Choice Hotels International Inc (CHH) 2009 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Good morning, and welcome to the Choice Hotels International second quarter 2009 earnings conference call. At this time, all lines are in a listen-only mode. Later, there will be a question and answer session and further instructions will be given at that time. As a reminder, today's 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, which can (inaudible) forward-looking statements under the safe harbor provisions of the Securities Reform Act of 1995. These forward-looking statements generally can be identified by phrases such as choice, or as management belief, expect, anticipate, foresees, forecasts, estimates, or other words or phrases of similar import.

Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Please consult the Company's form 10-K for the year ended December 31, 2008 and other SEC filings for information about the important risk factors affecting the Company that you should consider. 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, do not 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 our forward-looking statements to reflect subsequent events or circumstances.

You can find reconciliation of our non-GAAP financial measures referred to in our remarks as part of our second quarter 2009 earnings press release which is posted on our website at choicehotels.com under the investment information section.

With that being said, I would now like to introduce Steve Joyce, President and Chief Executive Officer of Choice Hotels International, Incorporated. Please go ahead, sir.

Thank you. Good morning and welcome to our second quarter earnings conference call. With me this morning, as usual, is David White, our Chief Financial Officer. And this morning, Dave and I will discuss our second quarter results, provide our perspective on recent trends we are seeing in the business, and share with you our outlook for the rest of 2009.

Obviously, we will also open up the call for your questions after our remarks. So let me start by commenting that our perspective on the overall lodging and economic environment don't feel all that dramatically different today than they did when we hosted our first quarter earnings call in late April.

It is still a very challenging marketplace, and in particular, consumer confidence, while there has been a marginal, marginal uptick and the employment markets, both of which are significant to their impact on travel demand, are not where we'd like them to be and are not moving in any significant way.

And while we have seen the relative decline in the hotel business stabilize, we haven't seen any significant upticks to help to make our outlook be more optimistic. Having said that, there are some signs and forecasts that the broader economy in terms of GDP is beginning to stabilize and is positioned to return to positive growth later this year, which should be a positive sign for the industry.

A sooner than expected recovery or a steeper than expected improvement in consumer confidence, employment and GP would be a positive catalyst for us in terms of our near-term unit growth, RevPAR and franchise development results. So let's talk about RevPAR for a little bit.

Our results in the second quarter and our revised RevPAR outlook for full year 2009 reflect this difficult environment. Our RevPAR for the second quarter 2009 declined 15.7%. We did, however, outperform the comparable industry-wide chain scale results reported by Smith Travel, which by our estimate declined approximately 17%. Correspondingly, we are picking up share and picked up roughly 60 basis points of RevPAR index as a result.

Our second quarter results were also significantly better than the total US lodging industry as the top end of that continues to suffer more dramatically than where our brands are, as those RevPAR results were reported by Smith Travel, which declined roughly 20% during the quarter when you bring in the other segments. This is due to the fact that most of our brands compete in the economy and mid-scale segments, which have outperformed the upscale luxury segments on a relative basis. And by the way, when some recovery begins, our segments of the business will be the first to show that recovery.

Unfortunately, the RevPAR outlook for the remainder of the year, in our view, is likely to remain depressed. This outlook is consistent with third-party industry-wide RevPAR projections that we have seen. And those projections now range for declines of 15% to 17% for full-year 2009 and have all been revised downwards since our first quarter earnings announcement. So in light of these factors, we are revising our full-year RevPAR expectations to a decline of 13%. Recall that when we previously were expecting a full-year RevPAR decline, we had forecasted it at 11%. And our expectation for third quarter RevPAR is a 15% decline.

This means that we are forecasting the rate of RevPAR decline for the third and fourth quarters of 2009 to moderate really only slightly, despite significantly easier comparisons in the fourth quarter.

There are a couple of positive signs that I'd like to highlight. But I'd also caution not to take too much into this until we see general improvement. First, while we skew more towards leisure travel, our business travel demand is down less than other lodging companies. This is account of our value-oriented nature of our business travelers and the location of our properties, which we believe, given the value orientation of travelers today, are picking up business while even in spite of the overall decline of that overall business. And over the last several weeks, we have seen signs of improvement in the rate of decline, not positive, but in the rate of decline for weekend occupancy rate and RevPAR, which we attribute to the leisure travelers.

We believe that the share gains we've made in recent months on account of our value-oriented brands, combined with the shift in the consumer mindset, positions us for strong performance versus our competitive set in the coming years.

I'd like to point out that RevPAR is inherently difficult for Choice to predict as a result of the significant range and breadth of the economic forecast and lack of agreement of those forecasters for GDP, consumer spending and unemployment, and our limited visibility into forward demand as our business mix is skewed more towards leisure and transient business customers. And these customers tend to have very short booking windows.

So let's talk about development for a little bit. While the franchise sales environment remains extremely challenging, I am quite pleased with our unit and room growth results this quarter, both of which increased more than 4%. With regard to new franchise contract sales, the significant declines in RevPAR and the lack of hotel financing continue to negatively impact both our new construction and conversion franchise developments.

