the
  registration statement;
 
    (iii) To include any material information with respect to the plan of
  distribution not previously disclosed in the registration statement or any
  material change to such information in the registration statement;
 
  (2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
 
  (3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of
the offering.
 
  Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Act") may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or otherwise,
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.
 
                                     II-2
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized in the City of Silver Spring, State of
Maryland, on September 19, 1997.
 
                                          Choice Hotels Franchising, Inc.
 
                                            
                                          By:  /s/ William R. Floyd 
                                              ----------------------------
                                            Name: William R. Floyd
                                            Title: Chief Executive Officer
 
                               POWER OF ATTORNEY
 
  Each person whose signature appears below appoints William R. Floyd and
Michael J. DeSantis, and each of them, as his true and lawful attorney-in-fact
and agent with full power of substitution and resubstitution, for him and in
his name, place and stead, in any and all capacities, to sign any or all
amendments (including post-effective amendments), to this Registration
Statement, and to file the same, with all exhibits thereto, and all documents
in connection therewith, with the Securities and Exchange Commission, granting
unto each said attorney-in-fact and agent full power and authority to do and
perform each and every act and thing, requisite and necessary to be done in
and about the foregoing, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that each said
attorney-in-fact and agent, or his substitute, may lawfully do or cause to be
done by virtue hereof.
 
  Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
 
 
<TABLE>
<CAPTION>
             SIGNATURE                           TITLE                    DATE
             ---------                           -----                    ----
<S>                                  <C>                           <C>
        /s/ William R. Floyd                                       September 19, 1997
------------------------------------
          William R. Floyd           Chief Executive Officer and
                                      Director (Principal
                                      Executive Officer)
      /s/ James A. MacCutcheon                                     September 19, 1997
------------------------------------
        James A. MacCutcheon         Executive Vice President,
                                      Chief Financial Officer and
                                      Director (Principal
                                      Financial Officer)
        /s/ Joseph M. Squeri                                       September 19, 1997
------------------------------------
          Joseph M. Squeri           Vice President, Finance and
                                      Controller (Principal
                                      Accounting Officer)
        /s/ Donald J. Landry                                       September 19, 1997
------------------------------------
          Donald J. Landry           Director
</TABLE>
 
                                     II-3
<PAGE>
 
                                                                    SCHEDULE II
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
TO CHOICE HOTELS FRANCHISING, INC.:
 
 
We have audited in accordance with generally accepted auditing standards, the
combined financial statements of Choice Hotels Franchising, Inc. included in
this Registration Statement on Form S-1, and have issued our opinion thereon
dated June 24, 1997. Our audit was made for the purpose of forming an opinion
on the basic combined financial statements taken as a whole. The schedule at
page S-2 hereof is presented for the purpose of complying with the Securities
and Exchange Commission's rules and is not part of the basic combined
financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic combined financial statements
and, in our opinion, fairly states in all material respects the financial data
required to be set forth therein in relation to the basic combined financial
statements taken as a whole.
 
                                       Arthur Andersen LLP
 
Washington, D.C. June 24, 1997
 
                                      S-1
<PAGE>
 
                                                                     SCHEDULE II
 
                        CHOICE HOTELS FRANCHISING, INC.
                SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                           (IN THOUSANDS OF DOLLARS)
 
 
<TABLE>
<CAPTION>
                          BALANCE AT  CHARGES TO                  BALANCE AT
                         BEGINNING OF   PROFIT                       END
      DESCRIPTION           PERIOD     AND LOSS  OTHER WRITE-OFFS OF PERIOD
      -----------        ------------ ---------- ----- ---------- ----------
<S>                      <C>          <C>        <C>   <C>        <C>
Year ended May 31, 1997
 Allowance for doubtful
  accounts                  4,515       2,238     --       (594)    6,159
                            =====       =====     ===    ======     =====
Year ended May 31, 1996
 Allowance for doubtful
  accounts                  3,976         685     --       (146)    4,515
                            =====       =====     ===    ======     =====
Year ended May 31, 1995
 Allowance for doubtful
  accounts                  8,743         692     --     (5,459)    3,976
                            =====       =====     ===    ======     =====
</TABLE>
 
                                      S-2
<PAGE>
 
                               INDEX OF EXHIBITS
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                DESCRIPTION
 -------                               -----------
 <C>     <S>
  *2.01  --Form of Distribution Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
  *3.01  --Form of Restated Certificate of Incorporation of Choice Hotels
           Franchising, Inc.
  *3.02  --Form of Amended and Restated Bylaws of Choice Hotels International,
           Inc.
  *4.01  --Form of Common Stock Certificate
   5.01  --Opinion of Michael J. DeSantis regarding the validity of Franchising
           Options and Franchising Common Stock
 *10.01  --Form of Strategic Alliance Agreement between Choice Hotels
           Franchising, Inc. and Choice Hotels International, Inc.
 *10.02  --Form of Employee Benefits and Other Employment Matters Allocation
           Agreement between Choice Hotels Franchising, Inc. and Choice Hotels
           International, Inc.
 *10.03  --Form of Employee Benefits Administration Agreement between Choice
           Hotels Franchising, Inc. and Choice Hotels International, Inc.
 *10.04  --Form of Tax Administration Agreement between Choice Hotel
           Franchising, Inc. and Choice Hotels International, Inc.
 *10.05  --Form of Tax Sharing Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
 *10.06  --Form of Amendment to Corporate Services Agreement among Manor Care,
           Inc., Choice Hotels Franchising, Inc. and Choice Hotels
           International, Inc.
 *10.07  --Form of Amendment to Risk Management Consulting Services Agreement
           among Manor Care, Inc., Choice Hotels Franchising, Inc. and Choice
           Hotels International, Inc.
 *10.08  --Form of Office Sublease Agreement between Choice Hotels Franchising,
           Inc and Choice Hotels International, Inc.
 *10.09  --Form of Noncompetition Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
 *10.10  --Form of Guarantee by Choice Hotels Franchising, Inc. to Manor Care,
           Inc.
 *21.01  --Subsidiaries of Choice Hotels Franchising, Inc.
  23.01  --Consent of Arthur Anderson LLP
  23.02  --Consent of Michael J. DeSantis (included in the opinion filed as
           Exhibit 5.01 hereto)
</TABLE>
--------
*  Incorporated by reference to the identically numbered exhibit to the
   Registration Statement on Form 10 filed with the Securities and Exchange
   Commission by Franchising on September 19, 1997.
[{"type": "S-1", "sequence": "1", "description": "FORM S-1", "secsgml_size_bytes": 547807}]
{"company-data": {"conformed-name": "CHOICE HOTELS FRANCHISING INC", "cik": "0001046311", "assigned-sic": "7011", "irs-number": "521209792", "state-of-incorporation": "DE", "fiscal-year-end": "1231"}, "filing-values": {"form-type": "S-1", "act": "33", "file-number": "333-36015", "film-number": "97683098"}, "business-address": {"street1": "10750 COLUMBIA PIKE", "city": "SILVER SPRING", "state": "MD", "zip": "20901", "phone": "3019795000"}, "mail-address": {"street1": "10750 COLUMBIA PIKE", "city": "SILVER SPRING", "state": "MD", "zip": "20901"}}
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 19, 1997
                                                      REGISTRATION NO. 333-
 
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ----------------
 
                                   FORM S-1
 
                            REGISTRATION STATEMENT
                                     UNDER
                          THE SECURITIES ACT OF 1933
 
                               ----------------
 
                        CHOICE HOTELS FRANCHISING, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
                               ----------------
 
         DELAWARE                    8999                    52-1209792
     (STATE OR OTHER         (PRIMARY INDUSTRIAL           (IRS EMPLOYER
     JURISDICTION OF          CLASSIFICATIONCODE       IDENTIFICATION NUMBER)
     INCORPORATION OR              NUMBER)
      ORGANIZATION)
                              10750 COLUMBIA PIKE
                         SILVER SPRING, MARYLAND 20901
                                (301) 979-5000
  (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
                   REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

                              MICHAEL J. DESANTIS
                              10750 COLUMBIA PIKE
                         SILVER SPRING, MARYLAND 20901
                                (301) 979-5000
 (NAME, ADDRESS, INCLUDING ZIP CODE, TELEPHONE NUMBER, INCLUDING AREA CODE, OF
                              AGENT FOR SERVICE)
 
                   PLEASE SEND COPIES OF COMMUNICATIONS TO:
                              BRUCE E. ROSENBLUM
                               LATHAM & WATKINS
                   1001 PENNSYLVANIA AVE., N.W., SUITE 1300
                          WASHINGTON, D.C. 20004-2505
 
                               ----------------
 
  Approximate date of commencement of proposed sale to the public: AS SOON AS
PRACTICABLE AFTER THE EFFECT DATE OF THIS REGISTRATION STATEMENT.
 
  IF ANY OF THE SECURITIES BEING REGISTERED ON THIS FORM ARE TO BE OFFERED ON
A DELAYED OR CONTINUOUS BASIS PURSUANT TO RULE 415 UNDER THE SECURITIES ACT OF
1933, CHECK THE FOLLOWING BOX. [X]
 
  IF THIS FORM IS FILED TO REGISTER ADDITIONAL SECURITIES FOR AN OFFERING
PURSUANT TO RULE 462(B) UNDER THE SECURITIES ACT, PLEASE CHECK THE FOLLOWING
BOX AND LIST THE SECURITIES ACT REGISTRATION STATEMENT NUMBER OF THE EARLIER
EFFECTIVE REGISTRATION STATEMENT FOR THE SAME OFFER. [_]
 
  IF THIS FORM IS A POST-EFFECTIVE AMENDMENT FILED PURSUANT TO RULE 462(C)
UNDER THE SECURITIES ACT, CHECK THE FOLLOWING BOX AND LIST THE SECURITIES ACT
REGISTRATION STATEMENT NUMBER OF THE EARLIER EFFECTIVE REGISTRATION STATEMENT
FOR THE SAME OFFERING. [_]
 
  IF DELIVERY OF THE PROSPECTUS IS EXPECTED TO BE MADE PURSUANT TO RULE 434,
PLEASE CHECK THE FOLLOWING BOX. [_]
 
                               ----------------
 
                        CALCULATION OF REGISTRATION FEE
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
                                                    PROPOSED        PROPOSED                      
                                     AMOUNT         MAXIMUM         MAXIMUM      AMOUNT OF       
     TITLE OF EACH CLASS OF          TO BE       OFFERING PRICE    AGGREGATE    REGISTRATION     
   SECURITIES TO BE REGISTERED     REGISTERED       PER UNIT     OFFERING PRICE     FEE      
--------------------------------------------------------------------------------------------
Common Stock, $.01 par value
 ("Common Stock")................    1,193,571       $.70(1)        $835,500      $253.18(1)
--------------------------------------------------------------------------------------------
Options to Purchase Shares of
 Common Stock, $.01 par value....    1,193,571         *(1)            *              *
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
*   Not Applicable.
(1) The registration fee has been calculated pursuant to Rule 457(h)(1) under
    the Securities Act of 19933 on the basis of a book value of $.70 per share
    for the maximum number of shares of Common Stock to be received upon
    exercise of options to purchase Common Stock. The exercise price of such
    options will not be determined until their issuance as described in this
    Registration Statement.
 
                               ----------------
 
  THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
 
-------------------------------------------------------------------------------
CHOICE HOTELS FRANCHISING, INC.
 
                             CROSS REFERENCE SHEET
                     PURSUANT TO ITEM 501 OF REGULATION S-K
S-1 ITEM NUMBER AND HEADING                        LOCATION IN PROSPECTUS
           ---------------------------                        ----------------------
1. Forepart of the Registration Statement and    
      Outside Front Cover Page of Prospectus.....  Facing Page; Cross Reference Sheet; Outside 
                                                    Front Cover Page                           
  2. Inside Front and Outside Back Cover Pages
      of Prospectus..............................  Inside Front Cover Page; Table of Contents
  3. Summary Information, Risk Factors and Ratio
      of Earnings to Fixed Charges...............  Prospectus Summary; Risk Factors
  4. Use of Proceeds.............................  Use of Proceeds
  5. Determination of Offering Price.............  Outside Front Cover Page; Plan of
                                                   Distribution
  6. Dilution....................................  Not Applicable
  7. Selling Securitiy Holders...................  Not Applicable
  8. Plan of Distribution........................  Outside Front Cover Page; Plan of
                                                    Distribution
  9. Description of Securities to be               
     Registered..................................  The Distribution--Description of Capital    
                                                   Stock; The Offering                       
 10. Interests of Named Experts and Counsel......  Legal Matters; Experts
 11. Information with Respect to Registrant......  Certain Information Concerning Franchising--Selected Historical Financial Data;
                                                    --Pro Forma Financial Data;--Management's Discussion and Analysis of Financial
                                                    Condition and Results of Operations;--Business and Properties;--Management;
                                                    Certain Relationships and Related Transactions; Security Ownership
 12. Disclosure of Commission Position on
      Indemnification for Securities Act
      Liabilities................................  Not Applicable
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+                                                                              +
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A         +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE   +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY  +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT        +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR   +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE      +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE    +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF  +
+ANY SUCH STATE.                                                               +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
 
                SUBJECT TO COMPLETION, DATED SEPTEMBER 19, 1997
 
PROSPECTUS
 
                        CHOICE HOTELS FRANCHISING, INC.
              (TO BE RENAMED "CHOICE HOTELS INTERNATIONAL, INC.")
 
                   1,193,571 OPTIONS TO PURCHASE COMMON STOCK
 
                        1,193,571 SHARES OF COMMON STOCK
 
                                  -----------
 
  This Prospectus relates to the issuance by Choice Hotels Franchising, Inc.
("Franchising") of options ("Franchising Options") to purchase up to 1,193,571
shares of common stock of Franchising, par value $0.01 per share ("Franchising
Common Stock") to thirty-three employees of Manor Care, Inc., a Delaware
corporation ("Manor Care" and such employees, the "Manor Care Employees") as
part of the equitable adjustments to outstanding options to purchase shares of
common stock ("Choice Common Stock") of Choice Hotels International, Inc.
("Choice"), as described below, and (ii) up to 1,193,571 shares of Franchising
Common Stock issuable upon exercise of the Franchising Options.
 
  Franchising is currently a wholly owned subsidiary of Choice. On or about
October 15, 1997, (the "Distribution Date"), Choice intends to make a special
dividend, consisting of the distribution (the "Distribution") to holders of
outstanding shares of Choice Common Stock at the close of business on October
7, 1997 (the "Distribution Record Date"), on a share for share basis, of all
outstanding shares of Franchising Common Stock. This Distribution will separate
Choice's hotel franchising business from its hotel ownership and management
business. Upon the Distribution, Choice will change its corporate name to
Sunburst Hospitality Corporation (as renamed after the Distribution,
"Sunburst") and will continue to own and operate hotel properties in the United
States (the "Hotel Business"). Upon the Distribution, Franchising will change
its name to Choice Hotels International, Inc. and will engage in the business
of franchising hotels under the Clarion, Quality, Comfort, Sleep Inn, Rodeway,
Econo Lodge and Mainstay brands and will own and operate 14 hotel properties in
France, Germany and the United Kingdom (together, the "Franchising Business").
The Distribution is described in more detail herein.
 
  As of the date hereof, the thirty-three Manor Care Employees, in the
aggregate, held options (the "Choice Options") to purchase up to 1,193,571
shares of Choice Common Stock issued by Choice in November 1996 as part of the
Manor Care Spin-off (as defined herein) pursuant to the Choice Hotels
International, Inc. 1996 Long-Term Incentive Plan (the "Choice Plan"). Under
the Choice Plan, each outstanding Choice Option will be adjusted as a result of
the Distribution in a manner described herein in order to preserve the
financial values of such Choice Options prior to the Distribution. On or prior
to the Distribution Date, each Manor Care Employee holding nonqualified Choice
Options may make a one-time election to choose a conversion award consisting of
any percentage combination of an option to acquire Franchising Common Stock and
an adjusted Choice Option, with the number of shares and the exercise price of
each option adjusted so as to preserve the financial value of the outstanding
Choice Options. The Franchising Options issuable to Manor Care Employees as
part of the aforementioned adjustment to Choice Options and the shares of
Franchising Common Stock issuable upon exercise of such Franchising Options
will be issued pursuant to the Registration Statement of which this Prospectus
is part.
 
  SEE "RISK FACTORS" BEGINNING ON PAGE 9 FOR A DISCUSSION OF CERTAIN RISKS
ASSOCIATED WITH AN INVESTMENT IN THE FRANCHISING OPTIONS AND THE FRANCHISING
COMMON STOCK OFFERED HEREBY.
 
                                  -----------
 
THESE SECURITIES  HAVE NOT BEEN APPROVED  OR DISAPPROVED BY THE  SECURITIES AND
 EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
 AND  EXCHANGE COMMISSION  OR ANY  STATE SECURITIES COMMISSION  PASSED ON  THE
  ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
  IS A CRIMINAL OFFENSE.
 
 
                 The date of this Prospectus is          , 1997
NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE SECURITIES REGISTERED HEREBY, AND IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY FRANCHISING. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY OF THE SECURITIES OFFERED
HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS NOT LAWFUL TO MAKE ANY
SUCH OFFER OR SOLICITATION IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY ISSUANCE OF SECURITIES HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF FRANCHISING SINCE THE DATE HEREOF OR THAT THE INFORMATION HEREIN IS
CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
 
                             AVAILABLE INFORMATION
 
  Franchising has filed a Registration Statement on Form S-1 (the
"Registration Statement") with the Securities and Exchange Commission (the
"Commission") under the Securities Act of 1933, as amended (the "Securities
Act"), with respect to the securities offered hereby. As permitted by the
rules and regulations of the Commission, this Prospectus omits certain
information, exhibits and undertakings contained in the Registration
Statement. Such additional information, exhibits and undertakings can be
inspected at and obtained from the Commission in the manner set forth below.
For further information with respect to the securities offered hereby and
Franchising, reference is made to the Registration Statement and the financial
schedules and exhibits filed as part thereof. Statements contained in this
Prospects as to the terms of any contract or other document are not
necessarily complete, and, in each case, reference is made to the copy of each
such contract or other document that has been filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference.
 
  Franchising Common Stock has been approved to submit an application for
listing on the New York Stock Exchange. In connection with such approval,
Franchising will become subject to informational and reporting requirements of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and be
required to file periodic reports and other information with the Commission.
Such reports and other information (when filed with the Commission), as well
as the Registration Statement, can be inspected and copied at the public
reference facilities of the Commission at 450 Fifth Street, N.W., Washington,
D.C. 20549, and at the Commission's regional offices located at 7 World Trade
Center, New York, New York 10048 and at Northwestern Atrium Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. Such reports and other
information can also be inspected (when filed) at the office of the New York
Stock Exchange, 20 Broad Street, New York, New York 10005. Such material may
also be accessed electronically by means of the Commission's home page on the
Internet at http://www.sec.gov.
 
  The aforementioned documents are also available upon request from Michael J.
DeSantis, Senior Vice President, General Counsel and Secretary, Choice Hotels
Franchising, Inc., 10750 Columbia Pike, Silver Spring, Maryland 20901, (301)
979-5000.
TABLE OF CONTENTS
PAGE
                                                                           ----
PROSPECTUS SUMMARY........................................................   1
RISK FACTORS..............................................................   9
USE OF PROCEEDS...........................................................  13
PLAN OF DISTRIBUTION......................................................  13
LEGAL MATTERS.............................................................  13
EXPERTS...................................................................  13
THE DISTRIBUTION..........................................................  14
  Manner of Effecting the Distribution....................................  14
  Federal Income Tax Aspects of the Distribution..........................  14
  Listing and Trading of Franchising Common Stock.........................  15
  Listing and Trading of Sunburst Common Stock............................  15
  Conditions; Termination.................................................  16
  Interest of Certain Persons in the Distribution.........................  16
RELATIONSHIP BETWEEN CHOICE AND FRANCHISING AFTER THE DISTRIBUTION........  18
FINANCING.................................................................  23
ACCOUNTING TREATMENT......................................................  24
POST-DISTRIBUTION DIVIDEND POLICY.........................................  25
CERTAIN INFORMATION CONCERNING FRANCHISING................................  25
  Pro Forma Financial Data................................................  25
  Selected Historical Financial Data......................................  27
  Management's Discussion and Analysis of Financial Condition and Results
   of Operations..........................................................  29
  Business And Properties.................................................  32
  Management..............................................................  47
  Employment Agreements...................................................  54
  Retirement Plans........................................................  55
  Certain Relationships and Related Transactions..........................  56
  Security Ownership......................................................  57
  Description of Franchising Capital Stock................................  59
  Purposes and Antitakeover Effects of Certain Provisions of the
   Franchising Certificate and Bylaws.....................................  60
  Liability and Indemnification of Officers and Directors.................  63
CERTAIN INFORMATION CONCERNING SUNBURST...................................  65
  Pro Forma Financial Data................................................  65
  Management's Discussion and Analysis of Sunburst Pro Forma Financial
   Condition and Results of Operations....................................  67
  Business and Properties.................................................  69
  Management..............................................................  76
AMENDMENTS TO THE CHOICE RESTATED CERTIFICATE OF INCORPORATION............  80
FRANCHISING BENEFIT PLAN..................................................  82
i
PAGE
                                                                          ----
INDEX TO FINANCIAL STATEMENTS............................................ F-1
ANNEX A: FORM OF RESTATED CERTIFICATE OF INCORPORATION OF CHOICE HOTELS
          FRANCHISING, INC............................................... A-1
ANNEX B: FORM OF AMENDED AND RESTATED BYLAWS OF CHOICE HOTELS
          INTERNATIONAL, INC............................................. B-1
ANNEX C: CHOICE HOTELS FRANCHISING, INC. 1997 LONG-TERM INCENTIVE PLAN... C-1
ii
PROSPECTUS SUMMARY
 
  The following summarizes certain information contained elsewhere in this
Prospectus, including the appendices hereto (the "Prospectus"). Reference is
made to, and this summary is qualified in its entirety by, the more detailed
information set forth in this Prospectus, which should be read in its entirety.
Unless the context otherwise requires, all references herein to Choice and to
Franchising shall include their respective subsidiaries and all references
herein to Franchising prior to the Distribution Date (as defined herein) shall
refer to the Franchising Business (as defined herein) as operated by Choice.
Unless otherwise indicated, all statistical information and data relating to
the hotel industry in this Prospectus are derived from information provided by
Smith Travel Research. Smith Travel Research has not consented to the use of
the hotel industry data presented herein or provided any form of consultation,
advice, or counsel regarding any aspects of, and is in no way whatsoever
associated with, the proposed transaction.
 
                                   BACKGROUND
 
  Franchising is currently a wholly owned subsidiary of Choice. On or about
October 15, 1997 (the "Distribution Date"), Choice intends to make a special
dividend, consisting of the distribution (the "Distribution") to holders of
outstanding shares of Choice Common Stock at the close of business on October
7, 1997 (the "Distribution Record Date"), on a share for share basis, of all
outstanding shares of Franchising Common Stock.
 
  This Distribution will separate Choice's hotel franchising business from its
hotel ownership and management business. Upon the Distribution, Choice will
change its corporate name to Sunburst Hospitality Corporation (as renamed after
the Distribution, "Sunburst") and will continue to own and operate hotel
properties in the United States (the "Hotel Business"). Upon the Distribution,
Franchising will change its name to Choice Hotels International, Inc. and will
engage in the business of franchising hotels under the Clarion, Quality,
Comfort, Sleep Inn, Rodeway, Econo Lodge and Mainstay brands and will own and
operate 14 hotel properties in France, Germany and the United Kingdom
(together, the "Franchising Business"). The Distribution is described in more
detail herein.
 
  As of the date hereof, the thirty-three Manor Care Employees held options
(the "Choice Options") to purchase up to 1,193,571 shares of Choice Common
Stock issued in November 1996 as part of the Manor Care Spin-off (as defined
herein) pursuant to the Choice Hotels International, Inc. 1996 Long-Term
Incentive Plan (the "Choice Plan"). Under the Choice Plan, each outstanding
Choice Option will be adjusted as a result of the Distribution in a manner
described herein in order to preserve the financial value of such Choice
Options prior to the Distribution. On or prior to the Distribution Date, each
Manor Care Employee holding nonqualifed Choice Options may make a one-time
election to choose a conversion award consisting of any percentage combination
of an option to acquire Franchising Common Stock and an adjusted Choice Option,
with the number of shares and the exercise price of each option adjusted so as
to preserve the financial value of the outstanding Choice Options. The
Franchising Options issuable to Manor Care Employees as part of the
aforementioned adjustment to Choice Options and the shares of Franchising
Common Stock issuable upon exercise of such Franchising Options will be issued
pursuant to the Registration Statement of which this Prospectus is a part.
 
 
                                       1
THE COMPANY
 
  Franchising is a Delaware corporation and a wholly owned subsidiary of
Choice, formed in 1981. Franchising currently conducts a significant portion of
the Franchising Business. Immediately prior to the Distribution, Franchising
will succeed to that portion of the Franchising Business currently conducted by
Choice or Choice's other subsidiaries. Franchising is one of the world's
largest franchisors of hotels with 3,344 properties open and operating in 33
countries at May 31, 1997. These properties operate under one of Franchising's
brand names: Comfort, Quality, Clarion, Sleep, Rodeway, Econo Lodge and
Mainstay Suites. At May 31, 1997, another 820 franchise properties with a total
of 72,093 rooms were under development.
 
  The principal executive offices of Franchising are located at 10750 Columbia
Pike, Silver Spring, Maryland 20901. Its telephone number is (301) 797-5000.
For additional information with respect to Franchising and the Franchising
Business expected to be conducted by Franchising after the Distribution, see
"Certain Information Concerning Franchising."
 
                                  THE OFFERING
 
Securities Offered............  (i) options (the "Franchising Options") to
                                purchase up to 1,193,571 shares of Franchising
                                Common Stock, and (ii) up to 1,193,571 shares
                                of Franchising Common Stock issuable upon
                                exercise of the Franchising Options.
Franchising Common Stock        
Outstanding...................  Franchising is currently a wholly owned
                                subsidiary of Choice. Based on the number of
                                shares of Choice Common Stock outstanding on
                                August 5, 1997, it is expected that
                                approximately 60,200,784 shares of Franchising
                                Common Stock will be issued in the
                                Distribution.
 
Use of Proceeds...............  The Franchising Options will be issued as part
                                of the adjustments of outstanding Choice
                                Options and Franchising will receive no
                                proceeds from such issuance. The proceeds to
                                Franchising to be received from exercise of the
                                Franchising Options will be used for working
                                capital and other general corporate purposes.
 
Proposed NYSE Symbol..........  CCH.
 
                                       2
The following portion of the Prospectus Summary presents a summary of the
Distribution, Franchising (as its expected to be constituted after the
Distribution), and Sunburst.
 
                                THE DISTRIBUTION
 
Distributed Company...........  Choice Hotels Franchising, Inc.
                                ("Franchising"), a Delaware corporation and a
                                wholly owned subsidiary of Choice Hotels
                                International, Inc., a Delaware corporation
                                (the "Choice"), will, on the Distribution Date,
                                own all of the business and assets of, and be
                                responsible for all of the liabilities
                                associated with, the business of franchising
                                hotels under the Clarion(R), Quality(R),
                                Comfort(R), Sleep Inn(R), Rodeway(R), Econo
                                Lodge(R) and MainStay SuitesSM brands currently
                                conducted by Franchising and certain of its
                                subsidiaries as well as all European real
                                estate assets currently held by Choice (the
                                "Franchising Business"). Upon the Distribution,
                                Franchising will change its corporate name to
                                Choice Hotels International, Inc.
 
Distributing Company..........  Choice Hotels International, Inc., a Delaware
                                corporation ("Choice"). Upon the Distribution,
                                Choice will continue to own and operate hotel
                                properties in the U.S. (the "Hotel Business")
                                and will change its corporate name upon the
                                Distribution to Sunburst Hospitality
                                Corporation (as renamed after the Distribution,
                                "Sunburst").

Securities to Be 
  Distributed.................. Approximately 60,200,784 shares of Franchising
                                Common Stock based on 60,200,784 shares of
                                Company Common outstanding as of August 5, 1997
                                (the "Annual Meeting Record Date").

Conditions to the 
  Distribution................. Choice's stockholders approved the Distribution
                                at Choice's Annual Meeting of Stockholders on
                                September 16, 1997; however, the Choice Board
                                of Directors has conditioned the effectiveness
                                of the Distribution on satisfaction of certain
                                conditions prior to the Distribution Record
                                Date. The Board of Directors will not waive any
                                of the conditions to the Distribution or make
                                any changes in the terms of the Distribution
                                unless the Board of Directors determines that
                                such changes would not be materially adverse to
                                Choice's stockholders. In determining whether
                                any such changes would be materially adverse to
                                Choice's stockholders, the Board of Directors
                                will consider, as appropriate, advice from its
                                outside advisors as well as the recommendation
                                of management as to the potential impact of
                                such changes on the Company and the Company's
                                Stockholders. See "The Distribution--
                                Conditions; Termination."
 
Distribution Ratio............  One share of Franchising Common Stock for each
                                share of Choice Common Stock.
 
                                       3
Tax Consequences..............  Choice has conditioned the Distribution on
                                receipt of a ruling from the Internal Revenue
                                Service to the effect that, among other things,
                                for federal income tax purposes, receipt of
                                shares of Franchising Common Stock by Choice
                                stockholders will be tax free. On September 12,
                                1997, Choice received such a ruling from the
                                Internal Revenue Service.
 
                                For a discussion of the effects on Choice and
                                Franchising if the Distribution were not to
                                qualify as tax free for federal income tax
                                purposes, see "Risk Factors--Certain Tax
                                Considerations."
 
Risk Factors..................  Manor Care Employees should carefully consider
                                all of the information contained in this Proxy
                                Statement, including the matters described
                                under "Risk Factors."
 
Relationship between Choice
 and Franchising after the
 Distribution.................  For purposes of governing the ongoing          
                                relationships between Choice and Franchising    
                                after the Distribution Date and in order to     
                                provide for an orderly transfer of the          
                                Franchising Business to Franchising and         
                                facilitate the transition to two separate       
                                publicly traded companies, Choice and           
                                Franchising will enter into a Distribution      
                                Agreement, a Strategic Alliance Agreement,      
                                Franchising Agreements and various other        
                                agreements with respect to, among other things, 
                                intercompany debt, tax matters, employee        
                                benefits, risk management and corporate and     
                                administrative services. See "Relationship      
                                Between Choice and Franchising After the        
                                Distribution." Choice and Franchising may be    
                                subject to certain potential conflicts of       
                                interest. See "Risk Factors--Potential          
                                Conflicts."                                     
                                                                                
 
Accounting Treatment..........  The historical combined financial statements of
                                Franchising present its financial position,
                                results of operations and cash flows as if it
                                were a separate entity for all periods
                                presented. Choice's historical basis in the
                                assets and liabilities of Franchising has been
                                carried over. See "Accounting Treatment," and
                                the combined financial statements of Choice
                                Hotels Franchising, Inc., contained elsewhere
                                herein.
 
Listing and Trading Market....  There is currently no public market for
                                Franchising Common Stock. Choice has been
                                approved to submit an application for listing
                                the Franchising Common Stock on the New York
                                Stock Exchange, subject to satisfaction of
                                certain conditions; however, there can be no
                                assurance that the Franchising Common Stock
                                will ultimately be accepted for listing on the
                                New York Stock Exchange or any other national
                                stock exchange or market. Choice expects that
                                no "when issued" trading market will exist
                                prior to the time that Franchising's
                                Registration Statement on Form 10 is declared
                                effective by the Commission. See "Risk
                                Factors--No Current Market for Franchising
                                Common Stock; and --The Distribution--Listing
                                and Trading of Franchising Common Stock."
 
                                       4
Record Date...................  The Choice Board of Directors set the record
                                date for the Distribution referred to herein as
                                October 7, 1997 (the "Distribution Record
                                Date") provided, however, that the Distribution
                                remains subject to satisfaction of certain
                                conditions prior to the Distribution Record
                                Date.
 
Distribution Date.............  The Choice Board of Directors set the
                                Distribution Date, as October 15, 1997. On the
                                Distribution Date, Choice will deliver all
                                outstanding shares of Franchising Common Stock
                                to the Distribution Agent. As soon as
                                practicable thereafter, the Distribution Agent
                                will mail account statements reflecting
                                ownership of the appropriate number of shares
                                of Franchising Common Stock to Choice's
                                stockholders entitled thereto. See "The
                                Distribution--Manner of Effecting the
                                Distribution."
 
Distribution Agent............  ChaseMellon Shareholder Services, L.L.C., the
                                transfer agent for the Company.
 
Reverse Stock Split...........  In connection with the Distribution, Choice
                                shall effect a one-for-three reverse stock
                                split of Choice Common Stock whereby every
                                three shares of Choice Common Stock will be
                                aggregated into one share of Choice Common
                                Stock. See "Amendments to the Restated
                                Certification of Incorporation of Choice--
                                Reverse Stock Split."
 
                                       5
CHOICE HOTELS FRANCHISING, INC.
 
Business......................  Franchising is presently a wholly owned
                                subsidiary of Choice. Following the
                                Distribution, Franchising will conduct the
                                Franchising Business as now conducted by
                                Franchising, Choice and certain other
                                subsidiaries of Choice. Franchising will be one
                                of the world's largest franchisors of hotels
                                with 3,344 properties open and operating in 33
                                countries at May 31, 1997. As a franchisor,
                                Franchising will license hotel operators to use
                                Franchising's brand names: Comfort(R),
                                Quality(R), Clarion(R), Sleep(R), Rodeway(R),
                                Econo Lodge(R) and MainStay SuitesSM
                                (collectively, the "Choice Brands"), and will
                                provide to these hotel operators products and
                                services designed to increase their revenues
                                and profitability. Following the Distribution,
                                Franchising will also conduct Choice's European
                                hotel operations, including Choice's indirect
                                investment in Friendly Hotels, PLC.
 
Board of Directors............  Effective as of the Distribution Date, the
                                Board of Directors of Franchising is expected
                                to consist of nine persons: Stewart Bainum,
                                Jr., Stewart Bainum, Barbara Bainum, William R.
                                Floyd, James H. Rempe, Robert C. Hazard, Jr.,
                                Gerald W. Petitt, Jerry E. Robertson, Ph.D and
                                Frederic V. Malek.

Post-Distribution Dividend    
 Policy.......................  The dividend policy of Franchising will be
                                determined by Franchising's Board of Directors
                                following the Distribution. It is expected that
                                the Franchising Credit Facility (as defined
                                below) will restrict Franchising's ability to
                                pay dividends. See "Financing."
 
Certain Restated Certificate  
 of Incorporation and Bylaw   
 Provisions...................  The Restated Certificate of Incorporation (the
                                "Franchising Certificate") and the Bylaws (the
                                "Franchising Bylaws") of Franchising are
                                substantially identical to, and contain no
                                material differences from, the Choice Restated
                                Certificate of Incorporation and Bylaws.
                                Certain provisions of the Franchising
                                Certificate and the Franchising Bylaws have the
                                effect of delaying or making more difficult an
                                acquisition of control of Franchising in a
                                transaction not approved by its Board of
                                Directors. These provisions have been designed
                                to enable Franchising, especially in its
                                initial years, to develop its businesses and
                                foster its long-term growth without disruptions
                                caused by the threat of a takeover not deemed
                                by its Board of Directors to be in the best
                                interests of Franchising. Such provisions
                                could, however, deter an offer for Franchising
                                Common Stock at a substantial premium to the
                                then current market price or hinder a potential
                                transaction that may be attractive to
                                stockholders. See "Certain Information
                                Concerning Franchising--Purposes and Effects of
                                Certain Provisions of the Franchising
                                Certificate and Bylaws." The Franchising
                                Certificate would eliminate certain liabilities
                                of directors in connection with the performance
                                of their duties. See "Certain Information
                                Concerning Franchising--Liability and
                                Indemnification of Officers and Directors--
                                Elimination of Liability in Certain
                                Circumstances."
 
Principal Office..............  10750 Columbia Pike, Silver Spring, Maryland
                                20901. Its telephone number is (301) 979-5000.
 
 
                                       6
SUNBURST HOSPITALITY CORPORATION
 
Business......................  Following the Distribution, Sunburst will
                                retain Choice's Hotel Business and will own and
                                manage 71 hotels in 25 states, primarily under
                                Franchising's brands, and will be Franchising's
                                largest franchisee.
 
Board of Directors............  Effective as of the Distribution Date, the
                                Board of Directors of Sunburst is expected to
                                consist of seven persons; Stewart Bainum, Jr.,
                                Stewart Bainum, Donald J. Landry, Frederic V.
                                Malek, Paul R. Gould, Carole Y. Prest and one
                                additional director to be selected by the
                                Company's Board of Directors prior to the
                                Distribution. The remaining vacancy will be
                                filled by a person who is not a Sunburst
                                employee or employee or director of
                                Franchising.
Post-Distribution Dividend      
 Policy.......................  The dividend policy of Sunburst will be
                                determined by its Board of Directors following
                                the Distribution. Choice currently is
                                prohibited from paying dividends pursuant to
                                the terms of its loan agreement with MNR
                                Finance Corp. It is expected that the Sunburst
                                Credit Facility will restrict Sunburst's
                                ability to pay dividends. See "Financing."
 
Listing and Trading Market....  The Sunburst Common Stock (formerly Choice
                                Common Stock) is expected to continue to be
                                listed on the New York Stock Exchange following
                                the Distribution. Following the Distribution,
                                Sunburst's financial results will no longer be
                                consolidated with those of Choice's Franchising
                                Business, and Sunburst's revenues, income and
                                other results of operations will be
                                substantially below those of Choice prior to
                                the Distribution. Accordingly, as a result of
                                the Distribution, the trading price range of
                                Sunburst Common Stock immediately after the
                                Distribution (prior to the effect of the
                                Reverse Stock Split) is expected to be
                                significantly lower than the trading range of
                                Choice Common Stock. See "--The Distribution--
                                Listing and Trading of Sunburst Common Stock;
                                and --Risk Factors--Changes in Trading Prices
                                of Sunburst Common Stock."
 
Principal Office..............  10750 Columbia Pike, Silver Spring, Maryland
                                20901. Its telephone number is (301) 979-3800.
 
                                       7
CHOICE HOTELS FRANCHISING, INC.
 
                         SUMMARY FINANCIAL INFORMATION
 
  The following table summarizes certain selected historical financial data of
Franchising for the three fiscal years ended May 31, 1997. The information set
forth below should be read in conjunction with "Certain Information Concerning
Franchising--Selected Historical Financial Data; and --Management's Discussion
and Analysis of Financial Condition and Results of Operations," and the
Combined Financial Statements of Franchising contained elsewhere herein.
YEAR ENDED MAY 31,
                                                  ----------------------------
                                                    1997      1996      1995
                                                  --------  --------  --------
                                                    (DOLLARS IN THOUSANDS)
Statement of Income Data
  Revenues....................................... $272,255  $250,654  $212,672
  Operating expense..............................  201,893   216,271   170,706
  Operating income...............................   70,362    34,383    41,966
  Net income.....................................   34,730    11,664    16,228
  Pro forma earnings per share(4)................ $   0.55  $   0.19  $   0.26
Other Data
  EBITDA(2)(3)................................... $ 80,800  $ 69,450  $ 51,534
  Cash flows from operating activities...........   46,448    32,742    37,851
  Cash flows from investing activities...........  (17,871)  (78,499)   (7,733)
  Cash flows from financing activities...........  (28,222)   48,513   (31,261)
  Number of franchised properties (unaudited)....    3,344     3,052     2,835
  Number of rooms (unaudited)....................  335,127   261,456   245,669
  Average royalty rate (unaudited)...............      3.4%      3.3%      3.2%
Balance Sheet Data
  Working capital (unaudited).................... $ (1,359) $ (3,927) $(29,423)
  Total assets...................................  221,473   212,803   189,087
  Notes payable to Parent........................   78,700    78,700    78,700
  Total debt.....................................  125,163   145,315   128,205
  Total investment and advances from (to)
   Parent........................................   57,193    30,532   (12,699)
--------
(1) 1996 includes a pre-tax charge of $24.8 million for impairment of certain
    long lived assets associated with Franchising's European operations.
(2) EBITDA consists of the sum of net income (loss), interest expense, income
    taxes, depreciation and amortization and non-cash asset writedowns. EBITDA
    is presented because such data is used by certain investors to determine
    Franchising's ability to meet debt service, fund capital expenditures and
    expand its business. Franchising considers EBITDA to be an indicative
    measure of operating performance particularly due to the large amount of
    goodwill and franchise rights amortization. Such information should not be
    considered an alternative to net income, operating income, cash flow from
    operations or any other operating or liquidity performance measure
    prescribed by GAAP. Cash expenditures (including nondiscretionary
    expenditures) for various long-term assets, interest expense and income
    taxes have been, and will be, incurred which are not reflected in the
    EBITDA presentation and therefore EBITDA does not represent funds available
    for management's discretionary use. EBITDA presented by Franchising may not
    be comparable to EBITDA defined and presented by other companies.
(3) 1996 EBITDA excludes a pre-tax charge of $24.8 million for impairment of
    certain long lived assets associated with Franchising's European
    operations.
(4) Pro forma earnings per share has been calculated based on the weighted
    average shares outstanding of its parent Manor Care, Inc. for fiscal year
    1995 and fiscal year 1996 of 62,480,000 and 62,628,000, respectively, and
    its parent Choice Hotels International, Inc. for fiscal year 1997 of
    62,680,000.
 
                                       8
RISK FACTORS
 
CERTAIN FINANCIAL AND OPERATING CONDITIONS
 
  While the Hotel Business and the Franchising Business have substantial
operating histories, Sunburst and Franchising do not have operating histories
as separate stand-alone companies. Prior to the Distribution, each of the two
businesses had access to the cash flow generated by the other and Choice's
credit, which was based on the combined assets of the Hotel Business and the
Franchising Business. Subsequent to the Distribution, Sunburst will not have
the benefit of either the cash flow generated by, or the assets of, the
Franchising Business, and Franchising will not have the benefit of either the
cash flow generated by, or the assets of, the Hotel Business.
 
  Subsequent to the Distribution, each of Sunburst and Franchising will be a
smaller and less diversified company than Choice prior to the Distribution. In
addition, the division of Choice may result in some temporary dislocation and
inefficiencies to the business operations, as well as the organization and
personnel structure, of each company. Nevertheless, Choice's Board of
Directors believes that separation of the two companies will also result in
long-term operating efficiencies by allowing the companies to focus on their
respective businesses.
 
SUBSTANTIAL LEVERAGE AT SUNBURST
 
  After the Distribution, Sunburst will be a highly leveraged corporation.
Assuming that the Distribution had been consummated on May 31, 1997, Sunburst
would have had, on a pro forma basis, total long-term indebtedness of
approximately $246.8 million (representing approximately 78.6% of its total
capitalization) and total stockholders' equity of $67.3 million, compared with
Choice's actual long-term indebtedness as of May 31, 1997, before allocation
of indebtedness to Franchising of $372.0 million (representing approximately
74.9% of its total capitalization) and total stockholder's equity of $124.5
million.
 
  Sunburst's Hotel Business is a capital-intensive business and Sunburst will
continue to have significant capital requirements in the future. As a highly
leveraged corporation, any new financing and refinancing by Sunburst of its
existing indebtedness may be at higher interest rates and on less advantageous
terms than may have been the case had the Distribution not taken place. For a
discussion of the financing for Sunburst expected to be implemented in
connection with the Distribution, see "Financing." This significant degree of
leverage could have a potential negative impact on the ability of Sunburst to
incur additional debt to fund future expansion. While Sunburst's operating
cash flow is expected to be sufficient to cover its expenses, including
interest costs, Sunburst may be required to supplement operating cash flow
with asset sales, refinancing proceeds, equity offerings or capital spending
reductions to meet principal repayment obligations in later years. There can
be no assurance that any refinancing or equity offering could be successfully
concluded. Any resort to alternative sources of funds may impair Sunburst's
competitive position and reduce its cash flow.
 
  The ability of Sunburst to satisfy its obligations, to reduce its debt and
to increase equity will also be dependent upon its future performance, which
will be subject to prevailing economic conditions and to financial, business
and other factors, including factors beyond the control of Sunburst, affecting
the business operations of Sunburst.
 
CERTAIN TAX CONSIDERATIONS
 
  Choice has conditioned the Distribution on the receipt of a favorable ruling
from the Internal Revenue Service. On September 12, 1997, Choice received such
a ruling from the Internal Revenue Service.
 
  Such rulings, while generally binding upon the Internal Revenue Service, are
subject to certain factual representations and assumptions. If such factual
representations and assumptions were incorrect in a material respect, such
ruling would be jeopardized. Choice is not aware of any facts or circumstances
which would cause such representations and assumptions to be untrue. Choice
and Franchising will agree to comply in all material respects with each
representation and statement made to a taxing authority in connection with the
Distribution to provide further assurances that the Distribution will qualify
as tax free. See "--Relationship Between Choice and Franchising After the
Distribution--Distribution Agreement."
 
                                       9
If the Distribution were not to qualify under Section 355 of the Code, then
in general a corporate tax would be payable by the consolidated group of which
Choice is the common parent based upon the difference between (x) the fair
market value of the Franchising Common Stock and (y) the adjusted basis of the
Franchising Common Stock immediately prior to the Distribution. The corporate
level tax would be payable by Choice and could be substantial. Under the
consolidated return rules, each member of the consolidated group (including
Franchising) is severally liable for such tax liability.
 
  Furthermore, each holder of Choice Common Stock who receives shares of
Franchising Common Stock in the Distribution would be treated as if such
stockholder received a taxable distribution in an amount equal to the fair
market value of the Franchising Common Stock received, which would result in
(x) a dividend to the extent of such stockholder's pro rata share of Choice's
current and accumulated earnings and profits, (y) a reduction in such
stockholder's basis in Choice Common Stock to the extent the amount received
exceeds such stockholder's share of earnings and profits and (z) gain from the
exchange of Choice Common Stock to the extent the amount received exceeds both
such stockholder's share of earnings and profits and such stockholder's basis
in Choice Common Stock.
 
NO CURRENT PUBLIC MARKET FOR FRANCHISING COMMON STOCK
 
  Currently, there is no public market for Franchising Common Stock and there
can be no assurances as to the prices at which trading in Franchising Common
Stock will occur after the Distribution. Until Franchising Common Stock is
fully distributed and an orderly market develops, the prices at which trading
in such stock occurs may fluctuate significantly. The prices at which
Franchising Common Stock trades will be determined by the marketplace and may
be influenced by many factors, including, among others, the depth and
liquidity of the market for Franchising Common Stock, investor perception of
Franchising and the industry in which Franchising participates, Franchising's
dividend policy and general economic and market conditions. The Franchising
Common Stock has been approved to submit an application for listing on the New
York Stock Exchange subject to certain conditions. See "The Distribution--
Listing and Trading of Franchising Common Stock."
 
CHANGES IN TRADING PRICES OF SUNBURST COMMON STOCK
 
  It is expected that Sunburst Common Stock (formerly Choice Common Stock)
will continue to be listed and traded on the New York Stock Exchange after the
Distribution. Following the Distribution, Sunburst's financial results will no
longer be consolidated with those of Choice's Franchising Business, and
Sunburst's revenues, income and other results of operations will be
substantially below those of Choice prior to the Distribution. Accordingly, as
a result of the Distribution, the trading price range of Sunburst Common Stock
immediately after the Distribution (prior to giving effect to the Reverse
Stock Split) is expected to be significantly lower than the trading price
range of Choice Common Stock. Additionally, the combined trading prices of
Sunburst Common Stock and Franchising Common Stock held by stockholders after
the Distribution may be less than, equal to or greater than the trading price
of Choice Common Stock prior to the Distribution. See "The Distribution--
Listing and Trading of Sunburst Common Stock."
 
  For a description of the Reverse Stock Split to be undertaken by Choice as
part of the Distribution and its anticipated impact on the trading price range
of Sunburst Common Stock, see "Amendments to the Restated Certificate of
Incorporation of Choice."
 
CERTAIN ANTITAKEOVER FEATURES
 
  If the Distribution is consummated, the Franchising Certificate and
Franchising Bylaws will contain several provisions, which are now in effect
with respect to Choice and will continue to be in effect with respect to
Sunburst, that may make the acquisition of control of Franchising difficult or
expensive, or increase the likelihood that incumbent management will retain
their positions or hinder a transaction that may be attractive to
stockholders. See "The Distribution--Certain Information Concerning
Franchising--Purposes and Antitakeover Effects of Certain Provisions of the
Franchising Certificate and Bylaws."
 
 
                                      10
POTENTIAL CONFLICTS
 
  Subsequent to the Distribution, the ongoing relationship between Sunburst
and Franchising may potentially give rise to conflicts of interests. In
connection with the Distribution, (i) Sunburst and Franchising will enter into
a Strategic Alliance Agreement pursuant to which Sunburst will grant to
Franchising a right of first refusal to franchise lodging properties developed
or acquired by Sunburst that Sunburst intends to operate under franchise;
Franchising will grant to Sunburst a conditional option to purchase the
MainStay Suites hotel system; each of the parties will continue to cooperate
with respect to matters of mutual interest, including new product and concept
testing for Franchising in hotels owned by Sunburst, and Sunburst will
authorize Franchising, in certain circumstances, to negotiate with third party
vendors on Sunburst's behalf; (ii) Sunburst and Franchising will be parties to
agreements pursuant to which Franchising will provide to Sunburst certain
administrative services after the Distribution and (iii) Sunburst, pursuant to
certain franchising agreements, will be the largest franchisee of Franchising.
See "Relationship Between Choice and Franchising After the Distribution." With
respect to these matters, the potential exists for disagreements as to the
quality of the services provided by the parties and as to contract compliance.
Nevertheless, Choice believes that there will be sufficient mutuality of
interest between the two companies to result in a mutually productive
relationship. In addition, Stewart Bainum, Jr. will serve as Chairman of the
Board of Directors of both Sunburst and Franchising. Stewart Bainum and
Frederick V. Malek will each serve as a director of each of Sunburst and
Franchising. Messrs. Bainum, Jr., Bainum and Malek as well as certain other
officers and directors of Sunburst and Franchising will also own shares
(and/or options or other rights to acquire shares) in both companies following
the Distribution. Appropriate policies and procedures will be followed by the
boards of directors of each company to limit the involvement of the
overlapping directors (and if appropriate, relevant officers of such
companies) in conflict situations, including requiring them to abstain from
voting as directors of either Sunburst or Franchising on certain matters which
present a conflict between the two companies.
 
FRAUDULENT TRANSFER CONSIDERATIONS; LEGAL DIVIDEND REQUIREMENTS
 
  Choice's Board of Directors does not intend to consummate the Distribution
unless it is satisfied regarding the solvency of Choice, Franchising and the
permissibility of the Distribution under Section 170 of the (DGCL). There is
no certainty, however, that a court would reach the same conclusion. If a
court (for example, in a lawsuit by an unpaid creditor or representatives of
creditors) were to find that, at the time the Company effected the
Distribution of Franchising, Choice or Franchising, as the case may be, (i)
was insolvent, (ii) was rendered insolvent by reason of the Distribution,
(iii) was engaged in a business or transaction for which Choice's or
Franchising's remaining assets, as the case may be, constituted unreasonably
small capital, or (iv) intended to incur, or believed it would incur, debts
beyond its ability to pay as such debts matured, such court may be asked to
void the Distribution (in whole or in part) as a fraudulent conveyance and
require that the stockholders return the special dividend (in whole or in
part) to Choice, or require Choice or Franchising, as the case may be, to fund
certain liabilities of the other company for the benefit of creditors. The
measure of insolvency for purposes of the foregoing will vary depending upon
the jurisdiction whose law is being applied. Generally, however, Choice,
Franchising, as the case may be, would be considered insolvent if the fair
value of their respective assets were less than the amount of their respective
liabilities or if they incurred debt beyond their ability to repay such debt
as it matures. In addition, under Section 170 of the DGCL (which is applicable
to Choice in the Distribution) a corporation generally may make distributions
to its stockholders only out of its surplus (net assets minus capital) and not
out of capital.
 
