<PAGE>
 
                      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)

[X]  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   December 31, 1998
                            -----------------
                                       OR
[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 [NO FEE REQUIRED].

For the transition period from _________ to _________

                      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)                          ZipCode

Registrant's telephone number, including area code  (301) 592-3800
                                                   -----------------------------

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 ________
                                               -----          
<PAGE>
 
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 $83,325,525 as of December 31, 1998 based
upon a closing price of $4.25 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 December 31, 1998 was 19,606,006.

                     DOCUMENTS INCORPORATED BY REFERENCE.

     None.

                                       2
<PAGE>
 
                                    PART I
                                        
ITEM 1.  BUSINESS

     Sunburst Hospitality Corporation ("Sunburst" or the "Company") owns and
operates hotels in one of four principal categories within the lodging industry:
extended-stay, traditional all-suites, full service and limited service.  As of
March 1, 1999, the Sunburst portfolio included 88 hotels open with 12,081 rooms
in 27 States and 6 hotels under construction or in development. Each hotel is
branded with a Choice Hotels International, Inc. ("Choice") brand and Sunburst
is Choice's largest franchisee.  Thirty-five of the 89 hotels, with a net book
value of $139.2 million at December 31, 1998, serve as collateral for the
Company's multi-class mortgage pass-through certificates.
 
     Sunburst has 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
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 and redeploying capital into 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, containing 7,809 rooms, 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 acquired hotels is approximately $290 million, approximately 60%
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, no
hotels have been acquired by the Company since February 1997 when the beachfront
Howard Johnson Hotel in Miami Beach, Florida was acquired. The Company will
continue to evaluate acquisitions on an opportunistic basis when it is felt that
long-term value can be created.

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 significantly exceeds supply. The mid-priced market of the 
extended-stay segment is particularly under-served.

                                       3
<PAGE>
 
     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.

          The following is a list of new hotels developed by Sunburst since 1994
or under development as of March 1, 1999.

<TABLE>
<CAPTION>
                                                                                     CALENDAR YEAR OF  
                                                                                     ----------------
MARKET                                                                 BRAND              OPENING      
------                                                                 -----              -------
<S>                                                                <C>               <C> 
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..........................................    MainStay Suites          1998
Denver/Tech Center, CO.........................................    MainStay Suites          1999
Jacksonville, FL...............................................    MainStay Suites          1998
Nashville, Brentwood, TN.......................................    MainStay Suites          1998
Miami/Airport, FL..............................................    MainStay Suites          1998
Pittsburgh/Airport, PA.........................................    MainStay Suites          1998
Fishkill/Poughkeepsie, NY......................................    MainStay Suites          1998
Denver/Tech Center, CO (1).....................................    Sleep Inn                1999
Tempe, AZ (1)..................................................    MainStay Suites          1999
Miami/Airport, FL (1)..........................................    Sleep Inn                1999
Annapolis, MD (2)..............................................    MainStay Suites          1999
Peabody, MA (2)................................................    MainStay Suites          1999
Raleigh, NC (2)................................................    MainStay Suites          1999
North Charleston, SC (2).......................................    MainStay Suites          1999
Malvern, PA (2)................................................    MainStay Suites          1999
Secaucus, NJ (2)...............................................    MainStay Suites          2000 
</TABLE>
________________________                                                

(1) Hotel under construction at December 31,1998, but completed prior to 
    March 1, 1999
(2) Hotel under construction at December 31, 1998.

     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 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, approximately
30% of total U.S. lodging industry demand. Only approximately 3% 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.

                                       4
<PAGE>
 
     The MainStay Suites brand, which was created by the Company in conjunction
with Choice Hotels International, Inc, 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 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 can produce
stabilized, unleveraged pre-tax property level returns on investment of
approximately 15%. This belief is supported by the Company's experience at the
MainStay Suites hotels that are nearing stabilization. The belief is further
supported by projections for the MainStay Suites recently opened and under
construction. These projections are based on rate and occupancy forecasts
generated internally by the Company and by external feasibility consultants, as
well as internal operating guidelines, land cost and projected construction
costs. The ultimate returns will, however, be impacted by a number of factors,
including the extent of new competitive supply in each market, and there can be
no assurance that projected returns 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 averages approximately 100
suites and are 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
which serves 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 with data ports, voice mail and other
automated phone services.

     The Company has sold one hotel since December 31, 1998 and currently has 12
hotels being marketed for sale. The Company anticipates closing on the sale of
these hotels during 1999. The net book value of hotels held for sale at December
31,1998 was $37.1 million.

Operations

     Sunburst's owned and managed hotels typically operate under one of the
Choice brand names. Sunburst's hotels take advantage of the same systems and
services available to Choice franchisees with respect to a particular brand.
The hotels participate in Choice's central reservation system, marketing and
advertising efforts and volume purchasing discounts and are subject to Choice's
same quality assurance program.  In addition, Sunburst has instituted the
following systems in the hotels it operates.

     .    Yield Management. An automated yield management system allows each
          property's management to take advantage of the supply and demand
          conditions in the local marketplace. The automated system performs
          calculations and suggests pricing strategies to the local hotel
          management. The system continuously updates information based on the
          availability of room supply, reservation volume and projected demand
          and stay patterns 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 solicits 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 

                                       5
<PAGE>
 
          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. Sunburst hotels maintains automated time
          and attendance systems that are tied into a central payroll system at
          the corporate headquarters. This computerized method of tracking time
          allows management to make quick decisions on controlling labor costs
          and provides immediate information on projected costs.

     .    Food and Beverage. The food and beverage efforts are headed by a vice
          president of food and beverage. The department is responsible for the
          daily food and beverage activities of the various hotels, as well as
          the development of new food concepts. This group was responsible for
          the development, testing and implementation of the Choice Picks food
          court concept. Recently, Sunburst opened a new food and beverage
          concept called "Classic Sports Food, Drink and Memories". 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 four categories of the lodging industry;
traditional/all-suite, extended stay, full service and limited service.  Hotels
are typically branded with Choice franchise flags.

                               ALL SUITE HOTELS

     All-Suite Hotels.  Sunburst has five hotels in the traditional all-suite
segment.  Sunburst's all-suite hotel properties compete in the mid-price and
upscale price segments.

<TABLE>
<CAPTION>
              BRAND                                      NUMBER OF HOTELS    NUMBER OF ROOMS    PRICE SEGMENT
              -----                                      ----------------    ---------------    -------------
<S>                                                      <C>                 <C>                <C>
Quality Suites.........................................          3                 345             upscale
Comfort Suites.........................................          2                 232            mid-price
</TABLE>

                             EXTENDED-STAY HOTELS
                                        
     Extended-Stay Hotels.  Sunburst has 15 hotels with another 6 under
construction in the extended stay segment.  All are branded MainStay Suites and
compete in the mid-price price segment.

<TABLE>
<CAPTION>
BRAND                                                    NUMBER OF HOTELS    NUMBER OF ROOMS    PRICE SEGMENT
-----                                                    ----------------    ---------------    -------------
<S>                                                      <C>                 <C>                <C>
MainStay Suites........................................         15                1,466           mid-price
</TABLE>

                                       6
<PAGE>
 
                              FULL-SERVICE HOTELS
                                        
     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.

<TABLE>
<CAPTION>
BRAND                                                    NUMBER OF HOTELS    NUMBER OF ROOMS    PRICE SEGMENT
-----                                                    ----------------    ---------------    -------------
<S>                                                      <C>                 <C>                <C>
Clarion Hotels & Inns..................................         11                2,114             upscale
Quality Hotel & Inns...................................          5                1,327            mid-price
</TABLE>

                            LIMITED SERVICE HOTELS

     Limited Service Hotels.  Sunburst has 52 hotels in the limited service
segment open.  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.

<TABLE>
<CAPTION>
BRAND                                                    NUMBER OF HOTELS    NUMBER OF ROOMS    PRICE SEGMENT
-----                                                    ----------------    ---------------    -------------
<S>                                                      <C>                 <C>                <C>
Comfort Inn............................................         29                3,914            mid-price
Quality Inns...........................................          8                1,014            mid-price
Sleep Inns.............................................         13                1,448            mid-price
Econo Lodge............................................          1                  120             economy
Rodeway Inns...........................................          1                  101             economy
</TABLE>

Franchise and Strategic Alliance Agreements

     Each Franchise Agreement with Choice Hotels International, Inc. 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 1998. Certain Franchise Agreements allow for unilateral
termination by either party on the 5th, 10th, or 15th anniversary of the
Franchise Agreement. Sunburst's Franchise Agreements with Choice allow for early
termination by Sunburst, subject to liquidated damage provisions which range
from zero dollars to a maximum of $100,000 per property.

     The Franchise Agreements require the payment of certain fees and charges,
including the following: (a) a royalty fee of between 1.93% to 5.0% of monthly
gross room revenues; (b) a marketing fee of between 0.7% and 2.5% plus $0.28 per
day multiplied by the specified room count; and (c) a reservation fee of 0.88%
to 1.75% of monthly gross room revenues (or 1% of monthly gross room revenues
plus $1.00 per room confirmed through Choice's reservation system). The
marketing fee and the reservation fee are subject to reasonable increases during
the term of the franchise if 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 Spin-off and as subsequently amended, Choice and the
Company entered into a Strategic Alliance Agreement pursuant to which: (i) the
Company granted a right of first refusal to 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 MainStay Suites hotels so that it will have
opened a total 25 MainStay Suites hotels by October 15, 2001; (iii) Choice and
the Company have agreed to continue to cooperate with respect to matters of
mutual interest, including new product and concept testing for Choice in hotels
owned by the Company; and (iv) the Company has authorized 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
unilateral rights of termination by either party on the fifth, tenth and
fifteenth anniversaries.

                                       7
<PAGE>
 
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 27 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
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, 1998, Sunburst employed approximately 4,000 employees.  As
is typical in the lodging industry, the Company experiences high rates of
employee turnover. Less than 5% of the Company's employees are represented by
unions. All of the Company's union employees 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 
March 1, 1999:

<TABLE>
<CAPTION>
                                                                                                 YEAR       
                                                                                 NO. OF    CONSTRUCTED/LAST  
HOTEL                                                       MARKET               ROOMS     MAJOR RENOVATION 
-----                                                       ------               -----     ----------------
<S>                                               <C>                            <C>       <C>
TRADITIONAL 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
</TABLE> 

                                       8
<PAGE>
 
<TABLE>
<CAPTION>
                                                                                                    YEAR       
                                                                                    NO. OF    CONSTRUCTED/LAST
HOTEL                                                       MARKET                  ROOMS     MAJOR RENOVATION
-----                                                       ------                  -----     ----------------
<S>                                               <C>                               <C>       <C>             
EXTENDED-STAY                                                                                           
  MainStay Suites Plano.........................  Dallas, Texas                        96              1996 
  MainStay Suites Warwick.......................  Providence, Rhode Island             94              1997
  MainStay Suites Blue Ash......................  Cincinnati, Ohio                    100              1997
  MainStay Suites Airport.......................  Kansas City, Missouri                88              1998
  MainStay Suites Northwest.....................  Indianapolis, Indiana                88              1997
  MainStay Suites Louisville....................  Louisville, Kentucky                100              1998
  MainStay Suites Tech Center...................  Denver, Colorado                    100              1998
  MainStay Suites Lake Mary.....................  Orlando, Florida                    100              1998
  MainStay Suites South Pointe..................  Jacksonville, Florida               100              1998
  MainStay Suites Greenville....................  Greenville, South Carolina          100              1998
  MainStay Suites Brentwood.....................  Nashville, Tennessee                100              1998
  MainStay Suites Miami Springs.................  Miami Springs, Florida              100              1998
  MainStay Suites Fishkill......................  Fishkill, New York                  106              1998
  MainStay Suites Annapolis(2)..................  Annapolis, Maryland                  88              1999
  MainStay Suites Pittsburgh....................  Pittsburgh, Pennsylvania            100              1998
  MainStay Suites Raleigh(2)....................  Raleigh, North Carolina             100              1999
  MainStay Suites Tempe(1)......................  Tempe, Arizona                       94              1999
  MainStay Suites Peabody(2)....................  Peabody, Massachusetts               97              1999
  MainStay Suites King of Prussia(2)............  Malvern, PA                          78              1999
  MainStay Suites Secaucus,(2)..................  Secaucus, NJ                        132              2000
  MainStay Suites N. Charleston(2)..............  Charleston, SC                       97              2000
                                                                                                                      
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(3).............  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 N.W. Pikesville(4)................  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        
</TABLE> 

                                       9
<PAGE>
 
<TABLE>
<CAPTION>
                                                                                                    YEAR       
                                                                                    NO. OF    CONSTRUCTED/LAST
HOTEL                                                       MARKET                  ROOMS     MAJOR RENOVATION
-----                                                       ------                  -----     ----------------
<S>                                               <C>                               <C>       <C>             
  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 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.......................  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(3).....................  San Francisco, California          135          1971/1996
  Comfort Inn Westport..........................  St. Louis, Missouri                170          1971/1995
  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
  Sleep Inn Raleigh.............................  Raleigh, North Carolina            107               1996
  Sleep Inn San Antonio.........................  San Antonio, Texas                 107               1995
  Sleep Inn University..........................  Charlotte, North Carolina          120               1997
  Sleep Inn Airport.............................  Kansas City, Missouri              107               1997
  Sleep Inn Rockville...........................  Washington, DC                     107               1997
  Sleep Inn Airport.............................  Denver, Colorado                   119               1998
  Sleep Inn Denver Tech(1)......................  Denver, Colorado                   119               1999
  Sleep Inn Miami Airport(1)....................  Miami Springs, Florida             119               1999
  Economy                                                                                                     
  Econo Lodge Tolleson..........................  Phoenix, Arizona                   120          1988/1997
  Rodeway Inn Tempe.............................  Phoenix, Arizona                   101               1989
</TABLE>

(1)  Hotel under construction at December 31, 1998 but completed prior to 
     March 1, 1999

(2)  Hotel under construction at March 1, 1999

(3)  Leased property

(4)  Hotel on leased land

                                       10
<PAGE>
 
     The following chart shows operating statistics for all of Sunburst's owned
and managed hotels presented by market segment for the four fiscal years ended
May 31, 1997, the seven months ended December 31, 1997, and the twelve months
ended December 31, 1998.

<TABLE>
<CAPTION>
                                  FY 1994                       FY 1995                       FY 1996
                         --------------------------    --------------------------    --------------------------
                          ADR    OCCUPANCY   REVPAR     ADR    OCCUPANCY   REVPAR     ADR    OCCUPANCY   REVPAR
                         ------  ----------  ------    ------  ----------  ------    ------  ----------  ------
<S>                      <C>     <C>         <C>       <C>     <C>         <C>       <C>     <C>         <C>
Traditional All-Suite..  $60.62      71.58%  $43.39    $58.74      61.34%  $36.03    $64.70      69.00%  $44.65
Extended-Stay..........       -          -        -         -          -        -         -          -        -
Full Service...........   54.37      60.74    33.02     54.04      65.43    35.36     58.85      65.41    38.49
Limited Service........   45.09      66.71    30.08     48.39      69.15    33.46     53.36      67.11    35.81
All Hotels.............   49.15      64.18    31.54     51.28      67.10    34.40     55.97      66.61    37.28
</TABLE>

<TABLE>
<CAPTION>
                                                            SEVEN MONTHS ENDED
                                   FY 1997                 DECEMBER 31, 1997(1)       YEAR ENDED DECEMBER 31, 1998
                         ---------------------------    --------------------------    ---------------------------- 
                          ADR    OCCUPANCY   REVPAR      ADR    OCCUPANCY   REVPAR      ADR     OCCUPANCY   REVPAR
                         ------  ----------  -------    ------  ----------  ------    -------  -----------  ------ 
<S>                      <C>     <C>         <C>        <C>     <C>         <C>       <C>      <C>          <C>
Traditional All-Suite..  $70.55      73.42%   51.80%    $70.03      72.05%  $50.45     $75.27       72.65%   $54.69
Extended-Stay..........   57.09      65.55    37.42      61.57      48.64    29.95      56.03       57.17     32.04
Full Service...........   63.25      67.05    42.41      65.23      66.46    43.35      67.69       66.81     45.23
Limited Service........   56.39      69.23    39.04      59.11      68.01    40.20      59.98       67.36     40.40
All Hotels.............   59.60      68.69    40.94      61.81      67.41    41.67      62.90       66.57     41.87
</TABLE>
_______________________________________

(1)  The information provided in the table above for the seven months ended
     December 31, 1997is not representative of a full fiscal year due to the
     seasonality of the hotel industry.