However, I'd like to note that during the second quarter, the number of conversion franchise sales applications, a leading indicator for franchise sales, increased compared to last year's second quarter. And I'd like to point out that this represents the first quarterly year-over-year increase in that metric for us since first quarter of 2008.

I would highlight that this represents only one quarter, so it may be early to consider it a trend, but we view it as very encouraging news as we believe an uptick in conversions will eventually come and that we will get more than our fair share of those conversions. So we remain optimistic for the development and RevPAR environment that they will eventually improve. And improvement in the credit markets and liquidity for hoteliers will be a key catalyst for improvement in our development results.

As I've said before, I believe that we would be one of the first hotel companies to benefit from improvements in the development environment in both the conversion and new construction areas because of the relative lower cost of investment for our properties and lenders moving cautiously back into the space starting at that end and working their way up. We remain committed to investing in marketing and reservation activities. And our franchisees and their operations, we've met with them recently. Obviously, it is a very difficult environment for them. The revenue drop that we experience is multiplied on their bottom lines. But in a recent meeting that we had in Clearwater with the leadership of those groups, they remain remarkably positive and resilient about their opportunities and about their relationship with Choice and the work that we're doing on their behalf.

And the interesting thing is we have an annual survey that we conduct. We are most of the way through from that. And the preliminary results would indicate that our franchisees are at the same relative level of satisfaction that they were last year in spite of the dramatic decline in business and revenues and profitability for them. So we commit -- we remain committed on their behalf to investing in marketing and reservation activities to drive guests into our hotels. Consumers are still staying in hotels this summer. They are looking for more value and ways to stretch their dollar when they travel. And we are aggressively promoting that value orientation that our hotels provide every day.

We have focused a significant amount of the Company's energies around adding members to our Choice Privileges Rewards Program. Choice Privileges today account for more than 20% of our domestic room revenues and stay in our hotels more frequently than non-members. And I am particularly pleased to report that year to date we have added over 1 million members to our CP Program and are well on our way to adding 1.75 million members to this program, which is one of our, and probably our top organizational priority for 2009. We have over 8.5 million members in this program today and we are committed to its global growth as we view that as a significant fueler of our success.

On the cost side of the business, we continue to focus on finding sustainable ways, sustainable ways, to be more efficient and cost effective organization in this challenging environment and economy. Since our last call, we have made additional adjustments on the cost side to reflect a continued challenging business environment. But I want to reiterate that those changes that we've made, we believe that we can sustain and it allows our company to operate as we need to, which then in the future will provide us scalability. David will provide more details regarding those efforts in his remarks.

So in summary, things remain relatively the same as they were when we reported first quarter results, and we have not seen a lot of change in the environment. The RevPAR environment is a bit worse than we'd anticipated, particularly for the back half of the year. And the development landscape remains challenging, particularly on the new construction side of things, with the exceptions of the second quarter results for conversions that I discussed and the pick-up on weekend business that we've noted over the last several weeks.

So finally, despite the near-term challenges, we continue to believe on account of our strong franchisee base, on account of our ten brands and their relative positioning, and on account of our management team and dedicated associates, that we are extremely well-positioned for the long-term to continue to grow our market share, improve our relative RevPAR performance, and create and return value to our shareholders as we have done historically.

So I'm going to turn it over now to Dave to cover our second quarter performance in a little more detail. David?

Thanks, Steve. I just want to highlight a few items from our release before we open up the call for questions. For second quarter 2009, domestic net unit and room growth increased 4.8% and 4.5%, respectively, compared to last year. Our domestic system-wide RevPAR declined 15.7% for second quarter 2009 compared to the same period of last year. This RevPAR decline reflects a 700 basis point decline in occupancy and a 4.1% decline in average daily rates.

We achieved a six basis point improvement in the system-wide effective royalty rate compared to last year, which increased to 4.26% for the three months ended June 30, 2009. And to re-emphasize one of the strengths of our model, we were able to offset a portion of the RevPAR declines we experienced through new unit growth and improved pricing on our contracts. As a result, our domestic royalty fees for second quarter of 2009 were $50 million compared to $56.9 million last year. The Company's international fees included in royalty fees revenue were $5 million for the second quarter of 2009 compared to $6.8 million last year.

Regarding development, the Company executed 118 new domestic hotel franchise contracts during second quarter 2009, a decrease of 40% compared to 198 contracts executed during the second quarter of 2008. As expected, new construction franchise sales were impacted significantly more than conversion franchise sales. New construction franchise sales declined by nearly 80% in the second quarter compared to a 19% decline for conversion franchise sales.

The number of re-licensing transactions for the second quarter of 2009 was 39, a 56% decline from the 88 re-licensing transactions we reported last year. The reduced contract volumes resulted in initial franchise and re-licensing fee revenues declining to $4 million for the second quarter of 2009, a 51% decline from last year's second quarter results.

