The following Management's Discussion and Analysis ("MD&A") is intended to help the reader understand Choice Hotels International, Inc. and its subsidiaries (together the "Company"). 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 6,243 hotels open and 482 hotels under construction, awaiting conversion or approved for development as of December 31, 2012, with 499,253 rooms and 38,969 rooms, respectively, in 49 states, the District of Columbia and over 35 countries and territories outside the United States. Our brand names include Comfort Inn, Comfort Suites, Quality, Clarion, Ascend Collection, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites, Suburban Extended Stay Hotel and Cambria Suites (collectively, the "Choice brands").
The Company's domestic franchising operations are conducted through direct franchising relationships while its international franchise operations are conducted through a combination of direct franchising and master franchising relationships. Master franchising relationships are governed by master franchising agreements which generally provide the master franchisee with the right to use our brands and sub-license the use of our brands in a specific geographic region, usually for a fee.
Our business philosophy has been to conduct direct franchising in those international markets where both franchising is an accepted business model and we believe our brands can achieve significant distribution. We elect to enter into master franchise agreements in those markets where direct franchising is currently not a prevalent or viable business model. When entering into master franchising relationships, we strive to select partners that have professional hotel and asset management capabilities together with the financial capacity to invest in building the Choice brands in their respective markets. Master franchising relationships typically provide lower revenues to the Company as the master franchisees are responsible for managing certain necessary services (such as training, quality assurance, reservations and marketing) to support the franchised hotels in the master franchise area and therefore retain a larger percentage of the hotel franchise fees to cover their expenses. In certain circumstances, the Company has and may continue to make equity investments in our master franchisees.
As a result of our use of master franchising relationships and international market conditions, revenues from international franchising operations comprised 8% and 9% of our total revenues in 2012 and 2011, respectively while representing approximately 19% of our franchise system hotels open at both December 31, 2012 and 2011. Therefore, our description of the franchise system is primarily focused on the domestic operations.
The Company previously had a 40% equity interest in Choice Hospitality (India) Ltd. ("CHN") which it accounted for under the equity method of accounting. On January 8, 2010, the Company purchased the remaining 60% of CHN at which time it became a wholly-owned subsidiary. The pro forma results of operations as if CHN had been combined at the beginning of all periods presented, would not be materially different from the Company's reported results for those periods. This transaction enabled Choice to continue its strategy of more closely directing the growth of our international franchise operations.
Our Company generates revenues, income and cash flows primarily from initial, relicensing and continuing royalty fees attributable to our franchise agreements. Revenues are also generated from qualified vendor arrangements, hotel operations and other sources. 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.
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 hotel rooms and effective royalty rates of our franchise contracts resulting in increased initial and relicensing fee revenue; ongoing royalty fees and procurement services revenues. In addition, our operating results can also be improved through our company-wide efforts related to improving property level performance. At December 31, 2012, the Company estimates, based on its current domestic portfolio of hotels under franchise, that a 1% change in revenue per available room ("RevPAR") or rooms under franchise would increase or decrease royalty revenues by approximately $2.5 million and a 1 basis point change in the Company's effective royalty rate would increase or decrease domestic royalties by approximately $0.6 million. In addition to these revenues, we also collect marketing and reservation system fees to support centralized marketing and reservation activities for the franchise system. As a lodging franchisor, Choice currently has relatively low capital expenditure requirements.

