<PAGE>   1
 
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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
 
                                   FORM 10-K
 
   FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15 (d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
 
<TABLE>
<C>          <S>
(MARK ONE)
    [X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
             SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED
             JANUARY 2, 1999
                                   OR
 
    [ ]      TRANSITION PERIOD REPORT PURSUANT TO SECTION 13 OR 15 (d)
             OF THE SECURITIES EXCHANGE ACT OF 1934
             FOR THE TRANSITION PERIOD FROM           TO
</TABLE>
 
                         COMMISSION FILE NUMBER 1-14058
 
                              RED ROOF INNS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                                 <C>
                  DELAWARE                                           31-1393666
---------------------------------------------       ---------------------------------------------
            (State incorporation)                       (I.R.S. Employer Identification No.)
 
             4355 DAVIDSON ROAD                                      43026-2491
               HILLIARD, OHIO
---------------------------------------------       ---------------------------------------------
  (Address of principal executive offices)                           (Zip Code)
</TABLE>
 
       Registrant's telephone number, including area code: (614) 876-3200
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
 
<TABLE>
<CAPTION>
                                                                Name of each exchange
             Title of each class                                 on which registered
---------------------------------------------       ---------------------------------------------
<S>                                                 <C>
        COMMON STOCK, $.01 PAR VALUE                           NEW YORK STOCK EXCHANGE
</TABLE>
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
 
                                      NONE
 
    Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.    Yes [X]    No [ ]
 
    Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Registration 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 this Form 10-K or any
amendments to this Form 10-K. [X]
 
  NUMBER OF SHARES OF COMMON STOCK OUTSTANDING WAS 26,960,188 AT FEBRUARY 26,
                                     1999.
 
  BASED ON THE CLOSING SALES PRICE OF FEBRUARY 26, 1999, THE AGGREGATE MARKET
                                     VALUE
     OF THE STOCK HELD BY NON-AFFILIATES OF THE REGISTRANT WAS $116,097,550
 
    Portions of the following documents are incorporated by reference into the
designated parts of this Form 10-K: definitive Proxy Statement, dated on or
about April 16, 1999 relating to Registrant's 1999 Annual Meeting of
Stockholders (in Part III), which Registrant intends to file not later than 120
days after the end of the fiscal year covered by this Form 10-K.
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<PAGE>   2
 
Unless the context otherwise requires, the "Company," "Red Roof" or "Red Roof
Inns" refers to Red Roof Inns, Inc., a Delaware corporation and any subsidiaries
of Red Roof Inns, Inc. from time to time.
 
Unless otherwise indicated, Inn data presented in this report is based on 238
Inns (the "Comparable Inns") that the Company owned and operated at the
beginning of and throughout the 1998 fiscal year following four successive
quarters as open, operating, fully renovated or constructed properties based on
a 52 week comparison. Management believes that the remaining company operated
Inns acquired or constructed (the "Inns in Stabilization") have not been
operated by the Company for a sufficient period to provide meaningful
period-to-period comparisons. Included in the Inns in Stabilization are acquired
Inns that underwent renovation causing rooms to be out of service. Therefore,
the average daily room rates and occupancies for these Inns are not comparable
to stabilized Red Roof Inns. Both acquired and newly constructed Inns
historically begin with lower occupancy and average daily room rates, which
should improve over time as these Inns implement the Company's operating
policies and procedures and become integrated into the Company's central
reservation system.
 
Red Roof Inns operates in the economy chain scale segment ("economy chain
segment") of the lodging industry as defined by Smith Travel Research ("STR"), a
leading industry research firm. STR categorizes lodging properties into the
following chain scale segments based upon average daily rates: upper upscale,
upscale, mid-scale with food and beverage, mid-scale without food and beverage,
economy and independents. Economy chain segment statistics presented herein
exclude Red Roof and extended stay properties.
 
PART 1
 ITEM 1.         BUSINESS
 
GENERAL
Red Roof Inns is a franchisor of and the largest owner/operator of economy chain
segment hotels in the United States, with 295 Inns (including 39 franchised
Inns) containing more than 34,100 rooms (including 4,600 franchised rooms) in 36
states, located primarily throughout the Midwest, East, South and Gulf Coast
regions. Red Roof Inns are designed to attract both the business and leisure
traveler seeking quality rooms and Inn locations that are generally comparable
to those of mid-price hotels, but at lower average room rates. By not providing
full-service, management-intensive facilities and services, such as in-house
restaurants or cocktail lounges, banquet centers, conference rooms, room
service, recreational facilities or other services and facilities that the
Company's targeted customers do not typically value, Red Roof is able to deliver
a product that addresses its customers' needs and price expectations. In
general, Red Roof's guests are evenly divided between business and leisure
travelers.
 
The following table sets forth total number of Inns and total number of rooms
open at the end of the years indicated:
 
<TABLE>
<CAPTION>
                            NUMBER OF INNS               NUMBER OF ROOMS
                      --------------------------   ----------------------------
FISCAL YEAR           OWNED   FRANCHISED   TOTAL   OWNED    FRANCHISED   TOTAL
<S>                   <C>     <C>          <C>     <C>      <C>          <C>
 
 1994                  220                  220    24,658                24,658
 1995                  231                  231    26,134                26,134
 1996                  248                  248    28,167                28,167
 1997                  254         5        259    29,120       541      29,661
 1998                  256        39        295    29,562     4,619      34,181
</TABLE>
 
According to STR, Red Roof has one of the highest occupancy rates in the economy
chain segment of the lodging industry. The Company's Comparable Inns had an
average occupancy percentage of 73.0% and an average daily room rate ("ADR") of
$46.80 for 1998. Comparable Inn revenue per available room ("RevPAR") over the
past four years has grown at a compound annual rate of 2.2% to $34.16 for 1998.
In 1998, the Company's Comparable Inns occupancy exceeded the economy chain
segment average occupancy of 56.4% by 16.6 percentage points and Comparable Inn
RevPAR was 33% higher than the economy chain segment average of $25.78.
 

                                       2
Red Roof Inns Inc. and Subsidiaries
<PAGE>   3
 
The following table sets forth certain data for the Company's Comparable Inns
for the years indicated:
 
<TABLE>
<CAPTION>
                         NUMBER      AVERAGE
      FISCAL YEAR        OF INNS   OCCUPANCY(1)   ADR(2)   REVPAR(3)
<S>                      <C>       <C>            <C>      <C>
 
 1994                      210         79.1%     $39.63     $31.35
 1995                      210         77.3       42.11      32.55
 1996                      223         74.2       44.36      32.92
 1997                      238         70.4       47.10      33.16
 1998                      238         73.0       46.80      34.16
 1994-98 Compound Annual
         Growth Rate                  (2.0)%        4.2%       2.2%
</TABLE>
 
(1) Average occupancy percentage represents total rooms occupied divided by
total available rooms. Total available rooms represents the number of rooms
available multiplied by the number of days in the reporting period.
 
(2) ADR represents total room revenues (net of allowances) divided by the total
number of rooms occupied.
 
(3) RevPAR represents the average occupancy percentage multiplied by the average
daily room rate for the reporting period.
 
In 1998, the Company's Comparable Inns RevPAR increased by 3.0% over 1997 due to
a .6% decrease in ADR and a 2.6 percentage point increase in the average
occupancy percentage. The Company attributes the decrease in ADR to planned
price decreases early in the year coupled with discount programs targeted toward
senior citizens and members of the American Automobile Association (AAA). The
decrease in ADR was more than offset by demand generated by these programs which
contributed to the occupancy and RevPAR increases. In addition, the Company
increased operating income for the four year period from 1994 through 1998 at a
compound annual growth rate of 6.4% (8.0%, excluding certain charges). These
increases in operating income were achieved by increasing RevPAR and controlling
costs.
 
Red Roof Inns is a price-value leader in the economy chain segment and operates
under the philosophy of offering Inn locations and quality rooms comparable to
many mid-priced hotels but at substantially lower room rates. Management
believes that the customers' perception of value is dependent on three
components: price, location and consistent quality. Guests who travel in the
economy chain segment do so to save money. Red Roof Inns is able to maintain its
low prices as a result of a consistent company-wide emphasis on cost control.
Red Roof Inns are generally located near interstate highways, major traffic
arteries or major destination areas such as airports, business districts,
universities, hospitals or convention centers. All locations are well
constructed and maintained and are attractively landscaped to enhance their
appearance. In addition, the Company strives to deliver a consistent guest
experience throughout the chain by following a chainwide set of operating,
marketing and hospitality standards. The Company's success in providing customer
value is demonstrated by its consistently high occupancy levels compared to the
average for the economy chain segment.
 
The Company believes that it has achieved significant brand awareness as a
result of its ability to provide high-quality, well located accommodations and
superior value, together with its national advertising campaign featuring
actor/comedian Martin Mull. This brand awareness and reputation for price,
quality and value have consistently placed Red Roof Inns among the leaders in
the economy chain segment in terms of occupancy and RevPAR, according to STR. In
addition, the brand name has earned the Company a strong following of loyal
guests. Management believes that the Company's brand identity provides it with a
significant advantage over independent hotel operators and other economy segment
chains. Together with its operational expertise, this enhances the performance
of existing and newly constructed and acquired properties. Management is
expanding the chain on a national basis through franchising and selective hotel
development.
 
The Company promotes and operates its own reservation centers and toll-free
number (1-800-THE-ROOF) to accept reservations. During 1998, the Company handled
approximately 2.9 million calls through the toll-free number, of which
approximately 40% were converted to reservations, contributing to the Company's
high level of occupancy. During the second quarter of 1998, the Company opened a
second reservation center in Springfield, Ohio. This second center provides
additional capacity, along with back-up capabilities, to handle the increased
call volume as a result of the growth in the franchise program. Calls are routed
to the first available agent at either center to ensure that all calls are
answered as quickly as possible.
 
                                                                            
                                       3
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   4
 
The Company has operated Inns since its first Inn opened in 1973. Red Roof's
management has substantial experience in the lodging industry. On average,
senior management has approximately 18 years experience in the lodging industry
and is supported by operational and administrative vice presidents with an
average of 16 years experience and on-site general managers with an average of 7
years experience. Each company-owned Red Roof Inn is operated as an individual
profit center by a general manager who oversees all day-to-day guest relations
and other operating activities and implements rate, occupancy and cost
containment strategies. Management believes this structure reduces operating
costs while creating incentives to maximize RevPAR, guest satisfaction and
enhance operating margins by adapting room rates to prevailing market conditions
at individual Inns.
 
STRATEGY
The Company's strategy is to increase cash flow and earnings per share by
increasing Company-owned Inn profits, becoming more fee intensive through
franchising and partner programs, pursuing selective development opportunities
through joint ventures and using the Company's free cash flow to take advantage
of market opportunities.
 
INCREASE COMPANY-OWNED INN PROFITS. The Company intends to increase cash flow
and earnings per share through increases in profit contributions from company-
owned Inns, primarily by moderate increases in ADR, by maintaining or increasing
the Company's strong occupancy levels and by controlling costs. The Company
believes that it will be able to increase RevPAR by stimulating room demand
through effective advertising, promotion and discount programs targeted toward
senior citizens and members of the AAA and through the implementation of an
automated revenue management system. The Company also believes that increases in
RevPAR will be achieved as a result of its chainwide Inn renewal program
("Project BIG RED"), which was completed in 1998. In addition to increasing
revenues at company-owned Inns, the Company has always focused on controlling
costs while not reducing customer service levels.
 
         -  Discount Programs -- During the first quarter of 1998, the Company
introduced programs for two key market segments -- senior citizens and members
of AAA. The senior market is the fastest growing population segment in the
United States today and is expected to remain so for years to come as the baby
boomer generation matures. Generally, the senior market has discretionary funds
available and the propensity to travel. AAA membership amounts to over 41
million people who generate significant travel and leisure business. In
addition, Red Roof was made a preferred partner of AAA in mid-1998. Management
believes that by providing appropriate discounts to the members of these two
groups, the Company will build demand for its service.
 
         -  Revenue Management System -- In the second quarter of 1998, the
Company implemented a fully automated revenue management system in conjunction
with the completion of the Company's Inn renewal program. The system is linked
to both the central reservation system and the individual property management
systems, providing real-time information. The system is essentially an inventory
control system that enables the Company to better manage both occupancy and rate
by analyzing historical data, trends and current reservation activity to
forecast future trends. Inn managers use the system to foresee peak occupancy
days and predict cancellations, no-shows, stay-overs and walk-in traffic which
enables them to adjust room rates and better manage both lengths of stay and
discount business.
 
         -  Project BIG RED -- In the fourth quarter of 1996, the Company
commenced Project BIG RED, a chainwide property renewal program that refurbished
and enhanced both the interior decor and exterior appearance of the majority of
company-owned Inns as well as provided additional room amenities and services
for guests. The property renewal program was completed in 1998 for a total cost
of approximately $68 million (including approximately $4 million for the revenue
management system). Project BIG RED gave the rooms a more modern, residential
feel with new carpet, wallcovering, furniture, bedspreads and drapes. A brighter
paint shade, new signs, improved lighting and additional landscaping enhanced
the exterior appeal of the Inns and highlighted the properties for approaching
travelers. The program added features to the Company's business king rooms that
better address the needs of the business traveler, as well
 
                                       4
Red Roof Inns Inc. and Subsidiaries
<PAGE>   5
 
as additional amenities to all rooms, which management believes will reinforce
Red Roof Inns' position as a price-value leader in the economy chain segment and
enhances revenues by allowing the Company to increase ADR and RevPAR.
 
         -  Controlling Costs -- The Company is constantly reevaluating its cost
structure with the emphasis on reducing costs through new technology and by
improving operating efficiencies. Also, the managers at the Inns have incentive
plans to keep costs down and improve efficiency. During 1998, the Company
reduced the amount of labor minutes per room sold by one minute. In addition,
during 1998, the Company installed energy efficient lighting at its Inns which
reduced electric costs. The Company is also investing in technology such as a
voice mail system which allows front desk personnel to better serve their guests
while reducing operating costs.
 
GROW FEE-BASED INCOME. The Company intends to increase cash flow and earnings
per share through the development of fee-based income. By becoming more fee
intensive, the Company expects to decrease its capital needs, increase the
return on assets, increase the stability of its revenue and income streams and
become less vulnerable to changing conditions in the lodging industry or changes
in factors which directly influence the operation of its Inns. The Company
believes that it will generate fee income from both its franchising program and
its partner marketing program.
 
         -  Franchising -- The franchising program is focused on developing
relationships with experienced, high quality hotel owners who will develop and
operate new Inns using the "Red Roof Inn" or "Red Roof Inn & Suites" marks or
convert existing hotels to one of the "Red Roof Inn" or "Red Roof Inn & Suites"
marks. The Company believes that this strategy will allow it to continue to
expand the Red Roof brand nationally without requiring significant capital
investment and will increase revenues and cash flow while maintaining consistent
quality across the entire chain. Franchise applicants are evaluated on hotel
operating expertise and financial stability. Franchise conversion properties and
developed hotel construction plans are reviewed for adherence to Company quality
standards. Approved applicants are granted the right to operate under the Red
Roof Inn brand name, obtain reservations through the Company's central
reservation system and use the Company's Inn designs, operating systems and
procedures. In return for this right, the franchisees pay to the Company an
initial franchise fee and ongoing royalty, marketing and reservation fees. These
ongoing fees are based on a percentage of gross room revenues (as defined in the
franchise agreement) at the franchised properties. In addition, franchisees pay
to the Company license fees for computer software that the Company provides to
the franchisees. The total amount of fees collected by the Company will vary
depending on the total revenues generated by all of its franchisees. The
Company's franchise fee structure contains a unique provision that allows a
franchisee to earn a discount to the royalty fee by achieving high levels of
customer satisfaction, as measured by an independent survey conducted by a
market research firm. The Company believes that this provision not only provides
it with a competitive advantage in attracting high quality franchisees, but also
promotes strict adherence to chain quality standards and operating consistency.
The Company also believes that its franchises are attractive because of the
Company's high occupancy, RevPAR and attractive operating margins.
 
The Company believes that it has a strong corporate infrastructure to
accommodate significant Inn expansion through franchising, including an
experienced development, acquisition and finance team, an effective central
reservation system, advertising and marketing programs, an experienced
operations group, a well-developed property management system and an extensive
management training program. In addition, the Company's newly designed buildings
with interior corridors and a high percentage of rentable space, significant
open territories in the Red Roof Inns system, consistency of the Company's
product and service, and the support provided by the Company's experience as an
owner/operator provide competitive advantages for the Company in the sale of its
franchises.
 
As of January 2, 1999, the Company had 39 franchised Inns open, 18 franchised
Inns under construction or conversion and projected to open in 1999 and 30
additional executed franchise agreements. The Company's goal is to open 50
franchised Inns in 1999.
 
                                                                            
                                       5
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   6
 
         -  Partnership Marketing -- The Company has a partnership marketing
program through which the Company forms alliances with other well-known consumer
product and service companies in order to offer its guests additional
value-added services. The Company actively promotes its partners' products or
services either at the Inns or through the central reservation centers in
exchange for fees from the partner companies. The Company believes that its
strong following of loyal guests (which represents over 8 million room nights
sold in 1998) and reputation for value, quality and service make it an
attractive partner and allow it to create alliances with high quality companies
that will further enhance the attractiveness of Red Roof Inns to its guests.
Management believes that this strategy generates increased revenue and cash flow
while providing additional value-added services to the Company's guests.
 
PURSUE SELECTIVE INN DEVELOPMENT. At the end of 1997, the Company made the
decision to reduce its company-owned Inn development program and focus on
growing fee-based income through franchising. Therefore, the Company's current
development and acquisition strategy is focused on locating a select number of
high visibility properties in key strategic locations, such as in central
business districts of major cities or near major airports. The Company currently
intends to use joint ventures or pre-sale structures for these projects. This
new approach to development should allow the Company to reduce the level of
development risk and the overall levels of its capital requirements.
 
During the last three years, the Company purchased 20 development sites (one
under a long-term lease agreement) located in Arizona, Florida, Georgia,
Indiana, Massachusetts, North Carolina, Ohio, Tennessee and Texas. One of these
sites, located in Georgia, was subsequently sold to a franchisee and two of
these sites, located in Indiana and Tennessee, are being held for sale to
prospective franchisees. The Company is in the process of completing the
construction of a total of 2,361 rooms on the 17 remaining development sites of
which 13 developed Inns consisting of 1,759 rooms were open as of January 2,
1999.
 
During the last three years, the Company acquired eight Inns consisting of 1,184
rooms (after conversion and room additions) located in Alabama, Florida,
Maryland, North Carolina, South Carolina, Virginia and Washington, D.C. A total
of eight acquired Inns with 1,135 rooms were open as of January 2, 1999.
 
Certain of the acquired Inns differ from the Company's existing Inns in terms of
construction, number of rooms, room size, building configuration, signage, decor
and other respects. See "Item 2. Properties." Each acquired Inn receives Red
Roof signage, installation of computer hardware to accommodate electronic
processing of reservations and the transmission of financial and other data to
the corporate offices in suburban Columbus, Ohio, as well as lobby modifications
designed to support operational practices and procedures. In addition, the
Company makes capital improvements, where needed, to guest rooms and
guest-sensitive areas to ensure that each acquired property adheres to Red
Roof's stringent operating standards. See "Item 7. Management's Discussion and
Analysis of Results of Operations and Financial Condition  -- Capital Resources
and Liquidity  -- Capital Expenditures." Although acquired properties, after
conversion, differ in certain respects from existing Inns, the renovated
properties offer quality accommodations and service consistent with Red Roof's
brand identity.
 
In evaluating expansion opportunities for company-owned Inns, the Company
generally reviews the competitive environment of the market, including room
supply, room demand, average daily room rates and local market wages. The
Company also evaluates demand generators such as area businesses, conference
centers, airports, universities, hospitals, theme parks, and other business and
leisure attractions. Each potential development site and Inn acquisition is
evaluated for accessibility, visibility and restrictive local ordinances. In
addition, the Company's evaluation of a potential Inn acquisition includes an
extensive review of its historical operating and financial results and the
estimated cost of converting the facility to Red Roof's standards of quality.
Each anticipated development site and Inn acquisition also must have the
potential to meet a stipulated minimum return based on the Company's investment
criteria.
 

                                       6
Red Roof Inns Inc. and Subsidiaries
<PAGE>   7
 
USE FREE CASH FLOW. Historically, the Company's growth strategies have focused
on increasing revenues and earnings before interest, taxes, depreciation and
amortization ("'EBITDA") through the development or acquisition of new Inns that
are owned and operated by the Company. The capital requirements of this strategy
generally exceeded the cash flows from operations, which required the Company to
issue additional debt and equity to finance this growth. At the end of 1997, the
Company made the decision to reduce its new Inn development program and focus on
expanding the chain through franchising and growing its fee-based income
streams. As a result, reduced capital outlays for the development and
acquisition of new company-owned Inns combined with the completion of the Inn
renewal program has significantly reduced the total capital requirements of the
Company. As part of the continuing capital expenditure program, the Company
expects to reinvest in its company-owned Inns through on-going renovation and
maintenance programs as well as make additional investments in systems related
technology.
 
