CHH-10Q-09.30.2012
Table of Contents

 
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, 2012
OR
o 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  o
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   o
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.
Large accelerated filer
x
 
Accelerated filer
o
Non-accelerated filer
o
 
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o No  x

Table of Contents

CLASS
 
SHARES OUSTANDING AT SEPTEMBER 30, 2012
Common Stock, Par Value $0.01 per share
 
58,053,476
 
 
 
 
 
 

Table of Contents

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX
 
 
 
 
PAGE NO.
 
 
 
 
 
 
 
 
 
 
 
 


3
Table of Contents

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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
REVENUES:
 
 
 
 
 
 
 
Royalty fees
$
80,845

 
$
77,090

 
$
194,762

 
$
182,504

Initial franchise and relicensing fees
3,247

 
3,583

 
8,953

 
9,083

Procurement services
3,839

 
4,103

 
13,990

 
14,037

Marketing and reservation
119,062

 
104,393

 
284,624

 
258,192

Hotel operations
1,238

 
1,236

 
3,440

 
3,173

Other
2,182

 
1,916

 
7,434

 
5,914

Total revenues
210,413

 
192,321

 
513,203

 
472,903

 

 
 
 
 
 

OPERATING EXPENSES:

 
 
 
 
 

Selling, general and administrative
23,170

 
22,555

 
72,073

 
72,941

Depreciation and amortization
1,995

 
2,073

 
5,989

 
5,976

Marketing and reservation
119,062

 
104,393

 
284,624

 
258,192

Hotel operations
933

 
900

 
2,609

 
2,593

Total operating expenses
145,160

 
129,921

 
365,295

 
339,702

 


 
 
 
 
 


Operating income
65,253

 
62,400

 
147,908

 
133,201

OTHER INCOME AND EXPENSES, NET:

 
 
 
 
 

Interest expense
10,166

 
3,228

 
16,823

 
9,719

Interest income
(425
)
 
(506
)
 
(1,156
)
 
(937
)
Loss on extinguishment of debt
526

 
—

 
526

 
—

Other (gains) and losses
(511
)
 
2,673

 
(2,137
)
 
3,678

Equity in net (income) loss of affiliates
(171
)
 
39

 
12

 
(262
)
Total other income and expenses, net
9,585

 
5,434

 
14,068

 
12,198

Income before income taxes
55,668

 
56,966

 
133,840

 
121,003

Income taxes
11,291

 
14,664

 
37,604

 
35,393

Net income
$
44,377

 
$
42,302

 
$
96,236

 
$
85,610

 


 


 
 
 
 
Basic earnings per share
$
0.77

 
$
0.71

 
$
1.66

 
$
1.43

Diluted earnings per share
$
0.76

 
$
0.71

 
$
1.65

 
$
1.43

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


4
Table of Contents

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED, IN THOUSANDS)
 
        
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
44,377

 
$
42,302

 
$
96,236

 
$
85,610

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Amortization of loss on cash flow hedge
215

 
215

 
646

 
646

Foreign currency translation adjustment, net
211

 
(1,167
)
 
191

 
(164
)
Amortization of pension related costs, net of tax:
 
 
 
 
 
 
 
Actuarial loss (net of income tax of $12 and $36 for the three and nine months ended September 30, 2012, respectively)
20

 
—

 
60

 
—

Actuarial pension loss (net of income tax of $6 for the nine months ended September 30, 2011)
—

 
—

 
—

 
(10
)
Other comprehensive income (loss), net of tax
446

 
(952
)
 
897

 
472

Comprehensive income
$
44,823

 
$
41,350

 
$
97,133

 
$
86,082


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

5
Table of Contents


CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 
September 30,
2012
 
December 31,
2011
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
115,064

 
$
107,057

Receivables (net of allowance for doubtful accounts of $10,885 and $9,979, respectively)
66,196

 
53,012

Investments, employee benefit plans, at fair value
3,668

 
12,094

Other current assets
29,749

 
22,633

Total current assets
214,677

 
194,796

Property and equipment, at cost, net
52,822

 
51,992

Goodwill
66,006

 
66,005

Franchise rights and other identifiable intangibles, net
14,554

 
17,255

Receivable – marketing and reservation fees
46,249

 
54,014

Investments, employee benefit plans, at fair value
12,530

 
11,678

Deferred income taxes
22,962

 
22,665

Other assets
53,271

 
29,284

Total assets
$
483,071

 
$
447,689

LIABILITIES AND SHAREHOLDERS’ DEFICIT
 
 
 
Current liabilities
 
 
 
Accounts payable
$
44,245

 
$
38,389

Accrued expenses
43,539

 
53,851

Deferred revenue
76,949

 
68,825

Deferred compensation and retirement plan obligations
17,870

 
18,935

Current portion of long-term debt
10,065

 
673

Deferred income taxes
2,820

 
2,784

Income taxes payable
11,686

 
1,108

Total current liabilities
207,174

 
184,565

Long-term debt
808,911

 
252,032

Deferred compensation and retirement plan obligations
19,992

 
20,593

Other liabilities
16,391

 
16,060

Total liabilities
1,052,468

 
473,250

Commitments and Contingencies


 


SHAREHOLDERS’ DEFICIT
 
 
 
Common stock, $0.01 par value, 160,000,000 shares authorized; 95,345,362 shares issued at September 30, 2012 and December 31, 2011 and 58,053,476 and 58,277,646 shares outstanding at September 30, 2012 and December 31, 2011, respectively
581

 
583

Additional paid-in capital
107,939

 
102,665

Accumulated other comprehensive loss
(5,904
)
 
(6,801
)
Treasury stock (37,291,886 and 37,067,716 shares at September 30, 2012 and December 31, 2011, respectively), at cost
(930,487
)
 
(916,955
)
Retained earnings
258,474

 
794,947

Total shareholders’ deficit
(569,397
)
 
(25,561
)
Total liabilities and shareholders’ deficit
$
483,071

 
$
447,689

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

6
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CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
 
Nine Months Ended
 
September 30,
 
2012
 
2011
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
96,236

 
$
85,610

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

Depreciation and amortization
5,989

 
5,976

Provision for bad debts, net
1,802

 
845

Non-cash stock compensation and other charges
7,306

 
10,262

Non-cash interest and other (income) loss
(633
)
 
3,079

Loss on extinguishment of debt
526

 
—

Dividends received from equity method investments
855

 
316

Equity in net (income) loss of affiliates
12

 
(262
)
Changes in assets and liabilities:
 
 

Receivables
(17,405
)
 
(15,494
)
Receivable – marketing and reservation fees, net
20,811

 
(1,474
)
Accounts payable
5,980

 
4,468

Accrued expenses
(10,309
)
 
(10,584
)
Income taxes payable/receivable
12,786

 
14,354

Deferred income taxes
(1,627
)
 
2,839

Deferred revenue
8,018

 
9,375

Other assets
(7,458
)
 
(556
)
Other liabilities
(1,613
)
 
