CHH-10Q-03.31.2014
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 March 31, 2014
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.)
1 CHOICE HOTELS CIRCLE, SUITE 400
ROCKVILLE, MD 20850
(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 OUTSTANDING AT MARCH 31, 2014
Common Stock, Par Value $0.01 per share
 
58,419,238
 
 
 
 
 
 

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
 
March 31,
 
2014
 
2013
REVENUES:
 
 
 
Royalty fees
$
51,681

 
$
49,736

Initial franchise and relicensing fees
3,740

 
3,777

Procurement services
4,778

 
3,950

Marketing and reservation
84,012

 
76,440

Other
3,072

 
2,013

Total revenues
147,283

 
135,916

 
 
 
 
OPERATING EXPENSES:
 
 
 
Selling, general and administrative
26,463

 
26,916

Depreciation and amortization
2,122

 
2,041

Marketing and reservation
84,012

 
76,440

Total operating expenses
112,597

 
105,397

 
 
 
 
Operating income
34,686

 
30,519

OTHER INCOME AND EXPENSES, NET:
 
 
 
Interest expense
10,171

 
10,770

Interest income
(503
)
 
(644
)
Other (gains) and losses
(59
)
 
(710
)
Equity in net loss of affiliates
35

 
141

Total other income and expenses, net
9,644

 
9,557

Income from continuing operations before income taxes
25,042

 
20,962

Income taxes
7,711

 
5,406

Income from continuing operations
17,331

 
15,556

Income (loss) from discontinued operations, net of income taxes
1,641

 
(33
)
Net income
$
18,972

 
$
15,523

 
 
 
 
Basic earnings per share
 
 
 
Continuing operations
$
0.30

 
$
0.27

Discontinued operations
0.03

 
—

 
$
0.33

 
$
0.27

Diluted earnings per share
 
 
 
Continuing operations
$
0.29

 
$
0.26

Discontinued operations
0.03

 
—

 
$
0.32

 
$
0.26

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

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CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED, IN THOUSANDS)
 
        
 
 
Three Months Ended
 
 
March 31,
 
 
2014
 
2013
Net income
 
$
18,972

 
$
15,523

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

 
215

Foreign currency translation adjustment
 
533

 
(232
)
Other comprehensive income (loss), net of tax
 
748

 
(17
)
Comprehensive income
 
$
19,720

 
$
15,506


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

5
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CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 
March 31,
2014
 
December 31,
2013
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
174,878

 
$
167,795

Receivables (net of allowance for doubtful accounts of $12,583 and $11,316, respectively)
59,241

 
53,521

Deferred income taxes
7,220

 
7,220

Investments, employee benefit plans, at fair value
174

 
400

Other current assets
36,201

 
29,710

Total current assets
277,714

 
258,646

Property and equipment, at cost, net
56,664

 
66,092

Goodwill
65,813

 
65,813

Franchise rights and other identifiable intangibles, net
9,204

 
9,953

Advances, marketing and reservation activities
18,856

 
19,127

Notes receivable, net of allowances
34,223

 
31,872

Investments, employee benefit plans, at fair value
16,852

 
15,950

Deferred income taxes
20,321

 
20,282

Other assets
55,253

 
52,164

Total assets
$
554,900

 
$
539,899

LIABILITIES AND SHAREHOLDERS’ DEFICIT
 
 
 
Current liabilities
 
 
 
Accounts payable
$
44,818

 
$
41,663

Accrued expenses
37,219

 
56,625

Deferred revenue
69,155

 
61,188

Current portion of long-term debt
11,026

 
10,088

Deferred compensation and retirement plan obligations
573

 
2,492

Income taxes payable
5,466

 
2,282

Total current liabilities
168,257

 
174,338

Long-term debt
795,497

 
783,471

Deferred compensation and retirement plan obligations
22,387

 
22,527

Other liabilities
23,392

 
23,808

Total liabilities
1,009,533

 
1,004,144

Commitments and Contingencies


 


Common stock, $0.01 par value, 160,000,000 shares authorized; 95,065,638 shares issued at March 31, 2014 and December 31, 2013 and 58,419,238 and 58,638,863 shares outstanding at March 31, 2014 and December 31, 2013, respectively
584

 
586

Additional paid-in-capital
118,020

 
117,768

Accumulated other comprehensive loss
(5,469
)
 
(6,217
)
Treasury stock (36,646,400 and 36,426,775 shares at March 31, 2014 and December 31, 2013, respectively), at cost
(917,226
)
 
(918,031
)
Retained earnings
349,458

 
341,649

Total shareholders’ deficit
(454,633
)
 
(464,245
)
Total liabilities and shareholders’ deficit
$
554,900

 
$
539,899

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

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CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
 
Three Months Ended
 
March 31,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
18,972

 
$
15,523

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

Depreciation and amortization
2,122

 
2,175

Gain on sale of assets
(2,572
)
 
—

Provision for bad debts, net
1,182

 
844

Non-cash stock compensation and other charges
2,887

 
2,549

Non-cash interest and other (income) loss
416

 
76

Deferred income taxes
(3
)
 
446

Dividends received from equity method investments
181

 
146

Equity in net loss of affiliates
35

 
141

Changes in assets and liabilities:
 
 
 
Receivables
(7,491
)
 
(3,531
)
Advances to/from marketing and reservation activities, net
5,309

 
(4,101
)
Forgivable notes receivable, net
(3,623
)
 
(1,729
)
Accounts payable
2,080

 
10,471

Accrued expenses
(19,861
)
 
(31,145
)
Income taxes payable/receivable
3,160

 
4,367

Deferred revenue
7,932

 
5,160

Other assets
(3,103
)
 
(3,869
)
Other liabilities
(2,359
)
 
2,622

Net cash provided by operating activities
5,264

 
145

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 

Investment in property and equipment
(3,015
)
 
