-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Qx4FXZmDXQ6c6qs+lHsynHxZmErE8w22OjGjuKnCKmkKWL6NDtJvQ6lDsfM6VXr0 vxKdrlfBrchGy7ivrNdlJQ== 0000928385-98-000635.txt : 19980401 0000928385-98-000635.hdr.sgml : 19980401 ACCESSION NUMBER: 0000928385-98-000635 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUNBURST HOSPITALITY CORP CENTRAL INDEX KEY: 0001018146 STANDARD INDUSTRIAL CLASSIFICATION: HOTELS & MOTELS [7011] IRS NUMBER: 521985619 STATE OF INCORPORATION: DE FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-11915 FILM NUMBER: 98580986 BUSINESS ADDRESS: STREET 1: 10770 COLUMBIA PIKE CITY: SILVER SPRING STATE: MD ZIP: 20901 BUSINESS PHONE: 3019795000 MAIL ADDRESS: STREET 1: 10770 COLUMBIA PIKE CITY: SILVER SPRING STATE: MD ZIP: 20901 FORMER COMPANY: FORMER CONFORMED NAME: CHOICE HOTELS INTERNATIONAL INC DATE OF NAME CHANGE: 19970108 FORMER COMPANY: FORMER CONFORMED NAME: CHOICE HOTELS HOLDINGS INC DATE OF NAME CHANGE: 19960705 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 _____________________ FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996]. For the fiscal year ended ---------------------------------------------- OR [X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]. For the transition period from June 1, 1997 to December 31, 1997 ------------ ----------------- Commission file number 001-11915 --------- SUNBURST HOSPITALITY CORPORATION -------------------------------- (Exact Name of Registrant as Specified in Its Charter) DELAWARE 52-1985619 ---------------------------- -------------------------- (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) 10770 Columbia Pike, Silver Spring, Maryland 20901 - -------------------------------------------- -------------- (Address of Principal Executive Offices) Zip Code Registrant's telephone number, including area code (301) 979-6127 -------------- Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered ------------------- ----------------------------------------- Common Stock, Par Value $.01 per share New York Stock Exchange - -------------------------------------- ----------------------------------------- - -------------------------------------- ----------------------------------------- Securities registered pursuant to Section 12(g) of the Act: - -------------------------------------------------------------------------------- (Title of Class) - -------------------------------------------------------------------------------- (Title of Class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed in Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months as for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ------ ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [_] The aggregate market value of voting stock of Sunburst Hospitality Corporation held by non-affiliates was $112,335,932 as of March 12, 1998 based upon a closing price of $8.5625 per share. APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes No ------ ------ (APPLICABLE ONLY TO CORPORATE REGISTRANTS) The number of shares outstanding of Sunburst Hospitality Corporation's common stock at March 12, 1998 was 19,947,042. DOCUMENTS INCORPORATED BY REFERENCE. PART III Proxy Statement dated March 30, 1998 2 PART I ITEM 1. BUSINESS Sunburst Hospitality Corporation ("Sunburst" or the "Company") owns and operates hotels in one of three principal segments of the lodging industry: extended stay all-suites, full service and limited service. Prior to October 15, 1997, Sunburst was named Choice Hotels International, Inc. On October 15, 1997, Sunburst distributed to its stockholders its hotel franchising business (which had previously been conducted primarily by a subsidiary) and its European hotel ownership pursuant to a pro rata distribution to its stockholders of all of the stock of its wholly-owned subsidiary, Choice Hotels Franchising, Inc. (the "Spinoff"or "distribution"). At the time of the Spinoff, the Company changed its name to "Sunburst Hospitality Corporation" and Choice Hotels Franchising, Inc. changed its name to "Choice Hotels International, Inc." ("New Choice"). Sunburst is a leading hotel owner and operator in the United States. As of February 28, 1998, the Sunburst portfolio included 81 hotels open with 11,380 rooms in 28 States and 16 hotels under construction or in development. Thirty- seven of the 81 hotels, with a net book value of $145.4 million serve as collateral for the Company's multi-class mortgage pass-through certificates. Each hotel is branded with one of the New Choice brands and Sunburst is New Choice's largest franchisee. Sunburst and its predecessors have a successful record of managing ahead of industry cycles. Prior to the last industry downturn in the late 1980s, the Company was able to liquidate a substantial portion of its existing hotel portfolio. Then in 1992, the Company began to opportunistically acquire hotels at prices well below their replacement cost. All of these hotels have benefited from a significant investment of capital used to renovate and upgrade the properties. The hotels have also benefited from the installation of professional management and marketing systems. In the past two years the Company has responded to changing industry cycles by shifting its development strategy to the new construction of limited-service Sleep Inn hotels and mid-market, all-suite extended stay MainStay Suites hotels. Sunburst's strategy is to: (i) actively manage the Company's existing portfolio to optimize performance by applying proven operating systems and procedures, to increase EBITDA and operating margins at newly-acquired hotels, to maintain the Company's competitive advantage through capital spending, and to sell hotels projected to underperform by redeploying capital in higher yielding assets; (ii) develop MainStay Suites hotels to capitalize on the positive fundamentals of the mid-market, extended stay segment; and (iii) selectively pursue opportunistic development, acquisition, renovation and repositioning opportunities. Historical Acquisition Strategy The primary focus of Sunburst from 1992 through 1996 was the acquisition of hotels. During this period many hotels were facing financial hardship, creating an opportunity for Sunburst to acquire properties at prices well below replacement cost. Sunburst's strategy was to acquire and renovate the hotels, install professional management and marketing systems, and in some cases reposition the hotels to a different brand or service level. Since June 1992, Sunburst has acquired 55 hotels for an aggregate purchase price of $187.7 million. An additional approximately $95.6 million has been spent on capital improvements to the same hotels. The total investment basis in the 55 hotels at December 31, 1997 is $283.3 million, which is 60.2% of the estimated replacement value of the hotels at their respective dates of acquisition.. The Company believes that there are currently limited opportunities to acquire hotels at a substantial discount to replacement value. As a result, only two hotels were acquired in fiscal year 1997 and no hotels were acquired during the seven months ended December 31, 1997. In February 1997 Sunburst acquired the beachfront Howard Johnson Hotel in Miami Beach, Florida. The hotel has since undergone extensive renovation and has been re-branded as the Comfort Inn Miami Beach. The Company believes that the property will benefit from strong market fundamentals and high barriers to entry. On August 1, 1996, Sunburst acquired the Springhouse Senior Assisted Living Center in Charlotte, NC. The property underwent major renovation and was converted to a hotel. The property reopened on August 27, 1997, as a Clarion Hotel and features Sunburst's "Classic Sports Food, Drink 3 and Memories Cafe." The hotel is strategically located at I-77 and Billy Graham Parkway and benefits from proximity to Charlotte's airports, sports arenas and growing suburban office concentration. The Company will continue to evaluate acquisitions on an opportunistic basis when it is felt that long-term value can be created. The following chart summarizes acquisition activity in each of the last five fiscal years.
SUNBURST EXISTING HOTEL ACQUISITIONS FISCAL YEAR --------------------------------------------------------------------------------------- 1993 1994 1995 1996 1997 -------------- -------------- -------------- -------------- -------------- Total acquisitions....................... 8 13 16 16 2 Total number of rooms acquired........... 1,429 1,780 2,336 1,940 324 Total cost of acquisitions (in millions) (including initial improvements)........ $ 27.3 $ 41.9 $ 58.6 $ 49.2 $ 10.7 Average cost per room.................... $19,073 $23,570 $25,074 $25,375 $32,691
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 the Company. Because many of the recently acquired and developed hotels have not yet reached stabilized levels of operating performance, the Company believes that revenues and gross profit at these hotels will continue to grow.
Sunburst Hotels Occupancy ---------------------------------------------------------------------------------------------- SEVEN MONTHS FISCAL YEAR ENDED ------------------------------------------------------------------------- December 31, 1993 1994 1995 1996 1997 1997 (1) ------------- ------------- ------------- ------------- ------------- ------------------- Original Domestic Portfolio 62.27% 64.16% 67.19% 68.02% 71.63% 70.72% Fiscal 1993 Acquisitions 56.17 64.28 73.94 76.00 74.96 70.92 Fiscal 1994 Acquisitions -- 63.99 70.88 73.69 73.61 70.24 Fiscal 1995 Acquisitions -- -- 48.96 58.49 66.27 66.18 Fiscal 1996 Acquisitions -- -- -- 53.23 61.16 68.83 Fiscal 1997 Acquisitions -- -- -- -- 54.65 38.82
____________________________ (1) The information provided in the table above for the seven months ended December 31, 1997 is not representative of a full fiscal year due to the seasonality of the hotel industry. Hotel Development The Company's recent strategy to concentrate on the development of MainStay Suites hotels is intended to capitalize on the demand/supply imbalance in the extended stay, all-suite segment. Historically, these hotels have produced higher than average returns on investment and management believes that demand in this segment exceeds supply by approximately 4 to 1. The mid-market, extended stay segment is particularly under-served. Sunburst's focus on external development is geared to capitalize on the under-served, high-growth, mid-priced extended stay all-suite segment, and the development of other high-quality, consumer-focused hotels. To implement its development strategies, Sunburst maintains a Real Estate Development and Construction Department staff. This staff is responsible for the identification of target markets, specific site identification, negotiation, due diligence, planning, zoning and other approval requirements, design and construction of new hotels. In addition, the group oversees the renovation and refurbishment of existing hotels. The Real Estate Development and Construction staff, with its dual capacity to effectively renovate older hotels or construct new hotels, allows Sunburst to respond quickly to changing market conditions. 4 The following is a list of new hotels developed by Sunburst since 1994 or under development as of February 28, 1998.
CALENDAR YEAR OF MARKET BRAND OPENING - --------------------------------------------------------------- ---------------------------- -------------------- Dallas/Plano, TX............................................... Sleep Inn 1994 San Antonio, TX................................................ Sleep Inn 1995 Baton Rouge, LA................................................ Sleep Inn 1996 Houston/Airport, TX............................................ Sleep Inn 1996 Austin/Round Rock, TX.......................................... Sleep Inn 1996 Dallas/Plano, TX............................................... MainStay Suites 1996 Raleigh, NC.................................................... Sleep Inn 1997 Dallas/Arlington, TX........................................... Sleep Inn 1997 Kansas City/Airport, MO........................................ Sleep Inn 1997 Charlotte, NC.................................................. Sleep Inn 1997 Rockville, MD.................................................. Sleep Inn 1997 Providence/Airport, RI......................................... MainStay Suites 1997 Cincinnati/Blue Ash, OH........................................ MainStay Suites 1997 Kansas City/Airport, MO........................................ MainStay Suites 1998 Indianapolis, IN............................................... MainStay Suites 1998 Louisville, KY................................................. MainStay Suites 1998 Greenville, SC................................................. MainStay Suites 1998 Denver/Airport, CO............................................. Sleep Inn 1998 Orlando/Lake Mary, FL (1)...................................... MainStay Suites 1998 Denver/Tech Center, CO (1)..................................... MainStay Suites 1998 Jacksonville, FL (1)........................................... MainStay Suites 1998 Nashville, Brentwood, TN (1)................................... MainStay Suites 1998 Miami/Airport, FL (1).......................................... MainStay Suites 1998 Miami/Airport, FL (1).......................................... Sleep Inn 1998 Pittsburgh/Airport, PA (1)..................................... MainStay Suites 1998 Fishkill/Poughkeepsie, NY (1).................................. MainStay Suites 1998 Tempe, AZ (1).................................................. MainStay Suites 1998 Denver/Tech Center, CO (1)..................................... Sleep Inn 1998 Annapolis, MD (2).............................................. MainStay Suites 1998 Orlando, FL (2)................................................ MainStay Suites 1998 Peabody, MA (2)................................................ MainStay Suites 1998 Raleigh, NC (2)................................................ MainStay Suites 1999 Mt. Laurel, NJ (2)............................................. MainStay Suites 1999 North Charleston, SC (2)....................................... MainStay Suites 1999
________________________ (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 developing the MainStay Suites all-suite, extended stay product is based on statistics indicating the demand/supply imbalance. According to various industry studies, demand in the all-suite, extended stay market is strong, yet supply is limited, particularly in the mid-price segment. Industry sources define the extended stay demand as stays of five or more nights, consisting of 228 million room nights annually, or 27% of total U.S. lodging industry demand. Only 1.5% of total room supply is dedicated to extended stay rooms. By applying its hotel real estate development expertise, Sunburst is targeting markets with ideal conditions for the extended stay product and building MainStay Suites hotels. The MainStay Suites brand, which was created by the Company in conjunction with New Choice, has a unique product design and service package which enhance property level appeal, productivity and profitability. Among the MainStay Suites most unique features are the automatic check-in kiosk (which allows guests to check in 5 and out without assistance from an employee) and the optional daily light touch housekeeping (full housekeeping just every five days). These features enable MainStay Suites hotels to operate with fewer full time equivalent employees than a similar limited service hotel that provides 24-hour front desk coverage and full housekeeping daily. Sunburst anticipates that its MainStay Suites projects will produce stabilized, unleveraged pre-tax property level returns on investment of 15% or higher. This belief is supported by the Company's experience at the first MainStay Suites opened in Plano, Texas. The belief is further supported by projections for the MainStay Suites recently opened and under development. These projections are based on rate and occupancy generated internally by the Company and by external feasibility consultants, as well as internal operating guidelines, land cost and projected construction costs. However, there can be no assurance that the projected return will be achieved or that actual results will not differ materially. (See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Forward Looking Statements, below.) Each of the Company's MainStay Suites hotels will average approximately 100 suites and will be developed on 2.5 to 3.0 acres of land in suburban office parks or locations in close proximity to major employers, restaurants and retail amenities. MainStay Suites feature high quality, interior corridor building construction with amenities and features provided in direct response to consumer demand. The suites feature bedroom areas, a living room area with a pull-out couch or recliner, private bathroom and fully furnished kitchen. The kitchen includes a full-size refrigerator, dishwasher, microwave, stove, coffee maker, toaster and all cooking utensils. Each suite also features an over-sized counter serving as an eating area and work 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. Operations Each of Sunburst's owned and managed hotels operates under one of the New Choice brand names. Sunburst's hotels take advantage of the same systems and services available to New Choice 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 also 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 corporate-based financial controllers. 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 6 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". This sports theme restaurant 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 hotels. "Classic Sports Food, Drink and Memories" are currently open in four Sunburst hotels in Springfield, Missouri, Charlotte, North Carolina, Richardson, Texas and Hot Springs, Arkansas. . Capital Reinvestment Program. Each of Sunburst's hotels completes a detailed capital spending budget annually. The hotels spend on average 5%-7% of total revenues on capital improvements annually. This reinvestment allows the hotels to maintain a competitive advantage in the local markets. . 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 annual plan serves as a fundamental measurement of management's performance. The Hotel Properties Sunburst's hotel properties serve three primary segments of the lodging industry; extended stay/all-suite, full service and limited service. Each hotel is branded with one of the New Choice franchise flags. All-Suite Hotels. Sunburst has 13 hotels in the all-suite segment open and 14 hotels under construction or in the development process. Sunburst's all- suite hotel properties compete in the mid-price and upscale price segments. The table below identifies Sunburst's all-suite hotels by brand and price segment as of February 28, 1998. ALL SUITE HOTELS
BRAND Number of Hotels NUMBER OF ROOMS PRICE SEGMENT ------ ------------------- ------------------- ------------------- Quality Suites......................................... 3 345 upscale Comfort Suites......................................... 3 397 mid-price MainStay Suites........................................ 7 666 mid-price
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
BRAND Number of Hotels NUMBER OF ROOMS PRICE SEGMENT ------ ------------------- ------------------- ------------------- Clarion Hotels & Inns.................................. 11 2,120 upper mid-price Quality Hotel & Inns................................... 5 1,327 mid-price
7 Limited Service Hotels. Sunburst has 52 hotels in the limited service segment open and two 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
BRAND Number of Hotels NUMBER OF ROOMS PRICE SEGMENT ------- ------------------- ------------------- ------------------- Comfort Inn............................................ 31 4,076 mid-price Quality Inns........................................... 8 1,014 mid-price Sleep Inns............................................. 11 1,214 mid-price Econo Lodge............................................ 1 120 economy Rodeway Inns........................................... 1 101 economy
Franchise and Strategic Alliance Agreements All of the Company's existing hotels are branded with one of New Choice's franchise flags under various franchise agreements with New Choice. Each Franchise Agreement has an initial term of twenty years, except the agreement for Tempe, Arizona which is a year to year agreement. The Franchise Agreements have varying original dates, from 1982 through 1997. Certain Franchise Agreements allow for unilateral termination by either party on the 5th, 10th, or 15th anniversary of the Franchise Agreement. 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 New Choice's reservation system). The marketing fee and the reservation fee are subject to reasonable increases during the term of the franchise if New Choice 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. At the time of the Spinoff, New Choice and the Company entered into a Strategic Alliance Agreement pursuant to which: (i) the Company granted a right of first refusal to New Choice to franchise any lodging property that the Company develops or acquires and intends to operate under franchise; (ii) the Company has also agreed, barring a material change in market conditions, to continue to develop Sleep Inns and MainStay Suites hotels so that it will have opened a total of 14 Sleep Inns and 15 MainStay Suites hotels by October 15, 2001 (48 months from the Distribution Date); (iii) New Choice has granted to the Company an option, exercisable under certain circumstances, to purchase the brand names, marks, franchise agreements and other assets of the MainStay Suites hotel system; (iv) New Choice and the Company have agreed to continue to cooperate with respect to matters of mutual interest, including new product and concept testing for New Choice in hotels owned by the Company; and (v) the Company has authorized New Choice to negotiate with third party vendors on the Company's behalf for the purchase of certain items. The Strategic Alliance Agreement extends for a term of 20 years with rights of mutual termination on the fifth, tenth and fifteenth anniversaries. 8 Competition The Company is a leading owner and operator of hotels in the United States. Competition in the United States lodging industry is generally based on convenience of location, price, range of services and guest amenities offered, plus the quality of customer service and overall product. Newer, recently constructed hotels compete effectively against older hotels if such hotels are not refurbished on a regular basis. The effect of local economic conditions on the Company's results is reduced by the Company's geographic diversity of its properties, which are located in 28 states, as well as its range of products and room rates. Seasonality The Company's principal sources of revenue are revenues generated by its properties. The Company experiences seasonal revenue patterns similar to those of the lodging industry in general. This seasonality can be expected to cause quarterly fluctuations in the Company's revenues, profit margins and net income. Regulation and Environmental Matters The Company's hotels are subject to numerous federal, state and local government regulation, including those pertaining to the preparation and sale of food and beverages (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. While the Company's operations have not been materially adversely affected by such regulation, the Company cannot predict the effect of future regulation or legislation. The hotel properties are subject to environmental regulations under Federal, state and local laws. Certain of these laws may require a current or previous owner or operator of real estate to clean up designated hazardous or toxic substances or petroleum product releases affecting the property. In addition, the owner or operator may be held liable to a governmental entity or to third parties for damages or costs incurred by such parties in connection with the contamination. The Company does not believe that it is subject to any material environmental liability. Employees At December 31, 1997, Sunburst employed approximately 3,332 employees. Less than 5% of the Company's employees are represented by unions. All of the Company's employees covered by unions are employed at Comfort Inn By the Bay, San Francisco, California. The Company considers its relations with its employees to be good. ITEM 2. PROPERTIES The following chart lists by market segment Sunburst's hotels at February 28, 1998:
Year No. of Constructed/Last HOTEL MARKET ROOMS MAJOR 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......................... Dallas, Texas 96 1996 MainStay Suites Warwick(4).................... Providence, Rhode Island 94 1997 MainStay Suites Blue Ash(4)................... Cincinnati, Ohio 100 1997
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Year No. of Constructed/Last HOTEL MARKET ROOMS MAJOR RENOVATION - ----- ------ MainStay Suites Airport(5).................... Kansas City, Missouri 88 1998 MainStay Suites Northwest(5).................. Indianapolis, Indiana 88 1997 MainStay Suites(5)............................ 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(5)............................ Greenville, South Carolina 100 1998 MainStay Suites Brentwood(1).................. Nashville, Tennessee 100 1998 MainStay Suites(1)............................ Orlando, FL 125 1998 MainStay Suites(1)........................... Miami Springs, Florida 100 1998 MainStay Suites(1)........................... Fishkill, New York 106 1998 MainStay Suites(1)........................... Annapolis, Maryland 88 1998 MainStay Suites(1)........................... Pittsburgh, Pennsylvania 100 1998 MainStay Suites(1)........................... Raleigh, North Carolina 100 1999 MainStay Suites(1)........................... Tempe, Arizona 94 1998 MainStay Suites(1)........................... Peabody, Massachusetts 97 1998 MainStay Suites(1)........................... Mt. Laurel, NJ 106 1999 MainStay Suites(1)........................... North Charleston, SC 100 1999 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................................. 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(2) 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 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(3)................ Baltimore, Maryland 186 1964/1994 Comfort Inn University........................ Baton Rouge, Louisiana 150 1972/1994 Comfort Inn Danvers........................... 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......................... Charlotte, North Carolina 150 1985/1996 Quality Inn & Suites--Crown Point............. Charlotte, North Carolina 100 1988/1996 Comfort Inn................................... Cincinnati, Ohio 117 1984/1996
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Year No. of Constructed/Last HOTEL MARKET ROOMS MAJOR RENOVATION - ----- ------ 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 Comfort Inn Miami Beach(4) 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, DC 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.......................... Austin, Texas 107 1996 Sleep Inn Six Flags........................... 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 Sleep Inn Raleigh............................. Raleigh, North Carolina 107 1996 Sleep Inn San Antonio......................... San Antonio, Texas 107 1995 Sleep Inn University(4)....................... Charlotte, North Carolina 120 1997 Sleep Inn Airport(4).......................... Kansas City, Missouri 107 1997 Sleep Inn Rockville(4)........................ Washington, DC 107 1997 Sleep Inn Airport(5).......................... Denver, Colorado 119 1998 Sleep Inn Denver Tech(1)...................... Denver, Colorado 119 1998 Sleep Inn Miami Springs(1)..................... Miami Springs, Florida 119 1998
(1) Hotel under construction or development (2) Leased property (3) Hotel on leased land (4) Partial year results only (5) Hotel under construction at December 31, 1997 but completed prior to February 28, 1998 11 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 31, 1997, and the seven months ended December 31, 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 64.18 31.54 51.28 67.10 34.40
SEVEN MONTHS ENDED DECEMBER FY 1996 FY 1997 31, 1997(1) -------------------------- -------------------------- ------------------------------------- ADR OCCUPANCY REVPAR ADR OCCUPANCY REVPAR ADR OCCUPANCY REVPAR ------ ---------- ------ ------ ---------- ------ ------ -------------- ------------- All Suite Hotels........... $64.70 69.00% $44.65 $69.48 72.73% $50.53 $66.65 70.52% $47.01 Full Service Hotels........ 58.85 65.41 38.49 63.25 67.05 42.41 65.60 65.48 42.96 Limited Service Hotels..... 53.36 67.11 35.81 56.38 69.25 39.04 59.11 68.01 40.20 All Hotels................. 55.97 66.61 37.28 59.62 68.70 40.96 61.81 67.41 41.67
_______________________________________ (1) The information provided in the table above for the seven months ended December 31, 1997 is not representative of a full fiscal year due to the seasonality of the hotel industry.
FISCAL YEAR Seven Months ---------------------------------------------------------------------------------- Ended December 31 -------------- 1993 1994 1995 1996 1997 1997 (1) ----------- -------------- -------------- -------------- --------------- ------------- Number of properties, end of 19 32 48 65 71 76 period......................... Number of rooms, end of period.. 3,686 5,605 7,941 9,713 10,330 10,885 Average occupancy percentage.... 61.36% 64.18% 67.10% 66.61% 68.70% 67.41% Average daily room rate (ADR)... $49.53 $49.15 $51.28 $55.97 $ 59.62 $ 61.81 RevPAR.......................... $30.39 $31.54 $34.40 $37.28 $ 40.96 $ 41.67
_____________________________________ (1) The information provided in the table above for the seven months ended December 31,1997 is not representative of a full fiscal year due to the seasonality of the hotel industry. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any litigation, other than routine litigation incidental to its 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 the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1997. 12 EXECUTIVE OFFICERS OF SUNBURST HOSPITALITY CORPORATION. The name, age, title, present principal occupation, business address and other material occupations, positions, offices and employment of each of the executive officers of Sunburst are set forth below. The business address of each executive officer is 10770 Columbia Pike, Silver Spring, Maryland 20901, unless otherwise indicated.
NAME AGE POSITION - ---- ------- ---------- Stewart Bainum, Jr................... 52 Chairman of the Board of Directors Donald J. Landry..................... 49 Vice Chairman and Chief Executive Officer James A. MacCutcheon................. 45 Executive Vice President, Chief Financial Officer and Treasurer Antonio DiRico....................... 44 President and Chief Operating Officer Kevin P. Hanley...................... 40 Senior Vice President, Real Estate and Development Gregory D. Miller.................... 44 Senior Vice President, Human Resources Charles M. Warczak, Jr............... 50 Vice President, Accounting and Hotel Systems
Stewart Bainum, Jr., Chairman of the Board of the Company since November 1996; Chairman of the Board of New Choice from March 1987 to November 1996 and since October 1997; Chairman of the Board and Chief Executive Officer of Manor Care and ManorCare Health Services, Inc. ("MCHS") since March 1987; Chief Executive Officer of Manor Care since March 1987 and President since June 1989; Vice Chairman of the Board of Vitalink Pharmacy Services, Inc. ("Vitalink") since December 1994; Vice Chairman of the Board of Manor Care and subsidiaries from June 1982 to March 1987; Director of Manor Care since August 1981, of Vitalink since September 1991 and of MCHS since 1976; President of MCHS 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. Donald J Landry. Chief Executive Officer and Vice Chairman of the Company since October 1997; President of the Company from January 1995 to October 1997; President of Manor Care Hotel Division ("MCHD") from March 1992 to November 1996; various executive positions with Richfield Hotel Management, Inc. and its predecessors for more than 20 years, including President of MHM Corporation. James A. MacCutcheon. Executive Vice President, Chief Financial Officer and Treasurer of the Company since November 1996; Senior Vice President, Chief Financial Officer and Treasurer of the Company from September 1993 to November 1996; 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 1996; Treasurer of Vitalink from September 1992 to January 1997 and a Director since September 1994. Antonio DiRico. President of the Company since October 1997; Senior Vice President, Hotel Operations of the Company from November 1996 to October 1997; Senior Vice President of MCHD from May 1992 to November 1996; Senior Vice President of Richfield Hotel Management, Inc. and its predecessor, MHM Corporation. Kevin P. Hanley. Vice President, Real Estate and Development of the Company 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. Gregory D. Miller. Senior Vice President, Human Resources of the Company since October 1997; Vice President, Marketing of MCHS from March 1995 to October 1997; Vice President, Strategic Planning of Manor Care from May 1992 to September 1995. Charles M. Warczak, Jr. Vice President, Accounting and Hotel Systems of the Company since October 1997; Vice President, Hotel Accounting of the Company from March 1997 to October 1997; Vice President, Finance and Controller of the Company from November 1996 to March 1997; Vice President, Finance of Manor Care from 1992 to November 1996. 13 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The shares of Sunburst's Common Stock are listed and traded on the New York Stock Exchange. The following table sets forth the high and low sales prices of Sunburst's Common Stock since it began trading on November 4, 1996:
QUARTERLY MARKET PRICE RANGE OF COMMON STOCK (Unaudited) Quarters Ended MARKET PRICE PER SHARE ----------------------------------------------------------------------------- HIGH (1) LOW (1) ----------------------------------------------------------------------------- FISCAL YEAR ENDED MAY 31, 1997 November 4 - $16 $13 3/4 November 30 February $17 5/8 $15 May $15 7/8 $12 3/4 FISCAL YEAR ENDED MAY 31, 1998 (2) August $19 1/16 $15 3/8 November $20 1/4 $9 3/8 CALENDER 1997 (2) December $20 1/4 $8 3/4 ---------------------------
(1) On October 16, 1997, the Company spun off its franchising business through a special dividend to shareholders of all of the stock of New Choice and effected a one-for-three reverse stock split. The stock prices above for the periods prior to October 16, 1997, including the high for the quarters ended November, 1997 and December 31, 1997 have not been adjusted to give effect to the spinoff of New Choice or the reverse stock split. (2) On September 16, 1997, the Company changed its fiscal year end from May 31 to December 31. On October 15, 1997, the Company made a special dividend, consisting of the distribution to holders of the Company's common stock, on a share-for-share basis, of all of the outstanding shares of the common stock of Choice Hotels Franchising, Inc. (now known as Choice Hotels International, Inc.). This was the only dividend paid since November 4, 1996. The Company does not anticipate the payment of any cash dividends on its common stock in the foreseeable future. Payments of dividends on Company common stock may be subject to limitations as may be imposed by the Company's credit facilities from time to time. The declaration of dividends will be subject to the discretion of the Board of Directors. As of March 12, 1998, there were 5,875 record holders of Company common stock. 14 ITEM 6. SELECTED FINANCIAL DATA
For the seven months ended For the year ended December 31, May 31, ---------------------------------------------------------------- 1997 1997 1996 1995 1994 1993 ------------ ------------ ------------ ------------ ------------ ------------ STATEMENT OF INCOME DATA REVENUES (unaudited) Rooms $100,670 $165,239 $137,001 $101,381 $66,031 $32,835 Food and beverage 9,231 13,356 11,392 8,121 5,001 5,027 Other 4,652 7,158 6,232 5,012 3,152 3,499 ------------ ------------ ------------ ------------ ------------ ------------ Total revenues 114,553 185,753 154,625 114,514 74,184 41,361 ------------ ------------ ------------ ------------ ------------ ------------ OPERATING EXPENSES Departmental Expenses Rooms 33,484 58,502 51,657 43,168 25,826 12,289 Food and beverage 7,319 10,887 9,792 6,866 4,335 4,059 Other 1,530 2,674 2,570 1,476 1,012 1,272 Undistributed Operating Expenses Administrative and general 9,486 17,990 16,358 11,550 6,741 4,539 Marketing 8,862 14,545 12,152 9,008 5,507 3,574 Utility costs 5,697 8,816 7,712 5,670 3,583 2,251 Property operation and maintenance 5,746 9,428 8,118 5,891 3,813 2,583 Property taxes, rent and insurance 5,010 6,857 6,044 3,959 2,241 1,766 Depreciation and amortization 14,246 20,632 16,636 12,513 8,434 5,423 Corporate 8,244 7,691 8,026 6,038 2,864 3,065 Provision for asset impairment and other non-recurring charges 5,119 - 24,595 - - - ------------ ------------ ------------ ------------ ------------ ------------ Total operating expenses 104,743 158,022 163,660 106,139 64,356 40,821 ------------ ------------ ------------ ------------ ------------ ------------ Operating income (loss) 9,810 27,731 (9,035) 8,375 9,828 540 ------------ ------------ ------------ ------------ ------------ ------------ Interest Expense 10,138 15,891 12,839 9,155 3,214 2,032 ------------ ------------ ------------ ------------ ------------ ------------ (Loss) income from continuing operations before income taxes (328) 11,840 (21,874) (780) 6,614 (1,492) Income taxes (44) 5,035 (8,523) (323) 3,000 (642) ------------ ------------ ------------ ------------ ------------ ------------ (Loss) income from continuing operations (284) 6,805 (13,351) (457) 3,614 (850) Discontinued operations (1) 16,369 35,219 21,809 17,268 6,045 8,504 ------------ ------------ ------------ ------------ ------------ ------------ Net income before extraordinary item 16,085 42,024 8,458 16,811 9,659 7,654 Extraordinary item -- loss from early extinguishment of debt (net of $747 tax benefit) - 1,144 - - - - ------------ ------------ ------------ ------------ ------------ ------------ Net income $16,085 $40,880 $8,458 $16,811 $9,659 $7,654 ============ ============ ============ ============ ============ ============ Basic earnings per share data From continuing operations ($0.01) $0.32 ($0.64) ($0.02) $0.18 ($0.04) From discontinued operations 0.82 1.69 1.05 0.83 0.30 0.44 From extraordinary items - (0.05) - - - - ------------ ------------ ------------ ------------ ------------ ------------ Net income $0.81 $1.96 $0.41 $0.81 $0.48 $0.40 =========== =========== =========== =========== =========== =========== Diluted earnings per share data From continuing operations ($0.01) $0.32 ($0.64) ($0.02) $0.18 ($0.04) From discontinued operations 0.82 1.66 1.05 0.83 0.30 0.44 From extraordinary items - (0.05) - - - - ------------ ------------ ------------ ------------ ------------ ------------ Net income $0.81 $1.93 $0.41 $0.81 $0.48 $0.40 =========== =========== =========== =========== =========== =========== Weighted average common shares outstanding (2) 19,979 20,893 20,876 20,827 20,175 19,105 =========== =========== =========== =========== =========== ===========
(1) Discontinued operations represents the income of the discontinued franchising business less applicable income taxes of $11,825, $25,165, $15,923, $13,467, $5,019, and $6,422, respectively) (2) Weighted average common shares outstanding represents the weighted average common shares outstanding of the Company's parent Manor Care, Inc. for fiscal years 1993 through 1996. Fiscal year 1997 represents the weighted average common shares of Manor Care, Inc. for the period through November 1, 1997. The period following November 1, 1997 represents the weighted average common shares of the Company. Fiscal year 1993 through 1997 have been adjusted for the one-for-three reverse stock split. 15
For the seven months ended For the year ended December 31, May 31, ---------------------------------------------------------------- 1997 1997 1996 1995 1994 1993 ------------ ------------ ------------ ------------ ------------ ------------ Balance Sheet Data Total assets 400,983 426,429 328,311 254,229 178,652 105,389 Notes payable to Manor Care, Inc. - 37,022 147,023 119,823 68,361 - Total debt 248,120 260,369 163,497 137,122 88,711 6,761 Total liabilities 311,676 301,942 180,752 188,400 123,444 14,642 Equity or investments and advances from Parent 89,307 124,487 147,559 65,829 55,208 90,747
16 ITEM 6. SELECTED FINANCIAL DATA ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company owned and operated 76 hotels with 10,885 rooms in 26 states at December 31, 1997. The hotels are under the brand names Comfort, Clarion, Sleep, Quality, Mainstay, Rodeway and Econolodge. The Company's continuing business consists primarily of guest room revenue, meeting room revenue, and food and beverage revenue from owned and operated hotels. On October 15, 1997, the Company distributed, through a special dividend, its franchising business and European hotel operations ("New Choice") to shareholders. On the date of distribution, Company shareholders of record on October 7, 1997, received one share of New Choice (renamed Choice Hotels International, Inc.) for each share of the Company held. In addition, the Company, which was previously named Choice Hotels International, Inc., changed its name to Sunburst Hospitality Corporation and effected a one-for-three reverse stock split. European hotel operations, which were distributed with New Choice, are presented as part of continuing operations in the consolidated financial statements in accordance with generally accepted accounting principles. However, for purposes of analyzing the operations of the Company, management focuses on domestic hotel operations. Therefore, the following discussion focuses on the results of operations of the domestic hotels which constitute the ongoing operations of the Company at December 31, 1997. Comparison of Calendar Year 1997 and Calendar Year 1996 Domestic hotels - ------------------------------------------------------------------------ In September 1997, the Company changed its year end from May 31 to December 31. This change in fiscal year end, combined with the seasonality of the lodging industry, has a significant impact on the comparability of the seven months ended December 31, 1997 with prior fiscal years. To assist in comparisons, the following discusses the operating results of calendar year 1996 as compared to calendar year 1997. The following tables present calendar quarter and full calendar year information showing the results of operations of the Company's domestic hotels for calendar years 1996 and 1997 (in thousands, unaudited).
