Document
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 June 30, 2018
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, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
 
Accelerated filer
o
Non-accelerated filer
o
 
Smaller reporting company
o
 
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 JUNE 30, 2018
Common Stock, Par Value $0.01 per share
 
56,633,606

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


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PART I. FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS

CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
        
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2018
 
2017
 
2018
 
2017
REVENUES
 
 
 
 
 
 
 
Royalty fees
$
103,219

 
$
91,599

 
$
179,917

 
$
159,893

Initial franchise and relicensing fees
6,481

 
5,728

 
12,695

 
11,534

Procurement services
17,833

 
14,372

 
27,771

 
21,735

Marketing and reservation system
157,347

 
140,477

 
264,348

 
239,330

Other
10,561

 
8,840

 
20,104

 
17,392

Total revenues
295,441

 
261,016

 
504,835

 
449,884

OPERATING EXPENSES
 
 
 
 
 
 
 
Selling, general and administrative
46,270

 
44,038

 
87,134

 
77,783

Depreciation and amortization
3,669

 
1,659

 
6,722

 
3,385

Marketing and reservation system
136,568

 
128,780

 
255,796

 
236,774

       Total operating expenses
186,507

 
174,477

 
349,652

 
317,942

Gain on sale of land and building, net
82

 
—

 
82

 
—

Operating income
109,016

 
86,539

 
155,265

 
131,942

OTHER INCOME AND EXPENSES, NET
 
 
 
 
 
 
 
Interest expense
11,705

 
11,280

 
23,014

 
22,485

Interest income
(1,643
)
 
(1,438
)
 
(3,252
)
 
(2,702
)
Other gains
(503
)
 
(576
)
 
(383
)
 
(1,473
)
Equity in net (income) loss of affiliates
(567
)
 
859

 
5,401

 
2,939

Total other income and expenses, net
8,992

 
10,125

 
24,780

 
21,249

Income before income taxes
100,024

 
76,414

 
130,485

 
110,693

Income taxes
20,185

 
25,729

 
25,560

 
35,739

Net income
$
79,839

 
$
50,685

 
$
104,925

 
$
74,954

 
 
 
 
 
 
 
 
Basic earnings per share
$
1.41

 
$
0.90

 
$
1.85

 
$
1.33

Diluted earnings per share
$
1.40

 
$
0.89

 
$
1.83

 
$
1.32

 
 
 
 
 
 
 
 
Cash dividends declared per share
$
0.215

 
$
0.215

 
$
0.43

 
$
0.43

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
(IN THOUSANDS)
(UNAUDITED)
 
        
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Net income
$
79,839

 
$
50,685

 
$
104,925

 
$
74,954

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Amortization of loss on cash flow hedge
216

 
216

 
431

 
431

Foreign currency translation adjustment
(1,869
)
 
1,423

 
(1,014
)
 
1,991

Other comprehensive income (loss), net of tax
(1,653
)
 
1,639

 
(583
)
 
2,422

Comprehensive income
$
78,186

 
$
52,324

 
$
104,342

 
$
77,376

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
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
 
June 30, 2018
 
December 31, 2017
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
37,148

 
$
235,336

Receivables (net of allowance for doubtful accounts of $14,087 and $12,221, respectively)
186,034

 
125,870

Income taxes receivable
50

 
—

Notes receivable, net of allowance
29,237

 
13,256

Other current assets
30,683

 
25,967

Total current assets
283,152

 
400,429

Property and equipment, at cost, net
112,567

 
83,374

Goodwill
173,741

 
80,757

Intangible assets, net
248,469

 
100,492

Notes receivable, net of allowances
78,921

 
80,136

Investments, employee benefit plans, at fair value
20,349

 
20,838

Investments in unconsolidated entities
133,478

 
134,226

Deferred income taxes
23,310

 
27,224

Other assets
49,029

 
67,715

Total assets
$
1,123,016

 
$
995,191

LIABILITIES AND SHAREHOLDERS’ DEFICIT
 
 
 
Current liabilities
 
 
 
Accounts payable
$
72,266

 
$
67,839

Accrued expenses and other current liabilities
73,940

 
84,315

Deferred revenue
58,190

 
52,142

Current portion of long-term debt
1,099

 
1,232

Liability for guest loyalty program
81,178

 
79,123

Total current liabilities
286,673

 
284,651

Long-term debt
795,124

 
725,292

Long-term deferred revenue
103,754

 
98,459

Deferred compensation and retirement plan obligations
24,866

 
25,566

Income taxes payable
29,041

 
29,041

Deferred income taxes
—

 
39

Liability for guest loyalty program
48,592

 
48,701

Other liabilities
38,918

 
42,043

Total liabilities
1,326,968

 
1,253,792

Commitments and Contingencies


 


Common stock, $0.01 par value, 160,000,000 shares authorized; 95,065,638 shares issued at June 30, 2018 and December 31, 2017 and 56,633,606 and 56,679,968 shares outstanding at June 30, 2018 and December 31, 2017, respectively
951

 
951

Additional paid-in-capital
204,899

 
182,448

Accumulated other comprehensive loss
(5,282
)
 
(4,699
)
Treasury stock (38,432,032 and 38,385,670 shares at June 30, 2018 and December 31, 2017, respectively), at cost
(1,112,376
)
 
(1,064,573
)
Retained earnings
707,856

 
627,272

Total shareholders’ deficit
(203,952
)
 
(258,601
)
Total liabilities and shareholders’ deficit
$
1,123,016

 
$
995,191


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
(IN THOUSANDS)
(UNAUDITED)
 
Six Months Ended
 
June 30,
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
104,925

 
$
74,954

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
6,722

 
3,385

Depreciation and amortization – marketing and reservation system
10,048

 
10,157

Franchise agreement acquisition cost amortization
4,375

 
3,305

Loss (gain) on disposal of assets
(82
)
 
4

Provision for bad debts, net
4,356

 
1,707

Non-cash stock compensation and other charges
7,716

 
8,082

Non-cash interest and other (income) loss
808

 
(274
)
Deferred income taxes
3,828

 
(732
)
Equity in net losses from unconsolidated joint ventures, less distributions received
6,702

 
3,543

Franchise agreement acquisition cost, net of reimbursements
(20,326
)
 
(14,108
)
Change in working capital and other, net of acquisition
(65,258
)
 
(25,915
)
Net cash provided by operating activities
63,814

 
64,108

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Investment in property and equipment
(21,611
)
 
(10,687
)
Investment in intangible assets
(1,329
)
 
(2,228
)
Proceeds from sales of assets
3,052

 
—

Business acquisition, net of cash acquired
(231,317
)
 
—

Contributions to equity method investments
(7,206
)
 
(42,127
)
Distributions from equity method investments
1,210

 
1,696

Purchases of investments, employee benefit plans
(2,047
)
 
(1,736
)
Proceeds from sales of investments, employee benefit plans
1,828

 
2,094

Issuance of mezzanine and other notes receivable
(19,005
)
 