On the cost side of the business, as a result of our focus on cost containment, our adjusted selling, general and administrative expenses for second quarter of 2009 were $25.2 million, or approximately 10% below last year's second quarter. As Steve mentioned in his remarks, during the year we have taken a close look at our cost structure and made adjustments that we believe better position our infrastructure for the environment we expect to operate in during the next 12 to 18 months.

We will continue to look for sensible, sustainable opportunities to make further improvements and to respond if the environment changes. We expect to manage the SG&A expenses of the business for full year 2009 to a high single-digit percentage decline compared to last year's full year SG&A expense, excluding the effect on SG&A of the special items we have previously described for 2009 and 2008.

Diluted earnings per share for second quarter 2009 were $0.42 per share, compared to $0.43 per share for the same period of last year. Our adjusted diluted earnings per share which excludes certain special items we described in yesterday's press release, for second quarter were $0.44 per share compared to $0.49 per share last year. Year to date through July 29, the Company repurchased approximately 1.7 million shares of our common stock at an average price of $26.54 per share for a total cost of approximately $45 million.

The Company has remaining authorization to repurchase up to an additional 4.3 million shares under the share repurchase program. We also paid cash dividends totaling approximately $22 million year to date through June 30, 2009.

Our balance sheet and liquidity position remains strong. We finished the second quarter with approximately $62 million of cash on hand and total long-term debt of $304 million, which represents a multiple of 1.8 times our adjusted EBITDA projections for 2009.

As of the close of business yesterday, the Company had approximately $40 million of available unused borrowing capacity pursuant to revolving bank facilities that are committed until June of 2011.

Turning to our outlook for the remainder of 2009, I would remind you that the continuing uncertainty around the economic environment and credit market conditions and the impact of those conditions on travel patterns and hotel development activities, make it difficult to predict future results. This particularly applies to underlying assumptions for RevPAR, new hotel franchise and re-licensing sales, and interest and investment income and expense.

With that in mind, in yesterday's release we shared our outlook for the third quarter and full year 2009. We currently expect third quarter 2009 adjusted diluted earnings per share of $0.51, and full year 2009 adjusted diluted earnings per share of $1.66. Adjusted EBITDA for full year 2009 are expected to be approximately $169 million.

These figures assume domestic unit growth of approximately 3.25% for full year 2009, an approximately 15% decline in RevPAR for third quarter 2009, and a 13% RevPAR decline for full year 2009. These figures also assume a 5 basis point increase in the effective royalty rate for full year 2009 and an effective tax rate of 36.5% for third quarter and full year 2009. All figures exclude currently anticipated operating expenses related to employee termination benefits and a loss on the sublease of office space as described in Exhibit 8 of yesterday's press release.

Now let me turn the call back over to Steve.

Thanks, Dave. So no doubt about it, 2009 continues to be a challenging year. But the strength, uniqueness, and resiliency of Choice's business model are on full display in today's challenging environment. As I've said before, I would not trade our business model for any other one in the industry. Our pure play fee-based franchising asset-like business model has enabled us to deliver profitable long-term growth in a variety of lodging and economic environments including the one today, while returning value to our shareholders at extraordinary levels.

Let me reiterate our focus on shareholder friendly policies. As always, our top priority is returning values to our shareholders through dividends and share repurchase. I can assure you that we remain confident in our long-term growth prospects as well due to this model, and our range of well-known value-oriented brands and our robust global distribution system.

I will now open up the call to answer any questions that you may have.

(Operator instructions.) Your first question comes from the line of Chris Woronka of Deutsche Bank. Please proceed, sir.

Hey, good morning, guys.

Good morning, Chris.

With the -- maybe some of the economic clouds at least starting to lift and in light of your balance sheet, can you maybe give us an update on what your position is on potentially acquiring some brands? It looks like there are going to be some more distressed situations or, at the very least, opportunities out there. And just maybe an update on what you're seeing and what your goals are. Thanks.

Yes. Obviously, given the environment and given our relative level of capacity and positioning, we believe this may -- it may create the right environment for the right acquisition. We're committed to ensuring that we pick up brands that resonate with guests but also meet shareholder expectations. And so while we believe that the additional brand opportunities that may come along are beginning to pick up and we are looking at everything that's out there, believe me, we have not yet found anything that works for our model at this point and fits in with the existing brands we've got.

We've previously said, obviously we would be very interested in an upscale brand in full service. That opportunity has not presented itself. But we are continuing to monitor the environment to see whether or not an opportunity that presents itself both with a brand that would fit in our portfolio well. And that means a value orientation sort of in all segments, one that is an asset-like model, where we continue our pure play franchising, and that the investment in that would yield the types of returns that our shareholders expect.

So while you can never predict and the opportunities jump up at you, we are actively looking and hoping something presents itself.

Great. And just a follow-up. You mentioned the data point on conversion applications. If most of those hold, what's kind of the lag time in terms of when we'd potentially begin to see that flowing through your P&L?

