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 September 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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    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 OCTOBER 31, 2018
Common Stock, Par Value $0.01 per share
 
55,980,838

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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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
REVENUES
 
 
 
 
 
 
 
Royalty fees
$
111,009

 
$
103,322

 
$
290,926

 
$
263,215

Initial franchise and relicensing fees
6,262

 
5,729

 
18,957

 
17,263

Procurement services
11,620

 
8,810

 
39,391

 
30,545

Marketing and reservation system
152,367

 
142,915

 
416,715

 
382,245

Other
10,232

 
9,154

 
30,336

 
26,546

Total revenues
291,490

 
269,930

 
796,325

 
719,814

OPERATING EXPENSES
 
 
 
 
 
 
 
Selling, general and administrative
38,191

 
46,573

 
125,325

 
124,356

Depreciation and amortization
3,815

 
1,601

 
10,537

 
4,986

Marketing and reservation system
138,316

 
128,661

 
394,112

 
365,435

       Total operating expenses
180,322

 
176,835

 
529,974

 
494,777

Gain (loss) on sale of land and building, net
—

 
(32
)
 
82

 
(32
)
Operating income
111,168

 
93,063

 
266,433

 
225,005

OTHER INCOME AND EXPENSES, NET
 
 
 
 
 
 
 
Interest expense
11,706

 
11,399

 
34,720

 
33,884

Interest income
(1,966
)
 
(1,575
)
 
(5,218
)
 
(4,277
)
Other gains
(972
)
 
(778
)
 
(1,355
)
 
(2,251
)
Equity in net (income) loss of affiliates
(43
)
 
274

 
5,358

 
3,213

Total other income and expenses, net
8,725

 
9,320

 
33,505

 
30,569

Income before income taxes
102,443

 
83,743

 
232,928

 
194,436

Income tax expense
22,484

 
26,554

 
48,044

 
62,293

Net income
$
79,959

 
$
57,189

 
$
184,884

 
$
132,143

 
 
 
 
 
 
 
 
Basic earnings per share
$
1.42

 
$
1.01

 
$
3.27

 
$
2.34

Diluted earnings per share
$
1.41

 
$
1.01

 
$
3.24

 
$
2.33

 
 
 
 
 
 
 
 
Cash dividends declared per share
$
0.215

 
$
0.215

 
$
0.645

 
$
0.645

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
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
79,959

 
$
57,189

 
$
184,884

 
$
132,143

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

 
215

 
646

 
646

Foreign currency translation adjustment
(250
)
 
851

 
(1,264
)
 
2,842

Other comprehensive (loss) income, net of tax
(35
)
 
1,066

 
(618
)
 
3,488

Comprehensive income
$
79,924

 
$
58,255

 
$
184,266

 
$
135,631

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)
 
September 30, 2018
 
December 31, 2017
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
30,916

 
$
235,336

Receivables (net of allowance for doubtful accounts of $15,509 and $12,221, respectively)
185,586

 
125,870

Income taxes receivable
308

 
—

Notes receivable, net of allowance
32,642

 
13,256

Other current assets
31,163

 
25,967

Total current assets
280,615

 
400,429

Property and equipment, at cost, net
117,610

 
83,374

Goodwill
173,641

 
80,757

Intangible assets, net
263,923

 
100,492

Notes receivable, net of allowances
83,034

 
80,136

Investments, employee benefit plans, at fair value
21,542

 
20,838

Investments in unconsolidated entities
107,905

 
134,226

Deferred income taxes
32,730

 
27,224

Other assets
80,037

 
67,715

Total assets
$
1,161,037

 
$
995,191

LIABILITIES AND SHAREHOLDERS’ DEFICIT
 
 
 
Current liabilities
 
 
 
Accounts payable
$
71,684

 
$
67,839

Accrued expenses and other current liabilities
78,591

 
84,315

Deferred revenue
65,810

 
52,142

Current portion of long-term debt
1,099

 
1,232

Liability for guest loyalty program
82,346

 
79,123

Total current liabilities
299,530

 
284,651

Long-term debt
781,433

 
725,292

Long-term deferred revenue
107,370

 
98,459

Deferred compensation and retirement plan obligations
26,137

 
25,566

Income taxes payable
26,276

 
29,041

Deferred income taxes
—

 
39

Liability for guest loyalty program
50,085

 
48,701

Other liabilities
38,285

 
42,043

Total liabilities
1,329,116

 
1,253,792

Commitments and Contingencies


 


Common stock, $0.01 par value; 160,000,000 shares authorized; 95,065,638 shares issued at September 30, 2018 and December 31, 2017; 56,223,839 and 56,679,968 shares outstanding at September 30, 2018 and December 31, 2017, respectively
951

 
951

Additional paid-in-capital
209,053

 
182,448

Accumulated other comprehensive loss
(5,317
)
 
(4,699
)
Treasury stock, at cost; 38,841,799 and 38,385,670 shares at September 30, 2018 and December 31, 2017, respectively
(1,148,441
)
 
(1,064,573
)
Retained earnings
775,675

 
627,272

Total shareholders’ deficit
(168,079
)
 
(258,601
)
Total liabilities and shareholders’ deficit
$
1,161,037

 
$
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)
 
Nine Months Ended
 
September 30,
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
184,884

 
$
132,143

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
10,537

 
4,986

Depreciation and amortization – marketing and reservation system
14,687

 
15,454

Franchise agreement acquisition cost amortization
6,662

 
5,190

(Gain) loss on disposal of assets
(58
)
 
32

Provision for bad debts, net
6,279

 
3,694

Non-cash stock compensation and other charges
11,455

 
20,215

Non-cash interest and other (income) loss
492

 
(451
)
Deferred income taxes
(5,610
)
 
51,126

Equity in net losses from unconsolidated joint ventures, less distributions received
7,122

 
4,278

Franchise agreement acquisition cost, net of reimbursements
(40,554
)
 
(21,443
)
Change in working capital and other, net of acquisition
(49,059
)
 
(50,205
)
Net cash provided by operating activities
146,837

 
165,019

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Investment in property and equipment
(34,129
)
 
(17,514
)
Investment in intangible assets
(1,665
)
 
(2,376
)
Proceeds from sales of assets
3,053

 
—

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

Asset acquisition, net of cash acquired
(3,179
)
 
—

Contributions to equity method investments
(9,050
)
 
(44,876
)
Distributions from equity method investments
1,429

 
4,307

Purchases of investments, employee benefit plans
(2,441
)
 
(2,140
)
Proceeds from sales of investments, employee benefit plans
2,646

 
2,150

Issuance of notes receivable
(28,876
)
 
(18,565
)
Collections of notes receivable
4,747

 
630

Other items, net
(1,065
)
 
109

Net cash used in investing activities
(299,847
)
 
(78,275
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Net borrowings (repayments) pursuant to revolving credit facilities
56,400

 
(39,974
)
Principal payments on long-term debt
(477
)
 
(484
)
Purchase of treasury stock
(109,266
)
 
(8,887
)
Dividends paid
(36,628
)
 
(36,483
)
Debt issuance costs
(2,590
)
 
—

Proceeds from issuance of long term debt
528

 
—

Proceeds from transfer of interest in notes receivable
173

 
24,237

Proceeds from exercise of stock options
41,155

 
9,799

Net cash used in financing activities
(50,705
)
 
(51,792
)
Net change in cash and cash equivalents
(203,715
)
 
34,952

Effect of foreign exchange rate changes on cash and cash equivalents
(705
)
 
1,433

Cash and cash equivalents at beginning of period
235,336

 
202,463

Cash and cash equivalents at end of period
$
30,916

 
$
238,848

Supplemental disclosure of cash flow information:
 
 
 
Cash payments during the period for:
 
 
 
Income taxes, net of refunds
$
50,806

 
$
31,254

Interest, net of capitalized interest
$
41,746

 
$
41,119

Non-cash investing and financing activities:
 
 
 
Dividends declared but not paid
$
12,087

 
$
12,167

Investment in property and equipment acquired in accounts payable
$
1,743

 
$
758


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 15 for additional information.

