Steve Joyce - President & Chief Executive Officer
Dave White - Chief Financial Officer
Steve Kent - Goldman Sachs
Robin Farley - UBS
Felicia Hendrix - Barclays
Nikhil Bhalla - FBR & Co.
Joe Greff - JP Morgan
Thomas Allen - Morgan Stanley
Patrick Scholes - SunTrust
Choice Hotels International, Inc. (CHH) Q4 2013 Results Earnings Conference Call February 18, 2014 10:00 AM ET
Ladies and gentlemen, thank you for standing by. Good morning and welcome to the Choice Hotels International, full year and fourth quarter 2013 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’s or its management's beliefs, 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, 2013, 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 fourth quarter 2013 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. Welcome to Choice Hotels’ earnings conference call. Joining me this morning as always is Dave White, our Chief Financial Officer.
This morning we are going to update you on our performance for the full year and the fourth quarter of last year, including both our core hotel franchising business, as well as key strategy growth initiatives; and we are pleased to share that 2013 is another strong year overall for Choice and we are very optimistic about the future for Choice and for our industry.
Several factors contributed to the continued growth of our lodging business last year. So for the full year ended December 31, 2013 franchising revenues grew 5%, driven by an increase in our domestic royalties initial and relicense fee and procurement services revenues. Domestic royalty growth for the year was driven by a RevPAR increase of 3%, with a 2% increase in the number of domestic hotels under franchise.
Initial franchising and relicensing fees increased 32%, driven by a 12% and 22% increase in new franchise agreements and relicensing and renewal transactions respectively. Now we view that double-digit percentage growth in both of these metrics as a positive sign about the desirability of out brands and as we singled that the development environment is continuing to improve as hotels begin to trade in.
Our strategic alliance with Bluegreen resorts resulted in more than 20 new Ascend Hotel Collection properties affiliating with our system last year and generated approximately $2.5 million of incremental franchising revenues.
On the development front more good news; we are seeing a development environment that is more promising than we have experienced in several years. In the fourth quarter we saw executing franchising agreements for new construction hotels increase by 13%. That is a great sign for Choice and for the industry.
Our development results for the year were also strong, our brands continue to be very attractive to franchisees and we experienced an increase in new domestic franchise contracts of 12% system-wide for the year.
Our strong development results for the year were lead by domestic conversion franchise sales, which increased 14% for the year. We executed 441 domestic conversion contracts compared to 387 during 2012. We were able to achieve this 14% increase in domestic conversion franchise agreements despite challenging prior year comps. As our 2012 results reflected the execution in the fourth quarter, our conversation franchise sales contracts related to 46 properties formally operated as Jameson Inns.
There are a number of other areas on the development and brand front that we were also pleased with. On Comfort, we are particularly excited about the development results of our Comfort Inn and Comfort Suites brands. This year development is up across our Comfort brands by 28%. The Comfort brand is gaining great momentum with its sleeping refresh called Comfort Re-imagined, designed to position the brand as a leader in the upper mid-scale segment.
Nine months after we announced our landmark $40 million brand improvement inventive, we are extremely pleased with the progress and response. Franchisees across the system expressed their interest in receiving the incentive and we are now have hundreds of hotels undergoing significant property improvements and some having completed the work already.
Importantly the financial incentive we are providing represents a fraction of the total refresh capital being invested in the brand. In other words, our franchise hotel owners are investing several times the amount of incentive, each improving their properties. This signals not only the value these owners placed on the brand, but also the improving optimism around the overall travel environment and business prospects.
Guest feedback has been extremely enthusiastic regarding the upgrades in new design prototypes. Franchises feedback has been equally positive about the results and the process. We are standing shoulder-to-shoulder with our franchises to take this iconic brand to new levels.
The Ascend Collection, our fast growing portfolio of independent hotels had a breakout year. Ascend continues to play an integral part of our growth strategy to expand into the upscale segment. This year the number of member hotels within the Ascend Collection grew by a remarkable 71%, going from 72 hotels at the beginning of the year, to a 123 hotels throughout the U.S, Canada, Europe, Central America, Australia and the Caribbean.
Recent noteworthy additions to the Ascend Collection include the Downtown Grand Las Vegas, the Equus in Hawaii and the Peacock Inn in Princeton, New Jersey.
We were also pleased with Ascend’s international growth over the past year, the brand opening another hotel in Australia and expanding for the first time into Ireland with The Gibson Hotel in Dublin. We are quite pleased that so many fine independent hotel operators recognize the benefits of affiliating with Choice.
Affiliating with the Ascend collection allows unbranded up-scale operators to focus on the day-to-day challenges of running a hotel, while capitalizing on the many benefits afforded by a recognizable brand and a robust distribution platform.
These hotels are experiencing increases in ADR, immediate benefits of our central reservation system, including reservations to choicehotels.com, our mobile phone and tablet apps and our aggressive marketing campaigns.
The growth of Ascend combined with the results we are generating for owners gives us a high degree of confidence and we can achieve a simile level of its success with our Cambria brand as the new construction environment continues to improve.
Cambria Suites has seen a number of new deals with institutional investors and new hotel openings and ground breaking in key markets. We recently opened a brand new Cambria Suites in Miami's Blue Lagoon business district, very close to Miami International Airport. In September we broke ground on our new Cambria Suites in Desert Ridge in Phoenix, following groundbreaking in some major markets across the country, including New York at Times Square, Chelsea and White Plains and in Washington DC.
