Choice Hotels International Inc (CHH) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Good morning, again, and welcome to the Choice Hotels International third quarter 2010 earnings conference call. At this time, all lines are in 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 constitute forward-looking statements under the Safe Harbor provision of the Securities Reform Act of 1995. These forward-looking statements generally can be identified by phrases such as Choice or its management believes, expects, anticipates, 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, 2009 and other SEC filings for information about 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 a reconciliation of our non-GAAP financial measures referred to in our remarks as part of our third quarter 2010 earnings press release which is posted on our website at choicehotels.com under the Investor Information section.

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

Thank you very much. Good morning, and welcome to Choice Hotels' third quarter 2010 earnings conference call. With me as always is Dave White, our Chief Financial Officer.

Last night we reported solid third quarter results driven by improving and actually better than expected RevPAR fundamentals, our continued disciplined cost management and continued strong execution of our long-term strategic plan.

I want to highlight a couple of the key results that we published in last night's press release and our perspective on the broader macro environment before handing the call off to Dave to discuss the financial results in some more detail.

Our domestic system-wide RevPAR increased over the summer at a faster pace than we had expected. For the third quarter, our domestic system-wide RevPAR increased 7.4% compared to last year. By our estimate, our RevPAR performance was at least 50 basis points better than the comparable industry performance in the mid tier and economy segments as measured by Smith Travel.

Another highlight that's been a pleasant surprise is the steepness we've seen in the RevPAR recovery as evidenced by its sequential improvement in recent quarters. If you recall, our domestic system-wide RevPAR declined approximately 10% in the first quarter of 2010, was slightly positive, increasing 0.3% in our second quarter, but as I just mentioned earlier, increased almost 7.5% for the third quarter. These positive RevPAR trends have continued over the past two months, which will be reflected in our fourth quarter results.

Not surprisingly, there is a strong correlation between our RevPAR results and our royalty revenues. Consistent with a steep RevPAR recovery, our domestic royalty revenues have also recovered steeply this year, declining 8% in the first quarter, increasing 3% in the second, but up 9% in the third.

We believe our RevPAR performance reflects higher demand for our brands due to their strong value proposition for our guests. Choice's brands truly represent great value for all types of travelers, offering an array in amenities and services in more than 6,000 locations around the globe.

In today's world, value really is king, and with brands that provide our guests with amenities like free breakfast, free high-speed internet, free parking, strong guest loyalty program, not to mention a hell of a waffle, at a fair price, we are incredibly well-positioned to capitalize on that trend and to capture more room demand.

Combined with what we believe is a best in class marketing and distribution platform and our continuing success in expanding the percentage and value of business delivered to our hotel owners, I feel very optimistic about our ability to expand the size of our system over time.

On the development front, we are encouraged by the stabilization which has occurred in the franchise sales environment. As you can see from our results, during the third quarter, we executed 79 new domestic franchise sales contracts which was flat compared to last year's third quarter, but a better performance than the first and second quarter.

Our franchise sales results benefited from a strong reaction to an incentive program that we put in place for the quarter for our Quality, Clarion, and Econo Lodge conversion brands, and the results are reflected in our conversion development agreements, which increased from 66 in last year's third quarter to 68 in the third quarter 2010.

Additionally, domestic conversion franchise sales apps increased modestly for the quarter as compared to last year's third quarter, which marked the first time that this has occurred since the second quarter of 2009 that we saw an increase in this metric. We continue to believe that the conversion activity in the US lodging industry will be where virtually all of the action is, at least for the next year or so.

As a reminder, the reason domestic conversion applications are of key importance to us is because we expect them to be a leading indicator of near term net unit growth. We remain optimistic that the strength of our brands, marketing, and distribution capabilities positions us well for continuing our strong track record of capturing conversion opportunities as they occur.

Our current full year domestic unit growth outlook remains directionally in line with the industry's supply growth numbers and consistent with our brand strategies which are designed to ensure that the quality and the value proposition of our brands to developers and to guests remain strong.

Our international expansion plans remain on track as we are developing and rolling out our industry only internet-based property management system to targeted high growth potential global markets. Over time, this should enable us to increase CRS contribution, our value proposition, and positions us to drive net unit growth and improved effective royalty rates overseas.

On the macro front, we continue to closely monitor consumer confidence, GDP growth, and unemployment. We expect our business performance to be strongly correlated with these macro indicators and that we would see improvement in these gauges as positive catalysts that can have significant impact on our room demand and RevPAR results.

