Choice Hotels International, Inc. and Subsidiaries

Background and Basis of Presentation

On March 7, 1996, Manor Care, Inc. (“Manor Care”) announced its intention to proceed with the separation of its lodging business (“Choice Hotels Holdings, Inc.” or “Holdings”) from its health care business via a spin-off of its lodging business (the “Manor Care Distribution”). On September 30, 1996 the Board of Directors of Manor Care declared a special dividend to its shareholders of one share of common stock of Holdings for each share of Manor Care stock, and the Board set the record date and the distribution date. The Manor Care Distribution was made on November 1, 1996 to holders of record of Manor Care’s common stock on October 10, 1996. Choice Hotels International, Inc. (the “Company”), which was a subsidiary of Manor Care became a wholly-owned subsidiary of Holdings.

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

On November 1, 1996, concurrent with the Manor Care Distribution, Holdings changed its name from Choice Hotels Holdings, Inc. to Choice Hotels International, Inc. (“CHI”) and the Company changed its name to Choice Hotels Franchising, Inc.

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

The Company is in the business of hotel franchising. As of December 31, 1999, the Company had franchise agreements with 4,248 hotels open and 761 hotels under development in 40 countries under the following brand names: Comfort, Quality, Econo Lodge, Sleep, Clarion, Rodeway, and MainStay Suites.

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

An analysis of the activity in the investments and advances from parent account for the fiscal year ended May 31, 1997 and the period June 1, 1997 through October 15, 1997 is as follows:

Reclassifications

Certain reclassifications have been made to the prior year consolidated financial statements to conform to the current year presentation.