Edgar Filing: CHOICE HOTELS INTERNATIONAL INC /DE

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Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010

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

COMMISSION FILE NO. 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, MD. 20901

(Address of principal executive offices)

(Zip Code)

(301) 592-5000

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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, and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months. Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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


CLASS		SHARES OUTSTANDING AT SEPTEMBER 30, 2010
Common Stock, Par Value $0.01 per share		59,554,040

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

INDEX


	PAGE NO.
PART I. FINANCIAL INFORMATION:

Item 1—Financial Statements (Unaudited)		3
Consolidated Statements of Income—For the three and nine months ended September 30, 2010 and September 30, 2009		3
Consolidated Balance Sheets—As of September 30, 2010 and December 31, 2009		4
Consolidated Statements of Cash Flows—For the nine months ended September 30, 2010 and September 30, 2009		5
Notes to Consolidated Financial Statements		6
Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations		28
Item 3—Quantitative and Qualitative Disclosures About Market Risk		51
Item 4—Controls and Procedures		51

PART II. OTHER INFORMATION:

Item 1—Legal Proceedings		52
Item 1A—Risk Factors		52
Item 2—Unregistered Sales of Equity Securities and Use of Proceeds		52
Item 3—Defaults Upon Senior Securities		52
Item 4—(Removed and Reserved)		52
Item 5—Other Information		52
Item 6—Exhibits		53

SIGNATURES		54

PART I. FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
REVENUES:
Royalty fees	$	72,565		$	66,401		$	171,029		$	164,771
Initial franchise and relicensing fees		1,970			2,957			6,537			9,599
Procurement services		3,756			3,922			13,612			14,084
Marketing and reservation		102,867			90,465			242,096			227,803
Hotel operations		1,068			934			3,044			3,231
Other		1,575			1,297			4,752			3,989

Total revenues		183,801			165,976			441,070			423,477


OPERATING EXPENSES:
Selling, general and administrative		23,156			24,517			67,796			73,054
Depreciation and amortization		2,078			2,105			6,470			6,252
Marketing and reservation		102,867			90,465			242,096			227,803
Hotel operations		823			764			2,387			2,378

Total operating expenses		128,924			117,851			318,749			309,487

Operating income		54,877			48,125			122,321			113,990

OTHER INCOME AND EXPENSES, NET:
Interest expense		1,864			926			3,160			3,731
Interest and other investment income		(1,671	)		(2,961	)		(1,645	)		(5,302	)
Equity in net income of affiliates		(342	)		(336	)		(890	)		(779	)

Total other income and expenses, net		(149	)		(2,371	)		625			(2,350	)

Income before income taxes		55,026			50,496			121,696			116,340
Income taxes		14,532			17,688			38,398			41,721

Net income	$	40,494		$	32,808		$	83,298		$	74,619


Basic earnings per share	$	0.68		$	0.55		$	1.40		$	1.24

Diluted earnings per share	$	0.68		$	0.55		$	1.40		$	1.24

Cash dividends declared per share	$	0.185		$	0.185		$	0.555		$	0.555

The accompanying notes are an integral part of these consolidated financial statements.

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)


	September 30, 2010			December 31, 2009
ASSETS

Current assets
Cash and cash equivalents	$	79,548		$	67,870
Receivables (net of allowance for doubtful accounts of $8,638 and $6,886, respectively)		53,682			41,898
Deferred income taxes		7,980			7,980
Other current assets		23,980			10,114

Total current assets		165,190			127,862

Property and equipment, at cost, net		52,976			43,627
Goodwill		66,040			65,813
Franchise rights and other identifiable intangibles, net		21,641			24,559
Receivable – marketing and reservation fees		46,127			33,872
Investments, employee benefit plans, at fair value		22,370			20,931
Deferred income taxes		16,905			14,143
Other assets		12,058			9,230

Total assets	$	403,307		$	340,037


LIABILITIES AND SHAREHOLDERS’ DEFICIT

Current liabilities
Accounts payable	$	40,304		$	33,859
Accrued expenses		35,936			37,074
Deferred revenue		71,296			51,765
Revolving credit facility		6,600			0
Current portion of long-term debt		294			0
Income taxes payable		19,775			6,310
Deferred compensation and retirement plan obligations		2,510			2,798

Total current liabilities		176,715			131,806

Long-term debt		251,613			277,700
Deferred compensation and retirement plan obligations		34,579			34,956
Other liabilities		15,894			9,787

Total liabilities		478,801			454,249


Commitments and Contingencies

SHAREHOLDERS’ DEFICIT
Common stock, $0.01 par value, 160,000,000 shares authorized; 95,345,362 shares issued at September 30, 2010 and December 31, 2009 and 59,554,040 and 59,541,106 shares outstanding at September 30, 2010 and December 31, 2009, respectively		596			595
Additional paid-in capital		89,611			90,731
Accumulated other comprehensive income (loss)		(7,545	)		333
Treasury stock (35,791,322 and 35,804,256 shares at September 30, 2010 and December 31, 2009, respectively), at cost		(872,999	)		(870,302	)
Retained earnings		714,843			664,431

Total shareholders’ deficit		(75,494	)		(114,212	)

Total liabilities and shareholders’ deficit	$	403,307		$	340,037

The accompanying notes are an integral part of these consolidated financial statements.

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED, IN THOUSANDS)


	Nine Months Ended September 30,
	2010			2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	83,298		$	74,619
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		6,470			6,252
Provision for bad debts		2,421			1,643
Non-cash stock compensation and other charges		6,969			8,796
Non-cash interest and other income		(987	)		(4,953	)
Dividends received from equity method investments		618			819
Equity in net income of affiliates		(890	)		(779	)
Changes in assets and liabilities, net of acquisitions:
Receivables		(14,511	)		(9,409	)
Receivable – marketing and reservation fees, net		(2,594	)		(13,742	)
Accounts payable		6,274			(2,061	)
Accrued expenses		(1,210	)		(5,754	)
Income taxes payable/receivable		11,940			22,314
Deferred income taxes		(2,704	)		0
Deferred revenue		19,443			5,349
Other assets		(11,755	)		2,087
Other liabilities		5,457			(5,215	)

Net cash provided by operating activities		108,239			79,966


CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in property and equipment		(17,673	)		(7,539	)
Acquisitions, net of cash acquired		(466	)		0
Issuance of notes receivable		(8,901	)		(1,731	)
Collections of notes receivable		5,055			190
Purchases of investments, employee benefit plans		(1,396	)		(3,239	)
Proceeds from sale of investments, employee benefit plans		1,018			13,839
Other items, net		(296	)		(447	)

Net cash provided (used) in investing activities		(22,659	)		1,073


CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) pursuant to revolving credit facility		(271,100	)		7,900
Proceeds from the issuance of long-term debt		247,733			0
Principal payments on long-term debt		(20	)		0
Settlement of forward starting interest rate swap agreement		(8,663	)		0
Debt issuance costs		(804	)		0
Purchase of treasury stock		(11,171	)		(57,042	)
Excess tax benefits from stock-based compensation		331			4,374
Dividends paid		(32,884	)		(33,335	)
Proceeds from exercise of stock options		1,321			6,744

Net cash used in financing activities		(75,257	)		(71,359	)

Net change in cash and cash equivalents		10,323			9,680
Effect of foreign exchange rate changes on cash and cash equivalents		1,355			1,285
Cash and cash equivalents at beginning of period		67,870			52,680

Cash and cash equivalents at end of period	$	79,548		$	63,645


Supplemental disclosure of cash flow information:
Cash payments during the period for:
Income taxes, net of refunds	$	26,561		$	16,726
Interest	$	1,924		$	4,268
Non-cash investing and financing activities:
Declaration of dividends	$	32,886		$	33,117
Capital lease obligation	$	2,483		$	0
Issuance of restricted shares of common stock	$	9,233		$	7,150
Issuance of performance vested restricted stock units	$	256		$	461
Issuance of treasury stock to employee stock purchase plan	$	454		$	465

The accompanying notes are an integral part of these consolidated financial statements.

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Company Information and Significant Accounting Policies

The accompanying unaudited consolidated financial statements of Choice Hotels International, Inc. and subsidiaries (together the “Company”) have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, all adjustments (which include any normal recurring adjustments) considered necessary for a fair presentation have been included. Certain information and footnote disclosures normally included in financial statements presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted. The year end balance sheet information was derived from audited financial statements, but does not include all disclosures required by GAAP. The Company believes the disclosures made are adequate to make the information presented not misleading. The consolidated financial statements should be read in conjunction with the consolidated financial statements for the year ended December 31, 2009 and notes thereto included in the Company’s Form 8-K, filed with the SEC on August 18, 2010 (the “8-K”). Interim results are not necessarily indicative of the entire year results because of seasonal variations. All intercompany transactions and balances between Choice Hotels International, Inc. and its subsidiaries have been eliminated in consolidation.

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with a maturity of three months or less at the date of purchase to be cash equivalents. As of September 30, 2010 and December 31, 2009, $3.9 million and $6.4 million, respectively, of book overdrafts representing outstanding checks in excess of funds on deposit are included in accounts payable in the accompanying consolidated balance sheets.

The Company maintains cash balances in domestic banks, which at times, may exceed the limits of amounts insured by the Federal Deposit Insurance Corporation. In addition, the Company also maintains cash balances in international banks which do not provide deposit insurance.

Derivatives

The Company uses derivative instruments as part of its overall strategy to manage exposure to market risks associated with fluctuations in interest rates. All outstanding derivative financial instruments are recognized at their fair values as assets or liabilities. The impact on earnings from recognizing the fair values of these instruments depends on their intended use, their hedge designation and their effectiveness in offsetting changes in the fair values of the exposures they are hedging. The Company does not use derivatives for trading purposes.