(14,977
)
Collections of mezzanine and other notes receivable
3,505

 
552

Other items, net
232

 
110

Net cash used in investing activities
(272,688
)
 
(67,303
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Net borrowings pursuant to revolving credit facilities
69,000

 
23,200

Principal payments on long-term debt
(362
)
 
(309
)
Purchase of treasury stock
(70,573
)
 
(7,414
)
Dividends paid
(24,454
)
 
(24,333
)
Debt issuance costs
(914
)
 
—

Proceeds from issuance of long term debt
352

 
—

Proceeds from transfer of interest in notes receivable
173

 
—

Proceeds from exercise of stock options
38,059

 
6,590

Net cash provided by (used in) financing activities
11,281

 
(2,266
)
Net change in cash and cash equivalents
(197,593
)
 
(5,461
)
Effect of foreign exchange rate changes on cash and cash equivalents
(595
)
 
955

Cash and cash equivalents at beginning of period
235,336

 
202,463

Cash and cash equivalents at end of period
$
37,148

 
$
197,957

Supplemental disclosure of cash flow information:
 
 
 
Cash payments during the period for:
 
 
 
Income taxes, net of refunds
$
22,470

 
$
30,813

Interest, net of capitalized interest
$
21,558

 
$
21,206

Non-cash investing and financing activities:
 
 
 
Dividends declared but not paid
$
12,114

 
$
12,133

Investment in property and equipment acquired in accounts payable
$
3,393

 
$
895

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.
Basis of Presentation    and Significant Accounting Policies
Basis of Presentation
The accompanying unaudited consolidated financial statements of Choice Hotels International, Inc. and its subsidiaries (together the "Company") have been prepared by the Company in accordance with United States of America generally accepted accounting principles ("GAAP") 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 the Company's 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 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, 2017 and notes thereto included in the Company’s Annual Report on Form 10-K, filed with the SEC on March 1, 2018 (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.
On February 1, 2018, the Company acquired 100% of the issued and outstanding equity interest of WoodSpring Hotels Franchise Services ("WoodSpring"). The transaction has been accounted for using the acquisition method of accounting and accordingly, assets acquired and liabilities assumed were recorded at their fair values as of the acquisition date. The results of WoodSpring have been consolidated with the Company since February 1, 2018. See Note 16 for additional information.
Summary of Significant Accounting Policies
The Company’s significant accounting policies are detailed in Note 1 “Summary of Significant Accounting Policies” in the Annual Report on Form 10-K for the year ended December 31, 2017. The significant accounting policies that changed in 2018 are set forth below.
Recently Adopted Accounting Standards

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue From Contracts with Customers (Topic 606) and issued subsequent amendments to the initial guidance at various points of 2015 and 2016 within ASU 2015-14, ASU 2016-08, ASU 2016-10, ASU 2016-12, and ASU 2016-20 (these ASUs collectively referred to as "Topic 606"). The Company adopted Topic 606 as of January 1, 2018 using the full retrospective method of adoption. The provisions of Topic 606 impacted the Company’s revenue recognition as follows:
  
•
Initial and relicensing fees earned upon execution of a franchise agreement are recognized as revenue ratably as services are provided over the enforceable period of the franchise license arrangement. This represents a change from prior practice, whereby the Company typically recognized revenue for initial and relicensing fees in full in the period of agreement execution.
•
Sales commissions, which are paid upon the execution of a franchise agreement, are recognized ratably over the period a hotel is expected to remain in the Company's franchise system rather than expensed as incurred.
•
Franchise agreement acquisition costs are capitalized as intangible assets, as opposed to notes receivable. Amortization of franchise agreement acquisition costs are recognized as a reduction of revenue rather than as a component of depreciation and amortization.
•
Revenue related to the Choice Privileges program, which is reported as a component of marketing and reservation system fees, is deferred as points are awarded and recognized upon point redemption, net of reward reimbursements paid to a third-party. Previously, revenue was recognized on a gross basis at the time the points were issued with a

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corresponding deferral of revenue equal to the expected future costs of the award. Deferred revenue was then recognized as actual points were redeemed and costs for those redemptions incurred.
•
Topic 606 also impacted the Company’s accounting for surpluses and deficits generated from marketing and reservation system activities. The Company has historically, consistent with its existing agreements, not earned a profit or generated a loss from marketing and reservation activities, and as a result, the Company recorded excess marketing and reservation system revenues or expenses as assets or liabilities on the Company’s balance sheet prior to the adoption of Topic 606. However, as a result of the adoption of Topic 606, the Company will no longer defer revenues and expenses or record assets and liabilities when system revenues exceed expenses in the current period or vice versa. The Company intends to manage these activities to break-even over time but anticipates that net income or loss may be generated quarterly due to the seasonal nature of the hotel industry and annually based on the level of investments needed for new initiatives that benefit our franchisees.

All amounts and disclosures set forth in this Form 10-Q reflect the necessary adjustments required for the adoption of Topic 606, including the reclassification of prior year balances to conform to current year presentation. See Note 2 for further details on the adoption of Topic 606 and impact to the Company's significant accounting policies. In accordance with Topic 606 requirements, the disclosure of the impact of adoption on the Company's prior period consolidated statements of income and balance sheet is presented below. The adoption of Topic 606 had no impact to cash from or used in operating, financing, or investing activities, but resulted in certain reclassifications within cash flows from operating activities, on the prior period consolidated statement of cash flows.

 
Three Months Ended June 30, 2017
 
As Previously Reported
 
Adoption of Topic 606
 
As Adjusted
Statement of Income
(in thousands, except per share amounts)
Total revenues
$
276,799

 
$
(15,783
)
 
$
261,016

Total operating expenses
199,293

 
(24,816
)
 
174,477

Income before income taxes
67,381

 
9,033

 
76,414

Income taxes
22,386

 
3,343

 
25,729

Net income
44,995

 
5,690

 
50,685

Diluted earnings per share
0.79

 
0.10

 
0.89


 
Six Months Ended June 30, 2017
 
As Previously Reported
 
Adoption of Topic 606
 
As Adjusted
Statement of Income
(in thousands, except per share amounts)
Total revenues
$
474,697

 
$
(24,813
)
 
$
449,884

Total operating expenses
344,684

 
(26,742
)
 
317,942

Income before income taxes
108,764

 
1,929

 
110,693

Income taxes
35,025

 
714

 
35,739

Net income
73,739

 
1,215

 
74,954

Diluted earnings per share
1.30

 
0.02

 
1.32


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December 31, 2017
 
As Previously Reported (1)(2)
 
Adoption of Topic 606
 
As Adjusted
Balance Sheet
(in thousands)
Receivables (net of allowance for doubtful accounts)
$
125,452

 
$
418

 
$
125,870

Current notes receivable, net of allowances
13,904

 
(648
)
 
13,256

Other current assets
28,241

 
(2,274
)
 
25,967

Intangible assets, net
14,672

 
85,820

 
100,492

Notes receivable, net of allowances
147,993

 
(67,857
)
 