As a result of this revised growth strategy, the Company's on-going capital
requirements are generally expected to be less than the cash flows from
operations. In addition, the Company has and will likely continue to generate
additional cash proceeds from the selective sale of existing company-owned Inns
to franchisees. Cash flows from operations combined with proceeds from asset
sales should exceed capital expenditures and therefore generate free cash flow
available for general corporate purposes. In 1998, the Company generated free
cash flow totaling approximately $26 million as compared to being a net user of
cash of approximately $52 million in 1997. In 1998, the Company used it's free
cash flow to repurchase shares of Company stock and reduce debt.
 
The Company expects that this free cash flow should provide the financial
flexibility to react to and take advantage of changes in the lodging industry
and the capital markets. The Company may use its free cash flow to: repurchase
additional shares of Company stock, reduce or restructure debt, and/or pursue
acquisition opportunities of additional brands and/or lodging owner-operators.
The Company believes that the combination of a growing fee-based revenue stream
along with the use of free cash flow to take advantage of changing market
opportunities will allow the Company to increase its earnings and cash flow per
share.
 
LODGING INDUSTRY
The lodging industry as a whole is continuing to experience positive operating
conditions. Though the rate of growth in supply of hotel rooms is currently
exceeding the rate of demand growth, ADR and RevPAR have continued to increase.
The economy chain segment, where the Company operates, has experienced a greater
rate of supply growth than the industry as a whole. As a result, occupancy
levels for the segment have been declining. However, the segment has continued
to increase ADR and has achieved moderate increases in RevPAR. Red Roof Inns has
one of the highest occupancy levels in the economy chain segment and has
consistently outperformed the segment in RevPAR.
 
COMPETITION
Small chains and independent hotels represent approximately one third of the
supply of rooms in the hotel industry. Direct competitors of Red Roof include
national chains which operate in the economy chain segment, as defined by STR,
such as Super 8 Motels, Motel 6, and Days Inns and regional chains such as Susse
Chalet. In certain locations, the Company's Inns also compete with mid-scale
properties, such as Baymont Inns, Comfort Inns, Fairfield Inns, Holiday Inn
Express, LaQuinta Inns and Hampton Inns. There is no single competitor or group
of competitors of Red Roof that is dominant in the lodging industry. However,
some of Red Roof's competitors have a larger network of locations and greater
resources than Red Roof.
 
Each Red Roof Inn competes in its market area on the basis of price, location
and quality with major national lodging chains, regional brands and privately
owned hotels. The Company is firmly established in most of its markets and the
Company believes many of its Inns are in locations superior to those available
for development today. The Inns are consistently well maintained, attractively
landscaped and competitively priced to appeal to both business and leisure
travelers.
 
                                                                            
                                       7
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   8
 
FRANCHISING
The rights and franchises under which the franchised Inns are operated are set
forth in the Company's Franchise Agreement. The Franchise Agreement gives the
franchisee the right to develop a site or convert a property, own and operate an
Inn accepted by the Company and to use the Company's systems in connection with
the operation of an Inn. A prospective franchisee is required to pay the Company
a refundable application fee of $5,000 when an application is made for a Red
Roof Inns franchise. The initial franchise fee for a Red Roof Inn franchise is
generally the greater of $400 per guest room in the Inn to be developed or
converted or $40,000, less the amount of the application fee. However, in very
limited specific situations the application and/or the initial franchise fee has
been negotiated depending upon such factors as the total number of rooms, the
total number of new or conversion properties, future development or conversion
commitments, market conditions, market penetration and other relevant factors.
The Company does not make a practice of negotiating any fees, except in limited
circumstances. The franchisee must also pay the Company approximately $5,300 in
owner, management and computer training tuition fees as well as approximately
$20,000 for the purchase of a property management system and other related
systems. In addition, the franchisee must pay travel, lodging and meal expenses
for Company computer trainers and the shipping expenses for the training
equipment for the front office system and training that the Company provides at
the Inn. The franchisee also is required to reimburse the Company for travel
agency commissions and other fees that the Company may pay to third parties for
electronic bookings at franchised Inns.
 
The Company has no formal Company-funded financial assistance program for
franchisees. However, the Company may, at its sole discretion, offer to
franchisees financing with terms that vary depending upon a number of factors
such as the number of inns involved, the number of rooms involved, market
conditions, market penetration and other such factors that may warrant and
justify the financial assistance. This financing typically must be repaid in
three years and requires appropriate collateral. In addition, the Company has a
contractual agreement with a financial institution to act as a placement agent
for franchisees who desire access to potential sources of third-party financing.
 
Generally, a franchisee is required to pay a royalty fee of 4% of gross room
revenue (as defined in the Franchise Agreement) during the first two years after
the opening of an Inn and 4.5% of gross room revenues for all periods hereafter.
A franchisee can receive a rebate of .5% of gross room revenues if, in any
calendar year, the franchised Inn achieves superior results in guest
satisfaction as measured by an independent guest survey conducted by a market
research firm. In addition to the royalty fees, a franchisee must pay, as a
percentage of gross room revenues, a marketing fund fee of 2.5% for national
advertising and a reservation fee of 2% to support the cost of reservation
services provided to the Inns.
 
Before a franchised Inn opens, the Company inspects and approves the Inn to
confirm that the Company's quality specifications have been met. Once a
franchised Inn opens, the Company provides continued sales support, assistance
and visitation by franchise operations directors to assist in day-to-day
operation of an Inn and provides optional training at various locations. The
Company currently employs 10 franchise sales personnel located throughout the U.
S. who market the Company's franchisees to qualified applicants. The Company
also employs six franchise operations directors, who are former Red Roof Inns
general managers, to assist franchisees with pre-opening and ongoing operations
issues.
 
OPERATIONS
The Company's Inns are managed from its corporate office in suburban Columbus,
Ohio. Centralized corporate functions include marketing, sales, reservations,
treasury, accounting, financial reporting, information systems, purchasing,
repairs and maintenance, legal, human resources and managerial training. The
corporate staff monitors Inn-level consistency with standards for guest service
through a guest satisfaction survey program, which is conducted by an
independent market research company, and its corporate office customer service
department. The corporate staff also monitors standards for maintenance and
appearance through an experienced design and maintenance staff.
 

                                       8
Red Roof Inns Inc. and Subsidiaries
<PAGE>   9
 
Each company-owned Inn is operated as an individual profit center, with a
general manager who oversees all day-to-day operating activities. Red Roof's
managers devote their attention to assuring friendly guest service and clean,
well maintained rooms, consistent with chainwide standards. Their
responsibilities also include recruiting, training and supervising the Inn's
staff. A typical Inn has approximately 20 employees, including the general
manager, housekeepers, laundry attendants, skilled and general maintenance
persons and front desk guest services representatives, including a night
auditor. Each general manager reports to one of 14 district operations vice
presidents, who in turn report to senior management.
 
Red Roof's general managers receive a three-week training program that
emphasizes operations, hospitality, rate management, legal issues, interviewing,
employee relations, training and budgeting prior to assuming responsibility at
an Inn. The Company has managers who assist the general managers at certain
Inns, providing a pool of experienced candidates to fill its needs for general
managers.
 
The Company uses target-driven operational budgets prepared by the general
managers that are implemented after review with senior management. Rates charged
by Red Roof are continually reviewed by the Inn managers, rate analysts and
operations vice presidents so that they can be appropriately adapted to the
prevailing market conditions at each Inn. In addition, implementation of the
fully automated revenue management system enables Inn managers to monitor rates
in relation to peak demand periods. Each general manager can earn financial
incentives based upon achieving favorable results in comparison to the revenue
and profit budgets along with guest satisfaction surveys for their respective
property. Management believes this incentive program increases the general
managers' focus on operating efficient, well maintained, profitable Inns.
 
Each Inn has property management software and hardware which is used for the
exchange of daily reservations, room rate changes, occupancy, payroll, credit
card authorizations and other financial data with the corporate office.
Management believes that this system has enhanced its ability to monitor and
maximize revenues and profitability of the Inns. Data is transmitted to and from
the corporate office using the Company's computer network, which allows for high
capacity data communications volume and real-time information.
 
SALES AND MARKETING
In general, Red Roof's guests are evenly divided between leisure and business
travelers. Leisure travelers served by the Company are typically en route by car
to another destination or attending a nearby special event or attraction. The
Company also serves business travelers, many of whom travel on a per diem or pay
their own expenses. Leisure demand is highest on Friday and Saturday nights with
business demand highest on Monday through Thursday nights.
 
Red Roof's national advertising campaigns, featuring actor/comedian Martin Mull,
emphasize the consistency and value associated with its Inns. The Company
markets through national and local cable and network television, newspapers,
other print media and its own Web site. The Company focuses its television
advertising on specific programs during certain months of the year and times of
the day for maximum impact. In addition, the Company utilizes billboard
advertisements located along interstate highways near many of its Inns.
 
The Company utilizes its own central reservation centers and toll-free number
(1-800-THE-ROOF) to accept reservations. During 1998, the reservation centers
handled approximately 2.9 million calls through the toll-free number, of which
approximately 40% were converted to reservations. During the second quarter of
1998, the Company opened a second reservation center in Springfield, Ohio. This
second center provides additional capacity, along with back-up capabilities, to
handle the increased call volume as a result of the growth in the franchise
program. Calls are routed to the first available agent at either center to
ensure that all calls are answered as quickly as possible. The reservation
system provides reservation agents with information about Inn locations,
available rooms and prices in order to assist customers in reserving rooms. The
agents are trained in telephone sales and cross-selling techniques. Through its
computer network, the Company continually updates the number of rooms sold at a
property, permitting the sale of all available
 
                                                                            
                                       9
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   10
 
rooms through either the Inn or the reservation centers. The Company has special
reservation agents for large group sales, motor coach sales and special event
bookings. Management estimates that approximately three-fourths of room sales
are to customers who have made a reservation through the central reservation
centers or by calling an Inn directly.
 
The Company offers a number of marketing programs aimed at creating customer
loyalty. The Company promotes a "RediCard" program which provides its members
with express reservation and check-in. Additional amenities include a USAToday
newspaper delivered to the member's room, personal check cashing, pay-by-check
privileges and a newsletter offering various discounts and coupons. The RediCard
program improves the administrative efficiency of the reservation agents and
front desk staff by providing a personal profile of the member. This includes
information such as room type preference, smoking or non-smoking rooms and
preferred method of payment. The Company currently has more than 445,000 active
RediCard members. In addition, the Company has formed and continues to seek
alliances with national travel and consumer organizations, such as AAA, to offer
special rates or promotions to the organizations customers, including discounted
rates to senior citizens.
 
The Company's corporate sales group increases room sales through the inclusion
of Red Roof Inns in approved or preferred lodging lists of corporate travel
managers and travel agencies on a national basis. The Company has five national
sales representatives, two tour and travel sales representatives and increased
the number of regional sales representatives from eight in 1996 to 16 in 1998.
The regional sales representatives conduct sales programs to develop local
corporate contacts and encourage local companies to utilize the Inns. These
sales efforts include developing brand loyalty through programs such as RediCard
and Volume Plan Plus, a plan which provides for negotiated rates based on the
volume of room nights per year that a company can offer Red Roof.
 
The Company developed a database management system to track its guests' spending
habits and travel patterns. This system, coupled with other corporate programs,
will enable the Company to effectively market its product toward its frequent
guests as well as potential new guests. The system will identify potential
guests for under-utilized markets and hotels, frequent guests by market area for
new Inns and franchisees and enhance its guest loyalty program. Management
believes the system, which was fully implemented in the fourth quarter of 1998,
will increase guest loyalty, retention and repeat business resulting in
increased market share and ultimately increase RevPAR.
 
ENVIRONMENTAL CONSIDERATIONS
A limited number of the Company's properties contained underground storage tanks
that were used to store petroleum products prior to the purchase of such
properties by the Company. The Company removed those tanks prior to construction
of its Inns on those properties. In addition, five Red Roof properties currently
contain underground or above-ground storage tanks that are used to store propane
for use at those properties. A substantial number of the Red Roof properties are
also adjacent to or near properties (mostly service stations, but including some
landfills and industrial operations) that contain or have contained storage
tanks or that have engaged or may in the future engage in activities that may
release petroleum products or other hazardous or toxic substances into the soil
or groundwater.
 
Most of the Company's properties have not been tested for the presence of
hazardous substances. The Company is aware of three Red Roof properties that
were developed with the use of landfill that has been found to contain hazardous
substances. With respect to two of these properties, the Company has determined
that no notification or remediation is required under current laws and
regulations. With respect to the third of these properties, state regulatory
authorities have issued a "No Further Action" approval letter based upon the
Company's execution and recording of a "Declaration of Environmental
Restrictions" limiting the property owner's right to disturb affected areas of
the property.
 
Based on its present knowledge and currently applicable laws and regulations,
the Company does not believe that environmental matters are likely to have a
material adverse effect on the Company's business, assets, financial condition
or results of operations. However, due to the absence of complete information,
possible future changes
 

                                       10
Red Roof Inns Inc. and Subsidiaries
<PAGE>   11
 
in laws and regulations, and other factors, no assurance can be given that
environmental matters will not ultimately have a material adverse impact on the
Company's business, assets, financial condition or results of operations.
 
EMPLOYEES
As of January 2, 1999, Red Roof employed approximately 5,900 persons, of whom
approximately 90% were compensated on an hourly basis. Approximately 480 of
these employees work at the corporate headquarters, of which approximately 150
are employed at the Company's reservation centers. The Company's employees are
not currently represented by labor unions and the Company has never experienced
any organized work stoppage. Management believes that its ongoing labor
relations are good.
 
SERVICEMARKS
"Red Roof Inn", "Red Roof Inn & Suites", "Red Roof", "RediCard", "Hit the Roof",
"Sleep Cheap" and various other marks are registered servicemarks of the
Company, which the Company considers important to its business. The Company
monitors use of similar names and takes appropriate action when possible
infringements occur.
 
 ITEM 2.         PROPERTIES
 
The Company believes that it has frequently benefited from identification and
development of attractive locations in local markets prior to many of its
competitors. In addition, since Red Roof was one of the first economy segment
chains, the Company is firmly established in many of its markets.
 
Red Roof adheres to rigorous standards in building and maintaining each Inn.
Management believes that its high-quality construction standards are superior to
those of many of its competitors.
 
A typical company-owned Red Roof Inn contains, on average, approximately 114
rooms. In addition to standard rooms, each Inn has rooms equipped for the
handicapped and has "business king" rooms containing a king-sized bed, a
recliner, a desk and computer tie-in services. Each Inn features a choice of
rooms for non-smokers and smokers, free unlimited local telephone calls, remote-
control television with CNN, ESPN and Showtime, pay-per-view movies and video
games, free coffee and USAToday newspapers in the lobby, 24-hour front desk and
message service, direct corporate billing and free parking. Many of the
Company's Inns are adjacent to free-standing restaurants affiliated with
restaurant chains such as Bob Evans, Shoney's and Cracker Barrel that provide
food service to Red Roof's guests.
 
A typical franchised property consists of approximately 110 rooms. As of January
2, 1999, there were a total of four newly-constructed franchised Inns and 35
franchised Inns that were converted properties. Each franchised Inn must adhere
to the same rigorous quality standards of construction and maintenance as a
company-owned Inn. Each franchised Inn is inspected by a franchise operations
director, at least annually, to assure that the franchised Inn adheres to the
Company's quality standards. The Company has the ability to terminate the
franchisee's agreement for failure to meet these quality standards as well as
for a franchisee's failure to fulfill other contractual obligations.
 
To maintain the overall quality of the Company's existing Inns, each Inn
undergoes periodic renovations and capital improvements as required. These
renovations are completed in accordance with established maintenance programs
that list specific tasks to be completed, including such items as seasonal
landscaping and inspection of the condition of sidewalks, parking areas and
signage. In 1996, 1997 and 1998, the Company spent approximately $17.1 million,
$6.9 million and $19.0 million (exclusive of BIG RED expenditures),
respectively, on capital improvements to existing Inns.
 
In the fourth quarter of 1996, the Company commenced Project BIG RED, a
chainwide property renewal program that refurbished and enhanced both the
interior decor and exterior appearance of the majority of company-owned Inns as
well as provided additional room amenities and services for guests. The property
renewal program was completed in 1998. Project BIG RED gave the rooms a more
modern, residential feel with new carpet, wallcovering, furniture, bedspreads
and drapes. A brighter paint shade, new signs, improved lighting and additional
landscaping enhanced the exterior appeal of the Inns and highlighted the
properties for approaching travelers. The program added features to the
Company's business king
 
                                                                            
                                       11
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   12
 
rooms that better address the needs of the business traveler, as well as
additional amenities to all rooms, which management believes will reinforce Red
Roof Inns' position as a price-value leader in the economy chain segment and
enhances revenues by allowing the Company to increase ADR and RevPAR.
 
The total cost for Project BIG RED was approximately $68 million (including
approximately $4 million for the revenue management system). The Company
recognized total charges to earnings of $24.5 million related to early asset
retirements and other charges associated with Project BIG RED. The Company
recognized $10.4 million of the charges ($7.8 million related to early asset
retirements) during the fourth quarter of 1996 and $14.1 million ($2.4 million
related to early asset retirements) throughout 1997. The Company did not incur
any charges to earnings related to BIG RED in 1998. See "Item 8. Financial
Statements and Supplementary Data -- Note 10 to the Consolidated Financial
Statements."
 
During 1998, the Company sold four of its California properties and a property
under construction in Atlanta, Georgia to franchisees. These properties were
sold, substantially at cost, for net cash proceeds of approximately $22 million
and the proceeds were used to repay borrowings on the Company's bank facility
("the Bank Facility") and mortgage notes. A sixth property located in California
was leased to a franchisee with an option to purchase.
 
At five company-owned Red Roof properties, the Company leases both the land and
the buildings. At two of these five properties (the Harrisburg-North,
Pennsylvania and Parkersburg, West Virginia Inns), the landlord in each case is
a partnership in which the Company owns or controls a substantial majority of
the partnership interests. At the Parkersburg, West Virginia property, the lease
will expire in 2001 and the Company does not have an option to extend the lease
or purchase the property. At the Harrisburg-North property, the Company
subleases the property from the partnership, which leases the property from the
Dauphin County Industrial Development Authority. The Harrisburg-North lease
expires in 2004 and the partnership has the option to purchase the property at
any time during or within 90 days after the expiration of the term of the lease,
for an amount equal to $100,000 above the balance then due on the industrial
revenue bonds issued to finance development of the property. The Company does
not have an option to extend the sublease or lease, or to purchase the
Harrisburg-North property. At the third property, located in Charleston, West
Virginia, the lease expires in 2016 (assuming the exercise of all renewals) and
the Company does not have an option to extend the lease or purchase the
property. At the fourth property, located in Colorado Springs, Colorado, the
lease expires in 2015 (including the exercise of all renewals) and the Company
has an option to purchase the property at fair market value. At the fifth
property, located in Columbus, Ohio, the lease expires in 2027 (assuming the
exercise of all renewals) and the Company does not have an option to purchase
the property.
 
Eleven company-owned Red Roof properties are subject to ground leases. All
ground leases have remaining terms, including renewal options, aggregating
longer than 24 years.
 
The remainder of the Company's Inns are 100% owned in fee simple by the Company.
As of January 2, 1999, 87 Inns were encumbered by mortgage loans or industrial
revenue bonds maturing in various years from 1999 to 2009. In addition, the
Company has a $250 million Bank Facility which is secured by 80 other Inns. See
"Item 8. Financial Statements and Supplementary Data -- Note 4 to the
Consolidated Financial Statements."
 
The Company owns its corporate office building located in suburban Columbus,
Ohio. It is encumbered by a mortgage loan that will mature in 2009.
 
The Company believes that it maintains adequate aggregate insurance coverage on
its properties, subject to appropriate deductibles. The Company used a
self-insurance plan for general liability and workers compensation insurance for
claims arising before May 1998. Subsequent to May 1998, the Company entered into
a three-year fixed premium agreement with a national insurance carrier for its
general liability and workers compensation insurance. The premium is subject to
adjustment on the annual anniversary date of the policy if actual insured losses
exceed 60% of the annual premium amount. See "Item 8. Financial Statements and
Supplementary Data -- Note 1 to the Consolidated Financial Statements."
 