On August 20, 2018, the Company entered into an Amended and Restated Senior Unsecured Credit Agreement (“Restated Credit Agreement”). In accordance with the Restated Credit Agreement, each of the entities that was a guarantor in accordance with the former credit agreement were released from their obligations and the guarantees were terminated. As a result, the Company is no longer required to prepare quarterly condensed consolidating statements of income, comprehensive income, balance sheets, and cash flows segregated by parent entity, guarantor entities, and non-guarantor entities. See Note 6 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.

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•
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 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 September 30, 2017
 
As Previously Reported
 
Adoption of Topic 606
 
As Adjusted
Statement of Income
(in thousands, except per share amounts)
Total revenues
$
295,088

 
$
(25,158
)
 
$
269,930

Total operating expenses
217,222

 
(40,387
)
 
176,835

Income before income taxes
68,514

 
15,229

 
83,743

Income taxes
20,919

 
5,635

 
26,554

Net income
47,595

 
9,594

 
57,189

Diluted earnings per share
0.84

 
0.17

 
1.01


 
Nine Months Ended September 30, 2017
 
As Previously Reported
 
Adoption of Topic 606
 
As Adjusted
Statement of Income
(in thousands, except per share amounts)
Total revenues
$
769,785

 
$
(49,971
)
 
$
719,814

Total operating expenses
561,906

 
(67,129
)
 
494,777

Income before income taxes
177,278

 
17,158

 
194,436

Income taxes
55,944

 
6,349

 
62,293

Net income
121,334

 
10,809

 
132,143

Diluted earnings per share
2.14

 
0.19

 
2.33


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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 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 using the modified retrospective approach 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 also expects the ASU to have a significant impact on the extent of lease disclosures in the financial statements. The Company does not expect a material effect on its consolidated statements of income.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"). ASU 2018-13 modifies disclosure requirements on fair value measurements. The guidance is effective for annual reporting periods beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the potential impact that ASU 2018-13 will have on the financial statement disclosures.

In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract ("ASU 2018-15"). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The guidance is effective for annual reporting periods beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the timing of adoption and the potential impact that ASU 2018-15 will have on the financial statements and disclosures.

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.
•
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 redemption pattern of the points is the basis for current and non-current designation of each liability. As of September 30, 2018, the current and non-current deferred revenue balances are $32.8 million and $19.9 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 15 for additional information.
Significant changes in the contract liabilities balances during the period December 31, 2017 to September 30, 2018 are as follows:
 
(in thousands)

Balance as of December 31, 2017
$
132,339

Increases to the contract liability balance due to cash received
66,518

Revenue recognized in the period
(49,681
)
Balance as of September 30, 2018
$
149,176

Remaining Performance Obligations
The aggregate amount of transaction price allocated to unsatisfied or partially unsatisfied performance obligations is $149.2 million as of September 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 $46.1 million within Other assets as of September 30, 2018. Amortization expense and impairment loss for the three and nine months ended September 30, 2018 was $2.0 million and $6.2 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:
 
Three Months Ended
 
Three Months Ended
 
September 30, 2018
 
September 30, 2017
 
Over time
 
Point in time
 
Total
 
Over time
 
Point in time
 
Total
Revenues:
(in thousands)
 
(in thousands)
Royalty fees
$
111,009

 
$
—

 
$
111,009

 
$
103,322

 
$
—

 
$
103,322

Initial franchise and relicensing fees
6,262

 
—

 
6,262

 
5,729

 
—

 
5,729

Procurement services
10,949

 
671

 
11,620

 
8,310

 
500

 
8,810

Marketing and reservation system
139,577

 
12,790

 
152,367

 
138,222

 
4,693

 
142,915

Other
9,769

 
122

 
9,891

 
6,912

 
1,891

 
8,803

Total Topic 606 revenues
$
277,566

 
$
13,583

 
291,149

 
$
262,495

 
$
7,084

 
269,579

Non-Topic 606 revenues
 
 
 
 
341

 
 
 
 
 
351

 
 
 
 
 
$
291,490

 
 
 
 
 
$
269,930

 
Nine Months Ended
 
Nine Months Ended
 
September 30, 2018
 
September 30, 2017
 
Over time
 
Point in time
 
Total
 
Over time
 
Point in time
 
Total
Revenues:
(in thousands)
 
(in thousands)
Royalty fees
$
290,926

 
$
—

 
$
290,926

 
$
263,215

 
$
—

 
$
263,215

Initial franchise and relicensing fees
18,957

 
—

 
18,957

 
17,263

 
—

 
17,263

Procurement services
37,433

 
1,958

 
39,391

 
29,259

 
1,286

 
30,545

Marketing and reservation system
371,321

 
45,394

 
416,715

 
351,638

 
30,607

 
382,245

Other
28,313

 
979

 
29,292

 
20,566

 
4,933

 
25,499

Total Topic 606 revenues
$
746,950

 
$
48,331

 
795,281

 
$
681,941

 
$
36,826

 
718,767

Non-Topic 606 revenues
 
 
 
 
1,044

 
 
 
 
 
1,047

 
 
 
 
 
$
796,325

 
 
 
 
 
$
719,814

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 12, the Corporate & Other amounts represent $3.7 million and $2.9 million for the three months ended September 30, 2018 and 2017, respectively, and $10.7 million and $8.0 million for nine months ended September 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:
 
September 30, 2018
 
December 31, 2017
 
(in thousands)
Prepaid expenses
$
20,306

 
$
14,205

Other current assets
3,857

 
4,762

Land held for sale
7,000

 
7,000

Total
$
31,163

 
$
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 nine months ended September 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 September 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:
 
September 30, 2018
 
December 31, 2017
Credit Quality Indicator
(in thousands)
Senior
$
89,568

 
$
73,700

Subordinated
25,728

 
18,647

Unsecured
2,517

 
3,182

Total notes receivable
117,813

 
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
$
115,676

 
$
93,392

Current portion, net
$
32,642

 
$
13,256

Long-term portion, net
83,034

 
80,136

Total
$
115,676

 
$
93,392


The Company utilizes the level of security it has in the 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 $1.7 million and $1.8 million of its subordinated notes receivable were impaired at September 30, 2018 and December 31, 2017, respectively, and recorded allowance for credit losses on these impaired loans totaling $1.6 million at both September 30, 2018 and December 31, 2017. The average notes receivable on non-accrual status was approximately $1.8 million for both the nine months ended September 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 nine months ended September 30, 2018 and 2017, respectively. The Company provided loan reserves on non-impaired loans totaling $0.5 million at September 30, 2018 and December 31, 2017. There were no changes in total loan reserves between December 31, 2017 and September 30, 2018.

