Form 10-K for the fiscal year ended December 31, 2005

10-K 1 d10k.htm FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005 Form 10-K for the fiscal year ended December 31, 2005

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-K

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 001-13393

CHOICE HOTELS INTERNATIONAL, INC.

(Exact Name of Registrant as Specified in Its Charter)


DELAWARE		52-1209792
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

10750 Columbia Pike, Silver Spring, Maryland		20901
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code (301) 592-5000

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class		Name of Each Exchange on Which Registered
Common Stock, Par Value $0.01 per share		New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of 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. ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):


Large accelerated filer x		Accelerated filer ¨		Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

The aggregate market value of common stock of Choice Hotels International, Inc. held by non-affiliates was $1,115,547,831 as of June 30, 2005 based upon a closing price of $32.85 per share.

The number of shares outstanding of Choice Hotels International, Inc.’s common stock at February 28, 2006 was 65,537,878.

DOCUMENTS INCORPORATED BY REFERENCE.

Certain portions of our definitive proxy statement, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than March 31, 2006, are incorporated by reference under Part III.

CHOICE HOTELS INTERNATIONAL, INC.

Form 10-K

Table of Contents


			Page No.
Part I
	Item 1.	Business.	1
	Item 1A.	Risk Factors.	17
	Item 1B.	Unresolved Staff Comments.	22
	Item 2.	Properties.	22
	Item 3.	Legal Proceedings.	23
	Item 4.	Submission of Matters to a Vote of Security Holders.	23

Part II
	Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.	25
	Item 6.	Selected Financial Data.	27
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation.	27
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk.	40
	Item 8.	Financial Statements and Supplementary Data.	41
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.	73
	Item 9A.	Controls and Procedures.	73
	Item 9B.	Other Information.	73

Part III
	Item 10.	Directors and Executive Officers of the Registrant.	73
	Item 11.	Executive Compensation.	74
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	74
	Item 13.	Certain Relationships and Related Transactions.	74
	Item 14.	Principal Accounting Fees and Services.	74

Part IV
	Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K.	74
		SIGNATURE	77

PART I

Throughout this report, we refer to Choice Hotels International, Inc., together with its subsidiaries as “we”, “us” or “the Company”.

Forward-Looking Statements

Certain statements in this report that are not historical facts constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act. Words such as “believes,” “anticipates,” “expects,” “intends,” “estimates,” “projects,” and other similar expressions, which are predictions of or indicate future events and trends, typically identify forward-looking statements. Such statements are subject to a number of risks and uncertainties which could cause actual results to differ materially from those projected, including: competition; business strategies and their intended results; the balance between supply of and demand for hotel rooms; our ability to obtain new franchise agreements; our ability to develop and maintain positive relationships with current and potential hotel owners; the effect of international, national and regional economic conditions and geopolitical events such as acts of god, acts of war, terrorism or epidemics; the availability of capital to allow potential hotel owners to fund investments in and construction of hotels; the cost and other effects of legal proceedings; and other risks described from time to time in our filings with the Securities and Exchange Commission, including those set forth in Item 1A “Risk Factors”. Given these uncertainties, you are cautioned not to place undue reliance on such statements. We also undertake no obligation to publicly update or revise any forward-looking statement to reflect current or future events or circumstances.

WHERE YOU CAN FIND MORE INFORMATION

We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). Our SEC filings are available to the public over the internet at the SEC’s web site at http://www.sec.gov. Our SEC filings are also available free of charge on our website at http://www.choicehotels.com as soon as reasonably practicable following the time that they are filed with or furnished to the SEC. You may also read and copy any document we file with the SEC at its public reference room located at 100 F Street, NE Washington DC 20549. Please call the SEC at (202) 551-8090 for further information on their public reference room.

Item 1. Business.

Reference is made to the consolidated financial statements included in Item 8 of this annual report on Form 10-K for the financial information required to be included herein.

Overview

Choice Hotels International, Inc. and subsidiaries is one of the largest hotel franchisors in the world with 5,210 hotels open and 687 hotels under development as of December 31, 2005, representing 427,056 rooms open and 54,075 rooms under development in 49 states, the District of Columbia and more than 45 countries and territories outside the United States. Choice franchises lodging properties under the proprietary brand names (the “Choice brands”): Comfort Inn^®, Comfort Suites^®, Quality^®, Clarion^®, Sleep Inn^®, Econo Lodge^®, Rodeway Inn^®, MainStay Suites^®, Suburban Extended Stay Hotel^®, Cambria Suites^™ and Flag Hotels^®. We operate in a single reportable segment encompassing our franchising business. Approximately 95% of the Company’s 2005 and 2004 revenues were generated from hotels franchised in the United States.

Our direct lodging property real estate exposure is limited to three company-owned MainStay Suites^® hotels.

With a focus on hotel franchising instead of ownership, we benefit from the economies of scale inherent in the franchising business. The fee and cost structure of our business provides opportunities to improve operating

results by increasing the number of franchised properties and effective royalty rates stated in franchise contracts resulting in increased initial fee revenue; ongoing royalty fees and partner services revenues. In addition, our operating results can also be significantly improved through our company wide efforts on improving property level performance. In addition to these revenues, we also collect marketing and reservation fees to support centralized marketing and reservation activities for the franchise system. As a lodging franchisor, Choice has relatively low capital expenditure requirements.

The principal factors that affect the Company’s results are: the number and relative mix of franchised hotels; growth in the number of hotels under franchise; occupancy and room rates achieved by the hotels under franchise; the effective royalty rate achieved; and our ability to manage costs. The number of rooms at franchised properties and occupancy and room rates at those properties significantly affect the Company’s results because our fees are based upon room revenues at franchised hotels. The key industry standard for measuring hotel-operating performance is revenue per available room (“RevPAR”), which is calculated by multiplying the percentage of occupied rooms by the average daily room rate realized. Our variable overhead costs associated with franchise system growth have historically been less than incremental royalty fees generated from new franchises. Accordingly, continued growth of our franchise business should enable us to realize benefits from the operating leverage in place and improve operating results.

Company History

Prior to becoming a separate, publicly held company on October 15, 1997 pursuant to the Company Spin-off (which we describe below), the Company was known as Choice Hotels Franchising, Inc. and was a wholly owned subsidiary of Choice Hotels International, Inc. (“Former Choice”). On October 15, 1997, Former Choice distributed to its stockholders its hotel franchising business (which had previously been primarily conducted by the Company) and its European hotel ownership and franchising business through a pro rata distribution to its stockholders of all of the stock of the Company (the “Company Spin-off”). At the time of the Company Spin-off, the Company changed its name to Choice Hotels International, Inc., and Former Choice changed its name to Sunburst Hospitality Corporation (or “Sunburst”).

The Lodging Industry⁽¹⁾

Companies participating in the lodging industry primarily do so through a combination of one or more of the three primary lodging industry activities: ownership, franchising and management. A company’s relative reliance on each of these activities determines which drivers most influence its profitability.

•

Ownership requires a substantial capital commitment and involves the most risk but offers high returns due to the owner’s ability to influence margins by driving revenue per available room (“RevPAR”) and managing operating expenses. The ownership model has a high fixed-cost structure that results in a high degree of financial leverage. As a result, profits escalate rapidly in a lodging up-cycle but erode quickly in a downturn as costs rarely fall as fast as revenue. Profits from an ownership model increase at a greater rate from RevPAR growth attributable to average daily rate (“ADR”) growth, versus occupancy gains since there are more incremental costs associated with higher guest volumes compared to higher pricing.

•

Franchisors license their brands to a hotel owner, giving the hotel the right to use the brand name, logo, operating practices, and reservations systems in exchange for a fee and an agreement to operate the hotel in accordance with the brand standards. Under a typical franchise agreement, the hotel pays the franchisor an initial fee, a percentage-of-revenue royalty fee and a marketing/reservation reimbursement. A franchisor’s revenues are dependent on the number of rooms in its system and the

⁽¹⁾

Certain industry statistics included in this section, such as the number of hotel rooms, number of affiliated and non-affiliated rooms, US Lodging Industry Trends From 1997 – 2005, etc. were obtained from Smith Travel Research.

top-line performance of those hotels. Earnings drivers include RevPAR increases, unit growth and effective royalty rate improvement. Franchisors enjoy significant operating leverage in their business model since it costs little to add a new hotel franchise to an existing system. Franchisors normally benefit from higher industry supply growth, because the benefits of unit growth usually outweigh lower RevPAR resulting from excess supply. As a result, franchisors benefit from both RevPAR growth and supply increases which aids in reducing the impact of lodging industry economic cycles.

•

Management companies operate hotels for owners that do not have the expertise and/or the desire to self-manage. These companies collect management fees predominately based on revenues earned and/or profits generated. Similar to franchising activities, the key drivers of revenue based management fees are RevPAR and unit growth and similar to ownership activities, profit based fees are driven by improved hotel margins and RevPAR growth.

The lodging industry has historically experienced economic cycles reflected in positive and negative operating performance for various periods of time. Positive cycles are characterized as periods of sustained occupancy growth. These cycles usually continue until the economy sustains a prolonged downturn, excess supply conditions exist or some external factor occurs such as war, terrorism or natural resource shortages. Recovery in the industry usually begins with an increase in occupancy followed by hoteliers increasing their room rates. As occupancies and rates continue to improve, growth stabilizes and demand begins to exceed room supply. These pressures result in increased hotel development.

The hotel industry posted positive and consistent RevPAR growth from the mid-1990’s until 2000 as the industry was able to increase its ADR at a pace faster than the increase in the Consumer Price Index (“CPI”), a common measure of inflation published by the US Department of Labor. The following chart demonstrates these trends:

US Lodging Industry Trends — 1997 - 2005


Year	Occupancy Rates		Average Daily Room Rates (ADR)		Increase in ADR Versus Prior Year		Increase in CPI Versus Prior Year		Revenue Per Available Room (RevPAR)		Profits (in billions)		New Rooms Added
1997	64.5	%	$	75.16	6.1	%	1.9	%	$	48.50	$	17.0	128,000
1998	64.0	%	$	78.62	4.6	%	2.3	%	$	50.29	$	22.0	143,000
1999	63.3	%	$	81.27	3.4	%	2.7	%	$	51.44	$	23.0	143,148
2000	63.5	%	$	85.24	4.9	%	3.4	%	$	54.13	$	24.0	121,476
2001	60.1	%	$	84.85	-0.5	%	2.9	%	$	50.99	$	16.7	101,279
2002	59.2	%	$	83.15	-2.0	%	1.6	%	$	49.22	$	16.1	86,366
2003	59.1	%	$	83.19	0.1	%	2.3	%	$	49.20	$	15.0	65,876
2004	61.3	%	$	86.41	3.9	%	2.7	%	$	52.93	$	17.0	55,245
2005	63.1	%	$	90.84	5.1	%	3.4	%	$	57.34	$	21.0	65,900

However, due to the economic recession, which began to affect the lodging industry during 2001, coupled with the terrorist attacks of September 11, 2001, industry profits and RevPAR declined between 2001 and 2003. Nonetheless, the industry remained profitable through this period.

In 2004, the resumption of economic growth increased lodging demand and occupancy rates. This coupled with the relatively slow growth in hotel supply, allowed hotels to aggressively raise room rates during 2004. These factors resulted in annual RevPAR growth in 2004 for the first time since the year 2000. The lodging industry recovery continued in 2005 with RevPAR increasing 8.3%.