80,136

Deferred income tax asset
13,335

 
13,889

 
27,224

Other assets
29,479

 
38,236

 
67,715

Accounts payable(1)
67,839

 
—

 
67,839

Accrued expenses and other current liabilities(1)
84,315

 
—

 
84,315

Current deferred revenue(2)
13,190

 
38,952

 
52,142

Current liability for guest loyalty program(2)
79,183

 
(60
)
 
79,123

Deferred revenue(1)(2)
18,335

 
80,124

 
98,459

Liability for guest loyalty program(2)
48,738

 
(37
)
 
48,701

Other liabilities(1)(2)
46,939

 
(4,896
)
 
42,043

Retained earnings
673,771

 
(46,499
)
 
627,272


(1) The Company performed reclassifications of certain payroll taxes from Accrued expenses and other current liabilities to Accounts payable totaling $4.3 million, and the entirety of Income taxes payable to Accrued expenses and other current liabilities totaling $2.8 million. In addition, $4.3 million was reclassified from Other liabilities to Deferred revenue.
(2) As a result of adoption of Topic 606 and in accordance with reporting requirements, the Company performed revisions to the presentation within Total liabilities in the consolidated balance sheet to add non-current Deferred revenue and current and non-current Liability for guest loyalty program line items. Amounts originally captured in current Deferred revenue and Other liabilities have been reclassified to the new line items in the table above.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15") and in November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) Restricted Cash ("ASU 2016-18"), which collectively provide additional guidance on nine specific cash flow issues. The Company adopted ASU 2016-15 and ASU 2016-18 on January 1, 2018, and it did not have an impact on the Company's consolidated financial statements.

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740) - Intra-Entity Transfers of Assets Other Than Inventory ("ASU 2016-16").  ASU 2016-16 provides guidance on recognition of current income tax consequences for inter-company asset transfers (other than inventory) at the time of transfer.  The Company adopted this ASU on January 1, 2018, and it did not have an impact on the Company's consolidated financial statements.

In February 2017, the FASB issued ASU 2017-05, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets ("ASU 2017-05"). ASU 2017-05 clarifies the scope and accounting of a financial asset that meets the definition of an “in-substance nonfinancial asset” and adds guidance for partial sales of nonfinancial assets. The Company adopted this ASU on January 1, 2018, and it did not have an impact on the Company's consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation: Scope of Modification Accounting ("ASU 2017-09"), which clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award changes as a result of the change in terms or conditions. ASU 2017-09 will be applied prospectively to awards modified on or after the adoption date. The Company adopted this ASU on January 1, 2018, and it did not have an impact on the Company's consolidated financial statements.


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Recently Issued Accounting Standards

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) ("ASU 2016-02"). ASU 2016-02 requires lessees to recognize most leases on their balance sheet by recording a liability for its lease obligation and an asset for its right to use the underlying asset as of the lease commencement date. The standard requires entities to determine whether an arrangement contains a lease or a service agreement as the accounting treatment is different between the two arrangements. The standard also requires the lessee to evaluate whether a lease is a financing lease or an operating lease as the accounting and presentation guidance between the two are different. ASU 2016-02 also modifies the classification criteria and accounting for sales-type and direct financing leases for lessors. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company intends to adopt the standard on January 1, 2019 and apply the package of practical expedients available upon adoption. The Company is currently assessing the impact that ASU 2016-02 will have on its financial statements and disclosures. The Company expects the ASU to have a material effect on its consolidated balance sheet as a result of recognizing a lease obligation and right-of-use asset for the Company's operating leases. This differs from present day treatment of operating leases, which primarily are not captured on the Company's consolidated balance sheet in accordance with current GAAP. The Company does not expect a material effect on its consolidated statements of income.

2.
Revenue

Revenue Recognition
Revenues are primarily derived from franchise agreements with third-party hotel owners. The majority of the Company’s performance obligations are a series of distinct services, as described in more detail below, for which the Company receives variable consideration through franchise fees. The Company enters into franchise agreements to provide franchisees with a limited non-exclusive license to utilize the Company’s registered brand trade names and trademarks, marketing and reservation services, and other miscellaneous franchise services. These agreements typically have an initial term from five to thirty years, with provisions permitting franchisees or the Company to terminate the franchise agreement upon designated anniversaries of the hotel opening before the end of the initial term. An up-front initial or relicensing fee is assessed to third-party hotel owners to affiliate with our brands, which is typically paid prior to agreement execution and is non-refundable. After hotel opening, fees are generated based on a percentage of gross room revenues or as designated transactions and events occur (such as when a reservation is delivered to the hotel through a specified channel) and are due to the Company in the following month.
The franchise agreements are comprised of multiple performance obligations, which may require significant judgment in identifying. The primary performance obligations are as follows:
•
License of brand intellectual property and related services (“brand intellectual property”): Grants the right to access the Company’s intellectual property associated with brand trade names, trademarks, reservation systems, property management systems and related services.
•
Material rights for free or discounted goods or services to hotel guests: Primarily consists of the points issued under the Company’s guest loyalty program, Choice Privileges.
•
Point in time sale of goods: The Company administers the delivery of chip-enabled credit card readers to its franchisees to aid in compliance with industry standards in exchange for a fee. Revenue is recognized at the point in time shipment is made to the franchisee within Other revenue. The Company determined the standalone selling price is equal to the amount invoiced to the franchisee.

Brand intellectual property
Fees generated from the brand intellectual property are recognized to revenue over time as hotel owners pay for access to these services for the duration of the franchise agreement. Franchise fees are typically based on the sales or usage of the underlying hotel, with the exception of fixed up-front fees that usually represent an insignificant portion of the transaction price. The variable consideration is recognizable after the completion of a hotel stay. As a result, variable transaction price is determined for the period when the underlying gross room revenues and transactions or events which generate fees are known.
Franchise fees include the following:
•
Royalty fees. Royalty fees are earned in exchange for a license to brand intellectual property typically based on a percentage of gross room revenues. These fees are billed and collected monthly and revenues are recognized in the same period that the underlying gross room revenues are earned by the Company’s franchisees.

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•
Initial franchise and relicensing fees. Initial and relicensing fees are charged when (i) new hotels enter the franchise system; (ii) there is a change of ownership; or (iii) existing franchise agreements are extended. These revenues are recognized as revenue ratably as services are provided over the enforceable period of the franchise agreement. The enforceable period is the period from hotel opening to the first point the franchisee or the Company can terminate the franchise agreement without incurring a significant penalty. Deferred revenues from initial and relicensing fees will typically be recognized over a five to ten-year period, unless the franchise agreement is terminated and the hotel exits the franchise system whereby remaining deferred amounts will be recognized to revenue in the period of termination.
•
Other revenue. Other revenue is a combination of miscellaneous non-marketing and reservation system fees, inclusive of quality assurance non-compliance and franchisee training fees, and is recognized in the period the designated transaction or event has occurred.

