Choice Hotels International Inc (CHH) 2002 Q2 法說會逐字稿

Good morning and welcome to the Choice Hotels International Second Quarter 2002 Earnings Conference Call. During the course of this conference call, certain predictive or forward-looking statements will be used to assist you in understanding the company and it's results. Such statements are subject to risks and uncertainties that could cause actual results to differ materially. The company's Form 10-Q for the quarter ended September 30th 2001 details some of the important risk factors that you should review. As a reminder, this call will be recorded. I would now like to introduce Chuck Ledsinger, President and Chief Executive Officer of Choice Hotels. Please go ahead sir.

Thank you. Well, good morning and welcome to our second quarter 2002 earnings conference call. I've got some prepared remarks I'm going to make. Joe Squeri is here with me, our Chief Financial Officer and our Senior VP of Development, and we will go through that and then we'll allow some time for questions. So let me get right to the prepared remarks. Earlier this morning we reported that Choice recorded diluted EPS of 38 cents, an increase of 27 percent, exceeded consensus estimates by 4 cents; a very good quarter. Our net income was up 13 percent for the quarter. Strong unit growth, improving royalty revenues, growing initial franchise fees, and excellent cost control all combined to produce these good quarterly results in a very solid first half for 2002.

Our product and service offerings and our brands and many segments, and our many drive to locations give us the opportunity to continue to expand year growth and royalty revenue whatever the economic climate. And given that much of the industry is still trying to recover from the impact of the economic slowdown, we see clear benefits of Choice's unique position as a pure play franchiser with our strong brands and highly efficient operating structure. We continue to drive this business model through innovative marketing programs, brand improvements and capital investments to drive future growth. Our summer promotions aimed at our vital leisure market; include an exciting free gas and food program for our six mid-scale brands, which we team up with McDonalds. And this promotion marks the first time that McDonalds has partnered with a hotel company in a co-branded promotion. And for our economy brands, we're continuing our 'Race in and win,' all our racing promotions. This time the blow is from improvement; Warehouse is our partner. We are very pleased about reaching more consumers this summer through these well planned, targeted and very much used promotions. Now, three of our brands Comfort Suites, Quality and Sleep Inn are beginning to enjoy the benefit of our yearlong re-imaging program that we now have about 800 properties with the new signage along the highways of America.

A changeover in image has been supported through out our marketing programs and it shows our commitment to building our strong brands for the future. On the international front, we recently acquired a controlling interest in Flag Choice hotels, our franchising partner in Australia and New Zealand. We currently have more than 400 hotels operating under the Flag, Comfort, Quality and Clarion brands. This acquisition allows to put in place a more effective business plan, will improve franchise services, enhance marketing programs, and build a solid foundation for future growth in the Pacific region. With these results and initiatives illustrated, we continue to execute well against our business model and strategy, which has proven to be the right course for Choice in virtually any economic setting. Our focus remains on delivering value-added products and exceptional services to our customers, our franchisees. Our franchising fee for services model provides the level of predictability that keeps our stocks attractive to investors. Now, I'd like to turn things over to Joe Squeri who'll review our second quarter in more detail, and after Joe is finished we'll take your questions. Joe.

Thanks, Chuck. As Chuck mentioned, we're extremely pleased with our second quarter results, which built upon the foundation of a solid first quarter to produce a very good first half of 2002. Our performance this year has largely been driven by unit growth, which is a combination of both new units and strong franchise retention. Domestic unit growth exceeded 4.5 percent for the quarter as we now have 3,394 properties open, an increase of 145 hotels. We believe we are well positioned with our brands to continue unit growth in the 2 to 3 percent range for the full year. On the development side, we're slightly ahead of last year's pace in new franchise contracts. We are very much focused on stimulating new unit sales and improving the returns our franchised hotel is generating for their owners. Much of the activity we are experiencing is in the conversion market where many of our brands offer the performance and support that independent and other branded hotels seek in challenging times. This performance demonstrates the strength of our business and our ability to grown regardless of the economic climate.