The Company has identified loans totaling approximately $10.8 million and $2.1 million, respectively, with stated interest rates that are less than market rate, representing a total discount of $1.6 million and $0.1 million as of September 30, 2018 and

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December 31, 2017, respectively. These discounts are reflected as a reduction of the outstanding loan amounts and are amortized over the life of the related loan.
Past due balances of 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
As of September 30, 2018
(in thousands)
Senior
$
—

 
$
—

 
$
—

 
$
89,568

 
$
89,568

Subordinated
—

 
—

 
—

 
25,728

 
25,728

Unsecured
—

 
—

 
—

 
2,517

 
2,517

 
$
—

 
$
—

 
$
—

 
$
117,813

 
$
117,813

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 notes receivables to certain entities that have created variable interests in these borrowers totaling $59.4 million and $35.2 million as of September 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.

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 September 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 interests in equity method investments with one or more partners. Investments in unconsolidated entities include investments in joint ventures totaling $102.9 million and $130.2 million at September 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 September 30, 2018 and 2017, the Company recognized losses totaling $1.1 million and $1.3 million, respectively, from these investments. For the nine months ended September 30, 2018 and 2017, the Company recognized losses totaling $7.6 million and $5.1 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 13 of these financial statements.

During the third quarter of 2018, a partner in a VIE previously accounted for under the equity method of accounting exercised a put option to the Company for its membership interest. As a result, the Company paid $3.2 million for the remaining interest and the purchase was accounted for as an asset acquisition. The financial results of the 100% owned entity have been consolidated in the Company's financial statements since August 9, 2018.

6.
Debt
Debt consists of the following:
 
September 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 $3.4 million and $3.9 million at September 30, 2018 and December 31, 2017, respectively
$
396,643

 
$
396,057

$250 million senior unsecured notes with an effective interest rate of 6.19% less a discount and deferred issuance costs of $0.6 million and $0.8 million at September 30, 2018 and December 31, 2017, respectively
249,412

 
249,182

$600 million senior unsecured credit facility with an effective interest rate of 3.23%, less deferred issuance costs of $3.1 million at September 30, 2018
123,255

 
—

$450 million senior unsecured credit facility with an effective interest rate of 2.84%, less deferred issuance costs of $2.1 million at December 31, 2017
—

 
67,936

Fixed rate collateralized mortgage with an effective interest rate of 4.57%, plus a fair value adjustment of $0.4 million and $0.6 million at September 30, 2018 and December 31, 2017, respectively
8,364

 
8,853

Economic development loans with an effective interest rate of 3.0% at September 30, 2018 and December 31, 2017, respectively
4,240

 
3,712

Other notes payable
618

 
784

Total debt
$
782,532

 
$
726,524

Less current portion
1,099

 
1,232

Total long-term debt
$
781,433

 
$
725,292

Restated Senior Unsecured Credit Facility
On August 20, 2018, the Company entered into the Restated Credit Agreement, which amended and restated the Company’s existing senior unsecured revolving credit agreement, dated July 21, 2015 (the “Former Credit Agreement”). The Former Credit Agreement provided for a $450 million unsecured revolving credit facility (the “Revolver”) with a final maturity date of July 21, 2021.
The Restated Credit Agreement increases the commitments under the Revolver to $600 million and extends the final maturity date of the Revolver to August 20, 2023, 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 Restated Credit Agreement. The effectiveness of such extensions is subject to the consent of the lenders under the Restated Credit Agreement and certain customary conditions. The Restated Credit Agreement also provides that up to $35 million of borrowings under the Revolver may be used for alternative currency loans and up to $25 million of borrowings under the Revolver may be used for swingline loans. The Company may from time to time designate one or more wholly owned subsidiaries of the Company as additional borrowers under the Restated Credit Agreement, subject to the consent of the lenders and certain customary conditions.
Pursuant to the Restated Credit Agreement, the previous guarantee by certain of the Company’s subsidiaries of its obligations under the Revolver (as increased by the Restated Credit Agreement) was released. As a result, as of August 20, 2018, there are no subsidiary guarantors under the Revolver. However, if certain subsidiaries of the Company subsequently incur certain recourse debt or become obligors in respect of certain recourse debt of the Company or certain of its other subsidiaries, the Restated Credit Agreement requires such obligated subsidiaries to guarantee the Company’s obligations under the Revolver. In the event that these subsidiary guarantees are triggered under the Revolver, the same subsidiary guarantees would be required under the Company’s 5.75% Senior Notes due 2022 and 5.70% Senior Notes due 2020 and certain hedging and bank product arrangements, if any, with lenders that are parties to the Restated Credit Agreement.
The Company may at any time prior to the final maturity date increase the amount of the Revolver or add one or more term loan facilities under the Restated Credit Agreement by up to an additional $250 million in the aggregate to the extent that any one or more lenders commit to being a lender for the additional amount of such term loan facility and certain other customary conditions are met.
The Restated Credit Agreement provides that the Company may elect to have borrowings under the Revolver bear interest at a rate equal to (i) LIBOR plus a margin ranging from 90 to 150 basis points or (ii) a base rate plus a margin ranging from 0 to 50 basis points, in each case, with the margin determined according to the Company’s senior unsecured long-term debt rating or under circumstances as set forth in the Restated Credit Agreement, the Company’s total leverage ratio in the event that such total leverage ratio is less than 2.5 to 1.0.
A total of $3.2 million in debt issuance costs were capitalized as part of the Restated Credit Facility, including $1.7 million in costs incurred on the Restated Credit Facility and remaining unamortized costs of $1.5 million attributable to the Former Credit Facility. The capitalized debt issuance costs are amortized on a straight-line basis, which is not materially different than the effective interest method, through the maturity. Amortization of these costs is included in interest expense in the consolidated statements of income. Additionally, the Restated Credit Agreement requires the Company to pay a fee on the total commitments under the Revolver, calculated on the basis of the actual daily amount of the commitments under the Revolver (regardless of usage) times a percentage per annum ranging from 0.075% to 0.25% (depending on the Company’s senior unsecured long-term debt rating or under circumstances as set forth in the Restated Credit Agreement, the Company’s total leverage ratio in the event that such total leverage ratio is less than 2.5 to 1.0).
The Restated 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.
The Restated Credit Agreement imposes financial maintenance covenants requiring the Company to maintain a consolidated fixed charge coverage ratio of at least 2.5 to 1.0 and a total leverage ratio of not more than 4.5 to 1.0 or, on up to two nonconsecutive occasions, 5.5 to 1.0 for up to three consecutive quarters following a material acquisition commencing with the fiscal quarter in which such material acquisition occurred. If the Company achieves and maintains an Investment Grade Rating, as defined in the Restated Credit Agreement, then the Company will not need to comply with the consolidated fixed charge coverage ratio covenant.
The Restated 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 Restated Credit Agreement to be immediately due and payable. At September 30, 2018, the Company was in compliance with all financial covenants under the Restated Credit Agreement.
The proceeds of the 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 Restated Credit Agreement.
For additional information regarding 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 nine months ended September 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
—

 
(1,264
)
 
(1,264
)
Amounts reclassified from accumulated other comprehensive loss
646

 
—

 
646

Net current period other comprehensive income
646

 
(1,264
)
 
(618
)
Ending balance, September 30, 2018
$
(1,652
)
 
$
(3,665
)
 