Momentum continues with the White Plains New York and Washington DC properties scheduled to open this year and Cambria has just announced a partnership with Maplewood Hotels & Resorts, to develop multiple Cambria Suites properties in Canada.
Overall we are very pleased with the performance of the Cambria Suites brand last year. Looking forward, our objective in 2014 is to continue to build on that momentum that we achieved and raised the bar even higher.
For 2014 our goal is to end the year with at least 24 Cambria Suites hotels opened and operating and at least another 30 under construction. We were pleased with the results of core lodging business, franchising revenues grew, RevPAR increased, new construction is improving, development is up overall and our brand strategy are delivering results for our franchisees.
Lets talk a little bit about SkyTouch. I want to talk about SkyTouch’s technology, the new division of choice that we announced last year. SkyTouch is focused on developing marketing and selling to third parties, cutting hedge cloud based technology products for the hotel industry. While still new to the third quarter hotel market, SkyTouch closed a large, widely distributed cloud base property management system.
Last year we continued to make progress on the sales front with SkyTouch and I am pleased to share that we have executed several third party customer contracts and brought many of those online for the SkyTouch division. Those new customers joined in more than 5,500 Choice franchisees who already use our cloud base technology system to enhance their efficiency.
Together, our new third party and existing users generate more than $30 million of corporate and marketing reservation system revenues for the company. As we outlined in our release this morning, and Dave will provide some additional details around this, we are targeting significant customer acquisition and revenue growth objectives for the SkyTouch division in 2014.
So we are very pleased with the progress of SkyTouch and we remain exciting about its potential impact on our future growth. We expect to continue to invest in the SkyTouch division in 2014, but importantly as have contemplated in our outlook, we expect tangible sales results to support that direction.
Overall we are pleased with the fourth quarter with the results for the year. Let me hand it over to Dave to share a little more details about the financial results. Dave.
Thanks Steve. As you may have read in this morning's press release, we reported diluted earnings per share of $0.46, which is in line with the high end of our previous published outlook for the quarter, a $0.44 to $0.46 per share and represented a 10% increase over the prior year.
In addition EBITDA from franchising activities for the fourth quarter increased 8% over the same period of the prior year, due to a combination of increased franchising revenues and reduced selling, general and administrative expenses from franchising activities.
The increase in our franchising revenues for the fourth quarter of 2013 was driven primary by strong franchise development results, which drove growth in initial franchise and relicensing fees and by growth of procurement services revenues. We expensed strong growth in our initial franchise and relicensing fees revenues, which increased 11% and exceeded our expectations.
During the fourth quarter of 2013, we executed 2015 new domestic franchise contracts, compared to 214 in 2012. Keep in mind that during the fourth quarter of 2012, we executed a multi-unit transaction related to the conversation of 46 Jameson hotels. Excluding that transaction, domestic franchise agreements executed in the fourth quarter of 2013 increased by 28%. And while new construction franchise agreements in the United States remain lower than historical pre-recession peak levels.
We are encouraged that new construction deals increased 13% for the fourth quarter and have now increased year-over-year in nine of the last 10 quarters. We remain optimistic that this overall trend will continue in future periods and along with improving conversions deal activity, we’ll provide a solid foundation for future domestic unit growth.
Our domestic pipeline of our sales under construction, awaiting conversation or approved for development at year-end reflects these trends and as a result the pipeline has increased 7% compared to last year. The number of relicensing and renewal contracts executed during the fourth quarter improved 8% and increased 22% for the full year, reflecting the improved hotel transaction environment.
For the year ended December 31, 2013 we executed 289 domestic relicensing and renewal contracts, which represents approximately 5.5% of the domestic system. As we had mentioned on previous calls, we are encouraged about the increased paper licensing and renewal activity and we are optimistic that there is additional headwinds for grow of transaction volumes and the related re-licensing fees strain as current volumes are still less than peak transaction levels we experienced between 2005 and 2007.
During those years the percentage of the domestic franchise system that we’re relicensing annually range between 8% and 10%.
Procurement services revenues increased 12% during the fourth quarter, driven primarily by our strategic alliance with Bluegreen Vacations. As a result of this alliance, which stated in 2013. We recognized approximately $3.5 million of royalties, initial fees, procurement services and marketing reservation revenues during 2013 and we expect to build up on these results in 2014 and beyond to expand our alliance with Bluegreen.
Our domestic royalty revenues for the fourth quarter was slightly lower than we had expected, primarily on account of our RevPAR performance which increased 1.3% compared to our outlook of approximately 2%. These RevPAR results reflected more severe than anticipated impact than we attribute to last quarter of government shutdown on our franchise development in the Northeast and Mid-Atlantic regions, as well as on hotels near national parks.
As a reminder, our RevPAR results for the fourth quarter reflect our franchisees' growth room revenue performance for the months of September, October and November. Therefore our fourth quarter results reflect a slightly weaker industry performance in the month of September compared with December. This and brand mix explains why our reported quarterly RevPAR compares unfavorable to our competitors that include December as part of their fourth quarter statistics.