SIGNIFICANT BAINUM FAMILY INTEREST
 
  Upon completion of the Distribution, certain members of the Bainum family
(including various trusts established by members of the Bainum family) in the
aggregate will have the right to vote approximately 34.43% of the outstanding
shares of Franchising Common Stock and Sunburst Common Stock. See "--Certain
Information Concerning Franchising--Security Ownership." In addition, Mr.
Bainum and Mr. Bainum, Jr. each will be a director of Sunburst and Mr. Bainum,
Mr. Bainum, Jr. and Ms. Bainum each will be a director of Franchising. As a
result, the Bainum family may be in a position to significantly influence the
affairs of each of Sunburst and Franchising, including the election of
directors.
 
                                      11
DIVIDEND POLICIES
 
  The dividend policies of Sunburst and Franchising will be determined by
their respective Boards of Directors following the Distribution. The
declaration and payment of dividends by Sunburst will be at the discretion of
the Sunburst Board of Directors. The declaration and payment of dividends by
Franchising will be at the discretion of the Franchising Board of Directors.
The Sunburst Board of Directors and the Franchising Board of Directors intend
to re-evaluate their respective dividend policies from time to time in light
of their respective companies' results of operations, financial condition,
cash requirements, future prospects and other factors deemed relevant. There
can be no assurance that any dividends will be paid by either company in the
future. Choice currently is prohibited from paying dividends pursuant to the
terms of its loan agreement with MNR Finance Corp. It is expected that the
Franchising Credit Facility (defined below) and the Sunburst Credit Facility
(defined below) will restrict Franchising and Sunburst's ability to pay
dividends. See "Financing."
 
IMPACT OF INFLATION AND OTHER EXTERNAL FACTORS
 
  Franchising's principal sources of revenues are franchise fees. Franchise
fees and revenues from owned and managed hotels can be impacted by two
external factors: the supply of hotel rooms within the lodging industry
relative to the demand for rooms by travelers, and inflation.
 
  Although industry-wide supply and demand for hotel rooms recently has been
fairly balanced, any excess in supply that might develop in the future could
have an unfavorable impact on room revenues at Franchising's franchised hotels
either by reducing the number of rooms reserved at Franchising's properties or
by restricting the rates hotel operators can charge for their rooms. In
addition, an excess supply of hotel rooms may discourage potential franchisees
from opening new hotels, unfavorably impacting the franchise fees received by
Franchising.
 
  Although Franchising believes that increases in the rate of inflation will
generally result in comparable increases in hotel room rates, severe inflation
could contribute to a slowing of the national economy, which could result in
reduced travel by both business and leisure travelers. That could lead to less
demand for hotel rooms, which could result in a temporary reduction in room
rates and fewer room reservations, negatively impacting revenues received by
Franchising. A weak economy could also reduce demand for new hotels,
negatively impacting the franchise fees received by Franchising.
 
  Among the other unpredictable external factors which may affect
Franchising's fee revenue stream are wars, airline strikes and severe weather.
 
FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY
 
  Certain statements contained in this Prospectus under the captions
"Prospectus Summary; Risks Factors; Certain Information Concerning
Franchising--Management's Discussion and Analysis of Financial Condition and
Results of Operations; Business and Properties; Certain Information Concerning
Sunburst--Management's Discussion and Analysis of Sunburst Pro Forma Financial
Condition and Results of Operations; and Business and Properties" and
elsewhere constitute estimates of future performance or other forward-looking
statements. Such forward-looking statements involve known and unknown risks,
uncertainties and other important factors that could cause the actual results,
performance or achievements of Choice or Franchising for industry results to
differ materially from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such risks,
uncertainties and other important factors include, among other things:
Sunburst's substantial leverage after the Distribution, and its plans to
realize cash proceeds through leveraging its remaining assets; Sunburst's
plans to make selected strategic investments and acquisitions and develop new
hotels; Franchising's plans to expand its international franchise operations;
Franchising's plans to market new brands and products; Sunburst's and
Franchising's success in implementing their respective business strategies,
including their success in arranging financing where required; competition;
government regulation; general economic and business conditions; and other
factors referenced in this Proxy Statement. These forward-looking statements
speak only as of the date of this Prospectus. Choice and Franchising expressly
disclaim any obligation or undertaking to disseminate any updates or revisions
to any forward-looking statement contained herein to reflect any change in
Choice's or Franchising's expectations with regard thereto or any change in
events, conditions or circumstances on which any such statement is based.
 
                                      12
USE OF PROCEEDS
 
  The Franchising Options will be issued as part of the adjustments to
outstanding Choice Options and Franchising will receive no proceeds from such
issuance. The proceeds to Franchising, if any, to be received from exercise of
the Franchising Options will be used for working capital and other general
corporate purposes.
 
  The number of Franchising Options issued to any Manor Care Employee and the
aggregate exercise price thereof will be set so that the number of shares of
Franchising Common Stock subject to the Franchising Options and the aggregate
exercise price thereof, when combined with the adjusted number of shares
under, and aggregate exercise price of, the Choice Options held by such Manor
Care Employees will preserve the aggregate exercise price and aggregate
financial value of the Choice Options held by such Manor Care Employee prior
to the adjustment.
 
                             PLAN OF DISTRIBUTION
 
  As of the date hereof, the thirty-three Manor Care Employees hold options
(the "Choice Options") to purchase up to 1,193,571 shares of Choice Common
Stock issued by Choice in November 1996 as part of the Manor Care Spin-off (as
defined herein) pursuant to the Choice Hotels International, Inc. 1996 Long-
Term Incentive Plan (the "Choice Plan"). Under the Choice Plan, each
outstanding Choice Option will be adjusted as a result of the Distribution in
the manner described herein in order to preserve the financial value of such
Choice Options prior to the Distribution.
 
  On or prior to the Distribution Date, each Manor Care Employee holding
nonqualified Choice Options may make a one-time election to choose a
conversion award consisting of any percentage combination of an option to
acquire any Franchising Common Stock and an adjusted Choice Option, with the
number of shares and the exercise price of each option adjusted so as to
preserve the financial value of the outstanding Choice Options. The
Franchising Options issuable to Manor Care Employees as part of the
aforementioned adjustment to Choice Options and the Shares of Franchising
Common Stock issuable upon exercise of such Franchising Options will be issued
pursuant to the Registration Statement of which this Prospectus is a part.
 
                                 LEGAL MATTERS
 
  The validity of the Franchising Common Stock and Franchising Options will be
passed upon for Franchising by Michael J. DeSantis, Senior Vice President,
General Counsel and Secretary of Franchising.
 
                                    EXPERTS
 
  The combined financial statements of Choice Hotels Franchising included in
this Registration Statement have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their reports with respect
thereto and have been included herein in reliance upon the authority of said
firm as experts in giving said reports.
 
                                      13
THE DISTRIBUTION
 
MANNER OF EFFECTING THE DISTRIBUTION
 
  The general terms and conditions of the Distribution will be set forth in a
Distribution Agreement (the "Distribution Agreement") to be entered into by
Choice and Franchising prior to the Distribution.
 
  If all conditions to the Distribution are satisfied (or waived by the Board
of Directors), the Distribution will be made on the Distribution Date to
stockholders of record of Choice as of the Record Date. On the Distribution
Date, the Franchising Common Stock will be delivered by Choice to ChaseMellon
Shareholder Services, L.L.C., as the distribution agent (the "Distribution
Agent"). As soon thereafter as practicable, account statements reflecting
ownership of shares of Choice Common Stock and Franchising Common Stock will
be mailed by the Distribution Agent to holders of Choice Common Stock as of
the Distribution Record Date to reflect the distribution of one share of
Franchising Common Stock for every share of Choice Common Stock held on such
date. All shares will be fully paid and non-assessable and the holders thereof
will not be entitled to preemptive rights.
 
  No holder of Choice Common Stock will be required to pay any cash or other
consideration for the shares of Franchising Common Stock received in the
Distribution or to surrender or exchange shares of Choice Common Stock in
order to receive Franchising Common Stock.
 
FEDERAL INCOME TAX ASPECTS OF THE DISTRIBUTION
 
  Choice has conditioned the Distribution on the receipt of a ruling from the
Internal Revenue Service to the effect that, among other things, for federal
income tax purposes, the Distribution will qualify as a tax-free spin-off
under Section 355 of the Internal Revenue Code of 1986 (the "Code"), as
amended, and that:
 
    (1) No gain or loss will be recognized by (and no amount will be included
  in the income of) holders of Choice Common Stock upon the receipt of shares
  of Franchising Common Stock in the Distribution;
 
    (2) Provided that on the Distribution Date a holder of Choice Common
  Stock holds such stock as a capital asset, the holding period for the
  shares of Franchising Common Stock to be received in the Distribution will
  include the holding period of Choice Common Stock with respect to which the
  Distribution was made;
 
    (3) A holder's basis in Choice Common Stock held immediately before the
  Distribution will be allocated, based upon relative fair market values at
  the time of the Distribution, between such Choice Common Stock and the
  shares of Franchising Common Stock received by the stockholder in the
  Distribution; and
 
    (4) No gain or loss will be recognized by Choice or Franchising upon the
  Distribution.
 
  On September 12, 1997, Choice received from the Internal Revenue Service a
ruling to the foregoing effect. For a description of the consequences to
Choice, Franchising and the stockholders if the Distribution were not to
qualify as tax free, see "--Risk Factors--Certain Tax Considerations."
 
                                      14
The foregoing summary of material federal income tax consequences of the
Distribution does not purport to cover all federal income tax consequences
that may apply to all categories of stockholders. Each stockholder should
consult its own tax advisor as to the particular consequences of the
Distribution to such stockholder, including the application of state, local
and foreign tax laws, and the effect of possible changes in tax laws that may
affect the tax consequences described above.
 
LISTING AND TRADING OF FRANCHISING COMMON STOCK
 
  Currently, there is no public market for Franchising Common Stock. It is
Choice's intention that no "when-issued" trading market for Franchising Common
Stock will exist prior to the time Franchising's Registration Statement on
Form 10 with respect to the Franchising Common Stock (the "Franchising Form
10") is declared effective by the Commission. Prices at which Franchising
Common Stock may trade prior to the Distribution (on a "when-issued" basis) or
after the Distribution cannot be predicted. Until the Franchising Common Stock
is fully distributed and an orderly market develops, the prices at which
trading in such stock occurs may fluctuate significantly. The prices at which
Franchising Common Stock trades will be determined by the marketplace and may
be influenced by many factors, including, among others, the depth and
liquidity of the market for Franchising Common Stock, investor perception of
Franchising and the industry in which Franchising participates, Franchising's
dividend policy and general economic and market conditions. Such prices may
also be affected by certain provisions of the Franchising Certificate and
Franchising Bylaws, as each will be in effect following the Distribution,
which may have an antitakeover effect. See "Risk Factors--Dividend Policies;
and--Certain Information Concerning Franchising--Purposes and Antitakeover
Effects of Certain Provisions of the Franchising Certificate and Bylaws."
 
  Franchising has received approval to submit an application to list the
Franchising Common Stock on the New York Stock Exchange. However, there can be
no assurance that the Franchising Common Stock will be accepted for listing on
the New York Stock Exchange or any other national stock exchange or market.
Franchising initially will have approximately 4,550 stockholders of record
based upon the number of stockholders of record of Choice as of August 5,
1997. For certain information regarding options to purchase Franchising Common
Stock that will be outstanding after the Distribution, see "Relationship
Between the Company and Franchising After the Distribution--Employee Benefits
Allocation Agreement."
 
  The distribution of the Franchising Common Stock need not be registered
under the Securities Act of 1933, as amended (the "Securities Act") and shares
of Franchising Common Stock distributed to Choice's stockholders in the
Distribution will be freely transferable, except for securities received by
persons who may be deemed to be "affiliates" of Choice within the meaning of
Rule 144 under the Securities Act. Persons who are affiliates of Franchising
within the meaning of Rule 144 may not publicly offer or sell the Franchising
Common Stock received in connection with the Distribution except pursuant to a
registration statement under the Securities Act or pursuant to Rule 144.
 
LISTING AND TRADING OF SUNBURST COMMON STOCK
 
  It is expected that the Sunburst Common Stock (formerly Choice Common Stock)
will continue to be listed and traded on the New York Stock Exchange after the
Distribution. Following the Distribution, Sunburst's financial results will no
longer be consolidated with those of Choice's Franchising Business, and
Sunburst's revenues, income and other results of operations will be
substantially below those of Choice prior to the Distribution. Accordingly, as
a result of the Distribution, the trading price range of Sunburst Common Stock
immediately after the Distribution (prior to the effect of the Reverse Stock
Split) is expected to be significantly lower than the trading price range of
Choice Common Stock, and the combined trading prices of Sunburst Common Stock
and Franchising Common Stock held by stockholders after the Distribution may
be less than, equal to or greater than the trading price of Choice Common
Stock, prior to the Distribution. The prices at which Sunburst Common Stock
trades after the Distribution will be determined by the marketplace and may be
influenced by many factors, including, among others, the continuing depth and
liquidity of the market for Sunburst Common Stock, investor perception of the
Hotel Business, Sunburst's dividend policy and general economic and market
conditions.
 
                                      15
CONDITIONS; TERMINATION
 
  Choice's stockholders approved the Distribution at the Choice Annual Meeting
of Stockholders on September 16, 1997, however, the Board of Directors has
conditioned the Distribution upon, among other things, satisfaction of the
following conditions prior to the Distribution Record Date: (i) the Internal
Revenue Service having issued a ruling in response to Choice's request in form
and substance satisfactory to the Board of Directors (which ruling has been
obtained by Choice); (ii) the Franchising Common Stock having been approved
for listing on the New York Stock Exchange subject to official notice of
issuance; (iii) the taking of all actions with respect to the Distribution
required or advisable under the Securities Act and the Exchange Act and the
rules and regulations promulgated thereto, including the Franchising Form 10
having become effective under the Exchange Act; (iv) any third-party consents
to the transactions contemplated by the Distribution Proposals having been
obtained, except for those the failure of which to obtain would not have a
material adverse effect on Choice or Franchising; and (v) the financing
arrangements described below in "--Financing" have been entered into. Any of
these conditions, may be waived in the discretion of the Board of Directors at
any time prior to the Distribution Date. The Board of Directors will not waive
any of the conditions to the Distribution or make any changes in the terms of
the Distribution unless the Board of Directors determines that such changes
would not be materially adverse to Choice's stockholders. In determining
whether any such changes would be materially adverse to the Choice's
stockholders, the Board of Directors will consider, as appropriate, advice
from its outside advisors as well as the recommendation of management as to
the potential impact of such changes on Choice and Choice's stockholders. See
"Relationship Between Choice and Franchising after the Distribution--
Distribution Agreement."
 
INTEREST OF CERTAIN PERSONS IN THE DISTRIBUTION
 
 Franchising
 
  It is anticipated that upon the Distribution, all of the current members of
Choice's Board of Directors except for Paul R. Gould will be appointed to the
Board of Directors of Franchising. Additionally, Stewart Bainum, Jr. will
serve as Chairman of the Boards of Directors of Choice and Franchising and
Stewart Bainum and Frederic V. Malek will be members of the Boards of
Directors of Choice and Franchising. Messrs. Bainum and Bainum, Jr., Ms.
Bainum and Messrs. Hazard, Jr., Malek, Petitt and Robertson will each receive
from Franchising compensation for serving as a director of Franchising that is
substantially the same as the compensation currently received by such persons
as directors of Choice.
 
  It is further anticipated that upon the Distribution, William R. Floyd will
become Vice Chairman and Chief Executive Officer of Franchising; James A.
MacCutcheon will become Executive Vice President, Chief Financial Officer and
Treasurer of Franchising; Thomas Mirgon will become Senior Vice President,
Human Resources of Franchising; Barry L. Smith will become Senior Vice
President--Marketing of Franchising; Michael J. DeSantis will become Senior
Vice President, General Counsel and Secretary of Franchising; and Joseph M.
Squeri will become Vice President--Finance and Controller of Franchising.
 
  Effective upon the Distribution Date, Franchising is expected to enter into
a series of employment agreements with current members of Choice's management
as follows. It is expected that Franchising will enter into an employment
agreement with Stewart Bainum, Jr., providing for Mr. Bainum, Jr.'s employment
as Chairman of the Board of Franchising. Either Franchising or Mr. Bainum may
terminate the agreement upon 30 days' prior written notice on the first and
second anniversary dates of the agreement. The agreement will provide that Mr.
Bainum, Jr. will devote 12.5% of his professional time to the affairs of
Franchising, 12.5% of his professional time to the affairs of Choice and the
remaining 75% of his professional time to the affairs of Manor Care. The
agreement provides for a base salary of $82,044 per annum for services to
Franchising and a maximum bonus of 60% of Mr. Bainum, Jr.'s base compensation
based upon the performance of Franchising.
 
  Effective upon the Distribution Date, Franchising is expected to assume
employment agreements between Choice and William R. Floyd, James A.
MacCutcheon and Thomas Mirgon, respectively. For additional discussion of
employment agreements between Franchising and its management, see "Certain
Information Concerning Franchising--Employment Agreements."
 
                                      16
Sunburst
 
  Sunburst has entered into an employment agreement with Donald J. Landry,
which will become effective upon the Distribution Date, providing for Mr.
Landry's employment as Chief Executive Officer of Sunburst.
 
 Outstanding Stock Options
 
  In connection with the Distribution, directors and officers of Choice will
have the opportunity to receive options to purchase Franchising Common Stock
and/or to retain Choice Common Stock as an adjustment to preserve the
financial value of their outstanding options to purchase Choice Common Stock.
For a discussion of the treatment of outstanding options to purchase Choice
Common Stock in connection with the Distribution, see "Relationship Between
Choice and Franchising After the Distribution--Employee Benefits Allocations
Agreement."
 
                                      17
RELATIONSHIP BETWEEN CHOICE
                    AND FRANCHISING AFTER THE DISTRIBUTION
 
  For purposes of governing the ongoing relationships between Choice and
Franchising after the Distribution Date, and in order to facilitate the
transition to two separate publicly-traded companies, Choice and Franchising
will enter into agreements setting forth Choice's and Franchising's on-going
responsibilities regarding the matters outlined below. The material terms of
such agreements are described below and the agreements summarized in this
section are included as exhibits to the Registration Statement of which this
Prospectus is a part.
 
DISTRIBUTION AGREEMENT
 
  On or prior to the Distribution Date, Choice and Franchising will enter into
a Distribution Agreement which provides for, among other things, the principal
corporate transactions required to effect the Distribution, the assumption by
Franchising of all liabilities relating to the Franchising Business and the
allocation between the Company and Franchising of certain other liabilities,
certain indemnification obligations of Choice and Franchising and certain
other agreements governing the relationship between Choice and Franchising
with respect to or in consequence of the Distribution. The Distribution
Agreement provides that the Distribution is subject to the prior satisfaction
of certain conditions including, among other things, the execution of all
ancillary agreements to the Distribution Agreement, certain of which are
described below, and the declaration of the Distribution by the Choice Board
of Directors.
 
  Subject to certain exceptions, Franchising has agreed to indemnify Choice
and its subsidiaries against any loss, liability or expense incurred or
suffered by Choice or its subsidiaries arising out of or related to the
failure by Franchising to perform or otherwise discharge liabilities allocated
to and assumed by Franchising under the Distribution Agreement, and Choice has
agreed to indemnify Franchising against any loss, liability or expense
incurred or suffered by Franchising arising out of or related to the failure
by Choice to perform or otherwise discharge the liabilities retained by Choice
under the Distribution Agreement. The foregoing cross-indemnities do not apply
to indemnification for tax claims and liabilities, which are addressed in the
Tax Sharing Agreement described below. The Distribution Agreement also
includes procedures for notice and payment of indemnification claims and
provides that the indemnifying party may assume the defense of a claim or suit
brought by a third party.
 
  To avoid adversely affecting the intended tax consequences of the
Distribution, the Distribution Agreement provides that each of Choice and
Franchising will agree to comply in all material respects with each
representation and statement made to any taxing authority in connection with
the IRS tax ruling or any other tax ruling obtained by Choice and Franchising
in connection with the Distribution.
 
  The Distribution Agreement also provides that by the Distribution Date,
Franchising's Amended and Restated Certificate of Incorporation and Bylaws
shall be in the forms attached hereto as Annexes A and B, respectively, and
that Franchising and Choice will take all actions which may be required to
elect or otherwise appoint, as directors of Franchising, the nine persons
indicated herein. See "Certain Information Concerning Franchising--Description
of Franchising Capital Stock; Purposes and Antitakeover Effects of Certain
Provisions of the Franchising Certificate and Bylaws; and Management."
 
  The Distribution Agreement also provides that each of Choice and Franchising
will be granted access to certain records and information in the possession of
the other, and requires the retention of such information in its possession
for specified periods and thereafter requires that each party give the other
prior notice of its intention to dispose of such information. In addition, the
Distribution Agreement provides for the allocation of shared privileges with
respect to certain information and requires each of Choice and Franchising to
obtain the consent of the other prior to waiving any shared privilege.
 
  The Distribution Agreement provides that except as otherwise specifically
provided, all costs and expenses incurred in connection with the preparation,
execution, delivery and implementation of the Distribution
 
                                      18
Agreement and with the consummation of the transactions contemplated by the
Distribution Agreement (including transfer taxes and the fees and expenses of
all counsel, accountants and other advisors) shall be paid by the party
incurring such cost or expense. Notwithstanding the foregoing, Choice shall be
obligated to pay the legal, filing, accounting, printing and other out-of-
pocket expenditures in connection with the preparation, printing and filing of
the Franchising Form 10 Registration Statement.
 
STRATEGIC ALLIANCE AGREEMENT
 
  On or prior to the Distribution Date, Choice and Franchising will enter into
a Strategic Alliance Agreement pursuant to which: (i) Choice will grant a
right of first refusal to Franchising to franchise any lodging property that
Sunburst develops or acquires and intends to operate under franchise; (ii)
Sunburst will, barring a material change in market conditions, continue to
develop Sleep Inns and MainStay Suites hotels so that it will have opened a
total of 14 Sleep Inns and 15 MainStay Suites hotels within 48 months of the
Distribution Date; (iii) Franchising will grant to Sunburst an option,
exercisable under certain circumstances, to purchase the brand names, marks,
franchise agreements and other assets of the MainStay Suites hotel system;
(iv) Sunburst and Franchising will continue to cooperate with respect to
matters of mutual interest, including new product and concept testing for
Franchising in hotels owned by Sunburst; and (v) Sunburst will authorize
Franchising to negotiate with third party vendors on Sunburst's behalf for the
purchase of certain items. The Strategic Alliance Agreement extends for a term
of 20 years with rights of mutual termination on the fifth, tenth and
fifteenth anniversaries.
 
TAX SHARING AGREEMENT
 
  Choice and Franchising will enter into the Tax Sharing Agreement for
purposes of allocating pre-Distribution tax liabilities among Sunburst and
Franchising and their respective subsidiaries. In general, Sunburst will be
responsible for (i) filing consolidated federal income tax returns for the
Sunburst affiliated group and combined or consolidated state tax returns for
any group that includes a member of the Sunburst affiliated group, including
in each case Franchising and its subsidiaries for the periods of time that
such companies were members of the applicable group and (ii) paying the taxes
relating to such tax returns to the applicable taxing authorities (including
any subsequent adjustments resulting from the redetermination of such tax
liabilities by the applicable taxing authorities). Franchising will reimburse
Sunburst for the portion of such taxes that relates to Franchising and its
subsidiaries, as determined based on their hypothetical separate company
income tax liabilities. Sunburst and Franchising have agreed to cooperate with
each other, and to share information, in preparing such tax returns and in
dealing with other tax matters.
 
EMPLOYEE BENEFITS ALLOCATION AGREEMENT
 
  On or prior to the Distribution Date, Choice and Franchising will enter into
an Employee Benefits and Other Employment Matters Allocation Agreement (the
"Employee Benefits Allocation Agreement"). The Employee Benefits Allocation
Agreement provides for the allocation subsequent to the Distribution of
employee benefits, as they relate to employees who remain employed by Sunburst
or its subsidiaries ("Sunburst Employees") after the Distribution and
employees who are employed by Franchising or its subsidiaries after the
Distribution ("Franchising Employees"). During the period beginning on the
Distribution Date and ending on December 31, 1997, Franchising shall pay to
Sunburst, on a monthly basis, a payment equal to 1.9% of the payroll for all
Franchising Employees. In consideration thereof, during such period, Sunburst
will assume all responsibility for all funding obligations and current plan
year matching contributions attributable to certain retirement and savings
plans specified in the Employee Benefits Allocation Agreement. During the same
period, Franchising will also pay to Sunburst a monthly fee of $216 for each
Franchising Employee receiving services and benefits under a Sunburst medical
plan. Sunburst shall be responsible for all liabilities and obligations
related to claims incurred through December 31, 1997 in respect of Sunburst
Employees and Franchising Employees (whether such claims are assessed before
or after December 31, 1997) under any Sunburst welfare plan and, with respect
to pre-tax medical and dependent care programs, will retain any funds
remaining on January 1, 1998. Pursuant to the Employee Benefits Allocation
Agreement, Sunburst will continue sponsorship of the various Choice profit
 
                                      19
sharing plans, stock plans and health and welfare plans with respect to
Sunburst Employees. Franchising will establish a number of plans which will
allow Franchising to provide to its employees substantially the same benefits
currently provided to them as employees of Choice. With respect to each Choice
profit sharing and retirement plan, Sunburst shall transfer to Franchising on
or before January 1, 1998, an amount representing the present value of the
full accrued benefit of all Franchising Employees who had earned a benefit
under any such Choice plan. The Employee Benefits Allocation Agreement
provides for cross-guarantees between Sunburst and Franchising with respect to
the payment of benefits under certain plans and for cross-indemnification with
respect to pre-Distribution employment-related claims.
 
  The Employee Benefits Allocation Agreement also provides for the adjustment
of outstanding options to purchase shares of Choice Common Stock held by
Choice Employees, Franchising Employees and employees of Manor Care (the
"Manor Care Employees") who hold such options as a result of the Manor Care
Spin-off. On the Distribution Date, each Choice Employee and Franchising
Employee holding an incentive stock option to purchase Choice Common Stock
will receive, for each such option, a conversion award consisting of an
incentive stock option to purchase the common stock of such employee's
employer after the Distribution (i.e., Franchising Common Stock for
Franchising Employees and Sunburst Common Stock for Sunburst Employees), with
the number of shares that may be acquired and the option price adjusted
pursuant to a formula designed to preserve the financial value of the options.
Each Sunburst Employee and Franchising Employee holding a non-qualified option
to purchase Choice Common Stock that has vested on or prior to the
Distribution Date may make a one-time election to choose a conversion award
consisting of an option to acquire any percentage combination of Sunburst
Common Stock and Franchising Common Stock with the number of shares and the
exercise price adjusted so as to preserve the financial value of the
outstanding option. Each Sunburst Employee and Franchising Employee holding a
non-qualified option to purchase Choice Common Stock that has not vested on or
prior to such date will receive a conversion award of which one-half of the
financial value of which will comprise an option to acquire shares of common
stock of such employee's employer after the Distribution, and one-half of the
financial value of which will comprise an option to acquire a pro rata
combination of shares of Sunburst Common Stock and Franchising Common Stock.
 
  On the Distribution Date, each Manor Care Employee holding nonqualified
options to purchase shares of Choice Common Stock may make a one-time election
to choose a conversion award consisting of any percentage combination of an
option to acquire Franchising Common Stock and an adjusted Choice Option with
the number of shares and the exercise price of each option adjusted so as to
preserve the financial value of the outstanding Choice Options.
 
LEASE AGREEMENTS
 
  On or prior to the Distribution Date, Choice and Franchising will enter into
a agreement with Manor Care amending the terms of the Gaithersburg Lease to
add Franchising as a guarantor of Sunburst's obligations under the
Gaithersburg Lease. Also on or prior to the Distribution Date, Choice and
Franchising will enter into a sublease agreement with respect to the Silver
Spring Lease. It is currently expected that Franchising will sublease
approximately 54.3% of the office space available under the Silver Spring
Lease with financial terms approximately equal (on a square foot basis) to the
terms of the Silver Spring Lease.
 
TRANSITIONAL SERVICE AGREEMENTS
 
  On or prior to the Distribution Date, Choice and Franchising will enter into
a number of agreements pursuant to which Franchising will provide certain
continuing services to Sunburst for a transitional period. Such services will
be provided on market terms and conditions. Subject to the termination
provisions of the specific agreements, Sunburst will be free to procure such
services from outside vendors or may develop an in-house
 
                                      20
capability in order to provide such services internally. Management believes
that these agreements are based on commercially reasonable terms including
pricing and payment terms. The primary transitional services agreements are
summarized below.
 
  Pursuant to the Employee Benefits Administration Agreement, Franchising will
provide certain benefits, compensation and other services. Such other services
may include benefit plan administration and accounting, COBRA administration,
regulatory compliance and certain fiduciary services. Pursuant to the Tax
Administration Agreement, Franchising will provide certain sales, use,
occupancy, real and personal property tax return administration, audit and
appeals services for Sunburst. Pursuant to the Vehicle Lease Agreement,
Franchising will provide the use of certain vehicles to Sunburst.
 
AMENDMENT TO AGREEMENTS WITH MANOR CARE
 
  Prior to November 1, 1996, Choice and Franchising were wholly owned
subsidiaries of Manor Care. On November 1, 1996, Manor Care effected the Manor
Care Spin-off. In connection with the Manor Care Spin-off Choice and Manor
Care entered into various agreements setting forth Choice's and Manor Care's
on-going responsibilities regarding various matters. In connection with the
Distribution, certain of these agreements will be amended to allocate certain
of Choice's rights and responsibilities thereunder between Franchising and
Sunburst.
 
FRANCHISE AGREEMENTS
 
  The Clarion, Comfort, Econo Lodge, Sleep Inn, Quality, MainStay Suites and
Rodeway marks are each owned by Franchising. Each property currently owned by
Choice is subject to a franchise agreement between Franchising and Choice, as
franchisee (the "Franchise Agreements"). Such agreements (the material terms
of which are described below) will remain in place between Sunburst and
Franchising after the Distribution.
 
  Term. Each Franchise Agreement has an initial term of 20 years, except the
agreement for Tempe, Arizona which is a year to year agreement. The Franchise
Agreements have varying original dates, from 1982 through 1996. Certain
Franchise Agreements allow for unilateral termination by either party on the
5th, 10th, or 15th anniversary of the Franchise Agreement.
 
  Termination by Sunburst. Sunburst (except with respect to one property as
described below) may terminate a Franchise Agreement if Franchising defaults
on its material obligations under such Franchise Agreement and fails to cure
such defaults within 30 days following written notice. The Franchise Agreement
with respect to the Quality Hotel--Arlington (the "Non-Standard Franchise
Agreement") does not allow Sunburst to terminate such Franchise Agreement.
 
  Termination by Franchising. Franchising (except with respect to the Non-
Standard Franchise Agreement) may suspend or terminate a Franchise Agreement
at any time, if, among other things, Sunburst (a) fails to submit reports when
due; (b) fails to pay amounts due under such Franchise Agreement; (c) fails to
pay its debts generally as they become due; or (d) receives two or more
notices of default for similar reasons for any 12 month period. Franchising
(except with respect to the Non-Standard Franchise Agreement) may terminate a
Franchise Agreement immediately upon notice to Sunburst if, among other
things, (a) certain bankruptcy events occur with respect to Sunburst; (b)
Sunburst loses possession or the right to possession of the Property; (c)
Sunburst breaches transfer restrictions in the related Franchise Agreement;
(d) any action is taken to dissolve or liquidate Sunburst; or (e) there is a
threat or danger to the public health and safety in the continued operation of
the Property. If a Franchise Agreement is terminated by Franchising for any of
the reasons discussed in the immediately preceding two sentences, Sunburst is
required to pay liquidated damages equal to the product of (i) the average
monthly gross room revenue for the preceding 12 months, multiplied by (ii) the
royalty fee percentage (more fully described below), multiplied by (iii) the
number of months unexpired under the term of the related Franchise Agreement
(in no event less than $21-$50 multiplied by the specified room count).
 
                                      21
The Non-Standard Franchise Agreement has termination provisions similar to
those in the other Franchise Agreements. Franchising may terminate the Non-
Standard Franchise Agreement immediately upon notice to Sunburst if, among
other things, (a) certain bankruptcy events occur with respect to Sunburst;
(b) certain breaches of the related agreements are not remedied; (c) any
action is taken to dissolve or liquidate Sunburst; or (d) legal proceedings
against Sunburst are not dismissed within a certain period of time. Upon
termination, the Franchise Agreement for the Rodeway Inn-Phoenix (Tempe) calls
for liquidated damages of the greater of (i) $50,000 and (ii) the sum of the
previous two years of fees paid by the licensee.
 
  Fees. The Franchise Agreements require the payment of certain fees and
charges, including the following: (a) a royalty fee of between 1.93% to 5.0%
of monthly gross room revenues; (b) a marketing fee of between 0.7% and 2.5%
plus $0.28 per day multiplied by the specified room count; and (c) a
reservation fee of 0.88% to 1.75% of monthly gross room revenues (or 1% of
monthly gross room revenues plus $1.00 per room confirmed through Choice's
reservation system). The marketing fee and the reservation fee are subject to
reasonable increases during the term of the franchise if Franchising raises
such fees uniformly among all its franchisees, generally. Late payments (i)
will be a breach of the Franchise Agreement and (ii) will accrue interest from
the date of delinquency at a rate of 1.5% per month or portion thereof.
 
  Certain Covenants. The Franchise Agreements impose certain affirmative
obligations upon Franchising including: (a) to lend the Franchisor an
operations manual; (b) to utilize money collected from marketing and
reservation fees to promote those aspects of the franchise business; and (c)
to periodically inspect the Property. The Franchise Agreements also impose
affirmative obligations upon Sunburst including: (a) to participate in a
specified reservation system; (b) to keep and comply with the up-to-date
version of Franchising's rules and regulations for properly running the
specified franchise; (c) to prepare monthly financial and other records; (d)
to not interfere with the franchised mark(s) and Franchising's rights thereto;
and (e) to maintain certain specified insurance policies.
 
  Assignments. Sunburst is prohibited from directly or indirectly selling,
assigning, transferring, conveying, pledging or mortgaging its interest in the
Franchise Agreement, or any equity interest in such franchise interests
without the consent of Franchising except that, among other things, certain
percentages of ownership interests in Sunburst may be transferred without
Franchising's consent. Franchising's consent to such transfers, will not be
given unless, among other things: (a) all monetary obligations due under the
Franchise Agreement are paid to Franchising; (b) no defaults under the
Franchise Agreement remain uncured; (c) the transferee agrees in writing to
upgrade the related Property to the then-current standards; and (d) the
transferee agrees to remain liable for all obligations under the Franchise
Agreement so transferred.
 
  Franchising is permitted to assign all or any part of its rights or
obligations under the Franchise Agreements. However, the Franchise Agreements
(with the exception of the Non-Standard Franchise Agreement) do not permit
Franchising to absolve itself from the obligations that it transfers under the
Franchise Agreement. Upon the assignment of Franchising's obligations under
the Non-Standard Franchise Agreement, Franchising will no longer be liable
with respect to the obligations it so transfers.
 
NONCOMPETITION AGREEMENT
 
  Choice and Franchising will enter into a noncompetition agreement that
defines the rights and obligations with respect to certain businesses to be
operated by Sunburst and Franchising. Under the noncompetition agreement, for
a period of five years from the Distribution (subject to extentions in the
event that the Strategic Alliance Agreement remains in effect), subject to the
exceptions set forth below, Sunburst will be prohibited from conducting any
business that competes with the Franchising Business. Sunburst will also be
prohibited from acquiring any entity conducting a business that competes with
the Franchising Business, with certain exceptions outlined below, unless,
prior to such acquisition, Sunburst offers to sell such competing business to
Franchising on substantially the same terms and conditions; provided, however,
that Sunburst will not be required to make such an offer to Franchising where
the competing business is not readily divisible from other businesses
permitted to be held or acquired by Sunburst and the gross sales from such
competing business for the 12 months prior to such acquisition do not exceed
the greater of $1,000,000 (as adjusted for increases to the Consumer Price
 
                                      22
Index during the term) or 5% of gross sales of the businesses to be acquired.
Subject to the foregoing, however, the noncompetition agreement will not
prohibit Sunburst from engaging in the following activities: (i) the continued
operation and development of any business operated as of the Distribution Date
by Choice; (ii) any activities otherwise permitted under the Strategic
Alliance Agreement; (iii) the ownership of up to 5% of the equity interests of
a publicly-traded entity that competes with the Franchising Business; and (iv)
the ownership of equity interests of any entity that competes with the
Franchising Business, if (A) the competing business does not comprise such
entity's primary business, (B) the gross sales of such entity for the prior 12
months attributable to such competing business does not exceed 20% of such
entity's consolidated gross sales, and (C) neither the fair market value of,
nor the value, if any, attributed by the acquisition agreement to, the
competing business is in excess of $5,000,000 (as adjusted for increases to
the Consumer Price Index during the term).
 
  During the term of the noncompetition agreement, subject to the exceptions
set forth below, Franchising will be prohibited from conducting any business
that competes with the Hotel Business. Franchising will also be prohibited
from acquiring any entity conducting a business that competes with the Hotel
Business, with certain exceptions outlined below, unless, prior to such
acquisition, Franchising offers to sell such competing business to Sunburst on
substantially the same terms and conditions; provided, however, that
Franchising will not be required to make such an offer to Sunburst where the
competing business is not readily divisible from other business permitted to
be held or acquired by Franchising and the gross revenues from such competing
business for the 12 months prior to such acquisition do not exceed the greater
of $1,000,000 (as adjusted for increases to the Consumer Price Index during
the term) or 5% of gross sales of the businesses to be acquired. Subject to
the foregoing, however, the noncompetition agreement will not prohibit
Franchising from the following activities: (i) continued operation and
development of any business operated as of the Distribution Date by
Franchising, (ii) any activities otherwise permitted under the Strategic
Alliance Agreement, (iii) the ownership of up to 5% of the equity interests of
a publicly-traded entity that competes with the Hotel Business, (iv) the
ownership of equity interests of any entity that competes with the Hotel
Business, if (A) the competing business does not comprise such entity's
primary business, (B) the gross revenue of such entity for the prior 12 months
attributable to such competing business does not exceed 20% of such entity's
consolidated gross sales, and (C) neither the fair market value of, nor the
value, if any, attributed by the acquisition agreement to, the competing
business is in excess of $5,000,000 (as adjusted for increases to the Consumer
Price Index during the term).
 
                                   FINANCING
 
SUNBURST
 
  As part of the Distribution, it is estimated that Sunburst will be allocated
approximately $250.0 million of long-term indebtedness, including (i)
approximately $117.0 million of commercial mortgage backed securities, with
respect to which an affiliate of Sunburst is the obligor and (ii) a
Subordinated Term Note in the amount of $115.0 million to Franchising (the
"Term Note"). The Term Note will not have any prepayment penalties. It is also
expected that on or prior to the Distribution Date, Sunburst will enter into a
revolving credit facility (the "Sunburst Credit Facility").
 
  Sunburst currently is negotiating a commitment from a bank lender pursuant
to which such lender, together with other financial institutions, will, from
and after the Distribution Date, provide Sunburst with a senior secured
revolving credit facility in an aggregate principal amount of up to $75.0
million with availability subject to a borrowing base formula. The Sunburst
Credit Facility will have a maturity of three years. Depending on the type of
loan requested by Sunburst and upon certain specified financial ratios,
interest on the loans will accrue at a rate based on LIBOR, certificate of
deposit rates, prime rates or federal funds rates. A portion of the Sunburst
Credit Facility not in excess of a specified percentage of the maximum
borrowing base shall be available for the issuance of letters of credit. The
Sunburst Credit Facility will be secured by a first priority pledge of certain
of the capital stock held by Sunburst and/or any of its subsidiaries. Upon
consummation of the Distribution, approximately $18.0 million will be drawn by
Sunburst under such facility, and together with the $115.0 million of proceeds
realized under the Term Note, will be used to repay $96.0 million in bank debt
and the $37.0 million
 
                                      23
of Sunburst's allocable portion of the debt outstanding to an affiliate of
Manor Care (the "Manor Care Note"). The remaining availability under the
Sunburst Credit Facility will be used for working capital, including capital
expenditures and acquisitions.
 
  The Sunburst Credit Facility is expected to contain customary covenants that
will, among other things, restrict the ability of Sunburst and its
subsidiaries to make certain investments, incur debt, change its line of
business, dispose of assets, create liens, enter into transactions with
affiliates and otherwise restrict certain corporate activities. In addition,
the Sunburst Credit Facility will contain, among other financial covenants,
requirements that Sunburst maintain specified financial ratios, including
minimum net worth, maximum leverage and minimum interest coverage. The
Sunburst Credit Facility is also expected to contain representations and
warranties of Sunburst and its subsidiaries and contain conditions to funding
customary in credit facilities of this type.
 
  It is expected that the Term Note will have a maturity of five years, and
will accrue interest at a rate equal to 500 basis points above the interest
rate on a 5-year U.S. Treasury Note. The Term Note will contain restrictive
covenants substantially equivalent to those contained in the Sunburst Credit
Facility and will also contain subordination provisions.
 
FRANCHISING
 
  As part of the Distribution, Franchising will be allocated $125.0 million of
Choice's long-term indebtedness, including approximately (i) $78.7 million of
indebtedness under the Manor Care Note and (ii) $32.9 million related to
foreign borrowings and other bank debt. It is expected that Franchising will
repay this indebtedness, as of the Distribution, with proceeds available under
a credit facility which Franchising intends to enter into on or prior to the
Distribution Date (the "Franchising Credit Facility").
 
  Franchising currently is negotiating a commitment from a bank lender
pursuant to which such lender, together with other financial institutions,
will, from and after the Distribution Date, provide Franchising with a senior
term loan and a senior competitive advance and multicurrency revolving credit
facility in an aggregate principal amount of up to $300.0 million. The
Franchising Credit Facility will have a maturity of five years. The term loan
portion of the Franchising Credit Facility will amortize on a quarterly basis
in specified annual amounts until maturity. Depending on the type of loan
requested by Franchising and on certain specified financial ratios, interest
on the loans will accrue at a rate based on LIBOR, certificate of deposit
rates, prime rates or federal fund rates. A portion of the revolving credit
facility not in excess of $10.0 million shall be available for the issuance of
letters of credit. Upon consummation of the Distribution, approximately $226.6
million will be drawn under the Franchising Credit Facility, representing
$115.0 million disbursed to Sunburst under the Term Note plus $111.6 million
to refinance obligations allocated to Franchising. The remaining availability
under the Credit Facility will be used for working capital and general
corporate purposes.
 
  The Franchising Credit Facility is expected to contain customary covenants
that will, among other things, restrict the ability of Franchising and its
subsidiaries to make certain investments, incur debt, change its line of
business, dispose of assets, create liens, enter into transactions with
affiliates and otherwise restrict certain corporate activities. In addition,
the Franchising Credit Facility will contain, among other financial covenants,
requirements that Franchising maintain specified financial ratios, including
minimum net worth, maximum leverage and minimum interest coverage. The
Franchising Credit Facility is also expected to contain representations and
warranties of Franchising and its subsidiaries and contain conditions to
funding customary in credit facilities of this type.
 
                             ACCOUNTING TREATMENT
 
  The historical combined financial statements of Franchising present its
financial position, results of operations and cash flows as if it were a
separate entity owning and operating the Franchising Business for all periods
presented. Choice's historical basis in the assets and liabilities of
Franchising has been carried over.
 
                                      24
POST-DISTRIBUTION DIVIDEND POLICY
 
  The dividend policies of Sunburst and Franchising will be determined by
their respective Boards of Directors following the Distribution. Choice
currently is prohibited from paying dividends pursuant to the terms of its
loan agreement with MNR Finance Corp. It is expected that the Sunburst Credit
Facility and the Franchising Credit Facility will restrict the ability of
Sunburst and Franchising, respectively, to pay dividends. See "Financing."
 
                  CERTAIN INFORMATION CONCERNING FRANCHISING
 
PRO FORMA FINANCIAL DATA
 
  The following unaudited Pro Forma Combined Statement of Income of
Franchising gives effect to (i) the Manor Care Distribution and related
transactions and (ii) the Distribution and related transactions as if the
foregoing had occurred on June 1, 1996. The pro forma financial data is
provided for information purposes only and does not purport to be indicative
of the results that actually would have been obtained if the Manor Care
Distribution and related transactions and the Distribution and related
transactions had been effected on the date indicated or of those results that
may be obtained in the future. There were no adjustments required to the Pro
Forma Combined Statements as of May 31, 1997 as a result of the Distribution.
 
 
                                      25
PRO FORMA COMBINED STATEMENT OF INCOME
                        FOR THE YEAR ENDED MAY 31, 1997
 
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
MANOR CARE
                                                     DISTRIBUTION
                                         HISTORICAL ADJUSTMENTS(A)  PRO FORMA
                                         ---------- --------------  ---------
Revenues
  Royalty fees..........................  $95,157                    $95,157
  Marketing and reservation fees........  104,216                    104,216
  Product sales.........................   23,643                     23,643
  European hotel operations.............   17,737                     17,737
  Initial franchise fees................   14,250                     14,250
  Other.................................   17,252                     17,252
                                          -------      -------       -------
    Total revenues......................  272,255                    272,255
                                          -------      -------       -------
Operating Expenses
  Marketing and reservation.............  101,421                    101,421
  Selling, general and administrative...   51,102                     51,102
  Product cost of sales.................   22,766                     22,766
  European hotel operations.............   16,166                     16,166
  Depreciation and amortization.........   10,438                     10,438
                                          -------      -------       -------
    Total operating expenses............  201,893      $ 3,400 (b)   205,293
                                          -------      -------       -------
    Operating income....................   70,362       (3,400)       66,962
                                          -------      -------       -------
OTHER
  Interest on notes payable to Manor
   Care.................................    7,083                      7,083
  Interest and other, net...............    3,704                      3,704
                                          -------      -------       -------
    Total other expenses................   10,787                     10,787
                                          -------      -------       -------
  Income before income taxes............   59,575       (3,400)       56,175
  Income taxes..........................  (24,845)       1,343 (c)   (23,502)
                                          -------      -------       -------
  Net income............................  $34,730      $(2,057)      $32,673
                                          =======      =======       =======
  Net income per share..................                             $  0.52 (d)
                                                                     =======
--------
(a) Reflects the effect of the Manor Care Distribution and related
    transactions.
(b) Reflects the net additional costs associated with staffing of accounting,
    finance, cash management, risk management, human resources and legal
    personnel, incremental rental costs and the payment of certain consulting
    fees to Manor Care.
(c) Represents the income tax impact of pro forma adjustments at statutory
    rates.
(d) Pro forma income per share is computed by dividing pro forma net income by
    the pro forma weighted average number of outstanding common shares,
    aggregating 62.7 million in fiscal year 1997. The pro forma weighted
    average number of outstanding common shares is based on Manor Care's
    weighted average number of outstanding common shares for the period June
    1, 1996 through October 31, 1996 and Choice's weighted average number of
    shares for the period November 1, 1996 through May 31, 1997.
 
                                      26
SELECTED HISTORICAL FINANCIAL DATA
 
  The following table presents selected historical combined financial data of
Franchising for the five fiscal years ended May 31, 1997.
 
  The combined financial statements of Franchising include the assets and
liabilities, revenues and expenses of the Franchising Business, including the
ownership and operation of 14 hotel properties in France, Germany and the
United Kingdom. The Franchising combined financial statements include certain
allocations of overhead expenses incurred by Choice, and prior to November 1,
1996 incurred by Manor Care, that support the Franchising Business. In
management's opinion, these allocations were made on a reasonable basis,
however, such allocations may not be indicative of the level of expenses which
will be incurred by Franchising after the Distribution. The expenses were
generally allocated based upon specific identification and estimates of the
relative time devoted to supporting Franchising.
 
  The combined income statement data for 1993 and the balance sheet data for
1993 and 1994 have been derived from unaudited combined financial statements
of Franchising which, in the opinion of management, include all material
adjustments necessary for those periods and were prepared as if Franchising
were a separate entity for all periods presented. The historical combined
financial data is not necessarily indicative of Franchising's future results
of operations or financial condition. The data set forth below should be read
in conjunction with the unaudited Pro Forma Financial Data and the notes
thereto of Franchising; the audited Combined Financial Statements of
Franchising and the notes thereto; and Management's Discussion and Analysis of
Financial Condition and Results of Operations of Franchising included
elsewhere in this Proxy Statement. For a discussion of the basis of
presentation of the Franchising Combined Financial Statements, see the "Basis
of Presentation" in the Notes to the Franchising Combined Financial
Statements.
 
                                      27
CHOICE HOTELS FRANCHISING, INC.
 
                      SELECTED HISTORICAL FINANCIAL DATA
YEAR ENDED MAY 31,
                          -----------------------------------------------------
                            1997      1996        1995      1994       1993
                          --------  --------    --------  --------  -----------
                                          (IN THOUSANDS)
                                                                    (UNAUDITED)
Statement of Income Data
 Revenues................ $272,255  $250,654    $212,672  $184,866   $143,054
 Operating expenses:
  Marketing and
   reservation...........  101,421    96,246      81,545    74,149     57,631
  Selling, general and
   administrative........   51,102    45,196      45,589    49,529     46,187
  Product cost of sales..   22,766    20,709      13,882    11,977      6,999
  European hotel
   operations............   16,166    17,521      17,922    10,263        --
  Depreciation and
   amortization..........   10,438    11,839      11,768    10,825      9,182
  Provision for asset
   impairment............      --     24,760(1)      --        --         --
                          --------  --------    --------  --------   --------
   Total operating
    expenses.............  201,893   216,271     170,706   156,743    119,999
                          --------  --------    --------  --------   --------
 Operating income........   70,362    34,383      41,966    28,123     23,055
                          --------  --------    --------  --------   --------
Other
 Interest expense on
  notes payable to Manor
  Care...................    7,083     7,083       7,083     7,083      7,083
 Minority interest
  expense................      --      1,532       2,200     1,476        900
 Interest and other,
  net....................    3,704     4,791       3,672     3,591        145
                          --------  --------    --------  --------   --------
   Total other expenses..   10,787    13,406      12,955    12,150      8,128
                          --------  --------    --------  --------   --------
Income before income
 taxes...................   59,575    20,977      29,011    15,973     14,927
Income taxes.............  (24,845)   (9,313)    (12,783)   (7,372)    (6,422)
                          --------  --------    --------  --------   --------
Net Income............... $ 34,730  $ 11,664    $ 16,228  $  8,601   $  8,505
                          ========  ========    ========  ========   ========
Pro forma earnings per
 share................... $   0.55  $   0.19    $   0.26  $   0.14   $   0.15
                          ========  ========    ========  ========   ========
Balance Sheet Data
 Total assets............ $221,473  $212,803    $189,087  $173,646   $170,815
 Notes payable to Manor
  Care................... $ 78,700  $ 78,700    $ 78,700  $ 78,700   $ 78,700
 Total debt.............. $125,163  $145,315    $128,205  $126,294   $122,909
 Total liabilities....... $164,280  $182,271    $201,786  $169,237   $144,982
 Total investments and
  advances from (to)
  Parent................. $ 57,193  $ 30,532    $(12,699) $  4,409   $ 25,833
--------
(1) In 1996 Franchising recorded a pre-tax charge of $24.8 million for
    impairment of long lived assets associated with Franchising's European
    operations.
(2) Pro forma earnings per share has been calculated based on the weighted
    average shares outstanding of its parent Choice Hotels International, Inc.
    for fiscal year 1997 of 62,680,000 and its parent Manor Care, Inc. for
    fiscal years 1996, 1995, 1994 and 1993 of 62,628,000, 62,480,000,
    60,524,000 and 57,316,000, respectively.
 
                                      28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 
  Franchising is one of the largest hotel franchisors in the world with 3,344
hotels open and 820 under development representing 355,127 rooms in 33
countries. Franchising franchises hotels under the Comfort, Quality, Econo
Lodge, Sleep, Clarion, Rodeway and MainStay Suites brand names.
 
  The principal factors that affect Franchising's results are: growth in the
number of hotels under franchise; occupancies and room rates achieved by
Franchising's brands; the number and relative mix of franchised hotels; and
Franchising's ability to manage costs. The number of rooms at franchised
properties and occupancies and room rates at those properties significantly
affect Franchising's results because franchise royalty fees are based upon
room revenues at franchised hotels. Increases in franchise fee revenues have a
disproportionate impact on Franchising's operating margin due to the lower
incremental costs associated with these revenues.
 