$
(5,317
)


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The amounts below were reclassified from accumulated other comprehensive loss to the following line items in the Company's Consolidated Statements of Income during the three and nine months ended September 30, 2018. There is no income tax expense or benefit attributable to the components below.
Component
 
Amount Reclassified from Accumulated Other Comprehensive Loss
 
Affected Line Item in the Consolidated Statement of Income
 
 
Three Months Ended September 30, 2018
 
Nine Months Ended September 30, 2018
 
 
Loss on cash flow hedge:
 
(in thousands)
 
 
Interest rate contract
 
$
215

 
$
646

 
Interest expense

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 nine months ended September 30, 2018.
As of September 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 September 30, 2018
 
 
 
 
 
 
 
Mutual funds(1)
$
21,928

 
$
21,928

 
$
—

 
$
—

Money market funds(1)
1,790

 
—

 
1,790

 
—

 
$
23,718

 
$
21,928

 
$
1,790

 
$
—

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.
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 Restated Credit Agreement 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 15 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 September 30, 2018 and December 31, 2017, the $250 million senior notes had an approximate fair value of $260.3 million and $269.2 million, respectively. At September 30, 2018 and December 31, 2017, the $400 million Senior Notes had an approximate fair value of $423.0 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 21.9% and 31.7% for the three months ended September 30, 2018 and 2017, respectively. The effective income tax rates were 20.6% and 32.0% for the nine months ended September 30, 2018 and 2017, respectively.

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 ("SAB 118") when accounting for the enactment-date effects of the Act. As of September 30, 2018, the Company finalized its calculations related to the tax effects of the Act and there were no significant changes to the impacts estimated as part of the year ended 2017 provision for income taxes.

The effective income tax rate for the three months ended September 30, 2018 was slightly higher than the U.S. federal income tax rate of 21.0% primarily due to an unfavorable $1.0 million adjustment to the SAB 118 deferred tax asset impairment estimate and the impact of state income taxes, partially offset by excess tax benefits from share-based compensation of $0.5 million, a favorable $0.2 million adjustment to the SAB 118 transition tax estimate, and the impact of foreign operations.

The effective income tax rate for the nine months ended September 30, 2018 was lower than the U.S. federal income tax rate of 21.0% due to excess tax benefits from share-based compensation of $4.0 million, a favorable $0.2 million adjustment to the SAB 118 transition tax estimate, and the impact of foreign operations, partially offset by an unfavorable $1.0 million adjustment to the SAB 118 deferred tax asset impairment estimate and the impact of state income taxes.

The effective income tax rate for the three and nine months ended September 30, 2017 was lower than the U.S. federal income tax rate of 35.0% due to excess tax benefits from share-based compensation of $0.9 million and $2.7 million, respectively, and the impact of foreign operations, partially offset by state income taxes.

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.

Due to the recent changes resulting from the Act, the Company has implemented a new foreign dividend policy effective during the quarter ended September 30, 2018. As a result of the new policy, the Company intends to limit any future foreign distributions to income which has been previously subject to US taxation, for which relevant taxes have been recorded. Nonetheless, the Company will continue to assert that any other outside basis difference of the foreign subsidiaries will be permanently (or indefinitely) reinvested outside of the U.S.  Consequently, the Company will not record any additional deferred taxes for this item in 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 nine months ended September 30, 2018 and 2017:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In millions)
2018
 
2017
 
2018
 
2017
Stock options
$
0.6

 
$
6.4

 
$
1.9

 
$
8.6

Restricted stock
1.7

 
3.9

 
5.0

 
7.3

Performance vested restricted stock units
1.4

 
3.7

 
4.0

 
5.8

Total
$
3.7

 
$
14.0

 
$
10.9

 
$
21.7

Income tax benefits
$
0.9

 
$
5.2

 
$
2.6

 
$
8.0

In conjunction with the acceleration of the Company's chief executive officer succession plan, stock option, restricted stock and performance vested restricted stock unit ("PVRSU") expense for the three and nine months ended September 30, 2017, included an additional $5.5 million, $2.1 million and $2.5 million, respectively, of accelerated recognition of share based payment awards.
A summary of stock-based award activity as of September 30, 2018 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, 2018
1,976,326

 
$
50.80

 
 
 
348,876

 
$
57.05

 
294,204

 
$
56.95

Granted
109,045

 
81.55

 
 
 
101,325

 
81.21

 
97,490

 
81.55

Exercised/Vested
(829,214
)
 
49.63

 
 
 
(94,981
)
 
55.88

 
(31,048
)
 
60.60

Expired
(2,018
)
 
63.47

 
 
 
—

 
—

 
—

 
—

Forfeited
(59,250
)
 
55.94

 
 
 
(41,574
)
 
59.78

 
(24,687
)
 
64.16

Outstanding at September 30, 2018
1,194,889

 
$
54.14

 
3.7 years
 
313,646

 
$
64.84

 
335,959

 
$
63.21

Options exercisable at September 30, 2018
757,276

 
$
49.59

 
3.0 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 nine months ended September 30, 2018 range from 12 - 48 months.

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The Company has granted PVRSUs 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.

Share Repurchases and Redemptions
The Company purchased 495,930 and 1,285,270 shares of common stock under the share repurchase program at a total cost of $38.5 million and $101.9 million during the three and nine months ended September 30, 2018, respectively.
During the three and nine months ended September 30, 2018, the Company redeemed 2,683 and 90,872 shares of common stock at a total cost of approximately $0.2 million and $7.3 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.

11.
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)
2018
 
2017
 
2018
 
2017
Computation of Basic Earnings Per Share:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income
$
79,959

 
$
57,189

 
$
184,884

 
$
132,143

Income allocated to participating securities
(447
)
 
(402
)
 
(1,081
)
 
(938
)
Net income available to common shareholders
$
79,512

 
$
56,787

 
$
183,803

 
$
131,205

Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
56,025

 
56,161

 
56,283

 
56,059

 
 
 
 
 
 
 
 
Basic earnings per share
$
1.42

 
$
1.01

 
$
3.27

 
$
2.34

 
 
 
 
 
 
 
 
Computation of Diluted Earnings Per Share:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income
$
79,959

 
$
57,189

 
$
184,884

 
$
132,143

Income allocated to participating securities
(444
)
 
(400
)
 
(1,073
)
 
(933
)
Net income available to common shareholders
$
79,515

 
$
56,789

 
$
183,811

 
$
131,210

Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
56,025

 
56,161

 
56,283

 
56,059

Diluted effect of stock options and PVRSUs
405

 
344

 
505

 
357

Weighted average common shares outstanding – diluted
56,430

 
56,505

 
56,788

 
56,416

 
 
 
 
 
 
 
 
Diluted earnings per share
$
1.41

 
$
1.01

 
$
3.24

 
$
2.33


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, 2018 and 2017, the Company had 1.2 million and 2.1 million outstanding stock options, respectively. Stock options are included in the diluted EPS 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, 2018, 0.1 million anti-dilutive stock options were excluded from the diluted EPS calculation. For the three and nine months ended September 30, 2017, the Company excluded 0.4 million of anti-dilutive stock options from the diluted EPS calculation.

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PVRSUs are also included in the diluted EPS calculation when the performance conditions have been met at the reporting date. However, at September 30, 2018 and 2017, PVRSUs totaling 318,215 and 297,548, respectively, were excluded from the computation since the performance conditions had not been met.

