Choice Hotels International, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods. Choice is primarily a hotel franchisor. At quarter-end, its system included 6,379 open hotels and 638 hotels in the development pipeline.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $241.5m (+12%) | $215.2m | $648.9m (+13%) | $572.6m |
| Franchising revenue, excluding marketing/reservation and non-franchising activities | $105.6m (+6%) | $99.4m | $280.2m (+6%) | $263.3m |
| Operating income | $73.8m (+10%) | $67.0m | $178.1m (+6%) | $168.3m |
| Net income | $41.4m (+5%) | $39.4m | $98.8m (+1%) | $97.9m |
| Diluted EPS | $0.72 | $0.67 | $1.71 | $1.66 |
| Adjusted EBITDA (non-GAAP) | $76.9m (+11%) | $69.3m | $186.9m (+7%) | $175.2m |
Q3 operating margin was approximately 30.6% of reported revenue, versus 31.1% a year earlier; reported revenue includes marketing and reservation fees matched by corresponding expenses, which management says generate no net income or loss. Domestic RevPAR increased 5.8% in Q3 and 7.2% year to date. Q3 domestic royalties benefited from higher RevPAR and a small increase in the effective royalty rate, partly offset by fewer domestic rooms open. International royalties declined amid unfavorable currency movements.
Cash flow, balance sheet and capital allocation
- Operating cash flow: $98.8m for the first nine months, down from $138.4m. Management attributed the decline primarily to lower cash generation from marketing and reservation activities and increased net advances under forgivable franchisee notes.
- Investing and financing: Investing used $63.1m, versus $5.3m in 2014; financing used $49.5m. The company spent $21.8m on capital expenditures, paid $34.2m in dividends and repurchased $56.5m of treasury stock.
- Liquidity: Cash and equivalents were $199.3m, down from $214.9m at year-end 2014. Current assets were $359.5m and current liabilities $191.1m.
- Debt: Total debt was $817.6m, compared with $785.1m at year-end; cash less debt was approximately $618.3m net debt. In July, Choice refinanced its prior facility with a $450m unsecured revolving facility, with $162m drawn at September 30. The company reported a 3.10x total leverage ratio and 6.55x fixed-charge coverage ratio and said it complied with its covenants.
- Shareholder deficit: $400.6m at September 30, versus $428.8m at year-end. The company declared a quarterly dividend of $0.195 per share.
Changes, outlook and management commentary
- Growth reflected stronger domestic hotel performance and franchise activity: Q3 domestic RevPAR rose 5.8%; domestic franchise agreements executed increased 14% in Q3 and 24% year to date. The domestic pipeline grew 28% year over year to 540 hotels.
- Domestic rooms open declined 0.9% year over year, as the company continued removing or repositioning underperforming hotels and enforcing brand standards. Year-to-date net domestic terminations rose to 193 from 163.
- Management expected 327 new franchise units to open during 2015, up from 302 in 2014. This is an operating expectation, not earnings guidance. The company also expected approximately $45.2m of regular dividends for 2015 at the then-current rate and share count, subject to board discretion.
- Choice planned to deploy $250m–$350m over three to five years to support Cambria growth through investments, loans, guarantees and land banking; approximately $97.3m was outstanding under these activities at quarter-end. Additional commitments included $76.1m of potential franchisee financing, subject to conditions.
- Choice acquired Maxxton, a vacation-rental software provider, in August for $23.6m total consideration, including $13.3m cash paid net of cash acquired. The preliminary purchase-price allocation included $13.7m goodwill. A contingent five-year compensation arrangement was estimated at $13.6m and was not recorded at acquisition.
Risks, contingencies and unusual items
- Foreign exchange reduced international royalty revenue; the company also cited lodging demand and supply, franchisee performance, brand appeal, technology, cybersecurity, growth execution and debt management among forward-looking risks.
- Variable-rate debt totaled $162m at an effective rate of 1.7%. Management estimated a 10% change in that rate would change annual interest expense by approximately $0.3m.
- Hotel development support exposes Choice to franchisee credit and investment risk. Net notes receivable were $76.2m; forgivable notes totaled $43.4m before allowances, including $1.2m past due more than 90 days. Management reported $6.8m in total loan reserves.
- Limited guarantees for loans to unconsolidated hotel ventures had stated maximum principal exposures of $4.5m, $11.6m and $1.8m, plus specified interest or expenses for certain guarantees. Management considered performance under these guarantees remote.
- Marketing and reservation fees collected exceeded cumulative expenses by $44.1m, recorded as a long-term liability. Recovery and ongoing system funding depend on franchise-system revenue and performance.
- Q3 other losses included investment valuation effects and a $0.3m loss related to the credit-facility refinancing. The 2014 comparison included $1.7m of discontinued-operations income, primarily a hotel-sale gain; there was no discontinued-operations income in 2015.
- Management said ordinary-course litigation was not expected to have a material adverse effect and reported no material change in risk factors from the 2014 Form 10-K.
Important facts for investors to verify
- Whether RevPAR, franchise additions and pipeline hotels translate into sustained royalty growth, particularly given room-count declines and elevated terminations.
- How much of reported revenue growth reflects pass-through marketing and reservation fees rather than core franchising revenue.
- Cash-flow trends, including marketing-system spending, franchisee advances and the timing of receivables and payables.
- Debt, covenant headroom, refinancing terms and capacity to sustain dividends and repurchases alongside planned Cambria investments and franchisee commitments.
- Collection performance and reserve adequacy for notes receivable, plus the actual exposure under hotel-venture guarantees.
- Final acquisition accounting, Maxxton’s results and any contingent compensation earned; the filing says the purchase-price allocation was preliminary.