The effective portion of changes in fair value of derivatives designated as cash flow hedging instruments are recorded as a component of accumulated other comprehensive income (loss) and the ineffective portion is reported currently in earnings. The amounts included in accumulated other comprehensive income are reclassified into earnings in the same period during which the hedged item affects earnings. Amounts reported in earnings are classified consistent with the item being hedged.

The Company formally documents all relationships between its hedging instruments and hedged items at inception, including its risk management objective and strategy for establishing various hedge relationships. Cash flows from hedging instruments are classified in the Consolidated Statements of Cash Flows consistent with the items being hedged.

Hedge accounting is discontinued prospectively when (i) the derivative instrument is no longer effective in offsetting changes in fair value or cash flows of the underlying hedged item, (ii) the derivative instrument expires, is sold, terminated or exercised, or (iii) designating the derivative instrument as a hedge is no longer appropriate. The effectiveness of derivative instruments is assessed at inception and on an ongoing basis.

Variable Interest Entities

In accordance with the guidance for the consolidation of variable interest entities (“VIE”), we analyze our variable interests, including loans, guarantees, and equity investments, to determine if the entity in which we have a variable interest is a variable interest entity. Our analysis includes both quantitative and qualitative reviews. We base our analysis on our consideration of who has the power to direct those activities that most significantly impact the economic performance of the entity and who has the obligation to absorb the majority of losses or rights to receive benefits that could potentially be significant to the VIE. We also use our quantitative and qualitative analyses to determine if we must consolidate a variable interest entity as the primary beneficiary.

Recently Adopted Accounting Guidance

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06, “Fair Value Measurements and Disclosures (Topic 820)—Improving Disclosures about Fair Value Measurements,” (“ASU 2010-06”) to require new disclosures and clarify existing disclosures relating to fair value measurements. The new

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of this standard did not have and is not expected to have an effect on the Company’s consolidated balance sheets, results of operations, or cash flows.

In September 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 167, “Amendments to FASB Interpretation No. 46(R)”, or ASU No. 2009-17, now included in FASB Accounting Standards Codification (“ASC”) 810-10, “Consolidation”, which amends FASB Interpretation No. 46 (revised December 2003) to address the elimination of the concept of a qualifying special purpose entity. This guidance replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity and the obligation to absorb losses of the entity or the right to receive benefits from the entity. Additionally, this guidance provides more timely and useful information about an enterprise’s involvement with a variable interest entity. The Company adopted this guidance on January 1, 2010. The adoption of these provisions did not have an impact on our consolidated financial statements.

In April 2010, the FASB issued authoritative guidance related to the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. A vendor can recognize consideration that is contingent upon achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved if the milestone is: (a) commensurate with either the vendor’s performance to achieve the milestone or the enhancement of the value of the item delivered; (b) relates solely to past performance; and (c) is reasonable relative to all deliverables and payment terms in the arrangement. This guidance is effective on a prospective basis for financial statements issued for interim and annual periods ending after June 15, 2010 with early adoption permitted. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position.

In October 2009, the FASB issued ASU 2009-13, “Revenue Recognition: Multiple-Deliverable Arrangements” now included in ASC 605-25, “Revenue Recognition”. This guidance modifies the fair value requirements of revenue recognition on multiple element arrangements by allowing the use of the “best estimate of selling price” in addition to vendor specific objective evidence and third-party evidence for determining the selling price of a deliverable. ASU 2009-13 also establishes a selling price hierarchy for determining the selling price of a deliverable. In addition, this guidance eliminates the residual method allocation and expands the disclosure requirements for such arrangements. This guidance is effective for contracts entered into during fiscal periods beginning on or after June 15, 2010. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position.

2. Other Current Assets

Other current assets consist of the following:


	September 30, 2010		December 31, 2009
	(In thousands)
Prepaid expenses	$	7,693	$	7,014
Land held for sale		11,006		—
Notes receivable (See Note 3)		3,975		2,378
Income taxes receivable		470		—
Other		836		722


Total	$	23,980	$	10,114

Land held for sale represents the Company’s purchase of various parcels of real estate as part of its program to incent franchise development in top markets for certain brands. The Company has acquired this real estate with the intent to resell it to third-party developers for the construction of hotels operated under the Company’s brands.

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

3. Notes Receivable


	September 30, 2010			December 31, 2009
	(In thousands)
Forgivable notes receivable	$	6,768		$	7,432
Mezzanine and other notes receivables		15,571			12,345

		22,339			19,777
Loan reserves		(9,716	)		(9,531	)

Total	$	12,623		$	10,246


Current portion, net	$	3,975		$	2,378
Long-term portion, net		8,648			7,868

Total	$	12,623		$	10,246

The Company classifies notes receivable due within one year as current assets and notes receivable with a maturity greater than one year as other assets in the Company’s consolidated balance sheets.

Forgivable Notes Receivable

From time to time, the Company provides financing to franchisees for property improvements and other purposes in the form of forgivable promissory notes. The terms of the notes typically range from 3 to 10 years, bearing market interest rates, and are forgiven and amortized over that time period if the franchisee remains in the system in good standing. As of September 30, 2010 and December 31, 2009, the unamortized balance of these notes totaled $6.8 million and $7.4 million, respectively. The Company recorded an allowance for credit losses on these forgivable notes receivable of $0.7 million at both September 30, 2010 and December 31, 2009. Amortization expense included in the accompanying consolidated statements of income related to the notes was $0.5 million and $1.4 million for the three and nine months ended September 30, 2010, respectively. Amortization expense for the three and nine months ended September 30, 2009 relating to the notes was $0.5 million and $1.5 million, respectively. At September 30, 2010, the Company had commitments to extend an additional $4.4 million in forgivable notes receivable provided certain commitments are met by its franchisees.

Mezzanine and Other Notes Receivable

The Company has provided financing to franchisees in support of the development of properties in key markets. These notes include non-interest bearing receivables as well as notes bearing market interest and are due upon maturity. Interest income associated with these notes receivable is reflected in the accompanying consolidated statements of income under the caption interest and other investment (income) loss. The Company does not accrue interest on notes receivable that are impaired. At September 30, 2010, notes receivable advanced and related interest totaled $15.6 million of which $10.8 million was determined to be impaired at September 30, 2010. The Company has recorded an $8.6 million allowance for credit losses on these impaired loans at both September 30, 2010 and December 31, 2009. In addition, at September 30, 2010 and December 31, 2009, the Company had provided loan reserves on non-impaired loans totaling $0.4 million and $0.2 million, respectively. The Company records bad debt expense in selling, general & administrative (“SG&A”) expenses in the accompanying consolidated statements of income. At September 30, 2010, the Company had a commitment to extend an additional $1.5 million in mezzanine and other notes receivables provided certain conditions are met.

4. Receivable – Marketing and Reservation Fees

As of September 30, 2010 and December 31, 2009, the Company’s balance sheet includes a receivable of $23.6 million and $19.2 million, respectively from cumulative marketing expenses incurred in excess of cumulative marketing fee revenues earned. The reservation fees receivable related to cumulative reservation expenses incurred in excess of cumulative reservation fee revenues earned was $22.5 million and $14.7 million at September 30, 2010 and December 31, 2009, respectively. Depreciation and amortization expense attributable to marketing and reservation activities was $3.0 million for both the three months ended September 30, 2010 and 2009. Depreciation and amortization expense attributable to marketing and reservation activities was $9.1 million and $7.9 million for the nine months ended September 30, 2010 and 2009, respectively. Interest expense attributable to marketing and reservation activities was approximately $0.3 million and $0.06 million for the three months ended September 30, 2010 and 2009, while interest expense attributable to marketing and reservation activities was approximately $0.5 million and $0.2 million for the nine months ended September 30, 2010 and 2009, respectively.

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

The Company evaluates the receivable for marketing and reservation costs in excess of cumulative marketing and reservation fees earned on a periodic basis for collectability. The Company will record an allowance when, based on current information and events, it is probable that we will be unable to collect all amounts due for marketing and reservation activities according to the contractual terms of the franchise agreements. The receivables are considered to be uncollectible if the expected net, undiscounted cash flows from marketing and reservation activities are less than the carrying amount of the asset.

5. Deferred Revenue

Deferred revenue consists of the following:


	September 30, 2010		December 31, 2009
	(In thousands)
Loyalty programs	$	66,798	$	48,686
Initial, relicensing and franchise fees		3,106		2,160
Procurement service fees		1,169		884
Other		223		35


Total	$	71,296	$	51,765

6. Debt

Debt consists of the following at:


	September 30, 2010		December 31, 2009
	(In thousands)
$350 million senior unsecured revolving credit facility with an effective interest rate of 0.68% and 0.65% at September 30, 2010 and December 31, 2009, respectively	$	6,600	$	277,700
$250 million senior notes with an effective interest rate of 6.19% at September 30, 2010, less discount of $637		249,363		—
Capital lease obligation due 2016 with an effective interest rate of 4.66%		2,483		—
Other notes payable		61		—


Total debt	$	258,507	$	277,700
Less current portion		6,894		—

Total long-term debt	$	251,613	$	277,700

On June 16, 2006, the Company entered into a $350 million senior unsecured revolving credit agreement (the “Revolver”), with a syndicate of lenders. The Revolver allows the Company to borrow, repay and reborrow revolving loans up to $350 million (which includes swingline loans for up to $20 million and standby letters of credit of up to $30 million) until the scheduled maturity date of June 16, 2011. The Company has the ability to request an increase in available borrowings under the Revolver by an additional amount of up to $150 million by obtaining the agreement of the existing lenders to increase their lending commitments or by adding additional lenders. The rate of interest generally applicable for revolving loans under the Revolver is, at the Company’s option, equal to either (i) the greater of the prime rate or the federal funds effective rate plus 50 basis points, or (ii) an adjusted LIBOR rate plus a margin between 22 and 70 basis points based on the Company’s credit rating. The Revolver requires the Company to pay a quarterly facility fee, based upon the credit rating of the Company, at a rate between 8 and 17¹/2 basis points, on the full amount of the commitment (regardless of usage). The Revolver also requires the payment of a quarterly usage fee, based upon the credit rating of the Company, at a rate between 10 and 12¹/2 basis points, on the amount outstanding under the commitment, excluding swingline loans, at all times when the amount borrowed under the Revolver exceeds 50% of the total commitment. The Revolver includes customary financial and other covenants that require the maintenance of certain ratios including maximum leverage and interest coverage. The Revolver also restricts the Company’s ability to make certain investments, incur certain debt, and dispose of assets, among other restrictions. As of September 30, 2010, the Company was in compliance with all covenants.

