Choice Hotels International, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; amounts below are in U.S. dollars. Choice is primarily a hotel franchisor, with 6,376 hotels open and 613 in its development pipeline worldwide at quarter-end.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $232.2 million | $197.7 million | $407.4 million | $357.4 million |
| Operating income | $62.9 million | $60.2 million | $104.3 million | $101.3 million |
| Continuing-operations net income | $35.8 million | $35.3 million | $57.4 million | $56.7 million |
| Net income | $35.8 million | $35.4 million | $57.4 million | $58.5 million |
| Diluted EPS | $0.62 | $0.60 | $0.99 | $0.99 |
| Adjusted EBITDA | $65.9 million | $62.5 million | $110.0 million | $105.9 million |
- Q2 total revenue grew 17%, but this includes marketing and reservation fees, which are matched by related expenses and do not generate company income. Excluding those activities and SkyTouch/other, franchising revenue increased 5% to $98.6 million. For the first half, franchising revenue rose 6% to $174.6 million.
- Operating income increased 5% in Q2 and 3% in the first half. On reported total revenue, operating margin was approximately 27.1% in Q2 versus 30.4% a year earlier; the comparison is heavily affected by the pass-through marketing and reservation activity. Adjusted EBITDA grew 5% in Q2 and 4% year to date.
- Domestic RevPAR rose 6.7% in Q2 and 8.1% for the first half. Domestic royalty growth was partly offset by a 0.7% decline in domestic rooms open and operating. The effective royalty rate was 4.28% in Q2 and 4.29% year to date.
- Q2 diluted EPS increased to $0.62 from $0.60. First-half net income declined from $58.5 million to $57.4 million, principally because 2014 included $1.8 million of after-tax discontinued-operation income from hotel disposals; continuing-operations income increased modestly.
Cash flow, debt and liquidity
- Cash and cash equivalents were $230.7 million at June 30, up from $214.9 million at year-end. Current assets were $397.6 million and current liabilities $201.7 million.
- Total debt was $801.2 million, up from $794.4 million at year-end; cash less debt was approximately negative $570.5 million. Shareholders’ deficit was $385.5 million. The company reported compliance with its credit facility covenants at quarter-end.
- First-half operating cash flow was $37.9 million, down from $65.8 million. Management attributed the decline mainly to lower net cash from marketing and reservation activities and $19.2 million of net advances on forgivable franchisee notes, compared with $6.7 million in 2014.
- Investing activities used $9.3 million, versus $4.6 million provided in the prior-year period; capital expenditures increased to $14.6 million from $7.3 million. Financing activities used $12.0 million, including $22.9 million of dividends paid.
- About $205 million of cash was held by foreign subsidiaries and treated as permanently reinvested; the company said it did not intend to use that cash in domestic operations and that domestic use could trigger additional U.S. taxes. Cash availability should therefore be considered alongside its location and tax treatment.
Material changes, outlook and risks
- Management cited stronger domestic room rates and occupancy, more executed franchise agreements, and higher initial and relicensing fees. Domestic RevPAR improved, while international royalties fell 15% for the first half, primarily due to unfavorable foreign currency movements despite more rooms available.
- Domestic franchise terminations rose to 121 in the first half from 102 a year earlier, reflecting increased removals for non-compliance. Management expects 356 new franchise unit openings in 2015, compared with 302 in 2014; pipeline hotels may not ultimately open.
- The company expects to invest $250 million to $350 million over three to five years to support Cambria and other strategic franchise growth, and had approximately $60 million outstanding under these support activities. It had $49.3 million of conditional commitments for franchisee financing, including $9.5 million expected to be advanced within 12 months, and $2.1 million of expected joint-venture contributions.
- SkyTouch, its hotel technology business, is expected to incur costs in excess of revenues during 2015 as product development and sales and marketing continue. No full-year earnings or revenue guidance is provided in the supplied filing text.
- On July 21, 2015, after quarter-end, Choice refinanced its $350 million secured facility with a $450 million unsecured revolver maturing in 2020, subject to extension options. The new facility includes leverage and fixed-charge coverage covenants and limits dividends under specified leverage conditions.
- Unusual items included a $1.3 million gain on sale of an interest in a joint venture, increased losses from equity-method hotel ventures during their ramp-up, and a first-half tax-rate benefit from settlement of uncertain tax positions. Management described performance under two hotel-loan guarantees as remote; maximum stated principal exposures were $4.5 million and $11.6 million. Ordinary-course litigation was not expected to have a material adverse effect.
- Key risks identified include lodging and economic conditions, foreign exchange, franchisee performance and brand appeal, hotel supply and demand, technology and cybersecurity, development and investment exposure, litigation, and management of indebtedness. Management reported effective disclosure controls and no material changes in internal control during the quarter.
Important facts for investors to verify
- Whether domestic RevPAR improvement and the franchise pipeline translate into room growth and recurring royalty revenue, given higher terminations and a slightly smaller domestic room base.
- The sustainability of cash generation after the decline in operating cash flow, increased franchisee financing advances, and elevated technology and system investment.
- How much of reported cash is practically available for domestic needs, considering the $205 million held abroad and potential tax consequences of repatriation.
- Debt-service capacity and covenant headroom following the July 2015 refinancing, including the effects of dividends, repurchases, and planned growth investments.
- Credit quality and recoverability of forgivable notes, joint-venture investments, and contingent guarantees; forgivable notes totaled $44.4 million gross, with $4.7 million reserved.