The principal factors that affect the Company's results are: the number and relative mix of franchised hotel rooms in the various hotel lodging price categories; growth in the number of hotel rooms under franchise; occupancy and room rates achieved by the hotels under franchise; the effective royalty rate achieved; the level of franchise sales and relicensing activity; 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 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 of our established brands 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.
We are required by our franchise agreements to use the marketing and reservation system 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 franchisees' profitability by providing our franchisees with hotel franchises that strive to generate the highest return on investment of any hotel franchise. We have developed an operating system dedicated to our franchisees' success that focuses on delivering guests to our franchised hotels and reducing costs for our hotel owners.
We believe that executing our strategic priorities creates value for our shareholders. 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, effective royalty rate improvement and maintaining a disciplined cost structure. 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 qualified 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. Currently, 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.
Historically, 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. During the year ended December 31, 2012, the Company purchased 0.5 million shares of its common stock under the share repurchase program at an average price of $37.02 for a total cost of $19.9 million. Since the program's inception through December 31, 2012, we have repurchased 45.3 million shares (including 33.0 million prior to the two-for-one stock split effected in October 2005) of common stock at a total cost of $1.1 billion. Considering the effect of the two-for-one stock split, the Company has repurchased 78.3 million shares at an average price of $13.89 per share. We currently believe that our cash flows from operations will support our ability to complete the current board of directors repurchase authorization of approximately 1.4 million shares remaining as of December 31, 2012. Upon completion of the current authorization, our board of directors will evaluate the advisability of additional share repurchases. The Company currently maintains the payment of a quarterly dividend on its common shares outstanding of $0.185 per share, however the declaration of future dividends are subject to the discretion of the board of directors. During the year ended December 31, 2012, the Company's board of directors elected to pay the four regular quarterly dividends as well as the regular quarterly dividend initially scheduled to be paid in the first quarter of 2013. As a result, the regular quarterly dividends paid during 2012 reflect five quarterly payments and totaled approximately $53.4 million.

On July 26, 2012, the Company's board of directors declared a special cash dividend in the amount of $10.41 per share or approximately $600.7 million in the aggregate, which was paid on August 23, 2012. The special cash dividend was paid with the proceeds from the Company's recent offering of the unsecured senior notes in the principal amount of $400 million and our new senior secured credit facility. The Company entered into a senior secured credit facility consisting of a $200 million revolving credit tranche and a $150 million term loan tranche, with a four year term. The Company utilized the proceeds from the term loan as well as borrowings under the revolving credit tranche to fund in part the special dividend. As a result of entering into the new senior credit facility, the Company's previous $300 million senior unsecured revolving credit facility was terminated.
We expect to continue to pay dividends in the future, subject to future business performance, economic conditions, changes in income tax regulations and other factors. Based on our present dividend rate and outstanding share count, we expect that aggregate annual regular dividends for 2013, excluding the first quarter payment which was paid to shareholders in December 2012, would be approximately $32.1 million.
Our board of directors previously authorized us to enter into programs which permit us to offer investment, financing and guaranty support to qualified franchisees as well as acquire and resell real estate to incent franchise development for certain brands in strategic markets. Recent market conditions have resulted in an increase in opportunities to incentivize development under these programs and as a result over the next several years, we expect to deploy capital opportunistically pursuant to these programs to promote growth of our emerging brands. The amount and timing of the investment in these programs will be dependent on market and other conditions. Our current expectation is that our annual investment in these programs will range from $20 million to $40 million. Notwithstanding these programs, the Company expects to continue to return value to its shareholders through a combination of share repurchases and dividends, subject to business performance, economic conditions, changes in income tax regulations and other factors.
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 2012, royalty fees revenue totaled approximately $260.8 million, a 6% increase from 2011. Operating income totaled $193.1 million for the year ended December 31, 2012, a 12% increase from 2011. Net income for the year ended December 31, 2012 increased $10.3 million to $120.7 million and diluted EPS were $2.07 compared to $1.85 for the year ended December 31, 2011. These measurements will continue to be a key management focus in 2013 and beyond. Refer to MD&A heading "Operations Review" for additional analysis of our results.
Liquidity and Capital Resources: Historically, the Company has generated significant cash flows from operations. In 2012 and 2011, net cash provided by operating activities was $161.0 million and $134.8 million, respectively. Since our business does not currently require significant reinvestment of capital, we typically utilize cash in ways that management believes provide the greatest returns to our shareholders which include share repurchases and dividends. However, we may determine to utilize cash for acquisitions and other investments in the future. We believe the Company's cash flow from operations and available financing capacity is 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. Inflation: Inflation has been moderate in recent years and has not had a significant impact on our business.

