10-Q
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, 2015
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
CLASS
 
SHARES OUTSTANDING AT SEPTEMBER 30, 2015
Common Stock, Par Value $0.01 per share
 
56,622,700
 
 
 
 
 
 

Table of Contents

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


2
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,
 
2015
 
2014
 
2015
 
2014
REVENUES:
 
 
 
 
 
 
 
Royalty fees
$
89,929

 
$
86,091

 
$
233,543

 
$
222,301

Initial franchise and relicensing fees
6,170

 
4,299

 
17,703

 
12,761

Procurement services
6,271

 
5,495

 
19,667

 
18,293

Marketing and reservation
134,463

 
115,653

 
366,298

 
309,025

Other
4,693

 
3,630

 
11,716

 
10,188

Total revenues
241,526

 
215,168

 
648,927

 
572,568

 
 
 
 
 
 
 
 
OPERATING EXPENSES:
 
 
 
 
 
 
 
Selling, general and administrative
30,152

 
30,236

 
95,712

 
88,329

Depreciation and amortization
3,108

 
2,293

 
8,793

 
6,903

Marketing and reservation
134,463

 
115,653

 
366,298

 
309,025

Total operating expenses
167,723

 
148,182

 
470,803

 
404,257

 
 
 
 
 
 
 
 
Operating income
73,803

 
66,986

 
178,124

 
168,311

OTHER INCOME AND EXPENSES, NET:
 
 
 
 
 
 
 
Interest expense
10,821

 
10,495

 
32,057

 
31,376

Interest income
(359
)
 
(355
)
 
(982
)
 
(1,205
)
Other (gains) and losses
1,402

 
375

 
(239
)
 
(158
)
Equity in net (income) loss of affiliates
(329
)
 
513

 
1,107

 
578

Total other income and expenses, net
11,535

 
11,028

 
31,943

 
30,591

Income from continuing operations before income taxes
62,268

 
55,958

 
146,181

 
137,720

Income taxes
20,849

 
16,542

 
47,355

 
41,556

Income from continuing operations, net of income taxes
41,419

 
39,416

 
98,826

 
96,164

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

 
(51
)
 
—

 
1,711

Net income
$
41,419

 
$
39,365

 
$
98,826

 
$
97,875

 
 
 
 
 
 
 
 
Basic earnings per share
 
 
 
 
 
 
 
Continuing operations
$
0.72

 
$
0.67

 
$
1.72

 
$
1.65

Discontinued operations
—

 
—

 
—

 
0.03

 
$
0.72

 
$
0.67

 
$
1.72

 
$
1.68

Diluted earnings per share
 
 
 
 
 
 
 
Continuing operations
$
0.72

 
$
0.67

 
$
1.71

 
$
1.63

Discontinued operations
—

 
—

 
—

 
0.03

 
$
0.72

 
$
0.67

 
$
1.71

 
$
1.66

 
 
 
 
 
 
 
 
Cash dividends declared per share
$
0.195

 
$
0.185

 
$
0.585

 
$
0.555

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

3
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,
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
Net income
$
41,419

 
$
39,365

 
$
98,826

 
$
97,875

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

 
215

 
646

 
646

Foreign currency translation adjustment
(951
)
 
(1,387
)
 
(2,223
)
 
(357
)
Other comprehensive income (loss), net of tax
(736
)
 
(1,172
)
 
(1,577
)
 
289

Comprehensive income
$
40,683

 
$
38,193

 
$
97,249

 
$
98,164


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

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CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 
September 30,
2015
 
December 31,
2014
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
199,261

 
$
214,879

Receivables (net of allowance for doubtful accounts of $9,184 and $10,084, respectively)
114,623

 
91,681

Deferred income taxes
26,193

 
23,860

Income taxes receivable
267

 
1,458

Investments, employee benefit plans, at fair value
174

 
214

Other current assets
19,015

 
17,197

Total current assets
359,533

 
349,289

Property and equipment, at cost, net
86,786

 
77,309

Goodwill
79,495

 
65,813

Franchise rights and other identifiable intangibles, net
12,181

 
8,912

Notes receivable, net of allowances
73,756

 
40,441

Investments, employee benefit plans, at fair value
17,102

 
17,539

Deferred income taxes
19,899

 
20,546

Other assets
64,010

 
58,068

Total assets
$
712,762

 
$
637,917

LIABILITIES AND SHAREHOLDERS’ DEFICIT
 
 
 
Current liabilities
 
 
 
Accounts payable
$
59,922

 
$
57,124

Accrued expenses and other current liabilities
50,683

 
63,530

Deferred revenue
68,439

 
66,382

Current portion of long-term debt
1,706

 
12,349

Deferred compensation and retirement plan obligations
174

 
628

Income taxes payable
10,194

 
85

Total current liabilities
191,118

 
200,098

Long-term debt
815,858

 
772,729

Deferred compensation and retirement plan obligations
22,145

 
23,987

Deferred income taxes
1,794

 
—

Other liabilities
82,490

 
69,904

Total liabilities
1,113,405

 
1,066,718

Commitments and Contingencies


 


Common stock, $0.01 par value, 160,000,000 shares authorized; 95,065,638 shares issued at September 30, 2015 and December 31, 2014 and 56,622,700 and 57,337,720 shares outstanding at September 30, 2015 and December 31, 2014, respectively
951

 
573

Additional paid-in-capital
146,973

 
127,661

Accumulated other comprehensive loss
(8,548
)
 
(6,971
)
Treasury stock (38,442,938 and 37,727,918 shares at September 30, 2015 and December 31, 2014, respectively), at cost
(1,037,256
)
 
(982,463
)
Retained earnings
497,237

 
432,399

Total shareholders’ deficit
(400,643
)
 
(428,801
)
Total liabilities and shareholders’ deficit
$
712,762

 
$
637,917

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

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Table of Contents

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED, IN THOUSANDS)
 
