CHOICE HOTELS INTERNATIONAL INC quarterly report, Q2 FY2017

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

MetricQ2 2017Q2 2016Six months 2017Six 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.