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CHH > SEC Filings for CHH > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for CHOICE HOTELS INTERNATIONAL INC /DE

Form 10-Q for CHOICE HOTELS INTERNATIONAL INC /DE


7-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The following Management's Discussion and Analysis ("MD&A") is intended to help the reader understand Choice Hotels International, Inc. and subsidiaries (together the "Company"). MD&A is provided as a supplement to-and should be read in conjunction with-our consolidated financial statements and the accompanying notes.

Overview
We are a hotel franchisor with franchise agreements representing 6,199 hotels open and 435 hotels under construction, awaiting conversion or approved for development as of September 30, 2012, with 496,929 rooms and 36,150 rooms, respectively, in 49 states, the District of Columbia and over 35 countries and territories outside the United States. Our brand names include Comfort Inn®, Comfort Suites®, Quality®, Clarion®, Ascend Collection®, Sleep Inn®, Econo Lodge®, Rodeway Inn®, MainStay Suites®, Suburban Extended Stay Hotel®, and Cambria Suites® (collectively, the "Choice brands").
The Company's domestic operations are conducted solely through direct franchising relationships while its international franchise operations are conducted through a combination of direct franchising and master franchising relationships. Master franchising relationships are governed by master franchising agreements which generally provide the master franchisee with the right to use our brands in a specific geographic region.
Our business philosophy has been to conduct direct franchising in those international markets where both franchising is an accepted business model and we believe our brands can achieve significant distribution. We elect to enter into master franchise agreements in those markets where direct franchising is currently not a prevalent or viable business model. When entering into master franchising relationships, we strive to select partners that have professional hotel and asset management capabilities together with the financial capacity to invest in building the Choice brands in their respective markets. Master franchising relationships typically provide lower revenues to the Company as the master franchisees are responsible for managing certain necessary services (such as training, quality assurance, reservations and marketing) to support the franchised hotels in the master franchise area and therefore retain a larger percentage of the hotel franchise fees to cover their expenses. In certain circumstances, the Company has and may continue to make equity investments in our master franchisees.
As a result of our use of master franchising relationships and international market conditions, total revenues from international franchising operations comprised 8% of our total revenues for the nine months ended September 30, 2012, while representing approximately 19% of hotels open at September 30, 2012. Therefore, our description of the franchise system is primarily focused on the domestic operations.
Our Company generates revenues, income and cash flows primarily from initial, relicensing and continuing royalty fees attributable to our franchise agreements. Revenues are also generated from qualified vendor arrangements, hotel operations and other sources. The hotel industry is seasonal in nature. For most hotels, demand is lower in December through March than during the remainder of the year. Our principal source of revenues is franchise fees based on the gross room revenues of our franchised properties. The Company's franchise fee revenues and operating income reflect the industry's seasonality and historically have been lower in the first quarter than in the second, third or fourth quarters.
With a focus on hotel franchising instead of ownership, we benefit from the economies of scale inherent in the franchising business. The fee and cost structure of our business provides opportunities to improve operating results by increasing the number of franchised hotel rooms and effective royalty rates of our franchise contracts resulting in increased initial fee and relicensing revenue, ongoing royalty fees and procurement services revenues. In addition, our operating results can also be improved through our company-wide efforts related to improving property level performance. The Company currently estimates, based on its current domestic portfolio of hotels under franchise, a 1% change in revenue per available room ("RevPAR") or rooms under franchise would increase or decrease annual domestic royalty revenues by approximately $2.3 million and a 1 basis point change in the Company's effective royalty rate would increase or decrease annual domestic royalties by approximately $0.5 million. In addition to these revenues, we also collect marketing and reservation system fees to support centralized marketing and reservation activities for the franchise system. As a lodging franchisor, the Company currently has relatively low capital expenditure requirements.
The principal factors that affect the Company's results are: the number and relative mix of franchised hotel rooms in the various hotel lodging price categories; growth in the number of hotel rooms under franchise; occupancy and room rates achieved by the hotels under franchise; the effective royalty rate achieved; the level of franchise sales and relicensing activity; and our ability to manage costs. The number of rooms at franchised properties and occupancy and room rates at those properties significantly affect the Company's results because our fees are based upon room revenues at franchised hotels. The key industry standard for measuring hotel-operating performance is RevPAR, which is calculated by multiplying the percentage of occupied rooms by the average daily room rate realized. Our variable overhead costs associated with franchise system growth of our established