Nine Months Ended
 
September 30,
 
2015
 
2014
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
98,826

 
$
97,875

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

Depreciation and amortization
8,793

 
6,903

Gain on sale of assets
(1,519
)
 
(2,809
)
Provision for bad debts, net
1,540

 
1,676

Non-cash stock compensation and other charges
8,929

 
8,093

Non-cash interest and other (income) loss
3,168

 
1,836

Deferred income taxes
(1,799
)
 
(19,216
)
Equity (earnings) losses from unconsolidated joint ventures, net of distributions received
2,917

 
1,679

Changes in assets and liabilities; net of acquisition:
 
 
 
Receivables
(24,532
)
 
(30,497
)
Advances to/from marketing and reservation activities, net
18,341

 
60,187

Forgivable notes receivable, net
(21,029
)
 
(8,776
)
Accounts payable
5,111

 
21,845

Accrued expenses and other current liabilities
(14,083
)
 
(11,082
)
Income taxes payable/receivable
11,066

 
7,981

Deferred revenue
2,122

 
4,751

Other assets
(4,826
)
 
(1,125
)
Other liabilities
5,748

 
(943
)
Net cash provided by operating activities
98,773

 
138,378

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 

Investment in property and equipment
(21,810
)
 
(11,886
)
Proceeds from sales of assets
6,347

 
15,612

Acquisition, net of cash acquired
(13,269
)
 
—

Contributions to equity method investments
(3,811
)
 
(14,362
)
Distributions from equity method investments
270

 
—

Purchases of investments, employee benefit plans
(2,977
)
 
(1,520
)
Proceeds from sales of investments, employee benefit plans
2,920

 
966

Issuance of mezzanine and other notes receivable
(25,253
)
 
(3,340
)
Collections of mezzanine and other notes receivable
3,697

 
9,832

Other items, net
(9,212
)
 
(592
)
Net cash used by investing activities
(63,098
)
 
(5,290
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 

Net borrowings pursuant to revolving credit facilities
162,032

 
—

Proceeds from issuance of long term debt
176

 
226

Debt issuance costs
(2,169
)
 
—

Principal payments on long-term debt
(130,194
)
 
(7,110
)
Purchases of treasury stock
(56,450
)
 
(23,757
)
Dividends paid
(34,173
)
 
(32,767
)
Excess tax benefits from stock-based compensation
4,885

 
2,297

Proceeds from exercise of stock options
6,381

 
4,984

Net cash used by financing activities
(49,512
)
 
(56,127
)
Net change in cash and cash equivalents
(13,837
)
 
76,961

Effect of foreign exchange rate changes on cash and cash equivalents
(1,781
)
 
(364
)
Cash and cash equivalents at beginning of period
214,879

 
167,795

Cash and cash equivalents at end of period
$
199,261

 
$
244,392

Supplemental disclosure of cash flow information:
 
 
 
Cash payments during the period for:
 
 
 
Income taxes, net of refunds
$
32,474

 
$
51,600

Interest, net of capitalized interest
$
39,187

 
$
40,126

Non-cash investing and financing activities:
 
 
 
Dividends declared but not paid
$
11,041

 
$
10,764

Investment in property and equipment acquired in accounts payable
$
1,611

 
$
890

Equity method investments
$
—

 
$
2,797

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

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Table of Contents

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 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, 2014 and notes thereto included in the Company’s Form 10-K, filed with the SEC on March 2, 2015 (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 in this Quarterly Report on Form 10-Q. For additional information regarding discontinued operations, see Note 19, 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 September 30, 2015 and December 31, 2014, $3.9 million and $5.4 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, as of September 30, 2015, the Company maintains cash balances of $180 million in international banks and money market funds which do not provide deposit insurance.
Recently Adopted Accounting Guidance

In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“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 No. 2014-08"). ASU No. 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 No. 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 adopted this ASU on January 1, 2015 and it did not have a material impact on its financial statements.
In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs ("ASU 2015-03"). ASU 2015-03 requires that debt issuance costs be presented as a direct deduction from the carrying amount of the related debt liability, consistent with the presentation of debt discounts. Prior to the issuance of ASU 2015-03, debt issuance costs were required to be presented as deferred charge assets, separate from the related debt liability. ASU 2015-03 does not change the recognition and measurement requirements for debt issuance costs. The Company early-adopted ASU 2015-03 as of September 30, 2015, and applied its provisions retrospectively. The adoption of ASU 2015-03 resulted in the reclassification of $9.9 million and $9.4 million

7
Table of Contents

of unamortized debt issuance costs related to the Company's outstanding borrowings (see Note 7) from other current and non-current assets to long-term debt within its consolidated balance sheets as of September 30, 2015 and December 31, 2014, respectively. In August 2015, the FASB issued ASU No. 2015-15, "Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements" ("ASU 2015-15"). ASU 2015-15 allows an entity to defer and present debt issuance costs as an asset when there are no amounts outstanding under line-of-credit arrangements and subsequently amortize the deferred debt issuance costs ratably over the term of the line-of-credit arrangement. Other than the aforementioned reclassification, the adoption of ASU 2015-03 did not have an impact on the Company's consolidated financial statements.

