Choice Hotels International, Inc. — 2017 Form 10-K
Business context and reporting period. This annual report covers the year ended December 31, 2017; quarterly figures are unaudited. Choice is primarily a hotel franchisor, with approximately 99% of revenue attributable to franchising. At year-end, its system included 6,627 open hotels and 923 hotels in development across the U.S. and more than 40 other countries and territories.
Key financial metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total revenue | $1,007.4 million | $924.6 million | +8.9% |
| Hotel franchising revenue (company-defined non-GAAP) | $429.5 million | $390.1 million | +10% |
| Operating income | $264.4 million | $238.9 million | +10.7% |
| Operating margin | 26.3% | 25.8% | +0.5 percentage points |
| Income before taxes | $224.0 million | $200.0 million | +12% |
| Net income | $114.9 million | $139.4 million | -17.6% |
| Diluted EPS | $2.02 | $2.46 | -17.9% |
| Cash from operating activities | $257.4 million | $152.0 million | +$105.3 million |
| Cash and cash equivalents | $235.3 million | $202.5 million | +$32.9 million |
| Total debt | $726.5 million | $840.6 million | -$114.1 million |
Operating margin is operating income divided by total revenue. The 2017 net margin was 11.4%, compared with 15.1% in 2016. Cash from operations less property/equipment and intangible-asset spending was approximately $231.4 million in 2017. Year-end current assets were $402.9 million and current liabilities $294.5 million, a current ratio of approximately 1.37. Total debt less cash was approximately $491.2 million.
Material changes versus the prior period
- Domestic royalty revenue increased 8% to $323.9 million. Domestic RevPAR rose 2.5%, domestic rooms grew 2.1%, and the effective royalty rate increased from 4.41% to 4.60%.
- Domestic RevPAR increased to $52.25, supported by a 1.7% increase in average daily rate and a 50-basis-point increase in occupancy. Domestic open hotels rose 2.6% to 5,501; rooms rose 2.1% to 413,015.
- Operating income rose despite a $14.6 million increase in SG&A. The year included $12.0 million of compensation expense related to accelerating the CEO succession plan. SkyTouch costs declined following completion of a multi-year product-development program.
- Net income fell despite higher operating and pretax income, principally because the 2017 tax provision included a $35.3 million transition tax on foreign earnings and a $4.7 million impairment of domestic deferred tax assets following U.S. tax-rate reductions. The filing estimates the tax legislation reduced 2017 net income by approximately $40 million.
- Operating cash flow increased substantially, partly reflecting timing of marketing/reservation cash flows, lower cash income-tax payments, and working-capital changes. Net cash used in investing was $90.1 million; financing activities used $135.8 million.
Outlook, management commentary, risks and unusual items
- Management emphasizes franchise-system growth, improved hotel performance, effective royalty-rate increases, cost discipline, and shareholder returns. The filing does not provide formal 2018 revenue or earnings guidance. It estimates 2018 regular dividends of approximately $48.7 million, subject to board approval and business conditions.
- Choice had 923 hotels and 72,917 rooms in its development pipeline at year-end. Management cautions that pipeline properties do not necessarily become open hotels. Domestic new-construction pipeline hotels increased 23% to 607.
- After year-end, on February 1, 2018, the company completed its approximately $231 million acquisition of the WoodSpring Suites brand and franchise business, adding 239 extended-stay hotels. The purchase was funded with cash and revolver borrowings; it is not included in 2017 year-end system statistics.
- Management expects to continue investing in Cambria development support. It described expected support of approximately $475 million over three to five years, subject to market and other conditions; $251.4 million was outstanding at year-end. Commitments included up to $240.1 million in franchise financing/incentives, $14.7 million in joint-venture contributions, and $3.8 million in development financing, subject to conditions.
- Debt comprised $400 million of senior notes due 2022, $250 million of senior notes due 2020, and $67.9 million outstanding under a $450 million revolver, along with other debt. The company reported a 2.24x total leverage ratio and 7.67x fixed-charge coverage ratio and compliance with credit covenants. Variable-rate debt was $70 million; a hypothetical 10% rate change would affect annual interest expense by about $0.2 million.
- Key risks include lodging demand, occupancy and room-rate declines; competition for franchisees and guests; reliance on online travel intermediaries; technology disruption and cybersecurity; franchisee financial health and property standards; international, currency and regulatory exposure; and credit risk from loans, guarantees, joint ventures and real estate development support.
- The company reported limited loan guarantees for hotel ventures and considered performance under them remote at year-end. It reported no litigation expected to have a material adverse effect. The 2017 tax accounting was provisional in certain respects and could change with further analysis or tax-authority guidance.
- Marketing and reservation system fees are reported gross with corresponding expenses; the company states these activities are contractually funded for franchise-system purposes and do not generate net income or loss under its current accounting. Adoption of revenue-recognition guidance in 2018 was expected to change the timing and presentation of certain fees, incentives and system-fund surpluses or deficits.
Investor verification priorities
- Verify the tax-law effects: the $35.3 million transition-tax estimate, deferred-tax remeasurement, provisional accounting, payment schedule, and expected foreign-cash repatriation of approximately $200 million in 2018.
- Assess underlying earnings growth separately from unusual items, including CEO-succession compensation, tax charges, investment gains/losses, and the large year-over-year operating-cash-flow movement.
- Track whether pipeline hotels open, domestic and international room growth, terminations, RevPAR, and effective royalty-rate gains are sustained.
- Review the WoodSpring acquisition’s funding, integration, and contribution to results, alongside the company’s planned Cambria financing and investment commitments.
- Monitor debt maturities, revolver usage and covenant headroom, as well as the credit quality and recoverability of franchisee notes, forgivable advances, joint-venture investments and guarantees.