<TABLE>
<CAPTION>
                                                             FISCAL YEAR ENDED MAY 31
                                        -------------------------------------------------------------
                                                                                         SEVEN MONTHS
                                                                                             ENDED         YEAR ENDED
                                                                                         DECEMBER 31,     DECEMBER 31,
                                             1994       1995       1996        1997        1997 (1)           1998
                                        ------------------------------------------------------------------------------
<S>                                     <C>            <C>        <C>        <C>         <C>              <C>
Number of properties, end of period.....        32         48         65          71               76               86
Number of rooms, end of period..........     5,605      7,941      9,713      10,330           10,885           11,910
Average occupancy percentage............     64.18%     67.10%     66.61%      68.70%           67.41%           66.57%
Average daily room rate (ADR)...........    $49.15     $51.28     $55.97     $ 59.62         $  61.81          $ 62.90
RevPAR..................................    $31.54     $34.40     $37.28     $ 40.96         $  41.67          $ 41.87
</TABLE>

_____________________________________

(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, 1998.

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.

                                       11
<PAGE>
 
<TABLE>
<CAPTION>
Name                                         Age   Position
<S>                                          <C>   <C>
Stewart Bainum, Jr.......................    53    Chairman of the Board of Directors
Donald J. Landry.........................    50    Vice Chairman and Chief Executive Officer
James A. MacCutcheon.....................    46    Executive Vice President, Chief Financial Officer and Treasurer
Antonio DiRico...........................    45    President and Chief Operating Officer
Kevin P. Hanley..........................    41    Senior Vice President, Real Estate and Development
Gregory D. Miller........................    44    Senior Vice President, Human Resources
Douglas H. Verner........................    45    Senior Vice President, General Counsel & Secretary
Charles G. Warczak, Jr...................    51    Vice President, Finance and Systems
Pamela W. Williams.......................    43    Vice President, Assistant General Counsel and Assistant Secretary
</TABLE>

Stewart Bainum, Jr., Chairman of the Board of the Company since December 1998
and from November 1996 to July 1998; Chairman of the Board of Choice from March
1987 to November 1996 and since October 1997; Chairman of the Board and Chief
Executive Officer of Manor Care, Inc. from March 1987 through September 1998;
Chairman of the Board of HCR/Manor Care since September 1998; 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 from September 1991 through June
1998; 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 October 1987 through November 1996; Treasurer of Vitalink from September
1992 to January 1997 and a Director from September 1994 to June 1998.

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.

Douglas H. Verner. Senior Vice President, General Counsel and Secretary of the
Company since March 1998; Executive Vice President, General Counsel and
Secretary of Chartwell Leisure from January 1996 to March 1998; Senior Vice
President, General Counsel and Secretary of Forte Hotels, Inc. from November
1990 to November 1996.

Charles G. Warczak, Jr.  Vice President, Finance and 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.

                                       12
<PAGE>
 
Pamela M. Williams.  Vice President, Assistant General Counsel and Assistant
Secretary of the Company since October 1997; Senior Attorney of the Company from
December 1996 to October 1997, Attorney from November 1996 to December 1996;
Attorney of Manor Care from December 1995 to November 1996; Associate of Hogan
and Hartson, L.L.P. from August 1988 to December 1995.

                                       13
<PAGE>
 
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:

<TABLE>
<CAPTION>
                                                                    High          Low
<S>                                                               <C>           <C>
FISCAL YEAR ENDED MAY 31, 1997
  November 4 - November 30, 1996                                  $ 16          $13 3/4
  Quarter ended February 28, 1997                                   17 5/8       15    
  Quarter ended May 31, 1997                                        15 7/8       12 3/4
TRANSITION PERIOD ENDED DECEMBER 31, 1997 (1)                                          
  Quarter ended August 30, 1997                                     19 5/16      15 1/2
  Quarter ended November 30, 1997 (2)                                                  
     Prior to October 15, 1997                                      20 3/8       18 3/4
     October 15, 1997 through November 30, 1997                     11 5/8        9 1/8
  December 1, 1997 - December 31, 1997                              10 1/4        8 5/8
FISCAL YEAR ENDED DECEMBER 31, 1998                                                    
  Quarter ended March 31, 1998                                       9 15/16      8 1/4
  Quarter ended June 30, 1998                                        9            5 3/8
  Quarter ended September 30, 1998                                   6 7/8        3    
  Quarter ended December 31, 1998                                    4 3/4        4 7/16
</TABLE>
_____________
(1) On September 16, 1997, the Company changed its fiscal year-end from May 31
    to December 31. The Company elected to continue reporting its operations
    pursuant to its historical fiscal quarters during the transition period
    ended December 31, 1997.
(2) On October 15, 1997, the Company spun off the Choice Franchising Business
    through a special dividend to the Company's shareholders of all of the
    common stock of Choice and effected a one-for-three reverse stock split. The
    stock prices for the quarter ended November 30, 1997 have not been adjusted
    to give effect to the substantially simultaneous spin-off of Choice and the
    reverse stock split. Accordingly, the high and low sales prices are
    presented for both the period prior to and after the Choice Spin-Off and the
    reverse stock split.

     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 1, 1999, there were 2,647 record holders of Company common
stock.

                                       14
<PAGE>
 
ITEM 6.   SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                For the seven                                                     
                                                                months ended                                                      
                                                 Calendar Year  December 31,                For the year ended May 31             
                                                                              ----------------------------------------------------
                                                     1998          1997            1997          1996          1995         1994  
                                                 ---------------------------------------------------------------------------------
<S>                                              <C>                            <C>           <C>           <C>           <C>     
STATEMENT OF INCOME DATA                                                                                                          
                                                                                                                                  
REVENUES                                                                                                                          
 Rooms                                                $178,755     $100,670      $165,239      $137,001      $101,381      $66,031
 Food and beverage                                      17,247        9,231        13,356        11,392         8,121        5,001
 Other                                                   8,094        4,652         7,158         6,232         5,012        3,152
                                                      --------     --------      --------      --------      --------      -------
                                                                                                                                  
   Total Revenues                                      204,096      114,553       185,753       154,625       114,514       74,184
                                                      --------     --------      --------      --------      --------      -------
OPERATING EXPENSES                                                                                                                
 Departmental Expenses                                                                                                            
   Rooms                                                51,227       33,484        58,502        51,657        43,168       25,826
   Food and beverage                                    13,183        7,319        10,887         9,792         6,866        4,335
   Other                                                 3,056        1,530         2,674         2,570         1,476        1,012
 Undistributed Operating Expenses                                                                                                 
   Administrative and general                           18,514        9,486        17,990        16,358        11,550        6,741
   Marketing                                            16,430        8,862        14,545        12,152         9,008        5,507
   Utility costs                                         9,632        5,697         8,816         7,712         5,670        3,583
   Property operation and maintenance                   10,470        5,746         9,428         8,118         5,891        3,813
   Property taxes, rent and insurance                    9,369        5,010         6,857         6,044         3,959        2,241
   Depreciation and amortization                        27,227       14,246        20,632        16,636        12,513        8,434
   Corporate                                            13,961        8,244         7,691         8,026         6,038        2,864
   Provision for asset impairment and                                                                                             
    other non-recurring charges                          4,264        5,119             -        24,595             -            -
                                                      --------     --------      --------      --------      --------      -------
     Total operating expenses                          177,333      104,743       158,022       163,660       106,139       64,356
                                                      --------     --------      --------      --------      --------      -------
                                                                                                                                  
 Operating income (loss)                                26,763        9,810        27,731        (9,035)        8,375        9,828
                                                      --------     --------      --------      --------      --------      -------
                                                                                                                                  
 Interest expense                                       20,512       10,138        15,891        12,839         9,155        3,214
                                                      --------     --------      --------      --------      --------      -------
                                                                                                                                  
 Income (loss) from continuing operations                                                                                         
   before income taxes                                   6,251         (328)       11,840       (21,874)         (780)       6,614
                                                                                                                                  
    Income taxes                                         2,563          (44)        5,035        (8,523)         (323)       3,000
                                                      --------     --------      --------      --------      --------      -------
 Income (loss) from continuing operations                3,688         (284)        6,805       (13,351)         (457)       3,614
                                                                                                                                  
 Discontinued operations (1)                                 -       16,369        35,219        21,809        17,268        6,045
                                                      --------     --------      --------      --------      --------      -------
                                                                                                                                  
 Net income before extraordinary item                    3,688       16,085        42,024         8,458        16,811        9,659
                                                                                                                                  
 Extraordinary item - loss from early                                                                                             
   extinguishment of debt (net of                                                                                                 
   tax benefit)                                            308            -         1,144             -             -            -
                                                      --------     --------      --------      --------      --------      -------
                                                                                                                                  
 Net income                                           $  3,380     $ 16,085      $ 40,880      $  8,458      $ 16,811      $ 9,659
                                                      ========     ========      ========      ========      ========      =======
                                                                                                                                  
Basic earnings per share data                                                                                                     
 From continuing operations                           $   0.18     $  (0.01)     $   0.32      $  (0.64)     $  (0.02)     $  0.18
 From discontinued operations                                -         0.82          1.69          1.05          0.83         0.30
 From extraordinary item                                  (.01)           -         (0.05)            -             -            -
                                                      --------     --------      --------      --------      --------      -------
 Net income                                           $   0.17     $   0.81      $   1.96      $   0.41      $   0.81      $  0.48
                                                      ========     ========      ========      ========      ========      =======
                                                                                                                                  
Diluted earnings per share data                                                                                                   
 From continuing operations                           $   0.18     $  (0.01)     $   0.32      $  (0.64)     $  (0.02)     $  0.18
 From discontinued operations                                -         0.82          1.66          1.05          0.83         0.30
 From extraordinary item                                 (0.01)           -         (0.05)            -             -            -
                                                      --------     --------      --------      --------      --------      -------
 Net income                                           $   0.17     $   0.81      $   1.93      $   0.41      $   0.81      $  0.48
                                                      ========     ========      ========      ========      ========      =======
                                                                                                                                  
Weighted average common shares outstanding(2)           19,956       19,979        20,893        20,876        20,827       20,175
                                                      ========     ========      ========      ========      ========      ======= 
</TABLE>

(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 1994 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 1994 through 1997 have
     been adjusted for the one-for-three reverse stock split.

                                       15
<PAGE>
 
<TABLE>
<CAPTION>
                                        As of December 31,                                As of May 31,                        
                                    -------------------------------------------------------------------------------------------
                                       1998            1997            1997            1996            1995            1994    
                                    -------------------------------------------------------------------------------------------
<S>                                 <C>                <C>             <C>             <C>             <C>             <C>         
BALANCE SHEET DATA                                                                                                             
 Total assets                           422,511         400,983         426,429         328,311         254,229         178,652
 Notes payable to Manor Care, Inc.            -               -          37,022         147,023         119,823          68,361
 Total debt                             281,189         248,120         260,369         163,497         137,122          88,711
 Total liabilities                      319,874         311,676         301,942         180,752         188,400         123,444
 Equity or investments and                                                                                                     
   advances from Parent                 102,637          89,307         124,487         147,559          65,829          55,208
</TABLE>

                                       16
<PAGE>
 
ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

     The Company owned and operated 86 hotels with 11,910 rooms in 28 states at
December 31, 1998. The hotels are under the brand names Comfort, Clarion, Sleep,
Quality, MainStay Suites, Rodeway and Econo Lodge. 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 ("Choice") to
shareholders. On the date of distribution, Company shareholders of record on
October 7, 1997, received one share of 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 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
the ongoing 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.

Comparison of Calendar Year 1998 and Calendar Year 1997 (Domestic Hotels)
-------------------------------------------------------------------------

     The following tables present calendar quarter and full calendar year
information showing the results of operations of the Company's ongoing domestic
hotel operations for 1998 and 1997 (in thousands, unaudited).

<TABLE>
<CAPTION>
                                                               Quarter Ending
                                         ---------------------------------------------------------------
                                           March 31       June 30      September 30      December 31    
                                         ---------------------------------------------------------------
<S>                                      <C>              <C>          <C>               <C>                     
Year ended December 31, 1998
     Domestic Revenue                        $46,139       $54,440       $56,320            $47,197                
     Recurring Domestic EBITDA (1)            12,549        16,518        16,719             12,468                
                                                                                                                   
Year ended December 31, 1997                                                                                       
     Domestic Revenue                        $41,258       $46,982       $49,052            $42,760                
     Recurring Domestic EBITDA (1)            11,793        15,484        14,092              8,413                 
</TABLE>

________________________
(1)  Recurring domestic EBITDA consists of the sum of net income (loss),
     interest expense, income taxes, and depreciation and amortization and non-
     recurring charges for the Company's ongoing domestic operations. 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
<PAGE>
 
<TABLE>
<CAPTION>
                                                                Year ending                          
                                                                December 31,                         
                                                     -------------------------------------      
                                                         1998                    1997            
                                                     -------------------------------------      
<S>                                                  <C>                       <C> 
Revenues                                                                                        
   Rooms                                                $178,755               $157,380         
   Food and beverage                                      17,247                 14,991         
   Other                                                   8,094                  7,681         
         Total revenues                                  204,096                180,052         
                                                     -------------------------------------      
Operating Expenses                                                                              
   Departmental Expenses                                                                        
      Rooms                                               51,227                 45,606         
      Food and beverage                                   13,183                 11,972         
      Other                                                3,056                  2,828         
   Undistributed Operating Expenses                                                             
      Administrative and general                          18,519                 16,662         
      Marketing                                           16,430                 14,975         
      Utility costs                                        9,632                  9,399         
      Property operation and maintenance                  10,470                  9,815         
      Property taxes, rent and insurance                   9,364                  7,933         
      Depreciation and amortization                       27,227                 22,372         
      Corporate                                           13,961                 11,079         
      Provision for asset impairment and other                                                  
         non-recurring charges                             4,264                  5,119         
            Total operating expenses                     177,333                157,760         
                                                     -------------------------------------      
                                                                                                
Operating income                                          26,763                 22,292         
                                                     -------------------------------------      
Interest expense                                          20,512                 16,461         
                                                     -------------------------------------      
                                                                                                
Income from continuing operations before                                                        
   Income taxes                                            6,251                  5,831         
      Income taxes                                         2,563                  2,537         
                                                     -------------------------------------      
Income from continuing operations                       $  3,688               $  3,294         
                                                     =====================================      
                                                                                                
Basic Earnings Per Share from Continuing                   $0.18                  $0.16         
 Operations                                                                                     
                                                     =====================================       
</TABLE>

     Hotel revenues increased from $180.1 million in calendar 1997 to $204.1
million in 1998, an increase of 13.3%. Gross operating margin (operating income
before corporate expense, depreciation and amortization and non-recurring
charges) increased from 21.4% in 1997 to 22.0% in 1998.

     Increases in revenue were the result of an increase in the size of the
Company's portfolio and improved Revenue Per Available Room ("RevPAR"). The
portfolio increased from 76 hotels in December 31, 1997 to 86 hotels at December
31,1998, an increase of 9.4% in the number of rooms. 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. RevPAR increased 0.5% from $41.67 to $41.87, due primarily to an
increase of 1.8% in average daily rate. A changing portfolio mix with greater
representation of newly opened, mid-priced, extended stay MainStay Suites
impacted the RevPAR comparisons as, on a same store basis, year-over-year RevPAR
increased 1.9%.

  In general, rate, occupancy and RevPAR trends have been consistent with
industry results. On a same store basis, the company's full service hotels
experienced a 2.8% increase in RevPAR, while the limited service hotels
increased RevPAR 0.54%.

                                       18
<PAGE>
 
  Food and beverage ("F&B") revenues increased 15.1% and F&B operating margins
increased from 20.1% to 23.6% as a result of an increased focus on improving F&B
operating margins.

  The increase in depreciation expense from 1997 to 1998 is the result of the
growth in the portfolio.  While two, older limited service hotels were sold
during 1998, the Company opened 12 newly-constructed hotels.

     Calendar year 1998 represented the first full year operating as a separate,
stand-alone company and, accordingly, general corporate expense increased from
6.2% of revenues to 6.8% of revenues in 1998.  Recurring domestic EBITDA
increased 17% to $58.3 million in 1998 from $49.8 million in 1997.  EBITDA
margin for 1998 was 28.5% as compared to 27.7% in 1997.

     Included in provision for asset impairment and other non-recurring charges
in 1998 were non-cash write-downs of approximately $4 million (pre-tax) to
reduce several hotels being marketed for sale to estimated net realizable value,
net of disposition costs. In 1997, non-recurring loss provisions of
approximately $5 million (pre-tax) were recorded in order to reserve for various
items related to the Manor Care and Choice spin-offs.

     Interest expense increased from $16.5 million to $20.5 million in 1998, an
increase of 24.2%. 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 development of hotels.

     Income from continuing operations of $3.7 million, increased 12% from $3.3
million in 1997.

     Not reflected in the above discussion are the European hotel operations
which were spun-off to shareholders along with the discontinued franchise
business. In 1997, European hotel operations contributed $7.0 million of revenue
and $0.40 in EBITDA, through the spin-off date in October, 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 1996 and 1997 (in thousands, unaudited).