On August 25, 2010, the Company completed a $250 million senior unsecured note offering (“the Senior Notes”) at a discount of $0.6 million, bearing a coupon of 5.7% with an effective rate of 6.19%. The Senior Notes will mature on

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

August 28, 2020, with interest on the Senior Notes to be paid semi-annually on February 28^th and August 28^th. The Company used the net proceeds from the offering, after deducting underwriting discounts and other offering expenses, to repay outstanding borrowings under the Revolver and for other general corporate purposes.

Debt issuance costs and bond discounts incurred in connection with the Senior Notes are amortized, on a straight-line basis, which is not materially different than the effective interest method, through the maturity of the Senior Notes. Amortization of these costs is included in interest expense in the Consolidated Statements of Income.

The Company may redeem the Senior Notes at its option at a redemption price equal to the greater of (a) 100% of the principal amount of the notes to be redeemed and (b) the sum of the present values of the remaining scheduled principal and interest payments from the redemption date to the date of maturity discounted to the redemption date on a semi-annual basis at the Treasury rate, plus 45 basis points.

The Company’s line of credit providing up to an aggregate of $5 million of borrowings matured on August 31, 2010 and was not renewed. Prior to maturity, borrowings under the line of credit bore interest at the lender’s sole option at either of the following rates (i) prime rate or (ii) LIBOR rate plus 0.80% per annum; due monthly and upon demand for final payment.

7. Acquisition of Choice Hospitality (India) Ltd.

In the first quarter of 2010, the Company acquired the remaining 60% ownership interest in one of the Company’s master franchisees, Choice Hospitality (India) Ltd. (“CHN”), which conducts franchising operations in the Republics of India, Sri Lanka, Maldives and the Kingdom of Nepal for $0.6 million and began including the results of its operations in the Company’s financial statements on January 8, 2010. Prior to the acquisition, the Company owned 40% of the outstanding common stock of CHN with the remaining 60% of the outstanding stock owned by unrelated parties. The Company allocated the purchase price based on management’s assessment of the fair value of assets acquired and liabilities assumed as of January 8, 2010. The Company allocated $0.3 million of the excess of the total purchase price over net tangible assets to franchise rights and the remaining $0.2 million to goodwill. The franchise rights are being amortized over their estimated useful life of 8 years. The pro forma results of operations as if this entity had been combined at the beginning of 2010 and 2009 would not be materially different from the Company’s reported results for those periods.

8. Pension Plan

The Company sponsors an unfunded non-qualified defined benefit plan (“SERP”) for certain senior executives. No assets are held with respect to the plan; therefore benefits are funded as paid to participants. For the three months ended September 30, 2010 and September 30, 2009, the Company recorded $0.1 million and $0.3 million, respectively, for the expenses related to the SERP which are included in SG&A expense in the accompanying consolidated statements of income. The expenses related to the SERP for the nine month periods ended September 30, 2010 and 2009 are $0.4 million and $0.9 million, respectively. Benefit payments totaling $0.4 million are currently scheduled to be remitted within the next twelve months.

The following table presents the components of net periodic benefit costs for the three and nine months ended September 30, 2010 and 2009:


	Three Months Ended September 30,				Nine Months Ended September 30,
(In thousands)	2010		2009		2010		2009
Components of net periodic pension cost:
Service cost	$	—	$	101	$	—	$	303
Interest cost		135		147		404		443
Amortization:
Prior service cost		—		58		—		173

Net periodic pension cost	$	135	$	306	$	404	$	919

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

The net periodic pension costs for the year ended December 31, 2010 are projected to decline from the prior year due to the amendment of the SERP, effective December 31, 2009, which froze participant benefits. As a result of freezing the benefits, future service costs and unrecognized prior service cost amortizations have been eliminated. The 2010 monthly net periodic pension costs are approximately $45,000. The components of projected pension costs for the year ended December 31, 2010 are as follows:


(in thousands)
Components of net periodic pension cost:
Service cost	$	—
Interest cost		538
Amortizations:
(Gain)/Loss		—
Prior service cost		—


Net periodic pension cost	$	538

The following is a reconciliation of the changes in the projected benefit obligation for the nine months ended September 30, 2010:


(in thousands)
Projected benefit obligation, December 31, 2009	$	9,176
Service cost		—
Interest cost		404
Benefit payments		(310	)


Projected benefit obligation, September 30, 2010	$	9,270

The amounts in accumulated other comprehensive income (loss) that have not yet been recognized as components of net periodic benefit costs at September 30, 2010 are as follows:


(in thousands)
Transition asset (obligation)	$	—
Prior service cost		—
Accumulated gain		93


Total	$	93

9. Non-Qualified Retirement, Savings and Investment Plans

The Company sponsors two non-qualified retirement savings and investment plans for certain employees and senior executives. Employee and Company contributions are maintained in separate irrevocable trusts. Legally, the assets of the trusts remain those of the Company; however, access to the trusts’ assets is severely restricted. The trusts cannot be revoked by the Company or an acquirer, but the assets are subject to the claims of the Company’s general creditors. The participants do not have the right to assign or transfer contractual rights in the trusts.

In 2002, the Company adopted the Choice Hotels International, Inc. Executive Deferred Compensation Plan (“EDCP”) which became effective January 1, 2003. Under the EDCP, certain executive officers may defer a portion of their salary into an irrevocable trust. Prior to January 1, 2010, participants could elect an investment return of either the annual yield of the Moody’s Average Corporate Bond Yield Index plus 300 basis points or a return based on a selection of available diversified investment options. Effective January 1, 2010, the Moody’s Average Corporate Bond Rate Yield Index plus 300 basis points is no longer an investment option for salary deferrals made on compensation earned after December 31, 2009. As of September 30, 2010 and December 31, 2009, the Company recorded a deferred compensation liability of $17.1 million and $17.6 million, respectively related to these deferrals and credited investment returns. Compensation expense is recorded in SG&A expense on the Company’s consolidated statements of income based on the change in the deferred compensation obligation related to earnings credited to participants as well as changes in the fair value of diversified investments. Compensation expense recorded in SG&A for the three months ended September 30, 2010 and 2009 were $0.3 million and $0.4 million, respectively. Compensation expense recorded in SG&A for the nine months ended September 30, 2010 and 2009 was $0.7 million and $0.9 million, respectively.

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

The Company has invested the employee salary deferrals in diversified long-term investments which are intended to provide investment returns that partially offset the earnings credited to the participants. The diversified investments held in the trusts totaled $12.6 million and $10.9 million as of September 30, 2010 and December 31, 2009, respectively, and are recorded at their fair value, based on quoted market prices. These investments are considered trading securities and therefore, the changes in the fair value of the diversified assets is included in other income and expenses, net in the accompanying statements of income. The Company recorded investment gains during the three months ended September 30, 2010 and 2009 totaling $0.8 million and $1.9 million, respectively. The Company recorded investment gains during the nine months ended September 30, 2010 and 2009 totaling $0.6 million and $3.3 million, respectively.

In 1997, the Company adopted the Choice Hotels International, Inc. Nonqualified Retirement Savings and Investment Plan (“Non-Qualified Plan”). The Non-Qualified Plan allows certain employees who do not participate in the EDCP to defer a portion of their salary and invest these amounts in a selection of available diversified investment options. As of September 30, 2010 and December 31, 2009, the Company had recorded a deferred compensation liability of $10.7 million and $11.0 million, respectively related to these deferrals. Compensation expense is recorded in SG&A expense on the Company’s consolidated statements of income based on the change in the deferred compensation obligation related to earnings credited to participants as well as changes in the fair value of diversified investments. The net increase in compensation expense recorded in SG&A for the three months ended September 30, 2010 and 2009 was $0.8 million and $1.1 million, respectively. The net increase in compensation expense recorded in SG&A for the nine months ended September 30, 2010 and 2009 was $0.5 million and $1.8 million, respectively.

The diversified investments held in the trusts were $9.8 million and $10.1 million as of September 30, 2010 and December 31, 2009, respectively, and are recorded at their fair value, based on quoted market prices. These investments are considered trading securities and therefore the changes in the fair value of the diversified assets is included in other income and expenses, net in the accompanying statements of income. The Company recorded investment gains during the three months ended September 30, 2010 and 2009 of $0.7 million and $1.0 million, respectively. The Company recorded investment gains during the nine months ended September 30, 2010 and 2009 of $0.5 million and $1.8 million, respectively. In addition, the Non-Qualified Plan held shares of the Company’s common stock with a market value of $0.9 million at both September 30, 2010 and December 31, 2009, respectively.

10. Fair Value of Financial Instruments

The Company believes that the fair values of its current assets and current liabilities approximate their reported carrying amounts due to the short-term nature of these items. In addition, the interest rates on the Company’s Revolver adjust frequently based on current market rates; accordingly its carrying amount approximates fair value.

The Company estimates the fair value of its long-term debt, excluding leases, using quoted market prices. At September 30, 2010, the long-term debt, excluding leases, had an approximate fair value of $251.9 million.