(13,645
)
Equity method investments
(3,379
)
 
(1,000
)
Issuance of mezzanine and other notes receivable
(587
)
 
—

Collections of mezzanine and other notes receivable
68

 
19

Purchases of investments, employee benefit plans
(890
)
 
(1,242
)
Proceeds from sales of investments, employee benefit plans
281

 
3,882

Proceeds from sales of assets
8,703

 
—

Other items, net
(154
)
 
(101
)
Net cash provided (used) in investing activities
1,027

 
(12,087
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 

Net borrowings pursuant to revolving credit facility
15,000

 
18,000

Principal payments on long-term debt
(2,052
)
 
(2,046
)
Purchase of treasury stock
(4,530
)
 
(3,634
)
Dividends paid
(10,784
)
 
(503
)
Excess tax benefits from stock-based compensation
1,024

 
952

Proceeds from exercise of stock options
1,547

 
5,367

Net cash provided by financing activities
205

 
18,136

Net change in cash and cash equivalents
6,496

 
6,194

Effect of foreign exchange rate changes on cash and cash equivalents
587

 
(146
)
Cash and cash equivalents at beginning of period
167,795

 
134,177

Cash and cash equivalents at end of period
$
174,878

 
$
140,225

Supplemental disclosure of cash flow information:
 
 
 
Cash payments during the period for:
 
 
 
Income taxes, net of refunds
$
5,842

 
$
1,029

Interest
$
19,613

 
$
20,400

Non-cash investing and financing activities:
 
 
 
Dividends declared but not paid
$
11,173

 
$
10,759

Issuance of restricted shares of common stock
$
6,062

 
$
7,151

Issuance of performance vested restricted stock units
$
1,191

 
$
1,298

Investment in property and equipment acquired in accounts payable
$
603

 
$
10,356

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

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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, 2013 and notes thereto included in the Company’s Form 10-K, filed with the SEC on March 3, 2014 (the "10-K"). Interim results are not necessarily indicative of the entire year results. 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.
Discontinued Operations
In the first quarter of 2014, the Company's management approved a plan to dispose of the three Company owned Mainstay Suites hotels. As a result, the Company has reported the operations related to these three hotels as discontinued operations beginning with our financial results presented in this Quarterly Report on Form 10-Q. The Company's results of operations for the comparative prior year period have also been restated to account for these operations as discontinued. For additional information regarding discontinued operations, see Note 17, Discontinued Operations.
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 March 31, 2014 and December 31, 2013, $6.1 million and $5.0 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, as of March 31, 2014, the Company maintains cash balances of $164.2 million in international banks which do not provide deposit insurance.
Recently Adopted Accounting Guidance

In February 2013, the Financial Accounting Standards Board ("FASB") issued ASU No. 2013-04, "Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date" ("ASU 2013-04"). The ASU requires entities to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, as the sum of the following: (a) The amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and (b) any additional amount the reporting entity expects to pay on behalf of its co-obligors. Required disclosures include a description of the joint-and-several arrangement and the total outstanding amount of the obligation for all joint parties. The ASU permits entities to aggregate disclosures (as opposed to providing separate disclosures for each joint-and-several obligation). ASU 2013-04 was effective for all interim and annual periods beginning after December 15, 2013. The Company has adopted this ASU on January 1, 2014 and the adoption of this ASU did not have a material impact on its financial statements.

In March 2013, the FASB issued ASU No. 2013-05, "Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign

8
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Entity" ("ASU 2013-05"). ASU 2013-05 clarifies that when a reporting entity ceases to have a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity, the parent is required to apply the guidance in ASC 830 "Foreign Currency Matters" Subtopic 830-30 to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The provisions of ASU 2013-05 are effective prospectively for reporting periods beginning after December 15, 2013 and the Company has adopted this ASU on January 1, 2014. The adoption of this ASU does not have a material impact on the Company's financial statements.

In July 2013, the FASB issued ASU No. 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" ("ASU 2013-11"). ASU 2013-11 requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for a net operating loss ("NOL") carryforward, or similar tax loss or tax credit carryforward, rather than as a liability when (1) the uncertain tax position would reduce the NOL or other carryforward under the tax law of the applicable jurisdiction and (2) the entity intends to use the deferred tax asset for that purpose. The ASU does not require new recurring disclosures. The provisions of ASU 2013-11 are effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013. The Company adopted this ASU on January 1, 2014 and the adoption of this ASU did not have a material impact on its financial statements.
Future Adoption of Recently Announced Accounting Guidance
In April 2014, the FASB issued ASU No. 2014-08, "Presentation of Financial Statements and Property, Plant, and Equipment: Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity" ("ASU 2014-08"). ASU 2014-08 changes the definition of a discontinued operation to include only those disposals of components of an entity that represent a strategic shift that has (or will have) a major effect on an entity's operations and financial results. ASU 2014-08 is effective for all disposals (or classifications as held for sale) of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. The Company is currently evaluating what impact, if any, the adoption of this ASU will have on the presentation of its consolidated financial statements.

2.
Other Current Assets
Other current assets consist of the following:
 
March 31, 2014
 
December 31, 2013
 
(In thousands)
Notes receivable, net of allowances (See Note 3)
$
13,312

 
$
12,816

Prepaid expenses
16,560

 
13,746

Assets held for sale
3,166

 
—

Other current assets
3,163

 
3,148

Total
$
36,201

 
$
29,710


Assets held for sale at March 31, 2014 represent a Company-owned MainStay Suites hotel located in Greenville, South Carolina and an office building located in Grand Junction, Colorado. The Company entered into a plan to dispose of these assets on January 1, 2014 and therefore has recorded these assets as held for sale. The Company expects to complete the sales of these properties within one year.

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.