By most indications and according to most experts, modest GDP growth and flattish unemployment continues to be the expectation in the near term. Meanwhile, consumer confidence moved slightly upward this week. However, consumers continue to be guarded about the future. We have established our business plans, our cost structure, our expectations, and our targets with that backdrop. We do expect that looking forward, the RevPAR environment should be good or possibly very good given the limited new supply growth in the hotel industry.

On a final note before turning the call over to Dave, over the past few months, I've attended our fall regional franchisee meetings, and bolstered by the improvement in industry fundamentals and how we are positioning ourselves for 2011 and beyond, our franchisees are very positive about the future and the direction of our brands and are actually beginning to talk about unit expansion. This is pleasing as we have prided ourselves in having satisfied and engaged franchisees and very solid franchisee relationships. We think the value of these relationships will continue to pay dividends for our franchisees, for our associates, and for our shareholders.

So let me turn the call over to Dave now to cover our third quarter performance in a little more detail.

Thanks, Steve. As you saw in last night's press release, we reported diluted earnings per share of $0.68 for the quarter, which exceeded by $0.11 our previously published outlook of $0.57 per share.

Compared to our outlook, there are several key items which impacted our results during the quarter. First, we recorded net tax expense benefits of approximately $0.06 per share related to discrete tax items resulting from a change in our methodology for computing certain tax deductions that are of a permanent nature, and out of period adjustment of our deferred tax asset and FIN 48 liabilities for uncertain tax positions. We recorded an additional $0.02 of tax benefits during the quarter related to lowering our full year estimated effective tax rate.

The impact of these items was to reduce our effective tax rate for the third quarter below our expectations to a rate of 26.4%. We do not expect the discrete items to have a meaningful impact on our effective tax rate going forward and as a result and as we indicated in last night's press release, we expect our fourth quarter effective tax rate to be approximately 35%, which is a rate that we consider to be a normalized effective tax rate for our business.

Approximately $0.01 of our outperformance for the quarter relative to our expectations relates to investment gains related to employee retirement plan assets, and an additional $0.03 of our outperformance is attributable to a combination of favorable revenue performance and favorable performance on the cost side of the business which I will discuss in more detail in a minute.

And finally, those positive variances were partially offset by a higher interest expense than contemplated on account of the completion of the senior note offering during the quarter. This item represented approximately $0.01 per share.

Now I'll turn to the key operating and financial metrics for the quarter. On the unit growth front, we continued to expand domestically and abroad the footprint and quality of our franchise system. While our headline domestic net unit growth rate of 1.2% is not at the same absolute levels we achieved in past years, our rate of net unit growth compares favorably to the net unit growth experience for the overall US lodging industry during the same time period, which accordingly to Smith Travel data is approximately 0.9%.

We attribute this outperformance to the strength of our distribution platform for hotels in the markets where we compete and believe this strength will remain a long-term competitive advantage for us in the United States and can also be leveraged as we expand our brand internationally.

As Steve indicated, we were very pleased with the RevPAR performance of our franchisees during the quarter, which had a meaningful impact on our royalty revenues and is the key reason that our revenues exceeded our expectations for the quarter. As a reminder, our RevPAR results for the third quarter reflect our franchisees' gross room revenue performance for the months of June through and including August.

Our RevPAR results in September and so far in October have continued to be positive and this is reflected in our outlook for the fourth quarter. In both September and October, we continued to achieve meaningful occupancy gains and slight improvements in average daily rate. Midweek and weekend performance has been consistently strong reflecting a broad improvement across all categories of travel demand. Finally, we achieved a 7 basis point improvement in our effective domestic royalty rate for the quarter.

As a result of our net unit growth, RevPAR, and effective royalty rate results, we achieved a 9% increase in our domestic royalty fees for third quarter, which increased to $66.4 million compared to $60.7 million last year. The Company's international fees included in royalty fees revenue were $6.1 million for third quarter 2010 compared to $5.7 million last year.

On the cost side of the business, our adjusted selling, general, and administrative expenses for third quarter 2010 declined 1%, which is slightly better than we anticipated and related to the timing of certain initiatives and represents a timing difference which we project will reverse later this year. The adjusted figures for SG&A and earnings per share exclude certain specific items which we described in the exhibits to yesterday's press release.

Our balance sheet and liquidity position remains strong. We finished the quarter with approximately $80 million of cash on hand, and as we noted in last night's release, we were pleased to complete on August 25 a $250 million senior unsecured public bond offering. We used the proceeds of this transaction to pay down our revolving credit facility which is scheduled to expire in June of next year. The senior notes have a coupon of 5.7% and, considering bond issuance and hedging costs, are expected to result in an annual effective interest cost of approximately 6.2%.