Quarter ending ---------------------------------------------------------------------------- March 31 June 30 September 30 December 31 ---------------------------------------------------------------------------- Year ended December 31, 1997 Domestic Revenue 41,258 46,982 49,052 42,760 Domestic EBITDA (1) 11,793 15,484 14,092 3,294 Year ended December 31, 1996 Domestic Revenue 34,656 40,987 43,615 37,683 Domestic EBITDA (1) 8,542 2,585 13,226 7,413
________________________ (1) EBITDA consists of the sum of net income (loss), interest expense, income taxes, and depreciation and amortization. EBITDA is presented because such data is used by certain investors to determine the Company's ability to meet debt service, fund capital expenditures and expand its business. The Company considers EBITDA to be an indicative measure of operating performance particularly due to the large amount of depreciation and 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. 17
Year ending December 31, ---------------------------------------------- 1997 1996 ---------------------------------------------- Revenues Rooms $157,380 $137,114 Food and beverage 14,991 12,950 Other 7,681 6,877 ---------------------------------------------- Total revenues 180,052 156,941 ---------------------------------------------- Operating Expenses Departmental Expenses Rooms 45,607 39,701 Food and beverage 11,972 10,835 Other 2,828 2,400 Undistributed Operating Expenses Administrative and general 16,662 18,520 Marketing 14,975 13,895 Utility costs 9,399 8,423 Property operation and maintenance 9,815 8,922 Property taxes, rent and insurance 7,933 7,521 Depreciation and amortization 22,142 17,335 Corporate 11,079 6,383 Provision for asset impairment and other non-recurring charges 5,119 8,575 ---------------------------------------------- Total operating expenses 157,531 142,510 ---------------------------------------------- Operating income 22,521 14,431 ---------------------------------------------- Interest expense 16,461 12,726 ---------------------------------------------- Income from continuing operations before Income taxes 6,060 1,705 Income taxes 2,629 716 ---------------------------------------------- Income from continuing operations 3,431 989 ============================================== Basic Earnings Per Share $0.17 $0.05 ==============================================
Domestic hotel revenues increased from $156.9 million in calendar year 1996 to $180.1 million in calendar year 1997, an increase of 14.7%. Domestic gross operating margin (operating income before corporate expense, depreciation and amortization, and non-recurring charges), increased from 29.8% in 1996 to 33.8% in 1997. Increases in revenues were due to improved Revenue Per Available Room ("RevPAR") and an increase in the number of hotels from 69 at the end of 1996 to 76 at the end of 1997. The Company utilizes RevPAR, which is calculated by multiplying the percentage of occupied rooms by the average daily room rate realized, as a measure of the operating performance of its hotels. Overall, RevPAR increased from $39.34 to $41.68, an increase of 6.0%. Increases in RevPAR by service sector are consistent with industry trends and are caused principally by aggressive rate increases. Average daily rates for the Company's full-service hotels increased 6.9% to $65.68 in calendar year 1997. Limited- service average daily rates of $58.25 in calendar year 1997 represented a 6.1% increase over the prior year. Consistent with past experience, hotels recently acquired and renovated enjoyed substantial RevPAR increases. For example, hotels acquired in fiscal year 1995 experienced a 12.0% increase in RevPAR and hotels acquired in 1996 had a 19.7% increase in RevPAR. 18 Comparison of Seven Months Ended December 31, 1997 and Seven Months Ended - ------------------------------------------------------------------------- December 31, 1996 Operating Results - ----------------------------------- Hotel revenues increased from $106.5 million for the seven months ended December 31, 1996, to $114.6 million for the same period of 1997. Domestic hotel revenues during those seven month periods increased from $95.5 million to $107.6 million, an increase of 12.7%. This increase in revenue was primarily a result of additional rooms achieved through hotel acquisition and development and overall RevPAR increases. At December 31, 1996, there were 69 domestic hotels open and operating as compared to 76 hotels as of December 31, 1997. The additional hotels contributed $3.6 million to the revenue increase. Domestic RevPAR for the comparative periods by service level are as follows:
1997 1996 % Increase ------------- ------------ ------------------ Full Service $42.96 $40.51 6.0% Limited Service $40.20 $39.19 2.6% Suite $47.01 $48.39 (2.9%) Combined $41.67 $40.38 3.2%
The Company's full-service hotels enjoyed RevPAR increases higher than the overall industry averages. The Company's limited service hotels, notwithstanding a 5.6% increase in ADR to $59.11, saw the rate of RevPAR growth slow as occupancies declined. The suite RevPAR comparison was impacted by the opening and occupancy ramp-up of two MainStay Suite hotels opened late in the calendar year. Hotels recently acquired and renovated continue to lead in terms of RevPAR growth as it typically takes several years to reach stabilized levels of operating performance. For example, hotels acquired and renovated in fiscal year 1996 realized a 20.0% RevPAR increase. Domestic operating income before non-recurring provisions amounted to $14.5 million during the seven months ended December 31, 1997. This compares to $14.4 million during the same period in the preceding year. Increases in depreciation and amortization due to the Company's development program and increases in general corporate expenses relating to the Company's emergence as a separate, stand-alone company, impact the year-over-year comparison of these stub periods. Earnings before interest, taxes, depreciation and amortization (EBITDA) and before non-recurring provisions was $29.2 million for the seven months ended December 31, 1997. This compares to $26.4 million for the same period in the preceding year. Property level gross operating profit, however, increased from $31.2 million in the seven month period ended December 31, 1996 to $37.4 million for the same period ended December 31, 1997, an increase of 19.9%. An increase in general corporate expense from 4.5% of revenues in 1996 to 7.2% of revenues in 1997 was due primarily to incremental costs associated with the Company's emergence as a stand-alone, publicly traded company and other investments in infrastructure to support a growing company. Included in provision for asset impairment and other non-recurring charges in 1997 are non-recurring loss provisions totaling $5.1 million (pre-tax). This loss provision was recorded in December 1997 in order to reserve $2.1 million of previously capitalized costs and future payment obligations related to a data processing services agreement and computer system which will be replaced in 1998, to accrue the estimated cost of $1.0 million for future lease costs associated with space the Company has vacated, and to reserve $2.0 million for future obligations related to an agreement expiring in May, 1999, for services which the Company will no longer utilize and, therefore, have no future benefits. The service and lease agreements are with Manor Care and New Choice and were entered into in conjunction with the distribution and the Manor Care distribution. Recent corporate decisions, including a consolidation of leased office space, resulted in the recognition of these costs currently. Interest expense increased from $8.6 million for the seven months ended December 31, 1996 to $10.1 million for the same period of 1997, an increase of 17.4%. The increase results from an increased amount of debt outstanding over the respective periods. The Company's debt has increased over the period to fund the acquisition and development of hotels. 19 The Company had a loss from continuing operations of $284,000 for the seven months ended December 31, 1997 as compared to income of $3.6 million for the same period of 1996. The decrease in income from continuing operations results primarily from the provision for asset impairment and other non-recurring charges and the increase in interest expense for the period ended December 31, 1997. Income from discontinued operations amounted to $16.4 million in the seven months ended December 31, 1997 compared to $22.5 million in the same period in the prior year as those amounts reflect the spun-off franchise business only through the October 15, 1997 distribution date. Included in continuing operations but also spun-off at October 16, 1997 were the Company's European hotel operations which contributed $7.0 million of revenue and $0.4 million of operating income in 1997 compared to $11.0 million of revenue and $0.4 million of operating income in the prior year. Comparison of Fiscal Year 1997 and Fiscal Year 1996 Operating Results - --------------------------------------------------------------------- Sunburst's domestic revenues were $168.0 million for fiscal year 1997, an increase of 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 3.1% 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 $2.0 million in fiscal year 1997 also contributed to revenue growth. Domestic operating expenses increased $12.7 million or 10.0% in fiscal year 1997 resulting primarily from the addition of six hotels during the year and to a lesser extent a $1.1 million increase in food and beverage costs. Depreciation expense increased 24.0% in fiscal year 1997 as a result of the addition of new hotels and renovation of existing hotel properties during fiscal years 1997 and 1996. Hotel gross operating margins increased to 30.2% in fiscal year 1997 from 26.0% in fiscal year 1996 due primarily to RevPAR increases significantly in excess of increases in operating costs. General corporate expense was 4.1% of revenue in fiscal year 1997 as compared to 5.2% of revenue in 1996. Operating income, before non-recurring provisions, increased from $15.6 million in 1996 to $27.7 million in 1997. Operating income margins, exclusive of non-recurring charges, increased from 10.1% in fiscal 1996 to 14.9% in fiscal 1997. Income from continuing operations before income taxes and non-recurring charges amounted to $11.8 million in 1997, an increase from $2.7 million in 1996. During fiscal 1996, the Company recorded a provision for asset impairment and other non-recurring charges amounting to $24.6 million (pre-tax). The provision related primarily to the impairment of certain European hotel operations subsequently spun-off with New Choice. Interest expense for the Company increased $3.1 million or 23.8% in fiscal year 1997 as a result of increased borrowings to support the development program. The discontinued franchise operations spun-off in October 1997 contributed $35.2 million of the after-tax income in 1997, an increase of 61.5% from the $21.8 million contributed in fiscal year 1996. The Company incurred an extraordinary loss of $1.1 million (net of tax) in fiscal year 1997 in connection with the prepayment of debt to Manor Care, Inc. 20 Comparison of Fiscal Year 1996 and Fiscal Year 1995 Operating Results - --------------------------------------------------------------------- The Company's revenues increased 35.0% from $114.5 million in fiscal year 1995 to $154.6 million in fiscal year 1996. Domestic revenues increased 40.8%, or $39.1 million, in fiscal year 1996 compared to fiscal year 1995. The increase in domestic revenues is attributable primarily to the net addition of 17 hotels to the Company's portfolio and an 8.4% increase in RevPAR. In addition, food and beverage revenues increased 40.3% in fiscal year 1996 as compared to fiscal year 1995, also contributing to the increase in total revenues. Total operating expenses, excluding the provision for asset impairment of $24.6 million, increased 31.0%, or $32.9 million. The increase in operating expenses, which is consistent with the Company's revenue growth over the period, is a result of the increase in the number of hotels owned and operated over the period. Overall, the Company had an operating loss for fiscal year 1996 as a result of the provision for asset impairment and other non-recurring charges. Excluding the impact of the provision for impairment, the Company`s operating income increased $7.2 million to $15.6 million as compared to $8.4 million in 1995. The operating margins for fiscal year 1996, excluding the impairment provision, increased from 7.3% in fiscal year 1995 to 10.1% in fiscal year 1996. Interest expense increased 40.2% in fiscal year 1996 as compared to fiscal year 1995. The $3.7 million increase results from additional funds borrowed under the note payable to Manor Care, Inc. for the acquisition of hotels. Income from discontinued operations, which contributed to the Company's net income in fiscal years 1995 and 1996, increased 26.3% in fiscal year 1996, to $21.8 million (net of taxes). Liquidity and Capital Resources - ------------------------------- Net cash provided by operating activities was $42.2 million for the seven months ended December 31, 1997, as compared to $87.3 million, $55.4 million, and $49.5 million for fiscal years 1997, 1996, and 1995, respectively. The Company maintains an $80 million committed line of credit with a group of four banks to support on-going operations and to fulfill capital requirements. The credit facility expires in October 2000. At December 31, 1997, availability under that line of credit amounted to $69.0 million of which $16.0 million was drawn. The facility's availability will expand to the full $80 million level as the Company's cash flow increases. The Company intends to aggressively develop MainStay Suites, a mid-priced extended stay hotel product. At December 31, 1997, three MainStay Suites were open and operating with another 12 under construction. In addition to those under construction, there are another 6 projects in development. The cost to develop a MainStay Suite averages approximately $5.7 million. In order for the Company to continue on a long-term basis the MainStay development program, additional capital will be required. Subject to market conditions, the Company anticipates raising additional equity and debt capital during calendar year 1998. At the distribution date, the Company owed New Choice $115.0 million in the form of a pay-in-kind subordinated note with a five year maturity. The note provides additional financial flexibility due to the fact that accrued interest is payable at maturity. The Company does, however, expect to refinance the New Choice note with a longer-term and lower cost subordinated debt financing as soon as practicable. At the distribution date, Sunburst owed New Choice an additional approximately $15.0 million relative to the final allocation of assets, liabilities and equity between the two parties. Sunburst intends to repay this to New Choice on or before December 31, 1998. In addition to the approximately $15.0 million, the Company owes New Choice for the reimbursement of various expenses subsequent to the date of distribution. These amounts are classified as "Payable to Choice Hotels International, Inc." on the balance sheet. On April 23, 1997, the Company, 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 21 by 37 hotel properties with a net book value of $145.4 million owned by the Company. The certificates bear a 7.8% blended weighted average interest rate and have a final maturity of May 5, 2012. The 37 hotel properties so collateralized reported EBITDA of $18.2 million for the seven months ended December 31, 1997. The Company used the proceeds to repay debt payable to its former parent, Manor Care, Inc. At December 31, 1997, the Company's debt to book capitalization amounted to 73.5%, while debt to market capitalization was 55.7%. Debt to domestic hotel EBITDA amounted to 5.6:1 and domestic hotel EBITDA to domestic hotel interest was 2.7:1 for the calendar year 1997. Notwithstanding the real estate intensive nature of the Company's business, the Company's objective is to reduce its overall leverage while continuing to grow through development. In addition to a planned equity offering, the Company intends to strategically dispose of mature hotels and utilize the proceeds to retire debt. The Company has identified six such properties which will be marketed for sale in calendar 1998. While cash flow along with the credit available under the Company's bank facility and the proceeds from the sale of the six identified hotels is expected to be adequate to fund operations and committed construction projects, accessing additional capital is imperative in order for the Company to continue executing its development and growth plans. Excluding development, recurring capital expenditures required to maintain operating assets in the appropriate condition are estimated to be approximately $15 million per year. Planned capital expenditures for the development of MainStay Suites and Sleep Inns in 1998 are projected to be approximately $83.6 million. Planned capital expenditures for the development of MainStay Suites in calendar 1999 are projected to be $93.5 million. Sunburst may also pursue additional acquisitions of significantly under valued properties. Year 2000 - ---------- Many existing computer programs use two digits to identify a year. These programs were designed and developed without considering the impact of the upcoming change in the century. If the programs are not corrected, computer applications could fail or create erroneous results at the turn of the century. The Company is currently evaluating the impact the year 2000 will have on its operations. While there is currently no estimate of the cost of addressing the issue and the full implication of the problem on the Company's operations is not yet known, it is not, at this time, believed to be significant. Seasonality - ----------- Demand at many of the hotels is affected by recurring seasonal patterns, depending upon the location of the hotel. Accordingly, the Company's operations are seasonal in nature, with lower revenue and operating profit in November through February and higher revenue and operating profit in March through October. Inflation - --------- Inflation has not had a material effect on the revenues or operating results of the Company during the seven months ended December 31, 1997 or the three fiscal years ended May 31, 1997. Forward Looking Statements - -------------------------- Management's Discussion and Analysis, as well as other parts of this Annual Report on Form 10-K, contain information based on management's beliefs and forward-looking statements that involve a number of risks, uncertainties and assumptions. There can be no assurances that actual results will not materially differ from the forward-looking statements as a result of various factors, including, but not limited to: the Company's substantial leverage and its plan to realize cash proceeds through leveraging its remaining assets; its plans to make selected strategic investments and acquisitions and develop new hotels; its success in implementing its business strategy, 22 including its success in arranging financing where required; competition; government regulation; and general economic and business conditions. The Company's intentions with respect to the development of MainStay Suites and other new hotels is subject to: the Company's ability to access sufficient capital to continue such development; the acceptance of and demand for such products by the consumer and competition. Item 8. Financial Statements and Supplementary Data. Page ---- Report of Independent Public Accountants 24 Consolidated Balance Sheets 25 Consolidated Statements of Income 26 Consolidated Statements of Cash Flows 27 Consolidated Statements of Stockholders' Equity 28 Notes to Consolidated Financial Statements 29-44 23 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders of Sunburst Hospitality Corporation: We have audited the accompanying consolidated balance sheets of Sunburst Hospitality Corporation and subsidiaries (the "Company" formerly Choice Hotels International, Inc., see Basis of Presentation) as of December 31, 1997 and May 31, 1997, the related consolidated statements of income and cash flows for the seven months ended December 31, 1997, and each of the three fiscal years in the period ended May 31, 1997, and stockholders' equity for the seven months ended December 31, 1997 and May 31, 1997. These financial statements and schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules 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 financial position of Sunburst Hospitality Corporation as of December 31, 1997, and May 31, 1997, and the results of its operations and its cash flows for the seven months ended December 31, 1997 and each of the three fiscal years in the period ended May 31, 1997, and the stockholders' equity for the seven months ended December 31, 1997 and May 31, 1997 in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the index at Item 14(a)(2) are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. Arthur Andersen LLP Washington, D.C. February 4, 1998 24 SUNBURST HOSPITALITY CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
As of ------------------------- December 31, May 31, 1997 1997 ------------ ------------ ASSETS Real estate, net $371,305 $338,419 Receivables (net of allowance for doubtful accounts of $616 and $585, respectively) 6,261 7,659 Deferred income taxes ($0 and $7,205, respectively) and other assets 17,509 20,982 Cash and cash equivalents 5,908 7,033 Net investment in discontinued operations - 52,336 ------------ ------------ Total assets $400,983 $426,429 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Debt Mortgages and other long term debt $133,648 $223,347 Note payable to Manor Care, Inc. - 37,022 Note payable to Choice Hotels International, Inc. 114,472 - ------------ ------------ 248,120 260,369 Accounts payable 24,053 25,605 Payable to Choice Hotels International, Inc. 25,066 - Accrued expenses 12,010 15,968 Deferred income taxes ($1,378 and $0, respectively) and other liabilities 2,427 - ------------ ------------ Total liabilities 311,676 301,942 ------------ ------------ STOCKHOLDERS' EQUITY Common stock (60,000,000 and 160,000,000 authorized, at $0.01 par value, 21,366,282 and 63,862,671 issued and 19,947,042 and 60,164,947 outstanding at December 31, 1997 and May 31, 1997, respectively) 200 602 Additional paid-in-capital 105,653 113,828 Retained earnings (16,546) 17,075 Cumulative translation adjustment - (7,018) ------------ ------------ Total stockholders' equity 89,307 124,487 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $400,983 $426,429 =========== ===========
The accompanying notes are an integral part of these Consolidated Balance Sheets. 25 SUNBURST HOSPITALITY CORPORATION CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
For the seven months ended For the fiscal year ended December 31, May 31, ------------ ------------ ------------ ------------ 1997 1997 1996 1995 ------------ ------------ ------------ ------------ REVENUES Rooms $100,670 $165,239 $137,001 $101,381 Food and beverage 9,231 13,356 11,392 8,121 Other 4,652 7,158 6,232 5,012 ------------ ------------ ------------ ------------ Total revenues 114,553 185,753 154,625 114,514 ------------ ------------ ------------ ------------ OPERATING EXPENSES Departmental Expenses Rooms 33,484 58,502 51,657 43,168 Food and beverage 7,319 10,887 9,792 6,866 Other 1,530 2,674 2,570 1,476 Undistributed Operating Expenses Administrative and general 9,486 17,990 16,358 11,550 Marketing 8,862 14,545 12,152 9,008 Utility costs 5,697 8,816 7,712 5,670 Property operation and maintenance 5,746 9,428 8,118 5,891 Property taxes, rent and insurance 5,010 6,857 6,044 3,959 Depreciation and amortization 14,246 20,632 16,636 12,513 Corporate 8,244 7,691 8,026 6,038 Provision for asset impairment and other non-recurring charges 5,119 - 24,595 - ------------ ------------ ------------ ------------ Total operating expenses 104,743 158,022 163,660 106,139 ------------ ------------ ------------ ------------ OPERATING INCOME (LOSS) 9,810 27,731 (9,035) 8,375 ------------ ------------ ------------ ------------ INTEREST EXPENSE 10,138 15,891 12,839 9,155 ------------ ------------ ------------ ------------ INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES (328) 11,840 (21,874) (780) Income taxes (44) 5,035 (8,523) (323) ------------ ------------ ------------ ------------ INCOME (LOSS) FROM CONTINUING OPERATIONS (284) 6,805 (13,351) (457) DISCONTINUED OPERATIONS: Income from operations of discontinued franchising business (less applicable income taxes of $11,825, $25,165, $15,923 and $13,467, respectively) 16,369 35,219 21,809 17,268 ------------ ------------ ------------ ------------ NET INCOME BEFORE EXTRAORDINARY ITEM 16,085 42,024 8,458 16,811 EXTRAORDINARY ITEM -- LOSS FROM EARLY EXTINGUISHMENT OF DEBT (NET OF $747 TAX BENEFIT) - 1,144 - - ------------ ------------ ------------ ------------ NET INCOME $16,085 $40,880 $8,458 $16,811 ============ ============ ============ ============ Basic earnings per share ------------------------ From continuing operations ($0.01) $0.32 ($0.64) ($0.02) From discontinued operations 0.82 1.69 1.05 0.83 From extraordinary item - (0.05) - - ------------ ------------ ------------ ------------ Earnings per share $0.81 $1.96 $0.41 $0.81 ============ ============ ============ ============ Diluted earnings per share -------------------------- From continuing operations ($0.01) $0.32 ($0.64) ($0.02) From discontinued operations 0.82 1.66 1.05 0.83 From extraordinary item - (0.05) - - ------------ ------------ ------------ ------------ Earnings per share $0.81 $1.93 $0.41 $0.81 ============ ============ ============ ============
The accompanying notes are an integral part of these Consolidated Statements of Income. 26 SUNBURST HOSPITALITY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
For the seven months ended For the fiscal year ended December 31, May 31, ------------ ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES 1997 1997 1996 1995 ------------ ------------ ------------ ------------ Income (loss) from continuing operations $ (284) $ 5,661 $ (13,351) $ (457) Reconciliation of net income to net cash provided by operating activities: Depreciation and amortization 14,246 20,632 16,636 12,513 Amortization of deferred financing fees 248 - - - Amortization of debt discount 528 29 34 171 Provision for bad debts, net 247 560 289 214 Decrease in deferred taxes 695 2,920 (7,726) 759 Loss on sale of operating hotel - 220 584 - Provision for asset impairment and other non-recurring charges 5,119 - 19,420 - Change in assets and liabilities: Change in receivables (152) (1,686) 468 (1,008) Change in other assets (357) (3,963) (3,106) (1,786) Change in accounts payable and accrued expenses (6,675) 17,391 7,722 1,952 Increase in payable to Choice Hotels International, Inc. 10,066 - - - Change in current taxes receivable (2,310) (1,230) 1,441 476 Change in other liabilities - - 384 (4,790) ------------ ------------ ------------ ------------ Net cash provided by continuing operations 21,371 40,534 22,795 8,044 Net cash provided by discontinued operations 20,876 46,724 32,645 41,454 ------------ ------------ ------------ ------------ Net cash provided by operating activities 42,247 87,258 55,440 49,498 ------------ ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Investment in property and equipment (61,460) (75,523) (46,966) (27,896) Acquisition of operating hotels - (5,550) (49,617) (59,766) Distribution of New Choice (4,166) - - - Proceeds from sale of property and equipment 170 2,522 5,479 - ------------ ------------ ------------ ------------ NET CASH UTILIZED BY CONTINUING OPERATIONS (65,456) (78,551) (91,104) (87,662) NET CASH UTILIZED BY DISCONTINUED OPERATIONS (118,474) (15,864) (78,844) (6,993) ------------ ------------ ------------ ------------ NET CASH UTILIZED BY INVESTING ACTIVITIES (183,930) (94,415) (169,948) (94,655) ------------ ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from mortgages and other long term debt 16,023 208,000 - - Proceeds from note payable to Choice Hotels International, Inc. 115,000 - - - Principal payments of debt (92,171) (1,157) (645) (2,890) (Principal payments on) proceeds from notes payable to Manor Care, Inc. (37,022) (110,000) 27,201 51,461 Payment of financing fees - (3,959) - - Proceeds from issuance of common stock 1,153 3,410 - - Purchases of treasury stock (10,554) (53,150) - - Payable to Choice Hotels International, Inc. for net worth guarantee 15,000 - - - Advances (to) from Manor Care, Inc., net - (9,971) 73,272 (6,190) ------------ ------------ ------------ ------------ NET CASH PROVIDED BY CONTINUING OPERATIONS 7,429 33,173 99,828 42,381 NET CASH PROVIDED BY (UTILIZED BY) DISCONTINUED OPERATIONS 129,337 (19,730) 17,131 2,075 ------------ ------------ ------------ ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES 136,766 13,443 116,959 44,456 ------------ ------------ ------------ ------------ NET CHANGE IN CASH AND CASH EQUIVALENTS (4,917) 6,286 2,451 (701) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 10,825 4,539 2,088 2,789 ------------ ------------ ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,908 $ 10,825 $ 4,539 $ 2,088 ============ ============ ============ ============ Cash and cash equivalents of continuing operations $ 5,908 $ 7,033 $ 1,436 $ 1,661 Cash and cash equivalents of discontinued operations $ - $ 3,792 $ 3,103 $ 427
The accompanying notes are an integral part of these Consolidated Statements of Cash Flows. 27 SUNBURST HOSPITALITY CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARES)
Common Stock Additional Translation Retained ------------------------- Shares Amount Paid-in-Capital Adjustment Earnings ---------------- -------- ------------ ------------ ------------ DISTRIBUTION FROM MANOR CARE INC., NOV. 1, 1996 63,081,129 $631 $162,512 $(1,750) $ - Net income 40,880 Transfer of net income to Manor Care, Inc. (23,805) Exercise of stock options/grants 781,542 8 4,651 Translation adjustment (5,268) Treasury purchases (3,697,724) (37) (53,335) ----------------------------------------------------------------- BALANCE, MAY 31, 1997 60,164,947 $602 $113,828 $(7,018) $17,075 ----------------------------------------------------------------- Net income 16,085 Adjustment to Nov. 1, 1996 distribution from Manor Care Inc. (1,044) Exercise of stock options/grants 202,386 2 1,910 Stock grants issued from Treasury shares 13,786 65 Treasury purchases (588,931) (6) (10,548) Translation adjustment (1,644) Distribution of Franchising 8,662 (48,662) One-for-three reverse stock split on October 15, 1997 (39,845,146) (398) 398 ----------------------------------------------------------------- BALANCE, DECEMBER 31, 1997 19,947,042 $200 $105,653 $ - ($16,546) =================================================================
The accompanying notes are an integral part of these Consolidated Statements of Stockholders' Equity. 28 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS BASIS OF PRESENTATION On March 7, 1996, Manor Care, Inc. ("Manor Care") announced its intention to proceed with the separation of its lodging business from its health care business through a Spinoff 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 Choice Hotels International Inc. (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. At that time, the operations of the Company 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, 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. ("New Choice"). On April 29, 1997, the Company's Board of Directors announced its intention to separate the Company's franchising business from its owned hotel business. On September 16, 1997 the Board of Directors and shareholders of the Company approved the separation of the businesses through a Spinoff of the franchising business, along with the Company's European hotel and franchising operations, to its shareholders (the "distribution"). The Board of Directors set October 15, 1997 as the date of distribution and on that date, Company shareholders received one share in New Choice (renamed "Choice Hotels International, Inc.") for every share of Company stock held on October 7, 1997 (the date of record). Concurrent with the October 15, 1997 distribution date, the Company changed its name to Sunburst Hospitality Corporation and effected a one-for-three reverse stock split of its common stock. The consolidated financial statements present the financial position, results of operations and cash flows of the Company for the period prior to November 1, 1996 as if it were formed as a separate entity of Manor Care. In connection with the Spinoff of the franchising business, the Company has presented the franchising business as a discontinued operation in the consolidated financial statements. Although the Company's European hotel operations were distributed to shareholders along with the franchising business, generally accepted accounting principles do not permit presenting this operation as discontinued. Therefore, the European hotel operations are included in continuing operations. The following tables illustrate the impact of the European hotel operations on the continuing operations of the Company (in thousands).
SEVEN MONTHS ENDED DOMESTIC HOTEL EUROPEAN HOTEL CONTINUING DECEMBER 31, 1997 OPERATIONS OPERATIONS OPERATIONS - ----------------------------------------------------------------------------------------------- Revenues $107,574 $6,979 $114,553 Operating expenses 98,169 6,574 104,743 ------------------------------------------------------------- Operating income 9,405 405 9,810 ------------------------------------------------------------- Interest expense 9,800 338 10,138 ------------------------------------------------------------- Pretax income (loss) (395) 67 (328) Income tax expense (benefit) (71) 27 (44) ------------------------------------------------------------- Net income (loss) from continuing operations $ (324) $ 40 $ (284) =============================================================
29 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FISCAL YEAR ENDING DOMESTIC HOTEL EUROPEAN HOTEL CONTINUING MAY 31, 1997 OPERATIONS OPERATIONS OPERATIONS - ------------------------------------------------------------------------------------------------ Revenues $168,016 $17,737 $185,753 Operating expenses 140,468 17,554 158,022 ------------------------------------------------------------- Operating income 27,548 183 27,731 ------------------------------------------------------------- Interest expense 14,899 992 15,891 ------------------------------------------------------------- Pretax income (loss) 12,649 (809) 11,840 Income tax expense (benefit) 5,355 (320) 5,035 ------------------------------------------------------------- Net income (loss) from continuing operations $ 7,294 $ (489) $ 6,805 =============================================================
FISCAL YEAR ENDING DOMESTIC HOTEL EUROPEAN HOTEL CONTINUING MAY 31, 1996 OPERATIONS OPERATIONS OPERATIONS - -------------------------------------------------------------------------------------------------- Revenues $135,022 $ 19,603 $154,625 Operating expenses 127,722 35,938 163,660 --------------------------------------------------------------- Operating income (loss) 7,300 (16,335) (9,035) --------------------------------------------------------------- Interest expense 12,419 420 12,839 --------------------------------------------------------------- Pretax loss (5,119) (16,755) (21,874) Income tax benefit (1,913) (6,610) (8,523) --------------------------------------------------------------- Net loss from continuing operations $ (3,206) $(10,145) $(13,351) ===============================================================
FISCAL YEAR ENDING DOMESTIC HOTEL EUROPEAN HOTEL CONTINUING MAY 31, 1995 OPERATIONS OPERATIONS OPERATIONS - ------------------------------------------------------------------------------------------------ Revenues $95,876 $18,638 $114,514 Operating expenses 85,777 20,362 106,139 ------------------------------------------------------------- Operating income (loss) 10,099 (1,724) 8,375 ------------------------------------------------------------- Interest expense 9,155 - 9,155 ------------------------------------------------------------- Pretax income (loss) 944 (1,724) (780) Income tax expense (benefit) 361 (684) (323) ------------------------------------------------------------- Net income (loss) from continuing operations $ 583 $(1,040) $ (457) =============================================================
DOMESTIC HOTEL EUROPEAN HOTEL AS OF MAY 31, 1997 OPERATIONS OPERATIONS CONSOLIDATED - ------------------------------------------------------------------------------------------------ Real estate, net $326,867 $11,552 $338,419 Net investment in discontinued operations 52,336 52,336 Other assets 25,312 10,362 35,674 -------------------------------------------------------------- Total assets $404,515 $21,914 $426,429 ============================================================== Debt $246,840 $13,529 $260,369 Other liabilities 38,907 2,666 41,573 -------------------------------------------------------------- Total liabilities 285,747 16,195 301,942 -------------------------------------------------------------- Stockholders' equity 118,768 5,719 124,487 -------------------------------------------------------------- Total liabilities and stockholders' equity $404,515 $21,914 $426,429 ==============================================================
30 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS An analysis of the activity in the "Advances (to) from Manor Care Inc., net" account for the two years ended May 31, 1996 and the five months ended October 31, 1996 is as follows (in thousands): Balance, May 31, 1994 $ 55,208 Cash transfers to Manor Care (6,190) Net income 16,811 ------------------- Balance, May 31, 1995 65,829 Cash transfers from Manor Care 73,272 Net income 8,458 ------------------- Balance, May 31, 1996 147,559 Cash transfers to Manor Care (9,971) Net income through October 31, 1996 23,805 ------------------- Balance, October 31, 1996 $161,393 =================== FISCAL Year
In October 1997, the Company changed its fiscal year end from May 31 to December 31. Therefore, the period ending December 31, 1997 includes seven months of operations. Information for the comparable seven month period of June 1, 1996 through December 31, 1996 is included in the table below (unaudited, in thousands, except per share data).
DOMESTIC HOTEL EUROPEAN HOTEL CONTINUING (Unaudited) OPERATIONS OPERATIONS OPERATIONS ------------------------------------------------------------- Revenues $95,535 $10,975 $106,510 Operating expenses 70,364 9,746 80,110 Depreciation and amortization 10,772 813 11,585 ------------------------------------------------------------- Operating income 14,399 416 14,815 Interest expense 7,987 606 8,593 ------------------------------------------------------------- Pretax income (loss) from continuing operations 6,412 (190) 6,222 Income tax expense (benefit) 2,697 (75) 2,622 ------------------------------------------------------------- Income (loss) from continuing operations $ 3,715 $ (115) $ 3,600 ============================================================= Earnings per share: Basic $0.18 $(0.01) $0.17 =============================================================
The following table presents the Company's results of operations for the full calendar year 1997 (unaudited, in thousands, except per share data).
(Unaudited) DOMESTIC HOTEL EUROPEAN HOTEL CONTINUING OPERATIONS OPERATIONS OPERATIONS ------------------------------------------------------------- Revenues $180,052 $13,741 $193,793 Operating expenses 135,388 12,401 147,789 Depreciation and amortization 22,142 1,399 23,541 ------------------------------------------------------------- Operating income 22,522 (59) 22,463 Interest expense 16,461 724 17,185 ------------------------------------------------------------- Pretax income (loss) from continuing operations 6,061 (783) 5,278 Income tax expense (benefit) 2,629 (310) 2,319 ------------------------------------------------------------- Income (loss) from continuing operations $ 3,432 $ (473) $ 2,959 ============================================================= Earnings per share: Basic $0.17 $(0.02) $0.15 =============================================================
31 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents. PRE-OPENING COSTS Pre-opening costs of an operating nature incurred prior to the opening of hotel properties are deferred and amortized over two years for hotels opened prior to November 1, 1996 and one year for hotels opened after that date. Such costs, which are included in other assets, amounted to $1.2 million and $1.6 million, net of accumulated amortization, at December 31, 1997 and May 31, 1997, respectively. REAL ESTATE The components of real estate are as follows:
(In thousands) December 31, May 31, 1997 1997 --------------------------------------- Land $ 61,959 $ 56,009 Buildings 263,405 240,963 Furniture, fixtures and equipment 70,598 68,704 Hotels under construction 41,869 36,633 --------------------------------------- 437,831 402,309 Less: accumulated depreciation (66,526) (63,890) --------------------------------------- $371,305 $338,419 =======================================
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
SELF-INSURANCE PROGRAM Prior to the Manor Care Distribution, the Company participated in Manor Care's self-insurance program for certain levels of general and professional liability, automobile liability and workers' compensation coverage. The estimated costs of these programs were accrued at present values based on actuarial projections for known and anticipated claims. All self-insurance liabilities through November 1, 1996, were assumed by Manor Care. Subsequent to the Manor Care distribution, the Company has maintained its own insurance program, which includes certain levels of retained risk. Estimated costs are accrued at present values based on actuarial projections for known and anticipated claims. IMPAIRMENT POLICY The Company evaluates the recoverability of long-lived assets 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 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 fair value. 32 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CAPITALIZATION POLICIES The Company capitalizes interest costs and property taxes incurred during the construction of capital assets. The Company capitalized $1.9 million and $0.8 million in interest costs for the seven months ending December 31, 1997 and the fiscal year ending May 31, 1997, respectively. Major renovations and replacements are capitalized to appropriate property and equipment accounts. Maintenance, repairs and minor replacements are charged to expense. RECLASSIFICATIONS Certain amounts previously presented have been reclassified to conform to the December 31, 1997 presentation. In addition, the Company's balance sheet was changed from a classified balance sheet to an unclassified balance sheet following the distribution of New Choice. This change was made in order to conform with real estate industry practice. 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. INCOME TAXES The Company was included in the consolidated Federal income tax returns of Manor Care prior to the Manor Care Distribution. Subsequent to November 1, 1996, the Company is a separate taxpayer and files its own tax returns. The income tax provision included in these consolidated statements reflects the historical income tax provision and temporary differences attributable to the operations of the Company on a separate return basis. Deferred taxes are recorded for the tax effect of temporary differences between book and tax income. Income before income taxes from continuing operations was derived from the following (in thousands):
For the seven months ended For the fiscal year ended May 31, December 31, ---------------------------------------------------- 1997 1997 1996 1995 --------------------------------------------------------------------------- Income (loss) before income taxes Domestic operations $(395) $12,649 $ (5,119) $ 944 Foreign operations 67 (809) (16,755) (1,724) ------------------- ---------------------------------------------------- Income (loss) before income taxes $(328) $11,840 $(21,874) $ (780) =================== ===================================================
33 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The provision for income taxes for continuing operations (in thousands):
For the seven months ended December 31, For the fiscal year ended May 31, ----------------------------------------------------- 1997 1997 1996 1995 ------------------- ----------------------------------------------------- Current tax (benefit) expense Federal $ 621 $2,583 $ 94 $ (32) Foreign operations 27 (320) (315) (684) State 134 292 26 (126) Deferred tax (benefit) expense Federal (680) 2,048 (1,676) 427 Foreign operations - - (6,295) - State (146) 432 (357) 92 ------------------- ----------------------------------------------------- $ (44) $5,035 $(8,523) $(323) =================== =====================================================
Deferred tax asset (liabilities) were composed of the following (in thousands):
December 31, May 31, 1997 1997 ------------------- ----------------- Depreciation and amortization $(2,956) $5,672 Foreign operations - 1,565 Accrued expenses 2,702 626 Other (1,124) (658) ------------------- ----------------- Net deferred tax (liability) asset $(1,378) $7,205 =================== =================
A reconciliation of income tax expense (benefit) at the statutory rate to income tax expense included in the accompanying consolidated statements follows:
For the seven months ended For the fiscal year ended May 31, December 31, ----------------------------------------------------- (In thousands, except Federal income tax rate) 1997 1997 1996 1995 ------------------- ----------------------------------------------------- Federal income tax rate 35% 35% 35% 35% Federal taxes at statutory rate $(115) $4,144 $(7,656) $(273) State income taxes, net of Federal tax benefit (4) 573 (982) (22) Other 75 318 115 (28) ------------------- ----------------------------------------------------- Income tax expense (benefit) $ (44) $5,035 $(8,523) $(323) =================== =====================================================
Cash paid for state income taxes was $486,000, $805,000, $165,000, and $86,000 for the seven months ending December 31, 1997 and the fiscal years ending May 31, 1997, 1996 and 1995, respectively. Federal income taxes were paid by Manor Care for the period ending October 31, 1996 and the fiscal years ended May 31, 1996 and 1995. The Company paid Federal income taxes for the consolidated group (including New Choice and its subsidiaries) of $5.8 million for the seven months ending December 31, 1997 and $5.5 million for the period from November 1, 1996 through May 31, 1997. At December 31, 1997, and May 31, 1997, the Company had an income tax receivable of $4.3 million and $1.2 million, respectively. The Company and Manor Care entered into a tax-sharing agreement for purposes of allocating pre-Manor Care Distribution tax liabilities among the Company and Manor Care and their respective subsidiaries. In general, Manor Care is responsible for (i) filing the consolidated Federal income tax return that include the Company and its subsidiaries and (ii) paying the taxes relating to such tax returns to the applicable taxing authorities. The Company 34 will reimburse Manor Care for the portion of such taxes that relates to the Company and its subsidiaries. In addition, the Company will assume liability for all taxes payable by the Company or by Manor Care in the event the Manor Care Distribution is determined not to be tax-free for Federal income tax purposes. Manor Care and the Company have agreed to cooperate with each other and to share information in preparing such tax returns and in dealing with other tax matters. Following the distribution of New Choice, the Company and New Choice entered into a tax-sharing agreement to allocate pre-distribution tax liabilities among the Company and New Choice and their respective subsidiaries. In general, the Company will be responsible for (i) filing the consolidated Federal income tax return for the Company's affiliated group (including New Choice and its subsidiaries through the date of the distribution) and (ii) paying the taxes related to such returns to the applicable taxing authorities. New Choice will reimburse the Company for the portion of such taxes that relates to New Choice and its subsidiaries. ACCRUED EXPENSES Accrued expenses were as follows (in thousands):
December 31, May 31, 1997 1997 ------------------- ----------------- Payroll $ 4,449 $ 8,479 Taxes, other than income 3,995 4,097 Other 3,566 3,392 ------------------- ----------------- $12,010 $15,968 =================== =================
LONG-TERM DEBT AND NOTES PAYABLE Debt consisted of the following at December 31, 1997 and May 31, 1997 (in thousands):
December 31, May 31, 1997 1997 ------------------- ----------------- $80.0 million revolving credit facility with an average rate of 8.27% at December 31, 1997 $ 16,000 $ - $125 million competitive advance and multi- currency revolving credit facility with an average rate of 6.28% at May 31, 1997 - 90,500 Multi-class mortgage pass-through certificates with a blended weighted average rate of 7.8% at December 31, 1997 and May 31, 1997 115,816 117,294 Note payable to Choice with an effective rate of 8.80% at December 31, 1997 114,472 - Note payable to Manor Care with a rate of 9% at May 31, 1997 - 37,022 Capital lease obligations 1,832 15,553 ------------------- ----------------- Total indebtedness $248,120 $260,369 =================== =================
35 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Maturities of debt at December 31, 1997 were as follows (in thousands):
Year 1998 $ 3,013 1999 3,254 2000 19,513 2001 4,087 2002 118,079 Thereafter 100,174 ----------------- $248,120 =================
On October 30, 1996, the Company entered into a $100.0 million competitive advance and multi-currency revolving credit facility (the "October 1996 credit facility") provided by a group of seven banks. This facility provided that up to $75.0 million was available for borrowings in foreign currencies. Borrowings under the October 1996 credit facility were, at the option of the borrower, at one of several rates including LIBOR plus 30 basis points. In addition, the Company had the option to request participation at lower rates than those contractually provided by the October 1996 credit facility. This facility required the Company to pay annual fees of 2/10 of 1% of the total loan commitment. On May 5, 1997, the Company increased the size of the facility from $100 million to $125 million through December 31, 1997, at which time the incremental difference of $25 million was due. The October 1996 credit facility was terminated on October 15, 1997 in conjunction with the distribution and the outstanding balance was repaid with proceeds from the New Choice note. On April 23, 1997 the Company, through its indirect subsidiary First Choice Properties Corporation, completed an offering of $117.5 million multi-class mortgage pass through certificates (collectively, "the mortgage securities"). The mortgage securities, which bear a blended, weighted average interest rate of 7.8% and have a final maturity of May 5, 2012, contain customary covenants with respect to, among other things, limits on levels of indebtedness, liens, certain investments, transactions with affiliates, asset sales, mergers, consolidations, and transfers of cash to affiliates. Net assets restricted related to these mortgage securities were $35.4 million and $34.8 million as of December 31, 1997 and May 31, 1997, respectively. The Company had $6.1 million and $3.9 million in escrow at December 31, 1997 and May 31, 1997, respectively, related to the mortgage securities. The escrow, which is included in other assets, is for property taxes, insurance and capital expenditures of the properties collateralizing the mortgage securities. The mortgage securities are nonrecourse and collateralized by 37 hotels owned by the Company. The offering's net proceeds of $110 million were used to prepay a portion of a loan from Manor Care. The prepayment resulted in an extraordinary loss from early debt redemption of $1.1 million, net of taxes. In conjunction with the April 1997 issuance of the mortgage securities, the Company entered into a series of interest rate swap agreements having a total notional principal amount of $50.0 million. The agreements were terminated concurrent with the pricing of the mortgage securities, resulting in a $862,000 gain. The gain has been deferred and is being amortized over the life of the mortgage securities as an offset to interest expense. The Company entered into two new debt facilities in October 1997 in connection with the distribution: (i) a $80.0 million revolving credit facility (the "October 1997 credit facility"); and (ii) a $115.0 million pay-in-kind note payable to New Choice (the "New Choice Note"). Proceeds from the new debt were used to repay the Company's remaining portion of the loan from Manor Care and the October 1996 credit facility, and for advances previously made by New Choice to the Company. The unused portion of the October 1997 credit facility will be used by the Company for working capital, capital expenditures and acquisitions. The October 1997 credit facility includes customary financial and other covenants that will require the maintenance of certain ratios including maximum leverage, minimum net worth and interest coverage, and will restrict the Company's ability to make certain investments, repurchase stock, incur debt, and dispose of assets. At December 31, 1997, the Company had $69.0 million of availability under the October 1997 credit facility. At the Company's option, the interest rate may be based on LIBOR, a certificate of deposit rate or an alternate base rate (as defined), plus a facility fee. The rate is determined based on the Company's consolidated leverage ratio at the time of borrowing. 36 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The New Choice Note has a maturity of five years, accrues simple interest at a rate equal to 500 basis points above the interest rate on a five-year U.S. Treasury Note, resulting in an effective rate of 8.8% through maturity. The note contains restrictive covenants that restrict or limit the ability of the Company to merge or consolidate with any other person or entity unless the Company is the surviving entity, or sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of the assets of the Company. At December 31, 1997, the Company had a discount of $528,000 recorded relating to the New Choice Note. Cash paid for interest was $10.7 million, $14.8 million, $12.8 million and $9.1 million for the seven months ended December 31, 1997 and fiscal years 1997, 1996 and 1995, respectively. At December 31, 1997, real estate property with a net book value of $ 145.4 million was pledged or mortgaged as collateral. LEASES The Company operates certain property and equipment under leases that expire at various dates through 2014. Future minimum lease payments are as follows (in thousands):
Operating Capitalized Leases Leases 1998 $ 5,205 $ 497 1999 5,605 497 2000 2,325 497 2001 685 819 2002 529 - Thereafter 8,265 - ------------------------------------------ Total minimum lease payments $22,614 2,310 ===================== Less: interest (478) --------------------- Present value of lease payments $1,832 -=====================
Rental expense under non-cancelable operating leases was $1.9 million, $329,000, $332,000, and $321,000 in the seven months ended December 31, 1997, and fiscal years 1997, 1996 and 1995, respectively. For the seven months ended December 31, 1997, the Company paid $2.9 million to Manor Care for office rent, of which New Choice reimbursed the Company $1.0 million for its portion of the total space occupied. In fiscal year 1997, the Company paid $4.5 million to Manor Care for office rent, of which New Choice reimbursed the Company $4.0 million for its portion of total space occupied. The total minimum future lease payments above have not been reduced by the non-cancelable sublease reimbursements from New Choice. ACQUISITIONS AND DIVESTITURES During fiscal year 1997, the Company acquired two hotels containing 324 rooms for $10.7 million and disposed of one hotel containing 153 rooms for $2.5 million. During fiscal year 1996, the Company purchased 16 hotels containing more than 1,900 rooms for $49.6 million. During fiscal year 1995, the Company purchased 16 hotels containing more than 2,300 rooms for $59.8 million. 37 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DISCONTINUED OPERATIONS The revenues, income from discontinued operations before income taxes, and net income from discontinued operations were as follows (in thousands):
Seven months ended December 31, Fiscal year ended May 31, ---------------------------------------------- 1997 1997 1996 1995 ----------------- ---------------------------------------------- Revenue $112,286 $249,822 $227,277 $190,441 Expenses 84,092 189,438 189,545 159,706 ----------------- ---------------------------------------------- Income from discontinued operations before income taxes 28,194 60,384 37,732 30,735 Income taxes 11,825 25,165 15,923 13,467 ----------------- ---------------------------------------------- Net income from discontinued operations $ 16,369 $ 35,219 $ 21,809 $ 17,268 ================= ==============================================
Net income from discontinued operations for the seven months ended December 31, 1997 includes the results of operations of the franchising business through October 15, 1997 and costs associated with the distribution of $1.9 million (net of taxes). Net investment in discontinued operations is composed of the following as of May 31, 1997 (in thousands):
Property and equipment, net $ 31,825 Goodwill, net 69,938 Franchising rights, net 50,504 Receivables, net 23,322 Other assets 31,880 ------------------- Total assets $207,469 =================== Debt $111,634 Other liabilities 43,499 ------------------- Total liabilities 155,133 ------------------- Net investment and advances from parent 52,336 ------------------- Total liabilities and equity $207,469 ===================
COMMITMENTS AND CONTINGENCIES The Company is a defendant in a number of lawsuits arising in the ordinary course of business. In the opinion of management, the ultimate outcome of such litigation will not have a material adverse effect on the Company's business, financial position, or results of operations. PENSION, PROFIT SHARING AND INCENTIVE PLANS Bonuses accrued for key executives of the Company under incentive compensation plans were $357,000, $200,000, $100,000, and $300,000 for the seven months ended December 31, 1997 and in fiscal years 1997, 1996 and 1995, respectively. 38 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Employees 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 the Company were based on the size of its payroll relative to the sponsor's payroll. Costs allocated to the Company for continuing operations were approximately $217,000, $800,000, $583,000 and $424,000 for the seven months ended December 31, 1997 and in fiscal 1997, 1996 and 1995, respectively. CAPITAL STOCK During the seven months ending December 31, 1997, the Company repurchased 588,931 shares of its common stock at a total cost of $10.6 million. During fiscal year 1997, the Company repurchased 3,697,724 shares of its common stock at a total cost of $53.4 million. At its February 1998 meeting, the Company's board of directors approved an amendment authorizing an additional 1.2 million shares under the Company's stock option plan. The authorization of additional shares under the plan requires ratification by the Company's shareholders at the April 22, 1998 Annual Meeting of Stockholders. Stock options may be granted to officers, key employees and non-employee directors with an exercise price not less than the fair market value of the common stock on the date of grant. Options outstanding at November 1, 1996 represent options that resulted from the Manor Care Distribution. Option activity under the above plans is as follows:
Number of Shares Weighted Option Price ----------------------------------------- Outstanding at November 1, 1996 5,920,648 $2.83 Granted 397,693 4.93 Exercised (1,110,164) 4.20 Cancelled (259,145) 3.67 ----------------------------------------- Outstanding at May 31, 1997 4,949,032 3.02 Adjustment as a result of the distribution (2,704,294) Granted 552,441 8.04 Exercised (202,386) 2.03 Cancelled (30,241) 4.94 ----------------------------------------- Outstanding at December 31, 1997 2,564,552 $5.67 =========================================
In connection with the distribution, the outstanding options held by current and former employees of the Company as of October 15, 1997 were redenominated in both Company and New Choice stock, and the number and exercise prices of the options were adjusted based on the relative trading prices of shares of the common stock of the two companies to retain the intrinsic value of the options. The option prices for the period prior to May 31, 1997 in the table above have been adjusted for the reverse stock split. The following table provides information on the exercise prices of options outstanding at December 31, 1997.
Weighted Average Number of Options Exercise Price Number of Options Weighted Average Contractual Life (in Currently Range Outstanding Exercise Price years) Exercisable ----- ----------- -------------- ----- ----------- $ 1.34 to $ 2.00 241,314 $1.67 1.75 214,078 $ 2.01 to $ 3.50 333,745 $2.74 3.91 80,745 $ 3.51 to $ 5.50 426,461 $4.32 5.72 93,004 $ 5.51 to $ 8.50 1,489,381 $7.18 8.71 120,276 $ 8.51 to $ 9.79 73,651 $9.42 9.29 1,000 ------------- ------------ 2,564,552 509,103 ============= ============
39 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS No. 123"), requires companies to provide additional disclosures about employee stock-based compensation plans based on a fair value based method of accounting. As permitted by this accounting standard, the Company continues to account for these plans under Accounting Principles Board Opinion 25, under which no compensation cost has been recognized. Compensation cost for the Company's stock option plan was determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123. The fair value of each option grant has been estimated on the date of grant using an option-pricing model. For the seven months ended December 31, 1997 and fiscal year 1997 the Company assumed a risk free interest rate of 5.7% and 6.4%, respectively, expected volatility of 25.7% and 30.0%, respectively, a dividend yield of 0% and expected lives of ten years. The weighted average fair value per option granted during the seven months ended December 31, 1997 and fiscal year 1997 was $4.12 and $8.35, respectively. If options had been reported as compensation expense based on their fair value pro forma, net income and earnings per share would have been as follows for the seven months ended December 31, 1997 and fiscal year 1997.
For the seven months ended For the year ended December 31, 1997 May 31, 1997 ------------------------------------------------ Net income: As reported $16,085 $40,880 Pro forma $15,563 $40,296 Earnings per share: Basic, as reported $ 0.81 $ 1.96 Basic, pro forma $ 0.78 $ 1.92 Diluted, as reported $ 0.81 $ 1.93 Diluted, pro forma $ 0.78 $ 1.90
The Company has not presented information for the period prior to the Manor Care Distribution since there were no options for the Company's stock granted until after the Manor Care Distribution. Since this methodology has not been applied to options granted prior to the Manor Care Distribution date, the resulting pro forma compensation cost is not likely to be representative of that to be expected in future years. EARNINGS PER SHARE The following table illustrates the reconciliation of income from continuing operations and number of shares used in the basic and diluted earnings per share calculation.
(in thousands, except per share amounts) May 31, 1997 ----------------- Computation of basic earnings per share Income from continuing operations $ 6,805 Weighted average shares outstanding 20,893 ----------------- Basic Earnings Per Share $ 0.32 ================= 40 Computation of diluted earnings per share Income from continuing operations $ 6,805 Weighted average share outstanding 20,893 Effect of dilutive securities: Employee stock option plan 298 ----------------- Shares for diluted earnings per share 21,191 ----------------- Diluted earnings per share $ 0.32 =================
The effect of dilutive securities is computed using the treasury stock method and average market prices during the period. Certain options to purchase common stock were not included in the computation of diluted earnings per share because the exercise price of the options exceeded the average market price of the common shares for the period. The following tables summarizes such options.
