Choice Hotels International Inc (CHH) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Choice Hotels International Fourth Quarter and Full-Year 2005 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, there will be an opportunity for your questions. Instructions will be given at that time. [Operator Instructions.] As a reminder, today’s conference call is being recorded.

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-K for the year-ended December 31, 2004 details some of the important risk factors that you should review.

I would now like to introduce Chuck Ledsinger, President and CEO of Choice Hotels. Please go ahead, sir.

Thank you. Good morning, everyone, and welcome to our Fourth Quarter and Fiscal Year 2005 Earnings Conference Call.

Yesterday afternoon, we reported record results for the Company, including diluted earnings per share for the year of $1.32, an increase of 22%, compared to full-year 2004 results. Adjusted diluted EPS for 2005 increased 18% to $1.26 from $1.07 in the previous year. The adjusted earnings per share amount for 2005 exclude tax benefits from the resolution of certain tax contingencies. They also exclude tax expense related to our repatriation of foreign earnings pursuant to the American Jobs Creation Act. For 2004, the adjusted per share amounts exclude similar tax benefits and a loss on the extinguishment of debt. Yesterday’s release includes a schedule summarizing these non-GAAP items and reconciliations of diluted earnings per share reported on a GAAP basis.

We also are pleased to report that operating income for the fourth quarter and for the year each increased more than 15% from the comparable periods in 2004. For full-year 2005, operating income was approximately $144 million, compared to $125 million in 2004. Cash flows from operations increased more than 20% to $133 million in 2005, compared to $108 million in the previous year. In short, 2005 was another strong year for Choice.

Our fourth quarter performance was also solid and exceeded our goals for RevPAR and earnings-per-share performance. We reported diluted earnings per share of $0.32 for the fourth quarter, an 8% increase from the same period in 2004. Adjusted diluted earnings per share, excluding the tax and debt extinguishment items described earlier, were also $0.32 for the quarter, an increase of 14% from the comparable amount for 2004, which was $0.28. For fourth quarter 2005, we achieved a RevPAR increase of more than 7%. We had expected RevPAR growth between 5% and 6% for the quarter, so we are particularly pleased by these results.

We also enjoyed record franchise development in 2005, a full-year domestic unit growth of 5.6%, boosted by the acquisition of Suburban Franchise Systems. And for the third straight year, we established a new record for new domestic hotel franchise contracts, with 639 executed in 2005. That’s an increase of 16% from the previous record of 552 set in 2004.

Because of this superb development performance, our domestic pipeline stands at more than 46,000 rooms under construction, awaiting conversion, or approved for development. Our international pipeline includes nearly 8,000 additional rooms. We believe our pipeline positions us well for the increasing supply of Choice brand and franchises, which contributes to profitable growth. Our system represents more than 5,200 hotels and 425,000 rooms open worldwide in more than 40 countries and territories. Over the past 3 years, we’ve increased our brands share of North American hotel rooms to approximately 7.3%, based on Smith Travel Research data.

During this same period, our annualized domestic room growth rate of 5.3% exceeded the annual industry supply growth rate, which was less than 1%. We believe this is a strong testament to the value and appeal of our brands to hotel owners and developers. While interest in and development prospects for Choice’s 8 Legacy brands remain strong, a major highlight in 2005 was the addition of 2 new brands in very dynamic segments – Cambria Suites in the upscale all-suite segment, and Suburban Extended Stay Hotels in the economy extended stay market. We executed 13 Cambria Suites contracts in 2005 and have applications in-house for 9 additional franchises.

The acquisition of Suburban contributes approximately $725,000 to royalties in the fourth quarter of 2005. The acquisition closed late in the year, so we didn’t execute any contracts in ’05, but like Cambria, we are optimistic about the growth potential for the Suburban brand in 2006 and beyond.

Free cash flow generation continues to be a vital strength of our Company and objective of our management team. Our business in not capital-intensive, so we redeployed capital to our shareholders in recent years through share repurchases and dividends. In 2005, we returned nearly $80 million to our shareholders through these programs.

We believe 2006 has the potential to be an outstanding year for Choice and the hotel industry in general. We’ll continue to strive to achieve profitable growth and to maximize financial returns for our franchisees and shareholders.