 Comparison of Fiscal Year 1997 Operating Results and Fiscal Year 1996
Operating Results
 
  Franchising recorded net income of $34.7 million for the year ended May 31,
1997 ("fiscal 1997"), an increase of $23.0 million, compared to net income of
$11.7 million for the year ended May 31, 1996 ("fiscal 1996"). Fiscal 1996
results include a $24.8 million asset impairment charge related to
Franchising's European hotel operations. Exclusive of this charge, fiscal 1996
net income was $26.7 million. The increase in net income for fiscal 1997 was
primarily attributable to an increase in franchise revenue as a direct result
of the addition of new licensees to the franchise system and improvements in
the operating performance of franchised hotels.
 
  Combined revenues increased $21.6 million (or 8.6%) to $272.3 million in
fiscal 1997 from $250.7 million in fiscal 1996.
 
  Franchise Operating Revenues. In operating the franchise business,
Franchising collects marketing and reservation fees and assessments from its
franchisees. Franchising is contractually obligated to disburse these fees for
marketing and reservation activities to be provided on behalf of its
franchisees. Management, therefore, analyzes its franchise business based on
revenues net of marketing and reservation fees ("net franchise revenue") and
expenses net of marketing and reservation expenses ("net franchise expenses").
 
  Net franchise revenues include base royalty fees, initial fees earned on
contracts signed and other revenues, including strategic vendor fees. Net
franchise revenues are dependent upon growth in the number of franchised
properties as well as the underlying performance of franchised hotels for
continued growth. The key industry standard for measuring hotel operating
performance is RevPAR, which is calculated by multiplying the percentage of
occupied rooms by the average daily room rate realized.
 
  Net franchise revenues were $126.7 million for fiscal 1997 and $110.6
million for fiscal 1996. Royalties increased $9.0 million to $95.2 million
from $86.2 million in fiscal 1996, an increase of 10.4%. The increase in
royalties is attributable to a net increase of 292 franchisees during the
period representing an additional 21,578 rooms added to the system, an
improvement in domestic RevPAR of 2.9% and an increase in the effective
royalty rate of the domestic hotel system to 3.43% from 3.34%. Domestic
initial fee revenue generated from franchise contracts signed increased 14.8%
to $14.0 million from $12.2 million in fiscal 1996. Total franchise agreements
signed in fiscal 1997 were 495, up 13.5% from the total contracts signed in
fiscal 1996 of 436. Revenues generated from strategic vendor relationships
increased to $6.1 million from $1.8 million in fiscal 1996. This revenue
relates to agreements that provide preferred vendors access to Franchising's
licensees.
 
  Franchise Operating Expenses. The cost to operate the franchising business
is reflected in selling, general and administrative expenses. Combined
selling, general and administrative expenses were $51.1 million in fiscal
1997, an increase of $5.9 million from the fiscal 1996 total of $45.2 million.
$4.8 million of the increase was directly attributable to additional costs of
operating as an independent company apart from Manor Care. These additional
costs are primarily additional staffing, incremental rental expenses, and
consulting fees as Franchising assumed certain administrative tasks previously
provided by Manor Care. The remaining increases in selling, general and
administrative expenses were primarily due to additional personnel to support
company growth and new company initiatives. Exclusive of the $4.8 million
increase resulting from the Manor Care Spin-off, as a
 
                                      29
percentage of net franchise revenues, selling, general and administrative
expenses declined to 36.5% in fiscal 1997 from 40.9% in fiscal 1996. The
improvement in the franchising margins relates to the economies of scale
generated from operating a larger franchisee base and improvements in
franchised hotel performance.
 
  Product Sales. Sales made to franchisees through Franchising's group
purchasing program increased $2.1 million to $23.6 million in fiscal 1997 from
$21.6 million in fiscal 1996. The group purchasing program utilizes bulk
purchases to obtain favorable pricing from third party vendors for franchisees
ordering similar products. Franchising acts as a "clearing-house" between the
franchisee and the vendor, and orders are shipped directly to the franchisee.
 
  Similarly, product cost of sales increased $2.1 million (or 9.9%) in fiscal
1997. The product services margins decreased in fiscal 1997 to 3.7% from 4.0%
in fiscal 1996. This purchasing program is provided to the franchisees as a
service and is not expected to be a major component of Franchising's
profitability.
 
  European Hotel Operations. Franchising owns or operates 14 hotels in
Germany, France and Great Britain. Total revenues at Franchising's owned hotel
operations in Europe declined to $17.7 million in fiscal 1997 from $19.6
million in fiscal 1996. Operating margins at the hotels declined to 8.9% in
fiscal 1997 from 10.6% in fiscal 1996. The decline in revenue and operating
performance reflects the difficult economic and competitive climates in which
a number of the European hotels operate. Franchising is pursuing strategies
with the objective of improving the profitability of the hotels including,
among others, divestiture, strategic alliances and joint ventures.
 
  Other Expenses. Depreciation and amortization decreased $1.4 million (or
11.9%) to $10.4 million in fiscal 1997 from $11.8 million in fiscal 1996. The
decrease was primarily due to an asset impairment charge against European
fixed assets which reduced the asset base upon which depreciation is
determined.
 
  In fiscal 1996, Franchising recorded a charge against earnings of $24.8
million relating to impairment of certain long-lived assets related to
Franchising's European hotel operations.
 
  In fiscal 1997, Franchising recognized $943,000 in dividend income from its
investment in Friendly Hotels, PLC.
 
 Comparison of Fiscal Year 1996 Operating Results and Fiscal Year 1995
Operating Results
 
  Net income for the fiscal year ended May 31, 1996 was $11.7 million, a
decrease of $4.5 million (or 27.8%) compared to net income of $16.2 million
for the fiscal year ended May 31, 1995 ("fiscal 1995"). Net income in fiscal
1996 includes a one time charge of $24.8 million relating to asset impairment.
Exclusive of the $24.8 million charge, net income increased to $26.7 million
in fiscal 1996, a 64.8% increase over fiscal 1995.
 
  Combined revenues increased $38.0 million (or 17.9%) to $250.7 million in
fiscal 1996 from $212.7 million in fiscal 1995.
 
  Franchise Operating Revenues. Net franchise revenues were $110.6 million for
fiscal 1996 and $95.9 million for fiscal 1995. Royalties increased $10.8
million to $86.2 million from $75.4 million in fiscal 1996, an increase of
14.3%. The increase in royalties is attributable to a net increase of 217
domestic franchisees during the period, representing an additional 15,787
rooms added to the system, an improvement in RevPAR of 5.1% and an increase in
the effective royalty rate of the domestic hotel system to 3.34% from 3.20%.
Initial fee revenue generated from franchising contracts signed increased
37.8% to $13.5 million from $9.8 million in fiscal 1996. Total franchise
agreements signed in fiscal 1996 were 436, up 21.4% from the total contracts
signed in fiscal 1995 of 359.
 
  Franchise Operating Expenses. The cost to operate the franchising business
is reflected in selling, general and administrative expenses. Combined
selling, general and administrative costs declined to $45.2 million in fiscal
1996 from $45.6 million in fiscal 1995.
 
                                      30
Selling, general and administrative expenses as a percentage of net
franchise revenues declined to 40.9% in fiscal 1996 from 47.7% in fiscal 1995.
The improvement in the franchising margins relates to the economies of scale
generated from operating a larger franchisee base and improved operating
performance of the franchised hotels.
 
  Product Sales. Sales made to franchisees through Franchising's group
purchasing program increased $7.1 million to $21.6 million in fiscal 1996 from
$14.5 million in fiscal 1995.
 
  Similarly, product cost of sales increased $6.8 million (or 49.2%) in fiscal
1996. The product services margins were 4.0% in fiscal 1996 and fiscal 1995.
This purchasing program is provided to the franchisees as a service and is not
expected to be a major component of Franchising's profitability.
 
  European Hotel Operations. Revenues from hotel operations increased 5.2% in
fiscal 1996. Operating margins increased to 10.6% in fiscal 1996 from 3.8% in
fiscal 1995. The increase in fiscal 1996 is primarily due to improved
performance of newly completed owned and managed hotels.
 
  Other Expenses. In fiscal 1996, Franchising recorded a charge against
earnings of $24.8 million relating to impairment of certain long-lived assets
associated with Franchising's European hotel operations.
 
 Liquidity and Capital Resources
 
  Historically, cash received by Franchising has been deposited in or combined
with its parent's corporate funds as part of its parent's cash management
system. Subsequent to the Distribution, Franchising will maintain its own cash
balances and implement its own internal cash management system.
 
  Choice had $225.7 million of indebtedness payable to Manor Care as of May
31, 1996, assumed as part of the Manor Care Spin-off. The portion of this
indebtedness related to acquisitions made by Franchising has been pushed down
to Franchising. As of May 31, 1997 and May 31, 1996, notes payable to Manor
Care by Franchising totaling $78.7 million were outstanding. Interest on the
amount of the loan is payable quarterly at a rate of 9% per annum. The loan
will mature on November 1, 1999 and may be prepaid in whole or in part,
together with accrued interest, at Franchising's option. If the loan is repaid
prior to November, 1, 1997, Franchising will be required to reimburse Manor
Care on demand for any actual loss incurred or to be incurred by Manor Care
(for the period up to and including November 1, 1997) in the redeployment of
the funds released by any prepayment of the loan. The notes payable to Manor
Care are expected to be repaid from operating cash flow or from third party
financing.
 
  During fiscal 1996 and through November 1, 1996, the Choice was a co-
guarantor with Manor Care and other affiliates for a $250 million competitive
advance and multi-currency revolving credit facility. On October 30, 1996
Choice entered into a $100.0 million competitive advance and multi-currency
revolving credit facility provided by a group of seven banks (the "Credit
Facility"). During November 1996 Choice repaid its portion of the Manor Care
multi-currency credit facility, $50.1 million, with an advance from the
Choice's newly acquired Credit Facility. On May 5, 1997, Choice increased the
size of the Credit Facility to $125 million. As of May 31, 1997, Franchising
had $31.1 million in advances against the multi-currency portion of the Credit
Facility outstanding. Franchising expects to obtain a new revolving credit
facility prior to the Distribution to repay its portion of borrowings under
Choice's Credit Facility. See "--Financing."
 
  Management believes cash flows from operations and third party financing
sources will be adequate to support on-going operations, capital expenditures
and meet debt service requirements for the foreseeable future. Franchising
expects to secure a revolving credit facility prior to the Distribution
sufficient to refinance its existing obligations, loan amounts to Sunburst
sufficient to support its refinancing requirements and meet working capital
and business development needs.
 
  Net cash provided by operating activities for the fiscal year ended May 31,
1997 was $46.4 million compared to $32.7 million for the same period of the
prior fiscal year. Improved cash flow resulted primarily from improved net
income.
 
                                      31
Franchising's working capital ratio at May 31, 1997 and May 31, 1996 was .99
and .89, respectively. Franchising attempts to minimize its investments in net
current assets, utilizing the Credit Facility to meet seasonal fluctuations in
working capital requirements.
 
  Cash used in investing activities was $17.9 million, $78.5 million, and $7.7
million in fiscal years 1997, 1996 and 1995, respectively. During fiscal 1995,
Franchising repurchased one-half of the 11% interest held by its management in
Choice Hotels Franchising, Inc. Approximately $19.8 million was allocated to
goodwill; the purchase cost of $27.4 million was paid in June and July 1995.
On May 31, 1996, Franchising repurchased the remaining 5.5% minority interest
in Choice Hotels Franchising, Inc. for $27.9 million. Approximately $26.4
million was allocated to goodwill. During fiscal 1996, Franchising purchased a
5% common stock interest and a preferred stock interest in Friendly Hotels,
PLC, a U.K. hotel company, for approximately $17 million.
 
  Investment in property and equipment includes computer hardware as well as
new developments and enhancements of reservation and finance systems. During
the fiscal year ended May 31, 1997, capital expenditures totaled $10.6 million
and related primarily to the development of a new property management system
and the installation of new financial systems. Capital expenditures in prior
years include amounts for computer hardware, reservation systems and European
hotel capital improvements.
 
 Impact of Recently Issued Accounting Standards
 
  Franchising has adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." The adoption
of SFAS No. 121 did not have a material impact on Franchising's financial
statements.
 
  Franchising plans to utilize the method under SFAS No. 123, "Accounting for
Stock-Based Compensation," which provides for disclosure of the impact of
stock-based compensation grants.
 
  Franchising is required to adopt SFAS No. 128, "Earnings Per Share," and
SFAS No. 129, "Disclosure of Information about Capital Structure," no later
than fiscal year 1998. The adoption of these pronouncements will not
materially affect Franchising's financial statements.
 
  Franchising is required to adopt SFAS No. 130, "Reporting Comprehensive
Income," and SFAS No. 131, "Disclosures About Segments of an Enterprise and
Related Information," no later than fiscal 1999. Management is still
evaluating the impact that these pronouncements will have on Franchising's
financial statements.
 
BUSINESS AND PROPERTIES
 
 General
 
  Franchising is a wholly owned subsidiary of Choice and currently conducts a
significant portion of the Franchising Business. Immediately prior to the
Distribution, Franchising will succeed to that portion of the Franchising
Business currently conducted directly by Choice and certain other subsidiaries
of Choice. The following description summarizes the current business of
Franchising, as well as the business to be transferred to Franchising prior to
the Distribution.
 
  Franchising is one of the world's largest franchisors of hotels with 3,344
properties open and operating in 33 countries at May 31, 1997. These
properties principally operate under one of Franchising's brand names:
Comfort(R), Quality(R), Clarion(R), Sleep(R), Rodeway(R), Econo Lodge(R) and
MainStay SuitesSM. At May 31, 1997, another 820 franchise properties with a
total of 72,093 rooms were under development. As a franchisor, Franchising
licenses hotel operators to use Franchising's brand names and provides to
these hotel operators products and services designed to increase their
revenues and profitability. Key products and services provided include
nationally recognized marketing and advertising programs, access to a
reservation system that delivers
 
                                      32
business to the franchisees' hotels, access to innovative products and
services developed by Franchising and other support services such as training
programs, purchasing discounts, operating manuals, quality standards and
inspections. In return for the use of Franchising's brand names and access to
Franchising's products and services, franchisees pay to Franchising fees that
are generally based on a percentage of the franchise hotels' gross room
revenues. Franchising's franchise operations have experienced significant
growth in revenues and profitability over the last few years. Franchising's
compound annual growth rate from fiscal year 1993 to fiscal year 1997 was
17.5% for revenues and 42.2% for net income.
 
 The Lodging Industry
 
  As of December 1996, there were approximately 3.4 million hotel rooms in the
United States in hotels/motels containing twenty or more rooms. Of those
rooms, approximately 1.2 million rooms were not affiliated with a national or
regional brand, while the remaining approximately 2.2 million rooms were
affiliated with a brand either through franchise or the ownership/management
of a national or regional chain.
 
  During the late 1980s, the industry added approximately 500,000 hotel rooms
to its inventory due largely to a favorable hotel lending environment, the
ability of hotel operators to regularly increase room rates and the
deductibility of passive tax losses, which encouraged hotel development. As a
result, the lodging industry saw an oversupply of rooms and a decrease in
industry performance.
 
  The lodging industry in recent years has demonstrated a recovery, based on
year-to-year increases in room revenues, occupancy rates, revenue per
available room ("RevPAR"), and lodging industry profitability. RevPAR is
calculated by multiplying the percentage of occupied rooms by the average
daily room rate charged. Since 1993, the lodging industry has been able to
increase its average daily rate ("ADR") at a pace faster than the increase in
the Consumer Price Index ("CPI"), a common measure of inflation published by
the US Department of Labor. Smith Travel Research's estimates indicate that
occupancy rates in 1996 increased to 65.2% from 65.1% in 1995, in part because
of increases in room demand attributable to the 1996 Summer Olympics, the 1996
national political campaigns and conventions, and a continued improvement in
the national economy. The following chart demonstrates the recent trends:
 
THE US LODGING INDUSTRY'S GROWTH TRENDS SINCE 1991
INCREASE IN           AVERAGE
                            ROOM                DAILY   INCREASE   INCREASE  REVENUE PER
                           REVENUE             (ROOM)    IN ADR     IN CPI    AVAILABLE                 NEW
                           VERSUS    OCCUPANCY  RATES    VERSUS     VERSUS      ROOM        PROFITS    ROOMS
YEAR                     PRIOR YEAR    RATES    (ADR)  PRIOR YEAR PRIOR YEAR  (REVPAR)   (IN BILLIONS) ADDED
----                     ----------- --------- ------- ---------- ---------- ----------- ------------- ------
1992....................     N/A       62.6%   $58.91     1.4%       2.9%      $36.87     break-even   36,000
1993....................    6.3%       63.5%   $60.53     2.7%       2.7%      $38.42        $ 2.4     40,000
1994....................    8.6%       64.7%   $62.86     3.8%       2.7%      $40.70        $ 5.5     45,000
1995....................    7.0%       65.1%   $65.81     4.7%       2.9%      $42.83        $ 8.5     64,000
1996....................     N/A       65.2%   $69.66     5.9%       2.9%      $45.47        $11.5     91,000
--------
Source: Smith Travel Research
 
  Franchising believes the lodging industry can be divided into three
categories: luxury or upscale, middle-market and economy. Franchising believes
the luxury category generally has room rates above $70 per night, the middle-
market category generally has room rates between $46 and $70 per night and the
economy category generally has room rates less than $46 per night.
 
  Service is a distinguishing characteristic in the lodging industry.
Generally there are three levels of service: full-service hotels (which offer
food and beverage services, meeting rooms, room service and similar guest
services); limited-service hotels (which offer amenities such as swimming
pools, continental breakfast, or similar services); and all-suites hotels
(which usually have limited public areas, but offer guests two rooms or one
room with distinct areas, and which may or may not offer food and beverage
services).
 
                                      33
Franchising's Econo Lodge, Rodeway and Sleep brands compete primarily in the
limited-service economy market; Franchising's Comfort and Quality brands
compete primarily in the limited-service middle-market; Franchising's Clarion
brand competes primarily in the full-service upscale market; and Franchising's
MainStay Suites brand competes primarily in the all-suites middle-market.
 
  New hotels opened in recent years typically have been limited service
hotels, as limited-service hotels are less costly to develop, enjoy higher
gross margins, and tend to have better access to financing. These hotels
typically operate in the economy and middle-market categories and are located
in suburban or highway locations. From 1991 to 1996, the average room count in
new hotels declined from 122 to 87, primarily because hotel developers found
it difficult to obtain financing of more than $3 million from their primary
lending sources (local banks and Small Business Administration guaranteed loan
programs).
 
  In recent years, operators of hotels not owned or managed by major lodging
companies have increasingly joined national hotel franchise chains as a means
of remaining competitive with hotels owned by or affiliated with national
lodging companies. Because hotels typically operate with high fixed costs,
increases in revenues generated by affiliation with a franchise lodging chain
can improve a hotel's financial performance. Of approximately 933 hotel
properties that changed their affiliation in 1995, 77% converted from
independent status to affiliation with a chain or converted from one chain to
another, while only 23% canceled or were required to cancel their chain
affiliation. The share of US hotel rooms affiliated with a chain was
approximately 63% in 1995.
 
  The shift to chain membership has been most pronounced among hotels in the
same categories as Franchising, i.e., the economy and middle-market
categories. In 1995, 53% of all conversions to a chain from independent status
or from another chain were in the economy category, 37% were in the middle-
market category, and 10% were in the upscale category. Often by affiliating
with a middle-market or economy brand, a hotel operator can reposition the
hotel property in the price category best suited to its market.
 
  The large franchise chains, including Franchising, provide a number of
services to hotel operators to improve the financial performance of their
properties, including national reservation systems, marketing and advertising
programs and direct sales programs. Franchising believes that national
franchise chains with a larger number of hotels enjoy greater brand awareness
among potential guests than those with fewer numbers of hotels, and that
greater brand awareness can increase the desirability of a hotel to its
potential guests.
 
  Franchising believes that hotel operators choose lodging franchisors based
primarily on the perceived value and quality of each franchisor's brand and
its services, and the extent to which affiliation with that franchisor may
increase the franchisee's reservations and profits.
 
 Franchise Business
 
  Economics of Franchise Business. The fee and cost structure of Franchising's
franchise business provides significant opportunities for Franchising to
increase profits by increasing the number of franchised properties. Hotel
franchisors such as Franchising derive substantially all of their revenue from
franchise fees. Franchise fees are comprised of an initial fee and ongoing
royalty and marketing and reservation fees charged by the franchisor as a
percentage of the franchisee's gross room revenues. The royalty portion of the
franchise fee is intended to cover the operating expenses of the franchisor,
such as expenses incurred in quality assurance, administrative support and
other franchise services and to provide the franchisor with operating profits.
The marketing and reservation portion of the franchise fee is intended to
reimburse the franchisor for the expenses associated with providing such
franchise services as the central reservation system and national marketing
and media advertising.
 
  Much of the variable costs associated with Franchising's activities are
reimbursed by the franchisees through the marketing and reservation fees.
Franchising's existing base of franchises more than covers the fixed cost of
the business at its current level so that the variable costs of overhead--in
such areas as quality assurance, franchise development, franchise services and
administration, finance and legal--represent the bulk of
 
                                      34
incremental costs associated with the addition of franchisees. Because the
variable overhead costs associated with incremental franchise system growth
are substantially less than the incremental royalty fees, Franchising is able
to capture a significant portion of these incremental royalty fees as
operating profit.
 
  Strategy. Franchising's strategy is based on creating an organization that
is focused on consumer and franchisee needs, optimizing the portfolio of
brands, strategically growing the franchise system, improving its and its
franchisees' margins, growing profitability internationally, and leveraging
its separation from Choice. Key components of Franchising's strategy include:
 
  .  Organize for Success. Franchising has created an organizational
     structure to focus on consumers, serve franchisees and leverage the
     franchise system.
 
     Consumer Focus--Brand management, new product development and
     traditional marketing and advertising are all combined under
     Franchising's Marketing Department to create consumer focus and to
     drive demand for Franchising's brand products. New product development
     will be based on consumer needs determined through consumer research.
     Franchising believes that a consumer focus will lead to greater demand
     for Franchising's products, which in turn will result in higher revenue
     from Franchising's franchise system.
 
     Franchisee Service--Franchise service and sales are consolidated under
     a regional structure made up of five regional operating teams. This
     structure provides each licensee one primary contact who is responsible
     for assessing and responding to each hotel's specialized needs.
     Franchising believes that its regional operating structure and the
     services it provides to franchisees will allow it to attract new hotels
     to the franchising system.
 
     Leveraging the Franchise System--Strategic partnerships, purchasing and
     other functions that leverage the scale of the franchise system are
     combined under the Partner Services Group. Franchising believes there
     is significant opportunity to leverage its size by entering into joint
     marketing arrangements with national and multi-national companies that
     want to gain exposure to the millions of guests who patronize
     Franchising's franchise hotels each year. In the past, these
     arrangements have added to Franchising's and its franchisees' revenues
     and profits by attracting business to its franchise hotels.
 
  .  Optimize the Brand Portfolio. Franchising believes that each of its
     brands has particular attributes and strengths. Franchising's strategy
     is to leverage the strengths of each brand for profit growth and for
     identifying new niches into which the company may expand.
 
  .  Increase Market Penetration on a Strategic Basis. Franchising will take
     advantage of its regional structure to analyze key markets in the U.S.
     and, in conjunction with its franchisees, identify the best
     opportunities for new development or conversion to one of Franchising's
     brands.
 
  .  Improve Margins Through Increased Productivity. Franchising addresses
     the competitiveness of its own and its franchisees' profitability by
     initiating revenue generating programs and improving cost productivity.
     A key component of this strategy is the roll out of Franchising's
     proprietary property and yield management system "Profit Manager by
     Choice," which Franchising believes will improve the RevPAR of its
     franchisees.
 
  .  Profitably Grow Internationally. During the ten fiscal years ended May
     31, 1997, the number of properties in Franchising's international
     franchise system increased to 563 properties with 47,603 rooms, from 81
     properties with 8,330 rooms. Franchising's international franchise
     system includes hotels in 32 countries outside the United States.
     Franchising plans to continue to profitably grow its brands
     internationally through a strategic pursuit of joint ventures, master
     franchising agreements and brand specific area development agreements.
 
  .  Leverage Spin-Off From Sunburst. The separation of Franchising from
     Sunburst will allow a pure focus on franchising, including the potential
     pursuit of acquisition opportunities complementary to Franchising's core
     business.
 
                                      35
Franchise System
 
  Franchising's franchise hotels principally operate under one of
Franchising's brand names: Comfort, Quality, Clarion, Sleep, Rodeway, Econo
Lodge and MainStay Suites. The following table presents key statistics
relative to Franchising's domestic franchise system over the four fiscal years
ended May 31, 1997.
 
                      COMBINED DOMESTIC FRANCHISE SYSTEM
AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
Number of properties, end of
 period...........................     2,283      2,311      2,495      2,781
Number of rooms, end of period....   203,019    200,792    214,613    235,431
Average Royalty Rate..............       3.1%       3.2%       3.3%       3.4%
Average occupancy percentage......      62.2%      63.8%      63.8%      62.6%
Average daily room rate (ADR).....  $  45.63   $  47.13   $  49.49   $  51.92
RevPAR............................ *$  28.40   $  30.08   $  31.60   $  32.52
Royalty fees ($000s)..............  $ 62,590   $ 71,665   $ 82,239   $ 91,724
--------
* Franchising's RevPAR figure for each fiscal year is an average of the
  RevPAR calculated for each month in the fiscal year. Franchising calculates
  RevPAR each month based on information actually reported by franchisees on
  a timely basis to Franchising.
 
  No master franchisee or other franchisee accounted for 10% or more of
Franchising's total revenues or revenues related to franchise operations
during the last three fiscal years. Following the Distribution, Sunburst will
be Franchising's largest franchisee.
 
 Brand Positioning
 
  Franchising's hotels are primarily limited-service hotels (offering
amenities such as swimming pools and continental breakfast) or limited-to-full
service (offering amenities such as food and beverage services, meeting rooms
and room service).
 
  Comfort. Comfort Inns and Comfort Suites hotels offer rooms in the limited-
service, middle market category. Comfort Inns and Comfort Suites are targeted
to traditional business and leisure travelers. Principal competitor brands
include Days Inn, Fairfield Inn, Hampton Inn, Holiday Express and LaQuinta. At
May 31, 1997, there were 1,441 Comfort Inn properties and 120 Comfort Suite
properties with a total of 113,729 and 9,935 rooms, respectively, open and
operating worldwide. An additional 193 Comfort Inn properties and 119 Comfort
Suite properties with a total of 17,550 and 9,671 rooms, respectively, were
under development.
 
                                      36
Comfort properties are located in the United States and in Australia, the
Bahamas, Belgium, Canada, France, Germany, India, Indonesia, Ireland, Italy,
Jamaica, Mexico, Norway, Portugal, Puerto Rico, Sweden, Switzerland, Thailand,
the United Kingdom and the United Arab Emirates. The following chart
summarizes the Comfort system in the United States:
 
                            COMFORT DOMESTIC SYSTEM
AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
Number of properties, end of
 period...........................       935      1,015      1,129      1,255
Number of rooms, end of period....    82,479     87,551     94,160    102,722
Royalty fees ($000s).............. $  31,187  $  37,635  $  44,657  $  50,758
Average occupancy percentage......      68.0%      69.5%      68.7%      67.2%
Average daily room rate (ADR)..... $   46.46  $   48.24  $   51.13  $   54.17
RevPAR............................ $   31.57  $   33.54  $   35.11  $   36.39
Quality. Certain Quality Inns and Quality Suites hotels compete in the
limited service, middle market category while others compete in the full
service, middle market category. Quality Inns and Quality Suites are targeted
to traditional business and leisure travelers. Principal competitor brands
include Best Western, Holiday Inn, Howard Johnson, Ramada Inn and Days Inn. At
May 31, 1997, there were 583 Quality Inn properties with a total of 67,995
rooms, and 36 Quality Suites properties with a total of 4,999 rooms open
worldwide. An additional 105 Quality Inn properties and 34 Quality Suites
properties with a total of 11,173 rooms and 3,315 rooms, respectively, were
under development.
 
  Quality properties are located in the United States and in Argentina,
Australia, Canada, Chile, Costa Rica, the Czech Republic, Denmark, France,
Germany, India, Indonesia, Ireland, Italy, Jamaica, Mexico, New Zealand,
Norway, Portugal, Russia, Spain, Thailand, the United Kingdom and the United
Arab Emirates.
 
  The following chart summarizes the Quality system in the United States:
 
                            QUALITY DOMESTIC SYSTEM
AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
Number of properties, end of
 period...........................       358        341        362        409
Number of rooms, end of period....    45,032     43,281     45,967     50,487
Royalty fees ($000s).............. $  14,890  $  15,632  $  16,606  $  17,623
Average occupancy percentage......      61.6%      63.1%      62.5%      61.3%
Average daily room rate (ADR)..... $   50.07  $   50.94  $   52.90  $   54.61
RevPAR............................ $   30.83  $   32.16  $   33.08  $   33.46
Econo Lodge. Econo Lodge hotels operate in the limited-service, economy
category of the lodging industry. Econo Lodges are targeted to the senior
travel market and rely to a large extent on strong roadside name recognition.
Principal competitor brands include Days Inn, Ho-Jo Inn, Motel 6, Ramada
Limited, Red Carpet Inn, Red Roof Inn, Super 8 and Travelodge.
 
                                      37
At May 31, 1997, there were 704 Econo Lodge properties with a total of
45,718 rooms open and operating in the United States and Canada, and an
additional 116 properties with a total of 8,330 rooms under development in
those two countries. The following chart summarizes the Econo Lodge system in
the United States:
 
                          ECONO LODGE DOMESTIC SYSTEM
AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
Number of properties, end of
 period...........................       677        633        641        682
Number of rooms, end of period....    46,570     42,801     42,726     44,636
Royalty fees ($000s).............. $  11,231  $  12,021  $  12,760  $  13,288
Average occupancy percentage......      56.7%      57.5%      58.0%      56.4%
Average daily room rate (ADR)..... $   37.27  $   38.31  $   39.97  $   41.33
RevPAR............................ $   21.14  $   22.04  $   23.17  $   23.30
Clarion. Clarion Inns, Clarion Hotels, Clarion Resorts and Clarion Suites
hotels are full-service properties which operate in the upscale category.
Clarion hotels are targeted to traditional business and leisure travelers.
Principal competitor brands include Holiday Inn, Holiday Select, Crowne Plaza,
Four Points by Sheraton, Radisson, Courtyard by Marriott and Doubletree.
 
  At May 31, 1997, there were 110 Clarion properties with a total of 17,249
rooms open and operating worldwide and an additional 32 properties with a
total of 5,022 rooms under development. The properties are located in the
United States, the Bahamas, Canada, France, Guatemala, Indonesia, Ireland,
Japan, Mexico, Norway, Russia, Thailand and Uruguay. The following chart
summarizes the Clarion system in the United States:
 
                            CLARION DOMESTIC SYSTEM
AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
Number of properties, end of
 period...........................        65         63         75         92
Number of rooms, end of period....    12,211     10,420     12,817     14,721
Royalty fees ($000s).............. $   2,735  $   2,995  $   3,602  $   4,081
Average occupancy percentage......      62.0%      63.7%      63.3%      63.3%
Average daily room rate (ADR)..... $   62.47  $   63.71  $   64.36  $   67.76
RevPAR............................ $   38.75  $   40.58  $   40.74  $   42.86
Rodeway. The Rodeway brand competes in the limited-service, economy category
and is targeted to the senior travel market. Principal competitor brands
include Ho-Jo Inn, Ramada Limited, Red Roof Inn, Budgetel, Shoney's Inn, Super
8 and Motel 6. At May 31, 1997, there were 216 Rodeway Inn properties with a
total of 13,509 rooms, open and operating in the United States and Canada, and
an additional 50 properties with a total of 3,481 rooms under development in
those two countries. The following chart summarizes the Rodeway system in the
United States:
 
                          RODEWAY DOMESTIC SYSTEM(1)
AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
Number of properties, end of
 period...........................       214        208        201        216
Number of rooms, end of period....    13,806     13,067     12,547     13,509
Royalty fees ($000s).............. $   1,941  $   2,302  $   2,506  $   2,631
Average occupancy percentage......      51.4%      50.5%      52.7%      52.7%
Average daily room rate (ADR)..... $   36.89  $   38.93  $   40.66  $   41.15
RevPAR............................ $   19.00  $   19.64  $   21.48  $   21.68
--------
(1) Includes data pertaining to the Friendship Inn system, which is being
    combined with the Rodeway Inn system.
 
                                      38
Sleep Inn. Established in 1988, Sleep Inn is a new-construction hotel brand
in the limited-service, economy category. Sleep Inns are targeted to the
traditional business and leisure traveler. Principal competitor brands include
Days Inn, Fairfield Inn, Holiday Express, LaQuinta Inn, Ho-Jo Inn and Ramada
Inn.
 
  At May 31, 1997, there were 133 Sleep Inn properties with a total of 9,806
rooms open and operating worldwide. An additional 150 properties with a total
of 11,497 rooms were under development. The properties are located in the
United States, Canada and the Cayman Islands. The following chart summarizes
the Sleep system in the United States:
 
                             SLEEP DOMESTIC SYSTEM
AS OF AND FOR THE YEAR ENDED MAY 31,
                                   ------------------------------------------
                                     1994       1995       1996       1997
                                   ---------  ---------  ---------  ---------
Number of properties, end of
 period...........................        34         51         87        131
Number of rooms, end of period....     2,921      3,672      6,396      9,635
Royalty fees ($000s).............. $     605  $   1,080  $   2,108  $   3,343
Average occupancy percentage......      64.6%      65.3%      65.5%      63.9%
Average daily room rate (ADR)..... $   39.11  $   41.89  $   45.11  $   48.11
RevPAR............................ $   25.28  $   27.37  $   29.56  $   30.75
MainStay Suites. MainStay Suites, Franchising's newest hotel brand, is a
middle market, extended-stay lodging product targeted to travelers who book
hotel rooms for five or more consecutive nights. The first MainStay Suites
hotel, which Sunburst owns and manages, opened in Plano, Texas, in November
1996. An additional 21 properties with 2,054 rooms were under development as
of May 31, 1997.
 
  The MainStay Suites brand is designed to fill the gap between existing
upscale and economy extended-stay lodging products. Principal competitors for
the brand include Candlewood hotels, TownPlace Suites, as well as competition
from all-suite hotel properties and traditional extended stay operators in
both the upscale market (Residence Inn, Homewood Suites, Hawthorne Suites and
Summerfield Suites) and the economy market (Extended Stay America, Studio Plus
and Oakwood).
 
 International Franchise Operations
 
  Franchising's international franchise operations have traditionally been
operated as a division separate from its domestic franchise operations. In
some cases, international master franchisees are not required to separately
report royalty results by brand, making brand results on a worldwide basis
unavailable. In the past fiscal year, Franchising entered into arrangements to
enter four new international markets. At May 31, 1997, Choice had 563
franchise hotels open in 32 countries outside the United States. The following
table illustrates the growth of Franchising's international franchise system
over the four fiscal years ended May 31, 1997. Choice does not track ADR,
RevPAR or occupancy rates for international properties.
 
                    COMBINED INTERNATIONAL FRANCHISE SYSTEM
AS OF AND FOR THE YEAR ENDED MAY 31,
                                        ---------------------------------------
                                          1994      1995      1996      1997
                                        --------- --------- --------- ---------
Number of properties, end of period....       430       524       557       563
Number of rooms, end of period.........    36,725    44,877    46,843    47,603
Royalty fees ($000s)................... $   1,667 $   1,998 $   1,586 $   1,672
Europe. Choice is the second-largest international franchised hotel chain in
Europe, with 270 hotels open in 14 countries at May 31, 1997. In a move to
realign and streamline its European operations, in May 1996 Franchising,
through its subsidiary, Manor Care Hotels (France) S.A., consummated a
transaction with Friendly Hotels, PLC ("Friendly") whereby Franchising
purchased an equity interest for approximately $17 million in
 
                                      39
Friendly to finance the development of ten new Comfort Inn or Quality Inn
hotels in the United Kingdom and Ireland. Additionally, Friendly purchased
from Franchising a master franchise for the United Kingdom and Ireland.
Franchising closed its London office as a result of the transaction.
Franchising's French and German operations were consolidated into
Franchising's Paris, France office, which directly operates Franchising's
business in most of Europe. There is also a master franchise arrangement in
Scandinavia.
 
  The Middle East. In August 1995, Franchising signed a master franchise for
Israel. Franchising opened its first franchised property in Dubai, United Arab
Emirates, in December 1995. At May 31, 1997, there were two properties open in
this region.
 
  Asia/Pacific. During fiscal year 1997, Choice franchisees opened four hotels
in Australia, four in New Zealand, three in India, one in Thailand and two in
Indonesia, bringing the total number of properties open in the Asia/Pacific
region at May 31, 1997 to 61.
 
  Caribbean. Franchising's master franchisee had 6 properties open in 4
Caribbean countries at May 31, 1997.
 
  Central and South America. Franchising recently signed master franchise
agreements covering Brazil, Uruguay, Paraguay and Argentina. Franchising also
has master franchisees operating in Guatemala, Costa Rica, Chile and Mexico.
In total there were 19 open properties in this region at May 31, 1997.
 
  Canada. Choice Hotels Canada (a joint venture with Journey's End Corporation
of Belleville, Ontario, Canada ("Journey's End")) is Canada's largest lodging
organization with 205 properties open at May 31, 1997. The joint venture,
owned 50% by Franchising and 50% by Journey's End, was formed in 1993 when
Journey's End converted substantially all of its controlled hotels to
Franchising's brands and Franchising contributed its operations in Canada to
form Choice Hotels Canada.
 
 Owned and Operated International Hotels
 
  After the Distribution, Franchising, through its wholly-owned subsidiary,
Quality Hotels Europe, Inc. and its affiliates, will own and operate hotels in
the United Kingdom, France and Germany. These hotels are located in:
Kensington, England; Troisdorf, Peine and Jena, Germany; and Moulins,
Perpignan, Lormont, Montlucon, Paris, Ponte-a-Mousson, Vierzon, St. Catherine,
Reims and Cherbourg, France.
 
 Franchise Sales
 
  Franchising markets franchises principally to: (i) developers of hotels,
(ii) owners of independent hotels and motels, (iii) owners of hotels
affiliated with other franchisors' brands, (iv) its own franchisees, who may
own, buy or build other hotels which can be converted to Franchising's brands,
and (iv) contractors who construct any of the foregoing. In fiscal year 1996,
existing franchisees accounted for approximately one-half of Franchising's new
franchise agreements. In considering hotels for conversion to one of
Franchising's brands, or sites for development of new hotels, Franchising
seeks properties in locations which are in close proximity to major highways,
airports, tourist attractions and business centers that attract travelers.
 
  At May 31, 1997, Franchising employed approximately 40 sales directors, each
of whom is responsible for a particular region or geographic area. Sales
directors contact potential franchisees directly and receive compensation
based on sales generated. Franchise sales efforts emphasize the benefits of
affiliating with one of Franchising's well-known brand names, Franchising's
commitment to improving RevPAR, Franchising's "celebrity in a suitcase"
television advertising campaign (formerly used for the entire Choice family of
brands and now used principally for its three largest brands, Comfort, Quality
and Econo Lodge), Franchising's reservation system, Franchising's training and
support systems, and Franchising's history of growth and profitability.
Because it offers brands covering a broad spectrum of the lodging marketplace,
Franchising is able to offer each prospective franchisee a brand that fits its
needs, lessening the chances that the prospective franchisee would need to
consider a competing franchise system.
 
 
                                      40
Because retention of existing franchisees is important to Franchising's
growth strategy, existing franchisees are offered the right to object to a
same-brand property within 15 miles, and are protected from the opening of a
same-brand property within a specific distance, generally two to five miles,
depending upon the size of the property and the market size. Franchising
believes that it is the only major franchise company to routinely offer such
territorial protection to its franchisees.
 
  During the fiscal year ended May 31, 1997, Franchising received 1,078
franchise applications, approved 874 applications, signed 715 franchise
agreements and placed 390 new properties into operation in the United States
under Franchising's brands. Of those placed into operation, 203 were newly
constructed hotels. By comparison, during the fiscal year ended May 31, 1996,
Franchising received 993 franchise applications, approved 862 applications,
signed 665 franchise agreements and had 284 new U.S. properties come on line.
Applications may not result in signed franchise agreements either because an
applicant is unable to obtain financing or because Franchising and the
applicant are unable to agree on the financial terms of the franchise
agreement.
 
 Franchise Agreements
 
  A franchise agreement grants a franchisee the right to non-exclusive use of
Franchising's franchise system in the operation of a single hotel at a
specified location, typically for a period of 20 years, with certain rights to
each of the franchisor and franchisee to terminate before the twentieth year.
When the responsibility for development is sold to a master franchisee, that
party has the responsibility to sell to local franchisees Franchising's brands
and the master franchisee generally must manage the delivery of necessary
services (such as quality assurance, reservations and marketing) to support
the franchised hotels in the master franchise area. The master franchisee
collects the fees paid by the local franchisee and remits an agreed share to
Franchising. Master franchise agreements generally have a term of at least 10
years.
 
  Franchise agreements, other than master franchise agreements, can be
terminated by either party prior to the conclusion of their term under certain
circumstances, such as at certain anniversaries of the agreement or if a
franchisee fails to bring properties into compliance with contractual quality
standards within specified periods of time. Early termination options give
Franchising flexibility in eliminating or re-branding properties which become
weak performers for reasons other than contractual failure by the franchisee.
Master franchise agreements typically contain provisions permitting
Franchising to terminate the agreement for failure to meet a specified
development schedule.
 
  Franchise fees vary among Franchising's different brands, but generally are
competitive with the industry average within their market group. Franchise
fees usually have four components: an initial, one-time affiliation fee; a
royalty fee; a marketing fee; and a reservation fee. Proceeds from the
marketing fee and reservation fee are used exclusively to fund marketing
programs and Franchising's central reservation system, respectively. Most
marketing fees support brand-specific marketing programs, although Franchising
occasionally contributes a portion of such fees to marketing programs designed
to support all of Franchising's brands. Royalty fees and affiliation fees are
the principal source of profits for Franchising.
 
                                      41
Under the terms of the standard franchise agreements, Franchising's
franchisees are typically required to pay the following initial fees and on-
going fees as a percentage of gross room revenues:
 
                             QUOTED FEES BY BRAND
INITIAL FEE         ON-GOING FEES AS A PERCENTAGE OF GROSS ROOM REVENUES
                          PER ROOM/   ---------------------------------------------------------------------
         BRAND             MINIMUM     ROYALTY FEES           MARKETING FEES             RESERVATION FEES
         -----           ------------ -----------------      -----------------          -------------------
Comfort Inn............. $300/$45,000      5.25%                    2.1%                       1.75%
Comfort Suites.......... $300/$50,000       5.0%                    2.1%                       1.75%
Quality Inn............. $300/$35,000       4.0%                    2.1%                       1.75%
Quality Suites.......... $300/$50,000       4.0%                    2.1%                       1.25%
Sleep Inn............... $300/$40,000       4.5%                    2.1%                       1.75%
Clarion................. $300/$40,000      2.75%                    1.0%                       1.25%
Econo Lodge............. $250/$25,000       4.0%                    3.5%(1)                     --
MainStay Suites......... $300/$30,000       4.5%                    2.5%(1)                     --
Rodeway.................                   
  Year 1................ $250/$25,000       3.5%                   1.25%                       1.25%
  Year 2................          --        3.0%                   1.25%                       1.25%
  Year 3................          --        3.0%                   1.00%                       1.00%
--------
(1) Fee includes both Marketing and Reservations
 
  For a description of the Franchising Agreements between Choice and
Franchising which will remain in effect after the Distribution between
Sunburst and Franchising, see "--Relationship Between Choice and Franchising
After the Distribution--Franchise Agreements."
 
  Franchising has increased its actual royalty rate since FY 93, primarily by
raising the royalty fee for Comfort franchisees to 5.25% of annual gross room
revenues ("GRR") from 4.0% of GRR in 1993, and by raising the royalty rate for
franchisees in the former Friendship franchise system to 3.0% of GRR from 2.0%
of GRR in 1991. For the fiscal year ended May 31, 1997, Franchising's average
actual royalty rate was 3.4%. Franchising believes that its average actual
royalty rate will continue to increase as older franchise agreements expire,
terminate or are amended.
 
  At May 31, 1997, Franchising had 2,781 franchise agreements in effect in the
United States and 563 franchise agreements in effect in other countries. The
average age of the franchise agreements was 4 years. One hundred nineteen of
the franchise agreements are scheduled to expire during the five year period
beginning May 31, 1997; however, franchise agreements generally contain early
termination provisions.
 
 Franchise Operations
 
  Franchising's operations are designed to improve RevPAR for Franchising's
franchisees, as this is the measure of performance that most directly impacts
franchisee profitability. It is Franchising's belief that by helping its
franchisees to become more profitable it will enhance its ability to retain
its existing franchisees and attract new franchisees. The key aspects of
Franchising's franchise operations are:
 
  Central Reservation System. On average, approximately 22% of the room nights
booked at franchisees' properties are reserved through the toll-free telephone
reservation system operated by Franchising. Franchising's reservation system
consists of a computer reservation system known as CHOICE 2001, five
reservation centers in North America and several international reservation
centers run by Franchising or its master franchisees. The CHOICE 2001 system
is designed to allow trained operators to match each caller with a Choice-
branded hotel meeting the caller's needs. It provides an instant data link to
Franchising's franchised properties as well as to the Amadeus, Galileo, SABRE
and Worldspan airline reservation systems thereby facilitating the reservation
process for travel agents.
 
                                      42
To more sharply define the market and image for each of its brands,
Franchising began advertising separate toll-free reservation numbers for all
of its brands in fiscal year 1995. Franchising allows its reservation agents
to cross-sell Franchising's hotel brands. If a room in the Choice hotel brand
requested by a customer is not available in the location or price range that
the customer desires, the agent may offer the customer a room in another
Choice brand hotel that meets the customer's needs. Franchising believes that
cross-selling enables Franchising and its franchisees to capture additional
business.
 
  On-line reports generated by the CHOICE 2001 system enable franchisees to
analyze their reservation patterns over time. In addition, Franchising
provides and is currently improving a yield management product for its
franchisees to allow them to improve the management of their mix of rates and
occupancy based on current and forecasted demand on a property by property
basis. Franchising also markets to its franchisees a property management
product. Such products are designed to manage the financial and operations
information of an individual hotel and improve its efficiency.
 
  Brand Name Marketing and Advertising. Franchising's marketing and
advertising programs are designed to heighten consumer awareness of
Franchising's brands. Marketing and advertising efforts are focused primarily
in the United States and include national television and radio advertising,
print advertising in consumer and trade media and promotional events,
including joint marketing promotions with vendors and corporate partners.
 
  Franchising is recognized for its "celebrity in a suitcase" television
advertisements. In fiscal year 1996, Franchising began using brand-specific
marketing and largely discontinued the strategy of advertising its multiple
brands under the Choice umbrella, although it continues to use its "suitcase"
ads for its three largest brands, Comfort, Quality and Econo Lodge. The
marketing fees generated by these brands are used, in part, to fund a national
network television advertising campaign. Franchising's smaller hotel brands
conduct advertising campaigns that also include cable television, radio and
print.
 
  Franchising conducts numerous marketing programs targeting specific groups,
including senior citizens, motorist club members, families, government and
military employees, and meeting planners. Other marketing efforts include
telemarketing and telesales campaigns, domestic and international trade show
programs, publication of group and tour rate directories, direct-mail
programs, discounts to holders of preferred credit cards, centralized
commissions for travel agents, fly-drive programs in conjunction with major
airlines, and twice yearly publication of a Travel and Vacation Directory.
 
  Marketing and advertising programs are directed by Franchising's Marketing
Department, which utilize the services of independent advertising agencies.
Franchising also employs sales personnel at its Silver Spring, Maryland,
headquarters and in its Phoenix, Arizona, office. These sales personnel use
telemarketing to target specific customer groups, such as potential corporate
clients in areas where Franchising's franchised hotels are located, the motor
coach market, and meeting planners. Most of these sales personnel sell
reservations and services for all of Franchising's brands, but four are
responsible exclusively for the Clarion brand.
 
  Franchising's regional sales directors work with franchisees to maximize
RevPAR. These directors advise franchisees on topics such as how to market
their hotels and how to maximize the benefits offered by Franchising's
reservations system.
 
  Quality Assurance Programs. Consistent quality standards are critical to the
success of a hotel franchise. Franchising has established quality standards
for all of its franchised brands which cover housekeeping, maintenance, brand
identification and level of services offered. Franchising inspects properties
for compliance with its quality standards when application is made for
admission to the franchise system. The compliance of existing franchisees with
quality standards is monitored through scheduled and unannounced Quality
Assurance Reviews conducted at least once per year at each property.
Properties which fail to maintain a minimum score are reinspected on a more
frequent basis until deficiencies are cured, or until such properties are
terminated.
 
  To encourage compliance with quality standards, Franchising offers various
brand-specific incentives to franchisees who maintain consistent quality
standards. Franchisees who fail to meet minimum quality standards
 
                                      43
may be subject to consequences ranging from written warnings to termination of
the franchisee's franchise agreement. During fiscal year 1997, Franchising
terminated forty-nine properties for failure to maintain minimum quality
assurance scores.
 
  Training. Franchising maintains a training department which conducts
mandatory training programs for all franchisees and their employees.
Franchising also conducts regularly scheduled regional and national training
meetings for both property-level staff and managers. Training programs teach
franchisees how to take advantage of Franchising's reservation system and
marketing programs, and fundamental hotel operations such as housekeeping,
maintenance, and inventory yield management.
 
  Training is conducted by a variety of methods, including group instruction
seminars and video programs. Franchising is developing an interactive
computer-based training system that will train hotel employees at their own
pace. Franchisees will be required to purchase hardware to operate the
training system, and will use software developed by Franchising.
 
  Research and Development. Franchising seeks to enhance RevPAR by providing
to franchisees systems and products that will reduce costs and/or improve
their operations. Research and development activity resulted in the launch of
three new franchise products in fiscal year 1996, Choice Picks food court,
MainStay Suites hotels and K-Minus food service.
 
  In January 1996, Franchising introduced its MainStay Suites franchise hotel
brand, an extended-stay product targeted to travelers who book hotel rooms for
five or more consecutive nights. See "--MainStay Suites."
 
  In November 1995, Franchising introduced Choice Picks food court, a
customized, modular food-service system tailored to the needs of middle-market
hotels. Choice Picks food courts offer hotel guests a "choice pick" of
nationally known branded food items, such as Nathan's Famous hot dogs,
sandwiches made with Healthy Choice(R) deli meats, Pizzeria Uno(R) pizza and
calzone, Nestle Toll House(R) cookies and muffins, I Can't Believe It's
Yogurt(R) desserts, and Coca-Cola(R) beverages. The typical Choice Picks food
court can be operated by as few as two employees, thus providing the
properties with lower operating costs than properties with conventional
restaurants. Franchisees pay Franchising a one-time affiliation fee and
monthly royalty fees equal to a percentage of gross revenues on Choice Picks
food court sales. Franchisees must buy equipment and food service modules
necessary to set up a Choice Picks food court. Franchising intends to market
Choice Picks food court to larger hotel operators and other potential
customers outside of Franchising's franchise system.
 
  In November 1995, Franchising also began to offer to its franchisees the K-
Minus food service system, which eliminates expensive banquet kitchens by
outsourcing food preparation and limiting on-site work to assembly and
rethermalization. Compared with a traditional banquet operation, the K-Minus
food service system saves labor costs and energy. Franchisees who wish to
implement the K-Minus system are given design and technical assistance by
Franchising. Franchising receives a one-time technical assistance fee for the
provision of these services based on the scope of the project.
 
  Purchasing. Franchising's product services department negotiates volume
purchases of various products needed by franchisees to run their hotels,
including such items as furniture, fixtures, carpets and bathroom amenities.
The department also helps to ensure consistency in such products across its
exclusively new-construction brands, Sleep Inn and MainStay Suites brands.
 
  Design and Construction. Franchising maintains a design and construction
department to assist franchisees in refurbishing, renovating, or constructing
their properties prior to or after joining the system. Department personnel
assist franchisees in meeting Franchising's brand specifications by providing
technical expertise and cost-savings suggestions.
 