(2,861
)
Net cash provided by operating activities
121,276

 
105,893

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 

Investment in property and equipment
(12,525
)
 
(8,129
)
Equity method investments
(9,454
)
 
(3,600
)
Issuance of notes receivable
(7,305
)
 
(4,320
)
Collections of notes receivable
326

 
15

Purchases of investments, employee benefit plans
(1,191
)
 
(1,051
)
Proceeds from sales of investments, employee benefit plans
10,909

 
566

Other items, net
(322
)
 
(312
)
Net cash used in investing activities
(19,562
)
 
(16,831
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 

Net borrowings (repayments) pursuant to revolving credit facilities
16,725

 
(200
)
Proceeds from issuance of long-term debt
543,500

 
75

Repayments of long-term debt
(502
)
 
(74
)
Purchase of treasury stock
(22,227
)
 
(24,796
)
Dividends paid
(632,751
)
 
(32,923
)
Excess tax benefits from stock-based compensation
793

 
1,108

Debt issuance costs
(4,753
)
 
(2,356
)
Proceeds from exercise of stock options
4,695

 
3,726

Net cash used by financing activities
(94,520
)
 
(55,440
)
Net change in cash and cash equivalents
7,194

 
33,622

Effect of foreign exchange rate changes on cash and cash equivalents
813

 
(147
)
Cash and cash equivalents at beginning of period
107,057

 
91,259

Cash and cash equivalents at end of period
$
115,064

 
$
124,734

Supplemental disclosure of cash flow information:
 
 

Cash payments during the period for:


 


Income taxes, net of refunds
$
25,700

 
$
17,222

Interest
$
15,666

 
$
15,098

Non-cash investing and financing activities:


 


Declaration of dividends
$
632,710

 
$
32,846

Capital lease obligation
$
—

 
$
1,053

Issuance of restricted shares of common stock
$
9,517

 
$
9,604

Issuance of treasury stock to employee stock purchase plan
$
—

 
$
550

Debt issuance costs
$
6,500

 
$
—

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

7
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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”). These unaudited consolidated financial statements include all adjustments that are necessary, in the opinion of management, to fairly present our financial position and results of operations. Except as otherwise disclosed, all adjustments are of a normal recurring nature.
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, 2011 and notes thereto included in the Company’s Form 10-K, filed with the SEC on February 29, 2012 (the “10-K”). Interim results are not necessarily indicative of the entire year results because of seasonal variations. All inter-company 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.
Certain amounts in the prior year’s financial statements have been reclassified to conform to the current year presentation with no effect on previously reported net income, cash flows or shareholders’ deficit.
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, 2012 and December 31, 2011, $2.6 million and $4.4 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.
Recently Adopted Accounting Guidance
The Company adopted Accounting Standards Update ("ASU") No. 2011-08, "Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment" ("ASU No. 2011-08") in the first quarter of 2012. The guidance, which was issued in September 2011, reduces the complexity and costs by allowing an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of a reporting unit. The amendment improves previous guidance by expanding upon the examples of events and circumstances that an entity should consider between annual impairment tests in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Furthermore, the amendment improves the examples of events and circumstances that an entity having a reporting unit with a zero or negative carrying amount should consider in determining whether to measure an impairment loss, if any, under the second step of the goodwill impairment test. The Company performs its annual goodwill impairment test in the fourth quarter and does not expect the adoption of this ASU to significantly impact its consolidated financial statements.
The Company adopted ASU No. 2011-05 “Comprehensive Income (Topic 220): Presentation of Comprehensive Income” (“ASU No. 2011-05”) in the first quarter of 2012. ASU No. 2011-05, which was issued in June 2011, amends existing guidance by allowing only two options for presenting the components of net income and other comprehensive income: (1) in a single continuous financial statement, statement of comprehensive income or (2) in two separate but consecutive financial statements, consisting of an income statement followed by a separate statement of other comprehensive income.

8
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Additionally, the Company adopted ASU No. 2011-12, "Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” ("ASU 2011-12"), which was issued in December 2011. ASU 2011-12 defers until further notice ASU No. 2011-05's requirement that items that are reclassified from other comprehensive income to net income be presented on the face of the financial statements. ASU No. 2011-05 required retrospective application. The Company has elected to present other comprehensive income in a separate statement following the consolidated statements of income.
The Company adopted ASU No. 2011-04 “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU No. 2011-04”) in the first quarter of 2012. ASU No. 2011-04 generally provides a uniform framework for fair value measurements and related disclosures between U.S. GAAP and International Financial Reporting Standards (“IFRS”). Additional disclosure requirements in the update include: (1) for Level 3 fair value measurements, quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs; (2) for an entity’s use of a non-financial asset that is different from the asset’s highest and best use, the reason for the difference; (3) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined; and (4) the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. The adoption of this update did not have a material impact on our financial statements.
The Company adopted ASU 2012-02, “Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment” ("ASU No. 2012-02") in the third quarter of 2012. The guidance, which was issued in July 2012, amends the indefinite-lived intangible asset impairment guidance by providing an option for companies to use a qualitative approach to test indefinite-lived intangible assets for impairment if certain conditions are met. The amendments are effective for annual and interim indefinite-lived intangible asset impairment tests performed for fiscal years beginning after September 15, 2012 (early adoption is permitted). The Company performs its annual indefinite-lived intangible asset impairment tests in the fourth quarter and does not expect the adoption of this ASU to significantly impact its consolidated financial statements.

2.
Other Current Assets
Other current assets consist of the following:
 
September 30, 2012
 
December 31, 2011
 
(In thousands)
Land held for sale
$
10,203

 
$
10,141

Prepaid expenses
10,191

 
8,202

Notes receivable (See Note 3)
6,527

 
3,104

Other current assets
2,828

 
1,186

Total
$
29,749

 
$
22,633

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 strategic 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. The real estate is accounted for as assets held for sale and therefore is carried at the lower of its carrying value or its estimated fair value (based on comparable sales), less estimated costs to sell.

3.
Notes Receivable and Allowance for Losses
The Company segregates its notes receivable for the purposes of evaluating allowances for credit losses between two categories: Mezzanine and Other Notes Receivable and Forgivable Notes Receivable. The Company utilizes the level of security it has in the various notes receivable as its primary credit quality indicator (i.e. senior, subordinated or unsecured) when determining the appropriate allowances for uncollectible loans within these categories.

