Choice Hotels International, Inc. — Q2 2010 Form 10-Q
Business context and period. The filing covers the quarter and six months ended June 30, 2010. Choice is primarily a hotel franchisor, with 6,074 hotels open and 683 in development, conversion or approval pipelines across the U.S. and more than 40 other countries and territories. Marketing and reservation fees are reported gross with matching expenses and are contractually dedicated to those activities.
Financial performance
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Total revenue | $149.8 million | $143.3 million | $257.3 million | $257.5 million |
| Operating income | $43.6 million | $38.1 million | $67.4 million | $65.9 million |
| Net income | $27.0 million | $25.5 million | $42.8 million | $41.8 million |
| Diluted EPS | $0.45 | $0.42 | $0.72 | $0.69 |
| Operating margin | 29.1% | 26.6% | 26.2% | 25.6% |
Q2 royalty fees rose 5% to $57.4 million; franchising revenue, which excludes marketing and reservation revenue and hotel operations, increased 2% to $68.4 million. For the six months, franchising revenue fell 2% to $116.1 million. Initial franchise and relicensing fees declined 34% in Q2 and 31% for the half year.
Cash flow and liquidity. Six-month operating cash flow was $41.6 million, down from $48.4 million. Investing used $21.4 million, including $12.2 million in capital expenditures and $8.0 million in franchisee notes. Financing used $16.4 million; dividends paid were $21.9 million and treasury-stock purchases were $9.2 million. Cash ended at $70.9 million, compared with $61.8 million a year earlier.
Debt was $291.1 million at June 30, outstanding under a $350 million revolving facility; it was classified as current because the facility matures June 16, 2011. The company reported covenant compliance, leverage of approximately 1.8x against a maximum of 3.25x, and EBITDA-to-interest coverage of approximately 51.1x against a minimum of 3.75x. Total liabilities were $487.2 million and shareholders’ deficit was $97.0 million. Current liabilities exceeded current assets, largely reflecting the debt classification.
Material changes and operating trends
- Q2 domestic RevPAR increased 0.3%: occupancy rose 130 basis points while average daily rate fell 2.2%. For the first six months, domestic RevPAR declined 4.3%, as average daily rate fell 3.2% and occupancy fell 50 basis points.
- Domestic franchised rooms grew 2.2% year over year to 389,625. However, the domestic development pipeline declined 29% to 586 hotels; new construction pipeline hotels fell 30%.
- New domestic franchise agreements fell 47% in Q2 to 62 and 34% for the half year to 117. Management attributed weaker signings and openings to economic conditions and limited hotel financing. It expected about 340 domestic hotel openings in 2010, versus 442 in 2009.
- SG&A declined 16% in Q2 and 8% for the half year. Lower sales-related compensation and deferred-compensation costs contributed; Q2 results also reflected volatile investment valuations in employee benefit plans.
- Six-month operating cash flow decreased $6.8 million, which management primarily attributed to working-capital timing. The receivable for marketing and reservation costs advanced beyond fees earned rose to $58.5 million from $33.9 million at year-end.
Outlook, risks and unusual items
- Management said franchise applications and agreements could remain below pre-recession levels while lodging conditions and hotel financing remain weak; a prolonged downturn could materially affect results. Pipeline hotels are not assured of opening.
- Management expected marketing and reservation activities to use $15–$20 million of cash in 2010. It expected annual investment of $20–$40 million in franchisee financing, guarantees and real estate development programs, subject to market conditions.
- The company expected to begin refinancing its revolver during 2010, ahead of its June 2011 maturity, and anticipated higher borrowing costs in the prevailing credit environment. It reported a July 2010 interest-rate swap entered into to reduce floating-rate exposure.
- Quarterly dividends were $0.185 per share; management indicated dividends and repurchases would remain subject to business performance, economic conditions and board discretion. Approximately 3.6 million shares remained authorized for repurchase at June 30.
- Six-month employee termination charges were $0.7 million. At June 30, $3.2 million in termination benefits remained unpaid, with $2.4 million expected within twelve months. The company also reported $10.8 million of impaired mezzanine and other notes, with an $8.6 million allowance, and $4.8 million of conditional commitments for additional forgivable notes.
- Other exposures include franchisee loan commitments, two $1 million loan guarantees, approximately $9 million of planned land purchases, and open tax examinations. Unrecognized tax benefits totaled $4.2 million; management said up to $2.1 million could be recognized within twelve months. Management stated ordinary-course lawsuits were not expected individually to have a material adverse effect.
- No full-year earnings or EPS guidance is provided in the filing. Management cautioned that interim results are seasonal and not necessarily indicative of full-year results.
Most important facts for investors to verify
- Whether the planned revolver refinancing was completed on acceptable terms before the June 2011 maturity, and how borrowing costs changed.
- Whether domestic hotel openings and franchise signings recovered from the reported declines, and whether the 2010 opening expectation was achieved.
- Whether room-rate trends, RevPAR and franchisee health improved, supporting royalty growth and collection of marketing and reservation receivables.
- Credit quality, collections and reserve adequacy for franchisee notes, plus execution and returns from planned financing and real estate investments.
- Cash-flow generation and the sustainability of dividends and share repurchases alongside planned development spending.