Choice Hotels International Inc (CHH) 2007 Q2 法說會逐字稿

Good morning and welcome to the Choice Hotels International second quarter 2007 earnings conference call. During the course of this conference call Choice Hotels will make certain predictive or forward-looking statements as defined by the federal securities laws. Generally our use of words such as expect, estimate, believe, anticipate, will, forecast, plan, project, assume or similar words of futurity identity statements that are forward-looking and that we intend to be included within the Safe Harbor protections provided by Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934.

Such statements may relate to projections for the Company's revenue, earnings and other financial and operational measures, Company debt levels, payment of stock dividends, and future operations. We caution you not to place undue reliance on any forward-looking statements. Actual results could differ materially from those projected in a forward-looking statement. Information concerning some of the factors that could cause actual results to differ materially from those in forward-looking statements is contained in the Risk Factors section of the Company's Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission on March 1, 2007.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. As a reminder, this conference is being recorded.

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

Good morning everyone and welcome to our second quarter 2007 earnings conference call. And joining me this morning is Dave White, our Chief Financial Officer. Yesterday after the market closed we reported second quarter 2007 results. After I discuss some of the highlights for the quarter I will open up the call for your questions.

Our second quarter 2007 royalty revenues of $59.2 million represented an 11% increase from last year. Domestic hotel franchise system royalties for the second quarter of 2007 were $53.9 million, an increase of approximately $4.3 million or 9% compared to last year. Domestic royalties reflected RevPAR growth of 3.3%, unit growth of 5.1%, and a 4 basis point improvement in the systemwide effective royalty rate compared to the second quarter of '06.

For full year 2007 we are maintaining our outlook for domestic RevPAR growth of approximately 4%, net unit growth of 4%, and systemwide effective royalty rate growth of 3 basis points. Royalties from our international hotel franchises were $5.3 million for the second quarter of '07, an increase of $1.7 million compared to the same period of last year.

A key item impacting comparability of international revenues with last year is the fourth quarter 2006 acquisition of the Continental European direct franchising business. As a result of that acquisition second quarter 2007 royalties include a incremental $1.1 million of revenues compared to last year.

Initial and relicensing fees were $7.6 million for the second quarter of '07, an increase of 14% compared to the second quarter of '06. The key driver of this increase was a 14% increase in the number of executed new domestic hotel franchise contracts. For the second quarter of '07 we executed 176 franchise agreements compared to 155 executed in the second quarter of '06.

Worldwide we executed 11 Cambria Suites franchise agreements in the second quarter of '07, up from 5 last year. And franchise development momentum remains strong behind this brand. We currently have 60 Cambria Suites hotels in the pipeline, including two international locations in the Toronto area and a key 100 room hotel under development in Brooklyn, New York. By the end of this year we anticipate 4 or 5 Cambria Suites hotels will be open.

Operating income for the second quarter of '07 increased 12% to $47.4 million. Strong operating income results from our core business, coupled with better than expected investment income on employee benefit plan assets, resulted in diluted earnings per share of $0.43 for the second quarter of 2007, which exceeded our guidance by $0.02.

During the second quarter we also continued to execute against our long-term strategy of returning capital to shareholders. Since the beginning of the year through July 24 we have used approximately $58 million to repurchase 1.5 million shares of stock. During the same period we paid cash dividends on our common stock of $29.5 million in the aggregate.

As we indicated in yesterday's press release, our third quarter diluted earnings per share is expected to be at least $0.52. And we increase our full year 2007 diluted EPS guidance from $1.61 to $1.62. Earnings before interest, taxes, depreciation and amortization, or EBITDA, for full year '07 is expected to be approximately $187.5 million.

In addition to the assumptions I mentioned earlier for RevPAR, unit growth and effective royalty rate, our full year 2007 estimates assume an effective tax rate of 36.5% and include a $3.7 million severance charge, which was recorded in the first quarter of this year.

In closing, we remain focused on maximizing our franchisees' returns as a means of maximizing the returns for our stakeholders. We're confident in our long-term growth prospects, which are driven by our strong portfolio of brand, franchise development expertise, talented management teams and successful proven business model.

I will now open it up for any questions anyone might have. So please go ahead.

(OPERATOR INSTRUCTIONS). Joseph Greff, Bear, Stearns.

A few questions just regarding the development pipeline. One, I was hoping you can provide us with I guess the average length it takes for your hotels to emerge from the development pipeline versus that average length, or that time to a year ago. And maybe you can break that out between newly constructed hotels and those that you describe as conversion hotels?

