Choice Hotels International Inc (CHH) 2003 Q3 法說會逐字稿

Good morning, and welcome to the Choice Hotels International third-quarter 2003 earnings conference call. (OPERATOR INSTRUCTIONS). During the course of this conference call, certain predictive or forward-looking statements will be used to assist you in understanding the company and its 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 March 31st, 2003 details some of the important risk factors that you should review. I would now like to turn the conference over to Chuck Ledsinger, President and Chief Executive Officer of Choice Hotels. Please go ahead.

Thank you. Good morning everybody. With me today is Joe Squeri, our Senior Vice President of Development and Chief Financial Officer. We had a very good third quarter. Late yesterday afternoon, we reported that Choice reported diluted EPS of 66 cents, a growth of 22 percent over third quarter of 2002, and these excellent results exceeded the analysts' expectations by 3 cents. We also reported our operating income increased 8.7 percent from 36.6 million to 39.8 million for the third quarter and 7 percent through September, from 80.1 million to 85.7 million. We remain very encouraged by our results and our ability to extend our development pipeline that is ensuring future growth that will drive royalties and earnings.

We now have 4,773 hotels open worldwide, with another 426 in development. On a rooms basis, we have 384,814 rooms in our distribution system now, with another 35,417 in development. By continuing to feed the development pipeline with new executed franchise contracts, we've been able to sustain our growth in the 4 to 5 percent range. This past quarter, enjoyed year-over-year net domestic unit growth of 4.9 percent, pushing our total number of domestic hotels past 3,600.

In our domestic hotels system, we had 119 net property additions in the first 9 months of this year, compared to 107 for the same period a year ago. And through the end of September, we had executed 294 new domestic franchise agreements. That is a 39 percent increase over the 211 for the same period of a year ago.

We continue to see high demand for our very solid conversion products, especially for our Quality and Clarion brands, while at the same time driving more new construction deals. We believe that our new prototypes for the EconoLodge, Comfort Suites, and Sleep brands will continue to attract even more new build activity, as the economy continues to improve and capital markets loosen up.

Recent economic trends have been much more encouraging. We recently reported significant gain in industrial production; the first report of job growth in 8 months; and jobless claims dropping and holding below the 400,000 threshold. We are hopeful that the positive momentum will keep building.

On the heels of the very successful summer promotions, we currently are running two fall promotions for our mid-scale and economy brands, and are producing strong results. For our mid-scale brands, we're using our Choice Privileges Frequent Traveler program as the vehicle for driving more business to our hotels. Choice Privileges members can earn a minimum bonus of 5,000 points after every two stays at one of our hotels, usually enough to get them a free night. And the amount of times they can earn the bonus through the end of the year is unlimited. We have seen very high demand for this and the numbers are very, very encouraging.

And for our economy brands, guests can enjoy -- can receive double Easy Choice reward stamps for each night's stay, which can earn them free stays or airline miles twice as fast. Both of these promotions have great appeal to both business and leisure travelers, and will go a long way towards building even greater brand loyalty, and more repeat business in our hotels. Supporting these promotions is an aggressive marketing campaign that includes an evolution in our advertising message. Overall consumer response has been very positive, and we believe our marketing effort continues to build our awareness and drive business to the hotels.

As we announced in August, our Board of Directors intends to initiate payment of a cash dividend on our common stock, beginning in the fourth quarter of this year. The plan approved by the Board anticipates an initial quarterly dividend of 20 cents per share, or 80 cents per share, annually. The board will make the final determination each quarter after reviewing the company's performance.

Now, I would like to turn things over to Joe, who will review our results in more detail. And after Joe is finished, we will take your questions. Joe?

Thanks Chuck. As Chuck mentioned, we're extremely pleased with our third quarter report, which demonstrates the fundamental strength of our franchising model and its ability to produce consistent results. Chuck has already talked about our strong unit growth. This renewed emphasis resulted in a 14.2 and 21.9 percent increase in initial franchise and re-licensing fees for the 3 months and 9 months ended September 30. In general, our application flow remains quite strong, up about 4 percent year-to-date, and we've been able to turn many of these into executed agreements.

