Choice Hotels International Inc (CHH) 2006 Q3 法說會逐字稿

Good morning, and welcome to the Choice Hotels International third quarter 2006 earnings conference call. During the course of this conference call, certain predictive and 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 from those expressed or implied by such statements. The company's Form 10K for the year ended December 31st, 2005, details some of the important risk factors that you should review.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We caution you not to place undue reliance on forward-looking statements, which reflect our analysis only, and speak only as of today's date. We undertake no obligation to publicly update the forward-looking statements to reflect subsequent events or circumstances.

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

Good morning. Welcome to our third quarter 2006 earnings conference call. And with me this morning is Joe Squeri, who actually is our President and Chief Operating Officer, and Dave White, our Chief Financial Officer. And following a few brief comments and highlights about the quarter, we'll open up the call to any questions you have.

As you know, yesterday after the market closed we reported third quarter results. Diluted EPS for the quarter was $0.69, compared to $0.48 for the same period in 2005. We reported adjusted diluted EPS of $0.50, an increase of 16% over the $0.43 reported in the third quarter of 2005. Adjusted diluted EPS excludes certain income tax items and debt extinguishment costs described in yesterday's release.

Operating income increased 14% to $54.6 million, compared to $47.8 million for the same period in 2005. EBIDTA also increased 14% to $56.9 million, from $50 million in the third quarter of '05.

Franchising revenues, which exclude marketing and reservations activities and owned hotel operations, increased 13% for the third quarter in '06 to $76.8 million, and total revenues increased 6% to $151 million, compared to the third quarter of '05.

Initial franchise and relicensing fees increased 34% for the third quarter in '06. New domestic hotel franchise contracts were 24% -- were up 24% to 178. Both new construction and conversion domestic hotel franchise contracts were strong, up 22% and 26% respectively for the quarter.

We experienced a 4.9% growth in domestic system-wide RevPAR. All of our eight established brands experienced RevPAR growth. RevPAR for our mid-scale without food and beverage, Comfort Inn, Comfort Suites, and Sleep Inn, which together represent just over 50% of our domestic supply of hotels, increased 7.3% for the quarter compared to last year.

Domestic unit growth increased 3.2%, compared to third quarter '05. And we still believe that our net unit growth will be approximately 4% for the year.

Domestic hotel pipeline of hotels under construction, awaiting conversion, or approved for development increased 48% to 736 hotels, representing 57,000 rooms. And the worldwide pipeline increased 39% to 808 hotels, representing more than 63,000 rooms.

During the third quarter, we signed five contracts for our new upscale Cambria Suites brand. We've signed 33 since launching the brand in early '05.

Yesterday we announced the framework for the assumption of responsibility for direct franchising in continental Europe and the termination of our master franchise agreement for continental Europe.

Our new estimate for adjusted diluted earnings per share, excluding the tax items and debt extinguishment costs described earlier, is $1.47. We expect diluted earnings per share for the fourth quarter of 2006 to be $0.34. The full year of 2006 diluted earnings per share are expected to be $1.66. Our estimate for full year 2006 EBIDTA remains at $175 million. These estimates assume 4% unit growth for the full year in '06, and a 4.5% increase in RevPAR for the fourth quarter.

We're very pleased with our third quarter results, and continue to believe that our long-term prospects are strong. Yesterday's announcement of our shift to a more brand-focused organization supports our efforts to build a high performance organization that positions us to leverage our brand equity and core strengths in order to take advantage of further opportunities for growth, innovation, and leadership, while maximizing returns for our shareholders and franchisees.

And I'll now be glad to answer any questions that you might have.

Very good, sir. [Operator Instructions] We have our first question from the line of Will Truelove with UBS. Please go ahead, sir.

Hello, guys. Good quarter.

Thanks, Will.

I've got several questions here. I hope you don't mind. Let's just first talk about the deal with CHE. I couldn't quite tell from the press releases, but how many net franchise contracts across all the countries did you actually acquire? And how many rooms sort of would that be representative?

I think it's around 200 franchises, which is about 70 in Germany and related countries, and then 140 or so in France. The number of rooms, I don't have that off the top of my head. But you probably - not additive to what we currently have under our existing master franchise arrangement with them.

It's a means by which we're exercising control over the relationships as opposed to actually physically acquiring more contracts. The profitability associated with those contracts would be enhanced, but it's the relationship and how we're administering our governance over the hotels that really changed.

And associated with that, will you also be now responsible for any new franchise contracts in those regions?

Yes. That's right.

Yes.

Okay. Cool. All right. Then just one last question then about that. Maybe you can give me more details offline. On the cost, it looks like you [inaudible] 1.1 million pounds in total, or $2.1 million in US dollars. Is that correct? And do you plan to expense that or capitalize it?

The total expected cost is going to be around just under $2 million US dollars. And essentially what we're acquiring there is kind of a net working capital of those businesses. And so essentially that'll be reflected like a purchase accounting, tax-wise, essentially.

