Choice Hotels International, Inc. — Q3 2018 10-Q
Reporting period: Three and nine months ended September 30, 2018. Choice is primarily a hotel franchisor, with 6,922 hotels open and 1,050 in its development pipeline at period-end. Comparisons with 2017 reflect retrospective adoption of Topic 606, which changed revenue and expense recognition and presentation.
Financial performance
| Metric | Q3 2018 | Q3 2017 | First 9 months 2018 | First 9 months 2017 |
|---|---|---|---|---|
| Revenue | $291.5 million | $269.9 million | $796.3 million | $719.8 million |
| Operating income | $111.2 million | $93.1 million | $266.4 million | $225.0 million |
| Net income | $80.0 million | $57.2 million | $184.9 million | $132.1 million |
| Diluted EPS | $1.41 | $1.01 | $3.24 | $2.33 |
| Operating cash flow | Not separately provided | Not separately provided | $146.8 million | $165.0 million |
- Q3 revenue grew 8%, operating income 19%, and net income 40%; nine-month revenue grew 11%, operating income 18%, and net income 40% year over year.
- Q3 operating margin was approximately 38.1% versus 34.5%; nine-month operating margin was approximately 33.5% versus 31.3%.
- Hotel franchising revenue, excluding marketing and reservation activities and non-franchising businesses, grew 9% in Q3 to $135.4 million and 12% in the first nine months to $368.9 million. Royalty revenue grew 7% in Q3 and 11% year to date.
- Domestic systemwide RevPAR declined 1.4% in Q3, as occupancy fell 160 basis points; for the first nine months, RevPAR increased 1.4%. Domestic rooms on-line increased 9.6% year over year, partly reflecting the WoodSpring acquisition.
- Marketing and reservation system revenues exceeded related expenses by $14.1 million in Q3 and $22.6 million for the first nine months. The company intends to manage these activities to break even over time; quarterly and annual surpluses or deficits can occur.
Balance sheet, cash flow and capital
- At September 30, 2018, cash and equivalents were $30.9 million, down from $235.3 million at December 31, 2017. Total debt was $782.5 million, up from $726.5 million. Shareholders’ deficit was $168.1 million.
- Current assets were $280.6 million and current liabilities $299.5 million. The company reported $1.16 billion in total assets and $1.33 billion in total liabilities.
- Nine-month operating cash flow was $146.8 million, down $18.2 million, primarily due to higher franchise agreement acquisition-cost outflows. Investing cash used was $299.8 million, including $231.3 million for WoodSpring. Financing cash used was $50.7 million, including $109.3 million of treasury-stock purchases and $36.6 million of dividends.
- The August 2018 restated revolving credit facility increased commitments from $450 million to $600 million and extended maturity to August 2023, with optional extensions subject to lender consent and conditions. The company reported $126.4 million of variable-rate debt outstanding and was in covenant compliance; fixed-charge coverage was 8.46x and total leverage was 2.16x.
- Quarterly dividends remained $0.215 per share. Management estimated 2018 regular dividends of approximately $48.7 million, subject to board approval and other conditions. About 2.7 million shares remained under the repurchase authorization.
Material developments, outlook and risks
- Choice acquired WoodSpring Hotels Franchise Services on February 1, 2018, for total consideration of approximately $231.6 million. WoodSpring had 239 hotels at acquisition; its results are included from the acquisition date. The purchase price allocation was finalized in Q3, including $115.0 million of acquired franchise agreements, a $22.0 million tradename and $93.4 million of goodwill.
- Topic 606 adoption changed recognition of initial and relicensing fees, franchise sales commissions, franchise acquisition costs and loyalty-program revenue. Management says adoption did not affect cash flows, though it changed certain operating cash-flow classifications.
- Management expects to deploy approximately $725 million over three to five years to support Cambria growth, subject to market conditions. Approximately $317.4 million was outstanding under the company’s financial-support activities at quarter-end. These activities include loans, joint ventures, guarantees and land banking.
- The company had $220.7 million of conditional commitments for franchisee incentives, $12.2 million of additional joint-venture contributions and approximately $10.1 million of conditional mezzanine-loan or credit-facility commitments. A $34.9 million construction loan was available for a hotel conversion project but had not been drawn.
- Management cited weather comparisons, Comfort-brand renovations at more than 1,000 hotels, and holiday timing as factors affecting Q3 occupancy. It also noted WoodSpring-related costs and higher depreciation and amortization following the acquisition. The prior-year quarter included $12.0 million of CEO-succession compensation expense, affecting SG&A comparisons.
- The 2018 effective tax rate was 21.9% for Q3 and 20.6% year to date, versus 31.7% and 32.0% in 2017. The lower 2018 rates primarily reflect the federal tax-rate reduction and share-based compensation tax benefits.
- Management expects the new lease standard, to be adopted January 1, 2019, to materially increase reported lease assets and liabilities, but does not expect a material income-statement effect. The filing identifies economic, lodging-industry, franchise-growth, technology, cybersecurity, international, development-financing and indebtedness risks.
- Maximum principal exposure under limited payment guarantees for joint ventures was $13.0 million, plus certain expenses and interest; management considered performance unlikely. Management did not expect ongoing ordinary-course litigation to have a material adverse effect.
Important facts for investors to verify
- How much reported growth reflects WoodSpring and system expansion versus underlying room performance, royalty rates and other organic drivers.
- Whether the decline in cash and operating cash flow, alongside higher debt and substantial repurchases, leaves adequate financial flexibility for planned investment and shareholder returns.
- Progress converting the 1,050-hotel pipeline into open hotels, and the effect of renovation-related occupancy weakness on future royalties.
- Credit quality, repayment and returns on franchisee loans, joint-venture investments and the $220.7 million of conditional incentive commitments.
- Future marketing-system surpluses or deficits, loyalty-program liability estimates, and the effect of Topic 606 and the upcoming lease standard on comparability and reported balances.
- Compliance with credit-facility covenants and the conditions governing dividends, repurchases and planned Cambria investment.