Choice Hotels International, Inc. — 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010; filed March 1, 2011. The filing also provides fourth-quarter results. Choice is primarily a hotel franchisor operating one reportable segment, with limited owned-hotel exposure (three MainStay Suites hotels).
Business context and operating footprint
At year-end, Choice had 6,142 hotels open with 495,145 rooms, plus 621 hotels and 50,787 rooms under construction, awaiting conversion or approved for development, across the United States and international markets. International operations represented 8% of 2010 revenue and about 19% of system hotels. Franchise fees are driven principally by hotel room revenue, system size and effective royalty rates; marketing and reservation fees are contractually spent on system services.
Financial performance
| Metric | 2010 | 2009 | Change |
|---|---|---|---|
| Total revenue | $596.1 million | $564.2 million | +5.7% |
| Franchising revenue, company-defined non-GAAP | $262.8 million | $254.7 million | +3% |
| Operating income | $160.8 million | $148.1 million | +9% |
| Net income | $107.4 million | $98.3 million | +9% |
| Diluted EPS | $1.80 | $1.63 | +10% |
| Operating cash flow | $144.9 million | $112.2 million | +$32.7 million |
| Capital expenditures | $24.4 million | $11.1 million | +$13.2 million |
| Cash and cash equivalents | $91.3 million | $67.9 million | +$23.4 million |
Operating margin on reported revenue was approximately 27.0% (2010) versus 26.2% (2009); net margin was approximately 18.0% versus 17.4%. These ratios include marketing and reservation revenue and matching expense, which the company says generate no income or loss. Royalty revenue rose 6% to $230.1 million; initial franchise and relicensing fees declined to $9.3 million from $12.9 million. Domestic RevPAR increased 2.8%, reflecting occupancy up 190 basis points and ADR down 1%. Domestic rooms grew 1.3%; the effective domestic royalty rate rose from 4.25% to 4.29%.
Fourth-quarter 2010 revenue was $155.0 million, operating income $38.4 million and net income $24.1 million, compared with $140.7 million, $34.1 million and $23.6 million, respectively, in fourth-quarter 2009. Diluted EPS was $0.40 in both quarters.
Debt, liquidity and capital allocation
Year-end debt totaled $252.2 million, primarily $249.4 million of 5.7% senior notes (effective rate 6.19%) due in 2020; the company had $0.2 million drawn on its old revolving facility. Long-term debt on the balance sheet was $251.6 million. The company reported covenant compliance and leverage of about 1.5x against a 3.25x maximum under the existing revolver. Its $350 million facility matured in June 2011; after year-end, Choice refinanced it with a $300 million unsecured revolver maturing in February 2016, with an option to increase commitments by up to $150 million.
Current assets were $163.6 million and current liabilities $165.3 million; total assets were $411.7 million and total liabilities $469.8 million. Shareholders’ deficit was $58.1 million, largely reflecting treasury stock. Operating cash flow funded dividends of $43.8 million; the company repurchased about $8.7 million of shares under its authorization. It invested $21.7 million in franchisee financing, guarantees and development-related real estate programs during 2010, of which $5 million was repaid. The company expected annual program investment of $20–$40 million and indicated 2011 dividends of about $43.8 million at the then-current rate.
Material changes, outlook and risks
- Hotel-sector recovery lifted domestic RevPAR and royalty revenue, but franchise pipeline and additions remained constrained by tight credit. Domestic pipeline hotels fell 29% to 516, and net domestic additions were 87 versus 190 in 2009.
- Management expected approximately 285 hotels to open in 2011, down from 327 in 2010, including an expected fall in new-construction openings from 78 to 28. Management noted actual openings may differ from pipeline counts.
- Marketing and reservation activities generated $4.7 million of cash in 2010; management expected a net cash use of $2–$6 million in 2011. The related receivable for cumulative system spending above fees collected rose to $42.5 million from $33.9 million. Recovery depends on franchisee performance and system growth.
- Interest expense increased to $6.7 million after issuance of the senior notes replaced low-cost revolving borrowings. A $8.7 million payment to settle a pre-issuance interest-rate swap was recorded as a deferred loss in other comprehensive income and is amortized over the debt term.
- 2010 included $1.7 million of termination benefits in the adjusted operating-income reconciliation; income taxes included a $3.3 million out-of-period deferred-tax adjustment, partly offset by $1.6 million of prior-period tax positions, plus $1.6 million of identified federal tax benefits. Management said the adjustments were not material.
- A franchisee class action filed in December 2010 challenges practices related to the Choice Privileges program. Choice moved to compel arbitration, disputed the claims and intended to defend the case; management did not expect ongoing legal proceedings to materially affect financial condition, results or cash flow.
- Other material risks include economic and lodging-cycle weakness, franchisee access to financing, brand competition and terminations, technology and data-security interruptions, international currency and political risks, debt covenant/default exposure, and credit losses from franchisee loans or guarantees. Notes receivable were $26.1 million gross with $10.0 million of reserves; $10.8 million of notes were identified as impaired, with an $8.6 million allowance.
- PricewaterhouseCoopers issued an unqualified opinion on the financial statements and internal controls; management and the auditor reported effective internal control over financial reporting at year-end.
Most important facts for investors to verify
- Whether domestic RevPAR recovery and royalty-rate improvement persist, and how occupancy and ADR trends evolve.
- Whether the smaller hotel pipeline converts into openings, particularly the forecast 2011 openings and new-construction units.
- Collectability and future growth of the $42.5 million marketing and reservation receivable, as well as the impaired franchisee loans and guarantees.
- Debt refinancing terms, covenant headroom, interest costs and the company’s ability to fund dividends, repurchases and planned $20–$40 million annual development support.
- Developments in the Choice Privileges class action, tax contingencies and other legal or regulatory exposures.