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brands have historically been less than incremental royalty fees generated from new franchises. Accordingly, continued growth of our franchise business should enable us to realize benefits from the operating leverage in place and improve operating results.
We are required by our franchise agreements to use the marketing and reservation system fees we collect for system-wide marketing and reservation activities. These expenditures, which include advertising costs and costs to maintain our central reservations system, help to enhance awareness and increase consumer preference for our brands. Greater awareness and preference promotes long-term growth in business delivery to our franchisees, which ultimately increases franchise fees earned by the Company.
Our Company articulates its mission as a commitment to our franchisees' profitability by providing our franchisees with hotel franchises that strive to generate the highest return on investment of any hotel franchise. We have developed an operating system dedicated to our franchisees' success that focuses on delivering guests to our franchised hotels and reducing costs for our hotel owners.
We believe that executing our strategic priorities creates value for our shareholders. Our Company focuses on two key value drivers:
Profitable Growth. Our success is dependent on improving the performance of our hotels, increasing our system size by selling additional hotel franchises, effective royalty rate improvement and maintaining a disciplined cost structure. We attempt to improve our franchisees' revenues and overall profitability by providing a variety of products and services designed to increase business delivery to and/or reduce operating and development costs for our franchisees. These products and services include national marketing campaigns, a central reservation system, property and yield management systems, quality assurance standards and qualified vendor relationships. We believe that healthy brands, which deliver a compelling return on investment for franchisees, will enable us to sell additional hotel franchises and raise royalty rates. We have established multiple brands that meet the needs of many types of guests, and can be developed at various price points and applied to both new and existing hotels. This ensures that we have brands suitable for creating growth in a variety of market conditions. Improving the performance of the hotels under franchise, growing the system through additional franchise sales and improving franchise agreement pricing while maintaining a disciplined cost structure are the keys to profitable growth.
Maximizing Financial Returns and Creating Value for Shareholders. Our capital allocation decisions, including capital structure and uses of capital, are intended to maximize our return on invested capital and create value for our shareholders. We believe our strong and predictable cash flows create a strong financial position that provides us a competitive advantage. Currently, our business does not require significant capital to operate and grow. Therefore, we can maintain a capital structure that generates high financial returns and use our excess cash flow to increase returns to our shareholders.
Historically, we have returned value to our shareholders in two primary ways:
share repurchases and dividends. In 1998, we instituted a share repurchase program which has generated substantial value for our shareholders. During the nine months ended September 30, 2012, the Company repurchased approximately 0.5 million shares of its common stock under the share repurchase program at an average price of $37.02 for a total cost of $19.9 million. Since the program's inception through September 30, 2012, we have repurchased 45.3 million shares (including 33.0 million prior to the two-for-one stock split effected in October 2005) of common stock at a total cost of $1.1 billion. Considering the effect of the two-for-one stock split, the Company has repurchased 78.3 million shares at an average price of $13.89 per share. We currently believe that our cash flows from operations will support our ability to complete the current board of directors repurchase authorization of approximately 1.4 million shares remaining as of September 30, 2012. Upon completion of the current authorization, our board of directors will evaluate the advisability of additional share repurchases.
The Company currently maintains the payment of a quarterly dividend on its common shares outstanding of $0.185 per share, however the declaration of future dividends are subject to the discretion of the board of directors. We expect that regular quarterly cash dividends will continue to be paid at a comparable rate in the future, subject to future business performance, economic conditions, changes in income tax regulations and other factors. During the nine months ended September 30, 2012, we paid regular quarterly cash dividends totaling approximately $32.1 million. Based on our present dividend rate and outstanding share count, aggregate annual recurring dividends for 2012 would be approximately $42.7 million.