I would now like to turn things over to Joe Squeri, our EVP, who runs our operations, runs our developments, our CFO, to review our results in more detail. And after Joe is finished, we’ll take your questions. And also joining us today, I neglected to mention, is David White, our VP and Controller.

Joe?

Thanks, Chuck. Chuck has already commented on Choice’s outstanding development and RevPAR performance, which were key contributors to our strong financial results in 2005. I would add that we also reported yesterday and are pleased with the 3 basis point improvement in the domestic system-wide effect of royalty rate. This improvement is a function of many positive factors, including brand mix, the runoff of development incentives, and the increased frequency of franchise contract re-pricing events. The effective rate improvement, along with unit and RevPAR growth contributed to a 12% increase in royalty fees for full-year 2005 to more than $187 million. Royalty fees for the fourth quarter of 2005 were up more than 14% from the prior year to approximately $49 million.

Chuck also mentioned that the number of executed new hotel franchise contracts for 2005 increased 16%. This increase, along with an increase in the number of re-licensing transactions last year contributed to initial franchise and re-licensing fees growth of 26% for full-year 2005. Initial franchise and re-licensing fees increased more than 33% for the fourth quarter of 2005 compared to the previous year. Franchising revenues increased by 13% in 2005 to nearly $230 million from $204 million in 2004. So, the heart of our business, hotel franchising, continues to perform very well for us.

We disclosed in yesterday’s release that the number of executed contracts for new construction hotels increased 30% for 2005 to 237 executed contracts. Our flagship Comfort brand, along with Comfort Suites, Sleep, MainStay, and Cambria Suites, each performed well in this regard. While there are still opportunities for increasing our share of supply through conversions, and in fact, the number of contracts for conversion hotels also increased last year by 9%, we are encouraged by the trend towards a higher mix of new construction hotels.

We expect that as more new build product comes online our brands become stronger, better differentiated in the eyes of consumers, and more profitable to Choice and our franchisees. We believe current lodging industry travel demand, supply growth, fundamentals, and credit market conditions relevant to new hotel construction are strong. In light of these conditions, we are confident that our strategy of terminating underperforming or noncompliant franchises, while at the same time adding new construction brands, like Cambria and Suburban, to our portfolio brands, will improve our brand equity and best position us for profitable long-term growth.

The strength of our development pipeline positioned us very well for future growth. We have a broad and appealing portfolio of hotel products to offer hotel developers and owners – products that offer both the brand appeal to draw guests and the potential for a solid return on their investment. Our application flow remains quite strong and was up approximately 14% last year compared to 2004 and we continue to be able to convert many of them into executed agreements.

Our major development objectives for 2006 include maximizing the growth potential for Cambria Suites and Suburban Extended Stay Hotel brands. At the same time, we are implementing brand improvement initiatives in our 8 other brands to balance and optimize royalties per room with supply growth. We believe that improved knowledge of hotel performance obtained through our proprietary property management systems can be used by our Franchise Services staff to more effectively work with out hotel owners to deliver more to their bottom lines, which in turn, proves brand equity. We have information technology, marketing, and reservation delivery initiatives underway that we expect will provide Choice and our franchisees with a competitive advantage by helping them build their businesses and maximizing their returns on their Choice-branded hotels.

We announced yesterday that for the first quarter of 2006 we expect diluted earnings per share to be in the range of $0.19 to $0.21. Full-year 2006 estimates are expected to be in the range of $1.38 to $1.41. EBITDA is expected to range between $170 and $173 million for the full-year 2006. These estimates are based on a number of assumptions described in yesterday’s release, including, among others, unit growth of 4%; RevPAR growth of 6.5 to 8% for the first quarter and 5 to 6% for the full-year; a 3 basis point increase in the effective royalty rate; and an effective tax rate of 37.5%. These estimates also assume our existing share count and includes stock-based compensation expense related to our adoption of SFAS 123R.

Given the overall strength of the economy, our industry, and our brands, Choice is well-positioned to sustain its solid financial performance this year and for long-term growth that will continue to generate value for our shareholders.

Now let me turn it back to Chuck.

Thanks, Joe. We’d be happy to take any questions now.

