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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
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FORM 10-K

(MARK ONE)

/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 0-23941
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U.S. FRANCHISE SYSTEMS, INC.

(Exact Name of Registrant as Specified in its Charter)

DELAWARE 58-2361501
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)

13 CORPORATE SQUARE, SUITE 250 30329
ATLANTA, GEORGIA (Zip Code)
(Address of Principal Executive
Offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (404) 321-4045

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Class A Common Stock, $0.01 par value

TITLE OF EACH CLASS

Indicate by check mark whether the registrant: (1) has filed all reports
required 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 Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /

The aggregate market value of the outstanding shares of the registrant's
Class A Common Stock and Class B Common Stock held by non-affiliates of the
registrant was approximately $74,136,465 as of March 10, 2000. There were
17,245,834 shares of the registrant's Class A Common Stock and 2,707,919 shares
of the registrant's Class B Common Stock outstanding as of March 14, 2000.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's definitive proxy statement to be delivered to
shareholders in connection with the Annual Meeting of Shareholders to be held on
May 25, 2000 are incorporated by reference in response to Part III of this
Report.

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PART I

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Annual Report on Form 10-K (this "Form 10-K"),
including statements under "Item 1. Business" and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations," that
are not historical facts constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform
Act"). Certain, but not necessarily all, of such forward-looking statements can
be identified by the use of forward-looking terminology such as "believes,"
"expects," "may," "will," "should," or "anticipates" or the negative thereof or
other variations thereon or comparable terminology, or by discussions of
strategy that involve risks and uncertainties. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of U.S. Franchise Systems, Inc.
(the "Company" or "USFS") and its subsidiaries to be materially different from
any future results, performance or achievements expressed or implied by such
forward-looking statements. Such factors include, but are not limited to, the
following: general economic and business conditions; aggressive competition in
the lodging and franchising industries; success of acquisitions and operating
initiatives; management of growth; risks relating to the Company's loans to, and
other investments in, franchisees; dependence on senior management; brand
awareness; general risks of the lodging and franchising industries; development
risk and construction; risk of loss of management contracts and uncertain future
of the management business; risk relating to the availability of financing for
franchisees; the existence or absence of adverse publicity; changes in business
strategy or development plan; availability, terms and deployment of capital;
business abilities and judgment of personnel; availability of qualified
personnel; labor and employee benefit costs; changes in, or failure to comply
with, government regulations; construction schedules; the costs and other
effects of legal and administrative proceedings; and other factors referenced in
this Form 10-K. The Company will not undertake and specifically declines any
obligation to publicly release the results of any revisions which may be made to
any forward-looking statement to reflect events or circumstances after the date
of such statements or to reflect the occurrence of anticipated or unanticipated
events. The Company does not intend to update the information contained herein
with respect to its exploration of potential strategic alternatives for any
future developments or circumstances unless and until there is a definitive
transaction agreement entered into between the Company and any third party or
until its exploration of potential alternatives is definitively terminated.
There can be no assurance whatsoever that any transaction between the Company
and any third party will take place or, even if one does occur, about the nature
and extent of any terms and conditions of any such potential transaction. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations--Risk Factors".

ITEM 1. BUSINESS.

USFS was formed in August 1995 to acquire, market and service
well-positioned brands with potential for rapid unit growth primarily through
franchising. The Company's brands, which are in the lodging industry, are
Microtel Inn & Suites, Hawthorn Suites and Best Inn & Suites. The Company
acquired the rights to these brands because of their potential for significant
growth, which reflects, among other things, their potential profitability for
franchisees at the property level and their positions in attractive segments of
the lodging industry. Microtel primarily competes in the budget and economy
segments, Hawthorn primarily in the upscale and mid-market segments, and Best
primarily in the mid-market and economy segments of the lodging industry. The
Company also manages certain properties on behalf of franchisees. Since it began
selling franchises in January 1996, the number of USFS branded hotel properties
open or in development has grown from 27 to 1,218 as of December 31, 1999,
consisting of 398 open, 120 under construction, 414 for which franchise
agreements had been executed but that were not under construction and 286
accepted applications from prospective franchisees. There can be no assurances
that hotels in

development or for which applications have been accepted will result in open
hotels. See "Risk Factors--Dependence on, and Obstacles to, Hotel Openings."

As a franchisor, the Company licenses the use of its brand names to
independent hotel owners and operators (i.e., franchisees). The Company provides
its franchisees with a variety of benefits and services designed to:
(i) decrease development costs, (ii) shorten the time frame and reduce the
complexity of the construction process and (iii) increase occupancy rates,
revenues and profitability of the franchised properties. The Company offers
prospective franchisees a business format, design and construction assistance
(including architectural plans), quality standards, training programs, national
reservations systems, national and local advertising and promotional campaigns
and volume purchasing discounts.

The Company expects that its future revenues will consist primarily of
(i) franchise royalty fees, (ii) franchise application fees, (iii) various
management fees, (iv) international master license agreement fees, and
(v) payments made by vendors who supply the Company's franchisees with various
products and services. The Company recognizes franchise application fees as
revenue only upon the opening of the underlying hotels.

USFS announced that in recent months it received a number of unsolicited
inquiries regarding the possible sale of the Company, including inquiries from
several competitors. In response to those unsolicited inquiries, the Company
retained Banc of America Securities LLC as an advisor. The Company has had
discussions with several of those persons, although none resulted in offers
which were satisfactory to the Company and to the Board of Directors. The
Company has requested that Banc of America Securities assist the Company more
generally in evaluating strategic alternatives and opportunities that may be or
become available to the Company.

USFS does not intend to update the information contained herein with respect
to its exploration of potential strategic alternatives for any future
developments or circumstances unless and until there is a definitive transaction
agreement entered into between USFS and any third party or until its exploration
of potential alternatives is definitively terminated. There can be no assurance
whatsoever that any transaction between USFS and any third party will take place
or, even if one does occur, about the nature and extent of any terms and
conditions of any such potential transaction.

The Company was incorporated in Delaware in November 1997 for purposes of
acquiring the Hawthorn Suites brand. See "Acquisition of the Microtel, Hawthorn
Suites and Best Inns Systems--Hawthorn Acquisition." The Company's predecessor,
also known as USFS, was incorporated in Delaware in August 1995. The Company's
executive offices are located at 13 Corporate Square, Suite 250, Atlanta,
Georgia 30329 and its telephone number is (404) 321-4045. The term "the Company"
refers to USFS before the Hawthorn merger, and as the surviving corporation in
the merger.

BUSINESS STRATEGY

The Company's business strategy is to: (i) rapidly increase the number of
open Microtel, Hawthorn Suites and Best Inns hotels, (ii) operate its
administrative and franchisee support departments in order to maximize the
operating leverage inherent in the franchising business, and (iii) acquire
additional lodging or other service-oriented brands that provide attractive unit
economics to franchisees and significant growth opportunities for the Company.
To successfully accomplish its growth strategy, the Company supports its
franchisees in their efforts to develop, acquire, open and operate hotels by
assisting in the areas of public relations, construction, design, marketing,
finance, national accounts purchasing, training and in certain cases, by
providing financing and other development subsidies.

THE COMPANY'S LODGING FRANCHISE SYSTEMS

MICROTEL INN & SUITES. Microtels are distinctively styled hotels with a
residential look that offer travelers an attractive and consistent appearance,
clean, comfortable rooms and the safety of interior

corridor room access, all for a competitive rate. Microtel typically is
categorized as a budget and economy hotel chain. Microtel's efficient
architectural design minimizes construction costs and maintenance expenses
through smaller room sizes, limited common areas, smaller land requirements and
built-in standardized furniture, all of which enable franchisees to own and
operate a Microtel at a lower cost. These lower costs may reduce a franchisee's
equity investment and may broaden its debt financing alternatives, thereby
expanding the appeal of the Microtel brand to prospective franchisees.

The Company acquired the Microtel brand in October 1995, at which time there
were 27 properties open or in development. The Company has realized the
following franchise sales growth over the past three years:

AS OF DECEMBER 31,
------------------------------
1999 1998 1997
MICROTEL FRANCHISE DATA -------- -------- --------

Properties open (1)......................................... 179 124 64
Executed agreements and under construction................ 58 62 52
Executed agreements but not under construction............ 248 276 253
Accepted applications..................................... 101 115 77
--- --- ---
Total in development and accepted applications(2)........... 407 453 382
--- --- ---
OPEN PLUS IN DEVELOPMENT PLUS ACCEPTED APPLICATIONS......... 586 577 446
=== === ===

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(1) The Company does not receive royalties from 27 hotels open as of
December 31, 1999.

(2) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels. During 1999,
five previously opened hotels ceased operating as a Microtel. Since the
Microtel brand was acquired by the Company, 35% of accepted applications did
not become executed agreements and 38% of executed agreements terminated
before resulting in open hotels. See "Risk Factors--Dependence on, and
Obstacles to, Hotel Openings."

In 1999, for Microtel hotels open one year or more, average daily rate,
occupancy and Revpar was $44.13, 60.8% and $26.93, respectively.

HAWTHORN SUITES. As an upscale, extended-stay hotel, Hawthorn Suites
provides the traveler with the convenience of a hotel and the amenities
typically found in an apartment. Hawthorn Suites' hotel rooms contain
full-service kitchens with appliances, cookware and utensils, video cassette
players, modem ports, exercise facilities and valet service. Hawthorn Suites
hotels also offer a hot breakfast buffet every morning and guests are invited to
an evening social hour. A center courtyard, an outdoor pool, a multi-use sport
court, a barbecue area and a retail store selling sundry and meal items, snacks
and beverages, will also be part of newly constructed Hawthorn Suites hotels. In
addition to participating in the upscale, extended-stay segment, the Company
also franchises (i) Hawthorn Suites LTD., a mid-price, all suites hotel brand
that is designed to meet the needs of both extended-stay and transient guests,
(ii) Hawthorn Suites Golf Resorts, an all suites lodging concept located on or
near golf courses and targeted to travelers who want to combine golf with a
meeting or conference retreat experience, (iii) Hawthorn Hotel & Suites,
designed for high barrier to entry locations, such as center city and airport
markets, featuring a minimum of 25% suites with the remainder being upgraded
hotel rooms, and (iv) Hawthorn Inn & Suites, designed for tertiary markets
featuring a minimum of 25% suites and the remainder being upgraded hotel rooms.

Hotels that are part of the Hawthorn Suites system use the Spirit
Reservation System ("Spirit"). Spirit is operated under contract with Hyatt
Hotels Corporation ("Hyatt") by CSC Outsourcing, Inc. ("CSC") and Sabre
Technology Solutions ("Sabre"). Spirit receives and processes calls made to a
toll-free number dedicated to Hawthorn Suites. The Spirit system is directly
linked by computer to all Hawthorn Suites hotels. Hyatt manages the voice and
Global Distribution System ("GDS") reservation activities for both Hawthorn
Suites and Hyatt through the Spirit Reservation Center located in Omaha,
Nebraska. Persons

calling the Hyatt toll-free number who experience sold out Hyatts or no Hyatts
in their desired market are transferred to a Hawthorn Reservation Agent. There
can be no assurance that CSC and Sabre will continue to service Hawthorn Suites'
future reservation needs.

The Company acquired the right to franchise the Hawthorn brand in
March 1996, at which time there were 17 properties open or in development. The
Company has realized the following franchise sales growth over the past three
years:

AS OF DECEMBER 31,
------------------------------
1999 1998 1997
HAWTHORN SUITES FRANCHISE DATA -------- -------- --------

Properties open............................................. 100 51 26
Executed agreements and under construction................ 40 29 14
Executed agreements but not under construction............ 132 96 54
Accepted applications..................................... 70 78 17
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Total in development and accepted applications(1)........... 242 203 85
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OPEN PLUS IN DEVELOPMENT PLUS ACCEPTED APPLICATIONS......... 342 254 111
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(1) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels. During 1999, no
previously opened hotels ceased operating as a Hawthorn. Since the Company
acquired the franchise rights to the Hawthorn brand in March 1996, 32% of
accepted applications did not become executed agreements and 14% of executed
agreements terminated before resulting in open hotels. See "Risk
Factors--Dependence on, and Obstacles to, Hotel Openings."

In 1999, for properties in the Hawthorn system one year or more, average
daily rate, occupancy and Revpar was $84.52, 65.4% and $55.30, respectively.

BEST INNS & SUITES. Best Inns & Suites is primarily an economy and
mid-market hotel chain. Properties offer single, double, and in some cases suite
accommodations with limited kitchens and business services. All Best Inns
properties offer free local phone calls, complimentary breakfast, cable
television with one free movie and a sports channel or pay per view. Best Suites
provide accommodations with separate living, dining and work areas, plus a wet
bar, microwave and refrigerator, exercise room, meeting facilities and a
convenience store.

The Company acquired the Best Inns brand in April 1998, at which time there
were 38 properties open or in development. Since that time, the Company has
realized the following franchise sales growth:

AS OF
DECEMBER 31,
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1999 1998*
BEST INNS FRANCHISE DATA (inception to date) -------- --------

Properties open............................................. 119 52
Executed agreements and under construction................ 22 12
Executed agreements but not under construction............ 34 21
Accepted applications..................................... 115 142
--- ---
Total in development and accepted applications(1)........... 171 175
--- ---
OPEN PLUS IN DEVELOPMENT PLUS ACCEPTED APPLICATIONS......... 290 227
=== ===

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* The Best Inns brand was acquired on April 28, 1998.

(1) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels. During 1999,
seven previously opened hotels ceased operating as a

Best Inns. Since the Company acquired the Best Inns brand in April 1998, 60%
of accepted applications did not become executed agreements and 11% of
executed agreements terminated before resulting in open hotels. See "Risk
Factors--Dependence on, and Obstacles to, Hotel Openings."

In 1999, for properties in the Best Inns system one year or more, average
daily rate, occupancy and Revpar was $47.94, 65.4% and $31.35, respectively.

HOTEL MANAGEMENT. When the Company acquired the Best Inn brand in 1998, it
also acquired the assets of a fee-based management company. In 1999, the Company
reduced the number of properties that it manages by 17 contracts. As of
December 31, 1999, the Company managed 24 hotels for various franchisees,
including 17 properties owned by one franchisee. See "Acquisition of the
Brands-Best Inns Acquisition." and "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations--Introduction." The Company is
currently evaluating the future prospects of its management business to
determine whether to continue to offer such services in the future. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Introduction."

OPERATIONS

FRANCHISE SALES. The Company employs a national franchise sales force
consisting of approximately 50 people. The primary objectives of the Company's
franchise sales strategy are to identify potential franchisees and possible
locations for each of the Company's brands and to create an awareness and
general acceptance of its products with numerous participants in the hospitality
industry, including hotel owners, lodging consultants, vendors and operators.
The franchise sales force seeks to achieve these objectives through the
implementation of a multi-faceted sales strategy, which includes cold calling,
telemarketing, direct mail, trade advertising and public relations. In addition
to stock option grants, the compensation program is structured so that each
franchise salesperson earns 100% of his or her annual income in commissions.

DESIGN AND CONSTRUCTION. The Company's design and construction department
provides development expertise in the disciplines associated with new
construction and renovation, with emphasis on low development costs, low
maintenance expense, quality construction and profit maximization for its
franchisees. The Company provides detailed architectural plans, CAD-CAM computer
files, specifications, system standards and manuals, and makes the services of
the department available to franchisees at various stages of the development
process. In order to maintain product quality and brand identity, the design and
construction department reviews the architectural plans of its franchisee's
projects.

QUALITY ASSURANCE. Franchise quality control is accomplished through
inspections prior to a franchisee's entry into the system and on an ongoing
basis. Quality assurance programs promote consistent standards throughout each
of the Company's franchise systems. The Company inspects each property up to
twice per year. Hotels that fail to meet certain franchise standards are
notified and are generally given 30 days to either correct the conditions that
led to the failure or to implement a plan to correct the failure. If they do not
correct the deficiencies, the Company can terminate the license.

MARKETING. The Company has two distinct marketing efforts. The first is
intended to build awareness of USFS among franchisees and shareholders. The
second marketing initiative is the brand-building campaigns for Microtel, Best
Inns and Hawthorn Suites. The Company utilizes television and newspaper
advertising, newsletters (both in print and in electronic/internet formats),
direct mail, trade press advertising and special web site pages on usfsi.com,
microtelinn.com, hawthorn.com and bestinn.com, as well as direct contact by the
franchise sales organization.

CENTRAL RESERVATIONS SYSTEM. Microtel's and Best Inns' central reservations
center in Marion, Illinois utilizes the Company's FIRST reservations system,
which communicates with the hotels via the Internet. Hawthorn outsources its
central reservations operation to SPIRIT, the reservation system used by Hyatt
hotels.