On July 26, 2012, the Company's board of directors declared a special cash dividend in the amount of $10.41 per share or approximately $600.7 million in the aggregate, which was paid on August 23, 2012. The special cash dividend was paid with the proceeds from the Company's recent offering of the $400 million, 5.75% unsecured senior notes and our new senior secured credit facility. On July 25, 2012, the Company entered into a senior secured credit facility consisting of a $200 million revolving credit tranche and a $150 million term loan tranche, with a four year term. The Company utilized the proceeds from the term loan as well as borrowings under the revolving credit tranche for payment of the special dividend. As a result of


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entering into the senior secured credit facility, the company's existing $300 million senior unsecured revolving credit facility was terminated. Our board of directors previously authorized us to enter into programs which permit us to offer investment, financing and guaranty support to qualified franchisees as well as to acquire and resell real estate to incent franchise development for certain brands in strategic markets. Recent market conditions have resulted in an increase in opportunities to incentivize development under these programs and as a result over the next several years, we expect to deploy capital opportunistically pursuant to these programs to promote growth of our emerging brands. The amount and timing of the investment in these programs will be dependent on market and other conditions. Our current expectation is that our annual investment in these programs will range from $20 million to $40 million. Notwithstanding these programs, the Company expects to continue to return value to its shareholders through a combination of share repurchases and dividends, subject to business performance, economic conditions, changes in income tax regulations and other factors.
We believe these value drivers, when properly implemented, will enhance our profitability, maximize our financial returns and continue to generate value for our shareholders. The ultimate measure of our success will be reflected in the items below.
Results of Operation: Royalty fees, operating income, net income and diluted earnings per share ("EPS") represent key measurements of these value drivers. In the three months ended September 30, 2012, royalty fees revenue totaled $80.8 million, a 5% increase from the same period in 2011. Operating income totaled $65.3 million for the three months ended September 30, 2012, a $2.9 million or 5% increase from the same period in 2011. Net income increased 5% from the same period of the prior year to $44.4 million. Diluted earnings per share for the quarter ended September 30, 2012 were $0.76 compared to $0.71 for the three months ended September 30, 2011. These measurements will continue to be a key management focus in 2012 and beyond.
Refer to MD&A heading "Operations Review" for additional analysis of our results.
Liquidity and Capital Resources: Historically, the Company has generated significant cash flows from operations. Since our business does not currently require significant reinvestment of capital, we typically utilize cash in ways that management believes provide the greatest returns to our shareholders, which include share repurchases and dividends. We believe the Company's cash flow from operations and available financing capacity is sufficient to meet the expected future operating, investing, and financing needs of the business.
Refer to MD&A heading "Liquidity and Capital Resources" for additional analysis.


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Operations Review
Comparison of Operating Results for the Three-Month Periods Ended September 30,
2012 and 2011
Summarized financial results for the three months ended September 30, 2012 and
2011 are as follows:
(in thousands, except per share amounts)     2012         2011
REVENUES:
Royalty fees                              $ 80,845     $ 77,090
Initial franchise and relicensing fees       3,247        3,583
Procurement services                         3,839        4,103
Marketing and reservation                  119,062      104,393
Hotel operations                             1,238        1,236
Other                                        2,182        1,916
Total revenues                             210,413      192,321
OPERATING EXPENSES:
Selling, general and administrative         23,170       22,555
Depreciation and amortization                1,995        2,073
Marketing and reservation                  119,062      104,393
Hotel operations                               933          900
Total operating expenses                   145,160      129,921
Operating income                            65,253       62,400
OTHER INCOME AND EXPENSES, NET:
Interest expense                            10,166        3,228
Interest income                               (425 )       (506 )
Loss on extinguishment of debt                 526            -
Other (gains) and losses                      (511 )      2,673
Equity in net (income) loss of affiliates     (171 )         39
Total other expenses, net                    9,585        5,434
Income before income taxes                  55,668       56,966
Income taxes                                11,291       14,664
Net income                                $ 44,377     $ 42,302
Diluted earnings per share                $   0.76     $   0.71