This and RevPAR trends are rebounded and based on actually results incurred to-date. We are currently forecasting RevPAR increases of approximately 4% for the first quarter of 2014. Our first quarter RevPAR results will reflection our franchisees gross room revenues performance for the month of December, January and February.
For the full year 2013 our domestic system wide RevPAR grew by 3%, driven by an average occupancy percentage increase of 80 basis points to 56.3% and a 1.6% increase in average daily rate.
The number of hotels in our domestic franchise system grew 1.9% over the past 12 months. This included the new unit growth experienced from the overall U.S. lodging industry as reported by Smith Travel Research and was in line with our expectations. As a result, we are pleased to report that in 2013 we continue to expand our market share of branded hotels, which now stands at 9.8% of U.S. Hotel Supply.
For full year 2013 we opened 340 new domestic hotels into the system, which represented a 10% increase over the prior year. Our growth in new hotel openings is fueled by our Ascend Hotel Collection membership program, which opened 48 new hotels in the U.S. during 2013. About half of these new Ascend Hotel Collection members were added in conjunction with our strategic alliance with Bluegreen Vacations Resorts.
Excluding the multi-unit transaction we executed with Bluegreen in 2013 and the 46 former Jameson properties we added in fourth quarter of 2012, unit openings increased by more than 20% in 2013 compared to 2012. This increase in domestic unit openings is encouraging and primary reflects improvements in the conversion franchise sales market due to a combination of an improving hotel purchase sale transaction market, our development instrument plans for select mid-scale and economy brands and an improving hotel lending environment.
Finally, our effective domestic royalty rate in the quarter declined five basis points from 4.36% for the fourth quarter of 2012 to 4.31%. We attribute this decline to a combination of factors, including our inventive plan for select mid-scale and economy brands and royalty rate discount provided to new construction hotels that’s for development. The growth of our Ascend Hotel Collection brand, which carries a lower effective royalty rate than our mid-scale and economy brand hotels, on account of these hotels significant ADR premium and higher revenue intensity compared to our other brands and finally on account of (inaudible).
As we have previously discussed, royalty rate discounts are the customer acquisition package. This will typically burn-off over the initial contract until they reach the rack rate of the brand, in effect at the time the contract in executed. As a result, over time we expect our effective royalty rate to continue to improve.
As the development environment continues to improve, we expect to reduce the level of royalty rate discount. In addition, acceleration in the pace of relicensing activities would represent an additional catalyst for improving the effective royalty rate of our brands.
On the cost side of the business, out franchising SG&A cost for the fourth quarter, which excludes our SkyTouch division and hotel operations declined by approximately $1.9 million. Excluding a loss on settlement of our pension plan during the fourth quarter of 2012 totaling $1.8 million, our SG&A costs was essentially flat year-over-year for the fourth quarter.
As a result, the combination of the top line revenue growth we achieved during the fourth quarter and continued discipline and cost management resulted in our franchising margins expanding from 60.3% in the fourth quarter of 2012 to 63.5% in the current quarter. SG&A expenses attributable to our SkyTouch Technology division totaled $2.9 million during the fourth quarter compared to $1.3 million in the prior year and were in line with our expectations.
Our full year free cash flow, which we defined as net cash provided by operating activities, plus net cash utilized in investing activities increased from approximately $103 million to $145 million or 21%. Our cash flows from operations for full year 2013 included a $12 million increase in cash provided by marketing reservations activities. These activities represent contractual reimbursement for expenses and therefore do not impact net income.
The increase in cash flows reflects the reimbursement of previously advanced cost for marketing reservation activities. We expect positive cash flows from market reservation activates to range between $18 million and $22 million during 2014.
Last year capital expenditures increased by approximately $16 million to $31.5 million. This increase primary reflects the relocation of our corporate headquarters, which was completed last year. We expect capital expenditures in 2014 to range between approximately $18 million and $22 million. In addition, as we have previously discussed, we are utilizing capital to offer financing and investment support to qualified franchisees to incent the development at Cambria Suites.
During 2012 we saw an increased opportunity to support the growth of the brand, and as a result the company advance net of repayments approximately $41 million of mezzanine financing and several equity positions to bring Cambria to such markets in New York City; Plano, Texas and Phoenix Arizona.
During 2013 we recycled the portion of the previous advances we made for Cambria development. This resulted in net cash inflows of $4 million during 2013 related to this program. Over the next several years we expect to continue to opportunistically deploy capital from those growth at Cambria Suites; however, the amount and timing of the event in these programs will depend on market and weather conditions.
Turning to our outlook for 2014, our consolidated outlook reflects continued growth to the company’s forward franchise growth and continued investment in and importantly extended revenue contribution from the SkyTouch division. In addition, our consolidated outlook contemplated the sale of three company and hotels.
As always, our outlook assumes mandatory purchases under the company’s share repurchase program. The effective tax rate is expected to be 30.5% for both the first quarter and full year 2014.
EBITDA from franchising activities for full-year 2014 are expected to range between $227 million and $232 million, an increase of approximately 6% to 8%. Net domestic unit growth is expected to increase by approximately 2% and RevPAR is expected to increase approximately 4% for the first quarter and 3.5% to 4.5% for the full-year 2014, and the effective royalty rate is expected to decline three basis points for the full-year 2014.