May 31, 1997 ------------------ Number of shares (in thousands) 60 Weighted average exercise price $5.20
Earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding. The weighted average number of common shares outstanding is after giving effect to the one for three reverse stock split and is based on Manor Care's weighted average number of outstanding common shares for the period prior to November 1, 1996 and the Company's own shares and stock options outstanding subsequent to November 1, 1996. Because the Company's continuing operations had a net loss for the seven months ending December 31, 1997, diluted earnings per share was not calculated as any potentially dilutive securities would have an anti-dilutive effect on earnings per share from continuing operations. No diluted earnings per share is presented for fiscal years 1996 and 1995 as the Company had no stock options or other dilutive securities outstanding prior to the Manor Care Distribution. RELATIONSHIP WITH MANOR CARE The Company entered into various agreements in connection with the Manor Care Distribution which provide, among other things, that (i) Manor Care is responsible for filing and paying the related taxes on consolidated Federal tax returns and consolidated or combined state tax returns for itself and any of its affiliates (including the Company and New Choice) for the periods of time that the affiliates were members of the consolidated group, (ii) the Company would reimburse Manor Care for the portion of such taxes that relates to the Company and its subsidiaries, (iii) Manor Care would lease office space to the Company in Silver Spring and Gaithersburg, Maryland, (iv) the Company would enter into a loan agreement with Manor Care for $225.7 million previously advanced at an interest rate of 9% ($37.0 million of which is outstanding at May 31, 1997 as an obligation of the Company following the distribution), and (v) Manor Care would provide certain corporate services to the Company. For the seven months ended December 31, 1997 and the fiscal year ended May 31, 1997, the Company incurred $1.9 million and $525,000, respectively, in rent expense for office space leased from Manor Care, $1.2 million and $12.4 million, respectively, in interest expense on the loan, and $1.4 million and $2.1 million, respectively, in corporate expense for corporate services provided by Manor Care. 41 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS RELATIONSHIP WITH CHOICE HOTELS INTERNATIONAL, INC. For purposes of providing an orderly transition after the distribution, the Company and New Choice entered into various agreements, including, among others, a Distribution Agreement, a Tax Sharing Agreement, a Corporate Services Agreement and an Employee Benefits Allocation Agreement. Effective as of October 15, 1997, these agreements provide, among other things, that the Company (i) would receive and/or provide certain corporate and support services, such as accounting, tax and computer systems support, (ii) would adjust outstanding options to purchase shares of Company common stock held by Company employees, New Choice employees, and employees of Manor Care, (iii) is responsible for filing and paying the related taxes on consolidated Federal tax returns and consolidated or combined state tax returns for itself and any of its affiliates (including New Choice) for the periods of time that the affiliates were members of the consolidated group, (iv) would be reimbursed by New Choice for the portion of income taxes paid that relate to New Choice and its subsidiaries, (v) would enter into a loan agreement with New Choice for $115.0 million at an interest rate of 500 basis points over the interest rate of a five-year U.S. Treasury Note, and (vi) guarantees that New Choice would, at the date of distribution, have a specified level of net worth. At December 31, 1997, approximately $25 million of liabilities are due to New Choice. This liability relates to the net worth guarantee and the reimbursement of various expenses subsequent to the distribution date. The Company and New Choice have entered into a strategic alliance agreement. Among other things, the agreement will provide for (i) a right of first refusal to New Choice to franchise 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, and (iv) continued cooperation with respect to third party vendor arrangements and 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. The Company and New Choice also entered into a financial consulting agreement which provides for certain payments to the Company by New Choice. During 1997, the Company operated substantially all of its hotels pursuant to franchise agreements with New Choice. Total fees paid to New Choice included in the accompanying financial statements for franchising marketing, reservation and royalty fees are $6.2 million, $9.5 million, $7.5 million, and $5.3 million for the seven months ended December 31, 1997 and the fiscal years ended May 31, 1997, 1996 and 1995, respectively. FAIR VALUE OF FINANCIAL INSTRUMENTS The balance sheet carrying amount of cash and cash equivalents and receivables approximate fair value due to the short term nature of these items. Mortgages and other long term debt consist of bank loans and mortgages. The interest rate on the October 1997 credit facility adjusts frequently based on market rates; accordingly, the carrying amount of bank loans is equivalent to fair value. The carrying amount for the notes payable to Choice and the mortgage securities approximates fair value. PROVISION FOR ASSET IMPAIRMENT AND OTHER NON-RECURRING CHARGES Included in the provision for asset impairment and other non-recurring charges in the seven months ended December 31, 1997 are non-recurring loss provisions totaling $5.1 million (pretax). This loss provision was recorded in December 1997 in order to reserve $2.1 million of previously capitalized costs and future payment obligations related to a data processing services agreement and computer system which will be replaced in 1998, to accrue the estimated cost of $1.0 million of future lease costs associated with space the Company has vacated, and to reserve $2.0 million for future obligations related to an agreement expiring in May 1999, for services which the Company will no longer utilize and, therefore, have no future benefits. The service and lease agreements are with Manor Care and New Choice and were entered into in conjunction with the distribution and the Manor Care Distribution. Recent corporate decisions, including a consolidation of leased office space, resulted in the recognition of these costs currently. 42 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS During fiscal year 1996, the Company began restructuring its European operations. This restructuring effort included the purchase of an equity interest in Friendly Hotels PLC and a re-evaluation of key geographic markets in Europe. In connection with this restructuring, the Company performed a review of its European operations and in May 1996 recognized a $19.4 million non-cash charge against earnings related primarily to the impairment of assets associated with certain European hotel operations. In addition, the Company recognized a restructuring charge of $5.2 million in May 1996. Restructuring costs include severance and employee benefit plan restructuring costs and other costs directly associated with the distribution. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS The Company is required to adopt SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," in 1998. The adoption of these pronouncements will not materially affect the continuing operations of the Company. The Company adopted SFAS No. 129, "Disclosure of Information about Capital Structure," which did not impact the financial statements. SUBSEQUENT EVENT (UNAUDITED) On February 4, 1998, the Board of Directors of the Company approved a plan to sell certain properties in the Company's portfolio. At December 31, 1997, the net book value of the properties the Company intends to sell is $17.8 million. The fair value of the properties is above the respective net book values, and therefore, no impairment charges have been recognized as of December 31, 1997. On February 23, 1998, the Board of Directors adopted a shareholder rights plan under which a dividend of one preferred stock purchase right will be distributed for each outstanding share of the Company's common stock to shareholders of record on April 3, 1998. Each right will entitle the holder to buy 1/100th of a share of a newly issued series of junior participating preferred stock of the Company at an exercise price of $50 per share. The rights will be exercisable, subject to certain exceptions, after a person or group acquires beneficial ownership of 10% or more of the Company's common stock (such a person or group, an "Acquiring Person"), or begins a tender or exchange offer that would result in a person or group becoming an Acquiring Person. The rights will be non- voting and will expire on January 31, 2008, unless exercised or previously redeemed by the Company for $.001 each. If the Company is involved in a merger or certain other business combinations not approved by the Board of Directors, each right will entitle its holder, other than the acquiring person or group, to purchase common stock of either the Company or the acquirer having a value of twice the exercise price of the right. 43 SUNBURST HOSPITALITY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
Quarters ended (in thousands, except per Operating NET INCOME BASIC EPS DILUTED EPS share data) REVENUES (1) Income (2,3) (4) (4) ---------------------------------------------------------------------------- SEVEN MONTHS ENDED DECEMBER 31, 1997 August 31, 1997 $54,098 $11,368 $16,115 $0.80 $0.80 November 30, 1997 48,169 5,510 5,503 0.28 0.27 Fiscal 1997 November 30, 1996 $44,950 $ 4,822 $10,615 $0.51 $0.50 February 28, 1997 39,703 2,263 3,448 0.16 0.16 May 31, 1997 51,447 9,920 11,420 0.56 0.55
(1) Revenues reflect revenues from continuing operations. (2) Operating income reflects income from continuing operations before interest expense, income taxes and extraordinary items. (3) Operating income for the quarter ending August 31, 1997 was adjusted to reclassify certain expenses relating to European hotels from discontinued operations to continuing operations. The adjustment has no impact on Net Income for the quarter. (4) Basic EPS and Diluted EPS for periods prior to October 15, 1997 have been effected for the one-for-three reverse stock split. 44 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The required information on directors is included on pages 4-5 of the Proxy Statement dated March 25, 1998 and is incorporated herein by reference. The required information on executive officers is set forth in Part I of this Form 10-K under an unnumbered item captioned "Executive Officers of Sunburst Hospitality Corporation." ITEM 11. EXECUTIVE COMPENSATION. The required information is included on pages 13-19 of the Proxy Statement dated March 25, 1998 and is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management. The required information is included on pages 7-9 of the Proxy Statement dated March 25, 1998 and is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions. The required information is included on pages 20-27 of the Proxy Statement dated March 25, 1998 and is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT 1. Financial Statements The Consolidated Financial Statements filed with this Form 10-K are listed in Item 8 above. 2. FINANCIAL STATEMENT SCHEDULES The following reports are filed herewith on the pages indicated: Report of Independent Public Accountants on Schedule p. 24 Schedule I: Condensed Financial Information p. 49 Schedule III: Real Estate and Accumulated Depreciation p. 55 All other schedules are not applicable. 3. EXHIBITS 3.01 Restated Certificate of Incorporation of the Registrant* 3.02 Amendments to Restated Certificate of Incorporation 3.03 By-laws of the Registrant* 4.01 Common Stock certificate* 45 4.02 Competitive Advance and Multi-Company Credit Facility Agreement between the Registrant and Chase Manhattan Bank dated October 15, 1997 4.03 Subordinated Note due October 15, 2002 by the Registrant payable to Choice Hotels International, Inc.*** 4.05 Promissory Note dated April 22, 1997 by First Choice Properties Corp. in favor of QI Capital Corp. in the principal amount of $117,500,000**** 4.06 Loan Agreement dated as of April 22, 1997 by and between First Choice Properties Corp. and QI Capital Corp.**** 10.01 Distribution Agreement, dated October 31, 1996, between Manor Care, Inc. and the Registrant* 10.02 Corporate Services Agreement between Manor Care, Inc. and the Registrant* 10.03 Office Lease between Manor Care, Inc. and the Registrant* 10.04 Office Lease between Manor Care, Inc. and the Registrant* 10.05 Strategic Alliance Agreement dated as of October 15, 1997 by and between the Registrant and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.)** 10.06 Non-Competition Agreement dated as of October 15, 1997 by and between the Registrant and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.)** 10.07 Amended and Restated Agreement dated as of October 15, 1997 by and between the Registrant and Stewart Bainum, Jr.** 10.08 Employment Agreement between the Registrant and James A. MacCutcheon* 10.09 Supplemental Executive Retirement Plan* 10.10 Non-Employee Director Stock Option and Deferred Compensation Stock Purchase Plan* 10.11 1996 Non-Employee Director Stock Compensation Plan* 10.12 1996 Long-Term Incentive Plan* 10.13 Pikesville Sublease between Manor Care, Inc. and the Registrant* 10.14 Employee Benefits and Other Employment Matters Allocation Agreement between Manor Care, Inc. and the Registrant* 10.15 Distribution Agreement dated as of October 15, 1997 by and between Registrant and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.)** 10.16 Employee Benefits Allocation Agreement dated as of October 15, 1997 by and between the Registrant and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.** 10.17 Employee Benefits Administration Agreement dated as of October 15, 1997 by and between the Registrant and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.)** 10.18 Tax Administration Agreement dated as of October 15, 1997 by and between the Registrant and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.) 10.19 Tax Sharing Agreement dated as of October 15, 1997 by and between the Registrant and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.)** 10.20 Office Sublease dated as of October 15, 1997 by and between the Registrant and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.)** 10.21 Corporate Services Agreement dated as of October 15, 1997 by and between the Registrant and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.)** 10.22 Omnibus Agreement and Guaranty dated as of October 15, 1997 by and among the Registrant, Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.) and Manor Care, Inc.** 21.01 Subsidiaries of the Registrant 23.01 Consent of Independent Public Accountants 27.01 Financial Data Schedule 99.01 Proxy Statement dated March 23, 1998 (information incorporated by reference) - ------------------- * Incorporated by reference to the Company's Registration Statement on Form 10, File No. 001-11915. **Incorporated by reference to the Company's Form 8-K dated October 15, 1997, filed October 29, 1997. ***Incorporated by reference to the Company's 8-K dated October 15, 1997, filed December 17, 1997. ****Incorporated by reference to the Company's Registration Form 10-k for the fiscal year ended May 31, 1997, filed August 15, 1997. (b) Three reports on Form 8-K were filed during the last quarter of the fiscal year ended December 31, 1997: 46 Form 8-k, dated September 16, 1997, and filed October 1, 1997, reported as Item 5 that (1) the Registrant's Shareholders had approved the separation of the franchising and owned hotel businesses and (2) the Registrant had checked its fiscal year end from May 31 to October 31. Form 8-K, dated October 15, 1997 and filed October 29, 1997, reported as Item 2 the consummation of the Company's spinoff of its wholly owned subsidiary, Choice Hotels Franchising, Inc. Under Item 5, the Company reported its name change to "Sunburst Hospitality Corporation" and that it effected a one-for- three reverse stock split. Form 8-K, dated October 15, 1997 and filed December 17, 1997, included under Exhibits the Subordinated Note due October 15, 2002 by Sunburst Hospitality Corporation payable to Choice Hotels International, Inc. 47 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: March 30, 1998 SUNBURST HOSPITALITY CORPORATION By: /s/ James A. MacCutcheon ------------------------------------ Executive Vice President, Chief Financial Officer and Treasurer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ Stewart Bainum, Jr. Chairman March 30, 1998 - ------------------------- Stewart Bainum, Jr. /s/ Donald J. Landry Vice Chairman and March 30, 1998 - ------------------------- Chief Executive Officer Donald J. Landry /s/ Steward Bainum Director March 30, 1998 - ------------------------- Stewart Bainum /s/ Paul A. Gould Director March 30, 1998 - ------------------------- Paul A. Gould /s/ Frederic V. Malek Director March 30, 1998 - ------------------------- Frederic V. Malek /s/ Keith B. Pitts Director March 30, 1998 - ------------------------- Keith B. Pitts 48 /s/ Carole Y. Prest Director March 30, 1998 - --------------------------- Carole Y. Prest /s/ Charles M. Warczak, Jr. Vice President March 30, 1998 - --------------------------- Accounting and Hotel Charles M. Warczak, Jr. Systems (Chief Accounting Officer) Schedule I SUNBURST HOSPITALITY CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS (IN THOUSANDS)
As of ------------------------ December 31, May 31, ------------ ----------- 1997 1997 ------------ ----------- ASSETS Real estate, net $225,893 $191,693 Receivables, net 3,896 4,693 Net investment in restricted subsidiaries 35,439 34,823 Other assets 6,664 12,965 Cash and cash equivalents 4,348 6,471 Net investment in discontinued operations - 52,336 ---------- ---------- Total assets $276,240 $302,981 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Debt $132,304 $143,075 Accounts payable and accrued expenses 52,202 35,419 Other liabilities 2,427 - ---------- ---------- Total liabilities 186,933 178,494 ---------- ---------- Stockholders' Equity Common stock 200 602 Additional paid-in-capital 105,653 113,828 Retained earnings (16,546) 17,075 Cumulative translation adjustment - (7,018) ---------- ---------- Total stockholders' equity 89,307 124,487 ---------- ---------- Total liabilities and stockholders' equity $276,240 $302,981 ========== ==========
SUNBURST HOSPITALITY CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF INCOME (IN THOUSANDS)
For the seven months ended For the fiscal year ended December 31, May 31, ------------ ------------ ------------ ------------ 1997 1997 1996 1995 ------------ ------------ ------------ ------------ Revenues $55,487 $87,262 $62,467 $41,744 Operating expenses 44,506 69,780 56,336 38,952 Provision for asset impairment and other non-recurring charges 5,119 - 24,595 - Depreciation and amortization 8,561 10,988 7,562 5,379 Interest expense 4,580 6,484 3,211 36 ------------ ------------ ------------ ------------ Total expenses 62,766 87,252 91,704 44,367 ------------ ------------ ------------ ------------ Income before income taxes and equity in earnings of restricted subsidiaries (7,279) 10 (29,237) (2,623) Equity in earnings of restricted subsdiaries 6,951 11,830 7,363 1,843 Income tax (benefit) expense (44) 5,035 (8,523) (323) ----------- ------------ ------------ ------------ Income (loss) from continuing operations (284) 6,805 (13,351) (457) Income from discontinued operations, net of tax 16,369 35,219 21,809 17,268 ----------- ------------ ------------ ------------ Net income before extraordinary item 16,085 42,024 8,458 16,811 Extraordinary item -- loss from early extinguishment of debt (net of tax) - 1,144 - - ---------- ------------ ------------ ------------ Net income $16,085 $40,880 $8,458 $16,811 ========== =========== =========== ===========
SUNBURST HOSPITALITY CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS (IN THOUSANDS)
For the seven months ended For the fiscal year ended December 31, May 31, ------------ ------------ ------------ ------------ 1997 1997 1996 1995 ------------ ------------ ------------ ------------ Net cash provided by (utilized by) continuing operations $2,316 $20,282 $10,474 ($3,908) Net cash provided by discontinued operations 20,876 46,724 32,645 41,454 ------------ ------------ ------------ ------------ Net cash provided from operating activities 23,192 67,006 43,119 37,546 ------------ ------------ ------------ ------------ Cash flows from investing activities Investment in property and equipment (51,383) (63,163) (34,214) (13,557) Acquisition of operating hotels - (5,550) (49,617) (24,869) Distribution of New Choice (4,166) - - - Proceeds from sale of property and equipment 170 2,522 5,479 - ------------ ------------ ------------ ------------ Net cash utilized by continuing operations (55,379) (66,191) (78,352) (38,426) Net cash utilized by discontinued operations (118,474) (15,864) (78,844) (6,993) ------------ ------------ ------------ ------------ Net cash utilized by investing activities (173,853) (82,055) (157,196) (45,419) ------------ ------------ ------------ ------------ Cash flows from financing activities Proceeds from mortgages and other long term debt 16,023 90,500 - - Principal payments of debt (90,694) (951) (645) (89) (Repayment of) proceeds from notes payable to Manor Care, Inc. (37,022) - 27,201 13,164 Proceeds from note payable to Choice Hotels International 115,000 - - - Proceeds from issuance of common stock 1,153 3,410 - - Purchases of treasury stock (10,554) (53,150) - - Payable to Choice Hotels International, Inc. for net worth guarantee 15,000 - - - Advances from (to) restricted subsidiaries 6,503 11,028 (73) (2,116) Advances (from) to Manor Care, Inc., net - (9,971) 73,272 (6,190) ------------ ------------ ------------ ------------ Net cash provided by continuing operations 15,409 40,866 99,755 4,769 Net cash provided by (utilized by) discontinued operations 129,337 (19,730) 17,131 2,075 ------------ ------------ ------------ ------------ Net cash utilized by financing activities 144,746 21,136 116,886 6,844 ------------ ------------ ------------ ------------ Net change in cash and cash equivalents (5,915) 6,087 2,809 (1,029) Cash and cash equivalents at beginning of period 10,263 4,176 1,367 2,396 ------------ ------------ ------------ ------------ Cash and cash equivalents at end of period $ 4,348 $10,263 $4,176 $1,367 =========== =========== =========== =========== Cash and cash equivalents of continuing operations $ 4,348 $6,471 $1,073 $940 Cash and cash equivalents of discontinued operations $ - $3,792 $3,103 $427
SUNBURST HOSPITALITY CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. BASIS OF PRESENTATION The accompanying condensed financial information of Sunburst Hospitality Corporation (the "Parent Company") presents the financial condition, results of operations and cash flows of the Parent Company with the investment in and operations of its restricted subsidiary, First Choice Properties Corporation ("First Choice") on the equity method of accounting. Pursuant to the rules and regulations of the Securities and Exchange Commission, the condensed financial statements of the registrant do not include all of the information and notes normally included with financial statements prepared in accordance with generally accepted accounting principles and the statements should therefore be read in conjunction with the Consolidated Financial Statements and Notes thereto included in this Form 10-K. As more fully described in the notes to the Company's consolidated financial statements, the Company distributed its franchising business to its shareholders on October 15, 1997 (distribution date). The accompanying condensed financial information has been stated to reflect the franchising business as discontinued operations through the distribution date. In April 1997, First Choice, an indirect, wholly-owned subsidiary of the Parent Company, issued $117.5 million multi-class mortgage pass-through certificates (collectively, "the mortgage securities"). The mortgage securities are non- recourse and collateralized by 36 hotels owned by First Choice. The mortgage securities bear a blended weighted average interest rate of 7.8% and have a final maturity of May 5, 2012. The mortgage securities contain customary covenants with respect to, among other things, limits on the incurrence of debt, liens, certain investments, transactions with affiliates, asset sales, mergers, and consolidations and transfer of cash to affiliates. The accompanying condensed financial statements present the debt of First Choice as a component of Net investment in restricted subsidiaries. Prior to the April 1997 issuance of the mortgage securities, the financial statements include the pushed down effect of $110 million in Manor Care notes payable, as the April 1997 proceeds of the mortgage securities were used to repay the Manor Care notes payable. B. DEBT Aggregate debt maturities at December 31, 1997, are (in thousands): 1998 $ 329 1999 364 2000 16,402 2001 737 2002 114,472 Thereafter ----------------- $132,304 =================
53 SUNBURST HOSPITALITY CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS C DIVIDENDS First Choice did not pay cash dividends to the Parent Company in the seven months ended December 31, 1997 and fiscal year 1997. 54 Schedule III SUNBURST HOSPITALITY CORPORATION REAL ESTATE AND ACCUMULATED DEPRECIATION 31-Dec-97 (IN THOUSANDS)
Initial cost to Company Gross Amount at December 31, 1997 ----------------------- Subsequent ----------------------------------- Building and Capitalized Asset Buildings and Accumulated Description Encumbrances Land improvements Costs Writedowns Land improvements Total Depreciation - ------------ ------------- ----------------------- ------------ ----------- --------- ------------- ------------ ------------ All properties, each less than 5% of total $133,648 $52,208 $191,182 $85,374 $3,400 $61,959 $263,405 $325,364 $43,911 Date of Depreciation Description Construction Date Acquired Life - ------------ ------------ ------------- ------------ All properties, Various Various Various each less than 5% of total
SUNBURST HOSPITALITY CORPORATION REAL ESTATE AND ACCUMULATED DEPRECIATION 31-Dec-97 (IN THOUSANDS)
Notes: (A) The change in total cost of properties for the seven months ended December 31, 1997 and fiscal years ended May 31, 1997, 1996 and 1995 is as follows: Balance at May 31, 1994 $127,760 Aditions: Acquisitions 57,214 Capital expenditures 7,945 Deductions: Dispositions and other - ------------ Balance at May 31, 1995 192,919 Additions: Acquisitions 52,270 Capital expenditures 17,599 Deductions: Dispositions and other (10,652) Write-downs (3,400) ------------ Balane at May 31, 1996 248,736 Additions: Acquisitions 21,278 Capital expenditures 16,363 Transfers from construction-in-progress 3,831 Deductions: Dispositions and other (7,008) ------------ Balance at May 31, 1997 283,200 Additions: Acquisitions - Capital expenditures 22,562 Transfer from construction-in-progress 19,772 Deductions: Dispositions and other (170) ------------ Balance at December 31, 1997 325,364 =========== (B) The change in accumulated depreciation and amortization for the seven months ended December 31, 1997, and fiscal years ended May 31, 1997, 1996, and 1995 is as follows: Balance at May 31, 1994 23,946 Depreciation and amortization 4,258 Disposals - ------------ Balance at May 31, 1995 28,204 ------------ Depreciation and amortization 6,478 Disposals (4,865) ------------ Balance at May 31, 1996 29,817 ------------ Depreciation and amortization 8,992 Disposals (2,145) ------------ Balance at May 31, 1997 36,664 ------------ Depreciation and amortization 7,247 Disposals - ------------ Balance at December 31, 1997 43,911 ===========
(C) The write-down in fiscal year 1996 relates to impairment charges taken in accordance with Statement of Financial Accounting Standards No. 121. (D) The total cost of properties excludes construction-in-progress and European hotels, which were distributed on October 15, 1997 with Franchising. (E) The aggregate cost of properties for Federal income tax purposes is approximately $326.4 million at December 31, 1997. EX-4.02 2 EXHIBIT 4.02 Exhibit 4.02 CONFORMED COPY ================================================================================ CREDIT AGREEMENT Dated as of October 15, 1997 among SUNBURST HOSPITALITY CORPORATION, as Borrower, THE LENDERS NAMED HEREIN, and THE CHASE MANHATTAN BANK, as Agent ================================================================================ [CS&M Ref. No. 6700-462] TABLE OF CONTENTS ARTICLE I Definitions -----------
SECTION 1.01. Defined Terms............................. 1 SECTION 1.02. Classification of Loans and Borrowings....25 SECTION 1.03. Terms Generally...........................25 ARTICLE II The Credits ----------- SECTION 2.01. Commitments...............................25 SECTION 2.02. Loans.....................................25 SECTION 2.03. Borrowing Procedures......................28 SECTION 2.04. Refinancings..............................28 SECTION 2.05. Fees......................................29 SECTION 2.06. Evidence of Indebtedness; Repayment of Loans..........................30 SECTION 2.07. Interest on Loans.........................30 SECTION 2.08. Default Interest..........................31 SECTION 2.09. Alternate Rate of Interest................32 SECTION 2.10. Termination and Reduction of Commitments.......................32 SECTION 2.11. Prepayment of Loans.......................33 SECTION 2.12. Reserve Requirements; Change in Circumstances.....................34 SECTION 2.13. Change in Legality........................36 SECTION 2.14. Indemnity.................................37 SECTION 2.15. Pro Rata Treatment........................37 SECTION 2.16. Sharing of Setoffs........................38 SECTION 2.17. Payments..................................39 SECTION 2.18. Taxes.....................................39 SECTION 2.19. Letters of Credit.........................42 ARTICLE III Representations and Warranties ------------------------------ SECTION 3.01. Organization; Powers......................47 SECTION 3.02. Authorization.............................47 SECTION 3.03. Enforceability............................48 SECTION 3.04. Governmental Approvals....................48 SECTION 3.05. Financial Statements......................48 SECTION 3.06. No Material Adverse Change................49 SECTION 3.07. Title to Properties; Possession Under Leases......................49
i SECTION 3.08. Subsidiaries..............................50 SECTION 3.09. Litigation; Compliance with Laws..........50 SECTION 3.10. Agreements................................50 SECTION 3.11. Federal Reserve Regulations...............51 SECTION 3.12. Investment Company Act; Public Utility Holding Company Act...............51 SECTION 3.13. Use of Proceeds...........................51 SECTION 3.14. Tax Returns...............................51 SECTION 3.15. No Material Misstatements.................51 SECTION 3.16. Employee Benefit Plans....................52 SECTION 3.17. Environmental Matters.....................52 SECTION 3.18. Solvency..................................53 SECTION 3.19. Spin-Off..................................53 SECTION 3.20. Pledge Agreement..........................53 ARTICLE IV Conditions of Lending --------------------- SECTION 4.01. All Credit Events......................... 54 SECTION 4.02. First Credit Event........................ 54 ARTICLE V Affirmative Covenants --------------------- SECTION 5.01. Existence; Businesses and Properties...... 60 SECTION 5.02. Insurance................................. 60 SECTION 5.03. Obligations and Taxes..................... 61 SECTION 5.04. Financial Statements, Reports, etc........ 61 SECTION 5.05. Litigation and Other Notices.............. 63 SECTION 5.06. ERISA..................................... 63 SECTION 5.07. Maintaining Records; Access to Properties and Inspections.............. 64 SECTION 5.08. Use of Proceeds........................... 65 SECTION 5.09. Additional Subsidiaries................... 65 SECTION 5.10. Further Assurances......................... 65 ARTICLE VI Negative Covenants ------------------ SECTION 6.01. Indebtedness............................... 66 SECTION 6.02. Liens...................................... 67 SECTION 6.03. Sale and Lease-Back Transactions........... 69 SECTION 6.04. Investments, Loans and Advances............ 69
SECTION 6.05. Mergers and Consolidations..................70 SECTION 6.06. Asset Sales.................................71 SECTION 6.07. Transactions with Affiliates................71 SECTION 6.08. Business of Borrower and Subsidiaries.......71 SECTION 6.09. Subsidiary Indebtedness.....................71 SECTION 6.10. Agreements..................................72 SECTION 6.11. Fiscal Year and Accounting Practices........72 SECTION 6.12. No Further Negative Pledges.................72 SECTION 6.13. Minimum Consolidated Net Worth..............72 SECTION 6.14. Limitation on Consolidated Funded Debt......72 SECTION 6.15. Limitation on Consolidated Senior Funded Indebtedness.......................73 SECTION 6.16. Fixed Charge Coverage Ratio.................73 SECTION 6.17. Borrowing Base Properties...................73 SECTION 6.18. Amendment or Prepayment of Approved Subordinated Indebtedness.................74 ARTICLE VII Events of Default ----------------- ARTICLE VIII The Agent --------- ARTICLE IX Miscellaneous ------------- SECTION 9.01. Notices.....................................81 SECTION 9.02. Survival of Agreement.......................82 SECTION 9.03. Binding Effect..............................82 SECTION 9.04. Successors and Assigns......................82 SECTION 9.05. Expenses; Indemnity.........................86 SECTION 9.06. Right of Setoff.............................88 SECTION 9.07. Applicable Law..............................88 SECTION 9.08. Waivers; Amendment..........................88 SECTION 9.09. Interest Rate Limitation....................89 SECTION 9.10. Entire Agreement............................90 SECTION 9.11. Waiver of Jury Trial; Punitive Damages.............................90 SECTION 9.12. Severability................................90 SECTION 9.13. Counterparts................................91 SECTION 9.14. Headings....................................91 SECTION 9.15. Jurisdiction; Consent to Service of Process..........................91 SECTION 9.16. Confidentiality.............................92
iii Exhibits - -------- Exhibit A Form of Borrowing Request Exhibit B Form of Administrative Questionnaire Exhibit C Form of Assignment and Acceptance Exhibit D Form of Borrowing Base Certificate Exhibit E Form of Opinion of Counsel Exhibit F Form of Issuing Bank Agreement Exhibit G Form of Guarantee Agreement Exhibit H Form of Pledge Agreement Exhibit I Form of Indemnity, Subrogation and Contribution Agreement Schedules - --------- Schedule 1.01(a) Approved Environmental Consultants Schedule 1.01(b) Criteria for Approved Subordinated Indebtedness Schedule 1.01(c) Hotel Properties Schedule 2.01 Commitments Schedule 3.07 Leased Hotel Properties Schedule 3.08 Subsidiaries Schedule 4.02(q) Leases Schedule 6.01(a) Existing Indebtedness Schedule 6.02 Existing Liens Schedule 6.04 Existing Investments iv CREDIT AGREEMENT dated as of October 15, 1997, among SUNBURST HOSPITALITY CORPORATION, a Delaware corporation (the "Borrower"), the Lenders referred to herein and THE -------- CHASE MANHATTAN BANK, a New York banking corporation, as agent for the Lenders (in such capacity, the "Agent"). ----- The Borrower has requested the Lenders to extend credit to the Borrower in order to enable it to borrow on a revolving credit basis on and after the Effective Date and at any time and from time to time prior to the Revolving Maturity Date (as herein defined) a principal amount not in excess of $80,000,000 at any time outstanding. The Borrower has requested the Issuing Bank (as herein defined) to issue letters of credit, in an aggregate face amount at any time outstanding not in excess of $5,000,000, to support payment obligations incurred in the ordinary course of business by the Borrower and its Subsidiaries (as herein defined). The proceeds of the borrowings hereunder shall be used for the refinancing of existing Indebtedness and general corporate purposes of the Borrower and the Subsidiaries, including working capital, capital expenditures (including hotel construction) and certain acquisitions. The Lenders are willing to extend such credit to the Borrower and the Issuing Bank is willing to issue letters of credit for the account of the Borrower on the terms and subject to the conditions herein set forth. Accordingly, the parties hereto agree as follows: ARTICLE I. DEFINITIONS SECTION 1.01. Defined Terms. As used in this Agreement, the -------------- following terms shall have the meanings specified below: "ABR Borrowing" shall mean a Borrowing comprised of ABR Loans. ------------- "ABR Loan" shall mean any Loan bearing interest at a rate determined -------- by reference to the Alternate Base Rate in accordance with the provisions of Article II. "Adjusted CD Rate" shall mean, with respect to any CD Borrowing for ---------------- any Interest Period, an interest rate per annum (rounded upwards, if necessary, to the next 1/100 of 1%) equal to the sum of (a) a rate per annum equal to the product of (i) the Fixed CD Rate in effect for such Interest Period and (ii) Statutory Reserves, plus (b) the Assessment Rate. For purposes hereof, the term "Fixed CD Rate" shall mean the arithmetic average (rounded upwards, if necessary, to the next 1/100 of 1%) of the prevailing rates per annum bid at or about 10:00 a.m., New York City time, to the Agent on the first Business Day of the Interest Period applicable to such CD Borrowing by three New York City negotiable certificate of deposit dealers of recognized national standing selected by the Agent for the purchase at face value of negotiable certificates of deposit of major United States money center banks in a principal amount approximately equal to the Reference Bank's portion of such CD Borrowing and with a maturity comparable to such Interest Period. "Adjusted Consolidated Leverage Ratio" shall mean the ratio of (a) ------------------------------------ Consolidated Funded Indebtedness (excluding up to $25,000,000 of Indebtedness the proceeds of which were used to acquire, construct or improve (i) Hotel Properties owned for less than four full fiscal quarters and (ii) Hotel Properties with certificates of occupancy that (A) are open for business and (B) were Construction Properties at some time during the preceding four fiscal quarters) to (b) Consolidated EBITDA. In the event the Borrower shall complete, directly or through a Subsidiary, an acquisition or divestiture of any Person or business unit during any period, the Adjusted Consolidated Leverage Ratio as of the end of and for such period shall thereafter be determined on a pro forma basis as if such acquisition or divestiture had been completed on the first day of such period. "Adjusted NOI" shall mean, with respect to any Hotel Property for any ------------ period, Net Operating Income for such period minus the sum of (a) the FF&E Reserve and (b) the amount (but not less than zero) by which 7% of Gross Revenue exceeds Franchise and Marketing Expenses. "Administrative Questionnaire" shall mean an Administrative ---------------------------- Questionnaire in the form of Exhibit B. "Affiliate" shall mean, when used with respect to a specified person, --------- another person that directly, or indirectly through one or more intermediaries, Controls or is Controlled by or is under common Control with the person specified. Following the Spin-Off, the Borrower and the Subsidiaries shall not be deemed to be Affiliates of International or its subsidiaries merely by virtue of such companies' having common shareholders or directors as a result of the Spin-Off. 2 "Agent and Administrative Fees" shall have the meaning assigned to ----------------------------- such term in Section 2.05(b). "Aggregate Adjusted NOI" shall mean the aggregate Adjusted NOI for all ---------------------- Hotel Properties; provided that Adjusted NOI shall be adjusted to exclude the -------- effect of any Hotel Properties which are no longer owned by the Borrower or any Subsidiary on the date of determination. "Aggregate Revolving Exposure" shall mean the aggregate amount of the ---------------------------- Lenders' Revolving Exposures. "Aggregate Value" shall mean, as of any date, the sum of (a) for each --------------- Borrowing Base Property (other than the Exception Properties) owned for four consecutive fiscal quarters or more, (i) the aggregate trailing four quarter Adjusted NOI for such Borrowing Base Property for the most recent period of four consecutive fiscal quarters for which information shall have been delivered pursuant to Section 5.04(f) divided by (ii) 0.11, (b) for each Borrowing Base Property owned for less than four consecutive fiscal quarters, the undepreciated cost basis at acquisition for such Borrowing Base Property and (c) for each Exception Property, (i) the aggregate trailing four quarter Adjusted NOI for such property for the most recent period of four consecutive fiscal quarters for which information shall have been delivered pursuant to Section 5.04(f) divided by (ii) 0.19. "Alternate Base Rate" shall mean, for any day, a rate per annum ------------------- (rounded upwards, if necessary, to the next 1/16 of 1%) equal to the greatest of (a) the Prime Rate in effect on such day, (b) the Base CD Rate in effect on such day plus 1% and (c) the Federal Funds Effective Rate in effect on such day plus 1/2 of 1%. For purposes hereof, "Prime Rate" shall mean the rate of interest per annum publicly announced from time to time by the Agent as its prime rate in effect at its principal office in New York City; each change in the Prime Rate shall be effective on the date such change is publicly announced as effective. "Base CD Rate" shall mean the sum of (a) the product of (i) the Three-Month Secondary CD Rate and (ii) Statutory Reserves and (b) the Assessment Rate. "Three-Month Secondary CD Rate" shall mean, for any day, the secondary market rate for three-month certificates of deposit reported as being in effect on such day (or, if such day shall not be a Business Day, the next preceding Business Day) by the Board through the public information telephone line of the Federal Reserve Bank of New York (which rate will, under the 3 current practices of the Board, be published in Federal Reserve Statistical Release H.15(519) during the week following such day), or, if such rate shall not be so reported on such day or such next preceding Business Day, the average of the secondary market quotations for three-month certificates of deposit of major money center banks in New York City received at approximately 10:00 a.m., New York City time, on such day (or, if such day shall not be a Business Day, on the next preceding Business Day) by the Agent from the New York City negotiable certificate of deposit dealers of recognized national standing selected by it. "Federal Funds Effective Rate" shall mean, for any day, the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published on the next succeeding Business Day by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations for the day of such transactions received by the Agent from three Federal funds brokers of recognized national standing selected by it. If for any reason the Agent shall have determined that it is unable to ascertain the Base CD Rate or the Federal Funds Effective Rate or both for any reason, including the inability or failure of the Agent to obtain sufficient quotations in accordance with the terms thereof, the Alternate Base Rate shall be determined without regard to clauses (b) or (c) of the first sentence of this definition, as appropriate, until the circumstances giving rise to such inability no longer exist. Any change in the Alternate Base Rate due to a change in the Prime Rate, the Three Month Secondary CD Rate or the Federal Funds Effective Rate shall be effective on the effective date of such change in the Prime Rate, the Three Month Secondary CD Rate or the Federal Funds Effective Rate, respectively. "Applicable Percentage" shall mean, with respect to any Eurodollar --------------------- Loan, CD Loan or ABR Loan or with respect to the Facility Fees, as the case may be, the applicable percentage set forth in the table below under the caption "LIBOR Margin", "CD Margin", "ABR Margin" or "Facility Fee Percentage", as the case may be, based upon the Adjusted Consolidated Leverage Ratio as of the end of and for the most recent period of four consecutive fiscal quarters for which financial statements of the Borrower are required to have been delivered under Section 5.04(a) or (b), whether or not financial statements in respect of any subsequent period shall have been delivered: 4
=============================================================================== Adjusted LIBOR CD Margin ABR Facility Fee Consolidated Margin ---------- Margin Percentage Leverage Ratio -------- -------- ------------- ------------------ - -------------------------------------------------------------------------------- Category 1 Less than 3.00 to 0% 1.00 1.625% 1.750% .150% - -------------------------------------------------------------------------------- Category 2 Equal to or greater than 3.00 to 1.00, but less than 4.00 to 1.00 1.750% 1.875% 0% .200% -------------------------------------------------------------------------------- Category 3 Equal to or greater than 4.00 to 1.00, but less than 5.00 to 1.00 2.000% 2.125% 0% .250% - -------------------------------------------------------------------------------- Category 4 Equal to or greater than 5.00 to 1.00, but less than or equal to 2.375% .125% .300% 5.50 to 1.00 2.250% - -------------------------------------------------------------------------------- Category 5 Greater than 5.50 to 1.00 4.250% 4.375% 2.125% .350% ================================================================================
;provided that the Applicable Percentage for the period commencing on the date -------- hereof and ending on the required delivery date pursuant to Section 5.04(a) or (b) for the Borrower's consolidated financial statements for the Borrower's second full fiscal quarter commencing after the Effective Date, shall be determined by reference to Category 4; provided further that at any time when ---------------- financial statements required to have been delivered under Section 5.04(a) or (b) have not been delivered, the Applicable Percentage shall be determined by reference to Category 5. "Approved Environmental Consultant" shall mean any environmental --------------------------------- consultant set forth in Schedule 1.01(a) hereto and any other environmental consultant that may be mutually agreed upon by the Borrower and the Agent; provided, however, that the Agent shall have the right to remove any - -------- ------- environmental consultant previously approved if it shall have a material basis for doing so. "Approved Subordinated Indebtedness" shall mean Indebtedness of the ---------------------------------- Borrower that satisfies the criteria set forth in Schedule 1.01(b) hereto. "Assessment Rate" shall mean for any date the annual rate (rounded --------------- upwards, if necessary, to the next 1/100 of 1%) identified by the Agent (or, if need be, reasonably estimated by the Agent) as the then current net 5 annual assessment rate that will be employed in determining amounts payable by the Agent to the Federal Deposit Insurance Corporation (or any successor) for insurance by such Corporation (or such successor) of time deposits made in dollars at the Agent's domestic offices. "Asset Sale" shall mean, with respect to the Borrower or any ---------- Subsidiary, any sale, transfer or other disposition of any assets or other properties (including individual business assets, patents, trademarks and other intangibles) of the Borrower or such Subsidiary, including the sale, transfer or disposition of any capital stock of or any merger or consolidation involving any Subsidiary and any issuance or sale by any Subsidiary of shares of its capital stock, other than (i) sales of inventory and used equipment in the ordinary course of business of the person (whether the Borrower or a Subsidiary) owning and selling such inventory or used equipment; (ii) sales, transfers and other dispositions of any tangible assets by the Borrower or any Subsidiary if the Borrower or such Subsidiary enters into a purchase or construction agreement with a third party to replace such assets with comparable assets as soon as practicable (and in no event later than three months) after the disposition and, pending such replacement, diligently pursues the replacement thereof, and the fair market value of the replacement assets is substantially equivalent to or exceeds that of the assets so disposed of; (iii) sales, transfers and other dispositions of any assets to the Borrower or any Subsidiary; (iv) Sale and Lease-Back Transactions; and (v) sales by the Borrower or Subsidiaries of assets acquired from persons other than the Borrower or other Subsidiaries, which sales occur not more than 12 months after the respective dates on which such assets were acquired. "Assignment and Acceptance" shall mean an assignment and acceptance ------------------------- entered into by a Lender and an assignee, and accepted by the Agent, in the form of Exhibit C. "Baron Entities" shall mean the collective reference to Baron Capital -------------- Group, Inc., Baron Capital, Inc., BAMCO, Inc., Baron Capital Management, Inc., Baron Asset Fund and Ronald Baron. "Board" shall mean the Board of Governors of the Federal Reserve ----- System of the United States. "Borrower" shall mean Sunburst Hospitality Corporation (formerly -------- Choice Hotels International, Inc.), a Delaware corporation, as renamed following the Spin-Off. 6 "Borrowing" shall mean a group of Loans of the same Type made by the --------- Lenders on a single date and as to which a single Interest Period is in effect. "Borrowing Base" shall mean, at any time, an amount equal to 50% of -------------- the Aggregate Value of the Borrowing Base Properties. "Borrowing Base Certificate" shall mean a certificate in the form of -------------------------- Exhibit D or any other form approved by the Agent, together with all attachments contemplated thereby. "Borrowing Base Properties" shall mean Hotel Properties that satisfy ------------------------- the following minimum criteria: (a) such properties shall be wholly owned directly by a Wholly Owned Subsidiary that has no Indebtedness and all the capital stock of which the Collateral Agent has a first priority security interest in pursuant to the Pledge Agreement; (b) such properties shall not be subject to any Lien, springing Lien or negative pledge agreement securing or created under any document or instrument governing Indebtedness; (c) such properties shall be free of all material structural and title defects (which shall be determined by the Agent based on a review of documentation and discussions with the Borrower, in each case satisfactory to the Agent) at the time of the initial inclusion of any such property in the Borrowing Base; (d) such properties shall be free from environmentally hazardous materials as verified by an environmental assessment report in a form acceptable to the Agent delivered to the Agent at the time of the initial inclusion of any such property in the Borrowing Base; (e) such properties shall be fully operational with less than 20% of keys out of service; (f) such properties shall be located in the United States; and (g) to the extent such properties are subject to ground leases, (i) the remaining terms of such ground leases shall be greater than 25 years and (ii) the other terms of such ground leases shall be acceptable to the Agent; provided that the Exception Properties shall constitute Borrowing Base -------- Properties for purposes of this Agreement despite their failure to satisfy the criteria set forth in clause (g)(i) above. "Borrowing Request" shall mean a request by the Borrower in accordance ----------------- with the terms of Section 2.03. "Business Day" shall mean any day (other than a day which is a ------------ 7 Saturday, Sunday or legal holiday in the State of New York) on which banks are open for business in New York City; provided, however, that when used in -------- ------- connection with a Eurodollar Loan, the term "Business Day" shall also exclude any day on which banks are not open for dealings in dollar deposits in the London interbank market. "Capital Lease Obligations" of any person shall mean the obligations ------------------------- of such person to pay rent or other amounts under any lease of (or other arrangement conveying the right to use) real or personal property, or a combination thereof, which obligations are required to be classified and accounted for as capital leases on a balance sheet of such person under GAAP applied on a consistent basis and, for the purposes of this Agreement, the amount of such obligations at any time shall be the capitalized amount thereof at such time determined in accordance with GAAP applied on a consistent basis. "CD Borrowing" shall mean a Borrowing comprised of CD Loans. ------------ "CD Loan" shall mean any Loan bearing interest at a rate determined by ------- reference to the Adjusted CD Rate in accordance with the provisions of Article II. A "Change in Control" shall be deemed to have occurred if (a) any ----------------- person or group (within the meaning of Rule 13d-5 of the Securities and Exchange Commission as in effect on the date hereof) other than Stewart Bainum and his family shall own directly or indirectly, beneficially or of record, shares representing more than 15% of the aggregate ordinary voting power represented by the issued and outstanding capital stock of the Borrower, except that such a person or group may own directly or indirectly, beneficially or of record, shares representing not more than 20%, or 33% in the case of the Baron Entities, of the aggregate voting power represented by the issued and outstanding capital stock of the Borrower if and for so long as such person or group reports and continues to report such ownership on Schedule 13G (filed pursuant to Rule 13d- 1(b), Rule 13d-1(c), or, in the case of amendments, Rule 13d-2(b), of the Securities and Exchange Commission as in effect on the date hereof); (b) a majority of the seats (other than vacant seats) on the board of directors of the Borrower shall at any time have been occupied by persons who were neither (i) nominated by the management of the Borrower or by the Nominating Committee of the Borrower's board of directors in connection with an annual meeting of the stockholders of the Borrower, nor (ii) appointed by 8 directors so nominated; or (c) any person or group other than Stewart Bainum and his family shall otherwise directly or indirectly Control the Borrower. Notwithstanding the foregoing, if a trust or foundation or other entity established by Stewart Bainum or his family holds shares representing in excess of 15% of the aggregate ordinary voting power represented by the issued and outstanding capital stock of the Borrower and Stewart Bainum or his family Controls such trust or foundation or such other entity and the vote of such shares held by such trust or foundation or such other entity and Stewart Bainum and his family remain in Control of the Borrower, there shall be no Change in Control for purposes of this Agreement; provided, however, that any transfer of -------- ------- such shares by Stewart Bainum, such trust or such foundation or such other entity shall stand on its own merits for purposes of this Agreement. "Code" shall mean the Internal Revenue Code of 1986, as the same may ---- be amended from time to time. "Collateral Agent" shall mean The Chase Manhattan Bank and any ---------------- successor thereto. "Consolidated EBITDA" shall mean, for any period, without duplication, ------------------- the sum for such period of (a) Consolidated Net Income, (b) depreciation and amortization expense, (c) Consolidated Interest Expense, (d) provisions for income tax expense, (e) restructuring charges incurred in connection with the Spin-Off and (f) non-cash charges related to the impairment of assets (pursuant to FAS 121), all as determined in accordance with GAAP consistently applied. "Consolidated Funded Indebtedness" shall mean, as of any date of -------------------------------- determination, all obligations shown as liabilities on a consolidated balance sheet of the Borrower on such date, in accordance with GAAP consistently applied, whether such obligations are classified as long-term or short-term. "Consolidated Interest Expense" shall mean, for any period, gross ----------------------------- total expenses of the Borrower and its consolidated Subsidiaries accounted for as interest expense (including capitalized interest determined in accordance with GAAP consistently applied) for such period, including (i) the portion of rental payments under Capital Lease Obligations deemed to represent interest in accordance with GAAP consistently applied, (ii) the amortization of debt discounts, (iii) the amortization of all fees (including fees with respect to interest rate protection agreements) 9 payable in connection with the incurrence of Indebtedness to the extent included in interest expense, all as determined on a consolidated basis in accordance with GAAP consistently applied. For purposes of the foregoing, gross interest expense shall be determined after giving effect to any net payments made or received with respect to interest rate protection agreements entered in to as a hedge against interest rate exposure. "Consolidated Net Income" shall mean, for any period, the net income ----------------------- (or loss) of the Borrower and its consolidated Subsidiaries for such period, as determined on a consolidated basis in accordance with GAAP consistently applied. "Consolidated Net Worth" shall mean, as at any date of determination, ---------------------- the consolidated stockholders' equity of the Borrower and its consolidated Subsidiaries, as determined on a consolidated basis in accordance with GAAP consistently applied. "Consolidated Senior Funded Indebtedness" shall mean, as of any date --------------------------------------- of determination, all obligations (other than Approved Subordinated Indebtedness) shown as liabilities on a consolidated balance sheet of the Borrower on such date, in accordance with GAAP consistently applied, whether such obligations are classified as long-term or short-term. "Consolidated Total Assets" shall mean, as at any date of ------------------------- determination, the total assets of the Borrower and its consolidated Subsidiaries at such time, as determined on a consolidated basis in accordance with GAAP consistently applied. "Construction Properties" shall mean (a) Hotel Properties under ----------------------- construction, (b) newly acquired Hotel Properties which require and are undergoing substantial refurbishment and which are not open for business and (c) vacant land. "Control" shall mean the possession, directly or indirectly, of the ------- power to direct or cause the direction of the management or policies of a person, whether through the ownership of voting securities, by contract or otherwise, and "Controlling" and "Controlled" shall have meanings correlative thereto; provided, however, the existence of a management contract by the -------- ------- Borrower or one of its Affiliates to manage another entity shall not be deemed to be Control. 