11. Fair Value Measurements

The Company estimates the fair value of our financial instruments utilizing a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. There have been no significant transfers into or out of Level 1 or Level 2 inputs during the three and nine months ended September 30, 2010. The following summarizes the three levels of inputs, as well as the assets that the Company values using those levels of inputs:

Level 1: Quoted prices in active markets for identical assets and liabilities. The Company’s Level 1 assets consist of marketable securities (primarily mutual funds) held in the Company’s EDCP and Non-Qualified Plan deferred compensation plans.

Level 2: Observable inputs, other than quoted prices in active markets for identical assets and liabilities, such as quoted prices for similar assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable. The Company’s Level 2 assets consist of money market funds held in the Company’s EDCP and Non-Qualified Plan deferred compensation plans and those recorded in cash and cash equivalents.

Level 3: Unobservable inputs, supported by little or no market data available, where the reporting entity is required to develop its own assumptions to determine the fair value of the instrument. The Company does not currently have any assets covered by the disclosure provisions whose fair value was determined using significant unobservable inputs.

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)


	Fair Value Measurements at Reporting Date Using
Assets (in thousands)	Total		Level 1		Level 2		Level 3
As of September 30, 2010
Money market funds, included in cash and cash equivalents	$	10,000	$	—	$	10,000	$	—
Investments, employee benefit plans, at fair value		22,370		20,215		2,155		—

	$	32,370	$	20,215	$	12,155	$	—


As of December 31, 2009
Investments, employee benefit plans, at fair value	$	20,931	$	18,505	$	2,426	$	—

	$	20,931	$	18,505	$	2,426	$	—

12. Income Taxes

The effective income tax rate was 26.4% and 35.0% for the three months ended September 30, 2010 and September 30, 2009, respectively. The effective income tax rate was 31.6% and 35.9% for the nine months ended September 30, 2010 and September 30, 2009, respectively.

The effective income tax rates for the three months and nine months ended September 30, 2010 differed from the U.S. federal statutory rate of 35% primarily due to a prior period adjustment of $3.3 million to our deferred tax assets, partially offset by an increase of $1.6 million related to identification of prior period unrecognized tax positions. The Company believes that these adjustments are not material to its financial statements for prior annual or interim periods, the nine months ended September 30, 2010 or the Company’s expected annual results for the year ended December 31, 2010. Also in the quarter, we identified $1.7 million of additional federal income tax benefits. These rates were also impacted by state income taxes, partially offset by the effect of foreign operations. The effective income tax rates for the three and nine months ended September 30, 2009 were impacted by state income taxes, offset by the effect of foreign operations and the resolution of certain income tax contingencies.

The effective income tax rates for the three and nine months ended September 30, 2009 were impacted by state income taxes, offset by the effect of foreign operations and the resolution of certain income tax contingencies.

As of September 30, 2010, the Company had $5.7 million of total unrecognized tax benefits, of which approximately $3.9 million would impact the effective tax rate if recognized. The Company believes it is reasonably possible that it will recognize tax benefits of up to $1.3 million within the next twelve months related to the anticipated lapse of applicable statutes of limitations.

13. Share-Based Compensation and Capital Stock

Stock Options

No stock options were granted by the Company in the three month period ended September 30, 2010. The Company granted 20,735 options to certain employees of the Company at a fair value of $0.2 million for the three month period ended September 30, 2009. The Company granted 0.3 million and 0.5 million options to certain employees of the Company at a fair value of $2.6 million and $4.0 million during the nine months ended September 30, 2010 and 2009, respectively. The stock options granted by the Company had an exercise price equal to the market price of the Company’s common stock on the date of grant. The fair value of the options granted was estimated on the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions:


	2010 Grants			2009 Grants
Risk-free interest rate		2.19	%		1.83	%
Expected volatility		41.92	%		39.71	%
Expected life of stock option		4.4 years			4.4 years
Dividend yield		2.26	%		2.74	%
Requisite service period		4 years			4 years
Contractual life		7 years			7 years
Weighted average fair value of options granted	$	10.07		$	7.41

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

The expected life of the options and volatility are based on historical data and are not necessarily indicative of exercise patterns or actual volatility that may occur. Historical volatility is calculated based on a period that corresponds to the expected life of the stock option. The dividend yield and the risk-free rate of return are calculated on the grant date based on the then current dividend rate and the risk-free rate of return for the period corresponding to the expected life of the stock option. Compensation expense related to the fair value of these awards is recognized straight-line over the requisite service period based on those awards that ultimately vest.

The aggregate intrinsic value of the stock options outstanding and exercisable at September 30, 2010 was $11.7 million and $6.3 million, respectively. The total intrinsic value of options exercised during the three months ended September 30, 2010 and 2009 was approximately $16,000 and $3.7 million, respectively. The total intrinsic value of options exercised during the nine months ended September 30, 2010 and 2009 was $1.0 million and $12.3 million, respectively.

The Company received approximately $6,000 and $2.1 million in proceeds from the exercise of approximately 600 and 0.2 million employee stock options during the three month periods ended September 30, 2010 and 2009, respectively. The Company received $1.3 million and $6.7 million in proceeds from the exercise of approximately 66,000 and 0.7 million employee stock options during the nine month periods ended September 30, 2010 and 2009, respectively.

Restricted Stock

The following table is a summary of activity related to restricted stock grants:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Restricted share grants		4,203		7,399		279,157		262,128
Weighted average grant date fair value per share	$	35.69	$	29.56	$	33.07	$	27.28
Aggregate grant date fair value ($000)	$	150	$	219	$	9,233	$	7,150
Restricted shares forfeited		2,354		23,935		11,183		35,072
Vesting service period of shares granted		4 years		4 years		3-4 years		3-4 years
Grant date fair value of shares vested ($000)	$	200	$	212	$	5,948	$	5,469

Compensation expense related to the fair value of these awards is recognized straight-line over the requisite service period based on those restricted stock grants that ultimately vest. The fair value of grants is measured by the market price of the Company’s stock on the date of grant. Restricted stock awards generally vest ratably over the service period beginning with the first anniversary of the grant date.

Performance Vested Restricted Stock Units

The Company has granted performance vested restricted stock units (“PVRSU”) to certain employees. The vesting of these stock awards is contingent upon the Company achieving performance targets at the end of specified performance periods and the employees’ continued employment. The performance conditions affect the number of shares that will ultimately vest. The range of possible stock-based award vesting is between 0% and 200% of the initial target. If a minimum of 50% of the performance target is not attained then no awards will vest under the terms of the PVRSU agreements. Compensation expense related to these awards will be recognized over the requisite service period regardless of whether the performance targets have been met based on the Company’s estimate of the achievement of the various performance targets. The Company has currently estimated that between 0% and 100% of the various award targets will be achieved. The fair value is measured by the market price of the Company’s common stock on the date of grant. Compensation expense is recognized ratably over the requisite service period based on those PVRSUs that ultimately vest.

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

The following table is a summary of activity related to PVRSU grants:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Performance vested restricted stock units granted at target		—		—		33,517		9,588
Weighted average grant date fair value per share	$	—	$	—	$	32.60	$	26.88
Aggregate grant date fair value ($000)	$	—	$	—	$	1,093	$	258
Stock units forfeited		—		2,035		9,650		6,046
Requisite service period		—		—		3 years		2 years

During the nine months ended September 30, 2010, PVRSU grants totaling 10,880 vested at a fair value of $0.3 million. These PVRSU grants were initially granted at a target of 15,541 units, however, since the Company achieved only 70% of the targeted performance conditions contained in the stock awards granted in prior periods, 4,661 shares out of the initial grant were forfeited. In addition, during the nine months ended September 30, 2010, 4,989 units were forfeited since the performance targets of the applicable PVRSU grant were not achieved. During the nine months ended September 30, 2009, PVRSU grants totaling 19,761 vested at a fair value of $0.5 million. These PVRSU grants were initially granted at a target of 14,638 units, however, since the Company exceeded targeted performance conditions contained in the stock awards granted in prior periods by 35%, an additional 5,123 shares were earned and issued. No PVRSU grants vested during the three month periods ended September 30, 2010 and 2009.

A summary of stock-based award activity as of September 30, 2010 and changes during the nine months ended are presented below:


	Nine Months Ended September 30, 2010
	Stock Options							Restricted Stock					Performance Vested Restricted Stock Units
	Shares			Weighted Average Exercise Price		Weighted Average Contractual Term		Shares			Weighted Average Grant Date Fair Value		Shares			Weighted Average Grant Date Fair Value
Outstanding at January 1, 2010		1,658,844		$	30.05				539,341		$	31.68		118,385		$	34.58
Granted		261,137			32.84				279,157			33.07		33,517			32.60
Exercised/Vested		(66,160	)		19.97				(181,671	)		33.68		(10,880	)		40.65
Forfeited/Expired		(19,661	)		8.57				(11,183	)		30.83		(9,650	)		36.74

Outstanding at September 30, 2010		1,834,160		$	31.04		4.6 years		625,644		$	31.75		131,372		$	33.42


Options exercisable at September 30, 2010		839,448		$	30.88		3.8 years

The components of the Company’s pretax stock-based compensation expense and associated income tax benefits are as follows for the three and nine months ended September 30, 2010 and 2009:


	Three Months Ended September 30,						Nine Months Ended September 30,
(in millions)	2010			2009			2010			2009
Stock options	$	0.7		$	0.8		$	1.9		$	1.9
Restricted stock		1.8			1.6			5.3			4.9
Performance vested restricted stock units		(0.7	)		(0.7	)		(0.4	)		(0.3	)

Total	$	1.8		$	1.7		$	6.8		$	6.5

Income tax benefits	$	0.7		$	0.6		$	2.5		$	2.4

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

During the three months ended September 30, 2010 and 2009, the Company revised its estimate of the projected achievement of various performance conditions that affect the number of PVRSUs that will ultimately vest. As a result, previously recognized stock-based compensation costs related to these PVRSUs has been reduced by $0.8 million for both the three and nine months ended September 30, 2010 and $0.9 million for both the three and nine months ended September 30, 2009.