9
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The following table shows the composition of our notes receivable balances:
 
September 30, 2012
 
December 31, 2011
 
($ in thousands)
 
($ in thousands)
Credit Quality Indicator
Forgivable
Notes
Receivable
 
Mezzanine
& Other
Notes
Receivable
 
Total
 
Forgivable
Notes
Receivable
 
Mezzanine
& Other
Notes
Receivable
 
Total
Senior
$
—

 
$
11,191

 
$
11,191

 
$
—

 
$
7,900

 
$
7,900

Subordinated
—

 
14,984

 
14,984

 
—

 
13,992

 
13,992

Unsecured
8,561

 
631

 
9,192

 
7,948

 
—

 
7,948

Total notes receivable
8,561

 
26,806

 
35,367

 
7,948

 
21,892

 
29,840

Allowance for losses on non-impaired loans
856

 
309

 
1,165

 
795

 
225

 
1,020

Allowance for losses on receivables specifically evaluated for impairment
—

 
8,289

 
8,289

 
—

 
8,208

 
8,208

Total loan reserves
856

 
8,598

 
9,454

 
795

 
8,433

 
9,228

Net carrying value
$
7,705

 
$
18,208

 
$
25,913

 
$
7,153

 
$
13,459

 
$
20,612

Current portion, net
$
150

 
$
6,377

 
$
6,527

 
$
102

 
$
3,002

 
$
3,104

Long-term portion, net
7,555

 
11,831

 
19,386

 
7,051

 
10,457

 
17,508

Total
$
7,705

 
$
18,208

 
$
25,913

 
$
7,153

 
$
13,459

 
$
20,612

 
 
 
 
 
 
 
 
 
 
 
 

The Company classifies notes receivable due within one year as other current assets and notes receivable with a maturity greater than one year as other assets in the Company’s consolidated balance sheets.
The following table summarizes the activity related to the Company’s Forgivable Notes Receivable and Mezzanine and Other Notes Receivable allowance for losses from December 31, 2011 through September 30, 2012:
 
Forgivable
Notes
Receivable
 
Mezzanine
& Other  Notes
Receivable
 
(In thousands)
Balance, December 31, 2011
$
795

 
$
8,433

Provisions
292

 
262

Recoveries
(33
)
 
(97
)
Write-offs
(214
)
 
—

Other(1)
16

 
—

Balance, September 30, 2012
$
856

 
$
8,598

 
(1) Consists of default rate assumption changes
Forgivable Notes Receivable
As of September 30, 2012 and December 31, 2011, the unamortized balance of the Company's forgivable notes receivable totaled $8.6 million and $7.9 million, respectively. The Company recorded an allowance for credit losses on these forgivable notes receivable of $0.9 million and $0.8 million at September 30, 2012 and December 31, 2011, respectively. At September 30, 2012 and December 31, 2011, the Company did not have any forgivable unsecured notes that were past due. Amortization expense included in the accompanying consolidated statements of income related to the notes was $0.7 million and $2.0 million for the three and nine months ended September 30, 2012, respectively. Amortization expense for the three and nine months ended September 30, 2011 was $0.6 million and $1.7 million, respectively.

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Mezzanine and Other Notes Receivable
The Company has determined that approximately $12.7 million and $11.2 million of its mezzanine and other notes receivable were impaired at September 30, 2012 and December 31, 2011, respectively. The Company has recorded allowance for credit losses on these impaired loans at September 30, 2012 and December 31, 2011 totaling $8.3 million and $8.2 million resulting in a carrying value of impaired loans of $4.4 million and $3.0 million, respectively for which we had no related allowance for credit losses. The Company recognized approximately $38 thousand and $100 thousand of interest income on impaired loans during the three and nine months ended September 30, 2012, respectively, on the cash basis. The Company did not recognize any interest on an accrual or cash basis on its impaired loans during the three and nine months ended September 30, 2011. The Company had provided loan reserves on non-impaired loans totaling $0.3 million and $0.2 million at September 30, 2012 and December 31, 2011, respectively.
Past due balances of mezzanine and other notes receivable by credit quality indicators are as follows:
 
30-89 days
Past Due
 
> 90 days
Past Due
 
Total
Past Due
 
Current
 
Total
Receivables
 
($ in thousands)
As of September 30, 2012
 
 
 
 
 
 
 
 
 
Senior
$
—

 
$
—

 
$
—

 
$
11,191

 
$
11,191

Subordinated
—

 
9,629

 
9,629

 
5,355

 
14,984

Unsecured
—

 
$
47

 
$
47

 
$
584

 
$
631

 
$
—

 
$
9,676

 
$
9,676

 
$
17,130

 
$
26,806

As of December 31, 2011
 
 
 
 
 
 
 
 
 
Senior
$
—

 
$
—

 
$
—

 
$
7,900

 
$
7,900

Subordinated
—

 
9,773

 
9,773

 
4,219

 
13,992

 
$
—

 
$
9,773

 
$
9,773

 
$
12,119

 
$
21,892


Loans Acquired with Deteriorated Credit Quality
On December 2, 2011, the Company acquired an $11.5 million mortgage, held on a franchisee hotel asset, from a financial institution for $7.9 million. At both September 30, 2012 and December 31, 2011, the carrying amount of this loan, which is reported under senior mezzanine and other notes receivables, was $7.9 million and there was no allowance for uncollectable amounts. The Company's accretable yield at acquisition was $1.8 million or 7.36% and a reconciliation of the accretable yield for the nine months ended September 30, 2012 is as follows:
 
 
Accretable Yield ($ in thousands)
Balance, December 31, 2011
 
$
1,793

Additions
 
—

Accretion
 
(388
)
Disposals
 
—

Reclassifications from nonaccretable yield
 
—

Balance, September 30, 2012
 
$
1,405

4.
Receivable – Marketing and Reservation Fees
The marketing fees receivable from cumulative marketing expenses incurred in excess of cumulative marketing fees earned at September 30, 2012 and December 31, 2011 was $14.3 million and $18.5 million, respectively. As of September 30, 2012 and December 31, 2011, the reservation fees receivable related to cumulative reservation expenses incurred in excess of cumulative reservation fees earned was $31.9 million and $35.5 million, respectively. Depreciation and amortization expense attributable to marketing and reservation activities for the three months ended September 30, 2012 and 2011 was $3.7 million and $3.4 million, respectively. Depreciation and amortization expense attributable to marketing and reservation activities for the nine months ended September 30, 2012 and 2011 was $10.7 million and $10.0 million, respectively. Interest expense attributable to marketing and reservation activities was $0.9 million and $1.0 million for the three month periods ended September 30, 2012 and 2011. Interest expense attributable to marketing and reservation activities was $3.0 million for both the nine months ended September 30, 2012 and 2011, respectively.

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The Company evaluates the receivable for marketing and reservation costs in excess of cumulative marketing and reservation system revenues earned on a periodic basis for collectibility. The Company will record an allowance when, based on current information and events, it is probable that it 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. Based on the Company's analysis of projected net cash flows from marketing and reservation activities for all periods presented, the Company concluded that the receivable for marketing and reservation activities was fully collectible and as a result no allowance for possible losses was recorded.

