Choice Hotels International, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods. Amounts are in millions except per-share data. Choice is primarily a hotel franchisor, with 7,045 hotels open and 1,111 hotels in its development pipeline at quarter-end.
Financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $317.7 | $295.4 | $536.0 | $504.8 |
| Operating income | $102.5 | $109.0 | $147.6 | $155.3 |
| Net income | $74.4 | $79.8 | $104.5 | $104.9 |
| Diluted EPS | $1.33 | $1.40 | $1.87 | $1.83 |
| Operating cash flow | Not provided by quarter | $97.7 | $63.8 |
Q2 revenue increased 7.5%, while operating income fell 5.9% and net income fell 6.8%. For the first half, revenue rose 6.2%, operating income declined 4.9%, and net income was nearly flat, down 0.4%. Reported operating margin was approximately 32.3% in Q2 versus 36.9% a year earlier, and 27.5% for the first half versus 30.8%. These margins include marketing and reservation system activity, which management describes as intended to break even over time.
Revenue excluding marketing and reservation system activity, a company-reported non-GAAP measure, was $145.2 million in Q2, up from $138.1 million, and $253.5 million in the first half, up from $240.5 million. Royalty fees increased 3% in Q2 and 4% in the first half. Domestic rooms under franchise grew 2.1%; domestic RevPAR declined 0.1% in Q2 and 0.4% for the first half. The domestic effective royalty rate rose to 4.84% from 4.74% in Q2 and from 4.73% for the first half-year comparison.
Cash, debt, and liquidity
- Cash and equivalents were $34.4 million at June 30, up from $26.6 million at year-end. Six-month operating cash flow was $97.7 million; investing activities used $45.3 million and financing activities used $44.8 million. Property and equipment investment was $38.2 million.
- Total debt was $784.8 million, including $97.3 million drawn on the $600 million revolving credit facility. The company reported a 1.92x total leverage ratio and compliance with applicable financial covenants. It exercised an option on July 2 to extend the revolver’s maturity to August 2024.
- Current assets of $276.9 million were below current liabilities of $321.0 million. Shareholders’ deficit was $122.7 million.
- Cash dividends declared were $0.215 per share quarterly. The company paid $24.1 million in dividends and repurchased $37.2 million of shares under its program in the first half.
Material changes and unusual items
- Q2 operating income was pressured by a $4.6 million loss on sale of the SaaS vacation-rental business and an $8.4 million year-over-year reduction in the surplus from marketing and reservation activities. The business was sold on June 3.
- In Q1, a key customer’s purported contract termination prompted impairment charges of $7.3 million for long-lived assets and $3.1 million for goodwill. The company said these charges and the sale loss did not affect liquidity or debt covenant calculations.
- First-half cash flow improved by $33.9 million year over year, which management attributed mainly to operating performance excluding certain noncash charges and working-capital timing.
- On July 23, after quarter-end, Choice bought the remaining interests in four Cambria hotel joint ventures for approximately $168.7 million and sold its interest in another for approximately $8.9 million. The purchase was funded with cash and revolver borrowings; Choice expected to consolidate the four acquired hotels.
Outlook, risks, and commitments
Management said operating cash flow and available financing capacity should meet expected business needs; the filing does not provide formal earnings guidance. It expected 2019 regular dividends of approximately $48.1 million, subject to board approval and business conditions. Over the next three to five years, Choice expected to deploy approximately $725 million to support Cambria growth, depending on market conditions; approximately $393.3 million was outstanding under these financial-support activities at June 30.
Key exposures include hotel demand and RevPAR, franchise system growth and brand appeal, technology and cybersecurity, international operations and currency, hotel-development and financing activities, investments in new businesses, and indebtedness. The filing reported $257.5 million of conditional commitments for franchise incentives, $11.4 million of further joint-venture contributions, and $34.6 million of conditional franchisee financing commitments. Limited payment guarantees had maximum principal exposure of $7.5 million, which management considered remote. Management reported no material change to the risk factors in its 2018 Form 10-K and no litigation expected to have a material adverse effect.
Important facts for investors to verify
- Whether domestic room growth and improved effective royalty rates can offset flat or declining RevPAR and slower franchise awards.
- The effect of the Cambria joint-venture acquisitions on debt, cash flow, hotel ownership exposure, and future results.
- Whether marketing and reservation system revenues and expenses move toward the expected break-even over time.
- Repayment performance and credit quality of franchisee notes receivable, including approximately $52.1 million identified as impaired, and execution of the company’s substantial conditional financing commitments.
- How the SaaS business sale and prior impairment charges affect ongoing Corporate & Other results and whether any further costs arise.