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The following table shows the composition of our notes receivable balances:
 
March 31, 2014
 
December 31, 2013
 
(In thousands)
 
(In thousands)
Credit Quality Indicator
Forgivable
Notes
Receivable
 
Mezzanine
& Other
Notes
Receivable
 
Total
 
Forgivable
Notes
Receivable

Mezzanine
& Other
Notes
Receivable

Total
Senior
$
—

 
$
18,101

 
$
18,101

 
$
—

 
$
18,052

 
$
18,052

Subordinated
—

 
14,745

 
14,745

 
—

 
14,152

 
14,152

Unsecured
23,341

 
3,363

 
26,704

 
20,625

 
3,405

 
24,030

Total notes receivable
23,341

 
36,209

 
59,550

 
20,625

 
35,609

 
56,234

Allowance for losses on non-impaired loans
2,079

 
1,587

 
3,666

 
1,650

 
1,607

 
3,257

Allowance for losses on receivables specifically evaluated for impairment
—

 
8,349

 
8,349

 
—

 
8,289

 
8,289

Total loan reserves
2,079

 
9,936

 
12,015

 
1,650

 
9,896

 
11,546

Net carrying value
$
21,262

 
$
26,273

 
$
47,535

 
$
18,975

 
$
25,713

 
$
44,688

Current portion, net
$
221

 
$
13,091

 
$
13,312

 
$
361

 
$
12,455

 
$
12,816

Long-term portion, net
21,041

 
13,182

 
34,223

 
18,614

 
13,258

 
31,872

Total
$
21,262

 
$
26,273

 
$
47,535

 
$
18,975

 
$
25,713

 
$
44,688

 
 
 
 
 
 
 
 
 
 
 
 

The Company classifies notes receivable due within one year as other current 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 for the three months ended March 31, 2014:
            
 
Three Months Ended March 31,
 
2014
 
Forgivable
Notes
Receivable
 
Mezzanine
& Other  Notes
Receivable
 
(In thousands)
Beginning balance
$
1,650

 
$
9,896

Provisions
633

 
60

Recoveries
(6
)
 
(20
)
Write-offs
(95
)
 
—

Other(1)
(103
)
 
—

Ending balance
$
2,079

 
$
9,936

 
(1) Consists of default rate assumption changes
Forgivable Notes Receivable
As of March 31, 2014 and December 31, 2013, the unamortized balance of the Company's forgivable notes receivable totaled $23.3 million and $20.6 million, respectively. The Company recorded an allowance for credit losses on these forgivable notes receivable of $2.1 million and $1.7 million at March 31, 2014 and December 31, 2013, respectively. Amortization expense included in the accompanying consolidated statements of income related to the notes for the three months ended March 31, 2014 and 2013 was $1.2 million and $0.9 million, respectively.

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Past due balances of forgivable notes receivable are as follows:
 
30-89 days
Past Due
 
> 90 days
Past Due
 
Total
Past Due
 
Current
 
Total
 Notes Receivable
 
(In thousands)
As of March 31, 2014
 
 
 
 
 
 
 
 
 
       Forgivable Notes
$
1,246

 
$
—

 
$
1,246

 
$
22,095

 
$
23,341

 
$
1,246

 
$
—

 
$
1,246

 
$
22,095

 
$
23,341

 
 
 
 
 
 
 
 
 
 
As of December 31, 2013
 
 
 
 
 
 
 
 
 
       Forgivable Notes
$
—

 
$
—

 
$
—

 
$
20,625

 
$
20,625

 
$
—

 
$
—

 
$
—

 
$
20,625

 
$
20,625

Mezzanine and Other Notes Receivable
The Company determined that approximately $12.5 million of its mezzanine and other notes receivable were impaired at both March 31, 2014 and December 31, 2013. The Company recorded allowance for credit losses on these impaired loans at March 31, 2014 and December 31, 2013 totaling $8.3 million, resulting in a carrying value of impaired loans of $4.2 million. The Company recognized approximately $54 thousand and $66 thousand of interest income on impaired loans during the three months ended March 31, 2014 and 2013, respectively, on the cash basis. The Company provided loan reserves on non-impaired loans totaling $1.6 million at both March 31, 2014 and December 31, 2013.
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
 Notes Receivable
 
(In thousands)
As of March 31, 2014
 
 
 
 
 
 
 
 
 
Senior
$
—

 
$
—

 
$
—

 
$
18,101

 
$
18,101

Subordinated
—

 
9,629

 
9,629

 
5,116

 
14,745

Unsecured
54

 
47

 
101

 
3,262

 
3,363

 
$
54

 
$
9,676

 
$
9,730

 
$
26,479

 
$
36,209

As of December 31, 2013
 
 
 
 
 
 
 
 
 
Senior
$
—

 
$
—

 
$
—

 
$
18,052

 
$
18,052

Subordinated
—

 
9,629

 
9,629

 
4,523

 
14,152

Unsecured
—

 
47

 
47

 
3,358

 
3,405

 
$
—

 
$
9,676

 
$
9,676

 
$
25,933

 
$
35,609


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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 the time of acquisition, the Company determined that it would be unable to collect all contractually required payments under the original mortgage terms. The contractually required payments receivable, including principal and interest, under the terms of the acquired mortgage totaled $12.0 million. The Company expects to collect $9.7 million of these contractually required payments. No prepayments were considered in the determination of contractual cash flows and cash flows expected to be collected. At both March 31, 2014 and December 31, 2013, 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 three months ended March 31, 2014 is as follows:
 
 
Accretable Yield
 
 
 
Three Months Ended March 31, 2014
 
 
 
(In thousands)
Beginning balance
 
$
582

 
Additions
 
—

 
Accretion
 
(143
)
 