At the end of June, we had signed a 129 new contracts representing 10,883 rooms, compared to 125 new deals representing 10,771 rooms in the same period a year ago. Of the first half 2002 contracts, 108 were conversions, substantially up from 72 conversions for the first half of 2002. We have renewed our emphasis on the economy segment of the industry. Our goal is to dramatically improve our market position in this segment. We believe that our distribution product and service offerings are unmatched in this segment, and we plan to market these attributes aggressively. Our decision to create a dedicated sales staff for our economy brand is already beginning to pay off. We have also created a very attractive incentive for developers in the Econo Lodge brand to keep that momentum going. While we continue to grow the business, we also continue to improve the efficiency of our business and service delivery. As you can see, we continue to do an excellent job managing our SG&A expense; which are down for the quarter on year-to-date. Consequently, our franchise EBITDA margins are up 100 basis points or 66.7 percent for the quarter. These results underscore the value of the significant technology investments and corporate wide restructuring we have undertaken in the past few years. They also demonstrate the commitment our associates had to using our resources widely. We also are continuing to drive ancillary business opportunities, such as partner service revenue to capitalize on the opportunities [forwarded] to us from our expense and distribution channels. In the second quarter, partner services income grew by 7.5 percent and by more than 10 percent for the year to date, which shows how affectively we can leverage our size, scale and distribution. As we have said before and as I've -- and as results have clearly demonstrated, Choice's franchising model generates a predictable and high level of free cash flow because of the low level of capital expenditures needed to run the business. This steady free cash flow enables us to be opportunistic in returning value to our shareholders through share repurchases. Since we began our program in June of 1998, we have purchased 24 million shares of common stock on an average price of 15.90 for a total investment of $381 million. We announced today that the third quarter estimate for diluted earnings per share should meet current expectations of 52 cents. And we have increased our full year estimate for 2002 to $1.45 to $1.47, and we expect full year EBITDA to approximate 107 million in 2002. Now, with that let me turn it back to Chuck.

117.

117 million -- sorry -- for 2002.

All right. Thanks Joe. Well, we certainly feel that Choice is well positioned to meet whatever travel patterns emerge in the US and given a wide range of economic scenarios, which we've certainly seen over the last year or so. As a result, we remain very optimistic about the company's performance in the future. So with that, I would open it up for any questions.

Ladies and gentleman, if you wish to ask a question, please depress the "1" on your touchtone phone. You will hear a tone indicating that you have been placed in queue. You may remove yourself from queue at anytime by depressing the "#" key. If you are using a speakerphone, please pick up your handset before pressing the numbers. Once again, if you have a question, press "1" on your touchtone phone. And one moment please for the first question.

And our first question today comes from the line of Mike Rietbrock from Salomon Smith Barney. Please, go ahead.

Hey guys.

Hi.

Hi Mike.

Hey Joe, just a quick question for you. This might be a mistake in my notes but number of hotels, either in design or construct -- franchise hotels design or construction at the end of the quarter was 391. I had 772 at the end of the first quarter in my notes. Is that right? And if so, what's going on with that number?

Probably -- the 700 number is probably a combination of both international and domestic. And we had...

Okay.

...another 150 or so -- I don't recall -- it's not in my head -- that are in international. So if you combine the two, it was probably 540. And then we opened about 100 and something plus hotels, you know, during the period. So -- I mean, that's probably where the reconciliation is.

That's probably it. Okay. That sounds good. And Chuck, just kind of, bigger picture question. There's just -- you know, there's been a lot in the press lately about Marriott's relationship with its franchisees and sort of the appropriateness of, you know, certain income streams that they generate from them. Has that affected your business at all, and how you look at it? And generally speaking, you know, how would you describe your relationship with your franchisees in general these days?

