(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", "we", or "our") 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.
Impact of the COVID-19 Pandemic
The rapidly evolving spread of COVID-19 has caused significant disruptions to the global economy and the hospitality industry, including in the U.S. where the majority of our franchised hotels are located. The COVID-19 pandemic has led governments and other authorities around the world to impose or recommend measures intended to control its spread, including temporary closures of many businesses, "shelter in place" orders, travel restrictions, cancellation of events including sporting events, conferences and meetings, social distancing measures and other governmental regulations that have significantly reduced demand for travel. As a result of the reduced demand for travel and other governmental actions, there have been complete or partial suspension of hotel operations in certain markets in which our hotels are located. All of these effects of the COVID-19 pandemic have negatively impacted the hospitality industry and the Company both financially and operationally.
For the Company, the impacts of COVID-19 were experienced most sharply in the final ten days of the first quarter of 2020. Domestic occupancy levels were below 50% overall for the month of March, but ranged between 25.5% and 32.5% in the last ten days of the month. As a result of these occupancy levels, we experienced decreases in revenue per available room ("RevPAR") from the comparative prior year quarter of 15.0%, and comparative prior year March of 36.5%. Lower occupancy and RevPAR trends have continued into April and May and, as a result, we expect significant impact on our second quarterly results of operations. As of March 31, 2020, and May 6, 2020, there were approximately 10% and 3%, respectively, of the Company's domestic hotel system that had temporarily suspended operations due to governmental restriction or a franchisee's election.
While the ultimate impact and duration of COVID-19 is uncertain and will depend on future developments, which are difficult to predict, the Company believes that it will continue to benefit in the long-term from its primarily franchise-only business model, which has historically provided a relatively stable earnings stream and low capital expenditure requirements. In addition, as of March 31, 2020, the Company has approximately $507.0 million in cash and additional available borrowing capacity through its senior unsecured revolving credit facility. The Company also entered into a $250 million unsecured term loan (the "Term Loan") on April 16, 2020, further bolstering its liquidity. Based on our business model, the financial mitigation measures describe below, and information known at this time, the Company believes that cash flows from operations and available financing capacity are adequate to meet the expected future operating, investing and financing needs of the business.
In response to the COVID-19 pandemic, we have implemented measures to focus on the safety of our customers, employees, franchisees and their staff, while at the same time seeking to mitigate the impact on franchisees' and our Company's financial position and operations. The duration of these measures cannot be predicted at this time. These measures include, but are not limited to, the following:
Implemented fee-deferral programs for domestic and international franchisees.
Suspended one-time finance charges, reputation management fees and guest relations handling fees through June 30, 2020. Extended capital-intensive brand deadlines and created more flexible brand standard options to assist franchisees. Successfully advocated to expand the amount of and eligibility requirements for government relief SBA programs and other CARES Act benefits to help franchisees retain employees and service their debt. Established a proactive, ongoing multi-channel franchisee outreach and education program that is actively helping thousands of hotel owners access this newly available capital. Revised its guest cancellation policy to provide travelers greater flexibility during these challenging times and deferred the expiration of loyalty points. Implemented travel restrictions and work-from-home practices for the Company's employees.
The Company has made a priority of working closely with its franchisees to drive business to their hotels across a wide variety of industries and government and emergency-management agencies. Many of the Company's franchisees have committed their rooms inventory at discounted rates, or on a complimentary basis, to support their communities in dealing with the effects of
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the pandemic, opening their hotels for hospital overflows and providing temporary housing for first responders, the National Guard, healthcare workers, critical infrastructure workers and others in dire need. In addition, to support local communities, the Company is working with its philanthropic partner, Operation Homefront, to provide complimentary lodging to service members and their families who have been displaced from their current housing. The Company is also working with Serta, Inc. to contribute to its "Stay Home, Send Beds" initiative, which is providing bed donations to help address nationwide shortages at hospitals and temporary medical facilities.
Management and the Board of Directors have taken steps to adjust the Company's cost structure and increase its financial flexibility, which include, but are not limited to, the following actions:
Reduced the compensation of the Board of Directors, chief executive officer, and other executive officers for the remainder of 2020. Implemented furloughs of certain domestic and international positions through June 30, 2020, subject to reevaluation by the Company. During the furlough period, impacted employees will continue to be covered under the Company's healthcare plans in which they currently participate, and the Company will cover each impacted employee's portion of their healthcare premiums. Terminated approximately 20 employees in connection with the consolidation of its call center operations. Introduced a hiring freeze except with respect to certain critical positions and suspended associates' 401(k) match. Eliminated, reduced or deferred non-essential expenditures, discretionary capital expenditures and investments. We are actively working with vendors to achieve relief on fees or timing of fee payment.
Temporarily suspended activity under the Company's share repurchase program.
Determined to suspend future, undeclared dividends for at least the remainder of 2020. Entered into the Term Loan on a precautionary basis, enhancing the Company's financial flexibility by increasing its borrowing capacity by $250 million.
As disclosed above, domestic occupancy has been severely impacted. However, approximately 90% of the Company's domestic hotels are in suburban, small town and interstate locations and have to-date experienced less severe occupancy declines related to COVID-19 than hotels in urban centers or resorts. Based on industry data, the Company's brands have been performing ahead of its upper-midscale, midscale and economy chain scale competitors, and the Company's hotels have experienced relatively stronger same-store RevPAR share gains versus their local competition for the past eight weeks.