Hotel room supply growth is cyclical as hotel construction responds to interest rates, construction and material costs, capital availability and industry fundamentals. Historically, the industry added hotel rooms to its

inventory through new construction due largely to a favorable lending environment that encouraged hotel development. This resulted in an over supply of rooms which, coupled with the decrease in industry performance between 2001 and 2003, has led to reduced hotel development. We believe that development of newly constructed hotels will not fully recover until economic gains and lodging trend improvements are sustained.

New hotel construction entered the recovery phase during 2005 with 65,900 rooms added to the industry. This growth marked the first annual increase in newly constructed hotel rooms since 1999. However, the volume of new room additions still lags the pre-2001 economic recession levels. Despite rising interest rates and construction costs, some economic forecasters have predicted a continuing rise in the supply of hotel rooms to meet demand.

As a franchisor, we are well positioned in any stage of the lodging cycle. We benefit from both the RevPAR gains typically experienced in the early stage of recovery, as our revenues are based on our franchisees’ gross room revenues, and the supply growth normally noted in the later stages as we increase our portfolio size. During lodging cycle downturns, we benefit from the conversion of independent and other hotel chain affiliates into our system in an effort to improve their performance.

Hotels are broadly segmented into two categories: full-service and limited service. Full-service hotels generally offer food and beverage (F&B) facilities and/or meeting facilities. Limited-service hotels, usually offer only rooms, although some offer modest F&B (e.g. breakfast buffets) and/or small meeting rooms. Full-service hotels are generally larger, command higher room rates, and generate higher profits, although overall margins are lower because F&B is a lower-margin business. The lodging industry can be further divided into chain scale segments or groupings of generally competitive brands as follows:


Chain Scale	Brand Examples	Room Count	% of Total		Avg. Hotel Size
Luxury	Four Seasons, Ritz Carlton	74,981	1.7	%	312
Upper Upscale	Marriott, Hilton, Sheraton	540,262	12.1	%	384
Upscale	Hilton Garden Inn, Courtyard, Residence Inn	393,647	8.8	%	157
Midscale w/ F&B	Quality, Clarion, Holiday Inn, Best Western, Ramada	557,980	12.4	%	121

Sub-Total Full Service		1,566,870	35.0	%	178

Midscale w/o F&B	Comfort, La Quinta, Baymont Inn, Hampton Inn	666,428	14.9	%	87
Economy	Econo Lodge, Days Inn, Super 8, Red Roof Inn	736,277	16.4	%	78

Sub-Total Limited Service		1,402,705	31.3	%	82

Independents		1,506,896	33.7	%	66

Total all Hotels		4,476,471	100.0	%	92

Source: Smith Travel Research (December 2005)

According to Smith Travel Research, Choice branded system-wide market share in the United States has increased 89 basis points to 7.35% of total industry rooms since 2002. The total number of domestic hotel rooms has increased at an annual rate of less than 1% per annum during these same 3 years.

Recently, independent operators of hotels not owned or managed by major lodging companies have increasingly joined national hotel franchise chains as a means of remaining competitive with hotels owned by or affiliated with national lodging companies. Over the past 15 years, the industry has seen a significant movement of hotels from independent to chain affiliation, with affiliated hotels increasing from 46% of the market in 1990 to 66% of the market in 2005. Because a significant portion of the costs of owning and operating a hotel are generally fixed, increases in revenues generated by affiliation with a franchise lodging chain can improve a hotel’s financial performance.

The large franchise lodging chains, including us, generally provide a number of services to hotel operators to improve the financial performance of their properties including central reservation systems, marketing and advertising programs, training and education programs, property systems, revenue enhancement services, creating partnerships with vendors to streamline purchasing processes and make lower cost products available and direct sales programs. We believe that national franchise chains with a large number of hotels enjoy greater brand awareness among potential guests than those with fewer hotels, and that greater brand awareness can increase the desirability of a hotel to its potential guests.

We believe that hotel operators choose lodging franchisors based primarily on the perceived value and quality of each franchisor’s brand and its services, and the extent to which affiliation with that franchisor may increase the hotel operator profitability.

Choice’s Franchising Business

Choice operates primarily as a hotel franchisor offering 10 brands. Our Clarion^® and Quality^® brands compete primarily in the full service midscale with food and beverage segment; our Comfort Inn^®, Comfort Suites^®, and Sleep Inn^® brands compete primarily in the limited service midscale without food & beverage segment; MainStay Suites^® and Suburban Extended Stay Hotel^® compete primarily in the extended stay segment and our Econo Lodge^® and Rodeway Inn^® brands compete primarily in the economy segment. In January 2005, we introduced a new brand, Cambria Suites^®, that will compete in the upscale segment. As a result of our acquisition of Suburban Franchise Holding Company, Inc., the Suburban Extended Stay Hotel^® brand was added to our portfolio on September 28, 2005.

Economics of Franchising Business. The fee and cost structure of our business provides opportunities for us to improve operating results by increasing the number of franchised properties, improving property level RevPAR performance and increasing the effective royalty rates quoted in our franchise contracts. As a hotel franchisor, we derive our revenue from various franchise fees. Our franchise fees consist primarily of an initial fee and ongoing royalty, marketing and reservation fees that are typically based on a percentage of the franchisee’s gross room revenues. The initial fee and on-going royalty portion of the franchise fees are intended to cover our operating expenses, such as expenses incurred in business development, quality assurance, administrative support and other franchise services and to provide us with operating profits. The marketing and reservation fees are used exclusively for the expenses associated with national marketing and media advertising and providing such franchise services as the central reservation system.

Our fee stream depends on the number of rooms in our system, the gross room revenues generated by our franchisees and effective royalty rates. We enjoy significant operating leverage since the variable operating costs associated with our franchise system growth have historically been less than incremental royalty fees generated from new franchisees. Our business is well positioned in the lodging industry since we benefit from both RevPAR growth and new hotel construction.

Our various brand offerings position us well within the lodging industry. Our Cambria Suites^®, Comfort Inn^®, Comfort Suites^®, Sleep Inn^®, Suburban Extended Stay Hotel^® and MainStay Suites^® are primarily new build brands which offer hotel developers an array of choices in the upscale, midscale and extended stay segments during periods of supply growth, while our Clarion^®, Quality^®, Econo Lodge^® and Rodeway Inn^® brands offer conversion opportunities to independent operators who desire to affiliate with a brand and take advantage of the services a franchisor has to offer.

Strategy. Our Company’s mission is a commitment to our customer’s profitability by providing our customers with hotel franchises that strive to generate the highest return on investment of any hotel franchise. Our business strategy is to create franchise system growth by leveraging Choice’s large and well-known hotel brands, franchise sales capabilities, effective marketing and reservation delivery efforts, RevPAR enhancing services and technology, and financial strength created by our significant free cash flow. We believe our brands’

growth will be driven by our ability to create a compelling return on investment for franchisees. Our strategic objective is to improve our franchisee’s profitability by providing services, which increase business delivery, reduce operating and development costs for our franchisees, and/or improve guest satisfaction. Specific elements of our strategy include: build strong brands, deliver exceptional services, reach more consumers and leverage size, scale and distribution that reduce costs for hotel owners.

Build Strong Brands. Each of our brands has particular attributes and strengths, including awareness with both consumers and developers. Our strategy is to utilize the strengths of each brand for unit growth, RevPAR gains and royalty rate improvement that create revenue growth. We believe brand consistency, quality and guest satisfaction are critical in improving brand performance and building strong brands.

We have multiple brands that are positioned to meet the needs of many types of guests, and can be developed at various price points and applied to both new and existing hotels. This ensures that we have brands suitable for creating unit growth in various types of markets, with various types of customers, and during both industry contraction and growth cycles. During times of lower industry supply growth and tighter capital markets, we can target conversions of existing non-Choice affiliated hotels seeking the awareness and proven performance provided by our brands. During periods of strong industry supply growth, we expect a greater portion of our unit growth to come from our new construction brands. We believe that a large number of markets can still support our hotel brands, and the growth potential for our brands as well as new brands we may introduce remain strong.

We believe each of our brands appeals to targeted hotel owners and guests because of unique brand standards, service levels and pricing.

Deliver Exceptional Services. We provide a combination of services and technological products to help our franchisees improve performance. We have approximately 84 field services staff members located nationwide that help franchisees improve RevPAR performance and guest satisfaction. In addition, we provide our franchisees with technology products designed to improve property level performance. These services and products promote revenue gains for franchisees and translate into both higher royalties for Choice and improved returns for owners, leading to further unit growth by making Choice brands attractive to franchisees. We develop our services based on customer needs and focus on activities that generate high return on investment for our customers.

Reach More Consumers. We believe hotel owners value the large volume of guests we deliver through corporate and brand marketing, reservation systems, key account sales, and Choice’s principal loyalty program, Choice Privileges^®. Our strategy is to maximize the effectiveness of these activities in delivering both leisure and business travelers to Choice-branded hotels.

Choice will continue to increase awareness of its brands through its multi-branded national marketing campaign which features re-imaged signs, our “We’ll See You There” tagline and our loyalty program promotions. This campaign is intended to generate the most compelling message in the midscale and economy segments and utilize Choice’s significant size to create even greater awareness for our brands. Local and regional co-op marketing campaigns will continue to leverage the national marketing programs to drive business to Choice properties at a local level. We expect our efforts at marketing directly to guests will continue to be enhanced through the use of our customer relationship management technology. Our continued focus on overall brand quality coupled with our marketing initiatives is designed to stimulate room demand for our franchised hotels through improved guest awareness and satisfaction.

Our central reservations system is a critical technology used to deliver guests to our franchisees through multiple channels, including our call centers and proprietary websites, and global distribution systems (e.g., SABRE, Amadeus, and internet distribution sites). We believe our well-known brands, combined with our ability to partner with many internet distribution web sites benefits our franchisees, by facilitating increased rate and reservations delivery, and reducing costs and operational complexity.

Leverage Size, Scale and Distribution. We continually focus on identifying methods for utilizing the significant number of hotels in our system to reduce costs and increase returns for our franchisees. For example, we create partnerships with vendors to: (i) make low-cost products available to our franchisees; (ii) streamline the purchasing process; and (iii) maintain brand standards and consistency. We plan to expand this business and identify new methods for decreasing hotel-operating costs by increasing penetration internally and enhancing our existing vendor relationships and/or creating new vendor relationships. We believe our efforts to leverage Choice’s size, scale and distribution benefit the Company by enhancing brand quality and consistency, improving our franchisees returns and satisfaction, and creating partner services revenues.

Franchise System

Our franchises operate domestically under one of nine Choice brand names: Comfort Inn^®, Comfort Suites^®, Quality^®, Clarion^®, Sleep Inn^®, Econo Lodge^®, Rodeway Inn^®, MainStay Suites^® and Suburban Extended Stay Hotel^®. The following table presents key statistics related to our domestic franchise system over the five fiscal years ended December 31, 2005.