5.
Other Assets
Other assets consist of the following:
 
September 30, 2012
 
December 31, 2011
 
(In thousands)
Notes receivable (see Note 3)
$
19,386

 
$
17,508

Equity method investments
12,959

 
4,338

Deferred financing fees
11,729

 
3,351

Land held for sale
1,300

 
1,300

Other
7,897

 
2,787

Total
$
53,271

 
$
29,284

During the three months ended March 31, 2011, the Company determined that one parcel of land no longer met the criteria to be classified as a current asset held for sale. As a result, the Company reclassified this land to other long-term assets on the Company’s consolidated balance sheets at the lower of its carrying amount or fair value. The Company determined that the carrying amount of the land exceeded its estimated fair value by approximately $1.8 million based on comparable sales. As a result, in the first quarter of 2011, the Company reduced the carrying amount of the land to its estimated fair value and recognized a $1.8 million loss in other gains and losses in the consolidated statements of income.
 
Fair Value Measurements Using
 
($ in millions)
Description
September 30, 2012
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total  Gains
(Losses)
 
 
 
 
 
 
 
 
 
 
Land held for sale
$
1.3

 
$
—

 
$
1.3

 
$
—

 
$
(1.8
)

6.
Deferred Revenue
Deferred revenue consists of the following:
 
September 30,
2012
 
December 31,
2011
 
(In thousands)
Loyalty programs
$
71,030

 
$
64,636

Initial, relicensing and franchise fees
4,269

 
3,198

Procurement service fees
1,146

 
957

Other
504

 
34

Total
$
76,949

 
$
68,825


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7.
Debt
Debt consists of the following at:
 
September 30, 2012
 
December 31, 2011
 
(In thousands)
$400 million senior unsecured notes with an effective interest rate of 5.94% at September 30, 2012
$
400,000

 
$
—

$250 million senior unsecured notes with an effective interest rate of 6.19% less discount of $0.5 million and $0.6 million at September 30, 2012 and December 31, 2011, respectively
249,491

 
249,444

$350 million senior secured credit facility with an effective interest rate of 2.82% at September 30, 2012
166,725

 
—

Capital lease obligations due 2016 with an effective interest rate of 3.18% at both September 30, 2012 and December 31, 2011, respectively
2,684

 
3,172

Other notes payable
76

 
89

Total debt
$
818,976

 
$
252,705

Less current portion
10,065

 
673

Total long-term debt
$
808,911

 
$
252,032

Senior Unsecured Notes Due 2022
On June 27, 2012, the Company completed a $400 million unsecured note offering ("the 2012 Senior Notes") at par, bearing a coupon of 5.75% with an effective rate of 5.94%. The 2012 Senior Notes will mature on July 1, 2022, with interest to be paid semi-annually on January 1st and July 1st. The Company used the net proceeds of this offering, after deducting underwriting discounts and commissions and other offering expenses, together with a portion of the proceeds from a new credit facility, to pay the special cash dividend totaling approximately $600.7 million paid to shareholders on August 23, 2012. The Company's 2012 Senior Notes are guaranteed jointly, severally, fully and unconditionally, subject to certain customary limitations by eight 100%-owned domestic subsidiaries.
The Company incurred debt issuance costs in connection with the 2012 Senior Notes totaling approximately $7.5 million, which are included in other current assets and other assets on the Company's consolidated balance sheets. These debt issuance costs are amortized, on a straight-line basis, which is not materially different than the effective interest method, through the maturity of the 2012 Senior Notes. Amortization of these costs is included in interest expense in the consolidated statements of income.
The Company may redeem the 2012 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 50 basis points.
Senior Unsecured Notes Due 2020
On August 25, 2010, the Company completed a $250 million senior unsecured note offering (“the 2010 Senior Notes”) at a discount of $0.6 million, bearing a coupon of 5.7% with an effective rate of 6.19%. The 2010 Senior Notes will mature on August 28, 2020, with interest to be paid semi-annually on February 28th and August 28th. The Company used the net proceeds from the offering, after deducting underwriting discounts and other offering expenses, to repay outstanding borrowings and for other general corporate purposes. The Company's 2010 Senior Notes are guaranteed jointly, severally, fully and unconditionally, subject to certain customary limitations by eight 100%-owned domestic subsidiaries.
Revolving Credit Facilities
On July 25, 2012, the Company entered into a $350 million senior secured credit facility, comprised of a $200 million revolving credit tranche (the "New Revolver") and a $150 million term loan tranche (the "Term Loan") with Deutsche Bank AG New York Branch, as administrative agent, Wells Fargo Bank, National Association, as administrative agent and a syndication of lenders (the "New Credit Facility"). The New Credit Facility has a final maturity date of July 25, 2016, subject to an optional one-year extension provided certain conditions are met. Up to $25 million of the borrowings under the New Revolver may be used for letters of credit, up to $10 million of borrowings under the New Revolver may be used for swing-line loans and up to $35 million of borrowings under the New Revolver may be used for alternative currency loans. The Term Loan

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requires quarterly amortization payments (a) during the first two years, in equal installments aggregating 5% of the original principal amount of the Term Loan per year, (b) during the second two years, in equal installments aggregating 7.5% of the original principal amount of the Term Loan per year, and (c) during the one-year extension period (if exercised), equal installments aggregating 10% of the original principal amount of the Term Loan.

The Company utilized the proceeds from the Term Loan and borrowings from the New Revolver, together with the net proceeds from the Company's recently issued senior notes offering, to pay during 2012 the special cash dividend of approximately $600.7 million in the aggregate to the Company's stockholders on August 23, 2012.

The New Credit Facility is unconditionally guaranteed, jointly and severally, by certain of the Company's domestic subsidiaries. The subsidiary guarantors currently include all subsidiaries that guarantee the obligations under the Company's Indenture governing the terms of its 2010 and 2012 Senior Notes.
The New Credit Facility is secured by first priority pledges of (i) 100% of the ownership interests in certain domestic subsidiaries owned by the Company and the guarantors, (ii) 65% of the ownership interests in (a) Choice Netherlands Antilles N.V. (“Choice NV”), the top-tier foreign holding company of Choice's foreign subsidiaries, and (b) the domestic subsidiary that owns Choice NV and (iii) all presently existing and future domestic franchise agreements (the “Franchise Agreements”) between the Company and individual franchisees, but only to the extent that the Franchise Agreements may be pledged without violating any law of the relevant jurisdiction or conflicting with any existing contractual obligation of the Company or the applicable franchisee. At the time that the maximum total leverage ratio is required to be no greater than 4.0 to 1.00 (beginning of year 4 of the New Credit Facility), the security interest in the Franchise Agreements will be released.
The Company may at any time prior to the final maturity date increase the amount of the New Credit Facility by up to an additional $100 million to the extent that any one or more lenders commit to being a lender for the additional amount and certain other customary conditions are met. Such additional amounts may take the form of an increased Revolver or Term Loan.
The Company may elect to have borrowings under the New Credit Facility bear interest at a rate equal to (i) LIBOR, plus a margin ranging from 200 to 425 basis points based on the Company's total leverage ratio or (ii) a base rate plus a margin ranging from 100 to 325 basis points based on the Company's total leverage ratio.
The New Credit Facility requires the Company to pay a fee on the undrawn portion of the New Revolver, calculated on the basis of the average daily unused amount of the New Revolver multiplied by 0.30% per annum.
The Company may reduce the New Revolver commitment and/or prepay the Term Loan in whole or in part at any time without penalty, subject to reimbursement of customary breakage costs, if any. Any Term Loan prepayments made by the Company shall be applied to reduce the scheduled amortization payments in direct order of maturity.
Additionally, the New Credit Facility requires that the Company and its restricted subsidiaries comply with various covenants, including with respect to restrictions on liens, incurring indebtedness, making investments, paying dividends or repurchasing stock, and effecting mergers and/or asset sales. In addition, the New Credit Facility imposes financial maintenance covenants requiring the Company to maintain:
•
a total leverage ratio of not more than 5.75 to 1.00 in year 1, 5.00 to 1.00 in year 2, 4.50 to 1.00 in year 3 and 4.00 to 1.00 thereafter,
•
a maximum secured leverage ratio of not more than 2.50 to 1.00 in year 1, 2.25 to 1.00 in year 2, 2.00 to 1.00 in year 3 and 1.75 to 1.00 thereafter, and
•
a minimum fixed charge coverage ratio of not less than 2.00 to 1.00 in years 1 and 2, 2.25 to 1.00 in year 3 and 2.50 to 1.00 thereafter.
The New Credit Facility includes customary events of default, the occurrence of which, following any applicable cure period, would permit the lenders to, among other things, declare the principal, accrued interest and other obligations of the Company under the New Credit Facility to be immediately due and payable. At September 30, 2012, the Company was in compliance with all covenants under the New Credit Facility.
The Company incurred debt issuance costs in connection with the New Credit Facility totaling approximately $3.7 million, which are included in other current assets and other assets on the Company's consolidated balance sheets. These debt issuance costs are amortized, on a straight-line basis, which is not materially different than the effective interest method, through the maturity of the New Credit Facility. Amortization of these costs is included in interest expense in the consolidated statements of income.