With regards to SkyTouch, we are projecting reductions in EBITDA for full year 2013 of approximately $21.5 million compared to approximately $11.5 million in 2013. Our projections assume that our SkyTouch division executes third party contracts with annualized revenue ranging between $4 million and $6 million, resulting in realized revenues for 2014 and totaling approximately $2.0 million.
SG&A expenses are forecasted to be approximately $23.5 million related to investment in business development, sales and marketing and continued software development expenditures related to the division's cloud-based hotel operating system products and services.
We are excited about the SkyTouch opportunity for a number of reasons, including the reasons Steve described earlier. The SkyTouch team is laser focused on building a recurring third party revenue stream, to position SkyTouch for further third party revenue growth in 2014 and beyond. This is reflected in our outlook for 2014. We will continue to update you on our progress in growing the SkyTouch platform and on how the divisions achievements will impact our investment plans.
As Steve mentioned, more than 5,500 choice franchisees are already using our cloud based hotel operating system, generating more than $30 million of corporate marketing and reservation system revenues. Based on our level of success to-date, we are optimistic about the revenue potential for SkyTouch. We also believe in addition to organic third party sales growth, there are other options that’s being expressed to create value for our long-term shareholders through monetization of SkyTouch.
As we noted in our release this morning, we have entered into purchase and sale agreements for our three companies and hotels. We have already closed on the sale of one of these hotels and we expect to close on the other two during the first quarter of 2014. We expect these transactions to generate net pretax proceeds of approximately $12 million and result in a gain totaling approximately $0.03 per share for the first quarter and full year 2014.
We are excited that the new owners of these hotels will execute franchise agreements and remain in our franchise system. As a reminder, these hotels generated approximately $1.1 million of EBITDA in 2013 and as a result of a pending sale, our 2014 projections exclude the EBITDA contribution of these hotels.
Considering our franchising, SkyTouch and owned hotel operating assumptions, we expect our first quarter 2014 diluted earnings per share to be $0.29. Our full year 2014 diluted EPS to range between $1.84 and $1.92 and our EBITDA for full year 2014 to range between $205 million and $211 million.
Choice is in a great position to continue to build upon our track record or creating strong return to our shareholders. Our core franchising business is poised for continued growth, where we believe SkyTouch has tremendous promise and we expect that division to begin to penetrate that opportunity in 2014 for a meaningful revenue growth.
Finally our strong cash flows and balance sheet position us to continue to both invest in our business and to return capital to shareholders over time.
And now I’m going to turn the call back over to Steve.
Thanks Dave. So overall it’s clear we’re pleased with our results and are optimistic, because of signs that economic conditions have improved notably. The U.S. economics recovery continued in the first month of 2014 with new jobs created in the private sector and overall.
GDP performance is projected to be more favorable in ’14 than it was last year; unemployment continues to decline; consumer confidence has been trending a more favorable territory over the past few months after the set back or being shut down. Industry performance forecasts overall our stronger for the year and let me conclude by reiterating that we are pleased with our results for the fourth quarter and last year. More importantly, as we look to the future, Choice hotels represent a valuable business for a reason.
Now more than ever we have multiple levers like SkyTouch, the potential to accelerate upscale franchise in growth opportunities with both Cambria and Ascend; created strategic alliances such as the one with Bluegreen that leverages our distribution competences and international growth opportunities. We are managing these levers with the intent of maximizing the growth trajectory of the business and we expect to drive meaningful long-term top line and cash flow growth and shareholder value creation through these and other opportunities.
Our core lodging business is growing and performing well and as the lodging cycle continues to mature, we are excited about the prospects for our upscale and mid scale new construction brands, as the new build scenario improves. Our cost management and capital allocation discipline that has been demonstrated over an extended period of time remains completed intact.
Finally our large cash balances, strong cash flow streams and improving balance sheet position put us in an enviable position of having options to both investment high growth areas and more importantly to return capital to shareholders over time as we have demonstrated year in and year out.
We like the cards that we’ve been dealt; we’re excited about the value creation opportunity ahead of us and now look to open up the call for any questions you might have.
(Operator Instructions). The first question comes from the line of Steve Kent, Goldman Sachs. Please proceed.
Steve Kent - Goldman Sachs
Hi, good morning.
Good morning Steve.
Steve Kent - Goldman Sachs
Good morning. Just a couple of questions; first, you noted that the royalty rates were a little but light and you said that they’d start to move up. Is there any way to quantify that? For you to give us when that starts to happen? Are there any cliff points or anything where the royalty rates start to kick up in a more significant way?
And then on conversion opportunities, what are you seeing out there? Any particular brand or any particular region and then finally on SkyTouch, what kinds of businesses are the most or hotels are the most interested in this technology?
Steve, let me take the first question about the effective royalty rate. So when you really step back on it, you can take our existing brand mix based on operating hotels and if you were to apply, the rack effective royalty rates that are in our SECs than we had in our 10-K. There’s still about 70 or 75 basis points of room based up on our existing brand mix for that effective royalty rate over an extended period of time to kind of move the advanced net rate higher.
There’s a couple of kind of catalysts I would say that really impact that effective royalty rate and I guess the answer to your question is its not a particular cliff or particular event that’s going to happen that I would call out, but more or less I would say the catalysts are as the licensing activity happens as hotels get sold and relicense of choice, that’s normally a very good opportunity for us to improve the affected royalty rates and we’re seeing some encouraging trends there and that’s one catalyst that should help us.