Dave, you want to --?

I think -- you know, you take new construction of hotels, my sense is that typically those hotels can take somewhere between call it 12 and 18 months or maybe even little bit longer to come online post execution. This probably moved out a little bit from where it was a year or so ago.

On the conversion side of things, I think six to nine months is kind of typical. And when you're modeling this thing, you always also keep in mind just the success rate in terms of conversions coming online is higher typically than it is for new construction hotels post execution of contracts. Because obviously there's a lot more steps in getting a new construction hotel open than there is in a conversion hotel, which is already open and operating.

What are the success rates?

We don't typically give the success rates. We don't really guide those out. We kind of imply it obviously in our unit growth guidance, but we don't it break down to contract level.

What has been -- say over the last year what has been sort of the average in hotels coming out or the churn coming out for whatever reason, quality assurance reasons issues, etc.?

The past couple of years we've had I think around 95% retention of our franchisee base.

David Katz, CIBC World Markets.

Could we just talk about sort of the circumstances that may or may not be out there under which you would -- it is terrific that you're starting to buy back stock again. And I think your leverage actually kicked up a little bit in the quarter. But is there a set of circumstances under which you would do so a bit more aggressively than you are? Is there a set of circumstances where a special dividend would be considered or some kind of a -- again, a little larger share repurchase event might occur?

Well, I'm not going to speculate as to what we may or may not do. What we have done historically, and I think it is a pretty good indication of the future, is return capital to shareholders. So the velocity at which we do it is somewhat dependent on I think what other opportunities may be out there for us. There is more than one way obviously to return capital. You can either repurchase shares, or pay it out in the dividend, or hopefully you can invest in the business for the longer run. So some combination of all three of those things is probably what is going to happen moving forward.

We have been opportunistic as we have repurchased shares. We have started paying the dividend and increased it annually. So I think we'll just monitor conditions. We're not going to build up large amounts of cash. We're not going to run the business with no debt. That doesn't make a lot of sense. So suffice it to say, we will find ways of returning that capital in the most efficient way. And how we do that I think I'm not prepared to really say today.

Felicia Hendrix, Lehman Brothers.

A few questions for you. First on your international business I was wondering if you could just give us color as to what CICA was there and maybe what RevPAR was there, just so we can get an idea of how your international business is trending?

And then my next question is just with your guidance it implies a higher fourth quarter than we were expecting. So I was wondering what you are seeing in the fourth quarter. Thanks.

Dave, you want to --?

Sure. On the international side of things the fees for the second quarter were $5.3 million international fees, which was $1.7 million increase compared to last year's second quarter. But keep in mind about $1.1 million of that for the quarter was attributable just to the comparability issue because of the acquisition of Continental European franchising business last year in the fourth quarter.

In terms of the second half -- and from a RevPAR perspective for international, because that business is a little bit different, meaning that we have a higher level of use of master franchisers, we don't have really RevPAR results for international properties per se that we disclose on a quarterly basis. But from a guidance perspective for the second half --.

Can we stick on international per a second? So maybe if we can't talk about specific numbers, I'm just trying to get directionally what you are seeing in your international business and how that is trending.

I think on balance we have seen -- when we bought back the master franchising rights on the Continent last year for Continental Europe, which I think is going to give us some -- over the long-term some good opportunities to continue to improve our franchisee system growth there. We have got a strong partner in India. I think we have 30 or 40 or so franchises open there. And I know that they just announced that they had executed an agreement with a large hotel, the developer, to grow that system out over the next four or five years.

We have got good exposure in Canada, Mexico. I think we feel like we have good growth prospects international franchise business over the long-term. Chuck, I don't know if you want to add anything do that?

No, I agree with that. I think the business is -- as David said, a lot of the master agreements we don't always get -- the way that works is there is basically some of the countries we are doing direct franchising, some we have master agreements. So it is a little hard to -- we don't actually get the individual property data all the time. It is more of a payment based upon the number of hotels and so forth.

But anyway I think the business generally is good. And we're strong in Australasia. We're strong in Japan. And I think we've got some pretty happy international franchisees. So hopefully we'll continue to grow and add units.

And then on the fourth quarter?

