Choice Hotels International, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Financial amounts below are in millions unless otherwise stated. Comparisons are with 2017; prior-period figures were retrospectively adjusted for adoption of Topic 606.
Business context
Choice is primarily a hotel franchisor. At June 30, 2018, its system included 6,883 open hotels and 1,024 hotels under construction, awaiting conversion, or approved for development, across 12 brands. The February 1 acquisition of WoodSpring added 239 economy extended-stay hotels at closing and is included in results from that date.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $295.4 | $261.0 | $504.8 | $449.9 |
| Operating income | $109.0 | $86.5 | $155.3 | $131.9 |
| Net income | $79.8 | $50.7 | $104.9 | $75.0 |
| Diluted EPS | $1.40 | $0.89 | $1.83 | $1.32 |
| Operating margin | 36.9% | 33.2% | 30.8% | 29.3% |
| Net margin | 27.0% | 19.4% | 20.8% | 16.7% |
- Q2 revenue increased 13.2%, operating income 26.0%, and net income 57.5%. For the first half, revenue rose 12.2%, operating income 17.7%, and net income 40.0%.
- Q2 hotel-franchising revenue, excluding marketing and reservation system fees and non-franchising activities, was $134.8 million, up 14%. Domestic royalty fees increased 13%; drivers included 2.7% domestic RevPAR growth, 8.8% growth in domestic rooms, improved effective royalty rates, and WoodSpring.
- Domestic RevPAR rose 3.1% for the first half. The domestic effective royalty rate increased to 4.73% from 4.58%. WoodSpring contributed $5.2 million to Q2 and $8.5 million to first-half domestic royalties.
- Marketing and reservation system revenue exceeded related expense by $20.8 million in Q2 and $8.6 million in the first half, versus surpluses of $11.7 million and $2.6 million in 2017. Management says these activities are intended to break even over time; period surpluses can reflect seasonality and investment timing.
- Six-month SG&A rose $9.4 million, including $4.2 million of WoodSpring transaction and transition costs. Depreciation and amortization increased $3.3 million, primarily due to WoodSpring. Equity-method affiliate losses increased to $5.4 million from $2.9 million for the first half, largely reflecting ramp-up of recently opened hotel projects.
- The effective tax rate fell to 20.2% in Q2 and 19.6% for the first half, from 33.7% and 32.3%, respectively. The filing attributes the lower 2018 rates principally to the lower federal statutory rate, foreign operations, and share-based compensation tax benefits.
Cash flow, debt, and liquidity
- First-half operating cash flow was $63.8 million, roughly unchanged from $64.1 million. Investing cash outflow was $272.7 million, including $231.3 million for WoodSpring and $21.6 million of property and equipment investment. Financing cash flow was $11.3 million.
- Cash and cash equivalents fell to $37.1 million from $235.3 million at year-end, principally reflecting the acquisition. Current assets were $283.2 million and current liabilities $286.7 million.
- Total debt was $796.2 million, up from $726.5 million at December 31, 2017. This included $650 million of senior unsecured notes and $137.2 million outstanding under the $450 million revolving facility. The company reported a 2.26x total leverage ratio and 8.24x fixed-charge coverage ratio and stated it complied with financial covenants.
- Shareholders’ deficit was $204.0 million. The company repurchased $63.5 million of shares under its program and paid $24.5 million in dividends during the first half. The declared quarterly dividend was $0.215 per share.
Outlook, changes, and risks
- No formal revenue or earnings guidance is provided in the filing. Management said operating cash flow and available financing capacity were adequate for expected needs, and estimated 2018 regular dividends of approximately $48.8 million at the then-current rate and share count, subject to board approval and other conditions.
- Management expected to deploy approximately $475 million over three to five years to support Cambria growth, subject to market and other conditions. At June 30, approximately $280.2 million was outstanding under these financial-support activities.
- Topic 606 was adopted January 1, 2018 using the full retrospective method. It changed timing and presentation for initial and relicensing fees, franchise acquisition costs, loyalty-program revenue, and marketing/reservation system surpluses or deficits. The adoption affected reported income and balance-sheet classifications, but not total cash flows.
- WoodSpring’s preliminary acquisition accounting included $115.0 million of acquired franchise agreements, a $22.0 million tradename, and $93.4 million of goodwill; valuation was not final. The company said the acquisition’s pro forma results were not presented because its effect on consolidated results was not material.
- Commitments included up to $225.4 million of conditional franchise incentives, $26.6 million of additional joint-venture capital contributions, and approximately $13.9 million of conditional franchisee financing. Limited-payment guarantees had maximum principal exposure of $11.2 million, which management considered remote.
- The company identified economic, lodging-industry, franchisee, technology and cybersecurity, acquisition-integration, development-financing, international, currency, and debt-management risks. It reported no material change to the risk factors in its 2017 Form 10-K. It also expected the 2019 lease-accounting standard to materially increase recognized lease assets and liabilities, with no material income-statement effect expected.
Most important facts for investors to verify
- How much of the earnings and royalty growth reflects underlying same-system performance versus WoodSpring’s inclusion and system expansion.
- Whether the marketing and reservation system surplus reverses or persists; the company says it expects these activities to break even over time.
- Cash use and funding plans after the WoodSpring acquisition, including share repurchases, dividends, development support, and the company’s reduced cash balance.
- Final WoodSpring purchase-price allocation and realization of expected acquisition benefits.
- Progress and potential exposure on the sizable conditional franchise-incentive and development commitments, equity investments, and guarantees.