                                       12
Red Roof Inns Inc. and Subsidiaries
<PAGE>   13
 
   The following represents the distribution of company-owned Inns and
franchised Inns as of January 2, 1999:
 
<TABLE>
<CAPTION>
                                               COMPANY-OWNED                 FRANCHISED                      TOTAL
                                          ---------------------------------------------------------------------------------
    STATE                                 # OF INNS    # OF ROOMS      # OF INNS    # OF ROOMS      # OF INNS    # OF ROOMS
    <S>                                   <C>          <C>             <C>          <C>             <C>          <C>
    Alabama                                    4            417                                          4            417
    Arkansas                                   1            108                                          1            108
    Arizona                                    5            640            2            260              7            900
    California                                 1            200           10          1,216             11          1,416
    Colorado                                   1            117                                          1            117
    Connecticut                                4            441                                          4            441
    Washington, DC                             1            197                                          1            197
    Delaware                                   1            119                                          1            119
    Florida                                   15          1,797            3            662             18          2,459
    Georgia                                    9          1,092            4            381             13          1,473
    Iowa                                       1            108                                          1            108
    Illinois                                  13          1,522                                         13          1,522
    Indiana                                    8            749            2            184             10            933
    Kansas                                     1            107            1             30              2            137
    Kentucky                                   5            553            2            157              7            710
    Louisiana                                  4            422                                          4            422
    Massachusetts                              4            548                                          4            548
    Maryland                                  10          1,239                                         10          1,239
    Michigan                                  20          2,096                                         20          2,096
    Minnesota                                  3            311                                          3            311
    Missouri                                   9          1,029            1            105             10          1,134
    Mississippi                                3            324                                          3            324
    North Carolina                            16          1,857            1            147             17          2,004
    North Dakota                                                           1             99              1             99
    New Hampshire                              2            223                                          2            223
    New Jersey                                 7            908                                          7            908
    New Mexico                                                             1             87              1             87
    New York                                   8            882                                          8            882
    Ohio                                      29          3,184            4            490             33          3,674
    Oklahoma                                                               1             93              1             93
    Pennsylvania                              15          1,731                                         15          1,731
    South Carolina                             8            933                                          8            933
    Tennessee                                 10          1,076            2            192             12          1,268
    Texas                                     22          2,894            4            516             26          3,410
    Virginia                                   8            876                                          8            876
    Wisconsin                                  2            216                                          2            216
    West Virginia                              6            646                                          6            646
                                             ---         ------           --          -----            ---         ------
           TOTAL                             256         29,562           39          4,619            295         34,181
                                             ===         ======           ==          =====            ===         ======
</TABLE>
 
                                       13
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   14
 
 ITEM 3.         LEGAL PROCEEDINGS
 
The Company is involved in various lawsuits arising in the normal course of
business. The Company believes that the ultimate outcome of these lawsuits will
not have a material adverse effect on the Company's business, assets, financial
condition or results of operations.

 ITEM 4.         SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
The Annual Meeting of the Stockholders was held on December 17, 1998, where the
following matters were voted upon by the Company's security holders through the
solicitation of proxies or otherwise:
 
<TABLE>
<CAPTION>
                                   NUMBER OF VOTING SHARES
                               -------------------------------
                                  FOR       AGAINST  ABSTAINED
<S>                            <C>          <C>      <C>
 
 1. To elect three Class III
   directors, each to hold
   office for a three-year
   term and until a successor
   is duly elected and
   qualified:
   Michael E. Foster           23,737,733         0   116,255
   William M. Lewis            23,737,733         0   116,255
   Judith A. Rogala            23,298,955         0   554,993

 2. To consider and vote upon  22,402,585    83,415     5,400
   a proposal to amend the
   1996 Employee Stock
   Purchase Plan to increase
   the number of shares of
   common stock available for
   issuance thereunder.

 3. To consider and vote upon  22,214,459   270,341     6,600
   a proposal to amend the
   Amended and Restated 1994
   Management Equity
   Incentive Plan to increase
   the number of shares of
   common stock available for
   issuance thereunder.

 4. To consider and vote upon  23,849,052     1,650     3,286
   a proposal to ratify the
   appointment of Deloitte &
   Touche LLP as the
   Company's independent
   accountants and auditors
   for the 1998 fiscal year.
</TABLE>
 
                                       14
Red Roof Inns Inc. and Subsidiaries
<PAGE>   15
 
PART II
                 MARKET FOR THE COMPANY'S
                 COMMON STOCK AND RELATED
 ITEM 5.         SECURITY HOLDER MATTERS
 
On January 31, 1996, the Company issued 10,000,000 shares of common stock, $.01
par value, in an initial public offering (the "Offering") at a price of $16 per
share. See "Item 8. Financial Statements and Supplementary Data -- Note 6 to the
Consolidated Financial Statements." The Company's common stock began trading on
the New York Stock Exchange (the "NYSE") on February 1, 1996. As of February 26,
1999, there were approximately 185 holders of record of the Company's common
stock, including the Morgan Stanley Real Estate Fund, L.P. ("MSREF") and its
affiliates, which collectively owned 18,400,000 shares as of that date. On
February 26, 1999, the closing sales price per share as reported by the NYSE was
$13 9/16. The following table presents the quarterly high and low sales prices
of the Company's common stock during 1998 and 1997 as reported by the NYSE.
 
<TABLE>
<S>                                <C>       <C>
 
   1998                            HIGH      LOW
   First quarter                    18 15/16 15 13/16
   Second quarter                   18 5/8   16 1/2
   Third quarter                    17 1/2   13 1/4
   Fourth quarter                   21 1/8   15
 
   1997                            HIGH      LOW
   First quarter                    18 3/4   14 1/4
   Second quarter                   17 3/4   14 7/8
   Third quarter                    19 1/2   16 3/8
   Fourth quarter                   19 1/4   14 11/16
</TABLE>
 
The Company has not paid any dividends on its common stock. It is the general
policy of the Company to retain its earnings to support the growth of its
business. Any dividends declared will be at the discretion of the Board of
Directors and will depend upon the Company's financial condition, earnings and
other factors. The Company's 9 5/8% Senior Unsecured Notes due 2003 ("the
Notes"), the Company's Bank Facility and an agreement relating to certain of the
Company's mortgage indebtedness contain restrictions or limitations upon the
payment of dividends by the Company. See "Item 8. Financial Statements and
Supplementary Data -- Notes 4 and 5 to the Consolidated Financial Statements."
 
                                       15
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   16
 
 ITEM 6.         SELECTED FINANCIAL DATA
 
The following selected financial data (excluding Comparable Inn statistics)
relating to the Company have been taken or derived from the historical financial
statements of the Company and are qualified in their entirety by reference to
such financial statements and notes. Certain amounts in the prior years'
selected financial data have been reclassed to conform with the 1998
presentation. See "Item 8. Financial Statements and Supplementary Data." The
financial data as of December 31, 1994, December 30, 1995, December 28, 1996 and
for the fiscal years 1994 and 1995 have been derived from audited financial
statements of the Company which are not included in this report.
 
<TABLE>
<CAPTION>
                                                                                 FISCAL YEARS (1)
                                                      -----------------------------------------------------------------------
                                                                                                    (53 weeks)
                                                        1994           1995           1996             1997            1998
                                                       ---------------------------------------------------------------------
                                                        (IN THOUSANDS EXCEPT PER SHARE DATA AND COMPARABLE INNS STATISTICS)
    <S>                                               <C>            <C>            <C>             <C>              <C>
 
    STATEMENT OF OPERATIONS DATA
     Revenues                                         $275,606       $298,353       $ 325,470       $ 360,805        $375,336
     Direct room, corporate and marketing expenses     172,479        189,894         208,355         236,107         234,843
     Depreciation and amortization                      23,874         26,892          36,527          36,386          38,787
                                                      --------       --------       ---------       ---------        --------
     Operating income                                   79,253         81,567(2)       80,588(3)       88,312(4)      101,706(5)
     Interest expense                                   52,174         51,260          41,777          46,205          46,358
     Income before income taxes and extraordinary
       item                                             28,100         30,838(2)       39,676(3)       42,723(4)       56,125(5)
     Income taxes                                       11,240         12,516          15,612          16,619          21,832
     Income before extraordinary item                   16,860         18,322(2)       24,064(3)       26,104(4)       34,293(5)
     Net income                                         16,860         18,322(2)       24,064(3)       25,358(4)       34,061(5)
     Income per share before extraordinary item:
       Basic                                              0.92(6)        1.00(2)(6)      0.88(3)         0.93(4)         1.24(5)
       Diluted                                            0.92(6)        0.99(2)(6)      0.87(3)         0.93(4)         1.24(5)
     Net income per share:
       Basic                                              0.92(6)        1.00(2)(6)      0.88(3)         0.91(4)         1.23(5)
       Diluted                                            0.92(6)        0.99(2)(6)      0.87(3)         0.90(4)         1.23(5)
     Shares used in per share calculation:
       Basic                                            18,400         18,400          27,362          27,982          27,566
       Diluted                                          18,400         18,521          27,549          28,167          27,732
    BALANCE SHEET DATA
     Total assets                                     $687,023       $755,348       $ 867,627       $ 954,758        $969,371
     Current maturities of debt                         15,996         11,951          12,020          11,998          15,048
     Long-term debt, excluding current maturities      510,646        544,871         484,158         539,207         512,890
     Stockholders' equity (7)                          116,389        152,711         319,099         338,736         369,176
    OTHER DATA
     Cash flow from operations                        $ 44,824       $ 47,785       $  60,548       $  79,176        $ 79,103
     Net cash used by investing activities             (49,571)       (87,414)       (126,558)       (131,265)        (55,809)
     Net cash provided (used) by financing
       activities                                       (8,286)        42,018          81,242          45,584         (33,719)
     EBITDA(8)                                         104,148        108,990(2)      117,980(3)      125,314(4)      141,270(5)
     EBITDA as a percentage of revenues(8)                37.8%          36.5%(2)        36.2%(3)        34.7%(4)        37.6%(5)
     Ratio of earnings to fixed charges(9)                 1.5x           1.5x            1.8x            1.8x            2.0x
     Capital expenditures:
       Development, acquisitions and related
         improvements(10)                             $ 31,677       $ 74,193       $ 101,494       $  85,631        $ 44,243
       Other                                            13,399         15,194          26,076          45,604          30,445
    COMPARABLE INN STATISTICS
     Inns open (at end of period)                          210            210             223             238             238
     Available rooms (at end of period)                 23,417         23,397          24,958          27,060          27,052
     Room nights occupied (in thousands)                 6,740          6,587           6,732           6,939           7,193
     Average occupancy percentage(11)                     79.1%          77.3%           74.2%           70.4%           73.0%
     ADR(12)                                          $  39.63       $  42.11       $   44.36       $   47.10        $  46.80
     RevPAR(13)                                       $  31.35       $  32.55       $   32.92       $   33.16        $  34.16
</TABLE>
 
<CN>
                                       16
Red Roof Inns Inc. and Subsidiaries
<PAGE>   17
 
(1) The Company operates on a 52-53 week fiscal year which ends on the Saturday
nearest to December 31. The 1994, 1995, 1996 and 1998 fiscal years each
consisted of 52 weeks while the 1997 fiscal year consisted of 53 weeks. The
actual year end for each fiscal year was as follows: December 31, 1994, December
30, 1995, December 28, 1996, January 3, 1998 and January 2, 1999.
 
(2) Included in direct room, corporate and marketing expenses for 1995 was a
charge of $3,142 relating to a change in management. Had such charge not been
incurred, operating income, income before income taxes and EBITDA would have
been $84,709, $33,980 and $112,132, respectively, with EBITDA as a percentage of
revenues being 37.6%. Net income for 1995 was reduced by $1,873 ($.10 per
share -- basic and diluted) due to such charge. Excluding this charge, net
income would have been $20,195 ($1.10 per share -- basic and $1.09 per
share -- diluted).
 
(3) Included in direct room, corporate and marketing expenses for 1996 was a
charge of $2,551 relating to the Inn renewal program. In addition, included in
depreciation and amortization are charges of $7,847 related to early asset
retirements associated with the Inn renewal program and $450 relating to an
adjustment to recognize impairments of certain long-lived assets. Had these
charges not been incurred, operating income and income before income taxes would
have been $91,436 and $50,524, respectively. EBITDA was reduced by $2,551
relating to these charges. EBITDA would have been $120,531 with EBITDA as a
percentage of revenues being 37.0%. Net income for 1996 was reduced by $6,481
($.24 per share -- basic and diluted) due to these charges. Excluding these
charges, net income would have been $30,545 ($1.12 per share -- basic and $1.11
per share -- diluted). See "Item 8. Financial Statements and Supplementary
Data -- Note 10 to the Consolidated Financial Statements."
 
(4) Included in direct room, corporate and marketing expenses for 1997 were
charges of $1,421 for severance compensation relating to re-engineering and
$11,679 relating to the Inn renewal program. In addition, included in
depreciation and amortization was a charge of $2,387 related to early asset
retirements associated with the Inn renewal program. Had such charges not been
incurred, operating income and income before income taxes and extraordinary item
would have been $103,799 and $58,210 respectively. EBITDA was reduced by $13,100
relating to these charges. EBITDA would have been $138,414 with EBITDA as a
percentage of revenues being 38.4%. Income before extraordinary item for 1997
was reduced by $9,462 ($.34 per share -- basic and $.33 per share -- diluted).
Net income was reduced by an extraordinary charge of $746, net of tax ($.02 per
share -- basic and $.03 per share -- diluted) related to the write-off of
unamortized loan costs of $1,228 related to the Company's refinancing of its
bank credit facility. Excluding these charges, net income would have been
$35,566 ($1.27 per share -- basic and $1.26 per share -diluted). See "Item 8.
Financial Statements and Supplementary Data -- Notes 1 and 10 to the
Consolidated Financial Statements."
 
(5) Included in direct room, corporate and marketing expenses for 1998 were
charges of $1,659 for severance compensation, $1,246 for conversion of the
Company's accounting system to be year 2000 compliant, $1,944 for write-offs of
preliminary site acquisition costs and $415 for termination of a pension plan.
In addition, included in depreciation and amortization is a charge of $914
related to impairments of certain long-lived assets. Had such charges not been
incurred, operating income and income before income taxes and extraordinary item
would have been $107,884 and $62,303, respectively. EBITDA was reduced by $5,264
relating to these charges. EBITDA would have been $146,534 with EBITDA as a
percentage of revenues being 39.0%. Income before extraordinary item for 1998
was reduced by $3,775 ($.14 per share-basic and $.13 per share-diluted) due to
these charges. Net income was reduced by an extraordinary charge of $232, net of
tax ($.01 per share -- basic and diluted) related to the write-off of
unamortized loan costs, net of purchase discount, associated with the Company's
partial repurchase of senior unsecured notes due in 2003. Excluding these
charges, net income would have been $38,068 ($1.38 per share -- basic and $1.37
per share -- diluted). See "Item 8. Financial Statements and Supplementary
Date -- Notes 5 and 10 to the Consolidated Financial Statements."
 
(6) Adjusted to give effect solely to the issuance of an additional 10,000
shares in the Offering, 1994 and 1995 net income per share would have been
$.59 -- basic and diluted in 1994 and $.65 -- basic and $.64 -- diluted in 1995.
 
(7) The Company has not paid any dividends on its common stock.
 
(8) EBITDA is operating income plus the sum of interest income, other income,
depreciation, amortization and loss on fixed asset retirements. EBITDA is not
intended to represent cash flow from operations as defined by generally accepted
accounting principles, and such information should not be considered as an
alternative to net income, cash flow from operations or any other measure of
performance prescribed by generally accepted accounting principles. EBITDA is
included herein because management believes that certain investors find it to be
a useful tool for measuring the ability to service debt.
 
(9) For purposes of calculating the ratio of earnings to fixed charges, earnings
include income before income taxes plus fixed charges, excluding capitalized
interest. Fixed charges consist of interest expense, including capitalized
interest, and the portion of rental expense representative of an interest
factor.
 
(10) In 1994, the Company purchased 10 Inns and one development site for an
aggregate cost, including renovation expenditures, of $31,677. In 1995, the
Company purchased 10 Inns, nine development sites and land previously under
lease for an aggregate cost, including renovation and construction costs, of
$63,217 and also spent $10,976 related to renovations and improvements to the 10
Inns and one development site acquired during the second half of 1994. In 1996,
the Company purchased seven Inns and eight development sites for an aggregate
cost, including renovation and construction costs, of $62,581 and also spent
$38,913 related to renovations and improvements to the 20 Inns and 10
development sites purchased in 1994 and 1995. In 1997, the Company purchased one
inn and 11 development sites for an aggregate cost, including renovation and
construction costs, of $36,993 and also spent $48,638 related to renovations and
improvements to 27 Inns and 18 development sites acquired prior to 1997. In
1998, the Company purchased two development sites for an aggregate cost,
including renovation and construction costs, of $4,123 and also spent $40,120
related to renovations and improvements to five Inns and 14 development sites
acquired in 1996 and 1997. A development site purchased in 1997, with a cost of
$506, is being held for sale to a prospective franchisee. One of the development
sites purchased in 1998, at a cost of $627, is being held for sale to a
prospective franchisee.
 
(11) Average occupancy percentage represents total rooms occupied divided by
total available rooms. Total available rooms represents the number of rooms
available multiplied by the number of days in the reported period.
 
(12) ADR represents total room revenues (net of allowances) divided by the total
number of rooms occupied.
 
(13) RevPAR represents the average occupancy percentage multiplied by the
average daily room rate for the reported period.
 
                                       17
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   18
 
                 MANAGEMENT'S DISCUSSION AND
 ITEM 7.         ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
 
OVERVIEW
The following table sets forth certain operating data for the periods indicated:
 
<TABLE>
<CAPTION>
                                      FISCAL YEARS(1)
                               ------------------------------
                                 1996       1997       1998
<S>                            <C>        <C>        <C>
 
 Company-owned Inns open
 (at end of year)                   248        254        256
 Franchised Inns open
 (at end of year)                                5         39
 Comparable Inn Statistics
 Inns open (at end of year)         223        238        238
 Available rooms
  (at end of year)               24,958     27,060     27,052
 Room nights occupied
  (in thousands)                  6,732      6,939      7,193
 Average occupancy percentage      74.2%      70.4%      73.0%
 ADR                           $  44.36   $  47.10   $  46.80
 RevPAR                           32.92      33.16      34.16
 Revenues (in thousands)        325,470    360,805    375,336
 Operating income
 (in thousands) (2)              80,588     88,312    101,706
 Operating income (as
 percentage of revenues) (2)       24.8%      24.5%      27.1%
</TABLE>
 
(1) The Company operates on a 52-53 week fiscal year which ends on the Saturday
nearest to December 31. The 1996 and 1998 fiscal years each consisted of 52
weeks and the 1997 fiscal year consisted of 53 weeks. The actual year end for
each fiscal year was as follows: December 28, 1996, January 3, 1998 and January
2, 1999.
 
(2) Operating income for 1996 was reduced by charges of $10,398 and $450
relating to the Inn renewal program and an adjustment to recognize impairments
of certain long-lived assets, respectively. Had such charges not been incurred,
operating income for 1996 would have been $91,436 and operating income as a
percentage of revenues would have been 28.1%. See "Item 8. Financial Statements
and Supplementary Data  -- Note 10 to the Consolidated Financial Statements."
 
Operating income for 1997 was reduced by charges of $1,421 for severance
compensation relating to re-engineering and $14,066 relating to the Inn renewal
program. Had such charges not been incurred, operating income for 1997 would
have been $103,799 and operating income as a percentage of revenues would have
been 28.8%. See "Item 8. Financial Statements and Supplementary Data -- Note 10
to the Consolidated Financial Statements."
 
Operating income for 1998 was reduced by charges of $1,659 for severance
compensation, $1,246 for conversion of the Company's accounting system to be
year 2000 compliant, $1,944 for write-offs of preliminary site acquisition
costs, $415 for termination of a pension plan and $914 related to impairments of
certain long-lived assets. Had such charges not been incurred, operating income
for 1998 would have been $107,884 and operating income as a percentage of
revenues would have been 28.7%. See "Item 8. Financial Statements and
Supplementary Data -- Note 10 to the Consolidated Financial Statements."
 
RESULTS OF OPERATIONS
 
  1998 Compared To 1997
The Company's revenues are principally derived from room rentals and fee-based
income. Revenues increased $14.5 million, or 4.0%, from $360.8 million in 1997
to $375.3 million in 1998. Fiscal year 1997 consisted of 53 weeks while 1998
consisted of 52 weeks. The extra week in 1997 accounted for approximately $5
million of revenue. RevPAR for the 238 Comparable Inns increased $1.00, or 3.0%,
from $33.16 in 1997 to $34.16 in 1998. The revenue increase for the Comparable
Inns was $3.0 million, primarily as a result of an increase in the average
occupancy from 70.4% in 1997 to 73.0% in 1998, which was partially offset by a
decrease in ADR of $.30, or .6%, from $47.10 in 1997 to $46.80 in 1998. The
Company attributes the decrease in ADR to planned price decreases early in the
year coupled with discount programs implemented during 1998 which targeted
senior citizens and members of the American Automobile Association (AAA). The
decrease in ADR was more than offset by demand generated by these programs which
contributed to the occupancy and RevPAR increases. The Company also attributes
the occupancy and RevPAR increase to the positive effects of its revenue
management system and the completion of its Inn renewal program. In addition,
$8.7 million of the increase in revenues was attributable to an increase in the
operating performance of 18 Inns in Stabilization. Management expects newly
developed or acquired Inns to operate initially below historical Company
averages of occupancy and ADR and to experience an occupancy stabilization
period after construction or renovation. Revenues in 1998 were reduced by
approximately $4 million as a result of the sale of four properties and the
lease of one property located in California to a franchisee early in the second
quarter of 1998. Also, room revenues were impacted by a decline in telephone
revenues in 1998 of approximately $3 million as more guests are using
alternative long distance services than those provided by the Company.
Management expects to see further declines in telephone revenues.
 