In the second half compared to our guidance we were $0.02 ahead. And the way we look at it, first on the guidance, was about $0.01 of that was the result of kind of operational type things. And the other $0.01 was driven by the investment performance of the employee benefit plans. And so looking out in the second half of the year we essentially kept our operating guidance or our EBITDA guidance kind of in line with what we had previously announced. Which reflects the fact that that $0.01 beat in Q2 from an operational perspective was kind of timing type things that we think will kind of reverse on its share of the second half of the year. And then we kept the $0.01 on the investment performance in the outlook.

Are you seeing maybe fourth quarter trending more stronger than the rest of the year?

Yes, from a RevPAR perspective I think we guided to 4.5% for Q3. And we think Q4 will be pretty good as well. You've got to keep in mind the seasonality of the business as well when you're modeling out the royalties. The third quarter and the fourth quarter are typically have a higher weighting than really the first quarter does in our full year RevPAR results. If that is -- does that answer your question?

Yes, we can talk more off-line. Okay, thanks.

Too there is a lag, a month lag in the --.

Right.

So that could impact -- compared to others that are talking about calendar months, that can skew it a little bit too.

Sure, sure. Okay, thanks.

William Truelove, UBS.

This is actually Michelle Coe for Will Truelove. I just had a couple of questions. I was wondering -- I know that you have said that you have executed on 11 Cambria contracts so far. Is it reasonable to assume that most of those come online by the end of next year or into 2009?

And then can you also give us a sense of the operating performance that you expect from the Cambria? And then also can you give us a sense of the runrate for SG&A? It seems to be pretty high for the past two quarters, and I was just wondering if there was anything extraordinary in SG&A for the past two quarters?

I will tackle part of that one. You know, you may have a better idea than I do about the -- if the pattern for Cambria has followed the typical new construction hotel in terms of timing from contract execution to opening. We only have one open so --. We will open another probably three this year. And the timing I think has probably maybe extended a little bit from the others, because the sites in some cases are a little tougher. But I think that that probably 18 months -- it is probably more like 18 months to two years I would guess is the probably time from contract execution to opening. So I think as far as modeling, Dave, I don't know what we have assumed kind of in the way we have thought about it, maybe you can help there.

Yes, I think in terms of our model, we have really assumed very minimal royalty rate -- royalties from Cambria for 2007. And in 2008 it will pick up a little bit. But I think we are thinking probably about four or five open by the end of this year. And I think we talked about another 10 or 15 or so open during 2008. So it gets you kind of maybe to 20 or so at the end of '08, and then hopefully grow from there.

And then the -- I forget the second -- there was the SG&A, but what was the other part?

I was just wondering if you could give us a sense for if you had a sense of what you were expecting in terms of operating performance? Would the operating performance look something more like the Comfort Suites or --?

No, it will be higher. It is an higher ADR -- basically a similar royalty rate, but a higher --. So it will be the value of the contract is higher. So we are looking for -- I don't know where we have pro forma'ed out, Dave, but probably in the low hundred dollar kind of ADR.

Yes, that's about right. The key things are that the prototype is like 119 rooms, which is basically 50% bigger than the number -- the average size of the hotel in our system today. And then as Chuck pointed out, ADR we're targeting for stabilized properties north of $100. Combine that with a royalty rate each of these contracts should deliver probably around $120,000 and higher in terms of annual royalties to us, which on a per unit basis relative to anything else in our system is significantly higher.

Great. That helps a lot.

And then the SG&A question. Dave, you want to --?

Yes, on the SG&A I think the way to think about that is that the way our business works, to the extent we're making investments in kind of talented people and building these brands, Cambria and the Extended Stay and our other growth opportunities that we have, it is -- we don't put those things on our balance sheet. So it flows through our SG&A. I think when you look at our SG&A growth rate we think we're kind of doing the right things for the long-term health of the business, and growing the enterprise value of the business. But certainly SG&A was a little bit higher this quarter than what we have seen in the past.

There was a -- part of that too was the addition of the foreign (multiple speakers) the international piece. So they're lapping -- in other words you are -- about half the increase was related to that. And then the other was investing in the business on some initiatives that -- some of that will continue. I think it will continue at the -- for one thing once you have lapped the international operations then that goes way.

Can you just remind us again when the international came on last year or --?

Yes, it is Q4 of '06. It was kind of a two part acquisition. I think one part of the transaction closed in October and the other piece in November.

(OPERATOR INSTRUCTIONS). Michael Millman, Soleil Securities.

I guess I just wanted to follow-up on the first question. The arithmetic suggests that the RevPAR in the fourth quarter could be 7 or 8%. So maybe you want to comment on that. But could you discuss what new capacity generally you're seeing in the suburban markets, where we hear that it is easier to construct, and as big a growth there how that you see affecting your markets going forward?