Our updated EPS outlook for the fourth quarter and full year 2010 reflects the dilutive effect of this transaction which we estimate to be approximately $0.03 per share for the fourth quarter compared to our previously implied fourth quarter EPS outlook. We were very pleased with the outcome of this transaction as it added a relatively permanent piece of long-term debt to our capital structure at an attractive price and was well received by high quality debt investors.

Turning to our outlook for the fourth quarter and remainder of 2010, we currently expect fourth quarter diluted earnings per share of $0.38 and we expect our full year 2010 diluted earnings per share to range between $1.77 and $1.79 per share.

We slightly increased our adjusted EBITDA to a range between $168.5 million and $170.5 million. These figures assume net domestic unit growth of 1% for full year 2010. These figures also assume domestic system-wide RevPAR to increase approximately 7% to 8% in the fourth quarter and to increase approximately 2% for full year 2010.

These figures assume a 6 basis point increase in the effective royalty rate for full year 2010 and an effective tax rate of approximately 35% for fourth quarter. All figures assume the existing share count.

Now, let me turn the call back over to Steve.

Thanks, Dave. Just to reiterate, this was another very strong quarter for us. It is feeding into very positive feelings that we have about our forward momentum as we continue to execute well against our long-term objectives.

The ongoing improvement in RevPAR is very encouraging, and we expect that as lodging fundamentals continue to improve, it will create a positive catalyst for increased domestic franchise sales, primarily conversion at first, but then also eventually new construction and long-term share improvement on our part.

Our fee for service business model positions us extraordinarily well for long-term profitable growth in a variety of segments and geographies on account of our well-known brands, exceptional franchise services, strong central reservation system, and collaborative relationships with our owners.

Our priorities remain focused on achieving our vision of providing Choice owners and operators the highest return on investment of any hotel franchising company, supporting the expansion of our emerging brands and international system, and seeking opportunities to build on our strong platform to create value for our stakeholders.

So with that, I'm going to open up the call to answer any questions you might have.

(Operator instructions.) And our first question comes from the line of David Loeb with Baird. Please proceed.

Good morning. I'd thought I'd just start and ask a question about free coffee at Suburban Extended Stay. I do want to say that I watched your TV debut, and I thought you were excellent.

Well, thank you very much.

Can we instead talk about your capital investment program in building the brands?

Sure.

I'm -- a couple of accounting housekeeping questions for David. I notice in the cash flow statement the issuance and the collection of notes receivable, but I'm wondering where the rest of those investments go in the cash flow and on the balance sheet? And then bigger picture, can you describe a few of the projects that you're actually investing in and what those investments look like, what you expect to achieve from them both on an individual basis and in terms of the brand rollout?

Sure. There's a couple spots on the cash flow statement where you have to think about those investments, so -- and I'll break it down between -- we do have an active land banking program where we are picking up what we think are attractive sites for the Cambria brand. And so during the first nine months of the year, within our -- up in the operating section of the cash flow statement, there's a line called other assets, which shows a use of cash of about $12 million for the first nine months of 2010. So, a portion of that use of cash is related to that land banking program.

And then we also, as you pointed out down in the financing -- or in the investing section, a portion of those investments goes through -- when they're more of a mezzanine type loan -- go through the issuance of notes receivable line items and then any collections would come through the line right below that.

On the balance sheet side of things, the investments from the land side of things and a portion of the -- current portion of the mezzanine loans is in that other current assets line, which at the end of September, the total of that line was $24 million of which only a portion of that is the land banking and mezzanine loans. And then within other assets, we have a longer term portion of our notes. And actually in the 10-Q, which we'll be filing next week, there's tables which kind of reconcile those captions and show you exactly what the breakdown is.

And I'll have Steve kind of talk through the (multiple speakers) broader program parameters.

So, the plan is similar to what we've discussed before, and that is we want to use a limited amount of our capital to help incent the growth of our emerging brands, primarily into Cambria. As we've discussed over the past two years, the opportunity to put sliver investments into deals to help them get done is still tough. And so we have seen opportunities where we felt we could pick up discounted land and then we are engaged in conversations to flip that land to franchisees for their development, and those were all going sort of as planned.

We think we're picking up some attractive sites in major markets that will allow us to bring in quality franchisees and have them develop and then own and operate the brand and then help build the system. I will tell you, though, given the financing environment, we are literally instead of at the point three years ago when I came in, we're hoping to sort of ramp up the development, particularly for Cambria but for all the emerging brands to pretty significant levels. The complete lack of any real sane amounts of construction financing and permanent financing for development at this point makes it extraordinarily difficult, so it'll continue to sort of move along at the kind of levels we've talked about. And originally, we had put out the note that said that we were hoping to put out $20 million to $40 million a year. The likelihood this year or next is that's tough to do given the environment.

