Choice Hotels International, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparisons are with Q1 2013 unless otherwise noted. Choice is primarily a hotel franchisor, with 6,364 hotels open and 493 in its development pipeline across the U.S. and more than 35 other countries and territories.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Total revenue | $147.3 million | $135.9 million | +8.4% |
| Franchising revenue, excluding marketing and reservation fees and SkyTouch | $63.2 million | $59.5 million | +6.3% |
| Operating income | $34.7 million | $30.5 million | +13.7% |
| Income from continuing operations | $17.3 million | $15.6 million | +11.4% |
| Net income | $19.0 million | $15.5 million | +22.2% |
| Diluted EPS | $0.32 | $0.26 | +23.1% |
| Adjusted EBITDA (non-GAAP) | $36.8 million | $32.6 million | +13.0% |
Total revenue includes marketing and reservation fees, which are matched by related expenses and do not generate net income for the Company. Operating margin on reported revenue was approximately 23.6%, versus 22.5% a year earlier. Royalty fees rose 3.9%; procurement services revenue increased 21% to $4.8 million. SG&A declined 1.7% to $26.5 million.
- Franchise performance: Domestic RevPAR rose 5.6%, with occupancy up 200 basis points and average daily rate up 1.1%. Domestic rooms open increased 1.6% to 402,417. International rooms were nearly flat, while international royalties fell 5%, partly due to foreign currency movements.
- Cash flow: Operating cash flow was $5.3 million, compared with $0.1 million. Investing activities provided $1.0 million, including $8.7 million of hotel-sale proceeds; capital expenditures were $3.0 million versus $13.6 million. Financing activities provided $0.2 million. Cash increased to $174.9 million.
- Debt and liquidity: Total debt was $806.5 million, including $11.0 million current and $795.5 million long-term, up from $793.6 million at year-end. The Company had $151.9 million outstanding under its credit facility, including $15.0 million on the revolver. It reported compliance with all covenants; leverage was 3.34x, secured leverage 0.63x, and fixed-charge coverage 5.72x.
- Balance sheet: Current assets were $277.7 million and current liabilities $168.3 million. Shareholders’ deficit was $454.6 million.
Material changes and unusual items
- Management approved disposal of three Company-owned MainStay Suites hotels; two were sold during Q1. A $2.6 million gain on disposal contributed to $1.6 million of discontinued-operations income, compared with a $33,000 loss in Q1 2013. The third hotel was expected to sell during 2014; a Greenville property sale for $3.1 million closed on April 29, 2014.
- Continuing-operations income growth reflected higher operating income, partly offset by the effective tax rate increasing to 30.8% from 25.8%. The prior-year rate benefited from tax-related settlements and legislation.
- SkyTouch Technology incurred $3.3 million of SG&A in Q1. Management expected 2014 SG&A in excess of SkyTouch revenue of approximately $20 million.
- Marketing and reservation activities generated $5.3 million of operating cash in Q1; the related cumulative advance asset was $18.9 million. Management expected these activities to provide $18 million to $22 million of cash flow in 2014.
Outlook, risks and contingencies
- Management expected approximately 348 new franchise openings in 2014, up from 340 in 2013. The filing cautions that pipeline properties may not ultimately open; financing constraints, competition and franchise terminations remain relevant.
- Management anticipated investing $20 million to $40 million annually in development incentives, financing and related growth opportunities over the next several years, generally seeking to recycle investments within five years.
- The Company expected regular 2014 dividends of approximately $43.6 million at the then-current rate of $0.185 per share per quarter. Future dividends remain subject to board approval, business performance and other factors.
- Approximately $164.2 million of cash was held by foreign subsidiaries and was intended to remain invested abroad; using it domestically could result in additional U.S. income taxes.
- Commitments included $11.1 million for franchisee financing, $31.1 million for qualifying Comfort Inn and Comfort Suites renovations, $4.1 million of additional joint-venture contributions, and $3.3 million of hotel-construction lending. These are conditional commitments, not necessarily funded amounts.
- Choice had limited payment guarantees for two franchisee-related hotel loans, generally covering up to 25% of outstanding principal, plus related obligations. It also provided construction-completion and environmental indemnities for one project. Management did not expect ordinary-course litigation to materially affect the Company.
- Disclosed risks include lodging demand and economic conditions, franchise-system performance and brand appeal, technology and cybersecurity, international operations, foreign exchange and interest rates, and the Company’s ability to manage debt. The filing reported $151.9 million of variable-rate debt; a 10% change in the effective rate was estimated to change annual interest expense by $0.3 million.
Key facts for investors to verify
- How much of earnings growth and diluted EPS was attributable to the nonrecurring hotel-sale gain versus continuing franchising operations.
- Whether domestic RevPAR and room growth translate into sustained royalty growth, and whether the effective royalty-rate decline continues.
- Whether the 2014 opening outlook, SkyTouch investment estimate and marketing-system cash-flow outlook are achieved.
- Debt levels, covenant headroom, dividend capacity, and the availability of foreign-held cash for domestic needs.
- Recoverability of franchisee notes and the marketing and reservation advance asset, as well as actual funding exposure under stated commitments and guarantees.