Choice Hotels International Inc (CHH) 2012 Q1 法說會逐字稿

Good morning and welcome to the Choice Hotels International first quarter 2012 earnings conference call. (Operator Instructions).

During the course of this conference. call, certain predictive or Forward-looking statements will be used regarding the Company's goals, plans, and projections. These statements constitute Forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and generally can be identified by words such as believe, expect, anticipate, foresee, forecast, estimate, plan, and other words or phrases of similar import.

Such statements are based on current expectations and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in such statements. Please consult the Company's Form 10-K for the year ended December 31, 2011 and other SEC filings for information about important risk factors affecting the Company that you should consider. 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 or revise any Forward-looking statements whether as a result of new information, future events or otherwise. You can find the reconciliation of our non-GAAP financial measures referred to in our remarks as part of our first quarter 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 Steve Joyce, President and Chief Executive Officer of Choice Hotels International Incorporated. Please go ahead, sir.

Thank you. Good morning. And welcome to Choice Hotels' first quarter 2012 earnings conference call. With me this morning as always is Dave White our Chief Financial Officer. As we noted last night in our press release, we are extremely pleased with our quarterly results and the strong start for Choice Hotels in 2012.

We are particularly enthused by our strong franchising revenue growth which was driven by both global system size expansion and significantly stronger than expected domestic RevPAR results. Our first quarter RevPAR results and our more recent RevPAR experience in March and so far through April are encouraging and point to continuation of the lodging cycle recovery. We are equally excited by the franchise sales results of our development team which drove new domestic franchise sales contracts to a mid teens percentage growth rate for the quarter.

The positive momentum in RevPAR and franchise sales area has continued since the quarter ended, and we are optimistic that these positive trends will make for a very strong year. Our EBITDA and diluted earnings per share for the first quarter exceeded our expectations due you to higher than anticipated revenues driven by domestic RevPAR growth and higher than expected domestic conversion franchise sales results and relicensing transactions. The growth rate of our franchising revenues continued for the second consecutive quarter to accelerate as first quarter revenues increased 11% over the prior year compared to a 10% increase in the fourth quarter of 2011.

Our franchising revenues were primarily impacted by an 8.6% increase in domestic RevPAR which was approximately 100 basis points better than we were expecting and exceeded the RevPAR growth rate of the overall lodging industry. We believe this speaks well of the ongoing strength and appeal of our brands to consumers, our strong central reservation system for franchisees and the continued prowess of our are franchisees in effectively managing their hotel assets.

Considering our first quarter RevPAR performance and our preliminary second quarter results, we are increasing our outlook for full year RevPAR growth to a range of 5% to 7%. This represents approximately 100 basis point increase from the outlook we shared with you in our earnings call last time. The increase in our franchising revenues coupled with the disciplined cost management resulted in a 19% increase in our EBITDA in the first quarter of 2012.

As a result of our first performance as well as our revised RevPAR outlook, we are raising our full year outlook for diluted earnings per share to a range of $2.03 to $2.08 per share. As I mentioned earlier, a significant highlight of the first quarter was our franchise sales results. For the quarter we executed 64 domestic hotel franchise contracts an increase of 14% compared to the 56 deals we executed in the first quarter of 2011.

As the franchise sales environment for new construction remains challenging, the increase in our new domestic hotel franchise contracts was primarily driven by an increase in conversion deals. Since our net unit growth has historically been more heavily dependent on conversion hotels, the building trend in conversion franchise sales is encouraging for our long-term growth prospects because in addition to that these are normally followed by an increase in new construction sales.

The improvement in our franchise sales resulted reflects adjustments we made in the fourth quarter of last year and the first quarter of 2012 to our sales organization structure, our sales strategy, and strengthening the value proposition for the right conversion and new conversion hotel opportunities. Based on first quarter results and the feedback we continue to receive from developers, we believe that our strategies will provide a catalyst for a significant increase in franchise sales in 2012.

In addition to strengthening new contract sales environments, we also saw a significant uptick in the number of relicensings and renewal contracts which indicates improvement in the hotel transaction and lodging environment. We believe this is another positive trend as an active transaction market is typically a leading indicator for growth in the pace of our conversion franchise sales.