And so we'll continue to do what's available to us and look for opportunities to either pick up some land that we think long term will be a good play for the brand and look for opportunities to put sliver investments into deals that can make them happen. But I can tell you, having been in a lot of these conversations over the last six to eight months, it's just a very difficult environment to operate in. So what we're hoping is that we continue to get a couple -- handful of deals done as a result of our support and wait for a better environment to actually significantly swing up the efforts around developing Cambria into a meaningful distribution level for us in the upscale segment, which is an important step for us to take. The only other issue is we've got to have the environment to do it in.

So what kind of returns do you expect on the land bank investments and on the mezzanine investments?

Yeah, the mezz is typically -- we're looking for -- it's an above our cost of capital return. And it depends on the deal and what's going into it, but you're typically looking at a spread of anywhere between 400 to 600 basis points above our cost. On the land banking, we're actually looking to just actually flip that to the franchisees at our cost, and our benefit will come from the franchise agreement that ensues. And when we do that, obviously, we will drive higher value franchise agreements because of our participation to get the land going which means basically longer terms and higher rates.

And, David, in the past, we've put out there in prior releases and prior calls that we think about the portfolio from a capital perspective that's going to be deployed against mezzanine loans, land banking, and that type of thing. The objective would be to get a return on the portfolio in kind of that high single-digit percentage area. And, obviously, in addition to that, you're building a brand that can be a very valuable asset to the company as a franchising system. So, I think you have to look at those two things together, not just at the capital on a stand-alone basis, although, as Steve pointed out, we do expect to get a return on the portfolio of investments, but really what we're after, right, is the -- building the franchise system into a valuable contributor to the company.

And so -- and then the other thing that I would be remiss if I did not say is, obviously, with our platform and with our strategy, our first primary and most important objective is returning value to our shareholders, which means our dividend policy and our share repurchase policy will continue to be the primary focus and we will use sort of other amounts of our capital to help continue to grow the business. But part of our formula for success and for long-term shareholder interest in our company is around that return of capital to them, and that will continue to be our primary focus.

One last follow-up. From what I've seen, yours is the only company that is using capital to incent franchise agreements as opposed to management agreements. What kind of a competitive advantage is that giving you as you compete versus other brands for developers' capital and attention?

Yes, I would say we were first to say that we were going to do it. I will tell you that the other brand companies are in the same game.

Very interesting. Great.

Yes, and so I -- look, we're going to -- we are in a position with a brand that we know has tremendous consumer reaction and there's a lot of developer interest so we're going to try to build on that. But at this point, because the development market for new builds is so tough and the other -- we benefit significantly from our conversion activity. And so we're going to -- if we get a swing up in transactions, we think we'll see a swing-up in conversions. Our growth, I think, will be -- we'll continue to gain market share as a result. The issue the other major brand companies have is they don't play in that conversion space in the US as much. And so what they're finding is they're going to have to get in and incent their brands, as well, in a way similar to what we're doing.

Okay. Great. Thank you.

And our next question comes from the line of Robin Farley with UBS. Please proceed.

Thanks. Yes, I wonder if you can quantify how many of the new franchise sales in the quarter you think were a result of that $20 million in financing and in terms of that as an incentive. And also is the -- what you refer to as the incentive program for Quality, Clarion, and Econo Lodge brands, is that different than this $20 million of investment and guarantees that you're talking about?

Yes, so let me answer the second part of that and I'll let Dave answer the first. So, we don't believe that we need to put capital into our core business strategy. We're viewed as sort of the strong conversion brand candidate out there, so we have a lot of interest in our brands. What we have found, though is that over the beginning of the year that there were folks reluctant to make that move because of the upfront cost of it and the initial build that would come from being hooked up to our brand versus the costs that came in. So, what we've essentially done is moved the benefit of maybe some ramped up fees more into the upfront part to help with that conversion, and the reaction's been very strong. The investment that we're making is almost exclusively related to building the Cambria brand.

Yes, and then so the specific numbers, to answer your question, on the -- on just the Quality, Econo Lodge, and conversion incentive program, which is a noncapital program -- that's, as Steve mentioned, just essentially a royalty rate discount type scenario, with the other piece -- the other thing we get out of that is we typically get a longer minimum years to first out -- minimum window. So we get an additional couple years of cash flow tacked onto the end of that minimum window, so we find that attractive. About 40% of our conversion deals executed during the quarter had that incentive as part of them -- as part of the program. And then in terms of the capital program for our emerging brands, and really realistically Cambria at this point, one Cambria contract has been a result in the near term of that program.