12.
Reportable Segment Information

Hotel Franchising: Hotel franchising includes the Company's hotel franchising operations consisting of its twelve brands. The twelve brands are aggregated within this segment in consideration of their similar economic characteristics, types of customers, distribution channels and regulatory business environments. Revenues from the hotel franchising business include royalty fees, initial franchise and relicensing fees, marketing and reservation system fees, procurement services revenue and other franchising related revenue. The Company is obligated under its hotel franchise agreements to provide marketing and reservation services appropriate for the operation of its systems. These services do not represent separate reportable segments as their operations are directly related to the Company's hotel franchising business. The revenues received from franchisees that are used to pay for part of the Company's ongoing operations are included in hotel franchising revenues and are offset by the related expenses paid for marketing and reservation activities to calculate hotel franchising operating income.
The financial results for the three and nine months ended September 30, 2017 have been updated to reflect the Company's adoption of Topic 606 as discussed in Note 1. In addition, the financial results related to SkyTouch are now reported as a component of Corporate & Other.

The Company evaluates its hotel franchising segment based primarily on the results of the segment without allocating corporate expenses, income taxes or indirect general and administrative expenses, which are included in the Corporate & Other column. Corporate & Other revenues include rental income related to an office building owned by the Company, as well as revenues related to the Company's vacation rental activities and its SaaS technology solutions divisions which provide cloud-based property management software to non-franchised hoteliers and vacation rental management companies. Equity in earnings or losses from hotel franchising related joint ventures is allocated to the Company's hotel franchising segment. The Company does not allocate interest expense, interest income, other gains and losses or income taxes to its segments.
The following table presents the financial information for the Company's hotel franchising segment:
 
Three Months Ended September 30, 2018
 
Three Months Ended September 30, 2017
(In thousands)
Hotel Franchising
 
Corporate &
Other
 
Consolidated
 
Hotel Franchising
 
Corporate &
Other
 
Consolidated
Revenues
$
287,813

 
$
3,677

 
$
291,490

 
$
267,071

 
$
2,859

 
$
269,930

Operating income (loss)
$
126,025

 
$
(14,857
)
 
$
111,168

 
$
116,500

 
$
(23,437
)
 
$
93,063

Income (loss) before income taxes
$
126,068

 
$
(23,625
)
 
$
102,443

 
$
116,225

 
$
(32,482
)
 
$
83,743

 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2018
 
Nine Months Ended September 30, 2017
(In thousands)
Hotel Franchising
 
Corporate &
Other
 
Consolidated
 
Hotel Franchising
 
Corporate &
Other
 
Consolidated
Revenues
$
785,621

 
$
10,704

 
$
796,325

 
$
711,843

 
$
7,971

 
$
719,814

Operating income (loss)
$
308,048

 
$
(41,615
)
 
$
266,433

 
$
276,203

 
$
(51,198
)
 
$
225,005

Income (loss) before income taxes
$
302,690

 
$
(69,762
)
 
$
232,928

 
$
272,989

 
$
(78,553
)
 
$
194,436



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13.
Commitments and Contingencies
The Company is not a party to any litigation other than litigation in the ordinary course of business. The Company's management and legal counsel do not expect that the ultimate outcome of any of its currently ongoing legal proceedings, individually or collectively, will have a material adverse effect on the Company's financial position, results of operations or cash flows.
Contingencies
The Company entered in to various limited payment guaranties with regards to the Company’s VIEs supporting the VIE’s efforts to develop and own hotels franchised under the Company’s brands.  Under these limited payment guaranties, the Company has agreed to guarantee a portion of the outstanding debt until certain conditions are met such as (a) the loan matures, (b) certain debt covenants are achieved, (c) the maximum amount guaranteed by the Company is paid in full or (d) the Company, through its affiliates, ceases to be a member of the VIE. The maximum exposure of principal incidental to these limited payment guaranties is $13.0 million, plus unpaid expenses and accrued unpaid interest.  The Company believes the likelihood of having to perform under the aforementioned limited payment guaranties is remote as of September 30, 2018 and December 31, 2017.  In the event of performance, the Company has recourse for two of the transactions in the form of a membership interest pledge as collateral for the guaranty.

The Company transferred a portion of an outstanding note receivable to a third party for $24.4 million. Under the agreement, the counter party may require the Company to purchase the outstanding interest in the note if the Company declares a default against the borrower and enters into foreclosure proceedings.  The Company believes the likelihood of foreclosure on the note is remote as of September 30, 2018.
Commitments
The Company has the following commitments outstanding at September 30, 2018:
•
The Company provides financing in the form of franchise agreement acquisition payments to franchisees for property improvements, hotel development efforts and other purposes. At September 30, 2018, the Company had commitments to extend an additional $220.7 million for these purposes provided certain conditions are met by its franchisees.
•
The Company committed to make additional capital contributions totaling $12.2 million to existing unconsolidated and consolidated joint ventures related to the construction of various hotels to be operated under the Company's Cambria Hotels brand.
•
The Company committed to provide financing in the form of mezzanine loans or credit facilities to franchisees for Choice brand development efforts. The Company has committed to provide an aggregate of approximately $10.1 million, upon certain conditions being met. As of September 30, 2018, $2.4 million have been disbursed.
•
In March 2018, the Company entered into a construction loan agreement for the rehabilitation and development of a former office building into a hotel through a consolidated joint venture with a commercial lender, which is secured by the building. The construction loan can be drawn up to $34.9 million. The Company has a carve-out guaranty and the unaffiliated joint venture partner has a completion guaranty in relation to the loan, in which both parties are required to meet certain financial covenants relating to liquidity and net worth. The rehabilitation of the building is considered a qualified asset in which requires a significant amount of time to prepare for its intended use. Therefore, any interest costs incurred during the development period of the building is considered an element of the historical cost of the qualifying asset. At September 30, 2018, the Company has not drawn on the construction loan or recorded any capitalized interest costs.
•
The Company’s franchise agreements require the payment of franchise fees, which include marketing and reservation system fees. These fees are described in Note 2. In accordance with terms of our franchise agreements, 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. To the extent revenues collected exceed expenditures incurred, the Company has a commitment to the franchisee system to make expenditures in future years. Conversely, to the extent expenditures incurred exceed revenues collected, the Company has the contractual enforceable right to assess and collect such amounts.
In the ordinary course of business, the Company enters into numerous agreements that contain standard indemnities whereby the Company indemnifies another party for breaches of representations and warranties or possible environmental contamination issues. Such indemnifications are granted under various agreements, including those governing (i) purchases or sales of assets

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or businesses, (ii) leases of real estate, (iii) licensing of trademarks, (iv) access to credit facilities, (v) issuances of debt or equity securities, and (vi) certain operating agreements. The indemnifications issued are for the benefit of the (i) buyers in sale agreements and sellers in purchase agreements, (ii) landlords in lease contracts, (iii) franchisees in licensing agreements, (iv) financial institutions in credit facility arrangements, (v) underwriters in debt or equity security issuances and (vi) parties under certain operating agreements. In addition, these parties are also generally indemnified against any third party claim resulting from the transaction that is contemplated in the underlying agreement. While some of these indemnities extend only for the duration of the underlying agreement, many survive the expiration of the term of the agreement or extend into perpetuity (unless subject to a legal statute of limitations). There are no specific limitations on the maximum potential amount of future payments that the Company could be required to make under these indemnities, nor is the Company able to develop an estimate of the maximum potential amount of future payments to be made under these indemnifications as the triggering events are not subject to predictability. With respect to certain of the aforementioned indemnities, such as indemnifications of landlords against third party claims for the use of real estate property leased by the Company, the Company maintains insurance coverage that mitigates potential liability.