Operations Review
Comparison of 2012 and 2011 Operating Results The Company recorded net income of $120.7 million for the year ended December 31, 2012, a $10.3 million or 9% increase from the year ended December 31, 2011. The increase in net income for the year ended December 31, 2012 is primarily attributable to a $21.3 million or 12% increase in operating income and a lower effective income tax rate than the prior year. Net income was further increased by a $4.4 million decline in other (gains) and losses. The decline in other (gains) and losses was due to a $2.0 million appreciation in the fair value of investments held in the Company's non-qualified benefit plans compared to a decline of $0.6 million in the fair value of these investments in the prior year and a $1.8 million loss on assets held for sale incurred in the prior year. These items were partially offset by a $14.3 million increase in interest expense resulting from the issuance of debt to finance the Company's $600.7 million special dividend paid on August 23, 2012 and a

$0.5 million loss on extinguishment of debt incurred as a result of refinancing the Company's $300 million revolving credit facility which was scheduled to mature in February 2016.

Summarized financial results for the years ended December 31, 2012 and 2011 are as follows:

Royalty fees                           $   260,782     $ 245,426
Initial franchise and relicensing fees      14,203        14,052
Procurement services                        17,962        18,111
Marketing and reservation                  384,784       349,036
Hotel operations                             4,573         4,356
Other                                        9,205         7,812
Total revenues                             691,509       638,793
OPERATING EXPENSES:
Selling, general and administrative        101,852       106,404
Depreciation and amortization                8,226         8,024
Marketing and reservation                  384,784       349,036
Hotel operations                             3,505         3,466
Total operating expenses                   498,367       466,930
Operating income                           193,142       171,863
OTHER INCOME AND EXPENSES, NET:
Interest expense                            27,189        12,939
Interest income                             (1,540 )      (1,306 )
Loss on extinguishment of debt                 526             -
Other (gains) and losses                    (1,989 )       2,442
Equity in net income of affiliates            (212 )        (269 )
Other income and expenses, net              23,974        13,806
Income before income taxes                 169,168       158,057
Income taxes                                48,481        47,661
Net income                             $   120,687     $ 110,396
Diluted earnings per share             $      2.07     $    1.85

The Company utilizes certain measures such as adjusted net income, adjusted diluted EPS, adjusted selling, general and administrative ("SG&A"), earnings before interest, taxes and depreciation and amortization ("EBITDA"), adjusted EBITDA and franchising revenues which do not conform to generally accepted accounting principles accepted in the United States ("GAAP") when analyzing and discussing its results with the investment community. This information should not be considered as an alternative to any measure of performance as promulgated under GAAP, such as net income, diluted EPS, SG&A, operating income and total revenues. The Company's calculation of these measurements may be different from the calculations used by other companies and therefore comparability may be limited. We have included a reconciliation of these measures to the comparable GAAP measurement below as well as our reasons for reporting these non-GAAP measures.
Franchising Revenues: The Company utilizes franchising revenues, which exclude marketing and reservation system revenues and hotel operations, rather than total revenues when analyzing the performance of the business. Revenues from marketing and reservation activities are excluded because the Company is contractually required by its franchise agreements to use these revenues for marketing and reservation activities; as such, no income or loss to the Company is generated. Cumulative marketing and reservation system fees not expended are recorded as a payable on the Company's financial statements and are carried over to the next fiscal year and expended in accordance with the franchise agreements. Cumulative marketing and reservation expenditures in excess of fees collected for marketing and reservation activities are recorded as a receivable on the Company's financial statements. Revenues from hotel operations are excluded because they do not reflect the

most accurate measure of the Company's core franchising business. This non-GAAP measure is a commonly used measure of performance in our industry and facilitates comparisons between the Company and its competitors.