[Operator instructions.] William Truelove, UBS

This is Michelle Coe for Will Truelove. I was just wondering why the SG&A costs were so high in the fourth quarter. Were they higher because of higher commissions paid for the higher initial fees? And also, the average SG&A cost increase for 2005 was about 12.5%. Is this a good run rate for next year -- for 2006?

Well, let me go to the fourth quarter first, I mean, the fourth quarter is always a little different for us. You have back-ended commission plans, you have bonus plans, and from time to time you have severance costs in there. And I think that’s what happened in the fourth quarter of this year and it’s not dissimilar to what’s happened in previous years. I don’t think any of that is reflective of any kind of -- of any fixed cost base -- fixed cost increase that anyone should be modeling going forward. I mean, our objective is to keep overall costs within 4 to 6% on an SG&A run rate basis, but when we continue to have the years that we’re having we do have variable commission and variable bonus plans that kick in.

And from time to time, like we did this year, we had some restructuring in our organization to consolidate our Partner Services organization more closely aligned with brands and some other action. So, I would say what we look at is expanding margins and we were able to achieve that again. And we have initiatives that we invest in and our main basis of investing in this Company is in our people. We have incentive plans, as I mentioned, and from time to time we have some reorganization that impact our variable costs. But I would stick with a 4 to 6% kind of growth and expect us to expand margins and look at the fourth quarter, as always, we always have some kind of slight anomaly based on these costs because of the way our bonus and commission plans were.

David Katz, CIBC World Markets

Two questions. One, when I looked through sort of the 2 pieces of debt you have, on the $100 million, I think as of last year’s K, the takeout premium on it was about $12.5 million, which I guess seemed a little bit high. Can you -- how does that sort of ratchet down? I mean, where would that be today? And I guess more broadly speaking I was looking at your balance sheet to see if there was anything for you to do there, so to speak.

There is a yield maintenance provision in that and it’s a public debt issuance that will come up, well, it will expire May 2007.

2008.

May 2008. I mean, we look at the yield maintenance provision. I mean, I haven’t looked at it lately. I mean, $12 million at the time, if you looked at it, didn’t make sense for us to pull the trigger and take that out. I mean, if there was an opportunity for us to do that, and with interest rates moving and the spread narrowing, I guess that penalty is getting smaller and smaller. But if we had an opportunity to replace that and it was accretive and it made sense, we’d do it. It’s just not something that we feel has made sense, at this point anyway.

Right. So, it doesn’t really look like there is anything sort of to do there in the short-term.

We’re not anticipating doing anything right now. Take that out.

My other question is we obviously track construction costs, and on the one hand we would expect that it keeps somewhat of a lid on supply growth, particularly in your segments of the market. On the flipside of it, your pipeline, obviously, is very robust. And are you -- should we take this to sort of mean that you’re getting a disproportionately high share of new construction opportunities or how should we be thinking about those 2 pieces of information with construction costs high and your pipeline continuing to grow? Would the batting average in that pipeline potentially go down with construction costs rising?

Well, I’ll just say that generally, and it’s obviously an accurate statement, construction costs are up, but also rates have been up pretty handsomely. I think the price points where most of our hotels compete developers are finding deals that work. And what some of what happens is is that there is replacement that goes on where you have an existing property that’s come up on the end of its license term and so we’ll take out, let’s say, a small Comfort Inn and replace it with a new Comfort Suites. And it’s in a market that can support the building costs and they seem to be working.

We really haven’t seen -- it’s taking a little longer to get some of the deals done, but we haven’t seen a whole lot of them falling off. So, I think we -- I feel pretty good about that mix, although it does cost more. It doesn’t seem to be slowing a whole lot of people down kind of in the mid-market. Some of the deals are tougher to do. Land costs are up in a lot of areas, so that’s had an effect. But we play both sides of that in that we have a lot of conversion products as well. But we’ve seen an increase in the percentage of new construction versus conversion in the last couple of years, which typically we see in a cycle like this where the demand and ADRs have been strong.

Congrats, guys; great quarter.

Bill Lerner, Prudential

Thanks, our question has been answered.

Samir Jain, Jefferies & Co.

A couple questions on Suburban. Did you say it contributed $125,000 to the quarter in fees, is that correct?

$750,000 in royalties.

