(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand the consolidated financial condition and results of operations of Choice Hotels International, Inc. and its subsidiaries (together the "Company") contained in this report. MD&A is provided as a supplement to -- and should be read in conjunction with -- our consolidated financial statements and the accompanying notes.
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The Company's domestic franchising operations are conducted through direct franchising relationships while its international franchise operations are conducted through a combination of direct franchising and master franchising relationships. Master franchising relationships are governed by master franchising agreements which generally provide the master franchisee with the right to use our brands and sub-license the use of our brands in a specific geographic region, usually for a fee.
With a primary focus on hotel franchising instead of ownership, we benefit from the economies of scale inherent in the franchising business. The fee and cost structure of our business provides opportunities to improve operating results by increasing the number of franchised hotel rooms and effective royalty rates of our franchise contracts resulting in increased initial and relicensing fee revenue; ongoing royalty fees and procurement services revenues. In addition, our operating results can also be improved through our company-wide efforts related to improving property level performance. The Company currently estimates, based on its current domestic portfolio of hotels under franchise, that a 1% change in revenue per available room ("RevPAR") or rooms under franchise would increase or decrease royalty revenues by approximately $3.8 million and a 1 basis point change in the Company's effective royalty rate would increase or decrease annual domestic royalties by approximately $0.8 million. In addition to these revenues, we also collect marketing and reservation system fees to support centralized marketing and reservation activities for the franchise system.
The principal factors that affect the Company's results are: the number and relative mix of franchised hotel rooms in the various hotel lodging price categories; growth in the number of hotel rooms under franchise; occupancy and room rates achieved by the hotels under franchise; the effective royalty rate achieved; the level of franchise sales and relicensing activity; and our ability to manage costs. The number of rooms at franchised properties and occupancy and room rates at those properties significantly affect the Company's results because our fees are based upon room revenues or the number of rooms at franchised hotels. The key industry standard for measuring hotel-operating performance is RevPAR, which is calculated by multiplying the percentage of occupied rooms by the average daily room rate realized. Our variable overhead costs associated with franchise system growth of our established brands have historically been less than incremental royalty fees generated from new franchises. Accordingly, continued growth of our franchise business should enable us to realize benefits from the operating leverage in place and improve operating results.
We are required by our franchise agreements to use the marketing and reservation system fees we collect for system-wide marketing and reservation activities. These expenditures, which include advertising costs and costs to maintain our central reservations and property management systems, help to enhance awareness and consumer preference for our brands and deliver guests to our franchisees. Greater awareness and preference promotes long-term growth in business delivery to our franchisees and increases the desirability of our brands to hotel owners and developers, which ultimately increases franchise fees earned by the Company.
Our Company articulates its mission as a commitment to our franchisees' profitability by providing our franchisees with hotel franchises that strive to generate the highest return on investment of any hotel franchise. We have developed an operating system dedicated to our franchisees' success that focuses on delivering guests to our franchised hotels and reducing costs for our hotel owners.
We believe that executing our strategic priorities creates value for our shareholders. Our Company focuses on two key goals:
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Profitable Growth. Our success is dependent on improving the performance of our hotels, increasing our system size by selling additional hotel franchises, effective royalty rate improvement and maintaining a disciplined cost structure. We attempt to improve our franchisees' revenues and overall profitability by providing a variety of products and services designed to increase business delivery to and/or reduce operating and development costs for our franchisees. These products and services include national marketing campaigns, maintaining a guest loyalty program, a central reservation system, property and yield management programs and systems, revenue management services, quality assurance standards and qualified vendor relationships. We believe that healthy brands, which deliver a compelling return on investment for franchisees, will enable us to sell additional hotel franchises and raise royalty rates. We have multiple brands that meet the needs of many types of guests, and can be developed at various price points and applied to both new and existing hotels. This ensures that we have brands suitable for creating growth in a variety of market conditions. Improving the performance of the hotels under franchise, growing the system through additional franchise sales and improving franchise agreement pricing while maintaining a disciplined cost structure are the keys to profitable growth.
The Company also allocates capital to financing, investment and guaranty support to incent franchise development for certain brands in strategic markets and to exploring growth opportunities in business areas that are adjacent or complementary to our core hotel franchising business, which leverage our core competencies and are additive to our franchising business model. The timing and amount of these investments are subject to market and other conditions. Notwithstanding investments in these alternative growth strategies, the Company expects to continue to return value to its shareholders over time through a combination of share repurchases and dividends.