CORPORATE COMMUNICATIONS. A targeted corporate communications program
supports marketing and franchise sales efforts by promoting awareness of the
Company and its brands. The Company works closely with such lodging industry
trade publications as HOTEL BUSINESS, HOTEL & MOTEL MANAGEMENT, LODGING and
BUSINESS TRAVEL NEWS. The Company also works to reach consumers and develop
storylines with such national outlets as CNN and USA TODAY, as well as daily and
business publications in local markets that regularly report on individual hotel
ground breaks and openings. To spearhead public relations at the local level,
the Company employs a public relations manager who acts as liaison with
franchisees and the local press. The manager places stories, helps plan local
public relations campaigns and special events, and publishes a monthly
newsletter for each brand.

TRAINING. The Company maintains training programs that are designed to
teach its franchisees how to best utilize the Company's reservations system and
marketing programs, as well as the fundamentals of hotel operations such as
recruiting, housekeeping, repairs and maintenance and personnel policies. The
Company also provides special on-site training upon request. In addition, each
franchise sales person must complete a structured initial training program and
regular retraining.

FRANCHISE RESOURCES. The franchise resources department functions as a
single point of contact for all franchisees to call for support on all issues
prior to, during, and after construction. Franchise resources acts as a liaison
between the franchisee and all departments of the Company.

PURCHASING. The Company has established relationships with various vendors
to make volume purchasing discounts for certain products, services, furnishings
and equipment available to its franchisees. In certain cases, the Company
receives payments from the vendors.

MANAGEMENT. The Company currently provides hotel management services to
certain franchisees. Such services include property oversight and accounting.
However, the Company recently has reduced the number of its management contracts
and there is no assurance that the Company will continue providing

such services in the future. See "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations."

FRANCHISE AGREEMENTS

The Company's franchise agreements grant hotel owners the right to utilize
one of the brand names associated with the Microtel, Hawthorn Suites or Best
Inns hotel systems under long-term franchise agreements. In order to qualify for
a franchise from the Company, a candidate must undergo a screening process,
which typically includes a review of the potential franchisee's financial
condition and the proposed lodging location. A representative of the Company
conducts a site inspection to determine whether the location meets standards and
whether the brand name selected is appropriate at that location. All of the
Company's franchise agreements offer an area of exclusivity to each location,
the degree of which is negotiated individually with each franchisee. The
Company's current standard agreements are typically 20-year terms although
actual lengths vary. The standard franchise agreements generally require
franchisees to satisfy certain development milestones.

Each franchise agreement provides for the payment of two primary types of
on-going fees: a royalty fee and a reservation and marketing fee, both of which
are based upon a percentage of the franchisee's gross room revenues. The royalty
fee is intended to cover the operating expenses of the franchisor, such as costs
incurred in providing quality assurance, administrative support and other
franchise services, and to provide the Company with operating profits. The
reservation and marketing fee is collected for administrative convenience by the
Company and remitted to independent not-for-profit reservation and marketing
corporations which exist for each of the three brands. The Company spends the
reservation and marketing funds on behalf of the franchisees for such services
as a reservation system, national advertising and certain promotional programs
(see "Reservations and Advertising Funds"). Reservation and marketing fees
collected by the Company on behalf of the three not-for-profit corporations
typically range from two (2%) percent to three (3%) percent of each franchisee's
gross room revenues per year. Franchisees also typically pay a franchise
application fee to the Company, the amount of which varies.

The terms of the Company's current standard forms of franchise agreements
state that, by year of operation, franchisees are required to pay the following
ongoing royalty fees (each, as a percentage of gross room revenues), although
actual fees may vary:

MICROTEL HAWTHORN BEST
-------- -------- --------

Year 1...................................................... 4.0% 5.0% 3.0%
Year 2...................................................... 5.0% 5.0% 4.0%
Year 3 and thereafter....................................... 6.0% 5.0% 5.0%

The Company has agreed, and may agree in the future, to offer a wide range
of incentives to various franchisees, including providing loans, development
subsidies or discounted fees. The Company's standard form of franchise agreement
is terminable by the Company if the franchisee fails to maintain certain quality
standards or to pay royalties, reservation and marketing fees or other charges.

ACQUISITION OF THE BRANDS

MICROTEL ACQUISITION. The Company acquired the Microtel brand from Hudson
Hotel Corporation ("Hudson") on October 5, 1995. As part of the purchase of the
Microtel brand, royalties are payable to Hudson as follows: 1.0% of the
"revenues subject to royalties" on the first 100 Microtel properties opened
after the closing, 0.75% of such revenues for the next 150 Microtel properties
opened, and 0.50% of such revenues for each Microtel property opened after the
first 250.

newly executed Microtel franchises open or under construction by December 31,
2001 in order to avoid being in default under the last remaining target. For
purposes of meeting this target, the 27 Microtel properties that do not pay
royalties to the Company and, if open or under construction, the additional 23
Microtel Inn properties and 10 Microtel Suites hotels that are currently
entitled to be built by certain parties without the payment of royalties to the
Company pursuant to the Microtel Acquisition Agreement, are excluded.

As of March 10, 2000, the Company had open or under construction 223
Microtel properties which counted toward satisfying the development schedule.
Therefore, from March 10, 2000 until December 31, 2001, the Company is required
to break ground on an additional 27 Microtel brand hotels in order to avoid
being in default under the Microtel Acquisition Agreement. If the Company fails
to so satisfy the development schedule, it may cure its default by making a
$1,000,000 payment to Hudson.

Upon the Company's initial public offering in 1996, the provisions of the
Microtel Acquisition Agreement which allowed Hudson the right to reacquire all
the rights to the Microtel System and all operating assets associated therewith
upon a default by the Company of its obligations under the agreement terminated
and are of no further effect. Accordingly, the Company has the exclusive right
to franchise the Microtel brand.

HAWTHORN ACQUISITION. On March 12, 1998, the Company completed a series of
transactions which enabled it to acquire the entire interest in the Hawthorn
Suites brand of hotels. The Company now has the exclusive right to franchise the
Hawthorn Suites brand of hotels and to retain 100% of the royalties derived
therefrom.

BEST INNS ACQUISITION. On April 28, 1998, the Company completed its
acquisition of the exclusive worldwide franchise rights to the Best Inns hotel
brands, including the franchise agreements for the existing Best Inns hotels. In
addition, the Company acquired management contracts and certain other assets
relating to the management of hotels on behalf of third party owners. To
facilitate the transaction, the Company made a $15 million unsecured
subordinated loan to Alpine Hospitality Ventures LLC ("Ventures") at an interest
rate of 12% per annum, interest on which will be paid in cash to the extent
available and otherwise will be paid-in-kind. The loan is subordinated to a
guarantee provided by Ventures in connection with a third-party senior loan in
the principal amount of approximately $65 million to its subsidiary that
acquired 17 Best Inns hotels in the Best Inns acquisition and is structurally
subordinated to such third party loan. In the fourth quarter of 1999, the
Company was advised that the senior lender informed Ventures of its intention to
institute a "lock-box" arrangement, thereby eliminating the payment of cash
interest to the Company while such arrangement is in place. The Company will
continue to receive interest in-kind payments, but will not include such in-kind
payments in income. In March 2000, the lock-box agreement was executed. The
Company has taken a $15.5 million reserve during the fourth quarter 1999 against
the value and accrued interest of the loan. If the senior debt is not paid
currently, certain management and franchisee fees could be deferred until cash
is available. A portion of these fees were deferred in the fourth quarter 1999.
The Company is also committed to make up to $7.5 million of additional loans to
Ventures under certain circumstances, including if required by Ventures in order
to make a capital contribution to the owner of the properties in order to
achieve compliance with certain debt service coverage ratios in order to obtain
an extension of the maturity date of the loan, or to obtain the release of a
property from the senior lender's liens in connection with a condemnation,
casualty or otherwise. No such additional loans have been made as of
December 31, 1999 but it is possible the loan, or a portion thereof, will be
required to be made in the future. The Company manages the hotels owned by the
subsidiary of Ventures. Commencing April 2001, the Company may be obligated to
reimburse the owner of the properties for as much as 90% of the management fee
if the owner's net profit for the 12-month period then ended, and each
subsequent 12-month period, falls below a specified level. If the performance of
the hotels does not materially improve by April 2001, the Company expects to
have to make a payment to the owner of the properties. In addition, the senior
lender to these properties has advised Ventures in March 2000 that it currently
has the right to require the termination of the

management contract, but is not doing so at this time. The Company also issued
to Alpine Hospitality Equities LLC ("Alpine Equities"), an affiliate of
Ventures, 350,000 shares (the "Alpine Shares") of Class A Common Stock for a
purchase price of $1.6 million. Alpine Equities was granted certain demand and
piggy-back registration rights on customary terms with respect to the Alpine
Shares, as well as certain tag-along rights on certain sales of Common Stock
made by Messrs. Leven and Aronson. Additionally, the Company agreed to pay to
Alpine Equities $1,000 per year for each hotel added to the Best Inns system
after the closing of the transaction, provided that such new hotels are paying
royalties to the Company or any of its affiliates. Richard D. Goldstein, a
director of the Company, is an Executive Vice President and a Senior Managing
Director of the general partner of Alpine Equity Partners L.P., the entity that
indirectly owns and controls a majority of Alpine Equities and Ventures.

ESTABLISHMENT OF DEVELOPMENT FUND

On March 17, 1998, NorthStar Constellation, LLC (together with its
affiliates, "NorthStar"), Lubert-Adler Real Estate Opportunity Funds (together
with its affiliates, "Lubert-Adler") and Constellation Equity Corp., an entity
controlled by NorthStar ("Constellation"), formed Constellation Development Fund
(the "Development Fund"). The Development Fund was established, in part, to
provide capital that will allow the Company to expand its Microtel and Hawthorn
Suites brands into high visibility, difficult to develop areas by providing debt
and equity financing to selected local developers. NorthStar, Lubert-Adler and
Constellation agreed to contribute to the Development Fund up to $50 million of
equity capital. On October 31, 1998 the Development Fund entered into a
$60 million senior credit facility with NationsBank, N.A. As of December 31,
1999 the Development Fund has invested in seven Microtel and two Hawthorn Suites
hotels which are in different stages of development. As of February 21, 2000,
the managers of the Development Fund agreed that no additional projects will be
commenced in the future. In connection with the establishment of the Development
Fund, the Company committed to make a loan of up to $10 million to
Constellation. Constellation will use the funds to make an investment which is
subordinated to certain debt and equity returns of investors in the Development
Fund. The loan bears interest at an annual rate of 8%, is non-recourse and is
repayable from distributions and payments made to Constellation from the
Development Fund. As of December 31, 1999, the Company had made loans of
approximately $5.7 million in the aggregate to Constellation and the Company
expects to lend approximately an additional $400,000 to Constellation in 2000.
Due to the uncertainty surrounding ultimate recoverability of the subordinated
loans, the Company is accounting for them on the cost-recovery basis, where
interest income is recorded only after recovery of principal. The Company will
be paid $3.5 million over the first five years to manage the Development Fund
and has earned $2 million of such payments as of December 31, 1999. In
connection with this transaction, the Company also sold an aggregate of 500,000
shares of Class A Common Stock to NorthStar and Lubert-Adler for $5.6 million.
Rights of Northstar and Lubert-Adler to acquire additional shares of Class A
common stock have expired. In addition, David T. Hamamoto, Co-Chief Executive
Officer of NorthStar was elected to the Board of Directors of the Company. Dean
Adler, a director of the Company, serves as a manager of Lubert-Adler, and
Mr. Adler, along with Mr. Hamamoto and Mr. Aronson, serve as managers of the
Development Fund.

THE HOTEL FRANCHISING AND LODGING INDUSTRIES

HOTEL FRANCHISING. Over the years, owners of hotels not affiliated with
regional or national lodging companies have increasingly chosen to join hotel
franchise chains. The Company and other hotel franchise chains provide a number
of services designed to directly or indirectly increase hotel occupancy rates,
revenues and profitability. The Company believes that hotel operators often view
franchise chain membership as an important means of remaining competitive with
hotels that are either owned by or affiliated with national or regional lodging
companies. In determining whether to affiliate with a franchise chain, hotel
operators will compare costs of affiliation with the incremental revenues
anticipated to be derived from chain membership, and any benefit the owner
perceives may be available with financing sources or if the hotel is sold in the
future. Costs of affiliation include capital expenditures and operating costs
required to

meet a chain's quality and operating standards, plus the ongoing payment of
franchise royalties and assessments for the reservations system and marketing
programs maintained by the franchisor.

LODGING INDUSTRY. The lodging industry has traditionally been divided into
five segments, each of which is identified by the average daily room rate
generally charged by hotel operators in the segment (the "ADR"). These
categories include, in descending order of ADR, luxury, upscale, mid-price,
economy and budget. Hotels are further segmented into limited-service and
full-service, depending on the degree of food and beverage and other services
offered, and hotels are also segmented into transient hotels, which serve short-
term guests, and extended-stay hotels, which serve guests on multiple night or
multiple week stays. The Company's franchised properties typically operate in
the budget and economy segments of the limited-service sectors through its
Microtel brand, the economy and mid-price segment through its Best Inns brand
and the upscale and mid-price segments through its Hawthorn Suites brand. In
1999, hotel owners in general were faced with a more difficult environment due
to declining occupancy rates, lower percentages of room rate increases,
increased room supply and higher interest rates. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Introduction."

COMPETITION

Competition among national brand franchisors and smaller chains in the
lodging industry to expand their franchise systems is significant. Competition
intensified in the franchising business in 1999 as new entrants that were
primarily builders or acquirors of hotels established franchising initiatives
during the year. The Company believes that competition for the sale of lodging
franchises is based principally upon (i) the name recognition and perceived
value and quality of the brand, (ii) the nature and quality of services provided
to franchisees, (iii) the franchisee's view of the relationship of building or
conversion costs and operating expenses to the potential for revenue and
profitability during operation and upon sale, (iv) the franchisee's ability to
finance and buy or sell the property, (v) the size and performance of the chain,
and (vi) the fees charged and financial assistance made available to the
franchisee. The Company's franchisees compete for guests with franchisees of,
and properties owned or operated by, other hotel chains, independent properties
and owner-operated chains. The success of the Company's franchisees affects the
profitability of the Company, as the Company's receipt of royalty fees under its
franchise agreements is tied directly to the gross room revenues earned by its
franchisees. In choosing a particular hotel, consumers consider differences in
room rates, quality and condition of accommodations, name recognition,
availability of alternative lodging (including short-term lease apartments),
service levels, reputation, safety, reservation systems and location.

Both among consumers and potential franchisees, Microtel competes with
independent hotels and regional/national brands, including but not limited to,
Comfort Inn-Registered Trademark-, Days Inn-Registered Trademark-, Econo
Lodge-Registered Trademark-, Fairfield Inn-Registered Trademark-, Sleep
Inn-Registered Trademark-, Red Roof Inn-Registered Trademark-, Budgetel
Inn-Registered Trademark-, Super 8-Registered Trademark-, Ramada
Limited-Registered Trademark-, Motel 6-Registered Trademark-, Jameson
Inns-Registered Trademark-, Travelodge-Registered Trademark-,
Thriftlodge-Registered Trademark-, Knights Inn-Registered Trademark-, Red Carpet
Inn-Registered Trademark- and Scottish Inns-Registered Trademark-. Best Inns
hotels compete for consumers and/or potential franchisees with independent
hotels and regional/ national brands, including but not limited to, Budgetel
Inn-Registered Trademark-, Comfort Inn-Registered Trademark-, Days
Inn-Registered Trademark-, Fairfield Inn-Registered Trademark-, Hampton
Inn-Registered Trademark-, La Quinta-Registered Trademark-, and Red Roof
Inn-Registered Trademark-. Hawthorn Suites properties compete for consumers
and/or potential franchisees with independent hotels and regional/national
brands, including but not limited to, Residence Inn-Registered Trademark-,
Homewood Suites-Registered Trademark-, Summerfield Suites-Registered Trademark-,
Woodfin Suites-Registered Trademark-, AmeriSuites-Registered Trademark-, Hampton
Inn and Suites-Registered Trademark-, Fairfield Suites-Registered Trademark-,
MainStay-Registered Trademark-, Candlewood-Registered Trademark-, Wingate
Inn-Registered Trademark-, Towne Place-Registered Trademark- and Courtyard by
Marriott-Registered Trademark-. Many of the Company's competitors are affiliated
with larger chains with substantially more properties, greater marketing budgets
and greater brand identity than the Company.