Okay. Great. Thank you very much.

And our next question comes from the line of Ryan Meliker. Please proceed.

Hey, guys. Just wanted to find out if -- it looked like for the quarter across the domestic system, rates were flat. Did you start to see rates turn positive as the quarter progressed, and into October, are we seeing rates positive? And if you are, is that a like-for-like rate growth or are we just seeing a little bit of shift in terms of whether it be demand segmentation or probably more likely for you guys maybe a channel shift away from some of the more discount distributors? Thanks.

Yes, I think -- the answer to your question is yes, we move from sort of a neutral into a slightly positive scenario. And then that has accelerated some into the last couple of months so we're seeing positive rate gains, not significant, but positive rate gains. And I would say that based on where we are in the cycle, the bulk of those are coming from segment shift versus real pricing power. And so as a result, we're able to work on channels that are less discounted and that have a higher return to us than the existing brands.

We're still a ways from, I think, the point in time where we'll see real pricing power as a result of demand that allows us to yield higher rates across the board. But the improvement that we've got, particularly for us over the weekends because we're an inverted sell strategy and our leisure -- our businesses are strongest -- over the weekends, we've got growing and strong occupancies. That allows us to cut off some of the discounts. And over time, given sort of the really nice rebound we're seeing in demand at this point, that will give us pricing power as well to push on those rates. I would say that's probably a ways off though, still.

What's it going to take to get to that pricing power? Is it just several quarters of strong demand growth? Is it a particular occupancy level that you might be looking for across --

Well, it's both. We need several quarters of strong occupancy growth to get to the occupancies where you're moving more towards an actual rate increase across the board versus a segmentation shift where you are cutting off discounted rates. And so I would suspect at least depending on the performance next year, which is an interesting scenario. Because one of the things that we've been talking about here is the only question -- next year is going to be a positive year. And it -- we normally say, look, if you want to follow our brands, follow employment because if you track employment, that's exactly how our performance is going to track.

Well, what we've seen this summer is actually a shift from that in that our performance has increased significantly with no -- well, with no improvement in employment. And as a result, our view is because of that very favorable supply/demand balance, you're going to go into a scenario next year where you're talking about 0.4 of an improvement in supply which means basically no supply increase.

And so, what you're going to have -- and you've got a growing demand base because the 90% of the folks that have jobs have decided that they're going to travel. That's what we saw this summer, and corporations are putting their folks back on the road, but with a strong orientation towards value. Both of those things, we think, serve us well. So our view is we're going to have a good year next year and then if we get some cooperation in the macroeconomic environment or in the employment picture, then that'll just feed onto that.

Great. Thanks a lot.

(Operator instructions.) And our next question comes from the line of Michael Millman with Millman Research Associates. Please proceed.

Thank you. A follow-up on that last question. Maybe you can talk about the economics or maybe put it in terms of the net ADR that you get looking at some different channels, for example, loyalty points or direct channels or OTAs and maybe you have some others. And we can also talk about the trends that you're seeing in the use of those channels.

Sure. Well, let's start with -- so our strongest rated business is the business we drive through our central reservation systems. So, if you look at all of our marketing and distribution tactics and efforts, you will see they're aimed at driving them through our central channels because those are our highest rated channels. And we have the best folks working with customers to yield the highest rates from those calls. So, that is kind of our primary strategy and with that comes our loyalty program. So with our loyalty program, not only do we get increased business, but those members tend to pay a higher rate. And as a result, that is the best business for us to have, even with the cost of the loyalty program and the points that are involved.

So, we see the environment of -- continuing this year we're going to top -- we think our goal was 2.5 million new members, which will -- which clearly makes us the fastest growing program in the business. I think when I came on, we had 7 million members. We're now pushing 12 million, I believe. So, that -- and that's really paid big dividends for us, both in the central res contribution, but then also in, we think, the loyalty of the business.

Because of the value orientation that has developed over the last three years, we think we're getting and holding customers more and we're getting new trial from other customers. So we're seeing folks that we haven't typically seen before, which I think bodes well for us going forward. I don't think that's -- I think that's at least a mid-term and probably a long-term phenomenon.