The Company’s franchise agreements require the payment of marketing and reservation system fees. The Company is obligated to use these marketing and reservation system fees to provide marketing and reservation services such as advertising, providing a centralized reservation and property management system, providing reservation and revenue management services, and performing certain franchise services to support the operation of the overall franchise system. These services are comprised of multiple fees including the following:
•
Fees based on a percentage of gross room revenues are recognized in the period the gross room revenue was earned, based on the underlying hotel’s sales or usage.
•
Fees based on the occurrence of a designated transaction or event are recognized in the period the transaction or event occurred.
•
System implementation fees charged to franchisees are deferred and recognized as revenue over the enforceable period of the franchise agreement.
•
Marketing and reservation system activities also include revenues generated from the Company’s guest loyalty program. The revenue recognition of this program is discussed in Material rights for free or discounted good or services to hotel guests below.

Marketing and reservation system expenses are those expenses incurred to facilitate the delivery of marketing and reservation system services, including direct expenses and an allocation of costs for certain administrative activities required to carry out marketing and reservation services. Marketing and reservation system expenses are recognized as services are incurred or goods are received, and as such may not equal marketing and reservation system revenues in a specific period but are expected to equal revenues earned from franchisees over time. The Company’s 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 and recover such advances in future periods through additional fee assessments or reduced spending.
Material rights for free or discounted good or services to hotel guests
Choice Privileges is the Company’s frequent guest loyalty program, which enables members to earn points based on their spending levels with the Company’s franchisees. The points, which the Company accumulates and tracks on the members’ behalf, may be redeemed for free accommodations or other benefits (e.g., gift cards to participating retailers). The Company collects from franchisees a percentage of program members’ gross room revenue from completed stays to operate the program. At such time points are redeemed for free accommodations or other benefits, the Company reimburses franchisees or third parties based on a rate derived in accordance with the franchise or vendor agreement.
Loyalty points represent a performance obligation attributable to usage of the points, and thus revenues are recognized at the point in time when the loyalty points are redeemed by members for benefits. The transaction price is variable and determined in the period when the loyalty points are earned and the underlying gross room revenues are known. No loyalty program revenues are recognized at the time the loyalty points are issued.
The Company is an agent in coordinating delivery of the services between the loyalty program member and franchisee or third party, and as a result, revenues are recognized net of the cost of redemptions. The estimated fair value of future redemptions is reflected in current and non-current Liability for guest loyalty program in our consolidated balance sheets. The liability for guest loyalty program is developed based on an estimate of the eventual redemption rates and point values using various actuarial methods. These significant judgments determine the required point liability attributable to outstanding points, which is relieved as redemption costs are processed. The amount of the loyalty program fees in excess of the point liability represents current and non-current Deferred revenue, which is recognized to revenue as points are redeemed including an estimate of future forfeitures (“breakage”). The anticipated

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redemption pattern of the points is the basis for current and non-current designation of each liability. As of June 30, 2018, the current and non-current deferred revenue balances are $29.2 million and $17.5 million, respectively. Loyalty program point redemption revenues are recognized within marketing and reservation system revenue in the consolidated statements of income.
The Company also earns revenues on contracts incidental to the support of operations for franchised hotels, including purchasing operations.
Partnerships
The Company maintains various agreements with third-party partners, including the co-branding of the Choice Privileges credit card. The agreements typically provide for use of the Company’s marks, limited access to the Company’s distribution channels, and sale of Choice Privileges points, in exchange for fees primarily comprising variable consideration paid each month. Choice Privileges members can earn points through participation in the partner’s program.
Partnership agreements include multiple performance obligations. The primary performance obligations are brand intellectual property and material rights for free or discounted goods or services to hotel guests. Allocation of fixed and variable consideration to the performance obligations is based on standalone selling price as estimated based on market and income methods, which represent significant judgments. The amounts allocated to brand intellectual property are recognized on a gross basis over time using the output measure of time elapsed, primarily within Procurement services revenue. The amounts allocated to material rights for free or discounted goods or services to hotel guests are recognized to revenue as points are redeemed including an estimate of breakage, primarily within Marketing and reservation system revenue.
Qualified Vendors
The Company generates procurement services revenues from qualified vendors. Procurement services revenues are generally based on marketing services provided by the Company on behalf of the qualified vendors to hotel owners and guests. The Company provides these services in exchange for either fixed consideration or a percentage of revenues earned by the qualified vendor pertaining to purchases by the Company’s franchisees or guests. Fixed consideration is paid in installments based on a contractual schedule, with an initial payment typically due at contract execution. Variable consideration is typically paid quarterly after sales to franchisees or guests have occurred.
Qualified vendor agreements comprise a single performance obligation, which is satisfied over time based on the access afforded and services provided to the qualified vendor for the stated duration of the agreement. Fixed consideration is allocated and recognized ratably to each period over the term of the agreement. Variable consideration is determined and recognized in the period when sales to franchisees or guests from vendors are known or cash payment has been remitted. Qualified vendor revenues are recognized within Procurement services revenue.
Other
The Company is party to other non-franchising agreements that generate revenue within Other revenue in the consolidated statements of income which are primarily Software as a Service (“SaaS”) arrangements for non-franchised hoteliers and vacation rental management companies. SaaS agreements typically include fixed consideration for installment and other initiation fees paid at contract onset, and variable consideration for recurring subscription revenue paid monthly. SaaS agreements comprise a single performance obligation, which is satisfied over time based on the access to the software for the stated duration of the agreement. Fixed consideration is allocated and recognized ratably to each period over the term of the agreement. Variable consideration is determined at the conclusion of each period, and allocated to and recognized in the current period.
Contract Liabilities
Contract liabilities relate to (i) advance consideration received, such as initial franchise and relicensing fees paid when a franchise agreement is executed and system implementation fees paid at time of installation, for services considered to be part of the brand intellectual property performance obligation and (ii) amounts received when points are issued under the Choice Privileges loyalty program but for which revenue is not yet recognized since the related points have not been redeemed. Initial and relicensing fees paid on WoodSpring franchise agreements executed after February 1, 2018 are included in the "Increases to the contract liability balance due to cash received" caption in the table below. No WoodSpring amounts are included in the "Revenue recognized in the period" caption, as WoodSpring balances were not included in the contract liability balance as of December 31, 2017. See Note 16 for additional information.
Significant changes in the contract liabilities balances during the period December 31, 2017 to June 30, 2018 are as follows:

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(in thousands)

