Choice Hotels International, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited. Amounts are in U.S. dollars unless noted. Choice is primarily a hotel franchisor, with 6,445 hotels open and 685 in its development pipeline worldwide at quarter-end.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total revenue | $207.1 million | $175.2 million | +18.2% |
| Franchising revenue, excluding marketing and reservation activities and non-franchising businesses | $78.7 million | $75.9 million | +3.7% |
| Operating income | $42.9 million | $41.4 million | +3.5% |
| Income before taxes | $30.4 million | $31.0 million | -2.1% |
| Net income | $19.6 million | $21.6 million | -9.2% |
| Diluted EPS | $0.35 | $0.37 | -5.4% |
| Cash from operating activities | $(22.9) million | $(15.8) million | More cash used |
Total revenue growth chiefly reflects marketing and reservation revenue, which is recorded gross with an equal expense and does not generate income for the Company. Consolidated operating margin was 20.7%, versus 23.6%; this comparison is affected by those pass-through amounts. The effective income tax rate rose to 35.5% from 30.4%, including a $1.2 million unfavorable adjustment related to the tax benefit from foreign operations.
At March 31, cash and cash equivalents were $194.1 million, current assets $338.1 million, and current liabilities $220.3 million (current ratio approximately 1.53). Total debt was $893.5 million, including $892.4 million long-term debt; shareholders’ deficit was $385.9 million. The $450 million revolving facility had $235.5 million drawn. The Company reported compliance with its debt covenants, with a 3.31x total leverage ratio and 6.68x fixed-charge coverage ratio. Approximately $189.9 million of cash related to undistributed foreign-subsidiary earnings that management intended to reinvest abroad.
Investing activities used $41.3 million, including $25.4 million for real estate acquisitions; financing activities provided $64.2 million, including $79.3 million of net revolving-facility borrowings. The Company paid $11.6 million in dividends and repurchased $3.6 million of shares under its repurchase program during the quarter.
Material changes and operating drivers
- Domestic royalties increased 5% to $60.5 million. Domestic RevPAR rose 1.2%, rooms increased 0.3%, and the effective royalty rate improved from 4.31% to 4.38%. Average daily rates rose 2.5%, while occupancy declined 70 basis points.
- Franchising revenue increased $2.8 million, supported by higher royalties and a 21% increase in procurement-services revenue; initial and relicensing fees declined 10%.
- Operating income rose $1.5 million, while SG&A increased $2.7 million. Interest expense rose $0.9 million and equity-method investment losses increased $1.2 million to $2.2 million, primarily reflecting ramp-up costs at hotel ventures.
- Marketing and reservation revenue and expense each increased to $126.4 million from $98.7 million. Revenue included recognition of $30.7 million of previously deferred system fees, compared with $1.7 million in the prior-year quarter. At quarter-end, cumulative system expenses exceeded fees by $15.6 million, recorded as an asset; at year-end 2015, fees exceeded expenses by $30.7 million, recorded as a liability.
- Operating cash use increased to $22.9 million, principally reflecting a $39.8 million net cash outflow from marketing and reservation activities, partly offset by deferred-revenue growth and lower net advances under forgivable notes.
Outlook, commentary, and risks
- Management expected 2016 domestic franchise-agreement executions to be at or above the prior year. The domestic pipeline was 582 hotels, up from 519 a year earlier; the filing cautions that pipeline projects may not open.
- The Company expected to deploy $250 million to $350 million over three to five years to support Cambria growth, subject to market conditions; approximately $167 million was outstanding under its financial-support activities at quarter-end. Commitments included $116.2 million for franchisee incentives and improvements, $26.1 million of additional joint-venture contributions, and $40.8 million of additional development financing expected within twelve months, subject to conditions.
- Management expected 2016 regular dividends of approximately $46.4 million at the then-current rate, subject to board approval, business conditions, and credit-facility limits. The quarterly dividend was $0.205 per share.
- Risks highlighted include lodging and economic conditions, foreign-exchange exposure, franchise growth and performance, technology and cybersecurity, development and investment exposures, and the ability to manage debt. Three limited guarantees for hotel venture loans had maximum stated exposures of $4.5 million, $11.6 million, and $1.8 million; management considered performance under them remote. Ordinary-course litigation was not expected to have a material adverse effect.
- Revenue from initial franchise fees may be affected by forthcoming revenue-recognition guidance; the Company was assessing the impact and had not selected a transition method. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Important facts for investors to verify
- Whether the $30.7 million release of previously deferred marketing-system fees is nonrecurring and how it affects comparisons of reported revenue and marketing-system balances.
- Whether franchise growth, hotel openings, RevPAR, occupancy, and effective royalty rates sustain the increase in core franchising revenue; also track franchise terminations and the Comfort-brand repositioning strategy.
- How the $15.6 million marketing-system deficit and substantial marketing-related cash outflows evolve, and whether advances remain recoverable under franchise agreements.
- Debt, revolver availability, covenant headroom, and the practical availability of cash held by foreign subsidiaries; confirm that investment and franchisee-financing commitments remain manageable.
- Performance and recoverability of Cambria joint ventures, notes receivable, real-estate investments, and the acquired vacation-rental technology business; monitor the stated guarantee exposures.