REGULATION

The sale of franchises is regulated by various state laws, as well as by the
Federal Trade Commission ("FTC"). The FTC requires that franchisors make
extensive disclosure to prospective franchisees, although it does not require
registration of offers to prospective franchisees. The required disclosure is

made through a Uniform Franchise Offering Circular, which must be provided to
potential franchisees at least 10 days prior to execution of a franchise
agreement. A number of states require registration and disclosure in connection
with franchise offers and sales. In addition, several states have "franchise
relationship laws" that limit the ability of franchisors to terminate franchise
agreements or to withhold consent to the renewal or transfer of these
agreements. While the Company's franchising operations have not been materially
adversely affected by such existing regulations, the Company cannot predict the
effect of any future legislation or regulation. Additionally, various federal,
state, and local laws and regulations may affect activities undertaken by the
Company in connection with the financing of franchisees. In particular, the
Company may be required to obtain a license or to register in certain states in
order to underwrite or promote loans to be made by third party lenders or to
make loans directly to franchisees.

EMPLOYEES

As of December 31, 1999 the Company and its subsidiaries employed 142 full
time and two part time employees and the three affiliated reservations and
marketing not-for-profit corporations together employed 28 full time and five
part-time employees. None of the Company's or the not-for-profit reservation and
marketing corporations' employees are represented by unions. Management
considers its employee relations to be satisfactory.

TRADEMARKS AND LICENSES

The Company either owns or has filed applications with regard to certain
trademarks and service marks, including, among others, US FRANCHISE SYSTEMS,
MICROTEL, MICROTEL with design, HAWTHORN SUITES, HAWTHORN SUITES with the tree
logo, HAWTHORN SUITES LTD. with design, BEST INNS OF AMERICA, BEST SUITES OF
AMERICA and BEST INNS & SUITES. The Company considers its marks to be material
to its business and certain of the marks are also registered with or
applications for registration are pending with various state and foreign
government agencies. The Company is not aware of any material adverse claim
concerning its owned or licensed marks, however the Company is contesting an
opposition to the registration (but not to the use) of certain Best Inns marks.
See "Item 3--Legal Proceedings."

ITEM 2. PROPERTIES.

The principal executive and administrative offices of the Company are
located at 13 Corporate Square, Suite 250, Atlanta, Georgia 30329. The Company
currently leases a total of 15,852 square feet of office space at the foregoing
address, pursuant to a lease that expires on September 30, 2005. The Company
also leases a total of 8,542 square feet of office space at 1205 Skyline Drive,
Marion, Illinois 62959 pursuant to a lease that expires on September 30, 2000.

ITEM 3. LEGAL PROCEEDINGS.

The Company is and may become party to claims and litigations that arise in
its normal course of business, including but not limited to those listed below.
In management's opinion, except for certain of the matters described below, the
outcome of any currently pending matters is not expected to have a material
adverse effect on the Company's consolidated financial statements.

Nomura Asset Capital Corporation has commenced an action against the Company
and its subsidiary seeking damages in an amount not less than $704,910. Nomura
has also asserted that it is entitled to foreclose on $432,949 in loan
participations previously funded by the Company and pledged to Nomura. The
complaint alleges, among other things, that the Company owes Nomura this amount
in connection with certain construction loans Nomura has made to the Company's
franchisees. The Company has filed a counterclaim for unspecified damages. The
Company cannot predict the outcome of this matter.

Best Western International and Cal-Vegas LP have filed notices of opposition
to the registration (but not to the use) by the Company of certain Best Inns
marks. The Company believes that the opposition rights of Cal-Vegas have
expired, and is contesting the Best Western opposition. While the Company cannot
predict the outcome of this matter, it does not believe that it will have a
material adverse effect on the Company's ability to market the Best Inns brands
or on the Company's consolidated financial statements.

The Company and certain subsidiaries are defendants in an action brought in
the United States District Court, Southern District of Illinois by the owner of
nine Best Inn properties for alleged mismanagement under management agreements
that the Company assumed in connection with its 1998 acquisition of the Best
Inns brand. USFS Management, Inc., a subsidiary of the Company, has filed a
counterclaim alleging fraudulent conduct by the owner and certain of his
affiliates. Discovery and settlement discussions are ongoing, and the Company is
opposing the claim. The amount of damages the plaintiff is seeking is
unspecified, and the Company cannot predict the outcome of this matter. The
Company believes it has meritorious defenses and is contesting this matter
vigorously.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matter was submitted during the fourth quarter ended December 31, 1999 to
a vote of security holders of the Company.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

The Company's Class A Common Stock is traded on the Nasdaq National Market
under the symbol USFS. As of March 10, 2000, there were 68 holders of record of
the Company's Class A Common Stock and 3 holders of record of the Company's
Class B Common Stock. Management of the Company believes that there are in
excess of 1,100 beneficial holders of its Class A Common Stock. The following
table shows the range of reported high and low bid prices per share of Class A
Common Stock.

1998 HIGH LOW
- ---- -------- --------

First quarter............................................... $13.63 $9.00
Second quarter.............................................. 12.75 7.63
Third quarter............................................... 7.88 3.94
Fourth quarter.............................................. 9.88 4.38

1999 HIGH LOW
- ---- -------- --------

First quarter............................................... $14.63 $8.88
Second quarter.............................................. 23.19 12.50
Third quarter............................................... 22.00 14.31
Fourth quarter.............................................. 16.88 4.25

DIVIDEND POLICY. The Company has not declared or paid any cash dividends on
its Class A or Class B Common Stock. The Company currently intends to retain any
earnings for use in its business and therefore does not anticipate paying any
cash dividends in the foreseeable future. Any future determination to pay cash
dividends will be made by the Board of Directors in light of the Company's
earnings, financial position, capital requirements and such other factors as the
Board of Directors deems relevant.

COMMITMENTS TO ISSUE SHARES. In connection with a letter agreement with
Leisure Hotel Management dated February 3, 1998, the Company has authorized the
issuance of up to $900,000 worth of shares of Class A Common Stock upon the
attainment of certain development milestones. On March 3, 2000, the Company
issued 48,290 shares of Class A Common Stock, valued at approximately $240,000,
in satisfaction of the first such milestone. The Company is also obligated to
grant options for shares of Class A Common Stock under its employee stock option
plan to certain members of the Company's franchise salesforce in the event they
achieve specified sales benchmarks in 2000.

ITEM 6. SELECTED FINANCIAL DATA.

Presented below is selected consolidated historical financial information of
the Company and its subsidiaries for the years ended December 31, 1999, 1998 and
1997, respectively. The selected financial data has been derived from the
consolidated financial statements which were audited by the Company's
independent public accountants and should be read in conjunction with the
Company's Consolidated Financial Statements (and the related notes and schedules
thereto, including Note 12, "Segment Reporting") included under "Item 8.
Financial Statements and Supplementary Data" of this Report and "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" of this Report.

SELECTED FINANCIAL DATA

YEAR ENDED DECEMBER 31,
------------------------------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 1999 1998 1997
- ----------------------------------------------- ---------- ---------- ----------

STATEMENT OF OPERATIONS DATA:
Revenues................................................. $ 19,696 $ 10,584 $ 1,867
Expenses................................................. 33,382 13,468 10,814
Net loss after tax....................................... 13,748 2,884 8,947
Loss applicable to common
Stockholders............................................. 13,748 2,884 8,947
Net loss applicable to common
Stockholders per share................................... 0.69 0.16 0.71
Weighted average common
Shares outstanding (1)................................... 19,886,030 17,670,591 12,563,772
BALANCE SHEET DATA (at period end):
Working capital.......................................... 6,348 $ 15,936 $ 12,144
Total assets............................................. 70,712 84,176 36,351
Total liabilities........................................ 13,874 14,467 32,153
Redeemable Preferred Stock (2)........................... -- --
Redeemable Common Stock.................................. 324 324 324
Stockholders' equity..................................... $ 56,514 $ 69,385 $ 3,874

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

(1) Includes 3,128,473 shares for the periods ended December 31, 1999, 1998, and
1997, respectively, of Class A Common Stock that are redeemable under
certain circumstances by the Company for reasons not under the Company's
control.

(2) On January 1, 1997, all the outstanding shares of redeemable preferred stock
were converted into $18,477,000 aggregate principal amount of 10%
subordinated debentures due September 29, 2007. The subordinated debentures
and associated interest were paid off with a portion of the proceeds from
the equity offering on May 19, 1998.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

GENERAL

This "Management's Discussion and Analysis of Financial Condition and
Results of Operations" should be read in conjunction with the consolidated
financial statements included herein of the Company and its subsidiaries.
Certain statements under this caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" constitute "forward-looking
statements" under the Reform Act. See "Special Note Regarding Forward-Looking
Statements" and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Risk Factors". Comparisons have been made
between the years ended December 31, 1999, 1998 and 1997 for the purposes of the
following discussion.

INTRODUCTION

Although 1999 was a challenging year in a number of respects, USFS recorded
record revenues, income from operations (before giving effect to certain charges
described below), franchise sales and hotel openings. The Company was profitable
on an operating basis (before giving effect to certain charges described below)
for the first time ever.

However, during 1999, the Company began to feel the effects of the
increasingly difficult environment now being encountered by some of its
franchisees. The hotel industry continues to experience declining

occupancies and percentages of room rate increases, and increases in the costs
of doing business, particularly in the limited services segment. Additionally,
hotel operators face increasing new room supply and higher interest rates. As a
result, the Company believes its franchise royalty and management fee income
suffered in 1999 due to timing delays of hotel openings and financial
performance of certain hotels. Furthermore, the Company believes that during
1999 the number of hotel companies participating in the hotel franchising
business increased. As reported in its Form 10-Q for the quarter ended
September 30, 1999, the Company is addressing this more competitive environment
by adding additional personnel in franchise services, quality, marketing and
training to provide additional support to customers which will result in higher
corporate overhead in 2000.

The effects of this more difficult and competitive environment caused the
Company to record a special charge of approximately $19.3 million in 1999. Of
the total charge, approximately $1 million relates to cash expenditures to be
made in 2000. The largest portion of the charge ($17.1 million) came from
reserves against the Company's loan portfolio, only approximately $0.4 million
of which relates to cash expenditures to be made in 2000. Of the $17.1 million
charge, $15.5 million related to reserves taken against the principal and
accrued interest on the loan made to Ventures in connection with the 1998
acquisition of the Best Inns brand. See "Item 1. Business--Acquisition of the
Brands--Best Inns Acquisition." In the fourth quarter 1999, the Company was
advised by Ventures that the senior lender to its operating subsidiary planned
to institute a "lock-box" arrangement because of the deteriorating financial
condition of the 17 hotels owned by that subsidiary. The lock-box arrangement,
which was executed in March 2000, effectively precludes the payment of cash
interest to the Company while such arrangement is in place. The Company will
continue to receive interest as in-kind payments. Based upon the current
performance level of the properties owned by the subsidiary of Ventures and the
institution of a lock-box by the senior lender, the Company concluded that the
value of the loan was impaired and therefore it was appropriate to take a
reserve against the value of the loan and the accrued interest. The Company did
not recognize the paid-in-kind interest interest income in the fourth quarter of
1999. Unless performance of these properties improves, the Company does not
intend to include in income the pay-in-kind interest related to the Ventures
loan in 2000.

To the extent that the difficult environment encountered by the Company's
franchisees during 1999 continues in 2000, the Company's royalty and management
fee revenues and profitability could be adversely affected and all or a portion
of the Company's remaining loan portfolio ($14.3 million net of $16.1 million of
reserves at December 31, 1999) could become impaired.

The difficult environment confronting hotel operators combined with the lack
of scale of the Company's hotel management operations has caused the Company to
begin to reevaluate the future prospects of its hotel management business line.
During 1999, 17 management contracts were terminated, leaving the Company with
24 contracts at December 31, 1999. As of March 10, 2000 the Company has agreed
to terminate three additional contracts, leaving the Company with 21 contracts
(including 17 with the operating subsidiary of Ventures). The Company is
currently considering various alternatives related to the remaining contracts.
Accordingly, because the Company is managing fewer properties, hotel management
revenues will decline substantially in 2000 as compared to 1999. If the Company
determines not to continue to provide management services, the Company may be
required to take a non-recurring charge related to exiting the management
business line in 2000. The amount of this charge cannot be determined at this
time.

RESULTS OF OPERATIONS

REVENUES:

The Company derived revenues from the following sources:

YEARS ENDED DECEMBER 31,
1999 1998 1997

Royalty and other fee income........................... $14,607,000 $ 7,578,000 $ 769,000
Franchise application fees............................. 5,089,000 3,006,000 1,098,000
----------- ----------- ----------
TOTAL.................................................. $19,696,000 $10,584,000 $1,867,000

1999 REVENUES COMPARED TO 1998 REVENUES

Royalty and other fee income increased $7.0 million for the year ended
December 31, 1999. The largest portion of the increase was in royalties
($5.9 million), which increased from $4.5 million to $10.4 million. This
increase resulted from an increase in the number of royalty paying hotels from
197 at the end of 1998 to 370 at the end of 1999. In addition, management
company revenues increased $0.5 million from $1.4 million to $1.9 million,
primarily due to the fact that 1998 only had a partial year of management
company results (USFS obtained management contracts on April 28, 1998 in
connection with the Best Inns acquisition). Management fee revenue is expected
to decline substantially in 2000 as discussed in the Introduction. Other fee
income increased $0.6 million primarily because of an increase in national
accounts revenue. Franchise application fees increased $2.1 million as a result
of an increase in the number of hotels opened during the year from 107 in 1998
to 182 in 1999.

1998 REVENUES COMPARED TO 1997 REVENUES

Royalty and other fee income increased $6.8 million in 1998 compared to
1997. The largest portion of the increase related to higher royalties
($4.3 million), which increased from $0.2 million to $4.5 million. This increase
resulted from the increase in the number of royalty paying hotels from 43 at the
end of 1997 to 197 at the end of 1998. In 1998, USFS began receiving hotel
management fees from third party property owners resulting from the completion
of the Best Inns acquisition on April 28, 1998. Hotel management fees were
$1.4 million in 1998. Other fee income increased $1.1 million due primarily to
the first year of management fees from Constellation Development Fund
($1.0 million) which was formed in March 1998. Franchise application fees
increased $1.9 million, as a result of an increase in the number of hotels
opened during the year from 42 in 1997 to 107 in 1998.

EXPENSES:

The Company's expenses are in the following areas:

YEARS ENDED DECEMBER 31,
1999 1998 1997

General and administrative............................ $12,175,000 $11,590,000 $ 9,083,000
Franchise sales commissions........................... 4,878,000 2,216,000 641,000
Depreciation and amortization......................... 1,677,000 1,393,000 571,000
Interest income....................................... (2,469,000) (2,493,000) (1,386,000)
Interest expense...................................... 762,000 1,905,000
Bad debt reserve...................................... 17,121,000 -- --
TOTAL EXPENSES........................................ $33,382,000 $13,468,000 $10,814,000

1999 EXPENSES COMPARED TO 1998 EXPENSES

Total expenses increased $19.9 million from 1998 to 1999. In 1999, total
expenses included approximately $19.3 million of special charges, $17.1 million
of which related to bad debt reserves (only approximately $0.4 million of which
relates to cash expenditures to be made in 2000), $1.4 million of which was in
general and administrative expenses and $0.6 million of which was in commission
expense. Excluding such charges, total expenses increased $0.6 million from
$13.5 million in 1998 to $14.1 million in 1999.

Excluding $1.4 million of the charges recorded in 1999, general and
administrative expenses otherwise decreased $0.8 million from $11.6 million in
1998 to $10.8 million in 1999. The primary reasons for this decline include:
(i) a reduction of approximately $0.4 million in compensation expense resulting
primarily from the change to a completely incentive-based plan for senior sales
personnel; (ii) a reduction in professional fees of approximately $0.2 million;
(iii) a reversal of approximately $0.2 million of a reserve taken in a previous
year in anticipation of a move to a new office space that was no longer required
after the Company executed an addendum to the lease for its existing office
space in July 1999, and (iv) lower marketing expenses of approximately
$0.4 million. This decline was partially offset by a $0.4 million increase in
general and administrative expenses related to the management business line.
Expenses associated with the management business line increased from
$0.9 million in 1998 to $1.3 million in 1999 primarily as a result of a full
year of operations in 1999 compared to 1998.

The $1.4 million of special charges included in general and administrative
expenses includes: (i) approximately $0.5 million related to the deposit
forfeiture and associated expenses resulting from the abandonment of the
proposed acquisition by the Company of an existing Hawthorn Suites hotel in
Atlanta, Georgia; (ii) a reserve of approximately $0.3 million related primarily
to the improvements associated with a parcel of land held for resale;
(iii) approximately $0.3 million related to various legal expenses, the primary
portion of which related to the disposition of a dispute over development fees
owed to a builder for two hotels built on behalf of the Company; and
(iv) approximately $0.3 million of other charges.

Franchise sales commissions increased $2.7 million primarily due to the
increased number of hotel openings in 1999 compared to 1998. Commission expense
for 1999 includes a net commission adjustment of approximately $0.6 million
primarily related to a non-recurring charge for license agreements defaulted due
to noncompliance with agreed upon milestones and a change in commissions for
executive management.

