Choice Hotels International, Inc. — Form 10-Q Summary
Business context and reporting period
Quarter ended September 30, 2013; comparisons are with the quarter and nine months ended September 30, 2012. Choice is primarily a hotel franchisor operating 11 brands. At quarter-end, its system included 6,303 open hotels and 455 hotels under construction, awaiting conversion or approved for development, across the U.S. and more than 35 other countries and territories.
Financial performance and liquidity
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $223.2M | $210.4M | $543.6M | $513.2M |
| Operating income | $66.5M | $65.3M | $147.3M | $147.9M |
| Net income | $41.5M | $44.4M | $85.3M | $96.2M |
| Diluted EPS | $0.70 | $0.76 | $1.45 | $1.65 |
| Adjusted EBITDA | $68.9M | $67.2M | $154.4M | $153.9M |
Revenue increased 6% in both periods, while operating income was nearly flat. Net margin declined to approximately 18.6% from 21.1% in Q3 and to 15.7% from 18.8% for the nine months. Q3 diluted EPS declined 8%; nine-month EPS declined 12%. Management attributed the nine-month earnings decline principally to $15.5M higher interest expense, following debt issued in 2012 to fund a $600.7M special dividend. Q3’s higher effective tax rate, 27.9% versus 20.3%, also weighed on net income; the prior-year quarter included a favorable $4.5M foreign tax adjustment.
Royalty fees were $83.1M in Q3 and $201.2M for nine months, up 3% year over year in both periods. Domestic Q3 RevPAR rose 3.0%, reflecting higher rates and occupancy; domestic rooms open increased 0.7%. Nine-month domestic RevPAR rose 3.6%. International royalties were slightly lower, with currency movements and operating performance offsetting room growth.
Operating cash flow was $105.0M for nine months, down from $118.4M. Capital expenditures were $26.4M versus $12.5M, largely for headquarters relocation and data-center technology. Cash and equivalents were $161.1M at September 30, 2013, versus $134.2M at year-end 2012; approximately $149.8M was held by foreign subsidiaries and management said it was intended to remain reinvested abroad. Current assets were $258.3M and current liabilities $179.1M.
Total debt was $825.1M, down from $855.3M at year-end; cash less total debt implies net debt of approximately $664.0M. The company reported compliance with credit-facility covenants and leverage ratios of 3.46x total leverage, 0.72x secured leverage and 5.52x fixed-charge coverage. Debt included $400M of senior notes due 2022, $250M due 2020 and borrowings under a $350M secured facility.
Material changes and management outlook
- Franchising revenue excluding marketing and reservation fees, hotel operations and SkyTouch was $95.5M for Q3, up 6%; nine-month franchising revenue was $237.6M, also up 6%. Growth reflected royalties, initial and relicensing fees, and procurement services.
- Q3 domestic RevPAR increased 3.0%; the effective royalty rate edged up to 4.30% from 4.29%. Domestic executed franchise agreements increased to 129 from 89 in Q3 2012. Management expected approximately 338 new hotel openings in 2013, compared with 308 in 2012, while noting that financing constraints continued to impede new construction.
- SG&A rose 16% in Q3 and 17% year to date. Drivers included SkyTouch investment, headquarters relocation costs, franchise-sales compensation and deferred-compensation expense. SkyTouch was expected to incur $12M–$14M of operating expenses for full-year 2013; $8.8M had been incurred through September.
- Management expected annual investment of $20M–$40M in franchisee support, development incentives and related strategic opportunities, generally seeking to recycle investments within five years. It also expected $26M–$30M of 2013 cash flows from marketing and reservation activities.
- The quarterly dividend was $0.185 per share; future dividends and repurchases remain subject to board discretion, business conditions and credit-facility restrictions. Management estimated approximately $32.8M of regular 2013 dividends, excluding the first-quarter payment made in December 2012.
Risks, contingencies and unusual items
The company recorded $1.5M of employee termination charges during the first nine months. It revised the classification of cash flows related to forgivable franchisee notes from investing to operating activities; management said this correction did not affect previously reported net income, comprehensive income, assets, liabilities or shareholders’ deficit. Certain prior-year cash-flow and consolidating-statement presentations were also revised, which the company assessed as immaterial.
Choice was added in May 2013 to a multidistrict class action alleging anticompetitive practices by online travel and hotel companies. The complaint seeks unspecified damages and equitable relief; Choice disputes the claims and did not expect a material effect. The company also guaranteed 25% of principal, interest and certain expenses on a developer’s $18M hotel loan, and provided construction-completion and environmental indemnities. It had $11.3M of conditional franchisee financing commitments and $4.9M of future joint-venture capital commitments reported in the notes; the MD&A separately cites $11.1M and $6.4M expected to be advanced within 12 months, so amounts should be reconciled.
Other risks include franchisee performance and credit quality, recovery of marketing/reservation advances, hotel financing constraints, foreign-exchange exposure, interest-rate risk, and the company’s ability to manage leverage. The company held $170.1M of variable-rate debt; a hypothetical 10% rate change was estimated to alter annual interest expense by $0.4M. Management stated that existing risk factors had not materially changed and that disclosure controls were effective.
Important facts for investors to verify
- Reconcile franchisee financing commitment amounts disclosed in the notes and MD&A, and track future advances and collectibility of notes receivable.
- Assess the availability and practical usability of cash held overseas, alongside debt maturities, facility capacity and covenant headroom.
- Monitor RevPAR, royalty rates, room counts, franchise openings and terminations, especially the conversion of the development pipeline into operating hotels.
- Evaluate whether SkyTouch and other growth investments deliver returns while SG&A rises, and whether marketing/reservation advances remain recoverable.
- Follow developments in the antitrust litigation, hotel-loan guarantees and other contingent commitments.