The other catalyst that you see in the current numbers and that we’re projecting into 2014 are two things. One is, we are continuing to have strong developmental centers on the conversion side of things.
Having said that, during 2014 we are in my mind discounting less than we were in prior years, so that’s our favorable thing and in the final things, and this is I guess a kind of a really good reason with the effective royalty rate. What you’re seeing is the growth of Ascend.
So Ascend, I mean this hotel asset should generally – is substantially more revenue intensive than our typical mid-tier hotel and given the types of services we provided, it’s a little bit different than a typical franchisee. They come with a lower effective royalty rate. So you’re seeing the impact of it in the coming – a bigger part of our brand next on that system wide effective royalty rate. But overall we feel like we got a lot of room to grow, that effected royalty rate at the time and those are the general catalysts that could help us do that.
One your second question related to the conversion side of things, we’re feeling really good. I think what we took from the script, that things are moving at a very positive direction there. I mean we’re seeing continued improvement in the hotel-lending environment. We’re seeing continued improvement in the hotel transaction environment with that all changing in and that really to me jumps out at you when you look at our results.
We try to highlight to the fourth quarter, but if you strip out some multi unit deals that we did in 2013 and 2012, the fourth quarter, our franchising contracts were up 28%, which is a very nice increase in our mind and its mostly being driven by conversions to this point. So we’re starting to see the signs that are giving us some optimism on the construction side as well. I don’t know if you want to add to that Steve.
Yes so, the way I think I see this is you got on the conversion side, your really kind of almost back to peak levels, alright. So if you go back in ’06, ’07 tight numbers, the conversion level is there without the assistance of hotels being pushed out of other systems. So we think that will bring us additional lift as those brands begin to open new construction hotels that they started last year. So we’ll have the opportunity to convert a number of those, because that piece of the business has really slowed down really a lot, almost four years now and so we’re expecting that to come back.
What is happening though is a lot of people are buying independent hotels and want to brand them well, so we’ll invest in that and that’s pushing a lot.
You can see the growth we had; its one of the bright spots. The Ascend clearly is probably the hottest one we got going and as Dave mentioned, that’s really just the sale of distribution and its priced accordingly, but we’re also finding that as that grand is picking up significant inventory that our ability to price it is improving. So we view that as positive.
The budget business grew strong last year, which was not unexpected, but was a nice plus as well, and we’re sort of seeing it on the conversion side in all markets, sort of all over and we think we got – you know we actually think there is more to come in terms of improved performance there and then the little nice thing that we try to highlight as it looks like the new construction is swinging back up and particularly for Cambria having 30 of those under construction by the end of the year is really exciting and then when we think comfort, this new prototype is responsible for customers off the charts and we probably quite frankly waited a little too long to do it, but we’re going to do it now in a hurry, that’s why we put that money out there. We’re going to make a big difference in that brand in the next two years.
We think likely that we’ll see something on the order of a $10 increase in rate as a result as we moved that through the system. We had 900 some people apply for that capital. There’s 375, I think underway as we speak. Those are all going to hit the mark. Well, some of them have already done, but mostly in the fall as they are ordering and doing the work now, so we’re tracking that very carefully and then the other is, we’re going to take out the bottom end of the hotels and we’ve budgeted for that in our numbers. So we think that brand’s on track for a complete revival in a way that should be exciting, not only for customer, but also from a royalty and profitability basis.
And then as we look at the future in terms of other growth opportunities, you mentioned SkyTouch. We got what we think is pretty exciting. So in answer to your question, we look at them as tier 1’s through tier 4’s; tier 1’s being the large brands, tier 4’s being independent hotels. We’re talking to several in every category and that’s sort of built in to the numbers that we’re seeing by the end of the year.
So we’ve got a long way to go. The business is up and running and we got obviously an existing business there, but the interest level is high and we are matching it with distribution capability, which is one of the big things that people are asking for, so they got a technology platform solution. If you look at how these tend to go, the fact that we had a strong existing business that we’re growing, we really like our opportunities there and so far we really like the reaction from the market.
Steve Kent - Goldman Sachs
The next question comes from the line of Robin Farley, UBS. Please proceed.
Robin Farley – UBS
Thanks. I have a couple of questions. First for SkyTouch; is there a targeted revenue around when you’d reached profitability there? Its not 2014, but its at least in a year or two of 2014?
So we haven’t put out profit targets for SkyTouch yet, because it’s in part based on how successful we’re going to be in bookings revenue. Obviously we’re pretty optimistic about how that’s going, but I think its fair to say we’re not a tech company looking to loose money. We are a profitable cash flow machine and if we didn’t think we were going to turn that profitable within the mid term, you would not see us putting this kind of investment into it.
Robin Farley – UBS
Okay, thanks. And for share repurchase, you mentioned its not in your guidance, but you also pointed out that you have share repurchase authorized. What’s the best way for us to think about that in terms of expectations for whether there will be share repurchase this year?
Yes. So Robin, consistent with how we’ve always mentioned it, we’re talking about returns of excess capital to shareholders. Its based on the – we’re pretty proud of our track record there and we look back at the record and we’ve done I think a good job of that through the share repurchase program, regular dividends and 2012, the breakout.