Balance as of December 31, 2017
$
132,339

Increases to the contract liability balance due to cash received
39,687

Revenue recognized in the period
(30,557
)
Balance as of June 30, 2018
$
141,469

Remaining Performance Obligations
The aggregate amount of transaction price allocated to unsatisfied or partially unsatisfied performance obligations is $141.5 million as of June 30, 2018. This amount represents fixed transaction price that will be recognized as revenue in future periods, which is primarily captured in the balance sheet as current and non-current deferred revenue.
Based on practical expedient elections permitted by Topic 606, the Company does not disclose the value of unsatisfied performance obligations for (i) variable consideration subject to the sales or usage-based royalty constraint or comprising a component of a series (including franchise, partnership, qualified vendor, and SaaS agreements), (ii) variable consideration for which we recognize revenue at the amount to which we have the right to invoice for services performed, or (iii) contracts with an expected original duration of one year or less. Additionally, as part of transition to Topic 606, the Company elected to not disclose the amount of the transaction price allocated to the remaining performance obligations as of December 31, 2017 or provide an explanation of when revenue is expected to be recognized.
Capitalized Franchise Agreement Costs
Sales commissions earned by Company personnel upon execution of a franchise agreement (“franchise sales commissions”) meet the requirement to be capitalized as an incremental cost of obtaining a contract with a customer. Capitalized franchise sales commission are amortized on a straight-line basis over the estimated benefit period of the arrangement, unless the franchise agreement is terminated and the hotel exits the system whereby remaining capitalized amounts will be expensed in the period of termination. The estimated benefit period is equal to or greater than the period of enforceable rights on the franchise agreement. Capitalized franchise sales commissions are $45.4 million within Other assets as of June 30, 2018. Amortization expense and impairment loss for the three and six months ended June 30, 2018 was $2.2 million and $4.2 million, respectively, and is reflected within selling, general and administrative expenses.

The Company makes certain payments to customers as an incentive to enter in to new franchise agreements (“Franchise agreement acquisition cost”). These payments are recognized as an adjustment to transaction price and capitalized as an intangible asset. Franchise agreement acquisition cost intangibles are amortized on a straight-line basis over the estimated benefit period of the arrangement as an offset to royalty fees and marketing and reservation system fees. Impairments from hotel terminations are recorded within the selling, general and administrative expenses and marketing and reservations expenses.

Sales Taxes

The Company presents taxes collected from customers and remitted to governmental authorities on a net basis and therefore they are excluded from revenues in the consolidated financial statements.

Disaggregation of Revenue
The following table presents our revenues by over time and point in time recognition:

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Three Months Ended
 
Three Months Ended
 
June 30, 2018
 
June 30, 2017
 
Over time
 
Point in time
 
Total
 
Over time
 
Point in time
 
Total
Revenues:
(in thousands)
 
(in thousands)
Royalty fees
$
103,219

 
$
—

 
$
103,219

 
$
91,599

 
$
—

 
$
91,599

Initial franchise and relicensing fees
6,481

 
—

 
6,481

 
5,728

 
—

 
5,728

Procurement services
16,919

 
914

 
17,833

 
13,816

 
556

 
14,372

Marketing and reservation system
130,616

 
26,731

 
157,347

 
120,564

 
19,913

 
140,477

Other
10,024

 
185

 
10,209

 
6,917

 
1,564

 
8,481

Total Topic 606 revenues
$
267,259

 
$
27,830

 
295,089

 
$
238,624

 
$
22,033

 
260,657

Non-Topic 606 revenues
 
 
 
 
352

 
 
 
 
 
359

 
 
 
 
 
$
295,441

 
 
 
 
 
$
261,016

 
Six Months Ended
 
Six Months Ended
 
June 30, 2018
 
June 30, 2017
 
Over time
 
Point in time
 
Total
 
Over time
 
Point in time
 
Total
Revenues:
(in thousands)
 
(in thousands)
Royalty fees
$
179,917

 
$
—

 
$
179,917

 
$
159,893

 
$
—

 
$
159,893

Initial franchise and relicensing fees
12,695

 
—

 
12,695

 
11,534

 
—

 
11,534

Procurement services
26,484

 
1,287

 
27,771

 
20,949

 
786

 
21,735

Marketing and reservation system
231,744

 
32,604

 
264,348

 
213,416

 
25,914

 
239,330

Other
18,544

 
857

 
19,401

 
13,654

 
3,042

 
16,696

Total Topic 606 revenues
$
469,384

 
$
34,748

 
504,132

 
$
419,446

 
$
29,742

 
449,188

Non-Topic 606 revenues
 
 
 
 
703

 
 
 
 
 
696

 
 
 
 
 
$
504,835

 
 
 
 
 
$
449,884

Non-Topic 606 revenues represent revenue from operations of office buildings and parking lots and are presented in Other revenues in the consolidated statements of income.
As presented in Note 13, the Corporate & Other amounts represent $3.3 million and $2.6 million for the three months ended June 30, 2018 and 2017, respectively, and $7.0 million and $5.1 million for six months ended June 30, 2018 and 2017, respectively, and are included in the Over time column of Other revenues and Non-Topic 606 revenues row. The remaining revenues relate to the hotel franchising segment.


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3.
Other Current Assets
Other current assets consist of the following:
 
June 30, 2018
 
December 31, 2017
 
(in thousands)
Prepaid expenses
$
19,028

 
$
14,205

Other current assets
4,655

 
4,762

Land held for sale
7,000

 
7,000

Total
$
30,683

 
$
25,967

Land held for sale represents certain parcels of land previously acquired by the Company as part of its program to incent franchise development in strategic markets for the Company's Cambria Hotels brand. During the six months ended June 30, 2018, the Company sold one parcel of land, classified as a long-term asset as of December 31, 2017, with a total book value of $3.0 million recognizing a gain on sale of $82 thousand. As of June 30, 2018, the Company has $7.0 million of Land held for sale, which represents one parcel of land that is expected to be sold prior to March 31, 2019.

4.
Notes Receivable and Allowance for Losses
The following table shows the composition of the Company's notes receivable balances:
 
 
June 30, 2018
 
December 31, 2017
 
Credit Quality Indicator
 
(in thousands)
 
Senior
 
$
85,763

 
$
73,700

 
Subordinated
 
21,631

 
18,647

 
Unsecured
 
2,901

 
3,182

 
Total notes receivable
 
110,295

 
95,529

 
Allowance for losses on non-impaired loans
 
490

 
490

 
Allowance for losses on receivables specifically evaluated for impairment
 
1,647

 
1,647

 
Total loan reserves
 
2,137

 
2,137

 
Net carrying value
 
$
108,158

 
$
93,392

 
Current portion, net
 
$
29,237

 
$
13,256

 
Long-term portion, net
 
78,921

 
80,136

 
Total
 
$
108,158

 
$
93,392

 

The Company utilizes the level of security it has in the mezzanine and other notes receivable as its primary credit quality indicator (i.e., senior, subordinated or unsecured) when determining the appropriate allowances for uncollectible loans. 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 Company determined that approximately $1.8 million of its subordinated mezzanine and other notes receivable were impaired at both June 30, 2018 and December 31, 2017, and recorded allowance for credit losses on these impaired loans totaling $1.6 million at both June 30, 2018 and December 31, 2017. The average mezzanine and other notes receivable on non-accrual status was approximately $1.8 million and $1.9 million for the six months ended June 30, 2018 and 2017, respectively. Approximately $43 thousand and $44 thousand of interest income on impaired loans was recognized on a cash basis during the six months ended June 30, 2018 and 2017. The Company provided loan reserves on non-impaired loans totaling $0.5 million at June 30, 2018 and December 31, 2017. There were no changes in total loan reserves between December 31, 2017 and June 30, 2018.