Disposals
 
—

 
Reclassifications from nonaccretable yield
 
—

 
Ending balance
 
$
439

 
4.
Advances, Marketing and Reservation Activities
The Company’s franchise agreements require the payment of franchise fees, which include marketing and reservation system fees. The Company is obligated to use the marketing and reservation system revenues it collects from the current franchisees comprising its various hotel brands to provide marketing and reservation services appropriate to support the operation of the overall system. In discharging its obligation to provide sufficient and appropriate marketing and reservation services, the Company has the right to expend funds in an amount reasonably necessary to ensure the provision of such services, whether or not such amount is currently available to the Company for reimbursement. The franchise agreements provide the Company the right to advance monies to the franchise system when the needs of the system surpass the balances currently available. As a result, expenditures by the Company in support of marketing and reservation services in excess of available revenues are deferred and recorded as an asset in the Company’s financial statements. Conversely, cumulative marketing and reservation system revenues not expended are recorded as a liability in the financial statements and are carried over to the next fiscal year and expended in accordance with the franchise agreements or utilized to reimburse the Company for prior year advances.
Under the terms of these agreements, the Company has the contractually enforceable right to assess and collect from its current franchisees, fees sufficient to pay for the marketing and reservation services the Company has procured for the benefit of the franchise system, including fees to reimburse the Company for past services rendered. The Company has the contractual authority to require that the franchisees in the system at any given point repay any deficits related to marketing and reservation activities. The Company’s current franchisees are contractually obligated to pay any assessment the Company imposes on its franchisees to obtain reimbursement of such deficit regardless of whether those constituents continue to generate gross room revenue and whether or not they joined the system following the deficit's occurrence. 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 cumulative advances for marketing and reservation activities recorded as an asset on the balance sheet were fully recoverable and as a result no reserves were necessary.
At March 31, 2014 and December 31, 2013, the Company incurred marketing and reservation system expenses in excess of cumulative marketing and reservation system fees earned of $18.9 million and $19.1 million, respectively. Depreciation and amortization expense attributable to marketing and reservation activities for the three months ended March 31, 2014 and 2013 was $3.8 million and $4.0 million, respectively. Interest expense attributable to marketing and reservation activities was $0.6 million and $0.9 million for the three months ended March 31, 2014 and 2013, respectively.


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5.
Other Assets
Other assets consist of the following:
 
March 31, 2014
 
December 31, 2013
 
(In thousands)
Equity method investments
35,391

 
$
32,257

Deferred financing fees, net
8,826

 
8,954

Land
10,087

 
10,097

Other assets
949

 
856

Total
$
55,253

 
$
52,164


Land represents the Company’s purchase 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 either resell it to third-party developers for the construction of hotels operated under the Company’s brands or contribute the land into joint ventures for the same purpose. The real estate is carried at the lower of its carrying value or its estimated fair value (based on comparable sales), less estimated costs to sell.

Equity Method Investments - Variable Interest Entities

Equity method investments include investments in joint ventures totaling $31.3 million and $28.9 million at March 31, 2014 and December 31, 2013, respectively that the Company determined to be variable interest entities. These investments relate to the Company's program to offer equity support to qualified franchisees to develop and operate Cambria Suites hotels in strategic markets. Based on an analysis of who has the power to direct the activities that most significantly impact these entities performance and who has an obligation to absorb losses of these entities or a right to receive benefits from these entities that could potentially be significant to the entity, the Company determined that it is not the primary beneficiary of any of its variable interest entities. The Company based its quantitative analysis on the forecasted cash flows of the entity and its qualitative analysis on its review of the design of the entity, its organizational structure including decision-making ability and the relevant development, operating management and financial agreements. As a result, the Company's investment in these entities is accounted for under the equity method. For the three months ended March 31, 2014 and 2013, the Company recognized losses totaling $44 thousand and $0.1 million, respectively, from these investments.

6.
Deferred Revenue
Deferred revenue consists of the following:
 
March 31,
2014
 
December 31,
2013
 
(In thousands)
Loyalty programs
$
56,806

 
$
53,875

Initial, relicensing and franchise fees
4,485

 
5,354

Procurement service fees
2,623

 
1,504

Other
5,241

 
455

Total
$
69,155

 
$
61,188



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7.
Debt
Debt consists of the following at:
 
March 31, 2014
 
December 31, 2013
 
(In thousands)
$400 million senior unsecured notes with an effective interest rate of 5.94% at March 31, 2014 and December 31, 2013
$
400,000

 
$
400,000

$250 million senior unsecured notes with an effective interest rate of 6.19% less discount of $0.4 million at March 31, 2014 and December 31, 2013
249,588

 
249,572

$350 million senior secured credit facility with an effective interest rate of 2.16% and 2.17% at March 31, 2014 and December 31, 2013, respectively
151,875

 
138,750

Economic development loans with an effective interest rate of 3.00% at March 31, 2014 and December 31, 2013
3,360

 
3,360

Capital lease obligations due 2016 with an effective interest rate of 3.18% at March 31, 2014 and December 31, 2013
1,673

 
1,848

Other notes payable
27

 
29

Total debt
806,523

 
$
793,559

Less current portion
11,026

 
10,088

Total long-term debt
795,497

 
$
783,471

Senior Notes Due 2022
On June 27, 2012, the Company issued unsecured senior notes in the principal amount of $400 million ("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 a special cash dividend in 2012 totaling approximately $600.7 million. The Company's 2012 Senior Notes are guaranteed jointly, severally, fully and unconditionally, subject to certain customary limitations by certain of the Company’s domestic subsidiaries.
Senior Notes Due 2020
On August 25, 2010, the Company issued unsecured senior notes in the principal amount of $250 million ("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 certain of the Company’s domestic subsidiaries.
Revolving Credit Facility
On July 25, 2012, the Company entered into a $350 million senior secured credit facility, comprised of a $200 million revolving credit tranche (the "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 "Credit Facility"). The 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 Revolver may be used for letters of credit, up to $10 million of borrowings under the Revolver may be used for swing-line loans and up to $35 million of borrowings under the Revolver may be used for alternative currency loans. The Term Loan 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 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.