It’s $750,000, I’m sorry, I had that wrong. Can you give us any idea what the RevPAR rate, occupancy, anything that’s over there? I know you didn’t put it in the press release because you didn’t have comparables, but just to get a general feel.

We think we use around $24 on a daily basis.

For RevPAR?

RevPAR.

Did you have any share repurchases in the quarter?

After the split, we had about 600,000 share repurchases. That split, which was October 6th, was the record date.

And then finally, should we continue to expect the Cambria properties to start contributing to EBITDA in 2007?

Yes.

And actually one more. You’ve made some changes to the board, I believe, yesterday.

Right.

Any commentary on that?

No. I mean, that’s sort of a normal course. I mean, Bill Jews was on our board and had left for a period, mainly because he’s a CEO of a company and mainly had some -- was very busy with some other things that were going on. And thankfully, he’s still the CEO of the same company, but he was able to come back and has actually gotten off of a couple of other boards that he was on. So, that’s a real positive for us. He’s a great guy.

And then we brought Dave Sullivan onboard, who was a long-time hotel franchising and industry veteran replacing a retired director, Ray Schultz, who is a great director too. So, I think both of our additions are going to be very strong and good additions to the board. And no news in the retirement, I mean, that was just age-related. We have a mandatory retirement policy.

Actually, if I could just ask one more question. It sort of goes back to what I think David was asking about the debt. The thing is you don’t really have an outlined plan to reduce the debt and I guess share repurchases will constantly be a partially use of free cash flow, but how are you guys thinking about the dividend at this point? Does it make more sense to increase that, especially with the stock price increasing considerably over the past few months just to get the yield back to maybe where it was 6 months ago?

Well, I mean, our policy, and when we’ve talked is in a case, and we’ve said this on a call, just keep our dividend growing consistent with our cash flow. I think that that’s -- given the tax rate and the advantages right now, I mean, that’s an important aspect of what we’re doing. And on share repurchases, I believe that the combination, too, is still a powerful story and thesis about what we’re trying to do from a financial standpoint. And from a share repurchases, I just think we look at that opportunistically. We’re not in everyday, we don’t buy for the sake of buying, we look at total value and total return to shareholders, and when the opportunity presents itself, we buy stock. But the policy, as it stands, and the way that the board has articulated it, is that we would like to have a steady and increasing dividend. We think that’s an element of the story. And so if we can keep our cash flow moving at a healthy rate you should expect that we would be able to increase our dividend at that point, provided that taxes stay -- the tax rate advantage stays in place and the financial condition of the Company stays in place. So, it’s still a combination of 2.

[Operator instructions.] Joe Greff, Bear Stearns

A question for you on the franchising margins in the quarter. They were down about 40 basis points. Can you explain that? Is that just a mix issue with Suburban?

No, I think that that has to do with some of the compensation programs that I mentioned before and some severance costs. I don’t think it has to do with the margins that are enjoyed in our franchise business as much as it is settling out those issues that I mentioned before.

So the SG&A and commission bonus severance stuff was a little bit greater this fourth quarter than last year’s fourth quarter?

Yeah, and we’re also getting -- well, to your point, I mean, there is a little mix. Our pipeline is getting deeper with new construction products and the average contribution on those assets is substantially higher than the conversion, but it’s going to take time for them to come online. So the commission payments are made once the fees are paid. But I would say the margins are being more impacted by the variable bonus expenses and severance charges.

And, Joe, with regard to the just under $17 million in cash on the balance sheet, how much do you actually need to hold or to operate with and how much of that would you say is sort of excess cash?

Well, essentially that cash is kind of like looking at it in 2 tranches. I mean, it’s about half of it that’s in our international operations, and we have operations in Australia, U.K., Mexico, and then the joint venture in Canada. So, we have to keep some cash on hand for those entities, as well as we repatriated everything we could in the fourth quarter. But the other half of it is essentially for the domestic operations and if you look at that cash onto kind of our annual expense or our quarterly expense run rate, I mean, I think it’s kind of in line with what we need to just run the day-to-day operations of the business, the other half, say, $8 million domestically.

There are no further questions at this time. Please go ahead with any closing remarks.

No closing remarks. Thank you for your attention and have a good day.

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