Depreciation and amortization expense increased approximately $0.3 million
for the year ended December 31, 1998 primarily due to increased amortization
related to issuance of development subsidies.

Interest income was substantially similar in 1999 and 1998. The Company did
not record pay-in-kind interest related to the loan to Ventures in the fourth
quarter of 1999, and does not expect to recognize pay-in-kind interest in 2000.
Therefore, interest income is expected to decline in 2000 compared to 1999.

Bad debt reserves increased by approximately $17.1 million in 1999 due
primarily to a $15.5 million reserve taken against the principal amount and
accrued interest of the note to Ventures and a $1.6 million reserve taken
against termination of the Nomura loan program and various monies due from
franchisees.

In May 1998, the Company repaid all outstanding debt with proceeds from its
common stock offering. Therefore, interest expense declined by $0.8 million in
1999 compared to 1998.

1998 EXPENSES COMPARED TO 1997 EXPENSES

Expenses increased approximately $2.7 million in 1998 compared to 1997.

General and administrative expenses increased $2.5 million in 1998 compared
to 1997, the largest portions of which are: (i) the addition of a management
company (approximately $0.9 million) due to the addition of the management
business on April 28, 1998 in connection with the Best Inn Acquisition,
(ii) additional salaries and wage-related costs pertaining to the increased
number of executed and open hotels (approximately $0.7 million), and
(iii) increased travel expenses (approximately $0.5 million) and (iv) increased
administrative expenses and other external advisory services (approximately
$0.4 million).

Franchise sales commissions increased $1.6 million due to the increased
number of hotel openings in 1998 compared to 1997.

Depreciation and amortization expense increased $0.8 million in 1998
compared to 1997 primarily due to (i) increased amortization related to the
acquisitions of the Hawthorn and Best Inns brands (approximately $0.6 million)
and (ii) increased depreciation due to the implementation of a new reservation
system, computers and related business equipment (approximately $0.2 million).

Interest income increased $1.1 million primarily due to additional loans to
franchisees and interest earned on the cash proceeds from the Company's
May 1998 equity offering. Interest expense decreased $1.1 million due to the
payoff of the Company's outstanding indebtedness in connection with the
May 1998 equity offering.

NET LOSS--A summary of operating results is as follows:

YEARS ENDED DECEMBER 31,
1999 1998 1997

Loss after taxes...................................... ($13,748,000) ($2,884,000) ($8,947,000)
Loss applicable to common stockholders................ ($13,748,000) ($2,884,000) ($8,947,000)

1999 NET LOSS COMPARED 1998 NET LOSS

The Company's net loss increased by $10.9 million in 1999 compared to 1998.
Excluding the $19.3 million in special charges in 1999, the Company earned net
profits from operations of approximately $5.5 in 1999 compared to a net loss
from operations of $2.9 million in 1998 representing an improvement of
approximately $8.4 million compared to 1998. The increase in profit from
operations is due primarily to the number of hotel openings and operating hotels
resulting in increased application fees and royalty revenues, various management
fees, and a reduction in interest expense due to the pay-off of the Company's
outstanding indebtedness in 1998. The Company had accumulated net operating loss
carry-forwards for income tax purposes of $12.7 million and $13.9 million as of
December 31, 1999 and 1998, respectively. Given the uncertainty regarding
eventual use of the carry-forward due to the limited operating history of the
Company, management recorded a valuation allowance for the full amount of the
deferred tax asset as of December 31, 1999.

1998 NET LOSS COMPARED TO 1997 NET LOSS

The Company's net loss decreased by $6.1 million during 1998 primarily due
to the increased number of hotel openings and operating hotels resulting in
increased application fees and royalty revenues, various management fees, a
reduction in interest expense due to the pay-off of the Company's outstanding
indebtedness and an increase in interest income. The Company had accumulated net
operating loss carry-forwards for income tax purposes of $13.9 million and
$11.5 million as of December 31, 1998 and 1997, respectively. Given the
uncertainty regarding eventual use of the carry-forward due to the limited
operating history of the Company, management recorded a valuation allowance for
the full amount of the deferred tax asset as of December 31, 1998.

LIQUIDITY AND CAPITAL RESOURCES

On October 24, 1996, the Company completed a public offering of 1,825,000
shares of Class A Common Stock at $13.50 per share. Net proceeds were
approximately $21 million, all of which have been spent by the Company.

On May 19, 1998, the Company completed a public offering of 4,250,000 shares
of Class A Common Stock at $10.50 per share. The Company received net proceeds
of approximately $41 million, of which approximately $30 million was used to
repay all of its outstanding indebtedness, including all principal and accrued
interest. The remaining $11 million was held either as cash or cash equivalents
to be used for working capital and general corporate purposes. Cash and cash
equivalents were $6.3 million as of

December 31, 1999. In management's opinion, based on the Company's current
operations, the Company's capital resources, including its cash on hand and
borrowing capability, are sufficient to fund operations for the next 12 months.

In connection with the establishment of the Development Fund (see "Item 1.
Business--Development Fund"), the Company committed to make a loan of up to
$10 million to Constellation. Constellation will use the funds to make an
investment which is subordinated to certain debt and equity returns of investors
in the Development Fund. The loan bears interest at an annual rate of 8%, is
non-recourse and is repayable from distributions and payments made to
Constellation from the Development Fund. As of December 31, 1999, the Company
had made loans of approximately $5.7 million in the aggregate to Constellation,
and expects to lend approximately an additional $400,000 to Constellation. Due
to the uncertainty surrounding ultimate recoverability of the subordinated
loans, the Company is accounting for them on the cost-recovery basis, where
interest income is recorded only after recovery of principal. In addition, the
Company sold an aggregate of 500,000 shares of Class A Common Stock to NorthStar
and Lubert-Adler for $5.6 million. Rights of NorthStar and Lubert-Adler to
acquire additional shares of Class A common stock have expired. The Company will
be paid $3.5 million over the first five years to manage the Development Fund
and has earned $2 million of such payments as of December 31, 1999.

In connection with the Best Inns Acquisition (see "Item 1.
Business--Acquisition of the Brands-Best Inns Acquisition"), the Company made a
$15 million unsecured subordinated loan to Ventures at an interest rate of 12%
per annum, interest on which will be paid in cash to the extent available and
otherwise will be paid-in-kind. The loan is subordinated to a guarantee provided
by Ventures in connection with a third-party senior loan in the principal amount
of approximately $65 million to its subsidiary that acquired 17 Best Inns hotels
in the Best Inns acquisition and is structurally subordinated to such third
party loan. In the fourth quarter 1999, the Company was advised that the senior
lender informed Ventures of its intention to institute a "lock-box" arrangement,
thereby eliminating the payment of cash interest to the Company while such
arrangement is in place. The Company will continue to receive interest in-kind
payments but will not include such in-kind payments in income. In March 2000,
the lock-box agreement was executed. The Company has taken a $15.5 million
reserve during the fourth quarter 1999 against the loan and accrued interest. If
the senior debt is not paid currently, certain management and franchisee fees
could be deferred until cash is available. A portion of these fees were deferred
in the fourth quarter 1999. The Company also committed to make up to
$7.5 million of additional loans to Ventures under certain circumstances,
including if required by Ventures in order to make a capital contribution to the
owner of the properties in order to achieve compliance with certain debt service
coverage ratios in order to obtain an extension of the maturity date of the
loan, or to obtain the release of a property from the senior lender's liens in
connection with a condemnation, casualty or otherwise. No such additional loans
have been made as of December 31, 1999, but it is possible the loan, or a
portion thereof, will be required to be made in the future. The Company manages
the hotels owned by the subsidiary of Ventures. Commencing April 2001, the
Company may be obligated to reimburse the owner of the properties for as much as
90% of the management fee if the owner's net profit for the 12-month period then
ended, and each subsequent 12-month period, falls below a specific level. If the
performance of the hotels does not materially improve by April 2001, the Company
expects to have to make a payment to the owner of the properties. In addition,
the senior lender to these properties has advised Ventures in March 2000 that it
currently has the right to require the termination of the management contract,
but is not doing so at this time. The Company also issued to Alpine Equities, an
affiliate of Ventures, 350,000 shares of Class A Common Stock for a purchase
price of $1.6 million. Additionally, the Company agreed to pay to Alpine
Equities $1,000 per year for each hotel added to the Best Inns system after the
closing of the transaction, provided that such new hotels are paying royalties
to the Company or any of its affiliates.

The Company currently has no outstanding lines of credit in place. The
Company currently uses cash and its own stock as its primary capital resource.

For the year ended December 31, 1999, the Company had a net loss of
$13.7 million. The net cash used in operating activities was $0.3 million. The
net use of cash was primarily in accounts receivable, prepaid expenses and
deposits. Net cash used was partially offset by cash inflows of application fees
for executed franchise agreements, depreciation and amortization, non-cash
compensation cost related to the Company's employee stock option plans and
increases in accrued expenses.

For the year ended December 31, 1998, the Company had a net loss of
$2.9 million. The net cash used in operating activities was $11.6 million. The
net use of cash was primarily a result of increases in promissory notes
receivable related to the application fees on executed franchise agreements,
increases in deferred commissions paid to salesmen for executed franchise
agreements, and increases in loans to franchisees. Net cash used was partially
offset by cash inflows of application fees for executed franchise agreements,
depreciation and amortization, non-cash compensation cost related to the
Company's employee stock option plans and increases in commissions payable.

For the year ended December 31, 1999, net cash used in investing activities
was $9.5 million which was primarily a result of the issuance of development
subsidies to franchisees and loans to Constellation Development Fund.

For the year ended December 31, 1998, net cash used in investing activities
was $17.0 million which was primarily a result of the issuance of the previously
discussed long term notes receivable, issuance of development subsidies to
franchisees, acquisition of property and equipment and acquisition of franchise
rights.

For the year ended December 31, 1999, net cash provided by financing
activities was $0.2 million resulting from the exercise of stock options.

For the year ended December 31, 1998, net cash provided by financing
activities was $28.8 million which was a result of the issuance of common stock,
partially offset by repayment of the Company's outstanding indebtedness.

YEAR 2000 COMPUTER MATTER.

The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions or customer
reservations or engage in similar normal business activities. The Company has
devoted substantial resources and time to analyzing and remediating Year 2000
Issues that are within the Company's control that may significantly impact the
Company's operations. Based on these efforts, the Company has experienced no
material disruptions or adverse effects due to Year 2000 issues and management
believes that the Year 2000 Issue will not pose material operational problems
for its computer systems and does not expect that any remaining costs of
compliance will have a materially adverse impact on the results of operations
during any quarterly or annual reporting period. The Company does not believe
that its operations and systems are vulnerable to those third parties' failure
to remediate their own Year 2000 Issues. There can be no guarantee that the
systems of other companies on which the Company's operations and systems rely
will not have an adverse effect in the Company's systems or results of
operations. There can be no assurances that circumstances will not arise in the
future that will require management to take action in addition to what has
already been performed on the Year 2000 Issues.

SEASONALITY.

Royalties generated by gross room revenues of franchised properties are
expected to be the largest source of revenue for the Company for the immediate
future. The Company expects to experience seasonal revenue patterns similar to
those experienced by the lodging industry generally. The summer

months, because of increase in leisure travel, are expected to produce higher
revenues for the Company than other periods. Accordingly, the Company may
experience lower revenues and profits in the first and fourth quarters and
higher revenues and profits in the second and third quarters.

INFLATION.

The rate of inflation has not had a material effect on the revenues or
operating results of the Company since its inception.

RESERVATIONS AND ADVERTISING FUNDS

During 1998, the Company created independent reservations and advertising
not-for-profit corporations owned by its franchisees (the "Funds") for the
purpose of collecting and disbursing reservations and advertising fees related
to the Microtel and Hawthorn brands. In connection with the creation of the
Funds, the Company ceased reporting reservations and advertising fees and
expenses related to these Funds within its consolidated financial statements
effective April 1, 1998. Any deficits arising from reservations and advertising
operations for quarterly periods prior to April 1, 1998 have been included in
general and administrative expenses. The Company manages the reservations and
advertising programs on behalf of the Funds, and has made interest-bearing loans
at 8.5% in aggregate principal amounts, net of reserves, of approximately
$1.0 million to the Microtel Fund to supplement reservation, advertising, and
promotional efforts, and may make additional loans in the future. The Company
also administers reservations and advertising programs on behalf of Best Inns
franchisees by virtue of its management of Best Reservations Corp., an Illinois
not-for-profit corporation and has made interest-bearing loans at 8.5% in
aggregate principal amounts of approximately $0.8 million to Best Reservation
Corp. as of December 31, 1999, and may make additional loans in the future.

RISK FACTORS

In evaluating the Company and its business, the following risks should be
considered. These are not the only risks the Company faces. Some risks are not
yet known to the Company and others that the Company does not consider material
but could later turn out to be so. All of these risks could adversely affect the
Company's business:

MANAGEMENT OF GROWTH

The Company has experienced rapid growth in the number of its employees and
the scope of its operations since its inception. This growth has resulted in,
and is expected to continue to create, new and increased responsibilities for
management personnel, as well as added demands on the Company's operating and
financial systems. The Company's success will depend on its ability to manage
this growth while implementing its strategy. The efforts of key management
personnel and the Company's ability to attract or develop new management
personnel and to integrate these new employees into its overall operations will
be crucial to continued growth. The recent aggressive competition in the
franchise business has made it more difficult and more costly to attract
qualified personnel. If the Company is unable to manage growth effectively, the
Company's business and results of operations could be materially and adversely
affected.

DEPENDENCE ON, AND OBSTACLES TO, HOTEL OPENINGS

The Company expects that in the future its principal source of revenue will
be franchise fees received from its franchisees. Accordingly, future revenues
will be highly dependent on the timing and the number of open hotels and their
gross room revenues. There are numerous factors beyond the control of the
Company which affect the probability and timing of a hotel opening and the
ability or desire for a hotel to stay in the Company's franchise system. These
factors include, but are not limited to, the ability of a

potential hotel owner to (i) secure adequate financing or satisfy financing
payments during the construction period; (ii) locate an appropriate site of a
hotel; (iii) obtain all necessary state and local construction, occupancy or
other permits and approvals; (iv) obtain necessary construction materials; and
(v) reach a satisfactory level of profitability at the hotel. Under industry and
general economic conditions that prevailed in 1999 and that are expected to
continue in 2000, hotel developers have had and may continue to have difficulty
accessing needed capital and attaining satisfactory levels of profitability. As
a result, the number and timing of franchised hotel openings, and accordingly
the Company's franchise fees, could be adversely affected if current conditions
do not improve. Additionally, there can be no assurance that accepted franchise
applications will result in executed franchise agreements or that executed
franchise agreements will result in open properties. Deteriorating conditions in
the lodging industry can be expected to adversely affect the likelihood that
properties in development will open on a timely basis or at all.

LIMITED OPERATING HISTORY; NET LOSSES; OUR RESULTS FLUCTUATE AND THESE
FLUCTUATIONS CAN BE UNPREDICTABLE

The Company began operating in October 1995 and therefore has a limited
operating history upon which investors can evaluate its performance. While the
Company was profitable during the first three quarters of 1999, the Company
incurred significant charges in the fourth quarter of 1999 that resulted in a
net loss for the year. There can be no assurance that the Company will be
profitable in the future. Additionally, events outside our control, including
those set forth in other risk factors, may cause the Company to experience
fluctuations in revenues and operating results. As a result, the Company's
future results may be below market expectations, including the expectations of
financial analysts and investors. A failure to meet such expectations may
adversely affect the trading price of the Company's Class A Common Stock.

MANAGEMENT, BY VIRTUE OF OWNERSHIP OF SUPERVOTING CLASS B COMMON STOCK, CONTROLS
THE COMPANY

Holders of Class A Common Stock are entitled to one vote per share and
holders of Class B Common Stock are entitled to ten votes per share. Each share
of Class B Common Stock is convertible at any time into one share of the
Class A Common Stock and, with limited exceptions, will convert automatically
upon any transfer thereof. Michael A. Leven, Chairman, President and Chief
Executive Officer, and Neal K. Aronson, Executive Vice President and Chief
Financial Officer, have the right to vote all of the outstanding shares of
Class B Common Stock, which, together with shares of Class A Common Stock which
they beneficially own (including stock held by other members of management),
represent approximately 65% of the combined voting power of the Company's
outstanding Common Stock. By reason of their right to vote the Class B Common
Stock, Messrs. Leven and Aronson will be able to (i) elect all of the Company's
directors (except as otherwise contractually provided), (ii) amend the Charter
with respect to most matters, (iii) effect a merger, sale or other major
corporate transaction, (iv) defeat any unsolicited takeover attempt and
(v) generally direct the affairs of the Company (including in a manner that may
benefit themselves disproportionately relative to other shareholders).