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Table of Contents

The 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) the top-tier foreign holding company of the Company's foreign subsidiaries, and (b) the domestic subsidiary that owns the top-tier foreign holding company of the Company's foreign subsidiaries 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 1.0 (beginning of year 4 of the 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 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 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 Credit Facility requires the Company to pay a fee on the undrawn portion of the Revolver, calculated on the basis of the average daily unused amount of the Revolver multiplied by 0.30% per annum.
The Company may reduce the 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 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. With respect to dividends, the Company may not make any payment if there is an existing event of default or if the payment would create an event of default. In addition, if the Company's total leverage ratio exceeds 4.50 to 1.00, the Company is generally restricted from paying aggregate dividends in excess of $50.0 million during any calendar year.
The Credit Facility also 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 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 Credit Facility to be immediately due and payable. At March 31, 2014, the Company was in compliance with all covenants under the Credit Facility.
At March 31, 2014, the Company had $136.9 million and $15.0 million outstanding under the Term Loan and Revolver, respectively. At December 31, 2013, the Company had $138.8 million outstanding under the Term Loan and no amounts outstanding under the Revolver.
Economic Development Loans
The Company entered into economic development agreements with various governmental entities in conjunction with the relocation of its corporate headquarters in April 2013. In accordance with these agreements, the governmental entities agreed to advance approximately $4.4 million to the Company to offset a portion of the corporate headquarter relocation and tenant improvement costs in consideration of the employment of permanent, full-time employees within the jurisdictions. At March 31, 2014, the Company had been advanced approximately $3.4 million pursuant to these agreements and expects to receive the remaining $1 million over the next several years, subject to annual appropriations by the governmental entities. These advances bear interest at a rate of 3% per annum.
Repayment of the advances is contingent upon the Company achieving certain performance conditions. Performance conditions are measured annually on December 31st and primarily relate to maintaining certain levels of employment within the various jurisdictions. If the Company fails to meet an annual performance condition, the Company may be required to repay a

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portion or all of the advances including accrued interest by April 30th following the measurement date. Any outstanding advances at the expiration of the Company's 10 year corporate headquarter lease in 2023 will be forgiven in full. The advances will be included in long-term debt in the Company's consolidated balance sheets until the Company determines that the future performance conditions will be met over the entire term of the agreement and the Company will not be required to repay the advances. The Company accrues interest on the portion of the advances that it expects to repay. The Company was in compliance with all current performance conditions as of March 31, 2014.

8.
Accumulated Other Comprehensive Income (Loss)

The following represents the changes in accumulated other comprehensive loss, net of tax, by component for the three months ended March 31, 2014 and 2013:

 
Three Months Ended March 31, 2014
 
Three Months Ended March 31, 2013
 
Loss on Cash Flow Hedge
 
Foreign Currency Items
 
Total
 
Loss on Cash Flow Hedge
 
Foreign Currency Items
 
Total
 
(In thousands)
 
(In thousands)
Beginning balance
$
(5,745
)
 
$
(472
)
 
$
(6,217
)
 
$
(6,607
)
 
$
2,391

 
$
(4,216
)
Other comprehensive income (loss) before reclassification
—

 
533

 
533

 
—

 
(232
)
 
(232
)
Amounts reclassified from accumulated other comprehensive income (loss)
215

 
—

 
215

 
215

 
—

 
215

Net current period other comprehensive income (loss)
215

 
533

 
748

 
215

 
(232
)
 
(17
)
Ending balance
$
(5,530
)
 
$
61

 
$
(5,469
)
 
$
(6,392
)
 
$
2,159

 
$
(4,233
)


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The amounts reclassified from other accumulated other comprehensive income (loss) during the three months ended March 31, 2014 and 2013 were reclassified to the following line items in the Company's Consolidated Statements of Income.

Component
 
Amount Reclassified from Accumulated Other Comprehensive Income(Loss)
 
Affected Line Item in the Consolidated Statement of Net Income
 
 
Three Months Ended March 31, 2014
 
Three Months Ended March 31, 2013
 
 
 
 
(In thousands)
 
 
Loss on cash flow hedge
 
 
 
 
 
 
Interest rate contract
 
$
215

 
$
215

 
Interest expense
 
 
—

 
—

 
Tax (expense) benefit
 
 
$
215

 
$
215

 
Net of tax

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 $9.3 million and $11.3 million, as of March 31, 2014 and December 31, 2013, 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 related to the EDCP for the three months ended March 31, 2014 and 2013 was $0.1 million and $0.3 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 $4.5 million and $4.1 million as of March 31, 2014 and December 31, 2013, respectively, and are recorded at their fair value, based on quoted market prices. At March 31, 2014, the Company expects $0.2 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 related to the EDCP during the three months ended March 31, 2014 and 2013 of approximately $30 thousand and $0.1 million, respectively. In addition, the EDCP Plan held shares of the Company's common stock with a market value of $0.2 million at both March 31, 2014 and December 31, 2013, 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 March 31, 2014 and December 31, 2013, the Company had recorded a deferred compensation liability of $13.6 million and $13.7 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 related to the Non-Qualified Plan for the three months ended March 31, 2014 and 2013 was $(0.1) million and $0.8 million, respectively.

