To Our Shareholders

Our company had a terrific year in 1998. Net income increased by 43 percent to $55.3 million. The number of hotels in operation grew to more than 3,600 in 36 countries. At the same time, we managed the business well, keeping our selling, general and administrative expense (SGA) virtually flat. As the world's second largest hotel franchisor, we offer more than 110 million available room nights to our guests, who continue to show high levels of satisfaction with our brands.

This strong growth sets the stage for another banner year in 1999. Much of the past year was dedicated to putting in place a revamped management team to better define our long-term strategy. Much of our energy this year will be devoted to enhancing our brand focus to provide our hotel guests and our franchisees with added value.

We are eagerly moving forward, BUILDING VALUE THROUGH BRANDS OF CHOICE - for guests, for franchisees, for vendors, for our associates and for you, our shareholders. This year's annual report tells the story of how we are building that value, and why we believe Choice Hotels will prove a valuable investment for its many constituents.

As a pure-play franchising company, Choice has no direct real estate ownership exposure. It has significant, growing free cash flow, an experienced management team and proven business systems. With more than 2,300 franchisees, no franchisee accounts for more than 5 percent of total royalty revenues. So the basic attributes of the business are fundamentally sound.

We have a superb foundation for future growth. And, we have a rich heritage in the lodging industry as an innovator and a leader, dating back 60 years to the first meeting of Quality Courts owners.

A VIBRANT, GROWING INDUSTRY

Some of you may wonder about the overall state of our industry. In 1998, the hotel industry earned record profits of $20 billion, as room demand remained very strong and new supply came on line in key markets. Some industry observers raised the possibility of a slowdown in development because supply growth moved slightly ahead of demand growth. As a result of the perceived slowdown, stock prices for the industry as a whole endured a drop.

But our experience in the segments we serve shows that the level of demand remains strong and will continue in a vibrant economy. This demand continues to encourage sound development in key locations. Our franchised hotels are less affected by tightening of credit markets because many of our projects are financed locally and have significant equity in them.

For 1999, many observers are forecasting another strong year for the industry since the economy shows little sign of slowing down. The surprising fourth quarter 1998 growth reported for the economy and the growing government surplus lead most economists to conclude that the risk of any recession is fading. If these trends hold, we have every expectation that 1999 will be a year of excellent growth for our branded hotels.

GROWTH PLATFORMS FOR THE FUTURE

Looking to the future, we have two growth platforms: our organic hotel growth and the distribution opportunity afforded by those 110 million available room nights.

By organic hotel growth, I mean the franchise development through which we continue to add hotels marketed under our brands: Comfort, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn and MainStay Suites. These brands enjoy growing consumer recognition and acceptance. They provide us with new construction and conversion development opportunities, both domestically and internationally.

In the past year, we executed 440 new hotel franchise contracts and opened 318 new hotels in the United States. At the beginning of this year, we had 866 domestic projects in design or under development, as well as another 611 international hotels in the pipeline.

Because we already have the infrastructure needed to service these hotels, such as our reservations system, our regional Market Area support and our International Regions, each new hotel adds significantly to our bottom line. At the same time, we are investing substantial resources to improve our infrastructure, including new computer capability for our central reservations system in Phoenix, an expanded call center in Minot, N.D., and the rollout of Profit Manager, our proprietary property management system for our hotels.

This year we also will open THE LEARNING CENTER, a new facility for training hotel owners, general managers and our associates. A key component of that training will be Choice Operations and Revenue Enhancement (CORE) training, which is designed to speed the integration of new properties into the Choice system and improve performance at the property level.

We also are tightening our brand standards and raising the bar on our quality assurance inspections. By sharpening our focus on service and quality in our franchisees' hotels, we help protect their individual investments and give our guests a more satisfying stay. Higher brand standards lead to more added value for our guests. And, in a highly competitive market, the battle for market share will be won by those who exceed their promises to the public.

DISTRIBUTION DRIVING FUTURE GROWTH

Which leads me to our second growth platform: distribution. With more than 110 million available room nights and 3,600 franchised properties in our system, we have a tremendous opportunity to take advantage of our scale and create new revenue streams for a host of products and services.

On our franchise side, we have created a proprietary purchasing system, ChoiceBuys.com, for our franchisees. Through the Internet, they can purchase goods and services for their hotels at our volume discounts. This program serves as a solid business model for other parts of our enterprise.

We believe that we can create a similar service for our guests that will open up new revenue streams while adding greater value to our room stay experience and to our franchisees. Discussions are underway with vendors, and we are hopeful to make this opportunity a reality for us in short order.

What makes this distribution opportunity so attractive is that our hotels operate in segments that reach about 70 percent of the domestic hotel guests available. With the sheer number of hotels in our system, the demographics of our guests and the scope of our operations worldwide, we believe we will have something truly unique to offer our guest and franchisees.

A WORLD OF OPPORTUNITY

The international arena provides us with a promising opportunity - and a challenge. The opportunity lies in the vast number of markets available to us for development and expansion of our brands. The challenge comes in finding the right strategic partners to establish hotel franchising as a valued and viable business concept in parts of the world where franchising is truly foreign.

In 1998, our partnerships with the Friendly organization in Europe and the Flag organization in Australia gave us new momentum to spur international growth. In Great Britain and Europe, our agreement with Friendly brought 250 properties in 10 countries under the Choice Hotels Europe banner into our system. Down under, our strategic alliance with Flag will bring almost 500 hotels into our system in 1999.

Other territories are opening up as well. Choice Atlantica, our partner in South America, has announced plans to develop 140 Comfort, Quality, Clarion and Sleep Inn hotels over the next five years. In Japan, the Vessel Group has unveiled plans to build 20 Sleep Inn hotels throughout eastern Japan.

A WORD OF THANKS

When I joined Choice last September, I found a company with solid fundamentals - great hotel brands, widespread consumer recognition, successful reservations and business systems, a strong base of committed franchisees and a dedicated core of 2,000 associates, many of whom have served our company for two and three decades.

Having worked for almost two decades in the hospitality industry, I appreciate the innovation Choice has brought to the industry. I also value the willingness of our associates to accept new leadership and new ideas. I cannot thank them enough for the warm reception I have received.

In 1998, two company leaders who played crucial roles in the company's growth and evolution into an industry leader retired from our Board of Directors. Stewart Bainum and Bob Hazard gave many years of dedicated service to Choice. Their legacy is a company that is the second largest hotel franchisor in the world. We salute them for their achievements and wish them well.

At the company's Annual Meeting this April, Fred Malek, a nine-year member of our Board, will be stepping down as well. We wish Fred every success in his future endeavors. Joining our Board on February 1, 1999, was Larry Levitan, recently retired from a 34-year career with Andersen Consulting, having most recently served as head of the Worldwide Communications Industry Group. Larry's vast experience in finance, technology and international business will serve our company well.

I am very excited about this company, its business prospects and the future we can create working together with our associates, franchisees and strategic partners. We enjoy the support of a committed Board of Directors, whose expertise has proven invaluable in creating a long-term strategy to drive this company to even higher performance.

Thank you for your continued support as we define an even brighter future for Choice Hotels.

Charles A. Ledsinger, Jr.
President & Chief Executive Officer