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At September 30, 2012, the Company had $150.0 million and $16.7 million outstanding under the Term Loan and New Revolver, respectively.
In connection with the entering into the New Credit Facility, the Company's $300 million senior unsecured revolving credit agreement, dated as of February 24, 2011, among the Company, Wells Fargo Bank, National Association, as administrative agent, and a syndicate of lenders (the “Old Credit Facility”), was terminated and replaced by the New Credit Facility. The Old Credit Facility permitted the Company to borrow, repay and re-borrow revolving loans until the scheduled maturity date of February 24, 2016. Upon refinancing, the Company had unamortized deferred financing fees totaling $1.7 million pertaining to the Old Credit Facility. Based on an analysis of the lenders participating in both the Old and New Credit Facilities, the Company recorded a loss on extinguishment of debt of approximately $0.5 million during the three and nine months ended September 30, 2012. The remaining unamortized deferred fees related to the Old Credit Facility will be amortized, on a straight-line basis through the maturity of the New Credit Facility.
Scheduled principal maturities of debt as of September 30, 2012 were as follows:
Year Ending
Senior Notes
 
Capital Lease
 
Revolving Credit
Facilities
 
Other Notes
Payable
 
Total
 
 
 
(In thousands)
 
 
 
 
 
 
September 30, 2013
$
—

 
$
1,024

 
$
9,375

 
$
21

 
$
10,420

September 30, 2014
—

 
1,024

 
8,437

 
23

 
9,484

September 30, 2015
—

 
1,024

 
11,250

 
22

 
12,296

September 30, 2016
—

 
854

 
137,663

 
10

 
138,527

September 30, 2017
—

 
—

 
—

 
—

 
—

Thereafter
649,491

 
—

 
—

 
—

 
649,491

Total payments
649,491

 
3,926

 
166,725

 
76

 
820,218

Less: Amount representing estimated executory costs
—

 
(1,071
)
 
—

 
—

 
(1,071
)
Less: Amounts representing interest
—

 
(171
)
 
—

 
—

 
(171
)
Net principal payments
$
649,491

 
$
2,684

 
$
166,725

 
$
76

 
$
818,976



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 SERP; therefore benefits are funded as paid to participants. For the three months ended September 30, 2012 and 2011, the Company recorded $0.2 million and $0.1 million, respectively, in expenses related to the SERP which are included in selling general and administrative ("SG&A") expense in the accompanying consolidated statements of income. The expenses related to the SERP for the nine month periods ended September 30, 2012 and 2011 were $0.5 million and $0.4 million, respectively.
On December 26, 2011, the Company's board of directors approved the termination of the SERP effective immediately. The Company will effectuate the termination of the SERP through the payment of lump sum distributions to all SERP participants based upon the actuarial equivalent commuted lump sum value of the full accrued benefit earned by each such participant, using the actuarial and other assumptions that have not yet been determined. The Company expects to complete the settlement of the plan benefits prior to December 31, 2012. Based on the assumptions chosen to calculate the lump sum value of distributions, the actual settlement of the SERP liability may differ from the Company's current estimate of the projected benefit obligation which totals $12.0 million resulting in a settlement gain or loss in 2012.


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The following table presents the components of net periodic benefit costs for the three and nine months ended September 30, 2012 and 2011:
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(In thousands)
2012
 
2011
 
2012
 
2011
Components of net periodic pension cost:
 
 
 
 
 
 
 
Interest cost
$
132

 
$
135

 
$
395

 
$
406

Amortization of actuarial loss
32

 
—

 
$
96

 
$
—

Net periodic pension cost
$
164

 
$
135

 
$
491

 
$
406

The 2012 net periodic pension costs are expected to be approximately $0.7 million. The components of projected pension costs for the year ended December 31, 2012 are as follows:
(in thousands)
 
Components of net periodic pension cost:
 
Interest cost
$
526

Amortization of actuarial loss
128

Net periodic pension cost
$
654

The following is a reconciliation of the changes in the projected benefit obligation for the nine months ended September 30, 2012:
(in thousands)
 
Projected benefit obligation, December 31, 2011
$
11,896

Interest cost
395

Benefit payments
(318
)
Projected benefit obligations, September 30, 2012
$
11,973

The amounts in accumulated other comprehensive income (loss) that have not yet been recognized as components of net periodic benefit costs at September 30, 2012 are as follows:
(in thousands)
 
Transition asset (obligation)
$
—

Prior service cost
—

Accumulated loss
(2,279
)
Total
$
(2,279
)

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 Rate 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. The Company recorded current and long-term deferred compensation liabilities of $14.8 million and $17.2 million, as of September 30, 2012 and December 31, 2011, 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