The average conversion, it varies, obviously, widely based on the work required. But I think six to nine months is a good way to think about it.

From the time the contract is executed, Chris. The metric that we referred to was applications. So that's the step right before a contract gets executed. So you've got to execute the contract. And from the time you execute the contact you're talking, as Steve said, it ranges anywhere from probably three months to a year, but kind of six months is kind of a good way to think about it.

Right. Okay, great, thanks.

Your next question comes from the line of Felicia Hendrix of Barclays Capital. Please proceed.

Good morning. I want to actually touch on that conversion application comment, because certainly it's encouraging. But I just want to understand, when a prospective franchisee fills out an application, what kind of financial commitment do they give you?

They normally make an application fee, Felicia, which ranges depending upon the brand. But think about it in kind of something in the range of $2,500 to $7,500 depending upon the specific brand. And then when they -- and then there's a relatively -- typically, there's a relatively short window from the application to the contract execution, at which point they would fund the full initial fee, which ranges for our brands, again, anywhere from, call it $7,500 up to $60,000, $65,000, depending upon the brand and the size of the actual hotel that we're potentially going to flag.

So is it fair to assume that with the increase in applications these are folks who already feel that they have adequate access to financing to actually go ahead with the process, not just the applica- --?

Yes, I think the way to think about it is a number of those applications, and we don't have the percentages with us, but a number of them are already by people that own the property and are looking to flag it or re-flag it. Or that they believe that by putting -- that they have access to the capital required to pick up that property. Because they do put some money down and the money that they put down, while it may not seem like a lot, in the environment that we're operating in at the lower end, that's significant capital to these franchisees. And so they typically are not making applications with the hope of it occurring, but that they feel that they've got a transaction that's going to come together. And I don't know the percentage, but a big chunk of those are for folks that already own it.

Right, because it's conversions, and then yes, because it didn't seem like it's an insignificant amount. That's why I asked that question. And Dave, those numbers that you had just given, those were for conversions, correct, not new builds?

That's right.

Okay. And then do you guys know in terms of the conversion -- I don't know if you have this metric, but -- or if anyone even measures it. But what your market share is in terms of conversion?

Yes, we don't -- we haven't measured it specifically in terms of conversions. We measure it more about overall share. Because again, one of the strengths of this model is that we can do both new construction brand and conversion brand. So both are important to us over the long term. But if you looked at our share for June of 2009 based upon hotels, we actually increased our market share to about 20.5% of branded hotels in the mid-scale and economy space. That's up from 20% at the same time last year. It was about a 50 basis point improvement. And on the rooms, if you looked at rooms that same time period, we increased it by about 30 basis points. We have about 18.3% share of branded rooms in the mid-scale and economy space.

So we don't look specifically at conversions, but we look more at the broader overall market share for our brands. And if you look at our projected unit growth this year of 3.25%, and you compare that to the overall industry-wide supply expectations, I think that would imply continued improvements in our share this year.

Right. And actually that gets to my next question. Because you did increase that number by about 25 basis points. So I'm wondering was that -- something moved up or was that just an overall increase?

Yes, I don't think anything really specific jumps out there, Felicia. It's just a little of timing around gross openings and the timing of expected terminations. There's nothing -- I don't think there's anything to really highlight.

Okay. And just my two -- my final questions are housekeeping. One is if you could just tell us what was in the interest and dividend income line. And the second is you alluded to some additional things that you're doing to cut costs. I was wondering if you could be more specific.

Sure. On the interest income line, that line, the majority of that relates to realized and unrealized gains and losses on our employee retirement plan assets. So I think the number for the second quarter was somewhere around $3 million.

One of the things to keep in mind about that is about one-third -- there's an offsetting expense that goes up through SG&A for about a third of that investment income because it relates to a liability to employees for their retirement plan obligations. So there's some offset up in SG&A for about a third of that.

And then to your second question around the specifics on the cost side of the business. I mean, frankly we've -- as Steve's come on board here over the past year, I think he's spent what's been a considerable amount of time working through each area of the operation to try to identify the optimum way we want to allocate the resources, the cost side of the business. So there's not one particular item that jumps out. It's more just kind of a general review of the organization and certainly we've hit kind of the low-hanging fruit type stuff and discretionary things, professional fees and things like that. But nothing else that really kind of jumps out other than that broader review of the overall business and cost structure.

Okay. I mean, is it more like eliminating people who were doing duplicative jobs or is it --?

Yes, that's the type of thing we're talking about.

Okay. Okay, great, thanks a lot.

Your next question comes from the line of David Katz of Oppenheimer. Please proceed.

Hi. Mine have been asked and answered. Nice quarter. Thanks.

Thanks, David.

Your next question comes from the line of Joe Greff of JP Morgan. Please proceed.