                                      44
Financial Assistance Programs. Franchising has established programs or
helped franchisees obtain financing through (i) a wholly owned subsidiary;
(ii) strategic partnerships with hotel lenders and/or (iii) by referral to
hotel lenders for hotel refinancing, acquisition, renovation and development.
Some of the specific programs include:
 
    (a) Second mortgage financing for the development and construction of
  Quality Inn, Quality Suites, Quality Inn & Suites, MainStay Suites and
  Sleep Inns. The terms of the financing will depend on each franchisee's
  credit worthiness, the amount of the proposed loan and the current economic
  conditions. Generally not more than 25% of the project will be financed.
  Total debt cannot exceed 75% of the fair market value.
 
    (b) Econo Lodge exterior renovation program. Loans up to an amount of
  $17,500 per property are given to qualified franchisees for standardized
  exterior renovation. Franchisee participation requires, among other things,
  extension of the franchise agreement. The loan is forgiven at the
  expiration of the extended franchise agreement, assuming no defaults have
  occurred thereunder.
 
    (c) Salomon Brothers in conjunction with Suburban Capital Markets Inc. is
  offering a $100 million construction to permanent financing program to
  qualified franchisees. All Choice brands are included in this program. The
  construction loan will be issued for a term up to three years at a floating
  rate of 355 basis points over the 30-day LIBOR. The loan amount will not
  exceed 75% of cost. The franchisee will be responsible for cost of all
  third party reports and fees in the amount of 2.75% of the loan amount. A
  stabilized debt service coverage ratio of at least 1.4:1 is required for
  the permanent loans, which are issued for a 10 year term with amortization
  up to 25 years and a fixed interest rate of 260 basis points over the 10
  year U.S. Treasury interest rate on the day of closing. The permanent loan
  will require a fee of 1% of the loan amount.
 
 Competition
 
  Competition among franchise lodging chains is intense, both in attracting
potential franchisees to the system and in generating reservations for
franchisees. In addition, hotel chains and independent hotels compete
intensely for guests and for meeting and banquet business.
 
  Franchising's principal competitor brands at the national and international
level in the economy category of the lodging industry are LaQuinta, Ho-Jo Inn,
Ramada Inn, Motel 6, Ramada Limited, Red Carpet Inn, Red Roof Inn, Budgetel,
Hampton Inn, Fairfield Inn, Holiday Express, Shoney's Inn, Super 8, Days Inn,
and Travelodge. Franchising's principal competitor brands at the national and
international level in the middle market category of the lodging industry are
Days Inn, Fairfield Inn, Hampton Inn, Holiday Express, LaQuinta, Holiday Inn,
Best Western, Howard Johnson and Ramada Inns. Franchising's principal
competitor brands at the national and international level in the upscale
category are Holiday Inn, Holiday Select, Crowne Plaza, Four Points by
Sheraton, Radisson, Courtyard by Marriott and Doubletree.
 
  Franchising believes that hotel operators choose lodging franchisors based
primarily on the perceived value and quality of each franchisor's brand and
services, and the extent to which affiliation with that franchisor may
increase the franchisee's reservations and profits. Hotel operators may also
select a franchisor in part based on the franchisor's reputation among other
franchisees, and the success of its existing franchisees.
 
  Choice is the second largest hotel franchiser in the world. The largest,
HFS, Inc., has over 4,600 franchised hotels. Holiday Inn Worldwide has 1,240,
Promus Hotel Corp. has 597, Marriott International has 394 and Carlson
Hospitality Worldwide has 248.*
--------
* The figures in this paragraph are with respect to U.S. hotel properties as
  indicated in the August 1996 issue of Lodging Hospitality.
 
                                      45
Franchising's prospects for growth are largely dependent upon the ability of
its franchisees to compete in the lodging market, since Franchising's
franchise system revenues are based on franchisees' gross room revenues (but
not directly on franchisees' profitability).
 
  The ability of a hotel to compete may be affected by a number of factors,
including the location and quality of its property, the number and quality of
competing properties nearby, its affiliation with a recognized name brand, and
general regional and local economic conditions. The effect of economic
conditions on Franchising's results is substantially reduced by the geographic
diversity of Franchising's franchised properties, which are located in all 50
states and in 33 countries, as well as its range of products and room rates.
 
 Service Marks and Other Intellectual Property
 
  The service marks Quality Inn, Quality Suites, Comfort Inn, Comfort Suites,
Clarion Hotel, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites and
related logos are material to the Franchising Business. Franchising, directly
and through its franchisees, actively uses these marks. All of the material
marks are registered with the United States Patent and Trademark Office,
except for MainStay Suites and K-Minus, which are the subject of pending
applications. In addition, Franchising has registered certain of its marks
with the appropriate governmental agencies in over 100 countries where it is
doing business or anticipates doing business in the foreseeable future.
Franchising seeks to protect its brands and marks throughout the world,
although the strength of legal protection available varies from country to
country.
 
 Non-Hotel Properties
 
  The principal executive offices of Franchising are located at 10750 Columbia
Pike, Silver Spring, Maryland, 20901. These offices are leased from Manor Care
pursuant to the Silver Spring Lease. For a description of the Silver Spring
Lease and the effect of the Distribution on the Silver Spring Lease, see "--
Relationship Between the Company of Franchising after the Distribution," and
"Proposal Five: Election of Directors--Certain Relationships and
Transactions." Franchising owns its reservation system offices in Phoenix, AZ
and Minot, ND. Franchising leases two additional reservation system offices in
Grand Junction, CO, pursuant to leases that expire in 1999 and 2000, and
occupies additional space in Toronto, Canada, on a month-to-month basis. In
addition, Franchising leases 12 sales offices across the United States.
Franchising's European headquarters, which Franchising leases pursuant to a
lease that expires on December 31, 1997, is located in Paris, France.
Franchising also leases one international sales offices in France pursuant to
a lease that terminates in June 1998. Management believes that its executive,
reservation systems and sales offices are sufficient to meet its present needs
and does not anticipate any difficulty in securing additional or alternative
space, as needed, on terms acceptable to Franchising.
 
 Seasonality
 
  Franchising's principal sources of revenues are franchise fees based on the
gross room revenues of its franchise properties and revenues generated by its
owned and managed hotels. Franchising experiences seasonal revenue patterns
similar to those of the lodging industry in general. This seasonality can be
expected to cause quarterly fluctuations in the revenues, profit margins and
net income of Franchising.
 
 Regulation
 
  Franchising's franchisees are responsible for compliance with all laws and
government regulations applicable to the hotels they own or operate. The
lodging industry is subject to numerous federal, state and local government
regulations, including those relating to the preparation and sale of food and
beverage (such as health and liquor license laws), building and zoning
requirements and laws governing a hotel owner's relationship with employees,
including minimum wage requirements, overtime, working conditions and work
permit requirements. The failure to obtain or retain liquor licenses or an
increase in the minimum wage rate, employee benefit costs or other costs
associated with employees could adversely affect Franchising's owned hotels.
Under the Americans
 
                                      46
with Disabilities Act of 1990 (the "ADA"), all public accommodations are
required to meet certain federal requirements related to access and use by
disabled persons. A determination that Franchising is not in compliance with
the ADA could result in the imposition of fines or an award of damages to
private litigants. These and other initiatives could adversely affect
Franchising as well as the lodging industry in general.
 
  The Federal Trade Commission (the "FTC") and certain other jurisdictions
(including France, Province of Alberta, Canada, and Mexico and various states)
regulate the sale of franchises. The FTC requires franchisors to make
extensive disclosure to prospective franchisees but does not require
registration. A number of states require registration or disclosure in
connection with franchise offers and sales. In addition, several states have
"franchise relationship laws" or "business opportunity laws" that limit the
ability of the franchisor to terminate franchise agreements or to withhold
consent to the renewal or transfer of these agreements. While Franchising's
franchising operations have not been materially adversely affected by such
regulation, Franchising cannot predict the effect of future regulation or
legislation.
 
 Impact of Inflation and Other External Factors
 
  Franchising's principal sources of revenues are franchise fees. Franchise
fees and revenues from owned and managed hotels can be impacted by two
external factors: the supply of hotel rooms within the lodging industry
relative to the demand for rooms by travelers, and inflation.
 
  Although industry-wide supply and demand for hotel rooms recently has been
fairly balanced, any excess in supply that might develop in the future could
have an unfavorable impact on room revenues at Franchising's franchised hotels
either by reducing the number of rooms reserved at Franchising's properties or
by restricting the rates hotel operators can charge for their rooms. In
addition, an excess supply of hotel rooms may discourage potential franchisees
from opening new hotels, unfavorably impacting the franchise fees received by
Franchising.
 
  Although Franchising believes that increases in the rate of inflation will
generally result in comparable increases in hotel room rates, severe inflation
could contribute to a slowing of the national economy, which could result in
reduced travel by both business and leisure travelers. That could lead to less
demand for hotel rooms, which could result in a temporary reduction in room
rates and fewer room reservations, negatively impacting revenues received by
Franchising. A weak economy could also reduce demand for new hotels,
negatively impacting the franchise fees received by Franchising.
 
  Among the other unpredictable external factors which may affect
Franchising's fee stream are wars, airline strikes, gasoline shortages and
severe weather.
 
 Legal Proceedings
 
  Neither Choice nor Franchising is a party to any litigation, other than
routine litigation incidental to the Franchising Business. None of such
litigation, either individually or in the aggregate, is expected to be
material to the business, financial condition or results of operations of
Franchising.
 
 Employees
 
  Franchising employed 2,070 people as of June 30, 1997. None of Franchising's
employees are represented by unions or covered by collective bargaining
agreements. Franchising considers its relations with its employees to be
satisfactory.
 
MANAGEMENT
 
 Board of Directors
 
  The current directors of Franchising are William R. Floyd, Donald J. Landry
and James A MacCutcheon. In connection with the Distribution, it is expected
that Messrs. Landry and MacCutcheon will resign as directors of Franchising
and that, prior to the Distribution Date, Choice, as sole stockholder of
Franchising, will expand
 
                                      47
the Franchising board of directors to a total of nine persons and appoint
seven persons to the resulting vacancies so that the persons listed below will
constitute the entire Franchising Board of Directors effective as of the
Distribution Date. From and after the Distribution Date, Franchising's Board
of Directors will be classified into three classes, designated Class I, Class
II and Class III, each class to be as nearly equal in number of directors as
possible. The term of the initial Class I directors will terminate on the date
of the 1998 annual meeting of Franchising's stockholders; the term of the
initial Class II directors will terminate on the date of the 1999 annual
meeting of Franchising's stockholders; and the term of the initial Class III
directors will terminate on the date of the 2000 annual meeting of
Franchising's stockholders. At each annual meeting of Franchising's
stockholders, successors to the class of directors whose term expires at that
annual meeting will be elected for a three-year term.
 
  The name, age and proposed class of directorship upon consummation of the
Distribution of the nine persons who are expected to be the directors of
Franchising from and after the Distribution Date are set forth below.
NAME                                                 AGE CLASS OF DIRECTOR
      ----                                                 --- -----------------
Stewart Bainum, Jr. ...................................  51     Class II
   Stewart Bainum.........................................  78     Class I
   Barbara Bainum.........................................  53     Class III
   William R. Floyd.......................................  52     Class II
   James H. Rempe.........................................  67     Class II
   Robert C. Hazard, Jr. .................................  62     Class III
   Frederic V. Malek......................................  60     Class III
   Gerald W. Petitt.......................................  51     Class I
   Jerry E. Robertson, Ph.D...............................  64     Class I
Background of Directors
 
  Stewart Bainum Jr. Chairman of the Board of Choice since November 1996;
Chairman of the Board of Choice Hotels from March 1987 to June 1990; Chairman
of the Board and Chief Executive Officer of Manor Care and Manor Care Health
Services, Inc. ("MCHS") since March 1987; Chief Executive Officer of Manor
Care since March 1987 and President since June 1989; Vice Chairman of the
Board of Vitalink Pharmacy Services, Inc. ("Vitalink") since December 1994;
Vice Chairman of the Board of Manor Care and subsidiaries from June 1982 to
March 1987; Director of Manor Care since August 1981, of Vitalink since
September 1991, of MCHS since 1976 and of Choice Hotels since 1977; Chief
Executive Officer of MCHS since June 1989 and President from May 1990 to May
1991; Chairman of the Board and Chief Executive Officer of Vitalink from
September 1991 to February 1995 and President and Chief Executive Officer from
March 1987 to September 1991.
 
  Stewart Bainum. Vice Chairman of the Board of Manor Care and subsidiaries
since March 1987; Chairman of the Board of Manor Care from August 1981 to
March 1987, Chief Executive Officer from July 1985 to March 1987, President
from May 1982 to July 1985; Chairman of the Board of MCHS from 1968 to March
1987 and a Director since 1968; Director of Vitalink from September 1991 to
September 1994; Chairman of the Board of Choice Hotels from 1972 to March 1987
and a Director since 1963; Chairman of the Board of Realty Investment Company,
Inc. since 1965.
 
  Barbara Bainum. President, Secretary and Director of the Commonwealth
Foundation since December 1990, December 1984 and December 1994, respectively;
Secretary and Director of Realty Investment Company, Inc. since July 1989 and
March 1982, respectively; Family Services Agency, Gaithersburg, Maryland,
Clinical Social Work since September 1994; Department of Social Services,
Rockville, Maryland, Social Work Case Management from September 1992 to May
1993; member of the Boards of Trustees of Columbia Union College (September
1987 to May 1991) and Atlantic Union College (September 1985 to May 1987).
 
                                      48
William R. Floyd. Chief Executive Officer of Choice since October 1996;
Chief Operating Officer of Taco Bell Corp., (a subsidiary of PepsiCo) from
July 1995 to October 1996, Chief Operating Officer of KFC (a subsidiary of
PepsiCo) from August 1994 to July 1995; National Vice President of Taco Bell
Company Operations from July 1992 to August 1994, Vice President of Taco Bell
Eastern Operations from December 1990 to January 1992; Director, Friendly
Hotels PLC since 1996.
 
  Robert C. Hazard, Jr. Hotel Developer. Co-Chairman of Choice Hotels from
January 1995 to November 1996 and a Director since December 1980; Chairman
from June 1990 to January 1995 and Chief Executive Officer from December 1980
to January 1995; President from December 1980 to June 1990. Advisory Board
Outrigger Hotels.
 
  Frederic V. Malek. Chairman of Thayer Capital Partners since March 1993, Co-
Chairman of CB Commercial Real Estate Group, Inc. from April 1989 to October
1996; Campaign Manager for Bush-Quayle 92 from January 1992 to November 1992;
Vice Chairman of NWA, Inc. (airlines), July 1990 to December 1991; Director:
Manor Care, Inc., American Management Systems, Inc., Automatic Data Processing
Corp., CB Commercial Real Estate Group, Inc., FPL Group, Inc. (an affiliate of
Florida Power and Light--power company); Northwest Airlines and various Paine
Webber mutual funds.
 
  Gerald W. Petitt. Hotel Developer, Co-Chairman of Choice Hotels from January
1995 to November 1996 and a Director since December 1980; President from June
1990 to January 1995 and Chief Operating Officer from December 1980 to January
1995.
 
  Jerry E. Robertson, Ph.D. Retired; Executive Vice President, 3M Life
Sciences Sector and Corporate Services from November 1986 to March 1994;
Director: Manor Care, Inc., Allianz Life Insurance Company of North America,
Cardinal Health, Inc., Coherent, Inc., Haemonetics Corporation, Medwave, Inc.,
Project Hope and Steris Corporation.
 
  James H. Rempe. Senior Vice President, General Counsel and Secretary of
Manor Care since August 1981 and of Franchising from February 1981 to November
1996. Director, In Home Health Inc. and Vitalink Pharmacy Services, Inc.
 
 The Board of Directors and Committees of the Board
 
  Upon consummation of the Distribution, the Franchising Board of Directors is
expected to consist of nine members. It is expected that the Board of
Directors will hold five meetings during the fiscal year and that the standing
committees of the Board of Directors will include the Audit Committee, the
Finance Committee, the Compensation/Key Executive Stock Option Plan Committee
and the Nominating Committee. The members of the committees are expected to be
the same members of Choice's current Committees.
 
  The Compensation/Key Executive Stock Option Plan Committee will administer
the Franchising stock option plans and grant stock options thereunder, will
review compensation of officers and key management employees, will recommend
development programs for employees such as training, bonus and incentive
plans, pensions and retirement, and will review other employee fringe benefit
programs.
 
  The Finance Committee will review the financial affairs of Franchising and
will recommend financial objectives, goals and programs to the Board of
Directors and to management.
 
  The Audit Committee will review the scope and results of the annual audit,
will review and approve the services and related fees of Franchising's
independent public accountants, will review Franchising's internal accounting
controls and will review Franchising's Internal Audit Department and its
activities.
 
  The Nominating Committee will recommend to the Board of Directors the
members to serve on the Board of Directors during the ensuing year. The
Committee will not consider nominees recommended by stockholders.
 
                                      49
Compensation of Directors
 
  Prior to the Distribution, it is expected that Franchising will adopt the
Choice Hotels Franchising, Inc. Non-Employee Director Stock Option and Deferred
Compensation Stock Purchase Plan. Part A of the Plan will provide that eligible
non-employee directors will be granted options to purchase 5,000 shares of
Franchise Common Stock on their first date of election and will be granted
options to purchase 1,000 shares on their date of election in subsequent
calendar years. Part B of the Plan will provide that eligible non-employee
directors may elect, prior to May 31 of each year, to defer a minimum of 25% of
committee fees earned during the ensuing fiscal year. The fees which are so
deferred will be used to purchase Franchise Common Stock on the open market
within 15 days after December 1, February 28 and May 31 of such fiscal year.
Pending such purchases, the funds will be credited to an Interest Deferred
Account, which will be interest bearing. Stock which is so purchased will be
deposited in a Stock Deferred Account pending distribution in accordance with
the Plan.
 
  Directors who will be employees of Franchising will receive no separate
remuneration for their services as directors. Pursuant to the Non-Employee
Director Stock Compensation Plan to be adopted by Franchising prior to the
Distribution, eligible non-employee directors will receive annually, in lieu of
cash, restricted stock of Franchising, the fair market value of which at the
time of grant will be equal to $30,000, which will represent the Board of
Directors retainer and meeting fees. In addition, all non-employee directors
will receive $1,610 per diem for Committee meetings attended, except where the
Committee meeting is on the same day as a Board meeting, and will be reimbursed
for travel expenses and other out-of-pocket costs incurred in attending
meetings.
 
 Executive Officers
 
  The name, age, proposed title upon consummation of the Distribution and
business background of each of the persons who are expected to become on the
Distribution Date the executive officers of Franchising are set forth below.
The business address of each prospective executive officer is 10750 Columbia
Pike, Silver Spring, Maryland 20901, unless otherwise indicated.
NAME               AGE                            POSITION
      ----               ---                            --------
Stewart Bainum, Jr......  51 Chairman of the Board of Directors
William R. Floyd........  52 Vice Chairman and Chief Executive Officer
James A. MacCutcheon....  45 Executive Vice President, Chief Financial Officer and Treasurer
Thomas Mirgon...........  41 Senior Vice President, Human Resources
Barry L. Smith..........  55 Senior Vice President, Marketing
Michael J. DeSantis.....  38 Senior Vice President, General Counsel and Secretary
Joseph M. Squeri........  32 Vice President, Finance and Controller
Rodney Sibley...........  48 Senior Vice President, Franchise Operations
James A. MacCutcheon. Executive Vice President, Chief Financial Officer and
Treasurer of Choice since November 1996; Senior Vice President, Chief Financial
Officer and Treasurer of Choice's predecessor (together with Choice, "Choice
Hotels") since September 1993; Senior Vice President, Chief Financial Officer
and Treasurer of Manor Care from September 1993 to November 1996; Senior Vice
President--Finance and Treasurer of Manor Care from October 1987 to September
1993; Treasurer of Vitalink from September 1992 to January 1997 and a Director
since September 1994.
 
  Thomas Mirgon. Senior Vice President, Human Resources of Choice since March
1997; Vice President, Administration of Interim Services from August 1993 to
February 1997; employed by Taco Bell Corp. from January 1986 to August 1993,
last serving as Senior Director, Field Human Treasures from February 1992 to
August 1993.
 
                                       50
Barry L. Smith. Senior Vice President--Marketing of Choice Hotels since
February 1989.
 
  Michael J. DeSantis. Senior Vice President, General Counsel and Secretary of
the Company since June 1997; Senior Attorney for the Company from November
1996 to June 1997; Senior Attorney for Manor Care from January 1996 to October
1996; Vice President, Associate General Counsel and Assistant Secretary for
Caterair International Corporation from April 1994 to December 1995; Assistant
General Counsel of Caterair International from May 1990 to March 1994.
 
  Rodney Sibley. Senior Vice President, Franchise Operations of Choice since
June 1997; Senior Vice President, Development for the Company from June 1996
to June 1997; Regional Vice President of Choice from 1992 to June 1996.
 
 
  For biographical information with respect to the other persons listed above,
see "Certain Information Concerning Franchising--Management--Board of
Directors."
 
 Compensation of Executive Officers
 
  Summary Compensation. The following tables set forth certain information
concerning the annual and long term compensation of those persons who,
following the Distribution, will serve as the chairman of the board, the chief
executive officer and the four other most highly compensated executive
officers of Franchising (the "Franchising Named Officers").
 
                          SUMMARY COMPENSATION TABLE
ANNUAL          LONG-TERM COMPENSATION
                                               COMPENSATION             RESTRICTED
                                             -----------------    -----------------------
                             FISCAL                                 STOCK    STOCK OPTION      ALL OTHER
NAME AND PRINCIPAL POSITION   YEAR   SALARY   BONUS    OTHER      AWARDS($)  SHARES(#)(1)   COMPENSATION(2)
---------------------------  ------ -------- -------- --------    ---------- ------------   ---------------
Stewart Bainum, Jr.(3)..      1997  $656,357 $388,520      (4)           --     60,000(5)           --
 Chairman                     1996   625,102  337,555      (4)           --     60,000(5)       $33,543
                              1995   572,308  343,385      (4)           --        --             9,000
William R. Floyd(6).....      1997   270,373  146,001 $107,831(7) $1,250,000   307,693              --
 Vice Chairman and            1996       --       --       --            --        --               --
 Chief Executive Officer      1995       --       --       --            --        --               --
James A.
 MacCutcheon(8).........      1997   313,578  155,953      (4)           --     67,500(9)        18,682
 Executive Vice President,    1996   301,517  135,682      (4)           --     25,000(10)       13,176
 Chief Financial Officer      1995   273,199  136,600      (4)           --        --            13,176  
  and Treasurer               
Barry L. Smith..........      1997   240,000  108,000      (4)           --     25,000(11)       11,086
 Sr. Vice President,          1996   233,640  116,820      (4)           --     5,000(12)        10,427          
  Marketing                   1995   221,668  104,561      (4)           --        --             6,750 
Thomas Mirgon(13).......      1997    58,477   26,315      (4)           --     40,000              --
 Senior Vice President,       1996       --       --                     --        --               --
 Human Resources              1995       --       --                     --        --               --
Rodney Sibley(14).......      1997   309,123  139,105      (4)           --     30,000(15)       27,329
 Senior Vice President,       1996   423,858      --       (4)           --        --            27,329
 Franchise Operations         1995   478,355      --       (4)           --        --            21,349
--------
 (1) For Messrs. Bainum, Jr., MacCutcheon, Smith and Sibley, represents
     options to purchase shares of Manor Care Common Stock granted in fiscal
     years 1997, 1996 and 1995. In connection with the Manor Care Spin-off,
     the options to purchase Manor Care Common Stock were converted, in some
     cases 100%, to options to purchase Choice Common Stock. In all cases,
     however, the exercise prices were adjusted to maintain the same financial
     value to the option holder before and after the Manor Care Spin-off.
 (2) Represents amounts contributed by Manor Care for fiscal years 1996 and
     1995 and Choice for fiscal year 1997 under their respective 401(k) Plan
     and Non-Qualified Savings Plan, which provide retirement and other
     benefits to eligible employees, including the Franchising Named Officers.
     The value of the amounts contributed in stock by Choice during fiscal
     year 1997 under the 401(k) Plan for the Franchising Named Offices were as
     follows: Mr. MacCutcheon, $6,240; Mr. Smith, $3,696 and Mr. Sibley,
     $9,000. The value of the amounts contributed in stock of Choice during
     fiscal year 1997 under the Non-Qualified Saving Plan for the Franchising
     Named Officers were as follows: Mr. MacCutcheon, $12,443; Mr. Smith
     $7,390 and Mr. Sibley $18,329.
 
                                      51
(3) For part of fiscal year 1997 and all of fiscal years 1996 and 1995, Mr.
     Bainum, Jr. was the Chairman and Chief Executive Officer of Manor Care
     and Choice. In November, 1996, he resigned as Chief Executive Officer of
     Choice. The compensation reflected here is the total compensation
     received for services rendered to both Manor Care and Choice. For the
     period of fiscal year 1997 after the Manor Care Spin-off, the amount of
     compensation paid solely by Choice was $88,302 for base salary and
     $47,683 for bonus.
 (4) The value of perquisites and other compensation does not exceed the
     lesser of $50,000 or 10% of the amount of annual salary and bonus paid as
     to any of the Franchising Named Officers.
 (5) In connection with the Manor Care Spin-off, these options were converted
     on a pro rata basis into options to purchase Manor Care Common Stock and
     options to purchase Choice Common Stock.
 (6) Mr. Floyd's employment as Chief Executive Officer of Choice commenced
     October 16, 1996.
 (7) Consists of relocation expenses.
 (8) For fiscal years 1996 and 1995 and part of fiscal year 1997, Mr.
     MacCutcheon was Senior Vice President, Chief Financial Officer and
     Treasurer of Manor Care and Choice. On November 1, 1996, Mr. MacCutcheon
     resigned from his position at Manor Care and assumed the position of
     Executive Vice President and Chief Financial Officer of Choice. The
     compensation reflected here is total compensation received for services
     rendered to both Manor Care and Choice. For the period of fiscal year
     1997 after the Manor Care Spin-off, the amount of compensation paid
     solely by Choice was $209,052 for base salary and $103,690 for bonus.
 (9) In connection with the Manor Care Spin-off, these options were converted
     into options to purchase 6,563 shares of Manor Care Common Stock at an
     adjusted exercise price of $25.0505, 36,387 options and 136,326 options
     to purchase Choice Common Stock at adjusted exercise prices of $14.5095
     and $13.8933, respectively.
(10) In connection with the Manor Care Spin-off, these options were converted
     into options to purchase 50,102 shares of Choice Common Stock at an
     adjusted exercise price of $11.1168 and 10,462 shares of Manor Care
     Common Stock at an adjusted exercise price of $19.1932.
(11) In connection with the Manor Care Spin-off, these options were converted
     into options to purchase 68,182 shares of Choice Common Stock at an
     adjusted exercise price of $14.5095.
(12) In connection with the Manor Care Spin-off, these options were converted
     into options to purchase 13,633 shares of Choice Common Stock at an
     adjusted exercise price of $11.1168.
(13) Mr. Mirgon's employment with Choice commenced March 3, 1997.
(14) Prior to fiscal year 1997, Mr. Sibley's compensation was based on
     commissions.
(15) In connection with the Manor Care Spin-off, such options were converted
     into options to purchase 81,818 shares of Choice Common Stock at an
     adjusted exercise price of $14.5095.
 
  Stock Options. The following tables set forth certain information at May 31,
1997 and for the fiscal year then ended concerning options to purchase Choice
Common Stock granted to the Franchising Named Officers. All common stock
figures and exercise prices have been adjusted to reflect stock dividends and
stock splits effective in prior fiscal years. In connection with the Manor
Care Spin-off, existing Manor Care stock options were subject to certain
adjustments or conversion into options to purchase Choice Common Stock.
 
                                      52
STOCK OPTION GRANTS IN FISCAL 1997
 
                               INDIVIDUAL GRANTS
PERCENTAGE OF                             POTENTIAL REALIZABLE
                                               TOTAL OPTIONS                           VALUE OF ASSUMED RATE OF
                                               GRANTED TO ALL                          STOCK PRICE APPRECIATION
                                    NUMBER OF   EMPLOYEES IN  EXERCISE BASE               FOR OPTION TERM(2)
                                     OPTIONS    FISCAL YEAR       PRICE     EXPIRATION ------------------------
          NAME             COMPANY* GRANTED(1)      1997        PER SHARE      DATE       5%(3)       10%(4)
          ----             -------- ---------- -------------- ------------- ---------- ----------- ------------
Stewart Bainum, Jr.(5)...   CHI       60,000        (6)         $14.5095     07/01/06  $   547,494 $  1,387,464
                            MNR       60,000        (6)         $25.0505     07/01/06      945,246    2,395,440
                                     -------                                           ----------- ------------
                            Total    120,000                                             1,492,740    3,782,904

William R. Floyd(5)......   CHI      307,693        (6)         $ 14.625     11/04/06    2,830,037    7,171,862
                            MNR            0        --               --           --           --           --
                                     -------                                           ----------- ------------
                            Total    307,693                                             2,830,087    7,171,862

James A. MacCutcheon(5)..   CHI       36,387        (6)         $14.5095     07/01/06      332,028      841,428
                            CHI      136,326        (6)         $13.8933     09/30/06    1,191,135    3,018,571
                            MNR        6,563        (6)         $25.0505     07/01/06      103,394      262,021
                                     -------                                           ----------- ------------
                            Total    179,276                                             1,626,557    4,122,020

Barry L. Smith(5)........   CHI       68,182        (6)         $14.5095     07/01/06      622,154    1,576,668
                            MNR            0        --               --           --           --           --
                                     -------                                           ----------- ------------
                            Total     68,182                                               622,154    1,576,668

Thomas Mirgon(5).........   CHI       40,000        (6)         $ 15.625     02/25/07      393,060      996,088
                            MNR            0        --               --           --           --           --
                                     -------                                           ----------- ------------
                            Total     40,000                                               393,060      996,088

Rodney Sibley(5).........   CHI       81,818        (6)         $14.5095     07/01/06      746,581    1,891,992
                            MNR            0        --               --           --           --           --
                                     -------                                           ----------- ------------
                            Total     81,818                                               746,581    1,891,992
--------
 *  References to "CHI" are to Choice and "MNR" are to Manor Care.
(1) Options granted to Messrs. Bainum, Jr., MacCutcheon, Smith and Sibley were
    granted prior to the Manor Care Spin-off and were thus granted as options
    to purchase Manor Care Common Stock. In connection with the Manor Care
    Spin-off, these options to purchase Manor Care Common Stock were
    converted, in some cases 100%, and in some cases partially to options to
    purchase Choice Common Stock. In all cases, however, the exercise prices
    were adjusted to maintain the same financial value to the option holder
    before and after the Manor Care Spin-off. The number of options set forth
    in the table represent the number of Choice and Manor Care options and the
    adjusted exercise prices after the conversion.
(2) The dollar amounts under these columns are the result of calculations at
    the 5% and 10% rates set by the Securities and Exchange Commission and
    therefore are not intended to forecast future possible appreciation, if
    any, of the stock price. Since options are granted at market price, a zero
    percent gain in the stock price will result in no realizable value to the
    optionees.
(3) A 5% per year appreciation in stock price from $13.8933 per share yields
    $22.6307, from $14.5095 per share yields $23.6344, from $14.625 per share
    yields $23.8226, from $25.0505 per share yields $40.8046, and from $15.625
    per share yields $25.4515.
(4) A 10% per year appreciation in stock price from $13.8933 per share yields
    $36.0356, from $14.5095 per share yields $37.6339, from $14.625 per share
    yields $37.9335, from $25.0505 per share yields $64.9745, and from $15.625
    per share yields $40.5272.
(5) The options granted to the officers vest at the rate of 20% per year on
    the first through the fifth anniversaries of the date of the stock option
    grant.
(6) Information with respect to the total options granted to all Manor Care
    employees is unavailable. With respect to the Company, the only options
    granted by Choice during the fiscal year were the grants to Messrs. Floyd
    and Mirgon as identified in the table and grants aggregating 25,000
    options to purchase Choice Common Stock to two additional new employees.
    All other options to purchase Choice Common Stock issued to employees were
    issued as a result of the conversion of Manor Care options in the Manor
    Care Spin-off.
 
                                      53
AGGREGATE OPTION EXERCISES IN FISCAL 1997
                         AND YEAR-END OPTION VALUES(1)
VALUE OF UNEXERCISED
                                                           NUMBER OF UNEXERCISED          IN-THE-MONEY
                                    SHARES                OPTIONS AS MAY 31, 1997  OPTIONS AT MAY 31, 1997(2)
                                  ACQUIRED ON   VALUE    ------------------------- -----------------------------
          NAME           COMPANY*  EXERCISE#  REALIZED$  EXERCISABLE UNEXERCISABLE EXERCISABLE    UNEXERCISABLE
          ----           -------- ----------- ---------- ----------- ------------- -------------  --------------
Stewart Bainum, Jr......   CHI      465,000   $3,105,452   239,000      221,000       $2,758,324      $1,334,863
                           MNR      293,791    2,318,180   174,000      221,000        3,633,404       2,749,771

William R. Floyd........   CHI          --           --          0      307,693              --          346,154
                           MNR          --           --          0            0              --              --

James A. MacCutcheon....   CHI          --           --    162,639      335,408        1,858,096       1,708,638
                           MNR          --           --     91,362       46,563        1,962,041         704,946
 
Barry L. Smith..........   CHI       39,537      156,324     9,815      166,336          117,676       1,000,544
                           MNR          --           --          0            0              --              --

Thomas Mirgon...........   CHI          --           --          0       40,000              --            5,000
                           MNR          --           --          0            0

Rodney Sibley...........   CHI          --           --     13,633       81,818          108,466         101,495
                           MNR          --           --          0            0              --              --
--------
*   References to "CHI" are to Choice and "MNR" are to Manor Care.
(1) Options granted to Messrs. Bainum, Jr., MacCutcheon, Smith and Sibley were
    granted prior to the Manor Care Spin-off and were thus granted as options
    to purchase Manor Care Common Stock. In connection with the Manor Care
    Spin-off, these options to purchase Manor Care Common Stock, were
    converted, in some cases 100%, to options to purchase Choice Common Stock.
    In all cases, however, the exercise prices were adjusted to maintain the
    same financial value to the option holder before and after the Manor Care
    Spin-off. The number of options set forth in the table represent the
    number of Choice and Manor Care options and the adjusted exercise prices
    after the conversion.
(2) The closing prices of Choice Common Stock and Manor Care Common Stock as
    reported by the New York Stock Exchange on May 30, 1997 were $15.75, and
    $28.625, respectively. The value is calculated on the basis of the
    difference between the option exercise price and such closing price
    multiplied by the number of shares of Choice Common Stock or Manor Care
    Common Stock underlying the option.
 
EMPLOYMENT AGREEMENTS
 
  Effective upon the Distribution Date, Franchising is expected to enter into
an employment agreement with Stewart Bainum, Jr., providing for Mr. Bainum,
Jr.'s employment as Chairman of the Board of Franchising. The agreement will
have a term of three years. Either Franchising or Mr. Bainum may terminate the
agreement upon 30 days' prior written notice on the first and second
anniversary dates of the agreement. The agreement will provide that Mr.
Bainum, Jr. will devote 12.5% of his professional time to the affairs of
Franchising, 12.5% of his professional time to the affairs of Choice and the
remaining 75% of his professional time to the affairs of Manor Care. The
agreement provides for a base salary of $82,044 per annum for services to
Franchising and a maximum bonus of 60% of Mr. Bainum, Jr.'s base compensation
based upon the performance of Franchising.
 
  Effective upon the Distribution Date, Franchising is expected to assume an
employment agreement between Choice and William R. Floyd. The agreement has a
term of five years from October 21, 1996 and provides for a base salary of
$425,000 per annum, subject to annual adjustments and an annual bonus of up to
60% of his base compensation, based on performance (including a customer
satisfaction component). Pursuant to the employment agreement, Choice granted
to Mr. Floyd 85,470 shares of restricted Choice Common Stock and options to
purchase 307,693 shares of Choice Common Stock, of which 34,188 of the options
are incentive stock options granted under the Choice 1997 Long Term Incentive
Plan. The remainder of the options are non-qualified stock options. Upon
assumption of the Employment Agreements by Franchising, such restricted stock
and options will be adjusted and converted into Franchising Common Stock and
options. See "Relationship Between
 
                                      54
Choice and Franchising after the Distribution--Employee Benefits Allocation
Agreement." Mr. Floyd's employment agreement further provides that, with
respect to Mr. Floyd's participation in the Choice Hotels International, Inc.
Supplemental Executive Retirement Plan (the "SERP"), (i) Mr. Floyd's normal
retirement age will be 62 and (ii) no minimum years of services for benefit
eligibility will be applicable.
 
  Effective upon the Distribution Date, Franchising is expected to assume an
employment agreement between Choice and Mr. MacCutcheon. The agreement has a
term of five years from November 1, 1996 and provides for a base salary of
$313,576 per annum, subject to annual adjustments and an annual bonus of up to
55% of his base compensation, based on Choice's performance (including a
customer satisfaction component).
 
  Effective upon the Distribution Date, Franchising is expected to assume an
employment agreement between Choice and Thomas Mirgon. The agreement has a
term of five years from March 3,1997 and provides for a base salary of
$230,000 per annum, subject to annual adjustments and an annual bonus of up to
50% of his base compensation, based on the Franchising's performance. The
agreement also provides for (i) a one-time cash payment of $50,000, payable in
two equal installments: the first within 30 days of March 3, 1997 and the
second within 30 days of March 3, 1998; and (ii) a grant of 30,000 non-
qualified options and 10,000 incentive stock options.
 
RETIREMENT PLANS
 
  Franchising will adopt the SERP. Participants are selected by the Board of
Directors or any designated committee and must be at the level of Senior Vice
President or above.
 
  Participants in the SERP receive a monthly benefit for life based upon final
average salary and years of service. Final average salary is the average of
the monthly base salary, excluding bonuses or commissions, earned in a 60
month period which produces the highest average out of the 120 months of
employment, prior to the first occurring of the early retirement date or the
normal retirement date. The normal retirement age is 65, and participants must
have a minimum of 15 years of service. Participants may retire at age 60 and
may elect to receive reduced benefits commencing prior to age 65, subject to
Board approval. All of the Named Officers who will be participants are age 55
or younger, so that none of their compensation reported above would be
included in the final average salary calculation. See "--Employment
Agreements" for a discussion of the terms applicable to Mr. Floyd's
participation in the SERP.
 
  Assuming that the following officers continue to be employed by Franchising
until they reach age 65, their credited years of service would be as follows:
CURRENT YEARS YEARS OF SERVICE
    NAME OF INDIVIDUAL                             OF SERVICE      AT AGE 65
    ------------------                            ------------- ----------------
Stewart Bainum, Jr.,..........................     22.5             38
   James A. MacCutcheon..........................        9             30
   Thomas Mirgon.................................        0             24
   Barry L. Smith................................        7             18
55
The table below sets forth estimated annual benefits payable upon retirement
to persons in specified compensation and years of service classifications.
These benefits are straight life annuity amounts, although participants have
the option of selecting a joint and 50% survivor annuity or ten-year certain
payments. The benefits are not subject to offset for social security and other
amounts.
 
                          YEARS OF SERVICE/BENEFIT AS
                      PERCENTAGE OF FINAL AVERAGE SALARY
25 OR
   REMUNERATION                                        15/15%  20/22.5% MORE/30%
   ------------                                        ------- -------- --------
$300,000........................................... $45,000 $ 67,500 $ 90,000
    350,000...........................................  52,500   78,750  105,000
    400,000...........................................  60,000   90,000  120,000
    450,000...........................................  67,500  101,250  135,000
    500,000...........................................  75,000  112,500  150,000
    600,000...........................................  90,000  135,000  180,000
It is expected that upon the Distribution, Franchising will establish the
Choice Hotels Franchising, Inc. Retirement Savings and Investment Plan (the
"Franchising 401(k) Plan"). The Franchising 401(k) Plan will be a defined
contribution retirement, savings and investment plan qualified under Section
401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), and will
include a cash or deferred arrangement under Section 401(k) of the Code. All
employees age 21 or over and who have worked for Franchising (or Choice) for a
twelve month period during which such employee completed at least 1,000 hours
will be eligible to participate. Subject to certain non-discrimination
requirements, each employee will be able to contribute an amount to the
Franchising 401(k) Plan on a pre-tax basis up to 15% of the employee's salary,
but not more than the current federal limit of $9,500. Franchising will match
contributions made by its employees subject to certain limitations. The amount
of the match will be equal to a percentage of the amount of salary reduction
contribution made on behalf of a participant during the plan year based upon a
formula that involves the profits of Franchising (or, prior to the
Distribution, Choice) for the year and the number of years of service of the
participant. Amounts contributed by Choice pursuant to its 401(k) Plan for the
Franchising Named Officers are included in the Summary Compensation Table
under the column headed "All Other Compensation."
 
  It is expected that upon the Distribution, Franchising will adopt the Choice
Hotels Franchising, Inc. Non-Qualified Retirement Savings and Investment Plan
("Franchising Non-Qualified Savings Plan"). Certain select highly compensated
members of management of Franchising will be eligible to participate in the
Franchising Non-Qualified Savings Plan. The Franchising Non-Qualified Savings
Plan is structured so as to provide the participants with a pre-tax savings
vehicle to the extent that pre-tax savings are limited under the 401(k) Plan
as a result of various governmental regulations, such as non-discrimination
testing. Amounts contributed by Choice under its Non-Qualified Savings Plan
for fiscal year 1997 for the Franchising Named Officers are included in the
Summary Compensation Table under the column headed "All Other Compensation."
 
  The Franchising match under the Franchising 401(k) Plan and the Franchising
Non-Qualified Savings Plan will be limited to a maximum aggregate of 6% of the
annual salary of a participant. Likewise, participant contributions under the
two plans will not exceed the aggregate of 15% of the annual salary of a
participant.
 
  For a discussion of the Franchising Incentive Plan and Franchising Stock
Purchase Plans, see "Franchising Benefit Plans."
 
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  Upon consummation of the Distribution, certain management employees of
Franchising and of Choice will hold options to purchase shares of Choice
Common Stock. See "Relationship Between Choice and Franchising After the
Distribution--Employee Benefits Allocation Agreement."
 
                                      56
For a discussion of certain contracts to be executed between Choice and
Franchising as of the Distribution Date, see "Relationship Between Choice and
Franchising After the Distribution." For a discussion of the historical
financial relationship between Choice and Franchising, see "--Management's
Discussion and Analysis of Financial Condition and Results of Operation--
Liquidity and Capital Resources."
 
SECURITY OWNERSHIP
 
  The following table sets forth the amount of Franchising Common Stock
expected to be beneficially owned by (i) each director and director nominee of
Franchising, (ii) the chief executive officer of Franchising and the other
Franchising Named Officers, (iii) all officers and directors of Franchising as
a group and (iv) all persons who are expected to own beneficially more than 5%
of Franchising Common Stock, based on Choice Common Stock beneficially owned
by such persons on the Annual Meeting Record Date. Unless otherwise specified,
the address for each of them is 10750 Columbia Pike, Silver Spring, Maryland
20901. On the Distribution Date, the holders of Choice Common Stock as of the
Distribution Record Date will be entitled to receive one share of Franchising
Common Stock for each share of Choice Common Stock. For purposes of the
following table, it is assumed that all options to purchase shares of Choice
Common Stock held by the persons specified will be converted into options to
purchase Franchising Common Stock. For a discussion of the treatment of
outstanding options to purchase Choice Common Stock in connection with the
Distribution, see "Relationship Between Choice and Franchising After the
Distribution--Employee Benefits Allocation Agreement."
TOTAL SHARES OF     PERCENT OF SHARES
                                 CHOICE COMMON STOCK      OUTSTANDING
                                   EXPECTED TO BE        EXPECTED TO BE
    NAME OF BENEFICIAL OWNER     BENEFICIALLY OWNED  BENEFICIALLY OWNED (1)
    ------------------------     ------------------- ----------------------
Stewart Bainum, Jr..............     16,003,408(2)           26.58%
Stewart Bainum..................     10,325,997(3)           17.15%
Barbara Bainum..................      5,520,867(4)            9.17%
William R. Floyd................         85,570(5)               *
Robert C. Hazard, Jr............         40,756(6)               *
James A. MacCutcheon............        181,910(7)               *
Frederic V. Malek...............          5,510(8)               *
Thomas Mirgon...................              0                  *
Gerald W. Petitt................         86,281(9)               *
James H. Rempe..................         67,527(10)              *
Jerry E. Robertson, Ph.D........         20,824(11)              *
Barry L. Smith..................        244,292(12)              *
Rodney Sibley...................         38,234(13)              *
All Directors and Officers as a
 Group (15 persons).............     21,592,499(14)          35.87%
Bruce Bainum....................      5,512,302(15)           9.16%
Ronald Baron....................     15,790,713(16)          26.23%
--------
*    Less than 1% of class.
 (1) Percentages are based on 60,200,784 shares outstanding on August 5, 1997
     (the "Annual Meeting Record Date") plus, for each person, the shares
     which would be issued assuming that such person exercises all options it
     holds which are exercisable on such date or become exercisable within 60
     days thereafter.
 (2) Includes 549,152 shares owned directly by the Stewart Bainum, Jr.
     Declaration of Trust dated March 13, 1996, the sole trustee and
     beneficiary of which is the reporting person. Also includes 5,417,761
     shares owned by Bainum Associates Limited Partnership ("Bainum
     Associates") and 4,415,250 shares owned by MC Investments Limited
     Partnership ("MC Investments"), in both of which Mr. Bainum, Jr. is
     managing general partner with the sole right to dispose of the shares;
     3,567,869 shares held directly by Realty Investment Company, Inc.
     ("Realty"), a real estate management and investment company in which Mr.
     Bainum, Jr. has shared voting authority; 1,779,628 shares owned by Mid
     Pines Associates Limited Partnership ("Mid Pines"), in which Mr. Bainum,
     Jr. is managing general partner and has shared voting
 
                                      57
authority and 10,600 shares owned by the Foundation for Maryland's Future,
     in which Mr. Bainum, Jr. is the sole director. Also includes 263,000
     shares which Mr. Bainum, Jr. has the right to acquire pursuant to stock
     options which are presently exercisable or which become exercisable within
     60 days after the Annual Meeting Record Date, and 148 shares which Mr.
     Bainum, Jr. has the right to receive upon termination of his employment
     with Choice pursuant to the terms of the Choice Hotels International, Inc.
     Non-Qualified Retirement Savings and Investment Plan ("Non- Qualified
     Savings Plan").
 (3) Includes 3,906,278 shares held directly by the Stewart Bainum Declaration
     of Trust, of which Mr. Bainum is the sole trustee and beneficiary, his
     joint interest in 895,466 shares owned by Bainum Associates and 1,082,857
     shares owned by MC Investments, each of which is a limited partnership in
     which Mr. Bainum has joint ownership with his wife as a limited partner
     and as such has the right to acquire at any time a number of shares equal
     in value to the liquidation preference of their limited partnership
     interests; 3,567,869 shares held directly by Realty, in which Mr. Bainum
     and his wife have shared voting authority; and 70,305 shares held by the
     Commonweal Foundation of which Mr. Bainum is Chairman of the Board of
     Directors and has shared voting authority. Also includes 798,711 shares
     held by the Jane L. Bainum Declaration of Trust, the sole trustee and
     beneficiary of which is Mr. Bainum's wife, and 1,667 shares which Mr.
     Bainum has the right to acquire pursuant to stock options which are
     presently exercisable or which become exercisable within 60 days after
     the Annual Meeting Record Date. Also includes 2,844 shares of restricted
     stock granted by the issuer to Mr. Bainum which are not vested but which
     Mr. Bainum has the right to vote.
 (4) Includes 101,013 shares owned directly by Ms. Bainum. Also includes
     1,779,628 shares owned by Mid Pines, in which Ms. Bainum's trust is a
     general partner and has shared voting authority, 3,567,869 shares owned
     by Realty, in which Ms. Bainum's trust has voting stock and shares voting
     authority and 70,305 shares owned by the Commonweal Foundation, in which
     Ms. Bainum is President and Director and has shared voting authority.
     Also includes 2,052 shares of restricted stock issued to Ms. Bainum under
     the Choice Hotels International, Inc. Non-Employee Director Stock
     Compensation Plan (the "Non-Employee Director Stock Compensation Plan")
     which shares are not vested, but which Ms. Bainum has the right to vote.
 (5) Consists of restricted shares granted pursuant to Mr. Floyd's employment
     agreement which are not yet vested, but which Mr. Floyd has the right to
     vote.
 (6) Includes 37,304 shares owned directly by Mr. Hazard; 2,844 restricted
     shares granted under the Non-Employee Director Stock Compensation Plan,
     which are not yet vested, but which Mr. Hazard has the right to vote, and
     113 shares and 415 shares, respectively, which Mr. Hazard has the right
     to receive upon termination of his employment pursuant to the terms of
     the Choice Hotels International, Inc. Retirement Savings and Investment
     Plan ("401(k) Plan") and Non-Qualified Savings Plan.
 (7) Includes 180,311 shares which Mr. MacCutcheon has the right to acquire
     pursuant to stock options which are presently exercisable or exercisable
     within 60 days of the Annual Meeting Record Date and 664 and 935 shares,
     respectively, which Mr. MacCutcheon has the right to receive upon
     termination of his employment with Choice pursuant to the terms of the
     401(k) Plan and Non-Qualified Savings Plan.
 (8) Includes 1,666 shares which Mr. Malek has the right to acquire pursuant
     to stock options which are presently exercisable and 2,844 restricted
     shares granted under the Non-Employer Director Stock Compensation Plan
     which are not vested, but which Mr. Malek has the right to vote.
 (9) Includes 74,776 shares held directly by Mr. Petitt and 8,661 shares held
     in trust for minor children for which Mr. Petitt is trustee. Beneficial
     ownership of such shares is disclaimed. Also includes 2,844 restricted
     shares granted under the Non-Employee Director Stock Compensation Plan
     which are not yet vested, but which Mr. Petitt has the right to vote.
(10) Includes 59,624 shares which Mr. Rempe has the right to acquire pursuant
     to stock options which are presently exercisable or exercisable within 60
     days of the Annual Meeting Record Date.
(11) Includes 15,500 shares owned by the JJ Robertson Limited Partnership, of
     which Mr. Robertson and his wife are the general partners with shared
     voting authority and 2,844 restricted shares granted under the Non-
     Employee Director Stock Compensation Plan which are not yet vested, but
     which Mr. Robertson has the right to vote. Also includes 1,666 shares
     which Mr. Robertson has the right to acquire pursuant to stock options
     which are presently exercisable and 814 shares acquired pursuant to the
     Choice Hotels International, Inc. Non-Employee Director Stock Option and
     Deferred Compensation Stock Purchase Plan.
 
                                      58
(12) Includes 243,483 shares which Mr. Smith has the right to acquire pursuant
     to stock options which are presently exercisable or exercisable within 60
     days of the Annual Meeting Record Date and 254 shares and 555 shares,
     respectively, which Mr. Smith has the right to receive upon termination
     of his employment pursuant to the terms of the 401(k) Plan and the Non-
     Qualified Savings Plan.
(13) Includes 5,800 shares held directly by Mr. Sibley, 29,996 shares which
     Mr. Sibley has the right to acquire pursuant to stock options which are
     presently exercisable or exercisable within 60 days of the Annual Meeting
     Record Date, and 963 and 1,475 shares, respectively, which Mr. Sibley has
     the right to receive upon termination of his employment pursuant to the
     terms of the 401(k) Plan and Nonqualified Savings Plan.
(14) Includes a total of 721,789 shares which the officers and directors
     included in the group have the right to acquire pursuant to stock options
     which are presently exercisable, or exercisable within 60 days of the
     Annual Meeting Record Date, and a total of 1,994 shares and 3,528 shares,
     respectively, which such directors and officers have the right to receive
     upon termination of their employment with Choice pursuant to the terms of
     the 401(k) Plan and the Non-Qualified Savings Plan.
(15) Includes 94,500 shares owned directly by Mr. Bainum. Also includes
     1,779,628 shares owned by Mid Pines, in which Mr. Bainum is a general
     partner and has shared voting authority, 3,568,869 shares owned by Realty
     in which Mr. Bainum's trust has voting stock and shares voting authority
     and 70,305 shares owned by the Commonwealth Foundation, in which Mr.
     Bainum is a Director and has shared voting authority. Mr. Bainum's
     address is 8737 Colesville Road, Suite 800, Silver Spring, Maryland,
     20910.
(16) As of July 31, 1997 based on a Schedule 13-D, as amended, filed by Mr.
     Baron with the Securities and Exchange Commission (the "Commission"). Mr.
     Baron's address is 450 Park Avenue, Suite 2800, New York, New York 10022.
 
