Choice Hotels International, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Unless stated otherwise, comparisons are with the corresponding 2013 periods, which were restated. Amounts below are in millions except per-share data and hotel statistics.
Business context
Choice is primarily a hotel franchisor. At June 30, 2014, its system comprised 6,372 open hotels and 516 hotels in the development pipeline, across 11 brands and more than 35 countries and territories. Franchise fees, including royalties tied to franchisees’ room revenue, are the principal earnings drivers. Marketing and reservation fees are generally required to be spent on services for the franchise system.
Financial performance
| Metric | Q2 2014 | Q2 2013 restated | Six months 2014 | Six months 2013 restated |
|---|---|---|---|---|
| Total revenue | $197.7 | $190.9 | $357.4 | $339.1 |
| Franchising revenue, excluding marketing and reservation fees and SkyTouch | $93.8 | $86.9 | $163.9 | $152.7 |
| Operating income | $60.2 | $54.7 | $101.3 | $91.9 |
| Net income | $35.4 | $31.8 | $58.5 | $51.6 |
| Diluted EPS | $0.60 | $0.54 | $0.99 | $0.88 |
| Adjusted EBITDA | $62.5 | $57.1 | $105.9 | $96.3 |
- Q2 total revenue rose 4%; franchising revenue increased 8%. For the first half, total revenue rose 5% and franchising revenue increased 7%.
- Operating margin was approximately 30.4% in Q2 versus 28.7% a year earlier, and 28.3% for the first half versus 27.1%. Marketing and reservation revenue and matching expenses are included in reported totals.
- Domestic RevPAR increased 7.6% in Q2 and 7.0% in the first half, supported by higher average daily rates and occupancy. Domestic rooms open rose 0.9% year over year; the effective royalty rate declined 6 basis points in both periods.
- Q2 SG&A increased 6% to $31.4 million, including higher SkyTouch spending. First-half SG&A increased 3% to $58.1 million; excluding SkyTouch, management reported lower SG&A than the prior year.
Cash flow, liquidity and debt
- First-half operating cash flow was $65.8 million, versus $30.0 million restated in 2013. Investing activities provided $4.6 million, compared with $21.6 million used in 2013, including $12.2 million in proceeds from hotel sales. Financing activities used $27.7 million, principally reflecting $22.0 million of dividends.
- Cash and cash equivalents were $211.5 million at June 30, 2014, up from $167.8 million at year-end. Current assets were $385.0 million and current liabilities $200.7 million. Shareholders’ deficit was $412.5 million.
- Total debt was $789.5 million, including $777.5 million long-term debt, compared with $793.6 million at year-end. The $200 million revolving facility had no borrowings; $135.0 million was outstanding on the term loan. The company reported compliance with debt covenants and a total leverage ratio of approximately 3.21x.
- The quarterly dividend remained $0.185 per share. Management estimated 2014 regular dividends of approximately $43.6 million at the then-current rate.
Material changes, outlook and risks
- Revenue-recognition restatement and control weakness: The company changed its method to recognize royalty and certain marketing and reservation fees in the period franchisees earn the underlying room revenue, rather than one month later. It concluded the prior method materially misstated certain interim periods, though not previously issued annual statements. 2013 Q2 comparisons in this filing are restated; amendments to other interim reports and revisions to 2011–2013 annual statements were planned.
- Disclosure controls were deemed ineffective at June 30, 2014 due to a material weakness concerning revenue recognition. Management said remediation was underway, subject to testing; it nevertheless concluded the statements in this filing were fairly presented in all material respects.
- The company sold its three company-owned MainStay Suites hotels by June 30. The first-half discontinued-operations result included a $2.8 million disposal gain and net income of $1.8 million.
- Management expected approximately 348 new franchise units to open in 2014, compared with 340 in 2013. It projected $20–$40 million of annual investment in development and franchisee-support opportunities, generally to be recycled within five years. For 2014, SkyTouch SG&A was expected to exceed its revenue by approximately $20 million.
- Management expected marketing and reservation activities to provide $45–$55 million of operating cash flow in 2014. The company stated its operating cash flow and financing capacity should meet expected needs.
- Risks include lodging demand and room supply, franchise growth and retention, brand performance, technology and cybersecurity, international operations and currency exposure, debt management, litigation, and the execution of growth investments. Approximately $172.5 million of cash was held by foreign subsidiaries; use of those funds domestically could result in additional U.S. taxes.
- Commitments included $13.3 million of potential franchisee financing, $25.3 million under a property-improvement incentive program, and $2.1 million of future joint-venture contributions. Two hotel-construction guarantees had maximum exposures of $4.5 million and $11.6 million, respectively. Management did not expect ordinary-course litigation to have a material adverse effect.
Key facts for investors to verify
- Review the restatement tables and subsequent amended filings, and track whether the revenue-recognition material weakness is fully remediated.
- Assess the quality and durability of royalty growth, including RevPAR, room additions, royalty-rate trends, and hotel openings versus terminations.
- Reconcile operating cash flow growth with the timing of marketing and reservation advances, franchisee financing, and working-capital movements.
- Monitor leverage, covenant headroom, dividends, and planned development investments alongside the company’s substantial debt and shareholders’ deficit.
- Evaluate SkyTouch’s spending and progress, hotel-pipeline conversion, and the sensitivity of international cash and earnings to currency and repatriation taxes.