And also, maybe you can give us some trends in what you're seeing in leisure versus corporate stays. And to what, if any, your long-term res book might look like? And are you doing any business with groups as possibly they get priced out of the urban markets?

The first part is the growth prospects of suburban versus urban. Definitely the suburban markets are lower barriers to entry in those cases. You are seeing -- and generally less expensive, so easier to develop. And that is basically where most of our hotels are located. We are in some city centers. And we obviously -- that is an opportunity hopefully for Cambria down the road. But we're more of a leisure driven, more suburban highway type location. And because of that, our mix -- our mix of business is probably 70% leisure, 30% business.

We don't have -- and because of that again, we don't have that much -- it is difficult to forecast out too far in terms of looking at the res, because the res volume, or reservations made because they are made pretty close in. So it is a little hard to get any predictors as to what is going to happen based on a res bookings looking forward.

Group business, we do a very small amount, mostly small meetings and things, because the hotels just don't have the meeting space to accommodate large groups. There are some in Clarions and those. There is a movement. Yes, I think when -- and I think that it is -- we tend to the road warrior type, the person that is out traveling by car working. We will get more of that type of business traveler than we will obviously the city center type traveler. There's a little bit of a trade I think when rates get tight and high of switching over and trading into some of the more sort of popular priced type products. But our business really is driven by -- predominately by leisure and with smaller business type travel.

I can't remember the fourth quarter RevPAR. Well, I think you have to look at the seasonality, as David said of the business. Ledsinger. Dave, you might want to -- I think we are --.

That is spot on. If you look at first half RevPAR growth of 3.3% or so, plus the second half in the mid 4s, because of the way the seasonality in the quarters work gets you close to 4% basically.

The question was more that the fourth quarter is a number that looks like it is more like 7 or 8%, and wondered if that seemed reasonable. And really wanted to dig in more on the suburban. With easier barrier to entry, and with the greater growth there, to what extent do you see that affecting your franchisees' growth, who is mostly in that market? Is that a market where -- we have seen in the first half that your occupancy rates have been down. Is that a market that looks like it is going to get tougher sooner?

I see what you are saying. I think -- we tend to track pretty much industry numbers. The industry occupancy has been a little bit softer overall. But rates have been up. I think that we are not atypical in that regard. And I think that the urban markets and the destination type markets have driven -- and business related markets have driven higher ADRs and higher RevPAR than the mid market or the suburban markets and roadside markets.

Yes, I think that business -- the business traveler has been less price sensitive, and therefore the rates have been up higher in that segment of the business than they have on the leisure side. What that means longer term, we think the business is going to remain pretty good for the next couple of years, because typically what your supply demand formula still look pretty good. And if the economy stays up, we will benefit.

I maybe pushing this -- and also just on the arithmetic on the fourth quarter -- maybe pushing this too much. With gasoline prices continuing to be high, and with more volume or more hotels in the Suburban, I guess trying to get some feeling as to how you see this continuing, or why you see a good continuation of growth in the suburban markets?

I think I answered it. I think that gasoline prices so far have had -- it is hard to tell. It is hard to tell if they have -- they probably have a little bit of an impact, but not a lot. The summer is still really strong. And so we haven't seen switching of behavior. I think if they go -- continue to rise, it will have an impact. It may have had already. It is just that we can't really tell. It is not something that is dramatic for one reason. You can't really track gas -- at least we haven't been able to track gas price increases to softening in the business, if you will, because actually the business was still -- it has remained pretty strong.

So if it goes to $5 a gallon, sure, or even $4, I suppose. But it has been kind of gradual and people seemed to have adjusted to it. Typically what happens in those suburban markets like I said, or any market for that matter, is that over time if there is money available developers develop and supply increases. And if supply increases overtake the demand then you have softness in the market. It is a cyclical business, but it is still in a pretty good growth cycle right now.

Great. Thank you.

The other thing I was going to add was that third quarter RevPAR growth at 4.5% plus RevPAR growth in the fourth quarter in the mid 4s gets you to approximately 4% for the full year just because of the seasonality. We're not implying 6 or 7% RevPAR growth in Q4 from a modeling perspective.

Speakers, there are no further questions from the phone lines at this time. Please continue.

Well, nothing else to add here. Thank you very much for your attention and good questions. And we look forward to talking to you again soon.

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