DESCRIPTION OF FRANCHISING CAPITAL STOCK
 
  Under the Restated Certificate of Incorporation of Franchising (the
"Franchising Certificate"), which is attached as Annex A to this Prospectus,
the total number of shares of capital stock that Franchising has authority to
issue is 165,000,000, consisting of 160,000,000 shares of common stock, par
value $.01 per share, and 5,000,000 shares of preferred stock (the "Preferred
Stock"), par value $.01 per share.
 
  Based on the number of shares of Choice Common Stock outstanding on the
Annual Meeting Record Date, it is expected that approximately 60,200,784
shares of Franchising Common Stock will be issued to stockholders of Choice in
the Distribution. All of the shares Franchising Common Stock to be distributed
to Choice stockholders in the Distribution and to Manor Care Employees upon
exercise of the Franchising Options will be fully paid and non-assessable.
 
 Common Stock
 
  The Franchising Certificate authorizes common stock consisting of
160,000,000 shares. Holders of Franchising Common Stock are entitled to
receive, subject to preferences that may be applicable from time to time with
respect to any outstanding Preferred Stock, such dividends as are declared by
the Board of Directors of Franchising, one vote for each share at all meetings
of stockholders, and, subject to preferences that may be applicable from time
to time with respect to any outstanding Preferred Stock, the remaining assets
of Franchising upon liquidation, dissolution or winding up of Franchising.
Franchising may issue additional shares of common stock without further
stockholder approval, up to the maximum authorized number of shares, except as
may be otherwise required by applicable law or stock exchange regulations.
 
  Shares of common stock may be issued from time to time in one or more
classes or series. With respect to the issuance of common shares of any class
or series, the Board of Directors of Franchising is authorized to determine,
without any further action by the holders of Franchising's Common Stock, among
other things, the dividend rights, dividend rate, conversion rights, voting
rights and rights and terms of redemption, as well as the number of shares
constituting such class or series. Should the Board of Directors of
Franchising elect to exercise its authority, the rights and privileges of
holders of Franchising's Common Stock could be made subject to rights
 
                                      59
and privileges of any such other series of common stock. Choice has no present
plans to issue any common stock of a class or series other than Franchising's
Common Stock.
 
  See "Post-Distribution Dividend Policy" for a description of the dividend
policy of Franchising after the Distribution.
 
 Preferred Stock
 
  Franchising's Board of Directors is authorized to issue up to 5,000,000
shares of Preferred Stock without further stockholder approval (except as may
be required by applicable law or stock exchange regulations) and to fix from
time to time, by resolution or resolutions, the relative powers, preferences
and rights and the qualifications, limitations or restrictions of any class or
series of Preferred Stock, as well as the number of shares constituting such
class or series and the designation thereof.
 
 Preemptive Rights
 
  Holders of shares of Franchising Common Stock have no preemptive rights.
 
PURPOSES AND ANTITAKEOVER EFFECTS OF CERTAIN PROVISIONS OF THE FRANCHISING
CERTIFICATE AND BYLAWS
 
  Prior to the Distribution Date, the Franchising Certificate and the Bylaws
of Franchising (the "Franchising Bylaws") will be amended by Choice as sole
stockholder of Franchising to make the Franchising Certificate and the
Franchising Bylaws substantially similar to Choice Certificate and Choice
Bylaws as currently in effect. Such amendment to the Franchising Certificate
and Franchising Bylaws may have an antitakeover effect with respect to
Franchising, deter an offer with a substantial premium to the then-current
trading price of Franchising Common Stock or hinder a potential transaction
that may be attractive to stockholders.
 
 Franchising Certificate and Bylaws
 
  The Franchising Certificate contains several provisions that will make
difficult an acquisition of control of Franchising, by means of a tender
offer, open market purchase, a proxy fight or otherwise, that is not approved
by the Franchising Board of Directors. The Franchising Bylaws also contain
provisions that could have an antitakeover effect.
 
  The purposes of the relevant provisions of the Franchising Certificate and
the Franchising Bylaws are to discourage certain types of transactions,
described below, which may involve an actual or threatened change of control
of Franchising and to encourage persons seeking to acquire control of
Franchising to consult first with the Board of Directors to negotiate the
terms of any proposed business combination or offer. The provisions are
designed to reduce the vulnerability of Franchising to an unsolicited proposal
for a takeover that does not contemplate the acquisition of all outstanding
shares or is otherwise unfair to stockholders of Franchising or an unsolicited
proposal for the restructuring or sale of all or part of Franchising. Choice
and Franchising believe that, as a general rule, such proposals would not be
in the best interests of Franchising and its stockholders.
 
  There has been a history of the accumulation of substantial stock positions
in public companies by third parties as a prelude to proposing a takeover or a
restructuring or sale of all or part of the company or another similar
extraordinary corporate action. Such actions are often undertaken by the
third-party without advance notice to, or consultation with, the management or
board of directors of the target company. In many cases, the purchaser seeks
representation on the company's board of directors in order to increase the
likelihood that its proposal will be implemented by the target company. If the
company resists the efforts of the purchaser to obtain representation on the
company's board, the purchaser may commence a proxy contest to have its
nominees elected to the board in place of certain directors or the entire
board. In some cases, the purchaser may not truly be interested in taking over
the company, but may use the threat of a proxy fight and/or a bid to take over
the company as a means of forcing the company to repurchase its equity
position at a substantial premium over market price.
 
                                      60
Choice and Franchising believe that the imminent threat of removal of
Franchising's management or Board of Directors in such situations would
severely curtail the ability of management or the board of directors to
negotiate effectively with such purchasers. The management or the Franchising
Board of Directors would be deprived of the time and information necessary to
evaluate the takeover proposal, to study alternative proposals and to help
ensure that the best price is obtained in any transaction involving
Franchising which may ultimately be undertaken. If the real purpose of a
takeover bid were to force Franchising to repurchase an accumulated stock
interest at a premium price, management or the Board of Directors would face
the risk that, if it did not repurchase the purchaser's stock interest,
Franchising's business and Franchising's management would be disrupted,
perhaps irreparably.
 
  Certain provisions of the Franchising Certificate and Bylaws, in the view of
Choice and Franchising, will help ensure that the Franchising Board of
Directors, if confronted by a surprise proposal from a third-party which has
acquired a block of stock, will have sufficient time to review the proposal
and appropriate alternatives to the proposal and to act in what it believes to
be the best interests of the stockholders. In addition, certain other
provisions of the Franchising Certificate are designed to prevent a purchaser
from utilizing two-tier pricing and similar inequitable tactics in the event
of an attempt to take over Franchising.
 
  These provisions, individually and collectively, will make difficult and may
discourage a merger, tender offer or proxy fight, even if such transaction or
occurrence may be favorable to the interests of the stockholders, and may
delay or frustrate the assumption of control by a holder of a large block of
Franchising Common Stock and the removal of incumbent management, even if such
removal might be beneficial to the stockholders. Furthermore, these provisions
may deter or could be utilized to frustrate a future takeover attempt which is
not approved by the incumbent Board of Directors, but which the holders of a
majority of the Franchising Common Stock may deem to be in their best
interests or in which stockholders may receive a substantial premium for their
stock over prevailing market prices of such stock. By discouraging takeover
attempts, these provisions may have the incidental effect of inhibiting
certain changes in management (some or all of the members of which might be
replaced in the course of a change of control) and also the temporary
fluctuations in the market price of the stock which often result from actual
or rumored takeover attempts.
 
  Set forth below is a description of all such material provisions in the
Franchising Certificate and Bylaws. Such description is intended as a summary
only and is qualified in its entirety by reference to the Franchising
Certificate and Bylaws, the forms of which are attached to this Prospectus as
Annexes A and B, respectively.
 
  Classified Board of Directors. The Franchising Certificate provides for the
Franchising Board of Directors to be divided into three classes serving
staggered terms so that directors' initial terms will expire either at the
1998, 1999 or 2000 annual meeting of stockholders. Starting with the 1998
annual meeting of Franchising stockholders, one class of directors will be
elected each year for three-year terms. See "--Management--Board of
Directors."
 
  The classification of directors will have the effect of making it more
difficult for stockholders to change the composition of the Franchising Board
of Directors in a relatively short period of time. At least two annual
meetings of stockholders, instead of one, will generally be required to effect
a change in a majority of the Franchising Board of Directors. Such a delay may
help ensure that the Franchising Board of Directors, if confronted by a holder
attempting to force a stock repurchase at a premium above market prices, a
proxy contest or an extraordinary corporate transaction, will have sufficient
time to review the proposal and appropriate alternatives to the proposal and
to act in what it believes are the best interests of the stockholders.
 
  The classified board provision could have the effect of discouraging a
third-party from making a tender offer or otherwise attempting to obtain
control of Franchising, even though such an attempt might be beneficial to
Franchising and its stockholders. The classified board provision could thus
increase the likelihood that incumbent directors will retain their positions.
In addition, since the classified board provision is designed to discourage
accumulations of large blocks of Franchising stock by purchasers whose
objective is to have such stock repurchased by Franchising at a premium, the
classified board provision could tend to reduce the temporary
 
                                      61
fluctuations in the market price of Franchising's stock that could be caused
by accumulations of large blocks of such stock. Accordingly, stockholders
could be deprived of certain opportunities to sell their stock at a
temporarily higher market price.
 
  Choice and Franchising believe that a classified board of directors will
help to assure the continuity and stability of the Franchising Board of
Directors and Franchising's business strategies and policies as determined by
the Board of Directors, because generally a majority of the directors at any
given time will have had prior experience as directors of Franchising. The
classified board provision will also help assure that the Franchising Board of
Directors, if confronted with an unsolicited proposal from a third-party that
has acquired a block of the voting stock of Franchising, will have sufficient
time to review the proposal and appropriate alternatives and to seek the best
available result for all stockholders.
 
  Removal; Filling Vacancies. The Franchising Certificate provides that only a
majority of the Board of Directors then in office shall have the authority to
fill any vacancies on the Board of Directors, including vacancies created by
an increase in the number of directors. In addition, the Franchising
Certificate provides that a new director elected to fill a vacancy on the
Board of Directors will serve for the remainder of the full term of his or her
class and that no decrease in the number of directors shall shorten the term
of an incumbent. These provisions relating to removal and filling of vacancies
on the Board of Directors will preclude stockholders from enlarging the Board
of Directors or removing incumbent directors and filling the vacancies with
their own nominees.
 
  Limitations on Stockholder Action By Written Consent; Special Meetings. The
Franchising Certificate and Bylaws provide that stockholder action can be
taken only at an annual or special meeting of stockholders and prohibit
stockholder action by written consent in lieu of a meeting. The Franchising
Certificate and Bylaws provide that special meetings of stockholders can be
called only by the Chairman or Vice Chairman of Franchising's Board of
Directors or by the Secretary of Franchising within 10 calendar days after
receipt of the written request of a majority of the total number of directors
Franchising would have if there were no vacancies. Stockholders are not
permitted to call a special meeting or to require that the Board of Directors
call a special meeting of stockholders. Moreover, the business permitted to be
conducted at any special meeting of stockholders is limited to the business
brought before the meeting by or at the direction of the Board of Directors.
 
  The provisions of the Franchising Certificate and Bylaws restricting
stockholder action by written consent may have the effect of delaying
consideration of a stockholder proposal until the next annual meeting unless a
special meeting is called by a majority of the entire Board of Directors.
These provisions would also prevent the holders of a majority of the voting
power of the voting stock from using the written consent procedure to take
stockholder action and from taking action by consent without giving all the
stockholders of Franchising entitled to vote on a proposed action the
opportunity to participate in determining such proposed action. Moreover, a
stockholder could not force stockholder consideration of a proposal over the
opposition of the Franchising Board of Directors by calling a special meeting
of stockholders prior to the time the Board of Directors believed such
consideration to be appropriate.
 
  Choice and Franchising believe that such limitations on stockholder action
will help to assure the continuity and stability of the Franchising Board of
Directors and Franchising's business strategies and policies as determined by
the Board of Directors, to the benefit of all of Franchising's stockholders.
If confronted with an unsolicited proposal from stockholders of Franchising,
the Board of Directors will have sufficient time to review such proposal and
to seek the best available result for all stockholders, before such proposal
is approved by such stockholders by written consent in lieu of a meeting or
through a special meeting of stockholders.
 
  Nominations of Directors and Stockholder Proposals. The Franchising Bylaws
establish an advance notice procedure with regard to the nomination other than
by or at the direction of the Board of Directors of candidates for election as
directors and with regard to stockholder proposals to be brought before an
annual meeting of stockholders. Specifically, Franchising's Bylaws require
that stockholders desiring to bring any business, including nominations for
directors, before an annual meeting of stockholders deliver advance written
notice
 
                                      62
thereof to the Secretary of Franchising. The Bylaws further require that the
notice by the stockholder set forth a description of the business to be
brought before the meeting and information concerning the stockholder
proposing such business and the beneficial owner, if any, on whose behalf the
proposal is made, including their names and addresses, the class and number of
shares of Franchising that are owned beneficially and of record by each of
them, and any material interest of either of them in the business proposed to
be brought before the meeting.
 
  The purpose of the advance notice provision is to provide the Franchising
Board of Directors the opportunity to inform stockholders, prior to an annual
meeting of stockholders, of any business propose to be conducted at such
meeting (including any recommendation as to the Board's position with respect
to any action to be taken). In the case of the advance notice nomination
procedures, the Franchising Board of Directors is afforded a meaningful
opportunity to consider and inform directors and stockholders of the
qualifications of the proposed nominees.
 
  Although the Franchising Bylaws do not give the Board of Directors any power
to approve or disapprove stockholder nominations for the election of directors
or any other proposal submitted by stockholders, the Franchising Bylaws may
have the effect of precluding a nomination for the election of directors or
precluding the conducting of business at a particular stockholder meeting if
the proper procedures are not followed, and may discourage or deter a third-
party from conducting a solicitation of proxies to elect its own slate of
directors or otherwise attempting to obtain control of Franchising, even if
the conduct of such solicitation or such attempt might be beneficial to
Franchising and its stockholders.
 
  Supermajority Vote for Business Combinations. The affirmative vote of
holders of shares representing not less than two-thirds of the voting power of
the Franchising is required for the approval of any proposal to merge or
consolidate with any other entity (other than an entity 90% owned by
Franchising) or sell, lease or exchange all or substantially all of
Franchising's assets. Likewise, the Franchising Certificate and Bylaws provide
that any change or repeal of this provision requires the same vote of shares
representing two-thirds of the voting power of Franchising. Although an
effective impediment to unwanted takeovers, these provisions may also make
desired alliances with other business more difficult and time consuming to
implement.
 
  Issuance of Preferred Stock. The Franchising Board of Directors is
authorized to issue up to 5,000,000 shares of preferred stock without
stockholder approval and to fix by resolution the relative powers, preferences
and rights and the qualifications, limitations or restrictions of any class or
series of preferred stock. Such action by the Franchising Board of Directors
could effectively dilute the voting power of any potential suitor of
Franchising, making a takeover substantially more difficult.
 
LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS
 
  Elimination of Liability in Certain Circumstances. Pursuant to authority
conferred by Delaware General Corporation Law Section 102, the Franchising
Certificate provides that no director of Franchising shall be liable to
Franchising or its stockholders for monetary damages for breach of fiduciary
duty as a director except for breach of the director's duty of loyalty to
Franchising or the stockholders, for acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, for
unlawful payment of dividends, unlawful stock redemptions or repurchases and
for any transaction from which the director derived an improper personal
benefit. This provision is intended to eliminate the risk that a director
might incur personal liability to Franchising or its stockholders for breach
of the duty of care. The Franchising Certificate also provides that if
Delaware law is amended to further limit the liability of directors, then the
liability of a director of Franchising shall be further limited to the fullest
extent permitted by Delaware law as so amended.
 
  Indemnification and Insurance. Delaware General Corporation Law Section 145
contains provisions permitting and, in some situations, requiring Delaware
corporations, such as Franchising, to provide indemnification to their
officers and directors for losses and litigation expense incurred in
connection with their service to the corporation in those capacities. The
Restated Certificate contains provisions requiring
 
                                      63
indemnification by Franchising of its directors and officers to the fullest
extent permitted by law. Among other things, the Franchising Certificate
provides indemnification for officers and directors against liabilities for
judgments in and settlements of lawsuits and other proceedings and for the
advancement and payment of fees and expenses reasonably incurred by the
director or officer in defense of any such lawsuit or proceeding.
 
                                       64
CERTAIN INFORMATION CONCERNING SUNBURST
 
PRO FORMA FINANCIAL DATA
 
  The following unaudited pro forma combined statement of income illustrates
the estimated effects on Sunburst of the Distribution and related
transactions. The pro forma balance sheet is based on the May 31, 1997 balance
sheet of Choice and assumes that the Distribution was consummated on that
date. The pro forma income statement is based on the income statement of
Choice for the fiscal year ended May 31, 1997, and assumes that the
Distribution was consummated on June 1, 1996. The pro forma financial data are
provided for informational purposes only and do not purport to be indicative
of the results that actually would have been obtained if the Distribution and
related transactions had been effected on the dates indicated or of those
results that may be obtained in the future.
 
                       SUNBURST HOSPITALITY CORPORATION
 
                  PRO FORMA CONDENSED COMBINED BALANCE SHEET
                              AS OF MAY 31, 1997
CHOICE HOTELS     DISTRIBUTION  PRO FORMA
                                  INTERNATIONAL, INC. ADJUSTMENTS(A) SUNBURST
                                  ------------------- -------------- ---------
ASSETS
Current Assets
  Cash and cash equivalents......      $  10,825        $   (4,167)  $   6,658
  Receivables (net of allowance
   for doubtful accounts)........         31,981           (24,472)      7,509
  Deferred taxes receivable......          1,219               --        1,219
  Other current assets...........         10,579            (5,676)      4,903
                                       ---------        ----------   ---------
    Total current assets.........         54,604           (34,315)     20,289
Property and equipment, at cost,
 net of accumulated
 depreciation....................        370,244           (43,377)    326,867
Lodging franchise rights, net of
 accumulated amortization........         50,503           (50,503)        --
Goodwill, net of accumulated
 amortization....................         69,939           (69,939)        --
  Other long term assets.........         29,044           (23,339)      5,705
                                       ---------        ----------   ---------
                                       $ 574,334        $ (221,473)  $ 352,861
                                       =========        ==========   =========
     LIABILITIES AND EQUITY
Current liabilities
  Current portion of mortgages
   and long-term debt............      $  27,955        $      (36)  $  27,919
  Accounts payable...............         42,489           (20,412)     22,077
  Accrued expenses...............         26,932           (10,965)     15,967
  Income tax payable.............          3,318            (3,318)        --
                                       ---------        ----------   ---------
    Total current liabilities....        100,694           (34,731)     65,963
                                       ---------        ----------   ---------
Mortgages and other long-term
 debt............................        228,325           (46,427)    181,898
Notes payable to Manor Care......        115,723           (78,700)     37,023
Deferred income taxes and other
 liabilities.....................          5,105            (4,422)        683
Equity...........................        124,487           (57,193)     67,294
                                       ---------        ----------   ---------
                                       $ 574,334        $ (221,473)  $ 352,861
                                       =========        ==========   =========
65
SUNBURST HOSPITALITY CORPORATION
 
               PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
                    FOR THE FISCAL YEAR ENDED MAY 31, 1997
CHOICE HOTELS     DISTRIBUTION     OTHER       PRO FORMA
                         INTERNATIONAL, INC. ADJUSTMENTS(A) ADJUSTMENTS    SUNBURST
                         ------------------- -------------- -----------    ---------
REVENUES
  Franchise.............      $244,176         $(254,518)    $ 10,342 (B)  $    --
  Hotel operations......       185,753           (17,737)         --        168,016
                              --------         ---------     --------      --------
    Total revenues......       429,929          (272,255)      10,342       168,016
                              --------         ---------     --------      --------
OPERATING EXPENSES
  Franchise.............       183,769          (183,769)         --            --
  Hotel operations......       148,250           (18,124)      10,342 (B)   140,468
                                   --                --         3,955 (C)     3,955
                              --------         ---------     --------      --------
    Total operating
     expenses...........       332,019          (201,893)      14,297       144,423
                              --------         ---------     --------      --------
INCOME BEFORE OTHER
 EXPENSES AND INCOME
 TAXES..................        97,910           (70,362)      (3,955)(C)    23,593
OTHER EXPENSES
  Interest expense on
   Notes payable to
   Manor Care...........        18,568            (7,083)      (8,815)(D)     2,670
  Other interest and
   other expenses, net..         7,118            (3,704)       8,309 (D)    11,723
                              --------         ---------     --------      --------
    Total other
     expenses...........        25,686           (10,787)        (506)       14,393
                              --------         ---------     --------      --------
Income before income
 taxes..................        72,224           (59,575)      (3,449)        9,200
                              --------         ---------     --------      --------
Income taxes............       (30,200)           24,845        1,380 (E)    (3,975)
                              --------         ---------     --------      --------
Net income before
 extraordinary item.....      $ 42,024         $ (34,730)    $ (2,069)     $  5,225
                              ========         =========     ========      ========
Pro forma earnings per
 share..................                                                        .25(F)
                                                                           ========
SUNBURST
 
          NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS
 
A. Represents adjustment to reflect the Distribution.
 
B. Represents the adjustment to record franchise fee revenue, franchise fee
   expense, and intercompany product sales on Sunburst-owned hotels previously
   eliminated in consolidation.
 
C. Represents the net additional costs associated with staffing of accounting,
   finance, cash management, risk management, human resources and legal
   personnel and directors' costs to operate Sunburst on a stand alone basis.
 
D. Represents incremental interest expense in deferred financing amortization
   relating to Sunburst's refinancing of $110 million of notes payable to
   Manor Care with $117.5 million of commercial backed mortgage securities in
   April 1997.
 
E. Represents the income tax impact of pro forma adjustments at statutory
   rates.
 
F. Represents pro forma earnings per share based on pro forma Sunburst Net
   Income divided by the pro forma weighted average share of Choice of 62,680
   adjusted for the proposed one-for-three stock split.
 
 
                                      66
MANAGEMENT'S DISCUSSION AND ANALYSIS OF SUNBURST PRO FORMA FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
  Sunburst is a leading national hotel company with a portfolio of 71 hotels
containing 10,330 rooms located in 25 states as of May 31, 1997. Each hotel is
branded with one of the Choice franchise brands.
 
  Sunburst's strategy is to (i) optimize the operating performance and value
of its existing portfolio of hotels through the consistent application of high
quality sales, marketing and operating programs; (ii) capitalize on the under-
served, high growth, mid-priced, extended-stay all-suite segment with the
development of 20 MainStay Suite hotels; (iii) develop other high quality,
consumer focused hotels such as Sleep Inns; and (iv) pursue the opportunistic
acquisition of existing hotels whereby substantial value can be created.
 
  The following discussion should be read in conjunction with the preceding
Pro Forma Condensed Combined Balance Sheet and the Pro Forma Condensed
Combined Statement of Income.
 
 Comparison of Fiscal Year 1997 Pro Forma Operating Results and Pro Forma
 Fiscal Year 1996 Operating Results
 
  Sunburst's hotel operations revenue consists principally of guest room
revenue, meeting room revenue and food-and-beverage revenue from owned and
operated hotels. The pro forma revenues for Sunburst are derived from Choice's
audited financial statements as follows:
FISCAL YEAR 1997 FISCAL YEAR 1996
                                              ---------------- ----------------
                                               (IN MILLIONS)    (IN MILLIONS)
Choice reported hotel operations
    revenue.................................      $185,753         $154,625
   Less: European hotel operations revenue..       (17,737)         (19,609)
                                                  --------         --------
   Total Sunburst pro-forma hotel operations
    revenue.................................      $168,016         $135,016
                                                  ========         ========
Sunburst's revenues were $168.0 million for fiscal year 1997, up 24.4% from
$135.0 million for fiscal year 1996. The increases in revenue were primarily
the result of additional rooms achieved through hotel acquisitions and the
construction of new hotels. Overall average daily room rates increased 6.5%
from fiscal year 1996 to fiscal year 1997, and occupancy increased 3.2% over
the corresponding period. Revenue per available room, or RevPAR, increased to
$40.96 from $37.28, an improvement of 9.9%. Increases in food-and-beverage
sales of $2.2 million in fiscal year 1997 also contributed to revenue growth.
 
  Sunburst's hotel operating expenses are derived from Choice's audited
financial statements as follows:
FISCAL YEAR 1997 FISCAL YEAR 1996
                                              ---------------- ----------------
                                               (IN MILLIONS)    (IN MILLIONS)
Choice reported hotel operations
    expense.................................      $127,599         $116,481
   Less: European hotel operations expense..       (16,166)         (17,521)
   Add: Franchise fees paid to Franchising..        10,342            7,500
     Pro-forma "spin-off" costs.............         3,955            3,955
     Allocable depreciation and
      amortization..........................        18,693           14,223
                                                  --------         --------
   Total Sunburst pro-forma hotel operations
    expense.................................      $144,423         $124,638
                                                  ========         ========
Hotel operations expenses increased $19.8 million or 15.9% in fiscal year
1997 resulting primarily from the addition of six hotels during the year and
to a lesser extent a $1.3 million increase in food-and-beverage costs. Pro
forma fiscal year 1996 expense excludes an $8.6 million one time charge for
restructuring costs associated with the Manor Care Spin-off. The increase in
franchise fees paid to Franchising results from the increase in hotel
operations revenue. Franchise fees paid are determined based on total revenues
multiplied by franchise fee rates. These rates vary based on the type of hotel
franchised. Depreciation expense increased 31.4% in fiscal
 
                                      67
year 1997 as a result of the addition of new hotels and renovations of
existing hotel properties during fiscal years 1997 and 1996.
 
  Hotel operating margins (before depreciation and amortization) increased to
25.2% in fiscal year 1997 from 18.2% in fiscal year 1996 due primarily to a
9.9% increase in RevPAR.
 
 Other Expenses
 
  Interest expense for Choice increased $2.3 million or 9.6% in fiscal year
1997 as a result of increased borrowings to support the stock repurchase
program. Pro forma interest expense for Sunburst was $15.3 million in fiscal
year 1997, an increase of $2.9 million from pro forma interest expense of
$12.4 million in fiscal year 1996. The increase in interest expense relates to
additional borrowings under Choice's credit facility for stock repurchases.
Certain amounts related to the incremental borrowings incurred to finance the
stock repurchase program have been allocated to Sunburst. See "--Liquidity and
Capital Resources."
 
 Liquidity and Capital Resources
 
  Sunburst is currently considering options, including entering into a new
credit facility, to secure long-term financing to meet the debt requirements
in fiscal 1998 as well as working capital and business development needs. See
"Financing." Management expects to have adequate financing secured prior to
the distribution date to finance Choice's near-term financing requirements and
development objectives.
 
  On a pro-forma basis, Sunburst has $246.8 million of long-term debt, $27.9
million of which is payable in fiscal year 1998. Pro-forma earnings before
interest, taxes, depreciation and amortization and non-cash asset writedowns
("EBITDA") was $43.2 million in fiscal year 1997. This represents an increase
of 75.6% from the $24.6 million of pro-forma EBITDA in fiscal year 1996.
EBITDA, while not a term defined by generally accepted accounting principles,
is often used by investors and other users of financial statements, to
determine Sunburst's ability to meet debt service, fund capital expenditures
and expand its business. Cash expenditures (including nondiscretionary
expenditures) for various long-term assets, interest expense and income taxes
have been and will be incurred which are not reflected in EBITDA and therefore
EBITDA does not represent funds available for Sunburst's discretionary use.
 
  On April 23, 1997, Choice, through its indirect subsidiary, First Choice
Properties, completed an offering of $117.5 million multi-class mortgage pass-
through certificates, which are non-recourse and collateralized by 36 hotel
properties with a net book value of $146.7 million owned by Choice. The
certificates bear a 7.8% interest rate, and have a final maturity of May 5,
2012. Choice used the proceeds to repay $110.0 million of the $225.7 million
9% long-term note payable to Manor Care. The mortgage pass-through
certificates have been allocated to Sunburst and are reflected on the
accompanying pro-forma balance sheet of Sunburst.
 
  On October 30, 1996, Choice entered into a $100.0 million competitive
advance and multi-currency revolving credit facility provided by a group of
seven banks. This facility provides that up to $75.0 million is available for
borrowings in foreign currencies. On May 5, 1997, Choice increased the size of
this facility from $100.0 million to $125.0 million. Borrowings under the
additional $25.0 million are due on December 31, 1997, and accordingly $25
million is classified as current on Choice's consolidated balance sheet.
Choice has $121.6 million drawn at May 31, 1997 under the facility. Sunburst
has been allocated $90.5 million of this bank debt.
 
  Total pro-forma capital expenditures for Sunburst were $79.7 million in
fiscal year 1997 versus $96.6 million in fiscal year 1996. The number of hotel
properties brought on-line in fiscal year 1997 was six versus 17 in fiscal
year 1996. Choice plans capital expenditures for development of Sleep Inn and
MainStay Suites hotels of $69.0 million and $32.0 million in fiscal years 1998
and 1999, respectively. These amounts include expected capital expenditures
relating to the construction of seven Sleep Inn hotels and 19 MainStay Suites
hotels over the next two fiscal years. Planned capital expenditures for
routine maintenance and renovation of existing properties are $13.5 million
and $14.4 million for fiscal years 1998 and 1999, respectively. Sunburst's
management will also pursue additional acquisitions of significantly under-
valued hotel properties.
 
                                      68
BUSINESS AND PROPERTIES
 
  Sunburst will operate the Hotel Business as previously operated by Choice.
 
  Sunburst will be a leading national hotel company with a portfolio of 71
hotels containing 10,330 rooms located in 25 States as of May 31, 1997. Each
hotel is branded with one of the Choice franchise brands and Sunburst will be
Franchising's largest franchisee. Sunburst's hotels operate in one of three
principal segments of the lodging industry: all-suite, full service and
limited service. The majority of Sunburst's hotels have been acquired by
Choice since 1992 at prices below their replacement cost. All of these hotels
have benefited from the investment of capital to improve the renovated hotels.
Since June 1992, Choice has spent $260.4 million to buy and renovate 54 hotel
properties. More recently, Choice shifted its development efforts to the
construction of Sleep Inn hotels and MainStay Suite hotels.
 
  Sunburst's strategy is to: (i) optimize the operating performance and value
of its existing portfolio of hotels through the consistent application of high
quality sales, marketing and operating programs; (ii) capitalize on the under-
served, high growth, mid-priced, extended-stay all-suite segment with the
development of 20 MainStay Suite hotels; (iii) develop other high quality,
consumer focused hotels such as Sleep Inns; and (iv) pursue the opportunistic
acquisition of existing hotels whereby substantial value can be created.
 
  Choice's performance is a beneficiary of the operating leverage inherent in
the lodging industry and is further supported by the substantial discount to
replacement cost of its existing portfolio. The 54 hotels acquired since 1992
have an investment basis of approximately 55.3% of current estimated
replacement cost. In addition to the initial renovation of acquired hotels,
Sunburst has spent approximately 5% of revenue for ongoing improvements to the
hotels, thereby maintaining the physical assets to optimize competitive
advantages in each local market.
 
  Sunburst's strategy to build 20 MainStay Suites hotels is intended to
provide it with hotels positioned to benefit from the demand/supply imbalance
in the mid-priced, extended stay all-suite segment which should produce higher
than average return on investment.
 
  Sunburst's historical existing hotel acquisition program and the current
MainStay Suite hotel development program are illustrative of management's
capabilities to timely ascertain market trends, conceive of strategies and to
implement those strategies.
 
 Historical Acquisition Strategy
 
  The primary focus of Sunburst from 1992 through 1995 was the acquisition of
existing hotels at prices below their replacement cost with the intent to
increase their value through (i) the investment of capital to improve the
hotels and (ii) the installation of professional management and marketing
teams to operate the renovated hotels. Since June 1992, Sunburst has spent
$260.4 million to buy and renovate 54 hotels containing 7,809 rooms. In fiscal
year 1997, Sunburst acquired two hotels and is in the process of renovating
them, one of which (located in Charlotte, NC) Sunburst is in the process of
converting to a Clarion Hotel from a senior assisted living facility.
 
  In addition to the acquired hotels, Sunburst owns and operates 8 hotels
developed or acquired prior to 1992, 7 Sleep Inn hotels and 1 MainStay Suites
hotel developed by Sunburst since 1994.
SUNBURST EXISTING HOTEL ACQUISITIONS
                                       ---------------------------------------
                                                     FISCAL YEAR
                                       ---------------------------------------
                                        1993    1994    1995    1996    1996
                                       ------- ------- ------- ------- -------
Total acquisitions....................       7      13      16      16       2
Total number of rooms acquired........   1,276   1,933   2,336   1,940     324
Total cost of acquisitions (in
 millions) (including initial
 improvements)........................ $  30.9 $  55.8 $  83.3 $  71.8 $  17.9
Average cost per room................. $24,216 $28,867 $35,659 $37,010 $55,246
69
Net operating income for the seven hotels purchased in fiscal year 1993
increased from $8.0 million in fiscal 1996 to $9.4 million in fiscal 1997, a
17% improvement. For the 13 hotels purchased in fiscal year 1994, net
operating income increased 14.4% to $11.5 million in fiscal year 1997 from
$10.0 million in fiscal year 1996. Net operating income for the 16 hotels
acquired in fiscal year 1995 was $12.8 million in fiscal year 1996, a 91%
increase over the $6.7 million achieved in fiscal year 1996. The following
chart summarizes occupancy improvements for original portfolio hotels, and
fiscal 1993, 1994, 1995, 1996 and 1997 acquisitions. Occupancy rates for the
year acquired reflect only the period during which the properties were owned
by Choice. Because many of the recently acquired and developed hotels have not
yet reached stabilized levels of operating performance, Choice believes that
revenues and gross profit at these hotels will continue to grow.
SUNBURST HOTELS OCCUPANCY
                                              ---------------------------------
                                                       FISCAL YEAR
                                              ---------------------------------
                                              1993   1994   1995   1996   1997
                                              -----  -----  -----  -----  -----
Original Domestic Portfolio.................. 62.27% 64.16% 67.19% 68.02% 71.63%
Fiscal 1993 Acquisitions..................... 56.17  63.20  73.68  76.17  75.02
Fiscal 1994 Acquisitions.....................   --   66.09  70.71  73.76  73.68
Fiscal 1995 Acquisitions.....................   --     --   48.96  58.49  66.27
Fiscal 1996 Acquisitions.....................   --     --     --   53.23  61.16
Fiscal 1997 Acquisitions.....................   --     --     --     --   54.65
The Hotel Properties
 
  Sunburst's hotel properties serve three primary segments of the lodging
industry; all-suites, full service and limited service. Each hotel, except for
one hotel in Miami Beach which is under physical renovation, is branded with
one of the Choice franchise flags.
 
  All-Suites Hotels. Sunburst has 6 hotels in the all-suite segment open and
13 hotels under construction or in the development process. Sunburst's all-
suite hotel properties compete in the moderate and upscale price segments. The
table below identifies Sunburst's all-suite hotels by brand and price segment.
 
                               ALL-SUITE HOTELS
NUMBER    NUMBER    PRICE
BRAND                                               OF HOTELS OF ROOMS  SEGMENT
-----                                               --------- -------- ---------
Quality Suites.....................................      3      345      upscale
Comfort Suites.....................................      2      232    mid-price
MainStay Suites....................................      1       96    mid-price
As of May 31, 1997, Sunburst had an additional 10 MainStay Suites hotels
under construction with 970 rooms.
 
  Full-Service Hotels. Sunburst has 16 hotels in the full service segment.
Sunburst's full service hotels compete in the mid-price and upscale price
segments. The table below identifies Sunburst's full service hotels by brand
and price segment.
 
                              FULL SERVICE HOTELS
NUMBER    NUMBER       PRICE
                    BRAND                     OF HOTELS OF ROOMS     SEGMENT
                    -----                     --------- -------- ---------------
Clarion Hotels & Inns........................     11     2,114   upper mid-price
Quality Hotel & Inns.........................      5     1,327         mid-price
70
Limited Service Hotels. Sunburst has 49 hotels in the limited service
segment open and six hotels under construction or in the development process.
Sunburst's limited service hotel properties compete in the mid-price and
economy price segments. The table below identifies Sunburst's limited service
hotels by brand and price segment.
 
                            LIMITED SERVICE HOTELS
NUMBER    NUMBER    PRICE
                       BRAND                        OF HOTELS OF ROOMS  SEGMENT
                       -----                        --------- -------- ---------
Comfort Inn........................................     31     4,074   mid-price
Quality Inns.......................................      8     1,014   mid-price
Sleep Inns.........................................      7       757   mid-price
Econo Lodge........................................      1       120     economy
Rodeway Inns.......................................      1       101     economy
Independent........................................      1       150     economy
As of May 31, 1997, Sunburst had an additional 4 Sleep Inns under
construction with 453 rooms.
 
 External Development
 
  Sunburst's focus on external development is geared to (i) capitalize on the
under-served, high-growth, mid-priced extended stay all-suite segment, and
(ii) the development of other high-quality, consumer-focused hotels.
 
  To effect these strategies, Sunburst maintains a Real Estate Development and
Construction Department staff. This staff effects the identification of target
markets, specific site identification, negotiation, due diligence, planning,
zoning and other approval requirements, design and construction of new hotels.
The Real Estate Development staff have served in the past as the focal point
to effect Sunburst's historical acquisition strategy. This dual capacity to
acquire existing hotels or build new hotels allows Sunburst to be responsive
to changing market conditions.
 
  The following is a list of the new hotels developed by Sunburst since 1994
or currently under development:
CALENDAR
                        MARKET                           HOTEL   YEAR OF OPENING
                        ------                          -------- ---------------
Dallas/Plano, TX....................................... Sleep         1994
San Antonio, TX........................................ Sleep         1995
Baton Rouge, LA........................................ Sleep         1996
Houston/Airport, TX.................................... Sleep         1996
Austin/Round Rock, TX.................................. Sleep         1996
Dallas/Plano, TX....................................... MainStay      1996
Raleigh, NC............................................ Sleep         1997
Dallas/Arlington, TX................................... Sleep         1997
Kansas City/Airport, MO(1)............................. Sleep         1997
Charlotte, NC(1)....................................... Sleep         1997
Rockville, MD(1)....................................... Sleep         1997
Providence/Airport, RI(1).............................. MainStay      1997
Cincinnati/Blue Ash, OH(1)............................. MainStay      1997
Kansas City/Airport, MO(1)............................. MainStay      1997
Indianapolis, IN(1).................................... MainStay      1997
Louisville, KY(1)...................................... MainStay      1997
Denver/Tech Center, CO(1).............................. MainStay      1998
Orlando/Lake Mary, FL(1)............................... MainStay      1998
Jacksonville, FL(1).................................... MainStay      1998
71
CALENDAR
                        MARKET                           HOTEL   YEAR OF OPENING
                        ------                          -------- ---------------
Greenville, SC(1)...................................... MainStay      1998
Nashville/Brentwood, TN(1)............................. MainStay      1998
Miami/Airport, FL(2)................................... MainStay      1998
Denver/Airport, CO(1).................................. Sleep         1998
Miami/Airport, FL(2)................................... Sleep         1998
Ft. Lauderdale/Cypress Creek, FL(2).................... MainStay      1998
Pittsburgh/Airport, PA(2).............................. MainStay      1998
Fishkill/Poughkeepsie, NY(2)........................... MainStay      1998
--------
(1) Hotel under construction
(2) Sunburst has acquired the land and is in final planning stages prior to
    start of construction.
 
  Sunburst's focus on the development of MainStay Suites is based on the
sector-wide demand/supply imbalance as evidenced by numerous industry studies.
According to various industry studies, demand for extended stay lodging far
exceeds supply. Demand in the mid-price market is very high, yet supply
additions have been minimal. The extended stay, all-suite segment, defined as
stays of five or more nights, consists of 228 million room nights annually, or
27% of total U.S. industry demand, according to industry sources. Only 1.5% of
total room supply is dedicated extended stay rooms. Sunburst believes that it
can utilize its real estate development expertise to locate attractive markets
for and build MainStay extended stay hotels. Sunburst also believes that it
can successfully operate these hotels based on its experience operating other
limited services hotels.
 
  MainStay Suites has been created by Choice with a unique product design and
service package which enhances property level appeal, productivity and
profitability. Two of these unique features of the MainStay product are the
use of an automatic check-in kiosk (which allows guests to check in without
assistance) and optional daily light touch housekeeping with full housekeeping
every five days. These features allow a MainStay Suites hotel to operate with
fewer full time equivalent employees than a similar size limited service hotel
that has 24-hour front desk coverage and provides full housekeeping daily.
Sunburst believes that MainStay Suites projects will produce a stabilized
unleveraged pre-tax property level return on investment of 15% or higher. This
return is supported by the experiences at the first MainStay Suites opened by
Sunburst in Plano, Texas and by projections for the MainStay Suites under
development which are based on rate and occupancy generated internally by
Sunburst and by external feasibility consultants, internal operating
guidelines, land cost and projected construction cost. However, there can be
no assurance that the projected return will be achieved or that actual results
will not differ materially. See "Risk Factors--Forward Looking Information is
Subject to Risk and Uncertainty."
 
  Sunburst's initial development of 20 MainStay Suites combined with
Franchising's efforts to franchise MainStay Suites is intended to result in a
brand with national recognition.
 
  Sunburst's MainStay Suites hotel properties will average approximately 100
suites and be developed on 2.5 to 3.0 acres of land in suburban office parks
or locations proximate to major employers, restaurants and retail amenities.
MainStay Suites feature high quality, interior corridor building construction
with amenities and features demanded by consumers. All suites feature a
bedroom area, living room area with a pull-out couch or recliner, private
bathroom and fully furnished kitchen. The kitchen area includes a full-size
refrigerator, dishwasher, microwave, stove, coffee maker, toaster and all
cooking and serving utensils. Each suite features an over-sized counter
serving as an eating or working center, along with two ergonomic chairs. Suite
alternatives include a studio suite or one-bedroom suite. Each suite includes
two direct dial phone lines, voice mail and other automated phone services.
 
  Sunburst and Franchising have developed a state-of-the-art automated check-
in/out property management system which enables guests with reservations to
obtain their key from the kiosk unassisted. This feature allows transaction
time to be shortened and provides operating efficiencies while enhancing guest
satisfaction.
 
                                      72
Based on experience from the first MainStay Suites opened by Sunburst in
Plano, Texas, guest satisfaction is very high. Financial results to-date have
met or exceeded Sunburst's expectations.
 
 Operations
 
  Each of Sunburst's owned and managed hotels operates under one of the Choice
brand names. The following table illustrates the growth of Sunburst over the
four fiscal years ended May 31, 1997.
FISCAL YEAR
                                        --------------------------------------
                                         1993    1994    1995    1996    1997
                                        ------  ------  ------  ------  ------
Number of properties, end of period....     19      32      48      65      71
Number of rooms, end of period.........  3,686   5,605   7,941   9,713  10,330
Average occupancy percentage...........  61.36%  64.18%  67.10%  66.61%  68.70%
Average daily room rate (ADR).......... $49.53  $49.15  $51.28  $55.97  $59.62
RevPAR................................. $30.39  $31.54  $34.40  $37.28  $40.96
Operating Systems and Procedures. Sunburst's hotels take advantage of the
same systems and services available to franchisees with respect to a
particular brand. The hotels participate in the central reservation system,
marketing and advertising efforts and volume purchasing discounts and are
subject to the same quality assurance program. In addition, Sunburst has
instituted the following systems in each of the hotels it operates.
 
  .  Yield Management. An automated yield management program has been
     installed at hotels which allows the local management to take advantage
     of the supply and demand conditions in their marketplace. The system is
     automated to the point that it performs calculations and suggests
     pricing strategies to the local hotel management. The program continues
     to update information based on the availability of room supply and
     reservation volume within each hotel.
 
  .  Training. Sunburst has developed a training system for all guest
     services representatives that teaches the basic sales techniques. A
     computerized guest comment system was developed to solicit the comments
     of guests and the experiences they had at the hotel while providing
     management with immediate guest feedback.
 
  .  Accounting Systems. Each of the Sunburst-operated hotels has a
     computerized front desk and accounting system. This system allows key
     financial indicators (such as daily occupancy and revenue) to be
     immediately gathered from each hotel and electronically transmitted to
     the key operating officers and managers of Sunburst. This instant access
     to information allows management to quickly spot trends and make
     corrections and changes where necessary. The system is completely
     computerized and allows for cost savings in the accounting and
     bookkeeping departments of each hotel. In addition, control over
     operational and capital expenditures is provided by a dedicated group of
     financial controllers in the corporate office. This group works with the
     hotel operations group to maintain expense standards as well as
     established operating procedures.
 
  .  Time and Attendance System. Each hotel maintains an automated time and
     attendance system that is tied into a central payroll system at the
     corporate headquarters. This computerized method of tracking time allows
     management to make quick decisions on controlling labor costs and
     provides immediate information on projected costs.
 
  .  Food and Beverage. The food and beverage efforts are headed by a vice
     president of food and beverage. The department is responsible for the
     daily food and beverage activities of the various hotels, as well as the
     development of new food concepts. This group was responsible for the
     development, testing and implementation of the Choice Picks food court
     concept. Recently, Sunburst opened a new food and beverage concept
     called "Classic Sports Food, Drink and Memories" in its Richardson,
     Texas hotel. A sports theme restaurant, this concept has been developed
     jointly with the Classic Sports Network, a national cable television
     service. This agreement allows for the use of certain trademarks at
     Sunburst's locations. Additional "Classic Sports Food, Drink and
     Memories" are planned for three other Sunburst hotels.
 
                                      73
.  Annual Business Planning Process. Each hotel prepares a zero-based
     annual business plan which incorporates historical performance and
     market conditions. The plan, which is reviewed and approved by senior
     management, provides detailed strategies in the key operating areas of
     marketing, guest services and food and beverage. The plan also includes
     a comprehensive capital expenditures process which serves to maintain
     the physical plant in optimal condition based on market conditions and
     operating strategies. The annual plan serves as a fundamental
     measurement of management's performance.
 
 Properties
 
  The following chart lists by market segment Sunburst's hotels at May 31,
1997:
YEAR
                                                                   CONSTRUCTED/
                                                            NO. OF  LAST MAJOR
    HOTEL                               MARKET              ROOMS   RENOVATION
    -----                               ------              ------ ------------
ALL SUITE
  Upscale
  Quality Suites
   Deerfield.............. Fort Lauderdale, Florida          107    1991/1995
  Quality Suites.......... Raleigh, North Carolina           114    1988/1994
  Quality Suites Shady
   Grove.................. Rockville, Maryland               124    1978/1996
  Mid-Price
  Comfort Suites
   Haverhill.............. Boston, Massachusetts             131    1989/1997
  Comfort Suites
   Deerfield.............. Fort Lauderdale, Florida          101    1991/1995
  MainStay Suites
   Plano(6)............... Dallas, Texas                      96         1996
  MainStay Suites
   Warwick(1)............. Providence, Rhode Island           94         1997
  MainStay Suites Blue
   Ash(1)................. Cincinnati, Ohio                  100         1997
  MainStay Suites
   Airport(1)............. Kansas City, Missouri              88         1998
  MainStay Suites
   Northwest(1)........... Indianapolis, Indiana              88         1997
  MainStay Suites(1)...... Louisville, Kentucky              100         1998
  MainStay Suites Tech
   Center(1).............. Denver, Colorado                  100         1998
  MainStay Suites Lake
   Mary(1)................ Orlando, Florida                  100         1998
  MainStay Suites South
   Pointe(1).............. Jacksonville, Florida             100         1998
  MainStay Suites(1)...... Greenville, South Carolina        100         1998
  MainStay Suites
   Brentwood(1)........... Nashville, Tennessee              100         1998
FULL SERVICE
  Upscale
  Clarion Hotel
   Baltimore.............. Baltimore, Maryland               103    1927/1996
  Clarion Hotel
   Worthington............ Columbus, Ohio                    232    1975/1996
  Clarion Hotel
   Richardson............. Dallas, Texas                     296    1982/1995
  Clarion on the Lake..... Hot Springs, Arkansas             151    1965/1997
  Clarion Hotel Miami
   Airport................ Miami, Florida                    103    1970/1996
  Clarion Hotel Hollywood
   Beach.................. Miami-Ft. Lauderdale, Florida     309    1972/1996
  Clarion Hotel........... Mobile, Alabama                   250    1979/1994
  Clarion Hotel Virginia
   Beach.................. Norfolk-Virginia Beach, Virginia  149    1985/1995
  Clarion Hotel Roanoke... Roanoke, Virginia                 148    1981/1997
  Clarion Hotel
   Springfield............ Springfield, Missouri             199    1974/1997
  Clarion Hotel(2)........ Charlotte, North Carolina         174    1974/1997
  Mid-Price
  Quality Inn South
   Point.................. Jacksonville, Florida             184    1988/1994
  Quality Hotel Airport... Los Angeles, California           278    1971/1994
  Quality Hotel Maingate
   Anaheim(4)............. Los Angeles, California           284    1970/1995
  Quality Inn & Suites
   Hampton................ Norfolk-Virginia Beach, Virginia  190    1972/1995
  Quality Hotel
   Arlington.............. Washington, DC                    391    1962/1997
74
YEAR
                                                                   CONSTRUCTED/
                                                            NO. OF  LAST MAJOR
    HOTEL                                 MARKET            ROOMS   RENOVATION
    -----                                 ------            ------ ------------
LIMITED SERVICE
  Mid-Price
  Comfort Inn Albuquerque...... Albuquerque, New Mexico      114    1985/1996
  Quality Inn Anderson......... Anderson, South Carolina     121    1988/1995
  Comfort Inn Norcross......... Atlanta, Georgia             110    1987/1996
  Comfort Inn N.W.
   Pikesville(5)............... Baltimore, Maryland          186    1964/1994
  Comfort Inn University....... Baton Rouge, Louisiana       150    1972/1994
  Comfort Inn Danvers(6)....... Boston, Massachusetts        136    1972/1997
  Comfort Inn Brooklyn......... Brooklyn, New York            67    1926/1997
  Comfort Inn Canton........... Canton, Ohio                 124    1989/1994
  Comfort Inn Airport.......... Charleston, South Carolina   122    1986/1994
  Comfort Inn Charlotte(6)..... Charlotte, North Carolina    150    1985/1996
  Quality Inn & Suites--Crown
   Point....................... Charlotte, North Carolina    100    1988/1996
  Comfort Inn.................. Cincinnati, Ohio             117    1984/1996
  Comfort Inn Middleburg
   Heights..................... Cleveland, Ohio              136         1989
  Comfort Inn College Station.. College Station, Texas       114    1984/1995
  Comfort Inn Columbia......... Columbia, South Carolina      98    1987/1996
  Comfort Inn DFW Airport...... Dallas-Fort Worth, Texas     152    1986/1995
  Quality Inn Plymouth......... Detroit, Michigan            123    1989/1996
  Comfort Inn Deerfield Beach.. Fort Lauderdale, Florida      69    1975/1997
  Comfort Inn Hershey.......... Hershey, Pennsylvania        125    1990/1997
  Comfort Inn Hilton Head...... Hilton Head, South Carolina  150    1988/1996
  Quality Inn & Suites
   Indianapolis................ Indianapolis, Indiana        116    1982/1996
  Quality Inn Lincoln.......... Lincoln, Nebraska            108    1969/1996
  Quality Inn & Suites
   Lumberton................... Lumberton, North Carolina    120    1974/1996
  Comfort Inn Collierville..... Memphis, Tennessee            94    1984/1996
  Comfort Inn & Suites, Miami
   Springs..................... Miami, Florida               165    1970/1996
  Comfort Inn Miami Springs.... Miami, Florida               110    1986/1996
  Miami Beach Hotel(3)(6)...... Miami, Florida               150    1952/1997
  Comfort Inn--Lee Road........ Orlando, Florida             145    1985/1994
  Comfort Inn--Turf Paradise... Phoenix, Arizona             155    1981/1995
  Comfort Inn--North........... Phoenix, Arizona             153    1986/1997
  Comfort Inn Portland......... Portland, Maine              126    1984/1996
  Quality Inn Richmond......... Richmond, Virginia           194    1985/1997
  Quality Inn Midvalley........ Salt Lake City, Utah         132    1972/1995
  Comfort Inn by the Bay....... San Francisco, California    135    1971/1996
  Comfort Inn Westport......... St. Louis, Missouri          170    1971/1995
  Comfort Inn Sturgis.......... Sturgis, Michigan             83    1965/1997
  Comfort Inn Traverse City.... Traverse City, Michigan       96    1989/1996
  Comfort Inn Tyson's.......... Washington, D.C              250    1982/1995
  Comfort Inn West Palm Beach.. West Palm Beach, Florida     158    1974/1995
  Comfort Inn Wichita.......... Wichita, Kansas              114    1985/1997
  Sleep Inn Round Rock(6)...... Austin, Texas                107         1996
  Sleep Inn Six Flags(6)....... Dallas-Fort Worth, Texas     124         1997
  Sleep Inn Baton Rouge........ Baton Rouge, Louisiana       101         1996
  Sleep Inn Plano.............. Dallas, Texas                104         1994
  Sleep Inn Intercontinental... Houston, Texas               107         1996
  Econo Lodge Tolleson......... Phoenix, Arizona             120    1988/1997
  Rodeway Inn Tempe............ Phoenix, Arizona             101         1989
75
YEAR
                                                                    CONSTRUCTED/
                                                             NO. OF  LAST MAJOR
    HOTEL                                   MARKET           ROOMS   RENOVATION
    -----                                   ------           ------ ------------
Sleep Inn Raleigh(6)............ Raleigh, North Carolina    107       1996
  Sleep Inn San Antonio........... San Antonio, Texas         107       1995
  Sleep Inn University(1)......... Charlotte, North Carolina  120       1997
  Sleep Inn Airport(1)............ Denver, Colorado           119       1997
  Sleep Inn Airport(1)............ Kansas City, Missouri      107       1998
  Sleep Inn Rockville(1).......... Washington, D.C.           107       1997
--------
(1) Hotel under construction
(2) Hotel closed for renovation
(3) Hotel under renovation
(4) Leased property
(5) Hotel on leased land
(6) Partial year results only
 
  The following chart shows operating statistics for all of Sunburst's owned
and managed hotels presented by market segment for the five fiscal years ended
May 30, 1997.
FY 1993                 FY 1994                 FY 1995
                          ----------------------- ----------------------- -----------------------
                           ADR   OCCUPANCY REVPAR  ADR   OCCUPANCY REVPAR  ADR   OCCUPANCY REVPAR
                          ------ --------- ------ ------ --------- ------ ------ --------- ------
All Suite Hotels........  $   --      --%  $   -- $60.62   71.58%  $43.39 $58.74   61.34%  $36.03
Full Service Hotels.....   54.06   61.42    33.20  54.37   60.74    33.02  54.04   65.43    35.36
Limited Service Hotels..   44.59   61.30    27.34  45.09   66.71    30.08  48.39   69.15    33.46
All Hotels..............   49.53   61.36    30.39  49.15   64.16    31.54  51.28   67.10    34.40
FY 1996                 FY 1997
                                ----------------------- -----------------------
                                 ADR   OCCUPANCY REVPAR  ADR   OCCUPANCY REVPAR
                                ------ --------- ------ ------ --------- ------
All Suite Hotels............... $64.70   69.00%  $44.65 $69.48   72.73%  $50.53
Full Service Hotels............  58.85   65.41    38.49  63.25   67.05    42.41
Limited Service Hotels.........  53.36   67.11    35.81  56.38   69.25    39.04
All Hotels.....................  55.97   66.61    37.28  59.60   68.70    40.94
EMPLOYEES
 
  Assuming the Distribution had occurred on June 30, 1997, Sunburst employed
approximately 3,380 people full-time. Less than 5% of Sunburst's employees are
represented by unions. All of Sunburst's employees covered by collective
bargaining agreements are employed at Comfort Inn by the Bay, San Francisco,
California which has four collective bargaining agreements covering laundry
workers, front desk workers, housekeeping and food service and maintenance
workers. Such agreements expire between August 1997 and December 1997.
Sunburst considers its relations with its employee to be satisfactory.
 