Well, I think, we have an excellent relationship with our franchisees which has improved rather dramatically, I think, over the last couple of years or a few years. We've spent a lot of time on that effort. We really view our franchisees as our primary customer. And personally, I spent a lot of time on it. So, you know, I think that the issues that Marriott had from what I can tell was more on the managed side properties where, you know, they were -- the issue that was alleged, whether it happened or not I don't know, -- but -- was that, you know, with purchasing -- you know, the manager had good [steered] certain purchasing, you know, to company owned facilities. And also, the issue of, you know, whether you mandate certain products; but we don't mandate any products. And you know, our partner services revenue streams are all purely by choice of the licensees. They choose to use our endorsed vendors; and then, you know, that can -- that'll hopefully result in a better deal for them and also result in a revenue stream for us. And the matter of fact we've -- you know, we continue to work with them as licensed in our franchisees to use our purchasing system. So, you know, I think, it works real well. And we really -- you know, that hasn't really been an issue. I think there's always, you know, an issue with, you know, license -- you know, a franchising company and franchisees about -- there is a balance between, you know, how much you're doing for them and their perceived value, and that's what we work at everyday. We really try to lower costs being [affiliated] with our system. And in our mind, for the type of hotels that we operate, that's a real winner. So -- and I think we're seeing it. We're seeing it in our, you know, more efficient operations and some of the restructuring we have done has gone directly to their benefit. So all of our purchasing programs are voluntary, and the fees are disclosed in the licensee association. So it's all pretty transparent.

Thanks.

Yes.

Thanks.

And our next question comes from the line of Gloria [Fu] from J.P. Morgan. Please, go ahead.

Hi.

Hi.

Lot of questions. First, some -- on the unit growth, have you guys had to discount to kind of accelerate the unit growth process, or you know, what's kind of happening there? Is there more of a discount associated with conversions versus new builds?

Well, in the conversion market and, you know, new construction market for that matter, two are very competitive environments; and we have some advertising -- some advertised specials on incentives, and we have others that are negotiated transactions. So I would say, we look at each transaction as a long-term annuity contract. And to the extent, that we have to discount upfront to get that 10-year royalty screening, we may do that. I don't think it's been any less competitive or we've discounted more this year versus last year. I think when you're in a conversion market, you tend to be even more aggressive; but you know, our focus is on adding as many units as possible, because we look at the long-term nature and stickiness of the contract. So to some degree, there has been, but you know, and then you look on the other side, our initial fees are actually up. So -- I think we've been pretty disciplined about when we enter into relationships.

Okay. Secondly, the effective royalty rate -- at what point, would we kind of hit an effective maximum on how much it could increase year-over-year or quarter-over-quarter?

Well, it all depends on your product mix; and I would expect it to be slower in periods of conversion and probably accelerate in periods of new construction. So that's simply because Comfort Inn, Comfort Suites and Sleep Inn have higher effective rates than Econo Lodge, Rodeway and Quality and Clarion. So probably, you know, if you look for a 10 basis point gain a year during the conversion market; that's probably the most you're probably going to get. You may get a little bit more. And then, if we were fortunate to some more Comfort Suites and Comfort Inns and the product mix would shift back that way, we'd probably accelerate it even more than that. But it's kind of hard to say, but we don't really bank on anything more than, you know, 8 to 10, 5 to 10 basis points on any given annual basis.

Okay. And lastly, could you kind of articulate more of the strategy with the Australian Master franchise agreement that you guys got and, you know, what kind of economics are you guys getting out of it, and should we expect more of those acquisitions?

Well, Australia was really an affiliation with Flag before, and there was a lot of -- many of the hotels were co-branded and frankly confusing in the market [indiscernible], as you might see, you know, a Quality Inn sign up there with a Flag sign with some other, you know, Joe's Broad House or whatever sign. So what this allows us to do is -- it was a -- Flag was a kind of -- was set up as a membership-type organization. So what this allows us to do is to convert properties into a, you know, signed franchise agreements and converting into, you know, franchising -- more of a franchising model, like in the US. The fees aren't as high. But over time, I think, as we prove that this is a cohesive system with a clear identity, you know, matters then we'll be able to tackle that. So -- I mean, the financial contribution now is the minimum; but, I think, over -- you know, over the years, it certainly can grow, and I think it'll be a good base for, you know, further expansion -- and not only a base but also, I think, a good model because it's -- you know, where those things work, and you can point to and say -- you know, points of successes. So it's taking, basically, an affiliation relationship and making it into more of a sure franchising contractual type situation.