10 "Credit Event" shall have the meaning assigned to such term in Section ------------ 4.01. "Default" shall mean any event or condition which upon notice, lapse ------- of time or both would constitute an Event of Default. "Distribution Agreement" shall mean the Distribution Agreement dated ---------------------- as of October 15, 1997, by and between International and the Borrower. "dollars" or "$" shall mean lawful money of the United States of ------- - America. "Effective Date" shall mean the date on and as of which each of the -------------- conditions set forth in Section 4.02 shall have been satisfied. "Environmental Laws" shall have the meaning set forth in Section 3.17. ------------------ "Environmental Permit" means any permit, approval, authorization, -------------------- certificate, registration, license, variance, filing or permission required by or from any Governmental Authority pursuant to any Environmental Law. "ERISA" shall mean the Employee Retirement Income Security Act of ----- 1974, as the same may be amended from time to time. "ERISA Affiliate" shall mean any trade or business (whether or not --------------- incorporated) that is a member of a group of which the Borrower is a member and which is treated as a single employer under Section 414 of the Code. "Eurodollar", when used in reference to any Loan or Borrowing shall ---------- refer to whether such Loan, or Loans comprising such Borrowing, are bearing interest at a rate determined by reference to the LIBO Rate in accordance with the provisions of Article II. "Event of Default" shall have the meaning assigned to such term in ---------------- Article VII. "Exception Properties" shall mean the Hotel Properties owned by a -------------------- Wholly Owned Subsidiary of the Borrower on the Effective Date that are located in Anaheim, California and San Francisco, California. "Excluded Subsidiaries" shall mean First Choice --------------------- 11 Properties Corp., First Choice Capital Corp. and QI Capital Corp. "Existing Credit Agreements" shall mean (a) the US $100MM Competitive -------------------------- Advance and Revolving Credit Facility Agreement dated as of October 30, 1996, among Choice Hotels International, Inc. (formerly Choice Hotels Holdings, Inc.), the lenders party thereto and the Agent, as agent thereunder and (b) the Agreement dated as of May 5, 1997 between Choice Hotels International, Inc. and The Chase Manhattan Bank, as lender, in each case as amended. "FF&E Reserve" shall mean, with respect to any Hotel Property, a ------------ furniture, fixture and equipment reserve equal to 4% of Gross Revenue attributable to such property. "Facility Fee" shall have the meaning assigned to such term in Section ------------ 2.05(a). "Fees" shall mean the Facility Fee, the Agent and Administrative Fees, ---- the L/C Participation Fees and the Issuing Bank Fees. "Financial Officer" of any corporation shall mean the chief financial ----------------- officer, principal accounting officer, Treasurer or Controller of such corporation. "Fixed Charge Coverage Ratio" shall mean, for any period, the ratio of --------------------------- (a) Consolidated EBITDA for such period minus the total FF&E Reserve for all Hotel Properties for such period to (b) the sum of (i) Consolidated Interest Expense for such period (excluding non-cash interest expense relating to the Approved Subordinated Indebtedness), (ii) principal amounts that become payable (whether or not paid and whether at stated maturity or otherwise, but excluding any balloon payments) during such period and (iii) scheduled dividends on preferred stock during such period. "Foreign Subsidiary" shall mean any Subsidiary that is organized under ------------------ the laws of a jurisdiction other than the United States of America or any State thereof or the District of Columbia. "Form 10" shall mean the registration statement on Form 10 under the ------- Securities Exchange Act of 1934 of the Borrower filed with the Securities and Exchange Commission on September 10, 1997, as amended and distributed to the Lenders prior to the date hereof. "Franchise and Marketing Expense" shall mean, for ------------------------------- 12 any Hotel Property, franchise (including royalty, reservation and national advertising costs and fees) and marketing expenses (including in-house marketing expenses) attributable to such property for the most recent period of four fiscal quarters for which information shall have been delivered pursuant to Section 5.04(a) or (b). "GAAP" shall mean generally accepted accounting principles. ---- "Governmental Authority" shall mean any Federal, state, local or ---------------------- foreign court or governmental agency, authority, instrumentality or regulatory body. "Gross Revenue" shall mean, as to any Hotel Property, the gross ------------- revenues attributable to such property for the most recent period of four fiscal quarters for which information shall have been delivered pursuant to Section 5.04(a) or (b). "Guarantee" of or by any person shall mean any obligation, contingent --------- or otherwise, of such person guaranteeing or having the economic effect of guaranteeing any Indebtedness of any other person (the "primary obligor") in any manner, whether directly or indirectly, and including any obligation of such person, direct or indirect, (a) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness or to purchase (or to advance or supply funds for the purchase of) any security for the payment of such Indebtedness, (b) to purchase property, securities or services for the purpose of assuring the owner of such Indebtedness of the payment of such Indebtedness or (c) to maintain working capital, equity capital or other financial statement condition or liquidity of the primary obligor so as to enable the primary obligor to pay such Indebtedness; provided, however, that the term Guarantee -------- ------- shall not include endorsements for collection or deposit, in either case in the ordinary course of business. "Guarantee Agreement" shall mean the Guarantee Agreement, ------------------- substantially in the form of Exhibit G, between the Subsidiary Loan Parties and the Collateral Agent. "Hotel Properties" shall mean the properties set forth on Schedule ---------------- 1.01(c) and any hotel properties acquired or constructed after the date hereof, including fixtures and personalty associated therewith. "Indebtedness" of any person shall mean, without duplication, (a) all ------------ obligations of such person for borrowed 13 money or with respect to deposits or advances of any kind, (b) all obligations of such person evidenced by bonds, debentures, notes or similar instruments, (c) all obligations of such person upon which interest charges are customarily paid, (d) all obligations of such person under conditional sale or other title retention agreements relating to property or assets purchased by such person, (e) all obligations of such person issued or assumed as the deferred purchase price of property or services, (f) all Indebtedness of others secured by (or for which the holder of such Indebtedness has an existing right, contingent or otherwise, to be secured by) any Lien on property owned or acquired by such person, whether or not the obligations secured thereby have been assumed, (g) all Guarantees by such person of Indebtedness of others, (h) all Capital Lease Obligations of such person, (i) all obligations of such person in respect of interest rate protection agreements, foreign currency exchange agreements or other interest or exchange rate hedging arrangements and (j) all obligations of such person as an account party in respect of letters of credit (other than (x) documentary letters of credit (including commercial and trade letters of credit) issued to secure payment obligations in respect of goods and services in the ordinary course of business and (y) letters of credit and surety bonds with respect to obligations of such person that are fully accounted for as liabilities in the financial records of such person) and bankers' acceptances. The Indebtedness of any person shall not include current accounts payable incurred in the ordinary course of business. The Indebtedness of any person shall include the Indebtedness of any partnership in which such person is a general partner. "Indemnity, Subrogation and Contribution Agreement" shall mean the ------------------------------------------------- Indemnity, Subrogation and Contribution Agreement, substantially in the form of Exhibit I, among the Borrower, the Subsidiary Loan Parties and the Collateral Agent. "Information Memorandum" shall mean the Confidential Information ---------------------- Memorandum dated September 1997 distributed by the Borrower to the Lenders. "Interest Payment Date" shall mean, with respect to any Loan, the last --------------------- day of the Interest Period applicable thereto and, in the case of a Eurodollar Loan with an Interest Period of more than three months' duration or a CD Loan with an Interest Period of more than 90 days' duration, each day that would have been an Interest Payment Date for such Loan had successive Interest Periods of three months' 14 duration or 90 days' duration, as the case may be, been applicable to such Loan and, in addition, the date of any refinancing or conversion of such Loan with or to a Loan of a different Type. "Interest Period" shall mean (a) as to any Eurodollar Borrowing, the --------------- period commencing on the date of such Borrowing and ending on the numerically corresponding day (or, if there is no numerically corresponding day, on the last day) in the calendar month that is 1, 2, 3 or 6 months thereafter, as the applicable Borrower may elect; provided that the Interest Period for each -------- Eurodollar Borrowing made prior to satisfaction of the covenant set forth in Section 5.04(d) shall be one month, (b) as to any CD Borrowing, a period of 30, 60, 90 or 180 days' duration, as the Borrower may elect, commencing on the date of such Borrowing and (c) as to any ABR Borrowing, the period commencing on the date of such Borrowing and ending on the date 90 days thereafter or, if earlier, on the Revolving Maturity Date or the date of prepayment of such Borrowing; provided, however, that if any Interest Period would end on a day other than a - -------- ------- Business Day, such Interest Period shall be extended to the next succeeding Business Day unless, in the case of Eurodollar Loans only, such next succeeding Business Day would fall in the next calendar month, in which case such Interest Period shall end on the next preceding Business Day. Interest shall accrue from and including the first day of an Interest Period to but excluding the last day of such Interest Period. "Interest Rate Determination Date" shall mean, with respect to a -------------------------------- Eurodollar Borrowing, the date which is two Business Days prior to the commencement of any Interest Period for such Borrowing. "International" shall mean Choice Hotels International, Inc. (formerly ------------- Choice Hotels Franchising, Inc.), a Delaware corporation, as renamed following the Spin-Off. "Issuing Bank" shall mean, as the context may require, (a) The Chase ------------ Manhattan Bank, or (b) any other Lender that may become an Issuing Bank pursuant to Section 2.19(h), with respect to Letters of Credit issued by such Lender. "Issuing Bank Agreement" shall mean an agreement in substantially the ---------------------- form of Exhibit F. "Issuing Bank Fees" shall have the meaning assigned to such term in ----------------- Section 2.05(c). 15 "L/C Commitment" shall mean, with respect to any Issuing Bank, the -------------- commitment of such Issuing Bank to issue Letters of Credit pursuant to Section 2.19. "L/C Disbursement" shall mean a payment or disbursement made by an ---------------- Issuing Bank pursuant to a Letter of Credit. "L/C Exposure" shall mean at any time the sum of (a) the aggregate ------------ undrawn amount of all outstanding Letters of Credit at such time, plus (b) the aggregate principal amount of all L/C Disbursements that have not yet been reimbursed at such time. The L/C Exposure of any Lender at any time shall mean its Pro Rata Percentage (based upon its Revolving Commitment) of the aggregate L/C Exposure at such time. "L/C Participation Fee" shall have the meaning assigned to such term --------------------- in Section 2.05(c)(i). "Lease" shall mean the collective reference to all leases, licenses, ----- concession agreements, franchises and other occupancy agreements and other agreements demising, leasing or granting rights of possession or use or, to the extent of the interest therein of the Borrower or any Subsidiary, any sublease, sub-sublease, underletting or sublicense, which now or hereafter may affect any Borrowing Base Property or any part thereof or interest therein. "Lender" shall mean a person listed on Schedule 2.01 and any other ------ person that shall become a party hereto pursuant to an Assignment and Acceptance, other than any such person that ceases to be a party hereto pursuant to an Assignment and Acceptance. "Letter of Credit" shall mean any letter of credit issued pursuant to ---------------- Section 2.19, as permitted hereby. "LIBO Rate" means, with respect to any Eurodollar Borrowing for any --------- Interest Period, the rate appearing on Page 3750 of the Telerate Service (or on any successor or substitute page of such Service, or any successor to or substitute for such Service, providing rate quotations comparable to those currently provided on such page of such Service, as determined by the Agent from time to time for purposes of providing quotations of interest rates applicable to dollar deposits in the London interbank 16 market) at approximately 11:00 a.m., London time, two Business Days prior to the commencement of such Interest Period, as the rate for dollar deposits with a maturity comparable to such Interest Period. In the event that such rate is not available at such time for any reason, then the "LIBO Rate" with respect to such --------- Eurodollar Borrowing for such Interest Period shall be the rate at which dollar deposits of $5,000,000 and for a maturity comparable to such Interest Period are offered by the principal London office of the Agent in immediately available funds in the London interbank market at approximately 11:00 a.m., London time, two Business Days prior to the commencement of such Interest Period. "Lien" shall mean, with respect to any asset, (a) any mortgage, deed ---- of trust, lien, pledge, encumbrance, charge or security interest in or on such asset, (b) the interest of a vendor or a lessor under any conditional sale agreement, capital lease or title retention agreement relating to such asset and (c) in the case of securities, any purchase option, call or similar right of a third party (excluding rights of first refusal) with respect to such securities. "Loans" shall mean the Loans made by the Lenders to the Borrower ----- pursuant to Section 2.01 and Section 2.03. Each Loan shall be a Eurodollar Loan, a CD Loan or an ABR Loan. "Loan Documents" shall mean this Agreement, the Guarantee Agreement, -------------- the Indemnity, Subrogation and Contribution Agreement, the Security Documents, the Letters of Credit, each Issuing Bank Agreement and, if requested by a Lender pursuant to Section 2.06(e), each Note. "Loan Party" shall mean the Borrower and the Subsidiary Loan Parties. ---------- "Margin Stock" shall have the meaning given such term under Regulation ------------ U. "Material Adverse Effect" shall mean a materially adverse effect on ----------------------- the business, assets, property or condition, financial or otherwise, of the Borrower and the Subsidiaries taken as a whole. "Moody's" shall mean Moody's Investors Service, Inc. ------- "Multiemployer Plan" shall mean a multiemployer ------------------ 17 plan as defined in Section 4001(a)(3) of ERISA to which the Borrower or any ERISA Affiliate (other than one considered an ERISA Affiliate only pursuant to subsection (m) or (o) of Section 414 of the Code) is making or accruing an obligation to make contributions, or has within any of the preceding five plan years made or accrued an obligation to make contributions. "Net Operating Income" shall mean, with respect to any Hotel Property -------------------- for any period, Operating Revenues less Operating Expenses. "Obligations" shall mean (a) the Borrower's obligations in respect of ----------- the due and punctual payment of principal of and interest on the Loans and reimbursement of the L/C Disbursements, in each case when and as due whether at maturity, by acceleration, upon one or more dates set for prepayment or otherwise, (b) all Fees, expenses, indemnities, reimbursements and other obligations, monetary or otherwise, of the Borrower under this Agreement or any other Loan Document, (c) all obligations, monetary or otherwise, of each Subsidiary under each Loan Document to which it is a party and (d) unless otherwise agreed upon in writing by the applicable Lender party thereto, all obligations of the Borrower, monetary or otherwise, under each interest rate protection agreement entered into with a counterparty that was a Lender (or an Affiliate thereof) at the time such interest rate protection agreement was entered into. "Operating Expenses" shall mean, with respect to any Hotel Property, ------------------ all fixed and variable operating expenses relating specifically to such Hotel Property (including Franchise and Marketing Expenses) except for (i) depreciation, amortization, or other noncash charges, (ii) principal or interest payments on account of any Indebtedness related to such Hotel Property or rent payable under any capital lease, (iii) income taxes, (iv) extraordinary losses and (v) capital expenditures of any kind, in each case as determined in accordance with GAAP. "Operating Revenues" shall mean, with respect to any Hotel Property, ------------------ all cash revenues and receipts of every kind derived from operating such Hotel Property and parts thereof, including, but not limited to: income (from both cash and credit transactions), before commissions and discounts for prompt or cash payments, from rental or sales of rooms, gift shops, meeting, exhibit, conference center or sales space of every kind; retail operations; license, lease 18 and concession fees and rentals (not including gross receipts of licensees, lessees and concessionaires); golf, club and spa operations; income from telephone and facsimile charges; income from vending machines; food and beverage sales, sales of merchandise (other than proceeds from the sale of FF&E no longer necessary to the operation of such Hotel Property); service charges, to the extent not distributed to the employees at such Hotel Property as, or in lieu of, gratuities; and proceeds, if any, from business interruption or other loss of income insurance; provided, however, that Operating Revenues shall not -------- ------- include the following: gratuities to employees of such Hotel Property, federal, state or municipal excise, sales, use or similar taxes collected directly from patrons or guests or included as part of the sales price of any goods or services; insurance proceeds (other than proceeds from business interruption or other loss of income insurance); condemnation proceeds; or any proceeds from any sale of other disposition of such Hotel Property. "PBGC" shall mean the Pension Benefit Guaranty Corporation referred to ---- and defined in ERISA. "Permitted Investments" shall mean: --------------------- (a) direct obligations of, or obligations the principal of and interest on which are unconditionally guaranteed by, the United States of America (or by any agency thereof to the extent such obligations are backed by the full faith and credit of the United States of America); (b) investments in commercial paper having credit ratings of at least A-2 from S&P and P-2 from Moody's; (c) investments in certificates of deposit, banker's acceptances and time deposits issued or guaranteed by or placed with, and money market deposit accounts issued or offered by, any domestic office of any commercial bank organized under the laws of the United States of America or any State thereof which has a combined capital and surplus and undivided profits of not less than $200,000,000; (d) investments in the ordinary course of business in customary repurchase agreements with respect to freely marketable, short-term securities of the type customarily subject to repurchase agreements; and (e) other readily marketable debt and equity 19 securities traded on national securities exchanges or on other nationally recognized markets, including over-the-counter markets. "person" shall mean any natural person, corporation, business trust, ------ joint venture, association, company, limited liability company, partnership or government, or any agency or political subdivision thereof. "Plan" shall mean any pension plan (other than a Multiemployer Plan) ---- subject to the provisions of Title IV of ERISA or Section 412 of the Code which is maintained for employees of the Borrower or any ERISA Affiliate. "Pledge Agreement" shall mean the Pledge Agreement, substantially in ---------------- the form of Exhibit H, among the Borrower, the Subsidiary Loan Parties and the Collateral Agent for the benefit of the Secured Parties. "Prepayment Event" shall mean: ---------------- (a) any sale, transfer or other disposition (including pursuant to a Sale and Lease-Back Transaction) of any Borrowing Base Property; or (b) any other sale, transfer or other disposition of property (including pursuant to a Sale and Lease-Back Transaction) that results or would reasonably be expected to result in the Borrower's failure to comply with any of the covenants set forth in Sections 6.06, 6.13, 6.14, 6.15 or 6.16. "Proceeds" shall mean, with respect to any Asset Sale or Prepayment -------- Event, (a) the gross amount of consideration or other amounts payable to or receivable by the Borrower or a Subsidiary in respect of such Asset Sale or Prepayment Event, less (b) the amount, if any, of all estimated taxes payable with respect to such Asset Sale or Prepayment Event, whether or not payable during the taxable year in which such Asset Sale or Prepayment Event shall have occurred, and less (c) reasonable and customary fees, commissions, costs and other expenses (other than those payable to the Borrower or a Subsidiary or Affiliate of the Borrower or to International or a subsidiary or Affiliate of International (excluding any fees, costs or expenses arising out of a termination of a franchise agreement or any ancillary agreement relating to such franchise agreement)) which are incurred in connection with such Asset Sale or Prepayment Event and are payable by the seller or the transferor of the assets or property to which such Asset 20 Sale or Prepayment Event relates, but only to the extent not already deducted in arriving at the amount referred to in clause (a) above. For purposes of determining Proceeds, the value of all noncash consideration payable or receivable by the Borrower or any Subsidiary, as the case may be, shall be the fair market value of such noncash consideration as determined in good faith by the Borrower and the Borrower shall provide to the Agent a certificate of a Financial Officer of the Borrower with respect to the fair market value of such consideration, in form and substance reasonably satisfactory to the Agent. "Pro Rata Percentage" of any Lender at any time shall mean the ------------------- percentage of the Total Revolving Commitment represented by such Lender's Revolving Commitment. In the event the Revolving Commitments shall have expired or been terminated, the Pro Rata Percentages shall be determined on the basis of the Revolving Commitments most recently in effect (giving effect to any assignments under Section 9.04). "Reference Bank" shall mean the Agent or, if the Agent's Revolving -------------- Commitment is not the largest of the Lenders' Revolving Commitments, the Lender possessing the largest Revolving Commitment. "Register" shall have the meaning given such term in Section 9.04(d). -------- "Regulation D" shall mean Regulation D of the Board as from time to ------------ time in effect and all official rulings and interpretations thereunder or thereof. "Regulation G" shall mean Regulation G of the Board as from time to ------------ time in effect and all official rulings and interpretations thereunder or thereof. "Regulation U" shall mean Regulation U of the Board as from time to ------------ time in effect and all official rulings and interpretations thereunder or thereof. "Regulation X" shall mean Regulation X of the Board as from time to ------------ time in effect and all official rulings and interpretations thereunder or thereof. "Reportable Event" shall mean any reportable event as defined in ---------------- Section 4043(c) of ERISA or the regulations issued thereunder with respect to a Plan (other than a Plan maintained by an ERISA Affiliate which is considered an ERISA Affiliate only pursuant to subsection (m) or (o) of Section 414 of the Code). 21 "Required Lenders" shall mean, at any time, Lenders having Revolving ---------------- Commitments representing more than 50% of the Total Revolving Commitment or, if the Revolving Commitments have been terminated, Lenders holding Loans and L/C Exposures representing more than 50% of the sum of the aggregate amount of L/C Exposures and aggregate principal amount of the Loans then outstanding. "Responsible Officer" of any corporation shall mean any executive ------------------- officer or Financial Officer of such corporation and any other officer or similar official thereof responsible for the administration of the obligations of such corporation in respect of this Agreement. "Revolving Availability Period" shall mean the period from and ----------------------------- including the Effective Date to but excluding the earlier of the Revolving Maturity Date and the date of termination of the Revolving Commitments. "Revolving Commitment" shall mean, with respect to each Lender, the -------------------- commitment of such Lender to make Loans and to acquire participations in Letters of Credit hereunder, expressed as an amount representing the maximum aggregate amount of such Lender's Revolving Credit Exposure hereunder, as such commitment may be (a) reduced from time to time pursuant to Section 2.10 and (b) reduced or increased from time to time pursuant to assignments by or to such Lender pursuant to Section 9.04. The initial amount of each Lender's Revolving Commitment is set forth on Schedule 2.01, or in the Assignment and Acceptance pursuant to which such Lender shall have assumed its Revolving Commitment, as applicable. The initial aggregate amount of the Lenders' Revolving Commitments is $80,000,000. "Revolving Exposure" shall mean with respect to any Lender at any ------------------ time, the sum of the outstanding principal amount of such Lender's Loans and its L/C Exposure at such time. "Revolving Maturity Date" shall mean October 15, 2000. ----------------------- "Sale and Lease-Back Transaction" shall mean any arrangement, directly ------------------------------- or indirectly, with any person whereby such person shall sell or transfer any property, real or personal, used or useful in its business, whether now owned or hereafter acquired, and thereafter rent or lease such property or other property which it intends to use for 22 substantially the same purpose or purposes as the property being sold or transferred. "Security Documents" shall mean the Pledge Agreement and each other ------------------ instrument or document executed and delivered pursuant to Section 5.09 and 5.10 to secure the Obligations. "Secured Parties" shall mean (a) the Lenders, (b) the Agent, (c) the --------------- Collateral Agent, (d) the Issuing Bank, (e) each counterparty to an interest rate protection agreement entered into with the Borrower if such counterparty was a Lender at the time the interest rate protection agreement was entered into and if the Borrower's obligations under such interest rate protection agreement constitute Obligations, (f) the beneficiaries (other than any Loan Party) of each indemnification obligation undertaken by any Loan Party under any Loan Document and (g) the successors and assigns of each of the foregoing. "Significant Subsidiary" shall mean at any time (a) any Subsidiary of ---------------------- the Borrower with revenues during the fiscal year of the Borrower most recently ended greater than or equal to 5% of the total revenues of the Borrower and its Subsidiaries during such year, computed and consolidated in accordance with GAAP consistently applied ("Consolidated Revenues"), (b) any Subsidiary of the --------------------- Borrower with assets as of the last day of the Borrower's most recently ended fiscal year greater than or equal to 5% of the total assets of the Borrower and its Subsidiaries at such date, computed and consolidated in accordance with GAAP consistently applied ("Consolidated Assets"), (c) any Subsidiary with ------------------- stockholder's equity as of the last day of the Borrower's most recently ended fiscal year greater than or equal to 5% of the stockholder's equity of the Borrower and the Subsidiaries at such date, computed and consolidated in accordance with GAAP consistently applied ("Net Stockholders' Equity"), (d) any ------------------------ Subsidiary designated in writing by the Borrower as a Significant Subsidiary, (e) any Subsidiary created or acquired by the Borrower after the date hereof that falls within or that comes to meet one of clauses (a) through (d), (f) any Subsidiary in existence on the date hereof which comes to meet one of clauses (a) through (d) after the date hereof or (g) any Subsidiary that directly or indirectly owns any capital stock of a Significant Subsidiary; provided, -------- however, that if at any time (x) the aggregate revenues of all Subsidiaries that - ------- are Significant Subsidiaries during any fiscal year of the Borrower shall not equal or exceed 90% of Consolidated Revenues for such fiscal year, (y) the aggregate assets of 23 all Subsidiaries that are Significant Subsidiaries as of the last day of any fiscal year of the Borrower shall not equal or exceed 90% of Consolidated Assets at such date, or (z) the aggregate stockholders' equity of all Subsidiaries that are Significant Subsidiaries as of the last day of any fiscal year of the Borrower shall not equal or exceed 90% of Net Stockholders' Equity at such date, then the term Significant Subsidiary shall be deemed to include such Subsidiaries (as determined pursuant to the next following sentence) of the Borrower as may be required so that none of clauses (x), (y) and (z) above shall continue to be true. For purposes of the proviso to the next preceding sentence, the Subsidiaries which shall be deemed to be Significant Subsidiaries shall be determined based on the percentage that the assets of each such Subsidiary are of Consolidated Assets, with the Subsidiary with the highest such percentage being selected first, and each other Subsidiary required to satisfy the requirements set forth in such proviso being selected in descending order of such percentage. "S&P" shall mean Standard & Poor's Ratings Group, a division of --- McGraw-Hill, Inc. "Spin-Off" shall mean the distribution by the Borrower to its -------- shareholders of all the shares of capital stock of Choice Hotels International, Inc. and the other related transactions contemplated by the Form 10 in the manner, on the terms and with the results set forth in the Form 10. "Statutory Reserves" shall mean a fraction (expressed as a decimal), ------------------ the numerator of which is the number one and the denominator of which is the number one minus the aggregate of the maximum reserve percentages (including any marginal, special, emergency or supplemental reserves) expressed as a decimal established by the Board and any other banking authority to which the Agent is subject for new negotiable nonpersonal time deposits in dollars of over $100,000 with maturities approximately equal to the applicable Interest Period. Statutory Reserves shall be adjusted automatically on and as of the effective date of any change in any reserve percentage. "subsidiary" shall mean, with respect to any person (herein referred ---------- to as the "parent"), any corporation, partnership, association or other business entity (a) of which securities or other ownership interests representing more than 50% of the equity or more than 50% of the ordinary voting power or more than 50% of the general partnership interests are, at the time any determination is 25 being made, owned, controlled or held, or (b) which is, at the time any determination is made, otherwise Controlled by the parent or one or more subsidiaries of the parent or by the parent and one or more subsidiaries of the parent. "Subsidiary" shall mean any subsidiary of the Borrower. ---------- "Subsidiary Loan Party" shall mean any Subsidiary other than (a) an --------------------- Excluded Subsidiary and (b) a Foreign Subsidiary. "Supermajority Lenders" shall mean, at any time, Lenders having --------------------- Revolving Commitments representing at least 662/3% of the Total Revolving Commitment or, if the Revolving Commitments have been terminated, Lenders holding Loans and L/C Exposures representing at least 662/3% of the sum of the aggregate amount of L/C Exposures and aggregate principal amount of the Loans then outstanding. "Total Revolving Commitment" shall mean at any time the aggregate -------------------------- amount of the Lenders' Revolving Commitments, as in effect at such time. "Transactions" shall have the meaning assigned to such term in Section ------------ 3.02. "Type", when used in respect of any Loan or Borrowing, shall refer to ---- the Rate by reference to which interest on such Loan or on the Loans comprising such Borrowing is determined. For purposes hereof, "Rate" shall include the LIBO Rate, the Adjusted CD Rate and the Alternate Base Rate. "Wholly Owned Subsidiary" shall mean a Subsidiary all the capital ----------------------- stock or other ownership interest of which is owned by the Borrower or a Wholly Owned Subsidiary of the Borrower (including any Subsidiary that would be wholly owned but for directors' qualifying shares or similar matters). "Withdrawal Liability" shall mean liability to a Multiemployer Plan as -------------------- a result of a complete or partial withdrawal from such Multiemployer Plan, as such terms are defined in Part I of Subtitle E of Title IV of ERISA. SECTION 1.02. Classification of Loans and Borrowings. For purposes --------------------------------------- of this Agreement, Loans and Borrowings may be classified and referred to by Type (e.g., a "Eurodollar Loan" or a "Eurodollar Borrowing"). ---- 25 SECTION 1.03. Terms Generally. The definitions herein shall apply ---------------- equally to both the singular and plural forms of the terms defined. Whenever the context may require, any pronoun shall include the corresponding masculine, feminine and neuter forms. The words "include", "includes" and "including" shall be deemed to be followed by the phrase "without limitation". All references herein to Articles, Sections, Exhibits and Schedules shall be deemed references to Articles and Sections of, and Exhibits and Schedules to, this Agreement unless the context shall oth erwise require. Except as otherwise expressly provided herein, all terms of an accounting or financial nature shall be construed in accordance with GAAP consistently applied, as in effect from time to time; provided, however, that, for purposes of determining the Borrowing -------- ------- Base or compliance with any covenant set forth in Article VI, such terms shall be construed in accordance with GAAP as in effect on the date of this Agreement applied on a basis consistent with the application used in preparing the Borrower's audited financial statements referred to in Section 3.05. ARTICLE II. THE CREDITS SECTION 2.01. Commitments. Subject to the terms and conditions and ------------ relying upon the representations and warranties herein set forth, each Lender agrees, severally and not jointly, to make Loans to the Borrower, at any time and from time to time during the Revolving Availability Period, in an aggregate principal amount at any time outstanding that will not result in (i) such Lender's Revolving Exposure exceeding such Lender's Revolving Commitment or (ii) the sum of the Revolving Exposures exceeding the Borrowing Base then in effect. Within the foregoing limits, the Borrower may borrow, prepay and reborrow Loans, on and after the Effective Date and prior to the Revolving Maturity Date, subject to the terms, conditions and limitations set forth herein. SECTION 2.02. Loans. (a) Each Loan shall be made as part of a ------ Borrowing consisting of Loans of the same Type made by the Lenders ratably in accordance with their respective Revolving Commitments; provided, however, that -------- ------- the failure of any Lender to make any Loan shall not in itself relieve any other Lender of its obligation to lend hereunder (it being understood, however, that no Lender shall be responsible for the failure of any other Lender to make any Loan required to be made by such other Lender). Except for Loans deemed made pursuant to Section 2.02(e), 26 the Loans comprising any Borrowing shall be in an aggregate principal amount which is an integral multiple of $1,000,000 and not less than $1,000,000 (or an aggregate principal amount equal to the remaining balance of the available Revolving Commitments). (b) Subject only to Section 2.09, each Borrowing shall be comprised entirely of Eurodollar Loans, CD Loans or ABR Loans as the Borrower may request pursuant to Section 2.03. Each Lender may at its option make any Eurodollar Loan by causing any domestic or foreign branch or Affiliate of such Lender to make such Loan; provided, however, that (i) any exercise of such option shall -------- ------- not affect the obligation of the Borrower to repay such Loan in accordance with the terms of this Agreement and (ii) in exercising such option, the Lender shall use its reasonable efforts to minimize any increased costs to the Borrower resulting therefrom (which obligation of the Lender shall not require it to take, or refrain from taking, actions that it determines would result in increased costs for which it will not be compensated hereunder or that it determines would be otherwise disadvantageous to it and in the event of such request for costs for which compensation is provided under this Agreement, the provisions of Section 2.12(c) shall apply). Borrowings of more than one Type may be outstanding at the same time; provided, however, that the Borrower shall -------- ------- not be entitled to request any Borrowing which, if made, would result in an aggregate of more than ten separate Loans of any Lender being outstanding hereunder at any one time. For purposes of the foregoing, Loans having different Interest Periods, regardless of whether they commence on the same date, shall be considered separate Loans. (c) Subject to Section 2.04 and except with respect to Loans made pursuant to Section 2.02(e), each Lender shall make each Loan to be made by it hereunder on the proposed date thereof by wire transfer of immediately available funds to such account as the Agent may designate, not later than 12:00 noon, New York City time, and the Agent shall by 3:00 p.m., New York City time, credit the amounts so received to an account designated by the Borrower with the Agent or, if a Borrowing shall not occur on such date because any condition precedent herein specified shall not have been met, return the amounts so received to the respective Lenders. Unless the Agent shall have received notice from a Lender prior to (or, in the case of an ABR Borrowing, on) the date of any Borrowing that such Lender shall not make available to the Agent such Lender's portion of such Borrowing, the Agent may assume that such Lender has 27 made such portion available to the Agent on the date of such Borrowing in accordance with this Section 2.02(c) and the Agent may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. If the Agent shall have so made funds available then, to the extent that such Lender shall not have made such portion available to the Agent, such Lender and the Borrower severally agree to repay to the Agent forthwith on demand such corresponding amount together with interest thereon, for each day from the date such amount is made available to the Borrower until the date such amount is repaid to the Agent at (i) in the case of the Borrower, the interest rate applicable at the time to the Loans comprising such Borrowing and (ii) in the case of such Lender, a rate determined by the Agent to represent its cost of overnight or short-term funds (which determination shall be conclusive absent manifest error). If such Lender shall repay to the Agent such corresponding amount, such amount shall constitute such Lender's Loan as part of such Borrowing for purposes of this Agreement. (d) Notwithstanding any other provision of this Agreement, the Borrower shall not be entitled to request any Borrowing if the Interest Period requested with respect thereto would end after the Revolving Maturity Date. (e) If the Issuing Bank shall not have received from the Borrower the payment required to be made by Section 2.19(e) in respect of any L/C Disbursement within the time specified in such Section, the Issuing Bank will promptly notify the Agent of the L/C Disbursement and the Agent will promptly notify each Lender of such L/C Disbursement and its Pro Rata Percentage thereof. Each Lender shall pay by wire transfer of immediately available funds to the Agent not later than 2:00 p.m., New York City time, on such date (or, if such Lender shall have received such notice later than 12:00 (noon), New York City time, on any day, not later than 10:00 a.m., New York City time, on the immediately following Business Day), an amount equal to such Lender's Pro Rata Percentage of such L/C Disbursement (it being understood that such amount shall be deemed to constitute an ABR Loan of such Lender and such payment shall be deemed to have reduced the L/C Exposure), and the Agent will promptly pay to the Issuing Bank amounts so received by it from the Lenders. The Agent will promptly pay to the Issuing Bank any amounts received by it from the Borrower pursuant to Section 2.19(e) prior to the time that any Lender makes any payment pursuant to this paragraph (e); any such amounts received by the Agent thereafter will be promptly remitted by the Agent to the Lenders that shall have made such payments and to the Issuing Bank, as their 28 interests may appear. If any Lender shall not have made its Pro Rata Percentage of such L/C Disbursement available to the Agent as provided above, such Lender and the Borrower severally agree to pay interest on such amount, for each day from and including the date such amount is required to be paid in accordance with this paragraph to but excluding the date such amount is paid, to the Agent for the account of the Issuing Bank at (i) in the case of the Borrower, the Alternate Base Rate plus the Applicable Percentage, and (ii) in the case of such Lender, for the first such day, the Federal Funds Effective Rate, and for each day thereafter, the Alternate Base Rate. SECTION 2.03. Borrowing Procedures. In order to request a Borrowing --------------------- (other than a deemed Borrowing pursuant to Section 2.02(e), as to which this Section 2.03 shall not apply), the Borrower shall hand deliver or telecopy to the Agent a duly completed Borrowing Request in the form of Exhibit A (a) in the case of a Eurodollar Borrowing, not later than 10:30 a.m., New York City time, three Business Days before a proposed borrowing, (b) in the case of a CD Borrowing, not later than 10:30 a.m., New York City time, one Business Day before a proposed borrowing and (c) in the case of an ABR Borrowing, not later than 10:30 a.m., New York City time, on the day of a proposed borrowing. Such notice shall be irrevocable and shall in each case specify (i) whether such Borrowing is to be a Eurodollar Borrowing, a CD Borrowing or an ABR Borrowing; (ii) the date of such Borrowing (which shall be a Business Day) and the amount thereof; and (iii) if such Borrowing is to be a Eurodollar Borrowing or CD Borrowing, the Interest Period with respect thereto. If no election as to the Type of Borrowing is specified in any such notice, then the requested Borrowing shall be an ABR Borrowing. If no Interest Period with respect to any Eurodollar Borrowing or CD Borrowing is specified in any such notice, then the Borrower shall be deemed to have selected an Interest Period of one month's duration, in the case of a Eurodollar Borrowing, or 30 days' duration, in the case of a CD Borrowing. If the Borrower shall not have given notice in accordance with this Section of its election to refinance a Borrowing prior to the end of the Interest Period in effect for such Borrowing, then the Borrower shall (unless such Borrowing is repaid at the end of such Interest Period) be deemed to have given notice of an election to refinance such Borrowing with an ABR Borrowing. If the Borrower shall not have satisfied the covenant set forth in Section 5.04(d) in the time period set forth therein, each request for or election to refinance a Borrowing from the date set forth therein for satisfaction of such covenant until such covenant is satisfied shall be 29 deemed a request for or election to refinance an ABR Borrowing. The Agent shall promptly advise the Lenders of any notice given pursuant to this Section and of each Lender's portion of the requested Borrowing. SECTION 2.04. Refinancings. The Borrower may refinance all or any ------------- part of any Borrowing with a Borrowing of the same or a different Type made pursuant to Section 2.03, subject to the conditions and limitations set forth herein and elsewhere in this Agreement. Any Borrowing or part thereof so refinanced shall be deemed to be repaid in accordance with Section 2.06 with the proceeds of a new Borrowing hereunder and the proceeds of the new Borrowing, to the extent they do not exceed the principal amount of the Borrowing being refinanced, shall not be paid by the Lenders to the Agent or by the Agent to the Borrower pursuant to Section 2.02(c). SECTION 2.05. Fees. (a) The Borrower agrees to pay to each Lender, ----- through the Agent, on last day of March, June, September and December of each year, on the date on which the Revolving Commitment of such Lender shall be terminated as provided herein and on the Revolving Maturity Date, a facility fee (a "Facility Fee") equal to the Applicable Percentage per annum in effect from ------------ time to time on the amount of the Revolving Commitment of such Lender, whether used or unused, in effect from time to time during the preceding quarter (or shorter period commencing with the date hereof or ending with the Revolving Maturity Date or any date on which the Revolving Commitment of such Lender shall be terminated). The Facility Fees shall be computed on the basis of the actual number of days elapsed in a year of 360 days. The Facility Fee due to each Lender shall commence to accrue on the date hereof and shall cease to accrue on the earlier of (i) the termination of the Revolving Commitment of such Lender and (ii) the Revolving Maturity Date. (b) The Borrower shall pay to the Agent, for its own account, agent and administrative fees (the "Agent and Administrative Fees") at the times and ----------------------------- in the amounts agreed upon in the letter agreement dated August 26, 1997, between the Borrower and the Agent. (c) The Borrower agrees to pay (i) to each Lender, through the Agent, on the last day of March, June, September and December of each year and on the date on which the Revolving Commitment of such Lender shall be terminated as provided herein, a fee (an "L/C Participation Fee") calculated on such Lender's --------------------- Pro Rata Percentage of the 30 average daily aggregate L/C Exposure (excluding the portion thereof attributable to unreimbursed L/C Disbursements) during the preceding quarter (or shorter period commencing with the date hereof or ending with the Revolving Maturity Date or the date on which all Letters of Credit have been canceled or have expired and the Revolving Commitments of all Lenders shall have been terminated) at a rate equal to the Applicable Percentage from time to time used to determine the interest rate on Borrowings comprised of Eurodollar Loans pursuant to Section 2.07, and (ii) to the Issuing Bank with respect to each Letter of Credit the fronting, issuance and drawing fees, specified in the Issuing Bank Agreement (the "Issuing Bank Fees"). All L/C Participation Fees and Issuing Bank Fees ----------------- shall be computed on the basis of the actual number of days elapsed in a year of 360 days. (d) All Fees shall be paid on the dates due, in immediately available funds, to the Agent for distribution, if and as appropriate, among the Lenders except that the Issuing Bank Fees shall be paid directly to the Issuing Bank. Once paid, none of the Fees shall be refundable under any circumstances unless such Fees were paid in error. SECTION 2.06. Evidence of Indebtedness; Repayment of Loans. (a) The --------------------------------------------- Borrower hereby unconditionally promises to pay to the Agent for the account of each Lender the then unpaid principal amount of each Loan on the last day of the Interest Period applicable thereto. (b) Each Lender shall maintain in accordance with its usual practice an account or accounts evidencing the indebtedness of the Borrower to such Lender resulting from each Loan made by such Lender, including the amounts of principal and interest payable and paid to such Lender from time to time hereunder. (c) The Agent shall maintain accounts in which it shall record (i) the amount of each Loan made hereunder, the Type thereof and the Interest Period applicable thereto, (ii) the amount of any principal or interest due and payable or to become due and payable from the Borrower to each Lender hereunder and (iii) the amount of any sum received by the Agent hereunder for the account of the Lenders and each Lender's share thereof. (d) The entries made in the accounts maintained pursuant to paragraphs (b) and (c) of this Section shall be prima facie evidence of the ----- ----- existence and amounts of the obligations recorded therein; provided that the -------- failure of 31 any Lender or the Agent to maintain such accounts or any error therein shall not in any manner affect the obligation of the Borrower to properly repay the Loans in accordance with the terms of this Agreement. (e) Any Lender may request that Loans made by it be evidenced by a promissory note. In such event, the Borrower shall prepare, execute and deliver to such Lender a promissory note payable to the order of such Lender (or, if requested by such Lender, to such Lender and its registered assigns) and in a form approved by the Agent. SECTION 2.07. Interest on Loans. (a) Subject to the provisions of ------------------ Section 2.08, the Loans comprising each Eurodollar Borrowing shall bear interest (computed on the basis of the actual number of days elapsed over a year of 360 days) at a rate per annum equal to the LIBO Rate for the Interest Period in effect for such Borrowing plus the Applicable Percentage. Interest on each Eurodollar Borrowing shall be payable on each applicable Interest Payment Date. The LIBO Rate for each Interest Period shall be determined by the Agent in accordance with the definition of LIBO Rate herein. The Agent shall promptly advise the Borrower and each Lender, as appropriate, of such determination. (b) Subject to the provisions of Section 2.08, the Loans comprising each CD Borrowing shall bear interest (computed on the basis of the actual number of days elapsed over a year of 360 days) at a rate per annum equal to the Adjusted CD Rate for the Interest Period in effect for such Borrowing plus the Applicable Percentage. Interest on each CD Borrowing shall be payable on each applicable Interest Payment Date. The Adjusted CD Rate for each Interest Period shall be determined by the Agent in accordance with the definition of Adjusted CD Rate herein. The Agent shall promptly advise the Borrower and each Lender of such determination. (c) Subject to the provisions of Section 2.08, the Loans comprising each ABR Borrowing shall bear interest (computed on the basis of the actual number of days elapsed over a year of (i) 365 or 366 days, as the case may be, during any period in which the Alternate Base Rate is based on the Prime Rate, and (ii) 360 days, during any period in which the Alternate Base Rate is based on the Base CD Rate or the Federal Funds Effective Rate) at a rate per annum equal to the Alternate Base Rate plus the Applicable Percentage. Interest on each ABR Borrowing shall be payable on each applicable Interest Payment Date. The Alternate 32 Base Rate shall be determined by the Agent in accordance with the definition of Alternate Base Rate herein. SECTION 2.08. Default Interest. If the Borrower shall default in the ----------------- payment of the principal of or interest on any Loan or any other amount becoming due hereunder, whether by scheduled maturity, notice of prepayment, acceleration or otherwise, the Borrower shall on demand from time to time from the Agent pay interest, to the extent permitted by law, on such defaulted amount up to (but not including) the date of actual payment (after as well as before judgment) at a rate per annum (computed on the basis of the actual number of days elapsed over a year of 360 days) equal to the Alternate Base Rate plus the Applicable Percentage plus 2%. SECTION 2.09. Alternate Rate of Interest. (a) In the event, and on --------------------------- each occasion, that on the day two Business Days prior to the commencement of any Interest Period for a Eurodollar Borrowing the Agent shall have determined that deposits in the principal amounts of the Loans comprising such Borrowing are not generally available in the London interbank market, or that the rates at which such deposits are being offered will not adequately and fairly reflect the cost to any Lender of making or main taining its Eurodollar Loan during such Interest Period, or that reasonable means do not exist for ascertaining the LIBO Rate, the Agent shall, as promptly as practicable, give written or telecopy notice of such determination to the Borrower and the Lenders. In the event of any such determination, until the Agent shall have advised the Borrower and the Lenders that the circumstances giving rise to such notice no longer exist, any request by the Borrower for a Eurodollar Borrowing pursuant to Section 2.03 shall be deemed to be a request for an ABR Borrowing. (b) In the event, and on each occasion, that on or before the day on which the Adjusted CD Rate for a CD Borrowing is to be determined the Agent shall have determined that such Adjusted CD Rate cannot be determined for any reason, including the inability of the Agent to obtain sufficient bids in accordance with the terms of the definition of Fixed CD Rate, or the Agent shall determine that the Adjusted CD Rate for such CD Borrowing will not adequately and fairly reflect the cost to any Lender of making or maintaining its CD Loan during such Interest Period, the Agent shall, in a timely manner, give written or telecopy notice of such determination to the Borrower and the Lenders. In the event of any such determination, any request by the Borrower for a CD Borrowing pursuant to 33 Section 2.03 shall, until the Agent shall have advised the Borrower and the Lenders that the circumstances giving rise to such notice no longer exist, be deemed to be a request for an ABR Borrowing. SECTION 2.10. Termination and Reduction of Commitments. (a) Unless ----------------------------------------- previously terminated, (i) the Revolving Commitments shall terminate on the Revolving Maturity Date and (ii) the LC Commitment shall terminate on the date 30 days prior to the Revolving Maturity Date. (b) Upon at least five Business Days' prior irrevocable written or telecopy notice to the Agent, the Borrower may at any time in whole permanently terminate, or from time to time in part permanently reduce, the Total Revolving Commitments; provided, however, that (i) each partial reduction of the Total -------- ------- Revolving Commitments shall be in an integral multiple of $1,000,000 and in a minimum principal amount of $5,000,000 and (ii) no such termination or reduction shall be made which would reduce the Total Revolving Commitments to an amount less than the Aggregate Revolving Exposure. (c) Each reduction in the Revolving Commitments hereunder shall be made ratably among the Lenders in accordance with their respective Revolving Commitments. The Borrower shall pay to the Agent for the accounts of the Lenders, on the date of each termination or reduction, the Facility Fees on the amount of the Revolving Commitments so terminated or reduced accrued through the date of such termination or reduction. SECTION 2.11. Prepayment of Loans. (a) The Borrower shall have the -------------------- right at any time and from time to time to prepay any Borrowing, in whole or in part. (b) On the date of any termination or reduction of the Revolving Commitments pursuant to Section 2.10, the Borrower shall pay or prepay so much of the Borrowings as shall be necessary in order that the Aggregate Revolving Exposure shall not exceed the Total Revolving Commitment after giving effect to such termination or reduction. (c) In the event and on such occasion that the Aggregate Revolving Exposure exceed the Borrowing Base, the Borrower shall prepay Borrowings (or if no such Borrowings are outstanding, deposit cash collateral in an account with the Agent pursuant to Section 2.19(i)) in an aggregate amount equal to such excess. 