Choice Hotels International, Inc. — 2012 Form 10-K Summary
Business context and reporting period
Annual report for the year ended December 31, 2012; the filing also provides unaudited fourth-quarter results. Choice is primarily a hotel franchisor, with one reportable segment. At year-end, its system included 6,243 open hotels and 499,253 rooms, plus 482 hotels and 38,969 rooms in the development pipeline, across the U.S. and more than 35 countries and territories.
Financial and operating performance
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Total revenue | $691.5 million | $638.8 million | +8% |
| Franchising revenue, excluding marketing and reservation revenue and hotel operations | $302.2 million | $285.4 million | +6% |
| Operating income | $193.1 million | $171.9 million | +12% |
| Net income | $120.7 million | $110.4 million | +9% |
| Diluted EPS | $2.07 | $1.85 | +12% |
| Operating cash flow | $161.0 million | $134.8 million | +$26.2 million |
Operating margin was approximately 27.9% of reported revenue; net margin was approximately 17.5%. Marketing and reservation revenue of $384.8 million is contractually spent on system activities and is matched by reported expense, so it does not generate company income. Domestic royalty revenue rose 7%, supported by 6.2% RevPAR growth, 0.8% room growth and a one-basis-point increase in the effective royalty rate to 4.33%. Domestic RevPAR increased 6.2% to $40.84, as occupancy rose 200 basis points to 55.5% and ADR increased 2.5% to $73.60.
Fourth-quarter revenue was $178.3 million versus $165.9 million, operating income was $45.2 million versus $38.7 million, and net income was $24.5 million versus $24.8 million. Diluted EPS was $0.42 in both quarters. The fourth quarter included a $1.8 million pension-settlement loss; annual results also benefited from a $4.5 million tax benefit related to foreign operations.
Liquidity, debt and capital allocation
Year-end cash and cash equivalents were $134.2 million, versus $107.1 million a year earlier. Current assets were $233.5 million and current liabilities $176.1 million. Total debt was $855.3 million, including $400 million of 2022 senior notes, $249.5 million of 2020 senior notes and $203.3 million outstanding under the secured credit facility. Long-term debt on the balance sheet was $847.2 million. Interest expense increased to $27.2 million from $12.9 million, primarily due to borrowing used to fund the special dividend.
In August 2012, Choice paid a special dividend of $10.41 per share, approximately $600.7 million in total, financed with debt proceeds. Regular dividends paid during 2012 totaled $53.4 million and included five quarterly payments; total dividends paid, including the special dividend, were $654.1 million. The company repurchased approximately $19.9 million of shares under its authorization. Shareholders’ deficit was $548.9 million at year-end, largely reflecting the special dividend and treasury stock.
Capital expenditures were $15.4 million; investing cash outflow was $58.0 million, including $34.9 million of notes advanced to franchisees and $20.3 million invested in equity-method ventures. The company reported $68 million invested in franchisee financing, investment and development-support programs. It was in compliance with credit-facility covenants at year-end, with total leverage of 3.62x, secured leverage of 0.87x and fixed-charge coverage of 8.18x. Approximately $125.3 million of cash related to undistributed foreign subsidiary earnings that management intended to reinvest abroad.
Changes, outlook, risks and unusual items
- Domestic hotels open increased by 82 to 5,083; domestic rooms increased 0.8%. Gross domestic openings rose to 308 from 256, driven mainly by conversions. Quality’s domestic room count grew 7.2%, while Comfort Inn’s declined 3.5%.
- Management expected 315 new franchise units to open in 2013. It anticipated annual investment of $20 million to $40 million in franchisee support and emerging-brand development, and approximately $32.1 million in regular 2013 dividends, excluding the first-quarter payment made in December 2012. These are operating and capital-allocation expectations, not earnings guidance.
- Operating cash flow improved, including a $30.3 million cash contribution from marketing and reservation activities. Management expected those activities to provide $12 million to $17 million of operating cash flow in 2013.
- Key risks include lodging demand and room-rate volatility, economic downturns, competition for franchisees and guests, franchisee access to financing and ability to maintain properties, international currency and political exposure, technology and cybersecurity disruption, and the company’s increased indebtedness and variable-rate exposure. Marketing and reservation advances are recoverable under franchise agreements, but collection could be affected by weaker franchisee performance or system growth.
- Unusual items included the debt-funded special dividend, $14.3 million of additional interest expense, a $0.5 million debt-extinguishment loss, a $1.8 million pension-settlement loss, and a $4.5 million foreign-operations tax benefit. The company also disclosed a limited guaranty of 25% of an $18 million developer loan for a Cambria Suites project, along with construction-completion and environmental guarantees.
- Management said routine litigation was not expected to have a material adverse effect. The independent auditor issued an unqualified opinion and reported effective internal control over financial reporting.
Most important facts for investors to verify
- Whether franchise growth and RevPAR gains continue to support royalty revenue, particularly given modest domestic room growth and the decline in international rooms.
- Debt balances, interest costs, covenant headroom and the effect of debt-funded distributions on future flexibility to invest, repurchase shares and pay dividends.
- Recoverability of the $42.2 million marketing and reservation receivable and the $49.5 million net notes-receivable portfolio, including impaired and past-due loans.
- Conversion of the 482-hotel global pipeline into open properties, and the quality and economics of incentives used to win franchise agreements.
- Exposure under development financing, joint-venture commitments, guarantees and other contingent obligations, including the White Plains project.