Okay. Thanks.

Once again, ladies and gentleman, if you have a question, press "1." And we do have a question from the line of William [Trollop] from UBS Warburg. Please, go ahead.

Yes, Chuck, just following up on Gloria's question. Do you -- I know you have these kind of master franchise agreements around the world with different organizations, not just Flag. Are you anticipating converting those kind into more of what you've done with Flag?

I wouldn't say that's a strategy; I'd say that was more opportunistic. I mean, I think, in the situations where it really depends on your relationship with the master franchiser, and we had an opportunity there to do this. We have gone through, as you know, over the last few years some transition in Europe, which is still, you know, in flux. And so I wouldn't say that, that is necessarily a model; but I wouldn't be surprised if it happens again at some point. I mean, the issue really becomes -[AUDIO GAP]. What we don't want to do is we don't want to put large capital investment dollars outside of the US or frankly inside of the US on real estate. But we do -- if we have an opportunity that we think we can grow and own part of the franchising business being on it makes sense, we're going to look at that. So that's really -- and it's really -- you have to really manage the resource side in terms of, you know, how much resources would be required outside of the US. We're not losing the sight of the fact that, you know, 95 plus percent of our income is inside the United States. But we also have 1,000 hotels outside. So, you know, and -it's, you know, over time, if we can find, you know, profitable ways to grow that business, we will. What we won't be doing is, you know, buying, you know, real estate and buying, you know, assets in terms of bricks and mortar and those types of things outside the US.

Okay. And about the pipeline outlook; I know you guys are doing a lot more conversions now, but is the visibility on conversions -- you know, it has to be shorter than may be new builds. So can you talk about how you see, maybe, the breakdown in new builds versus conversions in 2003?

Yes. See if I -- I would try and answer. I'm not sure I totally understand your question, but I'm -- I think that we don't see the construction of the financing markets turning around in the foreseeable future, which is 12 to, you know, 16 to 18 months. So what we try to do is maximize our opportunity given whatever the landscape is; and at this point in time, the way we see it rotating back is we're going to focus on our conversion markets, and we're going to focus on our new construction opportunities in the economy segment. I think, on balance, the financing for our products is a heck of a lot easier than for others; but I don't anticipate what you saw five or six years ago where we were executing a substantial amount of construction product simply because the financing is not there. So our emphasis for the foreseeable future is going to continue to be on the conversion opportunities.

But I -- and having said that, we're putting an awful lot of -- in the time, you know, when the conversion market is strong, you know, we're not losing sight of being ready for, you know, the new construction cycle when it comes back. So we've spent a lot of time focusing on prototypes, prototype development, turnkey type operations, getting, you know, product in place at a cost, you know, that's attractive to a developer, and also changing some prototype designs on some of the properties. So you know, we've really focused on, you know, what can provide -- what type of a product can provide a return, an attractive return to an investor, you know, in the form of a franchisee on a new build. So you know, I'm feeling good about not only that, but also on the service side, about really streamlining our services and our marketing. So you know, I think we're going to be well positioned when things turn back around. It's nice to have, you know, a portfolio of products that will work well in a conversion market and also will work well in a new build market; and we've always gotten, you know, more than our fair share of those. So you know, I don't see any reason why that wouldn't happen when things turn back around.

Yes and just to follow up on that, Will -- I mean, I don't anticipate our pipeline diminishing simply because the visibility on the conversion opportunities is down. I mean I look at it on an individual brand basis and compare each of our assets against a competitive set and I think we have a huge opportunity especially on the economy side and also amid price of food and beverage to penetrate those markets. I think that, on balance, we really haven't done -- we haven't gotten our fare share in those markets because our emphasis has been more on Comfort and Sleep Inn. But Chuck's point is absolutely right. I mean our products are being designed to meet the environment when it turns, and then our conversion opportunity has been aggressively marketed now to capture the opportunity that exists.

Okay. Great. Thanks a lot guys.

Thank you.

And Sir at this time, there are no other questions in queue. Please, go ahead.

Okay. Well, thank you very much for your attention; and we will speak to you soon.

Thank you.

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