<TABLE>
<CAPTION>
                                                              Quarter ending
                                 ----------------------------------------------------------------------------
                                       March 31           June 30         September 30        December 31
                                 ----------------------------------------------------------------------------
<S>                              <C>                      <C>             <C>                 <C> 
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       
</TABLE>

________________________
(1)  Recurring domestic EBITDA consists of the sum of net income (loss),
interest expense, income taxes, and depreciation and amortization and non-
recurring charges for the Company's ongoing domestic operations. 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

                                       19
<PAGE>
 
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.

<TABLE>
<CAPTION>
                                                           Year ending                               
                                                           December 31,                              
                                                  ----------------------------                    
                                                      1997            1996                        
                                                  ----------------------------                    
<S>                                               <C>               <C>                           
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                                           45,606          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                   22,372          17,335                      
      Corporate                                       11,079           6,383                      
      Provision for asset impairment and other                                                     
       non-recurring charges                           5,119           8,575                       
                                                  ----------------------------                    
         Total operating expenses                    157,760         142,510                      
                                                  ----------------------------                    
                                                                                                  
Operating income                                      22,292          14,431                      
                                                  ----------------------------                    
Interest expense                                      16,461          12,726                      
                                                  ----------------------------                    

Income from continuing operations before                                                          
  Income taxes                                         5,831           1,705                      
    Income taxes                                       2,537             716                      
                                                  ----------------------------                    
Income from continuing operations                 $    3,294        $    989                      
                                                  ============================                    
                                                                                                  
Basic Earnings Per Share from Continuing                                                          
 Operations                                       $     0.16        $   0.05                      
                                                  ============================                    
</TABLE>

     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. 

                                       20
<PAGE>
 
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.

Comparison of Seven Months Ended December 31, 1997 and Seven Months Ended
-------------------------------------------------------------------------
December 31, 1996 (Domestic Hotels) 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:

<TABLE>
<CAPTION>
                                       1997       1996       % Increase   
                                     --------   --------   -------------- 
               <S>                   <C>        <C>        <C>            
               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%     
</TABLE>

     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 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.

                                       21
<PAGE>
 
     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.

     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 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.

                                       22
<PAGE>
 
     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.

Liquidity and Capital Resources
-------------------------------

     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. Availability under
that line of credit is a function of trailing cash flow, but amounted to the
full $80.0 million at December 31, 1998.  Borrowings under the line amounted to
$41million at December 31, 1998.

     The Company intends to develop MainStay Suites, a mid-priced extended-stay
hotel product.  At December 31, 1998, 14 MainStay Suites were open and operating
with another seven hotels under construction.  The cost to develop a MainStay
Suites hotel approximates $5.5 to $6.0 million.  In order for the Company to
continue on a long-term basis the MainStay Suites development program,
additional capital will be required.  Subject to market conditions, the Company
anticipates raising additional debt capital during calendar year 1999.

     At the distribution date, the Company owed 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
Choice note with a longer-term and lower cost subordinated debt financing as
soon as practicable.

     At the distribution date, Sunburst owed Choice an additional approximately
$15.0 million relative to the final allocation of assets, liabilities and equity
between the two parties.  This obligation was effectively satisfied with the
execution in December 1998 of an amendment to the Company's Strategic Alliance
Agreement, which, among other things, terminated the Company's option to
purchase the MainStay Suites brand name.

     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.  This CMBS debt is non-recourse and is collateralized
by 35 hotel properties with a net book value of $139.2 million owned by the
Company.  The CMBS debt carries 7.8% blended weighted average interest rate and
has a final maturity of May 5, 2012.  The hotel properties so collateralized
reported EBITDA of $31.1 million for calendar year 1998.  The Company used the
proceeds to repay debt payable to its former parent, Manor Care, Inc.

     Net cash provided by continuing operating activities was $35.5 million for
the year ended December 31, 1998, as compared to $21.4 million, for the seven
months ended December 31, 1997.

     During 1998, the Company sold two hotels and an unimproved parcel of land
generating cash proceeds of $6.1 million.  The proceeds were used to retire
debt, including $2.2 million of CMBS debt which resulted in a pre-payment
penalty of $308,000, after-tax.

     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.  The Company intends to continue to strategically
dispose of hotels not meeting its criteria for long-term retention and utilize
the proceeds to retire debt and fund future development.  Between December 31,
1998 and March 1, 1999, the Company sold an additional hotel for $2.2 million in
cash and, at March 1, 1999, has an additional twelve hotels being marketed for
sale.

     At December 31, 1998, the Company's debt to book capitalization amounted to
73%, while debt to market capitalization was 77%.  Debt to recurring EBITDA
amounted to 4.8:1 and recurring EBITDA to interest was 2.5:1 for calendar year
1998.

     While operating cash flow along with the credit available under the
Company's bank facility and the proceeds from the sale of hotels is expected to
be adequate to fund operations and committed 

                                       23
<PAGE>
 
construction projects, accessing additional capital is imperative in order for
the Company to expand 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 construction of
hotels in 1999 are projected to be approximately $20 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 has developed a plan to address the impact of the Year 2000 on
its computer systems and other systems with embedded microprocessors that could
be date sensitive (collectively, "in-house systems"), as well as issues related
to third party vendors and suppliers of the Company.  The Company's plan
consists of four phases: 1) Assess computer systems and other systems with
embedded microprocessors and determine which such systems are critical to the
ongoing operations of the Company; 2) Inventory critical systems to determine
manufacturers, suppliers or vendors; 3) Test or assess the readiness of systems
and vendors and suppliers, and; 4) Inventory and assess the readiness of non-
critical systems.  Corrective actions are being taken as issues arise.  The
following discusses the Companies progress in addressing both in-house systems
and third party vendors.

     The Company's financial accounting and reporting systems are scheduled to
be upgraded in early 1999 to a version that has been certified to be Year 2000
compliant.  Following the upgrade, the accounting and reporting systems are
expected to adequately provide information and reporting needs into the next
century.  Non-compliant computer hardware and software at the Company's
corporate headquarters and all its hotels has been identified and a schedule to
upgrade affected systems by September 1999 has been established.  The Company
estimates that approximately 85% of its employee workstations will need to be
upgraded.  In order to accommodate a new property management system required by
Choice Hotels International, Inc., the Company had previously planned to update
these systems.  Therefore, the cost of upgrading the systems, outside of
previously planned upgrades, is estimated to be immaterial.

     The Company has inventoried systems with embedded chips used at the
Company's corporate headquarters as well as building systems at the company's 
hotel properties (i.e., elevators, room key systems, HVAC equipment, as fire
safety equipment) and has begun contacting manufacturers to determine the
readiness of the systems for the Year 2000. Any systems determined to be Year
2000 sensitive and non-compliant will be replaced or modified as necessary.
Although the Company does not have an estimate for the cost to bring all
critical systems into compliance, it is not believed to be material.

     The Company is developing a contingency plan to address the possible
failure of any in-house systems.  As critical non-compliant systems are
identified that the Company believes may not be compliant by the year 2000,
contingency plans will be created.

     The Company relies significantly on third party systems to provide various
goods and services.  The Company has identified those vendors and suppliers that
it believes to be critical to the ongoing operations of the Company and has
begun contacting them to verify their state of readiness and evaluate their
contingency plans.  Based on the responses received, the Company believes that
the critical third party systems are or will be Year 2000 compliant.  To the
extent that a third party cannot certify that their systems will be Year 2000
complaint, the Company will take actions to correct the non-compliant situation
or develop contingency plans.

     Because the Company relies significantly on Choice Hotels International,
Inc. ("Choice") for reservation and property management systems as well as
overall franchisee support, their state of readiness 

                                       24
<PAGE>
 
for Year 2000 is critical to the Company. Therefore, a description of Choice
plan to address the Year 20000 issue, as set forth in its SEC filings, follows.

       Choice's exposure to potential Year 2000 problems exists in two general
  areas: technological operations in the sole control of Choice, and
  technological operations dependent in some way on one or more third parties.
  With respect to internal systems, Choice has conducted Year 2000 compliance
  testing on all of its proprietary software, including its reservations and
  reservations support systems, its franchise support system and its franchisee
  property management support systems.  Choice has indicated that the
  proprietary software is Year 2000 compliant.

       Choice's Year 2000 Compliance Committee is currently identifying third
  party vendors and service providers whose non-compliant systems could have a
  material impact on Choice and undertaking an assessment as to such parties'
  compliant status.  These parties include franchisees, airline global
  distribution systems ("GDS"), utility providers, telephone service providers,
  banks and data processing services.  The GDS companies, which provide
  databases through which travel agents can book hotel rooms, have assured
  Choice in writing that they are making the necessary changes in their system
  to become compliant and Choice has begun conducting tests with the GDS
  companies.

       Additional information regarding Choice's Year 2000 preparedness can be
obtained from their SEC filings.

       Failure by the Company or one or more of its third party vendors to
adequately address the Year 2000 issue could have a material adverse impact on
the Company.  The Company is not able to estimate the impact such failure could
have due to its dependence on third parties including utility companies,
airlines, hotel reservation centers, Choice, banks and credit card payment
processing centers.  In addition, the severity and duration of failures will
greatly affect the impact of such failures on the Company.

       As a result of the considerable publicity surrounding, and the increased
consumer awareness of, the Year 2000 issue, it is possible that travel patterns
may be disrupted.  The Company is unable to estimate the effect such
disruptions, if any, may have on its hotel operations.

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 calendar 1998, 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, 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.

                                       25
<PAGE>
 
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

<TABLE>  
<CAPTION> 
                                                              Page
                                                              ----
<S>                                                           <C> 
Report of Independent Public Accountants..................     27  
Consolidated Balance Sheets...............................     28  
Consolidated Statements of Income.........................     29  
Consolidated Statements of Cash Flows.....................     30  
Consolidated Statements of Stockholders' Equity...........     31  
Notes to Consolidated Financial Statements................     32   
</TABLE>

                                       26
<PAGE>
 
                    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, 1998
and 1997, the related consolidated statements of income and cash flows for the
year ended December 31, 1998, the seven months ended December 31, 1997, and each
of the two fiscal years in the period ended May 31, 1997, and stockholders'
equity and comprehensive income for the year ended December 31, 1998 and 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 and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for the year ended December 31, 1998,
the seven months ended December 31, 1997 and each of the two fiscal years in the
period ended May 31, 1997, in conformity with generally accepted accounting
principles.

          Our audit was 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 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 10, 1999

                                       27
<PAGE>
 
                       SUNBURST HOSPITALITY CORPORATION
                          CONSOLIDATED BALANCE SHEETS
                     (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 
<TABLE> 
<CAPTION> 
                                                                                                       As of
                                                                                  ---------------------------------------------
                                                                                       December 31,             December 31,
                                                                                           1998                    1997
                                                                                  ---------------------    --------------------
                                                              ASSETS
<S>                                                                               <C>                      <C>  
Real estate, net                                                                  $             363,023    $            371,305
Real estate held for sale                                                                        37,122                       -
Receivables (net of allowance for doubtful
   accounts of $611 and $616, respectively)                                                       7,271                   6,261
Other assets                                                                                     10,982                  17,509
Cash and cash equivalents                                                                         4,113                   5,908
                                                                                  ---------------------    --------------------
 
                     TOTAL ASSETS                                                 $             422,511    $            400,983
                                                                                  =====================    ====================
 
 
                                               LIABILITIES AND STOCKHOLDERS' EQUITY
 
LIABILITIES
 
Debt
     Mortgages and other long term debt                                           $             153,341    $            133,648
     Note payable to Choice Hotels International, Inc.                                          127,848                 117,120
                                                                                  ---------------------    --------------------
                                                                                                281,189                 250,768
 
Accounts payable and accrued expenses                                                            32,633                  33,415
Payable to Choice Hotels International, Inc.                                                          -                  25,066
Deferred income taxes ($1,352 and $1,378, respectively) and
  other liabilities                                                                               6,052                   2,427
                                                                                  ---------------------    --------------------
 
                     Total liabilities                                                          319,874                 311,676
                                                                                  ---------------------    --------------------
 
 
STOCKHOLDERS' EQUITY
 
Common stock (60,000,000 and 60,000,000 authorized, at $0.01 par
   value, 21,445,696 and 21,366,282 issued and 19,606,004 and
   19,947,042 outstanding at December 31, 1998 and 1997,
   respectively)                                                                                    244                     243
Additional paid-in-capital                                                                      171,462                 169,536
Treasury stock (2,331,920 and 1,821,505 shares, respectively)                                   (65,856)                (63,926)
Retained earnings                                                                                (3,213)                (16,546)
                                                                                  ---------------------    --------------------
 
                     Total stockholders' equity                                                 102,637                  89,307
                                                                                  ---------------------    --------------------
 
                     TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                   $             422,511    $            400,983
                                                                                  =====================    ====================
</TABLE>


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

                                       28
<PAGE>
 
                       SUNBURST HOSPITALITY CORPORATION
                       CONSOLIDATED STATEMENTS OF INCOME
                   (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE> 
<CAPTION> 
                                                                                 For the seven 
                                                                                     months
                                                        For the year ended            ended           For the fiscal year ended 
                                                            December 31,          December 31,                  May 31, 
                                                                                                     ----------------------------- 
                                                                1998                  1997              1997             1996 
                                                       --------------------     ------------------   ------------   -------------- 
<S>                                                    <C>                      <C>                  <C>            <C> 
REVENUES
 
  Rooms                                                $           178,755      $         100,670    $   165,239    $   $137,001
  Food and beverage                                                 17,247                  9,231         13,356          11,392
  Other                                                              7,789                  4,652          7,378           6,816
  Net gains (losses) on property transactions                          305                      -           (220)           (584)
                                                       --------------------     ------------------   ------------   -------------- 
 
        Total revenues                                             204,096                114,553        185,753         154,625
                                                       --------------------     ------------------   ------------   --------------  

 
OPERATING EXPENSES
 
Departmental Expenses
  Rooms                                                             51,227                 33,484         58,502          51,657
  Food and beverage                                                 13,183                  7,319         10,887           9,792
  Other                                                              3,056                  1,530          2,674           2,570
Undistributed Operating Expenses 
  Administrative and general                                        18,514                  9,486         17,990          16,358
  Marketing                                                         16,430                  8,862         14,545          12,152
  Utility costs                                                      9,632                  5,697          8,816           7,712
  Property operation and maintenance                                10,470                  5,746          9,428           8,118
  Property taxes, rent and insurance                                 9,369                  5,010          6,857           6,044
  Depreciation and amortization                                     27,227                 14,246         20,632          16,636
  Corporate                                                         13,961                  8,244          7,691           8,026
  Provision for asset impairment and other                               
     non-recurring charges                                           4,264                  5,119              -          24,595
                                                       --------------------     ------------------   ------------   -------------- 
                        Total operating expenses                   177,333                104,743        158,022         163,660
                                                       ====================     ==================   ============   ============== 

 
OPERATING INCOME (LOSS)                                             26,763                  9,810         27,731          (9,035)
                                                       --------------------     ------------------   ------------   -------------- 
 
INTEREST EXPENSE                                                    20,512                 10,138         15,891          12,839
                                                       --------------------     ------------------   ------------   -------------- 
 
INCOME (LOSS) FROM CONTINUING
  OPERATIONS BEFORE INCOME TAXES                                     6,251                   (328)        11,840         (21,874)
        Income taxes                                                 2,563                    (44)         5,035          (8,523)
                                                       --------------------     ------------------   ------------   --------------  

 
INCOME (LOSS) FROM CONTINUING  
  OPERATIONS BEFORE EXTRAORDINARY ITEM                               3,688                   (284)         6,805         (13,351)
        
 DISCONTINUED OPERATIONS: Income from 
  operations of discontinued franchising business
  (less applicable income taxes of $0, $11,825, $25,165,
  and $15,923, respectively)                                             -                 16,369         35,219          21,809
                                                       --------------------     ------------------   ------------   -------------- 
 
NET INCOME BEFORE EXTRAORDINARY ITEM                                 3,688                 16,085         42,024           8,458
 
EXTRAORDINARY ITEM -- LOSS FROM EARLY
  EXTINGUISHMENT OF DEBT (NET OF $201 AND $747
  TAX BENEFIT)                                                         308                      -          1,144               -
                                                       --------------------     ------------------   ------------   --------------
 
  NET INCOME                                           $             3,380      $          16,085    $    40,880    $      8,458
                                                       ====================     ==================   ============   ============== 
 
Basic earnings per share
------------------------
  From continuing operations                           $              0.18      $           (0.01)   $      0.32    $      (0.64)
  From discontinued operations                                           -                   0.82           1.69            1.05
  From extraordinary item                                            (0.01)                     -          (0.05)              -
                                                       --------------------     ------------------   ------------   -------------- 
  Earnings per share                                   $              0.17      $            0.81    $      1.96    $       0.41
                                                       ====================     ==================   ============   ==============  

