Choice Hotels International, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods. Choice is primarily a hotel franchisor. At quarter-end, its system included 6,287 open hotels and 448 hotels in development or awaiting conversion.
Financial performance
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Total revenue | $183.6M | $173.6M | $320.5M | $302.8M |
| Operating income | $50.3M | $51.6M | $80.8M | $82.7M |
| Net income | $28.2M | $31.9M | $43.8M | $51.9M |
| Diluted EPS | $0.48 | $0.55 | $0.74 | $0.89 |
| Adjusted EBITDA (non-GAAP) | $52.8M | $53.6M | $85.5M | $86.6M |
Revenue rose about 6% in both periods, while operating income and adjusted EBITDA declined slightly. Net income fell about 11% in Q2 and 16% in the first half. Operating margin was approximately 27.4% in Q2 (29.7% prior year) and 25.2% for the first half (27.3% prior year); net margin was approximately 15.4% and 13.7%, respectively, versus 18.4% and 17.1% a year earlier.
- Revenue drivers: First-half franchising revenue, excluding marketing/reservation system revenue and hotel operations, increased 5% to $142.1M. Domestic royalty growth reflected RevPAR increases of 4.0% for the first half and 3.5% for Q2, modest room-count growth, and small increases in effective royalty rates. International royalties declined slightly.
- Costs and earnings: First-half SG&A rose 17% to $57.1M, including increased SkyTouch investment and headquarters-relocation costs. Interest expense increased $14.9M to $21.6M in the first half, primarily following debt issued in 2012 to finance a $600.7M special dividend.
- Cash flow: First-half operating cash flow was $29.0M, versus $36.3M; investing cash outflow was $20.6M, versus $8.9M. Capital expenditures were $21.0M, up from $6.2M, primarily due to headquarters tenant improvements. Operating cash flow less capital expenditures was approximately $8.0M, compared with $30.0M.
- Balance sheet and liquidity: Cash and equivalents were $143.8M and total debt was $866.5M at June 30, 2013. Current assets were $255.7M and current liabilities $180.6M. Shareholders’ deficit was $520.0M. Approximately $140.9M of cash was held by foreign subsidiaries and intended to remain reinvested abroad.
Material changes and notable items
- Compared with first-half 2012, the new debt burden materially increased interest expense and contributed to lower net income despite revenue growth.
- Domestic system RevPAR increased 4.0% in the first half; domestic rooms open grew 1.0%. Gross domestic additions increased, but net terminations also rose, to 126 from 89 in the first half of 2012. The domestic development pipeline declined to 365 hotels from 378.
- Management identified $12M–$14M of expected full-year 2013 SkyTouch operating expense; approximately $5.4M had been incurred in the first half. SkyTouch reported a first-half operating loss of $5.5M.
- The company revised prior cash-flow presentation for forgivable franchisee notes, moving the related cash flows from investing to operating activities. It said the reclassification was not material and did not change net income, assets, liabilities, or equity.
- First-half results included $1.1M in employee termination charges. The effective tax rate fell to 28.3% from 33.7%, reflecting foreign tax effects, a valuation-allowance release, tax-position settlements, and a retroactive tax-law extension.
Outlook, risks, and contingencies
- Management expected approximately 338 domestic hotel openings in 2013, compared with 308 in 2012, while noting restrictive construction financing, competition, and franchise terminations as constraints. Pipeline hotels may not ultimately open.
- Management expected annual investment of $20M–$40M in franchisee financing, development incentives, real estate, and related growth programs, subject to market conditions. It expected marketing and reservation activities to generate $13M–$17M of cash flow in 2013.
- The quarterly dividend was $0.185 per share. Management estimated approximately $32.8M of 2013 regular dividends, excluding the first-quarter payment made in December 2012; future dividends remain at the board’s discretion.
- The $350M secured credit facility had $72.2M outstanding under its revolver and $142.5M under its term loan. The company reported compliance with covenants; leverage was 3.68x, secured leverage 0.92x, and fixed-charge coverage 5.52x. The facility restricts dividends and other actions under specified conditions.
- Risks include recovery of the $54.8M marketing and reservation receivable, franchisee credit and development conditions, hotel demand and RevPAR, foreign currency movements, variable interest rates, and the ability to manage debt. The company had $214.7M of variable-rate debt; a hypothetical 10% rate change was estimated to change annual interest expense by $0.6M.
- Choice was added to a pending hotel and online-travel-company antitrust class action seeking unspecified damages and equitable relief; it disputes the allegations and did not expect a material effect. It also guaranteed 25% of an $18M developer loan for a Cambria Suites project, plus construction-completion and environmental obligations. Additional commitments included $10.0M of conditional franchisee financing and $6.7M of joint-venture contributions.
Important facts for investors to verify
- Whether revenue growth and RevPAR improvement can offset elevated SG&A, debt-service costs, and continuing SkyTouch losses.
- Whether franchise openings, terminations, and pipeline conversion support the stated growth expectations, particularly given financing constraints.
- Whether operating cash generation improves after the first-half decline and increased capital spending and franchisee advances.
- Whether the marketing and reservation receivable and franchisee notes remain collectible, including $9.7M of past-due mezzanine and other notes receivable.
- Whether the company continues to meet credit-facility covenants and can sustain dividends and planned investments; also monitor the antitrust case and contingent guarantees.