On occasion, the Company utilizes certain measures such as adjusted net income, adjusted diluted EPS, adjusted selling, general and administration expenses ("SG&A"), adjusted operating margin and franchising revenues which do not conform to generally accepted accounting principles in the United States ("GAAP") when analyzing and discussing its results with the investment community. This information should not be considered as an alternative to any measure of performance as promulgated under GAAP, such as net income, diluted EPS, SG&A, operating income and total revenues. The Company's calculation of these measures may be different from the calculations used by other companies and therefore comparability may be limited. We have included below a reconciliation of the measures utilized during this period to the comparable GAAP measures as well as our reason for reporting these non-GAAP measures. Franchising Revenues: The Company utilizes franchising revenues which exclude marketing and reservation system revenues and hotel operations rather than total revenues when analyzing the performance of the business. Marketing and reservation activities are excluded from revenues since the Company is required by its franchise agreements to use these fees collected for marketing and reservation activities; as such, no income or loss to the Company is generated. Cumulative marketing and reservation system fees not expended are recorded as a payable on the Company's financial statements and are carried over to the next fiscal year and expended in accordance with the franchise agreements. Cumulative marketing and reservation expenditures in excess of fees collected for marketing and reservation activities are recorded as a receivable on the Company's financial statements. Hotel operations are excluded since they do not reflect the most accurate measure of the Company's core franchising business. This non-GAAP measure is a commonly used measure of performance in our industry and facilitates comparisons between the Company and its competitors.


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Calculation of Franchising Revenues
                                             Three Months Ended September 30,
                                                    ($ amounts in thousands)
                                                    2012                 2011
Franchising Revenues:
Total Revenues                               $       210,413       $       192,321
Adjustments:
   Marketing and reservation system revenues        (119,062 )            (104,393 )
   Hotel operations                                   (1,238 )              (1,236 )
Franchising Revenues                         $        90,113       $        86,692

The Company recorded net income of $44.4 million for the three month period ended September 30, 2012, a 5% increase from the $42.3 million for the quarter ended September 30, 2011. The increase in net income for the three months ended September 30, 2012 is primarily attributable to the $2.9 million or 5% increase in operating income and a decline in the effective income tax rate from 25.7% for the three months ended September 30, 2011 to 20.3% for the current period. Net income was further increased by a $3.2 million decline in other (gains) and losses due to a $0.5 million increase in the fair value of investments held in the Company's non-qualified benefit plans compared to a $2.6 million decrease in the fair value of these investments in the prior year period. These items were partially offset by a $6.9 million increase in interest expense due to the issuance of debt to finance the Company's $600 million special dividend paid on August 23, 2012 and a $0.5 million loss on extinguishment of debt incurred as a result of refinancing the Company's $300 million revolving credit facility which was scheduled to mature in February 2016.
Operating income increased $2.9 million as the Company's franchising revenues for the three months ended September 30, 2012 increased $3.4 million or 4% from the same period of the prior year partially offset by a $0.6 million or 3% increases in SG&A expense.
Franchising Revenues: Franchising revenues were $90.1 million for the three months ended September 30, 2012 compared to $86.7 million for the three months ended September 30, 2011, an increase of 4%. The increase in franchising revenues is primarily due to a 5% increase in royalty revenues.
Domestic royalty fees for the three months ended September 30, 2012 increased $4.1 million to $74.3 million from $70.2 million in the three months ended September 30, 2011, an increase of 6%. The increase in royalties is attributable to a combination of factors including a 5.6% increase in RevPAR and a 1.0% increase in the number of domestic franchised hotel rooms. System-wide RevPAR increased due to a combination of a 2.7% increase in average daily rates and a 180 basis point increase in occupancy. The Company's effective royalty rate of the domestic hotel system was 4.29% for both the three months ended September 30, 2012 and 2011.


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A summary of the Company's domestic franchised hotels operating information is as follows:

                 For the Three Months Ended              For the Three Months Ended
                     September 30, 2012*                     September 30, 2011*                         Change
              Average                                 Average                               Average
               Daily                                   Daily                                 Daily
                Rate       Occupancy     RevPAR         Rate       Occupancy     RevPAR       Rate      Occupancy     RevPAR
Comfort Inn $    87.58         70.2 %   $ 61.46     $    85.05         68.6 %   $ 58.31        3.0 %     160    bps     5.4 %
Comfort
Suites           89.69         70.2 %     62.93          87.23         67.8 %     59.13        2.8 %     240    bps     6.4 %
Sleep            76.09         64.8 %     49.32          73.15         62.9 %     46.02        4.0 %     190    bps     7.2 %
Quality          75.02         61.2 %     45.88          72.90         59.8 %     43.60        2.9 %     140    bps     5.2 %
Clarion          79.73         58.7 %     46.82          78.13         55.1 %     43.01        2.0 %     360    bps     8.9 %
Econo Lodge      60.60         57.7 %     34.97          59.32         56.4 %     33.45        2.2 %     130    bps     4.5 %
Rodeway          59.62         60.8 %     36.23          58.23         58.8 %     34.22        2.4 %     200    bps     5.9 %
MainStay         73.17         76.5 %     55.96          69.45         77.3 %     53.68        5.4 %     (80 )  bps     4.2 %
Suburban         42.62         75.1 %     32.03          41.00         72.8 %     29.85        4.0 %     230    bps     7.3 %
Ascend
Collection      115.98         71.4 %     82.77         113.61         67.3 %     76.50        2.1 %     410    bps     8.2 %
Total       $    78.63         65.0 %   $ 51.09     $    76.53         63.2 %   $ 48.39        2.7 %     180    bps     5.6 %