Hey, guys. You touched on most of my topics. But with regard, Steve, your comments about the conversion apps being up in the second quarter. Is that concentrated among a couple of brands? Is it pretty broad-based among the different brands? Could you give us some comments on that, please?

Yes, it's obviously in the conversion brands. So that you'd see it picking up in Quality, in particular. We are doing some conversions for Comfort. But then if you look at Clarion and Econo Lodge, that's where we're seeing it.

Got you. And these are converting from independent or from other branches?

Yes, we get a mixture. So we get an independent that's looking to hopefully upgrade their performance, particularly as they turn down and our system is still generating a significant amount of room nights for folks. You get folks looking to up-brand. So they're in a brand that isn't performing for them and they know that we're sort of the premier conversion company for driving business into converted hotels.

And then you get the folks that are pushing hotels out of other systems. So whether it be Holiday Inn Express or Hampton, as those guys move their brands and look for a bigger more revenue-intensive box, push that brand out. That's a great opportunity for us for conversions into the Quality brand and sometimes Econo Lodge.

Great, excellent. Thank you.

You bet.

Your next question comes from the line of Steve Kent of Goldman Sachs. Please proceed.

Hi, good morning. Everybody has been asking about conversions. But I just wanted to know how big of a percentage pickup they were this past quarter year over year. You said that they were much better than what you've been seeing. And then also, just what the sources of those conversions are, whether it's banks or others, companies in financial duress who have taken over hotels, whether it's independents who are looking to re-brand, or whether you're taking share from another brand.

Sure. Steve, on the percentage change, what we're talking about there is on the application side of things in the second quarter. We saw a 15% increase in the number of applications received. Okay? So that's kind of the leading indicator, not -- and I just want to add, not every single one of those applications will necessarily become an executed franchise contract. But obviously, that's the first step along that path of becoming an executed contract. So it's a 15% increase in Q2 which was the first quarter, as Steve pointed out, since first quarter of 2008 where we had actually seen a percentage increase in that metric.

Then in terms of the sources, I think Steve kind of just hit that in terms of where they come from, kind of a combination of independents and other brands. But to your point about the bank side of things, we haven't at this point seen any major impact from hotels going into foreclosure, and therefore coming to us through a bank package to re-flag into our system. So it's not really -- we're not seeing anything meaningful in that regard at this point in the cycle.

And it's interesting, because we actually thought we would see a little bit more at this point. And our guys have aggressively been in contact with the folks that would end up with those properties. And we've seen some, but it's not what you would expect to see, sort of a lot of hotels getting in trouble. We haven't seen that yet. But we are positioned to look for that business aggressively when it does turn out.

Okay, thank you.

Your next question comes from the line of David [Voll] of [Bayard]. Please proceed.

Good morning. I wanted to ask about new build, particularly in light of the Lodging Econometrics release about dramatic decline in pipeline, in the hotel supply pipeline for 2011. I wonder if you could talk a little about your view of new supply growth over the next three to four years. And particularly not just when the financing markets come back and make it more easy to fund new development, but also when you think the RevPAR environment makes economic sense for franchisees to create -- to build new mid-scale and economy properties.

Well, let's start with where we are. I mean, the lack of financing has literally diminished the new build opportunities for us. I think we're off roughly 80-some percent. So dramatic decline in new builds. And so while we are still opening -- we opened five Cambria Suites in the last month, I think. We've got -- which those are finishing. The number of starts that we're getting out of the pipeline and then the number of new applications coming in have slowed a lot. And so I think you've got two things going on. One is, your question about when does the RevPAR environment turn around in time.

There's a couple of different ways to look at it. Now is if there were financing available, now is actually a great time to build. Because construction costs, particularly around the services trades, are down significantly. And the guys that are building are getting real cost advantage over where they've been in the previous couple of years. Now RevPAR declines obviously impact that performance, particularly in the early years. But depending on your viewpoint of pickup, if you started projects in '10 or '11 and were opening into '12, that is when I think there's a consensus that there should be relatively strong performance in RevPAR. 2011 is subject to debate.

And so our view is new capital, when it comes back, it will first come back available to our brands. So it's going to start at the lower ends in the smaller loans. And that's where our action still is today, from regional banks, much diminished, obviously, but regional banks making smaller loans for a new construction Sleep Inn or a Comfort Inn. And so the pickup, though, in the experts' view is it could be as much as 18 months away where first capital available is going to be for buying existing hotels. And then you'll see a shift from existing into new build over some period.

But then if you think about -- there's two things. One is when money is available, typically that spurs development. Developers develop when they can get loans. And then what will spur that, though, will be a perceived uptick in business, depending on your viewpoint, either for '11 or for '12. But if you're really starting a project today, while the construction period may be 12 to 15 months, the typical overall development period for a hotel now can run two and a half to three years. So those guys are viewing the opportunity as, "Hey, if I got a project that I'm starting in '10 and I'm really looking at a '12 opening, I'm opening up into an improving RevPAR environment,' which is -- that's the ideal circumstance for developers.