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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 June 30, 2018
 
 
 
 
 
 
 
 
 
Senior
$
2,603

 
$
3,019

 
$
5,622

 
$
80,141

 
$
85,763

Subordinated
—

 
—

 
—

 
21,631

 
21,631

Unsecured
—

 
—

 
—

 
2,901

 
2,901

 
$
2,603

 
$
3,019

 
$
5,622

 
$
104,673

 
$
110,295

As of December 31, 2017
 
 
 
 
 
 
 
 
 
Senior
$
—

 
$
—

 
$
—

 
$
73,700

 
$
73,700

Subordinated
—

 
—

 
—

 
18,647

 
18,647

Unsecured
—

 
—

 
—

 
3,182

 
3,182

 
$
—

 
$
—

 
$
—

 
$
95,529

 
$
95,529


Variable Interest through Notes Issued
The Company has issued mezzanine and other notes receivables to certain entities that have created variable interests in these borrowers totaling $50.6 million and $35.2 million as of June 30, 2018 and December 31, 2017, respectively. The Company has determined that it is not the primary beneficiary of these variable interest entities ("VIEs"). Each of these loans have stated fixed and/or variable interest amounts. The Company has identified loans totaling approximately $5.9 million and $2.1 million, respectively, with stated interest rates that are less than market rate, representing a total discount of $0.9 million and $0.1 million, respectively, as of June 30, 2018 and December 31, 2017. These discounts are reflected as a reduction of the outstanding loan amounts and are amortized over the life of the related loan.

Transfer of interest

On September 12, 2017, the Company entered into an agreement to transfer $24.2 million of a $49.1 million outstanding note receivable with a maturity date of November 30, 2019 to a third party. In the first quarter of 2018, an additional $0.2 million was transferred for a total of $24.4 million. The transaction did not qualify as a sale and therefore the outstanding note receivable was not de-recognized on the balance sheet.  The one-time cash proceeds were recorded as unrestricted cash and the future obligation to transfer principal and interest received under the note has been recorded within Other Long-Term liabilities.  The Company retains responsibility for collecting and distributing cash received on the note and interest paid to the participant is reflected as interest expense in the Company’s consolidated statements of income. As of June 30, 2018 and December 31, 2017, Other Long-Term liabilities includes $24.4 million and $24.2 million, respectively, pursuant to this transaction.

5.
Investments in Unconsolidated Entities

The Company maintains a portfolio of investments owned through noncontrolling interest in equity method investments with one or more partners. Investments in unconsolidated entities include investments in joint ventures totaling $129.2 million and $130.2 million at June 30, 2018 and December 31, 2017, respectively, that the Company determined to be VIEs. These investments relate to the Company's program to offer equity support to qualified franchisees to develop and operate Cambria 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 these 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 the three months ended June 30, 2018 and 2017, the Company recognized losses totaling $0.1 million and $1.4 million, respectively, from these investments. For the six months ended June 30, 2018 and 2017, the Company recognized losses totaling $6.5 million and $3.9 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 guaranties described in Note 14 "Commitments and Contingencies" of these financial statements.


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6.
Debt
Debt consists of the following:
 
June 30, 2018
 
December 31, 2017
 
(in thousands)
$400 million senior unsecured notes with an effective interest rate of 6.0% less deferred issuance costs of $3.6 million and $3.9 million at June 30, 2018 and December 31, 2017, respectively
$
396,445

 
$
396,057

$250 million senior unsecured notes with an effective interest rate of 6.19% less a discount and deferred issuance costs of $0.7 million and $0.8 million at June 30, 2018 and December 31, 2017, respectively
249,335

 
249,182

$450 million senior unsecured credit facility with an effective interest rate of 3.39% and 2.84%, less deferred issuance costs of $1.8 million and $2.1 million at June 30, 2018 and December 31, 2017, respectively
137,224

 
67,936

Fixed rate collateralized mortgage with an effective interest rate of 4.57%, plus a fair value adjustment of $0.5 million and $0.6 million at June 30, 2018 and December 31, 2017, respectively
8,529

 
8,853

Economic development loans with an effective interest rate of 3.0% at June 30, 2018 and December 31, 2017, respectively
4,064

 
3,712

Other notes payable
626

 
784

Total debt
$
796,223

 
$
726,524

Less current portion
1,099

 
1,232

Total long-term debt
$
795,124

 
$
725,292


For additional information regarding the senior unsecured credit facility and other debt, see the "Debt" caption under the "Liquidity and Capital Resources" section in Management's Discussion and Analysis of Financial Condition and Results of Operations.


7.
Accumulated Other Comprehensive Loss

The following represents the changes in accumulated other comprehensive loss, net of tax, by component for the six months ended June 30, 2018:
 
Loss on Cash Flow Hedge
 
Foreign Currency Items
 
Total
 
(in thousands)
Beginning balance, December 31, 2017
$
(2,298
)
 
$
(2,401
)
 
$
(4,699
)
Other comprehensive income before reclassification
—

 
(1,014
)
 
(1,014
)
Amounts reclassified from accumulated other comprehensive loss
431

 
—

 
431

Net current period other comprehensive income
431

 
(1,014
)
 
(583
)
Ending balance, June 30, 2018
$
(1,867
)
 
$
(3,415
)
 
$
(5,282
)


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The amounts reclassified from accumulated other comprehensive loss during the three and six months ended June 30, 2018 were reclassified to the following line items in the Company's Consolidated Statements of Income.
Component
 
Amount Reclassified from Accumulated Other Comprehensive Loss
 
Affected Line Item in the Consolidated Statement of Income
 
 
Three Months Ended June 30, 2018
 
Six Months Ended June 30, 2018
 
 
 
 
(in thousands)
 
 
Loss on cash flow hedge
 
 
 
 
 
 
Interest rate contract
 
$
216

 
$
431

 
Interest expense
 
 
—

 
—

 
Tax (expense) benefit
 
 
$
216

 
$
431

 
Net of tax

8.
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 Deferred Compensation Plan.
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 Deferred Compensation Plan and those recorded in cash and cash equivalents.
Level 3: Unobservable inputs, supported by little or no market data available, where the reporting entity is required to develop its own assumptions to determine the fair value of the instrument. The Company does not currently have any assets whose fair value was determined using Level 3 inputs.
 