We are also committed to increase our same store sales by focusing on increasing the amount of business we deliver to our franchisees. We remain unrelentingly focused on innovating in the areas of business delivery, enhancing our brands in the minds of consumers, and improving our central reservation systems. Our proprietary central reservation channels meaning our choicehotels.com website and our call centers had a particularly strong quarter with revenue from the CRS increasing 15% year-to-date.

Central bookings through our mobile apps continue to grow at a significant pace, and we are seeing traffic volumes on our website that we do not normally see until the summer travel season. We continue to execute strategies such as our multibrand marketing investments in television, digital and search channels to drive business through our central channels which provide our franchisees business at the highest average daily rate and at the lowest cost.

Looking forward, while slower than any of us would prefer, we are seeing steady positive improvement in the broad US economy, and we do not believe that the recent increases in gas prices at these levels will impact the summer travel season in any significant way. While consumer confidence is improving unemployment remains stubbornly high and people are still cautious.

However, we believe consumers will still continue to increase their travel but getting a good value will top their lift of priorities and certainly this is right in the sweet spot of our value-oriented brands. Looking ahead to the summer travel season, I am optimistic that we will see more people traveling, especially for leisure travel, then we have seen in the last couple of years which bodes very well for our franchisees and for Choice. Thank you, and I will now turn it over to Dave White to give you a little more detail on the financials. Dave?

Thanks, Steve. As you read in last night's press release, we reported diluted earnings per share for this year's first quarter of $0.34 which represented a 21% increase over the adjusted diluted earnings per share of $0.28 we reported for the same period last year. The increase in diluted earnings per share over the prior year reflects improvements in our EBITDA performance driven by both top line revenue performance and cost management.

Our franchising revenues increased by approximately 11% compared to the prior year primarily on account of improvements in our domestic royalty revenues which increased by approximately 9% over the prior year. The increase in domestic royalty revenues was driven by an 8.6% increase in RevPAR reflecting a combination of occupancy and average daily rate increases of 250 basis points and 2.5% respectively. This also compared favorably to your forecasted RevPAR increase for the first quarter which was approximately 8%.

We were pleased with the RevPAR performance as we saw strong gains across all of our domestic brands and the continued improvement in the occupancy rate which was particularly pleasing because it suggested our franchisees will continue to have opportunities to increase the room rates going forward. As a reminder, our RevPAR results for the first quarter reflect our franchisees' gross room revenue performance for the months of December, January and February. Our effective royalty rate declined by 1 basis point to 4.34% for the quarter.

The reduced effective royalty rate is attributable to an incentive program that was in place in 2010 through June of 2011 which provided for royalty rate discounts over a 12 to 18 month period for new franchisees. While these discounts were greater in the early term of the franchise agreements than in prior years, these discounts are expected to burn off at a steeper rate, and as a result, we expect royalty rates to increase at a quicker pace in the latter half of this year.

As a result of measures implemented in the fourth quarter of 2011 to increase productivity and streamline services, we were also able to improve our EBITDA margins through you the cost side of the business. If you exclude compensation expense related to fluctuations in the fair value of assets held in employee retirement plans our SG&A costs would have declined by approximately 1% for the quarter.

Two other key items below the line that impacted the comparison of the diluted earnings per share results for the first quarter of 2011 and 2012, and the first of those is the Company's effective income tax rate for the three months ended March 31, 2012 was 33.9% compared to 28.2% in 2011. Adjusted diluted EPS for the first quarter of 2011 included discrete tax items representing approximately $0.02 of diluted earnings per share that didn't recur in this year.

Secondly, our first quarter 2012 results reflect an increase in investment gains related to the fair value of investments in our employee retirement plan over the same period the prior year. The increase in these investment gains essentially offsets the impact of the higher effective income tax rate during the first quarter of 2012.

Our first quarter diluted earnings per share performance also exceeded our previously published outlook of at least $0.30 per share by $0.04. Compared to the outlook about half of the outperformance was the result of better than expected operating and EBITDA performance with the remainder of the outperformance relating to below the line gains on investments and employee retirement plans.

On the supply front, in spite of the continuing difficult development conditions, we were able to grow the number of hotels operating in our global franchise system by nearly 1%. In addition, our first quarter domestic franchise sales were encouraging. We executed 64 new domestic franchise sales contracts representing a 14% improvement compared to a year-ago and a 33% increase over our plan of 48 new contracts.