Given the uncertainty as to the potential duration of the crisis and its severity, the Company does not expect material improvement in the industry until there is a sense that the spread of the virus has been contained, shelter-in-place orders have been lifted and economic forecasts begin to improve. Once the industry begins to recover, the Company believes it will benefit from the expected faster rebound of leisure demand as a result of its higher share of leisure travel mix relative to competitors. The Company's properties are also well distributed in drive-to markets, which we believe will lead in the demand recovery for the industry.
While the Company believes that the long-term fundamentals of the business remain strong, it will continue to adjust business contingency plans as the COVID-19 pandemic evolves. Reference updates to the Company Risk Factors in Part II, Item 1A.
We are primarily a hotel franchisor with franchise agreements and owned hotels representing 7,145 hotels open comprising 598,223 rooms and 1,055 hotels under construction, awaiting conversion or approved for development comprising 86,590 rooms as of March 31, 2020, located in 50 states, the District of Columbia and over 40 countries and territories outside the United States. Our brand names include Comfort Inn(R), Comfort Suites(R), Quality(R), Clarion(R), Clarion Pointe(TM), Ascend Hotel Collection(R), Sleep Inn(R), Econo Lodge(R), Rodeway Inn(R), MainStay Suites(R), Suburban Extended Stay Hotel(R), WoodSpring Suites(R), Everhome(TM) Suites, and Cambria(R) Hotels (collectively, the "Choice brands").
On January 27, 2020, we announced the launch of Everhome Suites, a new-construction midscale extended-stay brand offering. We expect to open the first Everhome Suites hotel in 2021.
The Company's domestic operations are conducted through direct franchising relationships and the ownership of five Cambria hotels, 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.
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Our business strategy is to conduct direct franchising in those international markets where both franchising is an accepted business model and we believe our brands can achieve significant scale. We typically elect to enter into master franchise agreements in those markets where direct franchising is currently not a prevalent or viable business model. When entering into master franchising relationships, we strive to select partners that have professional hotel and asset management capabilities together with the financial capacity to invest in building the Choice brands in their respective markets. Master franchising relationships typically provide lower revenues to the Company as the master franchisees are responsible for managing certain necessary services (such as training, quality assurance, reservations and marketing) to support the franchised hotels in the master franchise area and, therefore, retain a larger percentage of the hotel franchise fees to cover their expenses. In certain circumstances, the Company has and may continue to make equity investments in our master franchisees. As a result of master franchise relationships and international market conditions, our revenues are primarily concentrated in the United States. Therefore, our description of our business is primarily focused on the domestic operations, which encompasses the United States and Caribbean countries and territories.
With a primary focus on hotel franchising, we benefit from the economies of scale inherent in the franchising business. The fee and cost structure of our franchising 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 and expanding the number of partnerships with travel related companies.
The principal factors that affect the Company's results are: the number and relative mix of hotel rooms in the various hotel lodging price categories; growth in the number of hotel rooms owned and under franchise; occupancy and room rates achieved by the hotels in our system; the effective royalty rate achieved on our franchise agreements; the level of franchise sales and relicensing activity; the number of qualified vendor arrangements and travel related partnerships and the level of engagement with these partners by our franchisees and guests; and our ability to manage costs. The number of rooms in our hotel system and the 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 owned and franchised hotels. All of these factors have been materially disrupted by the COVID-19 pandemic. 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, over the long-term, any continued growth of our franchise business should enable us to realize benefits from the operating leverage in place and improve operating results. The effects of the COVID-19 pandemic on our first quarter 2020 results and anticipated trends are discussed below under the heading "Operations Review."
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, 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. While we are actively managing and eliminating certain discretionary marketing and reservation system expenditures, as a result of lower occupancy and therefore lower marketing and reservation system fees generated, we anticipate marketing and reservation expenditures will exceed fees for the remainder of this year.
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 hotels and reducing hotel operating costs.
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As discussed above, the Company has taken numerous measures to combat the significant effects of the COVID-19 pandemic on our business. These measures are an immediate priority in order to mitigate the financial impacts to our franchisees and the Company. We believe these immediate measures support the Company's preparedness as the pandemic subsides and complement the strategic priorities we execute against to create value for our shareholders over the long-term. These key long-term goals are as follows:
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Due to the seasonal nature of the Company's hotel franchising business or multi-year investments that are required to support franchise operations, in addition to incremental spend by the Company to support franchisees during the COVID-19 pandemic, quarterly or annual deficits and surpluses may be generated. During the three months ended March 31, 2020 and 2019, marketing and reservation system expenses exceeded revenues by $20.1 million and $9.8 million, respectively.
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 March 31, (in thousands) 2020 2019 Total Revenues $ 218,175 $ 218,320 Adjustments: Marketing and reservation system revenues (110,385 ) (110,064 ) Revenues, excluding marketing and reservation system activities $ 107,790 $ 108,256
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Operations Review Comparison of Operating Results for the Three-Month Periods Ended March 31, 2020 and 2019 Summarized financial results for the three months ended March 31, 2020 and 2019 are as follows: (in thousands) 2020 2019 REVENUES Royalty fees $ 70,339 $ 80,353 Initial franchise and relicensing fees 7,284 6,807 Procurement services 13,797 11,947 Marketing and reservation system 110,385 110,064 Owned hotels 9,422 - Other 6,948 9,149 Total revenues 218,175 218,320 OPERATING EXPENSES Selling, general and administrative 28,835 39,514 Depreciation and amortization 6,529 3,616 Marketing and reservation system 130,447 119,839 Owned hotels 6,034 - Total operating expenses 171,845 162,969 Impairment of goodwill - (3,097 ) Impairment of long-lived assets - (7,304 ) Gain on sale of assets, net - 100 Operating income 46,330 45,050 . . .
May 11, 2020
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