SUCCESSFUL COMPLETION AND INTEGRATION OF ACQUISITIONS

One element of the Company's business strategy is to continuously evaluate
acquisitions and business combinations. These acquisitions may be of brands in
the lodging industry or in other industries, or of businesses that the Company
does not expect to franchise, which would require the Company to develop
expertise in areas that it does not currently operate. There can be no assurance
that the Company will identify and complete suitable acquisitions or if
completed, that such acquisitions will be successfully integrated. The Company
did not engage in any such transaction in 1999. Acquisitions involve numerous
risks, including difficulties assimilating new operations and brands. There can
be no assurance that any

acquisitions would result in long-term benefits to the Company or that
management would be able to manage effectively the resulting business.

DEPENDENCE ON SENIOR MANAGEMENT

The success of the Company is largely dependent on the efforts and abilities
of its senior management and certain other key personnel, particularly
Messrs. Leven, Aronson and Steve Romaniello, Executive Vice President-Franchise
Sales and Administration. The Company's success will depend in large part on its
ability to retain these individuals and other current members of its senior
management team and to attract and retain qualified personnel in the future. The
loss of members of senior management or of certain other key employees or the
Company's inability to retain and attract other qualified employees could have
an adverse impact on the Company's business and results of operations. Certain
franchise agreements have stipulations which allow franchisees to exit without
penalty if certain members of management are no longer affiliated with the
Company. The Company does not maintain key person life insurance on behalf of
the lives of any of its officers or employees.

COMPETITION FOR NEW FRANCHISE PROPERTIES AND HOTEL GUESTS

Competition among national brand franchisers and smaller chains in the
lodging industry to grow their franchise systems is fierce and intensified
during 1999. During 1999, an increasing number of hotel companies announced new
franchise initiatives. As a result, the Company believes there has been a marked
increase in franchise sales personnel throughout the lodging industry and more
aggressive financial incentives are being offered to hotel owners and
developers. Many of the Company's competitors are affiliated with larger chains
with substantially more properties, greater marketing budgets and greater brand
identity than the Company and its brands. There can be no assurance that the
Company can franchise a sufficient number of properties to generate operating
efficiencies that will enable it to compete with these larger chains. See
"Business--Competition."

GENERAL RISKS OF THE LODGING INDUSTRY

The Company is exposed to general risks of the lodging industry in a number
of ways. First, as a franchiser and manager, the Company's franchise royalty and
management fee revenues vary directly with its franchisees' gross room revenues.
As a result, the Company's franchise and management businesses are, and will be,
affected by risks experienced by hotel operators generally. In fact, because of
factors adversely affecting the lodging industry such as lower occupancy rates,
lower percentages of daily rate growth, higher interest rates and increased room
supply competition, the Company is currently evaluating the future prospects of
its management business to determine whether to continue to offer management
services. Second, to the extent the Company directly or indirectly makes equity
or debt investments in hotel properties, those investments will be subject to
the risks experienced by the underlying properties. Third, the Company may
directly acquire ownership interests in its branded hotel properties in order to
promote the brand or for other reasons. To the extent that the Company owns or
leases hotel properties, it will be subjected to the risks of a hotel operator.

The segments in which hotels franchised under the Company's brands currently
operate or plan to operate, may be adversely affected by changes in national or
local economic conditions and other local market conditions, such as an
oversupply of or a reduction in demand for lodging or a scarcity of potential
sites in a geographic area, changes in travel patterns, extreme weather
conditions, changes in governmental regulations that influence or determine
wages, prices, construction costs or methods of operation, changes in interest
rates, the availability of financing, and changes in real estate tax rates and
other operating expenses. In addition, due in part to the strong correlation
between the lodging industry's performance and economic conditions, the lodging
industry is subject to cyclical changes in revenues and profits. In fact, the
Company believes that hotel operators were negatively affected during 1999 by
increased room supply, weaker room demand and higher interest rates, among other
things. These risks may have been exacerbated by the relatively illiquid nature
of real estate holdings.

Downturns or prolonged adverse conditions in real estate or capital markets
or in national or local economies could have a material adverse impact on the
Company's ability to locate new franchisees, the timing of new hotel openings,
the number of rooms at newly-opened hotels, and the amount of royalty and
management fee income earned by the Company and could result in the cancellation
of the Company's franchise agreements and management contracts and increase
risks of impairment on loans or other investments made by the Company directly
or indirectly to or in franchisees and developers and potential deferral or loss
of the interest income associated with such potential write-offs. In fact,
during 1999, 12 of the Company's franchised hotels left their respective systems
and 17 of the Company's management contracts were terminated. In addition to the
aforementioned risks, the Company's current and potential future investments in
or ownership of hotel properties creates a risk of decreased earnings due to
losses related to start-up expenses or ongoing losses due to shortfalls in
expected performance of a hotel. In addition, any guaranty required to secure
construction or permanent loan financing could adversely affect the Company's
financial condition.

The Company expects to experience seasonal revenue patterns similar to those
experienced by participants in the lodging industry generally. Accordingly, the
summer months, because of increases in leisure travel, are expected to produce
higher revenues for the Company than other periods during the year.

DEVELOPMENT AND OWNERSHIP RISK

The Company's success depends upon the development or conversion and opening
of hotels. As a result, it is subject to risks experienced by hotel developers.
These risks, which are applicable to Microtels as new construction properties,
and to Hawthorn and Best Inns as both new construction and conversion
properties, include delays in the commencement or completion of construction,
failure to obtain all necessary zoning and construction permits, discovery of
environmental hazards, unavailability of financing on favorable terms, if at
all, the failure of developed properties to achieve desired revenue or
profitability levels once opened, competition for suitable development sites
from competing franchise chains, the risk of incurring substantial costs in the
event a development project must be abandoned prior to completion, changes in
governmental rules, regulations and interpretations and general economic and
business conditions. The Company's revenues may also be adversely affected by
increases in interest rates, which could increase the costs of financing new
hotel construction or the conversion of existing hotels. Any one of these risks
could discourage or prohibit potential franchisees from beginning or completing
hotel projects or harm the profitability of an open hotel, which could result in
the termination of franchise agreements and management contracts.

If the Company leases and/or owns hotel properties or makes, directly or
indirectly, equity or debt investments in hotel properties, it would be subject
to risks experienced by hotel operators generally. The Company recently incurred
costs of approximately $0.5 million in connection with its abandoned purchase of
a Hawthorn Suites property, representing a portion of a forfeited deposit and
transaction costs.

RISKS RELATING TO THE FINANCING OF FRANCHISEES

The Company participates, from time to time, in construction loans, equity
investments, and long-term mortgage loans made to franchisees. In particular,
the Company has committed to lend up to $10 million to Constellation Equity
Corp. ("Constellation") to be invested by Constellation in Constellation
Development Fund, LLC (the "Development Fund") and to be used by the Development
Fund to provide debt and equity financing to selected developers. As of
December 31, 1999, the Company has loaned approximately $5.7 million in the
aggregate to Constellation and expects to loan approximately an additional
$400,000 to Constellation in 2000. The loan to Constellation is subordinated to
returns of other members. If such returns are not met, this loan could be
jeopardized. Due to the uncertainty surrounding the ultimate recoverability of
the subordinated loan, the Company is accounting for them on a cost-recovery
basis, where interest income is recorded only after recovery of principal. As of
December 31,

1999, the Development Fund has invested in seven Microtels and two Hawthorn
Suites hotels which are in different stages of development. As of February 21,
2000 the managers of the Development Fund agreed that no additional projects
will be commenced in the future. In addition, the Company made a $15 million
unsecured subordinated loan to Alpine Hospitality Ventures LLC ("Ventures") in
connection with the Best Inns acquisition at an interest rate of 12% per annum,
interest on which will be paid in cash to the extent available and otherwise to
be paid in-kind. The loan is subordinated to a guaranty provided by Ventures in
connection with a third party senior loan in the principal amount of
approximately $65 million to its subsidiary that acquired 17 Best Inns hotels in
the Best Inns transaction and is structurally subordinated to such third party
loan. The Company is also committed to make additional loans of up to
$7.5 million to Ventures under certain circumstances. No such additional loans
were made as of December 31, 1999, but it is possible that the loan, or a
portion thereof, will be required to be made in the future. Each of Ventures and
Constellation is a highly leveraged entity and there can be no assurances that
any loans to Ventures or Constellation will be repaid. In the fourth quarter
1999, the Company was advised by Ventures that the senior lender to its
operating subsidiary planned to institute a "lock-box" arrangement because of
the deteriorating financial condition of the operating subsidiary. In
March 2000, the lock-box agreement was executed. The lock-box arrangement
effectively precludes the payment of cash interest to the Company while such
arrangement is in place. The Company will continue to receive interest in-kind
payments but will not include such in-kind payments in income. Recognition of
such in-kind payments as income is dependent upon the amount of underlying
property values of the borrower, relative to other lenders and shareholders.
There can be no assurance that those values will continue to be sufficient to
permit the Company to continue to record such interest income and, in fact, no
such income has been recognized by the Company in the fourth quarter 1999, and
the Company does not currently expect to record income in 2000. In fact, the
Company has taken a reserve of approximately $15.5 million associated with the
principal and accrued interest of the loan.

The Company has also made various loans and advances to individual
franchisees, the reservation and marketing funds for the Microtel and Best Inns
brands, and loan participations in a financing program with Nomura Asset Capital
Corp. See "Item 3. Legal Proceedings" for a discussion of a pending litigation
concerning these loan participations. The Company is subject to the risks
experienced by lenders generally, including risks of franchisee/borrower
defaults and bankruptcies. Among other things, the ability of the borrowers to
repay these loans will be affected by the factors discussed under "General Risks
of the Lodging Industry" and "Development and Ownership Risk." The failure of a
borrower to pay interest could have a material adverse effect on the Company's
results of operations. In the event of default under such loans, the Company, as
a lender, would bear the risk of loss of principal to the extent the value of
the collateral was not sufficient to pay lenders, which may be more senior in
the capital structure. As of December 31, 1999, in addition to the loans to
Ventures and Constellation, the Company had outstanding loans made to borrowers
of approximately $8.6 million aggregate principal amount (net of approximately
$1.1 million of reserves). If the financial condition of the borrowers of these
loans were to worsen, the loans could be deemed to be impaired, which could
result in a significant charge to the Company and future interest income related
to these loans could be deferred or eliminated which could have a materially
adverse effect on future income. In connection with equity investments, the
Company would be subject to risks as an equity investor. See
"Business--Regulation."

REGULATION

The sale of franchises is regulated by various state laws, as well as by the
FTC. To the extent that the Company manages, owns or leases hotel properties, it
will be subject to additional governmental regulations. For example, owners and
operators of hotels are subject to numerous federal, state and local government
regulations, including those relating to the preparation and sale of food and
beverages (such as health and liquor license laws) and building and zoning
requirements. Under the Americans with Disabilities Act of 1990 (the "ADA"), all
public accommodations are required to meet certain federal requirements related
to access and use by disabled persons. The determination that hotels owned,

managed or leased by the Company are not in compliance with the ADA could result
in the imposition of fines, and award of damages to private litigants or
significant expense to the Company in bringing these hotels into compliance.
Additionally, various national, state and local laws and regulations may affect
activities undertaken by the Company in connection with providing financing to
franchisees. In particular, the Company may be required to obtain a license or
to register in certain states in order to arrange loans to be made to
franchisees. See "Business--Regulation."

DEPENDENCE ON SPIRIT RESERVATION SYSTEM

Franchisees of the Hawthorn brand open one year or greater derived
approximately 21% of their reservations through the Spirit Reservation System,
which is operated under contract with Hyatt Hotels Corporation by CSC
Outsourcing, Inc. ("CSC") and Sabre Technology Solutions ("Sabre"). There can be
no assurance that CSC and Sabre will continue to service Hawthorn Suites'
reservations needs in the future. See "Business--The Company's Lodging Franchise
Systems--Hawthorn Suites".

ABSENCE OF DIVIDENDS

The Company has not paid a dividend on its Common Stock since its inception.
The Company intends to retain any earnings to finance its growth and for general
corporate purposes and therefore does not anticipate paying any cash dividends
in the foreseeable future. See "Dividend Policy". In addition, future financing
agreements may contain limitations on the payment of cash dividends or other
distributions of assets to the holders of Common Stock.

ANTI-TAKEOVER DEVICES

Certain identical provisions of the Certificate of Incorporation and the
By-laws of the Company may be deemed to have anti-takeover effects and may
delay, deter or prevent a change in control of the Company that stockholders
might otherwise consider in their best interests. These provisions (i) allow
only the Board of Directors, the Chairman of the Board of Directors or the Chief
Executive Officer of the Company to call special meetings of the stockholders,
(ii) eliminate the ability of stockholders to take any action without a meeting,
(iii) establish certain advance notice procedures for nomination of candidates
for election as directors and for stockholder proposals to be considered at
stockholders' meeting, (iv) generally authorize the issuance of one or more
classes of "blank check" preferred stock, with such designations, rights and
preferences as may be determined from time to time by the Board of Directors,
(v) require approval of holders of 75% of the outstanding Class B Common Stock
for the Board of Directors to create a series of Preferred Stock with general
voting rights or with the right to elect a majority of directors under any
circumstances and (vi) require approval of holders of 75% of the outstanding
voting power to amend or repeal items (i), (ii) or (v) above or this item (vi).

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

PAGE
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CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1999
AND 1998 AND FOR THE THREE YEARS ENDED DECEMBER 31, 1999:

Independent Auditors' Report.............................. 30

Consolidated Statements of Financial Position............. 31

Consolidated Statements of Operations..................... 32

Consolidated Statements of Stockholders' Equity........... 33

Consolidated Statements of Cash Flows..................... 34

Notes to Consolidated Financial Statements................ 35

INDEPENDENT AUDITORS' REPORT

Board of Directors and Stockholders
U.S. Franchise Systems, Inc.:

We have audited the accompanying consolidated statements of financial
position of U.S. Franchise Systems, Inc. and subsidiaries (the "Company") as of
December 31, 1999 and 1998 and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for the three years
ended December 31, 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 the Company at December 31,
1999 and 1998 and the results of its operations and its cash flows for the three
years ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States of America.

/s/ Deloitte & Touche LLP

Atlanta, Georgia
March 14, 2000

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

DECEMBER 31, DECEMBER 31,
1999 1998
------------ ------------

ASSETS
CURRENT ASSETS
Cash and temporary cash investments....................... $ 6,339,000 $ 15,966,000
Accounts receivable--Net.................................. 2,315,000 2,108,000
Deposits and prepaid expenses............................. 536,000 315,000
Promissory notes receivable............................... 1,898,000 980,000
Deferred commissions...................................... 2,564,000 1,754,000
------------ ------------
TOTAL CURRENT ASSETS.................................. 13,652,000 21,123,000
PROMISSORY NOTES RECEIVABLE................................. 12,369,000 24,667,000
PROPERTY AND EQUIPMENT--Net................................. 2,141,000 3,396,000
FRANCHISE RIGHTS--Net....................................... 24,691,000 25,490,000
DEFERRED COMMISSIONS........................................ 6,525,000 7,215,000
DEVELOPMENT SUBSIDIES--Net.................................. 10,837,000 1,263,000
OTHER ASSETS--Net........................................... 497,000 1,022,000
------------ ------------
TOTAL ASSETS.......................................... $ 70,712,000 $ 84,176,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 227,000 $ 498,000
Commissions payable....................................... 1,516,000 1,464,000
Deferred application fees................................. 3,686,000 1,973,000
Accrued expenses.......................................... 1,875,000 1,252,000
------------ ------------
TOTAL CURRENT LIABILITIES............................. 7,304,000 5,187,000
DEFERRED APPLICATION FEES................................... 6,570,000 9,280,000
------------ ------------
TOTAL LIABILITIES..................................... 13,874,000 14,467,000
REDEEMABLE STOCK:
Common shares, par value $0.01 per share; issued and
outstanding 3,128,473 (net of 58,807 shares in Treasury at
December 31, 1999 and December 31, 1998) entitled to
redemption under certain circumstances at $324,000 (net of
$6,000 in Treasury) as of December 31, 1999 and December
31, 1998.................................................. 324,000 324,000
STOCKHOLDERS' EQUITY:
Common shares, par value $0.01 per share; authorized
30,000,000 shares of Class A Common Stock and 5,000,000
shares of Class B Common Stock; issued and outstanding
14,063,496 Class A shares and 2,707,919 Class B shares at
December 31, 1999; issued and outstanding 14,038,721 Class
A shares and 2,707,919 Class B shares at December
31,1998................................................... 167,000 167,000
Capital in excess of par.................................. 90,293,000 89,416,000
Accumulated deficit....................................... (33,946,000) (20,198,000)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY............................ 56,514,000 69,385,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS(1)EQUITY............... $ 70,712,000 $ 84,176,000
============ ============

See notes to consolidated financial statements.

