Choice Hotels International, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Unless otherwise noted, financial amounts are in millions of dollars. Choice is primarily a hotel franchisor, with a smaller owned-hotel and investment business. At quarter-end, its system included 7,074 open hotels and 1,069 hotels in its development pipeline across the U.S. and more than 40 other countries and territories.
Key financial results
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Total revenue | $310.7 | $291.5 | $846.7 | $796.3 |
| Revenue excluding marketing and reservation activities | $153.7 | $139.1 | $407.2 | $379.6 |
| Operating income | $102.4 | $111.2 | $250.0 | $266.4 |
| Income before tax | $85.9 | $102.4 | $216.6 | $232.9 |
| Net income | $76.2 | $80.0 | $180.7 | $184.9 |
| Diluted EPS | $1.36 | $1.41 | $3.23 | $3.24 |
| Cash dividends declared per share | $0.215 | $0.215 | $0.645 | $0.645 |
Q3 revenue increased 6.6%, while net income declined 4.7% and diluted EPS declined 3.5%. For the first nine months, revenue grew 6.3%, while net income declined 2.3%. Operating income fell 7.9% in Q3 and 6.2% year to date. Approximate operating margins on reported total revenue were 33.0% versus 38.1% in Q3 and 29.5% versus 33.5% for the nine months; these comparisons are affected by marketing-system revenue and expense, which are intended to broadly offset over time.
- Franchise performance: Q3 royalty fees rose 2% to $113.7 million. Domestic room count grew 1.8% and the effective domestic royalty rate increased to 4.84% from 4.72%, but domestic RevPAR fell 0.7%. For the first nine months, domestic royalties rose 4%, while domestic RevPAR fell 0.5%. International royalties declined slightly despite growth in rooms, reflecting RevPAR and foreign-exchange effects.
- Other revenue drivers: Procurement-services revenue increased 27% in Q3 and 21% year to date. Revenue from owned hotels was $8.7 million, with $6.0 million of related expense; five hotels were acquired or opened during Q3.
- Marketing and reservation system: Fees exceeded related expenses by $1.4 million in Q3 2019, compared with a $14.1 million surplus in Q3 2018. The nine-month surplus was $1.2 million versus $22.6 million a year earlier, a major factor in lower operating income.
Cash flow, debt and liquidity
- Cash from operating activities was $191.0 million for the first nine months, up from $146.8 million. Investing activities used $220.2 million, and financing activities provided $34.2 million. Cash ended at $31.6 million, compared with $26.6 million at year-end 2018.
- Total debt was $876.4 million at September 30, up from $754.6 million at December 31, 2018; long-term debt was $875.8 million. The increase primarily reflects revolving-credit borrowings and financing of the hotel acquisition. Cash less total debt was approximately $844.8 million.
- The company had a $600 million unsecured revolving credit facility, with maturity extended to August 2024. It reported a 2.05x total leverage ratio under the facility and compliance with applicable financial covenants. A $250 million note due August 2020 was classified as long-term because the company said it could repay it using available revolver capacity.
- Current assets were $260.3 million and current liabilities were $316.3 million. The filing states that operating cash flows and available financing are adequate for expected needs. This assessment depends in part on continued access to credit and operating performance.
- Cash dividends paid were $36.1 million and share repurchases under the program totaled $39.1 million in the nine-month period. Management indicated an expected 2019 regular dividend total of approximately $48.1 million, subject to board declaration and other conditions; 4.0 million shares remained authorized for repurchase at quarter-end.
Material changes and unusual items
- In Q1, a dispute over a key customer contract at the SaaS vacation-rentals business triggered $7.3 million of long-lived-asset impairment and $3.1 million of goodwill impairment. The unit was sold in Q2, resulting in a further $4.7 million loss. The filing says these charges did not affect liquidity or debt-covenant calculations.
- In July, Choice paid approximately $169.0 million, net of cash acquired, to acquire the remaining interest in four Cambria hotels previously held through a joint venture; the transaction was accounted for as an asset acquisition. Choice sold its interest in a fifth hotel and recorded a $6.0 million loss in equity in affiliate results.
- Tax expense benefited from $12.2 million of tax credits recognized in Q3. The effective tax rate was 11.3% for Q3 and 16.6% for the first nine months, compared with 21.9% and 20.6%, respectively, in 2018. The lower rates supported net income relative to pretax income.
- Choice adopted lease-accounting Topic 842 on January 1, 2019. At September 30, it reported $26.3 million of operating lease right-of-use assets and $34.1 million of lease liabilities; adoption did not affect the income statement.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management said it expects operating cash flow and financing capacity to meet anticipated needs, expects to continue dividends subject to board approval and business conditions, and plans to continue investing in Cambria development. It expected outstanding capital deployed for Cambria support activities not to exceed $725 million over the next three to five years; approximately $554.9 million was outstanding at quarter-end. The hotel pipeline supports potential growth but does not guarantee hotels will open.
Risks highlighted include lodging demand and RevPAR, franchise-system growth and franchisee relationships, foreign exchange, technology and cybersecurity, acceptance of SaaS products, hotel-development and financing exposure, investments in new businesses, and management of indebtedness. The company had $220.6 million of variable-rate debt; a hypothetical 10% change in its effective interest rate would change annual interest expense by approximately $0.8 million. Limited payment guarantees associated with joint ventures had maximum principal exposure of $7.5 million plus expenses and interest; management considered performance remote. It also had substantial conditional commitments, including $256.6 million of franchise incentives, $10.1 million of joint-venture contributions and approximately $34.4 million of franchisee financing commitments, of which $10.0 million had been disbursed.
Management reported no material litigation expected to adversely affect financial position, results or cash flows, no material change in previously disclosed risk factors, and effective disclosure controls as of September 30, 2019.
Important facts for investors to verify
- Whether room growth, royalty-rate gains and procurement revenue can offset weaker RevPAR and the sharp reduction in the marketing-system surplus.
- The operating performance, financing requirements and returns of the newly owned Cambria hotels and broader Cambria investment program.
- The sustainability of reported earnings and cash generation apart from tax credits and the SaaS impairment and disposal charges.
- Debt repayment and refinancing plans, available revolver capacity, covenant headroom and the ability to sustain dividends and buybacks.
- Credit quality and recoverability of franchisee notes, equity-method investments, development commitments and contingent guarantees.