Choice Hotels International, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; unaudited, consolidated results. Choice is primarily a hotel franchisor, with 6,553 hotels open and 792 in its development pipeline across the U.S. and more than 40 other countries and territories.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $276.8m | $241.8m | $474.7m | $448.9m |
| Operating income | $77.5m | $64.9m | $130.0m | $107.8m |
| Income before taxes | $67.4m | $55.6m | $108.8m | $86.0m |
| Net income | $45.0m | $38.8m | $73.7m | $60.0m |
| Diluted EPS | $0.79 | $0.68 | $1.30 | $1.06 |
- Q2 revenue rose 14.5%, operating income 19.4%, net income 15.9%, and diluted EPS 16.2%. For the first half, revenue increased 5.8%, operating income 20.5%, net income 22.9%, and diluted EPS 22.6%.
- Marketing and reservation revenue and expense are reported gross and offset each other, so they do not generate net income. Excluding these pass-through fees and non-hotel activities, hotel franchising revenue was $116.2m in Q2, up 10%, and $202.1m in the first half, up 9%.
- Reported operating margin was 28.0% in Q2 versus 26.9% a year earlier, and 27.4% for the first half versus 24.0%. These ratios include gross marketing and reservation activity.
- Q2 domestic royalty growth reflected 2.0% RevPAR growth, 2.2% growth in rooms, and a higher effective royalty rate (4.58% versus 4.39%). First-half domestic RevPAR increased 2.8%; the effective royalty rate rose to 4.56% from 4.39%.
- Q2 SG&A fell 5% to $38.2m; first-half SG&A fell 5% to $71.1m. Results also benefited from higher initial and relicensing fees, procurement revenue, and other revenue. Other revenue included chip-enabled card-reader sales and non-compliance fees.
Cash flow, debt and liquidity
- First-half operating cash flow was $64.1m, up from $27.9m; investing cash outflow was $67.3m, versus $53.9m. Financing cash outflow was $2.3m, compared with $40.1m of inflow in 2016. Cash ended the period at $198.0m, down from $202.5m at year-end 2016.
- Operating cash flow benefited from improved operating income, marketing-system cash flows, and working-capital timing. The comparison was affected by the prior year’s $30.7m recognition of previously deferred Choice Privileges revenue following a change in the loyalty program’s points-expiration policy.
- Total debt was $864.3m, including $205.8m drawn on a $450m revolving facility; reported long-term debt was $863.0m. Cash less total debt was approximately $666.3m. The company reported leverage of 2.75x and fixed-charge coverage of 7.46x, and compliance with its credit covenants.
- Current assets were $380.2m and current liabilities $276.4m. Shareholders’ deficit was $252.6m. Approximately $190.3m of cash was held by foreign subsidiaries and management said it did not intend to use those funds domestically; repatriating them could trigger additional U.S. income taxes.
- First-half cash dividends paid were $24.3m. The quarterly dividend was $0.215 per share; management estimated 2017 regular dividends of approximately $48.6m, subject to board approval and business conditions. No shares were repurchased under the public repurchase program during the half-year.
Changes, outlook and material matters
- Domestic hotels open increased 136 year over year to 5,409; domestic rooms increased 2.2% to 406,902. Franchise agreements executed in the first half rose to 282 from 217. Management cautioned that pipeline hotels do not necessarily open.
- The company expected to deploy approximately $475m over three to five years to support Cambria and other growth through joint ventures, loans, guarantees, and land banking. At June 30, approximately $261.3m was outstanding under these financial-support activities; additional committed joint-venture contributions were $18.8m.
- Outstanding commitments included up to $193.9m of conditional franchisee financing or incentives, of which $84.9m was scheduled for the next 12 months. These commitments depend on franchisee conditions being met.
- Management expected cash flows from operations and available financing capacity to meet anticipated needs. It anticipated continuing dividends, subject to board discretion, operating performance, economic conditions, tax rules, and credit-facility restrictions.
- Potential risks include hotel demand and RevPAR changes, franchise growth and retention, brand appeal, technology and cybersecurity, international and currency exposure, and lending or investment risks from hotel-development support. Guarantees tied to certain joint-venture hotel loans had stated maximum amounts, and management considered performance under them remote at the reporting date. Ordinary-course litigation was not expected to have a material adverse effect.
- Management was evaluating new accounting standards. Topic 606 was planned for adoption in 2018; initial and relicensing fees and related sales commissions are expected to be recognized over the franchise-license period rather than generally at execution. The company had not determined the adoption method or quantified the full impact.
Investor verification points
- Assess whether hotel-franchising growth, room additions, RevPAR, and royalty-rate gains persist, and whether the development pipeline converts into operating hotels.
- Separate recurring franchise economics from gross marketing-system pass-throughs and other revenue items, including card-reader sales and non-compliance fees.
- Review the sustainability and cash conversion of earnings, including working-capital effects and the loyalty-program accounting comparison.
- Track leverage, revolver usage, covenant headroom, dividends, and the effect of cash held offshore.
- Monitor exposure to Cambria investments, franchisee lending commitments, loan-loss reserves, and contingent guarantees.
- Follow the quantified effects of Topic 606 adoption and any changes to franchise-fee and commission timing.