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE YEARS ENDED DECEMBER 31, 1999

1999 1998 1997
------------ ----------- -----------

REVENUES:
Royalty and other fee income........................ $ 14,607,000 $ 7,578,000 $ 769,000
Franchise application fees.......................... 5,089,000 3,006,000 1,098,000
------------ ----------- -----------
19,696,000 10,584,000 1,867,000
EXPENSES:
General and administrative.......................... 12,175,000 11,590,000 9,083,000
Franchise sales commissions......................... 4,878,000 2,216,000 641,000
Depreciation and amortization....................... 1,677,000 1,393,000 571,000
Interest income..................................... (2,469,000) (2,493,000) (1,386,000)
Interest expense.................................... 762,000 1,905,000
Bad debt reserves................................... 17,121,000
------------ ----------- -----------
33,382,000 13,468,000 10,814,000
NET LOSS BEFORE TAXES........................... (13,686,000) (2,884,000) (8,947,000)
Income taxes.......................................... 62,000 0 0
------------ ----------- -----------
NET LOSS AFTER TAXES............................ $(13,748,000) $(2,884,000) $(8,947,000)
============ =========== ===========
Weighted average number of common shares
outstanding......................................... 19,886,030 17,670,591 12,563,772
Loss per share (Basic).............................. $ (0.69) $ (0.16) $ (.71)
============ =========== ===========

See notes to consolidated financial statements.

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

FOR THE THREE YEARS ENDED DECEMBER 31, 1999

COMMON STOCK CAPITAL TOTAL
---------------------- IN EXCESS ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT OF PAR DEFICIT EQUITY
----------- -------- ----------- ------------ -------------

Balance as of December 31, 1996.... 9,394,115 $ 94,000 $20,549,000 $ (8,367,000) $12,276,000
Issuance of capital
stock--acquisition of computer
software......................... 30,303 -- 250,000 -- 250,000
Fair value of options granted...... -- -- 295,000 -- 295,000
Net loss........................... -- -- -- (8,947,000) (8,947,000)
----------- -------- ----------- ------------ -----------
Balance as of December 31, 1997.... 9,424,418 $ 94,000 $21,094,000 $(17,314,000) $ 3,874,000
=========== ======== =========== ============ ===========
Issuance of capital stock--Hawthorn
acquisition...................... 2,222,222 22,000 17,754,000 -- 17,776,000
Development fund................... 500,000 5,000 5,602,000 -- 5,607,000
Stock offering..................... 4,250,000 43,000 40,758,000 -- 40,801,000
Best acquisition................... 350,000 3,000 3,890,000 -- 3,893,000
Fair value of options granted...... -- -- 318,000 -- 318,000
Net loss........................... (2,884,000) (2,884,000)
----------- -------- ----------- ------------ -----------
Balance as of December 31, 1998.... 16,746,640 167,000 89,416,000 (20,198,000) 69,385,000
=========== ======== =========== ============ ===========
Stock options exercised............ 24,775 -- 211,000 211,000
Fair value of options granted...... 666,000 666,000
Net Income (loss).................. -- -- -- (13,748,000) (13,748,000)
----------- -------- ----------- ------------ -----------
Balance as of December 31, 1999.... $16,771,415 $167,000 $90,293,000 $(33,946,000) $56,514,000
=========== ======== =========== ============ ===========

See notes to consolidated financial statements.

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

THREE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997

DECEMBER 31, DECEMBER 31, DECEMBER 31,
1999 1998 1997
------------ ------------ ------------

OPERATING ACTIVITIES:
Net loss............................................ $(13,748,000) $ (2,884,000) $ (8,947,000)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization....................... 1,677,000 1,393,000 571,000
Deferred compensation amortization.................. 666,000 318,000 295,000
Gain on sale of land................................ (185,000)
Land impairment..................................... 279,000
Changes in assets and liabilities:
(Increase) in accounts receivable, prepaid
expenses and deposits........................... (428,000) (1,449,000) (519,000)
(Increase) Decrease in promissory notes
receivable...................................... 11,380,000 (6,337,000) (3,075,000)
(Increase) in deferred commissions................ (120,000) (3,777,000) (3,009,000)
Increase (Decrease) in other assets............... 756,000 (1,231,000) 187,000
Increase (Decrease) in accounts payable........... (271,000) (640,000) 459,000
Increase (Decrease) in accrued expenses........... 623,000 404,000 (120,000)
Increase in commissions payable................... 52,000 293,000 334,000
Increase (Decrease) in deferred application
fees............................................ (997,000) 2,265,000 3,323,000
Increase in subordinated debentures paid in
kind............................................ 935,000
------------ ------------ ------------
Net cash used in operating activities............... (316,000) (11,645,000) (9,566,000)
INVESTING ACTIVITIES:
Issuance of long-term note receivable............... (15,000,000)
Issuance of development subsidies................... (9,957,000) (1,190,000) (109,000)
Acquisition of property and equipment............... (261,000) (3,918,000) (5,162,000)
Proceeds from sale of properties.................... 809,000 5,752,000
Acquisition of franchise rights..................... (113,000) (2,690,000) (178,000)
------------ ------------ ------------
Net cash used in investing activities............... (9,522,000) (17,046,000) (5,449,000)
FINANCING ACTIVITIES:
Repayment of subordinated debt...................... (19,866,000)
Issuance of common stock, net....................... 211,000 48,633,000 --
Redemption of common stock.......................... (6,000)
Principal payments on borrowings.................... (277,000)
------------ ------------ ------------
Net cash provided by (used in) financing
activities........................................ 211,000 28,767,000 (283,000)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY
CASH INVESTMENTS.................................... (9,627,000) 76,000 $(15,298,000)
CASH AND TEMPORARY INVESTMENTS
Beginning of period................................. 15,966,000 15,890,000 31,188,000
------------ ------------ ------------
End of period....................................... $ 6,339,000 $ 15,966,000 $ 15,890,000
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest.............................. $ 762,000 $ 1,009,000
============ ============
Noncash activities:
Issuance of 30,303 shares of Class A common stock
for
Reservations System Software........................ $ 250,000
============

See notes to consolidated financial statements.

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

1. ORGANIZATION AND BASIS OF PRESENTATION

U.S. Franchise Systems, Inc. (the "Company") was incorporated in
November 1997 for purposes of acquiring the Hawthorn Suites brand. See "Hawthorn
Acquisition." The Company's predecessor also known as USFS, was incorporated in
Delaware in August 1995. The term "the Company" refers to USFS before the
Hawthorn merger, and as the surviving corporation in the merger. The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.

MICROTEL INNS AND SUITES FRANCHISING, INC.: On September 7, 1995, the
Company entered into an agreement (the "Microtel Agreement") with Hudson Hotels
Corporation ("Hudson") to acquire the exclusive worldwide franchising rights and
operating assets of the Microtel hotel system (the "Microtel Acquisition"). The
Microtel Agreement requires the Company to pay a royalty for the right to use,
and license others to use, certain trademarks, service marks, and trade names
associated with the Microtel hotel system.

HAWTHORN SUITES FRANCHISING, INC.: On March 12, 1998, the Company completed
a series of transactions which enabled it to acquire the entire interest in the
Hawthorn Suites brand of hotels. The Company now has the exclusive right to
franchise the Hawthorn Suites brand of hotels and to retain 100% of the
royalties derived therefrom.

BEST FRANCHISING, INC.: On April 28, 1998, the Company completed its
acquisition of the exclusive worldwide franchise rights to the Best Inns hotel
brands, including the franchise agreements for the existing Best Inns hotels. In
addition, the Company acquired management contracts and certain other assets
relating to the management of hotels on behalf of third-party owners.

RESERVATIONS AND ADVERTISING FUNDS: In 1998, the Company created
independent reservations and advertising not-for-profit corporations owned by
its franchisees (the "Funds") for the purpose of collecting and disbursing
reservations and advertising fees related to the Microtel and Hawthorn brands.
In connection with the creation of the Funds, the Company ceased reporting
reservations and advertising fees and expenses within its consolidated financial
statements effective April 1, 1998. Any deficits arising from reservations and
advertising operations for quarterly periods prior to April 1, 1998 have been
included in general and administrative expenses.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Application fee revenue and related costs--Initial franchise fee revenue
consists of application fees received by the Company's subsidiaries from
prospective franchisees. Such fees are recognized in income when the underlying
hotels open. Franchise sales commissions, and other related selling costs are
deferred until the underlying hotels open, at which time such costs are charged
to expense.

Royalty and other fee revenue--The Company recognizes royalty and other fee
income on the accrual method.

Allowance for doubtful trade accounts--During the years ended December 31,
1999, 1998 and 1997, the Company charged $530,000, $116,000 and $10,000
respectively as an allowance for estimated uncollectible accounts, and reduced
the allowance by $239,000, $59,000 and $39,000 respectively. Allowance for

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
doubtful account balances as of December 31, 1999 and 1998 was $313,000 and
$56,000, respectively. Charges to the account are made on a specific
identification basis.

Cash and temporary cash investments--The Company considers its investments
with an original maturity of three months or less to be cash equivalents.

Franchise rights--Franchise rights represent the cost of acquiring such
rights and are amortized on a straight-line basis over 25 years for Microtel,
31 years for Hawthorn and 33 years for Best Inns.

Development subsidies--Development subsidies consist of subsidies granted to
assist in the conversion or construction for prospective or existing
franchisees. They are amortized over the operating life of the license
agreement.

Impairment of long-lived assets--Long-lived assets, principally intangibles,
are evaluated quarterly and written down to fair value when management believes
that the unamortized balance cannot be recovered through future undiscounted
cash flows. Assets held for sale are carried at the lower of cost or net
realizable value. See note 4 and 5.

Other assets--Other assets primarily consist of architectural drawings and
renderings (amortized over 15 years) and loan participations. Accumulated
amortization for the years ended December 31, 1999 and 1998 was $279,000 and
$183,000, respectively.

Income taxes--The Company has adopted the provisions of SFAS 109,
"Accounting for Income Taxes," which requires the use of the asset and liability
approach in accounting for income taxes.

Fair value of financial instruments--The carrying amounts of cash and cash
equivalents, trade and notes receivables, other current assets, accounts
payable, accrueds, and notes payable meeting the definition of a financial
instrument approximate fair value.

Stock-based compensation plans--The Company has elected to account for its
stock option plans in accordance with SFAS 123, "Accounting for Stock-Based
Compensation." Under the provisions of SFAS 123, compensation is recognized for
the fair value of options granted over the vesting period.

Earnings per share--In February 1997, the Financial Accounting Standards
Board issued SFAS 128, "Earnings per Share," which simplifies the standards for
computing earnings per share (EPS) information and makes the computation
comparable to international EPS standards. SFAS 128 replaces the presentation of
"primary" (and when required "fully diluted") EPS with a presentation of "basic"
and "diluted" EPS. Net income per share--basic is computed based on net income
divided by the weighted average common shares outstanding. If required, net
income per share--diluted is computed by dividing net income by the weighted
average common and common shares during the year plus the incremental shares
that would have been outstanding under stock option plans.

Management estimates--The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
New accounting pronouncements: The Company adopted SOP 98-5 "Reporting on
the Cost of Start-up Activities" in fiscal year 1999. The effect on the
financial statements was not material. In June 1998, the Financial Accounting
Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133"), which was modified by SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities- Deferral of the
effective date of FASB Statement No. 133." SFAS 133 requires that an entity
recognize all derivatives as either assets or liabilities in the balance sheet
and measure those instruments at fair value. The Company plans to adopt
SFAS 133 beginning in the first quarter of 2001, and does not presently expect
such adoption to have any material effect on the Company's financial statements
at that time.

Reclassifications--Certain amounts in the prior year financial statements
have been reclassified to conform with the 1999 financial statement
presentation.

3. NOTES RECEIVABLE

In connection with the Best Inns Acquisition, the Company made a
$15 million unsecured subordinated loan to Alpine Hospitality Ventures LLC
("Ventures") at an interest rate of 12% per annum, interest on which will be
paid in cash to the extent available and otherwise will be paid-in-kind. The
loan is subordinated to a guarantee provided by Ventures in connection with a
third-party senior loan in the principal amount of approximately $65 million to
its subsidiary that acquired 17 Best Inns hotels in the Best Inns acquisition
and is structurally subordinated to such third-party loan. In the fourth quarter
1999, the Company was advised that the senior lender informed Ventures of its
intention to institute a "lock-box" arrangement, thereby eliminating the payment
of cash interest to the Company while such arrangement is in place, although
in-kind payment of interest accrues instead. Unless the properties improve
materially, the Company does not expect to recognize such in-kind interest as
income. In March 2000, the lock-box agreement was executed. During the fourth
quarter 1999, the Company took a reserve of $15.5 million against the loan and
accrued interest. If senior debt is not serviced currently, certain management
and franchise fees could be deferred until cash is available. A portion of these
fees were deferred in the fourth quarter 1999. The Company is also committed to
make up to $7.5 million of additional loans to Ventures under certain
circumstances, including, if required by Ventures in order to make a capital
contribution to the owner of the properties in order to achieve compliance with
certain debt service coverage ratios in order to obtain an extension of the
maturity date of the loan, or to obtain the release of a property from the
senior lender's liens in connection with a condemnation, casualty or otherwise.
No such additional loans were made as of December 31, 1999, but it is possible
that additional loans may be required in the future. The Company manages the
hotels owned by a subsidiary of Ventures. Commencing April 1, 2001, the Company
may be obligated to reimburse the owner of the properties for as much as 90% of
the management fee if the owner's net profit for the 12-month period then ended,
and each subsequent 12-month period, falls below a specified level. If the
performance of the hotels does not materially improve by April 2001, the Company
expects to have to make payments to the owner of the properties. In addition,
the senior lender to these properties has advised Ventures in March 2000 that it
currently has the right to require the termination of the management contract,
but is not doing so at this time. In 1999 and 1998, the Company earned franchise
royalty fees of $0.7 million and $0.5 million, respectively, and management fees
of $1.2 million and $0.9 million, respectively, from the owner of the
properties. The Company also issued to Alpine Hospitality Equities LLC ("Alpine
Equities"), an affiliate

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

3. NOTES RECEIVABLE (CONTINUED)
of Ventures, 350,000 shares (the "Alpine Shares") of Class A Common Stock for a
purchase price of $1.6 million. Alpine Equities was granted certain demand and
piggy-back registration rights on customary terms with respect to the Alpine
Shares, as well as certain tag-along rights on certain sales of Common Stock
made by the Company's CEO (Mr. Leven), and CFO (Mr. Aronson). Additionally, the
Company agreed to pay to Alpine Equities $1,000 per year for each hotel added to
the Best Inns system after the closing of the transaction, provided that such
new hotels are paying royalties to the Company or any of its affiliates.

The Company manages the reservations and advertising programs on behalf of
the Microtel Reservation and Advertising Fund and has made interest bearing
loans at 8.5% in an aggregate principal amount, net of reserves, of
approximately $1.0 million to the Microtel Fund to supplement reservation,
advertising and promotional efforts and may make additional loans in the future.
The Company also administers reservations and advertising programs on behalf of
Best Inns franchisees by virtue of its management of Best Reservations Corp, an
Illinois not-for-profit corporation and has made interest bearing loans at 8.5%
to the Best Reservation Corp. in aggregate principal amount of approximately
$0.8 million as of December 31, 1999, and may make additional loans in the
future.

On March 17, 1998, NorthStar Constellation, LLC (together with its
affiliates, "NorthStar"), Lubert-Adler Real Estate Opportunity Funds (together
with its affiliates, "Lubert-Adler") and Constellation Equity Corp., an entity
controlled by NorthStar ("Constellation"), formed Constellation Development Fund
LLC (the "Development Fund"). The Development Fund was established, in part, to
provide capital that will allow the Company to expand its Microtel and Hawthorn
Suites brands into high visibility, difficult to develop areas by providing debt
and equity financing to selected local developers. NorthStar, Lubert-Adler and
Constellation agreed to contribute to the Development Fund equity up to
$50 million. On October 31, 1998 the Development Fund entered into a
$60 million senior credit facility with NationsBank, N.A. As of December 31,
1999 the Development Fund has invested in seven Microtel and two Hawthorn Suites
hotels which are in different stages of development. As of February 21, 2000 the
managers of the Development Fund agreed that no additional projects would be
commenced in the future. In connection with the establishment of the Development
Fund, the Company committed to make a loan of up to $10 million to
Constellation. Constellation will use the funds to make an investment which is
subordinated to certain debt and equity returns of investors in the Development
Fund. The loan bears interest at an annual rate of 8%, is non-recourse and is
repayable from distributions and payments made to Constellation from the
Development Fund. As of December 31, 1999, the Company had made loans of
approximately $5.7 million in the aggregate to Constellation and the Company
expects to lend approximately an additional $400,000 to Constellation in 2000.
Due to the uncertainty surrounding ultimate recoverability of the subordinated
loan, the Company is accounting for it on the cost-recovery basis, where
interest income is recorded only after recovery of principal. The Company will
be paid $3.5 million over the first five years to manage the Development Fund,
$2 million of which was earned as of December 31, 1999. In connection with this
transaction, the Company also sold an aggregate of 500,000 shares of Class A
Common Stock to NorthStar and Lubert-Adler for $5.7 million. Rights of NorthStar
and Lubert-Adler to acquire additional shares of Class A Common Stock have
expired. In addition, David T. Hamamoto, Co-Chief Executive Officer of NorthStar
was elected to the Board of Directors of the Company. Dean Adler, a director of
the Company, serves as a manager of Lubert-Adler, and Mr. Adler, along with
Mr. Hamamoto and Mr. Aronson, serve as managers of the Development Fund.