___________________

*Operating statistics represent hotel operations from June through August The number of domestic rooms on-line increased by 3,960 rooms or 1% to 393,987 as of September 30, 2012 from 390,027 as of September 30, 2011. The total number of domestic hotels on-line increased by 1.3% to 5,034 as of September 30, 2012 from 4,969 as of September 30, 2011.
A summary of domestic hotels and rooms on-line at September 30, 2012 and 2011 by brand is as follows:

                  September 30, 2012      September 30, 2011                      Variance
                  Hotels       Rooms      Hotels       Rooms      Hotels     Rooms         %           %
Comfort Inn         1,367      106,970      1,413      110,652      (46 )   (3,682 )     (3.3 )%     (3.3 )%
Comfort Suites        603       46,647        616       47,667      (13 )   (1,020 )     (2.1 )%     (2.1 )%
Sleep                 390       28,232        392       28,431       (2 )     (199 )     (0.5 )%     (0.7 )%
Quality             1,101       95,469      1,037       90,368       64      5,101        6.2  %      5.6  %
Clarion               187       26,943        189       27,448       (2 )     (505 )     (1.1 )%     (1.8 )%
Econo Lodge           803       49,248        782       48,381       21        867        2.7  %      1.8  %
Rodeway               409       23,336        378       20,820       31      2,516        8.2  %     12.1  %
MainStay               39        2,997         39        3,027        -        (30 )        -  %     (1.0 )%
Suburban               60        6,978         58        6,934        2         44        3.4  %      0.6  %
Ascend
Collection             56        4,946         46        4,084       10        862       21.7  %     21.1  %
Cambria Suites         19        2,221         19        2,215        -          6          -  %      0.3  %
Total Domestic
Franchises          5,034      393,987      4,969      390,027       65      3,960        1.3  %      1.0  %

International royalties decreased by $0.4 million or 6% from $6.9 million in the third quarter of 2011 to $6.5 million for the same period of 2012 primarily due to a small decline in the number of rooms in the international system and the impact of foreign currency fluctuations partially offset by improvements in RevPAR.
International available rooms decreased 0.5% to 102,942 as of September 30, 2012 from 103,473 as of September 30, 2011. The total number of international hotels declined 0.3% from 1,169 as of September 30, 2011 to 1,165 as of September 30, 2012.
As of September 30, 2012, the Company had 360 franchised hotels with 29,142 rooms under construction, awaiting conversion or approved for development in its domestic system as compared to 430 hotels and 35,114 rooms at September 30, 2011. The


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number of new construction franchised hotels in the Company's domestic pipeline declined 28% to 220 at September 30, 2012 from 307 at September 30, 2011. The number of conversion franchised hotels in the Company's domestic pipeline increased by 17 units or 14% from September 30, 2011 to 140 hotels at September 30, 2012 primarily due to higher franchise sales for the Company's Quality and Clarion brands resulting from the increased use of incentives to stimulate demand. The domestic system hotels under construction, awaiting conversion or approved for development declined 16% from the prior year due to the decline in the number of new construction hotels which have been negatively impacted by the limited availability of hotel construction financing. As a result, the ability of existing projects to obtain financing and commence construction has been significantly impacted and has resulted in the termination of franchise agreements related to hotels that have not yet opened. The Company had an additional 75 franchised hotels with 7,008 rooms under construction, awaiting conversion or approved for development in its international system as of September 30, 2012 compared to 94 hotels and 8,715 rooms at September 30, 2011. While the Company's hotel pipeline provides a strong platform for growth, . . .

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