In September 2015, the FASB issued ASU No. 2015-16, "Simplifying the Accounting for Measurement-Period Adjustments " ("ASU 2015-16"). ASU 2015-16 requires that any adjustments to the provisional amounts of an acquisition and the effect on earnings in changes of depreciation, amortization, and other income effects from the adjustment should be recorded to the period in which the adjustment amount is determined. This standard is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The amendments in ASU 2015-16 should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this update with earlier application permitted for financial statements that have not been issued. The Company early adopted this newly issued guidance during the current period.
Future Adoption of Recently Announced Accounting Guidance
In May 2014, the FASB issued Accounting Standard Update ("ASU") No. 2014-09, Revenue From Contracts with Customers ("ASU 2014-09"), which impacts virtually all aspects of an entity's revenue recognition. ASU No. 2014-09 supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, as well as most industry-specific guidance, and significantly enhances comparability of revenue recognition practices across entities and industries by providing a principles-based, comprehensive framework for addressing revenue recognition issues. In order for a provider of promised goods or services to recognize as revenue the consideration that it expects to receive in exchange for the promised goods or services, the provider should apply the following five steps: (1) identify the contract with a customer(s); (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU No. 2014-09 also specifies the accounting for some costs to obtain or fulfill a contract with a customer and provides enhanced disclosure requirements. On July 9, 2015 the FASB voted to defer ASU No. 2014-09 for one year, and with that deferral, the standard will be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, which will be our 2018 first quarter. However, early adoption is permitted to the original effective date of January 1, 2017. We are permitted to use either the retrospective or modified retrospective method when adopting ASU No. 2014-09. We are still assessing the potential impact that ASU No. 2014-09 will have on our financial statements and disclosures.
In January 2015, the FASB issued ASU No. 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20) ("ASU No. 2015-01"). ASU No. 2015-01 was issued changing the requirements for reporting extraordinary and unusual items in the income statement. The update eliminates the concept of extraordinary items. The presentation and disclosure guidance for items that are unusual in nature or occur infrequently will be retained and will be expanded to include items that are both unusual in nature and infrequently occurring. ASU No. 2015-01 is effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The adoption of this newly issued guidance is not expected to have an impact to our consolidated financial statements.

In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810) ("ASU No. 2015-02"). ASU No. 2015-02 changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. This guidance must be applied using one of two retrospective application methods and will be effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. The Company is currently evaluating the impact, if any, the adoption of this newly issued guidance will have on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-05, Intangibles-Goodwill - Internal Use Software (Subtopic 350-40) ("ASU No. 2015-05"). ASU No. 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license or should be accounted for as a service contract. The standard is effective for annual reporting periods, including interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted and an entity can elect to adopt the amendment either (1) prospectively to all arrangements entered into or materially modified after the effective date or (2) retrospectively. The adoption of this newly issued guidance is not expected to have a material impact to our consolidated financial statements.



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2. Other Current Assets
Other current assets consist of the following:
 
September 30, 2015
 
December 31, 2014
 
(in thousands)
Notes receivable, net of allowances (See Note 3)
$
2,481

 
$
3,961

Prepaid expenses
15,219

 
12,280

Other current assets
1,315

 
956

Total
$
19,015

 
$
17,197



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.
The Company considers loans to be past due and in default when payments are not made when due. Although the Company considers loans to be in default if payments are not received on the due date, the Company does not suspend the accrual of interest until those payments are more than 30 days past due. The Company applies payments received for loans on non-accrual status first to interest and then principal. The Company does not resume interest accrual until all delinquent payments are received. For impaired loans, the Company recognizes interest income on a cash basis.
The following table shows the composition of our notes receivable balances:
 
September 30, 2015
 
December 31, 2014
 
(in thousands)
 
(in thousands)
Credit Quality Indicator
Forgivable
Notes
Receivable
 
Mezzanine
& Other
Notes
Receivable
 
Total
 
Forgivable
Notes
Receivable

Mezzanine
& Other
Notes
Receivable

Total
Senior
$
—

 
$
29,700

 
$
29,700

 
$
—

 
$
10,152

 
$
10,152

Subordinated
—

 
6,215

 
6,215

 
—

 
3,863

 
3,863

Unsecured
43,435

 
3,695

 
47,130

 
32,379

 
3,995

 
36,374

Total notes receivable
43,435

 
39,610

 
83,045

 
32,379

 
18,010

 
50,389

Allowance for losses on non-impaired loans
4,571

 
1,451

 
6,022

 
3,661

 
1,540

 
5,201

Allowance for losses on receivables specifically evaluated for impairment
—

 
786

 
786

 
—

 
786

 
786

Total loan reserves
4,571

 
2,237

 
6,808

 
3,661

 
2,326

 
5,987

Net carrying value
$
38,864

 
$
37,373

 
$
76,237

 
$
28,718

 
$
15,684

 
$
44,402

Current portion, net
$
148

 
$
2,333

 
$
2,481

 
$
124

 
$
3,837

 
$
3,961

Long-term portion, net
38,716

 
35,040

 
73,756

 
28,594

 
11,847

 
40,441

Total
$
38,864

 
$
37,373

 
$
76,237

 
$
28,718

 
$
15,684

 
$
44,402

 
 
 
 
 
 
 
 
 
 
 
 

The Company classifies notes receivable due within one year as other current assets in the Company’s consolidated balance sheets.

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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 nine months ended September 30, 2015:
            
 
Forgivable
Notes
Receivable
 
Mezzanine
& Other  Notes
Receivable
 
(in thousands)
Beginning balance
$
3,661

 
$
2,326

Provisions
1,471

 
—

Recoveries
(498
)
 
(89
)
Write-offs
(511
)
 
—

Other(1)
448

 
—

Ending balance
$
4,571

 
$
2,237

 
(1) Consists of default rate assumption changes
Forgivable Notes Receivable
As of September 30, 2015 and December 31, 2014, the unamortized balance of the Company's forgivable notes receivable totaled $43.4 million and $32.4 million, respectively. The Company recorded an allowance for credit losses on these forgivable notes receivable of $4.6 million and $3.7 million at September 30, 2015 and December 31, 2014, respectively. Amortization expense included in the accompanying consolidated statements of income related to the notes for the three months ended September 30, 2015 and 2014 was $2.1 million and $1.2 million, respectively. Amortization expense for the nine months ended September 30, 2015 and 2014 was $6.0 million and $3.6 million, respectively.
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 September 30, 2015
 
 
 
 
 
 
 
 
 
       Forgivable Notes
$
—

 
$
1,191

 
$
1,191

 
$
42,244

 
$
43,435

 
$
—

 
$
1,191

 
$
1,191

 
$
42,244

 
$
43,435

 
 
 
 
 
 
 
 
 
 
As of December 31, 2014
 
 
 
 
 
 
 
 
 