In terms of the breakout between conversion projects and new construction, it remains approximately 75 to 25 percent ratio. For third quarter 2003, we executed 78 conversion contracts and 30 new construction contracts. For the year through September, we have executed 216 conversion contracts and 78 new construction contracts. We are extremely pleased with the overall volume increase in the respective categories. Conversion deals are up 28 percent for the quarter and year-to-date through September, and new construction projects are up 43 percent for the quarter and 86 percent year-to-date. These results reflect the actions taken with our sales force in recognition of growing market demand for our product. By focusing both on the types of projects, as well as specific brands, we have been able to achieve superior results both in terms of the number of hotels added and in improved quality of the product entering our system. As a consequence, we're looking forward to adding more units to our development pipeline and extending our strong momentum in driving unit growth.

Overall, our franchise development effort has benefited greatly from our distribution and our major presence on the web. Prospective franchisees appreciate that we are able to use our electronic distribution channels -- both on our own proprietary site and those of online partners -- to generate rate premiums for them, as well as provide them with lower costs. As evidenced in our third-quarter results, our domestic hotels system has been able to grow average daily rates from 62.35 to 63.06, year-to-date. This ability to maintain and grow rate in the challenging environment helps build our overall attractiveness to hotel developers.

Our operating cash flow remains quite strong, as shown in the 9.8 percent increase in the first 9 months of this year, from 74.7 million to 82 million.

We announced yesterday that fourth quarter estimates for diluted EPS would be in the range of 42 to 44 cents. Full-year estimates have been revised upward from $1.80 to $1.82 for 2003, up from $1.74 to $1.77. These estimates (indiscernible) RevPAR to increase 1 to 2 percent for the fourth quarter, compared to last year.

Choice continues to enjoy a strong balance sheet, ready access to capital, and a high degree of free cash flow. The strength of our branding and national market, coupled with our outstanding reservations delivery, keeps our franchise system well-positioned for future success. We remain confident in our ability to compete successfully for new franchises and drive more unit growth.

Let me turn back to Chuck.

Thanks, Joe. Now we will open it up for any questions that you might have.

(OPERATOR INSTRUCTIONS). Gloria Fu, J.P. Morgan.

Great results. Joe, could you just go over those numbers again, for the conversion versus the new constructions breakdown?

Sure. We are still -- actually, we're at the 75/25 percent, which is conversion and new construction, which we have been at for most of the year. It is a bit of a change from last year, which was close to 80/20. In the third quarter, we did 78 conversion contracts and 30 new construction. And for the year, we've done 216 conversions and 78. So the percentages have not wavered that much, but just generally, our overall production has increased.

Okay. What were those numbers last year? (inaudible)

It was 80/20 last year, and I don't have the specific numbers right off for the percentages. But, it was just an 80/20 split last year versus 75/25.

Going forward with, I guess -- what should we think about for new construction? Should we think that as the economy gets better, your shift might be eventually more towards a 50/50 in a year and a half or so? And then, maybe can you discuss how -- I think, historically, when you had a lot more new construction in your pipeline, you had a lot more projects that would eventually fall out of the pipeline because they never got developed. So, maybe you could just refresh us on how to think of that, going forward?

Let me just make a couple of comments, and I will let Joe talk about the specifics. But, I mean, generally, the percentages will shift as there is more capital available for new construction. We have just been able to take advantage of this conversion market by focusing a lot of attention on that available pool of hotels out there, and also the demand for the product. And I think a lot of that has to do with -- you know, we're sort of hitting our stride with our business delivery, and with what we're doing in our field service organization, and a very focused effort on franchise sales. So, that has happened.

We fully expect that we will be able to continue aggressively selling new construction into that cycle. And part of it, frankly, is the -- is going to be some replacement product for existing hotels in our chains as they get older. And, you are right, Gloria -- I mean, you're going to see on new construction there is definitely a higher percentage of deals that fall through for whatever reason. Conversions -- you know pretty well right away what is going to happen unless there is a large amount of construction required or improvement plans required that may fall out. But that does not happen too often.

So, I think as far as the -- you know, we have been talking about that -- what is the sustainable, sort of, level of growth. Because we have seen in the last couple of years it's been in the 4 to 5 percent range. And we don't see any now on the horizon that would say that there is going to be substantially less than that. So, I mean, our new construction is -- we are seeing more of that; it is going at a faster pace. And know, I think we will just have to kind of wait and see. But, I feel pretty bullish about it. I mean, I think we've got the right focus on what we are doing out there. We are seeing a lot of demand for these new prototypes that we have, which also gives me a lot of confidence in our ability to continue to build.

