Choice Hotels International Q3 2007 Earnings Call Transcript

| About: Choice Hotels (CHH)
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Choice Hotels International, Inc (NYSE:CHH) Q3 2007 Earnings Call October 25, 2007 9:30 AM ET

Executives

Charles Ledsinger - Vice Chairman and Chief ExecutiveOfficer

Dave White - Chief Financial Officer

Analysts

William Truelove - UBS

David Katz - CIBC World Markets

Felicia Hendricks - Lehman Brothers

Joseph Greff - Bear Stearns

Jeff Donnelly - Wachovia Securities

Michael Millman - Soleil-Millman Research

Operator

Good morning andwelcome to the Choice Hotels International third quarter 2007 earnings conferencecall. (Operator Instructions).

Now during thecourse of this conference call certain predictive or forward-looking statementswill be use to assist you in understanding the company and its results.

Such statementsare subject to risks and uncertainties that could cause actual results todiffer materially from those expressed or implied by such statements.

The company’s Form10-K for the year ended December 31st, 2006 details some of the important risk factors that you should review.Although, we believe that the expectations reflected in the forward lookingstatements are reasonable. We cannot guarantee future results, levels ofactivity, performance or achievements.

We caution you notto place undo reliance on forward-looking statements, which reflect ouranalysis only, and speak only as of today’s date. We undertake no obligation topublicly update the forward-looking statements to reflect subsequent events orcircumstances.

Now with thatbeing said, I’d now like to introduce Charles Ledsinger, Vice Chairman andChief Executive Officer of Choice Hotels.

CharlesLedsinger

Thank you. Goodmorning everyone. And welcome to our third quarter 2007 earnings conferencecall. And with me this morning is Dave White, our Chief Financial Officer.

Yesterday afterthe market close, we reported the third quarter 2007 results. And after Idiscuss some of the highlights for the quarter, I’ll open up the call for yourquestions.

We continue toexecute our strategy for profitable growth and we’re pleased with our strongthird quarter results. For the quarter domestic unit and rooms growth were 5.7%and 4.4% respectively.

RevPAR increased5.6% for the quarter compared to the same period of last year. RevPAR for ourmid-scale without food and beverage brands Comfort Inn, Comfort Suites andSleep Inn increased 6.1% driven by improvement in occupancy and a 5.4% increasein average daily rate. These brands represent approximately half of ourdomestic room supply.

Coming offback-to-back record years franchise development in 2006 and 2005, we’re pleasedthat our 2007 franchise development results continue to be strong. During thethird quarter we executed a 182 new domestic hotel franchise contracts comparedto 178 for the third quarter in 2006, which was a record year. And year-to-datewe’ve executed 469 new franchise contracts, an increase from 453 during thesame period of 2006. Our strong unit growth RevPAR and franchise sales resultsfor key contributors to strong financial results for the quarter.

Operating incomefor the third quarter increased 14%, $62.4 million compared to $54.6 millionfor the third quarter in 2006. Adjusted diluted EPS, which excludes certainincome tax contingency reversals and in 2006 a loss on extinguishment of debt increased 16% to $0.58compared to adjusted diluted EPS of $0.50 for the third quarter in ’06. Dilutedearnings per share for the third quarter in 2007 were $0.59.

As we indicated inyesterday’s press release, we’re increasing our full year 2007 diluted EPSguidance from $1.62 to $1.67 and our EBITDA guidance for the full year 2007from $187.5 million to approximately $189 million. Our fourth quarter dilutedearnings per shares expected to be $0.41.

These figuresassume a 4% increase in RevPAR for the fourth quarter 2007 and full year 2007. Thesefigures also assume for full year '07 a net domestic unit growth of approximately5%, a 4 basis point increase in the effective royalty rate and an effective taxrate is 36.1%. And finally these figures include $3.7 million severance charge,which was recorded in the first quarter of this year.

During the thirdquarter, we also continued to execute against our long-term strategy ofreturning excess capital to shareholders. Since the beginning of the yearthrough the end of third quarter, we’ve repurchased 4.1 million shares of ourstock for approximately $155 million. During this same period we paid cashdividends on our common stock $29.5 million.

In closing, wecontinue to demonstrate strong performances; we add more hotels to ourdistribution system; grow our operating income, and return excess capital toour shareholders. We remain confident in our ability to continue to grow ourmarket share in the segments in which we operate.

And now I’d liketo open up the call to any question you might have.

Question-and-AnswerSession

Operator

(OperatorInstructions) And our first question this morning comes from the line ofWilliam,Truelove with UBS.

WilliamTruelove - UBS

Maybe David cantake a shot at this question. On leverage ratios, where do you want to targeteventually or what do you feel you are happy in terms of your leverage ratios?Where do you see the company being in the next few years? What's the goodrange, so we can try to model potentially what you might be buying in stock andadditions going forward? Thanks.

Dave White

We don’t have anyspecific target of leverage levels that we feel we have to maintain on thebalance sheet if you will. If you look back over the past five or six yearsthat the share repurchase program has been into place, we've certainly beencomfortable with leverage level up to three, three and a quarter.

So, we’re notuncomfortable with those levels. I think the credit rating agencies arecomfortable with us in that range as well, maintaining our investment and greatcredit rating.

So, the sharerepurchase program I think that nothing has changed there in terms of ourphilosophy that, if we have excess capital, excess cash, we will return that overa long period of time to ourshareholders through the dividend or the share repurchase programs.

Our firstpreference would be to continue to use it to grow the business, but we’ll dothe right thing from the shareholder perspective with their cash over time.

Operator

And our nextquestion then comes from the line of David Katz with CIBC World Markets.