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Table of Contents

The diversified investments held in the trusts were $12.5 million and $12.3 million as of March 31, 2014 and December 31, 2013, 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 related to the Non-Qualified Plan during the three months ended March 31, 2014 and 2013 of approximately $37 thousand and $0.6 million, respectively. In addition, the Non-Qualified Plan held shares of the Company's common stock with a market value of $1.1 million and $1.4 million at March 31, 2014 and December 31, 2013, 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'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. There were no transfers between Level 1, 2 and 3 assets during the three months ended March 31, 2014.
As of March 31, 2014 and December 31, 2013, 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 March 31, 2014
 
 
 
 
 
 
 
Money market funds, included in cash and cash equivalents
$
50,001

 
$
—

 
$
50,001

 
$
—

Mutual funds(1)
15,206

 
15,206

 
—

 
—

Money market funds(1)
1,820

 
—

 
1,820

 
—

 
$
67,027

 
$
15,206

 
$
51,821

 
$
—

As of December 31, 2013
 
 
 
 
 
 
 
Money market funds, included in cash and cash equivalents
$
50,001

 
$
—

 
$
50,001

 
$
—

Mutual funds(1)
14,564

 
14,564

 
—

 
—

Money market funds(1)
1,786

 
—

 
1,786

 
—

 
$
66,351

 
$
14,564

 
$
51,787

 
$
—

________________________ 
(1)
Included in Investments, employee benefit plans fair value on the consolidated balance sheets.
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 Credit Facility adjust frequently based on current market rates; accordingly its carrying amount approximates fair value.
The Company estimates 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, these

18
Table of Contents

notes receivables have been classified 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 fair value of the Company's 2010 and 2012 Senior Notes are classified as Level 2 as the significant inputs are observable in an active market. At March 31, 2014 and December 31, 2013, the 2010 Senior Notes had an approximate fair value of $270.0 million and $261.3 million, respectively. At March 31, 2014 and December 31, 2013, the 2012 Senior Notes had an approximate fair value of $424.0 million and $416.0 million, respectively.

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 for income from continuing operations were 30.8% and 25.8% for the three months ended March 31, 2014 and 2013, respectively. The effective income tax rate for discontinued operations was 37.1% for both the three months ended March 31, 2014 and 2013.
The effective income tax rate for continuing operations for the three months ended March 31, 2014 and 2013 was lower than the U.S federal income tax rate of 35% due to the recurring impact of foreign operations, partially offset by state income taxes. The effective income tax rate for continuing operations for the three months ended March 31, 2013 was further reduced by the settlement of unrecognized tax positions and by legislation retroactively extending the U.S. controlled foreign corporation look-through rules.
12.
Share-Based Compensation and Capital Stock
Stock Options
The Company granted 0.7 million and 0.2 million options to certain employees of the Company at a fair value of $5.7 million and $1.7 million for the three months ended March 31, 2014 and 2013, 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:
        
 
2014 Grants
 
2013 Grants
Risk-free interest rate
1.56
%
 
0.73
%
Expected volatility
25.01
%
 
38.14
%
Expected life of stock option
4.5 years

 
4.5 years

Dividend yield
1.62
%
 
2.01
%
Requisite service period
4 years

 
4 years

Contractual life
7 years

 
7 years

Weighted average fair value of options granted
$
8.82

 
$
9.89

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 March 31, 2014 was $31.6 million and $27.5 million, respectively. The total intrinsic value of options exercised during the three months ended March 31, 2014 and 2013 was approximately $1.3 million and $2.3 million, respectively.
The Company received approximately $1.5 million and $5.4 million in proceeds from the exercise of 58,749 and 204,323 employee stock options during the three month periods ended March 31, 2014 and 2013, respectively.

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Table of Contents

Restricted Stock
The following table is a summary of activity related to restricted stock grants: 
 
Three Months Ended
 
March 31,
 
2014
 
2013
Restricted share grants
129,793

 
194,541

Weighted average grant date fair value per share
$
46.71

 
$
36.76

Aggregate grant date fair value ($000)
$
6,062

 
$
7,151

Restricted shares forfeited
1,332

 
21,499

Vesting service period of shares granted
4 years

 
3 - 4 years

Grant date fair value of shares vested ($000)
$
7,269

 
$
6,999

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 non-employee 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 71% and 120% 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.
The following table is a summary of activity related to PVRSU grants:
 
Three Months Ended
 
March 31,
 
2014
 
2013
Performance vested restricted stock units granted at target
43,871

 
58,902

Weighted average grant date fair value per share
$
45.59

 
$
36.76

Aggregate grant date fair value ($000)
$
2,000

 
$
2,165

Stock units forfeited
—

 
—

Requisite service period
36 months

 
22-36 months

During the three months ended March 31, 2014, a total of 28,886 PVRSU grants vested at a fair value of $1.4 million. These PVRSU grants were initially granted at a target of 18,635 units. However, since the Company achieved 155% of the targeted performance conditions contained in the stock awards granted in prior periods, an additional 10,251 shares were earned and issued.
During the three months ended March 31, 2013, a total of 39,816 PVRSU grants vested at a fair value of $1.3 million. These PVRSU grants were initially granted at a target of 30,624 units. However, since the Company achieved 130% of the targeted performance conditions contained in the stock awards granted in prior periods, an additional 9,192 shares were earned and issued.

20
Table of Contents

A summary of stock-based award activity as of March 31, 2014 and changes during the three months ended are presented below:
 
Stock Options
 
Restricted Stock
 
Performance Vested
Restricted Stock Units
 
Options
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term
 
Shares
 
Weighted
Average
Grant Date
Fair Value
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Outstanding at January 1, 2014
1,661,952

 
$
26.44

 
 
 
563,345

 
$
36.64

 
216,342

 
$
37.34

Granted
651,757

 
$
45.59

 
 
 
129,793

 
$
46.71

 
43,871

 
$
45.59

Performance based leveraging (1)
—

 
$
—

 
 
 
—

 
$
—

 
10,251

 
$
41.25

Exercised/Vested
(58,749
)
 
$
26.33

 
 
 
(151,957
)
 
$
36.57

 
(28,886
)
 
$
41.25

Expired
—

 
$
—

 
 
 
—

 
$
—

 
—

 
$
—

Forfeited
—

 
$
—

 
 
 
(1,332
)
 