       Forgivable Notes
$
—

 
$
1,227

 
$
1,227

 
$
31,152

 
$
32,379

 
$
—

 
$
1,227

 
$
1,227

 
$
31,152

 
$
32,379

Mezzanine and Other Notes Receivable
The Company determined that approximately $0.8 million of its mezzanine and other notes receivable were impaired at both September 30, 2015 and December 31, 2014, respectively. The Company recorded allowance for credit losses on these impaired loans at both September 30, 2015 and December 31, 2014 totaling $0.8 million. For the nine months ended September 30, 2015 and 2014, the average mezzanine and other notes receivable on non-accrual status was approximately $0.8 million and $12.2 million, respectively. The Company recognized approximately $0 and $33 thousand of interest income on impaired loans during the three and nine months ended September 30, 2015, respectively, on the cash basis. The Company recognized approximately $11 thousand and $87 thousand of interest income on impaired loans during the three and nine months ended September 30, 2014. The Company provided loan reserves on non-impaired loans totaling $1.5 million at both September 30, 2015 and December 31, 2014.

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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 September 30, 2015
 
 
 
 
 
 
 
 
 
Senior
$
—

 
$
—

 
$
—

 
$
29,700

 
$
29,700

Subordinated
—

 
—

 
—

 
6,215

 
6,215

Unsecured
—

 
47

 
47

 
3,648

 
3,695

 
$
—

 
$
47

 
$
47

 
$
39,563

 
$
39,610

As of December 31, 2014
 
 
 
 
 
 
 
 
 
Senior
$
—

 
$
—

 
$
—

 
$
10,152

 
$
10,152

Subordinated
—

 
—

 
—

 
3,863

 
3,863

Unsecured
—

 
47

 
47

 
3,948

 
3,995

 
$
—

 
$
47

 
$
47

 
$
17,963

 
$
18,010


4.
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 in the current period are deferred and 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.
At September 30, 2015 and December 31, 2014, cumulative marketing and reservation system fees billed exceeded expenses by $44.1 million and $44.3 million, respectively, with the excess reflected as an other long-term liability in the accompanying consolidated balance sheets. Depreciation and amortization expense attributable to marketing and reservation activities for the three and nine and months ended September 30, 2015 were $5.8 million and $17.0 million, respectively. Depreciation and amortization expense attributable to marketing and reservation activities for the three and nine months ended September 30, 2014 were $4.4 million and $12.4 million, respectively. Interest expense attributable to marketing and reservation activities for the three and nine months ended September 30, 2015 was $6 thousand and $22 thousand, respectively.  Interest expense attributable to marketing and reservation activities for the three and nine months ended September 30, 2014 was $0.5 million and $1.5 million, respectively.


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5.
Other Assets
Other assets consist of the following:
 
September 30, 2015
 
December 31, 2014
 
(in thousands)
Equity method investments
$
47,739

 
$
50,605

Land
11,478

 
4,011

Other assets
4,793

 
3,452

Total
$
64,010

 
$
58,068



Equity Method Investments - Variable Interest Entities

Equity method investments include investments in joint ventures totaling $45.0 million and $47.1 million at September 30, 2015 and December 31, 2014, respectively, that the Company determined to be variable interest entities ("VIEs"). These investments relate to the Company's program to offer equity support to qualified franchisees to develop and operate Cambria hotel & 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 VIEs. The Company based 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. Although the Company is not the primary beneficiary of these VIEs, it does exercise significant influence through its equity ownership and as a result the Company's investment in these entities is accounted for under the equity method. For both the three and nine months ended September 30, 2015, the Company recognized losses totaling $0.2 million and $2.0 million, respectively, from these investments. For the three and nine months ended September 30, 2014, the Company recognized losses totaling $0.8 million and $0.9 million, respectively, from these investments.The Company's maximum exposure to losses related to its investments in VIEs is limited to its equity investments as well as certain guarantees described in Note 16 "Commitments and Contingencies" of these financial statements.
6.
Deferred Revenue
Deferred revenue consists of the following:
 
September 30,
2015
 
December 31,
2014
 
(in thousands)
Loyalty programs
$
59,270

 
$
57,757

Initial, relicensing and franchise fees
5,937

 
6,439

Procurement service fees
2,446

 
1,936

Other
786

 
250

Total
$
68,439

 
$
66,382




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7.
Debt
Debt consists of the following at:
 
September 30, 2015
 
December 31, 2014
 
(in thousands)
$400 million senior unsecured notes with an effective interest rate of 6.0% less deferred issuance costs of $5.5 million and $6.0 million at September 30, 2015 and December 31, 2014, respectively
$
394,450

 
$
393,961

$250 million senior unsecured notes with an effective interest rate of 6.19% less discount and deferred issuance costs of $1.5 million and $1.7 million at September 30, 2015 and December 31, 2014, respectively
248,492

 
248,262

$350 million senior secured credit facility with an effective interest rate of 2.17%, less deferred issuance costs of $1.9 million at December 31, 2014
—

 
127,435

$450 million senior unsecured credit facility with an effective interest rate of 1.72%, less deferred issuance costs of $3.1 million at September 30, 2015
158,863

 
—

Fixed rate collateralized mortgage plus a fair value adjustment of $1.0 million and $1.2 million at September 30, 2015 and December 31, 2014, respectively with an effective interest rate of 4.57%
10,200

 
10,667

Economic development loans with an effective interest rate of 3.0% at September 30, 2015 and December 31, 2014
3,712

 
3,536

Capital lease obligations due 2016 with an effective interest rate of 3.18% at September 30, 2015 and December 31, 2014
612

 
1,148

Other notes payable
1,235

 
69

Total debt
$
817,564

 
$
785,078

Less current portion
1,706

 
12,349

Total long-term debt
$
815,858

 
$
772,729

Senior Unsecured 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 6.0%. 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 borrowings under the Company's senior 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 Unsecured 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 5.70% 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 Facilities

On July 21, 2015, the Company refinanced its existing $350 million senior secured credit facility, comprised of a $200 million revolving credit tranche and a $150 million term loan tranche by entering into a new senior unsecured revolving credit agreement (“Credit Agreement”), with Deutsche Bank AG New York Branch, as administrative agent.