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

3. NOTES RECEIVABLE (CONTINUED)
The Company accepts promissory notes as part of the initial purchase price
of a franchise. No revenue is recognized upon receipt of such notes until such
time as the hotel opens and the notes are repaid by the franchisee. The balance
of such notes as of December 31, 1999 and 1998 were $3.0 million and
$2.9 million, respectively.

Additionally, the Company makes loans to certain franchisees to assist in
the construction and initial operation of the hotels. The amount of such loans
was $4.4 million and $4.0 million as of December 31, 1999 and 1998,
respectively, net of reserve for uncollectible amounts of $651,000 in 1999 and
$0 in 1998.

4. INTANGIBLE ASSETS

The Company has intangible assets related to the acquisition of its various
franchise rights which are carried at cost net of accumulated amortization. A
summary of such costs is as follows:

1999 1998
----------- -----------

Deferred franchise rights.......................... $26,810,000 $26,696,000
Accumulated amortization........................... 2,119,000 1,206,000
----------- -----------
Net deferred franchise rights...................... $24,691,000 $25,490,000
=========== ===========

The Company grants development subsidiaries to certain franchisees in
connection with the construction and conversion of properties into one of its
brands. A summary of such deferred costs is as follows:

1999 1998
----------- ----------

Development subsidies............................... $11,137,000 $1,299,000
Accumulated amortization............................ 300,000 36,000
----------- ----------
Development subsidies net........................... $10,837,000 $1,263,000
=========== ==========

During 1999, the Company determined that certain development subsidies would
not be recoverable from future cash flow and therefore has written off such
assets in the amount of $123,000.

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

5. PROPERTY AND EQUIPMENT

Property and equipment is recorded at historical cost and consisted of the
following at December 31, 1999 and 1998, respectively:

1999 1998
----------- -----------

Land............................................... -- $ 1,122,000
Construction in progress........................... -- 198,000
Furniture, fixtures, and equipment................. $ 659,000 594,000
Computer equipment and software.................... 2,162,000 1,978,000
----------- -----------
2,821,000 3,892,000
Less accumulated depreciation...................... 1,109,000 496,000
----------- -----------
1,712,000 3,396,000
Real Estate held for sale.......................... 429,000
----------- -----------
$ 2,141,000 $ 3,396,000
=========== ===========

PC based computer software is depreciated on a straight-line basis over a
period of three years. The reservation system and accounting system software are
depreciated on a straight-line basis over a period of five years. Computer
equipment is depreciated using the 200% declining-balance method over a period
of five years. The remaining fixed assets are depreciated using the 200%
declining-balance method over a period of seven years. Depreciation expense was
$316,000, $365,000 and $108,000 for the years ended December 31 1999, 1998 and
1997, respectively.

Land (with associated improvements) is held for sale in Redding, California.
It is expected to be sold during 2000. The land and associated improvements were
written down to net realizable value in fiscal 1999 resulting in a $279,000
reserve.

The Company recorded a reserve of approximately $0.5 million in the fourth
quarter of 1999 in connection with the abandoned purchase of a Hawthorn Suites
property, representing a portion of a forfeited deposit and associated
transaction costs.

6. REDEEMABLE PREFERRED STOCK AND SUBORDINATED DEBENTURES

Until December 31, 1996, the cumulative redeemable exchangeable preferred
stock earned cumulative dividends at an annual dividend rate of 10%, payable in
additional shares of redeemable preferred stock. On January 1, 1997, the Company
exercised its option to exchange the redeemable preferred stock at its
liquidation value of $18,477,000 into 10% subordinated debentures due
September 29, 2007. In May 1998, the Company repaid all outstanding principal
and interest on the subordinated debentures with a portion of the proceeds from
its $41 million equity offering (See Note 7).

7. STOCKHOLDERS EQUITY

The Company has two classes of common stock: Class A Common Stock, par value
$.01 per share and Class B Common Stock, par value $.01 per share outstanding at
December 31, 1999 and 1998, respectively. Shares of Class A Common Stock and
Class B Common Stock are identical in all respects except that:

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

7. STOCKHOLDERS EQUITY (CONTINUED)
(i) holders of Class B Common Stock are entitled to ten votes per share and
holders of Class A Common Stock are entitled to one vote per share; and
(ii) the shares of Class B Common Stock are convertible into Class A Common
Stock at the option of the holder and, with limited exceptions, upon the
transfer thereof. There are 30 million shares of Class A Common Stock and
5 million shares of Class B Common Stock authorized for issuance.

On October 24, 1996, the Company completed an initial public offering of
1,825,000 shares of Class A Common Stock at $13.50 per share. Net proceeds to
the Company were approximately $21 million. On May 19, 1998, the Company
completed a public offering of 4,250,000 shares of Class A Common Stock at
$10.50 per share. Net proceeds were approximately $41 million, of which
approximately $30 million was used by the Company to repay all of its
outstanding indebtedness including all principal and accrued interest and the
remaining $11 million of which was either used for working capital and general
corporate purposes or is currently available as cash balances.

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

8. STOCK PURCHASED BY EMPLOYEES

Under the terms of certain employee stock purchase agreements, Company
management holds 4,027,886 shares of unrestricted stock and 1,344,457 shares of
restricted stock at December 31, 1999.

The Company repurchased 30,921 unrestricted and 26,886 restricted shares
(57,807 shares in the aggregate) from two management employees who left the
Company during 1997 at $.1034 and $.1137 per share, respectively, pursuant to
the terms of the departing management employees' respective employee stock
purchase agreements. As of December 31, 1999 and 1998 the 57,807 shares are held
by the Company as treasury stock. Pursuant to the terms of their respective
employee stock purchase agreements, certain management shareholders had the
right to purchase, at any time, the repurchased shares from the Company at the
price paid by the Company. Such shareholders permanently declined the option to
repurchase such shares. Restricted shares and certain unrestricted shares are
subject to five year and ten year vesting periods, respectively, subject to,
among other things, certain management employees' continued employment by the
Company. Any shares which are forfeited will be repurchased by the Company and
reoffered to certain management shareholders at $.1034 or $.1137 per share, as
applicable, based on the price paid by the management employee for the shares.
Compensation expense will be recorded to the extent the fair value of the
reoffered shares exceeds $.1034 or $.1137, as applicable. All restricted shares
are subject to an earnings test formula based upon increases in the Company's
earnings before interest, taxes, and depreciation and are deemed earned upon the
satisfaction of these performance criteria (the "Earned Shares"). Earned Shares
are subject to forfeiture if the holder's employment ceases with the Company
before September 29, 2005. Any restricted shares that have not been earned by
September 29, 2005 will be redeemed by the Company and reissued to the original
stockholders of the Company (other than certain management shareholders) pro
rata based on their original holdings of common stock. Restricted shares and all
other shares subject to the employee stock purchase agreements held by other
members of management have been classified as redeemable common stock in the
balance sheet because they are redeemable by the Company under certain
circumstances for reasons beyond the Company's control.

9. STOCK OPTION PLANS

The Company has stock option plans which reserve shares of Class A Common
Stock for its officers, employees, consultants and advisors (the "Employee
Plan") and for its non-employee directors (the "Directors Plan"). Under the
Employee Plan, the Option Committee of the Board of Directors may grant options
for up to 975,000 shares of the Company's Class A Common Stock taking into
effect the amendment to the Employee Plan increasing by 250,000 the number of
options under the Employee Plan. The amendment was approved by the Board of
Directors of the Company subject to shareholder approval; however, holders of a
majority of the Company's voting stock entered into a Voting Agreement with the
Company dated January 25, 2000 which ensures such approval. The options
generally have a maximum life of seven years. Under the Directors Plan, the
Company may grant options to its non-employee directors for up to 125,000 shares
of the Company's Class A Common Stock. Non-employee directors are each awarded
options to purchase 2,000 shares upon their election to the Board of Directors.
In addition, commencing on January 1, 1998, each non-employee director receives
a grant of 2,000 stock options on January 1 of each year they continue to serve
on the Board. The director options become exercisable on the first anniversary
of the grant date and their maximum life is ten years. Options outstanding under
the Company's stock option plan have been granted at prices equal to the market
value of the stock on the

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

9. STOCK OPTION PLANS (CONTINUED)
date of the grant and vest over a 1, 4, or 5 year period. On December 31, 1999,
all stock options were repriced for all current employees and consultants to
$4.50 per share, resulting in incremental fair value of $327,000, which is
recognized over the remaining vesting period of the options. The Company is also
obligated to grant options for shares of Class A common stock to certain members
of its franchise sales force in the event they achieve specified sales
benchmarks in 2000.

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions.

1999 1998 1997
-------- -------- --------

Expected life (years).............................. 3.8 3.9 3.8
Expected volatility................................ 34.8% 30.0% 30.1%
Risk free interest rate............................ 5.9% 6.0% 6.0%
Dividend Yield..................................... 0.0% 0.0% 0.0%

Activity related to the Company's two stock option plans is summarized as
follows:

1999 1998 1997
------------------------- ------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVG. AVG. AVG.
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
-------- -------------- -------- -------------- -------- --------------

Options as of January 1.............. 484,857 $ 9.28 228,500 $11.39 178,500 $13.48
Granted.............................. 322,400 10.99 326,757 7.66 105,700 8.66
Forfeited............................ (62,175) 10.77 (70,400) 9.38 (55,700) 12.72
Exercised............................ (24,775) 8.51 0 0 0
------- ------ ------- ------ ------- ------
Options as of December 31............ 720,307 $ 4.90 484,857 $ 9.28 228,500 $11.39
======= ====== ======= ====== ======= ======
Options exercisable as of December
31................................. 161,793 53,163 39,950
Weighted-average fair value of
options granted during the year.... $10.99 $ 2.23 $ 2.78
====== ====== ======

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

9. STOCK OPTION PLANS (CONTINUED)
The following table summarizes information about stock options outstanding
at December 31, 1999:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------- -------------------------------
NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED
RANGE OF OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE
EXERCISE PRICES DEC. 31, 1999 CONTRACTUAL LIFE EXERCISE PRICE DEC. 31, 1999 EXERCISE PRICE
- ----------------------------- -------------- ---------------- -------------- -------------- --------------

.10340 to .11375............. 30,921 2.49 $0.11 7,730 $0.11
$4.50........................ 578,000 3.31 4.50 103,813 4.50
$5.81........................ 32,000 3.61 5.81 -- --
$8.13 to $13.50.............. 52,500 0.15 11.55 50,250 11.59
------- ---- ----- ------- -----
.10340 to $13.50............. 693,421 3.05 $4.90 161,793 $6.49
======= ==== ===== ======= =====
Performance
Based Options*............... 26,886
=======
Total options **........... 720,307
=======

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

* Performance Based options have been granted to an employee at an average
exercise price of $0.105 per share. Vesting of these options is conditional
on the Company's achieving certain profitability targets. Compensation cost
will be estimated and recorded for these options when management can
reasonably estimate the likelihood that the performance criteria will be
achieved by the Company.

** The fair value of options granted or repriced during the years ended
December 31, 1999 and 1998 was $975,000 and $610,000 respectively, which is
being amortized as compensation expense over the vesting period.
Compensation expense of $503,000, $318,000 and $295,000 was recorded for the
years ended December 31, 1999, 1998, and 1997 respectively. In 1999,
compensation expense includes $132,000 associated with the repricing of the
stock options during the fourth quarter.

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

10. INCOME TAXES

Deferred income taxes in the accompanying consolidated statement of
financial position includes the following amounts of deferred tax assets and
liabilities at December 31, 1999 and 1998, respectively:

1999 1998
----------- -----------

DEFERRED TAX LIABILITIES:
Deferred expenses................................ $(2,845,000) $(2,955,000)
Other............................................ (964,000) (251,000)
----------- -----------
Total.............................................. $(3,809,000) $(3,206,000)
=========== ===========
DEFERRED TAX ASSETS:
Operating loss carryforwards..................... $ 4,814,000 $ 6,781,000
Deferred revenue................................. 2,973,000 3,905,000
Compensation cost................................ 0 259,000
Allowances and reserves.......................... 6,650,000 0
Other............................................ 1,079,000 112,000
----------- -----------
Total.............................................. 15,516,000 11,057,000
----------- -----------
Valuation allowance................................ (11,707,000) (7,851,000)
----------- -----------
Net deferred tax asset (liability)................. $ 0 $ 0
=========== ===========

As of December 31, 1999 and 1998, the Company had accumulated net operating
loss carryforwards of $12,667,000 and $13,890,000, respectively which begin to
expire in the year 2010.

During the years ended December 31, 1999, and 1998 the Company increased the
valuation allowance against its net deferred tax asset by $3.9 million and
$1.6 million, respectively due to the uncertainty of the realizability of net
deferred tax assets.

The following is a reconciliation of the statutory tax rate to the effective
tax rate of the Company at December 31, 1999 and 1998, respectively:

1999 1998
-------- --------

Statutory federal rate...................................... 34% 34%
Statutory state rate less federal effect.................... 4% 4%
Effect of income not subject to tax.........................
Change in valuation allowance............................... (38%) (38%)
--- ---
Effective tax rate.......................................... --% --%
=== ===

11. SEGMENT REPORTING

The Company currently owns three brands and operates a management company in
the United States. Other/corporate represents overhead and assets not
specifically allocable to the brands or the management

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

11. SEGMENT REPORTING (CONTINUED)
company. Revenues, net income directly attributable to the business segment,
identifiable assets, and capital expenditures are estimated as follows.

MANAGEMENT OTHER/
MICROTEL HAWTHORN BEST COMPANY CORPORATE CONSOLIDATED
----------- ----------- ------------ ---------- ------------ ------------

Revenues
1999................. $ 6,497,000 $ 7,276,000 $ 4,005,000 $1,918,000 $ -- $ 19,696,000
1998................. $ 4,355,000 $ 3,750,000 $ 1,072,000 $1,407,000 $ -- $ 10,584,000
1997................. $ 1,664,000 $ 203,000 $ -- $ -- $ -- $ 1,867,000

Net Income (loss)
1999................. $ 3,193,000 $ 4,625,000 $(11,833,000) $ 433,000 $(10,166,000) $(13,748,000)
1998................. $ 3,748,000 $ 2,455,000 $ 2,034,000 $ 454,000 $(11,575,000) $ (2,884,000)
1997................. $ 1,139,000 $ (25,000) $ -- -- $(10,061,000) $ (8,947,000)

Identifiable Assets
1999................. $19,343,000 $32,048,000 $ 12,576,000 $ 646,000 $ 6,099,000 $ 70,712,000
1998................. $19,199,000 $24,358,000 $ 22,026,000 $ 917,000 $ 17,676,000 $ 84,176,000
1997................. $18,215,000 $ 2,957,000 $ -- $ -- $ 15,179,000 $ 36,351,000

Capital Expenditures
1999................. $ 12,000 $ 56,000 $ 57,000 $ 36,000 $ 213,000 $ 374,000
1998................. $ 3,360,000 $18,362,000 $ 4,583,000 $ 35,000 $ 523,000 $ 26,863,000
1997................. $ 4,167,000 $ 178,000 -- $ -- $ 995,000 $ 5,340,000

12. LEASES

The Company leases certain equipment and office space used in its
operations. Rental expense under operating leases was $343,000, $461,000 and
$366,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The
future minimum rental commitments under non-cancelable operating leases at
December 31, 1999 were as follows:

2000........................................................ $ 449,000
2001........................................................ 348,000
2002........................................................ 329,000
2003........................................................ 291,000
2004........................................................ 285,000
Beyond...................................................... 221,000
----------
Total....................................................... $1,923,000
==========

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

13. COMMITMENTS AND CONTINGENCES

The Microtel Acquisition Agreement requires the Company to satisfy a
development schedule, which requires the Company to have a specified number of
new Microtel properties open or under construction by certain target dates. The
Company has satisfied the development schedule to date and must have 250 newly
executed Microtel franchises open or under construction by December 31, 2001 in
order to avoid being in default under the last remaining target. For purposes of
meeting this target, the 27 Microtel properties that do not pay royalties to the
Company and, if open or under construction, the additional 23 Microtel Inn
properties and 10 Microtel Suites hotels that are currently entitled to be built
by certain parties without the payment of royalties to the Company pursuant to
the Microtel Acquisition Agreement, are excluded. As of March 10, 2000, the
Company had opened or under construction 223 Microtel properties which counted
toward satisfying the development schedule. Therefore, from March 10, 2000 until
December 31, 2001, the Company is required to break ground on an additional 27
Microtel brand hotels in order to avoid being in default under the Microtel
Acquisition Agreement. If the Company fails to so satisfy the development
schedule, it may cure its default by making a $1,000,000 payment to Hudson.