COMBINED DOMESTIC FRANCHISE SYSTEM


	As of and For the Year Ended December 31,
	2001			2002			2003			2004			2005
Number of properties, end of period		3,327			3,482			3,636			3,834			4,048
Number of rooms, end of period		270,514			282,423			294,268			309,586			329,353
Royalty fees ($000)	$	133,244		$	135,381		$	141,150		$	155,915		$	175,588
Average royalty rate^{(1), (3)}		3.95	%		3.97	%		4.01	%		4.04	%		4.08	%
Average occupancy percentage⁽³⁾		57.5	%		55.6	%		54.7	%		56.6	%		57.6	%
Average daily room rate (ADR)⁽³⁾	$	62.31		$	61.96		$	62.53		$	63.56		$	66.24
Revenue per available room (RevPAR)^{(2), (3)}	$	35.83		$	34.48		$	34.21		$	35.95		$	38.15

⁽¹⁾

Represents domestic royalty fees as a percentage of aggregate gross room revenues of all domestic Choice brand franchised hotels except for Suburban Extended Stay Hotel acquired on September 28, 2005.

⁽²⁾

The Company calculates RevPAR based on information reported to the Company on a timely basis by franchisees.

⁽³⁾

Statistics exclude the results of the Suburban Extended Stay Hotel chain acquired on September 28, 2005 since comparable pre-acquisition data is not available.

Approximately 95% of our 2005 and 2004 total revenues were generated from hotels franchised in the United States. Consequently, our description of our franchise system is primarily focused on the domestic operations. Currently, no individual franchisee or international master franchisee accounts for 2% or more of Choice’s royalty revenues or total revenues.

Brand Positioning

Our brands offer consumers and developers a wide range of choices from economy hotels to lower upscale, full service properties. Our domestic brands are as follows:

Comfort Inn: Comfort Inn hotels operate in the mid-scale without food and beverage segment. One of the original brands in the limited service segment, Comfort has built a reputation for consistent high-value accommodations for both business and leisure travelers. Principal competitor brands include Holiday Inn Express, Fairfield Inn and Country Inn & Suites.

Comfort Suites: Comfort Suites hotels operate in the upper portion of the mid-scale without food and beverage segment. Established in 1986 as an extension of the highly regarded Comfort Inn brand, Comfort Suites feature oversized, comfortable rooms at mid-priced rates. The brand competes with Hampton Inn, Holiday Inn Express, Fairfield Inn and Country Inn & Suites.

Quality: Quality Inn hotels have offered efficient and personable service and clean accommodations since 1968 in the midscale segment. Amenities and services typically include complimentary continental breakfast, “Quality Sleeper” by Serta mattresses, swimming pools and/or exercise rooms, free USA today or Wall Street Journal newspaper and meeting or event space. Principal competitor brands include Best Western, Ramada, Howard Johnson and Holiday Inn.

Clarion: Clarion hotels are full-service hotels competing in the mid-scale hotel category. The brand offers upscale lodging at an affordable price. Providing a full spectrum of superior facilities and amenities, which include restaurant, conference or banquet facilities, 24-hour business center, swimming pool or exercise room, guest laundry, room service and bell service. Principal competitor brands include Sheraton Four Points, Holiday Inn Select, Radisson and Doubletree.

Sleep Inn: Sleep Inn is a new construction brand that operates in the mid-scale without food & beverage category. Sleep delivers one of the most consistent product offerings in the segment, which targets both business and leisure travelers. Sleep competes with Baymont, Amerihost, La Quinta and Fairfield Inn.

MainStay Suites: MainStay Suites hotels compete in the mid-scale extended stay category. Complete with a residential feel and value-added amenities, the MainStay brand is designed as a more practical lodging option for guests whose stays are longer than just a few nights. Typically, longer hotel stays involve relocation, training, or temporary job assignments. All MainStay guests suites feature fully equipped kitchens with a two-burner range, dishes, utensils, dishwasher, sink with disposal, microwave, and full size refrigerator. All suites include a sleeper sofa, comfortable work area with ergonomic chair and large walk-in closets. MainStay competes directly with Studio Plus, TownePlace Suites, Sierra Suites, and Candlewood Suites.

Econo Lodge: Econo Lodge is a leading economy segment chain, which offers clean, attractive lodging for value-oriented travelers. Breakfast by Econo Lodge, free local calls, and free premium channels are just some of the amenities that position Econo Lodge as a great value in the economy segment. Principal competitor brands are Days Inn, Super 8, Motel 6, and Travelodge.

Rodeway Inn: Rodeway Inn is a leading budget segment chain, which offers clean, affordable lodging for savings-oriented travelers. With Always Fresh…Rodeway^{^®} breakfast and a free newspaper, Rodeway is well positioned to offer savings for the budget-minded traveler. Principal competitor brands are Best Value Inn, Knights Inn and Budget Host.

Cambria Suites: Cambria Suites is an upscale select service hotel chain with an upscale image and distinctive styling. Cambria offers well-appointed suites that emulate the “best of a modern home.” In-room amenities include luxury bedding, stereo with CD player, cordless phone and mini-refrigerator with microwave. Principal competitor brands include Marriott Courtyard and Hilton Garden Inn. The Cambria Suites brand was launched in January 2005.

Suburban Extended Stay Hotel: Suburban Extended Stay Hotel suites are built with today’s value-conscious extended stay guest in mind. All suites provide full kitchens, internet connections, and access to on-site laundry facilities. Suburban’s “just what you need” philosophy matches attractive weekly pricing with weekly housekeeping to provide extended stay guests with the all-suite accommodations they want without the cost of services they do not need. Principal competitor brands include Intown Suites and Sun Suites.

The following table presents key statistics related to the domestic system for each of our brands that is currently operational over the five fiscal years ended December 31, 2005.


	As of and For the Year Ended December 31,
	2001			2002			2003			2004			2005
COMFORT DOMESTIC SYSTEM
Number of properties, end of period		1,621			1,707			1,783			1,821			1,839
Number of rooms, end of period		126,998			134,326			140,416			143,007			143,849
Royalty fees ($000)	$	78,690		$	81,390		$	85,998		$	94,801		$	106,603
Average occupancy percentage		61.3	%		59.7	%		58.8	%		60.9	%		62.7	%
Average daily room rate (ADR)	$	65.30		$	65.18		$	65.92		$	67.34		$	70.85
RevPAR	$	40.01		$	38.93		$	38.79		$	41.04		$	44.40
QUALITY DOMESTIC SYSTEM
Number of properties, end of period		430			455			508			576			660
Number of rooms, end of period		48,014			48,472			52,766			58,785			66,316
Royalty fees ($000)	$	20,605		$	19,658		$	20,221		$	22,821		$	25,855
Average occupancy percentage		55.3	%		52.0	%		51.6	%		54.1	%		54.6	%
Average daily room rate (ADR)	$	64.72		$	63.82		$	64.19		$	63.62		$	64.86
RevPAR	$	35.80		$	33.16		$	33.14		$	34.41		$	35.41
CLARION DOMESTIC SYSTEM
Number of properties, end of period		119			132			138			158			153
Number of rooms, end of period		18,032			20,006			20,737			23,652			23,554
Royalty fees ($000)	$	7,189		$	7,479		$	7,534		$	8,375		$	9,385
Average occupancy percentage		54.3	%		51.8	%		49.2	%		51.1	%		52.5	%
Average daily room rate (ADR)	$	78.14		$	73.88		$	72.27		$	72.37		$	74.62
RevPAR	$	42.46		$	38.26		$	35.55		$	36.97		$	39.15
SLEEP DOMESTIC SYSTEM
Number of properties, end of period		285			301			309			311			319
Number of rooms, end of period		21,945			23,061			23,678			23,766			24,205
Royalty fees ($000)	$	9,635		$	10,258		$	10,856		$	12,387		$	13,862
Average occupancy percentage		57.5	%		56.8	%		57.5	%		59.5	%		61.0	%
Average daily room rate (ADR)	$	57.02		$	57.36		$	58.01		$	59.50		$	62.52
RevPAR	$	32.79		$	32.57		$	33.33		$	35.42		$	38.16
MAINSTAY DOMESTIC SYSTEM
Number of properties, end of period		39			40			26			27			27
Number of rooms, end of period		3,410			3,445			2,063			2,150			2,047
Royalty fees ($000)	$	853		$	970		$	980		$	1,163		$	1,375
Average occupancy percentage		65.8	%		67.9	%		62.9	%		62.2	%		65.7	%
Average daily room rate (ADR)	$	64.09		$	61.50		$	61.50		$	61.09		$	64.76
RevPAR	$	42.20		$	41.77		$	38.70		$	37.97		$	42.54
ECONO LODGE DOMESTIC SYSTEM
Number of properties, end of period		691			715			734			781			805
Number of rooms, end of period		42,936			44,522			45,420			48,301			49,763
Royalty fees ($000)	$	14,100		$	13,664		$	13,644		$	14,255		$	15,509
Average occupancy percentage		51.4	%		49.4	%		47.5	%		48.2	%		48.2	%
Average daily room rate (ADR)	$	47.30		$	47.36		$	47.88		$	48.92		$	50.95
RevPAR	$	24.30		$	23.38		$	22.76		$	23.57		$	24.56
RODEWAY DOMESTIC SYSTEM
Number of properties, end of period		142			132			138			160			180
Number of rooms, end of period		9,179			8,591			9,188			9,925			11,051
Royalty fees ($000)	$	2,171		$	1,962		$	1,917		$	2,114		$	2,256
Average occupancy percentage		47.2	%		45.5	%		44.8	%		48.7	%		46.7	%
Average daily room rate (ADR)	$	48.94		$	49.00		$	49.84		$	52.33		$	49.91
RevPAR	$	23.11		$	22.29		$	22.32		$	25.49		$	23.31
SUBURBAN DOMESTIC SYSTEM⁽¹⁾
Number of properties, end of period		—			—			—			—			65
Number of rooms, end of period		—			—			—			—			8,568
Royalty fees ($000)		—			—			—			—		$	743	⁽²⁾

⁽¹⁾

Statistics for average occupancy percentage, ADR and RevPAR for the three months ended December 31, 2005 have been excluded since comparable pre-acquisition data is not available.

⁽²⁾

Royalty fees include results of Suburban operations from September 28, 2005 through December 31, 2005

International Franchise Operations

We conduct our international franchise operations through a combination of master franchising, direct franchise agreements, and investments in non-domestic lodging franchise companies. The use of our brands by third parties in foreign countries are governed by master franchising agreements which generally provide the master franchisee with the right to use our brands in a specific geographic region, usually for a fee.

Outside the United States franchise branding is much less prevalent, and most markets are served primarily by independent operators. We believe that chain affiliation will increase in international markets as local economies grow and hotel owners seek the economies of centralized reservations systems and marketing programs.

As of December 31, 2005, we had 1,162 franchise hotels open and operating in more than 40 countries and territories outside of the United States. The following chart summarizes our franchise system outside of the United States.

COMBINED INTERNATIONAL FRANCHISE SYSTEM⁽¹⁾


	As of and For the Year Ended December 31,
	2001		2002		2003		2004		2005
Number of properties, end of period		1,218		1,182		1,174		1,143		1,162
Number of rooms, end of period		92,035		91,299		94,350		94,220		97,703
Royalty fees ($000)	$	5,215	$	6,335	$	9,237	$	10,071	$	10,971

⁽¹⁾

Reporting of operating statistics (e.g. average occupancy percentage and average daily room rate) of international franchisees is not required by all master franchise contracts, thus these statistics and RevPAR are not presented for international franchisees.