MANAGEMENT
 
 Board of Directors
 
  Immediately prior to the Distribution, five of the nine current members of
Choice's Board of Directors will resign and Donald J. Landry, the Chief
Executive Officer of Sunburst, and Carole Y. Prest are expected to be
appointed to fill two vacancies on the Sunburst Board of Directors.
 
                                      76
At the time of the Distribution, the Sunburst Board of Directors will
consist of up to seven directors. The name, age and proposed class of six of
the persons who are expected to be directors of Sunburst as of the
Distribution Date are set forth below. Choice's Board of Directors will select
a candidate to fill the remaining vacancy on the Sunburst Board of Directors.
The remaining vacancy will be filled by a person who is not a Sunburst
employee or a director or employee of Franchising.
NAME                                                         AGE POSITION
      ----                                                         --- ---------
Stewart Bainum, Jr..........................................  50 Class II
      Stewart Bainum..............................................  78 Class I
      Donald J. Landry............................................  48 Class III
      Frederic V. Malek...........................................  60 Class III
      Paul A. Gould...............................................  50 Class II
      Carole Y. Prest.............................................  46 Class I
Donald J. Landry. President of Choice since January 1995; President of Manor
Care Hotel Division ("MCHD") since March 1992; various executive positions
with Richfield Hotel Management, Inc. and its predecessors for more than 20
years, including President of MHM Corporation; Director, Friendly Hotels PLC,
since 1996.
 
  Paul A. Gould. Managing Director of Allen & Company Incorporated (investment
banking firm) for more than five years and other positions at Allen & Company
Incorporated since 1973. Director: Telecommunication International, Inc.,
United Video Satellite Group, Inc. and National Patent Development
Corporation; Board of Trustees: The New School, The Hackley School and The
Holderness School.
 
  Carole Y. Prest. Vice President, Corporate Strategic Planning of Manor Care
since September 1995; Vice President and General Manager and various other
positions at Gen Rad, Inc. from May 1985 to 1994.
 
  For biographical information with respect to the other persons listed above,
see "Certain Information Concerning Franchising--Management--Background of
Directors."
 
 The Board of Directors and Committees of the Board
 
  It is expected that the Sunburst Board of Directors will hold five meetings
during the fiscal year and will retain the standing committees of the
Company's Board of Directors which will include the Audit Committee, the
Finance Committee, the Compensation/Key Executive Stock Option Plan Committee
and the Nominating Committee.
 
  The Compensation/Key Executive Stock Option Plan Committee administers
Sunburst's stock option plans and grants stock options thereunder, reviews
compensation of officers and key management employees, recommends development
programs for employees such as training, bonus and incentive plans, pensions
and retirement, and reviews other employee fringe benefit programs.
 
  The Finance Committee reviews the financial affairs of Sunburst and
recommends financial objectives, goals and programs to the Board of Directors
and to management.
 
  The Audit Committee reviews the scope and results of the annual audit, will
review and approve the services and related fees of Sunburst's independent
public accountants, review Sunburst's internal accounting controls and review
Sunburst's Internal Audit Department and its activities.
 
  The Nominating Committee recommends to the Board of Directors the members to
serve on the Board of Directors during the ensuing year. The Committee does
not consider nominees recommended by stockholders.
 
                                      77
Compensation of Directors
 
  Choice has previously adopted the Choice Hotels International, Inc. Non-
Employee Director Stock Option and Deferred Compensation Stock Purchase Plan.
Part A of the Plan provides that eligible non-employee directors will be
granted options to purchase 5,000 shares of Sunburst Common Stock on their
first date of election and will be granted options to purchase 1,000 shares on
their date of election in subsequent calendar years. Part B of the Plan
provides that eligible non-employee directors may elect, prior to May 31 of
each year, to defer a minimum of 25% of committee fees earned during the
ensuing fiscal year. The fees which are so deferred will be used to purchase
Sunburst Common Stock on the open market within 15 days after December 1,
February 28 and May 31 of such fiscal year. Pending such purchases, the funds
will be credited to an Interest Deferred Account, which will be interest
bearing. Stock which is so purchased will be deposited in a Stock Deferred
Account pending distribution in accordance with the Plan.
 
  Directors who will be employees of Sunburst will receive no separate
remuneration for their services as directors. Pursuant to the Non-Employee
Director Stock Compensation Plan to be adopted by Sunburst prior to the
Distribution, eligible non-employee directors will receive annually, in lieu
of cash, restricted stock of Sunburst, the fair market value of which at the
time of grant will be equal to $30,000, which will represent the Board of
Directors retainer and meeting fees. In addition, all non-employee directors
will receive $1,610 per diem for Committee meetings attended, except where the
Committee meeting is on the same day as a Board of Directors meeting, and will
be reimbursed for travel expenses and other out-of-pocket costs incurred in
attending meetings.
 
 Executive Officers
 
  The name, age, proposed title upon consummation of the Distribution and
business background of each of the persons who are expected on the
Distribution Date to be the executive officers of Sunburst are set forth
below. Choice is currently seeking candidates for the positions of Senior Vice
President, Chief Financial Officer and Treasurer and Vice President- Finance
and Controller. The business address of each prospective executive officer is
10750 Columbia Pike, Silver Spring, Maryland 20901, unless otherwise
indicated.
NAME                 AGE                       POSITION
  ----                 ---                       --------
Stewart Bainum, Jr....  51 Chairman of the Board of Directors
Donald J. Landry......  48 Vice Chairman and Chief Executive Officer
Antonio DiRico........  44 President and Chief Operating Officer
Kevin P. Hanley.......  39 Senior Vice President, Real Estate and Development
Edward A. Kubis.......  38 Senior Vice President, General Counsel and Secretary
Joseph M. Squeri. Vice President, Finance and Controller of the Company
since March 1997; Director of Investment Funds, The Carlyle Group, from
November 1994 to February 1997; various positions with Arthur Andersen LLP
from July 1987 to November 1994, most recently as Manager.
 
  Antonio DiRico. Senior Vice President, Hotel Operations of the Company since
November 1996; Senior Vice President, Hotel Operations of MCHD from May 1992
to November 1996; Senior Vice President of Richfield Hotel Management, Inc.,
and its predecessor, MHM Corporation; Director, Friendly Hotels PLC, since
1996.
 
  Kevin P. Hanley. Vice President, Real Estate and Development of Choice since
December 1994; Vice President, Real Estate and Development of MCHD from
December 1994 to November 1996; Executive Vice President of Hospitality
Investment Trust from September 1994 to November 1994; Senior Vice President,
Development and Acquisitions of Motel 6, L.P. from May 1992 to September 1994;
various other positions with Motel 6, L.P. since January 1987.
 
  Edward A. Kubis. Senior Vice President and General Counsel of Choice
Management and Realty Services, a division of Choice, since June 1997; Senior
Vice President, General Counsel and Secretary of Choice from
 
                                      78
November 1996 to June 1997; Assistant General Counsel and Assistant Secretary,
Manor Care from December 1993 to November 1996; Senior Attorney, Real Estate,
from December 1990 to December 1993; Staff Attorney, Real Estate from June
1987 to December 1990.
 
  For biographical information with respect to the other persons listed above,
see "Certain Information Concerning Franchising--Management--Background of
Directors; and Certain Information Concerning Sunburst--Management--Background
of Directors."
 
                                      79
AMENDMENTS TO THE CHOICE RESTATED CERTIFICATE
                               OF INCORPORATION
 
  In connection with the Distribution, Choice intends to implement certain
amendments to the Restated Certificate of Incorporation of Choice to (i)
change the name of Choice to Sunburst Hospitality Corporation, (ii) decrease
the number of authorized shares of Choice Common Stock from 160,000,000 to
60,000,000 and (iii) effect a one-for-three reverse stock split of Choice
Common Stock whereby every three shares of Choice Common Stock would be
aggregated into one share of Sunburst Common Stock. Under the DGCL, the
amendments to the Choice Restated Certificate of Incorporation described
herein require the approval of a majority of the outstanding Company Common
Stock, which approval has been obtained.
 
NAME CHANGE
 
  The purpose and principal effect of the proposed amendment to the Restated
Certificate of Incorporation of Choice to change the name of Choice to
Sunburst Hospitality Corporation is to permit Franchising to adopt the name
Choice Hotels International, Inc. after the Distribution, to minimize
confusion to the public and to investors and to reflect that the principal
business of Choice after the Distribution will emphasize the ownership of
hotels and other lodging-related properties. This amendment should not have
any adverse effect on Choice shareholders.
 
REVERSE STOCK SPLIT AND REDUCTION IN NUMBER OF AUTHORIZED SHARES
 
  Purposes of the Reverse Stock Split. In order to enable Sunburst to maintain
an acceptable trading range for Sunburst Common Stock after the Distribution
while also retaining sufficient liquidity for Sunburst Common Stock, Choice
has proposed that, following the Distribution, the Choice Restated Certificate
of Incorporation be amended to effect a one-for-three reverse stock split
pursuant to which each three shares of Choice Common Stock will be exchanged
for one share of Sunburst Common Stock (i.e. common stock of Choice following
the Distribution). As of the Annual Meeting Record Date, Choice had
outstanding 60,200,784 shares of Choice Common Stock (not including shares
issuable upon exercise of options to purchase Choice Common Stock) and had
reserved for issuance under the 1996 Incentive Plan 6,732,307 shares of Choice
Common Stock. After giving effect to the Reverse Stock Split, such numbers
would be 20,054,432 and 2,244,102 respectively.
 
  Purposes of the Reverse Stock Split. The Board of Directors, after
considering the effects of the Distribution on the price per share of Choice
Common Stock, believes that the Reverse Stock Split is advisable and in the
best interests of Choice and its stockholders as a means of enhancing the
liquidity and marketability of Choice Common Stock. The reduction in the
number of issued and outstanding shares of Choice Common Stock as a result of
the Reverse Stock Split is expected to increase the market price of Choice
Common Stock, thereby reducing any negative attributes traditionally
associated with a low per share market price.
 
  A low per share market price often adversely effects the marketability of a
stock. Certain institutional investors have internal policies preventing the
purchase of low-priced stocks and many brokerage houses do not permit low-
priced stock to be used as collateral for margin accounts or to be purchased
on margin. Further, certain brokerage houses have adopted time-consuming
practices and procedures which act to discourage individual brokers from
dealing in low-priced stocks because such practices and procedures make the
handling of low-priced stocks economically unattractive. A low stock price
also has the effect of increasing the amount and percentage of transaction
costs paid by individual investors. Because brokers' commission on low-priced
stocks generally represent a higher percentage of the stock price than
commissions on higher priced stocks, a low stock price can result in
individual stockholders paying transaction costs (commissions, markups or
markdowns) which are a higher percentage of their total share value than would
be the case with stock with a higher share price. The Board of Directors
believes that the expected increase in the share price of Choice Common Stock
resulting from the Reverse Stock Split should reduce the effect of these
negative attributes traditionally associated with a low per share price,
thereby enhancing the acceptability of Choice Common Stock with the financial
community and investing public and resulting in a broader market for Choice
Common Stock than currently exists.
 
                                      80
There can be no assurance that the Reverse Stock Split will increase the
current market price per share, or that any increase in market price of Choice
Common Stock after the Reverse Stock Split will be maintained. The Reverse
Stock Split could result in an increase in the market price for Choice Common
Stock which is proportionately less than the decease in the number of shares
outstanding. Additionally, there can be no assurances that any of the effects
described above will be achieved.
 
  Certain Effects of the Reverse Stock Split. A holder of Choice Common Stock
will be entitled to receive a whole number of shares plus a fraction of a
share if the number of shares of Choice Common Stock held by him prior to the
Reverse Stock Split is not evenly divisable by three. However, no certificate
or scrip representing fractional shares of Choice Common Stock will be issued.
In lieu of fractional shares, the Transfer Agent of the Choice Common Stock on
behalf of all persons otherwise entitled to receive fractional shares
(including individual beneficial owners of shares held by a nominee holder)
will, promptly following the effective time of the Reverse Stock Split,
aggregate such fractional shares and sell the resulting whole shares of Choice
Common Stock for the accounts of those persons in open market transactions on
the NYSE. Those persons will thereafter be entitled to receive their allocable
portion of the net proceeds of the sale thereof upon surrender of their Choice
Common Stock certificates as described below.
 
  The Reverse Stock Split may result in some stockholders owning "odd-lots" of
less than 100 shares of Choice Common Stock. Brokerage commissions and other
costs of transactions in odd-lots are generally higher than the costs of
transactions in "round-lots" of even multiples of 100 shares.
 
  Choice Common Stock is currently registered under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), and as a result, Choice is
subject to the periodic reporting and other requirements of the Exchange Act.
The proposed Reverse Stock Split will not affect the registration of the
Choice Common Stock under the Exchange Act.
 
  Exchange of Stock Certificates. If the Reverse Stock Split is approved as
part of the Distribution Proposals, Choice will, after consummation of the
Distribution, file an amendment to the Choice's Restated Certificate of
Incorporation with the Secretary of State of the State of Delaware. Choice
will notify holders of Choice Common Stock of the effectiveness of the Reverse
Stock Split and will furnish the holders of record of shares of Choice Common
Stock at the close of business on such effective date with a letter of
transmittal for use in exchanging certificates. The holders of Choice Common
Stock will be required to promptly mail their certificates representing shares
of Choice Common Stock to the transfer agent, in order that new certificates
giving effect to the Reverse Stock Split may be issued and the proceeds of any
fractional shares may be distributed. Commencing with the effective date of
the Reverse Stock Split, previously outstanding certificates representing
shares of Choice Common Stock will be deemed for all purposes to represent
one-third of the number of shares previously represented thereby.
 
  Decreased Number of Authorized Shares. Choice has authorized 160,000,000
shares of Choice Common Stock, of which approximately 60,200,784 are issued
and outstanding as of the Annual Meeting Record Date. In connection with the
Reverse Stock Split, the outstanding shares of Choice Common Stock will be
reduced to approximately 20,066,928. To reflect this reduction in the number
of shares outstanding, it is proposed to amend the Choice's Restated
Certificate of Incorporation to decrease the total number of shares of Choice
Common Stock authorized by Choice from 160,000,000 to 60,000,000.
 
                                      81
FRANCHISING BENEFIT PLAN
 
  The Franchising Options to be issued to Manor Care Employees in the manner
set forth herein shall be issued pursuant to the Choice Hotels Franchising,
Inc. 1997 Long-Term Incentive Plan (the "Franchising Incentive Plan"). Set
forth below is a summary of the material terms of the Franchising Incentive
Plan, which is attached hereto as Exhibit C.
 
FRANCHISING INCENTIVE PLAN
 
  General. The continuing growth and development and financial success of
Franchising and its subsidiaries are dependent upon ensuring the best possible
management. The Franchising Board of Directors believes the Franchising
Incentive Plan will be an important aid to Franchising in attracting and
retaining individuals of outstanding abilities and in rewarding them for the
continued profitable performance of Franchising and its subsidiaries.
 
  The types of awards that may be granted under the Franchising Incentive Plan
are restricted shares, incentive stock options, nonqualified stock options,
stock appreciation rights and performance shares. The Franchising Incentive
Plan provides that over the next ten years restricted shares, incentive stock
options, nonqualified stock options, stock appreciation rights, and/or
performance shares involving up to six million shares (subject to adjustment
for stock splits and similar capital changes) of Franchising Common Stock may
be granted. Franchising Common Stock issued under the Franchising Incentive
Plan may be authorized and unissued stock, treasury stock or stock purchased
on the open market (including in private transactions). To the extent that an
award lapses or the rights of a participant to whom it was granted terminate,
any shares of Franchising Common Stock subject to the award will again be
available for awards under the Franchising Incentive Plan.
 
  Administration. The Franchising Incentive Plan provides that it will be
administered by one or more Key Executive Stock Option Plan Committee(s) of
the Board of Directors (the "Committee"), which establishes the conditions of
each grant made under the Franchising Incentive Plan and determines which key
employees will receive awards as well as the type and amount of each award.
 
  Eligibility. Key employees of Franchising and its subsidiaries (including
employees who are members of the Franchising Board of Directors, but excluding
directors who are not employees) who, in the opinion of the Committee, are
mainly responsible for the continued growth and development and financial
success of the business of Franchising or one of its subsidiaries are eligible
to be granted awards under the Franchising Incentive Plan. Subject to the
provisions of the Franchising Incentive Plan, the Committee shall from time to
time select from such eligible persons those to whom awards shall be granted
and determine the number of shares to be granted. Because eligibility is
determined by these subjective criteria, it is not possible at this time to
determine either the number of employees eligible to participate in the
Franchising Incentive Plan or the amount of awards which will be made.
 
  In connection with the Distribution, options to purchase Choice Common Stock
held by Choice employees will be converted into options to purchase
Franchising Common Stock and Sunburst Common Stock. Such converted options to
purchase Franchising Common Stock will be deemed to be governed by the
Franchising Incentive Plan but are not deemed to be issued under the
Franchising Incentive Plan. All of such awards will vest at the rate of twenty
percent per year for the first five years, and expire ten years after the date
of the award.
 
  Restricted Shares. Restricted share awards are shares of Franchising Common
Stock bearing restrictive legends prohibiting their sale, transfer, pledge or
hypothecation until the expiration of a restriction period of not more than
ten years set at the time of grant. In addition or in lieu of a restriction
period, the Committee may establish a performance goal which must be achieved
as a condition to retention of the award. The recipient of an award is
entitled to receive dividends and vote the restricted shares, unless
forfeited.
 
  Stock Options. Options granted under the Franchising Incentive Plan may be
either Incentive Stock Options, as defined in the Internal Revenue Code, as
amended, or options which do not so qualify ("nonqualified
 
                                      82
options"). At the time an option is granted, the Committee determines the
number of shares of Franchising Common Stock subject to each stock option, the
manner and time of exercise, and the vesting schedule. No options granted
under the Franchising Incentive Plan may be exercised more than 10 years after
date of grant; however, Incentive Stock Options granted to a Ten Percent
Shareholder (as defined) may not be exercised more than 5 years after the date
of grant. The option price per share for stock options will be set in the
grant, but will be equal to or greater than the fair market value of a share
of Franchising Common Stock on the date of grant, except with respect to an
Incentive Stock Option granted to a Ten Percent Shareholder (as defined) shall
be at least 110% of the fair market value on the date of grant. The option
exercise price may be paid with cash and/or shares of Franchising Common
Stock. Options will be evidenced by stock option agreements in a form approved
by the Committee and are not transferable except by will or the laws of
descent and distribution. Under the Franchising Incentive Plan, no Covered
Employee (as defined in Section 162(m)(3) of the Internal Revenue Code) may be
granted stock options for more than 100,000 shares during any calendar year.
With respect to Incentive Stock Options granted to any employee, the aggregate
fair market value determined on the date of grant with respect to which any
Incentive Stock Option is first exercisable shall not exceed $100,000.
 
  The granting of an option does not entitle the participant to any dividends,
voting or other rights of a stockholder, unless and until the participant
receives stock upon exercise of the option. The Committee may limit an option
by restricting its exercise in whole or in part for specified periods.
 
  Stock Appreciation Rights. An SAR is the right to receive payment for the
appreciation in value of one share of Franchising Common Stock over a
specified price. An SAR may be granted either in tandem with a stock option
award or independently. If the SAR is granted in tandem with a stock option
award, the payment is measured by the excess of the fair market value of
Franchising Common Stock at the time of exercise over the option price (which
cannot be less than the fair market value of the stock at the time of grant).
If the SAR is granted independent of a stock option, the Committee will
specify whether the award is a "regular" SAR or whether the award is a "book
value" SAR. If the award is a "regular" SAR, the payment is measured by the
excess of the fair market value of the stock at the time of exercise over the
fair market value at the time of grant. If the award is a "book value" SAR,
the payment is measured by the excess of the book value of Franchising Common
Stock at the time of exercise over the book value of Franchising Common Stock
at the time of grant.
 
  Stock appreciation payments, at the election of the participant, may be made
in cash or Franchising Common Stock or a combination of both. The Committee
must approve any election to receive cash.
 
  An SAR issued pursuant to an option cannot be exercised less than six months
after the grant; an SAR issued independently is subject to the terms and
conditions established on grant. SARs are deemed to be exercised on the last
day of the Exercise Period, if not previously exercised, which may not extend
more than ten years beyond the date of grant. The Committee may impose such
restrictions on transferability of SARs as it may determine.
 
  The granting of an SAR does not entitle the participant to any dividend,
voting or other rights of a stockholder, unless and until the participant
receives stock upon the exercise of an SAR. SARs which are not exercisable
immediately upon being granted may be made immediately exercisable upon the
occurrence of retirement or disability, as determined by the Committee in its
sole discretion. Under the Franchising Incentive Plan, no Covered Employee (as
defined in Section 162(m)(3) of the Internal Revenue Code) may be granted more
than 100,000 SARs during any calendar year.
 
  Performance Shares. A performance share award involves the grant of a right
to receive a specified number of shares of Franchising Common Stock upon
satisfaction of certain performance-related objectives specified in the
granting instrument. The performance-related objectives may relate to the
individual, Franchising, a department or a division of Franchising and/or a
group or class of participants. The measuring period used to establish the
performance criteria will be specified by the Committee at the time of grant
and may be subsequently waived or reduced, or the performance criteria may be
adjusted, upon the occurrence of events determined by the Committee in its
sole discretion to justify such waiver, reduction or adjustment. Under the
 
                                      83
Franchising Incentive Plan, no Covered Employee (as defined in Section
162(m)(3) of the Internal Revenue Code) may be granted more than 100,000
Performance Shares during any calendar year.
 
  Retirement or Disability. The Committee may, in its discretion, waive the
forfeiture, termination or lapse of an award in the event of retirement or
disability of the participant.
 
  Income Tax Consequences. The Federal income tax consequences of an award
under the Franchising Incentive Plan depend on the type of award, as discussed
below. The grant of a restricted share award or a performance share award does
not immediately produce taxable income to a recipient or a tax deduction to
Franchising. However, at the time the restrictions expire or the performance
objectives have been achieved, as the case may be, a recipient will recognize
taxable ordinary income in an amount equal to the fair market value of the
stock on the date the restrictions expire or the performance criteria are
achieved and Franchising will be entitled to a corresponding income tax
deduction. In the case of a restricted share award, during the restriction
period, a recipient will be taxed on the dividends received from the
restricted shares as additional compensation, and Franchising will be entitled
to a corresponding compensation deduction.
 
  Generally, a recipient of an incentive stock option will not recognize
taxable income at the time of grant or exercise and Franchising will not be
entitled to an income tax deduction. Provided the minimum holding periods are
satisfied, any gain on a disposition of stock acquired through an incentive
stock option will be taxable to a recipient as long-term capital gain. If the
minimum holding periods are not satisfied, a recipient will recognize ordinary
income in the amount of the excess of the fair market value of the stock on
the date the option is exercised over the option price, and Franchising will
be entitled to a corresponding income tax deduction.
 
  The grant of a nonqualified stock option does not result in taxable income
to a recipient or a tax deduction for Franchising. Upon exercise, a recipient
will recognize taxable ordinary income in an amount equal to the excess of the
fair market value of the stock on the date of exercise over the option price,
and Franchising will be entitled to a corresponding income tax deduction.
 
  A recipient of a stock appreciation right will not recognize taxable income
at the time the right is granted, and Franchising will not be entitled to a
tax deduction. However, ordinary taxable income will be recognized by a
recipient and a corresponding deduction will be taken by Franchising, at the
time of exercise, in an amount equal to the cash and the fair market value of
the stock received.
 
  Amendment and Termination. The Franchising Board of Directors may at any
time and from time to time alter, amend, suspend or terminate the Franchising
Incentive Plan in whole or in part, except (i) any such action affecting
options granted or to be granted under the Franchising Incentive Plan which
are intended to qualify as Incentive Stock Options shall be subject to
stockholder approval to the extent such stockholder approval is required
pursuant to Section 422 of the Internal Revenue Code and (ii) without the
consent of the participant to whom any award has been granted, no such action
may be taken which adversely affects the rights of such participant concerning
such award, except as such termination or amendment of the Franchising
Incentive Plan is required by statute, or rules and regulations promulgated
thereunder.
 
  The Franchising Incentive Plan terminates in October, 2007. Awards may be
granted under the Franchising Incentive Plan at any time and from time to time
prior to the termination of the Franchising Incentive Plan. Any award
outstanding at the time the Franchising Incentive Plan is terminated shall
remain in effect until said award is exercised or expires.
 
                                      84
INDEX TO FINANCIAL STATEMENTS
 
  Choice Hotels Franchising, Inc.
Report of Independent Public Accountants................................... F-2
Combined Balance Sheets as of May 31, 1997 and May 31, 1996................ F-3
Combined Statements of Income for the fiscal years ended May 31, 1997, May
 31, 1996 and May 31, 1995................................................. F-4
Combined Statements of Cash Flows for the fiscal years ended May 31, 1997,
 May 31, 1996 and May 31, 1995............................................. F-5
Notes to Combined Financial Statements..................................... F-6
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To Choice Hotels Franchising, Inc.:
 
  We have audited the accompanying combined balance sheets of Choice Hotels
Franchising, Inc., as defined under "Basis of Presentation" in the Notes to
Combined Financial Statements, as of May 31, 1997 and 1996, and the related
combined statements of income and cash flows for each of the three years in
the period ended May 31, 1997. These combined financial statements are the
responsibility of Franchising's management. Our responsibility is to express
an opinion on these combined financial statements based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the financial statements referred to above present fairly,
in all material respects, the combined financial position of Choice Hotels
Franchising, Inc. as of May 31, 1997 and 1996, and the combined results of
their operations and their combined cash flows for each of the three years in
the period ended May 31, 1997, in conformity with generally accepted
accounting principles.
 
                                          Arthur Andersen LLP
 
Washington, D.C.,
June 24, 1997
 
                                      F-2
CHOICE HOTELS FRANCHISING, INC.
                          (SEE BASIS OF PRESENTATION)
 
                            COMBINED BALANCE SHEETS
                                 (IN THOUSANDS)
MAY 31,
                                                              -----------------
                                                                1997     1996
                                                              -------- --------
ASSETS
CURRENT ASSETS
  Cash and cash equivalents.................................. $  4,167 $  3,812
  Receivables (net of allowance for doubtful accounts of
   $6,159 and $4,515, respectively)..........................   24,472   21,875
  Prepaid expenses...........................................      599    2,793
  Other......................................................    5,077    3,429
                                                              -------- --------
    Total current assets.....................................   34,315   31,909
                                                              -------- --------
PROPERTY AND EQUIPMENT, AT COST, NET OF ACCUMULATED
 DEPRECIATION................................................   43,377   38,305
                                                              -------- --------
GOODWILL, NET OF ACCUMULATED AMORTIZATION....................   69,939   65,377
                                                              -------- --------
FRANCHISE RIGHTS, NET OF ACCUMULATED AMORTIZATION............   50,503   53,138
                                                              -------- --------
INVESTMENT IN FRIENDLY HOTELS, PLC...........................   17,161   17,069
                                                              -------- --------
OTHER ASSETS.................................................    6,178    7,005
                                                              -------- --------
                                                              $221,473 $212,803
                                                              ======== ========
                   LIABILITIES AND EQUITY
CURRENT LIABILITIES
  Current portion of long term debt.......................... $     36 $     57
  Accounts payable...........................................   20,412   18,338
  Accrued expenses...........................................   10,965   15,184
  Income taxes payable.......................................    3,318    2,257
                                                              -------- --------
    Total current liabilities................................   34,731   35,836
                                                              -------- --------
LONG TERM DEBT...............................................   46,427   66,558
                                                              -------- --------
NOTES PAYABLE TO MANOR CARE..................................   78,700   78,700
                                                              -------- --------
DEFERRED INCOME TAXES ($3,498 AND $427, RESPECTIVELY) AND
 OTHER LIABILITIES...........................................    4,422    1,177
                                                              -------- --------
INVESTMENTS AND ADVANCES FROM PARENT.........................   57,193   30,532
                                                              -------- --------
                                                              $221,473 $212,803
                                                              ======== ========
The accompanying notes are an integral part of these combined balance sheets.
 
 
                                      F-3
CHOICE HOTELS FRANCHISING, INC.
                          (SEE BASIS OF PRESENTATION)
 
                         COMBINED STATEMENTS OF INCOME
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED MAY 31,
                                                  ----------------------------
                                                    1997      1996      1995
                                                  --------  --------  --------
REVENUES
  Royalty fees................................... $ 95,157  $ 86,173  $ 75,402
  Marketing and reservation fees.................  104,216    98,906    83,645
  Product sales..................................   23,643    21,570    14,461
  European hotel operations......................   17,737    19,609    18,638
  Initial franchise fees.........................   14,250    13,520     9,837
  Other..........................................   17,252    10,876    10,689
                                                  --------  --------  --------
    Total revenues...............................  272,255   250,654   212,672
                                                  --------  --------  --------
OPERATING EXPENSES
  Marketing and reservation......................  101,421    96,246    81,545
  Selling, general and administrative............   51,102    45,196    45,589
  Product cost of sales..........................   22,766    20,709    13,882
  European hotel operations......................   16,166    17,521    17,922
  Depreciation and amortization..................   10,438    11,839    11,768
  Provision for asset impairment.................      --     24,760       --
                                                  --------  --------  --------
    Total operating expenses.....................  201,893   216,271   170,706
                                                  --------  --------  --------
    Operating income.............................   70,362    34,383    41,966
                                                  --------  --------  --------
OTHER
  Minority interest expense......................      --      1,532     2,200
  Interest on notes payable to Manor Care........    7,083     7,083     7,083
  Interest and other, net........................    3,704     4,791     3,672
                                                  --------  --------  --------
    Total other expenses.........................   10,787    13,406    12,955
                                                  --------  --------  --------
Income before income taxes.......................   59,575    20,977    29,011
Income taxes.....................................  (24,845)   (9,313)  (12,783)
                                                  --------  --------  --------
NET INCOME....................................... $ 34,730  $ 11,664  $ 16,228
                                                  ========  ========  ========
Pro forma weighted average shares outstanding....   62,680    62,628    62,480
                                                  ========  ========  ========
Pro forma earnings per share..................... $   0.55  $   0.19  $   0.26
                                                  ========  ========  ========
The accompanying notes are an integral part of these combined statements of
                                    income.
 
 
                                      F-4
CHOICE HOTELS FRANCHISING, INC.
                          (SEE BASIS OF PRESENTATION)
 
                       COMBINED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
YEAR ENDED MAY 31,
                                                  ----------------------------
                                                    1997      1996      1995
                                                  --------  --------  --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income....................................... $ 34,730  $ 11,664  $ 16,228
  Reconciliation of net income to net cash pro-
   vided by operating activities:
    Depreciation and amortization................   10,438    11,839    11,768
    Provision for bad debts......................    2,238       685       692
    Increase (decrease) in deferred taxes........    3,171   (13,527)       68
    Provision for asset impairment...............      --     24,760       --
    Change in assets and liabilities:
      Change in receivables......................   (4,835)   (7,533)   (3,000)
      Change in prepaid expenses and other cur-
       rent assets...............................    1,615      (990)    1,524
      Change in current liabilities..............   (2,145)    4,050     3,694
      Change in income taxes payable.............    1,061      (265)      158
      Change in other liabilities................      175     2,059     6,719
                                                  --------  --------  --------
      NET CASH PROVIDED BY OPERATING ACTIVITIES..   46,448    32,742    37,851
                                                  --------  --------  --------
CASH FLOWS FROM INVESTING ACTIVITIES
  Investment in property and equipment...........  (10,630)   (6,506)  (13,611)
  Purchase of minority interest..................   (2,494)  (55,269)      --
  Investment in Friendly Hotels, PLC.............      --    (17,069)      --
  Other items, net...............................   (4,747)      345     5,878
                                                  --------  --------  --------
NET CASH UTILIZED IN INVESTING ACTIVITIES........  (17,871)  (78,499)   (7,733)
                                                  --------  --------  --------
CASH FLOWS FROM FINANCING ACTIVITIES
  Proceeds from mortgages and other long-term
   debt..........................................   31,107    17,296    15,567
  Principal payments of debt.....................  (51,260)     (350)  (13,492)
  Cash transfers (to) from Parent, net...........   (8,069)   31,567   (33,336)
                                                  --------  --------  --------
      NET CASH (UTILIZED IN) PROVIDED BY
       FINANCING ACTIVITIES......................  (28,222)   48,513   (31,261)
                                                  --------  --------  --------
Net change in cash and cash equivalents..........      355     2,756    (1,143)
Cash and cash equivalents at beginning of peri-
 od..............................................    3,812     1,056     2,199
                                                  --------  --------  --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD....... $  4,167  $  3,812  $  1,056
                                                  ========  ========  ========
The accompanying notes are an integral part of these combined statements of
                                  cash flows.
 
 
                                      F-5
CHOICE HOTELS FRANCHISING, INC.
 
                    NOTES TO COMBINED FINANCIAL STATEMENTS
 
                  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
BASIS OF PRESENTATION
 
  On March 7, 1996, Manor Care, Inc. ("Manor Care") announced its intention to
proceed with the separation of its lodging business ("Choice Hotels
International, Inc." or the "Company") from its health care business through a
spin-off of its lodging business (the "Manor Care Distribution"). On September
30, 1996 the Board of Directors of Manor Care declared a special dividend to
its shareholders of one share of common stock of the Company for each share of
Manor Care stock, and the Board of Directors set the Record Date and the
Distribution Date. The Manor Care Distribution was made on November 1, 1996 to
holders of record of Manor Care's Common Stock on October 10, 1996.
 
  The Manor Care Distribution separated the lodging and health care businesses
of Manor Care into two public corporations. The operations of the Company
consist principally of the hotel franchise operations and the owned and
managed hotel operations formerly conducted by Manor Care directly or through
its subsidiaries (the "Lodging Business").
 
  On November 1, 1996, concurrent with the Manor Care Distribution, the
Company changed its name from Choice Hotels Holdings, Inc. to Choice Hotels
International, Inc., and the Company's franchising subsidiary, formerly named
Choice Hotels International, Inc., changed its name to Choice Hotels
Franchising, Inc.
 
  On April 29, 1997, Choice Hotels International, Inc. announced its intention
to proceed with the separation of its domestic lodging business from its
franchising and European hotel business through a spin-off of its franchising
business (the "Distribution"). The Company's Board of Directors voted to
approve, in principle, the Distribution subject to receipt of other approvals
and consents and satisfactory implementation of the arrangements for the
Distribution. The Company intends to consummate the Distribution in the second
quarter of fiscal year 1998 through a special dividend to its stockholders of
one share of common stock of Choice Hotels Franchising, Inc. ("Franchising")
for each share of Company common stock. The Distribution is conditional upon
certain matters, including declaration of the special dividend by the
Company's Board of Directors, receipt of a ruling from the Internal Revenue
Service that the Distribution will be tax-free and approval by the Company's
shareholders of the special dividend and of the proposed reverse stock split
of the Company post-Distribution. It is anticipated that upon the
Distribution, the Company will change its corporate name to Sunburst
Hospitality Corporation ("Sunburst") and Choice Hotels Franchising, Inc. will
change its name to Choice Hotels International, Inc.
 
  As of May 31, 1997, Franchising had franchise agreements with 3,344 hotels
operating in 33 countries under the following brand names: Comfort, Clarion,
Sleep, Quality, Rodeway, Econo Lodge and MainStay Suites. Franchising also
owns or manages 14 hotels in Germany, France and England. The operations of
Franchising will consist principally of the hotel franchise operations and the
hotel operations in Europe formerly conducted by the Company.
 
  The combined financial statements present the financial position, results of
operations and cash flows of Franchising as if it were formed as a separate
entity of Manor Care which conducted the hotel franchising business and
European hotel operations of Manor Care through November 1, 1996 and as if
Franchising were a separate company for all periods presented. Manor Care's
and the Company's historical basis in the assets and liabilities of
Franchising has been carried over to the combined financial statements. All
material intercompany transactions and balances between Franchising and its
subsidiaries have been eliminated. Changes in the Investments and advances
from Parent represent the net income of Franchising plus the net change in
cash transferred between Franchising and Manor Care through November 1, 1996
and the Company through May 31, 1997.
 
 
                                      F-6
CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  An analysis of the activity in the "Investments and advances from Parent"
account for the three years ended May 31, 1997 is as follows:
(IN THOUSANDS)
                                                                  --------------
Balance, May 31, 1994.........................................    $  4,409
   Cash transfers to Parent, net.................................     (33,336)
   Net income....................................................      16,228
                                                                     --------
   Balance, May 31, 1995.........................................     (12,699)
   Cash transfers from Parent, net...............................      31,567
   Net income....................................................      11,664
                                                                     --------
   Balance, May 31, 1996.........................................      30,532
   Cash transfers to Parent, net.................................      (8,069)
   Net income....................................................      34,730
                                                                     --------
   Balance, May 31, 1997.........................................    $ 57,193
                                                                     ========
The average balance of the Investments and advances from Parent was $43.9
million, $8.9 million and ($4.1) million for fiscal years 1997, 1996 and 1995,
respectively.
 
RECLASSIFICATIONS
 
  Certain reclassifications have been made to the prior year combined
financial statements to conform to the current year presentation.
 
PRO FORMA INCOME PER SHARE (UNAUDITED)
 
  The pro forma income per common share is computed by dividing net income by
the pro forma weighted average number of outstanding common shares,
aggregating 62.7 million, 62.6 million and 62.5 million in fiscal years 1997,
1996 and 1995, respectively. The pro forma weighted average number of
outstanding common shares is based on the Company's weighted average number of
outstanding common shares for the period November 1, 1996 through May 31, 1997
and Manor Care's weighted average number of outstanding common shares for the
period June 1, 1996 through October 31, 1996 and for fiscal years 1996 and
1995.
 
CASH AND CASH EQUIVALENTS
 
  Franchising considers all highly liquid investments purchased with a
maturity of three months or less at the date of purchase to be cash
equivalents.
 
 
PROPERTY AND EQUIPMENT
 
  The components of property and equipment in the combined balance sheets
were:
MAY 31,
                                                              -----------------
                                                               1997      1996
                                                              -------  --------
                                                               (IN THOUSANDS)
Land...................................................... $ 3,033  $  3,124
   Building and improvements.................................  27,409    29,274
   Furniture, fixtures and equipment.........................  30,526    25,181
                                                              -------  --------
                                                               60,968    57,579
   Less: Accumulated depreciation............................ (17,591)  (19,274)
                                                              -------  --------
                                                              $43,377  $ 38,305
                                                              =======  ========
F-7
CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
  Depreciation has been computed for financial reporting purposes using the
straight-line method. A summary of the ranges of estimated useful lives upon
which depreciation rates have been based follows:
Building and improvements........................................ 10-40 years
   Furniture, fixtures and equipment................................  3-20 years
MINORITY INTEREST
 
  Prior to May 31, 1996, certain former members of the Company's management
had a minority ownership interest in Choice Hotels Franchising, Inc., a
majority owned subsidiary. Amounts reflected as minority interest represent
the minority owners' share of income in Choice Hotels Franchising, Inc. As of
May 31, 1997, the Company had repurchased all of the outstanding minority
ownership interest.
 
GOODWILL
 
  Goodwill primarily represents an allocation of the excess purchase price of
the stock of Choice Hotels Franchising, Inc. over the recorded minority
interest. Goodwill is being amortized on a straight-line basis over 40 years.
Such amortization amounted to $1.9 million in the year ended May 31, 1997,
$1.1 million in the year ended May 31, 1996, and $598,000 in the year ended
May 31, 1995. Goodwill is net of accumulated amortization of $5.0 million and
$3.1 million at May 31, 1997 and 1996, respectively.
 
FRANCHISE RIGHTS
 
  Franchise rights are an intangible asset and represent an allocation in
purchase accounting for the value of long-term franchise contracts. The
majority of the balance resulted from the Econo Lodge and Rodeway acquisitions
made in fiscal year 1991. Franchise rights acquired are amortized over an
average life of twenty-six years. Amortization expense for the fiscal years
ended May 31, 1997, 1996 and 1995 amounted to $2.9 million, $2.6 million and
$2.6 million, respectively. Franchise rights are net of accumulated
amortization of $14.0 million and $11.1 million at May 31, 1997 and 1996,
respectively.
 
SELF-INSURANCE PROGRAM
 
  Subsequent to the Manor Care Distribution, Franchising maintained its own
self-insurance program for certain levels of general and professional
liability, automobile liability and workers' compensation coverage. The
estimated costs of these programs are accrued at present values based on
actuarial projections for known and anticipated claims.
 
  Prior to the Manor Care Distribution, Franchising participated in Manor
Care's self-insurance program for certain levels of general and professional
liability, automobile liability and workers' compensation coverage. The
estimated costs of these programs are accrued at present values based on
actuarial projections for known and anticipated claims. All accrued self-
insurance costs through November 1, 1996 were assumed by Manor Care and have
been treated as paid to Manor Care, and as such, amounts paid to Manor Care up
to November 1, 1996 have been charged directly to Investments and advances
from Parent.
 
REVENUE RECOGNITION
 
  Franchising enters into numerous franchise agreements committing to provide
licensees with various marketing services, a centralized reservation system
and limited rights to utilize Franchising's registered tradenames. These
agreements are typically for a period of twenty years, with certain rights to
the franchisee to terminate after 5, 10 or 15 years.
 
  Initial franchise fees are recognized upon sale, because the initial
franchise fee is non-refundable and Franchising has no continuing obligations
related to the franchisee.
 
                                      F-8
CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  Royalty fees, primarily based on gross room revenues of each franchisee, are
recorded when earned. Reserves for uncollectible accounts are charged to bad
debt expense and included in selling, general and administrative expenses in
the accompanying combined statements of income.
 
  Franchising assesses franchisees monthly fees related to marketing and
reservations which are expended for national advertising, marketing, and
selling activities and the operation of a centralized reservation system.
 
IMPAIRMENT POLICY
 
  Franchising evaluates the recoverability of long lived assets, including
franchise rights and goodwill, whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Recoverability is measured based on net, undiscounted expected cash flows.
Assets are considered to be impaired if the net, undiscounted expected cash
flows are less than the carrying amount of the assets. Impairment charges are
recorded based upon the difference between the carrying value of the asset and
the expected net cash flows, discounted at an appropriate interest rate.
 
CAPITALIZATION POLICIES
 
  Major renovations and replacements are capitalized to appropriate property
and equipment accounts. Upon sale or retirement of property, the cost and
related accumulated depreciation are eliminated from the accounts and the
related gain or loss is taken into income. Maintenance, repairs and minor
replacements are charged to expense.
 
FOREIGN OPERATIONS
 
  Franchising accounts for foreign currency translation in accordance with
SFAS No. 52, "Foreign Currency Translation." Revenues generated by foreign
operations for the fiscal years ended May 31, 1997, 1996 and 1995 were $27.5
million, $29.9 million and $29.2 million, respectively. Losses were generated
by foreign operations for the fiscal years ended May 31, 1997, 1996 and 1995
of $1.8 million, $19.4 million and $5.7 million, respectively. Losses
generated by foreign operations for fiscal year 1996 include a $15.0 million
net of tax charge relating to a provision for asset impairment. The majority
of the revenues and losses of foreign operations relate to Franchising's
European business operations. Total assets relating to foreign operations were
$48.8 million and $56.8 million at May 31, 1997 and 1996, respectively.
Translation gains and losses are recorded in the cumulative translation
adjustment account included in Investments and advances from Parent in the
accompanying combined balance sheets as follows:
(IN THOUSANDS)
                                                                 --------------
Balance, May 31, 1994........................................    $    (31)
   Net adjustments..............................................         740
                                                                    --------
   Balance, May 31, 1995........................................         709
   Net adjustments..............................................      (2,459)
                                                                    --------
   Balance, May 31, 1996........................................      (1,750)
   Net adjustments..............................................      (5,268)
                                                                    --------
   Balance, May 31, 1997........................................    $ (7,018)
                                                                    ========
USE OF ESTIMATES
 
  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
 
                                      F-9
CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
 
                                 INCOME TAXES
 
  Franchising is included in the consolidated federal income tax returns of
Manor Care and the Company. The income tax provision included in these
combined financial statements reflects the historical income tax provision and
temporary differences attributable to the operations of Franchising on a
separate return basis. Deferred taxes are recorded for the tax effect of
temporary differences between book and tax income.
 
  Income before income taxes for the fiscal years ended May 31, 1997, 1996 and
1995 were derived from the following:
1997     1996     1995
                                                      -------  -------  -------
                                                          (IN THOUSANDS)
Income before income taxes
     Domestic operations............................. $62,641  $52,801  $38,385
     Foreign operations..............................  (3,066) (31,824)  (9,374)
                                                      -------  -------  -------
   Combined income before income taxes............... $59,575  $20,977  $29,011
                                                      =======  =======  =======
Income before income taxes for domestic operations and foreign operations
for fiscal year 1996 includes a pretax provision of $24.8 million for asset
impairment.
 
  The provisions for income taxes follows for the fiscal years ended May 31:
1997     1996     1995
                                                      -------  -------  -------
                                                          (IN THOUSANDS)
Current tax (benefit) expense
     Federal......................................... $19,421  $20,097  $14,169
     Federal benefit of foreign operations...........  (1,213)  (2,792)  (3,703)
     State...........................................   3,950    3,754    2,292
   Deferred tax (benefit) expense
     Federal.........................................   2,293      125       58
     Federal benefit of foreign operations...........     --    (9,778)     --
     State...........................................     394   (2,093)     (33)
                                                      -------  -------  -------
                                                      $24,845  $ 9,313  $12,783
                                                      =======  =======  =======
Deferred tax assets (liabilities) are comprised of the following at May 31:
1997     1996      1995
                                                     -------  -------  --------
                                                          (IN THOUSANDS)
Depreciation and amortization.................... $(5,145) $(1,637) $(12,755)
   Prepaid expenses.................................    (856)  (1,550)   (1,386)
   Other............................................  (2,799)  (1,542)   (2,165)
                                                     -------  -------  --------
   Gross deferred tax liabilities...................  (8,800)  (4,729)  (16,306)
                                                     -------  -------  --------
   Foreign operations...............................   2,271    1,931     1,086
   Accrued expenses.................................   3,181    2,065     1,343
   Net operating loss...............................     609      820     1,031
   Other............................................     310      655        61
                                                     -------  -------  --------
   Gross deferred tax assets........................   6,371    5,471     3,521
                                                     -------  -------  --------
   Net deferred tax (liability) asset............... $(2,429) $   742  $(12,785)
                                                     =======  =======  ========
F-10
CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
 
  A reconciliation of income tax expense at the statutory rate to income tax
expense included in the accompanying combined statements of income follows:
1997     1996      1995
                                                  --------  -------- --------
                                                    (IN THOUSANDS, EXCEPT
                                                  FEDERAL INCOME TAX RATE)
Federal income tax rate.......................       35%      35%       35%
   Federal taxes at statutory rate...............  $20,853   $7,345   $10,154
   State income taxes, net of Federal tax bene-
    fit..........................................    2,824    1,080     1,468
   Minority interest.............................      --       536       770
   Other.........................................    1,168      352       391
                                                  --------  -------  --------
   Income tax expense............................ $ 24,845  $ 9,313  $ 12,783
                                                  ========  =======  ========
Cash paid for state income taxes was $1.3 million, $1.4 million and $549,000
for the years ended May 31, 1997, 1996 and 1995, respectively. Federal income
taxes were paid by Manor Care for the years ended May 31, 1995 and May 31,
1996 and the period from June 1, 1996 through October 31, 1996. Federal income
taxes were paid by the Company for the short period beginning November 1, 1996
and ending May 31, 1997.
 
  Consistent with the existing Company tax sharing policy, all current Federal
provision amounts have been treated as paid to, or received from, the Company,
and as such, there are no current tax provision balances due to the Company at
May 31, 1997 or to Manor Care at May 31, 1996. Differences between amounts
paid to or received from Manor Care and the Company have been charged or
credited directly to Investments and advances from Parent.
 
