Choice Hotels International, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; comparisons are with the corresponding 2010 periods. Choice is primarily a hotel franchisor, with 6,138 hotels open and 524 in its development pipeline across the U.S. and more than 40 other countries and territories.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue | $192.3m | $183.8m | $472.9m | $441.1m |
| Operating income | $62.4m | $54.9m | $133.2m | $122.3m |
| Net income | $42.3m | $40.5m | $85.6m | $83.3m |
| Diluted EPS | $0.71 | $0.68 | $1.43 | $1.40 |
| Operating cash flow | — | — | $105.9m | $108.2m |
Q3 operating margin was approximately 32.5% versus 29.9%; nine-month operating margin was approximately 28.2% versus 27.7%. These margins use reported revenue, which includes marketing and reservation fees that are matched by related expenses. Management’s non-GAAP franchising revenue, excluding those pass-through fees and hotel operations, rose 9% to $86.7m in Q3 and 8% to $211.5m for the nine months.
At September 30, cash and cash equivalents were $124.7m, current assets $209.8m and current liabilities $181.8m. Total debt was $253.0m, including $249.4m of senior notes; no borrowings were outstanding under the $300m revolving facility. The company reported compliance with facility covenants, a 1.3x total leverage ratio and 11.5x interest coverage. Shareholders’ deficit was $14.4m, largely reflecting treasury stock.
Material changes versus prior periods
- Q3 royalty fees increased 7%; domestic RevPAR rose 5.4%, reflecting a 1.9% increase in average daily rate and a 200-basis-point occupancy increase. Domestic effective royalty rate rose from 4.27% to 4.29%.
- For the first nine months, royalty fees increased 8%; domestic RevPAR rose 5.7% and the effective royalty rate increased from 4.29% to 4.32%.
- Operating income grew faster than revenue, while net income growth was more modest because net other expense increased. Nine-month interest expense rose to $9.7m from $3.2m, principally following the 2010 issuance of $250m of senior notes.
- Domestic rooms open were nearly flat year over year, while international rooms increased 1.8%. The domestic development pipeline fell to 430 hotels from 545 a year earlier; new-construction pipeline hotels declined 22%.
- Nine-month cash from operations decreased modestly. Capital spending fell to $8.1m from $17.7m, while the company continued dividends and repurchases.
Outlook, commentary and risks
- Management expected approximately 273 domestic franchise additions to open in 2011, down from 327 in 2010, mainly due to constrained construction financing and fewer new-construction openings. The filing cautions that pipeline projects may not open.
- The company expected annual investment of $20m–$40m in franchisee financing, development support and real estate programs, depending on market conditions. It expected to continue dividends and repurchases, subject to business performance and other factors; the current repurchase authorization had about 2.8m shares remaining at September 30.
- After quarter-end through November 9, the company repurchased another 0.7m shares for $23.7m. The quarterly dividend was $0.185 per share. Management stated operating cash flow and financing capacity were adequate for expected needs.
- Marketing and reservation fee receivables reached $54.0m, up from $42.5m at year-end. Management identified weaker franchisee revenues, slower system growth, or prolonged occupancy and rate declines as factors that could hinder recovery of these advances.
- Other notable items included a $1.8m land impairment loss and $1.5m of employee termination charges during the first nine months. The company also reported $12.0m of subordinated notes receivable more than 90 days past due and $8.6m of specific reserves on impaired loans.
- A new headquarters lease is targeted to begin rent in 2013, with an initial 10-year term and approximately $67m of minimum rent expected over that term. The company also had franchisee financing commitments and real estate and joint-venture commitments.
- Risk factors cited include economic and lodging-industry conditions, franchisee and brand performance, hotel room supply and demand, technology, financing availability, foreign currency and the company’s ability to manage debt. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether RevPAR and royalty growth persist, and whether the smaller domestic pipeline translates into weaker future openings.
- Collectibility and recovery timing for the $54.0m marketing and reservation receivable and the impaired or delinquent franchisee loans.
- Use and accessibility of cash: $83.8m of cash was held by foreign subsidiaries and management said it did not intend to use those funds in domestic operations.
- Interest burden and covenant headroom under the revolving credit facility, alongside planned dividends, repurchases and franchise-development investments.
- The impact of the headquarters lease, other commitments, and the post-quarter repurchases on future liquidity and capital allocation.
- Underlying performance excluding investment-value fluctuations, the land impairment and termination costs; the filing’s adjusted measures are non-GAAP and may not be comparable with other companies’ measures.