Europe. Through our relationships with C.H.E. Group PLC (“CHE”) and Choice Hotels Scandinavia (“CHS”), we are one of the largest branded hotel chains in Europe. As of December 31, 2005, CHE’s portfolio consisted of 329 properties, which were owned, managed or franchised. The master franchise agreement with CHE expires in January 2008, subject to certain renewal rights of CHE. We currently assess only a reservation fee to the properties in CHE’s portfolio. Beginning in January 2006, we will begin to assess royalty and marketing fees as well as the current reservation fees. CHS had 148 open properties at December 31, 2005. The master franchise agreement with CHS expires in November 2014, but may be terminated in November 2009 by either CHS or Choice.

Canada. We conduct our operation in Canada through Choice Hotels Canada, Inc. (“CHC”) a joint venture owned 50% by us and 50% by InnVest Real Estate Investment Trust. CHC is one of the largest lodging organizations in Canada with 262 franchised properties open as of December 31, 2005.

Australasia. The Company conducts direct franchising operations in Australia, American Samoa, Fiji, New Zealand and Papua New Guinea through a wholly owned subsidiary, Choice Hotels Australasia Pty. Ltd. (“CHA”). As of December 31, 2005, CHA had 280 franchised properties open under the Choice brands and 13 franchised hotels under the Flag brand in Australia, American Samoa, New Zealand and Papua New Guinea. CHA is in the process of converting all remaining Flag branded franchises to the Company’s other brands and expects to complete this conversion during 2007.

Mexico. During 2004, we established a wholly owned subsidiary Choice Hotels Mexico S. de R.L. de C.V. (“CHM”) to begin direct franchising operations in Mexico. CHM is focused on establishing Clarion^®, Quality^® and Comfort^® brands through conversions of high quality unbranded hotels in Mexico. At December 31, 2005, CHM had 6 properties open and operating.

Other International Relationships. We have various master franchise and area representative arrangements in place with local hotel management and franchising companies doing business in South America, India, Central America, Japan and Indonesia. In addition, the Company has direct franchise relationships with properties in the Caribbean, Malaysia, China, and Lebanon.

The following table summarizes Choice’s non-domestic franchise system as of December 31, 2005:


	Comfort	Quality	Clarion	Sleep	Econo Lodge	Rodeway	Flag	Total
American Samoa	—	—	1	—	—	—	—	1
Australia	166	73	15	—	—	—	1	255
Austria	1	1	—	—	—	—	—	2
Belgium	1	—	—	—	—	—	—	1
Brazil	20	18	3	3	—	—	—	44
Canada	141	61	9	3	43	5	—	262
China	1	—	1	—	—	—	—	2
Costa Rica	—	1	1	1	—	—	—	3
Czech Republic	1	1	1	—	—	—	—	3
Denmark	7	6	4	—	—	—	—	17
Dominican Republic	—	1	1	—	—	—	—	2
El Salvador	2	1	—	—	—	—	—	3
Estonia	1	—	—	—	—	—	—	1
Finland	1	2	1	—	—	—	—	4
France	95	30	2	—	—	—	—	127
Germany	22	21	5	—	—	—	—	48
Guatemala	—	—	1	—	—	—	—	1
Honduras	—	—	2	—	—	—	—	2
India	10	14	3	—	—	—	—	27
Indonesia	1	5	—	—	—	—	—	6
Ireland	2	9	7	—	—	—	—	18
Italy	5	4	2	—	—	—	—	11
Japan	21	3	—	4	—	—	—	28
Lebanon	—	1	—	—	—	—	—	1
Lithuania	—	1	—	—	—	—	—	1
Malaysia	—	2	—	—	—	—	—	2
Mexico	3	3	—	—	—	—	—	6
New Caledonia	—	1	—	—	—	—	—	1
New Zealand	11	12	2	—	—	—	7	32
Norway	10	39	20	—	—	—	—	69
Papua New Guinea	—	—	—	—	—	—	5	5
Portugal	6	5	1	—	—	—	—	12
Singapore	—	1	1	—	—	—	—	2
Spain	4	3	4	—	—	—	—	11
Sweden	10	27	19	—	—	—	—	56
Switzerland	5	1	—	—	—	—	—	6
United Kingdom	32	49	4	5	—	—	—	90

Total Number of Properties	579	396	110	16	43	5	13	1,162

The following table presents key worldwide system size statistics as of and for the year ended December 31, 2005.


	Open and Operational		Under Development		Additions	Repositionings		Terminations
	Hotels	Rooms	Hotels	Rooms	Additions	Repositionings		Terminations
Comfort	2,418	182,473	326	24,919	138	(44	)	(91	)
Quality	1,056	105,790	91	8,165	129	16		(55	)
Clarion	263	38,407	28	3,130	37	33		(33	)
Sleep Inn	335	25,605	95	6,964	15	(1	)	(4	)
MainStay Suites	27	2,047	30	2,398	2	—		(2	)
Econo Lodge	848	52,010	59	3,582	72	3		(50	)
Rodeway Inn	185	11,299	35	2,363	39	1		(19	)
Suburban	65	8,568	11	1,166	67	—		(2	)
Cambria Suites	—	—	12	1,388	—	—		—
Flag Hotels	13	857	—	—	—	(8	)	(10	)

Totals	5,210	427,056	687	54,075	499	—		(266	)

Franchise Sales

Brand growth is important to our business model. We have identified key market areas, for certain brands, for hotel development based on supply/demand relationships and our strategic objectives. Development opportunities are typically offered to; (i) existing franchisees; (ii) developers of hotels; (iii) owners of independent hotels and motels; (iv) owners of hotels affiliated with other franchisors’ brands; and; (v) contractors who construct any of the foregoing.

The franchise sales organization employs both regional sales managers as well as franchise sales directors. The regional sales managers have geographic oversight over all of our brands to ensure each prospective hotel is placed in the appropriate brand, facilitate teamwork and information sharing amongst the sales directors and provide better service to our top developers. Our franchise sales directors operate in brand specific selling teams to leverage their brand expertise to enhance product consistency and deal flow. Franchise sales efforts emphasize the benefits of affiliating with one of the Choice brands, our commitment to improving hotel profitability, our television, radio and print brand advertising campaigns, the Choice central reservation system, our training and support systems (including our proprietary property management systems) and our history of growth and profitability.

During 2005, Choice received 962 applications for new franchise agreements (not including relicensings of existing agreements) compared to 847 in 2004. These applications resulted in the execution of 639 new franchise agreements in 2005, compared to 552 in 2004. An application received does not always result in an executed franchise agreement during the year received or at all due to various factors, such as financing and agreement on financial terms. Our objective is to continue to grow our portfolio by continuing to sell our existing brands, creating extensions of our existing brands and introducing new brands within the various lodging chain segments.

Because retention of existing franchisees is important to our growth strategy, we have a formal impact policy. This policy offers existing franchisees protection from the opening of a same-brand property within a specified distance, depending upon the market in which the property is located.

Franchise Agreements

Our standard domestic franchise agreement, excluding contracts for Suburban Extended Stay Hotel (“Suburban”), grants a franchisee the right to non-exclusive use of our franchise system in the operation of a single hotel at a specified location, typically for a period of 20 years, with certain rights to each of the franchisor and franchisee to terminate the franchise agreement before the twentieth year. Suburban franchise agreements acquired through the Company’s acquisition of Suburban Franchise Holding, Inc. contain 10-year terms.

When the responsibility for development is transferred to an international master franchisee, that party has the responsibility to sell to local franchisees the Choice brands and the master franchisee generally must manage the delivery of necessary services (such as training, quality assurance, reservations and marketing) to support the franchised hotels in the master franchise area. The master franchisee collects the fees paid by the local franchisee and remits an agreed share to us. Master franchise agreements generally have a term of at least 10 years. We have only entered into master franchise agreements with respect to franchised hotels outside the United States.

Either party to a franchise agreement, other than master franchise agreements, can terminate a franchise agreement prior to the conclusion of the agreement’s term under certain circumstances, such as upon designated anniversaries of the agreement. Early termination options give us flexibility in eliminating or re-branding properties, if they become weak performers for reasons other than contractual failure by the franchisee. We also have the right to terminate a franchise agreement if a franchisee fails to bring the property into compliance with contractual or quality standards within specified periods of time. Master franchise agreements typically contain provisions permitting us to terminate the agreement for failure to meet a specified development schedule.

In 2005, we increased our efforts to enforce quality and contractual standards as well as eliminate weak performers. However, in 2005 and 2004, we still retained 95% of franchisees, which were in our domestic system compared to the prior years.

Franchise agreements are individually negotiated and vary among the different Choice brands and franchises, but generally are competitive with the industry average within their market group. Franchise fees usually have four components: an initial, one-time affiliation fee; a royalty fee; a marketing fee; and a reservation fee. Proceeds from the marketing fee and reservation fee are used exclusively to fund the Company’s marketing and reservation activities. Most marketing fees support marketing programs designed to support all of the Choice brands, while some contribute to brand-specific marketing programs.

Our standard franchise fees are as follows:

QUOTED FEES BY BRAND AS OF DECEMBER 31, 2005


		On-Going Fees as a Percentage of Franchisee’s Gross Room Revenues
Brand	Initial Fee Per Room/Minimum	Royalty Fees		Marketing Fees		Reservation Fees		Combined Marketing and Reservation Fees
Cambria Suites	$500/$60,000	5.00	%	2.10	%	1.75	%	—
Comfort Inn	$500/$50,000	5.25	%	2.10	%	1.75	%	—
Comfort Suites	$500/$50,000	5.25	%	2.10	%	1.75	%	—
Quality Inn	$300/$35,000	4.65	%	2.10	%	1.75	%	—
Quality Suites	$300/$50,000	4.65	%	2.10	%	1.75	%	—
Clarion	$300/$40,000	4.25	%	2.00	%	1.25	%	—
Sleep Inn	$300/$40,000	4.65	%	2.10	%	1.75	%	—
MainStay Suites	$300/$30,000	5.00	%	—		—		2.50	%
Econo Lodge	$250/$25,000	4.50	%	—		—		3.50	%
Rodeway Inn	$5,000	⁽¹	⁾	⁽²	⁾	⁽²	⁾	—
Suburban	$225/$30,000	5.00	%	—		—		2.50	%

⁽¹⁾

Royalty rate is $13.00 per room per month with $1.00 escalations on each of the 2^nd, 3^rd, 4^th and 5^th anniversaries of the franchise agreement.

⁽²⁾

Marketing and reservation fees are $7.00 and $5.00 per room per month, respectively.

Franchise Operations

Our operations are designed to improve RevPAR and lower operating and development costs for our franchisees, as these are the measures of performance that most directly impact franchisee profitability. We

believe that by helping our franchisees to become more profitable we will enhance our ability to both retain our existing franchisees and attract new franchisees. The key aspects of our franchise operations are:

Central Reservation System (“CRS”). On average, approximately one-third of the gross room revenue booked at franchisees’ properties is reserved through our central reservation system, which consists of our toll-free telephone reservation system, our proprietary internet site, interfaces with global distribution systems, and other internet reservations sites. Our reservation system consists of a computer reservation system, three reservation centers in North America and several international reservation centers operated by our master franchisees or us. Reservation agents trained on the reservation system can match each caller with a Choice-branded hotel meeting the caller’s needs. Our CRS provides a data link to our franchised properties as well as to the Amadeus, Galileo, SABRE and Worldspan airline reservation systems that facilitate the reservation process for travel agents. We also offer our rooms for sale on our own proprietary internet site (www.choicehotels.com) as well as those of other travel companies.