 
Diluted earnings per share
--------------------------
  From continuing operations                           $              0.18      $           (0.01)   $      0.32    $      (0.64)
  From discontinued operations                                           -                   0.82           1.66            1.05
  From extraordinary item                                            (0.01)                     -          (0.05)              -
                                                       --------------------     ------------------   ------------   -------------- 
  Earnings per share                                   $              0.17      $            0.81    $      1.93    $       0.41
                                                       ====================     ==================   ============   ==============  

</TABLE>

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

                                       29
<PAGE>
 
                       SUNBURST HOSPITALITY CORPORATION
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                           For the year  For the seven                              
                                                                               ended      months ended   For the fiscal year ended
                                                                           December 31,   December 31,             May 31,        
                                                                                                         --------------------------
CASH FLOWS FROM OPERATING ACTIVITIES                                           1998           1997           1997           1996    
                                                                           ------------  ------------    -----------    ----------- 
<S>                                                                        <C>           <C>             <C>            <C>       
Income (loss) from continuing operations before extraordinary item           $    3,688     $    (284)      $  6,805    $   (13,351)

Reconciliation of net income (loss) to net cash                                                                                     
   provided by operating activities:                                                                                                
      Depreciation and amortization                                              27,227        14,246         20,632         16,636 
      Amortization of deferred financing fees                                       244           248              -              - 
      Amortization of debt discount                                               1,921           528             29             34 
      Deferred interest on Choice Hotels International, Inc. Note                 8,808         2,648              -              - 
      Provision for bad debts, net                                                  424           247            560            289 
      Increase (decrease) in deferred taxes                                         466           695          2,920         (7,726)
      (Gain) loss on sale of property                                               (65)            -            220            584 
      Provision for asset impairment and other non-recurring charges              3,983         5,119              -         19,420 
Change in assets and liabilities:                                                                                                   
      Change in receivables                                                      (1,434)         (152)        (1,686)           468 
      Change in other assets                                                     (2,351)         (357)        (3,963)        (3,106)
      Change in accounts payable and accrued expenses                              (781)       (9,323)        17,391          7,722 
      Change in payable to Choice Hotels International, Inc.                     (8,601)       10,066              -              - 
      Change in current taxes receivable                                          2,018        (2,310)          (483)         1,441 
      Change in other liabilities                                                    (9)            -              -            384 
                                                                           ------------  ------------    -----------    ----------- 
          NET CASH PROVIDED BY CONTINUING OPERATIONS                             35,538        21,371         42,425         22,795 
          NET CASH PROVIDED BY DISCONTINUED OPERATIONS                                -        20,876         44,833         32,645 
                                                                           ------------  ------------    -----------    ----------- 
          NET CASH PROVIDED BY OPERATING ACTIVITIES                              35,538        42,247         87,258         55,440 
                                                                           ------------  ------------    -----------    ----------- 
                                                                                                                                    
CASH FLOWS FROM INVESTING ACTIVITIES                                                                                                
      Investment in property and equipment                                      (60,720)      (61,460)       (75,523)       (46,966)
      Acquisition of operating hotels                                                 -             -         (5,550)       (49,617)
      Distribution of New Choice                                                      -        (4,166)             -              - 
      Proceeds from sale of property and equipment                                5,864           170          2,522          5,479 
                                                                           ------------  ------------    -----------    ----------- 
          NET CASH UTILIZED BY CONTINUING OPERATIONS                            (54,856)      (65,456)       (78,551)       (91,104)
          NET CASH UTILIZED BY DISCONTINUED OPERATIONS                                -      (118,474)       (15,864)       (78,844)
                                                                           ------------  ------------    -----------    ----------- 
          NET CASH UTILIZED BY INVESTING ACTIVITIES                             (54,856)     (183,930)       (94,415)      (169,948)
                                                                           ------------  ------------    -----------    ----------- 

CASH FLOWS FROM FINANCING ACTIVITIES                                                                                                
      Proceeds from mortgages and other long term debt                           25,000        16,023        208,000              - 
      Proceeds from note payable to Choice Hotels International, Inc.                 -       115,000              -              - 
      Principal payments of debt                                                 (5,256)      (92,171)        (1,157)          (645)
      (Payments on) proceeds from notes payable to Manor Care, Inc.                   -       (37,022)      (110,000)        27,201 
      Payment of financing fees                                                       -             -         (3,959)             - 
      Payment of prepayment penalty                                                (439)            -         (1,891)             - 
      Proceeds from issuance of common stock                                        359         1,153          3,410              - 
      Purchases of treasury stock                                                (2,141)      (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
                                                                           ------------  ------------    -----------    ----------- 
          NET CASH PROVIDED BY CONTINUING OPERATIONS                             17,523         7,429         31,282         99,828
          NET CASH PROVIDED BY (UTILIZED BY) DISCONTINUED OPERATIONS                  -       129,337        (17,839)        17,131
                                                                           ------------  ------------    -----------    ----------- 

          NET CASH PROVIDED BY FINANCING ACTIVITIES                              17,523       136,766         13,443        116,959
                                                                           ------------  ------------    -----------    ----------- 

NET CHANGE IN CASH AND CASH EQUIVALENTS                                          (1,795)       (4,917)         6,286          2,451
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                  5,908        10,825          4,539          2,088
                                                                           ------------  ------------    -----------    ----------- 

CASH AND CASH EQUIVALENTS AT END OF PERIOD                                   $    4,113     $   5,908       $ 10,825    $     4,539
                                                                           ============  ============    ===========    ===========

Cash and cash equivalents of continuing operations                           $    4,113     $   5,908       $  7,033    $     1,436
Cash and cash equivalents of discontinued operations                         $        -     $       -       $  3,792    $     3,103
</TABLE>

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

                                       30
<PAGE>
 
                       SUNBURST HOSPITALITY CORPORATION
   CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
                         (IN THOUSANDS, EXCEPT SHARES)
                                        
<TABLE>
<CAPTION>
                                                                                Accumulated                                        
                                                                                   Other                                           
                                              Common Stock       Additional    Comprehensive  Retained                 Comprehensive
                                           ------------------                                                                      
                                           Shares      Amount  Paid-in-Capital    Income      Earnings  Treasury Stock    Income   
                                           -----------------------------------------------------------------------------------------
<S>                                        <C>         <C>       <C>           <C>           <C>        <C>            <C>         
DISTRIBUTION FROM MANOR CARE INC.          63,081,129  $  631    $162,512      $(1,750)      $      -   $      -       $      -
Net Income                                                                                     40,880                    40,880 
Transfer of net income to Manor Care, Inc.                                                    (23,805)
Exercise of stock options/grants              781,542       8       4,651                                  
Other comprehensive income, net of tax

Translation adjustment                                                          (5,268)                                  (5,268)
                                                                                                                         -------
Comprehensive income                                                                                                    $35,612
                                                                                                                         =======

Treasury purchases                                                                                        (53,372)

                                           -----------------------------------------------------------------------
BALANCE, MAY 31, 1997                       63,862,671    639     167,163       (7,018)         17,075    (53,372)
                                           -----------------------------------------------------------------------
 
Net income                                                                                      16,085                   $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                                                                                        (10,554)

Other comprehensive income, net of tax

Translation adjustment                                                          (1,644)                                  (1,644)

Comprehensive income                                                                                                     $14,441
                                                                                                                         =======
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                  24,233,697    243     169,536            -         (16,546)   (63,926)
                                           ----------------------------------------------------------------------- 
 
Net income                                                                                       3,380
Sale of MainStay brand option to Choice
 Hotels International, Inc.                                                                      9,953
 
Exercise of stock options/grants                79,414      1       1,926
Stock grants issued from Treasury shares                                                                      216

Treasury purchases                                                                                         (2,146)
                                           -----------------------------------------------------------------------  
BALANCE, DECEMBER 31, 1998                  24,313,111   $244    $171,462       $    -         $(3,213)  $(65,856)
                                           =======================================================================
</TABLE>

The accompanying notes are an integral part of these consolidated statements of
stockholders' equity and comprehensive income.

                                       31
<PAGE>
 
                       SUNBURST HOSPITALITY CORPORATION
    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - DECEMBER 31, 1998 AND 1997

Summary of Significant Accounting Policies

BASIS OF PRESENTATION

On March 7, 1996, Manor Care, Inc. ("Manor Care") announced its intention to
proceed with the separation of its lodging business from its health care
business through a spin-off of its lodging business (the "Manor Care
Distribution"). On September 30, 1996 the Board of Directors of Manor Care
declared a special dividend to its shareholders of one share of common stock of
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 domestic and European 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. ("Choice").

On April 29, 1997, the Company's Board of Directors announced its intention to
separate the Company's franchising business from its owned, domestic hotel
business. On September 16, 1997 the Board of Directors and shareholders of the
Company approved the separation of the businesses through a Spin-off 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 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 Spin-off 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).

<TABLE>
<CAPTION>
        SEVEN MONTHS ENDED        DOMESTIC HOTEL    EUROPEAN HOTEL   CONTINUING
        DECEMBER 31, 1997           OPERATIONS        OPERATIONS     OPERATIONS
--------------------------------------------------------------------------------
<S>                               <C>               <C>              <C>       
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)
                                  ==============================================
</TABLE>                                                                       
                                                                             
                                      32
<PAGE>
 
<TABLE>                                                                     
<CAPTION>                                                                   
        FISCAL YEAR ENDING       DOMESTIC HOTEL       EUROPEAN HOTEL     CONTINUING                
           MAY 31, 1997            OPERATIONS           OPERATIONS       OPERATIONS                
                                                                                                   
-----------------------------------------------------------------------------------
<S>                              <C>                  <C>                <C>                       
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               
                                 ==================================================
</TABLE>

<TABLE>
<CAPTION>
        FISCAL YEAR ENDING       DOMESTIC HOTEL        EUROPEAN HOTEL         CONTINUING          
           MAY 31, 1996            OPERATIONS            OPERATIONS           OPERATIONS          
---------------------------------------------------------------------------------------------
<S>                              <C>                   <C>                    <C>                 
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)      
                                 ============================================================
</TABLE>

An analysis of the activity in the "Advances (to) from Manor Care Inc., net"
account for the year ended May 31, 1996 and the five months ended October 31,
1996 is as follows (in thousands):

<TABLE>
<S>                                           <C>              
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          
                                              ========          
</TABLE>

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).

                                       33
<PAGE>
 
<TABLE>
<CAPTION>
                                              SEVEN MONTHS ENDED DECEMBER 31, 1996
                                 -------------------------------------------------------------
                                     DOMESTIC HOTEL      EUROPEAN HOTEL         CONTINUING
(Unaudited)                            OPERATIONS          OPERATIONS           OPERATIONS
                                 -------------------------------------------------------------
<S>                              <C>                     <C>                    <C>
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
                                 =============================================================
</TABLE>

The following table presents the Company's results of operations for the full
calendar year 1997 (unaudited, in thousands, except per share data).

<TABLE>
<CAPTION>
                                                       CALENDAR YEAR 1997
                                 -------------------------------------------------------------
(Unaudited)                          DOMESTIC HOTEL      EUROPEAN HOTEL         CONTINUING
                                       OPERATIONS          OPERATIONS           OPERATIONS
                                 -------------------------------------------------------------
<S>                              <C>                     <C>                    <C>
Revenues                                     $180,052             $13,741             $193,793
Operating expenses                            135,388              12,401              147,789
Depreciation and amortization                  22,372               1,399               23,541
                                 -------------------------------------------------------------
Operating income                               22,292                 (59)              22,463
Interest expense                               16,461                 724               17,185
                                 -------------------------------------------------------------
Pretax income (loss) from
   continuing operations                        5,831                (783)               5,278
Income tax expense (benefit)                    2,537                (310)               2,319
                                 -------------------------------------------------------------
Income (loss) from continuing
   operations                                $  3,294             $  (473)            $  2,959
                                 =============================================================
Earnings per share:
    Basic                                    $   0.16             $ (0.02)            $   0.15
                                 =============================================================
</TABLE>

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 $724,000 and $1.2 million, net
of accumulated amortization, at December 31, 1998 and 1997, respectively.
Pursuant to the American Institute of Certified Public Accountants Statement of
Position No. 98-5, "Reporting on the Costs of Start-up Activities"(the "SOP"),
on January 1, 1999, the Company will begin expensing costs related to start-up
activities as incurred. Initial application of the SOP will be reported as a
cumulative effect of a change in accounting principle.

If the Company would have adopted this standard on January 1, 1998, the effect
would have been to increase income from continuing operations by approximately
$274,000 for the year ended December 31, 1998, and to decrease net income for
the year by approximately $420,000, as a result of a charge for the cumulative
effect of a change in accounting principle of $694,000 (net of taxes).

                                       34
<PAGE>
 
REAL ESTATE

The components of real estate are as follows:

<TABLE>
<CAPTION>
                                             December 31,       December 31, 
                                                 1998               1997     
                                         -------------------------------------
     <S>                                 <C>                    <C>           
     Land                                          $ 56,007           $ 61,959
     Buildings                                      281,821            263,405
     Furniture, fixtures and equipment               77,127             70,598
     Hotels under construction                       31,962             41,869
                                         -------------------------------------
                                                    446,917            437,831
     Less:  accumulated depreciation                (83,894)           (66,526)
                                         ------------------------------------- 
                                                   $363,023           $371,305 
                                         ===================================== 
</TABLE>

Depreciation has been computed for financial reporting purposes using the
straight-line method. A summary of the ranges of estimated useful lives upon
which depreciation rates have been based follows:

<TABLE>
<S>                                                       <C>  
     Building and improvements                            10-40 years
     Furniture, fixtures and equipment                     3-20 years
</TABLE>

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. 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. Real estate held for sale is recorded based on its estimated
fair value less cost to sell.

CAPITALIZATION POLICIES

The Company capitalizes interest costs and property taxes incurred during the
construction of capital assets. The Company capitalized $2.4 million, $1.9
million and $0.8 million in interest costs for the year ended December 31, 1998,
the seven months ending December 31, 1997 and the fiscal year ending May 31,
1997, respectively. Maintenance, repairs and minor replacements are charged to
expense.

IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS

The Company is required to adopt Statement of Financial Accounting Standard
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," in 2000. As the Company does not actively use derivative
instruments, the standard will not have a material impact on the financial
statements of the Company.

The Company has adopted SFAS No. 130, "Reporting Comprehensive Income," and SFAS
No. 131, "Disclosures About Segments of an Enterprise and Related Information,"
in 1998. The components of other comprehensive income consists solely of foreign
currency translation adjustments. Subsequent to the Distribution, the Company
does not have any items that are considered to be other comprehensive income.
The adoption of the standards did not have a material impact on the financial
statements of the Company.

                                       35
<PAGE>
 
RECLASSIFICATIONS

Certain amounts previously presented have been reclassified to conform to the
December 31, 1998 presentation.

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):

<TABLE>
<CAPTION>
                                         For the year       For the seven
                                             ended           months ended
                                         December 31,        December 31,          For the fiscal year ended May 31,
                                                                                 -------------------------------------
                                             1998                1997                   1997                1996
                                     ---------------------------------------------------------------------------------
<S>                                    <C>                <C>                    <C>                 <C>
Income (loss) from continuing
 operations before income taxes
   Domestic operations                        $6,251              $(395)               $12,649            $ (5,119)
   Foreign operations                              -                 67                   (809)            (16,755)
                                     ---------------------------------------------------------------------------------
     Income (loss) before
        income taxes                          $6,251              $(328)               $11,840            $(21,874)
                                     =================================================================================
</TABLE>

The provision for income taxes for continuing operations (in thousands):

<TABLE>
<CAPTION>
                                         For the year       For the seven
                                             ended           months ended
                                         December 31,        December 31,          For the fiscal year ended May 31,
                                                                                --------------------------------------
                                             1998                1997                   1997                1996
                                     ---------------------------------------------------------------------------------
<S>                                    <C>                <C>                   <C>                  <C>
Current tax (benefit) expense
   Federal                                        $1,723              $ 621                 $2,583             $    94
   Foreign operations                                  -                 27                   (320)               (315)
   State                                             386                134                    292                  26
Deferred tax (benefit) expense
   Federal                                           371               (680)                 2,048              (1,676)
   Foreign operations                                  -                  -                      -              (6,295)
   State                                              83               (146)                   432                (357)
                                     ---------------------------------------------------------------------------------
                                                  $2,563              $ (44)                $5,035             $(8,523)
                                     =================================================================================
</TABLE>

Deferred tax liabilities were composed of the following (in thousands):

<TABLE>
<CAPTION>
                                                    December 31,
                                              1998                  1997
                                     -------------------    -----------------
<S>                                    <C>                    <C>
Depreciation and amortization                    $(2,667)             $(2,956)
Accrued expenses                                   2,428                2,702
Other                                             (1,113)              (1,124)
                                     -------------------    -----------------
Net deferred tax liability                       $(1,352)             $(1,378)
                                     ===================    =================
</TABLE>

                                       36
<PAGE>
 
A reconciliation of income tax expense (benefit) at the statutory rate to income
tax expense included in the accompanying consolidated statements follows:

<TABLE>
<CAPTION>
                                         For the year     For the seven
(In thousands, except Federal income        ended          months ended
tax rate)                                December 31,      December 31,         For the fiscal year ended May 31,
                                                                            ---------------------------------------
                                             1998              1997                  1997                1996
                                     ------------------------------------------------------------------------------
<S>                                    <C>               <C>                  <C>                 <C>
Federal income tax rate                             35%               35%                    35%                 35%
 
Federal taxes at statutory rate                 $2,188             $(115)                $4,144             $(7,656)
State income taxes, net of Federal
 tax benefit                                       305                (4)                   573                (982)
Other                                               70                75                    318                 115
                                     ------------------------------------------------------------------------------
Income tax expense (benefit)                    $2,563             $ (44)                $5,035             $(8,523)
                                     ==============================================================================
</TABLE>

Cash paid for state income taxes was $687,000, $486,000, $805,000 and
$165,000, for the year ended December 31, 1998, the seven months ending December
31, 1997 and the fiscal years ending May 31, 1997 and 1996, respectively.
Federal income taxes were paid by Manor Care for the period ending October 31,
1996 and the fiscal year ended May 31, 1996. The Company paid Federal income
taxes of $2,630,000 for the Company for the year ended December 31, 1998 and for
the consolidated group (including 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, the Company
had an income tax receivable of $4.3 million.

