Choice Hotels International, Inc. — 2011 Form 10-K
Business context and reporting period
Annual report for the year ended December 31, 2011; fourth-quarter figures are unaudited. Choice is primarily a hotel franchisor operating 11 brands in one reportable segment. At year-end, its system comprised 6,178 open hotels and 490 hotels in the development pipeline, across the U.S. and more than 35 other countries and territories.
Financial and operating performance
| Metric | 2011 | 2010 |
|---|---|---|
| Total revenue | $638.8 million | $596.1 million |
| Operating income | $171.9 million | $160.8 million |
| Net income | $110.4 million | $107.4 million |
| Diluted EPS | $1.85 | $1.80 |
| Operating cash flow | $134.8 million | $144.9 million |
| Cash and cash equivalents | $107.1 million | $91.3 million |
| Total debt | $252.7 million | $252.2 million |
Revenue grew 7%; operating income grew 7%, and net income grew 3%. Operating margin was approximately 26.9% versus 27.0% in 2010; net margin was approximately 17.3% versus 18.0%. Core franchising revenue, excluding marketing and reservation fees and hotel operations, rose 9% to $285.4 million. Royalty revenue increased 7% to $247.2 million. Domestic system RevPAR rose 6.2%, reflecting occupancy growth of 220 basis points and ADR growth of 1.9%; the effective domestic royalty rate increased to 4.32% from 4.29%.
Fourth-quarter revenue was $165.9 million versus $155.0 million; operating income was $38.7 million versus $38.4 million; net income was $24.8 million versus $24.1 million; and diluted EPS was $0.42 versus $0.40.
Year-end current assets were $194.8 million and current liabilities $184.6 million. The company had no borrowings outstanding on its $300 million revolving credit facility and reported compliance with its covenants. Leverage was approximately 1.3x and interest coverage approximately 11.5x, against covenant limits of 3.5x and 3.5x, respectively. The company reported a shareholders’ deficit of $25.6 million, primarily reflecting accumulated treasury-stock repurchases.
Material changes versus the prior period
- Domestic franchised rooms declined 0.2% to 392,826, while international rooms increased 2.7% to 104,379. Total domestic hotels increased by eight, but gross domestic additions fell to 256 from 327 and the domestic pipeline declined 21% to 408 hotels.
- Management attributed weaker openings and pipeline activity largely to tight hotel construction financing, reduced execution of new agreements, and competition for conversion properties. Domestic franchise terminations increased to 248 from 240.
- Interest expense rose $6.3 million to $12.9 million, largely because $250 million of senior notes issued in 2010 carry a 6.19% effective rate, above the prior revolving-credit borrowing cost.
- Operating cash flow decreased $10.1 million, principally due to timing of loyalty-program partner payments and working-capital items.
- The marketing and reservation fee receivable increased to $54.0 million from $42.5 million. Management reported no allowance, citing contractual recovery rights, but acknowledged collection depends in part on franchisee performance and system growth.
Outlook, risks, contingencies, and unusual items
- Management expected approximately 237 new franchise units to open in 2012, down from 256 in 2011, citing financing conditions and competition. Pipeline hotels may not ultimately open.
- The company expected to invest approximately $20 million to $40 million annually in franchisee financing, guarantees, investments, and strategic real estate programs, subject to market conditions. It expected 2012 dividends of approximately $42.9 million at the then-current rate; future dividends and repurchases remain discretionary.
- Management expected marketing and reservation activities to generate $4 million to $8 million of operating cash flow in 2012. Cash of approximately $83.2 million held by foreign subsidiaries was intended to remain reinvested abroad; domestic use could trigger additional U.S. taxes.
- Unusual 2011 items included $6.6 million of company-wide employee termination charges, a $1.8 million land impairment, and favorable tax adjustments. The filing’s adjusted, non-GAAP measures exclude certain items and should be considered alongside GAAP results.
- Key risks include lodging demand and RevPAR volatility, weak hotel-owner financing and credit, franchisee financial health and property quality, brand competition and termination risk, recovery of system-service advances, real-estate and lending exposures, international currency and political risks, indebtedness, and technology, cybersecurity, privacy, litigation, and regulatory risks.
- Contractual obligations totaled $529.1 million, including $378.3 million of long-term debt payments and $104.1 million of operating lease obligations. A new headquarters lease was expected to begin rent payments in 2013, with minimum rent of approximately $67.6 million over its initial 10-year term.
- Management said routine litigation was not expected to have a material adverse effect. A franchisee dispute was being litigated in arbitration; the company denied the franchisee’s claims.
Most important facts for investors to verify
- Whether RevPAR gains and higher royalty rates can offset flat-to-declining domestic room counts and the smaller development pipeline.
- Whether the forecast of approximately 237 unit openings and the planned $20–$40 million annual development-support investment are realized, and what credit or real-estate losses result.
- The collectability and future trajectory of the $54.0 million marketing and reservation receivable, and the related system’s cash generation.
- The effect of fixed-rate debt costs, lease commitments, shareholder distributions, and foreign cash restrictions on liquidity and capital allocation.
- The contribution to 2011 earnings from tax benefits and other unusual items; reported diluted EPS was $1.85, while company-adjusted diluted EPS was $1.92.