                               ACCRUED EXPENSES
 
  Accrued expenses at May 31, 1997 and 1996 were as follows:
1997    1996
                                                             ------- -------
                                                               (IN THOUSANDS)
Payroll.................................................. $ 7,950 $ 7,041
   Other....................................................   3,015   8,143
                                                             ------- -------
                                                             $10,965 $15,184
                                                             ======= =======
LONG TERM DEBT AND NOTES PAYABLE
 
  Debt consisted of the following at May 31, 1997 and 1996:
1997     1996
                                                               -------- --------
                                                                (IN THOUSANDS)
$250 million competitive advance and multi-currency
    revolving credit facility with an average rate of 5.69%
    at May 31, 1996..........................................  $     -- $ 50,557
   $125 million competitive advance and multi-currency
    revolving credit facility with an average rate of 6.28%
    at May 31, 1997..........................................    31,107      --
   Notes payable to Manor Care, Inc. with a rate of 9% at May
    31, 1997 and 1996, respectively..........................    78,700   78,700
   Capital lease obligations.................................    13,531   13,951
   Other notes with an average rate of 5.94% and 6.33% at May
    31, 1997 and 1996, respectively..........................     1,825    2,107
                                                               -------- --------
   Total indebtedness........................................  $125,163 $145,315
                                                               ======== ========
F-11
CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
  Maturities of debt at May 31, 1997 were as follows:
FISCAL YEAR                                                    (IN THOUSANDS)
   -----------                                                    --------------
1998..........................................................    $     36
   1999..........................................................          87
   2000..........................................................     110,012
   2001..........................................................         210
   2002..........................................................         215
   Thereafter....................................................      14,603
                                                                     --------
                                                                     $125,163
                                                                     ========
During fiscal year 1996 and through November 1, 1996, the Company was a co-
guarantor with Manor Care and other affiliates for a $250 million competitive
advance and multi-currency revolving credit facility. The facility provided
that up to $75.0 million was available in foreign currency borrowings under
the foreign currency portion of the facility. Franchising's borrowings under
this facility amounted to $50.6 million at May 31, 1996. Franchising was
charged interest for amounts borrowed under the foreign currency portion of
the facility at one of several interest rates, including LIBOR plus 26.25
basis points. Subsequent to the Manor Care Distribution, the Company utilized
its new credit facility, as described below, to repay Franchising's portion of
borrowings under Manor Care's foreign currency portion of the facility, and
the Company was released from all liabilities and guarantees relating to the
Manor Care credit facility.
 
  On October 30, 1996, the Company entered into a $100.0 million competitive
advance and multi-currency revolving credit facility provided by a group of
seven banks. As a subsidiary of the Company, Franchising's cash requirements
and related borrowings were provided by the Company. This facility provides
that up to $75.0 million is available for borrowings in foreign currencies.
Borrowings under the facility are, at the option of the borrower, at one of
several rates including LIBOR plus from 20.0 to 62.5 basis points, based upon
a defined financial ratio and the loan type. In addition, the Company has the
option to request participating banks to bid on loan participation at lower
rates than those contractually provided by the facility. The facility
presently requires the Company to pay annual fees of 1/10 of 1% to 1/4 of 1%,
based upon a defined financial ratio, of the total loan commitment. The
facility will terminate on October 30, 1999. On May 5, 1997, the Company
increased the size of the facility from $100 million to $125 million. The
Company has $121.6 million outstanding under the facility at May 31, 1997 of
which $31.1 million has been allocated to Franchising. In connection with the
Distribution, Franchising intends to secure financing to repay its portion of
borrowings under the Company's foreign currency portion of the facility as
well as to provide for seasonal cash requirements.
 
  The Company has $115.7 million payable to Manor Care as of May 31, 1997
assumed as part of the Manor Care Distribution. The portion of this
indebtedness related to Franchising acquisitions has been pushed down to
Franchising and is reflected as Notes payable to Manor Care in the
accompanying combined balance sheets totaling $78.7 million at May 31, 1997
and 1996, respectively. The loan will mature on November 1, 1999 and may be
prepaid in whole or in part, together with accrued interest, at the Company's
option. If the loan is prepaid prior to November 1, 1997, the Company will be
required to reimburse Manor Care on demand for any actual loss incurred or to
be incurred by Manor Care (for the period up to and including November 1,
1997) in the redeployment of the funds released by a prepayment of the loan.
The Notes payable to Manor Care are expected to be repaid with the proceeds
from operating cash flow or with third-party financing. Interest expense on
those notes for each of the years ended May 31, 1997, 1996 and 1995 was $7.1
million. Interest on the amount of the loan is payable quarterly at an annual
rate of 9%.
 
  Cash paid for interest was $11.6 million, $11.8 million and $10.8 million
for fiscal years 1997, 1996 and 1995, respectively.
 
                                     F-12
CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
                                    LEASES
 
  Franchising operates certain property and equipment under operating leases
that expire at various dates through 2001. Future minimum lease payments total
approximately $280,000. Rental expense under non-cancellable operating leases
was $171,000 in 1997, $231,000 in 1996 and $400,000 in 1995. No amounts have
been included in minimum lease payments for office rent because Franchising is
not subject to a rental agreement. Franchising paid office rent of $4.0
million to the Company in 1997 based on the portion of total space occupied by
Franchising. Subsequent to the Distribution, Franchising will sublease office
space from Sunburst.
 
                         ACQUISITIONS AND DIVESTITURES
 
  On May 31, 1995, Franchising repurchased one-half of the 11% interest held
by its management in Choice Hotels Franchising, Inc. Approximately $19.8
million was allocated to goodwill; the purchase cost of $27.4 million was paid
in June and July 1995. On May 31, 1996, Franchising repurchased the remaining
5.5% minority interest in Choice Hotels Franchising, Inc. for $27.9 million.
Approximately $26.4 million was allocated to goodwill.
 
  On May 31, 1996, Franchising invested approximately $17.1 million in the
capital stock of Friendly Hotels, PLC ("Friendly"). In exchange for the $17.1
million investment, Franchising received 750,000 shares of common stock and
10,000,000 newly issued immediately convertible preferred shares. In addition,
Franchising granted to Friendly a Master Franchise Agreement for the United
Kingdom and Ireland in exchange for 333,333 additional shares of common stock.
At May 31, 1997, Franchising owned approximately 5% of the outstanding shares
of Friendly which would increase to approximately 27% if Franchising's
preferred stock were converted. The preferred shares carry a 5.75% dividend
payable in cash or in stock, at the Company's option. The dividend accrues
annually with the first dividend paid on the earlier of the third anniversary
of completion or on a conversion date. The proceeds of the investment received
by Friendly are to be used to support the construction of 10 Quality or
Comfort hotels. As a condition to the investment, Franchising has the right to
appoint two directors to the board of Friendly. Franchising is accounting for
the common stock investment under the equity method.
 
  Franchising recognized $943,000 in preferred dividend income from the
Friendly investment during 1997.
 
                          TRANSACTIONS WITH SUNBURST
 
  Franchising participates in a cash concentration system with the Company and
as such maintains no significant cash balances or banking relationships.
Substantially all cash received by Franchising has been immediately deposited
in and combined with the Company's corporate funds through its cash management
system. Similarly, operating expenses, capital expenditures and other cash
requirements of Franchising have been paid by the Company and charged to
Franchising. The net result of all of these intercompany transactions are
reflected in Investments and advances from Parent.
 
  Since the Manor Care Distribution, Franchising has provided certain services
to the Company including, among others, executive management, human resources,
legal, accounting, tax, information systems and certain administrative
services, as required. Also since the Manor Care Distribution, the Company has
provided services to Franchising, either directly or through the Corporate
Services Agreement with Manor Care, including, among others, cash management,
payroll and payables processing, employee benefits plans, insurance,
accounting and certain administrative services, as required. Costs associated
with the Manor Care Corporate Services Agreement as well as costs of services
provided by the Company to Franchising or provided by Franchising to the
Company
 
                                     F-13
CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
have been allocated between the entity providing the services and the entity
receiving the services in the accompanying financial statements. As a result,
future administrative and corporate expenses are expected to vary from
historical results. However, Franchising has estimated that general and
administrative expenses incurred annually will not materially change after the
Distribution.
 
  For purposes of providing an orderly transition after the Distribution, the
Company and Franchising will enter into various agreements, including, among
others, a Distribution Agreement, Tax Sharing Agreement, Corporate Services
Agreement and Employee Benefits Allocation Agreement. Effective at the
Distribution, these agreements will provide, among other things, that
Franchising (i) will receive and/or provide certain corporate and support
services, such as accounting, tax and computer systems support, (ii) will
establish pension, profit sharing and incentive plans similar to those in
place at the Company, (iii) will receive certain risk management services and
other miscellaneous administrative services and (iv) will adjust outstanding
options to purchase shares of Company Common Stock held by Company employees,
Franchising employees and employees of Manor Care. These agreements will
extend for a maximum period of 30 months from the Distribution date or until
such time as Franchising and the Company have arranged to provide such
services in-house or through another unrelated provider of such services.
 
  On or prior to the Distribution date, the Company and Franchising will enter
into a strategic alliance agreement. Among other things, the agreement will
provide for (i) a right of first refusal to Franchising to franchise lodging
properties to be acquired or developed by the Company, (ii) certain
commitments by the Company for the development of Sleep Inns and MainStay
Suites hotels, (iii) continued cooperation of both parties with respect to
matters of mutual interest, such as new product and concept testing, (iv)
continued cooperation with respect to third party vendor arrangements and (v)
certain limitations on competition in each others' line of business. The
strategic alliance agreement extends for a term of 20 years with mutual rights
of termination on the 5th, 10th and 15th anniversaries.
 
  During the periods presented, Sunburst operated substantially all of its
hotels pursuant to franchise agreements with Franchising. Total fees paid to
Franchising included in the accompanying financial statements for franchising
royalty, marketing and reservation fees were $9.5 million, $7.5 million, and
$5.3 million for the years ended May 31, 1997, 1996 and 1995, respectively.
 
                         COMMITMENTS AND CONTINGENCIES
 
  Franchising is a defendant in a number of lawsuits arising in the ordinary
course of business. In the opinion of management and general counsel to
Franchising, the ultimate outcome of such litigation will not have a material
adverse effect on Franchising's business, financial position or results of
operations.
 
                  PENSION, PROFIT SHARING AND INCENTIVE PLANS
 
  Bonuses accrued for key executives of Franchising under incentive
compensation plans were $1.4 million in 1997, $1.1 million in 1996 and $1.4
million in 1995.
 
  Employees of Franchising participate in retirement plans sponsored by the
Company, and prior to the Manor Care Distribution employees participated in
retirement plans sponsored by Manor Care. Costs allocated to Franchising are
based on the size of its payroll relative to the sponsor's payroll. Costs
allocated to Franchising were approximately $1.4 million in 1997, $817,000 in
1996 and $776,000 in 1995.
 
                                     F-14
CHOICE HOTELS FRANCHISING, INC.
 
              NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
 
 
                      FAIR VALUE OF FINANCIAL INSTRUMENTS
 
  Franchising is required to disclose the fair value of its financial
instruments in accordance with Statement of Financial Accounting Standards No.
107, "Disclosures about Fair Value of Financial Instruments." Fair values of
material balances were determined by using market rates currently available.
 
  The balance sheet carrying amount of cash, cash equivalents and receivables
approximate fair value due to the short term nature of these items. Long term
debt consist of bank loans and Notes payable to Manor Care. Interest rates on
bank loans adjust frequently based on current market rates; accordingly, the
carrying amount of bank loans is equivalent to fair value. The carrying
amounts for long-term debt approximate fair market values.
 
                        PROVISION FOR ASSET IMPAIRMENT
 
  During fiscal year 1996, Franchising began restructuring its European
operations. This restructuring effort included the purchase of an equity
interest in Friendly Hotels, PLC and a reevaluation of key geographic markets
in Europe. In connection with this restructuring, Franchising performed a
review of its European operations and in May 1996 recognized a $15.0 million
non-cash charge (net of a $9.8 million income tax benefit) against earnings
related to the impairment of assets associated with certain European hotel
operations.
 
                IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
 
  Franchising has adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The adoption
of SFAS No. 121 did not have a material impact on Franchising's financial
statements.
 
  Franchising plans to utilize the method under SFAS No. 123, "Accounting for
Stock-Based Compensation," which provides for disclosure of the impact of
stock-based compensation grants.
 
  Franchising is required to adopt SFAS No. 128, "Earnings Per Share," and
SFAS No. 129, "Disclosure of Information about Capital Structure," no later
than fiscal year 1998. The adoption of these pronouncements will not
materially affect Franchising's financial statements. Franchising is required
to adopt SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information," no
later than fiscal 1999. Management is still evaluating the impact that these
pronouncements will have on Franchising's financial statements.
 
 
                                     F-15
ANNEX A
 
                                    FORM OF
 
                     RESTATED CERTIFICATE OF INCORPORATION
 
                                      OF
 
                        CHOICE HOTELS FRANCHISING, INC.
 
  Choice Hotels Franchising, Inc. (the "Corporation"), a corporation
incorporated on December 12, 1980 and existing under and by virtue of the
General Corporation Law of the State of Delaware (the "GCL"), hereby certifies
as follows:
 
  FIRST: The board of directors of the Corporation (the "Board of Directors")
adopted a resolution proposing and declaring advisable the following
amendments to and restatement of the Certificate of Incorporation of the
Corporation.
 
  SECOND: This Restated Certificate of Incorporation was duly adopted by the
sole stockholder of the Corporation in accordance with the provisions of
Sections 228, 242 and 245 of the GCL.
 
  THIRD: The text of the Certificate of Incorporation is hereby amended and
restated as herein set forth in full:
 
    1. The name of the Corporation is CHOICE HOTELS INTERNATIONAL, INC. (the
  "Corporation").
 
    2. The address of the Corporation's registered office in the State of
  Delaware is 100 West Tenth Street, in the City of Wilmington, County of New
  Castle. The name of its registered agent at such address is The Corporation
  Trust Company.
 
    3. The purpose of the Corporation is to engage in any lawful act or
  activity for which corporations may be organized under the GCL.
 
    4. The total number of shares of capital stock of all classifications
  which the Corporation shall have authority to issue is One Hundred Sixty-
  Five Million (165,000,000), of which One Hundred Sixty Million
  (160,000,000) shares having a par value of One Cent ($.01) per share shall
  be common stock, and Five Million (5,000,000) shares having a par value of
  One Cent ($.01) per share shall be preferred stock.
 
  Shares of common stock of the Corporation may be issued from time to time in
one or more classes or series, each of which class or series shall have such
distinctive designation or title as shall be fixed by the Board of Directors
prior to the issuance of any shares thereof. Each such class or series of
common stock shall have such voting powers (full or limited) or no voting
powers, such preferences and relative participating, optional or other special
rights, relative ranking and such qualifications, limitations or restrictions,
as shall be stated in such resolution or resolutions providing for the issue
of such class or series of common stock as may be adopted from time to time by
the Board of Directors prior to the issuance of any shares thereof pursuant to
the authority hereby expressly vested in it, all in accordance with the laws
of the State of Delaware.
 
  Without limiting the generality of the foregoing, shares of a series of
common stock consisting of Seventy Five Million (75,000,000) shares, or such
larger number of shares as the Board of Directors shall from time to time fix
by resolution or resolutions, may be issued from time to time by the Board of
Directors. Shares of this series shall be designated, and are hereinafter
called "Common Stock."
 
  The holders of record of the Common Stock shall be entitled to the following
rights:
 
    (a) subject to the rights of any holders of any class or series of
  capital stock as specified in the resolution providing for such class or
  series of capital stock, to vote at all meetings of stockholders of the
 
                                      A-1
Corporation, and at all such meetings such holders shall have one vote in
  respect of each share of Common Stock held of record by them;
 
    (b) subject to the rights of any holders of any class or series of
  capital stock having a preference with respect to dividends, to receive
  when, if and as declared by the Board of Directors out of the assets of the
  Corporation legally available therefor, such dividends as may be declared
  by the Corporation from time to time to holders of Common Stock; and
 
    (c) subject to the rights of any holders of any class or series of
  capital stock having a preference with respect to distribution of assets
  upon liquidation or dissolution, to receive the remaining assets of the
  Corporation upon liquidation, dissolution or winding-up.
 
  Shares of preferred stock of the Corporation may be issued from time to time
in one or more classes or series, each of which class or series shall have
such distinctive designation or title as shall be fixed by the Board of
Directors prior to the issuance of any shares thereof. Each such class or
series of preferred stock shall have such voting powers (full or limited) or
no voting powers, such preferences and relative participating, optional or
other special rights, relative ranking and such qualifications, limitations or
restrictions, as shall be stated in such resolution or resolutions providing
for the issue of such class or series of preferred stock as may be adopted
from time to time by the Board of Directors prior to the issuance of any
shares thereof pursuant to the authority hereby expressly vested in it, all in
accordance with the laws of the State of Delaware.
 
  Subject to the rights of any holders of any class or series of capital
stock, as specified in the resolution providing for such class or series of
capital stock, the holders of Common Stock are expressly denied the preemptive
right to subscribe to any or all additional shares of capital stock of the
Corporation or any or all classes or series thereof.
 
    5. The Corporation expressly elects not to be governed by Section 203 of
  the GCL.
 
    6. Subject to the rights of any holders of any class or series of capital
  stock as specified in the resolution providing for such class or series of
  capital stock, any action required to be taken by the stockholders of the
  Corporation must be effected at a duly called annual or special meeting of
  stockholders of the Corporation and may not be effected by any consent in
  writing of such stockholders in lieu of a meeting.
 
  Special meetings of the stockholders of the Corporation may be called only
by (i) the Chairman or Vice Chairman of the Board of Directors or (ii) the
Secretary of the Corporation within 10 calendar days after receipt of the
written request of a majority of the total number of directors which the
Corporation would have if there were no vacancies (the "Whole Board").
 
  Meetings of stockholders may be held within or without the State of
Delaware, as the Bylaws may provide. The books of the Corporation may be kept
outside the State of Delaware at such place or places as may be designated
from time to time by the Board of Directors or in the Bylaws.
 
    7. A. Subject to the rights of any holders of any class or series of
  capital stock as specified in the resolution providing for such class or
  series of capital stock, the business and affairs of the Corporation shall
  be managed by or under the direction of the Board of Directors consisting
  of not less than 3 nor more than 12 directors, the exact number of
  directors to be determined from time to time solely by resolution adopted
  by the affirmative vote of a majority of the Whole Board. The directors
  shall be divided into three classes, designated Class I, Class II and Class
  III. Each Class of directors shall consist, as nearly as may be possible,
  of one-third of the total number of directors constituting the Whole Board.
  The initial term of the Class I directors shall expire upon the election
  and qualification of their successors at the 1998 annual meeting of
  stockholders; the initial term of the Class II directors shall expire upon
  the election and qualification of their successors at the 1999 annual
  meeting of stockholders; and the initial term of the Class III directors
  shall expire upon the election and qualification of their successors at the
  2000 annual meeting of stockholders. At each annual meeting of stockholders
  beginning with the 1998 annual meeting, successors to the Class of
  directors whose term expires at that annual meeting shall be elected for a
  three-year term and shall hold office until the annual meeting for the year
  in which his or her term expires and
 
                                      A-2
until his or her successor shall be elected and shall qualify, subject,
  however, to prior death, resignation, retirement, disqualification or
  removal from office.
 
    B. Subject to the rights of any holders of any class or series of capital
  stock as specified in the resolution providing for such class or series of
  capital stock, newly created directorships resulting from any increase in
  the number of directors and any vacancies on the Board of Directors
  resulting from death, resignation, retirement, disqualification, removal or
  other cause will be filled solely by the affirmative vote of a majority of
  the remaining directors then in office, even though less than a quorum of
  the Board of Directors. Increases or decreases in the number of directors
  shall be apportioned among the Classes so as to maintain the number of
  directors in each Class as nearly equal as possible, and any additional
  director of any Class elected to fill a vacancy resulting from an increase
  in such Class shall hold office for a term that shall coincide with the
  remaining term of that Class, but in no case will a decrease in the number
  of directors shorten the term of any incumbent director.
 
    C. The election of directors need not be by written ballot unless the
  Bylaws shall so provide.
 
    D. Notwithstanding the foregoing, whenever the holders of any one or more
  class or series of capital stock shall have the right, voting separately as
  a class or series, to elect directors, the election, removal, term of
  office, filling of vacancies and other features of such directorships shall
  be governed by the terms of this Restated Certificate of Incorporation
  applicable thereto, and such directors so elected shall not be divided into
  classes pursuant to Article 6, Section A, unless expressly provided by such
  terms.
 
    8. The affirmative vote of the holders of the outstanding shares of
  capital stock representing not less than two-thirds of the Voting Power (as
  defined) of the Corporation shall be required for the approval of any
  proposal for the Corporation to dissolve, liquidate, merge, or consolidate
  with any other entity (other than an entity 90% of the Voting Power of
  which is owned by the Corporation), or sell, lease or exchange all or
  substantially all of its property and assets, including its goodwill and
  its corporate franchises. "Voting Power" means the total number of votes
  that may be cast by holders of capital stock in the election of directors.
 
    9. The Corporation reserves the right to amend, alter, change or repeal
  any provision contained in this Restated Certificate of Incorporation, in
  the manner now or hereafter prescribed by statute, and all rights conferred
  upon stockholders herein are granted subject to this reservation.
  Notwithstanding anything contained in this Restated Certificate of
  Incorporation to the contrary, the affirmative vote of the holders of the
  outstanding shares of capital stock representing not less than two-thirds
  of the Voting Power of the Corporation shall be required to amend, alter,
  change or repeal, or to adopt any provision inconsistent with, Article 8 of
  this Restated Certificate of Incorporation. The Board of Directors shall
  have the power to make, adopt, alter, amend, change or repeal the Bylaws by
  resolution adopted by the affirmative vote of a majority of the Whole
  Board. Stockholders may not make, adopt, alter, amend, change or repeal the
  Bylaws except upon the affirmative vote of the holders of the outstanding
  shares of capital stock representing not less than two-thirds of the Voting
  Power of the Corporation and no Bylaws hereafter adopted by the
  stockholders or otherwise shall invalidate any prior act of the directors
  which would have been valid if such Bylaws had not been adopted.
 
    10. A. No director of the Corporation shall be liable to the Corporation
  or its stockholders for monetary damages for breach of fiduciary duty as a
  director, except for liability (i) for any breach of the director's duty of
  loyalty to the Corporation or its stockholders, (ii) for acts or omissions
  not in good faith or which involve intentional misconduct or a knowing
  violation of law, (iii) under Section 174 of the GCL, or (iv) for any
  transaction from which the director derived an improper personal benefit.
  No amendment to or repeal of this Article 10 shall apply to or have any
  effect on the liability or alleged liability of any director of the
  Corporation for or with respect to any acts or omissions of such director
  occurring prior to such amendment or repeal. If the GCL is amended
  hereafter to further limit the liability of a director, then the liability
  of a director of the Corporation shall be further limited to the fullest
  extent permitted by the GCL, as so amended.
 
    B. The Corporation shall indemnify each person who is or was or has
  agreed to become a director or officer of the Corporation, and may
  indemnify other employees and agents of the Corporation, to the fullest
 
                                      A-3
extent permitted by Section 145 of the GCL, as the same may be amended or
  supplemented, against all expenses and liabilities (including, but not
  limited to, counsel fees) reasonably incurred by or imposed upon such
  person in connection with any proceeding to which he or she may be made a
  party, or in which he or she may become involved, by reason of his or her
  being or having been a director, officer, employee or agent of the
  Corporation, or any settlement thereof, whether or not he or she is a
  director, officer, employee or agent at the time such expenses are incurred
  or liability incurred, except in such cases where the director, officer,
  employee or agent is adjudged guilty of willful misfeasance or malfeasance
  in the performance of his or her duties; provided that in the event of a
  settlement the indemnification herein shall apply only when the Board of
  Directors approves such settlement and reimbursement as being for the best
  interests of the Corporation. Without limiting the generality or the effect
  of the foregoing, the Corporation may adopt Bylaws, or enter into one or
  more agreements with any person, which provide for indemnification greater
  or different than that provided in this Article 10 or the GCL and the
  foregoing right of indemnification shall be in addition to and not
  exclusive of all other rights to which such director, officer, employee or
  agent may be entitled.
 
    C. The Corporation may purchase insurance on behalf of any person who is
  a director, officer, employee or agent of the Corporation, or is or was
  serving at the request of the Corporation as a director, officer, employee
  or agent of another corporation, partnership, joint venture, trust or other
  enterprise against any liability asserted by him or her and incurred by him
  or her in any such capacity, or arising out of his or her status as such,
  whether or not the Corporation would have the power or the obligation to
  indemnify him or her against such liability under the provisions of this
  Article 10.
 
    11. The Board of Directors, each committee of the Board of Directors and
  each individual director, in discharging their respective duties under
  applicable law and this Restated Certificate of Incorporation and in
  determining what they each believe to be in the best interests of the
  Corporation and its stockholders, may consider the effects, both short-term
  and long-term, of any action or proposed action taken or to be taken by the
  Corporation, the Board of Directors or any committee of the Board of
  Directors on the interests of (i) the employees, franchisees, licensees,
  customers, suppliers and/or creditors of the Corporation and its
  subsidiaries and (ii) the communities in which the Corporation and its
  subsidiaries own or lease property or conduct business, all to the extent
  that the Board of Directors, any committee of the Board of Directors or any
  individual director deems pertinent under the circumstances; provided,
  however, that the provisions of this Article 11 shall not limit in any way
  the right of the Board of Directors to consider any other lawful factors in
  making its determinations, including, without limitation, the effects, both
  short-term and long-term, or any action or proposed action on the
  Corporation or its stockholders directly; and provided further that this
  Article 11 shall be deemed solely to grant discretionary authority to the
  Board of Directors, each committee of the Board of Directors and each
  individual director and shall not be deemed to provide to any specific
  constituency any right to be considered.
 
    12. Whenever a compromise or arrangement is proposed between this
  Corporation and its creditors or any class of them and/or between this
  Corporation and its stockholders or any class of them, any court of
  equitable jurisdiction within the State of Delaware may, on the application
  in a summary way of this Corporation or of any creditor or stockholder
  thereof or on the application of any receiver or receivers appointed for
  this Corporation under the provisions of Section 291 of the GCL or on the
  application of trustees in dissolution or of any receiver or receivers
  appointed for this Corporation under the provisions of Section 279 of the
  GCL, order a meeting of the creditors or class of creditors, and/or of the
  stockholders or class of stockholders of this Corporation, as the case may
  be, to be summoned in such manner as the said court directs. If a majority
  in number representing three-fourths in value of the creditors or class of
  creditors, and/or of the stockholders or class of stockholders of this
  Corporation, as the case may be, agree to any compromise or arrangement and
  to any reorganization of this Corporation as consequence of such compromise
  or arrangement, the said compromise or arrangement and the said
  reorganization shall, if sanctioned by the court to which the said
  application has been made, be binding on all the creditors or class of
  creditors, and/or on all the stockholders or class of stockholders, of this
  Corporation, as the case may be, and also on this Corporation.
 
 
                                      A-4
IN WITNESS WHEREOF, the Corporation has caused this Restated Certificate of
Incorporation to be duly executed in its corporate name.
 
Dated:     , 1997
 
                                          -------------------------------------
                                          Name:   Stewart Bainum, Jr.
                                                  Chairman
 
 
                                      A-5
ANNEX B
 
                                    FORM OF
 
                             AMENDED AND RESTATED
 
                                   BYLAWS OF
 
                       CHOICE HOTELS INTERNATIONAL, INC.
             (FORMERLY KNOWN AS "CHOICE HOTELS FRANCHISING, INC."
               AND HEREINAFTER REFERRED TO AS THE "CORPORATION")
 
                      AS AMENDED AND RESTATED,       1997
 
                                   ARTICLE I
 
                                    OFFICES
 
  Section 1. Office. The registered office of the Corporation shall be in the
City of Wilmington, County of New Castle, State of Delaware.
 
  Section 2. Additional Offices. The Corporation may also have offices at such
other places, both within and without the State of Delaware, as the Board of
Directors may from time to time determine or as the business of the
Corporation may require.
 
                                  ARTICLE II
 
                           MEETINGS OF STOCKHOLDERS
 
  Section 1. Time and Place. Meetings of stockholders for any purpose may be
held at such time and place, within or without the State of Delaware, as the
Board of Directors may fix from time to time and as shall be stated in the
notice of the meeting or in a duly executed waiver of notice thereof.
 
  Section 2. Annual Meeting. Annual meetings of stockholders shall be held on
any date in the month of September or October in each year at 9:00 a.m. or at
such other [time and such] date and time as shall be designated, from time to
time, by the Board of Directors and stated in the notice of the meeting. At
such annual meeting, the stockholders shall elect directors and transact such
other business as may properly be brought before the meeting in accordance
with Section 7 of this Article II.
 
  Section 3. Notice of Annual Meeting. Written notice of the annual meeting
stating the place, date and time thereof shall be given to each stockholder
entitled to vote at such meeting not less than 10 nor more than 60 days prior
to the meeting.
 
  Section 4. List of Stockholders. The officer in charge of the stock ledger
of the Corporation or the transfer agent shall prepare and make, at least 10
days before every meeting of stockholders, a complete list of the stockholders
entitled to vote at the meeting, arranged in alphabetical order, and showing
the address of each stockholder and the number of shares registered in the
name of each stockholder. Such list shall be open to the examination of any
stockholder for any purpose germane to the meeting, during ordinary business
hours, for a period of at least 10 days prior to the meeting either at a place
within the city where the meeting is to be held (other than the place of the
meeting), which place shall be specified in the notice of the meeting, or, if
not so specified, at the place where the meeting is to be held. The list shall
also be produced and kept at the time and place of the meeting during the
whole time thereof, and may be inspected by any stockholder who is present.
 
  Section 5. Notice of Special Meeting. Written notice of a special meeting
stating the place, date and time thereof and the purpose or purposes for which
the meeting is called, shall be given to each stockholder entitled to vote at
such meeting not less than 10 nor more than 60 days prior to the meeting.
 
                                      B-1
Section 6. Stockholder Proposals. To be properly brought before an annual
meeting, business must be (1) specified in the notice of meeting (or any
supplement thereto) given by or at the direction of the Board of Directors,
(2) otherwise properly brought before the meeting by or at the direction of
the Board of Directors or (3) otherwise properly brought before the meeting by
a stockholder entitled to vote thereon. For business to be properly brought
before an annual meeting by a stockholder, the stockholder must have given
timely notice thereof in writing to the Secretary of the Corporation. To be
timely, a stockholder's notice must be received not less than sixty days nor
more than ninety days prior to the first anniversary of the preceding year's
annual meeting; provided, however, that in the event that the date of the
annual meeting is advanced by more than thirty days or delayed by more than
sixty days from such anniversary, notice by the stockholder to be timely must
be so received not earlier than the ninetieth day prior to such annual meeting
and not later than the close of business on the later of (1) the sixtieth day
prior to such annual meeting or (2) the tenth day following the date on which
notice of the date of the annual meeting was mailed or public disclosure
thereof was made by the Corporation, whichever first occurs. For purposes of
calculating the first such notice period following adoption of this Restated
Certificate of Incorporation. the first anniversary of the 1997 annual meeting
shall be deemed to be    , 1998. Each such notice shall set forth as to each
matter the stockholder proposes to bring before the annual meeting: (a) a
brief description of the business desired to be brought before the annual
meeting and the reasons for conducting such business at the meeting, (b) the
name and address, as they appear on the Corporation's books, of the
stockholder proposing such business and the name and address of the beneficial
owner on whose behalf the proposal is being made, (c) the class, series and
number of shares of the Corporation which are beneficially owned by the
stockholder or by the beneficial owner on whose behalf the proposal is being
made, (d) any material interest of the stockholder, or the beneficial owner on
whose behalf the proposal is being made, in such business, (e) a
representation that the stockholder is a holder of record of stock of the
Corporation entitled to vote at such meeting and intends to appear in person
or by proxy at the meeting, and (f) a description of all arrangements or
understandings between the stockholder, the beneficial owner on whose behalf
the proposal is being made, or any other person or persons (naming such person
or persons) relating to the matter being proposed.
 
  To be properly brought before a special meeting, business must be (1)
specified in the notice of meeting (or any supplement thereto) given by or at
the direction of the Board of Directors or (ii) otherwise properly brought
before the meeting by or at the direction of the Board of Directors,
 
  No business shall be conducted at any meeting of the stockholders except in
accordance with the procedures set forth in this Article II, Section 6. The
presiding officer of the meeting shall, if the facts warrant, determine and
declare to the meeting that business was not properly brought before the
meeting and in accordance with the provisions of this Article II, Section 6
and if he or she should so determine, any such business not properly brought
before the meeting shall not be transacted. Nothing herein shall be deemed to
affect any rights of stockholders to request inclusion of proposals in the
Corporation's proxy statement pursuant to Rule 14a-8 under the Securities
Exchange Act of 1934, as amended (the "Exchange Act").
 
  Section 7. Presiding Officer. Meetings of stockholders shall be presided
over by the Chairman of the Board, or, if he is not present, by the Vice
Chairman, or, if he is not present, by the Chief Executive Officer, or if he
is not present, by the President or, if he is not present, by such person who
may have been chosen by the Board of Directors or, if none of such persons is
present, by a chairman to be chosen by the stockholders owning a majority of
the shares of capital stock of the Corporation issued and outstanding and
entitled to vote at the meeting and who are present in person or by proxy. The
Secretary of the Corporation or, if he is not present, an Assistant Secretary
or, if he is not present, such person who may have been chosen by the Board of
Directors, shall act as secretary of meetings of stockholders, but if none of
such persons is present the stockholders owning a majority of the Voting Power
of the Corporation and who are present in person or by proxy shall choose any
person present to act as secretary of the meeting. "Voting Power" means the
total number of votes that may be cast by holders of capital stock in the
election of directors.
 
  Section 8. Quorum. The holders of a majority of the Voting Power of the
Corporation, present in person or represented by proxy, shall be necessary to,
and shall constitute a quorum for, the transaction of business at
 
                                      B-2
all meetings of stockholders, except as otherwise provided by statute or by
the Certificate of Incorporation. If, however, a quorum shall not be present
in person or by proxy at any meeting of the stockholders, the stockholders
entitled to vote thereat, present in person or represented by proxy, shall
have the power to adjourn the meeting from time to time, without notice of the
adjourned meeting if the time and place thereof are announced at the meeting
at which the adjournment is taken, until a quorum shall be present in person
or by proxy. At any meeting of the stockholders, the stockholders entitled to
vote thereat, present in person or represented by proxy, shall have the power
to adjourn the meeting from time to time for good cause, without notice of the
adjourned meeting if the time and place thereof are announced at the meeting
at which the adjournment is taken. until a date which is not more than 30 days
after the date of the original meeting. At such adjourned meeting, at which a
quorum shall be present in person or by proxy, any business may be transacted
which might have been transacted at the meeting as originally called. If the
adjournment is for more than 30 days, or if after the adjournment a new record
date is fixed for the adjourned meeting, a notice of the adjourned meeting
shall be given to each stockholder of record entitled to vote at the meeting.
 
  Section 9. Voting.
 
    (a) At any meeting of stockholders, every stockholder having the right to
  vote shall be entitled to vote in person or by proxy. Except as otherwise
  provided by law or the Certificate of Incorporation or a resolution of the
  Board of Directors creating a series or class of capital stock of the
  Corporation, each stockholder of record shall be entitled to one vote for
  each share of capital stock registered in his name on the books of the
  Corporation.
 
    (b) All elections shall be determined by a plurality vote, and except as
  otherwise provided by law or the Certificate of Incorporation, all other
  matters shall be determined by a vote of a majority of the Voting Power
  present in person or by proxy and voting, on such other matters.
 
                                  ARTICLE III
 
                                   DIRECTORS
 
  Section 1. General Powers: Number: Tenure. The business of the Corporation
shall be managed by its Board of Directors, which may exercise all powers of
the Corporation and perform all lawful acts and things as are not by law, the
Certificate of Incorporation or these Bylaws directed or required to be
exercised or performed by the stockholders. The number of directors
constituting the whole Board of Directors shall be not less than 3 nor more
than 12. The first Board of Directors shall consist of 9 directors.
Thereafter, within the limits above specified, the number of directors shall
be determined by the Board of Directors. The directors shall be elected and
shall hold office as specified in the Certificate of Incorporation. Directors
need not be stockholders. Directors, other than Stewart Bainum, Sr., shall
retire from the Board of Directors as of the annual meeting of stockholders
next following the date they attain the age of seventy (70) years.
 
  Section 2. Nomination of Directors. Any stockholder entitled to vote in the
election of directors generally may nominate one or more persons for election
as directors at an annual meeting only pursuant to the Corporation's notice of
such meeting or if written notice of such stockholder's intent to make such
nomination or nominations has been received by the Secretary of the
Corporation not less than sixty nor more than ninety days prior to the first
anniversary of the preceding year's annual meeting; provided, however, that in
the event that the date of the annual meeting is advanced by more than thirty
days or delayed by more than sixty days from such anniversary, notice by the
stockholder to be timely must be so received not earlier than the ninetieth
day prior to such annual meeting and not later than the close of business on
the later of (1) the sixtieth day prior to such annual meeting or (2) the
tenth day following the day on which notice of the date of the annual meeting
was mailed or public disclosure thereof was made by the Corporation, whichever
first occurs. For purposes of calculating the first such notice period
following adoption of this Restated Certificate of Incorporation, the first
anniversary of the 1997 annual meeting, shall be deemed to be      1998. Each
such notice shall set forth: (a) the name and address of the stockholder who
intends to make the nomination and the name, age, business
 
                                      B-3
address, residence address and principal occupation of the person or persons
to be nominated; (b) a representation that the stockholder is a holder of
record of stock of the Corporation entitled to vote at such meeting and
intends to appear in person or by proxy at the meeting to nominate the person
or persons specified in the notice; (c) a description of all arrangements or
understandings between the stockholder and each nominee and any other person
or persons (naming, such person or persons) relating to the nomination or
nominations; (d) the class and number of shares of the Corporation which are
beneficially owned by such stockholder and the person to be nominated as of
the date of such stockholder's notice and by any other stockholders known by
such stockholder to be supporting such nominees as of the date of such
stockholder's notice; (e) such other information regarding each nominee
proposed by such stockholder as would be required to be included in a proxy
statement filed pursuant to the proxy rules of the Securities and Exchange
Commission: and (f) the consent of each nominee to serve as a director of the
Corporation if so elected.
 
  In addition, in the event the Corporation calls a special meeting of
stockholders for the purpose of electing one or more directors, any
stockholder entitled to vote in the election of directors generally may
nominate one or more persons for election as directors at a special meeting
only pursuant to the Corporation's notice of meeting or if written notice of
such stockholder's intent to make such nomination or nominations, setting
forth the information and complying with the form described in the immediately
preceding paragraph, has been received by the Secretary of the Corporation not
earlier than the ninetieth day prior to such special meeting and not later
than the close of business on the later of (i) the sixtieth day prior to such
special meeting or (ii) the tenth day following the day on which notice of the
date of the special meeting was mailed or public disclosure thereof was made
by the Corporation, whichever comes first.
 
  No person shall be eligible for election as a director of the Corporation
unless nominated in accordance with the procedures set forth in this Article
III, Section 2. The presiding officer of the meeting shall, if the facts
warrant, determine and declare to the meeting that a nomination was not made
in accordance with the procedures prescribed by this Article III, Section 2;
and if he or she should so determine, the defective nomination shall be
disregarded.
 
  Section 3. Vacancies: Resignations.
 
    (a) If any vacancies occur in the Board of Directors, or if any new
  directorships are created, they shall be filled solely by a majority of the
  directors then in office, whether or not less than a quorum. Each director
  so chosen shall hold office until the expiration of the term of the class
  into which such director was elected and until his successor is duly
  elected and qualified. If there are no directors in office a special
  meeting of stockholders shall be called in accordance with the provisions
  of the Certificate of Incorporation or these Bylaws, at which meeting such
  vacancies shall be filled.
 
    (b) Any director may resign at any time by giving written notice to the
  Board of Directors, the Chairman of the Board, the Chief Executive Officer,
  the President or the Secretary of the Corporation. Unless otherwise
  specified in such written notice, a resignation shall take effect upon
  delivery thereof to the Board of Directors or the designated officer. It
  shall not be necessary for a resignation to be accepted before it becomes
  effective.
 
  Section 4. Place of Meeting. The Board of Directors may hold meetings, both
regular and special, either within or without the State of Delaware.
 
  Section 5. First Meeting. The first regular meeting of each newly elected
Board of Directors shall be held immediately following the annual meeting of
stockholders and no notice of such meeting shall be necessary to the newly
elected directors in order legally to constitute the meeting, provided a
quorum shall be present.
 
  Section 6. Regular Meetings. Additional regular meetings of the Board of
Directors may be held without notice, at such time and place as may from time
to time be determined by the Board of Directors.
 
  Section 7. Special Meetings. Special meetings of the Board of Directors may
be called by the Chairman of the Board of Directors or, in the event of his
disability, by the Vice Chairman, on 2 days' notice to each
 
                                      B-4
director in accordance with Article V. Special meetings shall be called by the
Chairman of the Board, Vice Chairman, Chief Executive Officer, President or
Secretary in like manner and on like notice on the written request of 4
directors or one-half (1/2) of the number of directors. whichever is less.
 
  Section 8. Quorum. At all meetings of the Board of Directors one-half (1/2)
of the number of directors then in office, or such greater number as equals
one-third (1/3) of the total number of directors shall constitute a quorum
for the transaction of business and the act of a majority of the directors
present at any meeting at which there is a quorum shall be the act of the
Board of Directors, except as may be otherwise specifically provided by law or
the Certificate of Incorporation. If a quorum is not present at any meeting of
the Board of Directors, the directors present may adjourn the meeting, from
time to time, without notice other than announcement at the meeting, until a
quorum shall be present.
 
  Section 9. Compensation. Directors shall be entitled to such compensation
for their services as directors and to such reimbursement for any reasonable
expenses incurred in attending directors' meetings as may from time to time be
fixed by the Board of Directors. The compensation of directors may be on such
basis as is determined by the Board of Directors. Any director may waive
compensation for any meeting. Any director receiving compensation under these
provisions shall not be barred from serving the Corporation in any other
capacity and receiving reasonable compensation for such other services.
 
  Section 10. Action by Consent. Any action required or permitted to be taken
at any meeting of the Board of Directors may be taken without a meeting if a
written consent to such action is signed by all members of the Board of
Directors and such written consent is filed with the minutes of its
proceedings.
 
                                  ARTICLE IV
 
                                  COMMITTEES
 
  Section 1. Executive Committee. The Board of Directors may appoint Executive
Committee consisting of not less than    directors, one of whom shall be
designated as Chairman of the Executive Committee.
 
  Section 2. Powers. The Executive Committee shall have and may exercise those
powers of the Board of Directors as may from time to time be granted to it by
the Board of Directors.
 
  Section 3. Procedure, Meetings. The Executive Committee shall fix its own
rules of procedure and shall meet at such times and at such place or places as
may be provided by such rules. The Executive Committee shall keep regular
minutes of its meetings and deliver such minutes to the Board of Directors.
 
  The Chairman of the Executive Committee, or, in his absence, a member of the
Executive Committee chosen by a majority of the members present, shall preside
at meetings of the Executive Committee and another member thereof chosen by
the Executive Committee shall act as Secretary of the Executive Committee.
 
  Section 4. Quorum. A majority of the Executive Committee shall constitute a
quorum for the transaction of business, and the affirmative vote of a majority
of the members thereof shall be required for any action of the Executive
Committee.
 
  Section 5. Other Committees. The Board of Directors may appoint such other
committee or committees as it shall deem advisable and with such functions and
duties as the Board of Directors shall prescribe.
 
  Section 6. Vacancies: Changes: Discharge. The Board of Directors shall have
the power at any time to fill vacancies in, to change the membership of, and
to discharge, any such committee.
 
  Section 7. Compensation. Members of any committee shall be entitled to such
compensation for their services as members of any such committee and to such
reimbursement for any reasonable expenses incurred in attending committee
meetings as may from time to time be fixed by the Board of Directors. Any
member may waive compensation for any meeting.
 
                                      B-5
Section 8. Action by Consent. Any action required or permitted to be taken
at any meeting of any committee of the Board of Directors may be taken without
a meeting, if written consent to such action is signed by all members of the
committee and such written consent is filed with the minutes of its
proceedings.
 
                                   ARTICLE V
 
                                    NOTICES
 
  Section 1. Form; Delivery. Whenever, under the provisions of law, the
Certificate of Incorporation or these Bylaws, notice is required to be given
to any director or stockholder, it shall not be construed to mean personal
notice unless otherwise specifically provided, but such notice may be given by
regular or overnight mail, addressed to such director or stockholder at his or
her address as it appears on the records of the Corporation, with postage
thereon prepaid. Notices given by regular mail shall be deemed to be given at
the time they are deposited in the United States mail. Notice to a director
may also be given personally, by telegram sent to his address as it appears on
the records of the Corporation, by facsimile (with a machine generated
confirmation) or by telephone.
 
  Section 2. Waiver. Whenever any notice is required to be given under the
provisions of law, the Certificate of Incorporation or these Bylaws, a written
waiver thereof signed by the person or persons entitled to said notice,
whether before or after the time stated therein, shall be deemed to be
equivalent to such notice. In addition, any stockholder who attends a meeting
of stockholders in person, or is represented at such meeting by proxy, without
protesting prior to the conclusion of the meeting the lack of notice thereof
to him, or any director who attends a meeting of the Board of Directors
without protesting, prior to the commencement of the meeting such lack of
notice, shall be conclusively deemed to have waived notice of such meeting.
 
                                  ARTICLE VI
 
                                   OFFICERS
 
  Section 1. Designations. The officers of the Corporation shall be chosen by
the Board of Directors and shall be a Chairman of the Board, Vice Chairman of
the Board, a Chief Executive Officer, a President, a Secretary and a
Treasurer. The Board of Directors may also choose one or more Executive or
Senior Vice Presidents, one or more additional vice presidents, one or more
assistant secretaries and assistant treasurers, and such other officers and
agents as it shall deem necessary. All officers of the Corporation shall hold
their offices for such terms and shall exercise such powers and perform such
duties as shall from time to time be determined by the Board of Directors. Any
number of offices may be held by the same person, unless the Certificate of
Incorporation or these Bylaws otherwise provide.
 
  Section 2. Term of Office, Removal. The Board of Directors at its first
meeting after each annual meeting of stockholders shall choose a Chairman, a
Vice Chairman, a Chief Executive Officer, a President, a Secretary and a
Treasurer and such other officers as the Board of Directors shall deem
appropriate. The officers of the Corporation shall hold office until their
successors are chosen and shall qualify. Any officer elected or appointed by
the Board of Directors may be removed, with or without cause, at any time by
the affirmative vote of a majority of the directors then in office. Such
removal shall not prejudice the contract rights, if any, of the person so
removed. Any vacancy occurring in any office of the Corporation may be filled
by the Board of Directors.
 
  Section 3. Compensation. The salaries of all officers of the Corporation
shall be fixed by the Board of Directors.
 
  Section 4. The Chairman of the Board.
 
    (a) The Chairman of the Board shall have general direction of the
  business affairs of the Corporation, subject to the control of the Board of
  Directors. The Chairman shall preside at all meetings of stockholders
 
                                      B-6
and the Board of Directors which he shall attend. Except where, by law, the
  signature of the President is required, the Chairman shall possess the same
  power as the President to execute all certificates, contracts, bonds,
  mortgages and other instruments of the Corporation.
 
    (b) Unless otherwise prescribed by the Board of Directors, the Chairman
  shall have full power and authority on behalf of the Corporation to attend,
  act and vote at any meeting of security holders of other corporations in
  which the Corporation may hold securities. At such meeting, the Chairman
  shall possess and may exercise any and all rights and powers incident to
  the ownership of such securities which the Corporation might have possessed
  and exercised if it had been present. The Board of Directors may from time
  to time confer like powers upon any other person or persons.
 
  Section 5. Vice Chairman. The Vice Chairman shall, in the absence of the
Chairman of the Board or in the event of his disability, preside at all
meetings of the Board of Directors and stockholders and perform the duties and
exercise the powers of the Chairman of the Board and shall perform such other
duties and have such other powers as may from time to time be prescribed by
the Board of Directors.
 
  Section 6. Chief Executive Officer. The Chief Executive Officer shall be the
chief administrator of the Corporation and shall have general direction of
administration of the business affairs of the Corporation, subject to the
direction of the Board of Directors, and shall perform such other duties and
have such other powers as may from time to time be prescribed by the Board of
Directors.
 
  Section 7. The President. The President shall be the chief operations
officer of the Corporation and shall have general direction of the operation
of the Corporation, subject to the direction of the Chief Executive Officer
and the Board of Directors, and shall perform such other duties and shall have
such other powers as may from time to time be prescribed by the Board of
Directors.
 
  Section 8. The Vice Presidents. The Vice President (or in the event there by
more than one, the Vice Presidents in the order designated, or in the absence
of any designation, then in order of their election) shall, in the absence of
the President or in the event of his disability, perform the duties and
exercise the powers of the President and shall generally assist the President
and perform such other duties and have such other powers as may from time to
time be prescribed by the Board of Directors.
 
  Section 9. The Secretary. The Secretary shall attend all meetings of the
Board of Directors and all meetings of stockholders and record all votes and
the proceedings of the meetings in a book to be kept for that purpose and
shall perform like duties for the Executive Committee or other committees, if
required. He shall give, or cause to be given, notice of all meetings of
stockholders and special meetings of the Board of Directors, and shall perform
such other duties as may from time to time be prescribed by the Board of
Directors, the Chairman of the Board or the President, under whose supervision
he shall act. He shall have custody of the seal of the Corporation and he, or
an Assistant Secretary, shall have authority to affix the same to any
instrument requiring it and, when so affixed, the seal may be attested by his
signature or by the signature of such Assistant Secretary. The Board of
Directors may give general authority to any other officer to affix the seal of
the Corporation and to attest the affixing thereof by his signature.
 
  Section 10. The Assistant Secretary. The Assistant Secretary (or in the
event there be more than one, the Assistant Secretaries in the order
designated, or in the absence of any designation, then in the order of their
election) shall, in the absence of the Secretary or in the event of his
disability, perform the duties and exercise the powers of the Secretary and
shall perform such other duties and have such other powers as may from time to
time be prescribed by the Board of Directors.
 
  Section 11. The Treasurer. The Treasurer shall have the custody of the
corporate funds and other valuable effects, including securities, and shall
keep full and accurate accounts of receipts and disbursements in books
belonging to the Corporation and shall deposit all moneys and other valuable
effects in the name and to the credit of the Corporation in such depositories
as may from time to time be designated by the Board of Directors. He shall
disburse the funds of the Corporation as may be ordered by the Board of
Directors, taking
 
                                      B-7
proper vouchers for such disbursements, and shall render to the Chairman of
the Board or the President, and the Board of Directors at regular meetings of
the Board, or whenever they may require it, an account of all of his
transactions as Treasurer and of the financial condition of the Corporation.
 
  Section 12. The Assistant Treasurer. The Assistant Treasurer (or in the
event there be more than one, the Assistant Treasurers in the order
designated, or in the absence of any designation, then in the order of their
election) shall, in the absence of the Treasurer or in the event of his
disability, perform the duties and exercise the powers of the Treasurer and
shall perform such other duties and have such other powers as may from time to
time be prescribed by the Board of Directors.
 
                                  ARTICLE VII
 
         INDEMNIFICATION OF OFFICERS, DIRECTORS, EMPLOYEES AND AGENTS
 
  Section 1. Action Other Than by or in the Right of the Corporation. The
Corporation shall indemnify any person who was or is a party or is threatened
to be made a party, to any threatened, pending or completed action, suit or
proceeding or investigation, whether civil, criminal or administrative, and
whether external or internal to the Corporation (other than a judicial action
or suit brought by or in the right of the Corporation) by reason of the fact
that he is or was a director, officer, employee or agent of the Corporation,
or that, being or having been such a director, officer, employee or agent, he
is or was serving at the request of the Corporation as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise (all such persons being referred to hereafter as an "Agent"),
against expenses (including attorneys' fees), judgments, fines and amounts
paid in settlement actually and reasonably incurred by him or her in
connection with such action, suit or proceeding, or any appeal thereof, if he
or she acted in good faith and in a manner he or she reasonably believed to be
in or not opposed to the best interests of the Corporation, and with respect
to any criminal action or proceeding, had no reasonable cause to believe his
or her conduct was unlawful. The termination of any action, suit or
proceeding--whether by judgment, order, settlement, conviction, or upon a plea
of nolo contendere or its equivalent -- shall not, of itself, create a
presumption that the person did not act in good faith and in manner which he
or she reasonably believed to be in or not opposed to the best interests of
the Corporation, or, with respect to any criminal action or proceeding, that
he or she had reasonable cause to believe that his or her conduct was
unlawful.
 
