Choice Hotels International, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. Unaudited consolidated results. Choice is primarily a hotel franchisor; at quarter-end it had 6,199 hotels open and 453 in its development pipeline across the U.S. and more than 35 other countries and territories. Financial amounts below are in millions, except per-share data.
Key financial results
| Metric | Q2 2012 | Q2 2011 | H1 2012 | H1 2011 |
|---|---|---|---|---|
| Total revenue | $173.6 | $165.3 | $302.8 | $280.6 |
| Operating income | $51.6 | $45.1 | $82.7 | $70.8 |
| Net income | $31.9 | $27.6 | $51.9 | $43.3 |
| Diluted EPS | $0.55 | $0.46 | $0.89 | $0.72 |
| Operating margin | 29.7% | 27.3% | 27.3% | 25.2% |
| Operating cash flow | — | — | $37.8 | $32.1 |
- Q2 royalty fees rose 7% to $66.1 million; H1 royalties increased 8% to $113.9 million. Management attributed domestic royalty growth mainly to higher RevPAR and room count. Domestic RevPAR increased 7.7% in Q2 and 8.0% in H1.
- Franchising revenue, excluding marketing/reservation fees and hotel operations, increased 6% to $77.8 million in Q2 and 8% to $135.0 million in H1. Marketing and reservation revenue is matched by related expenses under franchise agreements and does not generate reported operating income.
- SG&A declined 7% in Q2 and 3% in H1, reflecting productivity and cost-streamlining measures, partly offset in H1 by a $1.5 million litigation settlement and higher deferred-compensation expense. H1 other income and expenses improved from $6.8 million of expense to $4.5 million, including the absence of a prior-year $1.8 million land impairment loss and gains on benefit-plan investments.
Balance sheet, debt and liquidity
- At June 30, cash and cash equivalents were $485.4 million, versus $107.1 million at December 31, 2011. Current assets were $583.9 million and current liabilities $181.7 million.
- Total debt was $652.4 million, up from $252.7 million at year-end, following issuance of $400 million of 5.75% senior notes due 2022 on June 27. The existing $250 million senior notes due 2020 remain outstanding. No borrowings were outstanding under the then-existing $300 million unsecured revolver at June 30.
- H1 financing cash flow was $350.5 million, largely reflecting $393.4 million of debt proceeds, alongside $22.2 million of treasury-stock purchases and $21.4 million of dividends paid. Investing cash use was $10.4 million; capital expenditures were $6.2 million.
- Management reported compliance with the existing revolver covenants at June 30, with a total leverage ratio of approximately 3.2x and interest coverage of approximately 11.9x. Shareholders’ deficit was $11.2 million.
Changes, outlook and notable items
- Domestic hotels open increased 1.3% year over year to 5,024; rooms increased 1.0% to 393,315. The domestic development pipeline declined 16% to 378 hotels, including a 27% decline in new-construction pipeline units. Management cited restricted construction financing, competitive retention efforts and terminations of projects that had not opened.
- Management expected approximately 243 new franchise-unit openings in 2012, down from 256 in 2011. It estimated annual investment of $20–$40 million in franchisee financing, guarantees and development incentives, subject to market conditions, and expected $7–$11 million of cash flow from marketing and reservation activities in 2012.
- On July 26, after quarter-end, the board declared a special dividend of $10.41 per share, approximately $600 million, payable August 23, 2012. The company said it would fund it with proceeds from the $400 million notes and a new $350 million senior secured facility entered into July 25, including a $150 million term loan and planned $50 million revolver borrowing. The new facility replaced the unsecured revolver and is secured in part by domestic franchise agreements and subsidiary interests; it contains leverage, secured-leverage and fixed-charge-coverage covenants.
- The special dividend and new borrowing materially increase leverage. The filing cautions that debt may constrain financing, investment, dividends and repurchases, and that variable-rate borrowings expose the company to interest-rate risk. Management nevertheless believed operating cash flows and financing capacity would meet expected business needs.
- Other notable matters: the company agreed on June 27 to purchase land for $30 million; its planned headquarters lease has minimum expected rent payments of approximately $67.6 million over its initial 10-year term. The company had $64.8 million in marketing/reservation fee receivables, up from $54.0 million at year-end, and judged them fully collectible, while warning recovery could be affected by weaker hotel performance or system growth. A non-qualified executive pension plan was being terminated, with a projected obligation of about $12.0 million and a possible 2012 settlement gain or loss.
- Management cited routine litigation as not expected to have a material adverse effect; a franchisee arbitration settlement in April had no material financial impact. A $0.4 million employee termination charge was recorded in H1. No material change in risk factors was reported except the increased-indebtedness risk.
Important facts for investors to verify
- How the special dividend and new secured facility affect post-dividend cash, total debt, leverage, interest expense and covenant headroom.
- Whether hotel RevPAR growth continues and whether the smaller development pipeline translates into slower openings and royalty growth.
- Collectibility and recovery timing for the $64.8 million marketing and reservation receivable, and credit exposure in franchisee notes; approximately $9.2 million of loan-loss reserves were recorded against $34.2 million of notes receivable.
- Execution and costs of the $30 million land purchase and headquarters lease, plus the settlement outcome of the executive pension plan.
- Future quarterly dividends and repurchases remain subject to board discretion, business performance and financing restrictions.