And then as we see the business improve, one of the things that we historically have watched is when there's a change in employment either way, typically there's an exaggerated effect on the business. So -- and we saw that in the downturn -- when we saw the employment begin to wane in 2008 even before the financial crisis, we saw our numbers begin to turn down as consumer confidence waned and people were worried about their jobs.

What's happened here is you haven't had that upswing in employment, but we've had the upswing in performance, which is, we believe, a direct correlation to people feel secure enough in their jobs that they're going to travel and that the business traveler is back on the road looking for value. The corporation's profitability is high, and so that -- we believe that's going to hold, as well, and that barring something unforeseen, that continues, and then when you actually get a positive impact from GDP growth or from employment, that that will add to what will be already a pretty good performance the end of this year and into next.

Going back, could you give us a rough quantification of the different economics that you just discussed for the different roads to getting customers?

Well, here's what's happened -- so, let's -- I don't want to go too far afield here, but let's look at 2010. Coming into -- out of the back end of 2009 and into '10, you had strong GDP growth, okay, which was a direct result of the stimulus. And what's happened over the years as the stimulus has waned, so has that GDP growth. So, you have a scenario where you've got declining GDP growth and employment at best moderating. You can debate whether or not it's held its own or declined slightly, but employment going nowhere and a decline in consumer confidence at the same time.

In the face of that, our numbers went up strongly over the summer. That's an unusual set of circumstances for us, which is what makes us comfortable that not only is that holding into the fall, but that we're going to see, barring something unexpected, that we're going to see strong performance of our brands next year even without a lift in GDP growth or employment. And if you get that, and you can listen to the various experts who are pushing that further and further into next year, when that occurs, we think that'll compound the benefit to our brands.

The other piece that should be coming positive for us is it appears that not only our applications are up, but the transactions in our segments may be happening with more frequency. It's slow movement, but when that occurs, typically in the cycle, we get more than our fair share of those conversions while there'll be very little or no new build activity. I mean, literally, the number of hotels being added next year are at historic lows and that's going to continue into probably following 2011.

As a result of all that, we're kind of in the sweet spot for growth in the US markets vis-a-vis the other lodging companies because of our -- the strong demand for our conversion brands. And as a result, as those things begin to improve, we think we're going to have a -- we think we'll have a good year next year regardless. But we believe that if some of those indicators, particularly transactions begin to increase, that that'll just feed onto what should be a pretty good year.

Just to add onto that, so from a contribution perspective, I mean, obviously, that's a critical factor for us, right? The more contribution that you make to your franchisees' hotels, I think that makes it a lot easier to sell that next franchise and make your franchisees more profitable.

So, if you look at our history, I mean, we, in the quarter, last quarter, continued to improve upon our central reservation contribution, which is hovering around a third. And if you look at where that improvement is coming from, the strongest improvement was within our own proprietary channels, our website, our call centers. And we're heavily focused on continuing that trend because, as Steve pointed out, the rate differential between a room night booking to a hotel through our system and through -- compared to one of the other alternative channels is significant to our franchisees and to their profitability. So, those trends are continuing to move in the right direction and it's an area that we're incredibly focused on continuing to make progress in.

Thank you, and just a couple housekeeping. Deferred revenue sequentially was up a bunch and as also deferred compensation was up a huge number, which looks like some change in accounting, but maybe you can talk about that a bit.

So, let's see. The deferred revenue relates to a program -- the increase in the deferred revenue compared to the end of December relates -- a significant portion of that relates to a new cobranded credit card program that we launched as part of our loyalty program earlier this year. So as part of that program, we received a cash advance from our partner there, so that's revenue that will be kind of earned over time as part of that long-term cobranded credit card arrangement. When I look at the deferred comp liabilities September versus December, they're actually pretty close. I mean, 30 -- looks like if you combine the current and long-term, you're at about $37 million versus $35 million, so that increase would just really reflect --

Seems there was a change because it had been $2.5 million and now it's gone to $34.6 million, so it looks like some account- --

You have to add up the current and long-term portions. There's $2.5 million current at the end of September and $34.6 million long-term of deferred comp and retirement plan obligations compared to, basically, a comparable amount at the end of December.

I see. Thank you.

All right. You bet.

Ladies and gentlemen, one moment please. And our next question comes from the line of Tim Wengerd with Deutsche Bank. Please proceed.

Good morning. Just a quick question on cost [control]. You did a very nice job this quarter, and I was wondering if you could talk about how to think about G&A next year and what you guys are doing to maintain cost controls.

Yes, let me -- I'll just start and then, Dave, maybe you can chip in. So, our view is this. One is we believe we're sort of right sized at this point and that we are well positioned to handle the business we've got plus the expected uptick that we'll start to see over time. And so we will continue to look at strategic opportunities to do new things.