Dividends

On September 17, 2010, the Company’s board of directors declared a quarterly cash dividend of $0.185 per share (or approximately $11.0 million in the aggregate), which was paid on October 15, 2010 to shareholders of record as of October 1, 2010. On April 29, 2010, the Company’s board of directors declared a quarterly cash dividend of $0.185 per share (or approximately $11.0 million in the aggregate), which was paid on July 16, 2010 to shareholders of record as of July 2, 2010. On February 16, 2010, the Company’s board of directors declared a cash dividend of $0.185 per share (or approximately $11.0 million in the aggregate), which was paid on April 16, 2010 to shareholders of record on April 5, 2010.

On September 10, 2009, the Company declared a cash dividend of $0.185 per share (or approximately $10.9 million in the aggregate), which was paid on October 16, 2009 to shareholders of record on October 2, 2009. On May 4, 2009, the Company’s board of directors declared a quarterly cash dividend of $0.185 per share (or approximately $11.0 million in the aggregate), which was paid on July 17, 2009 to shareholders of record on July 2, 2009. On February 9, 2009, the Company’s board of directors declared a cash dividend of $0.185 per share (or approximately $11.1 million in the aggregate), which was paid on April 17, 2009 to shareholders of record on April 3, 2009.

Stock Repurchase Program

During the three months ended September 30, 2010, the Company purchased approximately 50,000 shares of common stock under the share repurchase program at a total cost of $1.9 million. During the nine months ended September 30, 2010, the Company purchased 0.3 million shares of common stock under the share repurchase program at a total cost of $8.7 million. During the three and nine months ended September 30, 2009, the Company purchased 0.7 million and 2.1 million shares of common stock under the share repurchase program at a total cost of $20.5 million and $55.3 million, respectively.

During the three and nine months ended September 30, 2010, the Company redeemed 1,736 and 75,432 shares of common stock at a total cost of approximately $60,000 and $2.4 million, respectively, from employees to satisfy statutory minimum tax requirements from the vesting of restricted stock and PVRSU grants.

During the three and nine months ended September 30, 2009, the Company redeemed 8,771 and 64,643 shares of common stock at a total cost of $0.2 million and $1.7 million, respectively, from employees to satisfy statutory minimum tax requirements from the vesting of restricted stock and PVRSU grants.

These redemptions were outside the share repurchase program initiated in September 1998.

14. Comprehensive Income

The components of accumulated other comprehensive income (loss) is as follows:


	September 30, 2010			December 31, 2009
	(In thousands)
Foreign currency translation adjustments	$	943		$	275
Deferred loss on cash flow hedge		(8,546	)		—
Changes in pension benefit obligation recognized in other comprehensive income (loss)		58			58


Total accumulated other comprehensive income (loss)	$	(7,545	)	$	333

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

The differences between net income and comprehensive income are described in the following table:


	Three Months Ended September 30,					Nine Months Ended September 30,
(In thousands)	2010			2009		2010			2009
Net income	$	40,494		$	32,808	$	83,298		$	74,619
Other comprehensive income (loss), net of tax:
Amortization of pension related costs, net of tax
Prior service costs		—			36		—			108
Settlement of forward starting interest rate swap agreement		(8,663	)		—		(8,663	)		—
Amortization of loss on cash flow hedge		117			—		117			—
Foreign currency translation adjustment, net		1,851			719		668			2,046

Other comprehensive income (loss), net of tax		(6,695	)		755		(7,878	)		2,154

Comprehensive income	$	33,799		$	33,563	$	75,420		$	76,773

Cash Flow Hedge

In July 2010, the Company entered into an interest rate swap agreement to protect itself from an increase in the market interest rate on $250 million of 10-year, fixed rate debt with the coupon to be set at market interest rates. The interest rate swap agreement was designated as a cash flow hedge under the guidance for derivatives and hedging. In August 2010, upon issuance of the related fixed-rate debt, the Company terminated and settled the interest rate swap agreement for a cash payment of $8.7 million. The Company recorded the effective portion of this deferred loss as a component of accumulated other comprehensive income (loss). The ineffective portion was calculated at less than $0.1 million and was recognized immediately as a component of earnings under interest expense in the Company’s consolidated statements of income during the three months ended September 30, 2010. The effective portion of the deferred loss is being amortized over the term of the related debt as interest expense in the Company’s consolidated statements of income.

15. Earnings Per Share

The computation of basic and diluted earnings per common share is as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
(In thousands, except per share amounts)	2010			2009			2010			2009
Computation of Basic Earnings Per Share:
Net income	$	40,494		$	32,808		$	83,298		$	74,619
Income allocated to participating securities		(426	)		(303	)		(865	)		(688	)

Net income available to common shareholders	$	40,068		$	32,505		$	82,433		$	73,931


Weighted average common shares outstanding – basic		58,965			59,182			58,948			59,686

Basic earnings per share	$	0.68		$	0.55		$	1.40		$	1.24


Computation of Diluted Earnings Per Share:
Net income	$	40,494		$	32,808		$	83,298		$	74,619
Income allocated to participating securities		(425	)		(302	)		(864	)		(687	)

Net income available to common shareholders	$	40,069		$	32,506		$	82,434		$	73,932


Weighted average common shares outstanding – basic		58,965			59,182			58,948			59,686
Dilutive effect of stock options and PVRSUs		66			85			80			171

Weighted average shares outstanding-diluted		59,031			59,267			59,028			59,857

Diluted earnings per share	$	0.68		$	0.55		$	1.40		$	1.24

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

The Company’s unvested restricted shares contain rights to receive non-forfeitable dividends, and thus are participating securities requiring the two-class method of computing earnings per share (“EPS”). The calculation of EPS for common stock shown above excludes the income attributable to the unvested restricted share awards from the numerator and excludes the dilutive impact of those awards from the denominator.

At September 30, 2010 and 2009, the Company had 1.8 million and 1.7 million outstanding stock options, respectively. Stock options are included in the diluted earnings per share calculation using the treasury stock method and average market prices during the period, unless the stock options would be anti-dilutive. For both the three and nine months ended September 30, 2010, the Company excluded 0.6 million of anti-dilutive stock options from the diluted earnings per share calculation. For both the three and nine months ended September 30, 2009, the Company excluded 1.0 million of anti-dilutive stock options from the diluted earnings per share calculation.

PVRSUs are also included in the diluted earnings per share calculation assuming the performance conditions have been met at the reporting date. However, at September 30, 2010 and 2009, PVRSUs totaling 131,372 and 118,385, respectively were excluded from the computation since the performance conditions had not been met.

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

16. Condensed Consolidating Financial Statements

Effective August 2010, the Company’s Senior Notes are guaranteed jointly, severally, fully and unconditionally by eight 100%-owned domestic subsidiaries. There are no legal or regulatory restrictions on the payment of dividends to Choice Hotels International, Inc. from subsidiaries that do not guarantee the Senior Notes. As a result of the guarantee arrangements, the following condensed consolidating financial statements are presented. Investments in subsidiaries are accounted for under the equity method of accounting.

The condensed consolidating balance sheet as of December 31, 2009 has been revised to reflect the reclassification of certain intercompany balances and transactions from prior filings between subsidiaries within the combined financial statements to which they related. These revisions are not material to our financial statements taken as a whole.

Choice Hotels International, Inc.

Condensed Consolidating Statement of Income

For the Three Months Ended September 30, 2010

(Unaudited, In Thousands)


	Choice Hotels International, Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
REVENUES:
Royalty fees	$	66,259		$	21,727		$	7,507		$	(22,928	)	$	72,565
Initial franchise and relicensing fees		1,970			—			—			—			1,970
Procurement services		3,756			—			—			—			3,756
Marketing and reservation		90,518			86,315			4,386			(78,352	)		102,867
Other items, net		1,568			1,069			6			—			2,643


Total revenues		164,071			109,111			11,899			(101,280	)		183,801


OPERATING EXPENSES:
Selling, general and administrative		23,243			19,622			3,219			(22,928	)		23,156
Marketing and reservation		95,355			82,306			3,558			(78,352	)		102,867
Other items, net		880			1,820			201			—			2,901


Total operating expenses		119,478			103,748			6,978			(101,280	)		128,924


Operating income		44,593			5,363			4,921			—			54,877
OTHER INCOME AND EXPENSES, NET:
Interest expense		2,134			(272	)		2			—			1,864
Other items, net		(147	)		(1,492	)		(374	)		—			(2,013	)
Equity in earnings of consolidated subsidiaries		(9,756	)		—			—			9,756			—


Total other income and expenses, net		(7,769	)		(1,764	)		(372	)		9,756			(149	)


Income before income taxes		52,362			7,127			5,293			(9,756	)		55,026
Income taxes		11,868			2,137			527			—			14,532


Net income	$	40,494		$	4,990		$	4,766		$	(9,756	)	$	40,494

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

Choice Hotels International, Inc.