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 six months ended June 30, 2018.
As of June 30, 2018 and December 31, 2017, 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 June 30, 2018
 
 
 
 
 
 
 
Mutual funds(1)
$
21,508

 
$
21,508

 
$
—

 
$
—

Money market funds(1)
1,664

 
—

 
1,664

 
—

 
$
23,172

 
$
21,508

 
$
1,664

 
$
—

As of December 31, 2017
 
 
 
 
 
 
 
Money market funds, included in cash and cash equivalents
$
50,419

 
$
—

 
$
50,419

 
$
—

Mutual funds(1)
20,869

 
20,869

 
—

 
—

Money market funds(1)
1,702

 
—

 
1,702

 
—

 
$
72,990

 
$
20,869

 
$
52,121

 
$
—

________________________ 
(1)
Included in Investments, employee benefit plans at fair value and Other current assets on the consolidated balance sheets.

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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 4.
The money market funds previously included in cash and cash equivalents were used to fund the WoodSpring acquisition on February 1, 2018. See Note 16 for further information on the acquisition. The fair values 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 June 30, 2018 and December 31, 2017, the $250 million senior notes had an approximate fair value of $259.2 million and $269.2 million, respectively. At June 30, 2018 and December 31, 2017, the $400 million senior notes had an approximate fair value of $417.5 million and $440.1 million, respectively.

Fair value estimates 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.

9.
Income Taxes
The effective income tax rates were 20.2% and 33.7% for the three months ended June 30, 2018 and 2017, respectively. The effective income tax rates were 19.6% and 32.3% for the six months ended June 30, 2018 and 2017, respectively.
The effective income tax rate for the three and six months ended June 30, 2018 was lower than the U.S. federal income tax rate of 21% due to the impact of foreign operations and excess tax benefits from share-based compensation of $1.9 million and $3.5 million, respectively, partially offset by state income taxes. The effective income tax rate for the three and six months ended June 30, 2017 was lower than the U.S. federal income tax rate of 35% due to the impact of foreign operations and excess tax benefits from share-based compensation of $0.6 million and $1.8 million, partially offset by state income taxes.

The Tax Cuts and Jobs Act (the "Act") was enacted on December 22, 2017. The Act reduces the U.S. federal corporate income tax rate from 35.0% to 21.0%, requires companies to pay a one-time transition tax on earnings of foreign subsidiaries that were previously tax deferred, and creates new taxes on certain foreign-sourced earnings. The Company applied the guidance in Staff Accounting Bulletin 118 when accounting for the enactment-date effects of the Act. As of June 30, 2018, the Company made a reasonable estimate of the tax effects of the Act and will continue to refine its calculations as additional analysis is completed. Estimates may also be affected as additional clarification and understanding of the tax law is provided. These changes could be material to income tax expense.

The Act subjects a U.S. shareholder to a minimum tax on “global intangible low-taxed income” ("GILTI") earned by certain foreign subsidiaries. The FASB Staff Q&A, Topic 740 No. 5, Accounting for Global Intangible Low-Taxed Income, states that an entity can make an accounting policy election to either recognize deferred taxes for temporary differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI resulting from those items in the year the tax is incurred. The Company has elected to recognize the resulting tax on GILTI as a period expense in the period the tax is incurred and expects to incur tax for the year ended December 31, 2018.

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10.
Share-Based Compensation and Capital Stock
The components of the Company’s pretax share-based compensation expense and associated income tax benefits are as follows for the three and six months ended June 30, 2018 and 2017:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(in millions)
2018
 
2017
 
2018
 
2017
Stock options
$
0.6

 
$
1.1

 
$
1.3

 
$
2.2

Restricted stock
1.6

 
1.7

 
3.3

 
3.4

Performance vested restricted stock units
1.5

 
1.1

 
2.6

 
2.1

Total
$
3.7

 
$
3.9

 
$
7.2

 
$
7.7

Income tax benefits
$
0.9

 
$
1.5

 
$
1.7

 
$
2.9

A summary of stock-based award activity as of June 30, 2018 and changes during the six 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, 2018
1,976,326

 
$
50.80

 
 
 
348,876

 
$
57.05

 
294,204

 
$
56.95

Granted
109,045

 
81.55

 
 
 
94,574

 
81.38

 
97,490

 
81.55

Exercised/Vested
(741,265
)
 
51.34

 
 
 
(89,609
)
 
55.82

 
(28,971
)
 
61.49

Expired
(2,018
)
 
63.47

 
 
 
—

 
—

 
—

 
—

Forfeited
(53,075
)
 
56.15

 
 
 
(33,643
)
 
57.51

 
(20,545
)
 
62.82

Outstanding at June 30, 2018
1,289,013

 
$
52.85

 
3.8 years
 
320,198

 
$
64.53

 
342,178

 
$
63.21

Options exercisable at June 30, 2018
842,719

 
$
48.05

 
3.1 years
 
 
 
 
 
 
 
 

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:
 
2018 Grants
Risk-free interest rate
2.58
%
Expected volatility
21.17
%
Expected life of stock option
4.6 years

Dividend yield
1.05
%
Requisite service period
4 years

Contractual life
7 years

Weighted average fair value of options granted (per option)
$
16.27

Restricted stock awards generally vest ratably over the service period beginning with the first anniversary of the grant date. Vesting service period of shares granted during the three and six months ended June 30, 2018 range from 12 - 48 months.
The Company has granted performance vested restricted stock units ("PVRSU") to certain employees. The vesting of these stock awards is contingent upon the Company achieving performance targets over a 36 month performance period and the employees' continued employment. The performance conditions affect the number of shares that will ultimately vest and can range between 0% and 200% of the shares granted.


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Table of Contents

Share Repurchases and Redemptions
The Company purchased 357,175 and 789,340 shares of common stock under the share repurchase program at a total cost of $28.5 million and $63.5 million during the three and six months ended June 30, 2018, respectively.
During the three and six months ended June 30, 2018, the Company redeemed 2,515 and 88,189 shares of common stock at a total cost of approximately $0.2 million and $7.1 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.

11.
Earnings Per Share
The computation of basic and diluted earnings per common share is as follows:    
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
(In thousands, except per share amounts)
2018
 
2017
 
2018
 
2017
Computation of Basic Earnings Per Share:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income
$
79,839

 
$
50,685

 
$
104,925

 
$
74,954

Income allocated to participating securities
(462
)
 
(359
)
 
(627
)
 
(535
)
Net income available to common shareholders
$
79,377

 
$
50,326

 
$
104,298

 
$
74,419

Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
56,364

 
56,073

 
56,414

 
56,007

 
 
 
 
 
 
 
 
Basic earnings per share
$
1.41

 
$
0.90

 
$
1.85

 
$
1.33

 
 
 
 
 
 
 
 
Computation of Diluted Earnings Per Share:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income
$
79,839

 
$
50,685

 
$
104,925

 
$
74,954

Income allocated to participating securities
(459
)
 
(357
)
 
(623
)
 
(532
)
Net income available to common shareholders
$
79,380

 
$
50,328

 
$
104,302

 
$
74,422

Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
56,364

 
56,073

 
56,414

 
56,007

Diluted effect of stock options and PVRSUs
468

 
355

 
557

 
361

Weighted average common shares outstanding – diluted
56,832

 
56,428

 
56,971

 
56,368

 
 
 
 
 
 
 
 
Diluted earnings per share
$
1.40

 
$
0.89

 
$
1.83

 
$
1.32


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 June 30, 2018 and 2017, the Company had 1.3 million and 2.2 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 six months ended June 30, 2018, 0.1 million anti-dilutive stock options were excluded from the diluted earnings per share calculation. For the three months ended June 30, 2017, no anti-dilutive stock options were excluded from the diluted earnings per share calculation. For the six months ended June 30, 2017, the Company excluded 0.4 million of 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 June 30, 2018 and 2017, PVRSUs totaling 324,434 and 294,334, respectively, were excluded from the computation since the performance conditions had not been met.