We continue to implement our integrated reservation strategy to improve reservations delivery, reduce franchisee costs and improve licensee satisfaction by enhancing our website, choicehotels.com, and selectively distributing our inventory with third parties that can drive additional business to Choice and its brands. We have established preferred partner agreements with key third party travel intermediaries to gain additional distribution points. These agreements typically offer Choice brands preferred placement on these third party sites at reduced transaction fees. We also continue to educate our individual franchisees about the unfavorable impact to their business of contracting with sites with which we do not have preferred agreements. We currently have agreements with many but not all major online third party sites.

Property Management System. Our proprietary property and yield management system, Profit Manager by Choice Hotels, is designed to help franchisees maximize profitability and compete more effectively by managing their rooms inventory, rates and reservations. The Profit Manager system is used by substantially all of our domestic non-economy brand franchises. The Profit Manager system synchronizes each hotel’s inventory with our system, giving our reservation sales agents last room sell capabilities at every hotel. Profit Manager includes a revenue management feature that calculates and suggests optimum rates based on each hotel’s past performance and projected occupancy. These tools are critical to business delivery and yield improvement as they remain critical to the franchisee’s ability to effectively manage their hotel operations, determine appropriate rates to profitability, drive occupancy and participate in Choice marketing programs.

Brand Name Marketing and Advertising. Our marketing and advertising programs are designed to heighten consumer awareness and preference for the Choice brands as offering the greatest value and convenience in the midscale and economy segments. Marketing and advertising efforts include national television, internet and radio advertising, print advertising in consumer and trade media and promotional events, including joint marketing promotions with vendors and corporate partners.

Numerous marketing and sales programs are conducted which target specific groups, including corporate travelers, senior citizens, automobile club members, families, government and military employees, and meeting planners. Other marketing efforts include domestic and international trade show programs, publication of group and tour rate directories, direct-mail programs, electronic direct marketing e-mail programs, centralized commissions for travel agents, fly-drive programs in conjunction with major airlines, and annual publication of a travel and vacation directory.

Since 1998, we have operated a loyalty program called Choice Privileges^®, which includes all of our mid-scale brands (Comfort, Clarion, Quality, Sleep and MainStay Suites) to attract and retain travelers by rewarding frequent stays with points towards free hotel stays and other rewards. During the spring of 2005, we again ran the “Stay Twice, Earn a Free Night” promotion for Choice Privileges members. This promotion has been a key contributor to the growth in the number of program members. As of December 31, 2005, the program had approximately 4.4 million members. In 2001, we launched a similar loyalty program called EA$Y CHOICE^®

for our Econo Lodge and Rodeway Inn brands. The EA$Y CHOICE program is a stamp redemption program and has no membership requirement to participate. Choice Privileges^® and EA$Y CHOICE participants can earn points/stamps redeemable for free stays in Choice brand properties. Choice also offers guests the ability to earn airline miles for qualifying stays redeemable for flights with Southwest Airlines, United Air Lines, American Airlines, US Airways, Continental Airlines, America West Airlines, Delta Air Lines, Northwest Airlines, Air Canada and Alaska Airlines. These programs allow us to conduct lower cost, more targeted marketing campaigns to our consumers.

Marketing and advertising programs are directed by our marketing department, which utilizes the services of independent advertising agencies. We also employ home-based sales personnel geographically located across the United States using personal sales calls, telemarketing and other techniques to target specific customer groups, such as potential corporate clients in areas where our franchised hotels are located, the motor coach market, and meeting planners. All sales personnel sell business for all of the Choice brands.

Our franchise service directors work with franchisees to maximize RevPAR. These directors advise franchisees on topics such as marketing their hotels, improving quality and maximizing the benefits offered by the Choice reservations system.

Quality Assurance Programs. Consistent quality standards are critical to the success of a hotel franchise. We have established quality standards for all of our franchised brands that cover housekeeping, maintenance, brand identification and minimum service offering. We inspect properties for compliance with our quality standards when application is made for admission to the franchise system. The compliance of existing franchisees with quality standards is monitored through scheduled and unannounced quality assurance reviews conducted periodically at each property. Properties that fail to maintain a minimum score are reinspected on a more frequent basis until deficiencies are cured, or until such properties are terminated.

To encourage compliance with quality standards, various brand-specific incentives and awards are used to reward franchisees that maintain consistent quality standards. We identify franchisees whose properties operate below minimum quality standards and assist them in complying with brand specifications. Franchisees who fail to improve on identified quality matters may be subject to consequences ranging from written warnings to termination of the franchisee’s franchise agreement.

Training. We maintain a training department that conducts mandatory training programs for all franchisees and their employees. Regularly scheduled regional and national training meetings are also conducted for both property-level staff and managers. Training programs teach franchisees how to best use the Choice reservation system and marketing programs and fundamental hotel operations such as housekeeping, maintenance and inventory yield management.

Training is conducted by a variety of methods, including group instruction seminars and video programs. We have developed an interactive computer-based training system that will train hotel employees at their own pace.

Design and Construction. We maintain a design and construction department to assist franchisees in refurbishing, renovating, or constructing their properties prior to or after joining the system. Department personnel assist franchisees in meeting our brand specifications by providing technical expertise and cost-savings suggestions.

Competition

Competition among franchise lodging chains is intense in attracting potential franchisees to the system, retaining existing franchisees and in generating reservations for franchisees. Franchise contracts are typically long-term in nature, but most allow the hotel owner to opt out of the agreement at mutually agreed upon anniversary dates.

We believe that hotel operators choose lodging franchisors based primarily on the value and quality of each franchisor’s brand and services and the extent to which affiliation with that franchisor may increase the franchisee’s reservations and profits. We also believe that hotel operators select a franchisor in part based on the franchisor’s reputation among other franchisees, and the success of its existing franchisees.

Our prospects for growth are largely dependent upon the ability of our franchisees to compete in the lodging market, since our franchise system revenues are based on franchisees’ gross room revenues, our ability to convert competitor franchises and independent hotels to our brands and the ability of our franchisees to obtain financing to construct new hotels.

The ability of a hotel to compete may be affected by a number of factors, including the location and quality of the property, the number and quality of competing properties nearby, its affiliation with a recognized name brand and general regional and local economic conditions. The effect of local economic conditions on our results is substantially reduced by the geographic diversity of our franchised properties, which are located in 49 states, the District of Columbia and more than 40 countries and territories outside the United States, as well as our range of products and room rates.

We believe that our focus on core business strategies, combined with our financial strength and size, scale and distribution will enable us to remain competitive.

Service Marks and Other Intellectual Property

The service marks Choice Hotels International, Comfort Inn, Comfort Suites, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites, Cambria Suites, Suburban Extended Stay Hotel, Choice Privileges, Easy Choice and related marks and logos are material to our business. We, directly and through our franchisees, actively use these marks. All of the material marks are registered with the United States Patent and Trademark Office. In addition, we have registered certain of our marks with the appropriate governmental agencies in over 100 countries where we are doing business or anticipate doing business in the foreseeable future. We seek to protect our brands and marks throughout the world, although the strength of legal protection available varies from country to country. Depending on the jurisdiction, trademarks and other registered marks are valid as long as they are in use and/or their registrations are properly maintained and they have not been found to have become generic.

Seasonality

The hotel industry is seasonal in nature. For most hotels, demand is lower in December through March than during the remainder of the year. Our principal source of revenues is franchise fees based on the gross room revenues of our franchised properties. The Company’s franchise fee revenues and operating income reflect the industry’s seasonality and historically have been lower in the first quarter than in the second, third or fourth quarters.

Regulation

The Federal Trade Commission (the “FTC”), various states and certain other foreign jurisdictions (including Australia, France, Canada, and Mexico) regulate the sale of franchises. The FTC requires franchisors to make extensive disclosure to prospective franchisees but does not require registration. A number of states in which our franchises operate require registration or disclosure in connection with franchise offers and sales. In addition, several states have “franchise relationship laws” or “business opportunity laws” that limit the ability of the franchisor to terminate franchise agreements or to withhold consent to the renewal or transfer of these agreements. While our franchising operations have not been materially adversely affected by such regulation, we cannot predict the effect of future regulation or legislation.

Our franchisees are responsible for compliance with all laws and government regulations applicable to the hotels they own or operate. The lodging industry is subject to numerous federal, state and local government regulations, including those relating to the preparation and sale of food and beverage (such as health and liquor license laws), building and zoning requirements and laws governing employee relations, including minimum wage requirements, overtime, working conditions and work permit requirements.

Impact of Inflation and Other External Factors

Franchise fees can be impacted by external factors, including, in particular the supply of hotel rooms within the lodging industry relative to the demand for rooms by travelers, and inflation.

We believe industry wide supply and demand for hotel rooms is lower than historical averages. We expect to benefit in the form of increased franchise fees from future growth in consumer demand as well as in the supply of hotel rooms, which do not result in excess lodging industry capacity. However, a prolonged decline in demand for hotel rooms would negatively impact our business.

Although we believe that increases in the rate of inflation will generally result in comparable increases in hotel room rates, severe inflation could contribute to a slowing of the national economy. Such a slowdown could result in reduced travel by both business and leisure travelers, potentially resulting in less demand for hotel rooms, which could result in a reduction in room rates and fewer room reservations, negatively impacting our revenues. A weak economy could also reduce demand for new hotels, negatively impacting the franchise fees received by us.

Among other unpredictable external factors, which may negatively impact us, are wars, acts of terrorism, airline strikes, gasoline shortages, severe weather and the risks described below under the heading Risk Factors.

Employees

We employed domestically approximately 1,728 people as of February 28, 2006. None of our employees are represented by unions or covered by collective bargaining agreements. We consider our relations with our employees to be good.

Item 1A. Risk Factors.

Choice Hotels International, Inc. and subsidiaries is subject to various risks, which could have a negative effect on the Company and its financial condition. These risks could cause actual operating results to differ from those expressed in certain “forward looking statements” contained in this Form 10-K as well as in other Company communications. Before you invest in our securities you should carefully consider these risk factors together with all other information included in our publicly filed documents.

We are subject to the operating risks common in the lodging and franchising industries.

A significant portion of our revenue is derived from fees based on room revenues at hotels franchised under our brands. As such, our business is subject, directly or through our franchisees, to the following risks common in the lodging and franchising industry, among others:

•

changes in the number of hotels operating under franchised brands;

•

changes in the relative mix of franchised hotels in the various lodging industry price categories;

•

changes in occupancy and room rates achieved by hotels;

•

desirability of hotel geographic location;

•

changes in general and local economic and market conditions, which can adversely affect the level of business and leisure travel, and therefore the demand for lodging and related services;

•

increases in costs due to inflation may not be able to be totally offset by increases in room rates;

•

over-building in one or more sectors of the hotel industry and/or in one or more geographic regions, could lead to excess supply compared to demand, and to decreases in hotel occupancy and/or room rates;

•

changes in travel patterns;

•

changes in governmental regulations that influence or determine wages, prices or construction costs;

•

other unpredictable external factors, such as acts of god, war, terrorist attacks, epidemics, airline strikes, transportation and fuel price increases and severe weather, may reduce business and leisure travel;

•

increases in the cost of human capital, energy, healthcare, insurance and other operating expenses resulting in lower operating margins;

•

the financial condition of franchisees and travel related companies;

•

franchisors’ ability to develop and maintain positive relations with current and potential franchisees; and,

•

changes in exchange rates or sustained recessionary periods in the U.S. (affecting domestic travel) and internationally could also unfavorably impact future results.