We also had a 250% increase in the number of relicensing and renewal contracts which indicate improvement in the hotel transaction and lending environment. As Steve mentioned, improvement in the hotel transaction and lending environment has historically been a leading indicator of the pace of conversion franchise sales.

Furthermore, relicensing revenues generate a high operating margin for the company so increases in these transactions are accretive to EBITDA and EPS growth. We are cautiously optimistic that these trends will continue throughout the remainder of 2012. Our balance sheet and liquidity position remain strong. We finished the quarter with approximately $90 million of cash-on-hand and total long-term debt of approximately $258 million which represents a net debt to EBITDA multiple of less than one times our expected 2012 EBITDA. During the first quarter, we repurchased approximately 300,000 shares of stock under our share repurchase program at an average price of $36.81 per share and since the end of the quarter have purchased an additional 100,000 shares at an average price of $37.28 per share.

We currently have remaining authorization to purchase up to an additional 1.5 million shares of stock. Turning to our outlook for 2012, we currently expect second quarter diluted earnings per share of $0.51 and full year 2012 diluted

earnings per share to range between $2.03 and $2.08 per share. Our outlook for 2012 assumes that our outperformance in the first quarter against our previous guidance is carried through the remainder of the year.

We expect full year 2012 EBITDA to range between $200 million and $203 million. The figures assume our domestic system wide RevPAR increase for the second quarter is 7% and rages between 5% and 7% for full year 2012. The figures assume a one basis point increase in the effective royalty rate for full year 2012 and an effective income tax rate of approximately 34.5% for second quarter and for full year 2012.

All figures assume the existing share count which was approximately 58 million shares as of April 26. So overall we are off to a strong start to 2012 and are excited about the opportunities that keep the momentum going throughout the remainder of the year. Now, let me turn the call back over to Steve.

Thanks, Dave. Overall we are off to a great start in 2012, and there are many signs that 2012 will be another strong year for our industry, for Choice Hotels in particular and for our franchisees. I remain extremely enthusiastic about our long-term profitable growth prospects through our exceptionally talented and experienced management team, we will continue to drive excellent results for our company and for our shareholders. So no I am going to open it up to any questions you may have.

Thank you. (Operator Instructions). Our first question comes from the line of Felicia Hendrix of Barclays. You may proceed.

Thank you. Hi, good morning, guys.

Good morning.

Good morning.

A few questions. Steve, for you first, you provided a really upbeat view of your new contract growth, and it was nice to see those numbers this quarter for sure. And then you discussed the prospects for that. But yet you maintain the guidance for unit growth to be flat this year. So the two points seem contradictory to me. I was wondering if you could clarify that.

Sure. We had a very strong quarter and looks like that is carrying through. We did not move the guidance up because we are balancing - - we talked before about our desire to clean up the Comfort brand and some of the hotels at the bottom of that. What we have got is sort of a flexible termination budget that we are effectively managing through deciding how much and how fast we want to move which is in part the develop environment, and in addition to that, in a market-by-market analysis, we are looking at when those properties that we take out can potentially be replaced with new larger more revenue intensive projects.

The balancing act of all of that is sort of - -we will look to see how much in addition we have got. We will determine whether or not in which markets we want to move in on the Comfort hotels, and how quickly, and when it makes sense based on replacement availability. You could see our guidance move, but right at this point given all that, we are going to stay with sort of a relatively flattish which may be a little positive, but we also think we may take advantage to move on some properties earlier.

Okay. That makes sense. So it seems like, one you are assuming one is offsetting the other for now.

Yes.

Great. And then Dave the SG&A in the quarter was higher than we expected. We were expecting actually it to decline year-over-year and it up. What was the driver behind that, and should we look at this as a run rate going forward, or were there things in your SG&A this quarter that were one time perhaps?

In this quarter, the primary thing that is causing that is the mark-to-market adjustment on the investments in our employee retirement plans which is causing us to have investment gains down below the line. There is an offsetting compensation expense increase tied to a portion of that. So that is the biggest reason that you did not see a decline in the SG&A line during the quarter. As you think about the balance of the year, and within our outlook you can get back into this.

We still remain committed to what we talked about in our last call in terms of an overall cost reduction exercise for the course of year. You will see that unfold more in kind of the second half of the year as compared to the first half given the timing of how our SG&A rolls out.

But given how it came out in the first quarter would we expect the full year to decline, or should we just think about it on a quarter to quarter basis?