14.
Transactions with Unconsolidated Joint Ventures

The Company has a management fee arrangement for marketing services with a joint venture partner. For the three and nine months ended September 30, 2018, fees earned and payroll costs reimbursed under this arrangement totaled $0.6 million and $1.4 million, respectively. For the three and nine months ended September 30, 2017, fees earned and payroll costs reimbursed under this arrangement totaled $0.5 million and $1.3 million, respectively.

The Company has entered into franchise agreements with certain of the unconsolidated joint ventures discussed in Note 5. Pursuant to these franchise agreements, for the three months ended September 30, 2018 and 2017, the Company recorded royalty and marketing reservation system fees of approximately $7.3 million and $7.2 million, respectively. For the nine months ended September 30, 2018 and 2017, the Company has recorded royalty and marketing reservation system fees of approximately $18.2 million and $16.1 million, respectively. The Company recorded $2.1 million and $1.3 million as a receivable due from these joint ventures as of September 30, 2018 and December 31, 2017, respectively. In addition, the Company paid commissions of $65 thousand and $66 thousand for the three months ended September 30, 2018 and 2017, respectively, and $0.2 million and $0.1 million for the nine months ended September 30, 2018 and 2017, respectively, to an on-line travel agent for which the Company is a joint venture member.
15.
Acquisition

On February 1, 2018, the Company acquired 100% of the issued and outstanding equity interest of WoodSpring. At the time of the acquisition, WoodSpring franchised 239 economy extended stay hotels across 35 U.S. states. The total consideration was $231.6 million, which consisted of cash paid, net of cash acquired, of $231.3 million as well as liabilities assumed of $0.4 million and a preliminary working capital adjustment of $0.1 million. 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 and are included in the Company’s hotel franchising segment.
The Company allocated the purchase price based upon a preliminary assessment of the fair value of the assets and liabilities assumed as of February 1, 2018. The Company completed its assessment of the WoodSpring acquisition in the third quarter of 2018, identifying no adjustments to the fair value determination. As a result, the purchase price allocation is final as of the third quarter of 2018, with no adjustments made from the preliminary allocation. 

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The fair value of the assets and liabilities is as follows:
 

(in thousands)
Cash
$
250

Accounts receivables
1,258

Prepaid
23

Contract assets
115,000

Tradename
22,000

Goodwill
93,384

Accounts payable
(348
)
Total Consideration
$
231,567


The purchase price was based on the projected business growth and cash flows over the next several years and indicated a value that was in excess of the current net book value of the business, resulting in the recognition of various identifiable intangible assets and goodwill as follows:
 

(in thousands)
 
Useful Life
Franchise agreements acquired
$
115,000

 
12-20 years
WoodSpring tradename
22,000

 
Indefinite
Goodwill
93,384

 
Indefinite
Total
$
230,384

 
 
The excess value recorded in goodwill is expected to be recovered through growth within the existing customer base, improvements in hotel RevPAR and new agreements signed with new franchisees and developers. The full amount of goodwill is deductible for tax purposes. The Company's pro forma results of operations for this acquisition have not been presented here because the effect of this acquisition was not material to the Company's consolidated results of operations.

ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand the consolidated financial condition and results of operations of Choice Hotels International, Inc. and its subsidiaries (together the "Company") contained in this report. MD&A is provided as a supplement to-and should be read in conjunction with-our consolidated financial statements and the accompanying notes.

Effective January 1, 2018, the Company adopted Accounting Standards Update No. 2014-09, Revenue From Contracts with Customers (Topic 606) and subsequent amendments to the initial guidance ("Topic 606"). The Company adopted Topic 606 under the full retrospective method. As a result, the Company’s results from operations for the three and nine months ended September 30, 2017 have been revised to reflect the requirements of Topic 606.

Overview
We are primarily a hotel franchisor with franchise agreements representing 6,922 hotels open and 1,050 hotels under construction, awaiting conversion or approved for development as of September 30, 2018, with 561,380 rooms and 85,473 rooms, respectively, in 50 states, the District of Columbia and over 40 countries and territories outside the United States. Our brand names include Ascend Hotel Collection®, Cambria® Hotels, Comfort®, Comfort Suites®, Sleep Inn®, Quality®, Clarion®, MainStay Suites®, Suburban Extended Stay Hotel®, WoodSpring Suites®, Econo Lodge®, and Rodeway Inn® (collectively, the "Choice brands").

On February 1, 2018, the Company acquired all of the issued and outstanding equity interests of WoodSpring Hotels Franchise Services LLC (“WSFS”). WSFS is the franchisor of WoodSpring Suites and at acquisition had 239 units (28,680 rooms) operating in the economy extended stay segment in 35 states in the United States. 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 of the acquisition date. The acquisition allowed the Company to accelerate its growth in the economy extended stay segment. The results of WSFS have been consolidated within the Company’s hotel franchising segment since February 1, 2018.

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The Company's domestic franchising operations are conducted through direct franchising relationships while its international franchise operations are conducted through a combination of direct franchising and master franchising relationships. Master franchising relationships are governed by master franchising agreements which generally provide the master franchisee with the right to use our brands and sub-license the use of our brands in a specific geographic region, usually for a fee.
Our business strategy is to conduct direct franchising in those international markets where both franchising is an accepted business model and we believe our brands can achieve significant scale. We typically elect to enter into master franchise agreements in those markets where direct franchising is currently not a prevalent or viable business model. When entering into master franchising relationships, we strive to select partners that have professional hotel and asset management capabilities together with the financial capacity to invest in building the Choice brands in their respective markets. Master franchising relationships typically provide lower revenues to the Company as the master franchisees are responsible for managing certain necessary services (such as training, quality assurance, reservations and marketing) to support the franchised hotels in the master franchise area and therefore, retain a larger percentage of the hotel franchise fees to cover their expenses. In certain circumstances, the Company has and may continue to make equity investments in our master franchisees. As a result of master franchise relationships and international market conditions, our revenues are primarily concentrated in the United States. Therefore, our description of the franchise system is primarily focused on the domestic operations.
Our Company generates revenues, income and cash flows primarily from initial, relicensing and continuing royalty fees attributable to our franchise agreements. Revenues are also generated from qualified vendor arrangements and other sources. The hotel industry is seasonal in nature. For most hotels, demand is lower in November through February than during the remainder of the year. Our principal source of revenues is franchise fees based on the gross room revenues or number of rooms of our franchised properties. The Company’s franchise fee revenues reflect the industry’s seasonality and historically have been lower in the first and fourth quarters than in the second and third quarters.

With a focus on hotel franchising instead of ownership, we benefit from the economies of scale inherent in the franchising business. The fee and cost structure of our business provides opportunities to improve operating results by increasing the number of franchised hotel rooms and effective royalty rates of our franchise contracts resulting in increased initial and relicensing fee revenue; ongoing royalty fees and procurement services revenues. In addition, our operating results can also be improved through our company-wide efforts related to improving property level performance. The Company currently estimates, based on its current domestic portfolio of hotels under franchise, that a 1% change in revenue per available room ("RevPAR") or rooms under franchise would increase or decrease royalty revenues by approximately $3.5 million and a 1 basis point change in the Company's effective royalty rate would increase or decrease annual domestic royalties by approximately $0.7 million. In addition to these revenues, we also collect marketing and reservation system fees to support centralized marketing and reservation activities for the franchise system.