Condensed Consolidating Statement of Income

For the Three Months Ended September 30, 2009

(Unaudited, In Thousands)


	Choice Hotels International, Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
REVENUES:
Royalty fees	$	57,468		$	26,943		$	8,732		$	(26,742	)	$	66,401
Initial franchise and relicensing fees		2,957			—			—			—			2,957
Procurement services		3,922			—			—			—			3,922
Marketing and reservation		79,108			83,011			3,636			(75,290	)		90,465
Other items, net		1,278			934			19			—			2,231

Total revenues		144,733			110,888			12,387			(102,032	)		165,976


OPERATING EXPENSES:
Selling, general and administrative		30,186			20,786			287			(26,742	)		24,517
Marketing and reservation		83,386			79,104			3,265			(75,290	)		90,465
Other items, net		816			1,876			177			—			2,869


Total operating expenses		114,388			101,766			3,729			(102,032	)		117,851


Operating income		30,345			9,122			8,658			—			48,125
OTHER INCOME AND EXPENSES, NET:
Interest expense		982			(55	)		(1	)		—			926
Other items, net		(60	)		(2,901	)		(336	)		—			(3,297	)
Equity in earnings of consolidated subsidiaries		(12,514	)		—			—			12,514			—

Total other income and expenses, net		(11,592	)		(2,956	)		(337	)		12,514			(2,371	)

Income before income taxes		41,937			12,078			8,995			(12,514	)		50,496
Income taxes		9,129			7,990			569			—			17,688


Net income	$	32,808		$	4,088		$	8,426		$	(12,514	)	$	32,808

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

Choice Hotels International, Inc.

Condensed Consolidating Statement of Income

For the Nine Months Ended September 30, 2010

(Unaudited, In Thousands)


	Choice Hotels International, Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
REVENUES:
Royalty fees	$	153,597		$	68,596		$	21,137		$	(72,301	)	$	171,029
Initial franchise and relicensing fees		6,537			—			—			—			6,537
Procurement services		13,612			—			—			—			13,612
Marketing and reservation		209,543			233,654			11,554			(212,655	)		242,096
Other items, net		4,606			3,045			145			—			7,796

Total revenues		387,895			305,295			32,836			(284,956	)		441,070


OPERATING EXPENSES:
Selling, general and administrative		68,450			61,119			10,528			(72,301	)		67,796
Marketing and reservation		219,945			224,359			10,447			(212,655	)		242,096
Other items, net		2,848			5,411			598			—			8,857


Total operating expenses		291,243			290,889			21,573			(284,956	)		318,749


Operating income		96,652			14,406			11,263			—			122,321
OTHER INCOME AND EXPENSES, NET:
Interest expense		3,597			(441	)		4			—			3,160
Other items, net		(328	)		(1,043	)		(1,164	)		—			(2,535	)
Equity in earnings of consolidated subsidiaries		(20,718	)		—			—			20,718			—

Total other income and expenses, net		(17,449	)		(1,484	)		(1,160	)		20,718			625

Income before income taxes		114,101			15,890			12,423			(20,718	)		121,696
Income taxes		30,803			6,242			1,353			—			38,398


Net income	$	83,298		$	9,648		$	11,070		$	(20,718	)	$	83,298

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

Choice Hotels International, Inc.

Condensed Consolidating Statement of Income

For the Nine Months Ended September 30, 2009

(Unaudited, In Thousands)


	Choice Hotels International, Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
REVENUES:
Royalty fees	$	148,909		$	68,873		$	18,236		$	(71,247	)	$	164,771
Initial franchise and relicensing fees		9,599			—			—			—			9,599
Procurement services		14,084			—			—			—			14,084
Marketing and reservation		194,600			239,657			10,229			(216,683	)		227,803
Other items, net		3,961			3,231			28			—			7,220

Total revenues		371,153			311,761			28,493			(287,930	)		423,477


OPERATING EXPENSES:
Selling, general and administrative		67,221			67,490			9,590			(71,247	)		73,054
Marketing and reservation		205,823			229,119			9,544			(216,683	)		227,803
Other items, net		2,402			5,713			515			—			8,630


Total operating expenses		275,446			302,322			19,649			(287,930	)		309,487


Operating income		95,707			9,439			8,844			—			113,990
OTHER INCOME AND EXPENSES, NET:
Interest expense		4,001			(221	)		(6	)		(43	)		3,731
Other items, net		(200	)		(5,102	)		(822	)		43			(6,081	)
Equity in earnings of consolidated subsidiaries		(13,724	)		—			—			13,724			—

Total other income and expenses, net		(9,923	)		(5,323	)		(828	)		13,724			(2,350	)

Income before income taxes		105,630			14,762			9,672			(13,724	)		116,340
Income taxes		31,011			9,460			1,250			—			41,721


Net income	$	74,619		$	5,302		$	8,422		$	(13,724	)	$	74,619

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

Choice Hotels International, Inc.

Condensed Consolidating Balance Sheet

As of September 30, 2010

(Unaudited, In thousands)


	Choice Hotels International, Inc.			Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations			Consolidated
ASSETS

Cash and cash equivalents	$	3,198		$	352	$	75,998	$	—		$	79,548
Receivables		46,756			1,548		5,378		—			53,682
Other current assets		15,472			13,238		5,810		(2,560	)		31,960

Total current assets		65,426			15,138		87,186		(2,560	)		165,190
Property and equipment, at cost, net		13,281			38,269		1,426		—			52,976
Goodwill		60,620			5,193		227		—			66,040
Franchise rights and other identifiable intangibles, net		13,953			4,107		3,581		—			21,641
Investments, employee benefit plans, at fair value		—			22,370		—		—			22,370
Investment in and advances to affiliates		321,100			190,704		162		(511,966	)		—
Receivable, marketing and reservation fees		46,127			—		—		—			46,127
Deferred income taxes		—			41,695		275		(25,065	)		16,905
Other assets		4,842			6,420		796		—			12,058

Total assets	$	525,349		$	323,896	$	93,653		(539,591	)	$	403,307


LIABILITIES AND SHAREHOLDERS’ DEFICIT
Accounts payable	$	10,746		$	25,895	$	3,663	$	—		$	40,304
Accrued expenses		14,866			19,523		1,547		—			35,936
Deferred revenue		17,454			52,989		853		—			71,296
Revolving credit facility		6,600			—		—		—			6,600
Current portion of long-term debt		—			267		27		—			294
Deferred compensation & retirement plan obligations		—			2,510		—		—			2,510
Income taxes payable		6,331			14,189		1,815		(2,560	)		19,775

Total current liabilities		55,997			115,373		7,905		(2,560	)		176,715
Long-term debt		249,363			2,216		34		—			251,613
Deferred compensation & retirement plan obligations		—			34,573		6		—			34,579
Advances from affiliates		262,229			7,208		29,221		(298,658	)		—
Deferred income taxes		25,065			—		—		(25,065	)		—
Other liabilities		8,189			7,685		20		—			15,894

Total liabilities		600,843			167,055		37,186		(326,283	)		478,801

Total shareholders’ (deficit) equity		(75,494	)		156,841		56,467		(213,308	)		(75,494	)

Total liabilities and shareholders’ deficit	$	525,349		$	323,896	$	93,653	$	(539,591	)	$	403,307

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

Choice Hotels International, Inc.

Condensed Consolidating Balance Sheet

As of December 31, 2009

(In Thousands)


	Parent			Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations			Consolidated
ASSETS

Cash and cash equivalents	$	4,281		$	303	$	63,286		—		$	67,870
Receivables		33,911			2,947		5,040		—			41,898
Other current assets		21,110			7,484		330		(10,830	)		18,094

Total current assets		59,302			10,734		68,656		(10,830	)		127,862

Property and equipment, at cost, net		17,660			24,604		1,363		—			43,627
Goodwill		60,620			5,193		—		—			65,813
Franchise rights and other identifiable intangibles, net		16,448			4,571		3,540		—			24,559
Investments, employee benefit plans, at fair value		—			20,931		—		—			20,931
Investment in and advances to affiliates		292,455			190,007		146		(482,608	)		—
Receivable, marketing and reservation fees		33,872			—		—		—			33,872
Deferred income taxes		—			41,695		111		(27,663	)		14,143
Other assets		1,680			6,958		592		—			9,230

Total assets	$	482,037		$	304,693	$	74,408	$	(521,101	)	$	340,037


LIABILITIES AND SHAREHOLDERS’ DEFICIT

Accounts payable	$	5,516		$	24,952	$	3,391		—		$	33,859
Accrued expenses		12,629			23,266		1,179		—			37,074
Deferred revenue		3,854			47,331		580		—			51,765
Deferred compensation and retirement plan obligations		—			2,798		—		—			2,798
Income taxes payable		—			14,272		2,868		(10,830	)		6,310

Total current liabilities		21,999			112,619		8,018		(10,830	)		131,806

Long-term debt		277,700			—		—		—			277,700
Deferred compensation & retirement plan obligations		—			34,951		5		—			34,956
Advances from affiliates		262,628			6,663		22,708		(291,999	)		—
Deferred income taxes		27,663			—		—		(27,663	)		—
Other liabilities		6,259			3,528		—		—			9,787


Total liabilities		596,249			157,761		30,731		(330,492	)		454,249


Total shareholders’ deficit		(114,212	)		146,932		43,677		(190,609	)		(114,212	)


Total liabilities and shareholders’ deficit	$	482,037		$	304,693	$	74,408	$	(521,101	)	$	340,037

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

Choice Hotels International, Inc.