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expenses to break even and therefore no income or loss will be generated from marketing and reservation system activities. As a result, the Company generally excludes the financial impacts of this program from the analysis of its operations.
The Company utilizes certain measures which do not conform to generally accepted accounting principles accepted in the United States ("GAAP") when analyzing and discussing its results with the investment community. This information should not be considered as an alternative to any measure of performance as promulgated under GAAP. The Company's calculation of these measurements may be different from the calculations used by other companies and therefore, comparability may be limited. We have included a reconciliation of these measures to the comparable GAAP measurement below as well as our reasons for reporting these non-GAAP measures.
Revenues, excluding marketing and reservation system activities: The Company utilizes revenues, excluding marketing and reservation system activities rather than total revenues when analyzing the performance of the business. Marketing and reservation activities are excluded since the Company is contractually required by its franchise agreements to utilize the fees collected specifically for system-wide marketing and reservation activities. This non-GAAP measure is a commonly used measure of performance in our industry and facilitates comparisons between the Company and its competitors.
Three Months Ended June 30, Six Months Ended June 30, 2019 2018 2019 2018 (in thousands) (in thousands) Total Revenues $ 317,684 $ 295,441 $ 536,004 $ 504,835 Adjustments: Marketing and reservation system revenues (172,465 ) (157,347 ) (282,529 ) (264,348 ) Revenues, excluding marketing and reservation system activities $ 145,219 $ 138,094 $ 253,475 $ 240,487
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Operations Review Comparison of Operating Results for the Three-Month Periods Ended June 30, 2019 and 2018 Summarized financial results for the three months ended June 30, 2019 and 2018 are as follows: (In thousands) 2019 2018 REVENUES Royalty fees $ 106,427 $ 103,219 Initial franchise and relicensing fees 6,675 6,481 Procurement services 20,829 17,833 Marketing and reservation system 172,465 157,347 Other 11,288 10,561 Total revenues 317,684 295,441 OPERATING EXPENSES Selling, general and administrative 46,980 46,270 Depreciation and amortization 3,405 3,669 Marketing and reservation system 160,121 136,568 Total operating expenses 210,506 186,507 Impairment of goodwill - - Impairment of long-lived assets - - Loss on sale of business (4,641 ) - Gain on sale of assets, net - 82 Operating income 102,537 109,016 OTHER INCOME AND EXPENSES, NET Interest expense 11,093 11,705 Interest income (2,784 ) (1,643 ) Other gains (906 ) (503 ) Equity in net (income) loss of affiliates 980 (567 ) Total other income and expenses, net 8,383 8,992 Income before income taxes 94,154 100,024 Income tax expense 19,765 20,185 Net income $ 74,389 $ 79,839
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The primary reasons for these fluctuations are described in more detail below.
Domestic royalty fees for the three months ended June 30, 2019 increased $3.2 million to $100.8 million from $97.6 million for the three months ended June 30, 2018, an increase of 3%. The increase in domestic royalties reflect a 2.1% increase in the number of domestic franchised hotel rooms and an increase in the effective royalty rate, partially offset by a 0.1% decrease in domestic RevPAR. System-wide RevPAR decreased due to a 0.1% decrease in average daily rates and no change in occupancy.
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The Company's effective royalty rate for the domestic hotel system increased from 4.74% for the three months ended June 30, 2018 to 4.84% for the three months ended June 30, 2019.