The principal factors that affect the Company’s results are: the number and relative mix of franchised hotel rooms in the various hotel lodging price categories; growth in the number of hotel rooms under franchise; occupancy and room rates achieved by the hotels under franchise; the effective royalty rate achieved; the level of franchise sales and relicensing activity; and our ability to manage costs. The number of rooms at franchised properties and occupancy and room rates at those properties significantly affect the Company’s results because our fees are based upon room revenues or the number of rooms at franchised hotels. The key industry standard for measuring hotel-operating performance is RevPAR, which is calculated by multiplying the percentage of occupied rooms by the average daily room rate realized. Our variable overhead costs associated with franchise system growth of our established brands have historically been less than incremental royalty fees generated from new franchises. Accordingly, continued growth of our franchise business should enable us to realize benefits from the operating leverage in place and improve operating results.

We are required by our franchise agreements to use the marketing and reservation system fees we collect for system-wide marketing and reservation activities. These expenditures, which include advertising costs and costs to maintain our central reservations and property management systems, help to enhance awareness and consumer preference for our brands and deliver guests to our franchisees. Greater awareness and preference promotes long-term growth in business delivery to our franchisees and increases the desirability of our brands to hotel owners and developers, which ultimately increases franchise fees earned by the Company.

Our Company articulates its mission as a commitment to our franchisees’ profitability by providing our franchisees with hotel franchises that strive to generate the highest return on investment of any hotel franchise. We have developed an operating system dedicated to our franchisees’ success that focuses on delivering guests to our franchised hotels and reducing costs for our hotel owners.

We believe that executing our strategic priorities creates value for our shareholders. Our Company focuses on two key goals:

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Profitable Growth. Our success is dependent on improving the performance of our hotels, increasing our system size by selling additional hotel franchises, effective royalty rate improvement and maintaining a disciplined cost structure. We attempt to improve our franchisees’ revenues and overall profitability by providing a variety of products and services designed to increase business delivery to and/or reduce operating and development costs for our franchisees. These products and services include national marketing campaigns, maintaining a guest loyalty program, a central reservation system, property and yield management programs and systems, revenue management services, quality assurance standards and qualified vendor relationships. We believe that healthy brands, which deliver a compelling return on investment for franchisees, will enable us to sell additional hotel franchises and raise royalty rates. We have multiple brands that meet the needs of many types of guests, and can be developed at various price points and applied to both new and existing hotels. This ensures that we have brands suitable for creating growth in a variety of market conditions. Improving the performance of the hotels under franchise, growing the system through additional franchise sales and improving franchise agreement pricing while maintaining a disciplined cost structure are the keys to profitable growth.
Maximizing Financial Returns and Creating Value for Shareholders. Our capital allocation decisions, including capital structure and uses of capital, are intended to maximize our return on invested capital and create value for our shareholders. We believe our strong and predictable cash flows create a strong financial position that provides us a competitive advantage. We maintain a capital structure that generates high financial returns and use our excess cash flow to provide returns to our shareholders primarily through share repurchases, dividends or investing in growth opportunities.
Historically, we have returned value to our shareholders through share repurchases and dividends. In 1998, we instituted a share repurchase program which has generated substantial value for our shareholders. Since the program's inception through September 30, 2018, we have repurchased 50.0 million shares (including 33.0 million prior to the two-for-one stock split effected in October 2005) of common stock at a total cost of $1.4 billion. Considering the effect of the two-for-one stock split, the Company has repurchased 83.0 million shares at an average price of $16.37 per share. The Company purchased 1.3 million shares of common stock under the share repurchase program at a total cost of $101.9 million during the nine months ended September 30, 2018. At September 30, 2018, we had approximately 2.7 million shares remaining under the current share repurchase authorization. We currently believe that our cash flows from operations will support our ability to complete the current repurchase authorization. Upon completion of the current authorization, our board of directors will evaluate the advisability of additional share repurchases.
The Company commenced paying quarterly dividends in 2004 and in 2012 the Company elected to pay a special cash dividend totaling approximately $600 million. The Company currently maintains the payment of a quarterly dividend totaling $0.215 per share on its common shares outstanding; however, the declaration of future dividends is subject to the discretion of the board of directors. During the nine months ended September 30, 2018, we paid cash dividends totaling approximately $36.6 million. We expect to continue to pay dividends in the future, subject to declaration by our board of directors as well as future business performance, economic conditions, changes in income tax regulations and other factors including limitations in the Company's credit facility. Based on the present outstanding share count and an annual dividend rate of $0.86 per common share outstanding, we expect that aggregate annual regular dividends for 2018 would be approximately $48.7 million.

The Company also allocates capital to financing, investment and guaranty support to incent franchise development for certain brands in strategic markets and to exploring growth opportunities in business areas that are adjacent or complementary to our core hotel franchising business, which leverage our core competencies and are additive to our franchising business model. The timing and amount of these investments are subject to market and other conditions.
Notwithstanding investments in these alternative growth strategies, the Company expects to continue to return value to its shareholders over time through a combination of share repurchases and dividends.
We believe our growth investments and strategic priorities, when properly implemented, will enhance our profitability, maximize our financial returns and continue to generate value for our shareholders. The ultimate measure of our success will be reflected in the items below.
Results of Operations: Royalty fees, operating income, net income and diluted earnings per share ("EPS") represent key measurements of these value drivers. These measurements are primarily driven by the operations of our hotel franchise system and, therefore, our analysis of the Company's operations is primarily focused on the size, performance and potential growth of the hotel franchise system as well as our variable overhead costs. Since our hotel franchising activities represents approximately 99% of total revenues, our discussion of our results from operations primarily relate to our hotel franchising activities.
Our discussion of the hotel franchising activities also excludes the Company’s marketing and reservation system revenues and expenses. The Company's franchise agreements require the payment of marketing and reservation system fees to be used exclusively by the Company for expenses associated with providing franchise services such as central reservation systems,

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national marketing and media advertising. The Company is obligated to expend the marketing and reservation system fees it collects from franchisees in accordance with the franchise agreements. Furthermore, franchisees are required to reimburse the Company for any deficits generated by these marketing and reservation system activities. Over time, the Company expects cumulative revenues and expenses to break even and therefore no income or loss will be generated. As a result, the Company excludes the financial impacts of this program from the analysis of its operations.
Due to the seasonal nature of the Company’s hotel franchising business or multi-year investments that are required to support franchise operations, quarterly or annual deficits and surpluses may be generated. During the three months ended September 30, 2018 and 2017, marketing and reservation system revenues exceeded expenses by $14.1 million and $14.3 million, respectively. During the nine months ended September 30, 2018 and 2017, marketing and reservation system revenues exceeded expenses by $22.6 million and $16.8 million, respectively.
Refer to MD&A heading "Operations Review" for additional analysis of our results.
Liquidity and Capital Resources: Historically, the Company has generated significant cash flows from operations. Since our business has not historically required significant reinvestment of capital, we typically utilize cash in ways that management believes provide the greatest returns to our shareholders which include share repurchases and dividends. However, we may determine to utilize cash for acquisitions and other investments in the future. We believe the Company’s cash flow from operations and available financing capacity is sufficient to meet the expected future operating, investing and financing needs of the business.
Refer to MD&A heading "Liquidity and Capital Resources" for additional analysis.
Inflation: Inflation has been moderate in recent years and has not had a significant impact on our business.
Non-GAAP Financial Statement Measurements

The Company utilizes certain measures which do not conform to generally accepted accounting principles accepted in the United States ("GAAP") when analyzing and discussing its results with the investment community. This information should not be considered as an alternative to any measure of performance as promulgated under GAAP. The Company’s calculation of these measurements may be different from the calculations used by other companies and therefore, comparability may be limited. We have included a reconciliation of these measures to the comparable GAAP measurement below as well as our reasons for reporting these non-GAAP measures.