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diversified investments. Compensation expense recorded in SG&A for the three months ended September 30, 2012 and 2011 was $0.2 million and $17 thousand, respectively. Compensation expense recorded in SG&A for the nine months ended September 30, 2012 and 2011 was $0.7 million and $0.5 million, respectively.
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 $6.1 million and $14.2 million as of September 30, 2012 and December 31, 2011, respectively, and are recorded at their fair value, based on quoted market prices. At September 30, 2012, the Company expects $3.7 million of the assets held in the trusts to be distributed to participants during the next twelve months. These investments are considered trading securities and therefore the changes in the fair value of the diversified assets is included in other gains and losses in the accompanying consolidated statements of income. The Company recorded investment gains (losses) during the three months ended September 30, 2012 and 2011 of approximately $0.1 million and ($1.4 million), respectively. The Company recorded investment gains (losses) during the nine months ended September 30, 2012 and 2011 of approximately $1.2 million and ($0.9 million), respectively. In addition, the EDCP Plan held shares of the Company's common stock at a market value of $0.1 million at September 30, 2012 which were recorded as a component of shareholders' deficit.
In 1997, the Company adopted the Choice Hotels International, Inc. Non-Qualified 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, 2012 and December 31, 2011, the Company had recorded a deferred compensation liability of $11.1 million and $10.4 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 (decrease) in compensation expense recorded in SG&A for the three months ended September 30, 2012 and 2011 was $0.2 million and ($1.3 million), respectively. The net increase (decrease) in compensation expense recorded in SG&A during the nine months ended September 30, 2012 and 2011 was $0.8 million and ($1.1 million), respectively.
The diversified investments held in the trusts were $10.1 million and $9.5 million as of September 30, 2012 and December 31, 2011, 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 gains and losses in the accompanying consolidated statements of income. The Company recorded investment gains (losses) during the three months ended September 30, 2012 and 2011 of approximately $0.4 million and ($1.2 million), respectively. The Company recorded investment gains (losses) during the nine months ended September 30, 2012 and 2011 of approximately $1.0 million and ($0.9 million), respectively. In addition, the Non-Qualified Plan held shares of the Company's common stock with a market value of $1.0 million and $0.9 million at September 30, 2012 and December 31, 2011, respectively, which are recorded as a component of shareholders' deficit.

10.
Fair Value Measurements
The Company estimates the fair value of its financial instruments utilizing a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. 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 whose fair value was determined using Level 3 inputs.

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As of September 30, 2012 and December 31, 2011, the Company had the following assets measured at fair value on a recurring basis:
 
Fair Value Measurements at
Reporting Date Using
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets (in thousands)
 
 
 
 
 
 
 
As of September 30, 2012
 
 
 
 
 
 
 
Money market funds, included in cash and cash equivalents
$
20,001

 
$
—

 
$
20,001

 
$
—

Mutual funds(1)
11,737

 
11,737

 
—

 
—

Money market funds(1)
4,461

 
—

 
4,461

 
—

 
$
36,199

 
$
11,737

 
$
24,462

 
$
—

As of December 31, 2011
 
 
 
 
 
 
 
Money market funds, included in cash and cash equivalents
$
20,001

 
$
—

 
$
20,001

 
$
—

Mutual funds(1)
21,534

 
21,534

 
—

 
—

Money market funds(1)
2,238

 
—

 
2,238

 
—

 
$
43,773

 
$
21,534

 
$
22,239

 
$
—

________________________ 
(1)
Included in Investments, employee benefit plans fair value on the consolidated balance sheets.
During the nine months ended September 30, 2012, the Company sold approximately $11.8 million of mutual funds (Level 1 assets) held in the employee benefit plan trusts. Approximately $8.4 million of these assets were distributed from the irrevocable trust with the remaining $3.4 million transferred to money market funds (Level 2 assets). There were no transfers between Level 1 and 2 assets during the three months ended September 30, 2012. The Company's policy is to recognize transfers in and transfers out of the three levels of the fair value hierarchy as of the end of each quarterly reporting period.
Other Financial Instruments
The Company believes that the fair value 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 of the Company's New Credit Facility adjust frequently based on current market rates; accordingly its carrying amount approximates fair value.
We estimated the fair value of notes receivable which approximate their carrying value, utilizing an analysis of future cash flows and credit worthiness for similar types of arrangements. Based upon the availability of market data, we have classified these notes receivables as Level 3 inputs. The primary sensitivity in these calculations is based on the selection of appropriate interest and discount rates. For further information on the notes receivables see Note 3.
The Company estimates the fair value of the Company's $250 million and $400 million senior notes using quoted market prices, which are directly observable Level 1 inputs. At September 30, 2012 and December 31, 2011, the $250 million senior notes had an approximate fair value of $270.6 million and $267.7 million, respectively. At September 30, 2012, the $400 million senior notes, which were entered into in 2012, had an approximate fair value of $436.0 million.

Fair values estimated are made at a specific point in time, are subjective in nature and involve uncertainties and matters of significant judgment.  Settlement of such fair value amounts may not be possible and may not be a prudent management decision.


11.
Income Taxes
The effective income tax rates were 20.3% and 25.7% for the three months ended September 30, 2012 and 2011, respectively.
The effective income tax rates were 28.1% and 29.2% for the nine months ended September 30, 2012 and September 30, 2011, respectively. The effective income tax rate for the three and nine months ended September 30, 2012 were lower than the U.S federal income tax rate of 35% due to the impact of foreign operations, partially offset by state taxes. Additionally, the effective income tax rates also reflect a nonrecurring favorable adjustment of $4.5 million related to foreign operations. The effective income tax rates for the three and nine months ended September 30, 2011 were lower than the U.S. federal statutory rate of 35% due to the identification of $2.1 million of additional federal tax benefits, and a nonrecurring favorable adjustment of $1.9

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million for unrecognized tax positions. Additionally, an adjustment to our current federal taxes payable of $1.4 million reduced the effective tax rate for the nine months ended September 30, 2011.
The Company's U.S. federal income tax returns for tax years 2007, 2009 and 2010 are currently under examination by the Internal Revenue Service. As of September 30, 2011, the Company has not been advised of any material adjustments.

12.
Share-Based Compensation and Capital Stock
Dividends
The Company currently maintains a quarterly dividend on its common shares outstanding, however, the declaration of future dividends are subject to discretion our board of directors. During the nine months ended September 30, 2012 and 2011, the Company paid dividends at a quarterly rate of $0.185 per share totaling approximately $32.1 million and $32.9 million, respectively.
On July 26, 2012, the Company's board of directors declared a special cash dividend to common shareholders in the amount of $10.41 per share or approximately $600.7 million ("Special Cash Dividend") which was paid on August 23, 2012.
On September 14, 2012, the Company's board of director declared a quarterly cash dividend of $0.185 per share (or approximately $10.7 million in the aggregate), which was paid on October 12, 2012 to shareholders of record as of October 2, 2012.

Stock Options
No stock options were granted during the three month periods ended September 30, 2012 and 2011. The Company granted 0.2 million and 0.2 million options to certain employees of the Company at a fair value of $1.6 million and $2.1 million for the nine months ended September 30, 2012 and 2011, 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:
            
 
2012 Grants
 
2011 Grants
Risk-free interest rate
0.78
%
 
2.10
%
Expected volatility
40.15
%
 
39.51
%
Expected life of stock option
4.4 years

 
4.4 years

Dividend yield
2.08
%
 
1.79
%
Requisite service period
4 years

 
4 years

Contractual life
7 years

 
7 years

Weighted average fair value of options granted
$
9.98

 
$
12.42

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, 2012 was $14.3 million and $10.6 million, respectively. The total intrinsic value of options exercised during the three months ended September 30, 2012 and 2011 was approximately $0.5 million and $0.2 million, respectively. The total intrinsic value of options exercised during the nine months ended September 30, 2012 and 2011 was $1.0 million and $2.5 million, respectively.