One more question, if I might. I think in '97, 98-ish, your initial franchising and re-licensing fees topped around 16.5 million. Today, given the fact that there is a lot more conversions with the bend (ph) more towards new construction, going forward, as the economy improves? What kind of peak number do you think that you guys could get back to?

Well, yeah, I mean -- Chuck is looking at me on that one. I think that -- you know, back in '97, 98, we did 280 new construction products. And, you know, we're looking -- we're tracking around 120 now. If you got back to a level of that type of production, you get more fees for new construction. That was really -- that was the peak of hotel cycle and what was going on.

Now, on conversions, you don't generate as much of initial fees. So, it is kind of hard to say. I mean, you get back to very strong RevPAR recoveries that approximates those types of levels. And with the supply conditions the way they are, we could have a blowout year. But, the way things are looking, we are sort of firing on all cylinders now and executing on all opportunities that are presented to us. So, we look as much at getting that hotel open and getting it online as quickly as possible, as we do at that initial fee. But, when the billing cycle comes back, we have more of an opportunity to do that. But, I would think you would have to have those types of RevPAR recoveries to see that level of new construction activity. And, what we were trying to do is just get the opportunities that are available now and maximize both conversion and new construction. So, that is a very long-winded way of saying I have no idea and I'm not sure I'm going to commit to what an initial fee number will be in the future.

Okay. So for modeling purposes, should we just, kind of -- if Chuck is saying that your level of growth is probably sustainable for over the near-term horizon, then maybe next year we should consider kind of a flat number to this year, given the extraordinary number of new franchise agreements you signed.

You know, I think we will give specific guidance in the fourth quarter after that is done. And we will have a better outlook into the future. I mean, we're putting up 39, 40 percent numbers. It is driven primarily by what we been able to capitalize in conversion and getting more acceleration in new construction. But, we are going through our budgeting process; we're going through our plans now. And we will have better insight as to what the number will look like in the future. But, I don't think we're prepared to say what that number should be in the future.

Okay. Thanks.

Andrew Board (ph), A.G. Edwards Asset Management.

Thank you. I've got a couple of questions for you. Can you give us some insight in the current market for financing new construction? Is it any easier to find financing than it was a few months ago? Any kind of details you can provide would be good.

The second question -- with the Sunburst note, I wonder if you could give us kind of an update on how things are going at Sunburst? And how you feel about that note? And when do you think that might get paid off? Maybe you can refresh our memories on that.

Well, as a general statement, the financing environment, I think, is still selective -- is a good way to put it, I think. Although there are more -- you know, we are seeing the result of, I think, some loosening. And I think that part of that is -- it is not always just availability of capital; I think it is potential developers seeing a turn where they are feeling confident about building the next hotel. So, it is kind of a combination of both of those things. I mean, interest rates remain low, and for the most part, our typical developer and owner is kind of a smaller, but multi-unit, type owner. And, most of the time these loans are credit loans. So, you know, they are able to get the money -- it is a question of how much capital they can get on a given project; how much debt they can get on a given project. And I think, frankly, there is kind of their confidence level. So, I think that the answer is -- it's getting a little better, although not -- you know, there hasn't been a seachange (ph). But, we're seeing people get more confident.

Usually what happens is -- if people start to see an increase in ADR and rates, that will usually start to bring some interest back into the new construction cycles. So, we are seeing some of that, so --

And the other question was the Sunburst note, and I will let Joe answer that.

We filed an 8-K a month or so ago. It was an incentive for them to pay the note off early. Hopefully, they are working towards that. Beyond that, we don't have anything else to add.

Okay. Thanks a lot.

Will Truelove (ph), UBS.

Congratulations on another good quarter. Just thinking strategically, Chuck, about the international operations and your master franchise agreements -- do you have any plans or thoughts as to how that may evolve at Choice Hotels?

Well, yeah, we do, obviously. We like what has happened in Asia (ph) and Australia and New Zealand, particularly in that -- you know, that model down there was a (indiscernible) was an association-type -- membership-type organization that we ended up buying and then converting to a fee-pay, more like our traditional franchising company we run here. And, so that model is a good one, I think, for thinking about certain parts of the world; it has not evolved everywhere, but certain parts of the world. And by that I mean a more-direct role where appropriate for us to go do direct franchising. That is the model in Canada. You know, Western Europe is different because of the relationship with Choice Hotels Europe over there with Friendlys (ph). And I think that -- but over time, you could start to see those changes. So I think that the goal, internationally, is certainly to expand. We think there's a lot of opportunities, internationally. It is really a region-by-region and a country-by-country type of analysis that we go through to see if we are better-served with a master franchise-type arrangement versus a direct franchising model.