The Company increased fee-based revenues $2.8 million from $1.2 million in 1997
to $4.0 million in 1998 due to programs implemented during 1997 to franchise the
brand and from the formation of alliances with well-known
 
                                       18
Red Roof Inns Inc. and Subsidiaries
<PAGE>   19
 
consumer products and service companies to promote their products and services.
The Company had 39 franchised Inns open at the end of 1998 compared to five
franchised Inns open at the end of 1997.
 
Direct room expenses include salaries, wages, utilities, repairs and
maintenance, property taxes, local advertising, room supplies, security, general
and administrative expenses. Direct room expenses increased $1.8 million, or
1.0%, from $179.8 million in 1997 to $181.6 million in 1998. As a percentage of
room revenues, direct room expenses decreased from 50.0% in 1997 to 48.9% in
1998. Direct room expenses in 1997 include $7.5 million related to Inn renewal
program expenses and 1998 includes $.4 million related to the termination of a
pension plan. Excluding these charges, direct room expenses, as a percentage of
room revenues, would have been 47.9% in 1997 and 48.8% in 1998. Direct room
expenses, excluding charges related to the Inn renewal program and termination
of the pension plan, increased primarily because of the addition of new Inns,
generally higher salary, wage and incentive expenses and an increase in planned
repairs and maintenance expenditures.
 
Depreciation and amortization increased $2.4 million, or 6.6%, from $36.4
million in 1997 to $38.8 million in 1998. The increase primarily reflects
depreciation on Inns opened in 1997 and 1998. Included in depreciation and
amortization for 1997 are asset impairment charges of $2.4 million related to
the Inn renewal program and 1998 includes asset impairment charges, primarily
related to land held for sale, of $.9 million.
 
Corporate expenses include the cost of general management, training and field
supervision of Inn managers, development, reservations, franchise, information
systems and administrative expenses. Corporate expenses increased $3.2 million
or 10.1%, from $31.8 million in 1997 to $35.0 million in 1998. Corporate
expenses for 1997 include charges of $.5 million related to the Inn renewal
program and $1.4 million for severance compensation related to the
re-engineering. 1998 includes charges of $1.7 million related to severance
compensation for certain officers and employees, $1.2 million for the conversion
of the Company's accounting system to be year 2000 compliant and $1.9 million
related to the write-off of preliminary site acquisition costs. As a percentage
of revenue, corporate expenses were 8.8% and 9.3% in 1997 and 1998,
respectively. Excluding previously mentioned charges, corporate expenses
increased primarily as a result of an increase in franchise expenses due to
increased staffing and increased reservation costs attributed to the increase in
occupancy. Management expects corporate expenses to increase in the future as
the Company adds new franchised Inns to the chain with increased reservation
expenses partially offset by the collection of franchise reservation fees.
 
Marketing expenses include the cost of media advertising and related production
costs, billboard expenses and expenses associated with the Company's corporate
sales group. Marketing expenses decreased $6.3 million, or 25.7%, from $24.5
million in 1997 to $18.2 million in 1998. As a percentage of revenue, marketing
expenses were 6.8% and 4.9% in 1997 and 1998, respectively. The decrease is
primarily related to a less expensive spring advertising campaign and a
reduction in billboard expenses. In addition, included in 1997 were promotional
costs of $3.7 million related to the Inn renewal program. These decreases were
partially offset by increases in payroll costs and expenses associated with
additional corporate sales staff. Management expects on-going marketing expenses
to remain at about the same percentage of revenues as in 1998 and will partially
fund on-going marketing expenses through the collection of franchise marketing
fees.
 
Had the Company not incurred charges of $15.5 million in 1997 related to the Inn
renewal program and severance compensation, operating expenses and operating
income for 1997 would have been $257.0 million and $103.8 million, respectively.
Had the Company not incurred charges of $6.2 million in 1998 related to the
termination of a pension plan, asset impairment charges, severance compensation,
conversion of the Company's accounting system and the write-off of preliminary
site acquisition costs, operating expenses and operating income for 1998 would
have been $267.4 million and $107.9 million, respectively. See "Item 8.
Financial Statements and Supplementary Data -- Note 10 to the Consolidated
Financial Statements."
 
                                       19
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   20
 
Interest expense increased $.2 million, or .4%, from $46.2 million in 1997 to
$46.4 million in 1998 because of increased borrowings under the Company's $250
million Bank Facility primarily related to development and acquisitions. At
January 2, 1999, approximately $198 million of the Company's debt bore interest
at variable rates.
 
  1997 Compared To 1996
Revenues increased $35.3 million, or 10.8%, from $325.5 million in 1996 to
$360.8 million in 1997. Fiscal year 1997 consisted of 53 weeks while 1996
consisted of 52 weeks. The extra week accounted for approximately $5 million of
the increase in revenues for 1997. RevPAR for the 223 Comparable Inns increased
$.33, or 1.0%, from $32.92 in 1996 to $33.25 in 1997. The revenue increase for
the Comparable Inns was primarily caused by an increase in ADR of $2.47, or
5.6%, from $44.36 in 1996 to $46.83 in 1997. The average occupancy percentage
for the Comparable Inns decreased from 74.2% in 1996 to 71.0% in 1997. The
Company attributes the decline in occupancy and nominal RevPAR growth to the
increased supply of competitive hotel rooms, aggressive price increases early in
the first quarter, low occupancies due to the New Year's holiday falling on a
Wednesday, and a significant reduction in demand for hotel rooms in the Atlanta
and Texas markets where approximately 10% of the Company's properties are
located. The Company believes that the decrease in the Atlanta market is due to
the high demand generated in 1996 related to the Summer Olympic Games while the
decrease in the Texas market is due to an increase in room supply. Approximately
$25 million ($1 million attributed to the extra week) of the increase in
revenues was attributable to an increase in the operating performance of 31 Inns
in Stabilization. Management expects newly developed or acquired Inns to
initially operate below historical company averages of occupancy and ADR and to
experience an occupancy stabilization period after construction or renovation.
In addition, $1.2 million of the revenue increase was from fee-based programs
implemented during 1997. The Company had five franchised Inns open at the end of
1997. No franchised Inns were open in 1996.
 
Direct room expenses increased $15.9 million, or 9.7%, from $163.9 million in
1996 to $179.8 million in 1997. The expenses increased primarily because of the
addition of new Inns and generally higher salary, wage and incentive expenses
that were partially offset by the need for fewer repairs and maintenance
expenditures as a result of the Inn renewal program. Inn renewal program
expenses, included in direct room expenses, were $2.3 million in 1996 and $7.5
million in 1997. As a percentage of room revenues, direct room expenses
decreased from 50.4% in 1996 to 50.0% in 1997. Excluding Inn renewal program
expenses, direct room expenses as a percentage of revenue decreased from 49.7%
in 1996 to 47.9% in 1997.
 
Depreciation and amortization decreased $.1 million, or .3%, from $36.5 million
in 1996 to $36.4 million in 1997. Included in depreciation and amortization
expense for 1996 and 1997 are asset impairment charges of $8.3 million and $2.4
million, respectively, related primarily to the Inn renewal program. Excluding
the asset impairment charges, depreciation and amortization increased $5.8
million which primarily reflects depreciation on Inns opened in 1996 and 1997.
 
Corporate expenses increased $3.6 million or 12.8%, from $28.2 million in 1996
to $31.8 million in 1997. The increase is attributed to the increased staffing
costs and related expenses associated with the Company's implementation of the
franchising program in the last quarter of 1996. In addition, 1997 includes a
charge of $1.4 million for severance compensation relating to re-engineering and
an increase in incentive compensation. As a percentage of revenue, corporate
expenses were 8.7% and 8.8% in 1996 and 1997, respectively. Corporate expense in
1996 and 1997 included charges of $.1 million and $.5 million, respectively,
related to the Inn renewal program.
 
Marketing expenses increased $8.3 million, or 51.2%, from $16.2 million in 1996
to $24.5 million in 1997. The increase in marketing is attributed to the
Company's expansion of the corporate sales group and to increased media expenses
related to additional advertising associated with the Company's first ever
summer advertising campaign to further enhance the Company's brand awareness. In
addition, the Company incurred promotion costs of $3.7 million in 1997 related
to the Inn renewal program. As a percentage of revenue, marketing expenses were
5.0% and 6.8% in 1996 and 1997, respectively. Excluding
 
                                       20
Red Roof Inns Inc. and Subsidiaries
<PAGE>   21
 
the promotion costs for the Inn renewal program, marketing expenses as a
percentage of revenues in 1997 were 5.8%.
 
Had the Company not incurred charges of $10.9 million in 1996 related to the inn
renewal program and the fixed asset impairments, operating expenses and
operating income for 1996 would have been $234.0 million and $91.4 million,
respectively. Had the Company not incurred charges of $15.5 million in 1997
related to the Inn renewal program and severance compensation, operating
expenses and operating income for 1997 would have been $257.0 million and $103.8
million, respectively. See "Item 8. Financial Statements and Supplementary Date
-Note 10 to the Consolidated Financial Statements."
 
Interest expense increased $4.4 million, or 10.5%, from $41.8 million in 1996 to
$46.2 million in 1997 because of increased borrowings under the Company's $250
million Bank Facility related to development, acquisitions and capital
expenditures associated with the Inn renewal program. At January 3, 1998,
approximately $178 million of the Company's debt bore interest at variable
rates.
 
SUPPLEMENTAL INFORMATION
Management believes the following supplemental information presents meaningful
comparisons to on-going operations and summarizes the results of operations of
the Company, adjusted to reflect (a) the effect of the Offering, as if the
Offering had occurred at the beginning of the fiscal year for 1996, (b) the
elimination of extraordinary losses in 1997 and 1998 and (c) the elimination of
certain charges in the year presented to arrive at adjusted operating income,
net income and earnings per share amounts. These amounts do not represent
operating income, net income, and earnings per share as defined by generally
accepted accounting principles. See "Item 8. Financial Statements and
Supplementary Data -- Notes 1, 5, 6 and 10 to the Consolidated Financial
Statements."
 
<TABLE>
<CAPTION>
                                                        1996                          1997                          1998
                                                     (52 weeks)                    (53 weeks)                    (52 weeks)
                                               ----------------------------------------------------------------------------------
                                               OPERATING        NET          OPERATING        NET          OPERATING        NET
                                                INCOME        INCOME          INCOME        INCOME          INCOME        INCOME
<S>                                            <C>            <C>            <C>            <C>            <C>            <C>
 
 As reported                                    $80,588       $24,064        $ 88,312       $25,358        $101,706       $34,061
   Interest expense adjustment for the
     Offering                                                     790
   Extraordinary loss                                                                           746                           232
                                                -------       -------        --------       -------        --------       -------
 Pro-forma before other charges                  80,588        24,854          88,312        26,104         101,706        34,293
 Adjustments for other charges:
   Inn renewal program expenses                  10,398         6,212          14,066         8,594
   Severance expenses                                                           1,421           868           1,659         1,014
   Asset impairment charges                         450           269                                           914           558
   Termination of pension plan                                                                                  415           254
   Costs of converting accounting system                                                                      1,246           761
   Write-off of preliminary site acquisition
     costs                                                                                                    1,944         1,188
                                                -------       -------        --------       -------        --------       -------
 Total other charges                             10,848         6,481          15,487         9,462           6,178         3,775
                                                -------       -------        --------       -------        --------       -------
 Comparative results                            $91,436       $31,335        $103,799       $35,566        $107,884       $38,068
                                                =======       =======        ========       =======        ========       =======
 Comparative earnings per share:
   Basic                                                      $  1.11                       $  1.27                       $  1.38
   Diluted                                                       1.10                          1.26                          1.37
</TABLE>
 
                                       21
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   22
 
CAPITAL RESOURCES AND LIQUIDITY
 
  General
 
The following table sets forth certain capital resource and liquidity
information for the years indicated (dollars in thousands):
 
<TABLE>
<CAPTION>
                                      FISCAL YEARS
                         --------------------------------------
                            1996          1997          1998
                         (52 weeks)    (53 weeks)    (52 WEEKS)
  <S>                    <C>           <C>           <C>
  Cash flow from
   operations             $ 60,548      $ 79,176      $ 79,103
  Net cash used by
   investing activities   (126,558)     (131,265)      (55,809)
  Net cash provided
   (used) by financing
   activities               81,242        45,584       (33,719)
  Gross operating
   profit (4)              161,500       179,811       189,778
  Gross operating
   profit as a
   percentage of
   revenues (4)               49.6%         50.0%         51.1%
  EBITDA (5)              $117,980(1)   $125,314(2)   $141,270(3)
  EBITDA as percentage
   of revenues (5)            36.2%(1)      34.7%(2)      37.6%(3)
  Ratio of earnings to
   fixed charges (6)           1.8x          1.8x          2.0x
</TABLE>
 
(1) EBITDA for 1996 was reduced by a charge of $2,551 relating to the Inn
renewal program. Had such charge not been incurred, EBITDA would have been
$120,531 and EBITDA as a percentage of revenues would have been 37.0%. See "Item
8. Financial Statements and Supplementary Data -- Note 10 to the Consolidated
Financial Statements."
 
(2) EBITDA for 1997 was reduced by total charges of $13,100 of which $1,421 was
for severance compensation related to reengineering and $11,679 related to the
Inn renewal program. Had such charges not been incurred, EBITDA would have been
$138,414 and EBITDA as a percentage of revenues would have been 38.4%. See "Item
8. Financial Statements and Supplementary Data -- Note 10 to the Consolidated
Financial Statements."
 
(3) EBITDA for 1998 was reduced by total charges of $5,264 of which $1,659 was
for severance compensation, $1,246 was for conversion of the Company's
accounting system, $1,944 was for write-offs of preliminary site acquisition
costs and $415 was for termination of a pension plan. Had such charges not been
incurred, EBITDA would have been $146,534 and EBITDA as a percentage of revenues
would have been 39.0%. See "Item 8. Financial Statements and Supplementary
Data -- Note 10 to the Consolidated Financial Statements."
 
(4) Gross operating profit is room revenues less direct room expenses.
 
(5) EBITDA is operating income plus the sum of interest income, other income,
depreciation, amortization and loss on fixed asset retirements. EBITDA is not
intended to represent cash flow from operations as defined by generally accepted
accounting principles, and such information should not be considered as an
alternative to net income, cash flow from operations or any other measure of
performance prescribed by generally accepted accounting principles. EBITDA is
included herein because management believes that certain investors find it to be
a useful tool for measuring the ability to service debt.
 
(6) For purposes of calculating the ratio of earnings to fixed charges, earnings
include income before income taxes plus fixed charges, excluding capitalized
interest. Fixed charges consist of interest expense, including capitalized
interest and the portion of rental expense representative of an interest factor.
 
In general, the Company has historically financed its development through
internal cash flow and secured debt. As of January 2, 1999, 167 of the Company's
256 Inns, in addition to the Company's corporate facilities, were pledged to
secure its long-term debt and its Bank Facility.
 
Cash and cash equivalents decreased $10.5 million from $13.2 million at January
3, 1998 to $2.7 million at January 2, 1999.
 
The Company has historically operated with current liabilities in excess of
current assets as a result of partially financing its expansion through
internally generated cash. The Company believes that cash flow from operations
will be sufficient to satisfy its working capital needs in 1999. At January 2,
1999, the Company had current liabilities of $56.1 million, including current
maturities of long-term debt of $15.0 million, and current assets of $34.9
million.
 
Current maturities of long-term debt increased $3.0 million from $12.0 million
at January 3, 1998 to $15.0 million at January 2, 1999 due to normal
amortization of mortgage notes and obligations under capital leases.
 
As of January 2, 1999, $63.5 million was available for borrowing under the
Company's $250 million Bank Facility. Borrowings under the Bank Facility bear
interest at either the administrative agent's prime rate or LIBOR plus tiered
spreads based upon the Company's leverage ratios. The Bank Facility contains
various covenants typical of senior secured bank facilities, and currently
requires the Company to maintain a tangible net worth of not less than $218
million and to maintain the following financial ratios: funded debt to EBITDA of
not more than 4.5 to 1.0, EBITDA to fixed charges and restricted payments
(including payment of dividends on the Company's Common Stock) of not less than
1.5 to 1.0 and senior debt to senior EBITDA of not more than 4.0 to 1.0. The
Bank Facility contains events of default for breach of these covenants
 
                                       22
Red Roof Inns Inc. and Subsidiaries
<PAGE>   23
 
as well as other events of default customary for financings of similar size and
nature, including a change in control of the Company.
 
As of January 2, 1999, the Company's total long-term indebtedness (including
current maturities) was approximately $528 million. Approximately $352 million
of such indebtedness is mortgage indebtedness and approximately $198 million of
such indebtedness bears interest at variable rates. A one percentage point
increase or decrease in interest rates will increase or decrease the Company's
pre-tax income by approximately $2 million. For a further description of the
Company's mortgage indebtedness, see "Item 8. Financial Statements and
Supplementary Data -- Notes 3, 4 and 5 to the Consolidated Financial
Statements."
 
During 1998, the Company was authorized to purchase up to $50 million of senior
unsecured notes on the open market and in privately negotiated transactions and,
as of January 2, 1999, had repurchased $27.6 million of senior unsecured notes.
In addition, the Company was authorized to purchase up to 1 million shares of
its outstanding common stock and, as of January 2, 1999, had purchased
approximately .4 million shares for an aggregate cost of a $5.5 million.
Subsequent to January 2, 1999, the Company has purchased an additional .4
million shares for an aggregate cost of $6.7 million.
 
    CAPITAL EXPENDITURES
The following table sets forth certain information regarding the Company's cash
flow from operations and capital expenditures, excluding software, development,
acquisitions and related improvements, for 1996, 1997 and 1998.
 
<TABLE>
<CAPTION>
                                     FISCAL YEARS
                           ---------------------------------
                            1996         1997         1998
<S>                        <C>          <C>          <C>
 
 Cash flow from
   operations              $60,548      $79,176      $79,103
 Capital expenditures (1)   26,076(2)    45,604(2)    30,445(2)
</TABLE>
 
(1) Includes furniture, fixtures, equipment, lobby conversions, room
renovations, exterior renovations such as roofing, paving and concrete walks and
general corporate expenditures.
 
(2) 1996, 1997 and 1998 capital expenditures include $6.4 million, $37.4 million
and $7.4 million, respectively, in improvements related to the Company's Inn
renewal program. Included in the Inn renewal program expenditures for 1997 and
1998 are $1.2 million and $.3 million, respectively, for hardware related to the
revenue management system. In addition, during 1996 and 1997, the Company spent
$1.7 million and $.7 million, respectively, on software related to the revenue
management system associated with the Company's Inn renewal program.
 
The Company has substantially completed improvements on 16 development sites (of
which 13 Inns are open) and has completed the renovation of eight Inns acquired
and opened during the last three years. In connection with the improvements and
renovations of these Inns, the Company spent $42.9 million in 1998, and expects
to spend approximately $9 million in 1999 to complete these improvements and
renovations. In 1998, the Company acquired one development site, for an
aggregate cost, including construction costs, of $3.5 million and expects to
spend approximately $15 million for improvements to this property over the next
18 months.
 
Currently, the Company has one development site under a long-term lease that can
be terminated by the Company before March 31, 1999.
 
Management expects to fund the Company's 1999 capital expenditures associated
with improvements for its Comparable Inns from cash flow from operations and
from available cash. Estimated 1999 expenditures associated with the developed
properties and acquired Inns will be financed from these sources together with
borrowing under the Bank Facility. The Company may issue additional equity or
debt, or expand its Bank Facility to fund future expansion activities.
 
    HISTORICAL CASH FLOWS
 
  1998 Compared To 1997
Cash provided by operations decreased $.1 million, or .1%, from $79.2 million in
1997 to $79.1 million in 1998, generally as the result of increases in net
income of $8.7 million and non-cash charges to income of $1.5 million, which
were offset by a net decrease from the prior year of $10.3 million in various
working capital components.
 
Net cash used by investing activities decreased $75.5 million from $131.3
million in 1997 to $55.8 million in 1998, primarily resulting from reduced
expenditures for acquisition, construction and renovation activities associated
with the Company's expansion program. In addition, 1997 included $38.1 million
for expenditures related to the Inn
 
                                       23
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   24
 
renewal program. Expenditures for property and equipment in 1998 include the
acquisition of two development sites (including one site held for sale to a
prospective franchisee) for a total cost, including improvements of $4.1 million
and $42.9 million related to improvements and renovations to 16 development
sites and eight properties acquired prior to 1998. During 1998, the Company sold
four of its California properties and a property under construction in Atlanta,
Georgia to franchisees. In addition, during 1998, the Company sold residual
ground at certain of its properties. Proceeds from these sales totaling
approximately $24 million were used to repay borrowings on the Bank Facility and
mortgage notes.
 