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 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 Choice, the Company and Choice entered into a tax-
sharing agreement to allocate pre-distribution tax liabilities among the Company
and 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 Choice and its subsidiaries through the
date of the distribution) and (ii) paying the taxes related to such returns to
the applicable taxing authorities. Choice will reimburse the Company for the
portion of such taxes that relates to Choice and its subsidiaries.

ACCRUED EXPENSES

Accrued expenses were as follows (in thousands):

<TABLE>
<CAPTION>
                                                   December 31,
                                     ---------------------------------------
                                             1998                 1997
                                     -------------------   -----------------
<S>                                    <C>                   <C>
Payroll                                          $ 5,534             $ 4,449
Taxes, other than income                           4,331               3,995
Other                                              6,354               3,566
                                                 $16,219             $12,010
                                     ===================   =================
</TABLE>

                                       37
<PAGE>
 
LONG-TERM DEBT AND NOTES PAYABLE

Debt consisted of the following at December 31, 1998 and 1997 (in thousands):
 
<TABLE>
<CAPTION>
                                                                December 31,
                                                  ---------------------------------------
                                                          1998                 1997
                                                  -------------------   -----------------
 
<S>                                                 <C>                   <C>
$80.0 million revolving credit facility with an
   average rate of 7.68% and 8.27% at December 31,
   1998 and 1997, respectively                               $ 41,000            $ 16,000
Multi-class mortgage pass-through certificates
   with a blended weighted average rate of 7.8% at
   December 31, 1998 and 1997                                 110,913             115,816
Note payable to Choice with an effective rate of
   10.60% and 8.80% at December 31, 1998 and
   1997, respectively                                         127,849             117,120
Capital lease obligations                                       1,427               1,832
                                                  -------------------   -----------------
 
Total indebtedness                                           $281,189            $250,768
                                                  ===================   =================
</TABLE>

Maturities of debt at December 31, 1998 were as follows (in thousands):

<TABLE>
<CAPTION>
Year
----
<S>                                            <C>                  
1999                                                   $  3,271     
2000                                                     44,543     
2001                                                      4,065     
2002                                                    131,518     
2003                                                      3,964     
Thereafter                                               93,828     
                                               ----------------     
Total                                                   281,189     
                                               ================     
</TABLE>

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 CMBS debt"). The CMBS
debt, which carries a blended, weighted average interest rate of 7.8% and has 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. Restricted net assets related to the CMBS
debt were $31.3 million and $35.4 million as of December 31, 1998 and 1997,
respectively. The Company had $2.2 million and $6.1 million in escrow at
December 31, 1998 and 1997, respectively, related to the CMBS debt. The escrow,
which is included in other assets, is for property taxes, insurance and capital
expenditures of the properties collateralizing the CMBS debt. The CMBS debt is
non-recourse and is collateralized by 36 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 the fiscal year ended May 31,
1997. During 1998, the sale of one of the collateralized hotels resulted in a
prepayment of CMBS debt in the amount of $2.2 million and a prepayment penalty.
This prepayment resulted in an extraordinary loss of $308,000, net of tax.

In conjunction with the April 1997 issuance of the CMBS debt, 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 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
Choice (the "Choice Note"). Proceeds from the new debt were used to repay the
Company's remaining portion of the loan from Manor Care and the outstanding
balance of revolving credit facility, and for advances previously made

                                       38
<PAGE>
 
by 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. Availability under the October 1997 credit facility is a
function of trailing cash flow. At December 31, 1998, the Company had the full
$80.0 million of availability under the October 1997 credit facility, resulting
in excess borrowing capacity of $39.0 million. 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.

The Choice Note has a maturity of five years and 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 December 28, 1998.
In December 1998, the Choice Note terms were amended providing that the Choice
Note will accrue interest at a rate of 11.0% per annum compounded daily on
principal and unpaid interest beginning on October 15, 2000. As a result of the
amendment, the effective rate of the note increased to 10.6%. The Choice 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.

Cash paid for interest was $9.9 million, $10.7 million, $14.8 million, and $12.8
million for the year ended December 31, 1998, the seven months ended December
31, 1997 and fiscal years 1997 and 1996, respectively. At December 31, 1998,
real estate property with a net book value of $138.6 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):

<TABLE>
<CAPTION>
                                        Operating Leases      Capitalized Leases              
                                    ---------------------------------------------             
<S>                                   <C>                   <C>                               
1999                                               $ 1,223                 $  497             
2000                                                 1,239                    497             
2001                                                 1,255                    819             
2002                                                 1,108                      -             
2003                                                   800                                    
Thereafter                                          14,565                      -             
                                    ---------------------------------------------             
Total minimum lease payments                       $20,190                  1,813             
                                    ======================                                    
Less:  interest                                                              (386)             
                                                          -----------------------             
Present value of lease payments                                            $1,427             
                                                          =======================              
</TABLE>

Rental expense under non-cancelable operating leases was $1.9 million, $1.9
million, $329,000 and $332,000 in the year ended December 31, 1998, the seven
months ended December 31, 1997, and fiscal years 1997 and 1996, respectively.
For the year ended December 31, 1998 and the seven months ended December 31,
1997, the Company paid $2.5 million and $2.9 million, respectively, to Manor
Care for office rent, of which Choice reimbursed the Company $1.0 million and
$1.0 million, respectively, 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 Choice reimbursed the Company $4.0 million for its portion of total
space occupied.

ACQUISITIONS AND DIVESTITURES

During 1998, the Company sold two hotels containing 193 rooms for $4.5 million
and two parcels of unimproved land for $1.6 million. During fiscal year 1997,
the Company acquired two hotels containing 324 rooms for $10.7 

                                       39
<PAGE>
 
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.

In addition to the two hotels sold in 1998, the Company has thirteen hotels that
are currently being marketed for sale with a carrying value of $37.1 million as
of December 31, 1998. The Company anticipates the sale of the properties to be
completed during 1999. In accordance with Statement of Financial Accounting
Standards No. 121 ("SFAS No. 121"), "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," the Company has
discontinued depreciating these assets while they are held for sale, which had
the effect of reducing depreciation expense in 1998 by approximately $1.3
million. In addition, SFAS No. 121 requires that assets held for sale be
reported at the lower of the carrying amount or fair value less costs to sell.
As the Company began actively marketing these hotels, it became apparent, given
current real estate values, that certain asset carrying values exceeded
sestimated fair values less costs to sell. As a result, the Company recognized a
$4.0 million provision for asset impairment (included in "Provision for asset
impairment and other non-recurring charges" in the Consolidated Statement of
Income) in 1998 to reduce the carrying value of certain of the assets to the
estimated fair value less costs to sell. The thirteen hotels held for sale
reported total revenues of $19.7 million for the year ended December 31, 1998.
Income from operations before interest, taxes, depreciation and amortization and
allocations for corporate expenses of the thirteen hotels was $5.1 million for
the year ended December 31, 1998.

DISCONTINUED OPERATIONS

The revenues, income from discontinued operations before income taxes, and net
income from discontinued operations were as follows (in thousands):

<TABLE>
<CAPTION>
                                        Seven months
                                       ended December
                                             31,                    Fiscal year ended May 31,
                                                         ---------------------------------------------- 
                                            1997                1997           1996           1995
                                     -----------------   ----------------------------------------------
<S>                                  <C>                 <C>                   <C>            <C>
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
                                     =================   ==============================================
</TABLE>

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).

COMMITMENTS AND CONTINGENCIES

The Company is a defendant in a number of lawsuits arising in the ordinary
course of business. In the opinion of management and legal counsel, 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 $1.1 million, $357,000, $200,000 and $100,000 for the year ended
December 31, 1998, the seven months ended December 31, 1997 and in fiscal years
ended May 31, 1997 and 1996, respectively.

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. Retirement costs were
approximately $506,000, $217,000, 

                                       40
<PAGE>
 
$800,000 and $583,000 for the year ended December 31, 1998, the seven months
ended December 31, 1997 and fiscal years ended May 31, 1997 and 1996,
respectively.

CAPITAL STOCK

On September 16, 1998, the Company's board of directors approved a plan for the
Company to repurchase up to 2.5 million shares of common stock. During the year
ended December 31, 1998, the Company repurchased 510,414 shares of its common
stock at a total cost of $2.1 million. During the seven months ended December
31, 1997 and the fiscal year ended May 31, 1997, the Company repurchased 588,931
and 3,697,724 shares of its common stock at a total cost of $10.6 million and
$53.4 million, respectively.

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, upon exercise, 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
are 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 are
non-voting and 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.

At December 31, 1998, the Company had 527,291 shares authorized under its stock
option program. 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:

<TABLE>
<CAPTION>
                                                    Number of Shares         Weighted
                                                                           Option Price
                                                 -----------------------------------------
<S>                                                <C>                  <C>
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                 (2,687,141)
Granted                                                       552,441                 8.04
Exercised                                                    (202,386)                2.03
Cancelled                                                     (30,241)                4.94
                                                 -----------------------------------------
Outstanding at December 31, 1997                            2,581,705                 5.67
Granted                                                       442,536                 6.57
Exercised                                                     (79,414)                1.80
Cancelled                                                    (114,458)                7.29
                                                 -----------------------------------------
Outstanding at December 31, 1998                            2,830,369                $5.88
                                                 =========================================
</TABLE>

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 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.

                                       41
<PAGE>
 
The following table provides information on the exercise prices of options
outstanding at December 31, 1998.

<TABLE>
<CAPTION>
                                                                     Weighted Average         Number of Options
  Exercise Price     Number of Options     Weighted Average          Contractual Life             Currently
      Range             Outstanding         Exercise Price              (in years)               Exercisable
      -----             -----------         --------------              ----------               -----------
  <S>                <C>                    <C>                      <C>                      <C>
$ 1.57 to $ 2.00           166,788              $ 1.67                     1.16                     166,768
   2.01 to  3.50           331,018                2.75                     2.90                     172,086
   3.51 to  5.50           416,004                4.33                     4.73                     154,442
   5.51 to  8.50         1,805,793                7.00                     8.04                     428,766
   8.51 to 10.00           110,766                9.24                     8.73                      12,906
                         ---------                                                                  -------
                         2,830,369                                                                  934,968
                         =========                                                                  =======
</TABLE>

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.  The fair value
of each option grant has been estimated on the date of grant using an option-
pricing model.  For the year ended December 31, 1998, the seven months ended
December 31, 1997 and fiscal year 1997 the Company assumed a risk free interest
rate of 4.7%, 5.7% and 6.4%, respectively, expected volatility of 34.5%, 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 year ended
December 31, 1998, the seven months ended December 31, 1997 and fiscal year 1997
was $4.16, $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 year ended December 31,
1998, the seven months ended December 31, 1997 and fiscal year 1997.

<TABLE>
<CAPTION>
                                                            For the seven           
                                   For the year ended        months ended          For the year ended 
                                   December 31, 1998        December 31, 1997         May 31, 1997
                                 ------------------------------------------------------------------------
<S>                              <C>                        <C>                    <C>
Net income:
   As reported                         $  3,380                 $ 16,085                 $ 40,880  
   Pro forma                           $  2,352                 $ 15,563                 $ 40,296  
Earnings per share:                                                                            
   Basic, as reported                  $   0.17                 $   0.81                 $   1.96  
   Basic, pro forma                    $   0.12                 $   0.78                 $   1.92  
   Diluted, as reported                $   0.17                 $   0.81                 $   1.93  
   Diluted, pro forma                  $   0.12                 $   0.78                 $   1.90   
</TABLE>

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 FROM CONTINUING OPERATIONS

The following table illustrates the reconciliation of income from continuing
operations and number of shares used in the calculation of basic and diluted
earnings per share from continuing operations.

                                       42
<PAGE>
 
<TABLE>
<CAPTION>
(in thousands, except per share amounts)                                   Fiscal Year
                                                                              Ended
                                                      December 31,           May 31,
                                                          1998                 1997
                                                  ------------------   ------------------
<S>                                               <C>                  <C>
Computation of basic earnings per share from
continuing operations:

 Income from continuing operations before
   extraordinary item                                  $     3,688           $    6,805
 Weighted average shares outstanding                        19,956               20,893
                                                       -----------           ----------
   Basic earnings per share from continuing
         operations                                    $      0.18           $     0.32
                                                       ===========           ==========
 
Computation of diluted earnings per share from
continuing operations:
 
 Income from continuing operations before
    extraordinary item                                 $     3,688           $    6,805
 
 Weighted average share outstanding                         19,956               20,893
 
 Effect of dilutive securities:
    Employee stock option plan                                 320                  298
                                                       -----------           ---------- 
 
 Shares for diluted earnings per share                      20,276               21,191
                                                       -----------           ---------- 
   Diluted earnings per share from continuing
         operations                                    $      0.18           $     0.32
                                                       ===========           ==========
</TABLE>

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
table summarizes such options.

<TABLE>
<CAPTION>
                                                      December 31,       Fiscal Year
                                                          1998          Ended May 31,
                                                                            1997
                                                  ------------------------------------
<S>                                               <C>                  <C>
Number of shares (in thousands)                            1,734                60
Weighted average exercise price                         $   7.28           $  5.20
</TABLE>

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 ended
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 year 1996 as the Company had no stock options or other
dilutive securities outstanding prior to the Manor Care Distribution.

                                       43
<PAGE>
 
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 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%, and (v) Manor Care would provide certain corporate and
consulting services to the Company.

For the year ended December 31, 1998, the seven months ended December 31, 1997
and the fiscal year ended May 31, 1997, the Company incurred $1.3 million, $1.9
million and $525,000, respectively, in rent expense for office space leased from
Manor Care, $0, $1.2 million and $12.4 million, respectively, in interest
expense on the loan that was repaid in October 1997, and $2.0 million, $1.4
million and $2.1 million, respectively, in corporate expense for corporate
services provided by Manor Care.

In February 1999, the Company entered into a release agreement with Manor Care
which effectively terminated all inter-company service, consulting and lease
agreements.

RELATIONSHIP WITH CHOICE HOTELS INTERNATIONAL, INC.

For purposes of providing an orderly transition after the distribution, the
Company and 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,
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 Choice) for the periods of time that the affiliates were members of
the consolidated group, (iv) would be reimbursed by Choice for the portion of
income taxes paid that relate to Choice and its subsidiaries, (v) would enter
into a five-year loan agreement with 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 Choice would, at the date of distribution, have a
specified level of net worth. At December 31, 1997, approximately $25 million of
liabilities were due to Choice that related to the net worth guarantee.  This
liability related to the net worth guarantee and the reimbursement of various
expenses subsequent to the distribution date.

On December 28, 1998, the Company and Choice entered into an agreement to amend
a prior strategic alliance agreement and amend the Choice Note.  The amendment
provided for, among other things, (i) the elimination of the Company's option to
purchase the MainStay Suites Hotel system from Choice in exchange for the
satisfaction of $16.5 million of the remaining $19.5 million payable to Choice;
(ii) waiver of liquidated damage provisions on all franchising agreements
entered into prior to December 28, 1998 (excluding MainStay Suites or Sleep
Inns) and limitation of liquidated damages on all other franchise agreements to
$100,000; (iii) commitment by the Company to develop a total of 25 MainStay
Suites hotels by October 2001, and; (iv) an increase in the effective interest
rate of the Note during its final two years.  In conjunction with this
agreement, the Company paid the remaining $3.0 million due to Choice for the net
worth guarantee.  The satisfaction of the Choice payable, net of tax, is
reflected as a credit to equity as an adjustment to the accounting for the
Distribution.

