Business context and reporting period
Choice Hotels International, Inc. is primarily a hotel franchisor. This unaudited Form 10-Q covers the three months ended March 31, 2011, compared with the three months ended March 31, 2010; balance-sheet comparisons are with December 31, 2010. The company reported 6,128 open hotels and 606 hotels in its development pipeline across the U.S. and more than 40 countries and territories. First-quarter results are seasonally weaker and are not necessarily indicative of full-year results.
Financial results and liquidity
Amounts below are in millions of dollars except per-share data. Marketing and reservation fees are contractually spent on system activities, so the related revenue and expense largely offset.
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Total revenue | $115.3 | $107.4 | +7.3% |
| Franchising revenue, excluding marketing/reservation and hotel operations | $51.5 | $47.7 | +7.8% |
| Operating income | $25.7 | $23.8 | +7.7% |
| Net income | $15.7 | $15.8 | -0.4% |
| Diluted EPS | $0.26 | $0.26 | Unchanged |
| Operating margin on total revenue | 22.3% | 22.2% | +0.1 percentage point |
- Royalty fees rose 8% to $44.2 million. Domestic RevPAR increased 5.5%, domestic rooms under franchise increased 0.8%, and the domestic effective royalty rate rose from 4.32% to 4.35%.
- Operating cash flow was negative $5.2 million, versus positive $7.0 million a year earlier. The filing attributes the decline mainly to senior-note interest payments, incentive compensation and working-capital timing. Investing cash outflow was $5.6 million; financing cash outflow was $4.4 million.
- Cash and cash equivalents were $76.4 million at March 31, down from $91.3 million at year-end. Current assets were $147.9 million and current liabilities $149.7 million. The company said cash flows and available financing capacity were adequate for expected needs.
- Total debt was $260.5 million, up from $252.2 million at year-end; cash exceeded the $8.1 million drawn on the revolver. Long-term debt included $249.4 million carrying value of $250 million senior notes due 2020. The new $300 million revolving facility matures in 2016.
- The company reported a shareholders’ deficit of $49.0 million, improved from a $58.1 million deficit at year-end. It declared a quarterly dividend of $0.185 per share; the quarter’s dividend payment was approximately $11.0 million.
Material changes versus the prior comparable period
- Revenue and operating income grew, supported by higher royalties and initial franchise and relicensing fees. Adjusted net income, a company-defined non-GAAP measure, was $16.9 million versus $16.0 million; adjusted diluted EPS was $0.28 versus $0.27.
- Reported net income was nearly flat despite operating growth. Interest expense increased to $3.2 million from $0.6 million, principally reflecting the 2010 issuance of senior notes at a higher effective rate than the former revolving borrowings. Other gains and losses shifted to a net expense of $1.0 million from net income of $1.0 million.
- The 2011 results included a $1.8 million land impairment charge and $0.3 million of employee termination charges. The effective tax rate fell to 28.2% from 35.9%, partly due to a $1.4 million adjustment reducing current federal taxes payable.
- The domestic development pipeline fell 23% to 508 hotels, and the number of domestic hotels open declined by 23 during the quarter. The company reported 42 gross domestic additions versus 78 in Q1 2010.
- The new revolver replaced a $350 million facility. At quarter-end, the company reported a 1.5x leverage ratio and 16.4x interest coverage, within the facility’s maximum leverage covenant of 3.5x and minimum coverage covenant of 3.5x.
Outlook, commentary, risks and unusual items
- Management expected approximately 277 new franchise openings in 2011, down from 327 in 2010, citing tight credit markets, reduced new construction and the development pipeline. The filing does not provide a clear full-year earnings or revenue forecast.
- Management expected annual investment of $20 million to $40 million in franchisee financing, investment, guarantees and development-related real estate programs, depending on market conditions. It expected marketing and reservation activities to use $2 million to $6 million of cash in 2011.
- The company expected to continue dividends, subject to business performance and other conditions; at the then-current rate, projected 2011 dividends were approximately $44 million. It also said operating cash flow was expected to support the remaining 3.6 million-share repurchase authorization, though no shares were repurchased under the program in Q1.
- Marketing and reservation fee receivables rose to $54.7 million from $42.5 million at year-end. Management noted that weak hotel revenues, slower system growth or lower occupancy and rates could impair recovery of these advances.
- Approximately $72.3 million of cash was held by foreign subsidiaries and treated as permanently reinvested; using it domestically could trigger additional U.S. taxes. The company had $7.0 million of conditional commitments for franchisee financing, including $3.6 million expected to be advanced within 12 months, and a further $3.4 million commitment to a joint venture expected to be funded in 2011.
- Credit, hotel demand and supply, franchisee performance and brand appeal, technology, foreign exchange, interest rates and debt management were identified as risks. The filing reported no derivatives and stated that disclosure controls were effective, with no material change in internal control over financial reporting during the quarter.
- A franchisee class action concerning the Choice Privileges rewards program was stayed pending arbitration on April 4, 2011; the company said it was then unaware of arbitration actions filed by plaintiffs. Management said ordinary-course lawsuits were not expected individually to have a material adverse effect.
Important facts for investors to verify
- Whether RevPAR, royalty rates and franchise-room growth continue to offset the weaker development pipeline and hotel openings.
- Whether operating cash flow turns positive and the marketing/reservation receivable remains recoverable as the system’s revenues and growth evolve.
- Debt costs, revolver usage, covenant headroom and the effect of senior-note interest on earnings and cash generation.
- The timing and actual funding of franchisee and joint-venture commitments, and any change in the treatment or availability of foreign-held cash.
- Progress and potential financial effects of the Choice Privileges arbitration, and any changes in the land valuation, franchisee loan reserves or other contingencies.