They are obviously also going to look at peak to trough. And peak to trough on the RevPAR side, we're going to be in the trough longer than we've been for awhile. And that means recovery is probably longer than we've seen in some of the other scenarios. And so that's up to the individual developer as to market by market how optimistic are they about those projects. And so our view is when the new builds come back, we'll see the Sleeps and the Comfort Inns pick up first, and then we'll shift into Cambria. And based on their performance and the relative attractiveness of that brand to consumers, I think people will see that as a brand that will shine in any environment, but is one that coming in into a new market is going to attract new customers as well as steal share from others.

And so we'll see that next, but that is -- I mean, at least in my experience in this business, it's a pretty extended recovery and cycle to where we get into that. So in the meantime, that's why you're going to hear us talking so much about conversations. Because that's where we see all the action for probably the next at least two years.

That's actually very, very helpful. Thank you. Can I ask one more on your balance sheet? It looks like you're getting a little closer to the limits of the capacity of your revolver. What are your thoughts going forward about adding leverage, buying in stock or paying down some of that leverage in this environment?

Yes, our thoughts kind of for the long term have been that the optimal cost of capital for us, we're better off having a little more leverage on the balance sheet over time than we currently do. As I mentioned in my remarks, we're at about 1.8 times our 2009 EBITDA expectations. So I think over time our view would be that we would be comfortable increasing the leverage on the balance sheet. I know the number that we've kind of talked about before as our longer range target is around 3, 3.25 turns on EBITDA.

And that's a number where -- a level where I think we're also reasonably comfortable that we could maintain our investment grade credit rating. But it's been one of those things where we're never felt that we had to have that much leverage on the balance sheet day in and day out. And obviously, as we've talked about in this environment with the uncertainty, with perhaps the opportunities that may be out there around acquisitions and whatnot, that we've been kind of managing the leverage side of the equation with that backdrop.

So I think over time our expectation is that the levels would go higher. And certainly, the uses in addition to accretive acquisitions would be shareholder friendly type activities and other accretive internal investments as well.

Yes, and I guess the other thing that's important to note is that over the last several months we have seen an improvement in the credit markets for us. We're sort of the highest rated company in the segment. And as a result, what we're seeing is capital availability at more reasonable pricing than we saw previously. So it gives us some confidence that if we saw something or decided we wanted to move aggressively or -- that we have access to capital, one. And that that access to capital is priced at a rate that's reasonable.

So you might -- in the near term, you might think about terming out some of that revolver debt just to create more capacity in the -- for more near-term transactions?

We look at a lot of different alternatives. We're kind of constantly monitoring it and communicating with our Board what our thoughts are. But it's more about over the long term, kind of getting those leverage levels up over time. It's certainly something that we think will make some sense.

Yes, well additionally, that credit line is incredibly attractive from a price standpoint.

Sure, but you're comfortable having $46 million of availability. You're not in a rush to create more capacity because you think tactically you'll be able to raise it quickly if you need it?

That's right. Plus we've also -- we've got $60 million of cash on the balance sheet which most of that cash is actually held offshore. But we can -- for periods of time under the tax regulations we can re-utilize that cash in our domestic business if we needed it from a liquidity perspective.

And the other thing -- one of the great things about this model is we've got stabilized cash flow coming from today's operations.

That's great, thank you.

Your next question comes from the line Michael Millman of Millman Research Associates. Please proceed.

Thank you. You earlier mentioned, I guess, a positive first derivative, if you will, in weekend leisure. I was wondering if you can drill down a little bit and whether that seems to be improvement or a better feeling about the economy or seems to be trading down or people taking shorter trips and so you're getting the benefit. Or anything else that you might be thinking is moving that needle?

No, you've pretty much answered it for me. So I would say you're thinking about the right thing. I think you've seen that really, really slight uptick in consumer confidence. That's got to help some. But I've got to tell you, the employment figures are really the other piece that we watch closely. And obviously, that's not changing significantly as you see unemployment forecasted by most folks to grow in the next year.

But then we believe -- and we like the term "value seeking" versus "trading down." But we believe there's a number of customers that are seeking value today and if you look at our messaging, it's all about you're going to spend less on your hotel so you can spend it someplace else with your family or your friends. And that seems to be very well received at this point.

And I think the fact that there is a sense of a right to travel amongst the American public that doesn't believe that they should sit home. And while their trips may be shorter, they're still taking them. If you look at the stats that the US Travel Association has put out, they would suggest that the relative level of vacations this summer are not down much from last year. The number of people staying in hotels is down some. But the American public believes they should be able to travel and stay out there. And so I think, given a lack of total hysteria, I think you're going to see some continued pickup there.

And the other thing to point out it is in light of the economic environment and kind of the view that the recovery will be kind of more gradual than past recoveries, we're optimistic that the RevPAR share we've picked up recently, that we have a good opportunity to kind of retain and improve upon that RevPAR share gain for a reasonably extended period of time, which is nice.