However, we believe that our core business and our current sizing are well-structured. And so as a result, our plan going forward, similar to the plans that we've had for the last couple of years is to, one, be very cautious about the environment that we're in and where things may go so that we don't have to make sudden adjustments. And then two, that we should be in a position where realistically we've got the platform that we need to service and grow our business and that you shouldn't see spikes in that unless they'll be particular things that we're deciding to invest in because of strategic reason in returns.

Yes, I think that pretty well captures it. Obviously, we're in the process of working through our 2011 budget currently. We go through that with our board of directors a little bit later this year, and we'll be in a better position to talk about that after that process unfolds. The only thing I would add is one of the costs that's relatively variable is commissions around franchise sales. So to the extent that you see a catalyst that increases franchise sales, you should expect an impact on the SG&A that kind of is above that trend that Steve outlined.

Okay. That's helpful. And then the discounted royalty and application fees that you guys offered in August, have you seen a material change in applications and -- since you guys offered that program at all?

Yes, well, we think it's a combination of -- the program clearly got people's attention. And so as a result, we went from sort of trailing in the year to sort of at the pace and then as we mentioned earlier, our application flow recently has actually been above where we've been. We started out the year pretty slow. Transactions were really, really slow in coming, and we just didn't see a lot of action for the first two quarters. The third quarter actually with the combination of, we think, some improved transaction activity and that incentive sort of moved us into an equilibrium with where we were the year before, which was a positive improvement from where we were in the beginning of the year.

And then what we hope we're seeing, but it's still early, is an improvement in that transaction environment that will then allow us to gain momentum in units above where we were last year. And then at some point in this cycle, and people are still waiting to see when it occurs, financing has a lot to do with it, you will see a significant swing up in transactions which will then forecast or portend a significant upswing in conversions. And then that's where we believe we'll see a swing up in our development activity as the new build market seems pretty far off at this point, at least a year.

And so that part of the cycle, though, is still remaining to be seen and if you listen to the relative experts in the industry, they are starting to talk about the end of this year and into next they're expecting to see an improvement in that. No one's forecasting a tidal wave of conversion activity, but that's the case. And so we're going to monitor our incentive program and adjust it as we believe the market dictates.

Okay. And I notice like with the incentive program for applications, there was -- you guys sort of said if the hotel opens before the year end then there's a better discount on royalty fees.

Yes.

Did that cause a noticeable change as far as what you're expecting for openings in the fourth quarter?

It -- well, it's still sort of in flux, but it's built into our forecast. But the answer is yes, it drove some more openings than we were counting on.

Okay. And you mentioned financing, and I know that's really important for the new development. I mean, just from what you're hearing, are banks just not even picking up the phone when it comes to financing requests or is it sort of a situation where they'll listen and they can't get the capital that they need from their superiors?

Yes, well, what you've got is, particularly in our circumstance, there's two things going on. The negative side is the bulk of the lenders to our community are community banks. They're the ones holding the real estate. They are not making loans. I mean, there may be a couple loans going on for relationship reasons, but community banks, for the most part, are out of the business of doing development construction loans.

The construction loans and development loans that we've seen out there are in the 50% and below leverage levels. It is extraordinarily hard at those kind of leverage levels to make returns that would make sense for taking the risk. And so that's why you've got across the board, not just for us but for every brand company out there, a virtual shutdown in new construction. So, until those community banks begin to clear their inventory and get back into the business of lending for where our hotels are, that's going to severely restrict new development.

It appears, though, that some of the regional banks and some of the community banks are moving into, slowly, into existing hotel lending, which is -- and that's our point about we believe that will improve the conversion market for us. And then the one bright spot that I'll tell you is the SBA small business bill that was passed moves the SBA lending levels up to points where it begins to make sense for some of our franchisees to take advantage of that. We think that's a positive. We haven't seen much in the numbers yet, but that over time should be somewhat helpful given the really, really barren market in the community bank lending environment.

Okay. All right. Thanks for the color.

And our next question comes from the line of Joe Gagan with Atlantic Equity. Please proceed. One moment.

-- or new construction --

Hey, Joe? We didn't hear the first part of your question. You mind starting over? Sorry about that.

Okay. Here's my question. When you bring new hotels into your system, whether they be conversions or new construction, is that included in RevPAR comparisons? Are you throwing these new additional hotels in the year-over-year RevPAR comparisons?

Yes, it is. We do not show RevPAR on a same-store basis. Our RevPARs are shown kind of on an absolute basis with all hotels that were opened and operating during the period we're referring to.