We are subject to risks relating to acts of God, terrorist activity, epidemics and war.

Our financial and operating performance may be adversely affected by acts of God, such as natural disasters and/or epidemics in locations where we have a high concentration of franchisees and areas of the world from which our franchisees draw a large number of guests. Some types of losses, such as from terrorism and acts of war may be either uninsurable or too expensive to justify insuring against. Should an uninsured loss or a loss in excess of insured limits occur, our results of operations and financial condition may be adversely affected.

We may not grow our franchise system or we may lose business by failing to compete effectively.

Our operational and growth prospects depend on the strength and desirability of our brands. We believe that hotel operators choose lodging franchisors based primarily on the value and quality of each franchisor’s brand and services, the extent to which affiliation with that franchisor may increase the hotel operator’s reservations and profits, and the franchise fees charged. Demographic, economic or other changes in markets may adversely affect the desirability of our brands and, correspondingly, the number of hotels franchised under the Choice brands.

We compete with other lodging companies for franchisees. As a result, the terms of new franchise agreements may not be as favorable as our current franchise agreements. Our competition may reduce fee structures, potentially causing us to charge lower fees, which may impact our margins. New competition may emerge using different business models with a lesser reliance on franchise fees. In addition, an excess supply of hotel rooms may discourage potential franchisees from constructing new hotels, thereby limiting a source of growth of the franchise fees received by us.

We may not achieve our objectives for growth in the number of franchised hotels.

The number of properties and rooms franchised under our brands significantly affects our results. There can be no assurance that we will be successful in achieving our objectives with respect to growing the number of franchised hotels in our system or that we will be able to attract qualified franchisees. The growth in the number

of franchised hotels is subject to numerous risks, many of which are beyond the control of our franchisees or us. Among other risks, the following factors affect our ability to achieve growth in the number of franchised hotels.

•

the ability of our franchisees to open and operate additional hotels profitably. Factors affecting the opening of new hotels, or the conversion of existing hotels to a Choice brand, include, among others:

•

the availability of hotel management, staff and other personnel;

•

the cost and availability of suitable hotel locations;

•

the availability and price of capital to allow hotel owners and developers to fund investments;

•

cost effective and timely construction of hotels (which construction can be delayed due to, among other reasons, labor disputes, local zoning and licensing matters, and weather conditions); and

•

securing required governmental permits.

•

our ability to continue to enhance our reservation, operational and service delivery systems to support additional franchisees in a timely, cost-effective manner;

•

the effectiveness and efficiency of our development organization;

•

our failure to introduce new brands that gain market acceptance, may adversely impact our unit growth potential;

•

our dependence on our independent franchisees’ skills and access to financial resources necessary to open the desired number of hotels; and,

•

our ability to attract and retain qualified domestic and international franchisees.

Contract terms for new hotel franchises may be less favorable.

The terms of the franchise agreements for new or conversion hotels are influenced by contract terms offered by our competitors at the time these agreements are entered into. Accordingly, we cannot assure you that contracts for new hotel franchises entered into or renewed in the future will be on terms that are as favorable to us as those under our existing agreements.

Under certain circumstances our franchisees may terminate our franchise contracts.

We franchise hotels to third parties pursuant to franchise contracts. These contracts may be terminated, renegotiated or expire. These franchise contracts typically have an initial term of twenty years with provisions permitting the franchisee to terminate the agreements after five, ten or fifteen years under certain circumstances. There can be no assurance that we will be able to replace terminated franchise contracts, or that the terms of renegotiated or new contracts will be as favorable as the terms that existed before such replacement or renegotiation.

Deterioration in the general financial condition of our franchisees may adversely affect our results.

Our operating results are impacted by the ability of our franchisees to generate revenues at properties they franchise from us. An extended period of occupancy or room rate declines may adversely affect the operating results and financial condition of our franchisees.

The hotel industry is highly competitive. Competition is based primarily on the level of service, quality of accommodations, convenience of locations and room rates. Our franchisees compete for guests with other hotel properties in their geographic markets. Some of their competitors may have substantially greater marketing and financial resources than our franchisees, and they may construct new facilities or improve their existing facilities, reduce their prices or expand and improve their marketing programs in ways that adversely affect our franchisees operating results and financial condition.

These factors, among others, could adversely affect the operating results and financial condition of our franchisees and result in declines in the number of franchised properties and/or franchise fees and other revenues derived from our franchising business.

Increasing use of internet reservation channels may decrease loyalty to our brands or otherwise adversely affect us.

A growing percentage of our hotel rooms are booked through internet travel intermediaries. If such bookings continue to increase, these intermediaries may be able to obtain higher commissions, reduced room rates or other significant contract concessions from our franchisees or us. Moreover, some of these internet travel intermediaries are attempting to commoditize hotel rooms, by increasing the importance of price and general indicators of quality at the expense of brand identification. These intermediaries hope that consumers will eventually develop brand loyalties to their reservations systems rather than to our lodging brands. If this happens our business and profitability may be significantly harmed. We have established preferred partner agreements with many key third party websites to limit transaction fees for hotels but we currently do not have agreements with several large internet travel intermediaries.

We are dependent upon our employees’ ability to manage our growth.

Our future success and our ability to manage future growth depend in large part upon the efforts and skills of our senior management and our ability to attract and retain key officers and other highly qualified personnel. Competition for such personnel is intense. There can be no assurance that we will continue to be successful in attracting and retaining qualified personnel. Accordingly, there can be no assurance that our senior management will be able to successfully execute and implement our growth and operating strategies.

We and our franchisees are reliant upon technology.

The lodging industry depends upon the use of sophisticated technology and systems including technology utilized for reservation systems, property management, procurement, operation of our customer loyalty programs and administrative systems. The operation of many of these systems is dependent upon third party data communication networks and software upgrades, maintenance and support. These technologies can be expected to require refinements and there is the risk that advanced new technologies will be introduced. There can be no assurance that as various systems and technologies become outdated or new technology is required we will be able to replace or introduce them as quickly as our competitors or within budgeted costs for such technology. There can be no assurance that we will achieve the benefits that may have been anticipated from any new technology or system. Further, there can be no assurance that disruptions of the operation of these systems will not occur as a result of failures related to third party systems and support.

Our international operations are subject to special political and monetary risks.

We have franchised properties open and operating in more than 40 countries and territories outside of the United States. We also have investments in several foreign hotel franchisors. International operations generally are subject to political and other risks that are not present in U.S. operations. These risks include the risk of war or civil unrest, expropriation and nationalization. In addition, some international jurisdictions restrict the repatriation of non-U.S. earnings. Various international jurisdictions also have laws limiting the right and ability of non-U.S. entities to pay dividends and remit earnings to affiliated companies unless specified conditions have been met. In addition, sales in international jurisdictions typically are made in local currencies, which subjects us to risks associated with currency fluctuations. Currency devaluations and unfavorable changes in international monetary and tax policies could have a material adverse effect on our profitability and financing plans, as could other changes in the international regulatory climate and international economic conditions.

We are subject to certain risks related to our indebtedness.

As a result of our debt obligations, we are subject to the following risks, among others:

•

the risk that cash flows from operations or available lines of credit will be insufficient to meet required payments of principal and interest when due;

•

the risk that (to the extent we maintain floating rate indebtedness) interest rates increase;

•

our leverage may adversely affect our ability to obtain additional financing for acquisitions, working capital, capital expenditures or other purposes, if required;

•

our existing debt agreements contain covenants that limit our ability to, among other things, borrow additional money, sell assets or engage in mergers. If we do not comply with these covenants, or do not repay our debt on time, we would be in default under our debt agreements. Unless any such default is waived by our lenders, the debt could become immediately payable and this would have a material adverse impact on us; and,

•

the liquidity of the market for our publicly traded senior notes depends upon the number of holders of those securities, our performance, the market for similar securities, the interest of securities dealers in making a market in those securities and other factors.

While our senior debt is currently rated investment grade by both of the major rating agencies, there can be no assurance we will be able to maintain this rating. In the event our senior debt is not investment grade, we would likely incur higher borrowing costs.

Anti-takeover provisions may prevent a change in control.

Our restated certificate of incorporation, the staggered terms of our board of directors and the Delaware General Corporation Law each contain provisions that could have the effect of making it more difficult for a party to acquire, and may discourage a party from attempting to acquire, control of our Company without approval of our board of directors. These provisions could discourage tender offers or other bids for our common stock at a premium over market price.

The concentration of share ownership may influence the outcome of certain matters.

The concentration of share ownership by our directors and affiliates allows them to substantially influence the outcome of matters requiring shareholder approval. As a result, acting together, they may be able to control or substantially influence the outcome of matters requiring approval by our shareholders, including the elections of directors and approval of significant corporate transactions, such as equity compensation plans.

Forward-looking statements may prove inaccurate.

We have made forward-looking statements in our reports on Form 10-Q, Form 10-K and other communications that are subject to risks and uncertainties. You should note that many factors, some of which are discussed in such reports, could affect future financial results and could cause those results to differ materially from those expressed in our forward-looking statements contained in such reports.

Government regulation could impact our business.

The Federal Trade Commission (the “FTC”), various states and certain foreign jurisdictions where we market franchises regulate the sale of franchises. The FTC requires franchisors to make extensive disclosure to prospective franchisees but does not require registration. A number of states in which our franchisees operate require registration or disclosure in connection with franchise offers and sales. In addition, several states in which our franchisees operate have “franchise relationship laws” or “business opportunity laws” that limit the ability of the franchisor to terminate franchise agreements or to withhold consent to the renewal or transfer of these agreements. While our business has not been materially affected by such regulation, there can be no assurance that this will continue or that future regulation or legislation will not have such an effect.

Failure to comply with Sarbanes-Oxley Act could impact our business.

There can be no assurance that the periodic evaluation of our internal controls required by the Sarbanes-Oxley Act will not result in the identification of significant control deficiencies or that our auditors will be able to attest to the effectiveness of our internal control over financial reporting. Failure to comply may have consequences on our business including, but not limited to, increased risks of financial statement misstatements, SEC sanctions and negative capital market reactions.

We are subject to certain risks related to litigation filed by or against us.

We cannot predict with certainty the cost of defense, the cost of prosecution or the ultimate outcome of litigation filed by or against us, including, remedies or damage awards. This litigation may include, but is not limited to, actions or negligence by franchisees outside of our control. We are not liable for the actions of our franchisees; however, there is no guarantee that we would be insulated from liability in all cases.

Disruption or malfunction in our information systems could adversely affect our business.

Our information technology system is vulnerable to damage or interruption from:

•

earthquakes, fires, floods and other natural disasters;

•

power losses, computer systems failures, internet and telecommunications or data network failures, operator negligence, improper operation by or supervision of employees, physical and electronic losses of data and similar events; and

•

computer viruses, penetration by individuals seeking to disrupt operations or misappropriate information and other breaches of security.

We rely on this system to perform functions critical to our ability to operate, including our central reservation systems. Accordingly, an extended interruption in the systems’ function could significantly curtail, directly and indirectly, our ability to conduct our business and generate revenue.

The weakening of our intellectual property could impact our business.