34 (d) In the event and on each occasion that any Proceeds are received by or on behalf of the Borrower or any Subsidiary in respect of any Prepayment Event, the Borrower shall immediately after the Proceeds are received, prepay Borrowings in (i) an aggregate amount equal to such Proceeds, in the case of a Prepayment Event of a type set forth in clause (a) of the definition thereof and (ii) in an amount equal to the lesser of (A) such Proceeds or (B) an amount sufficient to bring the Borrower into compliance with the financial covenants set forth in Sections 6.06, 6.13, 6.14, 6.15 and 6.16, in the case of a Prepayment Event of a type set forth in clause (b) of the definition thereof. (e) Prior to any optional or mandatory prepayment of Borrowings hereunder, the Borrower shall select the Borrowing or Borrowings to be prepaid and specify such selection in the notice of such prepayment delivered pursuant to paragraph (f) of this Section. (f) The Borrower shall notify the Agent by written or telecopy notice (or telephone notice promptly confirmed by written or telecopy notice) to the Agent before 10:00 a.m., New York City time, three Business Days prior to prepayment. Each partial prepayment of any Borrowing shall be in an amount which is an integral multiple of $1,000,000 and not less than $1,000,000, except as necessary to apply fully the required amount of a mandatory repayment. Each notice of prepayment shall specify the prepayment date and the principal amount of each Borrowing (or portion thereof) to be prepaid, shall be irrevocable and shall commit the Borrower to prepay such Borrowing (or portion thereof) by the amount stated therein on the date stated therein. All prepayments under this Section shall be subject to Section 2.14 but otherwise without premium or penalty and shall be applied ratably to the Loans included in the prepaid Borrowing. All prepayments under this Section shall be accompanied by accrued interest on the principal amount being prepaid to the date of payment. SECTION 2.12. Reserve Requirements; Change in Circumstances. (a) ---------------------------------------------- Notwithstanding any other provision herein, if after the date of this Agreement any change in applicable law or regulation or in the interpretation or administration thereof by any Governmental Authority charged with the interpretation or administration thereof (whether or not having the force of law) shall change the basis of taxation of payments to any Lender or Issuing Bank of the principal of or interest on any Eurodollar Loan or CD Loan made by such Lender or any Fees or other amounts payable hereunder (other than changes in respect of taxes imposed on 35 the overall net income of such Lender or Issuing Bank by any jurisdiction or any political subdivision thereof) or shall impose, modify or deem applicable any reserve, special deposit or similar requirement against assets of, deposits with or for the account of or credit extended by such Lender or such Issuing Bank (except any such reserve requirement which is already reflected in the definition of the applicable Rate), or shall impose on such Lender or such Issuing Bank or the London interbank market any other condition affecting this Agreement or any Eurodollar Loan or CD Loan made by such Lender or any Letter of Credit or participation therein, and the result of any of the foregoing shall be to increase the cost to such Lender or Issuing Bank of making or maintaining any Eurodollar Loan or CD Loan or increase the cost to any Lender of issuing or maintaining any Letter of Credit or purchasing or maintaining a participation therein or to reduce the amount of any sum received or receivable by such Lender or such Issuing Bank hereunder (whether of principal, interest or otherwise) by an amount deemed by such Lender or such Issuing Bank to be material, then the Borrower shall pay to such Lender or such Issuing Bank, as the case may be, upon demand such additional amount or amounts as will compensate such Lender or such Issuing Bank, as the case may be, for such additional costs incurred or reduction suffered. (b) If any Lender or Issuing Bank shall have determined that the adoption after the date hereof of any law, rule, regulation or guideline regarding capital adequacy, or any change in any of the foregoing or in the interpretation or administration of any of the foregoing by any Governmental Authority charged with the interpretation or administration thereof, or compliance by any Lender (or any lending office of such Lender) or any Issuing Bank or any Lender's or Issuing Bank's holding company with any request or directive regarding capital adequacy (whether or not having the force of law) of any such Governmental Authority, has or would have the effect of reducing the rate of return on such Lender's or Issuing Bank's capital or on the capital of such Lender's or Issuing Bank's holding company, if any, as a consequence of this Agreement or the Loans made or participations in Letters of Credit purchased by such Lender pursuant hereto or the Letters of Credit issued by such Issuing Bank pursuant hereto to a level below that which such Lender or Issuing Bank or such Lender's or Issuing Bank's holding company could have achieved but for such adoption, change or compliance (taking into consideration such Lender's or Issuing Bank's policies and the policies of such Lender's or Issuing Bank's holding company with respect to capital adequacy) by an amount deemed by such Lender or Issuing Bank to be material, then 36 from time to time the Borrower shall pay to such Lender or Issuing Bank, as the case may be, such additional amount or amounts as will compensate such Lender or Issuing Bank or such Lender's or Issuing Bank's holding company for any such reduction suffered. (c) A certificate of a Lender or Issuing Bank setting forth such amount or amounts as shall be necessary to compensate such Lender or Issuing Bank, as applicable, as specified in paragraph (a) or (b) above, as the case may be, shall be delivered to the Borrower. The Borrower shall pay each Lender or Issuing Bank the amount shown as due on any such certificate delivered by it within 10 days after the receipt of the same. In the event any Lender delivers such a certificate, the Borrower may, at its sole expense and effort, require such Lender to transfer and assign, without recourse (in accordance with Section 9.04) all its interests, rights and obligations under this Agreement to an assignee which shall assume such assigned obligations (which assignee may be another Lender, if a Lender accepts such assignment); provided, however, that -------- ------- (i) such assignment shall not conflict with any law, rule or regulation or order of any Governmental Authority, (ii) the Borrower shall have received a written consent of the Agent in the case of an assignee that is not a Lender, which consent shall not unreasonably be withheld, and (iii) the Borrower or such assignee shall have paid to the assigning Lender in immediately available funds the principal of and interest accrued to the date of such payment on the Loans made by it hereunder and all other amounts owed to it hereunder. (d) Failure on the part of any Lender or the Issuing Bank to demand compensation for any increased costs or reduction in amounts received or receivable or reduction in return on capital with respect to any period shall not constitute a waiver of such Lender's or Issuing Bank's right to demand compensation with respect to such period or any other period. (e) Without prejudice to the survival of any other agreement contained herein, the agreements and obligations contained in this Section shall survive the payment in full of the principal of and interest on all Loans made hereunder. SECTION 2.13. Change in Legality. (a) Notwithstanding any other ------------------- provision herein, if any change in any law or regulation or in the interpretation thereof by any Governmental Authority charged with the administration or interpretation thereof shall make it 37 unlawful for any Lender to make or maintain any Eurodollar Loan or to give effect to its obligations as contemplated hereby with respect to any Eurodollar Loan, then, by written notice to the Borrower and to the Agent, such Lender may: (i) declare that Eurodollar Loans shall not thereafter be made by such Lender hereunder, whereupon any request by the Borrower for a Eurodollar Borrowing shall, as to such Lender only, be deemed a request for an ABR Loan to the Borrower unless such declaration shall be subsequently withdrawn; and (ii) require that all outstanding Eurodollar Loans made by it be converted to ABR Loans, in which event all such Eurodollar Loans shall be automatically con verted to ABR Loans as of the effective date of such notice as provided in paragraph (b) below. In the event any Lender shall exercise its rights under (i) or (ii) above, all payments and prepayments of principal which would otherwise have been applied to repay the Eurodollar Loans that would have been made by such Lender or the converted Eurodollar Loans of such Lender shall instead be applied to repay the ABR Loans made by such Lender in lieu of, or resulting from the conversion of, such Eurodollar Loans. (b) For purposes of this Section, a notice to the Borrower by any Lender shall be effective as to each Eurodollar Loan if lawful, on the last day of the Interest Period then applicable to such Eurodollar Loan; in all other cases such notice shall be effective on the date of receipt by the Borrower. SECTION 2.14. Indemnity. The Borrower shall indemnify each Lender ---------- against any loss or expense which such Lender may sustain or incur as a consequence of (a) any failure by the Borrower to fulfill on the date of any borrowing hereunder the applicable conditions set forth in Article IV, (b) any failure by the Borrower to borrow or to refinance any Loan hereunder after irrevocable notice of such borrowing or refinancing has been given pursuant to Section 2.03, (c) any payment, prepayment, assignment pursuant to Section 2.12(c), conversion of a Eurodollar Loan pursuant to Section 2.13(a) or conversion of a Eurodollar Loan or CD Loan required by any other provision of this Agreement or otherwise made or deemed made on a date other than the last day of the Interest Period applicable thereto, (d) any default in payment or prepayment of the principal amount of any Loan or any part thereof or interest accrued 38 thereon, as and when due and payable at the due date thereof (whether by scheduled maturity, acceleration, irrevocable notice of prepayment or otherwise) or (e) the occurrence of any Event of Default, including, in each such case, any loss or reasonable expense sustained or incurred or to be sustained or incurred in liquidating or employing deposits from third parties acquired to effect or maintain such Loan or any part thereof as a Eurodollar Loan or CD Loan. Such loss or reasonable expense shall include an amount equal to the excess, if any, as reasonably determined by such Lender, of (i) its cost of obtaining the funds for the Loan being paid, prepaid, assigned, converted or not borrowed (based on the LIBO Rate or Adjusted CD Rate) for the period from the date of such payment, prepayment, assignment, conversion or failure to borrow to the last day of the Interest Period for such Loan (or, in the case of a failure to borrow, the Interest Period for such Loan which would have commenced on the date of such failure) over (ii) the amount of interest (as reasonably determined by such Lender) that would be realized by such Lender in reemploying the funds so paid, prepaid, assigned, converted or not borrowed for such period or Interest Period, as the case may be. A certificate of any Lender setting forth any amount or amounts which such Lender is entitled to receive pursuant to this Section and evidencing a loss suffered by such Lender of such amount or amounts shall be delivered to the Borrower. SECTION 2.15. Pro Rata Treatment. Except as required under Section ------------------- 2.13, each Borrowing, each payment or prepayment of principal of any Borrowing, each payment of interest on the Loans, each payment of the Facility Fees and L/C Participation Fees, each reduction of the Revolving Commitments and each refinancing of any Borrowing, shall be allocated pro rata among the Lenders in accordance with their respective Revolving Commitments (or, if such Revolving Commitments shall have expired or been terminated, in accordance with the respective principal amounts of their outstanding Loans). Each Lender agrees that in computing such Lender's portion of any Borrowing to be made hereunder, the Agent may, in its discretion, round each Lender's percentage of such Borrowing to the next higher or lower whole dollar amount. SECTION 2.16. Sharing of Setoffs. Each Lender agrees that if it ------------------- shall, through the exercise of a right of banker's lien, setoff or counterclaim against the Borrower, or pursuant to a secured claim under Section 506 of Title 11 of the United States Code or other security or interest arising from, or in lieu of, such secured claim, received by such Lender under any applicable bankruptcy, insolvency or 39 other similar law or otherwise, or by any other means (other than an assignment pursuant to Section 2.12(c) or 9.04), obtain payment (voluntary or involuntary) in respect of any Loan or L/C Disbursement as a result of which the unpaid principal portion of its Loans and participations in L/C Disbursements shall be proportionately less than the unpaid principal portion of the Loans and participations in L/C Disbursements of any other Lender, it shall be deemed simultaneously to have purchased from such other Lender at face value, and shall promptly pay to such other Lender the purchase price for, a participation in the Loans and L/C Exposure of such other Lender, so that the aggregate unpaid principal amount of the Loans and L/C Exposure and participations in the Loans and L/C Exposure held by each Lender shall be in the same proportion to the aggregate unpaid principal amount of all Loans and L/C Exposure then outstanding as the principal amount of its Loans and L/C Exposure prior to such exercise of banker's lien, setoff or counterclaim or other event was to the principal amount of all Loans or LC Exposure, as the case may be, outstanding prior to such exercise of banker's lien, setoff or counterclaim or other event; provided, however, that, if any such purchase or purchases or -------- ------- adjustments shall be made pursuant to this Section and the payment giving rise thereto shall thereafter be recovered, such purchase or purchases or adjustments shall be rescinded to the extent of such recovery and the purchase price or prices or adjustment restored without interest. The Borrower expressly consents to the foregoing arrangements and agrees that any Lender holding a participation in a Loan or L/C Disbursement deemed to have been so purchased may exercise any and all rights of banker's lien, setoff or counterclaim with respect to any and all moneys owing by the Borrower to such Lender by reason thereof as fully as if such Lender had made a Loan directly to the Borrower in the amount of such participation. SECTION 2.17. Payments. (a) The Borrower shall make each payment --------- (including principal of or interest on the Loans or any L/C Disbursement or any Fees or other amounts) hereunder and under any other Loan Document not later than 12:00 noon, New York time, on the date when due in dollars in immediately available funds to the Agent at its address referred to in Section 9.01. (b) Whenever any payment (including principal of or interest on any Borrowing or any Fees or other amounts) hereunder or under any other Loan Document shall become due, or otherwise would occur, on a day that is not a Business Day, such payment may (except as otherwise provided in the 40 definition of "Interest Period") be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of interest or Fees, if applicable. SECTION 2.18. Taxes. (a) Any and all payments by the Borrower ------ hereunder shall be made, in accordance with Section 2.17, free and clear of and without deduction for any and all present or future taxes, imposts, deductions, charges or withholdings, and all liabilities with respect thereto, excluding --------- taxes imposed on the Agent's or any Lender's or any Issuing Bank's (or any transferee's or assignee's, including a participation holder's (any such entity a "Transferee")) net income and franchise taxes imposed on the Agent or any ---------- Lender or any Issuing Bank (or Transferee) by any jurisdiction or any political subdivision thereof (all such nonexcluded taxes, levies, imposts, deductions, charges, withholdings and liabilities being hereinafter referred to as "Taxes"). ----- If the Borrower shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder to the Lenders or any Issuing Bank (or any Transferee) or the Agent, (i) the sum payable shall be increased by the amount necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section) such Lender or such Issuing Bank (or Transferee) or the Agent (as the case may be) shall receive an amount equal to the sum it would have received had no such deductions been made, (ii) the Borrower shall make such deductions and (iii) the Borrower shall pay the full amount deducted to the relevant taxing authority or other Governmental Authority in accordance with applicable law. (b) In addition, the Borrower shall pay any present or future stamp or documentary taxes or any other excise or property taxes, charges or similar levies which arise from any payment made hereunder or from the execution, delivery or registration of, or otherwise with respect to, this Agreement or any other Loan Document (hereinafter referred to as "Other Taxes"). ----------- (c) The Borrower shall indemnify each Lender and Issuing Bank (or Transferee) and the Agent for the full amount of Taxes and Other Taxes (including any Taxes or Other Taxes imposed by any jurisdiction on amounts payable under this Section) paid by such Lender or such Issuing Bank (or Transferee) or the Agent, as the case may be, and any liability (including penalties, interest and reasonable out-of-pocket expenses) arising therefrom or with respect thereto, whether or not such Taxes or Other Taxes were correctly or legally asserted by the relevant taxing 41 authority or other Governmental Authority. Payments pursuant to such indemnification shall be made within 30 days after the date any Lender or Issuing Bank (or Transferee) or the Agent, as the case may be, makes written demand therefor, which demand may be made notwithstanding the fact that such Lender, Issuing Bank (or Transferee) or the Agent has determined to challenge or contest such assertion of Taxes or Other Taxes. After the Borrower makes full payment to the Lender, Issuing Bank (or Transferee) or the Agent with respect to such indemnification for Taxes or Other Taxes asserted, if such Lender, Issuing Bank (or Transferee) or the Agent believes in its sole discretion that reasonable grounds exist to challenge or contest the Taxes or Other Taxes imposed, then such Lender, Issuing Bank (or Transferee) or the Agent, as the case may be, shall so contest or challenge in good faith the Taxes or Other Taxes asserted, which contest or challenge shall be at the sole expense of the Borrower. If a Lender, Issuing Bank (or Transferee) or the Agent shall become aware that it is entitled to receive a refund in respect of Taxes or Other Taxes, it shall promptly notify the Borrower of the availability of such refund and shall, within 30 days after receipt of a request by the Borrower, apply for such refund at the Borrower's reasonable out-of-pocket expense. If any Lender, Issuing Bank (or Transferee) or the Agent receives a refund in respect of any Taxes or Other Taxes for which such Lender, Issuing Bank (or Transferee) or the Agent has received payment from the Borrower hereunder it shall promptly notify the Borrower of such refund and shall promptly upon receipt repay such refund to the Borrower, net of all out-of-pocket expenses of such Lender or Issuing Bank and without interest; provided, however, that the Borrower, upon the request -------- ------- of such Lender, Issuing Bank (or Transferee) or the Agent, agrees to return such refund (plus penalties, interest or other charges) to such Lender, Issuing Bank (or Transferee) or the Agent in the event such Lender, Issuing Bank (or Transferee) or the Agent is required to repay such refund. (d) Within 30 days after the date of any payment of Taxes or Other Taxes withheld by the Borrower in respect of any payment to any Lender, Issuing Bank (or Transferee) or the Agent, the Borrower will furnish to the Agent, at its address referred to in Section 9.01, the original or a certified copy of a receipt evidencing payment thereof. (e) Without prejudice to the survival of any other agreement contained herein, the agreements and obligations contained in this Section shall survive the payment in full of the principal of and interest on all Loans made hereunder. 42 (f) On or before the date it becomes a party to this Agreement and from time to time thereafter upon any change in status rendering any certificate or documents previously delivered pursuant to this Section 2.18(f) invalid or inaccurate, each Lender, Issuing Bank or Transferee that is organized outside the United States shall (but (x) in the case of a Transferee or (y) in the case of a Lender or Issuing Bank with respect to any change in status, only if legally able to do so) upon written request of the Borrower, deliver to the Borrower such certificates, documents or other evidence, as specified by the Borrower and, as the case may be, required by, in the case of a non-United States Lender or Issuing Bank, the Code or Treasury Regulations issued pursuant thereto, properly completed and duly executed by such Lender (or Transferee) establishing that such payment is, as the case may be, (i) not subject to withholding under the Code because such payment is effectively connected with the conduct by such Lender, Issuing Bank or Transferee of a trade or business in the United States or (ii) totally exempt from United States tax under a provision of an applicable tax treaty. Unless the Borrower and the Agent have received forms or other docu ments satisfactory to them indicating that payments here under are not subject to United States withholding tax, as the case may be, or are subject to such tax at a rate reduced by an applicable tax treaty, the Borrower or the Agent shall withhold taxes from such payments at the appli cable statutory rate in the case of payments to or for any Lender, Issuing Bank or Transferee or assignee organized under the laws of a jurisdiction outside the United States or Germany, as the case may be. (g) The Borrower shall not be required to pay any additional amounts to any Lender, Issuing Bank or Transferee in respect of United States withholding tax pursuant to Section 2.18(a) if the obligation to pay such additional amounts would not have arisen but for a failure by such Lender, Issuing Bank or Transferee to comply with the provisions of Section 2.18(f) unless such failure results from (i) a change in applicable law, regulation or official interpretation thereof or (ii) an amendment, modification or revocation of any applicable tax treaty or a change in official position regarding the application or interpretation thereof, in each case after the Effective Date (and, in the case of a Transferee, after the date of assignment or transfer, when as a result of such change, amendment, modification or revocation withholding taxes were or would have been imposed on amounts payable to the 43 transferor was entitled to any additional amounts); provided, however, that the -------- ------- Borrower shall be required to pay those amounts to any Lender, Issuing Bank or Transferee that it was required to pay hereunder prior to the failure of such Lender, Issuing Bank or Transferee to comply with the provisions of Section 2.18(f). (h) Any Lender, Issuing Bank or Transferee claiming any additional amounts payable pursuant to this Section shall use reasonable efforts (consistent with legal and regulatory restrictions) to file any certificate or document in a timely manner requested by the Borrower or to change the jurisdiction of its applicable lending office if the making of such a filing or change would avoid the need for or reduce the amount of any such additional amounts which may thereafter accrue and would not, in the sole and reasonable determination of such Lender, Issuing Bank or Transferee be otherwise disadvantageous to such Lender, Issuing Bank or Transferee. SECTION 2.19. Letters of Credit. (a) General. The Borrower may ------------------ -------- request the issuance of a Letter of Credit for its own account, in a form reasonably acceptable to the Agent and the Issuing Bank, at any time and from time to time while the Revolving Commitments remain in effect. Each Letter of Credit shall be denominated in dollars. This Section shall not be construed to impose an obligation upon the Issuing Bank to issue any Letter of Credit that is inconsistent with the terms and conditions of this Agreement. (b) Notice of Issuance, Amendment, Renewal, Extension; Certain ---------------------------------------------------------- Conditions. In order to request the issuance of a Letter of Credit (or to - ----------- amend, renew or extend an existing Letter of Credit), the Borrower shall hand deliver or telecopy to the Issuing Bank and the Agent (reasonably in advance of the requested date of issuance, amendment, renewal or extension) a notice requesting the issuance of a Letter of Credit, or identifying the Letter of Credit to be amended, renewed or extended, the date of issuance, amendment, renewal or extension, the date on which such Letter of Credit is to expire (which shall comply with paragraph (c) below), the amount of such Letter of Credit, the name and address of the beneficiary thereof and such other information as shall be necessary to prepare such Letter of Credit. Following receipt of such notice and prior to the issuance of the requested Letter of Credit or the applicable amendment, renewal or extension, the Agent shall notify the Borrower and the Issuing Bank of the amount of the Aggregate Revolving Exposure after giving effect to 44 (i) the issuance, amendment, renewal or extension of such Letter of Credit, (ii) the issuance or expiration of any other Letter of Credit that is to be issued or will expire prior to the requested date of issuance of such Letter of Credit and (iii) the borrowing or repayment of any Loans that (based upon notices delivered to the Agent by the Borrower) are to be borrowed or repaid prior to the requested date of issuance of such Letter of Credit. A Letter of Credit shall be issued, amended, renewed or extended only if, and upon issuance, amendment, renewal or extension of each Letter of Credit the Borrower shall be deemed to represent and warrant that, after giving effect to such issuance, amendment, renewal or extension (A) the L/C Exposure shall not exceed $5,000,000 less the face amount of any letters of credit issued for the account of the Borrower or any Subsidiary by financial institutions other than an Issuing Bank and outstanding at such time and (B) the Aggregate Revolving Exposure shall not exceed the lesser of the Total Revolving Commitment and the Borrowing Base then in effect. (c) Expiration Date. Each Letter of Credit shall expire at the close ---------------- of business on the earlier of the date one year after the date of the issuance of such Letter of Credit and the date that is 30 days prior to the Revolving Maturity Date, unless such Letter of Credit expires by its terms on an earlier date. (d) Participations. By the issuance of a Letter of Credit and --------------- without any further action on the part of the Issuing Bank or the Lenders, the Issuing Bank hereby grants to each Lender, and each such Lender hereby acquires from the Issuing Bank, a participation in such Letter of Credit equal to such Lender's Pro Rata Percentage of the aggregate amount available to be drawn under such Letter of Credit, effective upon the issuance of such Letter of Credit. In consideration and in furtherance of the foregoing, each Lender hereby absolutely and unconditionally agrees to pay to the Agent, for the account of the Issuing Bank, such Lender's Pro Rata Percentage of each L/C Disbursement made by such Issuing Bank and not reimbursed by the Borrower forthwith on the date due as provided in Section 2.02(e). Each Lender acknowledges and agrees that its obligation to acquire participations pursuant to this paragraph in respect of Letters of Credit is absolute and unconditional and shall not be affected by any circumstance whatsoever, including the occurrence and continuance of a Default or an Event of Default or the termination of the Revolving Commitments, and that each such payment shall be made without any offset, abatement, withholding or reduction whatsoever. 45 (e) Reimbursement. If an Issuing Bank shall make any L/C -------------- Disbursement in respect of a Letter of Credit, the Borrower shall pay to the Agent an amount equal to such L/C Disbursement not later than two hours after the Borrower shall have received notice from such Issuing Bank that payment of such draft will be made, or, if the Borrower shall have received such notice later than 10:00 a.m., New York City time, on any Business Day, not later than 10:00 a.m., New York City time, on the immediately following Business Day. (f) Obligations Absolute. The Borrower's obligations to reimburse --------------------- L/C Disbursements as provided in paragraph (e) above shall be absolute, unconditional and irrevocable, and shall be performed strictly in accordance with the terms of this Agreement, under any and all circumstances whatsoever, and irrespective of: (i) any lack of validity or enforceability of any Letter of Credit or this Agreement, or any term or provision therein; (ii) any amendment or waiver of or any consent to departure from all or any of the provisions of any Letter of Credit or this Agreement; (iii) the existence of any claim, setoff, defense or other right that the Borrower, any other party guaranteeing, or otherwise obligated with, the Borrower, any Subsidiary or other Affiliate thereof or any other person may at any time have against the beneficiary under any Letter of Credit, any Issuing Bank, the Agent or any Lender or any other person, whether in connection with this Agreement or any other related or unrelated agreement or transaction; (iv) any draft or other document presented under a Letter of Credit proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect; (v) payment by the Issuing Bank under a Letter of Credit against presentation of a draft or other document that does not comply with the terms of such Letter of Credit; and (vi) any other act or omission to act or delay of any kind of any Issuing Bank, the Lenders, the Agent or any other person or any other event or circumstance 46 whatsoever, whether or not similar to any of the foregoing, that might, but for the provisions of this Section, constitute a legal or equitable discharge of the Borrower's obligations hereunder. Without limiting the generality of the foregoing, it is expressly understood and agreed that the absolute and unconditional obligation of the Borrower hereunder to reimburse L/C Disbursements will not be excused by the negligence or misconduct of any Issuing Bank. However, the foregoing shall not be construed to excuse any Issuing Bank from liability to the Borrower to the extent of any damages (as opposed to consequential damages, claims in respect of which are hereby waived by the Borrower to the extent permitted by applicable law) suffered by the Borrower that are caused by such Issuing Bank's negligence or misconduct in determining whether drafts and other documents presented under a Letter of Credit comply with the terms thereof; it is understood that each Issuing Bank may accept documents that appear on their face to be in order, without responsibility for further investigation, regardless of any notice or information to the contrary and, in making any payment under any Letter of Credit (i) an Issuing Bank's exclusive reliance on the documents presented to it under such Letter of Credit as to any and all matters set forth therein, including reliance on the amount of any draft presented under such Letter of Credit, whether or not the amount due to the beneficiary thereunder equals the amount of such draft and whether or not any document presented pursuant to such Letter of Credit proves to be insufficient in any respect, if such document on its face appears to be in order, and whether or not any other statement or any other document presented pursuant to such Letter of Credit proves to be forged or invalid or any statement therein proves to be inaccurate or untrue in any respect whatsoever and (ii) any noncompliance in any immaterial respect of the documents presented under such Letter of Credit with the terms thereof shall, in each case, be deemed not to constitute misconduct or negligence of an Issuing Bank. (g) Disbursement Procedures. The Issuing Bank shall, promptly ------------------------ following its receipt thereof, examine all documents purporting to represent a demand for payment under a Letter of Credit. Such Issuing Bank shall as promptly as possible give telephonic notification, confirmed by telecopy, to the Agent and the Borrower of such demand for payment and whether such Issuing Bank has made or will make an L/C Disbursement thereunder; provided that any failure -------- to give or delay in giving such notice shall not relieve the Borrower of its obligation to reimburse the Issuing Bank and the Lenders with respect to any such L/C Disbursement. The Agent shall promptly give each Lender notice thereof. 47 (h) Resignation or Removal of an Issuing Bank. An Issuing Bank may ------------------------------------------ resign at any time by giving 180 days' prior written notice to the Agent, the Lenders and the Borrower, and may be removed at any time by the Borrower by notice to the Issuing Bank, the Agent and the Lenders. Subject to the next succeeding paragraph, upon the acceptance of any appointment as an Issuing Bank hereunder by a Lender that shall agree to serve as successor Issuing Bank, such successor shall succeed to and become vested with all the interests, rights and obligations of the retiring Issuing Bank and the retiring Issuing Bank shall be discharged from its obligations to issue additional Letters of Credit hereunder. At the time such removal or resignation shall become effective, the Borrower shall pay all accrued and unpaid fees pursuant to Section 2.05(c)(ii). The acceptance of any appointment as an Issuing Bank hereunder by a successor Lender shall be evidenced by an agreement entered into by such successor, in a form satisfactory to the Borrower and the Agent, and, from and after the effective date of such agreement, (i) such successor Lender shall have all the rights and obligations of the previous Issuing Bank under this Agreement and (ii) references herein to the term "Issuing Bank" shall be deemed to refer to such successor or to any previous Issuing Bank, or to such successor and all previous Issuing Banks, as the context shall require. After the resignation or removal of an Issuing Bank hereunder, the retiring Issuing Bank shall remain a party hereto and shall continue to have all the rights and obligations of an Issuing Bank under this Agreement with respect to Letters of Credit issued by it prior to such resignation or removal, but shall not be required to issue additional Letters of Credit. (i) Cash Collateralization. If any Event of Default (other than an ----------------------- Event of Default described in clause (g) or (h) of Article VII) shall occur and be continuing, the Borrower shall, on the Business Day it receives notice from the Agent or the Required Lenders (or, if the maturity of the Loans has been accelerated, Lenders holding participations in outstanding Letters of Credit representing greater than 50% of the aggregate undrawn amount of all outstanding Letters of Credit) thereof and of the amount to be deposited, or, if an Event of Default described in clause (g) or (h) of Article VII shall occur, on the Business Day of such occurrence, deposit in an account with the Agent, for the benefit of the Lenders, an amount in cash equal to the L/C Exposure as of such date. The Borrower also shall deposit cash collateral pursuant to this paragraph as and to the extent 48 required by Section 2.11(c), and any such cash collateral so deposited and held by the Agent hereunder shall constitute part of the Borrowing Base for purposes of determining compliance with Section 2.11(c). Each such deposit shall be held by the Agent as collateral for the payment and performance of the obligations of the Borrower under this Agreement. The Agent shall have exclusive dominion and control, including the exclusive right of withdrawal, over such account. Other than any interest earned on the investment of such deposits in Permitted Investments, which investments shall be made at the option and sole discretion of the Agent, such deposits shall not bear interest. Interest or profits, if any, on such investments shall accumulate in such account. Moneys in such account shall (i) automatically be applied by the Agent to reimburse the Issuing Bank for L/C Disbursements for which they have not been reimbursed, (ii) be held for the satisfaction of the reimbursement obligations of the Borrower for the L/C Exposure at such time and (iii) if the maturity of the Loans has been accelerated (but subject to the consent of Lenders holding participations in outstanding Letters of Credit representing greater than 50% of the aggregate undrawn amount of all outstanding Letters of Credit), be applied to satisfy other obligations of the Borrower under this Agreement. If the Borrower is required to provide an amount of cash collateral hereunder as a result of the occurrence of an Event of Default, such amount (to the extent not applied as aforesaid) shall be returned to the Borrower within three Business Days after all Events of Default have been cured or waived. If the Borrower is required to provide an amount of cash collateral hereunder pursuant to Section 2.11(c), such amount (to the extent not applied as aforesaid) shall be returned to the Borrower as and to the extent that, after giving effect to such return, the Borrower would remain in compliance with Section 2.11(c) and no Default shall have occurred and be continuing. ARTICLE III. REPRESENTATIONS AND WARRANTIES The Borrower represents and warrants to each of the Lenders that: SECTION 3.01. Organization; Powers. Each of the Borrower and the --------------------- Subsidiaries (a) is duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization, (b) has all requisite power and authority to own its property and assets and to carry on its business as now conducted and as proposed to be conducted, (c) is qualified to do business in every jurisdiction 49 where such qualification is required, except where the failure so to qualify would not result in a Material Adverse Effect, and (d) in the case of each Loan Party, has the power and authority to execute, deliver and perform its obligations under each Loan Document to which it is party and each other agreement or instrument contemplated thereby and in the case of the Borrower, to borrow and incur other obligations hereunder. SECTION 3.02. Authorization. The execution, delivery and performance -------------- by each Loan Party of the Loan Documents to which it is to be a party and in the case of the Borrower, the borrowings of the Loans, the use of proceeds thereof and the Letters of Credit hereunder (collectively, the "Transactions") (a) have ------------ been duly authorized by all requisite action, including approval of such Loan Party's Board of Directors and if required, stockholder action on the part of such Loan Party, and (b) will not (i) violate (A) any provision of law, statute, rule or regulation, or of the certificate or articles of incorporation or other constitutive documents or by-laws of the Borrower or any Subsidiary, (B) any order of any Govern mental Authority or (C) any provision of any indenture, agreement or other instrument to which the Borrower or any Subsidiary is a party or by which any of them or any of their property is or may be bound, (ii) be in conflict with, result in a breach of or constitute (alone or with notice or lapse of time or both) a default under any such indenture, agreement or other instrument or (iii) result in the crea tion or imposition of any Lien upon or with respect to any property or assets now owned or hereafter acquired by the Borrower or any Subsidiary, except Liens created under the Loan Documents. SECTION 3.03. Enforceability. This Agreement has been duly executed --------------- and delivered by the Borrower and consti tutes, and each other Loan Document when executed and deliv ered by the Loan Parties party thereto will constitute, a legal, valid and binding obligation of the Borrower and the other Loan Parties enforceable against the Borrower and the other Loan Parties in accordance with its terms. SECTION 3.04. Governmental Approvals. No action, consent or approval ----------------------- of, registration or filing with or any other action by any Governmental Authority is or will be required in connection with the Transactions, except such as have been made or obtained and are in full force and effect. SECTION 3.05. Financial Statements. (a) The Borrower has heretofore --------------------- furnished to the Lenders (i) the 50 combined balance sheets and statements of income and cash flow of the Borrower and its combined Subsidiaries pre-Spin-Off as of and for the fiscal year ended May 31, 1997, audited by and accompanied by the opinion of Arthur Andersen & Co., independent public accountants, (ii) the unaudited pro-forma combined balance sheets and statements of income and the cash flow of the Borrower and its combined Subsidiaries post-Spin-Off as of and for the fiscal year ended May 31, 1997, each certified by a Responsible Officer of the Borrower, (iii) the unaudited combined balance sheets and statements of income and cash flow of the Borrower and its combined Subsidiaries pre-Spin-Off as of and for the fiscal quarter ended August 31, 1997, each certified by a Responsible Officer of the Borrower. Such financial state ments present fairly the financial condition and results of operations of the Borrower and its combined Subsidiaries as of such dates and for such periods. Such balance sheets and the notes thereto disclose all material liabilities, direct or contingent, of the Borrower and its combined Subsidiaries as of the dates thereof. Such financial statements and monthly summaries of pretax income or loss were prepared in accordance with GAAP applied on a consistent basis. (b) The Borrower has heretofore furnished to the Lenders its pro forma consolidated balance sheet as of October 15, 1997 prepared giving effect to the Spin-Off as if the Spin-Off had occurred on such date. Such pro forma consolidated balance sheet (i) has been prepared in good faith based on the same assumptions used to prepare the pro forma financial statements included in the Form 10 (which assumptions are believed by the Borrower and International to be reasonable), (ii) is based on the best information available to the Borrower and International after due inquiry, (iii) accurately reflects all adjustments necessary to give effect to the Spin-Off, (iv) presents fairly, in all material respects, the pro forma financial position of the Borrower and its consolidated Subsidiaries as of the date of such balance sheet as if the Spin-Off had occurred on such date and (v) is not materially inconsistent with the forecasts previously provided to the Lenders by the Borrower. SECTION 3.06. No Material Adverse Change. As of the date hereof, --------------------------- there has been no material adverse change in the business, assets, operations, property, condition, financial or otherwise, contingent liabilities or material agreements of the Borrower and the Subsidiaries, taken as a whole, since May 31, 1997 (it being understood that changes in general economic conditions shall not be deemed to constitute such a material adverse change). 51 SECTION 3.07. Title to Properties; Possession Under Leases. (a) --------------------------------------------- Each of the Borrower and the Subsidiar ies has good and marketable title to, or valid leasehold interests in, all its material properties and assets, except for minor defects in title that do not interfere with its ability to conduct its business as currently conducted or to utilize such properties and assets for their intended pur poses. All such material properties and assets are free and clear of Liens, other than Liens expressly permitted by Sec tion 6.02. (b) Each of the Borrower and the Subsidiaries has complied with all material obligations under all material leases to which it is a party and all such leases are in full force and effect. Each of the Borrower and the Subsidiaries enjoys peaceful and undisturbed possession under all such material leases. (c) On and as of the date of the initial Credit Event under this Agreement, the Borrower and the Subsidiaries will own, or have a valid leasehold interest in, all of the assets, business and operations currently conducted by that portion of the pre-Spin-Off operations that will be conducted by the Borrower post-Spin-Off (as described in the Distribution Agreement), (other than assets since disposed of prior to the date of such Borrowing in the ordinary course of business and assets described on Schedule 3.07). SECTION 3.08. Subsidiaries. Schedule 3.08 sets forth as of the date ------------- hereof and as of the Effective Date a list of all Subsidiaries of the Borrower and the percentage ownership interest of the Borrower therein. SECTION 3.09. Litigation; Compliance with Laws. (a) There are not --------------------------------- any actions, suits or proceedings at law or in equity or by or before any Governmental Authority now pending or, to the knowledge of the Borrower, threatened against or affecting the Borrower or any Subsidiary or any business, property or rights of any such person (i) which involve any Loan Document, the Transactions or the Spin-Off or (ii) as to which there is a reasonable probability of an adverse determination and which, if such probable adverse determination occurred, could, individually or in the aggregate, reasonably be anticipated to result in a Material Adverse Effect. (b) To the best knowledge of the Borrower, neither the Borrower nor any of the Subsidiaries is in violation 52 of any law, rule or regulation, or in default with respect to any judgment, writ, injunction or decree of any Governmental Authority, where such violation or default could reasonably be anticipated to result in a Material Adverse Effect. SECTION 3.10. Agreements. (a) Neither the Borrower nor any of the ----------- Subsidiaries is a party to any agreement or instrument or subject to any corporate or other restriction that has resulted or could reasonably be anticipated to result in a Material Adverse Effect. (b) Neither the Borrower nor any of its Subsidi aries is in default in any manner under any provision of any indenture or other agreement or instrument evidencing Indebtedness, or any other material agreement or instrument to which it is a party or by which it or any of its proper ties or assets are or may be bound, where such default could reasonably be anticipated to result in a Material Adverse Effect. SECTION 3.11. Federal Reserve Regulations. (a) Neither the Borrower ---------------------------- nor any of the Subsidiaries is engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying Margin Stock. (b) No part of the proceeds of any Loan or any Letter of Credit will be used, whether directly or indirectly, and whether immediately, incidentally or ultimately, (i) to purchase or carry Margin Stock or to extend credit to others for the purpose of purchasing or carrying Margin Stock or to refund indebtedness originally incurred for such purpose, or (ii) for any purpose which entails a violation of, or which is inconsistent with, the provisions of the Regulations of the Board, including Regulation G, U or X. SECTION 3.12. Investment Company Act; Public Utility Holding Company ------------------------------------------------------ Act. Neither the Borrower nor any Subsidiary is (a) an "investment company" as - ---- defined in, or subject to regulation under, the Investment Company Act of 1940 or (b) a "holding company" as defined in, or subject to regulation under, the Public Utility Holding Company Act of 1935. SECTION 3.13. Use of Proceeds. The Borrower will use the proceeds of ---------------- the Loans and will request the issuance of Letters of Credit only for the purposes specified in the preamble to this Agreement; provided, that the -------- 53 principal amount of outstanding Loans and Letters of Credit used to provide working capital for the Borrower and its Subsidiaries shall at no time exceed 10% of the Borrowing Base. SECTION 3.14. Tax Returns. Each of the Borrower and the Subsidiaries ------------ has filed or caused to be filed all Federal, state, local and foreign tax returns required to have been filed by it and has paid or caused to be paid all taxes shown to be due and payable on such returns or on any assessments received by it, except taxes that are being contested in good faith by appropriate proceedings and for which the Borrower or such Subsidiary shall have set aside on its books adequate reserves. SECTION 3.15. No Material Misstatements. None of the Information -------------------------- Memorandum, information, reports, financial statements, exhibits or schedules furnished by or on behalf of the Borrower to the Agent or any Lender in connection with the negotiation of any Loan Document or included therein or delivered pursuant thereto contained, contains or will contain any material misstatement of fact or omitted, omits or will omit to state any material fact necessary to make the statements therein, in the light of the circumstances under which they were, are or will be made, not misleading. SECTION 3.16. Employee Benefit Plans. Each of the Plans, the ----------------------- Borrower and its ERISA Affiliates is in compliance in all material respects with the applicable provisions of ERISA and the regulations and published interpretations thereunder. No Reportable Event has occurred as to which the Borrower or any ERISA Affiliate was required to file a report with the PBGC, and the present value of all benefit liabilities under each Plan (based on those assumptions used to fund such Plan) did not, as of the last annual valuation date applicable thereto, exceed by more than $5,000,000 the value of the assets of such Plan. Neither the Borrower nor any ERISA Affiliate has incurred any Withdrawal Liability or any other liability under Title IV of ERISA (other than premiums not yet due) that remains unpaid and that could result in a Material Adverse Effect. Neither the Borrower nor any ERISA Affiliate has received any notification that any Multiemployer Plan is in reorganization or has been terminated within the meaning of Title IV of ERISA, and to the best knowledge of the Borrower, no Multiemployer Plan is reasonably expected to be in reorganization or to be terminated, where such reorganization or termination has resulted or could reason ably be expected to result, through increases in the 54 contributions required to be made to such Plan or otherwise, in a Material Adverse Effect. Neither the Borrower nor any ERISA Affiliate has received any notice from the PBGC regarding the funded status of any Plan. SECTION 3.17. Environmental Matters. The Borrower and each ---------------------- Subsidiary has complied in all material respects with all Federal, state, local and other statutes, ordinances, orders, judgments, rulings and regulations relating to environmental pollution or to environmental regulation or control or to employee health or safety. Neither the Borrower nor any Subsidiary has received notice of any failure so to comply. The Borrower's and the Subsid iaries' facilities do not manage any hazardous wastes, hazardous substances, hazardous materials, toxic substances, toxic pollutants or substances similarly denominated, as those terms or similar terms are used in the Resource Conservation and Recovery Act, the Comprehensive Environ mental Response Compensation and Liability Act, the Hazard ous Materials Transportation Act, the Toxic Substance Control Act, the Clean Air Act, the Clean Water Act or any other applicable law (collectively, the "Environment Laws"), in material ---------------- violation of any such Environmental Law or any regulations promulgated pursuant thereto. SECTION 3.18. Solvency. As of the Effective Date and after --------- giving effect to the Spin-Off: (a) The fair salable value of the assets of the Borrower and each Significant Subsidiary will exceed the amount that will be required to be paid on or in respect of the existing debts and other liabilities of such Borrower or Significant Subsidiary as such debts and liabilities become absolute and mature. (b) The assets of the Borrower and each Significant Subsidiary will not constitute unreasonably small capital for the Borrower or Significant Subsidiary to carry out its businesses as now conducted and as proposed to be conducted including the capital needs of the Borrower or Significant Subsidiary, taking into account the particular capital requirements of the business conducted by the Borrower or Significant Subsidiary and projected capital requirements and capi tal availability thereof. (c) Neither the Borrower nor any Significant Subsidiaries intends to incur debts or liabilities beyond its ability to pay such debts and liabilities as they mature, taking into account the timing and amounts 55 of cash to be received by it, and of amounts to be payable on or in respect of its debts and liabilities. The cash flow of the Borrower and each Significant Subsidiary, after taking into account all anticipated uses of the cash of the Borrower or such Significant Subsidiary, will at all times be sufficient to pay all such amounts on or in respect of debt and liabilities of the Borrower or such Significant Subsidiary when such amounts are required to be paid. SECTION 3.19. Spin-Off. As of the Effective Date, the Spin-Off will --------- have been effected in a manner that (a) is not materially different from the description thereof in the Form 10 (including but not limited to the tax consequences of the Spin-Off) and (b) will not materially adversely affect the rights or interests of the Lenders or the creditworthiness of the Borrower. SECTION 3.20. Pledge Agreement. The Pledge Agreement is effective to ---------------- create in favor of the Collateral Agent, for the ratable benefit of the Secured Parties, a legal, valid and enforceable security interest in the Collateral (as defined in the Pledge Agreement) and, when the Collateral is delivered to the Collateral Agent, the Pledge Agreement shall constitute a fully perfected first priority Lien on, and security interest in, all right, title and interest of each pledgor thereunder in such Collateral, in each case prior and superior in right to any other Person. ARTICLE IV. CONDITIONS OF LENDING The effectiveness of this Agreement and the obligations of the Lenders to make Loans and of the Issuing Bank to issue, extend or renew Letters of Credit hereunder are subject to the satisfaction of the following conditions: SECTION 4.01. All Credit Events. On the date of each Borrowing or ------------------ issuance, extension or renewal of a Letter of Credit (each such event being called a "Credit Event"): ------------ (a) The Agent shall have received a notice of such Credit Event as required by Section 2.03 or Section 2.19, as the case may be, together with a completed Borrowing Base Certificate dated the date of such Credit Event. 56 (b) Except in the case of a refinancing of a Borrowing with a new Borrowing that does not increase the aggregate principal amount of the Loans of any Lender outstanding, the representations and warranties set forth in Article III hereof shall be true and correct in all material respects on and as of the date of such Credit Event with the same effect as though made on and as of such date, except to the extent such representations and warranties expressly relate to an earlier date. (c) Each Loan Party shall be in compliance with all the terms and provisions set forth herein and in each other Loan Document on its part to be observed or performed, and at the time of and immediately after such Credit Event, no Event of Default or Default shall have occurred and be continuing. Each Credit Event shall be deemed to constitute a representation and warranty by the Borrower on the date of such Credit Event as to the matters specified in paragraphs (b) and (c) of this Section 4.01. SECTION 4.02. First Credit Event. On the Effective Date: ------------------- (a) All legal matters incident to this Agreement and the borrowings hereunder and the other Loan Documents shall be satisfactory to the Lenders and their counsel and to the Issuing Bank and to Cravath, Swaine & Moore, counsel for the Agent. (b) The Agent shall have received (i) a copy of the certificate or articles of incorporation (or analogous documents) and all amendments thereto of each Loan Party, certified as of a recent date by the Secre tary of State (or other appropriate Governmental Authority) of the state (or country) of its organization or such other evidence as is reasonably satisfactory to the Agent; (ii) a certificate as to the good standing (or other analogous certification to the extent available) of each Loan Party as of a recent date, from the appropriate Secretary of State (or other appropriate Governmental Authority) or such other evidence as is reasonably satisfactory to the Agent; (iii) a certificate of the Secretary or Assistant Secretary of each Loan Party dated the Effective Date and certifying (A) that attached thereto is a true and complete copy of the by- laws (or such other analogous documents to the extent available) of such Loan Party as in effect on the Effective Date and at all times 57 since a date prior to the date of the resolutions described in clause (B) below, (B) that attached thereto is a true and complete copy of resolutions duly adopted by the Board of Directors of the such Loan Party authorizing the execution, delivery and performance of the Loan Documents to which it is party, and in the case of the Borrower, the borrowings hereunder, and that such resolutions have not been modified, rescinded or amended and are in full force and effect, (C) that the certificate or articles of incorporation (or analogous documents) of the such Loan Party have not been amended since the date of the last amendment thereto shown on the certificate of good standing (or other analogous certification or such other evidence reasonably satisfactory to the Agent) furnished pursuant to clause (i) or (ii) above, and (D) as to the incumbency and specimen signature of each officer executing any Loan Document or any other document delivered in connection herewith on behalf of such Loan Party; (iv) a certificate of another officer as to the incumbency and specimen signature of the Secretary or Assistant Secretary executing the certif icate pursuant to (iii) above; and (v) such other documents as the Lenders or their counsel, the Issuing Bank or Cravath, Swaine & Moore, counsel for the Agent, may reasonably request. (c) The Agent shall have received a certificate of the Borrower, dated the Effective Date and signed by a Responsible Officer of the Borrower confirming compliance with the conditions precedent set forth in paragraphs (b) and (c) of Section 4.01. (d) The Agent shall have received all Fees and other amounts due and payable on or prior to the Effective Date. (e) The Agent shall have received a favorable written opinion of the General Counsel of the Borrower, dated the Effective Date and addressed to the Lenders and the Issuing Bank, to the effect set forth in Exhibit D, and the Borrower hereby instructs such counsel to deliver such opinion to the Agent. (f) The Agent shall have received evidence of the receipt by the Borrower of all governmental and third party approvals, if any, necessary or advisable in connection with the Spin-Off and the other transactions contemplated by this Agreement and of the expiry of any applicable waiting or appeal periods, and there shall 58 be no governmental or judicial action, actual or threatened, that could reasonably be expected to restrain, prevent or impose burdensome conditions on the Spin-Off or the other transactions contemplated hereby. (g) The Lenders shall have received copies of the Form 10 and of the Distribution Agreement and other agreements governing the post Spin-Off relationship between the Borrower and International attached as exhibits thereto, which agreements shall have been executed by the parties thereto and shall be in full force and effect. (h) The Spin-Off shall have been consummated in accordance with applicable law and in a manner and with the consequences not materially different from the description thereof in the Form 10, and, after giving effect to the Spin-Off, the Lenders shall be satisfied with the corporate and capital structure of the Borrower and the Subsidiaries, all legal, tax and accounting matters relating to the Spin-Off, all arrangements and agreements between the Borrower and International governing their post- Spin-Off relationship and the sufficiency of amounts available hereunder to meet the ongoing working capital requirements of the Borrower and the Subsidiaries. (i) After giving effect to the Spin-Off, neither the Borrower nor any of its Subsidiaries shall have outstanding any shares of preferred stock or any Indebtedness, other than (i) Indebtedness incurred under the Loan Documents and (ii) other Indebtedness permitted under Section 6.01 and outstanding on the Effective Date. The terms and conditions of all Indebtedness to remain outstanding after the Effective Date shall be satisfactory in all respects to the Lenders. (j) (i) The Existing Credit Agreements and all commitments thereunder to lend shall have been terminated, all letters of credit issued thereunder shall have been terminated, all amounts outstanding thereunder shall have been paid in full and all Liens, if any, securing any obligations thereunder or under any related agreement shall have been permanently released and (ii) the Agent shall have received evidence satisfactory in form and substance to it demonstrating such termination, payment and release. 