Net cash provided by financing activities decreased $79.3 million from a source
of $45.6 million in 1997 to a use of $33.7 million in 1998. 1998 includes net
borrowings under the Bank Facility of $21.2 million which were primarily used to
purchase $27.6 million of senior unsecured notes and purchase common stock for
treasury of $5.5 million. 1997 includes net borrowings under the Bank Facility
of $89.2 million, which were offset by principal payments of long term debt of
$37.9 million and the net purchase of common stock for treasury of $5.7 million.
 
  1997 Compared To 1996
Cash provided by operations increased $18.7 million, or 30.9%, from $60.5
million in 1996 to $79.2 million in 1997, generally as the result of increases
in net income of $1.3 million, non-cash charges to income of $3.8 million and
$13.6 million in various working capital components.
 
Net cash used by investing activities increased $4.7 million from $126.6 million
in 1996 to $131.3 million in 1997, primarily resulting from expenditures for
acquisitions, construction and renovation activities associated with the
Company's expansion program and $38.1 million for expenditures related to the
Inn renewal program. Expenditures for property and equipment in 1997 include the
acquisition of nine development sites and one Inn for a total cost, including
improvements of $37.9 million and $48.6 million related to improvements and
renovations to 18 development sites and 27 properties acquired prior to 1997.
 
Net cash provided by financing activities decreased $35.6 million from $81.2
million in 1996 to $45.6 million in 1997. Cash provided by financing activities
in 1996 included $62.6 million in net proceeds from the Offering after principal
payments of long-term debt. 1997 includes net borrowings under the Bank Facility
of $89.2 million, which were offset by principal payments of long term debt of
$37.9 million and the net purchase of common stock for treasury of $5.7 million.
 
EBITDA
EBITDA increased $16.0 million, or 12.8%, from $125.3 million in 1997 to $141.3
million in 1998. EBITDA increased $7.3 million, or 6.2%, from $118.0 million in
1996 to $125.3 million in 1997. EBITDA in 1996 and 1997 includes charges of $2.5
million and $11.7 million, respectively, related to the Inn renewal program. In
addition, 1997 includes $1.4 million of severance compensation related to
re-engineering. 1998 includes charges of $1.7 million for severance
compensation, $1.2 million for conversion of the Company's accounting system,
$1.9 million for write-offs of preliminary site acquisition costs and $.4
million related to the termination of a pension plan. Had such charges not been
incurred, EBITDA would have been $120.5 million, $138.4 million and $146.5
million in 1996, 1997 and 1998, respectively. EBITDA is not intended to
represent cash flow from operations as defined by generally accepted accounting
principles, and such information should not be considered as an alternative to
net income, cash flow from operations or any other measure of performance
prescribed by generally accepted accounting principles. EBITDA is included
herein because management believes that certain investors find it to be a useful
tool for measuring the ability to service debt.
 
INFLATION
The rate of inflation as measured by changes in the average consumer price index
has not had a material effect on the revenues or net earnings of the Company in
the three most recent years.
 
YEAR 2000 REMEDIATION
The Company uses computer technologies throughout its business. Computer
technologies include both information technology in the form of hardware and
software, as
 
                                       24
Red Roof Inns Inc. and Subsidiaries
<PAGE>   25
 
well as embedded technology in the Company's facilities and equipment. Similar
to most businesses, the Company must determine whether its computer systems are
capable of recognizing and processing date-sensitive information properly as the
year 2000 approaches. The Company has assembled a task force of Company
personnel to assess the potential impact of the year 2000 on the Company's
operations and to develop solutions and contingency plans to assure that the
Company's ability to meet the needs of its employees, suppliers and customers
will not be impaired.
 
The Company has substantially completed its assessment of all date-sensitive
hardware and software and has identified four critical areas requiring
remediation: property management systems at the Inns; reservations system;
accounting systems; and telephone switching equipment. The Company has taken the
following actions to address year 2000 issues for these critical areas:
 
         -  Property management systems at the Inns -- All modifications
necessary to make the software year 2000 compliant have been completed. These
modifications have been tested and were implemented by the end of the fourth
quarter of 1998.
 
         -  Reservations system -- New software that is year 2000 compliant was
developed by Company personnel and was implemented during January of 1999.
 
         -  Accounting systems -- The Company has purchased accounting systems
software and hardware from outside vendors that are year 2000 compliant and is
currently installing and testing these systems and related sub-systems. The
Company expects implementation of the accounting systems to be completed during
the second quarter of 1999.
 
         -  Telephone switching equipment -- The Company has identified all
telephone switching equipment that is not year 2000 compliant. Equipment that
will not function properly as a result of non-compliance will be replaced during
1999.
 
In addition to the four critical areas identified above, the Company is actively
testing and correcting or replacing non-critical systems that are not year 2000
compliant. The Company currently believes it will be able to modify, replace, or
mitigate all affected systems in time to avoid any material detrimental impact
on its operations. The Company will verify the accuracy of this belief by
further testing significant critical and non-critical systems during the third
quarter of 1999 and then remediating any remaining non-compliance that may be
revealed during these tests. If the Company determines that it may be unable to
complete timely remediation and testing of an affected system, the Company
intends to develop appropriate contingency plans (to the extent reasonable
alternatives are available) for any non-compliant system that the Company may
determine would have a potential material detrimental impact upon Company
operations.
 
The Company is not currently aware of any significant possibility that its
systems will not be properly remediated on a timely basis. However, there can be
no assurance that all year 2000 remediation processes will be completed and
properly tested before the year 2000, or that contingency plans will
sufficiently mitigate the risk of a year 2000 readiness problem. An interruption
of the Company's ability to conduct its business due to a year 2000 readiness
problem could have a material adverse effect on the Company.
 
In addition to its internal systems, the Company is heavily dependent on public
utility services for its Inns and for its corporate operations, as well as a
national carrier for its telephone services both at Inn level and for its
reservations system and a national processing service for its credit card
transactions. The inability of these vendors to provide services to the Company
due to year 2000 issues could have a material adverse effect on the Company.
 
The Company has initiated formal communications with its significant suppliers
and critical partners to determine the extent to which the Company might be
vulnerable if any of those parties fails to remediate its own year 2000 issues.
The Company has taken steps to monitor the progress made by those parties and
intends to test critical system interfaces during 1999. The Company will develop
appropriate contingency plans (including the potential to convert to other
vendors or service providers if reasonable alternatives are available) to be
implemented if significant exposure is identified relative to the Company's
dependency on a non-compliant third-party sys-
 
                                       25
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   26
 
tem. While the Company is not currently aware that any critical third-party
system on which the Company relies is likely to be non-compliant at the
beginning of the year 2000, there can be no guarantee that the systems of
third-parties on which the Company relies will be converted in a timely manner,
or that a failure to properly convert by another vendor or service provider
would not have a material adverse effect on the Company.
 
The Company estimates that the aggregate costs (exclusive of internal salaries
and wages) for remediation of year 2000 issues will be approximately $7 million,
including $4.5 million of costs already incurred. The total estimated aggregate
costs include $5.5 million of capitalized costs associated with the replacement
of the Company's accounting system and phone switches at certain of its
locations. In addition, the Company estimates it will incur charges to earnings
of $1.6 million, the majority of which were incurred in 1998. The anticipated
impact and costs of the year 2000 remediation project, as well as the date on
which the Company expects to complete the project, are based on management's
best estimates using information currently available. However, there can be no
guarantee that these estimates will be achieved and actual results could differ
materially from those plans. Based on current estimates and information
currently available, the Company does not anticipate that the costs associated
with this project will have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows in future
periods.
 
FORWARD LOOKING STATEMENTS; CERTAIN FACTORS AFFECTING FUTURE RESULTS
This Form 10-K includes forward-looking statements, including, without
limitation, statements relating to expected openings of company-owned or
franchised Inns; expected performance of stabilized Inns; future fee-based
revenues; anticipated growth in company-owned Inn profitability; anticipated
financial flexibility; anticipated levels of franchising, marketing, and other
corporate expenses; timing and cost of year 2000 remediation; impact of the Inn
renewal program and the Company's new revenue management system; effectiveness
of discounts and other marketing programs; and expected increases in RevPAR,
earnings per share, cash flow per share and free cash flow. These and other
statements containing words or phrases such as "believes", "anticipates",
"estimates", "expects", "intends", and "the Company will" should be considered
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995.
 
The Company wishes to caution readers that these forward-looking statements
involve known and unknown risks and uncertainties, and are subject to change
based on various important risk factors that could cause actual Company plans,
goals, objectives, policies, operations, results and performance to differ
materially from those expressed or implied by the forward-looking statements.
The following factors, among others, in some cases have affected and in the
future could affect the plans, goals, objectives, policies, operations, results
and performance of the Company:
 
Company Expansion Risks. The Company's ability to expand depends on a number of
factors, including the selection and availability of suitable locations at
acceptable prices; hiring and training of sufficiently skilled management and
personnel; and availability of joint venture partners and financing. There can
be no assurance that financing or desirable locations for acquisition or new
development will be available on terms acceptable to the Company. Furthermore,
provisions in the indenture governing the Notes, in the Bank Facility and in
certain mortgage indebtedness agreements may restrict the Company's ability to
meet its expansion objectives. See " Capital Resources and Liquidity." There can
be no assurance that the Company's current plans for development will be
completed successfully or that the nature of such expansion will not be modified
to reflect future events or economic conditions. There can be no assurance that
newly acquired Inns will conform to the Company's previous standards of
construction and design or will perform in-line with Company expectations.
Although the Company believes that it has the infrastructure in place to
accommodate company-owned Inn expansion, the Company's corporate management
expenses will increase as the number of Inns grows. Any increase in expenses
could adversely affect the Company's financial performance. The Company's
inability to implement its expansion plans successfully would limit the
Company's ability to grow its revenue base.
 
                                       26
Red Roof Inns Inc. and Subsidiaries
<PAGE>   27
 
Lodging Industry Risks. The lodging industry in general, including the Company,
may be affected adversely by such factors as changes in national and regional
economic conditions (particularly if such changes were to occur in geographic
areas where the Company has a high concentration of Inns); changes in local
market conditions; oversupply of hotel space or a reduction in local demand for
rooms and related services; competition within the hotel industry; and other
factors relating to the operation of economy hotels.
 
Operating factors affecting the lodging industry generally, including the
Company, include (i) direct competition from operators of other hotels, motels
and recreational properties; (ii) competition with other hotel franchisors;
(iii) demographic changes; (iv) the recurring need for renovations,
refurbishment and improvements of Inns and increased expenses related to Inn
security; (v) restrictive changes in zoning and similar land use laws and
regulations that influence or determine wages, prices or construction costs;
(vi) changes in the characteristics of Inn locations; (vii) difficulty obtaining
property and liability insurance to fully protect against all losses or to
obtain such insurance at reasonable costs; (viii) increases in real estate tax
rates and other operating costs; (ix) changes in or cancellations of local
tourist, athletic or cultural events; (x) changes in travel patterns that may be
affected by increases in transportation costs or gasoline prices, changes in
airline schedules and fares, strikes, weather patterns or relocation or
construction of highways; (xi) increases in operating expenses and litigation as
a result of on-premise assaults of guests by third parties; and (xii) changes in
brand identity and reputation. Unexpected or adverse changes in these and
similar factors could have a material adverse effect on the Company's business,
assets, financial condition or results of operations.
 
Financial Market Risks. Changes in interest rates could affect the Company's
variable-rate debt. Changes in availability or cost of financing could affect
the Company's ability to expand, or affect the ability of Company franchisees to
develop or operate franchised inns, with or without Company financing and could
affect the ability of the Company to refinance debt as it matures. A reduction
in available financing sources for franchisees or for the Company could have a
material adverse effect on the Company's ability to grow its revenue base or on
the financial condition of the Company.
 
Cyclicality. The hotel industry is subject to periods of cyclical growth and
downturn. From 1990 through 1992, for example, the U. S. hotel industry
experienced a cyclical downturn that resulted from, among other things,
over-building in the industry and sluggish general economic conditions in the
United States. According to STR, in 1998, increases in room supply were greater
than increases in demand for both the industry as a whole and the economy chain
segment. There can be no assurance that downturns or prolonged adverse
conditions in the hotel industry, in real estate or capital markets or in
national or local economies will not have a material adverse impact on the
Company.
 
Seasonality. Demand, and thus room occupancy, is affected by normally recurring
seasonal patterns and, in most locations, is higher in the summer and early fall
months (May through October) than the balance of the year. Historically,
revenues in the first quarter have been lower than in other quarters and the
Company may incur net losses in the first quarter.
 
Competition. The Company operates in a single segment of the hotel industry,
which is the highly competitive economy segment. The Company competes with other
owner-operators as well as with other franchisors of economy lodging. The
Company's Inns generally operate in areas that contain numerous competitors.
Demographic, geographic, or other changes in one or more of the Company's
markets could impact the convenience or desirability of the sites of certain
Inns, which would adversely affect the operations of those Inns. There can be no
assurance that new or existing competitors will not significantly lower rates or
offer greater convenience, services or amenities or significantly expand or
improve facilities in a market in which the Company's Inns compete, thereby
adversely affecting the Company's operations. See "Item 2. Business
-Competition." In addition, some of the Company's competitors have a larger
network of locations and greater resources than the Company and are less
leveraged than the Company. Competition may generally reduce the number of
suitable Inn development
 
                                       27
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   28
 
or acquisition opportunities offered to the Company or may increase the
bargaining power of property owners seeking to sell, which could adversely
affect the Company's financial performance.
 
Year 2000 Issues. The Company is heavily dependent on computer technologies, a
national carrier for its telephone services, a national processing service for
its credit card transactions, and regional public utility systems. There can be
no assurance that the Company has identified and modified all systems requiring
remediation or that systems of third-parties on which the Company depends will
be converted in a timely manner. Failure of the Company or third party systems
to function properly as year 2000 approaches could adversely affect the
Company's performance.
 
Regulatory Risks. The lodging industry is subject to numerous federal, state and
local government regulations, including building and zoning requirements. Also,
the Company is subject to laws governing its relationships with employees,
including minimum wage requirements, overtime, working conditions and safety
standards, and work permit and immigration requirements. An increase in the
minimum wage rate, employee benefits costs or other costs associated with
employees, could adversely affect the Company. In addition, under the Americans
with Disabilities Act of 1990 (the "ADA"), all public accommodations, including
hotels, are required to meet certain federal requirements related to access and
use by disabled persons. The operation of the Company's franchise system also is
subject to regulations enacted by various states and is subject to rules
promulgated by the Federal Trade Commission. The Company cannot predict the
effect on its operations or franchising efforts of changes to existing laws or
regulations or of additional legislation that might be enacted in the future.
These existing laws and regulations, as well as other initiatives that may be
enacted in the future, could adversely affect the Company, as well as the
lodging industry in general.
 
Environmental Matters. Various federal, state and local laws, ordinances and
regulations impose liability on present and former real property owners and
operators for the cost of cleaning up or removing contamination caused by
hazardous or toxic materials. Such liability may be imposed without regard to
fault or legality of the original actions, and may be joint and several with
other responsible parties. If the liability is joint and several, the Company
could be responsible for payment of the full amount of the liability, whether or
not any other responsible party is also liable. The presence of contamination
at, or even adjacent to or near, a property also can affect the valuation of
that property or the ability of the owner to sell, lease or obtain financing for
the property and may in certain circumstances form the basis of liability to
third persons for personal injury or other damages. See "Item 2.
Business-Environmental Considerations."
 
Franchising Risks. The Company expects that its franchising business will face
competition from other hotel franchisors, which could impair the Company's
ability to attract franchisees. In addition, any or a combination of the
following risks could have a material adverse impact on the Company's
franchising results: franchisees may fail to uphold the Company's standards of
quality and service or may fail to fulfill their financial and other obligations
to the Company; franchisee operating and financial results may be materially
below franchisee expectations or the results generated by Company-owned Inns;
and franchisees may not be able to obtain suitable sites or financing. Other
franchising risks include, but are not limited to, the Company's ability to
obtain or maintain appropriate regulatory approvals; occurrence of one or more
contract disputes between the Company and a franchisee, or ultimate resolution
of such a contract dispute in favor of the franchisee; the Company's inability
to collect royalties or other fees due from franchisees; and the Company's
inability to collect amounts due from franchisees for repayment of Company
loans. Changes in any of these factors could have a material adverse effect on
the Company's growth from franchising as well as the Company's revenues from or
expenses of franchising or the financial condition of the Company.
 
Control by Existing Stockholders. MSREF and its affiliates collectively own
68.25% of the outstanding shares of the Company's common stock. Accordingly,
MSREF is in a position to control the election of the Company's directors and
thereby to control the plans, goals, objectives, policies, and operations of the
Company and to influence the Company's results and performance and the outcome
of
 
                                       28
Red Roof Inns Inc. and Subsidiaries
<PAGE>   29
 
corporate transactions or other matters submitted for stockholder approval.
These matters include mergers, consolidations, the sale of all or substantially
all of the Company's assets, and other changes in control of the Company.
 
Readers are cautioned not to place undue reliance on forward-looking statements,
which speak only as of the date thereof. The Company expressly disclaims any
obligation or undertaking to update or revise any forward-looking statements
contained in this document to reflect any changes in the Company's expectations
or results, or to reflect changes in events or factors that could cause material
deviations in results.
 
                                       29
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   30

                 FINANCIAL STATEMENTS AND
 ITEM 8.         SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                         PAGE
                                         ----
<S>                                      <C>
Independent Auditors' Report on the
  Company                                 31
Consolidated Balance Sheets of the
  Company as of January 3, 1998 and
  January 2, 1999                         32
Consolidated Statements of Income of
  the Company for the years ended
  December 28, 1996, January 3, 1998
  and January 2, 1999                     34
Consolidated Statements of
  Stockholders' Equity of the Company
  for the years ended December 28,
  1996, January 3, 1998 and January
  2, 1999                                 35
Consolidated Statements of Cash Flows
  of the Company for the years ended
  December 28, 1996, January 3, 1998
  and January 2, 1999                     36
Notes to Consolidated Financial
  Statements of the Company               37
</TABLE>


                                       30
Red Roof Inns Inc. and Subsidiaries
<PAGE>   31

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders of
Red Roof Inns, Inc.

We have audited the accompanying consolidated balance sheets of Red Roof Inns,
Inc. and its subsidiaries as of January 3, 1998 and January 2, 1999 and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the three years in the period ended January 2, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Red Roof Inns, Inc. and its
subsidiaries at January 3, 1998 and January 2, 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
January 2, 1999 in conformity with generally accepted accounting principles.