The Company has committed to make loans and other payments to Ventures and
the Development Fund (See Note 3).

The Company has agreed to provide development subsidies to various
franchisees to the extent certain milestones are achieved.

The Company has employment agreements with its Chief Executive Officer and
Chief Financial Officer. The agreements are for a ten year term expiring on
September 30, 2005 and provide minimum salary levels and other fringe benefits.

The Company is subject to litigation in the ordinary course of its business.
In the opinion of management, the outcome of such litigation will not have a
material impact of the earnings, financial position or cash flow of the Company.

The Company is currently in litigation with respect to certain financing
programs under which the Company retained an ongoing participation. Management
has reserved approximately $800,000 with respect to the termination of the loan
program as of December 31, 1999.

In connection with a letter agreement with Leisure Hotel Management dated
February 3, 1998, the Company has authorized the issuance of up to $900,000
worth of shares of Class A Common Stock upon the attainment of certain
development milestones. On March 3, 2000, the Company issued 48,290 shares of
Class A Common Stock, valued at approximately $240,000, in satisfaction of the
first such milestone. The Company is also obligated to grant options for shares
of Class A Common Stock to certain members of the Company's franchise salesforce
in the event they achieve specified sales benchmarks in 2000.

U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

AS OF DECEMBER 31, 1999 AND 1998 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

14. SELECTED QUARTERLY FINANCIAL DATA--(UNAUDITED)

1999 FIRST SECOND THIRD FOURTH TOTAL YEAR
- ---- ----------- ----------- ----------- ------------ ------------

Revenue..................... $ 3,176,000 $ 4,751,000 $ 6,992,000 $ 4,777,000 $ 19,696,000
Net income (loss)........... 505,000 1,513,000 3,034,000 (18,800,000) (13,748,000)
Income (loss) applicable to
common stockholders....... $ 505,000 $ 1,513,000 $ 3,034,000 $(18,800,000) $(13,748,000)
Weighted avg shares
outstanding............... 19,875,113 19,880,326 19,891,538 19,898,888 19,886,030
Weighted avg shares
outstanding--dilutive..... 20,023,661 20,044,600 20,087,111 -- --
Net income (loss) per
share--basic and dilutive
(a)....................... $ .03 $ .08 $ .15 $ (.94) $ (.69)
=========== =========== =========== ============ ============

1998 FIRST SECOND THIRD FOURTH TOTAL YEAR
- ---- ----------- ----------- ----------- ------------ ------------

Revenue..................... $ 1,296,000 $ 2,795,000 $ 3,354,000 $ 3,139,000 $ 10,584,000
Net income (loss)........... (1,855,000) (1,256,000) 109,000 118,000 (2,884,000)
Income (loss) applicable to
common stockholders....... $(1,855,000) $(1,256,000) $ 109,000 $ 118,000 $ (2,884,000)
Weighted avg shares
outstanding............... 13,094,249 17,837,891 19,875,113 19,875,113 17,670,591
Net income (loss) per
share--
basic (a)................. $ (.14) $ (.07) $ .01 $ .01 $ (.16)
=========== =========== =========== ============ ============

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

(a) Due to the changes in the numbers of shares outstanding, quarterly per share
amounts do not add to the total for the year.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

There have been no disagreements on accounting and financial disclosure
matters which are required to be described by Item 304 of Regulation S-K.

PART III

Items 10, 11, 12, and 13 to be furnished by amendment hereto on or prior to
April 30, 2000 or the Company will otherwise have filed a definitive Proxy
Statement involving the election of directors pursuant to Regulation 14A which
will contain such information.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(A) 1. FINANCIAL STATEMENTS:

See Table of Contents to Financial Statements ("Item 8. Financial Statements
and Supplementary Data").

2. FINANCIAL STATEMENT SCHEDULES:

No schedules are included with this Report, as they are not applicable or
the information required to be set forth therein is included in the consolidated
financial statements or notes thereto.

3. EXHIBITS: The following exhibits are filed with or incorporated by
reference into this Report. Except as otherwise indicated, the exhibit number
corresponds to the exhibit number in the referenced document.

EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------

2.1 Agreement and Plan of Merger, dated December 9, 1997,
between U.S. Franchise Systems, Inc. and USFS
Hawthorn, Inc. (incorporated by reference from the Company's
Registration Statement on Form S-4 (Registration
No. 333-46185)).

2.2 Contribution Agreement, dated December 9, 1997, among
Hawthorn Suites Associates, HSA Properties, Inc., USFS
Hawthorn, Inc. and U.S. Franchise Systems, Inc.
(incorporated by reference from the Company's Registration
Statement on Form S-4 (Registration No. 333-46185)).

3.1 Certificate of Incorporation (incorporated by reference from
the Company's Registration Statement on Form S-4
(Registration No. 333-46185)).

3.2 By-laws (incorporated by reference from the Company's
Registration Statement on Form S-4 (Registration
No. 333-46185)).

4.2 Specimen Class A Common Stock Certificate (incorporated by
reference from the Company's Registration Statement on
Form S-4 (Registration No. 333-46185)).

4.3 Specimen Class B Common Stock Certificate (incorporated by
reference from the Company's Registration Statement on
Form S-4 (Registration No. 333-46185)).

4.4 Shareholders Agreement, dated as of March 12, 1998 by and
among Hawthorn Suites Associates, HSA Properties, Inc.,
Michael A. Leven, Neal K. Aronson and U.S. Franchise
Systems, Inc. (incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
March 31, 1998 (File No. 0-23941)).

4.5 Registration and Tag-Along Rights Agreement dated as of
March 17, 1998 between (i) U.S. Franchise Systems, Inc.,
(ii) Sextant Trading LLC, Lubert-Adler Real Estate
Opportunity Fund,

EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------

L.P., Lubert-Adler Real Estate Opportunity Fund II, L.P. and
Lubert-Adler Capital Real Estate Opportunity Fund, L.P., and
(iii) Michael Leven and Neal K. Aronson (incorporated by
reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1998 (File
No. 0-23941)).

4.6 Registration Rights Agreement dated as of April 28, 1998
among U.S. Franchise Systems, Inc., Alpine Hospitality
Equities LLC, Michael A. Leven and Neal K. Aronson
(incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the quarterly period ended
March 31, 1998 (File No. 0-23941)).

10.3 Joint Venture Agreement between Microtel Franchise and
Development Corporation and U.S. Franchise Systems, Inc.
dated as of September 7, 1995 (incorporated by reference
from the Company's Registration Statement on Form S-1
(Registration No. 333-11427)).

10.5 Amended and Restated Stockholders' Agreement, dated as of
September 29, 1995, as amended on October 11, 1996, among
the Company and the Original Investors (incorporated by
reference from the Company's Registration Statement on
Form S-1 (Registration No. 333-11427)).

10.6 Amended and Restated Employee Stock Purchase Agreement
between U.S. Franchise Systems, Inc. and Michael A. Leven,
entered into as of September 29, 1995, as amended effective
October 24, 1996 (incorporated by reference from the
Company's Registration Statement on Form S- 1 (Registration
No. 333-11427)).

10.7 Amended and Restated Employee Stock Purchase Agreement
between U.S. Franchise Systems, Inc. and Neal K. Aronson,
entered into as of September 29, 1995, as amended effective
October 24, 1996 (incorporated by reference from the
Company's Registration Statement on Form S-1 (Registration
No. 333-11427)).

10.8 Employment Agreement by and between U.S. Franchise
Systems, Inc. and Michael A. Leven, dated October 1, 1995
(incorporated by reference from the Company's Registration
Statement on Form S-1 (Registration No. 333-11427)).

10.9 Employment Agreement by and between U.S. Franchise
Systems, Inc. and Neal K. Aronson, dated October 1, 1995
(incorporated by reference from the Company's Registration
Statement on Form S-1 (Registration No. 333-11427)).

10.10 Voting Agreement between Michael A. Leven and Andrea Leven
entered into on October 30, 1996 (incorporated by reference
from the Company's Registration Statement on Form S-1
(Registration No. 333-11427)).

10.11 Voting Agreement between Michael A. Leven and Neal K.
Aronson entered into on October 30, 1996 (incorporated by
reference from the Company's Registration Statement on
Form S-1 (Registration No. 333-11427)).

10.12 Office Lease Agreement between Hallwood Real Estate
Investors Fund XV and U.S. Franchise Systems, Inc., dated
September 25, 1995 (incorporated by reference from the
Company's Registration Statement on Form S-1 (Registration
No. 333-11427)).

10.13 First Amendment to Office Lease between Hallwood 95, L.P.,
and U.S. Franchise Systems, Inc., dated May 20, 1996
(incorporated by reference from the Company's Registration
Statement on Form S-1 (Registration No. 333-11427)).

10.14 U.S. Franchise Systems, Inc. Amended and Restated 1996 Stock
Option Plan (incorporated by reference from the Company's
Registration Statement on Form S-8 (Registration
No. 333-5707, Exhibit 4.3).

EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------

10.15 U.S. Franchise Systems, Inc. 1996 Stock Option Plan for
Non-Employee Directors (incorporated by reference from the
Company's Registration Statement on Form S-1 (Registration
No. 333-11427)).

10.17 Voting Agreement between Michael A. Leven and Andrea Leven
entered into on March 12, 1998 (incorporated by reference
from Exhibit 10.11 to the Company's Registration Statement
on Form S-4 (Registration No. 333-46185)).

10.18 Voting Agreement between Michael A. Leven and Neal K.
Aronson entered into on March 12, 1998 (incorporated by
reference from Exhibit 10.13 to the Company's Registration
Statement on Form S-4 (Registration No. 333-46185)).

10.21 Agreement of Purchase and Sale between America's Best
Inns, Inc. and The Other Selling Entities Listed on
Schedule I thereto and Best Acquisition, Inc., dated
December 15, 1997. The Registrant agrees to furnish copies
of the schedules hereto supplementally to the Commission on
request (incorporated by reference from the Company's
Registration Statement on Form S-4 (Registration
No. 333-46185)).

10.22 Promissory Note, dated March 18, 1998, from Constellation
Equity Corp. to the Registrant in the principal amount of
$10 million. (incorporated by reference from Exhibit 10.22
to the Company's Annual Report on Form 10-K for the year
ended December 31, 1999 (File No. 0-23941)).

10.23 Management Services Agreement, dated March 17, 1998, between
the Registrant and Constellation Development Fund LLC.
(incorporated by reference from Exhibit 10.23 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 0-23941)).

10.24 Asset Transfer Agreement dated as of April 28, 1998 among
Best Acquisition, Inc., Alpine Hospitality Ventures LLC,
RSVP-BI OPCO, LLC, RSVP-ABI REALCO, LLC, America's Best
Inns, Inc. and the entities identified on Schedule 1
thereto. The Company agrees to furnish copies of the
schedules hereto supplementally on request (incorporated by
reference from the Company's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1998 (File
No. 0-23941)).

10.25 Securities Purchase Agreement dated as of April 28, 1998 by
and between U.S. Franchise Systems, Inc. and Alpine
Hospitality Equities LLC. The Company agrees to furnish
copies of the schedules hereto supplementally on request
(incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the quarterly period ended
March 31, 1998 (File No. 0-23941)).

10.26 Hotel Management Agreement made and entered into on
April 28, 1998 by and among Alpine Hospitality Ventures LLC,
RSVP-BI OPCO, LLC, RSVP-ABI REALCO, LLC and USFS
Management, Inc. (incorporated by reference from the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 1998 (File No. 0-23941)).

10.27 Amended and Restated License Agreement dated April 28, 1998
by and between Best Franchising, Inc. and RSVP-BI OPCO, LLC
(incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the quarterly period ended
March 31, 1998 (File No. 0-23941)).

10.30 Senior Subordinated Note Purchase Agreement dated as of
April 28, 1998 between Alpine Hospitality Ventures LLC and
U.S. Franchise Systems, Inc. The Company agrees to furnish
copies of the schedules hereto supplementally on request
(incorporated by reference from the

EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------

Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 1998 (File No. 0-23941)).

10.31 Subscription Agreement dated as of March 17, 1998 between
(i) U.S. Franchise Systems, Inc., (ii) Sextant Trading LLC,
and (iii) Lubert-Adler Real Estate Opportunity Fund, L.P.,
Lubert-Adler Real Estate Opportunity Fund II, L.P. and
Lubert-Adler Capital Real Estate Opportunity Fund, L.P.
(incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the quarterly period ended
March 31, 1998 (File No. 0-23941)).

10.32* Amendment No. 1 to Employment Agreement by and between U.S.
Franchise Systems, Inc. and Michael A. Leven, dated as of
January 19, 1997

10.33* Amendment No. 1 to Employment Agreement by and between U.S.
Franchise Systems, Inc. and Neal K. Aronson, dated as of
January 19, 1997

10.34* Second Amendment to Office Lease by and between Hallwood 95,
L.P. and U.S. Franchise Systems, Inc., dated July 16, 1999.

10.35* Microtel Inns and Suites Franchising, Inc. current form of
License Agreement for Microtel hotels

10.36* Hawthorn Suites Franchising, Inc. current form of License
Agreement for Hawthorn hotels

10.37* Best Franchising, Inc. current form of License Agreement for
Best Inns hotels

21.1* List of Subsidiaries of U.S. Franchise Systems, Inc.

23.1* Consent of Deloitte & Touche, LLP.

27.1* Financial Data Schedule for the years ended December 31,
1999, 1998 and 1997, submitted to the Securities and
Exchange Commission in electronic format.

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

* Filed herewith.

Copies of the exhibits are available at a charge of $.25 per page upon
written request to the Secretary of the Company at 13 Corporate Square, Suite
250, Atlanta, Georgia 30329.

(B) REPORTS ON FORM 8-K

During the period from October 1, 1999 to December 31, 1999 the Company did
not file any reports on Form 8-K.

SIGNATURES

Pursuant to the requirement of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

U.S. FRANCHISE SYSTEMS, INC.
(REGISTRANT)

By /s/ MICHAEL A. LEVEN
-----------------------------------------
Michael A. Leven
CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF
EXECUTIVE OFFICER

Dated March 30, 2000

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on March 30, 2000 by the following persons on
behalf of the Registrant in the capacities indicated.

SIGNATURE TITLES
--------- ------

/s/ MICHAEL A. LEVEN Chairman, President and Chief Executive
------------------------------------------- Officer and Director (Principal Executive
(Michael A. Leven) Officer)

/s/ NEAL K. ARONSON Executive Vice President, Chief Financial
------------------------------------------- Officer and Director (Principal Financial
(Neal K. Aronson) and Accounting Officer)

/s/ DEAN ADLER
------------------------------------------- Director
(Dean Adler)

/s/ IRWIN CHAFETZ
------------------------------------------- Director
(Irwin Chafetz)

/s/ DOUG GEOGA
------------------------------------------- Director
(Doug Geoga)

/s/ RICHARD D. GOLDSTEIN
------------------------------------------- Director
(Richard D. Goldstein)

/s/ DAVID T. HAMAMOTO
------------------------------------------- Director
(David T. Hamamoto)

/s/ STEVE ROMANIELLO
------------------------------------------- Director
(Steve Romaniello)

/s/ JEFFREY A. SONNENFELD
------------------------------------------- Director
(Jeffrey A. Sonnenfeld)

EXHIBIT INDEX

10.32 Amendment No. 1 to Employment Agreement by and between U.S.
Franchise Systems, Inc. and Michael A. Leven, dated as of
January 19, 1997

10.33 Amendment No. 1 to Employment Agreement by and between U.S.
Franchise Systems, Inc. and Neal K. Aronson, dated as of
January 19, 1997

10.34 Second Amendment to Office Lease by and between Hallwood 95,
L.P. and U.S. Franchise Systems, Inc., dated July 16, 1999

10.35 Microtel Inns and Suites Franchising, Inc. current form of
License Agreement for Microtel hotels

10.36 Hawthorn Suites Franchising, Inc. current form of License
Agreement for Hawthorn hotels

10.37 Best Franchising, Inc. current form of License Agreement for
Best Inns hotels

21.1 List of Subsidiaries of U.S. Franchise Systems, Inc.

23.1 Consent of Deloitte & Touche, LLP.

27.1 Financial Data Schedule for the years ended December 31,
1999, 1998 and 1997, submitted to the Securities and
Exchange Commission in electronic format.