We are still expecting a full year decline in SG&A as we had talked about in the last quarter's call.

Perfect. And then just one last housekeeping question. David, you usually talk about the International royalties. If you did, I missed it. But if you did not can you just tell us what that was?

Yes. I am going to have to -- I will come back to that later on in the call. I do not have that right in front of me, but I will get that for you in just a second.

Okay. Great. Thanks so much.

Our next question comes from the line of Robin Farley with UBS. You may proceed.

This is actually [Artina ]covering for Robin. You raised the RevPAR guidance range obviously for the full year it looks like EBITDA high end of the range was not raised. Could you walk us through sort of the flow through to the EBITDA line, and what you are thinking there? Thank you.

Yes, if you think about the assumptions in our outlook, really the one that we changed was the one you pointed out the full year RevPAR outlook- - taking the range of the RevPAR outlook up slightly. If you think about the model a 1% move in RevPAR translates to about $2.5 million of EBITDA. When you put that in the context of our previous range was $199 million to $203 million.

We actually took up the -- we took up the bottom end of the range slightly and in that prior point I made about SG&A including the mark-to-market impact on the retirement plan assets, we do not contemplate those mark-to-market adjustments in our initial EBITDA outlook. So that is the other piece that is working on the cost side against this. So it is kind of a combination of the level of precision on our range is $2 million or $3 million spread combined with the SG&A adjustment we saw in the first quarter related to those retirement plan assets.

Great. Thanks. And then a follow-up question on Comfort and how many rooms are actually as of today out of the system because you talked about end of year about 10 -- actually taking out about 10% out of the system, rooms that do not actually meet the standards. Could you update us on that? Thank you.

So year-to-date between Comfort and Comfort Suites compared to last year there has been a net 2700 rooms that have left the system. That is net of additions. And that 10% figure just to be clear, that is not all expected to take place within the current year. That is more of a longer term type approach.

Right. Thank you.

And Felicia, to answer your question just to go back the International royalties for the first quarter of 2012 were $5.5 million compared to $5.1 million for the first quarter of 2011.

Our next question comes from the line of Shawn Kelly with (sic)Choice Hotels. You may proceed.

Good morning. I do not think I work at Choice Hotels, but good morning, guys. I just wanted to --

Would you like to?

Are you hiring?

Yes, we are.

Well, that is good. So look, I just wanted to ask real quickly, I think in the prepared remarks you had asked about- - you mentioned the initial franchise and relicensing frees and something regarding the conversions, but I did not fully catch it. Could you just give us a sense of what you are seeing in that line item? Are you seeing a pickup in interest on the conversion side or anything new in terms of new signings for actual new construction?

Let us break that down into a couple of things. First of all, we are seeing and signing more conversions than we have previously. And the rate of that is at a pickup is we think noticeable and meaningful. What we have been saying over the calls on literally the last two to three years is normally as you come out of the cycle, what you see is a pickup in your relicensings and renewals because that tends to indicate the transaction market is starting to pick up.

When the transaction market starts to pick up, then typically that has followed for us by a pickup in conversions which then- - and you follow out the cycle then followed by a pickup in new construction. So what we are seeing, and what we are hoping is the beginning of that recovery, and that we are seeing a sustained and moved and build upon movement in the level of conversions. So we are expecting our conversions to be up relatively significantly over the last year, and while the new construction activity is still somewhat muted what we are hearing on the initial developer response is a much higher level of interest than previously. They like our new Comfort prototype a lot.

There is a lot of dialogue going around that, and so we are assuming that that will eventally then begin to show itself in terms of appplications. The big thing that we have been talking about that we are starting to see is more transactions on the market. That clearly is going to be to our benefit, and that then follows with more conversion activity from existing brands who are moving those hotels out as well as independent hotels looking to upbrand, and then that typically moves us back into a more common scenario of the relative level of volume that we would expect, and what we are seeing at least through the first quarter looks like the start of that.

No, that is important. So appreciate that. And then second and a follow-up to that would be kind of obviously you are in dialogue with your franchisees regularly, and what are they saying and/or seeing on kind of the bank financing front? Is it getting easier? You think one of the big issues in the slow conversion part of the cycle and ultimately the construction cycle is the availability of financing for some of these franchisees. In your conversations is that market the discussions with regional banks? Are things getting easier for them? Is that something that you picked up at all?