So it'll be capitalized? All right. And then just on to just some basic questions. In just looking at your cash flow, I was -- I had to say I was a little surprised that with the stock down as much as it was in the -- or lately, that you didn't make more share purchases. Was that because you had to hold off because of this acquisition? Or can you talk about why you paid down your credit line versus buying back stock at this time?

Well, Will, we're opportunistic buyers of the stock, and we sometimes can buy and sometimes we can't. So there were some instances in the quarter when we couldn't buy. But we take a long-term view of the business. Paying down debt is a good way to frankly preserve our ability down the road to make acquisitions or to return that value to shareholders, which we will do. That's what we do. So we are - we're not going to change down the road with what we've done in the past in terms of returning value to shareholders.

And it's a matter sometimes of ability to do it, and sometimes it's a matter of strategy. We've increased our dividend pretty significantly over time, and I think we'll continue to return value between dividend increases, repurchase of shares, and hopefully growth in the business and some -- perhaps down the road in some other ways. So that's really kind of where we are.

Well, let me -- yes, that's great. But just in the near term because of the opportunistic aspect of the shares, are you still under some sort of restriction of repurchasing shares? Or has that been lifted?

It's not a restriction. It's a -- sometimes you can be in the market and sometimes you can't, depending on the circumstances within the company. You're blocked out or blacked out of the market sometimes.

Right.

But that's not -- that's here and there. That's not a --that wasn't the entire quarter. That wasn't really what we're doing. We're looking at just building a long-term -- looking at the long-term in the business. And so we will continue to be opportunistic purchasers of the shares when the time is right.

Cool. Great. Thanks, guys.

Yes. Our next question comes from the line of David Katz with CIBC World Markets. Please go ahead, sir.

Good morning, all.

Hi.

Hi. I wanted to just go back to the European situation for a moment. How do we -- should we be looking for an accelerating number of contracts going forward? Is that ultimately what the mission in all of this is?

I think it's, first and foremost, it gives us greater control over the quality and execution of our system over in Europe. And I think until we get our -- it's going to take some time for us to really set the direction and understand -- we have solid relationships, but we'll be in much closer [inaudible] with our customers than we've been before. It's a strategy -- we believe international can be a very profitable enterprise for us.

But I think it's too early to tell exactly what the success is going to be over our franchise development efforts. At this point in time, we're in the midst of undertaking a relationship directly that we haven't for some time. And I wouldn't build anything more into it from a development standpoint.

Okay. So there's no -- I'm sorry. Go ahead.

No, that's it.

Okay. There's no specific way that you would encourage us to sort of measure your progress on this, let's say the next four quarters or six quarters? Something like that?

I think you ought to wait at least four because we're -- as Joe said, part of this is frankly continuing to clean up the quality of the products over there. So there's a little bit of that, and a little bit of it's just getting our arms around the expense side of the equation as we move it forward. I suspect over time, when you can look at two, three, four years, it'll be a -- it'll become a larger profit contributor. But I think for now, it's -- let's sort of go slow here until we get it totally figured out.

Understood. And just following through on that, you all have been quite good at the franchise business for a while, and many of the other players are devoting more and more resources to it and focusing on it more and more. Could you talk a little bit about how much competition you're seeing out there, whether it's domestically or internationally? And how you're I guess reacting to that, if you see a need to do so.

I would tell you that the competition in the franchising has been intense for the 30 years I've been in the industry. So I think what happens is when times are good, you'll start to see some startup type businesses. Smaller companies will come in. We'll see new brands, new concepts come in. That's typically the pattern and the trend.

And then it's a cyclical business. So what I've seen over my time is that you're patient. When the times are good, you enjoy it, and you expand. But you're patient and [inaudible] consolidation time when those cycles turn. And they will. They'll turn. And so we -- the last time around, we were pretty good at being able to pick up some -- a fair number of contracts in that softened type period.

So what we're seeing now is we're seeing I think growth across the board. We're certainly getting our fair share. We're doing more new construction type projects, which has been the trend. And that's a good thing, because that helps in the overall quality of the system. And so I think it's pretty good, and you're seeing that kind of across the board. The competition's -- frankly, I'm not sure it's any tougher than it's ever been. It's -- the major players are still there and have been for a long time. And our competitors are still doing pretty much the same thing they've always done.

Right. One last one, then I'll get out of the way, which is just to be clear, in terms of share repurchase, your sort of posture and approach to that has not changed since the last quarter, since we last talked about it? Is that accurate?

Yes. And I think people need to --the answer to that question is yes, and that you need to look at it in the context of how we acquired stock in the past. We've never been in the market for long periods of time, let's say every week, buying stock on a repetitive basis. It's always been opportunistic, and we usually purchase large blocks of stock when the opportunity avails itself. We still have a lot outstanding left on our program. It's been very accretive in the past, and it should continue to supplement our performance going forward.

Great. Thanks so much.

We have our next question from the line of Michael Millman with Soleil Securities. Please go ahead, sir.

Thank you. It's actually Soleil Securities. A couple of questions. At the -- at your economy end, that performance was, I guess, not as good as your other categories. Maybe you could talk about what you're seeing there. If it's company specific or industry. And also, relatedly, could you talk about the new construction pipeline, particularly at the limited service and lower end, wherever that seems to be? How that pipeline seems to be satisfying demand. And then I had a question on Cambria Suites.