Three Months Ended Three Months Ended June 30, 2019 June 30, 2018 Change Average Average Average Daily Daily Daily Rate Occupancy RevPAR Rate Occupancy RevPAR Rate Occupancy RevPAR Comfort Inn $ 97.19 69.7 % $ 67.78 $ 97.22 70.2 % $ 68.20 -% (50 ) bps (0.6)% Comfort Suites 100.55 73.6 % 74.05 100.38 73.8 % 74.07 0.2% (20 ) bps -% Sleep 86.91 70.0 % 60.86 87.28 70.1 % 61.17 (0.4)% (10 ) bps (0.5)% Quality 81.16 64.4 % 52.30 81.67 64.3 % 52.52 (0.6)% 10 bps (0.4)% Clarion 87.43 61.5 % 53.75 86.19 62.6 % 53.91 1.4% (110 ) bps (0.3)% Econo Lodge 64.30 58.8 % 37.80 64.10 58.1 % 37.21 0.3% 70 bps 1.6% Rodeway 64.38 59.0 % 38.01 64.92 59.4 % 38.59 (0.8)% (40 ) bps (1.5)% WoodSpring 47.79 81.6 % 39.01 46.60 81.6 % 38.00 2.6% - bps 2.7% MainStay 87.31 72.4 % 63.17 84.68 74.9 % 63.39 3.1% (250 ) bps (0.3)% Suburban 58.67 77.6 % 45.50 56.23 78.6 % 44.22 4.3% (100 ) bps 2.9% Cambria Hotels 152.06 78.0 % 118.58 155.55 74.6 % 115.99 (2.2)% 340 bps 2.2% Ascend Hotel Collection 127.90 60.6 % 77.45 132.25 60.0 % 79.39 (3.3)% 60 bps (2.4)% Total $ 83.57 67.2 % $ 56.17 $ 83.64 67.2 % $ 56.23 (0.1)% - bps (0.1)%
The number of total domestic rooms on-line increased by 2.1% to 452,375 rooms as of June 30, 2019 from 442,875 as of June 30, 2018. The total number of domestic hotels on-line increased by 2.0% to 5,879 as of June 30, 2019 from 5,763 as of June 30, 2018. The increase in units and rooms is primarily attributable to the growth of the Quality and WoodSpring brands, which added 81 and 17 hotels and 5,265 and 2,129 rooms on-line, respectively, compared to June 30, 2018. A summary of domestic hotels and rooms on-line at June 30, 2019 and 2018 by brand is as follows:
June 30, 2019 June 30, 2018 Variance Hotels Rooms Hotels Rooms Hotels Rooms % % Comfort Inn 1,044 82,319 1,071 83,753 (27 ) (1,434 ) (2.5 )% (1.7 )% Comfort Suites 566 43,910 568 44,128 (2 ) (218 ) (0.4 )% (0.5 )% Sleep 397 28,099 387 27,579 10 520 2.6 % 1.9 % Quality 1,665 128,115 1,584 122,850 81 5,265 5.1 % 4.3 % Clarion 175 22,085 166 21,988 9 97 5.4 % 0.4 % Econo Lodge 823 49,838 830 50,568 (7 ) (730 ) (0.8 )% (1.4 )% Rodeway 597 34,749 601 34,292 (4 ) 457 (0.7 )% 1.3 % WoodSpring 262 31,515 245 29,386 17 2,129 6.9 % 7.2 % MainStay 66 4,387 61 4,263 5 124 8.2 % 2.9 % Suburban 56 5,807 52 5,481 4 326 7.7 % 5.9 % Cambria Hotels 42 5,923 37 5,301 5 622 13.5 % 11.7 % Ascend Hotel Collection 186 15,628 161 13,286 25 2,342 15.5 % 17.6 % Total Domestic Franchises 5,879 452,375 5,763 442,875 116 9,500 2.0 % 2.1 %
International royalty fees were $5.6 million for each of the three months ended June 30, 2019 and June 30, 2018. International rooms on-line increased by 6,207 from 114,077 as of June 30, 2018 to 120,284 as of June 30, 2019, with the total number of hotels on-line increasing by 46 from 1,120 as of June 30, 2018 to 1,166 as of June 30, 2019. Despite the increase in international hotels and rooms, international royalty fees remained flat due to RevPAR performance in the various countries where we operate.
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Initial Franchise and Relicensing Fees
Initial franchise fees are fees paid to the Company when a franchisee is awarded a franchise agreement; relicensing fees include fees charged to new owners of a franchised property whenever an ownership change occurs and the property remains in the franchise system, as well as fees required to renew existing franchise agreements.
During the second quarter of 2019, the Company awarded 181 domestic franchise agreements representing 14,301 rooms compared to 188 franchising agreements representing 15,187 rooms for the second quarter of 2018. Domestic franchise agreements awarded for new construction hotels totaled 60 contracts representing 5,100 rooms during the three months ended June 30, 2019, compared to 76 contracts representing 6,260 rooms for the three months ended June 30, 2018. Conversion hotel awarded franchise agreements totaled 121 representing 9,201 rooms for the three months ended June 30, 2019, compared to 112 agreements representing 8,927 rooms for the three months ended June 30, 2018.
The Company awarded 89 domestic relicensing contracts during the three months ended June 30, 2019, compared to 112 executed during the three months ended June 30, 2018. The Company awarded 10 domestic renewal agreements during the three months ended June 30, 2019, compared to 7 awarded during the three months ended June 30, 2018.
Initial franchise and relicensing fees are generally collected at the time the franchise agreement is awarded. However, the recognition of revenue is deferred until the hotel is open or the franchise agreement is terminated. Upon hotel opening, revenue is recognized ratably as services are provided over the . . .
Aug 06, 2019
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