Choice Hotels International, Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; comparisons are with Q1 2012 unless noted. Choice is primarily a hotel franchisor, with 6,264 hotels open and 476 in development, conversion or awaiting construction across the system. Results are seasonal; the company cautions that first-quarter results are not necessarily indicative of the full year. Financial figures below are in U.S. dollars; millions are used unless stated otherwise.
Key financial results
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Total revenue | $136.9 million | $129.2 million | Up 6.0% |
| Franchising revenue, company-defined non-GAAP | $59.5 million | $57.3 million | Up 4% |
| Operating income | $30.5 million | $31.1 million | Down 1.9% |
| Net income | $15.5 million | $20.0 million | Down 22% |
| Diluted EPS | $0.26 | $0.34 | Down 24% |
| EBITDA, company-defined non-GAAP | $32.6 million | $33.1 million | Down 1.3% |
| Operating cash flow | $1.9 million | $4.4 million | Down $2.5 million |
Operating margin was approximately 22.3%, versus 24.1%; net margin was approximately 11.3%, versus 15.5%. Royalty fees rose 4% to $49.7 million. Domestic royalty fees increased 5%, supported by 4.6% RevPAR growth, 0.8% growth in domestic franchised rooms and a five-basis-point increase in the effective royalty rate to 4.39%. Domestic RevPAR increased 4.6%, with average daily rate up 2.3% and occupancy up 100 basis points. Marketing and reservation revenue and expense each rose 8% to $76.4 million and are reported gross; the company says these funds are contractually dedicated to system marketing and reservation activities.
Net income was pressured chiefly by interest expense, which increased $7.7 million to $10.8 million, following debt issuance used to fund the 2012 special dividend. Other gains also fell, from $2.0 million to $0.7 million, largely reflecting lower investment gains in employee benefit plans. SG&A increased 11% to $26.9 million, including $2.2 million of alternative-growth spending, principally for SkyTouch Technology, and higher headquarters rent and franchise-sales compensation.
Cash, debt and liquidity
- Cash and cash equivalents were $140.2 million at March 31, 2013, compared with $134.2 million at year-end. Cash exceeded current liabilities of $183.0 million only when considered alongside other current assets; the reported current ratio was approximately 1.31.
- Total debt was $871.3 million, up from $855.3 million at December 31, 2012; long-term debt was $863.1 million. Cash-adjusted debt was approximately $731.1 million. The company reported $144.4 million outstanding on its term loan and $75.0 million on its revolving facility.
- Operating cash flow of $1.9 million was below $13.8 million of investing cash outflow, including $13.6 million of property and equipment investment. Financing provided $18.1 million, including $18.0 million of net revolving-credit borrowings.
- Cash includes $134.7 million associated with undistributed foreign-subsidiary earnings that management said it intended to keep invested abroad; using it domestically could create additional U.S. taxes.
- The company reported compliance with its credit-facility covenants. At quarter-end, leverage ratios were 3.72x total and 0.95x secured; fixed-charge coverage was 6.53x. The facility has a $200 million revolver and financial covenants that tighten over time.
Material changes and operating developments
- Domestic franchised rooms rose 0.8% year over year to 395,902; domestic hotels rose 1.7% to 5,091. International rooms increased 0.9% to 104,474, while international royalty fees declined 1% to $5.5 million, partly due to performance and currency movements.
- Domestic franchise agreements executed increased to 83 from 64, and gross domestic openings rose to 62 from 39. However, net domestic terminations increased to 54 from 34, principally due to standards non-compliance and unpaid fees. The domestic development pipeline had 395 hotels, including 232 new-construction projects; the filing notes financing constraints and that pipeline projects may not open.
- Marketing and reservation fees receivable increased to $51.3 million from $42.2 million. Management concluded the balance was fully collectible and recorded no allowance, but identified franchisee revenue, system growth and international growth as factors that could affect recovery.
- Capital expenditures increased to $13.6 million from $3.1 million, primarily due to tenant improvements for the headquarters relocation. The filing also reports $10.4 million of property-and-equipment investment as a non-cash investing and financing activity.
Outlook, risks and unusual items
- No consolidated revenue, earnings or EPS guidance is provided. Management expected approximately 324 new hotel openings in 2013, compared with 308 in 2012, and expected annual investment of $20 million to $40 million in franchise-development incentives and related support, subject to market conditions.
- SkyTouch Technology, a newly formed hotel-technology division, was expected to incur $12 million to $14 million of operating expenses for full-year 2013; approximately $2.2 million had been incurred in Q1. Management also expected $12 million to $17 million of cash flow from marketing and reservation activities in 2013.
- Management said operating cash flow and available financing capacity should be adequate for expected needs. It expected to continue quarterly dividends, subject to business performance, economic conditions, tax rules and board discretion. The regular Q1 dividend had been paid early in December 2012; a $0.185-per-share dividend was declared for payment in April, and another was declared for July.
- The $600.7 million special dividend paid in August 2012 was financed with proceeds from senior notes and the new credit facility; the resulting debt burden is a principal reason Q1 interest expense rose. The company reported $871.3 million of debt and $219.4 million of variable-rate debt. A 10% change in the effective rate on variable-rate debt would change annual interest expense by an estimated $0.6 million.
- Q1 included $0.8 million of employee termination charges; $2.0 million of termination benefits remained payable at quarter-end. The filing also describes a guarantee covering 25% of a developer’s $18 million hotel-construction loan, plus completion and environmental undertakings. Other commitments include franchisee financing and joint-venture contributions.
- Management identified risks including economic and lodging-industry conditions, franchisee and brand performance, room supply and demand, technology execution, development financing, litigation and management of indebtedness. It reported no material change to the risk factors in the 2012 Form 10-K, no expected material adverse effect from routine litigation, and effective disclosure controls as of March 31, 2013.
Important facts for investors to verify
- Whether RevPAR gains, franchise sales and the hotel pipeline translate into sustained openings and royalty growth, given higher terminations and constrained construction financing.
- How the higher debt and interest burden affect earnings, cash generation and covenant headroom; also confirm the location and potential tax consequences of the substantial foreign cash balance.
- Whether the $51.3 million marketing and reservation receivable remains recoverable as franchisee revenues and system growth evolve.
- Actual 2013 spending and results for SkyTouch and franchise-development investments versus management’s stated expectations.
- The scope, timing and potential exposure of the hotel-loan guarantee and outstanding franchisee and joint-venture funding commitments.