$
37.57

 
—

 
$
—

Outstanding at March 31, 2014
2,254,960

 
$
31.98

 
4.0
 
539,849

 
$
39.08

 
241,578

 
$
38.54

Options exercisable at March 31, 2014
1,326,714

 
$
25.24

 
2.3
 
 
 
 
 
 
 
 
_________________________________ 
(1)PVRSU units outstanding have been increased by 10,251 units due to the Company exceeding the targeted performance conditions contained in PVRSUs granted in prior periods during the three months ended March 31, 2014.
The components of the Company’s pretax share-based compensation expense and associated income tax benefits are as follows for the three months ended March 31, 2014 and 2013:
 
Three Months Ended
 
March 31,
(in millions)
2014
 
2013
Stock options
$
0.4

 
$
0.5

Restricted stock
1.9

 
1.8

Performance vested restricted stock units
0.7

 
0.6

Total
$
3.0

 
$
2.9

Income tax benefits
$
1.1

 
$
1.1

Dividends
The Company currently pays a quarterly dividend on its common stock of $0.185 per share, however the declaration of future dividends are subject to the discretion of the board of directors. During both the three months ended March 31, 2014 and 2013, the Company's board of directors declared a quarterly cash dividend of $0.185 per share or approximately $10.8 million.
  
In addition, during the three months ended March 31, 2014 and 2013, the Company recorded dividends totaling $0.4 million and $0.5 million related to previously declared dividends that were contingent upon the vesting of performance vested restricted stock units.

Share Repurchases and Redemptions
No shares of common stock were purchased by the Company under the share repurchase program during the three months ended March 31, 2014 and 2013.
During the three months ended March 31, 2014, the Company redeemed 94,443 shares of common stock at a total cost of approximately $4.5 million from employees to satisfy the option exercise price and minimum tax-withholding requirements related to the exercising of stock options and vesting of performance vested restricted stock units and restricted stock grants. During the three months ended March 31, 2013, the Company redeemed 96,977 shares of common stock at a total cost of

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approximately $3.6 million from employees to satisfy statutory minimum tax requirements from the vesting of restricted stock and performance vested restricted stock unit grants. These redemptions were outside the share repurchase program.
Other
Effective January 1, 2014, the Company reduced its reported number of common shares outstanding by 0.3 million shares to address a reconciling item with the Company's share transfer agent.

13.
Earnings Per Share
The computation of basic and diluted earnings per common share is as follows:
 
Three Months Ended
 
March 31,
(In thousands, except per share amounts)
2014
 
2013
Computation of Basic Earnings Per Share:
 
 
 
Numerator:
 
 
 
Net income from continuing operations
$
17,331

 
$
15,556

Net income (loss) from discontinued operations
1,641

 
(33
)
Net income
18,972

 
15,523

Income allocated to participating securities
(166
)
 
(163
)
Net income available to common shareholders
$
18,806

 
$
15,360

Denominator:
 
 
 
Weighted average common shares outstanding – basic
57,807

 
57,720

 
 
 
 
Basic earnings per share - Continuing operations
$
0.30

 
$
0.27

Basic earnings per share - Discontinued operations
$
0.03

 
$
—


$
0.33

 
$
0.27

 
 
 
 
Computation of Diluted Earnings Per Share:
 
 
 
Numerator:
 
 
 
Net income from continuing operations
$
17,331

 
$
15,556

Net income (loss) from discontinued operations
1,641

 
(33
)
Net income
18,972

 
15,523

Income allocated to participating securities
(165
)
 
(162
)
Net income available to common shareholders
$
18,807

 
$
15,361

Denominator:
 
 
 
Weighted average common shares outstanding – basic
57,806

 
57,720

Diluted effect of stock options and PVRSUs
493

 
361

Weighted average common shares outstanding – diluted
58,299

 
58,081

 
 
 
 
Diluted earnings per share - Continuing operations
$
0.29

 
$
0.26

Diluted earnings per share - Discontinued operations
$
0.03

 
$
—


$
0.32

 
$
0.26


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 March 31, 2014 and 2013, the Company had 2.3 million and 1.8 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

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during the period, unless the stock options would be anti-dilutive. For the three months ended March 31, 2014 and 2013, the Company did not exclude any anti-dilutive stock options from the diluted earnings per share calculation.
PVRSUs are also included in the diluted earnings per share calculation when the performance conditions have been met at the reporting date. However, at March 31, 2014 and 2013, PVRSUs totaling 241,578 and 198,394, respectively, were excluded from the computation since the performance conditions had not been met.
14.
Condensed Consolidating Financial Statements
The Company’s 2010 and 2012 Senior Notes are guaranteed jointly, severally, fully and unconditionally, subject to certain customary limitations, by certain of the Company’s 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.







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Choice Hotels International, Inc.
Condensed Consolidating Statement of Income
For the Three Months Ended March 31, 2014
(Unaudited, in thousands)
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
REVENUES:
 
 
 
 
 
 
 
 
 
Royalty fees
$
46,333

 
$
24,215

 
$
10,325

 
$
(29,192
)
 
$
51,681

Initial franchise and relicensing fees
3,584

 
—

 
156

 
—

 
3,740

Procurement services
4,631

 
—

 
147

 
—

 
4,778

Marketing and reservation
73,112

 
73,903

 
4,246

 
(67,249
)
 
84,012

Other
2,956

 
—

 
116

 
—

 
3,072

Total revenues
130,616

 
98,118

 
14,990

 
(96,441
)
 
147,283

OPERATING EXPENSES:
 
 
 
 
 
 
 
 
 
Selling, general and administrative
30,357

 
22,091

 
3,207

 
(29,192
)
 
26,463

Marketing and reservation
75,990

 
70,944

 
4,327

 
(67,249
)
 
84,012

Depreciation and amortization
751

 
1,162

 
209

 
—

 
2,122

Total operating expenses
107,098

 
94,197

 
7,743

 
(96,441
)
 