The Company received approximately $4.3 million and $0.6 million in proceeds from the exercise of 109,996 and 26,614 employee stock options during the three month periods ended September 30, 2012 and 2011, respectively. The Company received $4.7 million and $3.7 million in proceeds from the exercise of 135,200 and 164,150 of employee stock options during the nine month periods ended September 30, 2012 and 2011, respectively.


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Special Dividend Adjustment
The Company's long-term incentive plans ("the Plans") contain provisions which require the automatic adjustment of outstanding share-based awards in the event that the Company makes any changes to its capital structure, such as special dividends, stock splits or spin-offs, if such changes result in the dilution or enlargement of the benefits or potential benefits intended upon the grant of the award. The Company's board of directors concluded that the Special Cash Dividend paid on August 23, 2012 would result in the dilution of the value of the Company's outstanding stock options. Therefore, in accordance with the anti-dilution provision of the Plans, the Company's outstanding stock options were adjusted to maintain their pre-dividend value. The Company elected to maintain the pre-dividend value of the outstanding options by adjusting both the exercise price and the number of stock options outstanding as of the ex-dividend date of the Special Dividend so that the aggregate difference between the market price and exercise price multiplied by the number of shares issuable upon exercise was substantially the same immediately before and after the payment of the Special Cash Dividend. As a result of this adjustment, an additional 0.5 million stock options were awarded during the nine months ended September 30, 2012 and the exercise price of the outstanding options were reduced by approximately 24%. This adjustment did not result in additional stock-based compensation expense as the fair value of the options immediately before and after the payment of the Special Cash Dividend were substantially equal.
Restricted Stock
The following table is a summary of activity related to restricted stock grants: 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Restricted share grants
7,672

 
45,674

 
266,159

 
247,298

Weighted average grant date fair value per share
$
32.59

 
$
30.27

 
$
35.76

 
$
38.84

Aggregate grant date fair value ($000)
$
250

 
$
1,383

 
$
9,517

 
$
9,604

Restricted shares forfeited
13,619

 
5,884

 
23,921

 
33,252

Vesting service period of shares granted
36 months

 
36 months

 
12 - 68 months

 
12 - 48 months

Grant date fair value of shares vested ($000)
$
75

 
$
298

 
$
6,693

 
$
6,655

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. Awards granted to retirement eligible board of directors are recognized over the shorter of the requisite service period or the length of time until retirement since the terms of the grant provide that the awards will vest upon retirement.
Performance Vested Restricted Stock Units
The Company has granted performance vested restricted stock units (“PVRSU”) to certain employees. The fair value is measured by the market price of the Company's common stock on the date of the grant. 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 generally between 0% and 200% of the initial target. If minimum performance targets are not attained then no awards will vest under the terms of the various PVRSU agreements. Compensation expense related to these awards is recognized over the requisite service period based on the Company's estimate of the achievement of the various performance targets. The Company has currently estimated that between 100% and 160% of the various award targets will be achieved. Compensation expense is recognized ratably over the requisite service period only on those PVRSUs that ultimately vest.

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The following table is a summary of activity related to PVRSU grants:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Performance vested restricted stock units granted at target
6,137

 
—

 
100,046

 
25,036

Weighted average grant date fair value per share
$
32.59

 
$
—

 
$
35.68

 
$
41.25

Aggregate grant date fair value ($000)
$
200

 
$
—

 
$
3,570

 
$
1,033

Stock units forfeited
—

 
—

 
57,176

 
41,512

Requisite service period
41 months

 
—

 
36-60 months

 
36 months

During the three and nine months ended September 30, 2012 and 2011, no PVRSU grants vested. During the nine months ended September 30, 2012, PVRSU grants totaling 57,176 units were terminated in accordance with an amended and restated employment agreement. During the nine months ended September 30, 2011, PVRSU grants totaling 39,070 units were forfeited since the Company did not achieve the minimum performance conditions contained in the stock awards. The remaining 2,442 units were forfeited upon employee termination.
A summary of stock-based award activity as of September 30, 2012 and changes during the nine months ended are presented below:
 
Stock Options
 
Restricted Stock
 
Performance Vested
Restricted  Stock Units
 
Options
 
Weighted
Average
Exercise
Price(1)
 
Weighted
Average
Remaining
Contractual
Term
 
Shares
 
Weighted
Average
Grant Date
Fair Value
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Outstanding at January 1, 2012
1,573,726

 
$
33.30

 
 
 
565,627

 
$
34.43

 
109,769

 
$
35.57

Granted
160,408

 
35.60

 
 
 
266,159

 
35.76

 
100,046

 
35.68

Special Dividend Adjustment
497,497

 
25.31

 
 
 
—

 
—

 
—

 
—

Exercised/Vested
(135,200
)
 
34.73

 
 
 
(198,290
)
 
33.75

 
—

 
—

Forfeited/Expired
(30,843
)
 
36.97

 
 
 
(23,921
)
 
36.10

 
(57,176
)
 
34.98

Outstanding at September 30, 2012
2,065,588

 
$
25.31

 
4.1 years
 
609,575

 
$
35.17

 
152,639

 
$
35.86

Options exercisable at September 30, 2012
1,434,178

 
$
24.94

 
3.3 years
 
 
 
 
 
 
 
 
_________________________________ 
(1)The weighted average exercise price for options outstanding and exercisable reflect the reduction of the option price for outstanding options as described under "Special Dividend Adjustment". The weighted average exercise price for options granted, exercised or forfeited reflects the option price in effect at the time of the transaction.
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, 2012 and 2011:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(in millions)
2012
 
2011
 
2012
 
2011
Stock options
$
0.5

 
$
0.7

 
$
1.6

 
$
2.0

Restricted stock
1.8

 
1.9

 
5.7

 
5.6

Performance vested restricted stock units
0.8

 
0.1

 
1.3

 
0.4

Total
$
3.1

 
$
2.7

 
$
8.6

 
$
8.0

Income tax benefits
$
1.1

 
$
1.0

 
$
3.2

 
$
3.0



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Share Repurchases and Redemptions
No shares of common stock were purchased by the Company under the share repurchase program during the three months ended September 30, 2012. During the nine months ended September 30, 2012, the Company purchased 0.5 million shares of common stock under the share repurchase program at a total cost of $19.9 million, respectively. During the three and nine months ended September 30, 2011, the Company purchased 0.7 million shares of common stock under the share repurchase program at a total cost of $22.2 million.
During the three and nine months ended September 30, 2012, the Company redeemed 1,525 and 64,037 shares of common stock at a total cost of approximately $0.1 million and $2.3 million from employees to satisfy statutory minimum tax requirements from the vesting of restricted stock grants. During the three and nine months ended September 30, 2011, the Company redeemed 3,309 and 67,336 shares of common stock at a total cost of approximately $0.1 million and $2.6 million from employees to satisfy statutory minimum tax requirements from the vesting of restricted stock grants.
These redemptions were outside the share repurchase program initiated in June 1998.