59 (k) The Agent shall have received counterparts of the Pledge Agreement signed on behalf of the Borrower and each Subsidiary Loan Party that owns any capital stock of any other Subsidiary, together with stock certificates representing all the outstanding shares of capital stock of each Subsidiary owned by or on behalf of the Borrower or any such Subsidiary Loan Party as of the Effective Date after giving effect to the Spin-Off (except that the pledge of stock certificates representing shares of common stock of a Foreign Subsidiary may be limited to 65% of the outstanding shares of common stock of such Foreign Subsidiary), promissory notes evidencing all intercompany Indebtedness owed to the Borrower or any such Subsidiary Loan Party by the Borrower or any Subsidiary as of the Effective Date after giving effect to the Spin-Off, and undated stock powers and instruments of transfer, endorsed in blank, with respect to such stock certificates and promissory notes. (l) The Agent shall have received (i) counterparts of the Guarantee Agreement signed on behalf of each Subsidiary Loan Party and (ii) counterparts of the Indemnity, Subrogation and Contribution Agreement signed on behalf of the Borrower and each Subsidiary Loan Party. (m) The Lenders shall be reasonably satisfied as to the amount and nature of any environmental and employee health and safety exposures to which the Borrower and the Subsidiaries may be subject after giving effect to the Spin-Off and the other transactions contemplated hereby, and with the plans of the Borrower with respect thereto. (n) The Agent shall be reasonably satisfied with the sufficiency of amounts available under this Agreement to meet the ongoing working capital requirements of the Borrower and its Subsidiaries following the consummation of the Spin-Off and the other transactions contemplated hereby. (o) After giving effect to the Spin-Off, the Borrower shall be in pro forma compliance as of May 31, 1997 and for the period of four fiscal quarters then ended with Sections 6.13, 6.14, 6.15 and 6.16 (assuming for such purpose that the Spin-Off occurred on such date or at the beginning of such period, as the case may be). 60 (p) The Agent shall have received (i) a copy of the solvency opinion from American Appraisal Associates in the form delivered to the Board of Directors of the Borrower on the date of the Spin-Off and (ii) a certificate from a Responsible Officer of the Borrower as to the solvency of the Borrower and the Subsidiaries on a consolidated basis after giving effect to the Spin-Off. (q) The Agent shall have received executed or conformed, certified copies of each Lease listed on Schedule 4.02(q), franchise agreement and management agreement (each such agreement, a "Borrowing Base Agreement") ------------------------ relating to a proposed Borrowing Base Property and all amendments thereto on or prior to the Effective Date; each such Borrowing Base Agreement, as so amended and certified by a Responsible Officer of the Borrower, shall be in full force and effect and no term or condition thereof shall have been further amended or modified, or waived after the execution thereof, except as previously disclosed in writing to the Agent, and no Person shall have failed in any material respect to perform any material obligation or covenant or satisfy any material condition required by any such Borrowing Base Agreement to be performed or complied with on or before the Effective Date, except as previously disclosed in writing to the Agent. (r) The Agent shall have received with respect to each proposed Borrowing Base Property, as of the Effective Date, (a) a comprehensive environmental audit (which shall include a Phase I environmental audit and, if recommended by such Phase I environmental audit, a Phase II environmental audit) satisfactory in all respects to the Agent and prepared by an Approved Environmental Consultant, (b) evidence that all Environmental Permits have been obtained and (c) such other environmental reports, inspections and investigations as the Agent shall require, prepared, in each instance, by consultants satisfactory to the Agent. On or before the Effective Date, the Borrower shall have delivered to the Agent evidence satisfactory to the Agent that the Borrower has complied (or has made arrangements satisfactory to the Agent to comply) with the recommendations of all environmental consultant(s) referred to above and that all hazardous materials (as defined under Environmental Laws) have 61 been removed from any proposed Borrowing Base Property to the extent required by Environmental Law. (s) The Agent shall have received a certificate of insurance demonstrating compliance with the requirements of Section 5.02 and certifying that the insurance policies required by Section 5.02 with respect to any proposed Borrowing Base Property are in full force and effect on the Effective Date. (t) The Agent shall have received evidence satisfactory to it that the proposed Borrowing Base Properties, as of the Effective Date, are free of all material structural and title defects. (u) The Agent shall have received a completed Borrowing Base Certificate dated the Effective Date and signed by a Responsible Officer of the Borrower. (v) The Lenders shall have received a pro forma consolidated balance sheet of the Borrower as of the Effective Date, after giving effect to the Spin-Off and the consummation of the other transactions contemplated hereby, which shall not be materially inconsistent with the forecasts previously provided to the Lenders. The Agent shall notify the Borrower and the Lenders of the Effective Date, and such notices shall be conclusive and binding. Notwithstanding the foregoing, the obligations of the Lenders to make Loans and of the Issuing Bank to issue Letters of Credit hereunder shall not become effective unless each of the foregoing conditions is satisfied (or waived pursuant to Section 9.08) at or prior to 3:00 p.m., New York City time, on October 15, 1997 (and, in the event such conditions are not so satisfied or waived, the Revolving Commitments shall terminate at such time). ARTICLE V. AFFIRMATIVE COVENANTS The Borrower covenants and agrees with each Lender that, so long as this Agreement shall remain in effect or the principal of or interest on any Loan, any Fees or any other expenses or amounts payable under any Loan Document shall be unpaid, and until all Letters of Credit have been canceled or have expired and all amounts drawn thereunder have been reimbursed in full, unless the Required Lenders shall otherwise consent in writing, the Borrower shall, and shall cause each of the Subsidiaries to: 62 SECTION 5.01. Existence; Businesses and Properties. (a) Do or cause ------------------------------------- to be done all things necessary to preserve, renew and keep in full force and effect its legal existence, except as otherwise expressly permitted under Section 6.05. (b) Do or cause to be done all things necessary to obtain, preserve, renew, extend and keep in full force and effect the rights, licenses, permits, franchises, authorizations, patents, copyrights, trademarks and trade names material to the conduct of its business; maintain and operate such business in substantially the manner in which it is presently conducted and operated (except for the Spin-Off); comply in all material respects with all applicable laws, rules, regulations and orders of any Governmental Authority, whether now in effect or hereafter enacted; and at all times maintain and preserve all property material to the conduct of such business and keep such property in good repair, working order and condition and from time to time make, or cause to be made, all needful and proper repairs, renewals, additions, improvements and replacements thereto necessary in order that the business carried on in connection therewith may be properly conducted at all times. SECTION 5.02. Insurance. (a) The Borrower will, and will cause ---------- each of its Subsidiaries to, maintain, with financially sound and reputable insurance companies which are acceptable to the Agent: (i) a full risk policy with fire, extended coverage, vandalism and malicious vandalism insurance, on a full replacement cost basis, with respect to the Hotel Properties, and such other extended coverage insurance as the Agent may reasonably require, in each case in amounts satisfactory to the Agent; (ii) commercial general liability insurance against claims for bodily injury, death or property damage occurring upon, about or in connection with any properties owned, occupied or controlled by it, in amounts satisfactory to the Agent; (iii) business interruption insurance, insuring against loss of gross earnings for a period of not less than six months; and (iv) such other insurance as may be required by law. 63 (b) If at any time the area in which any Borrowing Base Property is located is designated (i) a "flood hazard area" in any Flood Insurance Rate Map published by the Federal Emergency Management Agency (or any successor agency), the Borrower shall obtain flood insurance in such total amount as the Agent or the Required Lenders may from time to time require, and otherwise comply with the National Flood Insurance Program as set forth in the Flood Disaster Protection Act of 1973, as amended from time to time or (ii) a "Zone 1" area, the Borrower shall obtain earthquake insurance in such total amount as the Agent or the Required Lenders may from time to time require. SECTION 5.03. Obligations and Taxes. Pay its Indebtedness and other ---------------------- obligations promptly and in accordance with their terms and pay and discharge promptly when due all taxes, assessments and governmental charges or levies imposed upon it or upon its income or profits or in respect of its property, before the same shall become delinquent or in default, as well as all lawful and valid claims for labor, materials and supplies or otherwise which, if unpaid, might give rise to a Lien upon such properties or any part thereof; provided, -------- however, that such payment and discharge shall not be required with respect to - ------- any such tax, assessment, charge, levy or claim so long as the validity or amount thereof shall be contested in good faith by appropriate proceedings and the Borrower or such Subsidiary shall have set aside on its books adequate reserves with respect thereto. SECTION 5.04. Financial Statements, Reports, etc. In the case of ----------------------------------- the Borrower, furnish to the Agent and each Lender: (a) within 90 days after the end of each fiscal year, its audited consolidated balance sheets and related statements of income and cash flow, showing the financial condition of the Borrower and its consolidated Subsidiaries as of the close of such fiscal year and the results of its operations and the operations of such Subsidiaries during such year, all audited by Arthur Andersen & Co. or other independent public accountants of recognized national standing acceptable to the Required Lenders and accompanied by an opinion of such accountants (which shall not be qualified in any material respect) to the effect that such consolidated financial statements fairly present the financial condition and results of operations of the Borrower on a consolidated basis in accordance with GAAP consistently applied; 64 (b) within 45 days after the end of each of the first three fiscal quarters of each fiscal year, its unaudited consolidated balance sheets and related statements of income and cash flow, showing the finan cial condition of the Borrower and its consolidated Subsidiaries as of the close of such fiscal quarter and the results of its operations and the operations of such Subsidiaries during such fiscal quarter and the then elapsed portion of the fiscal year, all certified by the Financial Officer of the Borrower as fairly presenting the financial condition and results of operations of the Borrower on a consolidated basis in accordance with GAAP consistently applied, subject to normal year-end audit adjustments; (c) concurrently with any delivery of financial statements under clause (a) or (b) above, a certificate of the accounting firm or the Financial Officer of the Borrower opining on or certifying such statements (which certificate, when furnished by an accounting firm, may be limited to accounting matters and disclaim responsibility for legal interpretations) (i) certifying that no Event of Default or Default has occurred or, if such an Event of Default or Default has occurred, specifying the nature and extent thereof and any corrective action taken or proposed to be taken with respect thereto and (ii) setting forth computations in reasonable detail satisfactory to the Agent demonstrating compliance with the covenants contained in Sections 6.06, 6.13, 6.14, 6.15 and 6.16; (d) within 60 days after the Effective Date, the audited combined balance sheets and related statements of income and cash flow of the Borrower and its Subsidiaries post-Spin-Off as and for the fiscal year ended May 31, 1997, audited by and accompanied by the opinion (which shall not be qualified in any material respect) of Arthur Anderson & Co., independent public accountants; (e) within 45 days after the end of each fiscal quarter, a completed Borrowing Base Certificate calculating and certifying the Borrowing Base as of the last day of such fiscal quarter, signed on behalf of the Borrower by a Financial Officer; (f) within 45 days after the end of each fiscal quarter, a certificate as to the Net Operating Income for each Borrowing Base Property for such fiscal quarter, signed on behalf of the Borrower by a Financial Officer; 65 (g) promptly after the same become publicly available, copies of all periodic and other reports, proxy statements and other materials filed by it with the Securities and Exchange Commission, or any Governmental Authority succeeding to any of or all the functions of said Commission, or with any national securities exchange, or distributed to its shareholders, as the case may be; and (h) promptly, from time to time, such other information regarding the operations, business affairs and financial condition (including any Leases relating to a Borrowing Base Property) of the Borrower or any Subsidiary, or compliance with the terms of any Loan Document, as the Agent or any Lender may reasonably request. SECTION 5.05. Litigation and Other Notices. Furnish to the Agent, the ----------------------------- Issuing Bank and each Lender prompt written notice of the following: (a) any Event of Default or Default, specifying the nature and extent thereof and the corrective action (if any) proposed to be taken with respect thereto; (b) any contemplated sale, encumbrance or transfer of any Hotel Property (or all or any portion of any partnership or other ownership interest therein), together with a certificate of a Financial Officer demonstrating pro forma compliance, after giving effect to such sale, encumbrance or transfer, with the covenants set forth in Section 6.06, 6.13, 6.14, 6.15 and 6.16 as if such transaction had occurred on each relevant date or at the beginning of each relevant period; (c) the filing or commencement of, or any threat or notice of intention of any person to file or commence, any action, suit or proceeding, whether at law or in equity or by or before any Governmental Authority, against the Borrower or any Affiliate thereof as to which there is a reasonable probability of an adverse determination and which, if such probable adverse determination occurred, could reasonably be anticipated to result in a Material Adverse Effect; and (d) any development that has resulted in, or could reasonably be anticipated to result in, a Material Adverse Effect. 66 SECTION 5.06. ERISA. (a) Comply in all material respects with the ------ applicable provisions of ERISA and (b) furnish to the Agent and each Lender (i) as soon as possible, and in any event within 30 days after any Responsible Officer of the Borrower or any ERISA Affiliate either knows or has reason to know that any Reportable Event has occurred that alone or together with any other Reportable Event could reasonably be expected to result in liability of the Borrower or any ERISA Affiliate to the PBGC in an aggregate amount exceeding $5,000,000, a statement of a Financial Officer of the Borrower setting forth details as to such Reportable Event and the action proposed to be taken with respect thereto, together with a copy of the notice, if any, of such Reportable Event given to the PBGC, (ii) promptly after receipt thereof, a copy of any notice the Borrower or any ERISA Affiliate may receive from the PBGC relating to the funded status of any Plan or to the intention of the PBGC to terminate any Plan or Plans (other than a Plan maintained by an ERISA Affiliate which is considered an ERISA Affiliate only pursuant to subsection (m) or (o) of Section 414 of the Code) or to appoint a trustee to administer any Plan or Plans, (iii) within 10 days after the due date for filing with the PBGC pursuant to Section 412(n) of the Code of a notice of failure to make a required installment or other payment with respect to a Plan, a statement of a Financial Officer of the Borrower setting forth details as to such failure and the action proposed to be taken with respect thereto, together with a copy of such notice given to the PBGC and (iv) promptly and in any event within 30 days after receipt thereof by the Borrower or any ERISA Affiliate from the sponsor of a Multiemployer Plan, a copy of each notice received by the Borrower or any ERISA Affiliate concerning (A) the imposition of Withdrawal Liability in excess of $500,000 or (B) a determination that a Multiemployer Plan is, or is expected to be, terminated or in reorganization, in each case within the meaning of Title IV of ERISA. SECTION 5.07. Maintaining Records; Access to Properties and --------------------------------------------- Inspections. (a) Maintain all financial records in accordance with GAAP - ------------ consistently applied and upon reasonable notice by any Lender permit any representatives designated by such Lender, subject to Section 9.16 of this Agreement, to visit and inspect the financial records and the properties of the Borrower or any Subsidiary at reasonable times and as often as requested and to make extracts from and copies of such financial records, 67 and permit any representatives designated by any Lender to discuss the affairs, finances and condition of the Borrower or any Subsidiary with the officers thereof and independent accountants therefor. (b) Permit any representatives designated by the Agent (including any consultants, accountants and lawyers retained by the Agent) to conduct evaluations of the Borrower's computation of the Borrowing Base and the assets included in the Borrowing Base, and furnish to such representatives all such information and documents as they shall request for such purpose, all at such reasonable times and as often as reasonably requested. The Borrower shall pay the reasonable fees and expenses of any representatives retained by the Agent to conduct any such evaluation. The Borrower also agrees to modify or adjust the Borrowing Base to the extent reasonably required by the Agent as a result of any such evaluation. SECTION 5.08. Use of Proceeds. Use the proceeds of the Loans and ---------------- request the issuance of Letters of Credit only for the purposes set forth in the preamble to this Agreement; provided that the principal amount of outstanding -------- Loans and Letters of Credit used to provide working capital for the Borrower and its Subsidiaries shall at no time exceed 10% of the Borrowing Base. SECTION 5.09. Additional Subsidiaries. If any additional Subsidiary ------------------------ is formed or acquired after the Effective Date, notify the Agent and the Lenders thereof and (a) if such Subsidiary is not a Foreign Subsidiary, cause such Subsidiary to become a party to the Guarantee Agreement, the Indemnity, Subrogation and Contribution Agreement and the Pledge Agreement, in each case in the manner provided therein within three Business Days after such Subsidiary is formed or acquired and promptly take such actions as are required thereunder and as may be reasonably requested by the Agent or the Required Lenders and (b) if any shares of capital stock or Indebtedness of such Subsidiary are owned by or on behalf of the Borrower or any Subsidiary Loan Party, cause such shares and promissory notes evidencing such Indebtedness to be pledged pursuant to the Pledge Agreement within three Business Days after such Subsidiary is formed or acquired (except that if such Subsidiary is a Foreign Subsidiary, shares of common stock of such Subsidiary to be pledged pursuant to the Pledge Agreement may be limited to 65% of the outstanding shares of common stock of such Subsidiary). 68 SECTION 5.10. Further Assurances. Execute any and all further ------------------- documents, financing statements, agreements and instruments, and take all further actions (including the filing of financing statements and other documents) that may be required under any applicable law, or that the Agent or the Required Lenders may reasonably request, to effectuate the transactions contemplated by the Loan Documents or to grant, preserve, protect or perfect the Liens created by the Security Documents or the validity or priority of any such Lien, all at the expense of the Loan Parties. The Borrower also agrees to provide to the Agent from time to time upon request evidence reasonably satisfactory to the Agent as to the perfection and priority of the Liens created or intended to be created by the Security Documents. ARTICLE VI. NEGATIVE COVENANTS The Borrower covenants and agrees with each Lender, the Issuing Bank and the Agent that, so long as this Agreement shall remain in effect or the principal of or interest on any Loan, any Fees or any other expenses or amounts payable under any Loan Document shall be unpaid, and until all Letters of Credit have been canceled or have expired and all amounts drawn thereunder have been reimbursed in full, unless the Required Lenders shall otherwise consent in writing, the Borrower shall not, and shall not cause or permit any of the Subsidiaries to: SECTION 6.01. Indebtedness. Incur, create, assume or permit to exist ------------- any Indebtedness, except (without duplication): (a) Indebtedness of the Borrower existing on the date hereof and set forth in Schedule 6.01(a) and any extensions, renewals or replacements of existing mortgages and Capital Lease Obligations included in such Indebtedness; provided, however, that (x) the principal amount of any such -------- ------- extension, renewal or replacement shall not exceed the principal amount of the mortgage or Capital Lease Obligation so extended, renewed or replaced, (y) the mortgage or Capital Lease Obligation so extended, renewed or replaced shall not be secured by any property or asset that was not already pledged to secure or subject to the existing mortgage or Capital Lease Obligation, and (z) such extension, renewal or replacement shall not be on terms materially more restrictive to the Borrower or its Subsidiaries or materially less favorable to the Lenders than the mortgage or Capital Lease Obligation so extended, renewed or replaced; 69 (b) Indebtedness outstanding under the Loan Documents; (c) Approved Subordinated Indebtedness in an aggregate principal amount not to exceed $115,000,000 plus accrued interest thereon; (d) Indebtedness incurred upon the acquisition of any property or asset after the Effective Date secured by Liens on such property or asset not prohibited by Section 6.02; provided, however, that (i) the amount of -------- ------- such Indebtedness shall not exceed the purchase price of any such property or asset and (ii) such Indebtedness shall be without recourse to the Borrower or any Subsidiary or any other property or assets of the Borrower or any Subsidiary; (e) unsecured Indebtedness of Subsidiaries existing at the time they are acquired by the Borrower and not incurred in contemplation of such acquisition in an amount not to exceed $1,000,000; (f) Indebtedness of Subsidiaries not prohibited by Section 6.09; (g) Indebtedness of (i) the Borrower to any Wholly Owned Subsidiary (other than an Excluded Subsidiary or a Foreign Subsidiary); and (ii) any Subsidiary to the Borrower or any Wholly Owned Subsidiary (other than an Excluded Subsidiary or a Foreign Subsidiary); (h) Indebtedness represented by notes or letters of credit issued for the account of the Borrower or any Subsidiary in connection with insurance policies and in a form substantially similar to the notes or letters of credit previously issued for the account of the Borrower or any Subsidiary issued in connection with insurance policies of the Borrower or such Subsidiary; (i) Indebtedness of the Borrower represented by letters of credit issued by a financial institution other than an Issuing Bank in an amount at any one time not to exceed $5,000,000 less the L/C Exposure; (j) Indebtedness represented by utility bonds, performance bonds, state self insurance bonds and miscellaneous other bonds other than those existing on the date hereof and listed in Schedule 6.01(a) (including any extensions, renewals and replacements), the aggregate principal amount of such Indebtedness at any one time not to exceed $2,000,000; (k) Indebtedness of the Borrower consisting of Guarantees in connection with pension and deferred compensation arrangements arising in 70 connection with the Spin-Off; provided, however, that the aggregate amount -------- ------- of such Indebtedness shall not exceed $25,000,000; (l) Indebtedness consisting of Sale and Lease-Back Transactions permitted under Section 6.03; and (m) other unsecured Indebtedness of the Borrower, in an aggregate principal amount at any one time outstanding not to exceed $1,000,000. SECTION 6.02. Liens. Create, incur, assume or permit to exist any ------ Lien on any property or assets (including stock or other securities of any person, including any Subsidiary) now owned or hereafter acquired by it or on any income or revenues or rights (excluding rights of first refusal) in respect of any thereof, except (without duplication): (a) Liens on property or assets of the Borrower and its Subsidiaries existing on the date hereof and set forth in Schedule 6.02; provided, -------- however, that such Liens shall secure only those obligations which they ------- secure on the date hereof except as otherwise permitted hereunder; (b) any Lien existing on any property or asset prior to the acquisition thereof by the Borrower or any Subsidiary that secures Indebtedness permitted by Section 6.01(d); provided, however, that (i) such -------- ------- Lien is not created in contemplation of or in connection with such acquisition and (ii) such Lien does not apply to any other property or assets of the Borrower or any Subsidiary; (c) Liens for taxes not yet due or which are being contested in compliance with Section 5.03; (d) carriers', warehousemen's, mechanic's, materialmen's, repairmen's or other like Liens arising in the ordinary course of business and securing obligations that are not due or which are being contested in compliance with Section 5.03; (e) statutory liens of landlords in respect of property leased by the Borrower or any Subsidiary; (f) pledges and deposits made in the ordinary course of business in compliance with workmen's compensation, unemployment insurance and other social security laws or regulations; 71 (g) deposits to secure the performance of bids, trade contracts (other than for Indebtedness), leases (other than Capital Lease Obligations), statutory obligations, surety and appeal bonds, performance bonds and other obligations of a like nature incurred in the ordinary course of business; (h) zoning restrictions, easements, rights-of-way, restrictions on use of real property and other similar encumbrances incurred in the ordinary course of business which, in the aggregate, are not substantial in amount and do not materially detract from the value of the property subject thereto or interfere with the ordinary conduct of the business of the Borrower or any of its Subsidiaries; (i) mortgages on properties securing Indebtedness permitted by Section 6.01(d); (j) Liens created under the Loan Documents; and (k) other Liens to secure Indebtedness of the Borrower; provided, -------- however, that the aggregate principal amount of the Indebtedness so secured ------- at any time does not exceed $5,000,000. SECTION 6.03. Sale and Lease-Back Transactions. Enter into any Sale --------------------------------- and Lease-Back Transaction unless immediately thereafter the net book value (determined as of the time of sale) of all property the subject of Sale and Lease-Back Transactions at any one time does not exceed $20,000,000. SECTION 6.04. Investments, Loans and Advances. Purchase, hold or -------------------------------- acquire any capital stock, comparable ownership interests, evidences of indebtedness or other securities of, make or permit to exist any loans or advances to, or make or permit to exist any investment or any other interest in, any other person, except: (a) the investments and guarantees existing on the date hereof set forth on Schedule 6.04 and investments by the Borrower or any Subsidiary in the capital stock or other ownership interests of the Subsidiaries (other than an Excluded Subsidiary or a Foreign Subsidiary), including by means of contributions by any Subsidiary of Hotel Properties to the Borrower or a Subsidiary (other than an Excluded Subsidiary or a Foreign Subsidiary); 72 (b) investments by the Borrower or any Subsidiary in (i) the capital stock or other ownership interests of Foreign Subsidiaries or (ii) hospitality properties located in Canada, Mexico or the Caribbean; provided -------- that the aggregate amount of investments permitted by clause (b)(i) and (b)(ii) at any time shall not exceed 5% of Consolidated Total Assets as of the preceding fiscal year; (c) investments by the Borrower or any Subsidiary in the capital stock or other ownership interests of Excluded Subsidiaries; provided that the -------- aggregate amount of investments permitted by this clause (c) at any one time shall not exceed $5,000,000; (d) loans or advances by the Borrower to Subsidiaries or by Wholly- Owned Subsidiaries to the Borrower or other Subsidiaries, in each case to the extent permitted under Section 6.01; (e) Guarantees permitted under Section 6.01(k); (f) Permitted Investments; and (g) other investments, capital contributions, loans and advances not to exceed at any time $1,000,000. SECTION 6.05. Mergers and Consolidations. Merge into or consolidate --------------------------- with any other person, or permit any other person to merge into or consolidate with it, or sell, transfer, lease or otherwise dispose of (in one transaction or in a series of transactions) all or substantially all its assets whether now owned or hereafter acquired, except that: (a) (i) the Borrower may merge or consolidate with a Subsidiary (other than a Subsidiary owning one or more Borrowing Base Properties) or (ii) a Subsidiary (other than a Subsidiary owning one or more Borrowing Base Properties) may merge or consolidate with the Borrower, in each case so long as the Borrower is the surviving entity; (b) any Subsidiary may merge or consolidate with any Subsidiary; provided that if all or part of the capital stock of either such Subsidiary -------- is pledged pursuant to the Pledge Agreement, at least the same percentage of the capital stock of the surviving or resulting corporation shall be so pledged; and (c) the Borrower or any Subsidiary may merge or consolidate with another person; provided, however, that: -------- ------- 73 (i) the Borrower or such Subsidiary is the surviving entity; (ii) no Event of Default or event which, with notice or the passage of time or both, would constitute an Event of Default exists after giving effect to such merger or consolidation; and (iii) the Agent shall receive a certificate signed by a Financial Officer of the Borrower confirming compliance with clause (ii) above. SECTION 6.06. Asset Sales. Consummate any Asset Sale, other than (a) ------------ sales of receivables for collection (and not for financing or factoring purposes) in the ordinary course of business and (b) Asset Sales resulting in Proceeds which, when added to the Proceeds from all other Asset Sales previously consummated in the same fiscal year, would not exceed 10% of Consolidated Total Assets as of the end of the preceding fiscal year; provided that Sunburst may -------- not sell any asset to International unless such sale is consummated on an arm's length basis at fair market value. SECTION 6.07. Transactions with Affiliates. Sell or transfer any ----------------------------- property or assets to, or purchase or acquire any property or assets from, or otherwise engage in any other transactions with, any of its Affiliates, except that as long as no Default or Event of Default shall have occurred and be continuing, the Borrower or any Subsidiary may (a) consummate the Spin-Off or (b) engage in any of the foregoing transactions (i) in the ordinary course of business at prices and on terms and conditions not less favorable to the Borrower or such Subsidiary than could be obtained on an arm's-length basis from unrelated third parties or (ii) between or among the Borrower and its Wholly Owned Subsidiaries (other than the Excluded Subsidiaries and Foreign Subsidiaries except to the extent expressly permitted by Section 6.04). SECTION 6.08. Business of Borrower and Subsidiaries. Engage at any -------------------------------------- time in any business or business activity other than (a) the ownership and operation of hospitality properties in the United States or related or collateral activities, (b) the ownership of hospitality properties in Canada, Mexico or the Caribbean or related or collateral activities; provided that the -------- aggregate amount of assets committed to such operations shall not at any one time exceed 5% of Total Consolidated Assets and (c) the franchising activities contemplated under the Strategic Alliance Agreement with International. 74 SECTION 6.09. Subsidiary Indebtedness. Permit any Subsidiary to ----------------------- create, incur, assume or permit to exist any Indebtedness except: (a) any Indebtedness expressly permitted by Section 6.01 (other than clause (f) thereof); and (b) other unsecured Indebtedness of any Subsidiary; provided, however, -------- ------- that the aggregate principal amount (the "Subsidiary Debt Amount") ---------------------- outstanding of all such other Indebtedness of all Subsidiaries (excluding amounts permitted under clause (a) above) may not exceed $1,000,000 at any one time. SECTION 6.10. Agreements. Permit any Subsidiary to enter into any ----------- agreement or incur any obligation the terms of which would impair the ability of any Subsidiary to pay dividends, to make permitted intercompany loans or advances or to make distributions (it being agreed that this Section shall not be breached by any such agreement or obligation binding upon a Subsidiary at the time it becomes a Subsidiary and not incurred in contemplation of its becoming a Subsidiary). SECTION 6.11. Fiscal Year and Accounting Practices. Change its ------------------------------------ fiscal year end or accounting practices from those in effect at May 31, 1996, other than as required by GAAP; provided, however, the Borrower may change its -------- ------- fiscal year end to December 31. SECTION 6.12. No Further Negative Pledges. Except (a) pursuant to the --------------------------- Loan Documents or (b) with respect to prohibitions against other encumbrances on specific property encumbered to secure payment of particular Indebtedness (which Indebtedness relates solely to such specific property, and improvements and accretions thereto, and is otherwise permitted hereby), enter into any agreement prohibiting the creation or assumption of any Lien upon the properties or assets of the Borrower or any Subsidiary, whether now owned or hereafter acquired, or requiring an obligation to be secured if some other obligation is secured. SECTION 6.13. Minimum Consolidated Net Worth. In the case of the ------------------------------ Borrower, permit its Consolidated Net Worth at any time to be less than the sum of (a) the amount that is equal to 75% of the Borrower's Consolidated Net Worth as of the last day of the month in which the Spin-Off occurs, plus (b) 75% of the Borrower's Consolidated Net Income accrued during the period (treated as one accounting period) commencing on the last day of the month in which the Spin-Off occurs and ending on the last day of the most 75 recent fiscal quarter for which financial statements have been delivered pursuant to Section 5.04 (which amount shall not include Consolidated Net Income for any fiscal quarter in which the Borrower's Consolidated Net Income is negative), plus (c) the aggregate net cash proceeds received by the Borrower from the issuance or sale of its capital stock since the date hereof. SECTION 6.14. Limitation on Consolidated Funded Debt. In the case of --------------------------------------- the Borrower, permit Consolidated Funded Indebtedness as of the last day of any period of four fiscal quarters ending during the period from and including the date hereof through the Revolving Maturity Date to exceed the sum, without duplication, of (a) 5.50X Consolidated EBITDA for such period, plus (b) the lesser of (i) 70% of the undepreciated cost basis at acquisition of all Hotel Properties owned for less than four fiscal quarters and (ii) 70% of the aggregate trailing four quarter Aggregate Adjusted NOI for Hotel Properties owned for less than four fiscal quarters, divided by 0.11, plus (c) 70% of the cost of Hotel Properties with certificates of occupancy that (i) are open for business and (ii) were Construction Properties at some time during the preceding four fiscal quarters; provided that the aggregate of the amount allowed under -------- (b) and (c) above shall in no event exceed $25,000,000 and provided, further, -------- ------- that any amount included pursuant to clause (c) above may not be so included for more than four fiscal quarters. SECTION 6.15. Limitation on Consolidated Senior Funded Indebtedness. ----------------------------------------------------- In the case of the Borrower, permit Consolidated Senior Funded Indebtedness as of the last day of any fiscal quarter ending during the period from and including the date hereof through the Revolving Maturity Date to exceed the sum, without duplication, of (a) 4.00X Consolidated EBITDA for such period, plus (b) the lesser of (i) 70% of the undepreciated cost basis at acquisition of all Hotel Properties owned for than four fiscal quarters and (ii) 70% of the aggregate trailing four quarter Adjusted NOI for all Hotel Properties owned for less than four fiscal quarters, divided by 0.11, plus (c) 70% of the cost of Hotel Properties with certificates of occupancy that (i) are open for business and (ii) were Construction Properties at some time during the preceding four fiscal quarters; provided that the aggregate amount allowed under (b) and (c) -------- above shall in no event exceed $25,000,000 and provided, further, that any -------- ------- amount included pursuant to clause (c) above may not be so included for more than four fiscal quarters. SECTION 6.16. Fixed Charge Coverage Ratio. In the case of the ---------------------------- Borrower, permit the Fixed Charge Coverage Ratio for any period of four fiscal quarters ending during 76 the period form and including the date hereof through the Revolving Maturity Date to be less than 1.75 to 1.00. SECTION 6.17. Borrowing Base Properties. (a) Permit the Borrowing -------------------------- Base Properties at any time to include fewer than 25 separate properties. (b) At any time permit (i) greater than 40% of the hotel rooms in the Borrowing Base Properties to be under one brand name, (ii) greater than 25% of the hotel rooms in the Borrowing Base Properties to be in one state or (iii) greater than 15% of the hotel rooms in the Borrowing Base Properties to be in one city. SECTION 6.18. Amendment or Prepayment of Approved Subordinated ------------------------------------------------ Indebtedness. (a) Amend, modify, supplement or waive any of the terms or - ------------- provisions of the Approved Subordinated Indebtedness or (b) prepay all or any portion of the Approved Subordinated Indebtedness. ARTICLE VII. EVENTS OF DEFAULT In case of the happening of any of the following events ("Events ------ of Default"): - ---------- (a) any representation or warranty made or deemed made (such representation or warranty being deemed made as provided in Section 2.19(b) and Section 4.01) in or in connection with any Loan Document or the borrowings or issuances of Letters of Credit hereunder, or any representation, warranty, statement or information contained in any report, certificate, financial statement or other instrument furnished in connection with or pursuant to any Loan Document, shall prove to have been false or misleading in any material respect when so made, deemed made or furnished; (b) default shall be made in the payment of any principal of any Loan or the reimbursement with respect to any L/C Disbursement when and as the same shall become due and payable, whether at the due date thereof or at a date fixed for prepayment thereof or by acceleration thereof or otherwise; (c) default shall be made in the payment of any interest on any Loan or any Fee or L/C Disbursement or any other amount (other than an amount referred to in clause (b) above) due under any Loan Document, when and as the same shall become due and payable, and such default shall continue unremedied for a period of five Business Days; 77 (d) default shall be made in the due observance or performance by the Borrower of any covenant, condition or agreement contained in Section 5.01(a), 5.05 or 5.09 or in Article VI; (e) default shall be made in the due observance or performance by any Loan Party of any covenant, condition or agreement contained in any Loan Document (other than those specified in clauses (b), (c) and (d) above) and such default shall continue unremedied for a period of five Business Days after notice thereof from the Agent or any Lender to the Borrower; (f) the Borrower or any Subsidiary shall (i) fail to pay any principal or interest, regardless of amount, due in respect of any Indebtedness in an aggregate principal amount in excess of $5,000,000, when and as the same shall become due and payable, or (ii) fail to observe or perform any other term, covenant, condition or agreement contained in any agreement or instrument evidencing or governing any Indebtedness in an aggregate principal amount in excess of $5,000,000, or permit any other event to occur, if the effect of any failure or event referred to in this clause (ii) is to cause, or to permit the holder or holders of such Indebtedness or a trustee on its or their behalf (with or without the giving of notice, the lapse of time or both) to cause, such Indebtedness to become due prior to its stated maturity; (g) an involuntary proceeding shall be commenced or an involuntary petition shall be filed in a court of competent jurisdiction seeking (i) relief in respect of the Borrower or any Subsidiary, or of a substantial part of the property or assets of the Borrower or a Subsidiary, under Title 11 of the United States Code, as now constituted or hereafter amended, or any other Federal, state or foreign bankruptcy, insolvency, receivership or similar law, (ii) the appointment of a receiver, trustee, custodian, sequestrator, conservator or similar official for the Borrower or any Subsidiary or for a substantial part of the property or assets of the Borrower or a Subsidiary or (iii) the winding-up or liquidation of the Borrower or any Subsidiary; and such proceeding or petition shall continue undismissed for 60 days or an order or decree approving or ordering any of the foregoing shall be entered; (h) the Borrower or any Subsidiary shall (i) voluntarily commence any proceeding or file any petition seeking relief under Title 11 of the United 78 States Code, as now constituted or hereafter amended, or any other Federal, state or foreign bankruptcy, insolvency, receivership or similar law, (ii) consent to the institution of, or fail to contest in a timely and appropriate manner, any proceeding or the filing of any petition described in clause (g) above, (iii) apply for or consent to the appointment of a receiver, trustee, custodian, sequestrator, conservator or similar official for the Borrower or any Subsidiary or for a substantial part of the property or assets of the Borrower or any Subsidiary, (iv) file an answer admitting the material allegations of a petition filed against it in any such proceeding, (v) make a general assignment for the benefit of creditors, (vi) become unable, admit in writing its inability or fail generally to pay its debts as they become due or (vii) take any action for the purpose of effecting any of the foregoing; (i) one or more judgments for the payment of money in an aggregate amount in excess of $5,000,000 shall be rendered against the Borrower, any Subsidiary or any combination thereof and the same shall remain undischarged for a period of 60 consecutive days during which execution shall not be effectively stayed, or any action shall be legally taken by a judgment creditor to levy upon assets or properties of the Borrower or any Subsidiary to enforce any such judgment; (j) a Reportable Event or Reportable Events, or a failure to make a required installment or other payment (within the meaning of Section 412(n)(l) of the Code), shall have occurred with respect to any Plan or Plans that reasonably could be expected to result in liability of the Borrower to the PBGC or to a Plan in an aggregate amount exceeding $5,000,000 and, within 30 days after the reporting of any such Reportable Event to the Agent or after the receipt by the Agent of the statement required pursuant to Section 5.06, the Agent shall have notified the Borrower in writing that (i) the Required Lenders have made a determination that, on the basis of such Reportable Event or Reportable Events or the failure to make a required payment, there are reasonable grounds (A) for the termination of such Plan or Plans by the PBGC, (B) for the appointment by the appropriate United States District Court of a trustee to administer such Plan or Plans or (C) for the imposition of a lien in favor of a Plan or the PBGC and (ii) as a result thereof an Event of Default exists hereunder; or a trustee shall be appointed by a United States District Court to administer any such Plan or Plans; or the PBGC shall institute proceedings to terminate any Plan or Plans; 79 (k) (i) the Borrower or any ERISA Affiliate shall have been notified by the sponsor of a Multiemployer Plan that it has incurred Withdrawal Liability to such Multiemployer Plan, (ii) the Borrower or such ERISA Affiliate does not have reasonable grounds for contesting such Withdrawal Liability or is not in fact contesting such Withdrawal Liability in a timely and appropriate manner and (iii) the amount of the Withdrawal Liability specified in such notice, when aggregated with all other amounts required to be paid to Multiemployer Plans in connection with Withdrawal Liabilities (determined as of the date or dates of such notification), exceeds $5,000,000 or requires payments exceeding $1,000,000 in any year; (l) the Borrower or any ERISA Affiliate shall have been notified by the sponsor of a Multiemployer Plan that such Multiemployer Plan is in reorganization or is being terminated, within the meaning of Title IV of ERISA, if solely as a result of such reorganization or termination the aggregate annual contributions of the Borrower and its ERISA Affiliates to all Multiemployer Plans that are then in reorganization or have been or are being terminated have been or will be increased over the amounts required to be contributed to such Multiemployer Plans for their most recently completed plan years by an amount exceeding $1,000,000; (m) there shall have occurred a Change in Control; or (n) any Lien purported to be created under any Security Document shall cease to be, or shall be asserted by any Loan Party not to be, a valid and perfected Lien on any Collateral, with the priority required by the applicable Security Document, except (i) as a result of the sale or other disposition of the applicable Collateral in a transaction permitted under the Loan Documents or (ii) as a result of the Collateral Agent's failure to maintain possession of any stock certificates, promissory notes or other instruments delivered to it under the Pledge Agreement; then, and in every such event (other than an event with respect to the Borrower described in clause (g) or (h) above), and at any time thereafter during the continuance of such event, the Agent, at the request of the Required Lenders, shall, by notice to the Borrower, take any or all of the following actions, at the same or different times: (i) terminate forthwith the Revolving Commitments or L/C Commitments, (ii) declare the Loans then outstanding to be forthwith due and payable in whole or in part, whereupon the principal of the Loans so declared to be due and payable, together with accrued interest thereon and any unpaid accrued Fees and all other liabilities of the Borrower accrued hereunder and under any other Loan Document, shall become forthwith due and payable, without presentment, demand, protest or any other notice of any kind, all of which are hereby expressly waived by the Borrower, anything contained herein or in any other Loan Document to the contrary notwithstanding and (iii) require cash collateral as contemplated by Section 2.19(i); and in any event with respect to the Borrower described in clause (g) or (h) above, the Revolving Commitments and L/C 80 Commitments shall automatically terminate and the principal of the Loans then outstanding, together with accrued interest thereon and any unpaid accrued Fees and all other liabilities of the Borrower accrued hereunder and under any other Loan Document, shall automatically become due and payable, and the Borrower shall automatically be required to provide cash collateral in respect of outstanding Letters of Credit, without presentment, demand, protest or any other notice of any kind, all of which are hereby expressly waived by the Borrower, anything contained herein or in any other Loan Document to the contrary notwithstanding. ARTICLE VIII. THE AGENT In order to expedite the transactions contemplated by this Agreement, The Chase Manhattan Bank is hereby appointed to act as Agent on behalf of the Lenders and the Issuing Bank. Each of the Lenders hereby irrevocably authorizes the Agent to take such actions on behalf of such Lender or Issuing Bank and to exercise such powers as are specifically delegated to the Agent by the terms and provi sions hereof, together with such actions and powers as are reasonably incidental thereto. The Agent is hereby expressly authorized by the Lenders and the Issuing Bank, without hereby limiting any implied authority, (a) to receive on behalf of the Lenders and the Issuing Bank all payments of principal of and interest on the Loans, all payments in respect of L/C Disbursements and all other amounts due to the Lenders hereunder, and promptly to distribute to each Lender or Issuing Bank its proper share of each payment so received; (b) to give notice on behalf of each of the Lenders to the Borrower of any Event of Default specified in this Agreement of which the Agent has actual knowledge acquired in connection with its agency hereunder; and (c) to distribute to each Lender copies of all notices, financial statements and other materials delivered pursuant to this Agreement as received by the Agent. 