So as you think about it going forward, I think share repurchases is one of the tools in the toolbox. As always, we have been very opportunistic in terms of exercising the share repurchase program. There’s a lot of different factors that go into doing that and we’re active in the market and its going to continue to evolve as we look at – but obviously our overall balance sheet position, look at our investment plans for the near term.
We look at the liquidity in the market and what’s available and factor all those things in, but the real point is, its not about the share repurchase program. It usually more about over time, what will we do with this capital and over time again we’ve done a pretty good job of returning excess capital to shareholders through those three levers and we’ll continue to look for a way to do that.
I mean the way you have to think of that is we’ve distributed more than we have made to the shareholders. We have made in the history of this company $1.5 billion, $1.6 billion and we’ve distributed more than that to the shareholders through those methods.
Robin Farley – UBS
Okay. Now that’s helpful, thanks. And then just a final question, just to clarify, how much capital was deployed. Right now you talked about that range of $20 million to $40 million for incentivize Cambria and you said $41 million in 2013. So is that sort of as of now you have $41 million deployed right now.
That’s actually included within the amount we disclosed in the balance sheet session of the release, because at the end of 2013 we had about $64 million of cash outstanding as part of that program, the problem mezzanine loans and silver equity investments.
Our belief is that that capital invested you get two things; you’ll get continued investment from us, but then we also think we’re going to see a fairly robust recycling of that capital. You know some of those hotels are going to – we believe the hotels in New York for example will stabilize quickly and we believe that the owners will want to recycle our capital out and own it entirely themselves. So as you look at those types of hotels, the kinds we’re doing opening, our expectation is that capital will be in there. When we model it, we’re thinking in terms of mid term, but in some of these markets they are going to stabilize quickly and so it could be recycled more rapidly in that.
Robin Farley – UBS
So the $20 million to $40 million annually, was that incremental to that $64 million?
Yes, but then you’ll have recycling bringing that number down. You should expect that balance to build for probably the next two years and then begin to start seeing it for recycling.
Robin Farley – UBS
Okay, great, thank you.
Your next question comes from the line of Felicia Hendrix, Barclays. Please proceed.
Felicia Hendrix - Barclays
Thank you. Good morning. Steve, you seemed very bullish. You ring a bell on that kind of – yet, you seem excited. Your still offering incentives to your franchisees. Now I had noticed that they are lower year-over-year as they have mentioned. But I’m just wondering if they are obviously giving away too much, just given your view of the economy and what’s going with conversions in the franchisee world.
Yes, I mean it’s a great question, because the market is packed, right, so your seeing very strong results and so we are constantly sort of testing the waters with how much we can dial back. I will yell you some if the other companies that haven’t done as well are being pretty aggressive out there, which is why we’re still continuing some of those incentives, because at this part of the cycle you’d like to be sort of back where the typical types of things, where your getting a point or two off a year or two when your done.
I can tell you that we are looking to dial those back, because we are in that part of the cycle and I think you’ll see that more this year. But it also is somewhat competitive and there are some folks out there that are happy with their supply growth, and as a result they are still very aggressive and so we need to – that’s one of the factors we have to take into consideration.
Felicia Hendrix - Barclays
That’s helpful, thanks. And then just on the royalties, I know you guys aren’t giving any kind of forecast for ’15, but you think – I’ll think about modeling and as we think and hopeful the Ascend Collection continues to grow. Are you kind of in a state now where your royalties, because of mix, you might see it decline further out past ’14?
I think if you see continued strength in this inflection, you can potentially see that. I mean people were optimistic about it, which you’ll see continued improvement in the conversion brands as well and then ultimately obviously with new construction. And as that unfolds, particularly as new construction around improves, I think we’re looking at that as one of the key milestones or key warnings signs that tell us, okay, that’s a good opportunity to be more aggressive on pricing on your conversion brands.
So I think there’s a lot of different variables, but the Ascend variables is a critical one, because it’s just that gross effective royalty rate in that brand is quite a bit less than our other brands. So if that brand continues to grow at the pace its growing, then I think you’ll see the continued pressure on the effective royalty rate, and then going forward we would see as we reduced our incentive on the development side, the rest of the portfolio gradually start to work its way back up over the next few years.
Felicia Hendrix - Barclays
Okay, helpful, thank you. And then just finally on your RevPAR outlook, obviously the weather that’s been initiated, we know for a lot of the country its having effects on different parts of the leisure and travel industry and just wondering if you contemplated any kind of weather disruption in your RevPAR forecast? If you could talk about that and how much of the increase that we’re seeing for the year, particularly visibly fourth quarter is just kind of the comp for pent up demand.
Yes, so Felicia for the first quarter of ’14, keep in mind that that includes our actual franchisee revenue results for the months of December, January and February. So that this is, we can say we’re only 2.5 months into the first quarter RevPAR results and we feel based upon what we’re actually seeing so far today, very good about that Q1 outlook and obviously that’s great news, because it certainly reflects a rebound in terms of the hotel RevPAR performance from what we saw in the fourth quarter on account of the government shut down impact. So we feel that getting more confused in the quarter to-date.
Felicia Hendrix - Barclays
Okay, great. All right, thank you.
The next question comes from the line of Nikhil Bhalla, FBR & Co. please proceed.
Nikhil Bhalla - FBR & Co.