The Credit Agreement provides for a $450 million unsecured revolving credit facility (the “New Revolver”) with a final maturity date of July 21, 2020, subject to optional one-year extensions that can be requested by the Company prior to each of the first, second and third anniversaries of the closing date of the New Revolver. The effectiveness of any such extensions is subject to the consent of the lenders under the Credit Agreement and certain customary conditions. Up to $35 million of borrowings under the New Revolver may be used for alternative currency loans and up to $15 million of borrowings under the New Revolver may be used for swing line loans.

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The New Revolver is unconditionally guaranteed, jointly and severally, by certain of the Company’s domestic subsidiaries, which are considered restricted subsidiaries under the Credit Agreement. The subsidiary guarantors currently include all subsidiaries that guarantee the obligations under the Company's Indenture governing the terms of its 5.75% senior notes due 2020 and its 5.70% senior notes due 2020. If the Company achieves and maintains an Investment Grade Rating, as defined in the Credit Agreement, then the subsidiary guarantees will at the election of the Company be released and the New Revolver will not be guaranteed.

The Company may at any time prior to the final maturity date increase the amount of the New Revolver by up to an additional $150 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.

The Company currently may elect to have borrowings under the New Revolver bear interest at a rate equal to (i) LIBOR plus a margin ranging from 135 to 175 basis points based on the Company’s total leverage ratio or (ii) a base rate plus a margin ranging from 35 to 75 basis points based on the Company’s total leverage ratio. If the Company achieves an Investment Grade Rating, then the Company may elect to use a different, ratings-based, pricing grid set forth in the Credit Agreement.

The Credit Agreement 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 0.20% per annum. If the Company achieves an Investment Grade Rating and it elects to use the ratings-based pricing grid set forth in the Credit Agreement, then the Company will be required to pay a fee on the total commitments under the New Revolver, calculated on the basis of the actual daily amount of the commitments under the New Revolver (regardless of usage) times a percentage per annum ranging from 0.10% to 0.25% (depending on the Company’s senior unsecured long-term debt rating).

The Credit Agreement requires that the Company and its restricted subsidiaries comply with various covenants, including with respect to restrictions on liens, incurring indebtedness, making investments and effecting mergers and/or asset sales. With respect to dividends, the Company may not declare or 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 4.0 to 1.0, the Company is generally restricted from paying aggregate dividends in excess of $50 million in any calendar year.

The Credit Agreement imposes financial maintenance covenants requiring the Company to maintain a total leverage ratio of not more than 4.5 to 1.0 and a consolidated fixed charge coverage ratio of at least 2.5 to 1.0. If the Company achieves and maintains an Investment Grade Rating, then the Company will not need to comply with the consolidated fixed charge coverage ratio covenant.

The Credit Agreement 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 Agreement to be immediately due and payable. At September 30, 2015, the Company was in compliance with all financial covenants under the Credit Agreement.

The proceeds of the New Revolver are expected to be used for general corporate purposes, including working capital, debt repayment, stock repurchases, dividends, investments and other permitted uses set forth in the Credit Agreement.
Fixed Rate Collateralized Mortgage
On December 30, 2014, a court awarded the Company title to an office building as settlement for a portion of an outstanding loan receivable for which the building was pledged as collateral. In conjunction with the court award, the Company also assumed the $9.5 million mortgage on the property with a fixed interest rate of 7.26%. The mortgage which is collateralized by the office building requires monthly payments of principal and interest and matures in December 2020 with a a balloon payment due of $6.9 million. At the time of acquisition, the Company determined that the fixed interest rate of 7.26% exceeded market interest rates and therefore the Company increased the carrying value of the debt by $1.2 million to record the debt at fair value. The fair value adjustment will be amortized over the remaining term of the mortgage utilizing the effective interest method.
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 headquarters relocation and tenant

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improvement costs in consideration of the employment of permanent, full-time employees within the jurisdictions. At September 30, 2015, the Company had been advanced approximately $3.7 million pursuant to these agreements and expects to receive the remaining $0.7 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 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 headquarters 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 September 30, 2015.

8.
Accumulated Other Comprehensive Income (Loss)

The following represents the changes in accumulated other comprehensive loss, net of tax, by component for the nine months ended September 30, 2015:

 
Loss on Cash Flow Hedge
 
Foreign Currency Items
 
Total
 
(in thousands)
Beginning balance, December 31, 2014
$
(4,884
)
 
$
(2,087
)
 
$
(6,971
)
Other comprehensive income (loss) before reclassification
—

 
(2,223
)
 
(2,223
)
Amounts reclassified from accumulated other comprehensive income (loss)
646

 
—

 
646

Net current period other comprehensive income (loss)
646

 
(2,223
)
 
(1,577
)
Ending balance, September 30, 2015
$
(4,238
)
 
$
(4,310
)
 
$
(8,548
)


The amounts reclassified from accumulated other comprehensive income (loss) during the three and nine months ended September 30, 2015 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 September 30, 2015
 
Nine Months Ended September 30, 2015
 
 
 
 
(in thousands)
 
 
Loss on cash flow hedge
 
 
 
 
 