Calculation of Franchising Revenues
                                             Year Ended December 31,
                                             ($ amounts in thousands)
                                                2012            2011
Total Revenues                            $     691,509      $ 638,793
Less Adjustments:
Marketing and reservation system revenues      (384,784 )     (349,036 )
Hotel operations                                 (4,573 )       (4,356 )
Franchising Revenues                      $     302,152      $ 285,401

EBITDA: We also utilize EBITDA to analyze our results which reflects earnings excluding the impact of interest expense, provision for income taxes, depreciation and amortization. We consider EBITDA to be an indicator of operating performance because we use it to measure our ability to service debt, fund capital expenditures, and expand our business. We also use EBITDA, as do analysts, lenders, investors and others, to evaluate companies because it excludes certain items that can vary widely across different industries or among companies within the same industry. For example, interest expense can be dependent on a company's capital structure, debt levels and credit ratings. Accordingly, the impact of interest expense on earnings can vary significantly among companies. The tax positions of companies can also vary because of their differing abilities to take advantage of tax benefits and because of the tax policies of the jurisdictions in which they operate. As a result, effective tax rates and provision for income taxes can vary considerably among companies. EBITDA also excludes depreciation and amortization because companies utilize productive assets of different ages and use different methods of both acquiring and depreciating productive assets. These differences can result in considerable variability in the relative costs of productive assets and the depreciation and amortization expense among companies.
Adjusted Net Income, Adjusted Diluted EPS, Adjusted SG&A and Adjusted EBTIDA: We also use adjusted SG&A and adjusted EBITDA which exclude employee termination benefits and a loss on the settlement of a pension plan for the year ended December 31, 2012 and employee termination benefits for the year ended December 31, 2011. Adjusted net income and adjusted diluted EPS also exclude these items as well as a loss on extinguishment of debt for the year ended December 31, 2012 totaling $0.5 million and a loss on a parcel of land held for sale during the year ended December 31, 2011 totaling $1.8 million. The loss on settlement of the pension plan primarily consisted of the recognition of previously unrecognized actuarial losses which had been recorded as a component of the Company's accumulated other comprehensive loss on the Company's consolidated balance sheets. The loss on extinguishment of debt during the year ended December 31, 2012 was incurred in conjunction with the refinancing of the Company's $300 million revolving credit facility, which was scheduled to mature in February 2016. These items have been excluded since they do not reflect on-going operations. The Company utilizes these non-GAAP measures to enable investors to perform meaningful comparisons of past, present and future operating results and as a means to emphasize the results of on-going operations.

Calculation of EBITDA and Adjusted EBITDA

                                      Year Ended December 31,
                                      ($ amounts in thousands)
                                         2012            2011
Net Income                         $     120,687      $ 110,396
Income taxes                              48,481         47,661
Interest expense                          27,189         12,939
Interest income                           (1,540 )       (1,306 )
Loss on extinguishment of debt               526              -
Other (gains) and losses                  (1,989 )        2,442
Equity in net income of affiliates          (212 )         (269 )
  Depreciation and amortization            8,226          8,024
EBITDA                                   201,368        179,887
Adjustments:
Employee termination benefits                491          4,444
Loss on settlement of pension plan         1,818              -
Adjusted EBITDA                    $     203,677      $ 184,331


Calculation of Adjusted SG&A
                                      Year Ended December 31,
                                      ($ amounts in thousands)
                                         2012            2011
SG&A                               $     101,852      $ 106,404
Adjustments:
Employee termination benefits               (491 )       (4,444 )
Loss on settlement of pension plan        (1,818 )            -
Adjusted SG&A                      $      99,543      $ 101,960

Calculation of Adjusted Net Income and Adjusted Diluted EPS

                                                                        Year Ended December 31,
                                                               (In thousands, except per share amounts)
                                                                       2012                       2011
Net Income                                                 $           120,687              $      110,396
Adjustments, net of tax:
Employee termination benefits                                              312                       2,813
Loss on settlement of pension plan                                       1,774                           -
Loss on extinguishment of debt                                             334                           -
Loss on land held for sale                                                   -                       1,119
Adjusted Net Income                                        $           123,107              $      114,328

Weighted average shares outstanding-diluted                             58,265                      59,525

Diluted EPS                                                $              2.07              $         1.85
Adjustments:
Employee termination benefits                                                -                        0.05
Loss on settlement of pension plan                                        0.03                           -
Loss on extinguishment of debt                                            0.01                           -
Loss on land held for sale                                                   -                        0.02
Adjusted Diluted EPS                                       $              2.11              $         1.92

The Company recorded adjusted net income of $123.1 million for the year ended . . .