A very good morning everyone. Steve, good morning. Just wanted to get some sense of, despite that impact that your expecting in 2014 in terms of $21.5 million, what do you expect beyond that in 2015? Should we start to think that that impact is limited just to the current year, should we start to think about liquid with some residual impact in the following years as well?
Well, I think what I said is probably where I think we should stay and that is we fully expect for this to be a profitable enterprise for us in the mid-term and your question is a good one, but its one that is in large part due to how successful we’ll be at growing the revenues rapidly and as we mentioned we like who we’re working with and the level of interest in the business and the product today. But we’ve got a long way to go before we could say we think we’ll be profitable in two years versus three or a year and a half and so.
So I think you should think about it as that it probably will be a continued investment at lesser levels, sort of through a mid-term period that doesn’t expect it to be profitable in the near term.
Nikhil Bhalla - FBR & Co.
Okay, and is it possible to just walk through what the unit level economics would be. You know you talked about tier 1 through 4, pick any of the tiers. Someone who is not already associated with Choice right now, what could it be in terms of initial fees, that when they pay – if you could just help us with that, I think it will help just understand the economics for each of these units.
Sure, this is David. It’s a little bit complicated, because I think it depends upon who’s the particular customer and so what I mean by that is, to the extent that one of the large brand companies because a customer, then their structure is one that they own hotels or they franchise hotels, we’re going to have a pretty meaningful impact as to how it creates value for them or it creates value for the franchisees. But I guess what I’ll do is I’ll walk you kind of through the, kind of a typical independent hotel owner operator as kind of by way of example.
So basically if you think about our existing installed base of 5,500 plus hotels, the average annual fee stream coming through those hotels is somewhere between $6,000 and $7,000 a year. So in terms what we sell the product for to the independent hotel owner or operator, it’s at a comparable level on a recurring basis plus some upfront installation fees that generally offset the cost. So a typical hotel owner who runs an independent hotel, who wants to come on in the SkyTouch system is going to pay somewhere around $6,000 to $8,000 per year, depending upon the balance and what they choose from the product.
So we think if you would compare that to their other options that development will be very attractive. Because not only is that pricing a very competitive, they also have – they are very limited in terms of the number or the type of hardware which you have to install.
So literally if you have an Internet connection at a moderate tier computer, you are going to be up and running, you are going to be up and running pretty fast; it’s fast to install. So there’s not a lot of capital cost, there is not a lot of cost to maintain the hardware. I know the annual fee strain is very compatible.
And in addition to that you get the benefits of a technology platform that’s been built and supports 5,500 hotels. So as you can imagine, its more robust than many of the other offerings you have to run in that space.
So that’s how you should think about the economics to an individual hotel. And as I said the brand economics, to a band company or to a larger hotel group is going to probably vary from there, but it gets a little complicated to explain on this call.
Nikhil Bhalla - FBR & Co.
Okay, I’ll probably take it with you off line. And on other question, just on this topic here, I think you talked about monetization of SkyTouch at some point in time. Steve would you mind given us some color on what you have in mind there?
Well obviously this play is a different business for us, and so we are doing it because we think we have an incredibly valuable asset, and so the question is how best to monetize that for our shareholders. So there is several ways it could go. We have been in discussions with other folks about joint venturing. There are lot of people that are pretty excited about what we got and would like to work with us on it or continuing those dialogs.
You could see it at some point being an independent company obviously. The clear options would be to do a spend. You could also see, we’ve had several aggressive outright purchase offers. So that’s an option on the table as well, but our goal is at this point to grow it as rapidly as we can, to reach a point where either its a self sustaining business obviously and then choose whichever one of those options creates the most value for our shareholder base and so we actually are looking at all of those options on an ongoing basis and we make the decision at the right time as to which is the best product for the shareholders.
Nikhil Bhalla - FBR & Co.
Perfect. Thank you very much.
The next question comes from the line of Joe Greff, JP Morgan. Please proceed.
Joe Greff - JP Morgan
Good morning everybody. You may have touched on this in the discussion on SkyTouch. But out of the $23.5 million this year in SG&A, how much of that would you characterize as one time or not recurring beyond 2014?
Yes Joe, this is David. If you look at the increase in 2014 compared to 2013, about a third of the increase I would estimate, somewhere between 25% and a third of the increase is tied to specific kind of revenue objectives, customer acquisitions. So that’s the piece that I would think about as, it will toggle or vary based upon our success in achieving our revenue objectives.
But then the rest of it I would say is it roughly reflections ramping up dramatically the sales force to support the expansion of it, and I would think about that is little more variable.
Joe Greff - JP Morgan
Great. In 2013 your net room growth was about 50% of your net property growth. How are you thinking of that relationship in ’14 based on the different mix that you have composed within your guidance?
Yes, generally speaking the room growth over time, the domestic room growth has trailed the unit growth percentage, which is really a function of the properties that we add and the properties that we subtract out. I think in 2013, we look back to the numbers, we added two larger properties that lead the system that we had in prior years. But generally speaking, the net unit growth and the net room growth are reasonably close, although the net room growth has traditionally trailed the percentage unit growth by just on a marginal amount I would say. I wouldn’t expect that to change going forwarded.