Yes. The economy segment has been lagging [all performance] within the industry, and I think that that's -- from our standpoint, that's always been a counter-cyclical kind of business. It's always performed at a relatively stable state in good times and in bad. We recently announced an organizational change to get more brand specific, and I think we have some opportunity to improve the overall image and customer experience at Econo Lodge and Roadway.

So while I don't think you're going to see dramatic RevPAR improvement as a result of that in the short-term, some of the brand initiatives that we'll put in place for Econo Lodge and Roadway going forward should have come to bear in the future. But typically, and that's not -- in the economy segment, that's not an unusual circumstance relative to our competitive [set]. But we're -- it's an area that we're focused on.

In mid-scale new construction, as Chuck alluded to in his comments before, I think we're very pleased with the pipeline, the way it's developed. Our contract and execution with respect to new construction has enhanced our performance for Comfort Inn, Comfort Suites, and Sleep Inn. It has been very solid from a RevPAR standpoint. We continue to make improvements in the brand, and from an execution standpoint, our customers are getting better and improving the overall performance of the product. So we're very pleased with the pipeline and how it's developed for new construction, and we're optimistic that that should continue.

Sorry. I guess I didn't ask the question correctly.

Okay.

I should have -- what I was looking at more was from an industry standpoint, and just generally whether because it's so much easier to construct that sector and out of the urban areas, whether it -- that demand --for the industry, now, seems to be getting satisfied.

I think it's probably fair to say that the mid-scale segments, probably the supply additions are a little bit higher there than they are at the higher end. But I still think that the overall supply/demand picture is pretty good, meaning that demand still is outstripping supply. So -- and that's partly a function of difficulty in development. Construction costs have been a little bit higher. Some of it's just timing. It just takes time to get projects up and going.

I see. Thank you. And on Cambria Suites, can you talk about whether it's difficult to upsell and [inaudible] as an investor or an owner, say, "Okay, we'll go with you rather than someone that's established." Do you have to give any particular deals to get into the business? Maybe just some color around it.

Well, what happens, and what we've seen over time is that our -- here's what typically will happen. You'll have a loyal -- perhaps you'll have a person who's been a developer of Choice product. And let's say that they've got a site that is a more expensive site and can drive a higher ADR, but your existing products have a limit or a cap on the amount of ADR that they could actually drive for that brand. So we were finding that we had developers who were leaving us to go to other brands because we didn't have a product that suited that particular site or that particular product that he was looking for. And so that's what -- that's the demand that Cambria has answered somewhat. That's partially from the existing pool of Choice developers.

Now I'll also tell you that there's not -- there are -- the trend has been, certainly in the last 10 to 20 years, that many of these developers have multiple brands. So they'll have some of ours. They'll have some of our competitors. And so I think they will -- that's the way they run their business. So you have some control over that, but obviously not total control.

So we answer that demand. And I think from a customer standpoint, I mean the guests in the hotel, we have large unsatisfied demand from our loyal customers for a product like Cambria. So we saw that we had existing unmet demand from our Choice customers from a guest standpoint. We were also -- we're seeing the same thing from the development standpoint.

And that's frankly the first place we went with our -- with Cambria, was to our existing Choice developers. Now we are attracting others, too, so it's been very successful. Thirty-three signed contracts is pretty strong for a brand that's -- started a year and a half ago.

Okay. Great. Thank you very much.

Sure.

Our next question comes from the line of Joseph Greff with Bear Stearns. Please go ahead, sir.

Good morning, everyone.

Good morning.

I know you don't really talk about 2007 in the press release or your earlier comments. Maybe you could just talk a little bit about you're viewing '07 beyond -- with respect to unit growth. What's a sustainable unit growth? I think you would have some degree of visibility there, given your pipeline.

Yes. We've always talked about unit growth as being at least 4% or better. 4% to 5%. So we're going through kind of the strategic planning and budgeting process right now. And we'll obviously put our guidance out there with our year end numbers. But kind of 4% unit growth or better is kind of where we set our targets.

Great. And then the effective royalty rate, you guys were able to do a good job in improving that a bit in 2006. Is there much more you can do as you look beyond this year with respect to moving that up?

Well, kind of the new construction brands tend to have higher royalty rates associated with them. So as those come online --

That's going to change. Right.

-- that should be a positive pickup for us. And we're obviously continuing to execute our relicensing strategy when properties change hands, ownership hands. And that's one of the key ways we've been able to improve that rate. So we're obviously optimistic about continuing to be able to do that.

Great. Thanks.

Our next question comes from the line of Samir Jain of [Hayground Cobe]. Please go ahead, sir. Please go ahead, the line of Samir Jain. Your line is open. Once again, please go ahead, the line of Samir Jain. Your line is open. At this time, we have no additional questions. [Operator Instructions] No additional questions. Please continue.

Okay. Thank you very much for your attention, and we'll look forward to talking to you next quarter. Bye bye.

Thank you very much, sir. [Operator Instructions] Now this does conclude your conference for today. Thank you for your participation.