No, no. No. I'm asking that if you're comparing the year before, so let's just take, for example, the third quarter of '09, if there wasn't hotels in the system then but they're added sometime between the end of the third quarter of '09 and now, are you counting that as same-store RevPAR?

Well, we don't report as same-store. Our RevPAR is not -- when you look at our press release, it's not reported on a same-store basis. It's just absolute RevPAR for the hotels that are in the system during those periods. So, I mean, to answer your question, within our exhibit where we lay out the RevPAR by brand, any hotel that is opened and operating during those time frames is included in that period's RevPAR calculation. Not -- we don't exclude hotels that haven't been opened for the full part of both periods.

Right. So the -- here's my -- so let me say it this way then. Say if a hotel opened in December of '09. That's included in RevPAR comparison even though it wasn't there in the third quarter of '09. Right?

Yes.

On a weighted basis.

Okay. Is that typical in the industry that people on a same -- would consider additional hotels on a RevPAR comparison?

Different competitors do it different ways. The reason that we have traditionally done it that way is that when you -- we're trying to simplify how you think about modeling our domestic royalty stream.

Yes.

So normally, that -- if we do it the way we do it, it's normally easier to just kind of combine net unit growth percentage, net RevPAR percentage change, put in a guess on the royalty rate increase, and you can get reasonably close to the --

Really? So, I guess my -- I think it seems strange, kind of, to be honest with you. So, like Marriott and Wyndham, they're adding in new hotels in their RevPAR comparisons year-over-year?

I can't speak to what they're doing. I do know that -- each of them individually. I do know that some of them do same-store RevPAR reporting whereas we don't.

But let me help you with this. Okay, so typically when you do a comp basis store comparison, you're using hotels that have been opened and operating for at least one year before you include them in a comparison. We put ours in right away, which means if there's an effect, it's to depress the results because as hotels ramp, they would be better. But the reason we do that is because when you have 5,000 hotels, 80 rooms at a time of a new hotel doesn't make any difference in the RevPAR numbers. So, if anything, it makes our results -- they would be slightly less, but you would never see it because of the size of the system and the types of hotels that we add.

But so you're -- now you're saying that -- well, you know something? I guess it's too much for on a quick phone call here.

All right, the other question I have is when you were talking before on the deferred revenues on the cobranded credit card arrangement, what specifically is that?

Well, we have a cobranded credit card that is partnered with our Choice Privileges loyalty program. So consumers can sign up for a card, a credit card, and as they make charges against the card, they earn -- the currency they get back is Choice Privileges points.

So, the way those programs work, and this is pretty common, I mean, there's quite a lot of these types of programs out there in the world, we collect -- basically, we partner with a third party bank. And as part of that arrangement, this is a long-term deal with that bank which kind of makes sense because they want to have a long-term partner in this regard. So as part of that arrangement, they advanced us from a cash perspective essentially a contribution towards future earnings under that arrangement, which we earn that deferred revenue as additional cards are issued and as those consumers who have those cards use the cards to earn Choice Privileges points. So, it's basically just an advance cash payment under that multiyear arrangement.

So, and I think -- how much was the increase in deferred revenues, I guess, sequentially quarter over quarter?

The increase was -- sequentially versus June was about $20 million.

So this bank --

Since year end.

All right. So, this bank gave you a check for $20 million?

Rough order of magnitude, yes.

And they're doing that because they think that they're going to get the money back when people use the credit card?

It was just part of a negotiated arrangement around that credit card. So, yes, I think they've gone through an economic model where the more cards that are out there and the more those cards are used, that can be a profitable deal for them. And they value the Choice Privileges currency and at the end of the day they wanted to be partnered with a strong loyalty program in the lodging industry. So, they landed with us.

Okay.

So, but just so we're clear, the card was launched. The results that we're getting are better than expected. We believe we're going to earn well in excess of what is going on with the advance payment, so that's why it goes into the deferred revenue line.

Okay, great. Thank you very much.

Thanks, Joe.

Ladies and gentlemen, this concludes today's question and answer session. I would now like to turn the call back over to Mr. Steve Joyce for closing remarks.

Well, thanks. We appreciate your attendance on the call. We are very encouraged by what we've seen during the third quarter, believe that will continue into the end of this year and next. And we are hoping for an improved environment for transactions which will lend us the opportunity to do more conversions and then eventually also into the new build market as well. But we're very pleased where we are positioned. We're happy with the performance we had in the third quarter and we're looking to improve performance going forward. Thanks very much.

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect. Have a good day.