Business context and reporting period
Choice Hotels International, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. The company is primarily a hotel franchisor: 6,557 hotels were open and 817 were in development, conversion, or awaiting development across its system. Marketing and reservation system fees are reported gross with corresponding expenses and are not intended to generate company income.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $295.1M | $267.6M | $769.8M | $716.4M |
| Operating income | $77.8M | $78.6M | $207.8M | $186.4M |
| Net income | $47.6M | $47.6M | $121.3M | $107.6M |
| Diluted EPS | $0.84 | $0.84 | $2.14 | $1.90 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $165.0M | $88.4M |
Q3 total revenue rose about 10%, while operating income was down about 1% and net income was essentially flat. Nine-month revenue rose about 7%, operating income about 11%, and net income about 13%. Reported operating margin was approximately 26.4% in Q3 2017 versus 29.4% in Q3 2016, and 27.0% for the first nine months of 2017 versus 26.0% a year earlier. Marketing and reservation fees and their matching expenses materially affect these total-revenue margin comparisons.
At September 30, 2017, cash and cash equivalents were $238.8M, current assets $455.3M, and current liabilities $273.0M. Total debt was $801.3M, including $142.8M drawn on a $450M revolving facility; cash less total debt was approximately $562.5M. The company reported a 2.48x total leverage ratio and 7.63x fixed-charge coverage ratio and was in compliance with its credit covenants. Shareholders’ deficit was $200.4M.
Material changes versus prior periods
- Hotel franchising revenue, excluding marketing and reservation activities and other non-franchising activities, increased 10% in both Q3 ($124.5M) and the first nine months ($326.5M).
- Domestic RevPAR increased 2.1% in Q3 and 2.6% year to date; domestic rooms in operation increased 2.1% year over year. The domestic effective royalty rate rose to 4.58% in Q3 from 4.39%, and to 4.57% year to date from 4.39%.
- Q3 SG&A rose $12.0M year over year, including $12.0M of compensation expense related to accelerating the CEO succession plan. Management said operating income would have increased approximately $11.2M excluding this charge.
- Nine-month operating cash flow increased $76.6M, reflecting operating improvement, marketing-system cash flows, and working-capital timing. Investing outflows increased to $78.3M, including $44.9M of equity-method investment contributions.
- Marketing and reservation system revenue increased 6% year to date; the prior-year period included $30.7M of previously deferred revenue. Excluding that item, management reported growth of approximately 14%.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management said operating cash flow and available financing capacity were expected to meet future business needs. It projected 2017 regular dividends of approximately $48.6M at the then-current rate, subject to board approval and business conditions.
- The company expected to deploy approximately $475M over three to five years to support Cambria growth, subject to market conditions; approximately $243.6M was outstanding under related financial-support activities at quarter-end. It also had $206.0M of conditional commitments for franchisee financing and incentives, including $77.7M expected to be advanced within 12 months, plus $17.1M of committed joint-venture contributions.
- Equity-method investments generated $3.2M of losses for the first nine months, versus $0.3M of losses in the prior-year period, largely reflecting ramp-up of recently opened hotel projects. Net notes receivable were $150.6M, including $66.7M of forgivable notes; related allowances totaled $8.7M.
- A September transfer of a $24.2M interest in a note receivable did not qualify as a sale: the receivable remained on the balance sheet, with a corresponding $24.2M liability. The transaction generated financing cash inflow, not a reduction in the receivable.
- Approximately $212.8M of cash related to undistributed foreign-subsidiary earnings that management intended to keep abroad; using it domestically could trigger additional U.S. income taxes. The company cited economic and lodging-industry conditions, franchise-system growth, technology and cybersecurity, international operations, development-financing exposure, and debt management among its risks.
- Topic 606 adoption was planned for January 1, 2018. The company expected initial and relicensing fees and related sales commissions to be recognized over the franchise-license period rather than generally at contract execution; the impact was still being assessed. Management reported no material change in risk factors from the 2016 Form 10-K, and said ongoing litigation was not expected to have a material adverse effect.
Most important facts for investors to verify
- How much of revenue growth and operating performance reflects recurring franchise economics versus pass-through marketing fees, equipment sales, non-compliance fees, and the CEO succession charge.
- Whether hotel pipeline additions convert to operating properties and sustain room growth, RevPAR, and effective royalty-rate improvement.
- Actual funding, repayment, and credit performance of the company’s substantial franchisee financing, forgivable notes, Cambria investments, and joint-venture exposures.
- Revolver availability, covenant headroom, and the effect of debt, dividends, and planned growth investments on liquidity and capital returns.
- The eventual financial-statement impact and adoption method for Topic 606, including loyalty-program accounting and deferred franchise fees.