/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Columbus, Ohio
February 17, 1999

                                                                            
                                       31
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   32

RED ROOF INNS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
January 3, 1998 and January 2, 1999
(in thousands)

<TABLE>
<CAPTION>

                                                                    JANUARY 3, 1998       JANUARY 2, 1999
      <S>                                                           <C>                   <C>

      ASSETS
      Current Assets:
        Cash and cash equivalents                                      $ 13,154              $  2,729
        Receivables:
            Trade (net of allowance for bad debts, 1997 -- $651;
              1998 -- $1,332)                                             9,006                 9,772
            Income taxes                                                                        1,847
        Supplies                                                         10,002                12,177
        Prepaid insurance                                                   278                 2,978
        Other prepaid expenses                                              573                   845
        Deferred income taxes                                             3,569                 4,581
                                                                       --------              --------
              Total current assets                                       36,582                34,929
      Property and Equipment:
        Land                                                            155,456               153,596
        Buildings and improvements                                      608,323               654,564
        Furniture, fixtures and equipment                               108,564               135,861
        Construction in progress                                         49,326                19,541
                                                                       --------              --------
              Total property and equipment                              921,669               963,562
        Less accumulated depreciation and amortization                   89,287               117,473
                                                                       --------              --------
              Property and equipment -- net                             832,382               846,089
      Other Assets:
        Goodwill, net of accumulated amortization                        70,181                67,915
        Deferred loan fees and costs, net of accumulated
          amortization                                                    8,103                 6,080
        Software, net of accumulated amortization                         4,043                 6,769
        Other                                                             3,467                 7,589
                                                                       --------              --------
              Total other assets                                         85,794                88,353
                                                                       --------              --------
      Total                                                            $954,758              $969,371
                                                                       ========              ========
</TABLE>

    see notes to consolidated financial statements


                                       32
Red Roof Inns Inc. and Subsidiaries
                                                                        
                                                                        
<PAGE>   33

RED ROOF INNS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
January 3, 1998 and January 2, 1999
(in thousands, except par values)

<TABLE>
<CAPTION>

                                                                    JANUARY 3, 1998       JANUARY 2, 1999
      <S>                                                           <C>                   <C>
      LIABILITIES AND STOCKHOLDERS' EQUITY
      Current Liabilities:
        Accounts payable                                               $ 15,128              $ 12,943
        Accrued expenses:
            Insurance                                                     4,157                 3,554
            Compensation                                                  7,534                 8,693
            Property taxes                                                3,769                 5,003
            Sales and use taxes                                           3,772                 4,244
            Income taxes                                                    313
            Other                                                         5,072                 6,637
                                                                       --------              --------
              Total accrued expenses                                     24,617                28,131
        Current maturities of long-term debt:
            Mortgage notes                                               10,472                13,491
            Obligations under capital leases                              1,526                 1,557
                                                                       --------              --------
              Total current liabilities                                  51,743                56,122
      Long-Term Debt (Less Current Maturities):
        Mortgage notes                                                  171,885               152,337
        Bank facility                                                   165,365               186,545
        Senior unsecured notes                                          200,000               172,385
        Obligations under capital leases                                  1,957                 1,623
                                                                       --------              --------
              Total long-term debt                                      539,207               512,890
      Other Long-Term Liabilities (Less Current Maturities):
        Pension obligation                                                  590                   451
        Insurance                                                         7,298                 6,030
        Deferred income taxes                                            17,184                24,702
                                                                       --------              --------
              Total long-term liabilities                                25,072                31,183
      Commitments and Contingencies
      Stockholders' Equity:
        Preferred stock, $.01 par value; 10,000 shares authorized,
          no shares outstanding
        Common stock, $.01 par value; 100,000 shares authorized,
          shares issued: 1997 -- 28,531, 1998 -- 28,592                     285                   286
        Additional paid-in capital                                      268,140               269,264
        Less treasury stock, at cost: 1997 -- 951 shares,
          1998 -- 1,251 shares                                          (13,822)              (18,568)
        Retained earnings                                                84,133               118,194
                                                                       --------              --------
              Total stockholders' equity                                338,736               369,176
                                                                       --------              --------
      Total                                                            $954,758              $969,371
                                                                       ========              ========
</TABLE>

    see notes to consolidated financial statements

                                                                            
                                       33
                                             Red Roof Inns Inc. and Subsidiaries
                                                                        
                                                                        
<PAGE>   34

RED ROOF INNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 28, 1996, January 3, 1998 and January 2, 1999
(in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                               YEARS ENDED
                                                          DECEMBER 28,          JANUARY 3,          JANUARY 2,
                                                              1996                 1998                1999
                                                           (52 weeks)           (53 weeks)          (52 WEEKS)
      <S>                                               <C>                  <C>                  <C>
      Revenues:
        Room                                                $325,407             $359,605            $371,374
        Fee-based                                                 63                1,200               3,962
                                                            --------             --------            --------
              Total revenues                                 325,470              360,805             375,336
      Operating Expenses:
        Direct room                                          163,907              179,794             181,596
        Depreciation and amortization                         36,527               36,386              38,787
        Corporate                                             28,208               31,775              35,011
        Marketing                                             16,240               24,538              18,236
                                                            --------             --------            --------
              Total operating expenses                       244,882              272,493             273,630
                                                            --------             --------            --------
      Operating Income                                        80,588               88,312             101,706
      Interest Income                                            394                  183                 273
      Interest Expense                                       (41,777)             (46,205)            (46,358)
      Other Income                                               471                  433                 504
                                                            --------             --------            --------
      Income Before Income Taxes and Extraordinary
        Item                                                  39,676               42,723              56,125
      Income Taxes                                           (15,612)             (16,619)            (21,832)
                                                            --------             --------            --------
      Income Before Extraordinary Item                        24,064               26,104              34,293
      Extraordinary Loss                                                             (746)               (232)
                                                            --------             --------
      Net Income                                            $ 24,064             $ 25,358            $ 34,061
                                                            ========             ========            ========
      Income Per Share Before Extraordinary Item:
        Basic                                               $   0.88             $   0.93            $   1.24
                                                            ========             ========            ========
        Diluted                                             $   0.87             $   0.93            $   1.24
                                                            ========             ========            ========
      Extraordinary Loss Per Share:
        Basic                                                                    $  (0.02)           $  (0.01)
                                                                                 ========            ========
        Diluted                                                                  $  (0.03)           $  (0.01)
                                                                                 ========            ========
      Net Income Per Share:
        Basic                                               $   0.88             $   0.91            $   1.23
                                                            ========             ========            ========
        Diluted                                             $   0.87             $   0.90            $   1.23
                                                            ========             ========            ========
      Weighted Average Shares Outstanding:
        Basic                                                 27,362               27,982              27,566
                                                            ========             ========            ========
        Diluted                                               27,549               28,167              27,732
                                                            ========             ========            ========
</TABLE>

    see notes to consolidated financial statements


                                       34
Red Roof Inns Inc. and Subsidiaries
                                                                        
                                                                        
<PAGE>   35

RED ROOF INNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Years Ended December 28, 1996, January 3, 1998 and January 2, 1999
(in thousands)

<TABLE>
<CAPTION>
                                         COMMON STOCK         TREASURY STOCK        ADDITIONAL
                                        --------------------------------------       PAID-IN         RETAINED
                                        Shares   Amount      Shares    AMOUNT        CAPITAL         EARNINGS        TOTAL
      <S>                               <C>      <C>         <C>      <C>           <C>              <C>            <C>

      BALANCES AT DECEMBER 30, 1995     18,400    $184                               $117,816        $ 34,711       $152,711
      Public stock offering (net of
        $11,368 of expenses)            10,000     100                                148,532                        148,632
      Stock options exercised               12                                            168                            168
      Purchase of treasury stock                               (500)  $ (6,476)                                       (6,476)
      Net income                                                                                       24,064         24,064
                                        ------    ----       ------   --------       --------        --------       --------
      BALANCES AT DECEMBER 28, 1996     28,412     284         (500)    (6,476)       266,516          58,775        319,099
      Stock options exercised              119       1                                  1,639                          1,640
      Sale of treasury stock                                     49        630            (15)                           615
      Purchase of treasury stock                               (500)    (7,976)                                       (7,976)
      Net income                                                                                       25,358         25,358
                                        ------    ----       ------   --------       --------        --------       --------
      BALANCES AT JANUARY 3, 1998       28,531     285         (951)   (13,822)       268,140          84,133        338,736
      Stock options exercised
        (including a                        61       1           15        226          1,101                          1,328
        related tax benefit of $261)
      Sale of treasury stock                                     35        508             23                            531
      Purchase of treasury stock                               (350)    (5,480)                                       (5,480)
      Net income                                                                                       34,061         34,061
                                        ------    ----       ------   --------       --------        --------       --------
      BALANCES AT JANUARY 2, 1999       28,592    $286       (1,251)  $(18,568)      $269,264        $118,194       $369,176
                                        ======    ====       ======   ========       ========        ========       ========
</TABLE>

    see notes to consolidated financial statements

                                                                            
                                       35
                                             Red Roof Inns Inc. and Subsidiaries
                                                                        
                                                                        
<PAGE>   36

RED ROOF INNS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 28, 1996, January 3, 1998 and January 2, 1999
(in thousands)

<TABLE>
<CAPTION>
                                                                                YEARS ENDED
                                                            DECEMBER 28,          JANUARY 3,         JANUARY 2,
                                                                1996                 1998               1999
                                                             (52 weeks)           (53 weeks)         (52 WEEKS)
      <S>                                                 <C>                  <C>                 <C>
      Cash Flows From Operations:
        Net income                                            $ 24,064             $ 25,358           $ 34,061
        Adjustments to reconcile net income to net cash
          provided by operations:
          Depreciation and amortization                         25,477               30,891             33,663
          Amortization of goodwill                               2,266                2,265              2,266
          Loss from asset disposals and impairments              8,297                2,627              2,033
          Amortization of other assets                           2,010                2,046              2,353
          Write-off of loan fees and costs                                            1,228                498
          Deferred income taxes                                  4,088                6,708              6,506
        Change in assets and liabilities:
          Receivables                                           (2,987)               1,971             (2,613)
          Supplies                                                (950)                (192)            (2,434)
          Prepaid expenses                                          42                  161               (218)
          Accounts payable                                      (2,479)               2,026                619
          Accrued expenses                                         720                4,087              2,369
                                                              --------             --------           --------
            Net cash provided by operations                     60,548               79,176             79,103
                                                              --------             --------           --------
      Cash Flows From Investing Activities:
        Proceeds from sale of assets                                                  1,357             24,243
        Expenditures for property and equipment               (122,201)            (132,117)           (77,492)
        Change in other assets                                  (4,357)                (505)            (2,560)
                                                              --------             --------           --------
            Net cash used by investing activities             (126,558)            (131,265)           (55,809)
                                                              --------             --------           --------
      Cash Flows From Financing Activities:
        Proceeds from mortgage notes and bank facility         160,706              359,578            220,246
        Principal reduction in mortgage notes and bank
          facility                                            (220,962)            (307,994)          (222,164)
        Redemption of senior unsecured notes                                                           (27,615)
        Principal reduction in obligations under capital
          leases                                                  (826)                (279)              (303)
        Issuance of common stock                               148,800                2,255              1,597
        Purchase of treasury stock                              (6,476)              (7,976)            (5,480)
                                                              --------             --------           --------
            Net cash provided (used) by financing
              activities                                        81,242               45,584            (33,719)
                                                              --------             --------           --------
      Net Increase (Decrease) In Cash and Cash
        Equivalents                                             15,232               (6,505)           (10,425)
      Cash and Cash Equivalents at Beginning of Year             4,427               19,659             13,154
                                                              --------             --------           --------
      Cash and Cash Equivalents at End of Year                $ 19,659             $ 13,154           $  2,729
                                                              ========             ========           ========
      Interest Paid                                           $ 43,229             $ 47,115           $ 47,198
                                                              ========             ========           ========
      Interest Capitalized                                    $  2,841             $  2,846           $  2,541
                                                              ========             ========           ========
      Income Taxes Paid                                       $ 14,399             $  4,937           $ 16,827
                                                              ========             ========           ========
      Non-Cash Transactions:
        Capital expenditures included in accounts
          payable                                             $  7,181             $  6,299           $  3,495
                                                              ========             ========           ========
        Prepaid insurance premiums financed by note
          payable                                                                                     $  6,569
                                                                                                      ========
        Note received from sale of property                                                           $  1,439
                                                                                                      ========
</TABLE>

    see notes to consolidated financial statements


                                       36
Red Roof Inns Inc. and Subsidiaries
                                                                        
                                                                        
<PAGE>   37

RED ROOF INNS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 28, 1996, January 3, 1998 and January 2, 1999

                 SUMMARY OF SIGNIFICANT
 NOTE 1.         ACCOUNTING POLICIES

GENERAL - The Company was formed in November 1993 and is a subsidiary of The
Morgan Stanley Real Estate Fund, L.P. (MSREF). The Company operates on a 52-53
week fiscal year which ends on the Saturday nearest to December 31. At December
28, 1996 (1996), January 3, 1998 (1997), and January 2, 1999 (1998) the Company
operated 248, 254 and 256 Inns, respectively. The 1996 and 1998 years consist of
52 weeks each and the 1997 year consists of 53 weeks.

PRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial statements
include the accounts of Red Roof Inns, Inc. and its wholly owned subsidiaries,
RRI Investment Co. and RRI Financial Inc. All material intercompany transactions
and balances have been eliminated in consolidation.

NATURE OF OPERATIONS - The Company, whose revenues are primarily derived from
room rentals, is an owner/operator and franchisor of economy Inns. The Company's
properties are primarily located throughout the Midwest, East, South and Gulf
Coast regions of the United States. The Company began franchising economy Inns
in 1997 and at January 3, 1998 and January 2, 1999 five franchised Inns and 39
franchised Inns, respectively, were in operation.

FRANCHISE REVENUE - Franchise revenue consists of royalty fees, which are based
on a percentage of franchised Inns gross room sales (as defined in the franchise
agreement), and initial franchise fees which are recorded as revenue when an Inn
opens as a franchised unit. Total franchise revenue, included in fee-based
revenues, for 1997 and 1998 was $225,000 and $1,753,000, respectively.
Reservation fees and marketing fees charged by the Company to its franchised
Inns (total of approximately $12,000 and $15,000, respectively for 1997 and
$331,000 and $498,000, respectively for 1998) are recorded as a reduction of
corporate and marketing expenses.

PARTNER PROGRAM REVENUE - The Company has a partnership marketing program
through which the Company forms alliances with other well-known consumer product
and service companies in order to offer its guests additional value-added
services. The Company actively promotes its partners' products or services
either at the Inns or through the central reservation centers in exchange for
fees from the partner companies. Revenues are recognized by the Company when the
partners' products are sold or the services have been rendered. The total
partner program revenue, included in fee-based revenues, for 1996, 1997 and 1998
was $63,000, $975,000 and $2,209,000, respectively.

USE OF ESTIMATES - The preparation of the consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Actual results could
differ from these estimates, but it is management's opinion that any changes in
estimates would not have a material effect on the consolidated financial
statements.

SUPPLIES - Supplies inventory is stated at cost, which represents the cost to
supply the Inns with their respective initial operating inventories.
Replacements needed to maintain the original operating inventory are charged to
expense in the period such replacement occurs.

PROPERTY AND EQUIPMENT - Property and equipment are stated at cost. Depreciation
and amortization of property and equipment is based on the straight-line method
over estimated composite useful lives that range from 3 to 15 years for
furniture, fixtures and equipment and 12 to 40 years for buildings and
improvements.

CAPITALIZATION OF DEVELOPMENT EXPENSES - Costs incurred by the Company related
to site development and acquisitions are capitalized and allocated to the
properties developed or acquired. Costs capitalized during 1996, 1997 and 1998
totaled $2,162,000, $2,385,000 and $567,000, respectively.

GOODWILL - The excess of the purchase price over the fair values of net assets
acquired (goodwill) is being amortized on a straight-line basis over 35 years.
Goodwill at January 3, 1998 and January 2, 1999 is net of accumulated
amortization of $9,187,000 and $11,453,000, respectively.

                                                                            
                                       37
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   38

DEFERRED LOAN FEES AND COSTS - Deferred Loan Fees and Costs -- Deferred loan
fees and costs are amortized using the straight-line method over the terms of
the loans ranging from 5 to 15 years. Deferred loan fees and costs at January 3,
1998 and January 2, 1999 are net of accumulated amortization of $3,571,000 and
$4,632,000, respectively.

In May 1997, the Company refinanced its $150 million bank credit facility with a
$250 million bank credit facility. In connection with the refinancing, the
Company recognized an extraordinary charge against income of $746,000, net of
tax, ($.02 per share -- basic and $.03 per share -- diluted) related to the
write off of unamortized loan costs of $1,228,000.

During the fourth quarter of 1998, the Company repurchased $27,615,000 of senior
unsecured notes on the open market and in privately negotiated transactions. In
connection with this repurchase, the Company recognized an extraordinary charge
against income of $232,000, net of tax ($.01 per share -- basic and diluted)
related to the write-off of unamortized debt fees of $379,000, net of purchase
discount.

OTHER ASSETS - Other assets principally include software costs, net of
accumulated amortization using the straight-line method over a useful life of
five years, preliminary site acquisition costs, deferred franchise expenses,
escrow deposits for furniture replacements and investments in affiliates.

ASSET IMPAIRMENTS - Annually, or more frequently if events or circumstances
change, a determination is made by management, in accordance with Statement of
Financial Accounting Standards (SFAS) No. 121, to ascertain whether property and
equipment, goodwill, and other intangible assets have been impaired based on the
sum of estimated future undiscounted cash flows from operating activities. If
the estimated net cash flows are less than the carrying amount of such assets,
the Company recognizes an impairment loss in an amount necessary to write down
such assets to a fair value as determined from expected discounted cash flows.
(See Note 10).

Based upon its most recent analysis, the Company believes that property,
goodwill and other intangibles at January 2, 1999 are realizable and the
depreciation and amortization periods are appropriate.

INCOME TAXES - The Company is subject to federal, state and local income taxes.
Income taxes are provided for all taxable items included in the statements of
income in accordance with SFAS No. 109.

SELF-INSURANCE PROGRAMS - Prior to May 1998, the Company used a retrospective
self-insurance plan for general liability and workers' compensation. Subsequent
to May 1998, the Company entered into a three-year fixed premium agreement with
a national insurance carrier for its general liability and workers compensation
insurance. The premium is subject to adjustment on the annual anniversary date
of the policy if actual losses exceed 60% of the annual premium amount. A
liability has been recorded in the financial statements for estimated claims
prior to May 1998 based on information currently available as to the estimated
ultimate cost for incidents incurred prior to the balance sheet dates. Losses in
excess of certain limits are insured with third-party insurance companies.
Estimated payments against the insurance liability for each of the next five
years are: 1999 -- $3,554,000; 2000 -- $2,531,000; 2001 -- $1,567,000;
2002 -- $760,000 and 2003 -- $455,000.

ADVERTISING - The Company expenses the costs of advertising (including
production costs) the first time advertising takes place. Advertising expenses
consist of local advertising which is included in direct room expenses and
billboard and national media advertising which is included in marketing
expenses. Advertising expense was $16,847,000, $24,242,000 and $16,390,000 for
1996, 1997 and 1998, respectively.

EARNINGS PER SHARE - Basic income per share amounts are based on the weighted
average number of shares of common stock outstanding during the years presented.
Diluted income per share amounts are based on the weighted average number of
shares of common stock and stock options outstanding during the years presented.

CASH EQUIVALENTS - Cash in excess of daily requirements is invested in money
market and government securities with maturities of three months or less. Such


                                       38
Red Roof Inns Inc. and Subsidiaries
<PAGE>   39
 
investments are considered to be cash equivalents. The majority of such funds
are held by the Company's bank. The Company has not experienced any losses on
these investments.
 
SEGMENT - The Company presently operates in one segment as determined under SFAS
No. 131 "Disclosures About Segments of an Enterprise and Related Information."
 
RECLASSIFICATIONS - Certain amounts in the prior years' financial statements
have been reclassed to conform with the 1998 presentation.
                 TRANSACTIONS WITH
 NOTE 2.         AFFILIATES
 
The Company operates two hotels under long-term capital lease agreements with
affiliated partnerships that own the hotels. Such affiliation exists because the
Company is a partner in the partnerships. The Company's ownership interests in
the operating profits and losses of such partnerships are 3% and 29%,
respectively, and ownership in the residual values of such partnerships is 73%
and 80%, respectively. The partnerships are consolidated as capital leases and
are immaterial to the consolidated financial statements.
 
The Company was provided certain underwriting services through an affiliate of
MSREF in connection with the Company's 1996 initial public stock offering and
obtains certain shared administrative services with unrelated parties through
master contracts available through MSREF.
 
                                                                            
                                       39
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   40

 NOTE 3.         LEASES

The Company leases certain assets used in its operations under long-term capital
leases, principally three hotels (including one with an unrelated party) and
land. These leases typically contain renewal and purchase options and expire at
various dates through 2006. The leases generally require payment of property
taxes, insurance and maintenance costs. The Company leases land, hotels, a
warehouse and billboard advertising space under noncancelable operating leases.
Land leases expire at various dates through 2034 and other leases expire at
various dates through 2019. Total operating rent expense for 1996, 1997 and 1998
was $12,622,000, $12,248,000 and $9,926,000, respectively.

   Future minimum lease payments under non-cancelable leases January 2, 1999 are
as follows (in thousands):

<TABLE>
<CAPTION>
                                                                      CAPITAL             OPERATING
    YEAR                                                               LEASES              LEASES
    <S>                                                             <C>                  <C>
    1999                                                               $1,730              $ 6,244
    2000                                                                  497                3,462
    2001                                                                  359                2,238
    2002                                                                  359                1,303
    2003                                                                  359                1,301
    Thereafter                                                            493               17,127
                                                                       ------              -------
           Total minimum lease payments                                 3,797              $31,675
                                                                                           =======
    Less amount representing interest                                     617
                                                                       ------
           Present value of minimum lease payments                      3,180
    Less current maturities                                             1,557
                                                                       ------
           Total non-current                                           $1,623
                                                                       ======
</TABLE>

   The following is a summary of property and equipment under capital leases (in
thousands):

<TABLE>
<CAPTION>
                                                                     JANUARY 3,          JANUARY 2,
                                                                        1998                1999
    <S>                                                             <C>                  <C>

    Land                                                               $1,220              $1,220
    Buildings                                                           3,251               3,251
                                                                       ------              ------
           Total                                                        4,471               4,471
    Less accumulated depreciation and amortization                      1,328               1,657
                                                                       ------              ------
           Property and equipment under capital leases -- net          $3,143              $2,814
                                                                       ======              ======
</TABLE>


                                       40
Red Roof Inns Inc. and Subsidiaries
<PAGE>   41

                 MORTGAGE NOTES AND
 NOTE 4.         BANK FACILITY

<TABLE>
<CAPTION>
                                          JANUARY 3,    JANUARY 2,
                                             1998          1999
                                          ------------------------
                                               (IN THOUSANDS)
------------------------------------------------------------------
<S>                                       <C>           <C>

 Mortgage notes, weighted average fixed
   interest rates of 10.1% at January 3,
   1998 and 10.0% at January 2, 1999,
   monthly payments of principal and
   interest due through January 2009       $170,057      $154,600
 Mortgage notes, weighted average
   variable interest rates of 6.9% at
   January 3, 1998 and 6.5% at January
   2, 1999, interest adjustable at
   intervals from one month to six
   years, varying monthly payments of
   principal and interest due through
   January 2000.                             12,300        11,228
 Bank facility, weighted average
   variable interest rates of 7.7% at
   January 3, 1998 and 7.2% at January
   2, 1999 due May 2002                     165,365       186,545
                                           --------      --------
     Total                                  347,722       352,373
     Less current maturities                 10,472        13,491
                                           --------      --------
     Total mortgage notes and bank
       facility (less current
       maturities)                         $337,250      $338,882
                                           ========      ========
</TABLE>

Principal payments due (including normal amortization) for each of the next five
years are: 1999 -- $13,491,000; 2000 -- $25,542,000; 2001 -- $27,923,000;
2002 -- $207,901,000 and 2003 -- $27,581,000.

