Choice Hotels International, Inc. and Subsidiaries

signed in Calendar 1997 of 421. Revenues generated from partner service relationships decreased to $6.4 million from $7.1 million in Calendar 1997.

The number of domestic rooms under development increased to 75,232 from 62,384, an increase of 20.6% for the year ended December 31, 1998. The total number of international hotels on-line increased to 632 from 605, an increase of 4.5% for the year ended December 31, 1998. International rooms on-line increased to 53,095 as of December 31, 1998 from 50,639, an increase of 4.9%. The total number of international hotels under development increased to 611 from 119 for the year ended December 31, 1998. The number of international rooms under development increased to 40,375 as of December 31, 1998 from 12,029 as of December 31, 1997. These increases are primarily attributable to a strategic alliance in June 1998 with Flag International Limited.

Franchise Expenses: Selling, general and administrative expenses were $52.9 million for Calendar 1998, an increase of $2.1 million from the Calendar 1997 total of $50.8 million. As a percentage of net franchise revenues, selling, general and administrative expenses declined to 36.9% in Calendar 1998 from 37.8% in Calendar 1997. The improvement in the franchising margins relates to the economies of scale generated from operating a larger franchisee base, cost control initiatives, and improvements in franchised hotel performance.

Marketing and Reservations: The total marketing and reservation fees received by the Company (previously reported as revenue) were $127.4 million and $110.2 million for the years ended December 31, 1998 and December 31, 1997, respectively. Depreciation and amortization charged to the marketing and reservation funds was $6.2 million and $2.9 million for the years ended December 31, 1998 and December 31, 1997, respectively. As of December 31, 1998 the Company’s balance sheet includes a receivable of $18.7 million related to advances made to the marketing ($7.8 million) and reservation ($10.9 million) funds. As of December 31, 1997, the Company’s balance sheet includes a receivable of $5.2 million related to advances made to the marketing fund and a current liability in accounts payable of $4.5 million related to excess monies in the reservation fund.

Product Sales: Sales made to franchisees through the Company’s group purchasing program declined $3.1 million to $20.7 million in Calendar 1998 from $23.8 million in Calendar 1997. Similarly, product cost of sales decreased $3.2 million (or 14.2%) from Calendar 1997. The product services margins increased for the year ended December 31, 1998 to 5.9% from 4.4% in Calendar 1997.

Depreciation and Amortization: Depreciation and amortization decreased to $6.8 million in Calendar 1998 from $9.2 million in Calendar 1997. This decrease was primarily attributable to the sale of the Company’s European hotels.

Interest Expense and Interest and Dividend Income: The increase in interest expense of $5.8 million in Calendar 1998 from $13.3 million in Calendar 1997 resulted from additional debt incurred in connection with the Sunburst Distribution (as defined in the Notes to the Consolidated Statements). Included in Calendar 1998 results is approximately $10.4 million of interest income earned on the note receivable from Sunburst Hospitality Corporation and $2.1 million in dividend income from the Company’s investment in Friendly.

Extraordinary Item: During 1998, the Company recorded an extraordinary gain from the early extinguishment of debt. The Company retired $13.7 million in debt and removed related assets of $1.8 million from the consolidated balance sheets. The extraordinary gain was $7.2 million, after income tax expense of $4.7 million, or $0.12 per diluted share.

Comparison of Seven Month Period Ended December 31, 1997 Operating Results and Seven Month Period Ending December 31, 1996 Operating Results

The Company recorded net income of $27.3 million for the seven months ended December 31, 1997, an increase of $4.0 million compared to net income of $23.3 million for the seven months ended December 31, 1996. The increase in net income for the seven months ended December 31, 1997 was primarily attributable to an increase in franchise revenue as a direct result of the addition of new franchised hotels to the system, improvements in the operating performance of hotels and an increase in the effective royalty rates achieved.