The Company operates substantially all of its hotels pursuant to franchise
agreements with Choice.  Total fees paid to Choice included in the accompanying
financial statements for franchising marketing, reservation and royalty fees are
$11.5 million, $6.2 million, $9.5 million and $7.5 million for the year ended
December 31, 1998, the seven months ended December 31, 1997 and the fiscal years
ended May 31, 1997 and 1996, respectively.

                                       44
<PAGE>
 
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 is equivalent to fair value.  At December 31,
1998, the fair value of the Choice Note and the mortgage securities is $132.7
million and $106.9 million, respectively, based on rates for similarly
structured instruments.  At December 31, 1997, the carrying amount of the Choice
note and the mortgage securities approximated fair value.

PROVISION FOR ASSET IMPAIRMENT AND OTHER NON-RECURRING CHARGES

The Company recognized a provision for asset impairment and other non-recurring
charges of $4.3 million (pre-tax) in the year ended December 31, 1998.  Included
in the provision is a $4.0 million in asset impairment charge related to certain
hotels held for sale and $300,000 in non-recurring charges.  Non-recurring
charges includes a restructuring charge of $146,000 to account for a reduction
in force at the Company's corporate headquarters.  The restructuring charge
includes transition pay and benefits of the twelve employees terminated.
Benefits totaling $109,000 have been paid and charged against the liability
through December 31, 1998.

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 was 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 Choice and were entered into in conjunction with the distribution and the
Manor Care Distribution.

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.

GEOGRAPHIC AND BUSINESS SEGMENT INFORMATION

The Company operates in one business segment, hotel ownership.  The Company's
hotels are operated under Choice Hotels International, Inc. brands, contain an
average of 140 rooms, and supply other amenities such as meeting space; a
variety of restaurants and lounges, gifts shops and swimming pools.  They are
typically located in suburban locations.  The Company evaluates the performance
of its segment based primarily on operating profit before depreciation,
corporate expenses, and interest expense.

                                       45
<PAGE>
 
     The following table presents segmented financial information, (in
thousands):

<TABLE>
<CAPTION>
                                                                      For the year ended December 31, 1998
                                                       -------------------------------------------------------------------
                                                           Hotels           Corporate & Other        Consolidated
                                                       -------------------------------------------------------------------
<S>                                                    <C>                  <C>                      <C>
Revenues..........................................           $  203,822        $    274               $  204,096
Operating income..................................               33,392          (6,629)                  26,763
Interest expense..................................                    -          20,512                   20,512
Depreciation and amortization.....................                    -          27,227                   27,227
Capital expenditures..............................                    -          60,720                   60,720
Total assets......................................              419,661           2,850                  422,511
 
                                                                      For the Seven Months Ended December 31, 1997
                                                       -------------------------------------------------------------------
                                                           Hotels           Corporate & Other        Consolidated
                                                       -------------------------------------------------------------------
Revenues..........................................           $  113,251        $  1,302               $  114,553
Operating income..................................               18,067          (8,257)                   9,810
Interest expense..................................                    -          10,138                   10,138
Depreciation and amortization.....................                    -          14,246                   14,246
Capital expenditures..............................                    -          61,460                   61,460
Total assets......................................              397,527           3,456                  400,983
 
                                                                      For the Fiscal Year Ended May 31, 1997
                                                       -------------------------------------------------------------------
                                                           Hotels           Corporate & Other        Consolidated
                                                       -------------------------------------------------------------------
Revenues..........................................           $  184,707        $  1,046               $  185,753
Operating income..................................               27,072             659                   27,731
Interest expense..................................                    -          15,891                   15,891
Depreciation and amortization.....................                    -          20,632                   20,632
Capital expenditures..............................                    -          75,523                   75,523
Total assets......................................              424,033           2,396                  426,429
</TABLE>

         There were no intercompany sales between the properties and the
Company.  The following table presents revenues and long-lived assets for each
of the geographical areas in which the Company operates (in thousands):

<TABLE>
<CAPTION>
                                                   For the Year             For the Seven Months Ended    For the Fiscal Year Ended
                                              Ended December 31, 1998          December 31, 1997                   May 31, 1997
                                              -------------------------------------------------------------------------------------
                                                             Long-lived                    Long-lived                  Long-lived
                                              Revenues         assets        Revenues        assets       Revenues       assets
                                              -------------------------------------------------------------------------------------
<S>                                           <C>            <C>            <C>            <C>            <C>          <C> 
Unites States...............                   $ 204,096     $  400,145      $  107,574    $  371,305     $  168,016   $ 321,119
International...............                           -              -           6,979             -         17,737      17,300
                                               ---------     ----------      ----------    ----------     ----------   ---------
  Total.....................                   $ 204,096     $  400,145      $  114,553    $  371,305     $  185,753   $ 338,419
                                              ==========     ==========      ==========    ==========     ==========   =========
</TABLE>

                                       46
<PAGE>
 
SUMMARY OF QUARTERLY RESULTS (UNAUDITED)

<TABLE>
<CAPTION>
QUARTERS ENDED (IN
THOUSANDS, EXCEPT PER                         OPERATING        NET          BASIC       DILUTED 
SHARE DATA)                REVENUES (1)      INCOME (2,3)     INCOME        EPS (4)     EPS (4)
                           ------------------------------------------------------------------------
1998
<S>                        <C>               <C>              <C>           <C>         <C>
March 31, 1998               $ 46,139           $  6,167       $    708        $ 0.04     $ 0.03
June 30, 1998                  54,440              9,194          2,358          0.12       0.12
September 30, 1998             56,320              6,237            448          0.02       0.02
December 31, 1998              47,197              5,165           (134)        (0.01)     (0.01)
                                                                                          
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
</TABLE>

(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.

                                       47
<PAGE>
 
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 name, age, title present principal occupation, business
address and other material occupations, positions, offices and employment of
each of the Company's executive directors are set forth below. The business
address of each director is 10770 Columbia Pike, Silver Spring, Maryland 20901.

<TABLE>
<CAPTION>
                NAME                    Age              Position
                ----                    ---              -------
<S>                                     <C>       <C>
Stewart Bainum, Jr..................     53       Chairman of the Board of Directors
Frederic V. Malek...................     62       Director
Paul A. Gould.......................     53       Director
Carole Y. Prest.....................     47       Director
Keith B. Pitts......................     41       Director
Christine A. Shreve.................     41       Director
Donald J. Landry....................     50       Chief Executive Officer and Vice Chairman
</TABLE>

     Stewart Bainum, Jr.  Chairman of the Board of the Company from November
1996 to July 1998 and since December 1998; a member of the Board of the
Company's predecessors from 1982 to July 1998; Chairman of the Board of Choice
from March 1987 to November 1996 and since October 1997; Chairman of the Board
of HCR/Manor Care since September 1998; Chairman of the Board and Chief
Executive Officer of Manor Care and Manor Care Health Services, Inc. ("MCHS")
March 1987 to September 1998, 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 198 to March 1987; Director of
Manor C are 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.

     Frederic V. Malek.  Member of the Board of the Company since November 1996.
Chairman of Thayer Capital Partners since March 1993; Co-Chairman of CB
Commercial Real Estate group, Inc. from April 1989 to October 1996; Champaign
Manager for Bush-Quayle '92 from January 1992 to November 1992; Vice Chairman of
NWA, Inc. (airlines), July 1990 to December 1991; Director: American Management
Systems, Inc., Automatic Data Processing Corp., CB Commercial Real Estate Group,
Inc., Choice Hotels International, Inc., Northwest Airlines and various Paine
Webber mutual funds.

     Paul A. Gould.  Member of the Board of the Company since November 1996.
Managing Director of Allen & Company Incorporated (investment banking firm) for
over five years and other positions at Allen Company Incorporated since 1973.
Director: Telecommunications International, Inc.,: Ascent Entertainment Group;
United Video Satellite Group, Inc.: and National Patent Development Corporation;
Board of Trustees of The New School, The Hackley School and The Holderness
School.

     Carole Y Prest.  Member of the Board of the Company since November 1997.
Vice President, Corporate Strategic Planning of Manor Care since September 1995;
Vice President and General Manager and various other positions at Gen Rad, Inc.
from May 1985 to 1994.

                                       48
<PAGE>
 
     Keith B. Pitts.  Member of the Board of the Company since November 1997.
Chairman and Chief Executive Officer of the Mariner Post-Acute Network, Inc.
since November 1997; Consultant to Apollo from August 1997 to November 1997;
Consultant to Tenant Healthcare Corp. ("Tenant") from February 1997 to August
1997; Executive Vice President and Chief Executive Financial Officer of orNda
HealthCorp from August 1992 until its merger with Tenet in January 1997.
Director: Mariner Post-Acute Network, Inc.

     Christine A. Shreve.  Member of the Board of the Company since June 1998.
President, Shreve, Bowersox, P.C. since 1992.

     Donald J. Landry.  Chief Executive Officer and Vice Chairman of the Company
since October 1997; President of the Company from January 1995 to October 197;
President of Manor Care Hotel Division ("MCHD") from March 1992 to November
1996; various executive positions with Richfield Hotel Management, Inc. ("RHM")
and its predecessors for more than 16 years, including President of MHM
Corporation.

     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.

                            EXECUTIVE COMPENSATION

<TABLE> 
<CAPTION> 
                                        Summary Compensation Table                                                   
                                          ANNUAL COMPENSATION(1)                     LONG-TERM COMPENSATION          
                                          ----------------------                     ----------------------          
                                         Fiscal                                                Restricted Stock                
     Name and Principal Position         Year(1)    Salary         Bonus         Other          Awards ($)(2)                 
     ---------------------------         -------    ------         -----         -----          -------------                 
<S>                                     <C>         <C>           <C>         <C>              <C> 
Stewart Bainum, Jr. (5)                    1998           0                       (6)                    --                 
Chairman                                   1997A    148,310        47,683         (6)                    --                 
                                           1997B    656,357       388,520         (6)                    --                 
                                                                                                                     
Donald J. Landry (8)                       1998     424,463       198,533                         95,077.85                 
Vice Chairman and Chief                    1997A    421,975       200,508                                            
 Executive Officer                         1997B    404,250       200,508         (6)                    --                 
                                                                                                                     
                                                                                                                     
James A. MacCutcheon (11)                  1998     322,980,      141,196                         52,542.01                 
Executive Vice President,                  1997A    312,900        52,263                                --                 
Chief Financial Officer & Treasurer        1997B    313,578       158,953         (6)                    --                 
                                                                                                                     
Antonio DiRico                             1998     259,500       100,120                         35,194.56                 
President                                  1997A    259,499        86,524                                --                 
                                           1997B    196,200        86,584         (6)                    --                 
                                                                                                                     
Kevin D. Hanley                            1998     175,000        51,594                         27,750.79                 
Senior Vice President                      1997A    174,999        84,452         (6)                    --                 
Real Estate Development                    1997B    144,890        51,776         (6)                    --                 
                                                                                                                     
Gregory Miller                             1998     158,350.34     66,538.92      (6)             20,297.20                 
Senior Vice President                      1997A         --            --                                --                 
Human Resources                            1997B         --            --                                --                 
                                                                                                                     
Douglas H. Verner                          1998     117,691.68(18) 12,326.09  76,660.70(19)        7,610.32                 
Senior Vice President                      1997A         --            --                                --                 
General Counsel & Secretary                1997B         --            --                                --                 
 
<CAPTION> 
                                             Stock Option           All Other      
     Name and Principal Position             Shares (#)(3)       Compensation (4)  
     ---------------------------             -------------       ----------------  
<S>                                          <C>                 <C> 
Stewart Bainum, Jr. (5)                                 --                 --  
Chairman                                                --                 --  
                                                    60,000  (7)            --  
                                                                              
Donald J. Landry (8)                               110,000             19,631
Vice Chairman and Chief                            106,000  (9)         6,035 
Executive Officer                                  100,000 (10)         6,035  
                                                                              
                                                                              
James A. MacCutcheon (11)                           50,000             20,304  
Executive Vice President,                           46,500 (12)        18,682  
Chief Financial Officer & Treasurer                 67,500 (13)        18,682  
                                                                              
Antonio DiRico                                      65,000              8,360     
President                                           80,600 (14)         3,043     
                                                    25,000 (15)         3,043     
                                                                              
Kevin D. Hanley                                     45,000                 --     
Senior Vice President                               51,200 (16)            --     
Real Estate Development                              2,727 (17)            --     
                                                                              
Gregory Miller                                      20,000              7,110     
Senior Vice President                                   --                 --     
Human Resources                                         --                 --     
                                                                              
Douglas H. Verner                                   45,036                 --       
Senior Vice President                                  --                  --       
General Counsel & Secretary                            --                  --        
</TABLE> 


(1)  On September 16, 1997, the Company changed its fiscal year end on 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"). Summary compensation data paid to the Named
     Officers during the period between January 1, 1997 and May 31, 1997 is
     reflected in each of the 1997A and 1997B periods.

                                       49
<PAGE>
 
(2)  On June 29, 1998, the Company issued restricted stock to officers in lieu
     of merit increases for calendar year 1998.  The restricted stock vest over
     three (3) years.

(3)  For all of the Named Officers, except for Mr. MacCutcheon the grants in
     1997B represent options to purchase shares of Manor Care common stock.  In
     connection with the Manor Care Spin-off, the options to purchase Manor Care
     common stock were converted, in some cases 100%, to options to purchase
     Company common stock.  For Mr. MacCutcheon and 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 Spin-off, the options to purchase Company common stock
     were converted to successor options to purchase Company common stock and
     Choice common stock.  In all cases, however, the exercise prices were
     adjusted to maintain the same financial value to the option holder before
     and after the Manor Care Spin-off and the Choice Spin-off.

(4)  Represents amounts contributed by the Company for 1998, 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 1998, 1997A and 1997B under the 401(k) Plan and Non-qualified
     Savings Plan, respectively, for the Named Offices were as follows: Mr.
     Landry, $19,631.91, $2,375 and $3,660; Mr. MacCutcheon, $20,304.00, $6,240
     and $12,443; Mr. DiRico, $8,360.15, $966 and $2,077; and Mr. Miller
     $7,110.37.

(5)  For part of 1998 and 1997B, Mr. Bainum, Jr. was the Chairman and Chief
     Executive Officer of Manor Care and the Company.  The compensation
     reflected here for 1997B is the total compensation received for services
     rendered to both Manor Care and Company.  Nineteen Hundred and ninety-seven
     A (1997A), represents the amount of compensation paid solely by the
     Company.

(6)  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.

(7)  In connection with the Spin-off, 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 Choice at an exercise price
     of $12.1130.

(8)  Mr. Landry was appointed Vice Chairman and Chief Executive Officer upon the
     Spin-off.  Prior to the Spin-off, he was President of the Company.

(9)  In connection with the Spin-off, 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 Choice common stock at an exercise price of
     $13.2791.

(10) In connection with the Spin-off, 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 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 are total
     compensation received for services rendered to both Manor Care and the
     Company.  For the period of 1997B after the Manor Care Spin-off, the amount
     of compensation paid solely by the Company was 209,052 for salary and
     $103,690 for bonus.  In connection with the Spin-off, the Company and
     Choice entered into a Consulting Agreement whereby 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 Spin-off, 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 Choice common stock at an exercise price of
     $13.2008.

                                       50
<PAGE>
 
(13) In connection with the Spin-off, 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 Choice at an exercise price of $11.5986 and
     15,642 shares of Choice common stock at an exercise price of $12.113.

(14) In connection with the Spin-off, 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 Choice common stock at an exercise price of
     $13.2008.

(15) In connection with the Spin-off, 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 Choice common stock at an exercise price of
     $12.113.

(16) In connection with the Spin-off, 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 Choice common stock at an exercise price of
     $13.2008.

(17) In connection with the Spin-off, 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 Choice common stock at an exercise price of
     $12.113.

(18) Mr. Verner joined Sunburst in March 1998 as Senior Vice President, General
     Counsel and Secretary.  On an annualized basis, his base salary is $150,000
     per year.

(19) Other compensation for Mr. Verner is reimbursement of relocation expenses.


STOCK OPTIONS

The following tables set forth certain information at December 31, 1998 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 Choice Spin-off, existing Company stock options were
subject to certain adjustments or conversions into options to purchase shares of
Company common stock and Choice common stock.  The table below represents the
options grants on a post-conversion basis.