It is improving for our strongest franchisees, and the lending is beginning to loosen slightly. Before the banks would say, "Oh, we are open to lending, and we will lend you 50% loan to value or loan to cost," and typically for most investment scenarios that kind of leverage is not going to provide the returns that the equity is looking for.

Those leverages have moved up into more of a 60/40 scenario for the common developer, and then for the developers with strong relationships with their lenders typically based on a long history of success and track record, they are seeing much better types of underwriting from the banks. It is still not enough for us to say hey, we think new construction is coming back but we are seeing improvement and what we are hoping is that while we are not counting on it for this year that that financing market sometime next year may open up some more.

That is great. That is it for are me. Thanks, guys.

Thanks.

Our next question comes from the line of Tim Wenegerd with Deutsche bank. You may proceed.

Good morning. In a hypothetical environment where unit growth is flat for the next couple of years, and where you are replacing some of the Comfort franchisees, how would you expect the effective royalty rate to change?

Well, essentially we have got a pretty good track record of gradual improvement in the effective royalty rate. We would generally expect that to continue over the medium term. Kind of the year-in-year out timing of it is going to be impacted by the types of incentive programs we are running.

Right no believe we are on track for a 1 basis point increase in the effective royalty rate for 2012 which is a little bit lower than the effective royalty growth rate we had in past years but that is on account of our approach on the franchise sales incentive front. Going forward if things keep the way they are currently, we think there will be an opportunity to use less incentives frankly which should improve that trend as we move forward.

Not to argue with your hypothetical question, but we do not give future guidance for future years, but our expectation is not flat growth for several years.

Okay. That is helpful. If you back out all of the incentive fees impact on the effective royalty rate, how big of an impact is that?

I think the way to think about that is our effective royalty rate increase for the full year is 1 basis point. And traditionally it has been more ranging anywhere between about 4 and 7 basis points per year. Every one basis point change in the effective royalty rate translates to about a half a million dollars of royalty revenue and EBITDA. I do not know. Hopefully that gives you some perspective.

That is helpful. Another thing going back to the SG&A line how much of the $2 million in the other income line was directly related to SG&A.

The other revenue line?

Yes.

Yes. That would have been about half of it.

Okay. Is that like -- is that a good proxy I guess going forward?

It as relatively volatile metric. It just tied that other revenue line is tied to predominantly termination awards related to franchisees. So that number can kind of ebb and flow dependent upon activity. It is kind of tough to predict, but from a materiality perspective that is probably a good place to start.

Okay. Thanks.

(Operator Instructions). Our next question comes from the line of Nikhil Bhalla with FBR and Co. You may proceed.

Hi, good morning, everyone. Just trying to get some sense of how many of the 64 contracts you executed in 1Q, how many of those were related to your franchisees switching from one of your brands into one of our other brands?

I think it was about 15% compared -- which would be actually comparable to what it was last year as a percentage.

Got it. So the remaining 85% were all new self-franchisees to the system?

That is right.

Okay, that is pretty good. The other thing I want to just get some color on was you hinted about the transaction market opening up. What are you seeing are there specific geographies or specific types of brands that are seeing more transactions than others?

Well, actually I cannot comment on the geographies because I have not seen that, but what you are seeing is like you saw the lift last year in the number of transactions primarily in the upscale and upper upscale space. You are now starting to see that transaction growth move down into the moderate tier which is sort of where we play, and so there is several forecasts out there that are not ours, but about the level of transactions and they grow -- they go from pretty -- from some pretty robust numbers that some of the brokers are putting out there to kind of mid teens growth in the transaction base. In any scenario we think we are going to see more transactions, and that typically benefits us interest a conversion standpoint.

Yes, thank you very much.

And we have no further questions at this time.

All right. Well, we appreciate everyone's attendance. We are obviously based on our conversation, pretty enthusiastic about where the quarter ended and sort of where we see it continuing for the year. We think we are well positioned for significant upticks in unit contribution from our existing hotels, and we think that is going to last for several years given the supply demand balance scenario that we are looking at, and at the same time. we think on the development side we are finally starting to see signs of life which we think is extraordinarily encouraging since we he have been waiting so long, and so we cannot wait to talk to you again second quarter, and hopefully tell you things are continuing. Thanks. Have a great day.

Ladies and gentlemen, that concludes today's conference. Thank you so much for your participation. You may now disconnect. Have a great day.