  Section 2. Action by or in the Right of the Corporation. The Corporation
shall indemnify any person who was or is a party or is threatened to be made a
party to any threatened, pending or completed juridical action or suit brought
by or in the right of the Corporation to procure a judgment in its favor by
reason of the fact that he or she is or was an Agent (as defined above)
against expenses (including attorneys' fees) actually and reasonably incurred
by him or her in connection with the defense, settlement or appeal of such
action or suit if he or she acted in good faith and in a manner he or she
reasonably believed to be in or not opposed to the best interests of the
Corporation, except that no indemnification shall be made in respect of any
claim, issue or matter as to which such person shall have been adjudged to be
liable for gross negligence or misconduct in the performance of his or her
duty to the Corporation unless and only to extent that the Court of Chancery
or the court in which such action or suit was brought shall have determined
upon application that, despite the adjudication of liability but in view of
all the circumstances of the case, such person is fairly and reasonably
entitled to indemnity for such expenses which the Court of Chancery or other
such court shall deem proper.
 
  Section 3. Determination of Right of Indemnification. No indemnification
under Section 1 or 2 of this Article VII (unless ordered by a court) shall be
made by the Corporation if a determination is reasonably and promptly made (i)
by the Board of Directors by a majority vote consisting of directors who were
not parties to such action, suit or proceeding, even though less than a quorum
or (ii) if there are no such directors or if such directors so direct, by
independent legal counsel in a written opinion, or (iii) by the stockholders.
that such person did not act in good faith and in a manner that such person
reasonably believed to be in or not opposed to the best interests of the
Corporation, or, with respect to any criminal proceeding, that such person
believed or had reasonable cause to believe that his or her conduct was
unlawful.
 
 
                                      B-8
Section 4. Indemnification Against Expenses of Successful
Party. Notwithstanding the other provisions of this Article, to the extent
that an Agent has been successful on the merits or otherwise, including the
dismissal of an action without prejudice or the settlement of an action
without admission of liability, in defense of any action, suit or proceeding
or in defense of any, claim, issue or matter therein, or on appeal from any
such proceeding, action, claim or matter, such Agent shall be indemnified
against all expenses actually and reasonably incurred in connection therewith.
 
  Section 5. Advances of Expenses. Except as limited by Section 6 of this
Article, expenses incurred in defending any civil, criminal, administrative or
investigative action, suit or proceeding or investigation or any appeal
therein shall be paid by the Corporation in advance of the final disposition
of such matter, if the Agent shall undertake to repay such amount in the event
that it is ultimately determined, as provided herein, that such person is not
entitled to indemnification. Notwithstanding the foregoing, no advance shall
be made by the Corporation if a determination is reasonably and promptly made
by the Board of Directors by a majority vote of disinterested directors, or
(if there are no such directors or such directors so direct) by independent
legal counsel in a written opinion, that, based upon the facts known to the
Board or counsel at the time such determination is made, such person did not
act in good faith and in a manner that such person believed to be in or not
opposed to the best interests of the Corporation, or, with respect to any
criminal proceeding, that such person believed or had reasonable cause to
believe his or her conduct was unlawful. In no event shall any advance be made
in instances where the Board of Directors or independent legal counsel
reasonably determines that such person deliberately breached his duty to the
Corporation or its shareholders.
 
  Section 6. Right of Agent to Indemnification Upon Application; Procedure
Upon Application. Any indemnification under Sections 1, 2, or 4. or advance
under Section 5 of this Article, shall be made promptly, and in any event
within ninety days, upon the written request of the Agent, unless with respect
to applications under Sections 1, 2 or 5, a determination is reasonably and
promptly be made by the Board of Directors by a majority vote of disinterested
directors that such Agent acted in a manner set forth in such Sections as to
justify the Corporation's not indemnifying or making an advance to the Agent.
In the event there are no such disinterested directors, the Board of Directors
shall promptly direct that independent legal counsel shall decide whether the
Agent acted in the manner set forth in such Sections as to justify the
Corporation's not indemnifying or making an advance to the Agent. The right to
indemnification or advances as granted by this Article shall be enforceable by
the Agent in any court of competent jurisdiction, if the Board or independent
legal counsel denies the claim, in whole or in part, or if no disposition of
such claim is made within ninety days. The Agent's expenses incurred in
connection with successfully establishing his right to indemnification, in
whole or in part, in any such proceeding shall also be indemnified by the
Corporation.
 
  Section 7. Contribution. In order to provide for just and equitable
contribution in circumstances in which the indemnification provided for in
this Article is held by a court of competent jurisdiction to be unavailable to
an indemnitee in whole or part, the Corporation, shall, in such an event,
after taking into account, among other things, contributions by other
directors and officers of the Corporation pursuant to indemnification
agreements or otherwise, and in the absence of personal enrichment, acts of
intentional fraud or dishonesty or criminal conduct on the part of the Agent,
contribute to the payment of Agent's losses to the extent that, after other
contributions are taken into account, such losses exceed: (i) in the case of a
director of the Corporation or any of its subsidiaries who is not an officer
of the Corporation or any of such subsidiaries, the amount of fees paid to him
or her for serving as a director during the 12 months preceding the
commencement of the suit, proceeding, or investigation; or (ii) in the case of
a director of the Corporation or any of its subsidiaries who is also an
officer of the Corporation or any of such Subsidiaries, the amount set forth
in clause (i) plus 5% of the aggregate cash compensation paid to said director
for such office(s) during the 12 months preceding the commencement of the
suit, proceeding, or investigation; or (iii) in the case of an officer of the
Corporation or any of its subsidiaries, 5% of the aggregate cash compensation
paid to such officer for service in such office(s) during the 12 months
preceding the commencement of such suit, proceeding or investigation.
 
  Section 8. Other Rights and Remedies. The indemnification provided by this
Article shall not be deemed exclusive of, and shall not affect, any other
rights to which an Agent seeking indemnification may be
 
                                      B-9
entitled under any Bylaws, agreement, vote of stockholders or disinterested
directors or otherwise, both as to action in his official capacity and as to
action in another capacity while holding such office, and shall continue as to
a person who has ceased to be an Agent and shall inure to the benefit of the
heirs, executors and administrators of such a person. All rights to
indemnification under this Article shall be deemed to be provided by a
contract between the Corporation and the Agent who serves in such capacity, at
any time while these Bylaws and other relevant provisions of the General
Corporation Law and other applicable law, if any, are in effect. Any repeal or
modification thereof shall not affect any rights or obligations then existing.
 
  Section 9. Insurance. Upon resolution passed by the Board, the Corporation
may purchase and maintain insurance on behalf of any person who is or was an
Agent against any liability asserted against him and incurred by him in any
such capacity, or arising out of his status as such, whether or not the
Corporation would have the power to indemnify him against such liability under
the provisions of this Article. The Corporation may create a trust fund, grant
a security interest or use other means (including, without limitation, a
letter of credit) to ensure the payment of such sums as may become necessary
to effect indemnification as provided herein.
 
  Section 10. Constituent Corporations. For the purposes of this Article,
references to "the Corporation" include all constituent corporations absorbed
in a consolidation or merger as well as the resulting or surviving
corporation, so that any person who is or was a director, officer, employee,
or trustee of such a constituent corporation or who, being or having been such
a director, officer, employee or trustee, is or was serving at the request of
such constituent corporation as a director, officer, employee, trustee of
another corporation, partnership, joint venture, trust or other enterprise
shall stand in the same position under the provisions of this Article with
respect to the resulting or surviving corporation as he would if he had served
the resulting or surviving corporation in the same capacity.
 
  Section 11. Other Enterprises, Fines, and Serving at Corporation's
Request. References to "other enterprises" in Sections 1, 7 and 10 shall
include employee benefit plans; references to "fines" shall include any excise
taxes assessed on a person with respect to any employee benefit plan; and
references to "serving at the request of the Corporation" shall include any
service by Agent as director, officer, employee, trustee or agent of the
Corporation which imposes duties on, or involves services by, such Agent with
respect to any employee benefit plan, its participants, or beneficiaries; and
a person who acted in good faith and in a manner he reasonably believed to be
in the interests of the participants and beneficiaries of an employee benefit
plan shall be deemed to have acted in a manner "not opposed to the best
interests of the Corporation" as referred to in this Article.
 
  Section 12. Savings Clause. If this Article or any portion thereof shall be
invalidated on any ground by any court of competent jurisdiction, then the
Corporation shall nevertheless indemnify each Agent as to expenses (including
attorneys' fees), judgments, fines and amounts paid in settlement with respect
to any action, suit, appeal, proceeding or investigation, whether civil,
criminal or administrative, and whether internal or external, including a
grand jury proceeding and an action or suit brought by or in the right of the
Corporation, to the full extent permitted by any applicable portion of this
Article that shall not have been invalidated, or by any other applicable law.
 
                                 ARTICLE VIII
 
                              STOCK CERTIFICATES
 
  Section 1. Form: Signatures.
 
    (a) Every holder of stock in the Corporation shall be entitled to have a
  certificate, signed by the Chairman of the Board or the Chief Executive
  Officer and the Treasurer or an Assistant Treasurer or the Secretary or an
  Assistant Secretary of the Corporation, exhibiting the number, and class
  (and series, if any), of shares owned by him, and bearing the seal of the
  Corporation. Such seal may be a facsimile. Where a certificate is manually
  signed (i) by a transfer agent other than the Corporation or its employee
  or (ii) by a registrar other than the Corporation or its employee, the
  signature of any such officer may be a facsimile. In case any officer who
  has signed, or whose facsimile signature was placed on, a certificate shall
  have ceased to be such officer before such certificate is issued, it may
  nevertheless be issued by the Corporation with the same effect as if he
  were such officer at the date of its issue.
 
                                     B-10
(b) All stock certificates representing shares of capital stock which are
  subject to restrictions on transfer or to other restrictions, may have
  imprinted thereon a notation to such effect, as shall be determined by the
  Board of Directors.
 
  Section 2. Registration of Transfer. Upon surrender to the Corporation or
any transfer agent of the Corporation of a certificate for shares duly
endorsed or accompanied by proper evidence of succession, assignment or
authority to transfer, it shall be the duty of the Corporation or its transfer
agent to issue a new certificate to the person entitled thereto, to cancel the
old certificate and to record the transaction upon its books.
 
  Section 3. Registered Stockholders.
 
    (a) Except as otherwise provided by law, the Corporation shall be
  entitled to recognize the exclusive right of a person who is registered on
  its books as the owner of shares of capital stock to receive dividends or
  other distributions and to vote as such owner, and to hold liable for calls
  and assessments a person who is registered on its books as the owner of
  shares of its capital stock. The Corporation shall not be bound to
  recognize any equitable or legal claim to or interest in such shares on the
  part of any other person.
 
    (b) Stockholders are responsible for giving written notice to the
  Corporation or the transfer agent and registrar, if any, of any change of
  name or address, and failure to do so shall relieve the Corporation, its
  directors, officers and agents, and its transfer agent and registrar, if
  any, of liability for failure to send notices or pay dividends or other
  distributions to a name or address other than the name or address appearing
  on the stock ledger maintained by the Corporation or by the transfer agent
  and registrar, if any.
 
  Section 4. Lost, Stolen or Destroyed Certificates. The Board of Directors
may direct a new certificate to be issued in place of any certificate
theretofore issued by the Corporation which is claimed to have been lost,
stolen or destroyed, upon the making of an affidavit of that fact by the
person claiming the certificate of stock to be lost, stolen or destroyed. When
authorizing such issue of a new certificate, the Board of Directors may, in
its discretion and as a condition precedent to the issuance thereof, require
the owner of such lost. stolen or destroyed certificate. or his legal
representative, to advertise the same in such manner as it shall require
and/or to give the Corporation a bond in such sum as it may direct as
indemnity against any claim that may be made against the Corporation with
respect to the certificate claimed to have been lost, stolen or destroyed.
 
                                  ARTICLE IX
 
                              GENERAL PROVISIONS
 
  Section 1. Dividends. Subject to the provisions of the Certificate of
Incorporation, dividends upon the outstanding capital stock of the Corporation
may be declared by the Board of Directors at any regular or special meeting,
pursuant to law, and may be paid in cash, in property, or in shares of the
Corporation's capital stock.
 
  Section 2. Reserves. The Board of Directors shall have full power, subject
to the provisions of law and the Certificate of Incorporation, to determine
whether any, and, if so, what part, of the funds legally available for the
payment of dividends shall be declared as dividends and paid to the
stockholders of the Corporation. The Board of Directors may fix a sum which
may be set aside or reserved over and above the paid-in capital of the
Corporation for working capital or as a reserve for any proper purpose, and
may, from time to time, increase or diminish any such fund in its absolute
judgment and discretion.
 
  Section 3. Fiscal Year. The fiscal year of the Corporation shall begin on
January 1 in each calendar year and end on December 31 in that calendar year.
 
  Section 4. Seal. The corporate seal shall have inscribed thereon the name of
the Corporation, the year of its incorporation and the words "Corporate Seal,
Delaware."
 
                                     B-11
ANNEX C
 
                        CHOICE HOTELS FRANCHISING, INC.
 
                         1997 LONG-TERM INCENTIVE PLAN
 
                                  SECTION ONE
 
                        Designation and Purpose of Plan
 
  The purpose of the Choice Hotels Franchising, Inc. 1997 Long-Term Incentive
Plan (the "Plan") is to increase the ownership of Company Stock by those
officers, professional staff and other key employees who are mainly
responsible for the continued growth and development and financial success of
the Company and its subsidiaries. Such stock ownership gives such employees a
proprietary interest in the Company which induces them to continue in its
employ. The Plan also enables the Company to attract and retain such employees
and reward them for the continued profitable performance of Choice Hotels
Franchising, Inc.
 
                                  SECTION TWO
 
                                  Definitions
 
  The following definitions are applicable herein:
 
  A. "Award"--Individually or collectively, Options, Stock Appreciation
Rights, Performance Shares or Restricted Stock granted hereunder.
 
  B. "Award Period"--the period of time during which a Stock Appreciation
Right which has not been granted pursuant to an Option may be exercised. The
Award Period shall be set forth in the document issuing the Stock Appreciation
Right to the selected Eligible Employee.
 
  C. "Board"--the Board of Directors of the Company.
 
  D. "Book Value"--the book value of a share of Stock determined in accordance
with the Company's regular accounting practices as of the last business day of
the month immediately preceding the month in which a Stock Appreciation Right
is exercised as provided in Section Nine D.
 
  E. "Code"--the Internal Revenue Code of 1986, as amended. Reference in the
Plan to any section of the Code shall be deemed to include any amendments or
successor provisions to such section and any regulations promulgated
thereunder.
 
  F. "Committee"--the Key Executive Stock Option Plan Committee appointed to
administer the Plan pursuant to Section Four. "If two or more Key Executive
Stock Option Plan Committees are appointed with the power to grant Awards to
different classes of employees, references in this Plan to the "Committee'
shall refer to the Key Executive Stock Option Plan Committee administering the
portion of the Plan pertaining to Awards to the applicable class of
employees."
 
  G. "Company"--Choice Hotels Franchising, Inc., including any present or
future "subsidiary corporation" as such term is defined in Section 424(f) of
the 1986 Internal Revenue Code, as amended.
 
  H. "Covered Employee"--an individual described in Section 162(m)(3) of the
Code.
 
  I. "Date of Grant"--the date on which the granting of an Award is authorized
by the Committee or such later date as may be specified by the Committee in
such authorization.
 
  J. "Eligible Employee"--any person employed by the Company or a Subsidiary
on a regularly scheduled basis who satisfies all of the requirements of
Section Six.
 
                                      C-1
K. "Exercise Period"--the period or periods during which a Stock
Appreciation Right is exercisable as described in Section Nine B.
 
  L. "Fair Market Value"--the fair market value of the Stock as determined in
accordance with Section Eight D.
 
  M. "Incentive Stock Option"--an incentive stock option within the meaning of
Section 422 of the Code.
 
  N. "Option" or "Stock Option"--either a nonqualified stock option or an
Incentive Stock Option granted under Section Eight. It also means any Option
which remains after a Participant has exercised his Option with respect to
part of the shares covered by a Stock Option Agreement as described in Section
Eight B.
 
  O. "Option Period" or "Option Periods"--the period or periods during which
an Option is exercisable as described in Section Eight E.
 
  P. "Option Price"--the price, expressed on a per share basis, for which the
Company Stock can be acquired by the holder of an Option pursuant to the
exercise of such Option.
 
  Q. "Participant"--an Eligible Employee of the Company or a Subsidiary who
has been granted an Option, a Stock Appreciation Right, a Performance Share
Award or a Restricted Stock Award under this Plan.
 
  R. "Performance Share"--an Award granted under Section Ten.
 
  S. "Restricted Stock"--an Award granted under Section Seven.
 
  T. "Stock" and "Company Stock"--the common stock of the Company.
 
  U. "Stock Appreciation Right"--an Award granted under Section Nine.
 
  V. "Subsidiary"--any corporation of which fifty percent (50%) or more of its
outstanding voting stock or voting power is beneficially owned, directly or
indirectly, by the Company.
 
  W. "Ten Percent Shareholder"--a Participant who, at the Date of Grant, owns
directly or indirectly (within the meaning of Section 424(d) of the Internal
Revenue Code) stock possessing more then ten percent (10%) of the total
combined voting power of all classes of stock of the Company or a subsidiary
thereof.
 
  X. Wherever appropriate, words used in this Plan in the singular may mean
the plural, the plural may mean the singular and the masculine may mean the
feminine.
 
                                 SECTION THREE
 
               Effective Date, Duration and Stockholder Approval
 
  A. Effective Date and Stockholder Approval. Subject to the approval of the
Plan by a majority of the outstanding shares of Stock, the Plan shall be
effective as of [   ], 1997.
 
  B. Period for Grant of Awards. Awards may be made as provided herein for a
period of ten (10) years after [   ],1997.
 
                                 SECTION FOUR
 
                                Administration
 
  A. Appointment of Committee. The Board of Directors shall appoint one or
more Key Executive Stock Option Plan Committees which shall consist of not
less than two (2) members of such Board of Directors and
 
 
                                      C-2
which members shall be Non-Employee Directors as defined in Rule 16b-3 under
the Securities Exchange Act of 1934, as amended (or such greater number of
members which may be required by said Rule 16b-3). In addition, such Board of
Directors shall designate a member of the Committee to act as Chairman of the
Committee, and such Board of Directors may remove any member of the Committee
at any time and appoint any director to fill any vacancy on the Committee.
 
  B. Committee Meetings. The Committee shall hold its meetings at such times
and places as specified by the Committee Chairman. A majority of the Committee
shall constitute a quorum. All actions of the Committee shall be taken by all
of the members of the meeting duly called by its Chairman; provided, however,
any action taken by a written document signed by a majority of the members of
the Committee shall be as effective as action taken by the Committee at a
meeting duly called and held.
 
  C. Committee Powers. Subject to the provisions of this Plan, the Committee
shall have full authority in its discretion to (i) designate the Participants
to whom Awards shall be granted, (ii) determine the number of shares to be
made available under each such Award, (iii) determine the period or periods in
which the Participant may exercise such Award, (iv) determine the date when
such Award expires, (v) determine the price for Stock under such Award, and
(vi) determine the grounds of forfeiture of an Award. The Committee shall have
all powers necessary to administer the Plan in accordance with its terms,
including the power to interpret this Plan and resolve all questions arising
thereunder. The Committee may prescribe such rules and regulations for
administering this Plan as the Committee deems appropriate.
 
                                 SECTION FIVE
 
                              Grant of Awards and
                Limitation of Number of Shares Subject to Award
 
  The Committee may, from time to time, grant Awards to one or more Eligible
Employees, provided that (i) subject to any adjustment pursuant to Section
Eleven, the aggregate number of shares of Stock subject to Stock Options,
Stock Appreciation Rights, Performance Share Awards or Restricted Stock Awards
under this Plan may not exceed 7,100,000 shares; (ii) to the extent that a
Stock Option, Stock Appreciation Right, Performance Share Award or Restricted
Stock Award lapses or the rights of the Participant to whom it was granted
terminate, expire or are cancelled for any other reason, in whole or in part,
shares of Stock (or remaining shares) subject to such Award shall again be
available for the grant of an Award under the Plan; and (iii) Shares delivered
by the Company under the Plan may be authorized and unissued Stock, Stock held
in the treasury of the Company or Stock purchased on the open market
(including private purchases) in accordance with applicable securities laws.
In determining the size of Awards, the Committee shall take into account the
responsibility level, performance, potential, and cash compensation level of a
Participant, and the Fair Market Value of the Stock at the time of Awards, as
well as such other considerations it deems appropriate.
 
                                  SECTION SIX
 
                                  Eligibility
 
  Key employees of the Company and its Subsidiaries (including employees who
are members of the Board, but excluding directors who are not employees) who,
in the opinion of the Committee, are mainly responsible for the continued
growth and development and financial success of the business of the Company or
one or more of its Subsidiaries shall be eligible to be granted Awards under
the Plan. Subject to the provisions of the Plan, the Committee may from time
to time select from such eligible persons those to whom Awards shall be
granted and determine the nature and amount of each Award. No employee of the
Company or its Subsidiaries shall have any right to be granted an Award under
this Plan. A member of the Committee shall not be eligible for any Award
hereunder.
 
                                      C-3
Notwithstanding any provision to the contrary contained herein, Options
shall be granted under this Plan to persons, including without limitation,
employees of Manor Care, Inc., its subsidiaries, and affiliated companies in
substitution for prior Options under plans of Manor Care, Inc. in accordance
with the terms of the Employee Benefits and other Employee Matters Allocation
Agreement between Manor Care, Inc. and the Company.
 
                                 SECTION SEVEN
 
                            Restricted Stock Awards
 
  A. Grants of Shares of Restricted Stock. An Award made pursuant to this
Section Seven shall be granted in the form of shares of Stock, restricted as
provided in this Section Seven. Shares of the Restricted Stock shall be issued
to the Participant without the payment of consideration by the Participant.
The shares of Restricted Stock shall be issued in the name of the Participant
and shall bear a restrictive legend prohibiting sale, transfer, pledge or
hypothecation of the shares of Restricted Stock until the expiration of the
restriction period.
 
  The Committee may also impose such other restrictions and conditions on the
shares of Restricted Stock as it deems appropriate.
 
  B. Restriction Period. At the time a Restricted Stock Award is made, the
Committee may establish a restriction period applicable to such Award which
shall not be more than ten (10) years. Each Restricted Stock Award may have a
different restriction period, at the discretion of the Committee. In addition
to or in lieu of a restriction period, the Committee may establish a
performance goal which must be achieved as a condition to the retention of the
Restricted Stock. The performance goal may be based on the attainment of
specified types of performance measurement criteria, which may differ as to
various Participants or classes or categories of Participants. Such criteria
may include, without limitation, the attainment of certain performance levels
by the individual Participant, the Company, a department or division of the
Company and/or a group or class of participants. Any such performance goals,
together with the ranges of Restricted Stock Awards for which the Participants
may be eligible shall be set from time to time by the Committee and shall be
timely communicated to the Eligible Employees in advance of the commencement
of the performance of services to which such performance goals relate. The
total number of shares of Restricted Stock which may be granted to any single
Covered Employee under this Plan during any calendar year shall be limited to
100,000.
 
  C. Forfeiture or Payout of Award. In the event a Participant ceases
employment during a restriction period, or in the event performance goals
attributable to a Restricted Stock Award are not achieved, subject to the
terms of each particular Restricted Stock Award, and subject to discretionary
action by the Committee as set forth below in Section Thirteen, a Restricted
Stock Award is subject to forfeiture of the shares of stock which had not
previously been removed from restriction under the terms of the Award.
 
  Any shares of Restricted Stock which are forfeited will be transferred to
the Company.
 
  Upon completion of the restriction period and satisfaction of any
performance-goal criteria, all restrictions upon the Award will expire and new
certificates representing the Award will be issued without the restrictive
legend described in Section Seven A. As a condition precedent to receipt of
the new certificates, the Participant (or the designated beneficiary or
personal representative of the Participant) will agree to make payment to the
Company in the amount of any taxes, payable by the Participant, which are
required to be withheld with respect to such shares of Stock.
 
                                 SECTION EIGHT
 
                                 Stock Options
 
  A. Grant of Option. One or more Options may be granted to any Eligible
Employee. Upon the grant of an Option to an Employee, the Committee shall
specify whether the Option is intended to constitute a non-
 
                                      C-4
qualified stock option or an Incentive Stock Option. The total number of
shares of Stock subject to Options which may be granted to any single Covered
Employee under this Plan during any calendar year shall be limited to 100,000.
 
  B. Stock Option Agreement. Each Option granted under the Plan shall be
evidenced by a written "Stock Option Agreement" between the Company and the
Participant containing such terms and conditions as the Committee determines,
including, without limitation, provisions to qualify Incentive Stock Options
as such under Section 422 of the Code. Such agreements shall incorporate the
provisions of this Plan by reference. The date of granting an Option is the
date specified in the written Stock Option Agreement which is signed by the
Participant and the Company.
 
  C. Determination of Option Price. The Option price for Stock shall be not
less than 100% of the fair market value of the Stock on the date of grant.
Notwithstanding the foregoing, in the case of an Option which is designed to
qualify as an Incentive Stock Option (as defined in Section 422 of the Code)
which is granted to a Ten Percent Shareholder, the Option Price shall not be
less than 110% of such fair market value.
 
  D. Determination of Fair Market Value. The fair market value of the Stock on
the date of granting an Option shall be the mean of the high and low prices at
which the Stock was sold on the market on such date. In the event no such
sales of Stock occurred on such date, the fair market value of the Stock shall
be determined by the Committee in accordance with applicable Regulations of
the Internal Revenue Service.
 
  E. Term of Option. The term of an Option may vary within the Committee's
discretion; provided, however, that the term of an Option shall not exceed ten
(10) years from the date of granting the Option to the Participant, and, to
this end, all Options granted pursuant to this Plan must provide that each
such Option cannot be exercised after the expiration of ten (10) years from
the date each such Option is granted. Notwithstanding the foregoing, in the
case of any Option which is designed to qualify as an Incentive Stock Option
(as defined in Section 422 of the Code) which is granted to a Ten Percent
Shareholder, the term of such Option may not exceed five (5) years from the
date of grant of such Option.
 
  F. Limitation on Exercise of Option. The Committee may limit an Option by
restricting its exercise in whole or in part for specified periods.
 
  G. Method of Exercising an Option. Subject to the terms of a particular
Option, a Participant may exercise it in whole or in part by written notice to
the Secretary of the Company stating in such written notice the number of
shares of Stock such Participant elects to purchase under his Option.
 
  H. No Obligation to Exercise Option. A Participant is under no obligation to
exercise an Option or any part thereof.
 
  I. Payment for Option Stock. Stock purchased pursuant to an Option shall be
paid in full at the time of purchase. Payment may be made (a) in cash, (b)
with the approval of the Committee, by delivery to the Company of shares of
Stock having an aggregate fair market value equal to the exercise price, or
(c) a combination of (a) and (b). Payment may also be made, in the discretion
of the Committee, by delivery (including by facsimile transmission) to the
Company or its designated agent of an executed irrevocable Option exercise
form together with irrevocable instructions to a broker-dealer to sell (or
margin) a sufficient portion of the shares and deliver the sale (or margin
loan) proceeds directly to the Company to pay for the exercise price. Upon
receipt of payment and subject to paragraph J of this Section Eight, the
Company shall, without transfer or issue tax to the Participant or other
person entitled to exercise the Option, deliver to the Participant (or other
person entitled to exercise the Option) a certificate or certificates for such
shares.
 
  J. Delivery of Stock to Participant. The Company shall undertake and follow
all necessary procedures to make prompt delivery of the number of shares of
Stock which the Participant elects to purchase upon exercise of an Option
granted under this Plan. Such delivery, however, may be postponed, at the sole
discretion of the Company, to enable the Company to comply with any applicable
procedures, regulations or listing requirements of any government agency,
stock exchange or regulatory authority.
 
                                      C-5
K. Failure to Accept Delivery of Stock. If a Participant refuses to pay for
Stock which he has elected to purchase under his Option, in accordance with
the terms of payment, which had previously been agreed upon, his Option shall
thereupon, at the sole discretion of the Committee, terminate, and such funds
previously paid for unissued Stock shall be refunded. Stock which has been
previously issued to the Participant and been fully paid for shall remain the
property of the Participant and shall be unaffected by such termination.
 
  L. Non-Transferability of Options. During the lifetime of a Participant, an
Incentive Stock Option granted to him may be exercised only by him. It may not
be sold, assigned, pledged or otherwise transferred except by will or by the
laws of descent and distribution. In the case of Options which are not
Incentive Stock Options, the Committee may impose such restrictions on
transferability, if any, as it may in its sole discretion determine.
 
  M. Purchase for Investment
 
    (a) Written Agreement by Participants. Unless a registration statement
  under the Securities Act of 1933 is then in effect with respect to the
  Stock a Participant receives upon exercise of his Option, a Participant
  shall acquire the Stock he receives upon exercise of his Option for
  investment and not for resale or distribution and he shall furnish the
  Company with a written statement to that effect when he exercises his
  Option and a reference to such investment warranty shall be inscribed on
  the Stock certificate(s).
 
    (b) Registration Requirement. Each Option shall be subject to the
  requirement that, if at any time the Board determines that the listing,
  registration or qualification of the shares subject to the Option upon any
  securities exchange or under any state or Federal law is necessary or
  desirable as a condition of, or in connection with, the issuance of shares
  thereunder, the Option may not be exercised in whole or in part unless such
  listing, registration or qualification shall have been effected or obtained
  (and the same shall have been free of any conditions not acceptable to the
  Board).
 
  N. Special Limitations on Exercise of Incentive Stock Options. The aggregate
fair market value (determined at the time the Incentive Stock Option is
granted) of the Stock with respect to which any Incentive Stock Option is
first exercisable during any calendar year shall not exceed $100,000.
 
                                 SECTION NINE
 
                           Stock Appreciation Rights
 
  A. Grant of Stock Appreciation Rights. Stock Appreciation Rights may be
granted under the Plan in conjunction with an Option either at the time of
grant or by amendment or may be separately awarded. Stock Appreciation Rights
shall be subject to such terms and conditions not inconsistent with the Plan
as the Committee shall impose. However, the total number of Stock Appreciation
Rights which may be granted to a single Covered Employee under this Plan
during any calendar year shall be limited to 100,000.
 
  B. Right to Exercise; Exercise Period. A Stock Appreciation Right issued
pursuant to an Option shall be exercisable to the extent the Option is
exercisable. A Stock Appreciation Right issued independent of an Option shall
be exercisable pursuant to such terms and conditions established in the grant.
 
  C. Automatic Redemption of Unexercised Stock Appreciation Rights. If on the
last day of the Option Period, in the case of a Stock Appreciation Right
granted pursuant to an Option, or the specified Award Period, in the case of a
Stock Appreciation Right issued independent of an Option, the Participant has
not exercised such Stock Appreciation Right, then such Stock Appreciation
Right shall be automatically redeemed by the Company for an amount equal to
the payment that would otherwise have been made to the Participant if the
Participant had chosen to exercise the Stock Appreciation Right on the last
day of the Option Period or the specified Award Period, as the case may be.
 
 
                                      C-6
D. Rights Upon Exercise. An exercisable Stock Appreciation Right granted
pursuant to an Option shall entitle the Participant to surrender unexercised
the Option or any portion thereof to which the Stock Appreciation Right is
attached, and to receive in exchange for the Stock Appreciation Right a
payment (in cash or Stock or a combination thereof as described below) equal
to the Fair Market Value of one share of Stock at the date of exercise minus
the Option Price times the number of shares called for by the Stock
Appreciation Right (or portion thereof) which is so exercised. With respect to
the issuance of Stock Appreciation Rights which are not granted pursuant to an
Option, the Committee shall specify upon the Date of the Grant of the Stock
Appreciation Right whether the Stock Appreciation Right is a "regular" Stock
Appreciation Right or a "book value" Stock Appreciation Right. Upon the
exercise of a regular Stock Appreciation Right, the Participant will receive a
payment equal to the Fair Market Value of one share of Stock at the date of
exercise minus the Fair Market Value of one share of Stock as of the Date of
Grant of the Stock Appreciation Right times the number of shares called for by
the Stock Appreciation Right (or portion thereof) which is so exercised. Upon
the exercise of a book value Stock Appreciation Right, the Participant will
receive a payment equal to the Book Value of one share of Stock at the date of
exercise minus the Book Value of one share of Stock as of the Date of the
Grant of the Stock Appreciation Right times the number of shares called for by
the Stock Appreciation Right (or portion thereof) which is so exercised.
 
  The value of any Stock to be received upon exercise of a Stock Appreciation
Right shall be the Fair Market Value of the Stock on such date of exercise. To
the extent that a Stock Appreciation Right issued pursuant to an Option is
exercised, such Option shall be deemed to have been exercised, and shall not
be deemed to have lapsed.
 
  E. Transferability. The Committee may impose such restrictions on
transferability of Stock Appreciation Rights, if any, as it may in its sole
discretion determine.
 
                                  SECTION TEN
 
                              Performance Shares
 
  A. Grant of Performance Share Units. Awards made pursuant to this Section
Ten shall be granted in the form of Performance Shares, subject to such terms
and conditions not inconsistent with the Plan as the Committee shall impose.
Performance Shares shall be issued to the Participant without the payment of
consideration by the Participant. Awards shall be based on the attainment of
specified types and combination of performance measurement criteria, which may
differ as to various Participants or classes or categories of Participants.
Such criteria may include, without limitation, the attainment of certain
performance levels by the individual Participant, the Company, a department or
division of the Company and/or a group or class of Participants. Such
criteria, together with the ranges of Performance Shares from which employees
may be eligible shall be set from time to time by the Committee and shall be
communicated to the Eligible Employees. The total number of Performance Shares
which may be granted to any single Covered Employee under this Plan during any
calendar year shall be limited to 100,000.
 
  B. Performance Period. The measuring period to establish the performance
criteria set forth in a Performance Share Award shall be determined by the
Committee. A Performance Share Award may initially provide, or the Committee
may at any time thereafter, but no more frequently than once in any six (6)
month period, amend it to provide, for waiver or reduction of the measuring
period and, if appropriate, for adjustment of the performance criteria set
forth in the Performance Share Award, upon the occurrence of events determined
by the Committee in its sole discretion to justify such waiver, reduction or
adjustment.
 
  C. Form of Payment. Upon the completion of the applicable measuring period,
a determination shall be made by the Committee in accordance with the Award as
to the number of shares of Stock to be awarded to the Participant. The
appropriate number of shares of Stock shall thereupon be issued to the
Participant in accordance with the Award in satisfaction of such Performance
Share Award.
 
                                      C-7
SECTION ELEVEN
 
                    Changes in Capital Structure or Shares
 
  In the event any reorganization, merger, consolidation, recapitalization,
liquidation, reclassification, stock dividend, stock split, combination of
shares, rights offering, or extraordinary dividend or divestiture (including a
spin-off), or any other change in the capital structure or shares of the
Company, the Committee shall make adjustments, determined by the Committee in
its discretion to be appropriate, as to the number and kind of securities
subject to this Plan and specified in Section Five of this Plan and as to the
number and kind of securities covered by each outstanding Award and, where
applicable, the price per share thereunder; provided, however, that with
respect to Incentive Stock Options, such adjustments shall be made in
accordance with Section 424(h) of the Code unless the Committee determines
otherwise.
 
                                SECTION TWELVE
 
                    Corporate Reorganization or Dissolution
 
  A. Discontinuation of the Plan. The Plan shall be discontinued in the event
of the dissolution or liquidation of the Company or in the event of a
Reorganization (as hereinafter defined) in which the Company is not the
surviving or acquiring company, or in which the Company is or becomes a
wholly-owned subsidiary of another company after the effective date of the
Reorganization and no plan or agreement respecting the Reorganization is
established which specifically provides for the continuation of the Plan and
the change, conversion, or exchange of the stock relating to existing Awards
under this Plan for securities of another corporation. Upon the dissolution of
the Plan in connection with an event described in this Paragraph A, all Awards
shall become fully vested and all outstanding Options and Stock Appreciation
Rights shall become immediately exercisable by the holder thereof. Any Options
or Stock Appreciation Rights granted under the Plan may be terminated as of a
date fixed by the Committee, provided that no less than fifteen (15) days
written notice of the date so fixed shall be given to each Participant and
each such Participant shall have the right during such period to exercise all
or any portion of such Options or Stock Appreciation Rights. Any Stock
Appreciation Rights not so exercised shall be redeemed.
 
  B. Continuation of the Plan Upon a Reorganization. In the event of a
Reorganization (as hereinafter defined) (i) in which the Company is not the
surviving or acquiring company, or in which the Company is or becomes a
wholly-owned subsidiary of another company after the effective date of the
Reorganization, and (ii) with respect to which there is a reorganization
agreement which undertakes to continue the Plan and to provide for the change,
conversion or exchange of the Stock attributable to outstanding Awards for
securities of another corporation, then the Plan shall continue and the
Committee shall adjust the shares under such outstanding Awards (and shall
adjust the shares remaining under the Plan which are then to be available for
the grant of additional Awards under the Plan, if the reorganization agreement
makes specific provisions therefor), in a manner not inconsistent with the
provisions of the reorganization agreement and this Plan for the adjustment,
change, conversion or exchange of such Awards.
 
  The term "Reorganization" as used in this Section Twelve shall mean any
statutory merger, statutory consolidation, sale of all or substantially all of
the assets of the Company, or sale, pursuant to an agreement with the Company,
of securities of the Company pursuant to which the Company is or becomes a
wholly-owned subsidiary of another company after the effective date of the
Reorganization.
 
  C. Adjustments and Determinations. Adjustments and determinations under this
Section Twelve shall be made by the Committee, whose decisions as to what
adjustments or determinations shall be made, and the extent thereof, shall be
final, binding, and conclusive.
 
 
                                      C-8
SECTION THIRTEEN
 
                           Retirement and Disability
 
  The Committee may, in its discretion, waive the forfeiture, termination, or
lapse of an Award in the event of retirement or disability of a Participant
(each as determined by the Committee, in its discretion). Exercise of such
discretion by the Committee in any individual case, however, shall not be
deemed to require, or to establish a precedent suggesting such exercise in any
other case.
 
                               SECTION FOURTEEN
 
                           Miscellaneous Provisions
 
  A. Nontransferability. The Committee may impose such restrictions on the
transferability of an Award, if any, as it may in its sole discretion
determine.
 
  B. No Employment Right. Neither this Plan nor any action taken hereunder
shall be construed as giving any right to be retained as an officer or
employee of the Company or any of its Subsidiaries.
 
  C. Tax Withholding. Either the Company or a Subsidiary, as appropriate,
shall have the right to deduct from all Awards paid in cash any federal, state
or local taxes as it deems to be required by law to be withheld with respect
to such cash payments. In the case of Awards paid in Stock, the employee or
other person entitled to receiving such Stock shall be required to satisfy any
tax withholding obligations in connection with such Awards in any of the
following ways, as elected by such employee or other person: (i) by paying in
cash to the Company or a Subsidiary, as appropriate, the amount of any
federal, state or local taxes required to be withheld (as determined by the
Company or a Subsidiary, as appropriate), (ii) by having the Company retain a
sufficient number of shares of Stock otherwise payable under the Award to
cover any federal, state or local taxes required to be withheld (as determined
by the Company or a Subsidiary, as appropriate), provided, however, that
management shall assure that the amount of such stock withholding does not
cause the Company to incur additional compensation expense, or (iii) by a
combination of (i) and (ii). The number of shares of Stock to be retained for
this purpose shall be determined on the basis of the Fair Market Value of the
Stock on the date of exercise.
 
  D. Fractional Shares. Any fractional shares concerning Awards shall be
eliminated at the time of payment by rounding down for fractions of less than
one-half and rounding up for fractions of equal to or more than one-half. No
cash settlements shall be made with respect to fractional shares eliminated by
rounding.
 
  E. Government and Other Regulations. The obligation of the Company to make
payment of Awards in Stock or otherwise shall be subject to all applicable
laws, rules, and regulations, and to such approvals by any government agencies
as may be required. The Company shall be under no obligation to register under
the Securities Act of 1933, as amended ("Act"), any of the shares of Stock
issued, delivered or paid in settlement under the Plan. If Stock awarded under
the Plan may in certain circumstances be exempt from registration under the
Act, the Company may restrict its transfer in such manner as it deems
advisable to ensure such exempt status.
 
  F. Severance. Subject to the provision of Paragraph B of this Section
Fourteen, in the event a Participant's employment with the Company terminates,
his rights under any Award which constitutes an Option or a Stock Appreciation
Right terminate one (1) month from the date of such termination of employment.
Such rights shall be exercisable only to the extent the Participant was
entitled to exercise such rights under the Award on the date of such
termination of employment.
 
  G. Death. If a Participant dies prior to the full exercise of his Option
and/or Stock Appreciation Right, his Option to purchase Stock under such
Option and/or Stock Appreciation Right may be exercised to the extent, if any,
that Participant would be entitled to exercise it at the date of the death of
the Participant by the person to whom the Option and/or Stock Appreciation
Right shall pass by will or by the laws of descent and distribution within
twelve (12) months of the death of the Participant or the expiration of the
term of the Option and/or Stock Appreciation Right whichever date is sooner.
 
  H. Limitation. In no event may an Option be exercised by anyone after the
expiration date provided for in Section Eight of the Plan.
 
                                      C-9
I. Limits on Discretion. Anything in this Plan to the contrary
notwithstanding, if the Award so provides, the Committee shall not have any
discretion to increase the amount of compensation payable under the Award to
the extent such discretion would cause the Award to lose its qualification as
performance-based compensation for purposes of Section 162(m)(4)(C) of the
Code and the regulations thereunder.
 
  J. Governing Law. All matters relating to the Plan or to Awards granted
hereunder shall be governed by the laws of the State of Maryland, without
regard to its principles of conflict of laws.
 
  K. Titles and Headings. The titles and headings of the sections in the Plan
are for convenience of reference only, and in the event of any conflict, the
text of the Plan, rather than such titles and headings, shall control.
 
                                SECTION FIFTEEN
 
                               Amendment of Plan
 
  A. Discretion of the Board. The Board may at any time and from time to time
alter, amend, suspend or terminate the Plan in whole or in part, except (i)
any such action affecting Options granted or to be granted under this Plan
which are intended to qualify as Incentive Stock Options shall be subject to
stockholder approval to the extent such stockholder approval is required
pursuant to Section 422 of the Internal Revenue Code and (ii) no such action
may be taken without the consent of the Participant to whom any Award shall
theretofore have been granted, which adversely affects the rights of such
Participant concerning such Award, except as such termination or amendment of
the Plan is required by statute, or rules and regulations promulgated
thereunder.
 
  B. Automatic Termination. This Plan shall terminate on [   ], 2007. Awards
may be granted under this Plan at any time and from time to time prior to the
termination of the Plan. Any Award outstanding at the time the Plan is
terminated shall remain in effect until said Award is exercised or expires.
 
 
                                     C-10
INFORMATION NOT REQUIRED ON PROSPECTUS
 
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
 
  The following is an itemized statement of all expenses in connection with
the issuance and distribution of the securities registered hereby. The
information is subject to future contingencies.
Registration Fee................................................. $  253
      Blue Sky Fees and Expenses....................................... $    0
      Legal Fees....................................................... $2,500*
      Accounting Fees.................................................. $1,500*
      Miscellaneous.................................................... $3,000*
                                                                        ------
      Total............................................................ $7,253
                                                                        ======
      * Estimate
ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS
 
  See the section of the Prospectus entitled "Certain Information Concerning
Franchising--Liability and Indemnification of Officers and Directors."
 
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
 
  None.
 
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
  (a) Exhibits
EXHIBIT
 NUMBER                                DESCRIPTION
 -------                               -----------
*2.01  --Form of Distribution Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
  *3.01  --Form of Restated Certificate of Incorporation of Choice Hotels
           Franchising, Inc.
  *3.02  --Form of Amended and Restated Bylaws of Choice Hotels International,
           Inc.
  *4.01  --Form of Common Stock Certificate
   5.01  --Opinion of Michael J. DeSantis regarding the validity of Franchising
           Options and Franchising Common Stock
 *10.01  --Form of Strategic Alliance Agreement between Choice Hotels
           Franchising, Inc. and Choice Hotels International, Inc.
 *10.02  --Form of Employee Benefits and Other Employment Matters Allocation
           Agreement between Choice Hotels Franchising, Inc. and Choice Hotels
           International, Inc.
 *10.03  --Form of Employee Benefits Administration Agreement between Choice
           Hotels Franchising, Inc. and Choice Hotels International, Inc.
 *10.04  --Form of Tax Administration Agreement between Choice Hotel
           Franchising, Inc. and Choice Hotels International, Inc.
 *10.05  --Form of Tax Sharing Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
 *10.06  --Form of Amendment to Corporate Services Agreement among Manor Care,
           Inc., Choice Hotels Franchising, Inc. and Choice Hotels
           International, Inc.
 *10.07  --Form of Amendment to Risk Management Consulting Services Agreement
           among Manor Care, Inc., Choice Hotels Franchising, Inc. and Choice
           Hotels International, Inc.
II-1
EXHIBIT
 NUMBER                                DESCRIPTION
 -------                               -----------
*10.08  --Form of Office Sublease Agreement between Choice Hotels Franchising,
           Inc and Choice Hotels International, Inc.
 *10.09  --Form of Noncompetition Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
 *10.10  --Form of Guarantee by Choice Hotels Franchising, Inc. to Manor Care,
           Inc.
 *21.01  --Subsidiaries of Choice Hotels Franchising, Inc.
  23.01  --Consent of Arthur Anderson LLP
  23.02  --Consent of Michael J. DeSantis (included in the opinion filed as
           Exhibit 5.01 hereto)
  24.01  --Power of Attorney (contained on page II-3 hereof)
--------
*  Incorporated by reference to the identically numbered exhibit to the
   Registration Statement on Form 10 filed with the Securities and Exchange
   Commission by Franchising on September 19, 1997.
 
  (b) Financial Statements Schedules
 
  Schedule II -- Valuation and Qualifying Accounts
 
  All other schedules are omitted because they are not applicable or the
required information is included in the combined financial statements or notes
thereto.
 
ITEM 17. UNDERTAKINGS
 
  The undersigned registrant hereby undertakes:
 
  (1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this Registration Statement:
 
    (i) To include any prospectus required by Section 10(a)(3) of the
  Securities Act of 1933;
 
    (ii) To reflect in the prospectus any facts or events arising after the
  effective date of the registration statement (or the most recent post-
  effective amendment thereof) which, individually or in the aggregate,
  represent a fundamental change in the information set forth in the
  registration statement;
 
    (iii) To include any material information with respect to the plan of
  distribution not previously disclosed in the registration statement or any
  material change to such information in the registration statement;
 
  (2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
 
  (3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of
the offering.
 
  Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Act") may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or otherwise,
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.
 
                                     II-2
SIGNATURES
 
  Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized in the City of Silver Spring, State of
Maryland, on September 19, 1997.
 
                                          Choice Hotels Franchising, Inc.
 
                                            
                                          By:  /s/ William R. Floyd 
                                              ----------------------------
                                            Name: William R. Floyd
                                            Title: Chief Executive Officer
 
                               POWER OF ATTORNEY
 
  Each person whose signature appears below appoints William R. Floyd and
Michael J. DeSantis, and each of them, as his true and lawful attorney-in-fact
and agent with full power of substitution and resubstitution, for him and in
his name, place and stead, in any and all capacities, to sign any or all
amendments (including post-effective amendments), to this Registration
Statement, and to file the same, with all exhibits thereto, and all documents
in connection therewith, with the Securities and Exchange Commission, granting
unto each said attorney-in-fact and agent full power and authority to do and
perform each and every act and thing, requisite and necessary to be done in
and about the foregoing, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that each said
attorney-in-fact and agent, or his substitute, may lawfully do or cause to be
done by virtue hereof.
 
  Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURE                           TITLE                    DATE
             ---------                           -----                    ----
/s/ William R. Floyd                                       September 19, 1997
------------------------------------
          William R. Floyd           Chief Executive Officer and
                                      Director (Principal
                                      Executive Officer)
      /s/ James A. MacCutcheon                                     September 19, 1997
------------------------------------
        James A. MacCutcheon         Executive Vice President,
                                      Chief Financial Officer and
                                      Director (Principal
                                      Financial Officer)
        /s/ Joseph M. Squeri                                       September 19, 1997
------------------------------------
          Joseph M. Squeri           Vice President, Finance and
                                      Controller (Principal
                                      Accounting Officer)
        /s/ Donald J. Landry                                       September 19, 1997
------------------------------------
          Donald J. Landry           Director
II-3
SCHEDULE II
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
TO CHOICE HOTELS FRANCHISING, INC.:
 
 
We have audited in accordance with generally accepted auditing standards, the
combined financial statements of Choice Hotels Franchising, Inc. included in
this Registration Statement on Form S-1, and have issued our opinion thereon
dated June 24, 1997. Our audit was made for the purpose of forming an opinion
on the basic combined financial statements taken as a whole. The schedule at
page S-2 hereof is presented for the purpose of complying with the Securities
and Exchange Commission's rules and is not part of the basic combined
financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic combined financial statements
and, in our opinion, fairly states in all material respects the financial data
required to be set forth therein in relation to the basic combined financial
statements taken as a whole.
 
                                       Arthur Andersen LLP
 
Washington, D.C. June 24, 1997
 
                                      S-1
SCHEDULE II
 
                        CHOICE HOTELS FRANCHISING, INC.
                SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                           (IN THOUSANDS OF DOLLARS)
BALANCE AT  CHARGES TO                  BALANCE AT
                         BEGINNING OF   PROFIT                       END
      DESCRIPTION           PERIOD     AND LOSS  OTHER WRITE-OFFS OF PERIOD
      -----------        ------------ ---------- ----- ---------- ----------
Year ended May 31, 1997
 Allowance for doubtful
  accounts                  4,515       2,238     --       (594)    6,159
                            =====       =====     ===    ======     =====
Year ended May 31, 1996
 Allowance for doubtful
  accounts                  3,976         685     --       (146)    4,515
                            =====       =====     ===    ======     =====
Year ended May 31, 1995
 Allowance for doubtful
  accounts                  8,743         692     --     (5,459)    3,976
                            =====       =====     ===    ======     =====
S-2
INDEX OF EXHIBITS
EXHIBIT
 NUMBER                                DESCRIPTION
 -------                               -----------
*2.01  --Form of Distribution Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
  *3.01  --Form of Restated Certificate of Incorporation of Choice Hotels
           Franchising, Inc.
  *3.02  --Form of Amended and Restated Bylaws of Choice Hotels International,
           Inc.
  *4.01  --Form of Common Stock Certificate
   5.01  --Opinion of Michael J. DeSantis regarding the validity of Franchising
           Options and Franchising Common Stock
 *10.01  --Form of Strategic Alliance Agreement between Choice Hotels
           Franchising, Inc. and Choice Hotels International, Inc.
 *10.02  --Form of Employee Benefits and Other Employment Matters Allocation
           Agreement between Choice Hotels Franchising, Inc. and Choice Hotels
           International, Inc.
 *10.03  --Form of Employee Benefits Administration Agreement between Choice
           Hotels Franchising, Inc. and Choice Hotels International, Inc.
 *10.04  --Form of Tax Administration Agreement between Choice Hotel
           Franchising, Inc. and Choice Hotels International, Inc.
 *10.05  --Form of Tax Sharing Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
 *10.06  --Form of Amendment to Corporate Services Agreement among Manor Care,
           Inc., Choice Hotels Franchising, Inc. and Choice Hotels
           International, Inc.
 *10.07  --Form of Amendment to Risk Management Consulting Services Agreement
           among Manor Care, Inc., Choice Hotels Franchising, Inc. and Choice
           Hotels International, Inc.
 *10.08  --Form of Office Sublease Agreement between Choice Hotels Franchising,
           Inc and Choice Hotels International, Inc.
 *10.09  --Form of Noncompetition Agreement between Choice Hotels Franchising,
           Inc. and Choice Hotels International, Inc.
 *10.10  --Form of Guarantee by Choice Hotels Franchising, Inc. to Manor Care,
           Inc.
 *21.01  --Subsidiaries of Choice Hotels Franchising, Inc.
  23.01  --Consent of Arthur Anderson LLP
  23.02  --Consent of Michael J. DeSantis (included in the opinion filed as
           Exhibit 5.01 hereto)
--------
*  Incorporated by reference to the identically numbered exhibit to the
   Registration Statement on Form 10 filed with the Securities and Exchange
   Commission by Franchising on September 19, 1997.