81 Neither the Agent nor any of its directors, offi cers, employees or agents shall be liable to the Lenders as such for any action taken or omitted by any of them except for its or his own gross negligence or wilful misconduct, or be responsible for any statement, warranty or representation herein or the contents of any document delivered in connec tion herewith (other than any statement, representation or warranty relating to the Agent or relating to the functions of the Agent hereunder), or be required to ascertain or to make any inquiry concerning the performance or observance by the Borrower of any of the terms, conditions, covenants or agreements contained in any Loan Document. The Agent shall not be responsible to the Lenders for the due execution, genuineness, validity, enforceability or effectiveness of this Agreement or any other Loan Documents or other instruments or agreements. The Agent may deem and treat the payee of any note referred to in Section 2.06 as the owner thereof for all purposes hereof until it shall have received from the payee of such note notice, given as provided herein, of the transfer thereof. The Agent shall in all cases be fully protected in acting, or refraining from acting, in accordance with written instructions signed by the Required Lenders and, except as otherwise specifically provided herein, such instructions and any action or inac tion pursuant thereto shall be binding on all the Lenders. The Agent shall, in the absence of knowledge to the contrary, be entitled to rely on any instrument or document believed by it in good faith to be genuine and correct and to have been signed or sent by the proper person or persons. Neither the Agent nor any of its directors, officers, employees or agents shall have any responsibility to the Borrower on account of the failure of or delay in performance or breach by any Lender or Issuing Bank of any of its obligations hereunder or to any Lender or Issuing Bank on account of the failure of or delay in performance or breach by any other Lender or Issuing Bank or the Borrower of any of their respective obligations hereunder or under any other Loan Document or in connection herewith or therewith. The Agent may execute any and all duties here under by or through agents or employees and shall be enti tled to rely upon the advice of legal counsel selected by it with respect to all matters arising hereunder, subject to the first sentence of this paragraph, and shall not be liable for any action taken or suffered in good faith by it in accordance with the advice of such counsel. The Lenders hereby acknowledge that the Agent shall be under no duty to take any discretionary action per mitted to be taken by it pursuant to the provisions of this Agreement unless it shall be requested in writing to do so by the Required Lenders; provided that the Agent shall -------- 82 promptly notify each Lender of any Event of Default that the Agent has knowledge of. Subject to the appointment and acceptance of a successor Agent as provided below, the Agent may resign at any time by notifying the Lenders and the Borrower. Upon any such resignation, the Required Lenders shall have the right to appoint a successor subject to the written consent of the Borrower to such successor (which consent will not be unreasonably withheld). If no successor shall have been so appointed by the Required Lenders and shall have accepted such appointment within 30 days after the retiring Agent gives notice of its resignation, then the retiring Agent may, on behalf of the Lenders, appoint a successor Agent which shall be a bank with offices in New York, New York, having a combined capital and surplus of at least $500,000,000 or an Affiliate of any such bank. Upon the acceptance of any appointment as Agent hereunder by a suc cessor bank, such successor shall succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent and the retiring Agent shall be dis charged from its duties and obligations hereunder. After the Agent's resignation hereunder, the provisions of this Article and Section 9.05 shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as Agent. With respect to the Loans made by it hereunder, the Agent in its individual capacity and not as Agent shall have the same rights and powers as any other Lender and may exercise the same as though it were not the Agent, and the Agent and its Affiliates may accept deposits from, lend money to and generally engage in any kind of business with the Borrower or any Subsidiary or other Affiliate thereof as if it were not the Agent. Each Lender agrees (i) to reimburse the Agent, on demand, in the amount of its pro rata share (based on its Revolving Commitment hereunder or, if the Revolving Commitments shall have been terminated, on its Revolving Commitment most recently in effect) of any expenses incurred for the benefit of the Lenders by the Agent, including counsel fees and compensation of agents and employees paid for services rendered on behalf of the Lenders, which the Borrower shall be obligated to reimburse under Section 9.05 but which shall not have been reimbursed by the Borrower and (ii) to indemnify and hold harmless the Agent and any of its directors, officers, employees or agents, on demand, in the amount of such pro rata share, from and against any and all liabilities, taxes, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever which may be imposed 83 on, incurred by or asserted against it in its capacity as the Agent or any of them in any way relating to or arising out of the Agent's role under this Agreement or any other Loan Document or any action taken or omitted by it or any of them under this Agreement or any other Loan Document, to the extent the same shall not have been reimbursed by the Borrower; provided, however, that no -------- ------- Lender shall be liable to the Agent for any portion of such liabilities, obliga tions, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements resulting from the gross negligence or wilful misconduct of the Agent or any of its directors, officers, employees or agents. Each Lender acknowledges that it has, indepen dently and without reliance upon the Agent or any other Lender and based on such documents and information as it has deemed appropriate, made its own credit analysis and deci sion to enter into this Agreement. Each Lender also acknow ledges that it will, independently and without reliance upon the Agent or any other Lender and based on such documents and information as it shall from time to time deem appropri ate, continue to make its own decisions in taking or not taking action under or based upon this Agreement or any other Loan Document, any related agreement or any document furnished hereunder or thereunder. ARTICLE IX. MISCELLANEOUS SECTION 9.01. Notices. Notices and other commu nications provided -------- for herein shall be in writing and shall be delivered by hand or overnight courier service, mailed or sent by telex, graphic scanning or other telegraphic commu nications equipment of the sending party, as follows: (a) if to the Borrower, at 10770 Columbia Pike, Silver Spring, MD 20901, Attention of General Counsel, with a copy to the Chief Financial Officer of the Borrower (Telecopy No. (301) 979-6127); (b) if to the Agent, to it at The Chase Manhattan Bank, Agent Bank Services Group, One Chase Manhattan Plaza, 8th Floor, New York, New York 10081. Attention of Christina Gould (Telecopy No. (212) 522-5700), with a copy to (i) The Chase Manhattan Bank, 270 Park Avenue, New York, New York 10017, Attention of William Viets (Telecopy No. (212) 270-2873) and (ii) The Chase Manhattan Bank, 380 Madison Avenue, New York, New York 10017, Attention of Marc Costantino (Telecopy No. (212) 622-3395); and 84 (c) if to a Lender, to it at its address (or telecopy number) set forth in Schedule 2.01 or in the Assignment and Acceptance pursuant to which such Lender became a party hereto. Except as otherwise provided in Section 9.15(c), all notices and other communications given to any party hereto in accordance with the provisions of this Agreement shall be deemed to have been given on the date of receipt, in each case delivered, sent or mailed (properly addressed) to such party as provided in this Section 9.01 or in accordance with the latest unrevoked direction from such party given in accordance with this Section 9.01. SECTION 9.02. Survival of Agreement. All covenants, agreements, ---------------------- representations and warranties made by the Loan Parties herein and in the certificates or other instruments prepared or delivered in connection with or pursuant to this Agreement or any other Loan Document shall be considered to have been relied upon by the Lenders and the Issuing Bank and shall survive the making by the Lenders of the Loans and the issuance of Letters of Credit by the Issuing Bank, regardless of any investigation made by the Lenders or the Issuing Bank or on their behalf, and shall continue in full force and effect as long as the principal of or any accrued interest on any Loan or any Fee or any other amount payable under this Agreement or any other Loan Document is outstanding and unpaid or any Letter of Credit is outstanding and so long as the Revolving Commitments have not been terminated. SECTION 9.03. Binding Effect. This Agreement shall become effective --------------- when it shall have been executed by the Borrower and the Agent and when the Agent shall have received copies hereof which, when taken together, bear the signatures of each Lender, and thereafter shall be binding upon and inure to the benefit of the Borrower, the Agent and each Lender and their respective successors and assigns, except that the Borrower may not assign or delegate its rights or obligations hereunder or any interest herein without the prior consent of all the Lenders. SECTION 9.04. Successors and Assigns. (a) Whenever in this Agreement ----------------------- any of the parties hereto is referred to, such reference shall be deemed to include the successors and assigns of such party; and all covenants, promises and agreements by or on behalf of the Borrower, the Agent, the Issuing Bank or the Lenders that are contained in this Agreement shall bind and inure to the benefit of their respective successors and assigns. (b) Each Lender may assign to one or more assignees all or a portion of its interests, rights and 85 obligations under this Agreement (including all or a portion of its Revolving Commitment and the Loans at the time owing to it); provided, however, that (i) -------- ------- except in the case of an assignment to a Lender or an Affiliate of such Lender, the Borrower and the Agent (and, in the case of any assignment of a Revolving Commitment, the Issuing Bank) must give their prior written consent to such assignment (which consent shall not be unreasonably withheld), (ii) the amount of the Revolving Commitment of the assigning Lender subject to each such assignment (determined as of the date the Assignment and Acceptance with respect to such assignment is delivered to the Agent) shall not be less than $5,000,000 and the amount of the Revolving Commitment of such Lender remaining after such assignment shall not be less than $5,000,000 or shall be zero, (iii) the parties to each such assignment shall execute and deliver to the Agent an Assignment and Acceptance, together with a processing and recordation fee of $2,000 and (iv) the assignee, if it shall not be a Lender, shall deliver to the Agent an Administrative Questionnaire. Upon acceptance and recording pursuant to Section 9.04(e), from and after the effective date specified in each Assignment and Acceptance, which effective date shall be at least five Business Days after the execution thereof, (A) the assignee thereunder shall be a party hereto and, to the extent of the interest assigned by such Assignment and Acceptance, have the rights and obligations of a Lender under this Agreement and (B) the assigning Lender thereunder shall, to the extent of the interest assigned by such Assignment and Acceptance, be released from its obligations under this Agreement (and, in the case of an Assignment and Acceptance covering all or the remaining portion of an assigning Lender's rights and obligations under this Agreement, such Lender shall cease to be a party hereto (but shall continue to be entitled to the benefits of Sections 2.12, 2.14, 2.18 and 9.05, as well as to any Fees accrued for its account hereunder and not yet paid)). (c) By executing and delivering an Assignment and Acceptance, the assigning Lender thereunder and the assignee thereunder shall be deemed to confirm to and agree with each other and the other parties hereto as follows: (i) such assigning Lender warrants that it is the legal and beneficial owner of the interest being assigned thereby free and clear of any adverse claim and that its Revolving Commitment, and the outstanding balances of its Loans, in each case without giving effect to assignments thereof which have not become effective, are as set forth in such Assignment and Acceptance, (ii) except as set forth in (i) above, such assigning Lender makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with this Agreement, or the execution, legality, 86 validity, enforceability, genuineness, sufficiency or value of this Agreement, any other Loan Document or any other instrument or document furnished pursuant hereto or the financial condition of the Borrower or any Subsidiary or the performance or observance by the Borrower or any Subsidiary of any of its obligations under this Agreement, any other Loan Document or any other instrument or document furnished pursuant hereto; (iii) such assignee represents and warrants that it is legally authorized to enter into such Assignment and Acceptance; (iv) such assignee confirms that it has received a copy of this Agreement, together with copies of the most recent financial statements delivered pursuant to Section 5.04 and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into such Assignment and Acceptance; (v) such assignee will independently and without reliance upon the Agent, such assigning Lender or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement; (vi) such assignee appoints and authorizes the Agent to take such action as agent on its behalf and to exercise such powers under this Agreement as are delegated to the Agent by the terms hereof, together with such powers as are reasonably incidental thereto; and (vii) such assignee agrees that it will perform in accordance with their terms all the obligations which by the terms of this Agreement are required to be performed by it as a Lender. (d) The Agent shall maintain at one of its offices in The City of New York a copy of each Assignment and Acceptance delivered to it and a register for the recordation of the names and addresses of the Lenders, and the Revolving Commitment of, and principal amount of the Loans owing to, each Lender pursuant to the terms hereof from time to time (the "Register"). The entries in the -------- Register shall be conclusive in the absence of manifest error and the Borrower, the Agent, the Issuing Bank and the Lenders may treat each person whose name is recorded in the Register pursuant to the terms hereof as a Lender hereunder for all purposes of this Agreement. The Register shall be available for inspection by the Borrower, the Issuing Bank and any Lender, at any reasonable time and from time to time upon reasonable prior notice. (e) Upon its receipt of a duly completed Assignment and Acceptance executed by an assigning Lender and an assignee together with an Administrative Questionnaire completed in respect of the assignee (unless the assignee shall already be a Lender hereunder), the processing and recordation fee referred to in Section 9.04(b) and, if required, the written consent of the 87 Borrower, the Issuing Bank and the Agent to such assignment, the Agent shall (i) accept such Assignment and Acceptance, (ii) record the information contained therein in the Register and (iii) give prompt notice thereof to the Lenders and the Issuing Bank. (f) Each Lender may without the consent of the Borrower, the Issuing Bank or the Agent sell participations to one or more banks or other entities in all or a portion of its rights and obligations under this Agreement (including all or a portion of its Revolving Commitment and the Loans owing to it); provided, however, that (i) such Lender's obligations under this Agreement shall - -------- ------- remain unchanged, (ii) such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, (iii) the participating banks or other entities shall be entitled to the benefit of the cost protection provisions contained in Sections 2.12, 2.14 and 2.18 to the same extent as if they were Lenders but not in excess of those cost protections to which the Lender from which it purchased its participation would be entitled to under Sections 2.12, 2.14 and 2.18 and (iv) the Borrower, the Agent, the Issuing Bank and the other Lenders shall continue to deal solely and directly with such Lender (and shall not be required to deal with any participating bank or other entity, notwithstanding any other provision contained herein) in connection with such Lender's rights and obligations under this Agreement, and such Lender shall retain the sole right to enforce the obligations of the Borrower relating to the Loans or L/C Disbursements and to approve any amendment, modification or waiver of any provision of this Agreement (other than amendments, modifications or waivers decreasing any fees payable hereunder, increasing the Revolving Commitment of such Lender or decreasing the amount of principal of or the rate at which interest is payable on the Loans of such Lender, extending any scheduled principal payment date or date fixed for the payment of interest on the Loans of such Lender or releasing (i) any party to the Guarantee Agreement or (ii) Collateral subject to the Pledge Agreement representing all or substantially all of such Collateral). (g) Any Lender or participant may, in connection with any assignment or participation or proposed assignment or participation pursuant to this Section 9.04, disclose to the assignee 88 or participant or proposed assignee or participant any information relating to the Borrower furnished to such Lender by or on behalf of the Borrower; provided, -------- however, that, prior to any such disclosure of information designated by the - ------- Borrower as confidential, each such assignee or participant or proposed assignee or participant shall execute an agreement whereby such assignee or participant shall agree to preserve the confidentiality of such confidential information (subject to those exceptions set forth in Section 9.16). (h) Any Lender may at any time assign all or any portion of its rights under this Agreement to a Federal Reserve Bank; provided, however, that -------- ------- no such assignment shall release a Lender from any of its obligations hereunder. SECTION 9.05. Expenses; Indemnity. (a) The Borrower agrees to pay -------------------- all reasonable out-of-pocket expenses incurred by each of the Agent and the Issuing Bank and its Affiliates in connection with the preparation of this Agree ment and the other Loan Documents and the syndication of the facilities provided for herein or in connection with any amendments, modifications or waivers of the provisions hereof or thereof (whether or not the transactions hereby contemplated shall be consummated) or incurred by the Agent or any Lender in connection with the enforcement or protec tion of their rights (as such rights may relate to the Borrower or any Subsidiary) in connection with this Agree ment and the other Loan Documents or in connection with the Loans made or Letters of Credit issued hereunder and under the Issuing Bank Agreements, as applicable, including the reasonable fees and disbursements of Cravath, Swaine & Moore, counsel for the Agent, and, in connection with any "work-out" or any enforcement or protection of the rights of the Lenders, the Agent or the Collateral Agent hereunder, any other counsel for the Agent and counsel for any Lender, including the allocated costs of in-house counsel. (b) The Borrower agrees to indemnify the Agent, each Lender, and the Issuing Bank, and their respective directors, officers, employees, agents and Affiliates (each such person being called an "Indemnitee") against, and to hold each Indemnitee harmless from, any and all losses, claims, damages, liabilities and related expenses, including reasonable counsel fees and expenses, incurred by or asserted against any Indemnitee arising out of, in any way connected with, or as a result of (i) the execution or delivery of this Agreement or any other Loan Document or any agreement or instrument contemplated thereby, the perform ance by the parties thereto of their respective obligations thereunder or the consummation of the Transactions, the Spin-Off and the other transactions contemplated thereby, (ii) the use of the proceeds of the Loans or issuance of Letters of Credit, or (iii) any claim, litigation, investi gation or proceeding relating to any of the foregoing, whether or not any Indemnitee is a party thereto; provided, however, that such indemnity shall not, as to any -------- ------- Indemnitee, be available to the extent that such losses, claims, 89 damages, liabilities or related expenses are determined by a court of competent jurisdiction by final and nonappealable judgment to have resulted from the negligence or misconduct of such Indemnitee. Promptly after receipt by an Indemnitee of notice of any complaint or the commencement of any action or proceeding with respect to which indemnification is being sought hereunder, such person shall notify the Borrower of such complaint or of the commencement of such action or pro ceeding, but failure so to notify the Borrower will relieve the Borrower from any liability which the Borrower may have hereunder only if and to the extent that such failure results in the forfeiture by the Borrower of substantial rights and defenses, and shall not in any event relieve the Borrower from any other obligation or liability that the Borrower may have to any Indemnitee otherwise than under this Agreement. If the Borrower so elects or is requested by such Indemnitee, the Borrower shall assume the defense of such action or proceeding, including the employment of counsel reasonably satisfactory to the Indemnitee and the payment of the reasonable fees and disbursements of such counsel. In the event, however, such Indemnitee reasonably determines in its judgment that having common counsel would present such counsel with a conflict of interest or if the defendant in, or targets of, any such action or proceeding include both the Indemnitee and the Borrower, and such Indemnitee reasonably concludes that there may be legal defenses available to it or other Indemnitees that are different from or in addition to those available to the Borrower or if the Borrower fails to assume the defense of the action or proceeding or to employ counsel reasonably satisfactory to such Indemnitee, in either case in a timely manner, then the Indemnitee may employ separate counsel to represent or defend it in any such action or proceeding and the Borrower shall pay the reasonable fees and disbursements of such counsel. In any action or proceeding the defense of which the Borrower assumes, the Indemnitee shall have the right to participate in such litigation and to retain its own counsel at the Indemnitee's own expense. The Borrower further agrees that it shall not, without the prior written consent of the Indemnitee, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action, suit or proceeding in respect of which indemnification may be sought hereunder (whether or not an Indemnitee is an actual or potential party to such claim, action, suit or proceeding) unless such settlement, compro mise or consent includes (i) an unconditional release of each Indemnitee hereunder from all liability arising out of such claim, action, suit or proceeding or (ii) a covenant not to sue each Indemnitee, or another similar alternative which is consented to by each Indemnitee party to such claim, action, suit or proceeding, which covenant not to sue or other approved alternative has the effect of an unconditional 90 release of each Indemnitee hereunder from all liabil ity arising out of such claim, action, suit or proceeding. (c) The provisions of this Section shall remain operative and in full force and effect regardless of the expiration of the term of this Agreement, the consummation of the transactions contemplated hereby, the repayment of any of the Loans, the expiration of any Letter of Credit, the invalidity or unenforceability of any term or provision of this Agreement or any other Loan Document, or any investigation made by or on behalf of the Agent or any Lender or any Issuing Bank. All amounts due under this Section shall be payable on written demand therefor. SECTION 9.06. Right of Setoff. If an Event of Default shall have ---------------- occurred and be continuing, each Lender is hereby authorized at any time and from time to time, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebted ness at any time owing by such Lender to or for the credit or the account of the Borrower against any of and all the obligations of the Borrower now or hereafter existing under this Agreement held by such Lender (subject to the last sentence of this Section), irrespective of whether or not such Lender shall have made any demand under this Agreement and although such obligations may be unmatured. The rights of each Lender under this Section are in addition to other rights and remedies (including other rights of setoff) which such Lender may have. The provisions of Section 2.16 shall apply to any such setoff. SECTION 9.07. APPLICABLE LAW. THIS AGREEMENT SHALL BE CONSTRUED IN --------------- ACCORDANCE WITH AND GOVERNED BY THE LAWS OF THE STATE OF NEW YORK WITHOUT REFERENCE TO ITS CONFLICTS OF LAWS PRINCIPLES OR PROVISIONS. EACH LETTER OF CREDIT SHALL BE GOVERNED BY, AND SHALL BE CONSTRUED IN ACCORDANCE WITH, THE LAWS OR RULES DESIGNATED IN SUCH LETTER OF CREDIT, OR IF NO SUCH LAWS OR RULES ARE DESIGNATED, THE UNIFORM CUSTOMS AND PRACTICE FOR DOCUMENTARY CREDITS (1993 REVISION), INTERNATIONAL CHAMBER OF COMMERCE, PUBLICATION NO. 500 (THE "UNIFORM CUSTOMS") AND, AS TO MATTERS NOT GOVERNED BY THE UNIFORM CUSTOMS, THE LAWS OF THE STATE OF NEW YORK. SECTION 9.08. Waivers; Amendment. (a) No fail ure or delay of the ------------------- Agent or any Lender or any Issuing Bank in exercising any power or right hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any such right or power, or any abandonment or discontinuance of steps to enforce such a right or power, preclude any other or further exercise thereof or the 91 exercise of any other right or power. The rights and remedies of the Agent, the Issuing Bank and the Lenders hereunder and under the other Loan Documents are cumulative and are not exclusive of any rights or remedies which they would otherwise have. No waiver of any provision of this Agreement or any other Loan Document or consent to any departure by the Borrower therefrom shall in any event be effective unless the same shall be permitted by Section 9.08(b), and then such waiver or consent shall be effective only in the specific instance and for the purpose for which given. No notice or demand on the Borrower in any case shall entitle the Borrower to any other or further notice or demand in similar or other circumstances. (b) Neither this Agreement nor any other Loan Document nor any provision hereof or thereof may be waived, amended or modified except, in the case of this Agreement, pursuant to an agreement or agreements in writing entered into by the Borrower and the Required Lenders or, in the case of any other Loan Document, pursuant to an agreement or agreements in writing entered into by the Agent and the Loan Party or Loan Parties that are parties thereto, in each case with the consent of the Required Lenders; provided, however, that -------- ------- no such agreement shall (i) decrease the principal amount of, or extend the maturity of or any scheduled principal payment date or date for the payment of any interest on any Loan or any date for reimbursement of an L/C Disbursement, or Fees, or waive or excuse any such payment or any part thereof, or decrease the rate of interest on any Loan or L/C Disbursement, without the prior written consent of each Lender affected thereby, (ii) increase the Revolving Commitment or change the Facility Fees of any Lender without the prior written consent of such Lender, (iii) amend or modify the provisions of Section 2.15, the provisions of this Section, the definition of the "Required Lenders" or the provisions of Section 9.03, without the prior written consent of each affected Lender, (iv) amend or modify the definition of "Aggregate Value", "Borrowing Base" or "Borrowing Base Properties" without the prior written consent of the Supermajority Lenders, (v) release any Subsidiary Loan Party from its Guarantee under the Guarantee Agreement (except as expressly provided in the Guarantee Agreement), or limit its liability in respect of such Guarantee, without the written consent of each Lender, or (vi) except in strict accordance with the express provisions thereof, release or replace all or any substantial part of the Collateral (as defined in the Pledge Agreement) from the Liens of the Security Documents, without the written consent of each Lender; provided further ---------------- that no such agreement shall amend, modify or otherwise affect the rights or duties of the Agent or any Issuing Bank hereunder without the prior written consent of the Agent or such Issuing Bank. 92 (c) Notwithstanding the foregoing, any Issuing Bank Agreement may be waived, amended or modified by the parties thereto with the written approval of the Agent if and to the extent that such waiver, amendment or modification would be permitted in connection with the execution and delivery of a replacement of such agreement. SECTION 9.09. Interest Rate Limitation. Notwith standing anything ------------------------- herein to the contrary, if at any time the applicable interest rate on any Loan or participation in any L/C Disbursement, together with all fees and charges which are treated as interest or such Loan or participation in any L/C Disbursement under applicable law (collectively the "Charges"), as provided for herein or in any other document executed in connection herewith, or otherwise contracted for, charged, received, taken or reserved by any Lender, shall exceed the maximum lawful rate (the "Maximum Rate") which may be contracted for, ------------ charged, taken, received or reserved by such Lender in accordance with applicable law, together with all Charges payable to such Lender, shall be limited to the Maximum Rate. SECTION 9.10. Entire Agreement. This Agreement and the other Loan ----------------- Documents and the letter agreement referred to in Section 2.05(b) constitute the entire con tract between the parties relative to the subject matter hereof. Any previous agreement among the parties with respect to the subject matter hereof is superseded by this Agreement and the other Loan Documents. Nothing in this Agreement or in the other Loan Documents, expressed or implied, is intended to confer upon any party other than the parties hereto and thereto any rights, remedies, obligations or liabilities under or by reason of this Agreement or the other Loan Documents. SECTION 9.11. Waiver of Jury Trial; Punitive Damages. Each party --------------------------------------- hereto hereby waives, to the fullest extent permitted by applicable law, (a) any right it may have to a trial by jury in respect of any litigation direct ly or indirectly arising out of, under or in connection with this Agreement or any of the other Loan Documents and (b) any claims for punitive damages. Each party hereto (i) certifies that no representative, agent or attorney of any other party has represented, expressly or otherwise, that such other party would not, in the event of litigation, seek to enforce the foregoing waiver and (ii) acknowledges that it and the other parties hereto have been induced to enter into this Agreement and the other Loan Documents, as applicable, by, among other things, the mutual waivers and certifications in this Section. 93 SECTION 9.12. Severability. In the event any one or more of the ------------- provisions contained in this Agreement or in any other Loan Document should be held invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein and therein shall not in any way be affected or impaired thereby. The parties shall endeavor in good-faith negotia tions to replace the invalid, illegal or unenforceable pro visions with valid provisions the economic effect of which comes as close as possible to that of the invalid, illegal or unenforceable provisions. SECTION 9.13. Counterparts. This Agreement may be executed in two or ------------- more counterparts, each of which shall constitute an original but all of which when taken together shall constitute but one contract, and shall become effec tive as provided in Section 9.03. SECTION 9.14. Headings. Article and Section headings and the Table --------- of Contents used herein are for con venience of reference only, are not part of this Agreement and are not to affect the construction of, or to be taken into consideration in interpreting, this Agreement. SECTION 9.15. Jurisdiction; Consent to Service of Process. (a) The -------------------------------------------- Borrower hereby irrevocably and uncondi tionally submits, for itself and its property, to the nonex clusive jurisdiction of any New York State court or Federal court of the United States of America sitting in New York City, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Agreement or the other Loan Documents, or for recognition or enforcement of any judgment, and each of the parties hereto hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in such New York State court or, to the extent permitted by law, in such Federal court. Each of the parties hereto agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing in this Agreement shall affect any right that the Agent, any Issuing Bank, or any Lender may otherwise have to bring any action or proceeding relating to this Agreement or the other Loan Documents against the Borrower or its properties in the courts of any jurisdiction. (b) The Borrower hereby irrevocably and uncondi tionally waives, to the fullest extent it may legally and effectively do so, any objection which it may now or hereafter have to the laying of venue of any suit, action or 94 proceeding arising out of or relating to this agreement or the other Loan Documents in any New York State or Federal court. Each of the parties hereto hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court. (c) The Borrower and each other party hereto consents to service of process in the manner provided for notices in Section 9.01. Nothing in this Agreement will affect the right of any party to this Agreement to serve process in any other manner permitted by law. SECTION 9.16. Confidentiality. Unless otherwise agreed to in writing ---------------- by the Borrower, the Issuing Bank, the Agent and each Lender, each of the Borrower, the Issuing Bank, the Agent and the Lenders hereby agrees to keep all Proprietary Information (as defined below) confidential and not to disclose or reveal any Proprietary Information to any person other than the Agent's or such Lender's directors, officers, employees, Affiliates and agents and to actual or potential assignees and participants, and then only on a confidential basis; provided, however, that the Agent, the Issuing Bank or any Lender may disclose - -------- ------- Proprietary Information (a) as required by law, rule, regulation or judicial process, (b) to its attorneys and accountants, (c) as requested or required by any state or Federal or foreign authority or examiner regulating banks or banking or (d) subject to appropriate confidentiality protections, in any legal proceedings between the Agent, the Issuing Bank or such Lender and the Borrower arising out of this Agreement. For purposes of this Agreement, the term "Proprietary Information" shall include all information about the Borrower or - ------------------------ any of their Affiliates which has been furnished by the Borrower or any of its Affiliates, whether furnished before or after the date hereof, and regardless of the man ner in which it is furnished; provided, however, that Proprietary -------- ------- Information does not include information which (x) is or becomes generally available to the public other than as a result of a disclosure by the Agent, the Issuing Bank or any Lender not permitted by this Agreement, (y) was obtained or otherwise became available to the Agent, the Issuing Bank or any Lender on a nonconfidential basis prior to its disclosure to the Agent, the Issuing Bank or such Lender by the Borrower or any of its Affiliates or (z) becomes available to the Agent, the Issuing Bank or any Lender on a nonconfidential basis from a person other than the Borrower or its Affiliates who, to the best knowledge of the Agent, the Issuing Bank or such Lender, as the case may be, is not otherwise bound by a confidentiality agreement with the Borrower or any of its Affiliates, or is not otherwise prohibited from transmitting the information to the Agent, the Issuing Bank or such Lender. 95 IN WITNESS WHEREOF, the Borrower, the Agent, the Issuing Bank and the Lenders have caused this Agreement to be duly executed by their respective authorized officers as of the day and year first above written. SUNBURST HOSPITALITY CORPORATION by /s/ Edward A. Kubis -------------------------- Name: Edward A. Kubis Title:Senior Vice President THE CHASE MANHATTAN BANK, individually and as Issuing Bank and Agent, by /s/ Thomas H. Kozlark ----------------------------- Name: Thomas H. Kozlark Title: Vice President CRESTAR BANK, by /s/ Michael E. Forry ---------------------------- Name: Michael E. Forry Title: Vice President WESTDEUTSCHE LANDESBANK GIROZENTRALE, New York Branch, by /s/ Michael F. McWalters ---------------------------- Name: Michael F. McWalters Title: Managing Director by /s/ Mark H. Lanspa --------------------- Name: Mark H. Lanspa Title: Vice President 96 BHF-BANK AKTIENGESELLSCHAFT, by /s/ Nicholas Nouvel ------------------------------ Name: Nicholas Nouvel Title: Vice President by /s/ Dana McDougall ----------------------------- Name: Dana McDougall Title: Vice President 97 EX-21.01 3 EXHIBIT 21.01 EXHIBIT 21.01 SUBSIDIARIES BOULEVARD MOTEL CORP. Arlington Spirits Corp. Bay Ridge Spirits Corp. Biscayne Land Associates, Inc. Biscayne Properties, Inc. Bowling Green Inn - Brandywine, Inc. Cardinal Beverage Corp. Everglades Beverage Corp. Fairways Beverage Corp. Fairways, Inc. First Choice Properties Corp. First Choice Capital Corp. QI Capital Corp. MCH Baltimore Corp. MCH Hot Springs Corp. MCH Lincoln Corp. MCH Roanoke Corp. MCH Springfield Corp. MCH Sturgis Corp. MCH Wichita Corp. MCHD Cypress Creek Corp. MCHD Ft. Lauderdale Corp. MCHD Hampton Corp. Pikesville Hotel Corp. Raleigh Hotel Holding, Inc. West Montgomery Hotel Holdings, Inc. MCH Shady Grove Corp. CACTUS HOTEL CORP. CHOICE MANAGEMENT & REALTY SERVICES, INC. Beltway Management Company COMFORT CALIFORNIA, INC. GULF HOTEL CORP. HEFRU FOOD SERVICES, INC. QCM BEVERAGES, INC. (49%; 51% Texas resident) QCM CORPORATION SUNBURST HOTEL CORP. THICKET, INC. (THE) (Non-profit; owned by members) Subsidiaries are wholly-owned except where indicated. EX-23.01 4 EXHIBIT 23.01 Exhibit 23.01 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K, into the Company's previously filed Registration Statements File No. 333-14203, No. 333-17577 and No. 333-17575. Arthur Andersen LLP Washington, D.C. March 30, 1998 EX-27.01 5 EXHIBIT 27.01
5 1,000 7-MOS DEC-31-1997 JUN-01-1997 DEC-31-1997 5,908 0 6,877 616 0 0 437,831 66,526 400,983 0 248,120 0 0 200 89,107 400,983 0 114,553 0 99,624 5,119 0 10,138 (328) (44) (284) 16,369 0 0 16,085 0.81 0.81
EX-99.01 6 EXHIBIT 99.01 SCHEDULE 14A INFORMATION Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Amendment No. ) Filed by the Registrant [X] Filed by a Party other than the Registrant [_] Check the appropriate box: [_] Preliminary Proxy Statement [_] CONFIDENTIAL, FOR USE OF THE COMMISSION ONLY (AS PERMITTED BY RULE 14A-6(E)(2)) [X] Definitive Proxy Statement [_] Definitive Additional Materials [_] Soliciting Material Pursuant to Section 240.14a-11(c) or Section 240.14a-12 Sunburst Hospitality Corporation - -------------------------------------------------------------------------------- (Name of Registrant as Specified In Its Charter) Sunburst Hospitality Corporation - -------------------------------------------------------------------------------- (Name of Person(s) Filing Proxy Statement, if other than the Registrant) Payment of Filing Fee (Check the appropriate box): [X] No fee required [_] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11. (1) Title of each class of securities to which transaction applies: ------------------------------------------------------------------------- (2) Aggregate number of securities to which transaction applies: ------------------------------------------------------------------------- (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the filing fee is calculated and state how it was determined): ------------------------------------------------------------------------- (4) Proposed maximum aggregate value of transaction: ------------------------------------------------------------------------- (5) Total fee paid: ------------------------------------------------------------------------- [_] Fee paid previously with preliminary materials. [_] Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. (1) Amount Previously Paid: ------------------------------------------------------------------------- (2) Form, Schedule or Registration Statement No.: ------------------------------------------------------------------------- (3) Filing Party: ------------------------------------------------------------------------- (4) Date Filed: ------------------------------------------------------------------------- Notes: SUNBURST HOSPITALITY CORPORATION 10770 COLUMBIA PIKE SILVER SPRING, MARYLAND 20901 ---------------- NOTICE OF ANNUAL MEETING TO BE HELD APRIL 22, 1998 ---------------- To the Stockholders of SUNBURST HOSPITALITY CORPORATION The 1998 Annual Meeting of Stockholders (the "Annual Meeting") of Sunburst Hospitality Corporation, a Delaware corporation ("Sunburst" or the "Company"), will be held at the Quality Suites Shady Grove, 3 Research Court, Rockville, Maryland at 9:00 a.m. (E.S.T.) on Wednesday, April 22, 1998 for the following purposes: 1. To elect two Class II directors to hold office for a three year term ending at the 2001 Annual Meeting of Stockholders and until their successors are elected and qualified; 2. To approve an increase of 1.2 million in the number of authorized shares under the Sunburst Hospitality Corporation 1996 Long-Term Incentive Plan; and 3. To transact such other business as may properly come before the Annual Meeting. Holders of record of Sunburst common stock at the close of business on March 12, 1998 will be entitled to notice of, and to vote at, the Annual Meeting or any adjournment(s) or postponement(s) thereof. Stockholders are reminded that your shares of Sunburst common stock cannot be voted unless you properly execute and return the enclosed proxy card or make other arrangements to have your shares represented at the meeting. A list of stockholders will be available for inspection at the office of the Company located at the address above, at least 10 days prior to the Annual Meeting. By Order of the Board of Directors SUNBURST HOSPITALITY CORPORATION /s/ Pamela M. Williams Pamela M. Williams Assistant Secretary March 25, 1998 Silver Spring, Maryland TO VOTE YOUR SHARES, PLEASE SIGN, DATE AND COMPLETE THE ENCLOSED PROXY AND MAIL IT PROMPTLY IN THE ENCLOSED RETURN ENVELOPE. SUNBURST HOSPITALITY CORPORATION 10770 COLUMBIA PIKE SILVER SPRING, MARYLAND 20901 ---------------- PROXY STATEMENT ANNUAL MEETING OF STOCKHOLDERS APRIL 22, 1998 ---------------- GENERAL INFORMATION This Proxy Statement is furnished in connection with the solicitation of proxies by the Board of Directors of Sunburst Hospitality Corporation, a Delaware corporation ("Sunburst" or the "Company"), for use at the 1998 Annual Meeting of Stockholders of the Company to be held at 9:00 a.m. (E.S.T.) on April 22, 1998, at the Quality Suites Shady Grove, 3 Research Court, Rockville, Maryland and at any adjournment(s) or postponement(s) thereof (the "Annual Meeting"). It is anticipated that this Proxy Statement and proxy will first be mailed to the Company's stockholders on or about March 25, 1998. The Company's Annual Report on Form 10-K (including certified financial statements) for the seven month period ended December 31, 1997 is accompanying this Proxy Statement. The Annual Report is not part of the proxy solicitation material. Background of Spinoffs; Change In Fiscal Year Prior to October 15, 1997, the Company was named Choice Hotels International, Inc. On October 15, 1997, the Company distributed to its stockholders its hotel franchising business and its European hotel ownership pursuant to a pro rata distribution to its stockholders of all of the stock of its wholly-owned subsidiary, Choice Hotels Franchising, Inc. (the "Spinoff"). At the time of the Spinoff, the Company changed its name to "Sunburst Hospitality Corporation" and Choice Hotels Franchising, Inc. changed its name to "Choice Hotels International, Inc." ("New Choice"). Prior to November 1996, the Company was a subsidiary of Manor Care, Inc. ("Manor Care") which, directly and through its subsidiaries, engaged in the ownership and management of hotels currently conducted by the Company as well as the hotel franchising business currently conducted by New Choice (together, the "Lodging Business") and the health care business. On November 1, 1996, Manor Care separated the Lodging Business from its health care business through a pro rata distribution to the holders of Manor Care's common stock of all of the stock of the Company (the "Manor Care Spinoff"). In September 1997, the Company changed its fiscal year from May 31 to December 31. Voting of Proxies Your vote is important. Shares can be voted at the Annual Meeting only if you are present in person or represented by proxy. Even if you plan to attend the meeting, you are urged to sign, date and return the accompanying proxy card. When the enclosed proxy card is properly signed, dated and returned, the stock represented by the proxy will be voted in accordance with your directions. You can specify your voting instructions by marking the appropriate box on the proxy card. If your proxy card is signed and returned without specific voting instructions, your shares of Sunburst common stock will be voted as recommended by the directors: "FOR" the election of the two nominees for director named on the proxy card and "FOR" the amendment to the 1996 Long-Term 1 Incentive Plan (the "1996 Incentive Plan"). Abstentions marked on the proxy card have the effect of being voted "against" the directors' proposals but are counted in the determination of a quorum. You may revoke your proxy at any time before it is voted at the meeting by (i) filing with ChaseMellon Shareholder Services, L.L.C. in its capacity as transfer agent for the Company (the "Transfer Agent"), at or before the Annual Meeting, a written notice of revocation bearing a later date than the proxy, (ii) executing a later-dated proxy relating to the same shares of Company Common Stock and delivering it to the Transfer Agent at or before the Annual Meeting, or (iii) attending the Annual Meeting and voting in person (although attendance at the Annual Meeting will not, in and of itself, constitute a revocation of a proxy). Any written notice revoking a proxy should be sent to ChaseMellon Shareholder Services, L.L.C., Overpeck Centre, 85 Challenger Road, Ridgefield Park, New Jersey 07660. Votes Required The close of business on March 12, 1998 has been fixed as the record date for determination of holders of Company common stock entitled to notice of and to vote at the Annual Meeting. On that date, there were outstanding and entitled to vote 19,963,190 shares of Company common stock. The presence, either in person or by proxy, of persons entitled to cast a majority of such votes constitutes a quorum for the transaction of business at the Annual Meeting. Abstentions and broker no-votes on returned proxies are counted as shares present in the determination of whether the shares of stock represented at the Annual Meeting constitute a quorum. A broker "non-vote" occurs when a nominee holding shares of Sunburst common stock for a beneficial owner does not vote on a particular item and has not received instructions from the beneficial owner. Stockholders are entitled to one vote per share on all matters submitted for consideration at the Annual Meeting. With regard to the election of directors, votes may be cast in favor of or withheld from nominees. Votes that are withheld will be excluded entirely from the vote and will have no effect. Abstentions may be specified on all proposals other than the election of directors. Each proposal is tabulated separately. Abstentions are counted in tabulations of the votes cast on proposals presented to the stockholders, whereas broker non-votes are not counted for purposes of determining whether a proposal has been approved. The affirmative vote of a plurality of shares of Company common stock present in person or represented by proxy at the Annual Meeting is required to elect the directors nominated. "Plurality" means that the individuals who receive the largest number of votes cast are elected as directors up to the maximum number of directors to be chosen at the meeting. Certain members of the Bainum family (including various trusts, partnerships and corporations established by members of the Bainum family) in the aggregate have the right to vote approximately 34.59% of the number of outstanding shares of Company common stock and have indicated an intention to vote in accordance with the recommendations of the Board of Directors. Solicitation of Proxies The Company will bear the cost of the solicitation. In addition to solicitation by mail, the Company will request banks, brokers and other custodian nominees and fiduciaries to supply proxy material to the beneficial owners of Company common stock of whom they have knowledge, and will reimburse them for their expenses in so doing; and certain directors, officers and other employees of the Company, not specially employed for the purpose, may solicit proxies, without additional remuneration therefor, by personal interview, mail, telephone or telegraph. Relationship With Independent Public Accountants Since 1996, Arthur Andersen LLP has served as the Company's independent public accounting firm. It is expected that representatives of Arthur Andersen will be present at the annual meeting. They will be given an 2 opportunity to make a statement if they desire to do so, and it is expected that they will be available to respond to appropriate questions. Procedures for Stockholder Proposals and Nominations Under the Company's Bylaws, nominations for director may be made only by the Board of Directors or a committee of the board, or by a stockholder entitled to vote who has delivered notice to the Company not less than 60, nor more than 90, days before the first anniversary of the preceding year's annual meeting. The Bylaws also provide that no business may be brought before an annual meeting except as specified in the notice of meeting (which includes stockholder proposals that the Company is required to set forth in its proxy statement under SEC Rule 14a-8) or as otherwise brought before the meeting by or at the direction of the board or by a stockholder entitled to vote who has delivered notice to the Company (containing certain information specified in the Bylaws) within the time limits described above for a nomination for the election of a director. These requirements are separate and apart from, and in addition to, the SEC's requirements that a stockholder must comply with in order to have a stockholder proposal included in the Company's proxy statement under SEC Rule 14a-8. Stockholder Proposals for 1999 Annual Meeting Stockholder proposals intended to be presented at the Company's 1999 Annual Meeting of Stockholders must be received by the Company's Corporate Secretary no later than February 21, 1999. Such proposals must meet the requirements set forth in the rules and regulations of the SEC in order to be eligible for inclusion in the Company's 1999 proxy materials. Other Matters to Come Before the Meeting The Board of Directors does not know of any matters which will be brought before the 1998 annual meeting other than those specifically set forth in the notice of meeting. If any other matters are properly introduced at the meeting for consideration, including, among other things, consideration of a motion to adjourn the meeting to another time or place, the individuals named on the enclose proxy card will have discretion to vote in accordance with their best judgment. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended, (the "Exchange Act") requires the Company's reporting officers and directors, and persons who own more than ten percent of the Company's common stock, to file reports of ownership and changes in ownership on Forms 3, 4 and 5 with the Securities and Exchange Commission (the "Commission"), the New York Stock Exchange and the Company. Because of the failure of the Commission to correct EDGAR filing information for the Company after the Company's timely request, the following Form 5's were timely filed electronically but rejected from the EDGAR system: Stewart Bainum, Stewart Bainum, Jr., Federic V. Malek, Carole Y. Prest, James A. MacCutcheon and Antonio DiRico. The Form 5's were subsequently refiled and accepted. A Form 5 for Paul A. Gould was filed late. None of the transactions covered in the late filings were subject to short swing liability under Section 16(b) of the Exchange Act. Except as previously noted and based on a review of the copies of such reports furnished to the Company and written representations that no other reports were required, the Company believes that all of its reporting officers, directors and greater than ten percent beneficial owners complied with all filing requirements applicable to them during the fiscal year ended December 31, 1997. ELECTION OF CLASS II DIRECTORS The Board of Directors currently consists of three classes of directors, as nearly equal in number as possible. Directors hold office for staggered terms of three years (or less if they are filling a vacancy) and until their successors are elected and qualified. One of the three classes, comprising approximately one third of the 3 directors, is elected each year to succeed the directors whose terms are expiring. The directors in Class II will be elected at the Annual Meeting to serve for a term expiring at the Company's Annual Meeting in the year 2001. The directors in Classes III and I are serving terms expiring at the Company's Annual Meeting of Stockholders in 1999 and 2000, respectively. In connection with the Spinoff, Barbara Bainum, Robert C. Hazard, Jr., Gerald W. Petitt, Jerry E. Robertson and William R. Floyd resigned from the Board of Directors on October 15, 1997, and Donald J. Landry and Carole Y. Prest were appointed to the Board of Directors. On November 13, 1997, Keith B. Pitts was appointed to the Board of Directors. The Company's Board of Directors has proposed the following nominees for election as directors at the annual meeting: NOMINEES FOR CLASS II DIRECTORS WITH TERMS EXPIRING AT THE ANNUAL MEETING IN THE YEAR 2001: STEWART BAINUM, JR. PAUL A. GOULD THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE ELECTION OF THE ABOVE- NAMED NOMINEES AS DIRECTORS FOR A TERM OF THREE YEARS. Proxies solicited by the Board of Directors will be voted "FOR" the election of the nominees, unless otherwise instructed on the proxy card. Information is provided below with respect to each nominee for election and each director continuing in office. Should one or more of these nominees become unavailable to accept nomination or election as a director, the individuals named as proxies on the enclosed proxy card will vote the shares that they represent for the election of such other persons as the board may recommend, unless the board reduces the number of directors. The Board of Directors knows of no reason why any of the nominees will be unavailable or unable to serve. NOMINEES FOR ELECTION AS DIRECTORS Class II -- Nominees for Terms Expiring in 2001 STEWART BAINUM, JR., 51, Chairman of the Board of the Company since November 1996; Chairman of the Board of New Choice since October 1997 and from March 1987 to November 1996; Chairman of the Board and Chief Executive Officer of Manor Care and ManorCare Health Services, Inc. ("MCHS") since March 1987; Chief Executive Officer of Manor Care since March 1987 and President since June 1989; Vice Chairman of the Board of Vitalink Pharmacy Services, Inc. ("Vitalink") since December 1994; Vice Chairman of the Board of Manor Care and subsidiaries from June 1982 to March 1987; Director of Manor Care since August 1981, of Vitalink since September 1991, of MCHS since 1976 and of the Company since 1977; Chief Executive Officer of MCHS since June 1989 and President from May 1990 to May 1991; Chairman of the Board and Chief Executive Officer of Vitalink from September 1991 to February 1995 and President and Chief Executive Officer from March 1987 to September 1991. PAUL A. GOULD, 53, Managing Director of Allen & Company Incorporated (investment banking firm) for more than five years and other positions at Allen & Company Incorporated since 1973; Director of the Company since November 1996. Director: Tele-Communications, Inc., Tele-Communications International, Inc. and Ascent Entertainment Group. 4 DIRECTORS WHOSE TERM OF OFFICE CONTINUE Class III -- Term Expires in 1999 DONALD J. LANDRY, 49, Chief Executive Officer and Vice Chairman of the Company since October 1997; President of New Choice from January 1995 to October 1997; President of Manor Care Hotel Division ("MCHD") from March 1992 to November 1996; various executive positions with Richfield Hotel Management, Inc. and its predecessors for more than 16 years, including President of MHM Corporation. FREDERIC V MALEK, 61, 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 of the Company since November 1996. Director: Manor Care, New Choice, 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. Class I -- Terms Expire 2000 STEWART BAINUM, 78, 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; Director of the Company since November 1996; Chairman of the Board of New Choice from 1972 to March 1987 and a Director since 1963; Chairman of the Board of Realty Investment Company, Inc. since 1965. CAROLE Y. PREST, 46, Senior Vice President, Strategy and Marketing of Manor Care since September 1997; Vice President, Corporate Strategic Planning of Manor Care from September 1995 to September 1997; Vice President and General Manager and various other positions at Gen Rad, Inc. from May 1985 to 1994. Director of the Company since October 1997. KEITH B. PITTS, 40, Chairman, President and Chief Executive Officer of Paragon Health Network, Inc. since November, 1997; Consultant to Apollo from August 1997 to November 1997; Consultant to Tenet Healthcare Corp. ("Tenet") from February 1997 to August 1997; Executive Vice President and Chief Financial Officer of orNda HealthCorp from August 1992 until its merger with Tenet in January, 1997. Director of the Company since November 1997. THE BOARD OF DIRECTORS The Board of Directors is responsible for overseeing the overall performance of the Company. Members of the board are kept informed of the Company's business through discussions with the Chairman, the Chief Executive Officer and other members of the Company's management, by reviewing materials provided to them and by participating in board and committee meetings. Prior to October 15, 1997, the Board of Directors consisted of nine member, five of whom resigned upon the Spinoff. Donald J. Landry and Carole Y. Prest were appointed to the Board of Directors upon the Spinoff and Keith B. Pitts was appointed on November 13, 1997. Since November 13, 1997, the Board of Directors has consisted of seven directors, four of who were not present or past officers of the Company. For the twelve months ended December 31, 1997, the Board of Directors held five meetings. Each director attended all of the meetings of the Board of Directors and of the committees of the Board of Directors on which such director served since the time that such director joined the Board of Directors. COMMITTEES OF THE BOARD The standing committees of the Board of Directors include the Audit, Ethics and Compliance Committee, the Compensation/Key Executive Stock Option Plan Committee and the Compensation/Key Executive Stock 5 Option Plan Committee No. 2. At the November 13, 1997 Board Meeting, the Nominating Committee was abolished and the Nominating and Corporate Governance Committee was established. The current members of the standing committees are as follows: COMPENSATION/KEY EXECUTIVE STOCK OPTION NOMINATING & CORPORATE PLAN COMMITTEE GOVERNANCE COMMITTEE Frederic V. Malek, Chair Carole Y. Prest, Chair Stewart Bainum Paul A. Gould Stewart Bainum, Jr. Frederic V. Malek Keith B. Pitts COMPENSATION/KEY EXECUTIVE STOCK OPTION AUDIT, ETHICS AND PLAN COMMITTEE NO. 2 COMPLIANCE Frederic V. Malek, Chair COMMITTEE Keith B. Pitts Paul A. Gould, Chair Keith B. Pitts The Compensation/Key Executive Stock Option Plan Committees administer the Company's stock option plans and grant stock options thereunder, review compensation of officers and key management employees, recommend development programs for employees such as training, bonus and incentive plans, pensions and retirement, and review other employee fringe benefit programs. The Compensation/Key Executive Stock Option Plan Committees each met twice during the twelve months ended December 31, 1997. The Nominating and Corporate Governance Committee is responsible for administering the Sunburst Corporate Governance Guidelines, assessing the functioning of the Board, determining size and composition of the Board, recommending candidates to fill vacancies on the Board, determining actions to be taken with respect to directors who are unable to perform their duties, setting the company's policies regarding the conduct of business between the company and any other entity affiliated with a director and determining the compensation of non-employee directors. The Nominating and Corporate Governance Committee was established in November, 1997 and held no meetings during the twelve month period ended December 31, 1997. The Audit, Ethics and Compliance Committee reviews the scope and results of the annual audit, reviews and approves the services and related fees of the Company's independent public accountants, reviews the Company's internal accounting controls and reviews the Company's Internal Audit Department and its activities. The Audit Committee met three times during the twelve month period ended December 31, 1997. COMPENSATION OF DIRECTORS The Company has adopted the Sunburst Hospitality Corporation Non-Employee Director Stock Option and Deferred Compensation Stock Purchase Plan. Part A of the Plan provides that eligible non-employee directors are granted options to purchase 5,000 shares of the Company's common stock on their first date of election and are granted options to purchase 1,000 shares on their date of election in subsequent calendar years. Part B of the Plan provides that eligible non-employee directors may elect, prior to May 31 of each year, to defer a minimum of 25% of committee fees earned during the ensuing fiscal year. The fees which are so deferred will be used to purchase the Company's common stock on the open market within 15 days after December 1, February 28 and May 31 of such fiscal year. Pending such purchases, the funds will be credited to an Interest Deferred Account, which will be interest bearing. Stock which is so purchased will be deposited in a Stock Deferred Account pending distribution in accordance with the Plan. Pursuant to the Non-Employee Director Stock Compensation Plan adopted by the Company, eligible non-employee directors will receive annually, in lieu of cash, restricted shares of the Company's common stock, the fair market value of which at the time of grant will be equal to $30,000, which will represent the Board of 6 Directors retainer and meeting fees. In addition, all non-employee directors receive $1,610 per diem for Committee meetings attended and are reimbursed for travel expenses and other out-of-pocket expenses. Directors who are employees of the Company receive no separate remuneration for their services as directors. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth the amount of the Company's common stock beneficially owned by (i) each director of the Company, (ii) the Company's chief executive officer and the other four most highly compensated executive officers (the "Named Officers"), (iii) all officers and directors of the Company as a group and (iv) all persons who are expected to own beneficially more than 5% of the Company's common stock, as of March 12, 1998, the Record Date. Unless otherwise specified, the address for each of them is 10770 Columbia Pike, Silver Spring, Maryland, 20901.