21
Table of Contents

12.
Condensed Consolidating Financial Statements
The Company’s Senior Notes due 2020 and 2022 are guaranteed jointly, severally, fully and unconditionally, subject to certain customary limitations, by 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. The financial results for the 2017 periods have been updated to reflect the Company's adoption of Topic 606 as discussed in Note 1.

Choice Hotels International, Inc. and Subsidiaries
Condensed Consolidating Statement of Income
For the Three Months Ended June 30, 2018
(Unaudited, in thousands)
 
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
REVENUES
 
 
 
 
 
 
 
 
 
 
Royalty fees
 
$
97,414

 
$
39,194

 
$
10,377

 
$
(43,766
)
 
$
103,219

Initial franchise and relicensing fees
 
6,349

 
—

 
132

 
—

 
6,481

Procurement services
 
17,345

 
258

 
440

 
(210
)
 
17,833

Marketing and reservation system
 
117,741

 
144,761

 
4,119

 
(109,274
)
 
157,347

Other
 
8,093

 
135

 
2,734

 
(401
)
 
10,561

Total revenues
 
246,942

 
184,348

 
17,802

 
(153,651
)
 
295,441

OPERATING EXPENSES
 
 
 
 
 
 
 
 
 
 
Selling, general and administrative
 
45,438

 
38,999

 
5,834

 
(44,001
)
 
46,270

Marketing and reservation system
 
126,281

 
116,196

 
3,741

 
(109,650
)
 
136,568

Depreciation and amortization
 
2,295

 
578

 
796

 
—

 
3,669

Total operating expenses
 
174,014

 
155,773

 
10,371

 
(153,651
)
 
186,507

Gain on sale of land and building, net
 
—

 
175

 
(93
)
 
—

 
82

Operating income
 
72,928

 
28,750

 
7,338

 
—

 
109,016

OTHER INCOME AND EXPENSES, NET
 
 
 
 
 
 
 
 
 
 
Interest expense
 
11,386

 
—

 
319

 
—

 
11,705

Equity in earnings of consolidated subsidiaries
 
(32,528
)
 
(165
)
 
—

 
32,693

 
—

Other items, net
 
(744
)
 
(288
)
 
(1,681
)
 
—

 
(2,713
)
Total other income and expenses, net
 
(21,886
)
 
(453
)
 
(1,362
)
 
32,693

 
8,992

Income before income taxes
 
94,814

 
29,203

 
8,700

 
(32,693
)
 
100,024

Income taxes
 
14,975

 
4,759

 
451

 
—

 
20,185

Net income
 
$
79,839

 
$
24,444

 
$
8,249

 
$
(32,693
)
 
$
79,839












22
Table of Contents

Choice Hotels International, Inc. and Subsidiaries
Condensed Consolidating Statement of Income
For the Six Months Ended June 30, 2018
(Unaudited, in thousands)
 
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
REVENUES
 
 
 
 
 
 
 
 
 
 
Royalty fees
 
$
169,029

 
$
75,403

 
$
18,847

 
$
(83,362
)
 
$
179,917

Initial franchise and relicensing fees
 
12,401

 
—

 
294

 
—

 
12,695

Procurement services
 
27,024

 
382

 
718

 
(353
)
 
27,771

Marketing and reservation system
 
206,136

 
251,187

 
7,865

 
(200,840
)
 
264,348

Other
 
14,095

 
135

 
6,367

 
(493
)
 
20,104

Total revenues
 
428,685

 
327,107

 
34,091

 
(285,048
)
 
504,835

OPERATING EXPENSES
 

 

 

 

 

Selling, general and administrative
 
86,795

 
71,613

 
12,624

 
(83,898
)
 
87,134

Marketing and reservation system
 
235,528

 
212,051

 
9,367

 
(201,150
)
 
255,796

Depreciation and amortization
 
3,944

 
1,127

 
1,651

 
—

 
6,722

Total operating expenses
 
326,267

 
284,791

 
23,642

 
(285,048
)
 
349,652

Gain on sale of land and buildings, net
 
—

 
175

 
(93
)
 
—

 
82

Operating income
 
102,418

 
42,491

 
10,356

 
—

 
155,265

OTHER INCOME AND EXPENSES, NET
 

 

 

 

 

Interest expense
 
22,377

 
—

 
637

 
—

 
23,014

Equity in earnings of consolidated subsidiaries
 
(43,294
)
 
906

 
—

 
42,388

 
—

Other items, net
 
(1,241
)
 
5,328

 
(2,321
)
 
—

 
1,766

Total other income and expenses, net
 
(22,158
)
 
6,234

 
(1,684
)
 
42,388

 
24,780

Income before income taxes
 
124,576

 
36,257

 
12,040

 
(42,388
)
 
130,485

Income taxes
 
19,651

 
5,486

 
423

 
—

 
25,560

Net income
 
$
104,925

 
$
30,771

 
$
11,617

 
$
(42,388
)
 
$
104,925

 

23
Table of Contents

Choice Hotels International, Inc. and Subsidiaries
Condensed Consolidating Statement of Income
For the Three Months Ended June 30, 2017
(Unaudited, in thousands)
 
 
Parent
 
Guarantor
Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
REVENUES
 
 
 
 
 
 
 
 
 
 
Royalty fees
 
$
85,945

 
$
41,918

 
$
10,821

 
$
(47,085
)
 
$
91,599

Initial franchise and relicensing fees
 
5,548

 
—

 
180

 
—

 
5,728

Procurement services
 
14,312

 
—

 
60

 
—

 
14,372

Marketing and reservation system
 
128,970

 
111,793

 
3,849

 
(104,135
)
 
140,477

Other
 
6,521

 
41

 
2,582

 
(304
)
 
8,840

Total revenues
 
241,296

 
153,752

 
17,492

 
(151,524
)
 
261,016

OPERATING EXPENSES
 

 

 

 

 

Selling, general and administrative
 
46,997

 
37,842

 
6,592

 
(47,393
)
 
44,038

Marketing and reservation system
 
123,045

 
105,544

 
4,322

 
(104,131
)
 
128,780

Depreciation and amortization
 
377

 
469

 
813

 
—

 
1,659

Total operating expenses
 
170,419

 
143,855

 
11,727

 
(151,524
)
 
174,477

Operating income
 
70,877

 
9,897

 
5,765

 
—