Choice Hotels International, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; unaudited consolidated results, compared with Q1 2011. Choice is primarily a hotel franchisor, with 6,174 hotels open and 471 in its development pipeline across the U.S. and more than 40 countries and territories. Marketing and reservation fees are collected and spent for the franchise system; they do not generate income for the company.
Financial performance
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenue | $129.2 million | $115.3 million | 12% |
| Franchising revenue, company-defined | $57.3 million | $51.5 million | 11% |
| Operating income | $31.1 million | $25.7 million | 21% |
| Net income | $20.0 million | $15.7 million | 27% |
| Diluted EPS | $0.34 | $0.26 | 31% |
| Operating margin | 24.1% | 22.3% | Increased |
Royalty fees rose 9% to $47.9 million. Domestic RevPAR increased 8.6%, driven by 2.5% higher average daily rates and occupancy up 250 basis points; domestic rooms on line increased 0.6%. Total revenue growth also reflects marketing and reservation fees, which rose 13% to $70.9 million and are offset by corresponding expenses.
Net cash provided by operating activities was $4.4 million, versus cash used of $5.2 million in Q1 2011. Investing activities used $1.5 million, including $3.1 million of capital expenditures, $2.6 million in equity-method investments and $3.7 million in notes advanced. Financing activities used $19.0 million, including $14.9 million for treasury stock purchases and $10.7 million of dividends, partly offset by $5.9 million of revolving-credit borrowings. Cash ended the quarter at $91.3 million, down from $107.1 million at year-end.
At March 31, total debt was $258.5 million, including $249.5 million in senior notes and $5.9 million outstanding on the revolving facility. Current assets were $178.5 million and current liabilities $176.4 million. Shareholders’ deficit was $26.2 million. The company reported a 1.3x leverage ratio and 11.8x interest coverage and compliance with its credit-facility covenants. Approximately $85.8 million of cash was held by foreign subsidiaries and intended to remain reinvested abroad.
Material changes and notable items
- Operating income increased $5.4 million, supported by higher franchising revenue; SG&A rose only 2% to $24.3 million. Management said SG&A would have declined about $1.7 million excluding a litigation settlement and higher deferred-compensation expense.
- Other income and expense improved to a net expense of $0.8 million from $3.8 million. Q1 2012 included approximately $2.0 million of other gains, principally fair-value gains on investments held for non-qualified benefit plans. Q1 2011 included a $1.8 million land impairment loss.
- The effective tax rate rose to 33.9% from 28.2%; the prior-year rate benefited from a $1.4 million nonrecurring adjustment to federal taxes payable.
- The domestic development pipeline fell 29% year over year to 388 hotels, primarily reflecting limited construction financing. New domestic openings in 2012 were expected to be approximately 240, compared with 256 in 2011.
- Subordinated notes receivable included $9.9 million past due more than 30 days, including $9.7 million over 90 days. Mezzanine and other loans of approximately $12.6 million were impaired, with an $8.4 million allowance. The company recorded no allowance against its $63.7 million marketing and reservation receivable, which management considered fully collectible.
Outlook, risks and contingencies
- No specific earnings or revenue forecast is provided. Management said it expects cash from operations and available financing capacity to meet anticipated needs. It expects marketing and reservation activities to generate $4 million to $8 million of cash flow in 2012.
- Management expects annual investment of $20 million to $40 million in franchisee financing, investment and real-estate programs, depending on market conditions, while continuing dividends and share repurchases. The company paid a quarterly dividend of $0.185 per share and estimated 2012 aggregate dividends of approximately $42.8 million at the then-current rate and share count.
- The company repurchased 0.3 million shares for $12.9 million in Q1; an additional 0.2 million shares were repurchased for $7.0 million through May 9, 2012. About 1.6 million shares remained under the authorization at quarter-end.
- Risks highlighted include economic and lodging-industry conditions, franchisee and hotel performance, room supply and demand, brand appeal, franchise terminations, technology needs, financing availability and debt management. A prolonged decline in occupancy, room rates or system size could also impair recovery of marketing and reservation advances.
- The company disclosed a planned headquarters lease with minimum expected rent of approximately $67.6 million over its initial 10-year term; rent was targeted to begin in June 2013, subject to construction and other conditions. It also had contingent franchisee-financing and joint-venture commitments. Management stated routine litigation was not expected to have a material adverse effect; a franchisee arbitration was settled April 4, 2012 without material financial-statement impact.
- The board approved termination of the non-qualified SERP; settlement of its approximately $11.9 million projected benefit obligation was expected before year-end 2012, and the ultimate amount could produce a gain or loss.
Most important facts for investors to verify
- Whether RevPAR gains, royalty growth and franchise-room additions persist, particularly given the shrinking domestic development pipeline and constrained hotel financing.
- The recoverability and timing of the $63.7 million marketing and reservation receivable, and the credit quality and collections on past-due or impaired franchisee loans.
- How much reported earnings benefited from investment fair-value gains and how the higher effective tax rate affects comparable earnings.
- Cash availability for domestic uses: most quarter-end cash was held by foreign subsidiaries and management said domestic use could trigger additional U.S. taxes.
- The effects of ongoing buybacks, dividends, planned franchisee investments, headquarters lease obligations and the SERP settlement on liquidity and capital allocation.