Which is a great point. Because we do have this view that the psych of the consumer, psyche of the consumer has changed significantly. And that for at least -- for a longer period of time than we've seen before, maybe more mid-term than normal, that because of what's occurred with people's savings and their relative feeling of the wealth that they've accumulated, that that value orientation, which is normal in the cycle, is probably a little stronger and will last a little bit longer than they have in previous cycles.

Okay. Thank you. Also, changing the subject a bit, to what extent do your franchisees or, in fact, the Company use some of the search engines or some of the OTAs to help promote -- ?

That's a great question because it's a very active environment in today's marketplace. So for those -- probably everybody on the call knows, but online travel agencies, obviously, play a role in today's environment, the Expedias, hotels.com, et cetera. They are a force in this marketplace. Our general rule is and what we have pushed for significantly in the last couple of months is a rate parity environment where you can go to any channel, but you're not going to get a lower price than you're going to get on the Choice channels.

And that's for a couple of reasons. One is, we like presenting ourselves and selling ourselves because that's what we do for a living. But secondly, we believe that for our franchisees, obviously, our channels that we control are the lowest cost channels for us to bring customers in.

So while we do participate significantly with the online travel agencies and everybody else, choicehotels.com's share is up versus those third parties. And when you book through those third parties, you don't get your loyalty points, which is big with a lot of consumers. So while we welcome that business, if that's the way customers want to buy, we want customers to know that they're going to get the same price point on choice.com and they get their points. And for us, that's a much lower cost channel than paying a third party.

Can you give us some idea -- quantify what you've seen on your channel versus those others?

Well, in general, all of our stuff runs higher rates through our channels than through others. And I can tell you that the differential in the rate that our franchisees receive from an OTA, from a third party versus choice.com, is roughly $20 differential. So and -- let's see, we're pulling up some other stats right here.

So our net share across the CRS is roughly at 62%. And we've got -- and that is two things occurring. One is choice.com picking up business. And then the other is, our existing customers are shifting more away from voice and booking more online, which gives them better information to book from, but also is a much lower cost channel for us.

There's a slide, Michael, in the investor presentation, you can go grab it off of choicehotels.com that's got some more numbers and statistics around that.

Great , thank you very

Your next question comes from the line of Joe Gagan, Atlantic Equity and Research. Please proceed.

Hi, guys, how you doing. A couple of questions. The first one is on the line item on the operating cash flow, it says $20 million for income tax payable/receivables. What is that?

Well, essentially, that's just our estimated tax payments during the course of the year. Obviously, we're a profitable company, pretty profitable pre-tax earnings. So that's just our estimated tax payment and the timing of those payments. It can -- if you look back over time at our cash flow statement, you can see some volatility in that line item because it just depends upon the specifics of how you calculate your estimated tax payments for the particular quarter. There's some things that can cause that to change quarter in and quarter out.

Is it your experience that you've ever had that big an increase from that $20 million increase to your operating cash flow from that line item?

I would look -- well, I don't recall off the top of my head, but I'd have to look back at that. So that was -- it's frankly, it's timing in terms of tax payments, so we can get some volatility there.

And then on the line item for -- on the balance sheet for receivables for marketing and reservations fees, that went -- I guess it's like $35 million and it was $18 million last year. Now I would read that to be, and you correct me when I'm wrong, would be the receivables from collecting marketing and reservation fees from your franchisees? Is that what that is?

That's right. Basically, we collect the marketing reservation fee separate and apart from our royalty fee. And in any given period, quarter, year, five-year period, we can spend more or less than we receive in terms of those marketing and reservation fees. We can make advances or run surpluses. So that's just essentially the net cumulative deferral of marketing and reservation fees.

Okay. So can a human being logically assume that that simply means that the franchises are paying these market and reservation fees not as well as before --

No.

-- because it's such a big jump compared --?

No, let me touch on this. So the way that we've always used these funds and the way the franchisees and we work together around this, is they pay a set fee, percentage fee of revenues. So, obviously in an environment like this, revenues dropping, that means there's less marketing and res dollars to go around. It's often at those times where you want to be more aggressive. And so what you should read into that is that increase is in part due to timing, but also in part due to we are spending more in this year than we're going to get in terms of the actual revenue performance. And we will then collect that in later years.

And so as a result, it's not about whether or not they're paying them on time. They are doing that. Our relative days credit sales outstanding is within the relative same margin that it has been. But what has occurred is that we have made the decision with the franchisees to be more aggressive and spend a little bit more this year because we think that's helping. That's why -- one of the reasons we think we're gaining share is getting our value message out there. And then we'll pick that back up next year or later years.

Okay, great. And then the other question is, I notice that you increased your royalty rates that you charge the franchises.

Yes. That's -- yes.

And apparently, I think you mentioned earlier, that more of the sales are going online, right. So do you think that puts pressure at all on the franchisees, they're experiencing like 15% to 20% RevPAR declines and then you're charging them more royalties percentages and there's more online as part of their -- that they have to pay fees to, both to you and to Expedia and so forth.