And I guess the other is, the new construction cycle, those new constriction tend to be larger units than the conversion. So what you got is the conversion business is come back fully. New construction is yet to comeback and then the other is the number of brands that we are looking at are larger brands to the extent we are successful in growing Cambria, as well as we think its going to go in with Ascend, those tend to be larger hotels as well. So I think part of that is also cycle.
Joe Greff - JP Morgan
Got it and my final question, this is not a huge number, but depreciation, amortization was $2.4 million in the fourth quarter. What is that run rate going forward with these three mainstay hotels out of the picture?
Joe, that’s a great question. I don’t have the Mainstay depreciation expense right here in front of me to be honest with you. So let us think about it. We can probably file that in our 10-K, which is going to be filed here shorter, give you a more up-guidance. It’s not a very big amount.
Joe Greff - JP Morgan
We have a question from the line of Thomas Allen, Morgan Stanley. Please proceed.
Thomas Allen - Morgan Stanley
Hey, good morning. You talked about how Ascend has had a negative impact on your royalty rates and you expect that to continue. Have you been able to spot out what royalty rates would have done at decent in 2013 and then a then any thoughts on 2014 and then also had this had an impact on your RevPAR growth just given average RevPAR percent in around $78 versus your $42 company-wide? Thanks.
Yes, on the RevPAR front, we have an exhibit in the press release and we can defiantly see that the Ascend Collection is having a positive impact on our overall RevPAR results. We don’t breakout the effective royalty rate given on a brand-by-brand basis, so I think we’re going to have to just stick with what we talked about early on the call, that to the extent that Ascend Collection continues to out pace growth wise, our moderate tier and economy brands and Cambria Suites brands, then that will be a catalyst that will have some downward pressure on the effective royalty rate.
Having said that that’s a great outcome, because you know one of our core growth objectively is obviously to expand our budding presence in the SPL segment. But as far as providing any more specific 2014 effective royalty rate guidance, I think we are going to leave it at what we put in the release last night
Thomas Allen - Morgan Stanley
Okay and then I read recently you promoted a new COO, what was behind that decision and can you just talk about a little bit about that role and if you should expect any changes to come from it. Thanks?
Sure Pat Pacious is a long-term veteran of the company. Has been in a rapidly increased area of reasonability over the last five years really. He is the one responsible for overseeing all of our distribution, IT strategy and we added to that brand and marketing to create a more effective organization, because we felt we weren’t getting the full integrated benefit of the systems in the other organization and also to reflect the value that he’s created with the company over the last several years.
When I came in, he and I started partnering right away on the distribution and on the IT side and he has made really great strides. We have great talent out in Phoenix. We actually view ourselves as obviously we can talk about this as when this is in the lodging business, but as sort of tech leaders from our strategy and from a technology standpoint.
We’ve done lots of firsts out there, first iPhone app, we did Rapid Book last year, which is three clicks to book a room, our mobile is growing rapidly. So he was reasonable for much of that. And then we felt the organization would be more responsible, more integrated by brining the final pieces of the business underneath him and that has gone very well and the organizational changes were made early at the end of the year, but we are expecting to see benefits from that in terms of our marketing and overall distribution efforts being more integrated and more aligned and your also going to see some, got some pretty existing grind work that’s coming out as a result as well.
And so it was both, to recognize for the achievement that we’ve had over the last several years, but also to create a more effective organization, where he is running our businesses and it allows me to focus more on the growth and investment alternatives and its looking like more support.
Thomas Allen - Morgan Stanley
All very helpful color. Thank you.
Our final question comes from the line of Patrick Scholes, SunTrust. Please proceed.
Patrick Scholes – SunTrust
Hi, good morning. Just two question questions here. Did you say what your reduction in EBITDA from our SkyTouch investment was in 2013?
Yes, it was $11.5 million.
Patrick Scholes – SunTrust
Okay, and then secondly, as I look across sort of industry expectations for new openings in 2014, it defiantly looks like economy hotels are by far the laggard of the industry. What do you think is holding economy back as opposed to the upscale or the upper mid-scale segment? Financing, popularity of the brands, what’s your opinion on that? Thank you.
Well so, I think it’s hard to build economy hotels because the basic cost of it, you can almost build a mid-tier hotel. So I think that’s where the new construction is going on. We are mostly moderate above and so that’s where we are focused.
The economy business is good business for us, but if you watched the cycles over the last several years, even in the up cycle not many people are building in the budget brands at this point and if you look at where the new construction is, its really focused at the upper moderate and quality tiers. And so that’s why you are seeing us move in that direction as it relates to our new construction efforts.
And so, a particular cycle, I’m sure some budget has been, but it has been a steady decline in new construction environment for those segments over the last probably 10 years.
Patrick Scholes – SunTrust
Okay. Thank you, that’s it.
So we are apperceive of your interest in SkyTouch and one of the things that we think about often and the investment in this business is, if the accounting rules were different and we are investing those hours as we are, the balance would not be signification. But we think the upsides are, so – but we’ll continue to talk about that as we learn more about the customer reaction to it and our success in those areas.
But as always, thank you for your interest in Choice. We are obviously very excited about what 2014 holds for us and the businesses that we’re investing in and the growth that will bring our shareholders and as always, we are focused on returning value to those shareholders in ways that we think are best and we will continue to focus on that.
So thanks for your interest and have a great day.
Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.
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