Our intellectual property is fundamental to our brands and our franchising business. We generate, maintain, utilize and enforce a substantial portfolio of trademarks and other intellectual property rights. We use our intellectual property rights to protect development activities, to protect our good name, to promote our brand name recognition, to enhance our competitiveness and to otherwise support our business goals and objectives. Our intellectual property rights, however, may be challenged, cancelled, invalidated or circumvented, or may fail to provide us with significant competitive advantages.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

Our principal executive offices are located at 10750 Columbia Pike, Silver Spring, MD 20901. The offices are leased from a third party. We own our reservation and property system’s information technology office in Phoenix, AZ, and reservation centers in Minot, ND and Grand Junction, CO. We also lease office space in Atlanta, GA, Australia, London, Canada and Mexico. Management believes that the Company’s existing properties are sufficient to meet its present needs and does not anticipate any difficulty in securing additional or alternative space, as needed, on terms acceptable to the Company.

We own three MainStay Suites hotels located in Brentwood, TN, Pittsburgh, PA and Greenville, SC.

Item 3. Legal Proceedings.

The Company is not a party to any litigation, other than routine litigation incidental to its business. None of such litigation, either individually or in the aggregate, is expected to be material to the business, financial position, liquidity or results of operations of the Company.

Item 4. Submission of Matters to a Vote of Security Holders.

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2005.

EXECUTIVE OFFICERS OF CHOICE HOTELS INTERNATIONAL, INC.

The name, age, title, present principal occupation, business address and other material occupations, positions, offices and employment of each of the executive officers of the Company are set forth below. The business address of each executive officer is 10750 Columbia Pike, Silver Spring, Maryland 20901.


Name	Age	Position
Stewart Bainum, Jr.	59	Chairman of the Board of Directors
Charles A. Ledsinger, Jr.	56	Chief Executive Officer and President
Joseph M. Squeri	40	Executive Vice President, Operations and Chief Financial Officer
Wayne W. Wielgus	51	Executive Vice President, and Chief Marketing Officer
Michael J. DeSantis	47	Senior Vice President, General Counsel and Secretary
Bruce N. Haase	45	Senior Vice President, International
Thomas Mirgon	49	Senior Vice President, Human Resources and Administration
Janna Morrison	44	Senior Vice President, Customer Care and Technology Services
Daniel Rothfeld	46	Senior Vice President, Partner Services and Emerging Business Opportunities
Gary Thomson	51	Senior Vice President, Chief Information Officer
David Pepper	38	Senior Vice President, Franchise Growth and Performance
David E. Goldberg	38	Senior Vice President, Brand Value
Dan Head	42	Senior Vice President, Business Intelligence and Strategy
David L. White	37	Vice President, Finance & Controller

Background of Executive Officers:

Stewart Bainum, Jr. Director from 1977 to 1996 and since 1997. Chairman of the Board of Choice Hotels from March 1987 to November 1996 and since October 1997; Chairman of the Board of Realty Investment Company, Inc. since December 2005; Chairman of the Board of Sunburst Hospitality Corporation since November 1996. He was a director of Manor Care, Inc. from September 1998 to September 2002, serving as Chairman from September 1998 until September 2001. From March 1987 to September 1998, he was Chairman and Chief Executive Officer of the Manor Care, Inc. He served as President of Manor Care of America, Inc. and Chief Executive Officer of ManorCare Health Services, Inc. from March 1987 to September 1998, and as Vice Chairman of Manor Care of America, Inc. from June 1982 to March 1987.

Charles A. Ledsinger, Jr. President, Chief Executive Officer and Director of the Company since August 1998. He was President and Chief Operating Officer of St. Joe Company from February 1998 to August 1998, Senior Vice President and Chief Financial Officer of St. Joe Company from May 1997 to February 1998; Senior Vice President and Chief Financial Officer of Harrah’s Entertainment, Inc. from June 1995 to May 1997; and Senior Vice President and Chief Financial Officer of Promus Companies Incorporated from August 1990 to June 1995. He serves as a director of Darden Restaurants, FelCor Lodging Trust, Inc. and TBC Corporation.

Joseph M. Squeri. Executive Vice President, Operations and Chief Financial Officer since May 2005. He was Executive Vice President and Chief Financial Officer from May 2004 to May 2005. He was Senior Vice President, Development and Chief Financial Officer of the Company from March 2002 until May 2004; Treasurer of the Company from April 1998 to February 2004 and since December 2004; Vice President, Finance and Controller of the Company from March 1997 to June 1999 and of Former Choice from March 1997 to October 1997.

Wayne W. Wielgus. Executive Vice President and Chief Marketing Officer since September 2004. He was Senior Vice President, Marketing of Choice From September 2000 until September 2004. He was Vice President, Marketing of Best Western International, Inc., in Phoenix, Arizona, from 1996 until September 2000 and Senior Vice President, Marketing-Americas from 1993 until 1996 for Forte Hotels PLC.

Michael J. DeSantis. Senior Vice President, General Counsel and Secretary of the Company since June 1997 and of Former Choice from June 1997 to October 1997. He was Senior Attorney for Former Choice from November 1996 to June 1997; Senior Attorney for Manor Care from January 1996 to October 1996; Vice President, Associate General Counsel and Assistant Secretary for Caterair International Corporation from April 1994 to December 1995; and Assistant General Counsel of Caterair International from May 1990 to March 1994.

Bruce N. Haase. Senior Vice President, International of the Company since October 2000. He was Vice President – Finance and Treasurer from April 2000 until October 2000. He was Vice President, Finance and Treasurer of The Ryland Group, Inc., in Columbia, Maryland, from August 1999 until March 2000 and Vice President and Treasurer from October 1995 until August 1999.

Thomas Mirgon. Senior Vice President, Human Resources and Administration since April 1998. He was Senior Vice President, Human Resources of the Company from March 1997 to April 1998 and of Former Choice from March 1997 to October 1997; Vice President, Administration of Interim Services from August 1993 to February 1997; and employed by Taco Bell Corp. from January 1986 to August 1993, last serving as Senior Director, Field Human Resources from February 1992 to August 1993.

Janna Morrison. Senior Vice President, Customer Care and Technology Services of Choice since December 2005. She was Senior Vice President, Franchise Services from November 2001 until December 2005. She was Vice President, Property Systems from 1998 to November 2001; Vice President, Revenue Management from 1995 to 1998.

Daniel Rothfeld. Senior Vice President, Partner Services and Emerging Business Opportunities since December 2000. He was Vice President – Partner Services from December 1997 until December 2000 and Vice President of Corporate Services of Interim Services, Inc., in Ft. Lauderdale, Florida, from January 1987 until December 1997.

Gary Thomson. Senior Vice President, Chief Information Officer of Choice since August 2000. He was Vice President – Information Systems Technologies from November 1993 until August 2000.

David Pepper. Senior Vice President, Franchise Growth and Performance of Choice since December 2005. He was Senior Vice President, Development of Choice from January 2005 until December 2005. He was Vice President, Franchise Sales from June 2002 until January 2005. He was Vice President, Franchise Sales with USFS in Atlanta, Georgia from 1996 through June 2002.

David E. Goldberg. Senior Vice President, Brand Value of Choice since December 2005. He was Senior Vice President, Corporate and Brand Strategy from January 2005 until December 2005. He was Vice President, Corporate and Brand Strategy and Treasurer from February 2004 until January 2005. He was Vice President, Strategy and Business Development from February 2002 to February 2004; Senior Director, Strategy and Business Development from January 2001 to February 2002; Director of Corporate Development from July 1999 to January 2001. He was Managing Associate with McManis Associates from January 1998 through July 1999 and a Consultant with Andersen Consulting from September 1994 through January 1998.

Dan Head. Senior Vice President, Business Intelligence and Strategy of Choice since December 2005. He was Vice President, Corporate Brand Strategy from September 2005 until December 2005. He served as a Managing Director for Bearing Point from July 2002 until September 2005; and employed by Arthur Andersen Business Consulting as a partner in the technology, media and communications practice areas from September 1998 until July 2002.

David L. White. Vice President, Finance & Controller of Choice since December 2002; Vice President, Financial/SEC Reporting from September 2002 to December 2002. He was Senior Manager, Ernst & Young, LLP from May 2002 to September 2002. He was employed by Arthur Andersen LLP as Senior Manager from May 1999 to May 2002, and manager from October 1998 to May 1999. He served as Assistant Controller for the energy marketing division of Statoil Energy, Inc. from May 1997 to September 1998.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The shares of the Company’s common stock are listed and traded on the New York Stock Exchange. The following table sets forth information on the high and low prices of the Company’s common stock and cash dividends declared per share for each quarterly period for the two most recently completed fiscal years.

QUARTERLY MARKET PRICE RANGE OF COMMON STOCK AND CASH DIVIDENDS DECLARED


	Market Price Per Share*				Cash Dividends Declared Per Share*
Quarters Ended	High		Low		Cash Dividends Declared Per Share*
FISCAL 2004
March 31,	$	23.12	$	17.13	$	0.10
June 30,		25.37		20.92		0.10
September 30,		28.86		24.45		0.1125
December 31,		30.00		23.68		0.1125
FISCAL 2005
March 31,	$	31.66	$	27.94	$	0.1125
June 30,		33.95		29.31		0.1125
September 30,		33.70		29.65		0.13
December 31,		42.56		31.47		0.13

Per share amounts have been retroactively adjusted for a two-for-one stock split effected in the form of a stock dividend distributed on October 21, 2005 to shareholders of record on October 7, 2005.

The Company currently maintains the payment of a quarterly dividend on its common shares outstanding, however, the declaration of future dividends are subject to the discretion of the board of directors. We expect that cash dividends will continue to be paid at a comparable or increased rate in the future, subject to future business performance.

As of February 28, 2006 there were 2,454 holders of record of the Company’s common stock.

EQUITY COMPENSATION PLAN INFORMATION

The following table sets forth information regarding the number of shares of the Company’s common stock that were subject to outstanding stock options at December 31, 2005.


	Number of shares to be issued upon exercise of outstanding options, warrants and rights*	Weighted average exercise price of outstanding options, warrants and rights*		Number of shares remaining available for future issuance under equity compensation plans (excluding shares reflected in column (a))*
Plan Category	(a)	(b)		(c)
Equity compensation plans approved by shareholders	3,415,675	$	11.26	1,182,621
Equity compensation plans not approved by shareholders	337,326	$	6.27	Not applicable

Per share amounts have been retroactively adjusted for a two-for-one stock split effected in the form of a stock dividend distributed on October 21, 2005 to shareholders of record on October 7, 2005.

ISSUER PURCHASES OF EQUITY SECURITIES

The following table sets forth purchases of Choice Hotels International, Inc. common stock made by the Company during the twelve months ended December 31, 2005.


Month Ending	Total Number of Shares Purchased*	Average Price Paid per Share*		Total Number of Shares Purchased as Part of Publicly Announced *Plans or Programs⁽²⁾**	Maximum Number of Shares that may yet be Purchased Under the Plans or Programs, End of Period*
January 31, 2005	—	$	—	—	3,655,776
February 28, 2005	14,750		29.64	—	3,655,776
March 31, 2005	454,852		29.94	452,110	3,203,666
April 30, 2005	—		—	—	3,203,666
May 31, 2005	158,000		30.32	158,000	3,045,666
June 30, 2005	—		—	—	3,045,666
July 31, 2005	—		—	—	3,045,666
August 31, 2005	—		—	—	3,045,666
September 30, 2005	166,400		30.60	166,400	2,879,266
October 31, 2005	557,800		32.02	557,800	2,321,466
November 30, 2005	218,765		33.62	218,765	2,102,701
December 31, 2005	—		—	—	5,102,701	⁽¹⁾

Total	1,570,567	$	31.30	1,553,075	5,102,701

⁽¹⁾

On December 8, 2005, the board of directors increased the number of authorized shares to be repurchased by 3.0 million shares.