Condensed Consolidating Statement of Cash Flows

For the Nine Months Ended September 30, 2010

(Unaudited, in thousands)


	Choice Hotels International, Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Consolidated
Net cash provided from operating activities	$	79,156		$	17,001		$	12,082			—	$	108,239

CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in property and equipment		(1,409	)		(15,993	)		(271	)		—		(17,673	)
Acquisitions, net of cash acquired		—			—			(466	)		—		(466	)
Issuance of notes receivable		(7,906	)		(995	)		—			—		(8,901	)
Collection of notes receivable		5,000			55			—			—		5,055
Purchases of investments, employee benefit plans		—			(1,396	)		—			—		(1,396	)
Proceeds from the sales of investments, employee benefit plans		—			1,018			—			—		1,018
Other items, net		(351	)		23			32			—		(296	)

Net cash used in investing activities		(4,666	)		(17,288	)		(705	)		—		(22,659	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments pursuant to revolving credit facility		(271,100	)		—			—			—		(271,100	)
Proceeds from the issuance of long-term debt		247,733			—			—			—		247,733
Principal payments on long term debt		—			—			(20	)		—		(20	)
Settlement of forward starting interest rate swap agreement		(8,663	)		—			—			—		(8,663	)
Purchase of treasury stock		(11,171	)		—			—			—		(11,171	)
Dividends paid		(32,884	)		—			—			—		(32,884	)
Other items, net		512			336			—			—		848

Net cash provided (used) in financing activities		(75,573	)		336			(20	)		—		(75,257	)

Net change in cash and cash equivalents		(1,083	)		49			11,357			—		10,323
Effect of foreign exchange rate changes on cash and cash equivalents		—			—			1,355			—		1,355
Cash and cash equivalents at beginning of period		4,281			303			63,286			—		67,870


Cash and cash equivalents at end of period	$	3,198		$	352		$	75,998			—	$	79,548

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

Choice Hotels International, Inc.

Condensed Consolidating Statement of Cash Flows

For the Nine Months Ended September 30, 2009

(Unaudited, In thousands)


	Choice Hotels International, Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Consolidated
Net cash provided (used) from operating activities	$	37,862		$	(5,382	)	$	47,486			—	$	79,966

CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in property and equipment		(3,077	)		(3,627	)		(835	)		—		(7,539	)
Issuance of notes receivable		(162	)		(1,569	)		—			—		(1,731	)
Collection of notes receivable		—			190			—			—		190
Purchases of investments, employee benefit plans		—			(3,239	)		—			—		(3,239	)
Proceeds from the sales of investments, employee benefit plans		—			13,839			—			—		13,839
Other items, net		(450	)		(187	)		190			—		(447	)

Net cash provided (used) in investing activities		(3,689	)		5,407			(645	)		—		1,073

CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings pursuant to revolving credit facility		7,900			—			—			—		7,900
Purchase of treasury stock		(57,042	)		—			—			—		(57,042	)
Excess tax benefits from stock-based compensation		4,374			—			—			—		4,374
Dividends paid		(33,335	)		—			—			—		(33,335	)
Proceeds from exercise of stock options		6,744			—			—			—		6,744

Net cash used in financing activities		(71,359	)		—			—			—		(71,359	)

Net change in cash and cash equivalents		(37,186	)		25			46,841			—		9,680
Effect of foreign exchange rate changes on cash and cash equivalents		—			—			1,285			—		1,285
Cash and cash equivalents at beginning of period		42,734			225			9,721			—		52,680


Cash and cash equivalents at end of period	$	5,548		$	250		$	57,847			—	$	63,645

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

17. Reportable Segment Information

The Company has a single reportable segment encompassing its franchising business. Revenues from the franchising business include royalty fees, initial franchise and relicensing fees, marketing and reservation fees, procurement services revenue and other revenue. The Company is obligated under its franchise agreements to provide marketing and reservation services appropriate for the operation of its systems. These services do not represent separate reportable segments as their operations are directly related to the Company’s franchising business. The revenues received from franchisees that are used to pay for part of the Company’s ongoing operations are included in franchising revenues and are offset by the related expenses paid for marketing and reservation activities to calculate franchising operating income. Corporate and other revenue consists of hotel operations. Except as described in Note 4, the Company does not allocate interest income, interest expense or income taxes to its franchising segment.

The following table presents the financial information for the Company’s franchising segment:


	Three Months Ended September 30, 2010							Three Months Ended September 30, 2009
(In thousands)	Franchising		Corporate & Other			Consolidated		Franchising		Corporate & Other			Consolidated
Revenues	$	182,733	$	1,068		$	183,801	$	165,042	$	934		$	165,976
Operating income (loss)	$	64,424	$	(9,547	)	$	54,877	$	59,438	$	(11,313	)	$	48,125

	Nine Months Ended September 30, 2010							Nine Months Ended September 30, 2009
(In thousands)	Franchising		Corporate & Other			Consolidated		Franchising		Corporate & Other			Consolidated
Revenues	$	438,026	$	3,044		$	441,070	$	420,246	$	3,231		$	423,477
Operating income (loss)	$	150,056	$	(27,735	)	$	122,321	$	146,798	$	(32,808	)	$	113,990

18. Commitments and Contingencies

The Company is a defendant in a number of lawsuits arising in the ordinary course of business. In the opinion of management and the Company’s legal counsel, the ultimate outcome of any such lawsuit individually will not have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.

In June 2008, the Company guaranteed $1 million of a bank loan funding a franchisee’s construction of a Cambria Suites in Columbus, Ohio. The guaranty will terminate on the earlier of (i) the repayment of all outstanding obligations under the bank loan that it supports (the current initial loan term runs through June 2013), or (ii) when the franchisee achieves certain debt service coverage ratios outlined in the underlying bank loan agreement. The Company has received a pledge of an equity interest in the entity constructing the property as well as personal guarantees from several of the franchisee’s principal owners related to the repayment of any amounts the Company may be required to pay under this guaranty.

In July 2008, the Company guaranteed $1 million of a bank loan funding a franchisee’s construction of a Cambria Suites in Noblesville, Indiana. The guaranty will terminate on the earlier of (i) the repayment of all outstanding obligations under the bank loan that it supports (the current initial loan term runs through September 2011), or (ii) when the franchisee achieves certain debt service coverage ratios outlined in the underlying bank loan agreement. The Company has received a pledge of an equity interest in the entity constructing the property as well as personal guarantees from several of the franchisee’s principal owners related to the repayment of any amounts the Company may be required to pay under this guaranty.

The Company has made a commitment to purchase a parcel of real estate to support the development of its brands. Providing certain conditions are met by the seller, the Company expects to acquire this parcel of land for a total price of approximately $3.5 million during the year ended December 31, 2010.

In the ordinary course of business, the Company enters into numerous agreements that contain standard indemnities whereby the Company indemnifies another party for breaches of representations and warranties. Such indemnifications are granted under various agreements, including those governing (i) purchases or sales of assets or businesses, (ii) leases of real estate, (iii) licensing of trademarks, (iv) access to credit facilities, (v) issuances of debt or equity securities, and (vi) certain operating agreements. The indemnifications issued are for the benefit of the (i) buyers in sale agreements and sellers in purchase agreements, (ii) landlords in lease contracts, (iii) franchisees in licensing agreements, (iv) financial institutions in credit facility arrangements, (v) underwriters in debt or equity security issuances and (vi) parties under certain operating agreements. In addition, these parties are also generally indemnified against any third party claim resulting from the

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

transaction that is contemplated in the underlying agreement. While some of these indemnities extend only for the duration of the underlying agreement, many survive the expiration of the term of the agreement or extend into perpetuity (unless subject to a legal statute of limitations). There are no specific limitations on the maximum potential amount of future payments that the Company could be required to make under these indemnities, nor is the Company able to develop an estimate of the maximum potential amount of future payments to be made under these indemnifications as the triggering events are not subject to predictability. With respect to certain of the aforementioned indemnities, such as indemnifications of landlords against third party claims for the use of real estate property leased by the Company, the Company maintains insurance coverage that mitigates potential liability.

19. Termination Charges

During nine months ended September 30, 2010, the Company recorded one-time employee termination charges totaling $1.6 million in SG&A and marketing and reservation expenses. These charges related to salary and benefits continuation payments for employees separating from service with the Company. At September 30, 2010, the Company had approximately $0.9 million of these salary and benefits continuation payments remaining to be remitted. The Company recorded a $2.8 million charge in SG&A and marketing and reservations expenses related to salary and benefits continuation for terminated employees during the nine months ended September 30, 2009. At September 30, 2010 the Company had approximately $2.3 million of benefits remaining to be paid on these termination benefits as well as those incurred prior to January 1, 2009.

At September 30, 2010 and December 31, 2009, approximately $3.2 million and $5.5 million, respectively, of termination benefits remained unpaid and are included as current and non-current liabilities in the Company’s consolidated financial statements. At September 30, 2010, the Company expects $2.6 million of these benefits to be paid within the next twelve months.

20. Future Adoption of Accounting Standards

In July 2010, the FASB issued ASU No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” (“ASU 2010-20”), which is included in the codification under ASC 815, “Derivatives and Hedging” (“ASC 815”). ASU 2010-20 sets forth requirements to improve financial reporting by companies with financial receivables (as defined in ASU 2010-20) and to provide more relevant and reliable information to the users of the financial statements. A significant change in ASU 2010-20 is that companies will be required to provide information for both the financing receivable and the related allowance on credit losses at disaggregated levels. ASU 2010-20 will be effective for both interim and annual reporting periods ending after December 15, 2010. The Company is currently evaluating the impact of this guidance on its consolidated financial statements, if any.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand Choice Hotels International, Inc. and 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 6,091 hotels open and 638 hotels under construction, awaiting conversion or approved for development as of September 30, 2010, with 492,152 rooms and 52,723 rooms, respectively, in 49 states, the District of Columbia and over 40 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 conducts its international franchise operations through a combination of direct franchising and master franchising relationships. Master franchising relationships allow the use of our brands by third parties in foreign countries. The Company has made equity investments in certain non-domestic lodging franchise companies that conduct franchise operations for the Choice brands under master franchising relationships. As a result of our use of master franchising relationships and international market conditions, total revenues from international franchising operations comprised only 7% of our total revenues for both the three and nine months ended September 30, 2010, while representing approximately 19% of hotels open at September 30, 2010.

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 2010 and 2009, 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 procurement services 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.

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. Industry recovery usually begins with an increase in occupancy followed by hoteliers increasing room rates. As demand begins to exceed room supply, occupancies and rates continue to improve. These factors result in increased hotel development.