 
Interest rate contract
 
$
215

 
$
646

 
Interest expense
 
 
—

 
—

 
Tax (expense) benefit
 
 
$
215

 
$
646

 
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

15
Table of Contents

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 $10.3 million and $10.2 million, as of September 30, 2015 and December 31, 2014, 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 September 30, 2015 and 2014 was $(0.2) million and $48 thousand, respectively. Compensation expense recorded in SG&A related to the EDCP for the nine months ended September 30, 2015 and 2014 was $0.1 million and $0.4 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 $5.3 million and $4.6 million as of September 30, 2015 and December 31, 2014, respectively, and are recorded at their fair value, based on quoted market prices. At September 30, 2015, 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 losses related to the EDCP during the three months ended September 30, 2015 and 2014 of approximately $0.3 million and $0.1 million, respectively. The Company recorded investment gains and (losses) related to the EDCP during the nine months ended September 30, 2015 and 2014 of approximately $(0.3) million and $41 thousand, respectively. In the third quarter of 2015, all shares of the Company's common stock held in the EDCP Plan were sold and therefore, the EDCP Plan held no shares of the Company's common stock at September 30, 2015. At December 31, 2014, the EDCP Plan held shares of the Company's common stock with a market value of $0.2 million, 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, 2015 and December 31, 2014, the Company had recorded a deferred compensation liability of $12.0 million and $14.4 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 related to the Non-Qualified Plan for the three months ended September 30, 2015 and 2014 was $(0.8) million and $(0.1) million, respectively. The net increase (decrease) in compensation expense recorded in SG&A related to the Non-Qualified Plan for the nine months ended September 30, 2015 and 2014 was $(1.1) million and $0.1 million, respectively.
The diversified investments held in the trusts were $12.0 million and $13.1 million at September 30, 2015 and December 31, 2014, 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 losses related to the Non-Qualified Plan during the three months ended September 30, 2015 and 2014 of approximately $0.8 million and $0.3 million, respectively. The Company recorded investment gains (losses) related to the Non-Qualified Plan during the nine months ended September 30, 2015 and 2014 of approximately $(0.8) million and $0.1 million, respectively. In the third quarter of 2015, all shares of the Company's common stock held in the Non-Qualified Plan were sold and therefore, the Non-Qualified Plan held no shares of the Company's common stock at September 30, 2015. At December 31, 2014, the Non-Qualified Plan held shares of the Company's common stock with a market value of $1.3 million, which is 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.

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Table of Contents

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 and nine months ended September 30, 2015.
As of September 30, 2015 and December 31, 2014, 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, 2015
 
 
 
 
 
 
 
Money market funds, included in cash and cash equivalents
$
50,001

 
$
—

 
$
50,001

 
$
—

Mutual funds(1)
16,006

 
16,006

 
—

 
—

Money market funds(1)
1,270

 
—

 
1,270

 
—

 
$
67,277

 
$
16,006

 
$
51,271

 
$
—

As of December 31, 2014
 
 
 
 
 
 
 
Money market funds, included in cash and cash equivalents
$
50,001

 
$
—

 
$
50,001

 
$
—

Mutual funds(1)
16,405

 
16,405

 
—

 
—

Money market funds(1)
1,348

 
—

 
1,348

 
—

 
$
67,754

 
$
16,405

 
$
51,349

 
$
—

________________________ 
(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, the notes receivable 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 $250 million and $400 million senior notes are classified as Level 2 as the significant inputs are observable in an active market. At September 30, 2015 and December 31, 2014, the $250 million senior notes had an approximate fair value of $269.7 million and $268.9 million, respectively. At September 30, 2015 and December 31, 2014, the $400 million senior notes had an approximate fair value of $426.9 million and $437.7 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.


17
Table of Contents

11.
Income Taxes
The effective income tax rates from continuing operations were 33.5% and 29.6% for the three months ended September 30, 2015 and 2014, respectively. The effective income tax rates from continuing operations were 32.4% and 30.2% for the nine months ended September 30, 2015 and 2014, respectively.
The effective income tax rates from continuing operations for the three and nine months ended September 30, 2015 and 2014 were lower than the U.S. federal income tax rate of 35.0% due to the recurring impact of foreign operations, partially offset by state income taxes. The effective income tax rate for the nine months ended September 30, 2015 and 2014 were further reduced by the settlement of unrecognized tax positions. The effective income tax rate for the three months ended September 30, 2014 was also reduced by the settlement of unrecognized tax positions.
12.
Share-Based Compensation and Capital Stock
No stock options were granted during the three months ended September 30, 2015 and 2014. The Company granted 0.5 million and 0.7 million options to certain employees of the Company at a fair value of $6.2 million and $5.7 million for the nine months ended September 30, 2015 and 2014, 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:
        
 
2015 Grants
 
2014 Grants
Risk-free interest rate
1.45
%
 
1.56
%
Expected volatility
23.94
%
 
25.01
%
Expected life of stock option
4.6 years

 
4.5 years

Dividend yield
1.23
%
 
1.62
%
Requisite service period
4 years

 
4 years

Contractual life
7 years

 
7 years

Weighted average fair value of options granted (per option)
$
12.39

 
$
8.82

The expected life of the options and volatility are based on historical data which is believed to be indicative of future exercise patterns or actual volatility. Historical volatility is calculated based on a period that corresponds to the expected term 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, 2015 was $21.6 million and $18.7 million, respectively. The total intrinsic value of options exercised during the three months ended September 30, 2015 and 2014 was approximately $0.9 million and $3.1 million, respectively. The total intrinsic value of options exercised during the nine months ended September 30, 2015 and 2014 was approximately $9.5 million and $4.4 million, respectively.
The Company received approximately $6.4 million and $5.0 million in proceeds from the exercise of 263,600 and 190,557 employee stock options during the nine months ended September 30, 2015 and 2014, respectively. The Company received approximately $0.7 million and $3.4 million in proceeds from the exercise of 30,808 and 131,808 employee stock options during the three months ended September 30, 2015 and 2014, respectively.