I think we crossed you up there a little bit. Let's separate those two. The percentage of effective royalty rate is due to the contractual percentage in their franchise agreement that they pay. The reason that that percentage rate goes up is two things. One is, typically in new hotels there might be a little bit of a ramp in a franchise. So, I mean, if its top franchise fee is 5.5%, it may ramp from 4.5% to 5.5% over the first year or two.

The second is the history of the franchise brand. When Comfort started out, it was probably -- I'm not even sure, but it was probably a 4% of revenues brand. Now it's 5.5%. So as those contracts expire and we renew them, we put them to the then current rate, which then picks up the whole system. Okay? So that's separate and distinct from the other piece that you were talking about, the online. That's about the consumer. So that's about the hotel traveler booking online either through choice.com or through the third party.

Okay, great. All right. Well, thank you very much.

Your next question comes from the line of Andrew Boord of Fenimore. Please proceed.

Hi, guys. I'm a little behind on the story. I was lucky enough to own the stock a few years ago and I'm trying to get caught up. So maybe you've gone over this in past conference calls, and I apologize if so. But I'm kind of curious. You talked about how to be offensive if more franchises get in trouble, somebody else's franchises. That makes sense to convert to your flag.

But what about your own franchisees? How should I think about that or are we at risk of losing a few percentage of them to closures and failures over the next couple of years? Or would they just continue with your flag but the bank might own it?

Yes, let me just step back a little bit and just kind of --on the franchisee financial health, kind of make a few comments. Because as Steve mentioned earlier, there's no doubt that the RevPAR environment we're in right now is pretty tough on these owner-operators. And we're seeing some impact on the metrics that we monitor as it relates to health of franchisees. But just to give you a few specifics.

The days sales outstanding on our franchise royalty billings at the end of June of this year is 26 days, which is up a couple days from last year, but that's still very low, in my view, in absolute terms. So I think it's kind of -- sort of a mix. It's kind of positive that's it at low in absolute terms, and certainly we're continuing to monitor the trends there.

The other thing I'd point out is the number of pure credit terminations that we've seen in the first half of this year compared to last year, where we terminate a franchise for failure to pay. They have increased, but the absolute numbers of those terminations remains very low. And so I think, on balance, we feel reasonably good about the health of our franchisees and -- but we'll continue to monitor the situation.

I think that at the end of the day, if a franchise were to go through bankruptcy and go to the bank, obviously there is an opportunity that that franchise -- at that point the bank would have to make a decision as to whether or not they want to run it as an independent with our brand or some other hotel brand. So it's -- that will -- but as I pointed out and as Steve pointed out, we haven't seen really a high level of that at this point.

Yes, and our levels are normally low. And I'll remind you of a comment I made, is from the standpoint of conversion brands, we really are sort of one of the premier companies out there. :And so while franchisees can always view something different in general, we've seen not a very high level of turnover and we haven't really seen any change in that..

Okay, so that all sounds like it's holding up pretty well. And obviously, when you're talking about 3.25% room growth, you're essentially estimating closures, right, to get to that number ?

That's right. That's unit growth, but that does include an estimate of franchises that would leave the system.

Okay. All right, thanks a lot, guys.

You bet.

(Operator instructions.) You have a follow-up question from the line of Chris Woronka of Deutsche Bank. Please proceed, sir.

Hey, guys, just a quick follow up on the unit growth guidance. I think you're running well over 4%, close to 5% year to date. And I know some of it probably has to do with some burn-off on new construction in second half. But just kind of -- is that right and does that get you down to 3.25% or --?

It's mostly, Chris, the comps. If you look back at least year's second half, that was a real strong -- those were real strong quarters for us in terms of net unit growth. So it's just primarily the comps. I mean, the total number of gross openings for the full year is roughly in line with where we were last year. I think we're a little bit higher on terminations overall, but what I think you're seeing there is mostly the comps for last year's second half.

Okay, and then just finally on the initial and re-licensing fees, just kind of looking at your third quarter guidance versus your full year guidance. Is it -- directionally, is it safe to assume third quarter is still pretty depressed and then you're kind of ramping that up in the fourth quarter?

Well, for the second half of this year, relative to -- for the second half of 2009 relative to our previous guidance from first quarter, we certainly did take into account for the initial fee line, in particular, and the RevPAR line or the royalty line as impacted by RevPAR, on the environment. So we did see -- we did anticipate within our guidance a reduced outlook there.

Okay, thanks.

There are no further questions at this time. I would like to turn the call back to Steve Joyce for closing remarks.

Well, we appreciate your time and attention. As we've said before, we think this is the time that our model will shine, but we also think as things recover that that presents excellent opportunity for us going forward. And I think we're poised and positioned for both. And so we'll look forward to telling you more about our story in the fall. Thank you.

Thank you for attending today's conference. This concludes your presentation. You may now disconnect. Have a great day.