13.
Earnings Per Share
The computation of basic and diluted earnings per common share is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(In thousands, except per share amounts)
2012
 
2011
 
2012
 
2011
Computation of Basic Earnings Per Share:
 
 
 
 
 
 
 
Net income
$
44,377

 
$
42,302

 
$
96,236

 
$
85,610

Income allocated to participating securities
(470
)
 
(417
)
 
(1,016
)
 
(848
)
Net income available to common shareholders
$
43,907

 
$
41,885

 
$
95,220

 
$
84,762

Weighted average common shares outstanding – basic
57,388

 
59,182

 
57,455

 
59,169

Basic earnings per share
$
0.77

 
$
0.71

 
$
1.66

 
$
1.43

Computation of Diluted Earnings Per Share:
 
 
 
 
 
 
 
Net income
$
44,377

 
$
42,302

 
$
96,236

 
$
85,610

Income allocated to participating securities
(493
)
 
(417
)
 
(1,032
)
 
(848
)
Net income available to common shareholders
$
43,884

 
$
41,885

 
$
95,204

 
$
84,762

Weighted average common shares outstanding – basic
57,388

 
59,182

 
57,455

 
59,169

Diluted effect of stock options and PVRSUs
225

 
36

 
157

 
44

Weighted average shares outstanding-diluted
57,613

 
59,218

 
57,612

 
59,213

Diluted earnings per share
$
0.76

 
$
0.71

 
$
1.65

 
$
1.43


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, 2012 and 2011, the Company had 2.1 million and 1.6 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 month periods ended September 30, 2012, the Company excluded 0.3 million of anti-dilutive stock options from the diluted earnings per share calculation. For the three and nine month periods ended September 30, 2011, the Company excluded 1.1 million and 0.7 million of anti-dilutive stock options from the diluted earnings per share calculation, respectively.
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, 2012 and 2011, PVRSUs totaling 152,639 and 111,436, respectively were excluded from the computation since the performance conditions had not been met.

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14.
Condensed Consolidating Financial Statements
The Company’s Senior Notes due 2020 and 2022 are guaranteed jointly, severally, fully and unconditionally, subject to certain customary limitations, 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.

Choice Hotels International, Inc.
Condensed Consolidating Statement of Income
For the Three Months Ended September 30, 2012
(Unaudited, in Thousands)
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
REVENUES:
 
 
 
 
 
 
 
 
 
Royalty fees
$
74,186

 
$
16,347

 
$
22,925

 
$
(32,613
)
 
$
80,845

Initial franchise and relicensing fees
2,996

 
—

 
251

 
—

 
3,247

Procurement services
3,489

 
—

 
350

 
—

 
3,839

Marketing and reservation
109,793

 
90,986

 
4,783

 
(86,500
)
 
119,062

Other items, net
1,991

 
1,238

 
191

 
—

 
3,420

Total revenues
192,455

 
108,571

 
28,500

 
(119,113
)
 
210,413

OPERATING EXPENSES:
 
 
 
 
 
 
 
 
 
Selling, general and administrative
39,781

 
19,525

 
(3,523
)
 
(32,613
)
 
23,170

Marketing and reservation
111,831

 
89,498

 
4,233

 
(86,500
)
 
119,062

Other items, net
706

 
2,018

 
204

 
—

 
2,928

Total operating expenses
152,318

 
111,041

 
914

 
(119,113
)
 
145,160

Operating income (loss)
40,137

 
(2,470
)
 
27,586

 
—

 
65,253

OTHER INCOME AND EXPENSES, NET:
 
 
 
 
 
 
 
 
 
Interest expense
11,005

 
(839
)
 
—

 
—

 
10,166

Equity in earnings of consolidated subsidiaries
(27,029
)
 
—

 
—

 
27,029

 
—

Other items, net
215

 
(511
)
 
(285
)
 
—

 
(581
)
Total other income and expenses, net
(15,809
)
 
(1,350
)
 
(285
)
 
27,029

 
9,585

Income (loss) before income taxes
55,946

 
(1,120
)
 
27,871

 
(27,029
)
 
55,668

Income taxes
11,569

 
(647
)
 
369

 
—

 
11,291

Net income (loss)
$
44,377

 
$
(473
)
 
$
27,502

 
$
(27,029
)
 
$
44,377



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Choice Hotels International, Inc.
Condensed Consolidating Statement of Income
For the Three Months Ended September 30, 2011
(Unaudited, in Thousands)

 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
REVENUES:
 
 
 
 
 
 
 
 
 
Royalty fees
$
69,968

 
$
20,112

 
$
8,481

 
$
(21,471
)
 
$
77,090

Initial franchise and relicensing fees
3,363

 
—

 
220

 
—

 
3,583

Procurement services
3,984

 
—

 
119

 
—

 
4,103

Marketing and reservation
91,827

 
89,219

 
4,803

 
(81,456
)
 
104,393

Other items, net
1,652

 
1,236

 
264

 
—

 
3,152

Total revenues
170,794

 
110,567

 
13,887

 
(102,927
)
 
192,321

OPERATING EXPENSES:
 
 
 
 
 
 
 
 
 
Selling, general and administrative
20,510

 
19,019

 
4,497

 
(21,471
)
 
22,555

Marketing and reservation
94,644

 
86,779

 
4,426

 
(81,456
)
 
104,393

Other items, net
703

 
2,044

 
226

 
—

 
2,973

Total operating expenses
115,857

 
107,842

 
9,149

 
(102,927
)
 
129,921

Operating income (loss)
54,937

 
2,725

 
4,738

 
—

 
62,400

OTHER INCOME AND EXPENSES, NET:
 
 
 
 
 
 
 
 
 
Interest expense
4,209

 
(984
)
 
3

 
—

 
3,228

Equity in earnings of consolidated subsidiaries
(5,186
)
 
—

 
—

 
5,186

 
—

Other items, net
(153
)
 
2,646

 
(287
)
 
—

 
2,206

Total other income and expenses, net
(1,130
)
 
1,662

 
(284
)
 
5,186

 
5,434

Income (loss) before income taxes
56,067

 
1,063

 
5,022

 
(5,186
)
 
56,966

Income taxes
13,765

 
533

 
366

 
—

 
14,664

Net income (loss)
$
42,302

 
$
530

 
$
4,656

 
$
(5,186
)
 
$
42,302


























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Choice Hotels International, Inc.
Condensed Consolidating Statement of Income
For the Nine Months Ended September 30, 2012
(Unaudited, in Thousands)
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
REVENUES:
 
 
 
 
 
 
 
 
 
Royalty fees
$