18
Table of Contents

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,
 
2015
 
2014
2015
 
2014
Restricted share grants
7,836

 
2,853

114,281

 
149,908

Weighted average grant date fair value per share
$
51.07

 
$
52.59

$
62.45

 
$
46.58

Aggregate grant date fair value ($000)
$
400

 
$
150

$
7,137

 
$
6,983

Restricted shares forfeited
9,522

 
13,922

17,964

 
18,218

Vesting service period of shares granted
24 - 48 months

 
36 months

12 - 48 months

 
12 - 48 months

Fair value of shares vested ($000)
$
553

 
$
2,076

$
12,292

 
$
10,280

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 0% and 180% 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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
Performance vested restricted stock units granted at target
—

 
—

 
51,309

 
24,678

Weighted average grant date fair value per share
$
—

 
$
—

 
$
60.94

 
$
45.59

Aggregate grant date fair value ($000)
$
—

 
$
—

 
$
3,126

 
$
1,125

Stock units forfeited
6,079

 
3,900

 
6,079

 
3,900

Requisite service period
—

 
—

 
36 - 43 months

 
36 months

During the three months ended September 30, 2015 and 2014, no PVRSU grants vested. During the nine months ended September 30, 2015, a total of 42,326 PVRSU grants vested at a grant date fair value of $1.5 million. These PVRSU grants were initially granted at a target of 38,476 units. However, since the Company achieved 110% of the targeted performance conditions contained in the stock awards granted in prior periods, an additional 3,850 shares were earned and issued.
During the nine months ended September 30, 2014, a total of 28,886 PVRSU grants vested at a grant date 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.

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A summary of stock-based award activity as of September 30, 2015 and changes during the nine 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, 2015
1,903,177

 
$
33.03

 
 
 
479,556

 
$
40.14

 
200,286

 
$
38.28

Granted
498,911

 
$
63.47

 
 
 
114,281

 
$
62.45

 
51,309

 
$
60.94

Performance based leveraging (1)
—

 
$
—

 
 
 
—

 
$
—

 
3,850

 
$
35.60

Exercised/Vested
(263,600
)
 
$
24.21

 
 
 
(200,360
)
 
$
38.93

 
(42,326
)
 
$
35.60

Expired
—

 
$
—

 
 
 
—

 
$
—

 
—

 
$
—

Forfeited
(21,437
)
 
$
54.91

 
 
 
(17,964
)
 
$
45.99

 
(6,079
)
 
$
32.90

Outstanding at September 30, 2015
2,117,051

 
$
41.08

 
4.2 years
 
375,513

 
$
47.30

 
207,040

 
$
44.55

Options exercisable at September 30, 2015
1,022,639

 
$
29.32

 
2.5 years
 
 
 
 
 
 
 
 
_________________________________ 
(1)PVRSU units outstanding have been increased by 3,850 units due to the Company exceeding the targeted performance conditions contained in PVRSUs granted in prior periods during the nine months ended September 30, 2015.
The components of the Company’s pretax share-based compensation expense and associated income tax benefits are as follows for the three and nine months ended September 30, 2015 and 2014:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(in millions)
2015
 
2014
 
2015
 
2014
Stock options
$
0.8

 
$
0.6

 
$
2.4

 
$
1.7

Restricted stock
1.6

 
1.7

 
5.1

 
5.5

Performance vested restricted stock units
1.0

 
0.8

 
1.6

 
0.7

Total
$
3.4

 
$
3.1

 
$
9.1

 
$
7.9

Income tax benefits
$
1.3

 
$
1.1

 
$
3.4

 
$
2.9

During the three and nine months ended September 30, 2015, the Company revised its estimate of the projected achievement of various performance conditions that affect the number of PVRSUs that will ultimately vest. As a result, previously recognized share-based compensation costs related to these PVRSUs has been increased by $0.4 million and $0.2 million for the three and nine months ended September 30, 2015.
During the nine months ended September 30, 2014, the Company revised its estimate of the projected achievement of various performance conditions that affect the number of PVRSUs that will ultimately vest. As a result, previously recognized share-based compensation costs related to these PVRSUs was decreased by $0.9 million for the nine months ended September 30, 2014.
Dividends
The Company currently pays a quarterly dividend on its common stock of $0.195 per share, however the declaration of future dividends is subject to the discretion of the board of directors. During the three and nine months ended September 30, 2015, the Company's board of directors declared dividends totaling $0.195 and $0.585 per share or approximately $11.0 million and $33.5 million, respectively, in the aggregate. During the three and nine months ended September 30, 2014, the Company's board of directors declared dividends totaling $0.185 and $0.555 per share or approximately $10.8 million and $32.4 million, respectively, in the aggregate.
  

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Table of Contents

In addition, during the nine months ended September 30, 2015 and 2014, the Company recorded dividends totaling $0.5 million and $0.4 million, respectively, related to previously declared dividends that were contingent upon the vesting of performance vested restricted stock units. No dividends on performance vested restricted stock units were paid during the three months ended September 30, 2015 and 2014.

Share Repurchases and Redemptions
The Company purchased 1.0 million shares of common stock under the share repurchase program at a total cost of $50.0 million during the three and nine months ended September 30, 2015.
The Company purchased 0.4 million shares of common stock under the share repurchase program at a total cost of $18.4 million during the three and nine months ended September 30, 2014. These shares were repurchased from certain family members of the Company's largest shareholder at their fair market value.
During the three and nine months ended September 30, 2015, the Company redeemed 3,512 and 106,265 shares of common stock at a total cost of approximately $0.2 million and $6.4 million, respectively, from employees to satisfy the option exercise price and statutory 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 and nine ended September 30, 2014, the Company redeemed 15,834 and 110,579 shares of common stock at a total cost of approximately $0.8 million and $5.3 million, respectively, from employees to satisfy the option exercise price and statutory minimum tax-withholding requirements related to the exercising of stock options and vesting of performance vested restricted stock units and restricted stock grants. These redemptions were outside the share repurchase program.