112,597

Operating income
23,518

 
3,921

 
7,247

 
—

 
34,686

OTHER INCOME AND EXPENSES, NET:
 
 
 
 
 
 
 
 
 
Interest expense
10,168

 
1

 
2

 
—

 
10,171

Equity in earnings of consolidated subsidiaries
(10,946
)
 
61

 
—

 
10,885

 
—

Other items, net
(428
)
 
(67
)
 
(32
)
 
—

 
(527
)
Total other income and expenses, net
(1,206
)
 
(5
)
 
(30
)
 
10,885

 
9,644

Income from continuing operations before income taxes
24,724

 
3,926

 
7,277

 
(10,885
)
 
25,042

Income taxes
5,752

 
1,862

 
97

 
—

 
7,711

Income from continuing operations
18,972

 
2,064

 
7,180

 
(10,885
)
 
17,331

Income (loss) from discontinued operations, net of income taxes
—

 
1,641

 
—

 
—

 
1,641

Net income
$
18,972

 
$
3,705

 
$
7,180

 
$
(10,885
)
 
$
18,972








24
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Choice Hotels International, Inc.
Condensed Consolidating Statement of Income
For the Three Months Ended March 31, 2013
(Unaudited, in thousands)
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
REVENUES:
 
 
 
 
 
 
 
 
 
Royalty fees
$
44,236

 
$
24,205

 
$
9,195

 
$
(27,900
)
 
$
49,736

Initial franchise and relicensing fees
3,568

 
—

 
209

 
—

 
3,777

Procurement services
3,800

 
—

 
150

 
—

 
3,950

Marketing and reservation
65,159

 
76,131

 
4,582

 
(69,432
)
 
76,440

Other
1,788

 
—

 
225

 
—

 
2,013

Total revenues
118,551

 
100,336

 
14,361

 
(97,332
)
 
135,916

OPERATING EXPENSES:
 
 
 
 
 
 
 
 
 
Selling, general and administrative
29,082

 
22,438

 
3,296

 
(27,900
)
 
26,916

Marketing and reservation
67,698

 
73,136

 
5,038

 
(69,432
)
 
76,440

Depreciation and amortization
714

 
1,127

 
200

 
—

 
2,041

Total operating expenses
97,494

 
96,701

 
8,534

 
(97,332
)
 
105,397

Operating income
21,057

 
3,635

 
5,827

 
—

 
30,519

OTHER INCOME AND EXPENSES, NET:
 
 
 
 
 
 
 
 
 
Interest expense
10,736

 
33

 
1

 
—

 
10,770

Equity in earnings of consolidated subsidiaries
(7,967
)
 
—

 
—

 
7,967

 
—

Other items, net
(548
)
 
(711
)
 
46

 
—

 
(1,213
)
Total other income and expenses, net
2,221

 
(678
)
 
47

 
7,967

 
9,557

Income from continuing operations before income taxes
18,836

 
4,313

 
5,780

 
(7,967
)
 
20,962

Income taxes
3,313

 
1,911

 
182

 
—

 
5,406

Income from continuing operations
$
15,523

 
$
2,402

 
$
5,598

 
$
(7,967
)
 
$
15,556

Income (loss) from discontinued operations, net of income taxes
—

 
(33
)
 
—

 
—

 
(33
)
Net income
$
15,523

 
$
2,369

 
$
5,598

 
$
(7,967
)
 
$
15,523























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Choice Hotels International, Inc.
Condensed Consolidating Statement of Comprehensive Income
For the Three Months Ended March 31, 2014
(Unaudited, in thousands)

 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
 
 
 
 
 
 
 
 
 
 
Net income
$
18,972

 
$
3,705

 
$
7,180

 
$
(10,885
)
 
$
18,972

Other comprehensive income (loss), net of tax:

 

 

 

 
 
Amortization of loss on cash flow hedge
215

 
—

 
—

 
—

 
215

Foreign currency translation adjustment
533

 
—

 
533

 
(533
)
 
533

Other comprehensive income (loss), net of tax
748

 
—

 
533

 
(533
)
 
748

Comprehensive income
$
19,720

 
$
3,705

 
$
7,713

 
$
(11,418
)
 
$
19,720



26
Table of Contents

Choice Hotels International, Inc.
Condensed Consolidating Statement of Comprehensive Income
For the Three Months Ended March 31, 2013
(Unaudited, in thousands)


 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
 
 
 
 
 
 
 
 
 
 
Net income (loss)
$
15,523

 
$
2,369

 
$
5,598

 
$
(7,967
)
 
$
15,523

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

 
—

 
—

 
—

 
215

Foreign currency translation adjustment
(232
)
 
—

 
(232
)
 
232

 
(232
)
Other comprehensive income (loss), net of tax
(17
)
 
—

 
(232
)
 
232

 
(17
)
Comprehensive income
$
15,506

 
$
2,369

 
$
5,366

 
$
(7,735
)
 
$
15,506



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Table of Contents

Choice Hotels International, Inc.
Condensed Consolidating Balance Sheet
As of March 31, 2014
(Unaudited, in thousands)
 
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
10,363

 
$
298

 
$
164,217

 
$
—

 
$
174,878

Receivables, net
51,720

 
1,615

 
5,906

 
—

 
59,241

Other current assets
24,176

 
21,469

 
1,224

 
(3,274
)
 
43,595

Total current assets
86,259

 
23,382

 
171,347

 
(3,274
)
 
277,714

Property and equipment, at cost, net
11,114

 
44,600

 
950

 
—

 
56,664

Goodwill
60,620

 
5,193

 
—

 
—

 
65,813

Franchise rights and other identifiable intangibles, net
6,017

 
1,941

 
1,246

 
—

 
9,204

Advances, marketing and reservation activities
18,856

 
—

 
—

 
—

 
18,856

Notes receivable, net of allowances
13,182

 
19,282

 
1,759

 
—

 
34,223