Choice Hotels International, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited. Choice is primarily a hotel franchisor. At quarter-end, its system included 6,494 open hotels and 795 hotels in its development pipeline across the U.S. and more than 40 other countries and territories.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $197.9 million | $207.1 million | Down 4.5% |
| Operating income | $52.5 million | $42.9 million | Up 22.5% |
| Income before taxes | $41.4 million | $30.4 million | Up 36% |
| Net income | $28.7 million | $21.2 million | Up 35.8% |
| Diluted EPS | $0.51 | $0.37 | Up $0.14 |
| Operating cash flow | $24.2 million | $(21.4) million | Improved $45.6 million |
Royalty fees rose 6.4% to $69.0 million. Domestic RevPAR increased 3.8%, domestic rooms open increased 0.9%, and the effective domestic royalty rate rose to 4.55% from 4.38%. Hotel franchising revenue, a company-defined measure excluding marketing/reservation and other non-core revenue, grew 9% to $85.9 million. Total revenue fell mainly because Q1 2016 included recognition of $30.7 million of previously deferred marketing and reservation revenue following a loyalty-program policy change. Excluding that item, marketing and reservation revenue increased approximately $13.8 million.
Operating income benefited from higher hotel-franchising revenue and a $2.3 million decline in selling, general and administrative expense. Reported operating margins were 26.5% versus 20.7%; these figures include marketing and reservation activity that the company describes as generating no net income or loss. Net income margin was approximately 14.5% versus 10.2%.
Cash, debt and liquidity
- Cash and cash equivalents were $187.5 million, down from $202.5 million at year-end. Approximately $183.1 million related to undistributed foreign-subsidiary earnings that the company intends to reinvest abroad; using those funds domestically could trigger additional U.S. taxes.
- Total debt was $863.6 million, up from $840.6 million. The company had $205.3 million outstanding under its $450 million revolving credit facility. Its reported leverage ratio was 2.83x and fixed-charge coverage ratio was 7.25x; it reported compliance with all credit covenants.
- Current assets were $342.9 million and current liabilities $274.1 million (current ratio approximately 1.25). Shareholders’ deficit was $292.5 million.
- Investing cash outflow was $47.8 million, including $31.6 million of equity-method investment contributions. Financing cash inflow was $8.2 million, including $22.8 million of net revolving-credit borrowings, offset in part by $12.1 million of dividends paid and $7.3 million of employee share redemptions.
- The quarterly dividend was $0.215 per share. The company estimated regular 2017 dividends of approximately $48.6 million, subject to board approval and other conditions. No shares were repurchased under the public repurchase program in the quarter.
Business developments, outlook and risks
Domestic rooms open grew 0.9%, while hotels open declined by 19 year over year; domestic net terminations rose to 68 from 58. Domestic franchise agreements executed increased 51% to 106, and the domestic pipeline rose to 724 hotels from 582. Management cautioned that pipeline properties may not ultimately open.
No general earnings or revenue guidance is provided in the filing. Management expected SkyTouch revenue to approximate its selling, general and administrative expenses for 2017, reflecting a slower investment pace. It anticipated deploying approximately $475 million over three to five years to support Cambria and other growth initiatives; $244.2 million was outstanding under these financial-support activities at quarter-end. Commitments included $180.1 million of potential franchisee financing/incentives, $23.1 million of additional joint-venture contributions, and up to $49.1 million for a hotel redevelopment loan, of which $40.2 million had been advanced.
Risks include franchisee and hotel-market performance, franchise-system growth and terminations, technology and cybersecurity, international and foreign-currency exposure, development and investment execution, and the company’s ability to manage debt. The company reported limited guarantees related to joint-venture hotel loans and considered the likelihood of payment remote. Management did not expect ordinary-course litigation to materially affect results.
Topic 606 was expected to be adopted in 2018. The company anticipated recognizing initial and relicensing fees over the franchise-license period, rather than generally upon agreement execution, and matching franchise sales commissions over that period; the impact was still being assessed. The prior-year comparison was adjusted for adoption of the stock-compensation accounting standard, which increased reported Q1 2016 net income from $19.6 million to $21.2 million.
Important facts for investors to verify
- Whether RevPAR, royalty-rate, room-count and pipeline trends persist, particularly given higher domestic terminations.
- How much of cash is practically available for domestic obligations, considering foreign earnings and potential tax costs.
- Returns, funding needs and credit quality of Cambria-related joint ventures, loans and franchisee incentives, including the outstanding commitments.
- The effect of Topic 606 on upfront franchise fees, commissions and reported growth once the company completes its assessment.
- Debt covenant headroom, revolving-credit usage, dividend sustainability and the execution of management’s SkyTouch outlook.