21
Table of Contents

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)
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
Computation of Basic Earnings Per Share:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income from continuing operations
$
41,419

 
$
39,416

 
$
98,826

 
$
96,164

Net income from discontinued operations
—

 
(51
)
 
—

 
1,711

Net income
41,419

 
39,365

 
98,826

 
97,875

Income allocated to participating securities
(278
)
 
(343
)
 
(695
)
 
(867
)
Net income available to common shareholders
$
41,141

 
$
39,022

 
$
98,131

 
$
97,008

Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
56,843

 
57,932

 
57,019

 
57,878

 
 
 
 
 
 
 
 
Basic earnings per share - Continuing operations
$
0.72

 
$
0.67

 
$
1.72

 
$
1.65

Basic earnings per share - Discontinued operations
—

 
—

 
—

 
0.03


$
0.72

 
$
0.67

 
$
1.72

 
$
1.68

 
 
 
 
 
 
 
 
Computation of Diluted Earnings Per Share:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income from continuing operations
$
41,419

 
$
39,416

 
$
98,826

 
$
96,164

Net income from discontinued operations
—

 
(51
)
 
—

 
1,711

Net income
41,419

 
39,365

 
98,826

 
97,875

Income allocated to participating securities
(277
)
 
(340
)
 
(691
)
 
(862
)
Net income available to common shareholders
$
41,142

 
$
39,025

 
$
98,135

 
$
97,013

Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
56,843

 
57,932

 
57,019

 
57,878

Diluted effect of stock options and PVRSUs
378

 
524

 
479

 
503

Weighted average common shares outstanding – diluted
57,221

 
58,456

 
57,498

 
58,381

 
 
 
 
 
 
 
 
Diluted earnings per share - Continuing operations
$
0.72

 
$
0.67

 
$
1.71

 
$
1.63

Diluted earnings per share - Discontinued operations
—

 
—

 
—

 
0.03


$
0.72

 
$
0.67

 
$
1.71

 
$
1.66


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, 2015 and 2014, the Company had 2.1 million and 2.1 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 the three and nine months ended September 30, 2015, the Company excluded 0.5 million of anti-dilutive stock options from the diluted earnings per share calculation. For the three and nine months ended September 30, 2014, the Company did not exclude any anti-dilutive stock options from the diluted EPS calculation.

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Table of Contents

PVRSUs are also included in the diluted earnings per share calculation when the performance conditions have been met at the reporting date. However, at September 30, 2015 and 2014, PVRSUs totaling 207,040 and 218,485, 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.(1) 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, 2015
(Unaudited, in thousands)
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
REVENUES:
 
 
 
 
 
 
 
 
 
Royalty fees
$
84,572

 
$
28,786

 
$
8,660

 
$
(32,089
)
 
$
89,929

Initial franchise and relicensing fees
6,040

 
—

 
130

 
—

 
6,170

Procurement services
6,012

 
—

 
259

 
—

 
6,271

Marketing and reservation
123,775

 
126,547

 
4,142

 
(120,001
)
 
134,463

Other
3,377

 
3

 
1,313

 
—

 
4,693

      Total revenues
223,776

 
155,336

 
14,504

 
(152,090
)
 
241,526

OPERATING EXPENSES:
 
 
 
 
 
 
 
 
 
Selling, general and administrative
32,846

 
25,603

 
3,792

 
(32,089
)
 
30,152

Marketing and reservation
129,268

 
121,690

 
3,506

 
(120,001
)
 
134,463

Depreciation and amortization
602

 
2,044

 
462

 
—

 
3,108

Total operating expenses
162,716

 
149,337

 
7,760

 
(152,090
)
 
167,723

Operating income
61,060

 
5,999

 
6,744

 
—

 
73,803

OTHER INCOME AND EXPENSES, NET:
 
 
 
 
 
 
 
 
 
Interest expense
10,682

 
1

 
138

 
—

 
10,821

Equity in earnings of consolidated subsidiaries
(9,350
)
 
84

 
—

 
9,266

 
—

Other items, net
(76
)
 
1,260

 
(470
)
 
—

 
714

Total other income and expenses, net
1,256

 
1,345

 
(332
)
 
9,266

 
11,535

Income from continuing operations before income taxes
59,804

 
4,654

 
7,076

 
(9,266
)
 
62,268

Income taxes
18,385

 
1,853

 
611

 
—

 
20,849

Income from continuing operations, net of income taxes
41,419

 
2,801

 
6,465

 
(9,266
)
 
41,419

Income from discontinued operations, net of income taxes
—

 
—

 
—

 
—

 
—

Net income
$
41,419

 
$
2,801

 
$
6,465

 
$
(9,266
)
 
$
41,419



(1) On July 21, 2015, the Company refinanced its existing $350 million senior secured credit facility ("Old Credit Facility") by entering into a new senior unsecured revolving credit agreement ("New Credit Facility").  As a result of this refinancing, certain guarantor subsidiaries under the Old Credit Facility have been released as a guarantor under the New Credit Facility. As a result, the following condensed consolidating financial statements for the prior year periods have been reclassified to reflect the current guarantors under the New Credit Facility. 





23
Table of Contents

Choice Hotels International, Inc.
Condensed Consolidating Statement of Income
For the Three Months Ended September 30, 2014
(Unaudited, in thousands)

 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
Eliminations
 
Consolidated
REVENUES:
 
 
 
 
 
 
 
 
 
 
Royalty fees
 
$
79,326

 
$
28,799

 
$
10,829

 
$
(32,863
)
 
$
86,091

Initial franchise and relicensing fees
 
4,125

 
—

 
174

 
—

 
4,299

Procurement services
 
5,215

 
—

 
280

 
—

 
5,495

Marketing and reservation
 
104,093

 
106,438

 
4,981

 
(99,859
)
 
115,653

Other
 
3,500

 
2

 
128

 
—

 
3,630

      Total revenues
 
196,259

 
135,239

 
16,392

 
(132,722
)
 
215,168

OPERATING EXPENSES:
 
 
 
 
 
 
 
 
 
 
Selling, general and administrative
 
33,301

 
26,249

 
3,549

 
(32,863
)
 
30,236

Marketing and reservation
 
109,086

 
102,108

 
4,318

 
(99,859
)
 
115,653

Depreciation and amortization
 
765

 
1,383

 
145

 
—

 
2,293

Total operating expenses
 
143,152

 
129,740

 
8,012

 
(132,722
)
 
148,182

Operating income
 
53,107

 
5,499

 
8,380

 
—

 
66,986

OTHER INCOME AND EXPENSES, NET:
 

 

 

 

 

Interest expense
 
10,485

 
1

 
9