In May 1997, the Company refinanced its $150 million bank facility with a $250
million bank facility. The available borrowing commitment declines to $245
million in March 2000 and periodically declines thereafter to $150 million at
the May 2002 maturity date. Borrowings under the bank facility bear interest at
either LIBOR plus tiered spreads based upon the Company's leverage ratios or the
administrative agent's prime rate. The bank facility also contains various
covenants that include restrictions on the incurrence of additional debt, stock
repurchases and the payment of dividends which are similar to the covenants
related to the senior unsecured notes. The bank facility contains events of
default. Both the convenants and events of default, including provisions
relating to the effect of a change in control of the Company, are customary for
financing of similar size and nature.

Notes payable and the bank facility are collateralized by certain property and
equipment with a net book value totaling $470,000,000 and $457,000,000 at
January 3, 1998 and January 2, 1999, respectively.

As of January 2, 1999, the Company has $2,743,000 in standby letters of credit
from banks, expiring at various dates through December 2009.

 NOTE 5.         SENIOR UNSECURED NOTES

In December 1993, the Company issued $200,000,000 of senior unsecured notes (the
"Notes") due 2003. The Notes bear interest at 9 5/8% payable semi-annually. The
Notes contain covenants that include restrictions on the incurrence of
additional debt, stock repurchases and the payment of dividends. At January 2,
1999, $199,092,000 is available for restricted payments under the terms of the
Notes of which $66,598,000 is available from retained earnings.

The Notes were not redeemable by the Company until December 15, 1998 at which
time they became redeemable at 104.813% of their principal amount, declining
ratably to par, plus accrued interest, on and after December 15, 2000.

During the fourth quarter of 1998, the Company was authorized to purchase up to
$50,000,000 of senior unsecured notes on the open market and in privately
negotiated transactions and has repurchased $27,615,000 of senior unsecured
notes at an average cost of 99.6% of the face amount.

 NOTE 6.         STOCKHOLDERS' EQUITY

On January 31, 1996, the Company issued 10,000,000 shares of common stock in an
initial public offering (the "Offering") at a price of $16.00 per share. Net
proceeds of the Offering were approximately $149 million which were used to
repay approximately $128 million of mortgage indebtedness. Approximately $21
million was retained for inn acquisitions, conversions, new development and for
general corporate purposes.

                                                                            
                                       41
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   42

In connection with the Offering, $9.6 million in underwriting discounts and
commissions were paid to certain underwriters, including an affiliate of MSREF.

In August 1996, the Company repurchased 500,000 shares of its common stock in
the open market for an aggregate purchase price of $6,476,000, or $12.95 per
share. During the fourth quarter of 1997, the Company purchased 500,000 shares
of its common stock in the open market for an aggregate purchase price of
$7,976,000, or $15.95 per share. During the fourth quarter of 1998, the Company
was authorized to repurchase up to 1,000,000 shares of its outstanding common
stock and has purchased approximately 350,000 shares of common stock in the open
market for an aggregate purchase price of $5,480,000, or $15.68 per share. In
addition, subsequent to January 2, 1999, the Company has purchased an additional
426,000 shares for an aggregate purchase price of $6,700,000, or $15.73 per
share. The shares were placed in treasury and will be used to fulfill the
Company's requirements for its stock option and stock purchase plans.

                 EMPLOYEE AND DIRECTOR
 NOTE 7.         STOCK PLANS

In March 1995, the Company adopted a non-qualified Management Stock Option Plan
for certain officers and employees effective as of December 29, 1994. In
December 1995, the Company's Board of Directors adopted the Amended and Restated
1994 Management Equity Incentive Plan (the "Plan"). The Plan is overseen by the
Compensation Committee appointed by the Board of Directors, which is comprised
of not less than two directors who are not officers or employees of the Company.

Under the terms of the Plan, awards may be granted in the form of: (i) incentive
stock options, which are intended to qualify under Sec. 422 of the Internal
Revenue Code of 1986, as amended; (ii) stock options which are not intended to
so qualify; (iii) shares of the Company's common stock which will be subject to
certain conditions and restrictions ("restricted shares"); or (iv) performance
units ("performance units"), which represent the right to receive an amount
equal to the value related to the performance units awarded, such as the fair
market value of a share of common stock. Awards may be granted by the committee
at its discretion to key employees (including officers and directors who are
employees) of the Company. The Plan generally provides that the number of shares
of common stock with respect to which options, restricted shares and performance
units may be granted to any individual employee may not exceed 400,000 during
any single fiscal year. The aggregate number of shares of common stock which may
be issued under the Plan is 4,000,000 provided that in no event shall more than
10% of the shares of common stock authorized for issuance under the Plan be
granted in the form of awards other than options.

Generally, each option will have a term ending 10 years from the date of grant.
Each option will vest and become exercisable on such date or dates and on the
basis of other criteria, including without limitation the performance of the
Company, as the committee may determine at its discretion and as shall be
specified in the option agreement evidencing the grant of such options. The
option price is determined by the committee at the time of the grant and may not
be less than the fair market value of the shares of common stock on the date of
grant (exclusive of the options granted in 1994, which were issued at less than
fair market value at the time of the grant.) Options granted in 1996, 1997 and
1998 vest at the rate of 25% per year.

In October 1995, the Company adopted the 1995 Director Stock Option Plan for
directors who are not officers or employees of the Company. The plan is
administered by a committee of not less than two directors appointed by the
Board of Directors. Any eligible director is automatically granted an initial
option to purchase 10,000 shares. Subsequently, following each annual meeting of
the stockholders of the Company, each eligible director shall be granted an
option to purchase 1,000 shares. The initial option to purchase 10,000 shares
vests in equal amounts over a five-year period and future grants vest
immediately. The exercise price of the options is based on the fair market value
of the common stock on the last trading day prior to the date on which the
option is granted. All options expire 10 years after the date of grant. The


                                       42
Red Roof Inns Inc. and Subsidiaries
<PAGE>   43

Company has reserved 60,000 shares under the Plan and has granted options to
purchase 24,000 shares through January 2, 1999.

The following table summarizes option activity for the years presented:

<TABLE>
<CAPTION>
                                     NUMBER     WEIGHTED AVERAGE
                                    OF SHARES    EXERCISE PRICE
----------------------------------------------------------------
<S>                                 <C>         <C>

 Outstanding December 30, 1995        642,700        $ 9.52
   Granted                            760,900         14.74
   Exercised                          (14,175)         6.12
   Cancelled                         (117,925)         5.92
                                    ---------        ------

 Outstanding December 28, 1996      1,271,500         13.02
   Granted                            521,000         15.73
   Exercised                         (152,275)         8.88
   Canceled                          (191,525)        14.71
                                    ---------        ------

 Outstanding January 3, 1998        1,448,700         14.21
   Granted                            777,250         18.35
   Exercised                          (83,650)         8.48
   Canceled                          (227,800)        16.97
                                    ---------        ------
 Outstanding January 2, 1999        1,914,500        $15.81
                                    =========        ======
</TABLE>

At December 28, 1996, January 3, 1998 and January 2, 1999, options exercisable
under the Company's stock option plans totaled 518,149, 734,640 and 798,375
shares, respectively, and had a weighted average option price per share of
$11.51, $13.01 and $13.76, respectively. For options outstanding at January 2,
1999, 335,800, 267,675 and 194,900 shares are exercisable at a weighted average
exercise price of $11.82, $14.44 and $16.16, respectively. The weighted average
remaining contractual life of these options is 6.5, 7.7 and 8.5 years,
respectively.

At January 2, 1999, 1,895,400 shares are available for future grants of stock
options.

During 1996 and 1997, the Company recognized compensation expense in corporate
expenses of $339,000 and $281,000, respectively, related to the granting of
options in 1994 at less than fair market value at the date of grant. Grants
after 1994 were issued at fair market value.

SFAS No. 123, "Accounting for Stock-Based Compensation," defines a fair value
method of accounting for stock options and similar equity instruments. Under the
fair value method, compensation cost is measured at the grant date based on the
fair value of the award and is recognized over the service period, which is
usually the vesting period. Companies are encouraged, but not required, to adopt
the fair value method of accounting for employee stock-based transactions.
Companies are also permitted to continue to account for such transactions under
Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued
to Employees," but are required to disclose in a note to the financial
statements pro forma net income and earnings per share as if the company had
applied the new method of accounting. The Company applies APB No. 25 in
accounting for its stock-based compensation plans. Had compensation cost been
determined on the basis of fair value pursuant to SFAS No. 123, for options
granted in 1996, 1997 and 1998, net income and earnings per share would have
been as follows (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                  1996       1997       1998
---------------------------------------------------
<S>                              <C>        <C>        <C>

 NET INCOME
   As reported                   $24,064    $25,358    $34,061
                                 =======    =======    =======
   Pro forma                     $22,710    $23,940    $32,229
                                 -------    -------    -------
 BASIC EARNINGS PER SHARE
   As reported                   $   .88    $   .91    $  1.23
                                 =======    =======    =======
   Pro forma                     $   .83    $   .86    $  1.17
                                 -------    -------    -------
 DILUTED EARNINGS PER SHARE
   As reported                   $   .87    $   .90    $  1.23
                                 =======    =======    =======
   Pro forma                     $   .82    $   .85    $  1.16
                                 -------    -------    -------
</TABLE>

The following weighted average assumptions were used in the option pricing
model: a risk free interest rate of 6.7%, 6.8% and 5.5% for 1996, 1997 and 1998,
respectively; an expected life of the options of 7.5 years for 1996 and 1997 and
5.4 years for 1998; no expected dividend yield and a volatility factor of .25
for 1996, a volatility factor of .26 for 1997 and a volatility factor of .29 for
1998. The weighted average per share fair value of the options granted in 1996,
1997 and 1998 was $6.59, $7.40 and $6.90, respectively.

Due to the inclusion of only 1995 through 1998 option grants, the effects of
applying SFAS No. 123 in 1996, 1997 and 1998 may not be representative of the
pro forma impact in future years.

                                                                            
                                       43
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   44

                 EMPLOYEE STOCK
 NOTE 8.         PURCHASE PLAN

In February 1998, the Company's Board of Directors adopted the Company's Amended
and Restated 1996 Employee Stock Purchase Plan (the "Stock Purchase Plan"),
which is intended to qualify under Sec. 423 of the Internal Revenue Code. The
purpose of the Stock Purchase Plan is to provide employees of the Company with
an opportunity to acquire or increase a proprietary interest in the Company by
purchasing shares of the Company's common stock at a discounted price. All
employees of the Company are eligible to participate in the Stock Purchase Plan.
The stock purchase price is 85% of the fair market value of the Company's common
stock at the beginning of the contribution period, which begins on the last
Sunday of January of each year and ends on the last Saturday of the following
January or, if less, 85% of such fair market value on the last day of the
contribution period. The Stock Purchase Plan allows employees to purchase shares
through contribution or payroll deductions of up to 10% of base pay, and
provides that no employee may purchase in any calendar year shares having a
value (determined at the time the right to purchase is granted) in excess of
$25,000. The aggregate number of shares of common stock reserved for purchase
under the stock purchase plan is 300,000. Such shares may be either authorized
but unissued shares or issued shares reacquired by the Company and held as
treasury shares.

In January 1997, the Company sold 48,647 shares of common stock out of treasury
to employees at $12.64 per share for the 1996 plan year. In January 1998, the
Company sold 34,916 shares of common stock out of treasury to employees at
$15.19 per share for the 1997 plan year. In January 1999, the Company sold
35,103 shares of common stock out of treasury to employees at $13.33 per share
for the 1998 plan year. The weighted average per share fair value of the shares
issued in 1997, 1998 and 1999 was $3.26, $3.87 and $3.52, respectively.
 NOTE 9.         RETIREMENT PLANS

At the time of the Offering, the Company had a defined benefit pension plan (the
"Pension Plan") that covered all employees except seasonal employees. The
benefits were based on years of service, final average compensation and final
average compensation in excess of average social security covered compensation
at retirement. The Company's funding policy was to contribute annually at least
the minimum amount required under the funding standards of ERISA. Pension Plan
assets were held by a bank trust company and were invested primarily in cash
equivalents and fixed income investments.

On December 28, 1996, the Company froze the Pension Plan, which decreased the
Company's projected benefit obligations by $2,500,000 and resulted in a
curtailment gain of $286,000. During 1997, the Company terminated the Pension
Plan and in 1998 received appropriate regulatory approvals to distribute plan
assets. Earned benefits totaling $10,410,000, through the date the Pension Plan
was frozen, were paid to employees during 1998, at which time a final settlement
expense of $415,000 was recognized by the Company and included in direct room
expenses. (See Note 10). During 1996, the Company recognized an expense of
$547,000 and in 1997 recognized a credit of $94,000 related to the Pension Plan.

In addition to the Pension Plan described above, the Board of Directors
established a supplementary pension plan for its President and Chief Executive
Officer. Accordingly, the Company has an accrued liability of $131,000 and
$330,000 as of January 3, 1998 and January 2, 1999, respectively, related to
such supplementary pension plan.

In July 1997, the Board of Directors adopted the Company's 401(k) Savings Plan
(the "Savings Plan") which qualifies under Section 401(a) of the Internal
Revenue Code. The purpose of the Savings Plan is to encourage current employees
to save funds for retirement, to attract new employees and to retain current
employees. All Company employees who meet certain minimum age requirements are
eligible to participate in the Savings Plan on the first day of the month
following six months of employment by the Company. The Savings Plan allows
employees to deduct up to 15% of their base and bonus


                                       44
Red Roof Inns Inc. and Subsidiaries
<PAGE>   45
 
pay, subject to various limitations required by the I.R.S. The Company matched
25% of employee contributions up to 6% of base and bonus pay in 1997 and 1998
and has sole discretion to elect whether to match these or other amounts in the
future.
The Company adopted a Deferred Compensation Plan and Executive Deferred
Compensation Plan (the "Compensation Plans") effective February 1, 1998 to
provide a tax deferred accumulation opportunity to a select group of management
employees through deferrals of cash compensation and company related
contributions. Participants in the Deferred Compensation Plan may contribute 1%
to 15% of their base annual salary which, when added to their Savings Plan
deferral, does not exceed the dollar limitation in effect under Internal Revenue
Service Code Section 402(g). Participants in the Executive Deferred Compensation
portion of the Compensation Plans may contribute up to 50% and 100% of their
base salary and bonus, respectively. During 1998, the Company matched 10% of
qualified employee contributions under the Compensation Plans.
 
The 1997 and 1998 expense related to the Savings and Compensation Plans was
approximately $171,000 and $391,000, respectively.
                 INN RENEWAL
 NOTE 10.        PROGRAM AND OTHER CHARGES
 
The following charges were incurred by the Company during the years presented
(in thousands):
 
<TABLE>
<CAPTION>
                                  1996       1997       1998
---------------------------------------------------
<S>                              <C>        <C>        <C>
 Severance compensation (1)                 $ 1,421    $ 1,659
 Asset impairment charges (2)    $   450                   914
 Inn renewal program expenses
   (3)                            10,398     14,066
 Accounting system conversion
   (1)                                                   1,246
 Write-off of preliminary site
   acquisition costs (1)                                 1,944
 Pension plan termination (4)                              415
                                                       -------
       Total charges             $10,848    $15,487    $ 6,178
                                 =======    =======    =======
</TABLE>
 
(1) Included in corporate expenses
(2) Included in depreciation and amortization
 
(3) Inn renewal program expenses:
 
<TABLE>
<CAPTION>
                                  1996       1997
                                 -------    -------
   <S>                           <C>        <C>        <C>
    Direct room expenses         $ 2,297    $ 7,504
    Depreciation and
      amortization                 7,847      2,387
    Corporate expense                148        490
    Marketing expenses               106      3,685
                                 -------    -------
          Total Inn renewal
           program expenses      $10,398    $14,066
                                 =======    =======
</TABLE>
 
(4) Included in direct room expenses
 
During 1996, the Company commenced Project BIG RED, a chainwide property renewal
program that refurbished and enhanced both the interior decor and exterior of
the majority of company-owned Inns and provided additional room amenities and
services for guests. Included in the program were expenditures to update guest
rooms with new carpet, wallcovering, furniture, bedspreads and drapes.
Improvements to the exterior of the properties included painting, new signs,
improved lighting and additional landscaping. The program was completed during
1998 at a total cost of approximately $68 million (including approximately $4
million related to the Company's revenue management system). In 1996, 1997 and
1998, the Company incurred expenditures of $10,646,000, $49,813,000 and
$7,422,000, respectively, related to this program of which $8,095,000,
$38,134,000 and $7,422,000 was capitalized, respectively. In addition, the
Company recognized charges of $7,847,000 and $2,387,000 in 1996 and 1997,
respectively, related to early asset retirements in connection with the program.
During 1996 and 1998, the Company recorded impairment charges of $450,000 and
$914,000, respectively, in accordance with SFAS No. 121, primarily related to
land held for sale.
 
In the second half of 1997, the Company commissioned a task force to perform a
thorough examination of its corporate structure and processes to increase
productivity and reduce costs in relation to its strategic growth plans
("re-engineering program"). Accordingly, the Company took a fourth quarter
charge to income in 1997 of $1,421,000 related to severance expenses associated
with the re-engineering program. In the fourth quarter of 1998, the Executive
Vice President and Chief Financial Officer and certain other officers and
employees terminated their employment with the Company. Accordingly, the Company
 
                                                                            
                                       45
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   46
 
recognized a fourth quarter charge to earnings of $1,659,000 related to
severance expenses associated with these terminations. At January 2, 1999,
$1,425,000 is included in accrued compensation related to such terminations
($1,065,000 at January 3, 1998). Totals of 25 and 14 corporate employees were
terminated in 1997 and 1998, respectively. Total termination benefits paid in
1997 and 1998 were $356,000 and $1,298,000, respectively.
 
The Company is currently converting its financial accounting and human resources
systems to be year 2000 compliant. During 1998, the Company recorded charges to
earnings of $1,246,000 related to the conversion of these systems and associated
training costs.
 
As a result of the Company's decision to reduce its Inn development and focus on
fee-based income, the Company recognized a charge to earnings of $1,944,000
related to the write-off of preliminary site acquisitions costs.
 
The Company recognized charges to earnings in 1998 of $415,000 related to the
termination of a defined pension benefit plan. (See Note 9).
 NOTE 11.        INCOME TAXES
The components of the provision for income taxes consist of the following (in
thousands):
 
<TABLE>
<CAPTION>
                                   1996      1997      1998
<S>                               <C>       <C>       <C>
 Federal:
 Current                          $ 9,304   $ 9,326   $13,027
 Deferred                           3,660     4,903     5,633
                                  -------   -------   -------
   Total federal                   12,964    14,229    18,660
                                  -------   -------   -------
 
 State and local:
 Current                            2,220       585     2,299
 Deferred                             428     1,805       873
                                  -------   -------   -------
   Total state and local            2,648     2,390     3,172
                                  -------   -------   -------
 
 Total                            $15,612   $16,619   $21,832
                                  =======   =======   =======
 
 Effective tax rate                  39.4%     38.9%     38.9%
                                  =======   =======   =======
</TABLE>
 
The effective tax rate differs from the statutory rate as follows:
 
<TABLE>
<CAPTION>
                                            1996   1997   1998
<S>                                         <C>    <C>    <C>
 Statutory rate                             35.0%  35.0%  35.0%
 State and local taxes, net of federal tax   4.3    3.6    3.6
   effect
 Other                                       0.1     .3     .3
                                            ----   ----   ----
 Total                                      39.4%  38.9%  38.9%
                                            ====   ====   ====
</TABLE>
 
The tax effects of significant items comprising the Company's net deferred tax
balances are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                          JANUARY 3,   JANUARY 2,
                                             1998         1999
<S>                                       <C>          <C>
 
 Deferred tax assets:
 Self-insured expenses                     $ 4,444      $ 4,143
 Capital lease obligations                     897          768
 Other expense accruals                      2,341        2,304
                                           -------      -------
   Total deferred tax assets                 7,682        7,215
                                           -------      -------
 
 Deferred tax liabilities:
 Goodwill and basis of assets acquired      11,504       11,957
 Excess tax over book depreciation and
   amortization                              9,793       15,379
                                           -------      -------
   Total deferred tax liabilities           21,297       27,336
                                           -------      -------
 
 Net deferred tax liability                $13,615      $20,121
                                           =======      =======
</TABLE>
 
                 COMMITMENTS AND
 NOTE 12.        CONTINGENCIES
 
The Company is involved in various claims and legal proceedings arising from the
normal course of business. While the ultimate liability, if any, from these
proceedings currently is indeterminable, in the opinion of management, these
matters should not have a material adverse effect on the consolidated financial
statements of the Company.
 