Hotel Franchising Revenues: The Company utilizes franchising revenues, which exclude revenues from marketing and reservation system activities, SaaS technology solutions divisions, vacation rental activities, and revenue generated from the ownership of an office building that is leased to a third-party, rather than total revenues when analyzing the performance of the business. Marketing and reservation activities are excluded from hotel franchising revenues since the Company is contractually required by its franchise agreements to utilize the fees collected specifically for franchisee marketing and reservation activities. Our SaaS technology solutions divisions and vacation rental activities are excluded from hotel franchising revenues since those operations do not reflect the Company's core hotel franchising business but represent adjacent, complementary lines of business. This non-GAAP measure is a commonly used measure of performance in our industry and facilitates comparisons between the Company and its competitors.
Calculation of Hotel Franchising Revenues
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
(in thousands)
 
(in thousands)
Total Revenues
$
291,490

 
$
269,930

 
$
796,325

 
$
719,814

Adjustments:
 
 
 
 
 
 
 
     Marketing and reservation system revenues
(152,367
)
 
(142,915
)
 
(416,715
)
 
(382,245
)
     Non-hotel franchising activities
(3,677
)
 
(2,859
)
 
(10,704
)
 
(7,971
)
Hotel Franchising Revenues
$
135,446

 
$
124,156

 
$
368,906

 
$
329,598


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Operations Review
Comparison of Operating Results for the Three-Month Periods Ended September 30, 2018 and 2017

Summarized financial results for the three months ended September 30, 2018 and 2017 are as follows:
(In thousands)
2018
 
2017
REVENUES
 
 
 
Royalty fees
$
111,009

 
$
103,322

Initial franchise and relicensing fees
6,262

 
5,729

Procurement services
11,620

 
8,810

Marketing and reservation system
152,367

 
142,915

Other
10,232

 
9,154

Total revenues
291,490

 
269,930

OPERATING EXPENSES
 
 
 
Selling, general and administrative
38,191

 
46,573

Depreciation and amortization
3,815

 
1,601

Marketing and reservation system
138,316

 
128,661

Total operating expenses
180,322

 
176,835

Gain (loss) on sale of land and building, net
—

 
(32
)
Operating income
111,168

 
93,063

OTHER INCOME AND EXPENSES, NET
 
 
 
Interest expense
11,706

 
11,399

Interest income
(1,966
)
 
(1,575
)
Other gains
(972
)
 
(778
)
Equity in net (income) loss of affiliates
(43
)
 
274

Total other income and expenses, net
8,725

 
9,320

Income before income taxes
102,443

 
83,743

Income tax expense
22,484

 
26,554

Net income
$
79,959

 
$
57,189


Results of Operations
The Company recorded income before income taxes of $102.4 million for the three month period ended September 30, 2018, a $18.7 million or 22% increase from the same period of the prior year. The increase in income before income taxes primarily reflects a $18.1 million increase in operating income, a $0.4 million increase in interest income, and a $0.3 million increase in equity in net (income) loss of affiliates partially offset by a $0.3 million increase in interest expense.

Operating income increased $18.1 million primarily due to a $11.3 million or 9% increase in the Company's hotel franchising revenues, a $8.4 million decrease in SG&A expenses, and a $0.8 million increase in non-hotel franchising revenues partially offset by a $2.2 million increase in depreciation and amortization expenses. The primary reasons for these fluctuations are described in more detail below.

Hotel Franchising Revenues

Hotel franchising revenues were $135.4 million for the three months ended September 30, 2018 compared to $124.2 million for the three months ended September 30, 2017, an increase of $11.3 million or 9%. The increase in hotel franchising revenues is primarily due to a $7.7 million or 7% increase in royalty revenues, a $2.8 million or 32% increase in procurement services revenues, a $0.5 million or 9% increase in initial franchise and relicensing fees, and a $0.3 million increase in non-compliance, contract termination fees and other franchise revenues.


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Royalty Fees

Domestic royalty fees for the three months ended September 30, 2018 increased $7.7 million to $105.0 million from $97.3 million for the three months ended September 30, 2017, an increase of 8%.

The increase in domestic royalties reflect an 9.6% increase in the number of domestic franchised hotel rooms and an increase in the effective royalty rate partially offset by a 1.4% decrease in domestic RevPAR. System-wide RevPAR decreased due to a 160 basis point decrease in occupancy rates, partially offset by a 0.9% increase in average daily rates. The decline in occupancy rates in the third quarter 2018 primarily relate to weather-related events such as hurricanes that drove higher occupancy rates in the third quarter of 2017 and the timing of the fourth of July holiday which fell on a Wednesday in the third quarter 2018 compared to Tuesday in the prior year. These items either resulted in either lower leisure travel demand in the quarter or provided tougher comparable prior period results. In addition, lobby and room renovations at over 1,000 of the Company’s Comfort brand franchises resulted in lower occupancy in the third quarter of 2018. The Company's effective royalty rate for the domestic hotel system increased from 4.60% for the three months ended September 30, 2017 to 4.72% for the three months ended September 30, 2018. The increase in the effective royalty rate is attributable to improved royalty rate pricing on recently executed domestic franchise agreements, annual contractual royalty rate increases contained in existing franchise agreements and the acquisition of WSFS. Overall, the acquisition of WSFS on February 1, 2018 increased domestic royalties for the three months ended September 30, 2018 by $5.5 million.
A summary of the Company's domestic franchised hotels operating information is as follows:
 
Three Months Ended
September 30, 2018
 
Three Months Ended
September 30, 2017
 
Change
 
Average
Daily
Rate
 
Occupancy
 
RevPAR
 
Average
Daily
Rate
 
Occupancy
 
RevPAR
 
Average
Daily
Rate
 
Occupancy
 
RevPAR
Comfort Inn
$
101.37

 
71.8
%
 
$
72.74

 
$
101.25

 
73.9
%
 
$
74.82

 
0.1%
 
(210
)
bps
 
(2.8)%
Comfort Suites
101.55

 
73.5
%
 
74.59

 
101.43

 
75.5
%
 
76.55

 
0.1%
 
(200
)
bps
 
(2.6)%
Sleep
87.95

 
69.6
%
 
61.24

 
86.85

 
71.3
%
 
61.88

 
1.3%
 
(170
)
bps
 
(1.0)%
Quality
85.61

 
66.2
%
 
56.66

 
85.44

 
67.2
%
 
57.43

 
0.2%
 
(100
)
bps
 
(1.3)%
Clarion
90.98