Choice Hotels International, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Choice is primarily a hotel franchisor, with 6,853 hotels open and 956 in its development pipeline across 50 U.S. states and more than 40 countries and territories.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $209.4 million | $188.9 million | Up 10.9% |
| Operating income | $46.2 million | $45.4 million | Up 1.9% |
| Income before taxes | $30.5 million | $34.3 million | Down 11.1% |
| Net income | $25.1 million | $24.3 million | Up 3.4% |
| Diluted EPS | $0.44 | $0.43 | Up $0.01 |
| Operating cash flow | $4.6 million | $24.2 million | Down $19.6 million |
Royalty fees increased 12% to $76.7 million; procurement services revenue rose 35% to $9.9 million. Domestic RevPAR, excluding WoodSpring, increased 3.1%, while rooms under franchise increased 2.5%; the effective domestic royalty rate rose to 4.68% from 4.55%. Marketing and reservation system expenses exceeded related revenues by $12.2 million, versus a $9.1 million deficit in Q1 2017. Approximate consolidated operating margin was 22.1%, compared with 24.0%; net margin was 12.0%, compared with 12.8%.
Balance sheet, liquidity and capital allocation
- Cash and cash equivalents were $36.8 million at March 31, down from $235.3 million at year-end. The decline primarily reflects the WoodSpring acquisition.
- Total debt was $797.0 million, up from $726.5 million at December 31; the $450 million revolving facility had $138.1 million drawn. The company reported a 2.31x total leverage ratio and an 8.16x fixed-charge coverage ratio and compliance with its financial covenants.
- Current assets were $231.8 million and current liabilities $269.3 million. Shareholders’ deficit was $259.9 million.
- Investing cash outflow was $241.2 million, including $231.3 million paid, net of cash acquired, for WoodSpring. Financing cash inflow was $38.1 million, including $70 million of net revolving-credit borrowings.
- The company repurchased $35.0 million of shares and paid $12.3 million in dividends. The quarterly dividend remained $0.215 per share; management estimated 2018 regular dividends of approximately $48.8 million, subject to board approval and other conditions.
Material changes and unusual items
- On February 1, 2018, Choice acquired WoodSpring Hotels Franchise Services for total consideration of approximately $231.6 million. WoodSpring had 239 hotels at acquisition. The preliminary purchase accounting included $115.0 million of franchise-agreement assets, $22.0 million of tradename and $93.4 million of goodwill; the allocation was not final.
- Operating income increased modestly despite higher SG&A, depreciation and amortization, and the larger marketing-system deficit. SG&A included $4.2 million of WoodSpring transaction and transition costs. Equity-method affiliate losses rose to $6.0 million from $2.1 million, primarily due to ramp-up losses at recently opened hotel projects.
- Income before taxes fell 11%, chiefly reflecting higher affiliate losses and the absence of prior-year other gains. The effective tax rate declined to 17.6% from 29.2%, including the effect of the lower federal corporate tax rate and share-based compensation tax benefits.
- Q1 2018 operating cash flow was lower because of increased franchise contract-acquisition costs and working-capital timing. Net franchise agreement advances were $11.9 million, versus $4.5 million a year earlier.
- Choice adopted Topic 606 using the full retrospective method. The 2017 comparative figures in this filing are adjusted: adoption reduced Q1 2017 revenue by $9.0 million, net income by $4.5 million and diluted EPS by $0.08. Adoption had no effect on cash flows overall.
Outlook, risks and contingencies
No specific full-year revenue or earnings guidance is provided in the filing. Management said operating cash flow and available financing capacity should be adequate for expected needs. It expects to invest approximately $475 million in Cambria-related financial support over the next three to five years, depending on market and business conditions; approximately $260.9 million was outstanding at quarter-end.
Commitments include up to $215.1 million of conditional franchise-development and property-improvement financing, $13.5 million of additional contributions to existing joint ventures, and $14.4 million for a Cambria hotel development. A separate construction loan of up to $34.9 million had not been drawn at quarter-end. The company also disclosed limited guarantees related to joint-venture hotel loans; management considered the likelihood of performance under the specified guarantees remote. Ordinary-course litigation was not expected to have a material adverse effect.
Management cited risks including economic and lodging-market changes, franchisee and brand performance, technology and cybersecurity, international operations, development and financing exposures, acquisition integration and indebtedness. It reported no material changes to the risk factors in its latest Form 10-K. Hotel demand is seasonal, and first-quarter results are not necessarily indicative of full-year performance.
Investor verification priorities
- Assess WoodSpring’s contribution to ongoing royalty growth and whether acquisition synergies offset integration costs and added debt.
- Track cash conversion and working-capital trends, including franchise incentives and contract-acquisition spending.
- Monitor affiliate losses, Cambria investment commitments, loan collectability and guarantee exposure.
- Review the final WoodSpring purchase-price allocation and the effects of Topic 606 when comparing periods.
- Verify leverage, revolver availability, covenant headroom and the sustainability of buybacks and dividends.