CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

The Company is one of the largest hotel franchisors in the world with 4,545 hotels open and 689 hotels under development as of December 31, 2001, representing 362,549 rooms open and 56,360 rooms under development in 44 countries. The Company franchises hotels under the Comfort, Comfort Suites, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn and MainStay Suites brand names. No single franchisee accounts for more than 5% of the Company’s royalty or total revenues. The Company operates in all 50 states and the District of Columbia and 37 additional countries with 97% of its franchising revenue derived from hotels franchised in the United States.

The principal factors that affect the Company’s results are: growth in the number of hotels under franchise; occupancies and room rates achieved by the hotels under franchise; the number and relative mix of franchised hotels; the effective royalty rate achieved; and the Company’s ability to manage costs. The number of rooms at franchised properties and occupancies and room rates at those properties significantly affect the Company’s results because franchise royalty 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. The variable overhead costs associated with franchise system growth are substantially less than incremental royalty fees generated from new franchisees; therefore, the Company is able to capture a significant portion of those royalty fees as operating income.

The Company revised its presentation of marketing and reservation fees during the fourth quarter of 2001 to comply with the Emerging Issues Task Force (“EITF”) Issue 99-19 “Reporting Revenue Gross as a Principal versus Net as an Agent”. The Company had previously presented these fees net of related expenses on its Consolidated Statements of Income. EITF 99-19 requires that these fees be recorded gross and accordingly the Company has revised its financial statement presentation for all periods presented. In addition, net advances and repayments of marketing and reservation fees has been reclassified to present these activities as cash flows from operating activities for all prior periods. This revision has no effect on the net income or cash flows reported during the periods presented.

Critical Accounting Policies

Revenue Recognition

The Company enters into numerous franchise agreements committing to provide franchisees with various marketing services, a centralized reservation system and limited rights to utilize the Company’s registered tradenames. These agreements are typically for a period of twenty years, with certain rights to the franchisee to terminate after five, ten, or fifteen years. In most instances, initial franchise fees are recognized upon sale because the initial franchise fee is non-refundable and the Company has no continuing obligations related to the franchisee. However, when the franchise agreements are entered into which include future potential rebates and/ or incentive payments, the initial franchise fees are deferred and recognized when the incentive criteria are met or the deal is terminated, whichever occurs first, in compliance with Statement of Financial Accounting Standards (“SFAS”) No. 45, “Accounting for Franchise Fee Revenue”. Royalty fees, primarily based on a percentage of gross room revenues of each franchisee, are recorded when earned. Reserves for uncollectible accounts are charged to bad debt expense and are included in selling, general and administrative expenses in the accompanying consolidated statements of income.

The Company’s franchise agreements require the payment of franchise fees which include marketing and reservation fees, which are used exclusively by the Company’s marketing and reservation funds for expenses associated with providing such franchise services as central reservation systems, national marketing and media advertising. The Company is contractually obligated to expend the marketing and reservation fees it collects from franchisees in accordance with the franchise agreements; as such, no income or loss to the Company is generated. As noted above, the Company changed its presentation of marketing and reservation service arrangements to a gross basis during the fourth quarter of 2001. Reservation fees and marketing fees not expended in the current year are carried over to the next fiscal year and expended in accordance with the franchise agreements. Shortfall amounts are similarly recovered in subsequent years. Excess or shortfall amounts from the operation of these programs are recorded as a payable or receivable from the particular fund. Under the terms of the franchise agreements, the Company may advance capital as necessary to the marketing and reservation funds and recover such advances through future fees (see Note 6 to the Consolidated Financial Statements).