SHARES OF COMMON STOCK PERCENT OF SHARES NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED OUTSTANDING(1) ------------------------ ------------------ ----------------- Stewart Bainum, Jr.......................................... 5,333,203(2) 26.72% Stewart Bainum.............................................. 3,397,955(3) 17.02% Antonio DiRico.............................................. 16,059(4) * William R. Floyd............................................ 37,707(6) * Paul A. Gould............................................... 980(7) * Kevin P. Hanley............................................. 822(8) * Edward A. Kubis(9).......................................... 7,973(10) * Donald J. Landry............................................ 112,205(11) * James A. MacCutcheon........................................ 73,998(12) * Frederic V. Malek........................................... 2,464(13) * Keith B. Pitts.............................................. 1,611(14) * Carole Y. Prest............................................. 4,778(15) * All Directors and Officers as a Group (12 persons).......... 7,126,943(16) 35.70% Barbara Bainum.............................................. 1,840,585(17) 9.22% Bruce Bainum................................................ 1,837,434(18) 9.20% Ronald Baron................................................ 5,870,140(19) 29.40%
- -------- * Less than 1% of class. (1) Percentages are based on 19,963,190 shares outstanding on March 12, 1998 (the "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 183,051 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 1,805,920 shares owned by Bainum Associates Limited Partnership ("Bainum Associates") and 1,471,750 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; 1,189,290 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; 593,209 shares owned by Mid Pines Associates Limited Partnership ("Mid Pines"), in which Mr. Bainum, Jr. is managing general partner and has shared voting authority and 3,533 shares owned by the Foundation for Maryland's Future, in which Mr. Bainum, Jr. is the sole director. Also includes 86,401 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 Record Date, and 49 shares which Mr. Bainum, Jr. has the right to receive upon termination of his employment with Sunburst pursuant to the terms of the Non-Qualified Retirement Savings and Investment Plan ("Non- Qualified Savings Plan"). 7 (3) Includes 1,302,595 shares held directly by the Stewart Bainum Declaration of Trust, of which Mr. Bainum is the sole trustee and beneficiary, his joint interest in 259,848 shares owned by Bainum Associates and 345,284 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; 1,189,290 shares held directly by Realty, in which Mr. Bainum and his wife have shared voting authority; and 23,435 shares held by the Commonweal Foundation of which Mr. Bainum is Chairman of the Board of Directors and has shared voting authority. Also includes 266,237 shares held by the Jane L. Bainum Declaration of Trust, the sole trustee and beneficiary of which is Mr. Bainum's wife, and 1,221 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 Record Date. Also includes 829 shares of restricted stock granted under the Company's Non-Employee Director Stock Compensation Plan ("Non-Employee Director Stock Compensation Plan") to Mr. Bainum which are not vested but which Mr. Bainum has the right to vote. (4) Includes 214 shares held directly by Mr. DiRico and 421 shares and 937 shares, respectively, which Mr. DiRico has the right to receive upon termination of his employment pursuant to the terms of the Retirement Savings and Investment Plan ("401(k) Plan") and Non-Qualified Savings and Investment Plan ("Non-Qualified Plan"). Also includes 14,487 share which Mr. DiRico has the right to acquire pursuant to stock options which are currently exercisable or become exercisable upon 60 days of the Record Date. (5) In connection with the Spinoff, Mr. Floyd resigned from the Company on October 15, 1997. (6) Includes 9,597 shares held directly by Mr. Floyd and 18,993 shares of restricted stock granted pursuant to Mr. Floyd's employment agreement which are not yet vested, but which Mr. Floyd has the right to vote. Also includes 9,117 shares Mr. Floyd has the right to acquire pursuant to stock options which are presently exercisable or become exercisable within 60 days after the Record Date. (7) Includes 228 shares held directly by Mr. Gould and 752 shares of restricted stock granted under the Non-Employee Director Stock Compensation Plan to Mr. Gould which are not vested but which Mr. Gould has the right to vote. (8) Includes 66 shares held directly by Mr. Hanley and 756 shares Mr. Hanley has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after the Record Date. (9) Mr. Kubis resigned from the Company on December 31, 1997. (10) Consists of 7,973 shares Mr. Kubis has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after the Record Date. (11) Includes 2,000 shares owned directly by Mr. Landry; and 88 shares and 336 shares, respectively, which Mr. Landry has the right to receive upon termination of his employment pursuant to the terms of the 401(k) Plan and Non-Qualified Savings Plan. Also includes 109,781 shares Mr. Landry has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after the Record Date. (12) Includes 1,000 shares owned directly by Mr. MacCutcheon. Also includes 75 shares held by minor children. Beneficial ownership of such shares is disclaimed. Also includes 72,923 shares Mr. MacCutcheon has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after the Record Date. (13) Includes 747 shares held directly by Mr. Malek; 1,221 shares which Mr. Malek has the right to acquire pursuant to stock options which are presently exercisable or become exercisable within 60 days of the Record Date and 829 restricted shares granted under the Non-Employer Director Stock Compensation Plan which are not vested, but which Mr. Malek has the right to vote. (14) Consists of 1,611 restricted shares granted under the Non-Employer Director Stock Compensation Plan which are not vested, but which Mr. Pitts has the right to vote. 8 (15) Includes 1,750 restricted shares granted under the Non-Employer Director Stock Compensation Plan which are not vested, but which Ms. Prest has the right to vote. Also includes 3,028 shares Ms. Prest has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after the Record Date. (16) Includes a total of 296,185 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 Record Date, and a total of 509 shares and 1,322 shares, respectively, which such directors and officers have the right to receive upon termination of their employment with Sunburst pursuant to the terms of the 401(k) Plan and the Non-Qualified Savings Plan. (17) Includes 33,899 shares held directly by Ms. Bainum and 752 restricted shares granted under the Non-Employer Director Stock Compensation Plan which are not vested, but which Ms. Bainum has the right to vote. Also includes 593,209 shares owned by Mid Pines, in which Ms. Bainum is a general partner and has shared voting authority, 1,189,290 shares owned by Realty in which Ms. Bainum's trust has voting stock and shared voting authority and 23,435 shares owned by Commonweal Foundation, in which Ms. Bainum is a Director and has shared voting authority. Ms. Bainum's address is 8738 Colesville Road, Suite 800, Silver Spring, Maryland, 20910. (18) Includes 31,500 shares held directly by Mr. Bainum. Also includes 593,209 shares owned by Mid Pines, in which Ms. Bainum is a general partner and has shared voting authority, 1,189,290 shares owned by Realty in which Ms. Bainum's trust has voting stock and shared voting authority and 23,435 shares owned by Commonweal Foundation, in which Ms. Bainum is a Director and has shared voting authority. Mr. Bainum's address is 8738 Colesville Road, Suite 800, Silver Spring, Maryland, 20910. (19) As of October 16, 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. THE FOLLOWING COMPENSATION COMMITTEE REPORT AND THE PERFORMANCE GRAPH THAT APPEARS IMMEDIATELY AFTER SUCH REPORT SHALL NOT BE DEEMED TO BE SOLICITING MATERIAL OR TO BE FILED WITH THE SECURITIES AND EXCHANGE COMMISSION UNDER THE SECURITIES ACT OF 1933 OR THE SECURITIES EXCHANGE ACT OF 1934 OR INCORPORATED BY REFERENCE IN ANY DOCUMENT SO FILED. BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION There are currently two compensation committees for the Company, the Compensation/Key Executive Stock Option Plan Committee and the Compensation/Key Executive Stock Option Plan Committee No. 2 ("Committee No. 2") (collectively, the "Committee"). The role of Committee No. 2, which is comprised of "outside directors" as defined in Section 162(m)(3) of the Code, is to approve awards under the 1996 Long-Term Incentive Plan to the Chief Executive Officer and the executive officers, including the Named Officers defined below. Of the current members of the Committee, Messrs. Malek (Chairman) and Bainum (not a member of Committee No. 2), were appointed on November 4, 1996. Mr. Bainum, Jr. (not a member of Committee No. 2) was appointed upon the Spinoff and Mr. Pitts was appointed on November 13, 1997. Prior to the Spinoff, the committees were comprised of Messrs. Malek and Bainum (not a member of Committee No. 2) and Barbara Bainum and Jerry E. Robertson. In connection with the Spinoff, Ms. Bainum and Mr. Robertson resigned from the Board of Directors. The following philosophy and principles have been set forth as a framework within which the Committee will operate. COMPENSATION COMMITTEE PHILOSOPHY AND GUIDING PRINCIPLES .Attract and retain talented management; 9 . Closely align management's interests and actions with those of shareholders through the establishment of appropriate award vehicles; . Reward employees for enhancing shareholder value through sustained improvement in operating cash flow and earnings per share; . Position base pay at market so that the Company can vary total compensation costs with financial results by means of variable pay; and . Recognize the concept that executive officers individually, and as a group, should have a significant ownership stake in the Company. EXECUTIVE COMPENSATION POLICIES Compensation Levels The Committee relates total compensation levels for the Company's executive officers to the total compensation paid to similarly situated executives based on various independently published compensation surveys, primarily conducted and evaluated by independent consultants. Summary data on companies of similar size in the service sector are used as the primary comparison and companies in the hotel industry are used as a secondary comparison. Compensation for the executive officers was set in June 1997, prior to the Spinoff, and from January 1, 1997 until the Spinoff, the current Vice Chairman and Chief Executive Officer ("CEO") was serving and President and Chief Operating Officer. Because of this, one set of secondary comparison companies was used for the executive officers as a group and a second set was used for compensation to be paid to the Vice Chairman and CEO upon the Spinoff. Total compensation is targeted to approximate the median of the competitive market data and comparison companies. However, because of the performance- oriented nature of the incentive programs, total compensation may exceed market norms when the Company's targeted performance goals are exceeded. Similarly, total compensation may lag the market when performance goals are not achieved. For the twelves months ended December 31, 1997, compensation for the Vice Chairman and CEO and for the Executive Vice President and Chief Financial Officer was slightly above the primary survey data but was consistent with the secondary comparison companies. The compensation for all of the other executive officers, as a group, was approximately at the median. One of the companies in the general secondary comparison, Marriott International, Inc., and one of the companies in the CEO specific secondary comparison, Starwood Hotels and Resorts Worldwide, Inc. were not included in as part of the Peer Group Index (defined below) for the performance graph. Marriott was included in the comparison because it is located in the Washington, D.C. metropolitan area and, at the time, the Company was also engaged in the franchising business. However, since the Spinoff, the Company is no longer engaged in the franchising business. The Starwood comparison compensation information was from 1996 and at that time, Starwood had a profile similar to the expected profile of the Company after the Spinoff. However, Starwood's growth in hotel portfolio and market capitalization since that time no longer make it an appropriate comparison for performance purposes. Policy with Respect to Qualifying Compensation for Deductibility The Company's policy with respect to the deductibility limit of Section 162(m) of the Internal Revenue Code generally is to preserve the federal income tax deductibility of compensation paid when it is appropriate and is in the best interests of the Company and its stockholders. However, the Company reserves the right to authorize the payment of nondeductible compensation if it deems that is appropriate. The Committee intends to monitor the Company's compensation programs with respect to such laws. 10 Annual Compensation The base salary pay practice is to target at the 55th percentile of the market range among the comparison groups for a particular position and to adjust as appropriate for experience and performance. Awards under the annual cash bonus program for the twelve months ended December 31, 1997 were based on certain performance measurements, which were based 60% on achieving targeted gross operating profits, 20% on customer satisfaction goals and 20% on RevPAR. For the twelve months ended December 31, 1997, actual performance exceeded the measurement goals for each component. For fiscal year 1998, the Committee has proposed revising the performance measurements to focus heavily on management's responsibility to deliver increased operating cash flow and earnings per share based on earnings per share from continuing operations at established annual targets. For executive officers other than the Chief Executive Officer, the proposal also includes specific performance measurements directly accountable to the executive officer. These performance measurements, where applicable, would include customer satisfaction and RevPAR and would incorporate each executive officer's accountability for the successful execution of key initiatives tied to achievement of the Company's strategic plan. LONG-TERM INCENTIVES The Company will award long-term incentives under the 1996 Incentive Plan. The plan gives the Compensation Committee the latitude of awarding Incentive Stock Options, non-qualified stock options, restricted stock, and other types of long-term incentive awards. The recommended awards were developed by analyzing peer group average market data and the Company's past practice. In June 1997, the Compensation Committee approved a Stock Option Guide Chart for the Company's executives. The Stock Option Guide Chart was reviewed and revised in February 1998. It utilizes a market based salary multiple to establish a competitive range of stock options from which executive awards can be determined. In accordance with common competitive practice, some of the stock option grants to Company executive officers in the twelve months ended December 31, 1997 by the Compensation Committee prior to the Spinoff were larger than competitive annual grants in contemplation of the Spinoff. COMPENSATION OF THE CHIEF EXECUTIVE OFFICER Donald J. Landry was appointed CEO upon consummation of the Spinoff on October 15, 1997. Prior to that time, William R. Floyd was the Chief Executive Officer of the Company and Mr. Landry served as the President and Chief Operating Officer. The Compensation Committee approved an employment agreement with Mr. Landry which became effective upon the Spinoff. The terms of the agreement are described below under "Executive Compensation--Employment Agreements." In setting the base compensation for Mr. Landry under the Employment Agreement, the Board of Directors deliberations included consideration of Mr. Floyd's base compensation as well as Mr. Landry's compensation in his prior role of President and Chief Operating Officer. THE COMPENSATION COMMITTEE Frederic V. Malek, Chairman Stewart Bainum (not a member of Committee No. 2) Stewart Bainum, Jr. (not a member of Committee No. 2) Keith B. Pitts 11 PERFORMANCE GRAPH The following graph compares the performance of Sunburst common stock with the performance of the New York Stock Exchange Composite Index ("NYSE Composite Index") and a peer group index (the "Peer Group Index") by measuring the changes in common stock prices from November 4, 1996, (the first day of regular way trading) plus assumed reinvested dividends. The Commission's rules require that the Company select a peer group in good faith with which to compare its stock performance by selecting a group of companies in lines of business similar to its own. Accordingly, the Company has selected a peer group that includes companies which are actively traded on the New York Stock Exchange and the NASDAQ Stock Market and which are in the hospitality industry. The common stock of the following companies have been included in the Peer Group Index: Bristol Hotel Company, LaQuinta Hotel Corporation, Prime Hospitality Corp., Red Roof Inns, Inc., CapStar Hotel Company and Servico Inc. The graph assumes that $100 was invested on November 4, 1996, in each of Sunburst common stock, the NYSE Composite Index and the Peer Group Index, and that all dividends were reinvested. In addition, the graph weighs the constituent companies on the basis of their respective capitalization, measured at the beginning of each relevant time period. Comparison of Cumulative Return Among Sunburst, NYSE Composite Index and Peer Group [LINE GRAPH APPEARS HERE] November 4, December 31, June 30, December 31, 1996 1996 1997 1997 ----------- ------------ -------- ------------ Sunburst 100 108.5 104.2 122.6 NYSE Composite Index 100 105.3 124.9 139.9 Peer Group 100 100.0 121.2 119.4 12 EXECUTIVE COMPENSATION Compensation received by the Named Officers prior to consummation of the Manor Care Spinoff was paid by Manor Care. Compensation received by the Named Officers after the Manor Care Spinoff was paid by the Company. SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION(1) LONG-TERM COMPENSATION ---------------------------------- -------------------------- RESTRICTED FISCAL STOCK STOCK OPTION ALL OTHER NAME AND PRINCIPAL POSITION YEAR(1) SALARY BONUS OTHER AWARDS($) SHARES(#)(2) COMPENSATION(3) - --------------------------- ------- -------- -------- -------- ---------- ------------ --------------- Stewart Bainum, Jr. (4).................... 1997A $148,310 $ 47,683 (5) -- -- -- Chairman 1997B 656,357 388,520 (5) -- 60,000(6) -- 1996 625,102 337,555 (5) -- 60,000(7) $ 33,543 Donald J. Landry (8).... 1997A 421,975 200,508 106,000(9) 6,035 Vice Chairman and 1997B 404,250 200,508 (5) -- 100,000(10) 6,035 Chief Executive Officer 1996 366,702 201,686 (5) -- -- 5,000 James A. MacCutcheon (11)................... 1997A 312,900 52,263 46,500(12) 18,682 Executive Vice President, 1997B 313,578 158,953 (5) -- 67,500(13) 18,682 Chief Financial Officer 1996 301,517 135,682 (5) -- 25,000(14) 13,176 & Treasurer Antonio DiRico.......... 1997A 259,499 86,524 80,600(15) 3,043 President 1997B 196,200 86,584 (5) -- 25,000(16) 3,043 1996 179,904 71,961 (5) -- 80,000(17) 2,225 Kevin P. Hanley......... 1997A 174,999 84,452 (5) -- 51,200(18) -- 1997B 144,890 51,776 (5) -- 2,727(19) -- 1996 130,208 1,500 (5) -- -- -- William R. Floyd (20)... 1997A 371,875 267,233 $139,403(21) -- 65,000(22) -- 1997 B 270,373 146,001 107,833(23) $250,000(24) 307,693(25) -- 1996 -- -- -- -- -- -- Edward A. Kubis (26).... 1997A 139,539 55,890 (5) -- 18,000(27) 6,300 1997B 138,000 24,830 (5) -- 15,000(28) 6,300 1996 110,584 -- (5) -- 5,000(29) --
(1) On September 16, 1997, the Company changed its fiscal year end from May 31 to December 31. Accordingly, the summary compensation information presented is for the twelve months ended December 31, 1997 ("1997A"), the fiscal year ended May 31, 1997 ("1997B") and the fiscal year ended May 31, 1996 ("1996"). Summary compensation data paid to the Named Officers during the period between January 1, 1997 and May 31, 1997 are reflected in each of the 1997A and 1997B periods. (2) For all of the Named Officers, except for Messrs. MacCutcheon and Floyd, the grants in 1997B and 1996 represent options to purchase shares of Manor Care common stock. In connection with the Manor Care Spinoff, the options to purchase Manor Care common stock were converted, in some cases 100%, to options to purchase Company common stock. For Messrs. MacCutcheon and Floyd with respect to grants in 1997B and or all of the Named Officers with respect to grants in 1997A, represents options to acquire shares of Company common stock. In connection with the Spinoff, the options to purchase Company common stock were converted to successor options to purchase Company common stock and New 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 Spinoff and the Spinoff. (3) Represents amounts contributed by Manor Care for 1996 and the Company 1997A and 1997B under their respective 401(k) Plan and Non-Qualified Savings Plan, which provide retirement and other benefits to eligible employees, including the Named Officers. The value of the amounts contributed in stock by the Company for 1997A and 1997B under the 401(k) Plan and Non-qualified Savings Plan, respectively, for 13 the Named Offices were as follows: Mr. Landry, $2,375 and $3,660; Mr. MacCutcheon, $6,240 and $12,443; Mr. DiRico, $966 and $2,077; and Mr. Kubis, $2,520 and $3,780. (4) For part of 1997B and all of 1996, Mr. Bainum, Jr. was the Chairman and Chief Executive Officer of Manor Care and the Company. In November, 1996, he resigned as Chief Executive Officer of the Company. The compensation reflected here for 1997B and 1996 is the total compensation received for services rendered to both Manor Care and Company. For 1997A, represents the amount of compensation paid solely by the Company. (5) The value of perquisites and other compensation does not exceed the lesser of $50,000 or 10% of the amount of annual salary and bonus paid as to any of the Named Officers. (6) In connection with the Spinoff, these options were converted on a pro rata basis into options to acquire 20,000 shares of Company common stock at an exercise price of $7.1894 and 60,000 shares of New Choice at an exercise price of $12.1130. (7) In connection with the Spinoff, these options were converted on a pro rata basis into options to acquire 20,000 shares of Company common stock at an exercise price of $5.5083 and 60,000 shares of New Choice at an exercise price of $9.2807. (8) Mr. Landry was appointed Vice Chairman and Chief Executive Officer upon the Spinoff. Prior to the Spinoff, he was President of the Company. (9) In connection with the Spinoff, these options were converted into options to purchase 124,631 shares of Company common stock at an exercise price of $7.8815 and 53,000 shares of New Choice common stock at an exercise price of $13.2791. (10) In connection with the Spinoff, these options were converted into options to purchase 291,795 shares of Company common stock at an exercise price of $7.1894 and 153,497 shares of New Choice common stock at an exercise price of $12.113. (11) For 1996 and part of 1997B, Mr. MacCutcheon was Senior Vice President, Chief Financial Officer and Treasurer of Manor Care and the Company. On November 1, 1996, Mr. MacCutcheon resigned from Manor Care and assumed the position of Executive Vice President, Chief Financial Officer and Treasurer of the Company. The compensation reflected for 1996 and 1997B is total compensation received for services rendered to both Manor Care and the Company. For the period of 1997B after the Manor Care Spinoff, the amount of compensation paid solely by the Company was $209,052 for salary and $103,690 for bonus. In connection with the Spinoff, the Company and New Choice entered into a Consulting Agreement whereby New Choice would reimburse the Company for 30% of Mr. MacCutcheon's base salary and bonus from October 15, 1997 through November 1, 2001. See "Certain Relationships and Related Transactions." (12) In connection with the Spinoff, these options were converted into options to purchase 54,673 shares of Company common stock at an exercise price of $7.835 and 23,250 shares of New Choice common stock at an exercise price of $13.2008. (13) In connection with the Spinoff, these options were converted into options to purchase 138,806 shares of Company common stock at an exercise price of $6.884, 47,082 shares of Company common stock at an exercise price of $7.1894, 30,308 shares of New Choice at an exercise price of $11.5986 and 15,642 shares of New Choice common stock at an exercise price of $12.113. (14) In connection with the Spinoff, these options were converted into options to purchase 59,035 shares of Company common stock at an exercise price of $5.083 and 24,976 shares of New Choice common stock at an exercise price of $9.2807. (15) In connection with the Spinoff, these options were converted into options to purchase 111,739 shares of Company common stock at an exercise price of $7.835 and 30,225 shares of New Choice common stock at an exercise price of $13.2008. (16) In connection with the Spinoff, these options were converted into options to purchase 82,498 shares of Company common stock at an exercise price of $7.1894 and 32,706 shares of New Choice common stock at an exercise price of $12.113. (17) In connection with the Spinoff, these options were converted into options to purchase 22,543 shares of Company common stock at an exercise price of $5.5083 and 12,747 shares of New Choice common stock at an exercise price of $9.2807. 14 (18) In connection with the Spinoff, these options were converted into options to purchase 70,981 shares of Company common stock at an exercise price of $7.835 and 19,200 shares of New Choice common stock at an exercise price of $13.2008. (19) In connection with the Spinoff, these options were converted into options to purchase 3,779 shares of Company common stock at an exercise price of $7.1894 and 1,024 shares of New Choice common stock at an exercise price of $12.113. (20) Mr. Floyd was employed as Vice Chairman and Chief Executive Officer of the Company from October 16, 1996 until the Spinoff. In connection with the Spinoff, Mr. Floyd resigned from the Company and was appointed Chief Executive Officer of New Choice. (21) Consists of relocation expenses and $11,700 in automobile allowance. Includes $107,831 in relocation expenses reported for 1997B. (22) In connection with the Spinoff, these options were converted into options to purchase 10,883 shares of Company common stock at an exercise price of $9.786 and 71,631 shares of New Choice common stock at an exercise price of $16.488. (23) Consists of relocation expenses. (24) Represents a grant of 85,470 shares of restricted shares of the Company granted on November 4, 1996. The shares vest in three equal annual installments beginning on November 4, 1997. The restricted shares are entitled to dividends and in connection with the Spinoff, Mr. Floyd received 85,470 shares of New Choice common stock as a dividend on such shares of Company common stock, of which 56,980 shares remain unvested. In connection with the one-for-three reverse stock split, the Company shares were converted into 28,490 shares of Company common stock. (25) In connection with the Spinoff, these options were converted into options to purchase 45,584 shares of Company common stock at an exercise price of $7.2466 and 341,515 shares of New Choice common stock at an exercise price of $12.2095. (26) Mr. Kubis resigned from the Company on December 31, 1997. (27) In connection with the Spinoff, these options were converted into options to purchase 24,954 shares of Company common stock at an exercise price of $7.835 and 6,750 shares of New Choice common stock at an exercise price of $13.2008. (28) In connection with the Spinoff, these options were converted into options to purchase 40,356 shares of Company common stock at an exercise price of $7.1894 and 13,407 shares of New Choice common stock at an exercise price of $12.113. (29) In connection with the Spinoff, these options were converted into options to purchase 11,806 shares of Company common stock at an exercise price of $5.5083 and 4,669 shares of New Choice common stock at an exercise price of $9.2887. Stock Options. The following tables set forth certain information at December 31, 1997 and for the twelve months then ended concerning options to purchase Company common stock granted to Named Officers. All common stock figures and exercise prices have been adjusted to reflect stock dividends and stock splits effective in prior fiscal years. With the Spinoff, existing Company stock options were subject to certain adjustments or conversions into options to purchase shares of Company common stock and New Choice common stock. The table below represents the options grants on a post-conversion basis. 15 STOCK OPTION GRANTS IN 1997
POTENTIAL REALIZABLE VALUE OF ASSUMED RATE OF STOCK PRICE APPRECIATION FOR INDIVIDUAL GRANTS OPTION TERM(2) ------------------------------------------------ --------------------- PERCENTAGE OF TOTAL OPTIONS NUMBER OF GRANTED TO ALL EXERCISE OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION NAME COMPANY* GRANTED 1997 PER SHARE DATE 5%(3) 10%(4) ---- -------- --------- -------------- ---------- ---------- --------- ----------- Stewart Bainum, Jr...... SNB 0 -- -- -- -- -- CHH 0 -- -- -- -- -- ------- Total 0 Donald J. Landry(5)..... SNB 124,631 21.92%(6) $ 7.8815 6/25/07 $ 617,746 $ 1,565,502 CHH 53,000 (7) $13.2791 6/25/07 442,613 1,121,665 ------- Total 177,631 James A. MacCutcheon(5)......... SNB 54,673 9.62%(6) $ 7.8350 6/24/07 269,395 682,701 CHH 23,250 (7) $13.2008 6/24/07 193,019 489,149 ------- Total 77,923 Antonio DiRico(5)....... SNB 111,739 19.65%(6) $ 7.835 6/24/07 551,253 1,395,284 CHH 30,225 (7) $13.2008 6/24/07 250,924 635,894 ------- Total 141,964 Kevin P. Hanley......... SNB 70,981 12.49%(6) $ 7.835 6/24/07 349,751 886,339 CHH 19,200 (7) $13.2008 6/24/07 159,396 403,943 ------- Total 90,181 William R. Floyd(5)..... SNB 10,833 1.91%(6) $ 9.786 9/16/07 168,955 66,670 CHH 71,431 (7) $ 16.488 9/16/07 740,682 1,114,066 ------- Total 82,264 Edward A. Kubis(5)...... SNB 24,954(8) 4.39%(6) $ 7.835 6/24/07 123,108 311,600 CHH 6,750(8) (7) $13.2008 6/24/07 56,037 142,011 ------- Total 31,704
- -------- * References to SNB are to the Company and CHH are to New Choice. (1) Options granted to the named officers were granted prior to the Spinoff. In connection with the Spinoff, these options were converted to successor options to purchase Company common stock and New Choice common stock. In all cases, however, the number of options and the exercise prices were adjusted to maintain the same financial value to the option holder before and after the Spinoff. The number of options set forth in the table represent the number Company and New Choice 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 $9.786 per share yields $15.9404, from $16.488 per share yields $26.8572, from $7.8815 per share yields $12.8381, from $13.2791 per share yields $21.6303, from $7.835 per share yields $12.7684, and from $13.2008 per share yields $21.5027. (4) A 10% per year appreciation in stock price from $9.786 per share yields $25.3824, from $16.488 per share yields $42,7656, from $7.8815 per share yields $20.4426, from $13.2791 per share yields $34.4426, from $7.835 per share yields $20.322, and from $13.2008 per share yields $34.2395. (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) The options presented in this table are presented post-Spinoff and, therefore, the percentages relate to the total number of Company options granted in 1997 on a post-Spinoff conversion basis. Since the actual 16 option grants occurred prior to the Spinoff and related conversion, the percentage presented is not equivalent to the percentage if calculated on a pre-Spinoff basis. (7) In the twelve months ended December 31, 1997, New Choice only granted options to two individuals for a total of 120,000 options granted. All other outstanding New Choice options (including those listed in this table) were issued in connection with the conversion of Company options in the Spinoff. (8) These grants lapsed upon Mr. Kubis' resignation from the Company. AGGREGATED OPTION EXERCISES IN 1997 AND YEAR-END OPTION VALUES
NUMBER OF UNEXERCISED OPTIONS AT SHARES DECEMBER 31, 1997 VALUE OF UNEXERCISED ACQUIRED VALUE ------------------------- IN-THE-MONEY OPTIONS NAME COMPANY* ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE AT DECEMBER 31, 1997(1) - ---- -------- ----------- ---------- ----------- ------------- ------------------------- # $ # # EXERCISABLE UNEXERCISABLE ----------- ---------- ----------- ------------- ----------- ------------- Stewart Bainum, Jr. .... SNB 46,500(3) $3,705,452 101,000 52,334 $ 750,906 $ 254,990 CHH -- -- 303,000 157,000 3,602,207 1,188,693 Donald J. Landry........ SNB -- -- 42,462 789,105 192,559 3,348,905 CHH -- -- 251,197 313,105 2,221,843 2,098,091 James A. MacCutcheon.... SNB -- -- 72,923 369,076 470,259 1,445,011 CHH -- -- 256,699 133,252 2,861,047 814,798 Antonio DiRico.......... SNB -- -- 14,487 226,338 246,129 912,798 CHH -- -- 29,617 64,454 189,482 279,579 Kevin P. Hanley......... SNB -- -- 756 74,004 2,030 152,920 CHH -- -- 205 20,019 797 56,929 William R. Floyd........ SNB -- -- 9,117 47,300 23,963 96,815 CHH -- -- 68,303 334,643 258,902 1,000,752 Edward A. Kubis......... SNB -- -- 7,973 52,952 29,418 181,122 CHH -- -- 9,775 13,744 56,633 76,341
- -------- * References to "SNB" are to the Company and "CHH" are to New Choice. (1) Options granted to the named employees were granted prior to the Spinoff. In connection with the Spinoff, these options were converted to options to purchase Company common stock and New 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 Spinoff. The number of options set forth in the table represent the number Company and New Choice options and the adjusted exercise prices after the conversion. (2) The closing prices of Company common stock and New Choice's common stock as reported by the New York Stock Exchange on December 31, 1997 were $9.875 and $16.00, respectively. The value is calculated on the basis of the difference between the option exercise price and such closing price multiplied by the number of shares of Company common stock or New Choice's common stock underlying the option. (3) These exercises occurred prior to the Spinoff and therefore involved the exercise of Company common stock before the distribution and the one-for- three reverse stock split. 17 EMPLOYMENT AGREEMENTS AND CHANGE IN CONTROL ARRANGEMENTS On October 15, 1997, the Company amended and restated an employment agreement with Stewart Bainum, Jr., providing for Mr. Bainum, Jr.'s employment as Chairman of the Company's Board of Directors. The agreement has a term of three years. Either the Company 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 provides that Mr. Bainum, Jr. devote 12.5% of his professional time to the Company's affairs, 12.5% of his professional time to the affairs of the Company, 12.5% to New 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 the Company and a maximum bonus of 60% of Mr. Bainum, Jr.'s base compensation based upon the performance of the Company. The Company entered into an Employment Agreement with Donald J. Landry on June 25, 1997, effective upon the Spinoff on October 15, 1997. The agreement has a term of three years from October 15, 1997 and provides for a base salary of $424,462 per annum, subject to annual adjustments, and an annual bonus of up to 60% of his base compensation, based upon the Company's performance. The agreement also provides for an award of options to acquire 106,000 shares of the Company's common stock, granted on June 25, 1997. The stock options vest in five equal annual installments beginning on June 25, 1998. In connection with the Spinoff, these options were converted into 124,631 options to acquire Sunburst common stock and 53,000 options to acquire New Choice common stock. The Company entered into an Employment Agreement with James A. MacCutcheon on October 31, 1996, effective November 1, 1996. The agreement has a term of five years and provides for a base salary of $313,578 per annum, subject to annual adjustments, and an annual bonus of up to 55% of his base compensation, based upon the Company's performance. In February 1998, the Board of Directors approved an amendment to the 1996 Incentive Plan which provides for accelerated vesting of all outstanding options and restricted stock grants if a participant is terminated as a result of involuntary termination other than for Cause, or voluntary termination for Good Reason (as such terms are defined in the 1996 Incentive Plan) within twelve months of certain events defined in the 1996 Incentive Plan as a Change in Control of the Company. RETIREMENT PLANS The Company has adopted the Sunburst Hospitality Corporation Supplemental Executive Retirement Plan (the "SERP"). Participants are Senior Vice Presidents and other officers who selected by the Board of Directors to participate. Participants in the SERP receive a monthly benefit for life based upon final average salary and years of service. Final average salary is the average of the monthly base salary, excluding bonuses or commissions, earned in a 60 month period which produces the highest average out of the 120 months of employment, prior to the first occurring of the early retirement date or the normal retirement date. The nominal retirement age is 65, and participants must have a minimum of 15 years of service. Participants may retire at age 60 and may elect to receive reduced benefits commencing prior to age 65, subject to Board approval. All of the Named Officers who are participants are age 55 or younger, so that none of their compensation reported above would be included in the final average salary calculation. Assuming that the following officers continue to be employed by the Company until they reach age 65, their credited years of service are as follows:
CURRENT YEARS YEARS OF SERVICE AT NAME OF INDIVIDUAL OF SERVICE AGE 65 ------------------ ------------- ------------------- Donald J. Landry........................... 6 22 James A. MacCutcheon....................... 10 30
18 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
REMUNERATION 25 OR MORE/30% 15/15% 20/22.5% - ------------ -------- -------- $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
In November 1996, the Company established the Sunburst Hospitality Corporation Retirement Savings and Investment Plan (the "401(k) Plan"). The 401(k) Plan is a defined contribution retirement, savings and investment plan qualified under Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), and includes a cash or deferred arrangement under Section 401(k) of the Code. All employees age 21 or over and who have worked for the Company for a twelve month period during which such employee completed at least 1,000 hours will be eligible to participate. Subject to certain non- discrimination requirements, each employee will be able to contribute an amount to the 401(k) Plan on a pre-tax basis up to 15% of the employee's salary, but not more than the current Federal limit of $10,000. The Company will match contributions made by its employees subject to certain limitations. The amount of the match will be equal to a percentage of the amount of salary reduction contribution made on behalf of a participant during the plan year based upon a formula that involves the profits of the Company for the year and the number of years of service of the participant. Amounts contributed by the Company pursuant to its 401(k) Plan for Named Officers are included in the Summary Compensation Table under the column headed "All Other Compensation." The Company also adopted the Sunburst Hospitality Corporation Non-Qualified Retirement Savings and Investment Plan ("Non-Qualified Savings Plan"). Certain select highly compensated members of management of the Company will be eligible to participate in the Non-Qualified Savings Plan. The Non-Qualified Savings Plan is structured so as to provide the participants with a pre-tax savings vehicle to the extent that pre-tax savings are limited under the 401(k) Plan as a result of various governmental regulations, such as non- discrimination testing. Amounts contributed by the Company under its Non- Qualified Savings Plan for fiscal year 1997 for the Named Officers are included in the Summary Compensation Table under the column headed "All Other Compensation." The Company match under the 401(k) Plan and the Non-Qualified Savings Plan is limited to a maximum aggregate of 6% of the annual salary of a participant. Likewise, participant contributions under the two plans will not exceed the aggregate of 15% of the annual salary of a participant. PROPOSAL TO AMEND THE 1996 LONG-TERM INCENTIVE PLAN (ITEM 2 ON PROXY CARD) General On October 11, 1996, the Board of Directors adopted the 1996 Long-Term Incentive Plan (the "1996 Incentive Plan") for key employees (including officers) of the Company and its subsidiaries subject to approval of the 1996 Incentive Plan by the affirmative vote of the holders of a majority of the number of shares of Company common stock. Such shareholder approval was received at the 1997 Annual Meeting of Shareholders. The types of awards that may be granted under the 1996 Incentive Plan are restricted shares, incentive stock options, nonqualified stock options, stock appreciation rights and performance shares. 19 The 1996 Incentive Plan originally authorized the awarding of a maximum of 7.1 million shares of Company common stock to eligible employees. Because of the Company's one-for-three reverse stock split on October 15, 1997, the 7.1 million shares was converted to 2.36 million shares. Effects of Spinoffs and Reverse Stock Split The initial authorization of 7.1 million shares eligible under the 1996 Incentive Plan was intended to be a sufficient number of shares to cover grants under the 1996 Incentive Plan for the next five to ten years. The grant by the Company of 1,038,454 awards from November 1996 to the Spinoff in October 1997 was consistent with this belief. However, this calculation did not fully anticipate the impact of the Manor Care Spinoff and the Spinoff. In the Manor Care Spinoff, existing Manor Care options held by employees of the Company, as well as by a small number of Manor Care employees, were converted into successor Manor Care and Company options. These successor Company options were deemed to be issued out of the 7.1 million authorized shares under the 1996 Incentive Plan. Likewise, in the Spinoff, Company options were converted into successor New Choice options and Company options. In many instances, the conversion required an increase in the number of an optionee's grant of Company options in order to maintain the same financial value of the options before and after the Spinoff. To the extent that the number of successor Company options outstanding after the Spinoff was greater than the number of Company options outstanding before the Spinoff, this difference was also deemed to have been issued out of the original number of authorized shares (which is now 2.36 million because of the one-for-three reverse stock split). These conversions of Company options in each of the spinoffs has resulted in a depletion of the authorized shares under the 1996 Incentive Plan. Proposed Amendment On February 4, 1998, the Board of Directors approved an amendment to Section 5 of the 1996 Incentive Plan to increase the number of authorized share by 1.2 million shares. Pursuant to the requirements of the New York Stock Exchange, the amendment is subject to shareholder approval. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE PROPOSAL TO APPROVE THE AMENDMENT TO SECTION 5 OF THE 1996 INCENTIVE PLAN TO INCREASE THE AUTHORIZED NUMBER OF SHARES AVAILABLE UNDER THE 1996 INCENTIVE PLAN BY 1.2 MILLION SHARES. Proxies solicited by the Board of Directors will be voted "FOR" this proposal, unless otherwise instructed on the proxy card. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS RELATIONSHIP WITH MANOR CARE Stewart Bainum, Jr. is the Chairman of the Company's Board of Directors and is also the Chairman of the Board of Directors and Chief Executive Officer of Manor Care. Additionally, Stewart Bainum is a Director of the Company and of Manor Care. Additionally, Messrs. Bainum and Bainum Jr., as well as certain other officers and directors of the Company and of Manor Care own shares and/or options or other rights to acquire shares of each of the Company and Manor Care. Manor Care Lease Agreements In connection with the Manor Care Spinoff, the Company and Manor Care entered into a lease agreement with respect to the complex at 10750 and 10770 Columbia Pike, Silver Spring, Maryland (the "Silver Spring Complex") at which the Company's principal executive offices were located (the "Silver Spring Lease"). After the Spinoff, the Company remained obligated under the Silver Spring Lease and has subleased the space at 10750 Columbia Pike to New Choice pursuant to a sublease. The Company leases from Manor Care for a period of 30 20 months certain office space (approximately 30% of the Silver Spring Complex initially, including the space subleased to New Choice), with provisions to allow the Company to use additional square footage as needed at a monthly rental rate equal to one-twelfth of the operating expenses (as defined therein) of the Silver Spring Complex net of third party rental income paid to Manor Care by other tenants of the complex, less a pro rata portion of the operating expenses attributable to the space occupied by Manor Care (initially approximately 29% of the Silver Spring Complex). At the beginning of each fiscal year following November 1, 1996 (the date of the Manor Care Spinoff), Manor Care's occupancy percentage is redetermined. Currently, Manor Care is not occupying any space at the Silver Spring Complex. Operating expenses include all of the costs associated with operating and maintaining the complex including, without limitation, supplies and materials used to maintain the complex, wages and salaries of employees who operate the complex, insurance for the complex, costs of repairs and capital improvements to the complex, the fees of the property manager (which may be Manor Care), costs and expenses associated with leasing space at the complex and renovating space rented to tenants, costs of environmental inspection, testing or cleanup, principal and interest payable on indebtedness secured by mortgages against the complex, or any portion thereof, and charges for utilities, taxes and facilities services. The Company and Manor Care also entered into (i) a sublease agreement with respect to certain office space in Gaithersburg, Maryland (the "Gaithersburg Lease") pursuant to which the Company is obligated to rent from Manor Care, on terms similar to the Silver Spring Lease, certain additional space as such space becomes available during the 30 month period following the date of the Manor Care Spinoff and (ii) a sublease agreement with respect to the Comfort Inn N.W., Pikesville, Maryland, pursuant to which the Company subleases the property from Manor Care on the same terms and conditions that govern Manor Care's rights and interests under the lease relating to such property. During the twelve month period ended December 31, 1997, the Company paid to Manor Care under the Gaithersburg Lease and the Silver Spring Lease approximately $4.7 million. The Manor Care Loan Agreement On November 1, 1996, the Company and a subsidiary of Manor Care entered into a loan agreement (the "Loan Agreement"), governing the repayment by the Company of an aggregate of $225.7 million previously advanced to the Company by Manor Care. Prepayments made on or before November 1, 1997 resulted in a prepayment penalty equal to the difference between the stated interest rate and the annualized interest rate on a U.S. Treasury Note for a relevant period until November 1, 1997. Prepayments made after November 1, 1997 do not result in a penalty. On April 23, 1997, the Company, through its wholly owned subsidiary First Choice Properties, completed an offering of mortgage securities. The net proceeds of $110 million from the offering were used to prepay a portion of the loan. A total yield maintenance payment of $1.9 million was made to Manor Care as a result of the prepayment. The Company repaid the remaining portion of the loan at the time of the Spinoff with the proceeds from a Term Note with New Choice (described below) and advances from the Company's credit facility. Corporate Services Agreement The Company and Manor Care entered into the Corporate Services Agreement (the "Corporate Services Agreement") which provides for the provision, by Manor Care, of certain corporate services, including administrative, accounting, systems and, for a fixed annual fee of $1.0 million, certain consulting services. The term of the Consulting Services Agreement is 30 months from November 1, 1996. Time Sharing Agreement On October 10, 1996, the Company entered into a Time Sharing Agreement with Manor Care under which the Company has the right to use from time to time a Cessna Citation III and a Cessna Conquest I owned by Manor Care. The agreement has term of one year with automatic renewals unless otherwise terminated. In 21 January 1998, Manor Care gave notice that it was terminating the Time Share Agreement. During the twelve month period ended December 31, 1997 the Company incurred a total of $176,948 for aircraft usage pursuant to the agreement. RELATIONSHIP WITH NEW CHOICE In connection with the Spinoff, the Company and New Choice entered into certain agreements intended to govern the relationship between the parties after the Spinoff. In addition, the Company is New Choice's largest franchisee. The material terms of certain of these agreements and other arrangements, entered into between the Company and New Choice, including the franchise agreements with respect to the Company's hotels, are described below. Distribution Agreement In connection with the Spinoff, the Company and New Choice entered into a Distribution Agreement which provided for, among other things, the principal corporate transactions required to effect the Spinoff, the assumption by New Choice of all liabilities relating to its business and the allocation between the Company and New Choice of certain other liabilities, certain indemnification obligations of the Company and New Choice and certain other agreements governing the relationship between the Company and New Choice with respect to or in consequence of the Spinoff. Subject to certain exceptions, New Choice has agreed to indemnify the Company and its subsidiaries against any loss, liability or expense incurred or suffered by the Company or its subsidiaries arising out of or related to the failure by New Choice to perform or otherwise discharge liabilities allocated to and assumed by New Choice under the Distribution Agreement, and the Company has agreed to indemnify New Choice against any loss, liability or expense incurred or suffered by New Choice arising out of or related to the failure by the Company to perform or otherwise discharge the liabilities retained by the Company under the Distribution Agreement. The foregoing cross- indemnities do not apply to indemnification for tax claims and liabilities, which are addressed in the Tax Sharing Agreement described below. To avoid adversely affecting the intended tax consequences of the Spinoff, each of New Choice and the Company 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 New Choice and the Company in connection with the Spinoff. Under the Distribution Agreement, each of New Choice and the Company 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 New Choice and the Company to obtain the consent of the other prior to waiving any shared privilege. As of December 31, 1997, the Company owed New Choice approximately $25 million, of which approximately $15 million represents a net equity adjustment payment required under the terms of the Distribution Agreement. The Company and New Choice have agreed that the Company will pay this amount on or before December 31, 1998. The remainder of the amount owed to New Choice represents the reimbursement of various expenses incurred subsequent to the Spinoff. The Company paid $7.5 million of this indebtedness in March 1998. Strategic Alliance Agreement At the time of the Spinoff, New Choice and the Company entered into a Strategic Alliance Agreement pursuant to which: (i) the Company granted a right of first refusal to New Choice to franchise any lodging property that the Company develops or acquires and intends to operate under franchise; (ii) the Company has 22 also agreed, barring a material change in market conditions, to continue to develop Sleep Inns and MainStay Suites hotels so that it will have opened a total of 14 Sleep Inns and 15 MainStay Suites hotels by October 15, 2001 (48 months of the Distribution Date); (iii) New Choice has granted to the Company an option, exercisable under certain circumstances, to purchase the brand names, marks, franchise agreements and other assets of the MainStay Suites hotel system; (iv) New Choice and the Company have agreed to continue to cooperate with respect to matters of mutual interest, including new product and concept testing for New Choice in hotels owned by the Company; and (v) the Company has authorized New Choice to negotiate with third party vendors on the Company's behalf for the purchase of certain items. The Strategic Alliance Agreement extends for a term of 20 years with rights of mutual termination on the fifth, tenth and fifteenth anniversaries. Amendment and Guaranty In connection with the Spinoff, New Choice entered into the Amendment and Guaranty for the purpose of adding New Choice as a party to certain agreements entered into between Former Choice and Manor Care in connection with the Manor Care Spinoff and adding New Choice as a guarantor of certain payment obligations of the Company to Manor Care pursuant to agreements between Former Choice and Manor Care. For a discussion of the Amendment and Guaranty, see "Certain Relationships and Related Transactions--Relationship with Manor Care" and "--Lease Agreements." Term Note In connection with the Spinoff, New Choice loaned to the Company approximately $115 million which, together with borrowings under a new bank credit agreement, was used by the Company to repay approximately $96 million outstanding under Former Choice's credit facility and to repay that portion of the Former Choice indebtedness under the MNR Note allocated to the Company in connection with the Spinoff (approximately $37 million). This loan is represented by a Term Note in an aggregate principal amount of $115 million (the "Term Note"). The Term Note has a maturity of five years and accrues interest at a rate equal to 500 basis points above the interest rate on a 5-year U.S. Treasury Note. The Term Note is subordinated to all senior debt of the Company and contains certain restrictive covenants comparable to those contained in the Company's senior credit facility (including restrictions on the Company's ability to make certain investments, incur debt, pay dividends, dispose of assets and create liens on its assets). Consulting Agreement The Company and New Choice entered into a Consulting Agreement in which the Company will provide consulting and advisory services to New Choice related to financial issues affecting New Choice. The term of the agreement commences October 15, 1997 and terminated on November 1, 2001. The Company is entitled to an annual retainer fee equal to 30% of the annual compensation (including base salary, incentive bonus and fringe benefits) paid to James A. MacCutcheon by the Company during such period. If Mr. MacCutcheon ceases to be employed by the Company, the agreement can be terminated by either party, but if terminated by New Choice, then New Choice shall pay the Company a termination fee equal to 30% of any amount due by the Company to Mr. MacCutcheon under his employment agreement as a result of his separation. Tax Sharing Agreement New Choice and the Company have entered into a Tax Sharing Agreement for purposes of allocating tax liabilities of Former Choice from before the Spinoff among New Choice and the Company and their respective subsidiaries. In general, the Company will be responsible for (i) filing consolidated federal income tax returns for the Company affiliated group and combined or consolidated state tax returns for any group that includes a member of the Company affiliated group, including in each case New Choice 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 23 returns to the applicable taxing authorities (including any subsequent adjustments resulting from the redetermination of such tax liabilities by the applicable taxing authorities). New Choice will reimburse the Company for the portion of such taxes that relates to New Choice and its subsidiaries, as determined based on their hypothetical separate company income tax liabilities. New Choice and the Company have agreed to cooperate with each other, and to share information, in preparing such tax returns and in dealing with other tax matters. Employee Benefits Allocation Agreement In connection with the Spinoff, New Choice and the Company entered into an Employee Benefits and Other Employment Matters Allocation Agreement (the "Employee Benefits Allocation Agreement"). The Employee Benefits Allocation Agreement provides for the allocation subsequent to New Choice Spinoff of employee benefits, as they relate to employees who remained employed by the Company or its subsidiaries ("Sunburst Employees") after the Spinoff and employees who are employed by New Choice or its subsidiaries after the Spinoff ("Choice Employees"). Pursuant to the Employee Benefits Allocation Agreement, the Company will continue sponsorship of the various Sunburst profit sharing plans, stock plans and health and welfare plans with respect to Sunburst Employees. New Choice has established a number of plans which allow it to provide to its employees substantially the same benefits currently provided to them as employees of the Company. The Employee Benefits Allocation Agreement provides for cross-guarantees between New Choice and the Company with respect to the payment of benefits under certain plans and for cross-indemnification with respect to employment-related claim relating to prior to the Spinoff. The Employee Benefits Allocation Agreement also provided for the adjustment of outstanding options to purchase shares of Sunburst common stock held by Sunburst Employees, Choice Employees and employees of Manor Care who hold such options as a result of the Manor Care Spinoff. Lease Agreements Pursuant to the Amendment and Guaranty, New Choice, the Company and Manor Care have added New Choice as a guarantor of the Company's obligations under the Gaithersburg Lease and the Silver Spring Lease. Additionally, the Company and Choice have entered into a sublease agreement (the "Silver Spring Sublease") with respect to the Silver Spring Lease for New Choice's principal executive offices at 10750 Columbia Pike, Silver Spring, Maryland, 20901. New Choice subleases approximately 54.3% of the office space available under the Silver Spring Lease with financial terms approximately equal (on a square foot basis) to the terms of the Silver Spring Lease. From the date of the consummation of the Spinoff through December 31, 1997, New Choice has paid to the Company approximately $375,000 under the Silver Spring Sublease. Transitional Service Agreements New Choice and the Company have entered into a number of agreements pursuant to which New Choice provides, or will provide, certain continuing services to the Company for a transitional period. Such services will be provided on market terms and conditions. Subject to the termination provisions of the specific agreements, the Company will be free to procure such services from outside vendors or may develop an in-house capability in order to provide such services internally. The primary transitional services agreements are summarized below. Pursuant to the Employee Benefits Administration Agreement, New Choice provides certain benefits, compensation and other services. Such other services may include benefit plan administration and accounting, COBRA administration, regulatory compliance and certain fiduciary services. Pursuant to the Tax Administration Agreement, New Choice provides certain sales, use, occupancy, real and personal property tax return administration, audit and appeals services for the Company. 24 Franchise Agreements The Clarion, Comfort, Econo Lodge, Sleep Inn, Quality, MainStay Suites and Rodeway marks are each owned by Choice. Each hotel property owned by the Company is subject to a franchise agreement between New Choice and the Company, as franchisee (the "Franchise Agreements"). (The material terms of such agreements are described below.) 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. The Company (except with respect to one property as described below) may terminate a Franchise Agreement if New Choice 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 the Company to terminate such Franchise Agreement. Termination by New Choice. New Choice (except with respect to the Non-Standard Franchise Agreement) may suspend or terminate a Franchise Agreement at any time, if, among other things, the Company (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. New Choice (except with respect to the Non-Standard Franchise Agreement) may terminate a Franchise Agreement immediately upon notice to the Company if, among other things, (a) certain bankruptcy events occur with respect to the Company; (b) the Company loses possession or the right to possession of the Property; (c) the Company breaches transfer restrictions in the related Franchise Agreement; (d) any action is taken to dissolve or liquidate the Company; 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 New Choice for any of the reasons discussed in the immediately preceding two sentences, the Company is required to pay Special Interest 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 between $21-$50 depending on the hotel brand multiplied by the specified room count). The Non-Standard Franchise Agreement has termination provisions similar to those in the other Franchise Agreements. New Choice may terminate the Non- Standard Franchise Agreement immediately upon notice to the Company if, among other things, (a) certain bankruptcy events occur with respect to the Company; (b) certain breaches of the related agreements are not remedied; (c) any action is taken to dissolve or liquidate the Company; or (d) legal proceedings against the Company are not dismissed within a certain period of time. Upon termination, the Franchise Agreement for the Rodeway Inn-Phoenix (Tempe) calls for Special Interest of the greater of (i) $50,000 and (ii) the sum of the previous two years of fees paid by the licensee. Fees. The Franchise Agreements require the payment of certain fees and charges, including the following: (a) a royalty fee of between 1.93% to 5.0% of monthly gross room revenues; (b) a marketing fee of between 0.7% and 2.5% 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 New Choice's reservation system). The marketing fee and the reservation fee are subject to reasonable increases 25 during the term of the franchise if New Choice 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 New Choice including: (a) to lend the Franchisee 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 the Company including: (a) to participate in a specified reservation system; (b) to keep and comply with the up-to-date version of New Choice'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 New Choice's rights thereto; and (e) to maintain certain specified insurance policies. Assignments. The Company 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 New Choice except that, among other things, certain percentages of ownership interests in the Company may be transferred without New Choice's consent. New Choice'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 New Choice; (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. New Choice 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 New Choice to absolve itself from the obligations that it transfers under the Franchise Agreement. Upon the assignment of New Choice's obligations under the Non-Standard Franchise Agreement, New Choice will no longer be liable with respect to the obligations it so transfers. Noncompetition Agreement New Choice and the Company have entered into a noncompetition agreement that defines the rights and obligations with respect to certain businesses to be operated by New Choice and the Company. Under the noncompetition agreement, for a period of five years from the date of the Spinoff, subject to the exceptions set forth below, the Company will be prohibited from conducting any business that competes with the business operated by Former Choice transferred to New Choice as part of the Spinoff ("the Choice Business"). The Company will also be prohibited from acquiring any entity conducting a business that competes with the Choice Business, with certain exceptions outlined below, unless, prior to such acquisition, the Company offers to sell such competing business to New Choice on substantially the same terms and conditions; provided, however, that the Company will not be required to make such an offer to New Choice where the competing business is not readily divisible from other businesses permitted to be held or acquired by the Company and the gross sales from such competing business for the 12 months prior to such acquisition do not exceed the greater of $1,000,000 (as adjusted for increases to the Consumer Price Index during the term) or 5% of gross sales of the businesses to be acquired. Subject to the foregoing, however, the noncompetition agreement does not prohibit the Company from engaging in the following activities: (i) the continued operation and development of any business operated as of the date of the Spinoff by the Company and retained by the Company; (ii) any activities otherwise permitted under the Strategic Alliance Agreement; (iii) the ownership of up to 5% of the equity interests of a publicly-traded entity that competes with New Choice's business; and (iv) the ownership of equity interests of any entity that competes with New Choice's business, if (A) the competing business does not comprise such entity's primary business, (B) the gross sales of such entity for the prior 12 months attributable to such competing 26 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, New Choice will be prohibited from conducting any business that competes with the business operated by the Company and retained by Company in the Spinoff (the "Hotel Business"). New Choice is also prohibited from acquiring any entity conducting a business that competes with the Hotel Business, with certain exceptions outlined below, unless, prior to such acquisition, New Choice offers to sell such competing business to the Company on substantially the same terms and conditions; provided, however, that New Choice will not be required to make such an offer to the Company where the competing business is not readily divisible from other business permitted to be held or acquired by New Choice 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 New Choice from the following activities: (i) continued operation and development of any business operated as of the date of the Spinoff by New 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 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). Potential Conflict The ongoing relationship between New Choice and the Company resulting from the agreements and arrangements described above may potentially give rise to conflict of interest between New Choice and the Company. With respect to the agreements between the parties, the potential exists for disagreements as to the quality of the services provided by the parties and as to contract compliance. Nevertheless, the Company believes that there will be sufficient mutuality of interest between the two companies to result in a mutually productive relationship. Appropriate policies and procedures are followed by the Board of Directors of New Choice and the 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 New Choice or the Company on certain matters which present a conflict between the two companies. OTHER RELATIONSHIPS During the twelve months ended December 31, 1997, the Company paid to Allen & Company Incorporated a total of $110,523 in brokerage commissions in connection with the repurchase of Company common stock by the Company. Paul A. Gould, a director of the Company, is a Managing Director of Allen & Company. 27 SUNBURST HOSPITALITY CORPORATION 107750 Columbia Pike, Silver Spring, Maryland 20901 PROXY SOLICITED BY THE BOARD OF DIRECTORS FOR ANNUAL MEETING OF SHAREHOLDERS TO BE HELD APRIL 22, 1998 The undersigned hereby appoints PAUL A. GOULD and FREDERIC V. MALEK, and each of them, the true and lawful attorneys and proxies, with full power of substitution, to attend the Annual Meeting of Stockholders of Sunburst Hospitality Corporation (the "Company") to be held on April 22, 1998 at 9:00 a.m. in the Ballroom located at the Quality Suites Shady Grove, 3 Research Court, Rockville, Maryland and at any adjournment thereof, and to vote all shares of common stock held of record which the undersigned could vote, with all the powers the undersigned would possess if personally present at such meeting, as designated below. All shares of Company common stock that are represented at the Annual Meeting by properly executed proxies received prior to or at the Annual Meeting and not revoked will be voted at the Annual Meeting in accordance with the instructions indicated herein. If no instructions are indicated for Items 1 or 2, such proxies will be voted in accordance with the Board of Directors' recommendations as set forth herein with respect to such proposal(s). - -------------------------------------------------------------------------------- THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT SHAREHOLDERS VOTE FOR ITEM 1 AND ITEM 2. (1) Election of two Directors: / / FOR all nominees listed below: / / WITHHOLD AUTHORITY to vote FOR all nominees listed below: STEWART BAINUM, JR. and PAUL A. GOULD (Instructions: to withhold authority to vote for any individual nominee, write that nominee's name in the space provided below.) _________________________________________________________________ (2) Amendment of 1996 Long-Term Incentive Plan FOR AGAINST ABSTAIN to increase the number of authorized shares: / / / / / / If you plan to attend the Annual Meeting of Stockholders, please mark the following box and promptly return this Proxy Card. / / Dated , 1998 -------------------------------------------- -------------------------------------------------- Signature -------------------------------------------------- Signature (Signatures should correspond exactly with the name or names appearing above. Attorneys, trustees, executors, administrators, guardians and others signing in a representative capacity should designate their full titles. If the signer is a corporation, please sign the full corporate name by a duly authorized officer.) -----END PRIVACY-ENHANCED MESSAGE-----