                          STOCK OPTION GRANTS IN 1998

<TABLE> 
<CAPTION> 
                                                                        Individual Grants
                                                                        -----------------
                                                           Percentage of                                       Rate of Stock Price
                                               Number of   Total Options                                        Appreciation for
                                               Options     Granted to all      Exercise Base     Expiration      Option Term (1)
                                                                                                                 ---------------
          Name                                 Granted     Employees in 1998   Price Per Share   Date          5%(2)       10%(3)
          -----                                -------     -----------------   ---------------   ----------    -----       ------  
          <S>                                  <C>         <C>                 <C>               <C>          <C>        <C> 
          Stewart Bainum, Jr..........               0            --                  --                --           --          --
          Donald J. Landry (4)........          10,000          25.6%           $  6.406           6/29/08    $ 443,157  $1,123,045
          James A. MacCutcheon (4)....          50,000          11.5%              6.406           6/29/08      201,435     510,475
          Antonio DiRico (4)..........          65,000          15.1%              6.406           6/29/08      261,866     663,618
          Kevin P. Hanley (4).........          45,000          10.4%              6.406           6/29/08      181,292     459,428
          Gregory Miller (4)..........          20,000           4.6%              6.406           6/29/08       80,574     204,190
          Douglas Verner (4)..........          35,036          10.4%              8.759           3/31/08      192,798     489,089
                                                10,000                             6.406           6/29/08       40,287     102,095
</TABLE>

(1)  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

                                       51
<PAGE>
 
     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.
(2)  A 5% per year appreciation in stock price from $6.406 per share yields
     $10.437 and from $8.759 per share yields $14.2675.
(3)  A 10% per year appreciation in stock price from $6.406 per share yields
     $16.6155 and from $8.759 per share yields $22.7186.
(4)  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.

                      AGGREGATED OPTION EXERCISES IN 1998
                           AND YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
                                                             Shares                      Number of Unexercised Options at     
                                                           Acquired on       Value          Options at December 31, 1998      
                                                                                            ----------------------------      
                                                            Exercise        Realized     Exercisable        Unexercisable     
                                                            --------        --------     -----------        -------------     
                          Name                                 #               $              #                   #           
                          ----                                ---             ---            ---                 ---          
          <S>                                              <C>              <C>          <C>                <C> 
          Stewart Bainum, Jr...........................                                           83,889             36,112   
          Donald J. Landry.............................                                          233,605            707,962   
          James A. MacCutcheon.........................                                          181,595            310,332   
          Antonio DiRico...............................                                           66,595            239,230   
          Kevin P. Hanley..............................                                           15,707            104,053   
          Gregory Miller...............................                                           10,739             62,953   
          Douglas H. Verner............................                                                -             45,036    

<CAPTION> 
                                                                Value of Unexercised in-the-money
                                                                  Options at December 31, 1998   
                                                                  ----------------------------   
                          Name                                Exercisable           Unexercisable
                          ----                                -----------           -------------
          <S>                                                 <C>                   <C>          
          Stewart Bainum, Jr...........................        126,381.38               8,811.35 
          Donald J. Landry.............................         96,294.03             238,468.96 
          James A. MacCutcheon.........................         92,639.01              41,629.29 
          Antonio DiRico...............................          2,513.98               4,154.01 
          Kevin P. Hanley..............................                 -                      - 
          Gregory Miller...............................                 -                      - 
          Douglas H. Verner............................                 -                      -  
</TABLE> 

(1)  The closing prices of Company common stock and Choice's common stock as
     reported by the New York Stock Exchange on December 31, 1998 was $4.25.
     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 underlying the option.

EMPLOYMENT AGREEMENTS

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 had a term of three years.
The Agreement terminated on July 15, 1998 when Mr. Bainum, Jr. resigned form the
Board.  Mr. Bainum, Jr. rejoined the Board on December 4, 1998, as a non-
employee director.

The Company entered into an Employment Agreement with Donald J. Landry on June
25, 1997, effective upon the Spin-off 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 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.

The Company adopted an Officer Retention and Severance Plan (the "Plan")
effective January 21, 1999, which provides that any officer who is terminated
(i) due to a Change of Control as that term is defined in the Second Amendment
to the 1996 Long-Term Incentive Plan; (ii) without cause; or (iii)
constructively through a significant reduction in compensation and
responsibilities measured as of the date of the Plan and, who is not under
contract with the Company, shall receive base salary for twelve months plus two
weeks for each year of service with the Company and its predecessor companies,
to be paid bi-weekly. Payments will be reduced by any salary earned from other
employment by the officer. Any officer under contract will be covered by the
terms of the individual contract.

                                       52
<PAGE>
 
RETIREMENT PLANS

The Company has adopted the Sunburst Hospitality Corporation Supplemental
Executive Retirement Plan (the "SERP").  Participants are Senior Vice Presidents
and other officers 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:

<TABLE>
<CAPTION>
                                         CURRENT YEARS      YEARS OF SERVICE 
               NAME OF INDIVIDUAL          OF SERVICE          AT AGE 65     
               ------------------        ----------------------------------  
               <S>                       <C>                <C> 
               Donald J. Landry                7                 22        
               James A. MacCutcheon           11                 30        
               Antonio DiRico                  5                 25        
               Kevin P. Hanley                 4                 28        
               Douglas H. Verner               1                 20        
               Gregory Miller                  5                 26        
</TABLE>

The table below sets forth estimated annual benefits payable upon retirement to
persons in specified compensation and years of service classifications.  These
benefits are straight life annuity amounts, although participants have the
option of selecting a joint and 50% survivor annuity or ten-year certain
payments.  The benefits are not subject to offset for social security and other
amounts.

                          YEARS OF SERVICE/BENEFIT AS
                       PERCENTAGE OF FINAL AVERAGE SALARY
                       ----------------------------------

<TABLE>
<CAPTION>
                                                  25 OR
          REMUNERATION                 15/15%    20/22.5%
          ------------                 ------    --------
            MORE/30%
            --------
          <S>               <C>        <C>       <C> 
             $ 300,000      $ 45,000   $ 67,500   $ 90,000
               350,000        52,500     78,750    105,000
               400,000        60,000     90,000    120,000
               450,000        67,500    101,250    135,000
               500,000        75,000    112,500    150,000
               600,000        90,000    135,000    180,000
</TABLE>

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 

                                       53
<PAGE>
 
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 1998 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.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

              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 December 31, 1998.  Unless otherwise
specified, the address for each of them is 10770 Columbia Pike, Silver Spring,
Maryland, 20901.

<TABLE>
<CAPTION>
                                                                            SHARES OF                                    
                                                                           COMMON STOCK                PERCENT OF SHARES 
                       NAME OF BENEFICIAL OWNER                         BENEFICIALLY OWNED               OUTSTANDING(1)  
                       ------------------------                         ------------------               --------------  
     <S>                                                                <C>                            <C>               
     Stewart Bainum, Jr..........................................          5,330,691(2)                      27.19%      
     Antonio DiRico..............................................             85,854(3)                          *       
     Gregory Miller..............................................             13,881(4)                          *       
     Paul A. Gould...............................................            126,038(5)                          *       
     Kevin P. Hanley.............................................             19,773(6)                          *       
     Donald J. Landry............................................            252,103(7)                          *       
     James A. MacCutcheon........................................            188,393(8)                          *       
     Frederic V. Malek...........................................              7,938(9)                          *       
     Keith B. Pitts..............................................              5,318(10)                         *       
     Carole Y. Prest.............................................              8,485(11)                         *       
     Christine A. Shreve.........................................              5,782(12)                         *       
     All Directors and Officers as a Group (12 persons)..........          7,126,943(13)                     36.35%      
     Barbara Bainum..............................................          1,925,585(14)                      9.82%      
     Bruce Bainum................................................          1,922,434(15)                      9.81%      
     Stewart Bainum..............................................          3,484,597(16)                     17.77%      
     Ronald Baron................................................          5,870,140(17)                     29.94%       
</TABLE>

___________________________________
*Less than 1% of class.

(1)  Percentages are based on 19,606,006 shares outstanding on December 31, 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.

                                       54
<PAGE>
 
(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 83,889 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").

(3)  Includes 3,561 shares held directly by Mr. DiRico and 3,779 shares and
     11,919 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 66,595 shares, 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.

(4)  Includes 2,406 held directly by Mr. Miller and 164 and 572 shares,
     respectively, which Mr. Miller has the right to receive upon termination of
     his employment pursuant to the terms of the 401(k) Plan and Non-Qualified
     Plan.  Also includes 10,739 shares which Mr. Miller has the right to
     acquire pursuant to stock options which are currently exercisable or become
     exercisable upon 60 days of the Record Date.

(5)  Includes 124,079 shares held directly by Mr. Gould, 4132 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 and 1,959 shares which Mr. Gould has a right to acquire pursuant to
     stock options which are presently exercisable or become exercisable within
     60 days of the Record Date.

(6)  Includes 4,066 shares held directly by Mr. Hanley and 15,707 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.

(7)  Includes 18,498 shares owned directly by Mr. Landry and 233,605 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.

(8)  Includes 5,000 shares owned directly by Mr. MacCutcheon and 659 and 1,167
     shares, respectively, which Mr. MacCutcheon has the right to receive upon
     termination of his employment pursuant to the 401(k) and Non-Qualified
     Plan.  Also includes 100 shares held by minor children.  Beneficial
     ownership of such shares is disclaimed.  Also includes 181,567 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.

(9)  Includes 1,162 shares held directly by Mr. Malek, 2,555 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 4,221 restricted shares granted under the Non-Employer Director
     Stock Compensation Plan which are not vested, but which Mr. Malek has the
     right to vote.

(10) Consists of 5,318 restricted shares granted under the Non-Employer Director
     Stock Compensation Plan which are not vested, but which Mr. Pitts has the
     right to vote.

(11) Includes 5,457 restricted shares granted under the Non-Employer Director
     Stock Compensation Plan which are not vested, but which Ms. Prest has the
     right to 

                                       55
<PAGE>
 
     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.

(12) Includes 1,600 shares held directly by Ms. Shreve and 4,182 restricted
     shares granted under the Non-Employer Director Stock Compensation Plan
     which are not vested, but which Ms. Shreve has the right to vote.

(13) Includes a total of 599,644 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 4,602 shares and 13,707 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.

(14) Includes 34,236 shares held directly by Ms. Bainum and 415 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 85,000 shares owned by Vintage LP in which Ms. Bainum is a 
     shareholder and director of the corporate general partner and has share
     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 8737 Colesville Road, Suite 800, Silver Spring,
     Maryland, 20910.

(15) 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 Mr.
     Bainum's trust has voting stock and shared voting authority, 85,000 shares
     owned by Vintage LP in which Mr. Bainum is a shareholder and director of 
     the corporate general partner and has shared voting authority, and 23,435
     shares owned by Commonweal Foundation, in which Mr. Bainum is a Director
     and has shared voting authority.  Mr. Bainum's address is 8737 Colesville
     Road, Suite 800, Silver Spring, Maryland, 20910.

(16) Includes 1,303,010 shares held directly by the Stewart Bainum Declaration
     of Trust, of which Mr. Bainum is the sole trustee and beneficiary, his
     interest in 312,308 shares owned by Bainum Associates and 387,803 shares
     owned by MC Investments, each of which is a limited partnership in which
     Mr. Bainum has ownership 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 his 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 2,000 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 514 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.

(17) 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.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

RELATIONSHIP WITH MANOR CARE

Stewart Bainum, Jr. is the Chairman of the Company's Board of Directors and of
HCR Manor Care's Board of Directors.

                                       56
<PAGE>
 
at which the Company's principal executive offices were located (the "Silver
Spring Lease"). After the Spin-off, the Company remained obligated under the
Silver Spring Lease and had subleased space at 10750 Columbia Pike to Choice
Hotels International, Inc. ("Choice") pursuant to a sublease. In June 1998,
Manor Care sold the Silver Spring Complex and the Company enter into a new lease
with the new owner. The sublease was terminated.

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 was obligated to rent from Manor Care,
certain additional space as such space became available during the 30 month
period following the date of the Manor Care Spin-off.  The Gaithersburg lease
was terminated in February 1999.  In addition, at the time of the Manor Care
spin-off, the parties entered into 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, 1998, the Company paid to
Manor Care under the Gaithersburg Lease and the Silver Spring Lease
approximately $1.3 million.

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.
The Company terminated all services except the consulting services under the
Corporate Service Agreement in the first quarter of 1998.  In February 1999,
this Company entered into a release with Manor Care which effectively terminated
the consulting services payment obligation.

TIME SHARING AGREEMENT

On October 10, 1996, the Company entered into a Time Sharing Agreement with
Manor Care under which the Company had the right to use from time to time a
Cessna Citation III and a Cessna Conquest I owned by Manor Care.  The agreement
had a term of one year with automatic renewals unless otherwise terminated.  In
January 1998, Manor Care gave notice that it was terminating the Time Share
Agreement.  During 1998, there were no charges for aircraft usage pursuant to
the agreement.

RELATIONSHIP WITH CHOICE

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

DISTRIBUTION AGREEMENT

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

Subject to certain exceptions, 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
Choice to perform or otherwise discharge liabilities allocated to and assumed by
Choice under the Distribution Agreement, and the Company has agreed to indemnify
Choice against any loss, liability or expense incurred or suffered by Choice
arising out of or related to the failure by the Company to perform or otherwise
discharge the 

                                       57
<PAGE>
 
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 Choice Spin-
off, each of 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 Choice
and the Company in connection with the Choice Spin-off.

Under the Distribution Agreement, each of 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 Choice and the Company to obtain the
consent of the other prior to waiving any shared privilege.

In accordance with the Distribution Agreement, Choice agreed to assume and pay
certain liabilities of the Company, subject to Choice maintaining a minimum net
worth of $40 million, at the date of the Choice Spin-off.  As of December 31,
1997, the Company reflected a $25 million receivable due to Choice on its
consolidated balance sheet.  In 1998, net payments of approximately $8 million
were paid in cash to Choice.  On December 28, 1998, the Company and Choice
amended the Strategic Alliance Agreement (defined below).  As part of that
amendment, Choice exchanged the remaining $17 million balance in return for,
among other things, the termination of the Company's option for the exclusive
rights to the MainStay Suites brand and a commitment to build a total of 25
MainStay Suites.

STRATEGIC ALLIANCE AGREEMENT

At the time of the Choice Spin-off, Choice and the Company entered into a
Strategic Alliance Agreement pursuant to which: (i) the Company granted a right
of first refusal to 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 of the Distribution Date); (iii) 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) Choice and the Company have agreed to continue to cooperate with
respect to matters of mutual interest, including new product and concept testing
for Choice in hotels owned by the Company; and (v) the Company has authorized
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.

On December 28, 1998, Choice and the Company amended the Strategic Alliance
Agreement to: (i) cancel the Company's option to acquire the MainStay Suites
system; (ii) eliminate liquidated damages with respect to franchise agreements
entered into before December 12, 1998 (except for MainStay Suites and Sleep Inn
franchise agreements); (iii) cap liquidated damages for MainStay Suites and
Sleep Inn franchise agreements; (iv) change the Company's development
obligations to 13 Sleep Inns and 25 MainStay Suites by October 15, 2001; and (v)
provide certain other global amendments to the Company's franchise agreements.

AMENDMENT AND GUARANTY

In connection with the Choice Spin-off, Choice entered into the Amendment and
Guaranty for the purpose of adding Choice as a party to certain agreements
entered into between Former Choice and Manor Care in connection with the Manor
Care Spin-off and adding 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."

                                       58
<PAGE>
 
TERM NOTE

In connection with the Choice Spin-off, Choice loaned to the Company
approximately $115 million which 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 Note allocated to the Company in
connection with the Spin-off (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).

CORPORATE SERVICES AGREEMENT

The Company and Choice entered into a Corporate Service Agreement which provides
that Choice will provide to the Company certain corporate support services,
including human resources, accounting, tax and computer systems support, and the
Company will provide to Choice certain services including asset management and
accounts payable processing. As of March 31, 1999, all services provided by
either party under the Corporate Services Agreement, except for human resources
and tax services provided by Choice, will be terminated.  During fiscal year
1998, Choice paid the Company $168,660 and the Company paid Choice $1,664,750
for services under the Corporate Services Agreement.

CONSULTING AGREEMENT

The Company and Choice entered into a Consulting Agreement in which the Company
will provide consulting and advisory services to Choice related to financial
issues affecting 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 Choice,
then 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.   During fiscal year 1998, Choice paid the Company $116,268
pursuant to the Consulting Agreement.

TAX SHARING AGREEMENT

Choice and the Company have entered into a Tax Sharing Agreement for purposes of
allocating tax liabilities of Former Choice from before the Choice Spin-off
among 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 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 returns to the applicable taxing authorities (including any
subsequent adjustments resulting from the redetermination of such tax
liabilities by the applicable taxing authorities). Choice will reimburse the
Company for the portion of such taxes that relates to Choice and its
subsidiaries, as determined based on their hypothetical separate company income
tax liabilities. 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 Choice Spin-off, 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 Choice Spin-off of employee
benefits, as 

                                       59
<PAGE>
 
they relate to employees who remained employed by the Company or its
subsidiaries ("Sunburst Employees") after the Spin-off and employees who are
employed by Choice or its subsidiaries after the Spin-off ("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. 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 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 Choice Spin-off.

The Employee Benefits Allocation Agreement also provided for the adjustment of
outstanding options to purchase shares of Sunburst common stock held by Sunburst
Employees, Choice Employees and employees of Manor Care who held such options as
a result of the Manor Care Spin-off.