⁽²⁾

The Company’s share repurchase program was initially approved by the board of directors on June 25, 1998.

Share and price per share amounts have been retroactively adjusted for a two-for-one stock split effected in the form of a stock dividend distributed on October 21, 2005 to shareholders of record on October 7, 2005.

During the year ended December 31, 2005, the Company purchased 17,492 shares of common stock from employees to satisfy tax-withholding requirements from the vesting of restricted stock grants. These purchases were outside the board repurchase authorization.

Item 6. Selected Financial Data.

Company results (in millions, except per share data)


	As of and for the year ended December 31,
	2001		2002		2003		2004		2005
Total Revenues	$	341.4	$	365.6	$	385.9	$	428.2	$	477.4
Net Income		14.3		60.8		71.9		74.3		87.6
Basic Earnings per Share⁽¹⁾		0.16		0.78		1.01		1.12		1.36
Diluted Earnings per Share⁽¹⁾		0.16		0.76		0.98		1.08		1.32
Total Assets		321.2		316.8		267.3		263.4		265.1
Long-term Debt		281.3		307.8		246.7		328.7		274.1
Cash Dividends Declared Per Common Share⁽¹⁾		—		—		0.10		0.425		0.485

⁽¹⁾

Per share amounts have been retroactively adjusted for a two-for-one stock split effected in the form of a stock dividend distributed on October 21, 2005 to shareholders of record on October 7, 2005.

Matters that affect the comparability of our annual results are as follows:

•

Year 2001 results reflect charges of $22.7 million and $16.4 million related to the permanent impairment of and equity in the losses of the Company’s investment in Friendly, respectively. The permanent impairment was the result of the Company’s disposal of its equity stake in Friendly. The equity losses resulted from adverse fixed asset valuation adjustments due to economic conditions and continued restructuring charges. These charges lowered diluted earnings per share by $0.42.

•

Net income in 2003 included a $3.4 million ($0.05 per share) gain on the prepayment of a note receivable from Sunburst. As a result of this prepayment, interest income earned on this note receivable totaling approximately $4.5 million per annum will not be received in future years.

•

Net income in 2004 included a $0.7 million loss on extinguishment of debt related to the refinancing of the Company’s senior credit facility. In addition, results reflect a reduction of income tax related to the resolution of certain tax contingencies of approximately $1.2 million. Those items represent diluted EPS of $0.01, net.

•

Net income in 2005 included additional income tax expense of approximately $1.2 million related to the Company’s repatriation of foreign earnings pursuant to the American Jobs Creation Act and a reduction of income tax expense related to the resolution of certain tax contingencies of approximately $4.9 million. Those items represent diluted EPS of $0.06, net.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.

The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand Choice Hotels International, Inc. and subsidiaries. MD&A is provided as a supplement to – and should be read in conjunction with – our consolidated financial statements and the accompanying notes.

Overview

We are a hotel franchisor with franchise agreements representing 5,210 hotels open and 687 hotels under development as of December 31, 2005, with 427,056 rooms and 54,075 rooms, respectively, in 49 states, the District of Columbia and more than 45 countries and territories outside the United States. Our brand names include Comfort Inn, Comfort Suites, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites, Cambria Suites, Suburban Extended Stay Hotel and Flag Hotels. Approximately 95% of the Company’s revenues are derived from hotels franchised in the United States.

During 2005, the Company acquired 100% of the stock of Suburban Franchise Holding Company, Inc. (“Suburban”) and its wholly owned subsidiary, Suburban Franchise Systems, Inc for $12.8 million. Suburban is the franchisor of Suburban Extended Stay Hotel and at acquisition had 67 units (8,942 rooms) operating in the

economy extended stay segment primarily in the southeastern United States. The acquisition allowed the Company to enter, on an accelerated basis, the economy extended stay segment, a market in which it did not previously compete. The results of Suburban have been consolidated with the Company since September 28, 2005.

On September 14, 2005, the Company’s board of directors declared a two-for one stock split effected in the form of a stock dividend. The stock dividend was distributed on October 21, 2005 to shareholders of record on October 7, 2005. Share data and earnings per share data included in MD&A reflect the stock split, applied retroactively, to all periods presented.

Our Company generates revenues, income and cash flows primarily from initial and continuing royalty fees attributable to our franchise agreements. Revenues are also generated from partner services endorsed vendor arrangements, hotel operations and other sources.

We are contractually required by our franchise agreements to use the marketing and reservation fees we collect for system-wide marketing and reservation activities. These expenditures, which include advertising costs and costs to maintain our central reservations system, help to enhance awareness and increase consumer preference for our brands. Greater awareness and preference promotes long-term growth in business delivery to our franchisees, which ultimately increases franchise fees earned by the Company.

Our Company articulates its mission as a commitment to our customer’s profitability by providing our customers with hotel franchises that generate the highest return on investment of any hotel franchise. We have developed an operating system dedicated to our franchisees’ success: One that focuses on delivering guests to our franchised hotels and reducing costs for our hotel owners. We strive every day to continuously improve our franchise offerings to enhance our customer’s profitability and create the highest return on investment of any hotel franchise.

We believe that executing our strategic priorities creates value. Our Company focuses on two key value drivers:

Profitable Growth. Our success is dependent on improving the performance of our hotels, increasing our system size by selling additional hotel franchises and effective royalty rate improvement. We attempt to improve our franchisees’ revenues and overall profitability by providing a variety of products and services designed to increase business delivery to and/or reduce operating and development costs for our franchisees. These products and services include national marketing campaigns, a central reservation system, property and yield management systems, quality assurance standards and endorsed vendor relationships. We believe that healthy brands, which deliver a compelling return on investment for franchisees, will enable us to sell additional hotel franchises and raise royalty rates. We have established multiple brands that meet the needs of many types of guests, and can be developed at various price points and applied to both new and existing hotels. This ensures that we have brands suitable for creating growth in a variety of market conditions. Improving the performance of the hotels under franchise, growing the system through additional franchise sales and improving franchise agreement pricing while maintaining a disciplined cost structure are the keys to profitable growth.

Maximizing Financial Returns and Creating Value for Shareholders. Our capital allocation decisions, including capital structure and uses of capital, are intended to maximize our return on invested capital and create value for our shareholders. We believe our strong and predictable cash flows create a strong financial position that provides us a competitive advantage. Our business does not require significant capital to operate and grow, therefore, we can maintain a capital structure that generates high financial returns and use our excess cash flow to increase returns to our shareholders. We have returned value to our shareholders in two primary ways: share repurchases and dividends. In 1998, we instituted a share repurchase program which has generated substantial value for our shareholders. We have repurchased 33.6 million shares (including 33.0 million prior to the 2 for 1 stock split effected in October 2005) of common stock at a total cost of $711.9 million, or an average price of

$21.16 per share since the program’s inception. On December 8, 2005, the board of directors authorized a 3 million share increase in the number of shares available for repurchase under the program. Our cash flows from operations support our ability to complete the repurchase of approximately 5.1 million shares presently remaining under our current board of directors’ authorization. The Company expects to continue to return value to its shareholders through a combination of dividends and share repurchases, subject to market and other conditions and upon completion of the current authorization we will evaluate the propriety of additional share repurchases with our board of directors. During 2005, we paid cash dividends totaling approximately $30.2 million and we presently expect to continue to pay dividends in the future. Based on our present dividend rate and outstanding share count, aggregate annual dividends would be approximately $33.8 million.

We believe these value drivers, when properly implemented, will enhance our profitability, maximize our financial returns and continue to generate value for our shareholders. The ultimate measure of our success will be reflected in the items below.

Results of Operation: Royalty fees, operating income, net income and diluted earnings per share (“EPS”) represent key measurements of these value drivers. In 2005, royalty fees revenue totaled approximately $187.3 million, a 12% increase from 2004. Operating income totaled $143.8 million for the year ended December 31, 2005, a 15% increase from 2004. Net income for the year ended December 31, 2005 increased to $87.6 million, an increase of $13.2 million over the year ended December 31, 2004, an 18% increase. Diluted earnings per share were $1.32, a 22% improvement over 2004 resulting from increased net income and a reduction in the number of shares outstanding attributable to our share repurchase program. Net income and diluted earnings per share in 2005 included additional income tax expense of approximately $1.2 million related to the Company’s repatriation of foreign earnings pursuant to the American Jobs Creation Act and a reduction of income tax expense related to the resolution of certain tax contingencies of approximately $4.9 million. Those items represent diluted EPS of $0.06, net, for the year ended December 31, 2005. Net income and diluted earnings per share in 2004 include a loss on extinguishment of debt of approximately $0.7 million ($0.4 million, net of the related tax effect) related to the refinancing of the Company’s senior credit facility and a reduction of income tax expense related to the resolution of certain tax contingencies of approximately $1.2 million. Those items represented diluted EPS of $0.01 per share, net, for the year ended December 31, 2004. These measurements will continue to be a key management focus in 2006 and beyond.

Refer to MD&A heading “Operations Review” for additional analysis of our results.

Liquidity and Capital Resources: The Company generates significant cash flows from operations. In 2005 and 2004, net cash provided by operating activities was $132.9 million and $108.1 million, respectively. Since our business does not require significant reinvestment of capital, we utilize cash in ways that management believes provide the greatest returns to our shareholders which include share repurchases and dividends. We believe the Company’s cash flow from operations and available financing capacity are sufficient to meet the expected future operating, investing and financing needs of the business.

Refer to MD&A heading “Liquidity and Capital Resources” for additional analysis.

Operations Review

Comparison of 2005 Operating Results and 2004 Operating Results

The Company recorded net income of $87.6 million for the year ended December 31, 2005, an increase of $13.3 million, or 18% from $74.3 million for the year ended December 31, 2004. The increase in net income for the year is primarily attributable to an $18.8 million improvement in operating income and a decline in the effective income tax rate from 35.1% to 33.0% partially offset by a $2.5 million expense increase in other income and expenses. The effective income tax rate declined primarily due to the resolution of tax contingencies of approximately $4.9 million in 2005 compared to $1.2 million in 2004 offset by additional income tax expense of $1.2 million in 2005 related to the Company’s repatriation of foreign earnings. The increase in net other income and expenses was primarily related to a $3.7 million increase in interest expense offset by the loss on extinguishment of debt of $0.7 million incurred during 2004. Operating income increased as a result of a $26.2 million, or 12.9% increase in franchising revenues (total revenues excluding marketing and reservation revenues and hotel operations) and a decrease in depreciation and amortization expense partially offset by an $8.7 million increase in selling, general and administrative expense.

Summarized financial results for the years ended December 31, 2005 and 2004 are as follows:


	2005		2004
	(In thousands)
REVENUES:
Royalty fees	$	187,340	$	167,135
Initial franchise and relicensing fees		25,388		20,112
Partner services		13,382		12,524
Marketing and reservation		243,123		220,732
Hotel operations		4,293		3,729
Other		3,873		3,976

Total revenues		477,399		428,208

OPERATING EXPENSES:
Selling, general and administrative		78,250		69,542
Depreciation and amortization		9,051		9,947
Marketing and reservation		243,123		220,732
Hotel operations		3,225		3,004