For instance, in Japan, we have a master relationship that we think is going to be pretty good over there, because that is a very difficult place to direct franchise. So, you know, Australia is different. And so, it is going to -- I think we've got a lot of opportunity internationally to grow, and I think it will continue to a combination of both. Although we're not going to be everywhere in the world; we know that. And so we're really concentrating where we think we can have a successful and profitable investment. So that is kind of how we look at it.

How would you sort of characterize that shift? Or, sort of, your strategic plans on that in terms of contribution to earnings. Obviously, right now it is dominated by domestic with a little bit added from international. Do you see that mix changing over the next, say, 3 to 5 years?

Well, I think we will continue to grow internationally at a pretty good clip. But, you know, it will be a long time before -- probably never. As a matter of fact, I don't think it will ever approach the size of the domestic system, just because of the way that that business model works in the U.S. It is very different from the way that it works in most other parts of the world. I mean, as you know, there is a lot of countries that just are not -- do not have a franchising model that they look to. It's been more owner/operators. Or when international companies have gotten involved, it's been through management or through some equity-type ownership. And we don't intend to do that.

Right. Another question, maybe for Joe. Could you talk a little bit about how we can think about what your SG&A expenses, relative to your portfolio -- (indiscernible) your portfolio is growing quite rapidly, and congratulations on that. But then also, your corporate expenses seem to be declining a little bit. How can we think about that relationship? Should -- or is there one?

I think that when you look at our income statement for the 9 months ended and focus on that, there's two reasons that has gone up -- well, three reasons, really. You have your normal SG&A increases for benefit costs and salary increases, which we try to keep around 2 to 4 percent. And then you have to change it. I mean, we had the consolidation of Flag, which accounted for maybe a million dollars or so -- $2 million. Then you have us adopting the stock options pronouncement, which required us to expense options. So, I think the way to look at our income statement for the periods that are presented in our press release, is that the 9 months ended represents probably what you are going to see for the 12 months type of run rate.

In terms of how our system is growing and the relative effect on our SG&A -- really the only variable cost in our business is the commissions that we pay for new entrance into the domestic hotel system. And I think every time we do one of those transactions (inaudible) the earnings. It may be slightly diluted for the margin, but really, you are not going to see a substantial increase in our fixed costs as a result of system growth. We've got capacity in our call centers. We've got capacity in our technology operations. We've got capacity in our service organizations. So, I think the only thing that you will see, going forward, would be commission expense if we continue to see rapid growth in our unit domestic systems, and just the normal SG&A-type things that I mentioned.

Great. And one last question -- in terms of the decisions of new developments -- and you mentioned rising rates, and things of that nature -- can you sort of talk about -- or do you know what the differential is between the cost-to-build versus what the going kind of transaction costs are? I mean, in the full-service segment, we are definitely seeing a lot of hotels that are being acquired at low replacement costs. It that the same kind of phenomenon that we're seeing in the limited service segment? Or, is it much more (indiscernible)?

I think it is a completely different animal. I think you have opportunities in local market; I don't think you have that buy-or-build (ph) situation that is -- where you have the displacement in valuation that you do in some of the larger assets. But, that being said, I think that our developers -- for the most part, they are either -- there are two kinds -- they are either hotel developers, where they are actually doing ground-up construction, or they may be some asset owners or money partners that we have that are looking for assets that are in the distress situations and looking for flagging (ph) opportunities.

So, occasionally, you will see your new construction guy that is going to go buy an asset, but it is usually going to be an existing brand that he is comfortable with; that he sees an opportunity and he'll convert it to Comfort. But I can say, when you look at our breakdown in our customers, building new construction -- Comfort, Sleeps, and MainStays -- typically continue to do that. And they may vary into other brands. And the guys that are doing Qualitys and EconoLodges and the Clarions are different customers. We do not have a whole lot of customers lapping over into the various brands.

All right. Thank you very much, gentlemen.

(OPERATOR INSTRUCTIONS). We have no further questions in queue. Please continue.

Okay. Well, thank you very much for your attention and good questions and we will talk to all of you soon. Thank you very much.

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