TRANSITIONAL SERVICE AGREEMENTS

Choice and the Company have entered into a number of agreements pursuant to
which 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, 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, Choice provides certain sales, use, occupancy, real
and personal property tax return administration, audit and appeals services for
the Company.

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 Choice and the Company, as
franchisee (the "Franchise Agreements").  (The material terms of such agreements
are described below.)   Total fees paid to Choice for franchising, royalty,
marketing and reservation fees for fiscal year 1998 were $11.2 million.

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.   In addition, all franchise
agreements allow for early termination by Sunburst, subject to liquidated damage
provisions which range from zero dollars to a maximum of $100,000 per property.

TERMINATION BY SUNBURST

The Company (except with respect to one property as described below) may
terminate a Franchise Agreement if 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 such a
termination.

TERMINATION BY CHOICE

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 

                                       60
<PAGE>
 
two or more notices of default for similar reasons for any 12 month period.
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.

The Non-Standard Franchise Agreement has termination provisions similar to those
in the other Franchise Agreements.  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 Choice's reservation system). The
marketing fee and the reservation fee are subject to reasonable increases during
the term of the franchise if 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.

In December 1998, the Company and Choice entered into an amendment which
provided that (i) the Company shall pay an application fee of $20,000 on all
future MainStay Suites franchise agreements, and (ii) no royalties, marketing or
reservation fees shall be payable for a period of two years for the next ten
MainStay Suites franchise agreements entered into after the amendment.

CERTAIN COVENANTS

The Franchise Agreements impose certain affirmative obligations upon 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 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 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 Choice except that, among other things, certain percentages of
ownership interests in the Company may be transferred without Choice's consent.
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 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.

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 Choice to absolve itself
from the obligations that it transfers under the Franchise Agreement. Upon the
assignment of Choice's 

                                       61
<PAGE>
 
obligations under the Non-Standard Franchise Agreement, Choice will no longer be
liable with respect to the obligations it so transfers.

NONCOMPETITION AGREEMENT

Choice and the Company have entered into a non-competition agreement that
defines the rights and obligations with respect to certain businesses to be
operated by Choice and the Company.  Under the non-competition agreement, for a
period of five years from the date of the  Spin-off, 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 Choice
as part of the Spin-off ("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 Choice
on substantially the same terms and conditions; provided, however, that the
Company will not be required to make such an offer to 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 non-competition 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 Spin-off 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 Choice's business; and (iv) the
ownership of equity interests of any entity that competes with 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 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 non-competition agreement, subject to the exceptions set
forth below, Choice will be prohibited from conducting any business that
competes with the business operated by the Company and retained by Company in
the Spin-off (the "Hotel Business"). 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, Choice
offers to sell such competing business to the Company on substantially the same
terms and conditions; provided, however, that 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 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 non-
competition agreement will not prohibit Choice from the following activities:
(i) continued operation and development of any business operated as of the date
of the Spin-off by Choice, (ii) any activities otherwise permitted under the
Strategic Alliance Agreement, (iii) the ownership of up to 5% of the equity
interests of a publicly-traded entity that competes with the 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 Choice and the Company resulting from the
agreements and arrangements described above may potentially give rise to
conflict of interest between 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.

Stewart Bainum Jr. serves as Chairman of the Boards of Directors of both the
Company and Choice.  Frederick V. Malek serves as a director of each of the
Company and Choice.  As a result of the Choice Spin-off, Messrs. Bainum, 

                                       62
<PAGE>
 
     Jr. and Malek, as well as certain other officers and directors of the
     Company and Choice, also own shares and/or options or other right to
     acquire shares in each of the Company and Choice. Appropriate polices and
     procedures are followed by the Board of Directors of 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 Choice or the
     Company on certain matters which present a conflict between the two
     companies.


     OTHER RELATIONSHIPS

     During the twelve months ended December 31, 1998, the Company paid to Allen
     & Company Incorporated a total of $12,350 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.


     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

<TABLE> 
                    <S>                                                                      <C> 
                    The following reports are filed herewith on the pages indicated:
                    Schedule I:  Condensed Financial Information.........................    p.
                    Schedule III:  Real Estate and Accumulated Depreciation..............    p.
                    All other schedules are not applicable.
</TABLE> 

                    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*
     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.)**

                                       63
<PAGE>
 
     10.07  Amended and Restated Agreement dated as of October 15, 1997 by and
            between the Registrant and Stewart A, 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  A 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.**
     10.23  The Rights Agreement dated February 23, 1998 by and between the
            Registrant and Chase Mellon Shareholder Services, L.L.C., as Rights
            Agents*****
     10.24  Omnibus Amendment Agreement dated as of December 29, 1998 by and
            among Registrant and Choice Hotels International, Inc.******
     21.01  Subsidiaries of the Registrant
     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 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.
*****  Incorporated by reference to Company's 8-K dated February 23, 1998, filed
       March 11, 1998.
****** Incorporated by reference to Company's 8-K dated December 29, 1998, filed
       December 31, 1998.

                                       64
<PAGE>
 
(b)  One report on Form 8-K was filed during the last quarter of the fiscal year
     ended December 31, 1998.

Form 8-K, dated December 29, 1998 and filed December 31, 1998 reporting that the
Company and Choice entered into an Omnibus Amendment Agreement (the "OAA") which
(i) resolved matters relating to a debt of $19.9 million owed by the Company to
Choice; (ii) eliminated the Company's option to acquire the MainStay Suites
brand from Choice; (iii) limited the Company's liability for terminating Choice
franchise agreements in the event of the sale or rebranding of a Company hotel;
and (iv) committed the Company to open 25 MainStay Suites hotels by October
2001.

                                       65
<PAGE>
 
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 29, 1999             SUNBURST HOSPITALITY CORPORATION
                  --                                                         


                               By:________________________________
                                       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
  ---------                      -----                    ----

____________________________
Stewart Bainum, Jr.              Chairman                 March 29, 1999
                                                                --      

                                 Vice Chairman and        March 29, 1999
____________________________     Chief Executive Officer        --
Donald J. Landry                 

                                 Director                 March 29, 1999 
____________________________                                    --         
Paul A. Gould

                                 Director                 March 29, 1999   
____________________________                                    --         
Frederic V. Malek

                                 Director                 March 29, 1999     
____________________________                                    --        
Keith B. Pitts

                                 Director                 March 29, 1999
____________________________                                    --      
Carole Y. Prest

                                 Director                 March 29, 1999     
____________________________                                    --        
Christine A. Shreve

                                 Vice President-          March 29, 1999    
____________________________     Accounting and Hotel           --             
Charles M. Warczak, Jr.          Systems (Chief     
                                 Accounting Officer) 
                                                     

                                       66
<PAGE>
 
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.333-15661, No. 333-17577 and No.
333-17575.

                                                       Arthur Andersen LLP

Washington, D.C.

March 26, 1999

                                       67
<PAGE>
 
                        SUNBURST HOSPITALITY CORPORATION             
                 CONDENSED FINANCIAL INFORMATION OF REGISTRANT       PAGE 1 OF 4
                                 BALANCE SHEETS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                       As of
                                                     -------------------------------------- 
                                                        December 31,          December 31,
                                                            1998                  1997
                                                     ----------------      ----------------
                             ASSETS
<S>                                                  <C>                   <C>
Real estate, net                                             $253,812              $225,893
Real estate held for sale                                       7,698                     -
Receivables, net                                                4,620                 3,896
Net investment in restricted subsidiaries                      31,342                35,439
Other assets                                                    4,914                 6,664
Cash and cash equivalents                                       3,576                 4,348
                                                     ----------------      ----------------
 
   TOTAL ASSETS                                              $305,962              $276,240
                                                     ================      ================
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
LIABILITIES
Debt                                                         $170,292              $132,304
Accounts payable and accrued expenses                          26,981                52,202
Other liabilities                                               6,052                 2,427
                                                     ----------------      ----------------
 
   Total liabilities                                          203,325               186,933
 
STOCKHOLDERS' EQUITY
 
   Total stockholders' equity                                 102,637                89,307
                                                     --------------------------------------
 
   TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                $305,962              $276,240
                                                     ================      ================
</TABLE>
<PAGE>
 
                       SUNBURST HOSPITALITY CORPORATION             
                 CONDENSED FINANCIAL INFORMATION OF REGISTRANT      PAGE 2 OF 4
                              STATEMENTS OF INCOME
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                             
                                              For the year       For the seven
                                                  ended          months ended      For the fiscal year ended May 31,
                                              December 31,       December 31,      -----------------------------------
                                                  1998               1997               1997                1996
                                         -------------------    ---------------    ---------------   -----------------
<S>                                      <C>                    <C>                <C>               <C>
Revenues                                           $104,494            $55,487            $87,262             $ 62,467
 
Operating expenses                                   82,480             44,506             69,780               56,336
Provision for asset impairment and other
   non-recurring charges                              4,264              5,119                  -               24,595
Depreciation and amortization                        17,118              8,561             10,988                7,562
Interest expense                                     11,549              4,580              6,484                3,211
                                         -------------------    ---------------    ---------------   -----------------
     Total expenses                                 115,411             62,766             87,252               91,704
                                         -------------------    ---------------    ---------------   -----------------
 
Income before income taxes and equity
   in earnings of restricted subsidiaries           (10,917)            (7,279)                10              (29,237)
Equity in earnings of restricted                     17,168              6,951             11,830                7,363
 subsidiaries
Income tax (benefit) expense                          2,563                (44)             5,035               (8,523)
                                         -------------------    ---------------    ---------------   -----------------
 
Income (loss) from continuing operations              3,688               (284)             6,805              (13,351)
 
Income from discontinued operations, net                               
 of tax                                                                 16,369             35,219               21,809 
                                         -------------------    ---------------    ---------------   -----------------
 
Net income before extraordinary item                  3,688             16,085             42,024                8,458
 
Extraordinary item -- loss from early
extinguishment of debt (net of tax)                     308                  -              1,144                    -
                                         -------------------    ---------------    ---------------   -----------------
 
Net income                                         $  3,380            $16,085            $40,880             $  8,458
                                         ===================    ===============    ===============   =================
</TABLE>
<PAGE>
 
                        SUNBURST HOSPITALITY CORPORATION             
                 CONDENSED FINANCIAL INFORMATION OF REGISTRANT       PAGE 3 OF 4
                            STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
                                        
<TABLE>
<CAPTION>
                                                         For the year        For the seven
                                                             ended           months ended            For the fiscal year ended
                                                         December 31,        December 31,                     May 31
                                                      ----------------    --------------------------------------------------------
                                                             1998                1997                1997                1996
                                                      ----------------    ----------------    ----------------    ----------------
<S>                                                   <C>                 <C>                 <C>                 <C>
Net cash provided by (utilized by)
  continuing operations                                       $ 27,411           $   2,316            $ 20,282           $  10,474
Net cash provided by discontinued operations                         -              20,876              46,724              32,645
                                                      ----------------    ----------------    ----------------    ----------------
     Net cash provided from operating activities                27,411              23,192              67,006              43,119
                                                      ----------------    ----------------    ----------------    ----------------
 
Cash flows from investing activities
   Investment in property and equipment, net                   (52,735)            (51,213)            (60,641)            (28,735)
   Acquisition of operating hotel                                    -                   -              (5,550)            (49,617)
   Distribution of Franchising segment                               -              (4,166)                  -                   -
                                                      ----------------    ----------------    ----------------    ----------------
        Net cash utilized by continuing operations             (52,735)            (55,379)            (66,191)            (78,352)
        Net cash utilized by discontinued operations                 -            (118,474)            (15,864)            (78,844)
                                                      ----------------    ----------------    ----------------    ----------------
        Net cash utilized by investing activities              (52,735)           (173,853)            (82,055)           (157,196)
                                                      ----------------    ----------------    ----------------    ----------------
 
Cash flows from financing activities
   Proceeds from mortgages and other long term debt             25,000              16,023              90,500                   -
   Principal payments of debt                                     (353)            (90,694)               (951)               (645)
   (Repayment of) proceeds from notes payable to
      Manor Care, Inc.                                               -             (37,022)                  -              27,201
   Proceeds from note payable to Choice Hotels
     International                                                   -             115,000                   -                   -
   Proceeds from issuance of common stock                          359               1,153               3,410                   -
   Purchases of treasury stock                                  (2,141)            (10,554)            (53,150)                  -
   Payable to Choice Hotels International, Inc.
  for net worth guarantee                                            -              15,000                   -                   -
  Advances from (to) restricted subsidiaries                     1,687               6,503              11,028                 (73)
  Advances (from) to Manor Care, Inc., net                           -                   -              (9,971)             73,272
                                                      ----------------    ----------------    ----------------    ----------------
        Net cash provided by continuing operations              24,552              15,409              40,866              99,755
        Net cash provided by (utilized by)
        discontinued operations                                      -             129,337             (19,730)             17,131
                                                      ----------------    ----------------    ----------------    ----------------
        Net cash utilized by financing activities               24,552             144,746              21,136             116,886
                                                      ----------------    ----------------    ----------------    ----------------
 
        Net change in cash and cash equivalents                   (772)             (5,915)              6,087               2,809
        Cash and cash equivalents at beginning of 
          period                                                 4,348              10,263               4,176               1,367
                                                      ----------------    ----------------    ----------------    ----------------
 
        Cash and cash equivalents at end of period            $  3,576           $   4,348            $ 10,263           $   4,176
                                                      ================    ================    ================    ================
 
        Cash and cash equivalents of continuing         
         operations                                           $  3,576           $   4,348            $  6,471           $   1,073
        Cash and cash equivalents of discontinued
        operations                                                   -                   -               3,792               3,103
</TABLE>
<PAGE>
 
                        SUNBURST HOSPITALITY CORPORATION             
                 CONDENSED FINANCIAL INFORMATION OF REGISTRANT       PAGE 4 OF 4
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


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 of 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, "CMBS debt").  The CMBS debt are non-recourse and collateralized
by 36 hotels owned by First choice.  CMBS debt carries a blended weighted
average interest rate of 7.8% and have a final maturity of May 5, 2012.

The CMBS debt contains 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 to cash to
affiliates.

The accompanying condensed financial statements present the debt of First Choice
as a components of net investment in restricted subsidiaries.  Prior to the
April 1997 issuance of the CMBS debt, 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.

DEBT

Aggregate debt maturities at December 31, 1998, are (in thousands):


1999                                                  $    377
2000                                                    41,399
2001                                                       688
2002                                                   127,828
                                                      --------
Total                                                 $170,292
                                                      ======== 

DIVIDENDS

First Choice has not ever paid cash dividends to the Parent Company.
<PAGE>
 
                        SUNBURST HOSPITALITY CORPORATION           
                    REAL ESTATE AND ACCUMULATED DEPRECIATION         PAGE 1 OF 2
                               DECEMBER 31, 1998          
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                   Initial cost to Company          Subsequent                    Gross Amount at December 31, 1998
                             ----------------------------------                                  ----------------------------------
                                            Building and           Capitalized       Asset                Buildings and       
Description   Encumbrances     Land         Improvements               Costs       Writedowns     Land     Improvements     Total 
-----------  --------------  -------  -------------------------   --------------  ------------   ------- ---------------  ----------
<S>          <C>             <C>      <C>                         <C>             <C>            <C>     <C>              <C>   
All
properties,
each less    
than 5% of
total          $110,913      $45,846           $210,666              $84,716        $(3,400)     $56,007    $281,821       $337,828
 
<CAPTION>  
                   Accumulated         Date of          Date        Depreciation  
Description        Depreciation      Construction     Acquired          Life       
-----------       --------------    --------------   ----------   ---------------  
<S>               <C>               <C>              <C>          <C> 
All
properties,
each less      
than 5% of
total                 $55,078          Various         Various       Various   
</TABLE> 
<PAGE>
 
                        SUNBURST HOSPITALITY CORPORATION            
                    REAL ESTATE AND ACCUMULATED DEPRECIATION        PAGE 2 OF 2
                               DECEMBER 31, 1998
                                 (IN THOUSANDS)

(A)  The change in total cost of properties for the calendar year ended December
31, 1998, the seven months ended December 31, 1997 and fiscal years ended May
31, 1997 and 1996 is as follows:


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)
                                                      ------------ 
Balance 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 
      Additions:                                                          
             Acquisitions                                        - 
             Cap. Exp.                                       6,478 
             Transfer from construction-in-progress         48,930 
      Deductions:                                                         
             Dispositions and other                        (42,944)
                                                      ------------ 
Balance at December 31, 1998                              $337,828 
                                                      ============ 

 
(B)  The change in accumulated depreciation and amortization for the calendar
year ended December 31, 1998, the seven months ended December 31, 1997, and
fiscal years ended May 31, 1997, 1996, and 1995 is as follows:


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   
                                                      ------------   
      Depreciation and amortization                         16,154   
      Disposals                                             (4,987)  
                                                      ------------   
Balance at December 31, 1998                              $ 55,078   
                                                      ============   

(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
approximates $337 million at December 31, 1998.