Choice Hotels International, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited consolidated results; amounts below are in U.S. dollars and rounded to millions unless noted. Choice is primarily a hotel franchisor, with 6,117 hotels open and 554 in its development pipeline at quarter-end.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $165.3m | $149.8m | $280.6m | $257.3m |
| Operating income | $45.1m | $43.6m | $70.8m | $67.4m |
| Net income | $27.6m | $27.0m | $43.3m | $42.8m |
| Diluted EPS | $0.46 | $0.45 | $0.72 | $0.72 |
| Operating cash flow | Not separately stated | Not separately stated | $32.1m | $41.6m |
- Q2 revenue rose 10.3%, operating income 3.5%, and net income 2.1%. Six-month revenue rose 9.1%, operating income 5.0%, and net income 1.2%; diluted EPS was unchanged.
- Q2 royalty fees increased 8% to $62.3m. Domestic RevPAR rose 6.6%, reflecting a 2.0% increase in average daily rate and 230 basis points of occupancy improvement; the effective domestic royalty rate increased from 4.29% to 4.33%.
- Q2 operating margin on total revenue was approximately 27.3%, versus 29.1% a year earlier. This measure includes marketing and reservation revenue and matching expenses, which are contractually pass-through and do not generate income for the Company.
- Six-month interest expense increased to $6.5m from $1.3m, primarily due to the $250m senior notes issued in August 2010. The notes bear a 5.70% coupon and a 6.19% effective rate.
- Six-month cash from operations declined $9.6m, principally reflecting timing of deferred revenue, incentive compensation payments, and other working capital items. Cash used in investing was $10.3m, versus $21.4m; capital expenditures were $5.1m, versus $12.2m.
Balance sheet, debt and liquidity
- At June 30, cash and cash equivalents were $91.0m; current assets were $171.5m and current liabilities $165.0m, implying a current ratio of about 1.04. The Company reported a shareholders’ deficit of $27.9m.
- Total debt was $252.5m, including $249.4m carrying value of senior notes and $3.0m of capital leases. The $300m revolving credit facility, maturing February 2016, had no borrowings outstanding. The Company reported compliance with its covenants, a 1.4x leverage ratio and 12.4x interest coverage, against limits of 3.5x and a minimum 3.5x, respectively.
- Approximately $80.3m of cash was held by foreign subsidiaries and management said it was intended to remain reinvested abroad; domestic use could trigger additional U.S. taxes.
- The $60.5m marketing and reservation fee receivable, up from $42.5m at year-end, reflects cumulative system costs exceeding fees earned. Recovery depends in part on franchisee revenue and system growth.
Changes, outlook and risks
- Domestic RevPAR improved, but domestic open rooms edged down 0.1% year over year and the domestic development pipeline fell to 451 hotels from 586. Management attributed weaker new construction activity to tight credit and financing constraints. Net domestic terminations increased, primarily from nonpayment or failure to meet standards.
- Management expected approximately 273 new franchise openings in 2011, down from 327 in 2010, including 34 new-construction openings versus 78 in 2010. The pipeline is not a guarantee that hotels will open.
- The Company expected annual investment of $20m–$40m in franchisee financing, guarantees, investments and real estate programs, depending on market conditions. It expected marketing and reservation activities to use between $1m and generate $3m of cash in 2011.
- Management expected to continue quarterly dividends, subject to business and economic conditions; at the then-current rate, 2011 dividends were estimated at approximately $44m. No shares were repurchased under the public program in the first half; 3.57m shares remained authorized.
- Unusual items included a $1.8m first-quarter land impairment and $0.9m of employee termination charges for the first half. Six-month non-GAAP adjusted net income was $44.7m and adjusted diluted EPS $0.75, excluding the land loss and termination benefits; these are management-defined measures, not GAAP results.
- Credit exposure merits attention: $12.7m of mezzanine and other notes were impaired, with $9.4m of specific reserves; $10.9m was more than 90 days past due. The Company also had $5.7m of conditional franchisee financing commitments and expected a $1.9m past-due note maturity to be renegotiated.
- Other commitments included $3.4m of additional joint-venture investment expected during 2011 and approximately $3.5m of planned land purchases, subject to conditions. A July 2011 headquarters lease signed after quarter-end has an initial 10-year term and estimated minimum rent payments of approximately $67m.
- Management identified economic conditions, lodging demand and room supply, brand appeal, franchisee performance, technology, financing availability, debt management and recovery of marketing advances as risks. It reported no material legal proceeding and stated disclosure controls were effective.
Important facts for investors to verify
- Whether RevPAR gains, royalty-rate improvement and franchise openings can offset a smaller development pipeline and elevated terminations.
- Whether operating cash flow recovers and the $60.5m marketing and reservation receivable remains collectible without impairing franchisee economics.
- Progress on impaired and past-due franchisee loans, including the renegotiated maturity, and the adequacy of loan-loss reserves.
- Debt-service costs, covenant headroom, and the availability and domestic accessibility of cash, given foreign cash restrictions.
- Actual 2011 hotel openings, franchisee-support spending, dividends and share repurchases versus management’s stated expectations, plus the eventual cost and commencement of the headquarters lease.