The Internal Revenue Service ("IRS") is currently undergoing an examination of
the Company's federal income tax returns for the years 1993 through 1996. The
Company has estimated this examination could result in proposed adjustments of
approximately $10 million in additional current federal income taxes for the
years 1993 through 1997, plus interest. The proposed adjustments relate
 

                                       46
Red Roof Inns Inc. and Subsidiaries
<PAGE>   47
 
primarily to the allocation of the purchase price of the assets acquired as a
result of the acquisition of the Company by MSREF in December 1993 and the tax
accounting treatment for removal costs for assets replaced. These adjustments do
not affect the overall tax liability recognized by the Company but impact the
classification between current and deferred tax accounts. The Company has filed
a response vigorously contesting the majority of the proposed adjustments. While
it is not possible to determine the final disposition, the Company is of the
opinion that the ultimate resolution of this matter should not have a material
adverse effect on the consolidated financial statements of the Company.
 NOTE 13.        FAIR VALUE OF FINANCIAL INSTRUMENTS
 
The estimated fair values of financial instruments disclosed below as of January
3, 1998 and January 2, 1999 were determined using available market information
and appropriate valuation methodologies. However, considerable judgment is
required to interpret market data to develop the estimates of fair value.
Accordingly, the estimates presented may not be indicative of the amounts the
Company could realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies could have a significant effect on
the estimated fair value amounts.
 
The following methods and assumptions were used to estimate the fair value of
financial instruments; (i) mortgage notes -- the estimated fair value is based
on current rates and payment terms offered to the Company and (ii) senior
unsecured notes -- the estimated fair value is based upon a quoted published
market price (in thousands):
 
<TABLE>
<CAPTION>
                           CARRYING VALUE         ESTIMATED FAIR VALUE
                       -----------------------   -----------------------
                       JANUARY 3,   JANUARY 2,   JANUARY 3,   JANUARY 2,
                          1998         1999         1998         1999
<S>                    <C>          <C>          <C>          <C>
 Mortgage notes and
   bank facility        $347,722     $352,373     $361,000     $369,000
 
 Senior unsecured
   notes                 200,000      172,385      208,000      175,000
</TABLE>
 
                                                                            
                                       47
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   48
 
             SELECTED QUARTERLY
 NOTE 14.    FINANCIAL DATE (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                            FIRST         SECOND         THIRD         FOURTH          FULL
                                                           QUARTER       QUARTER        QUARTER        QUARTER         YEAR
                                                           ------------------------------------------------------------------
                                                                        (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
    <S>                                                    <C>           <C>            <C>            <C>           <C>
 
    1997
     Revenues                                              $74,544       $ 94,959       $102,317       $88,985       $360,805
     Operating income                                       5,350(1)       27,400(1)      36,028(1)    19,534(1)       88,312(1)
     Income (loss) before extraordinary item               (3,562)(1)       9,713(1)      14,952(1)     5,001(1)       26,104(1)
     Extraordinary loss                                                      (746)(2)                                    (746)(2)
     Net income (loss)                                     (3,562)(1)       8,967(1)(2)   14,952(1)     5,001(1)       25,358(1)(2)
     Income (loss) per share before extraordinary item:
       Basic                                                (0.13)(1)        0.35(1)        0.53(1)      0.18(1)         0.93(1)
       Diluted                                              (0.13)(1)        0.35(1)        0.53(1)      0.18(1)         0.93(1)
     Extraordinary loss per share:
       Basic                                                                (0.03)(2)                                   (0.02)(2)
       Diluted                                                              (0.03)(2)                                   (0.03)(2)
     Net income (loss) per share:
       Basic                                                (0.13)(1)        0.32(1)(2)     0.53(1)      0.18(1)         0.91(1)(2)
       Diluted                                              (0.13)(1)        0.32(1)(2)     0.53(1)      0.18(1)         0.90(1)(2)
    1998
     Revenues                                              $85,066       $101,295       $104,688       $84,287       $375,336
     Operating income                                      12,866          34,624         38,386(3)    15,830(3)      101,706(3)
     Income before extraordinary item                         540          14,131         16,641(3)     2,981(3)       34,293(3)
     Extraordinary loss                                                                                  (232)(4)        (232)(4)
     Net income                                               540          14,131         16,641(3)     2,749(3)(4)    34,061(3)(4)
     Income per share before extraordinary item:
       Basic                                                 0.02            0.51           0.60(3)      0.11(3)         1.24(3)
       Diluted                                               0.02            0.51           0.60(3)      0.11(3)         1.24(3)
     Extraordinary loss per share:
       Basic                                                                                            (0.01)(4)       (0.01)(4)
       Diluted                                                                                          (0.01)(4)       (0.01)(4)
     Net income per share:
       Basic                                                 0.02            0.51           0.60(3)      0.10(3)(4)      1.23(3)(4)
       Diluted                                               0.02            0.51           0.60(3)      0.10(3)(4)      1.23(3)(4)
</TABLE>
 
(1) Operating income, income before extraordinary item and net income were
reduced by charges related to the Inn renewal program as follows: first
quarter -- $4,771 and $2,899 ($.10 per share -- basic and diluted); second
quarter -- $4,770 and $2,897 ($.10 per share -basic and diluted); third
quarter -- $2,333 and $1,417 ($.05 per share -- basic and diluted); fourth
quarter -- $2,192 and $1,381 ($.05 per share -- basic and diluted), and full
year -- $14,066 and $8,594 ($.31 per share -- basic and $.30 per
share -- diluted), respectively. In addition, operating income, income before
extraordinary item and net income were reduced by a charge in the fourth quarter
for severance compensation of $1,421 and $868 ($.03 per share -- basic and
diluted), respectively.
 
(2) Net income was reduced by an extraordinary charge of $746, net of tax, ($.02
per share basic and $.03 per share -- diluted) related to the write-off of
unamortized loan costs on the refinancing of the Company's bank credit facility.
 
(3) Operating income, income before extraordinary item and net income were
reduced by pre-tax charges in the third quarter of $461 and $282, respectively,
($.01 per share -- basic and diluted), primarily for termination of a pension
plan and by pre-tax charges in the fourth quarter of $5,717 and $3,493,
respectively, ($.13 per share -- basic and diluted), related to severance
compensation of $1,659, asset impairment charges of $914, accounting system
conversion charges of $1,156, write-offs of preliminary site acquisition costs
of $1,944 and costs related to termination of a pension plan of $44. Operating
income, income before extraordinary item and net income for the full year were
reduced by the aforementioned charges of $6,178 and $3,775 ($.14 per
share -- basic and $.13 per share -- diluted), respectively.
 
(4) Net income was reduced by an extraordinary charge of $232, net of tax ($.01
per share -- basic and diluted) related to the write-off of unamortized loan
costs, net of discount, associated with the partial repurchase of senior
unsecured notes.
 
                 CHANGES IN AND DISAGREEMENTS
                 WITH ACCOUNTANTS AND
 ITEM 9.         FINANCIAL DISCLOSURE
 
None.
 

                                       48
Red Roof Inns Inc. and Subsidiaries
<PAGE>   49
 
PART III
 ITEM 10.        DIRECTORS AND EXECUTIVE OFFICERS
 
The information in the proxy statement for the Company's 1999 annual meeting of
stockholders under the headings "Election of Directors", "Compensation of
Directors", "Executive Officers" and "Compliance With Section 16 (a) of The
Exchange Act" is incorporated herein by reference.

 ITEM 11.        EXECUTIVE COMPENSATION
 
The information in the proxy statement for the Company's 1999 annual meeting of
stockholders under the heading "Executive Compensation" is incorporated herein
by reference.

                 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
 ITEM 12.        MANAGEMENT
 
The information in the proxy statement for the Company's 1999 annual meeting of
stockholders under the heading "Voting Securities and Principal Holders Thereof"
is incorporated herein by reference.

                 CERTAIN RELATIONSHIPS AND
 ITEM 13.        RELATED TRANSACTIONS
 
The information in the proxy statement for the Company's 1999 annual meeting of
stockholders under the headings "Election of Directors," "Compensation Committee
Interlocks and Insider Participation" and "Certain Relationships and Related
Transactions" is incorporated herein by reference.

                 EXHIBITS AND FINANCIAL
 ITEM 14.        STATEMENT SCHEDULES
 
(a) The following documents are filed as part of this report:
 
    (1)  Financial Statements
 
         -  Independent Auditors' Report on the Company.
 
         -  Consolidated Balance Sheets of the Company as of January 3, 1998 and
January 2, 1999.
 
         -  Consolidated Statements of Income of the Company for the years ended
December 28, 1996, January 3, 1998 and January 2, 1999.
 
         -  Consolidated Statements of Stockholders' Equity of the Company for
the years ended December 28, 1996, January 3, 1998 and January 2, 1999.
 
         -  Consolidated Statements of Cash Flows of the Company for the years
ended December 28, 1996, January 3, 1998 and January 2, 1999.
 
         -  Notes to Consolidated Financial Statements of the Company.
 
    (2)  Financial Statement Schedules
 
         The financial statement schedules listed below are included in the
pages following.
 
         -  Financial Statement Schedule II, Valuation and Qualifying Accounts,
for the years ended December 28, 1996, January 3, 1998 and January 2, 1999.
 
Schedules other than those mentioned above are omitted because the conditions
requiring their inclusion in this document do not exist or because the
information is given in the financial statements or notes thereto.
 
    (3) The following exhibits are filed as a part of this report:
 
<TABLE>
<C>        <S>
      2.1  The Merger Agreement dated as of August
           12, 1993, as amended, among the Company,
           MSREF and the Trueman Trust
           (incorporated by reference to Exhibit
           2.01 to the Company's Registration
           Statement on Form S-1, File No.
           33-76848).
     3.01  Amended and Restated Certificate of
           Incorporation of the Company
           (incorporated by reference to Exhibit
           3.01 to the Company's Annual Report on
           Form 10-K for the fiscal year ended
           December 30, 1995).
</TABLE>
 
                                       49
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   50
 
<TABLE>
<C>        <S>
     3.02  Form of Amended and Restated Bylaws of
           the Company (incorporated by reference
           to Exhibit 3.02 to the Company's
           Registration Statement on Form S-1, File
           No. 33-97914).
     4.01  Form of certificate representing shares
           of Common stock, par value $.01 per
           share (incorporated by reference to
           Exhibit 4.01 to the Company's
           Registration Statement on Form S-1, File
           No.33-97914).
    10.01  Indenture, dated as of December 17,
           1993, from the Company to The Bank of
           New York, as Trustee (incorporated by
           reference to Exhibit 4.02 to the
           Company's Annual Report on Form 10-K for
           the fiscal year ended December 31,
           1994).
   *10.02  Employment Agreements between the
           Company and Messrs. Campbell and Tallis
           (incorporated by reference to Exhibit
           10.02 to the Company's Annual Report on
           Form 10-K for the fiscal year ended
           December 31, 1994).
   *10.03  Employment Agreement between the Company
           and Mr. Cash (incorporated by reference
           to Exhibit 10 to the Company's Quarterly
           Report on Form 10-Q for the 26 weeks
           ended July 1, 1995).
    10.04  Loan Agreement, dated as of November 9,
           1995, between the Company and Huntington
           National Bank and a bank group
           (incorporated by reference to Exhibit
           10.1 to the Company's Quarterly Report
           on Form 10-Q for the 39 weeks ended
           September 30, 1995).
    10.05  First, Second and Third Amendments dated
           November 21, 1995, December 12, 1995 and
           April 6, 1996, respectively, to Loan
           Agreement, dated as of November 9, 1995,
           between the Company and Huntington
           National Bank and a bank group
           (incorporated by reference to Exhibits
           10.01, 10.02 and 10.03 to the Company's
           Quarterly Report on Form 10-Q for the 13
           weeks ended March 30, 1996).
    10.06  Fourth Amendment dated June 27, 1996 to
           Loan Agreement, dated as of November 9,
           1995, between the Company and Huntington
           National Bank and a bank group
           (incorporated by reference to Exhibit
           10.01 to the Company's Quarterly Report
           of Form 10-Q for the 26 weeks ended June
           29, 1996).
   *10.07  1995 Director Stock Option Plan
           (incorporated by reference to Exhibit
           10.02 to the Company's Quarterly Report
           on Form 10-Q for the 39 weeks ended
           September 30, 1995).
    10.08  Shareholders Agreement among the Company
           and all its shareholders, dated as of
           April 6, 1994 (incorporated by reference
           to Exhibit 10.07 to the Company's
           Registration Statement on Form S-1, File
           No. 33-97914).
    10.09  Amendment No. 1 to Shareholders
           Agreement among the Company and all its
           shareholders (incorporated by reference
           to Exhibit 10.07 to the Company's Annual
           Report on Form 10-K for the fiscal year
           ended December 30, 1995).
   *10.10  Form of 1996 Employee Stock Purchase
           Plan (incorporated by reference to
           Exhibit 10.09 to the Company's
           Registration Statement on Form S-1, File
           No. 33-97914).
   *10.11  Form of Amended and Restated 1994
           Management Equity Incentive Plan
           (incorporated by reference to Exhibit
           10.10 to the Company's Registration
           Statement on Form S-1, File No.
           33-97914).
   *10.12  Employment Agreement between the Company
           and Mr. Chichester (incorporated by
           reference to Exhibit 10.11 to the
           Company's Annual Report on Form 10-K for
           the fiscal year ended December 30,
           1995).
</TABLE>
 
                                       50
Red Roof Inns Inc. and Subsidiaries
<PAGE>   51
 
<TABLE>
<C>        <S>
   *10.13  1996 Management Incentive Compensation Plan
           (incorporated by reference to Exhibit 10.04
           to the Company's Quarterly Report of Form
           10-Q for the 13 weeks ended March 30, 1996).
   *10.14  Amended and Restated Credit Agreement, dated
           May 21, 1997, between the Company and The
           Huntington National Bank and a bank group
           (incorporated by reference to Form 8-K dated
           June 30, 1997).
    10.15  First Amendment to Credit Agreement, dated
           December 14, 1998, between the Company and
           Huntington National Bank, CIBC Oppenheimer
           Corp. and a bank group included herein.
   *10.16  Amended and Restated Executive Severance
           Agreement between the Company and Mr. Rea
           included herein.
   *10.17  Executive Severance Agreement between the
           Company and Mr. Cash included herein.
   *10.18  Executive Severance Agreement between the
           Company and Mr. Tallis included herein.
   *10.19  Employment Agreement between the Company and
           Mr. Rea included herein.
    11.01  Statement re computation of per share
           earnings.
    12.01  Statement re computation of ratios.
    21.00  Subsidiaries of the Registrant
    23.00  Consent of Deloitte & Touche LLP.
  24.00 -  Directors and Officers Powers of
    24.07  Attorney
    27.00  Financial Data Schedule
</TABLE>
 
* Executive plans and arrangements required to be filed pursuant to Item 601 (b)
(10) of Regulation S-K.
 
(b) Reports on Form 8-K:
 
    Red Roof Inns, Inc. appoints David L. Rea to the position of Executive Vice
President, Chief Financial Officer, and Treasurer effective October 6, 1998.
 
    On October 6, 1998, David N. Chichester, Executive Vice President and Chief
Financial Officer terminated his employment as Executive Vice President and
Chief Financial Officer and resigned from the Board of Directors of Red Roof
Inns, Inc. to pursue other interests. He received severance benefits provided
under his employment agreement of approximately $.8 million which was recognized
in the fourth quarter ended January 2, 1999. The Board vacancy is not being
filled at this time.
 
(c) Exhibits:
 
    The exhibits are submitted following the signatures.
 
(d) Financial Statement Schedules:
 
    The financial statement schedules and the independent auditor's report
thereon are submitted following the signatures.
 
                                       51
                                             Red Roof Inns Inc. and Subsidiaries
<PAGE>   52

                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, Red Roof Inns, Inc. has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on this 25th day of March
1999.

                                RED ROOF INNS, INC.

                                By: /s/ Francis W. Cash
                                  -------------------------------------
                                  Name: Francis W. Cash
                                  Title: Chairman of the Board, President,
                                         Chief Executive Officer and Director

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of Red Roof Inns, Inc. and in
the capacities and on the dates indicated.

<TABLE>
<CAPTION>
                  SIGNATURE                                        TITLE                               DATE
                  ---------                                        -----                               ----
<C>                                            <S>                                           <C>

             /s/ FRANCIS W. CASH               Chairman of the Board, President, Chief            March 25, 1999
---------------------------------------------  Executive Officer and Director
               Francis W. Cash

              /s/ DAVID L. REA                 Executive Vice President, Chief Financial          March 25, 1999
---------------------------------------------  Officer and Treasurer
                David L. Rea

          /s/ ROBERT M. HARSHBARGER            Senior Vice President, Controller and Chief        March 25, 1999
---------------------------------------------  Accounting Officer
            Robert M. Harshbarger

                      *                        Director                                           March 25, 1999
---------------------------------------------
             Thomas E. Dobrowski

                      *                        Director                                           March 25, 1999
---------------------------------------------
              Michael E. Foster

                      *                        Director                                           March 25, 1999
---------------------------------------------
                John A. Henry

                      *                        Director                                           March 25, 1999
---------------------------------------------
            William M. Lewis, Jr.

                      *                        Director                                           March 25, 1999
---------------------------------------------
              Edward D. Powers

                      *                        Director                                           March 25, 1999
---------------------------------------------
              Judith A. Rogala

                      *                        Director                                           March 25, 1999
---------------------------------------------
               Owen D. Thomas

*By /s/ David L. Rea
    ----------------------------------------
    David L. Rea
    Attorney-in-Fact
</TABLE>

                                       52
Red Roof Inns Inc. and Subsidiaries
<PAGE>   53

                                                                     SCHEDULE II
RED ROOF INNS, INC. AND SUBSIDIARIES
CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>

                                                BALANCE AT         CHARGED TO         CHARGED TO         DEDUCTIONS
                                               BEGINNING OF        COSTS AND            OTHER               FROM
                   DESCRIPTION                    PERIOD            EXPENSES           ACCOUNTS           RESERVES
      <S>                                    <C>                <C>                <C>                <C>
      YEAR ENDED JANUARY 2, 1999
        Allowance for doubtful accounts            $651               $903               $                 $(222)(1)
                                                   ====               ====               ====              =====

      YEAR ENDED JANUARY 3, 1998
        Allowance for doubtful accounts            $420               $477               $                 $(246) (1)
                                                   ====               ====               ====              =====

      YEAR ENDED DECEMBER 28, 1996
        Allowance for doubtful accounts            $490               $368               $                 $(438) (1)
                                                   ====               ====               ====              =====

<CAPTION>
                                                 BALANCE
                                                  AT END
                                                    OF
                   DESCRIPTION                    PERIOD
      <S>                                    <C>
      YEAR ENDED JANUARY 2, 1999
        Allowance for doubtful accounts          $  1,332
                                                 ========
      YEAR ENDED JANUARY 3, 1998
        Allowance for doubtful accounts          $    651
                                                 ========
      YEAR ENDED DECEMBER 28, 1996
        Allowance for doubtful accounts          $    420
                                                 ========
</TABLE>

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

    (1) Uncollectible accounts written off, net of amounts recovered.

                                                                            
                                       53
                                             Red Roof Inns Inc. and Subsidiaries
                                                                        
                                                                        
<PAGE>   54

INDEPENDENT AUDITORS' REPORT
ON FINANCIAL STATEMENT SCHEDULES

The Board of Directors and Stockholders of
Red Roof Inns, Inc.

We have audited the consolidated financial statements of Red Roof Inns, Inc. and
its subsidiaries as of January 3, 1998 and January 2, 1999, and for each of the
three years in the period ended January 2, 1999, and have issued our report
thereon dated February 17, 1999; such report is included elsewhere in this Form
10-K. Our audits also included the consolidated financial statement schedules of
Red Roof Inns, Inc. and its subsidiaries, listed in Item 14. These consolidated
financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits. In
our opinion, such consolidated financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly in all material respects the information set forth therein.

/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Columbus, Ohio
February 17, 1999


                                       54
Red Roof Inns Inc. and Subsidiaries
<PAGE>   55


                                  EXHIBIT INDEX


<TABLE>
<CAPTION>
Exhibit
   No.                                              Description
-------                                             -----------
<S>                 <C>
10.15               First Amendment to Credit Agreement, dated December 14, 1998, between the Company and
                    Huntington National Bank, CIBC Oppenheimer and a bank group.
10.16               Amended and Restated Executive Severance Agreement between the Company and Mr. Rea.
10.17               Executive Severance Agreement between the Company and Mr. Cash.
10.18               Executive Severance Agreement between the Company and Mr. Tallis.
10.19               Employment Agreement between the Company and Mr. Rea.
11.01               Statement re computation of per share amounts.
12.01               Statement re computation of ratio of earnings to fixed charges.
21.00               Subsidiaries of the Registrant
23.00               Consent of Deloitte & Touche LLP.
24.00-24.07         Directors and Officers Powers of Attorney.
27.00               Financial Data Schedule
</TABLE>