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 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. The Company currently estimates that 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 annual domestic royalty revenues by approximately $2.1 million and a 1 basis point change in the Company’s effective royalty rate would increase or decrease annual domestic royalties by approximately $0.5 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, the Company 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; 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 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 contractually 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 them 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 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. Our Company focuses on two key value drivers:

Profitable Growth. We believe 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 procurement services 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 nine months ended September 30, 2010, the Company repurchased 0.3 million shares of its common stock under the share repurchase program at a total cost of $8.8 million. Since the program’s inception through September 30, 2010, we have repurchased 43.2 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 $1.0 billion. Considering the effect of the two-for-one stock split, the Company has repurchased 76.2 million shares at an average price of $13.35 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 3.6 million shares remaining as of September 30, 2010. Upon completion of the current authorization, our board of directors will evaluate the advisability of additional share repurchases. During the nine months ended September 30, 2010, we paid cash dividends totaling approximately $32.9 million and we presently expect to continue to pay dividends in the future, subject to future business performance, economic conditions and changes in income tax regulations. Based on our present dividend rate and outstanding share count, aggregate annual dividends for 2010 would be approximately $43.8 million.

Our Board previously authorized us to enter into programs which permit us to offer financing, investment and guaranty support to qualified franchisees as well as to acquire and resell real estate to incent franchise development for certain brands in top markets. Recent market conditions have resulted in an increase in opportunities to incentivize development under these programs. As a result, during the nine months ended September 30, 2010, the Company has invested approximately $18.9 million pursuant to these programs, of which $5 million has subsequently been repaid.

Over the next several years, we expect to continue 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 market and other conditions.

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 the three months ended September 30, 2010, royalty fees revenue totaled $72.6 million, a 9% increase from the same period in 2009. Operating income totaled $54.9 million for the three months ended September 30, 2010, a $6.8 million or 14% increase from the same period in 2009. Net income increased $7.7 million or 23% from the same period of the prior year to $40.5 million. Diluted earnings per share for the quarter ended September 30, 2010 were $0.68 compared to $0.55 for the three months ended September 30, 2009. These measurements will continue to be a key management focus in 2010 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 the nine months ended September 30, 2010 and 2009, net cash provided by operating activities was $108.2 million and $80.0 million, respectively. Since our business does not currently 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 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.

Operations Review

Comparison of Operating Results for the Three-Month Periods Ended September 30, 2010 and 2009

The Company recorded net income of $40.5 million for the three months ended September 30, 2010, a $7.7 million, or 23% increase from the $32.8 million for the quarter ended September 30, 2009. The increase in net income for the three months ended September 30, 2010, is primarily attributable to a $6.8 million or 14% increase in operating income and a lower effective income tax rate, partially offset by an increase in effective borrowing rates due to the issuance of new debt and lower appreciation in the fair value of investments held in the Company’s non-qualified employee benefit plans compared to the prior year period.

Summarized financial results for the three months ended September 30, 2010 and 2009 are as follows:


(in thousands, except per share amounts)	2010			2009
REVENUES:
Royalty fees	$	72,565		$	66,401
Initial franchise and relicensing fees		1,970			2,957
Procurement services		3,756			3,922
Marketing and reservation		102,867			90,465
Hotel operations		1,068			934
Other		1,575			1,297

Total revenues		183,801			165,976


OPERATING EXPENSES:
Selling, general and administrative		23,156			24,517
Depreciation and amortization		2,078			2,105
Marketing and reservation		102,867			90,465
Hotel operations		823			764

Total operating expenses		128,924			117,851

Operating income		54,877			48,125


OTHER INCOME AND EXPENSES, NET:
Interest expense		1,864			926
Interest and other investment income		(1,671	)		(2,961	)
Equity in net income of affiliates		(342	)		(336	)

Total other income and expenses, net		(149	)		(2,371	)

Income before income taxes		55,026			50,496
Income taxes		14,532			17,688

Net income	$	40,494		$	32,808

Diluted earnings per share	$	0.68		$	0.55

The Company utilizes certain measures such as adjusted net income, adjusted diluted EPS, adjusted SG&A, adjusted operating income and franchising revenues which do not conform to generally accepted accounting principles 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 below a reconciliation of these measures to the comparable GAAP measurement as well as our reason for reporting these non-GAAP measures.

Franchising Revenues: The Company utilizes franchising revenues which exclude marketing and reservation revenues and hotel operations rather than total revenues when analyzing the performance of the business. Marketing and reservation activities are excluded from revenues since the Company is contractually required by its franchise agreements to use these fees collected for marketing and reservation activities; as such, no income or loss to the Company is generated. Cumulative reservation and marketing 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. Hotel operations are excluded since 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


	Three Months Ended September 30,
	($ amounts in thousands)
	2010			2009
Franchising Revenues:

Total Revenues	$	183,801		$	165,976
Adjustments:
Marketing and reservation revenues		(102,867	)		(90,465	)
Hotel operations		(1,068	)		(934	)

Franchising Revenues	$	79,866		$	74,577

Adjusted Net Income, Adjusted Diluted EPS, Adjusted SG&A and Adjusted Operating Income: We also use adjusted net income, adjusted diluted EPS, adjusted SG&A and adjusted operating income all of which exclude employee termination benefits for the three months ended September 30, 2010 and 2009. 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 Adjusted Operating Income


	Three Months Ended September 30,
	($ amounts in thousands)
	2010		2009

Operating Income	$	54,877	$	48,125
Adjustments:
Employee termination benefits		263		1,496

Adjusted Operating Income	$	55,140	$	49,621

Calculation of Adjusted SG&A


	Three Months Ended September 30,
	($ amounts in thousands)
	2010			2009

SG&A	$	23,156		$	24,517
Adjustments:
Employee termination benefits		(263	)		(1,496	)

Adjusted SG&A	$	22,893		$	23,021

Calculation of Adjusted Net Income and Adjusted Diluted EPS


	Three Months Ended September 30,
	(In thousands, except per share amounts)
	2010		2009

Net Income	$	40,494	$	32,808
Adjustments:
Employee termination benefits		165		936

Adjusted Net Income	$	40,659	$	33,744


Weighted average shares outstanding – diluted		59,658		59,818

Diluted EPS	$	0.68	$	0.55
Adjustments:
Employee termination benefits		—		0.01

Adjusted Diluted EPS	$	0.68	$	0.56

The Company recorded adjusted net income of $40.7 million for the three months ended September 30, 2010 a $7.0 million increase compared to an adjusted net income of $33.7 million for the three months ended September 30, 2009. The increase in adjusted net income for the three months ended September 30, 2010 is primarily attributable to a $5.5 million increase in adjusted operating income and a lower effective income tax rate, partially offset by lower appreciation in the fair value of investments held in the Company’s non-qualified employee benefit plans compared to the same period in 2009. Adjusted operating income increased $5.5 million as the Company’s franchising revenues for the three months ended September 30, 2010 increased $5.3 million or 7% from the same period of the prior year and adjusted SG&A expenses declined $0.1 million.

Franchising Revenues: Franchising revenues were $79.9 million for the three months ended September 30, 2010 compared to $74.6 million for the three months ended September 30, 2009. The increase in franchising revenues is primarily due to a 9% increase in royalty revenues partially offset by a 33% decline in initial franchise and relicensing fees.

Domestic royalty fees for the three months ended September 30, 2010 increased $5.7 million to $66.4 million from $60.7 million in the three months ended September 30, 2009, an increase of 9%. The increase in royalties is attributable to a combination of factors including a 7.4% increase in RevPAR, a 0.7% increase in the number of domestic franchised hotel rooms and an increase in the effective royalty rate of the domestic hotel system from 4.23% to 4.30%. System-wide RevPAR increased due to a 420 basis point increase in occupancy while average daily rates approximated the prior year period.

A summary of the Company’s domestic franchised hotels operating information is as follows:


	For the Three Months Ended September 30, 2010*							For the Three Months Ended September 30, 2009*							Change
	Average Daily Rate		Occupancy			RevPAR		Average Daily Rate		Occupancy			RevPAR		Average Daily Rate			Occupancy		RevPAR
Comfort Inn	$	82.46		66.7	%	$	54.99	$	81.35		62.7	%	$	51.04		1.4	%		400 bps		7.7	%
Comfort Suites		85.78		64.2	%		55.03		86.67		60.0	%		52.02		(1.0	%)		420 bps		5.8	%
Sleep		72.03		60.4	%		43.52		72.14		57.9	%		41.74		(0.2	%)		250 bps		4.3	%

Midscale without Food & Beverage		81.84		65.1	%		53.28		81.32		61.4	%		49.89		0.6	%		370 bps		6.8	%


Quality		71.76		58.3	%		41.84		72.71		53.7	%		39.02		(1.3	%)		460 bps		7.2	%
Clarion		80.18		51.5	%		41.27		81.07		47.8	%		38.75		(1.1	%)		370 bps		6.5	%

Midscale with Food & Beverage		73.44		56.8	%		41.72		74.33		52.4	%		38.97		(1.2	%)		440 bps		7.1	%


Econo Lodge		58.62		55.4	%		32.47		58.54		51.2	%		29.94		0.1	%		420 bps		8.5	%
Rodeway		57.40		56.0	%		32.15		57.37		51.1	%		29.30		0.1	%		490 bps		9.7	%

Economy		58.24		55.6	%		32.37		58.19		51.1	%		29.75		0.1	%		450 bps		8.8	%


MainStay		68.96		72.5	%		49.98		73.01		63.6	%		46.44		(5.5	%)		890 bps		7.6	%
Suburban		40.61		67.8	%		27.52		41.68		60.1	%		25.06		(2.6	%)		770 bps		9.8	%

Extended Stay		49.01		69.1	%		33.87		50.88		61.1	%		31.10		(3.7	%)		800 bps		8.9	%

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