David Katz -CIBC World Markets

Nice job on thequarter. I know we keep asking this question and I think we know what theanswer is, but I’m just going to keep asking it anyway. Just in case the answerchanges, but are you perceiving or seeing anything that’s showing up in yourbusiness in terms of weakness on the consumer, weakness from gas prices. Theperception out there seems to be, that companies like Choice and the categoriesthat you are in are susceptible to consumer trends that are out there. So likeI said I'll just keep asking it just in case something does show up in yourbusiness.

CharlesLedsinger

It’s a goodquestion Dave. And to be honest with you, not really. The main thing is we'renot only just RevPAR growth we're unit growth. So it seems like, if look backhistorically kind of what happens is is that we play the cycles and we're avery good defensive play, but we also do well in the up cycles too.

So, if things froma development standpoint, what happens is is that often the new hotels and newbrands or small brands or new hotels have been created sometimes--it may beindependence too--when the cycles turn and things get little bit tougher theystart look for the larger brand organizations to affiliate with, largerplatforms. And so we benefit in that scenario.

We also benefitfrankly, in under-supply growth because we have both new build and conversion.So, I'd say from the development side which is for us--we are unit growthmarket share company--the most important thing.

Secondly, RevPARis important, but probably not quite as important on a margin. And we're notseeing it; we had a very strong summer and I'm not saying we're showing thefourth quarter we don’t have a lot of visibility, we don’t put lots of roomsout very far. So it’s hard for us to really I think with a lot of clear sightednesssay, ‘this is what we can see on the books, and this is going to happen.’ Wetend to follow the industry; we are a little stronger in the summer months whenthere is a little more leisure travel.

And also I think,I'd just say they're popular price brands, and so, they're value-oriented brands.So, sometimes you do see switching from some of the higher price brand if thereis squeeze on the consumer.

So, gas reallyhadn't had an impact on us, we haven't seen it really in the RevPAR. A recessionin the economy is going to have an impact on everybody. But probably frankly alittle less us than some others.

David Katz -CIBC world markets

Now, if we canjust go back to something that I think was an answer to Will's originalquestion. I want to make sure I heard you right. You talked about beingcomfortable, at the 3 to 3.25 times leverage range?

CharlesLedsinger

Mm-hm.

David Katz -CIBC world markets

And you’reobviously quite a bit below that, at this point.

CharlesLedsinger

Uh-huh.

David Katz -CIBC world markets

So, when I look atyour guidance and I think one of the assumptions in your guidance is that theshare count basically remains the same for the forth quarter. Right? We don’tonly want to think about this in terms of the fourth quarter, but taking alittle longer-term view, the assumption that your share count remains anythingclose to the same is given that comment is probably not really all thatrelevant. Is it?

CharlesLedsinger

Well, I think whatyou should look at is just what the historical practice has been. As we sithere today we don’t see the future much different than we've seen the past. Meaningthat, we’re going to return capital to shareholders.

David Katz -CIBC world markets

Got it.

CharlesLedsinger

We’re also,as Dave said we'd like to find ways to grow our business profitably and sohopefully we're going to get some opportunities going forward to do that. It’sa balancing act between opportunistic ability to purchase valuations and whatalternatives might be.

David Katz -CIBC world markets

Right. And if youcould forgive me for not knowing this, were you not permitted to buy back anystock since September 30th or did you choose not do so for one reason oranother?

CharlesLedsinger

We weren’tprohibited.

David Katz -CIBC world markets

So for the last threeweeks or so you elected not to for one reason or another.

CharlesLedsinger

We haven’treally disclosed anything for post-quarter end but between the announcementdate of our increased authorization from the Board and the end of the quarterwe didn’t buy anything else.

I think if you lookback, we’ve announced Board authorization increases over the past ten yearsthat that program has been in place and as Chuck mentioned over time, a prettygood track record of actually executing on them over time.

David Katz -CIBC world markets

Okay. One last oneand then I will get out of the way here, but on the international side I justwanted to check back on that. I know we should be measuring this more in terms ofyears more than months, but how long before we start to see some real evidenceof that business becoming meaningful for you all.

Dave White

I think it’sobviously in terms of rooms share and unit share, probably close 20% of ourroom supply and unit supply. The model's a little bit different internationallythan it is in the domestic market; we’ve got great scale here in the U.S., 4300properties so it obviously makes the business profitability a lot better thanit is internationally, but we feel pretty good about the partners we have internationallywhere we do master franchising and spots where we’re doing it direct, in Canada,Australia, Asia. It will take time to have a more meaningful financial impact butwe feel like we’re doing well there.

Operator

Thanks and thenext question comes from the line of Felicia Hendricks with Lehman Brothers.

FeliciaHendricks - Lehman Brothers

Just a fewquestions, one is you’ve been asked this before and the answer’s been it’s beentoo early but I’m just wondering where we are now.

In terms of havingany kind of insight to your franchisees and their ability to access the debtmarkets, has that gotten more costly for them and is that going to become anissue in terms of growing units and then I have some follow-up questions.

CharlesLedsinger

Felicia we reallyhaven’t seen that. Most of our franchisees are using local and smaller lendersand so they really just haven’t been affected the same way that some of thelarger institutions have. It’s really a little bit different animal and it maybe costing them little more, but probably more likely is they are required toput in a little bit more equity in.

But that reallyhasn’t been a constraint, we are still selling a lot of new franchises and weare opening a lot of hotels and I haven’t heard that getting the financing hasbeen the issue; construction time, because of some of the permitting and allthe things that have to come together has stretched out a little bit longer

We had a quarter,good year this year in terms of new hotels opening and also very good on newsales on contracts. So we just haven’t seen; I’ve talked to a lot of people,they haven’t said that that’s really been the constraint.

FeliciaHendricks - Lehman Brothers

That’s good.

Charles Ledsinger

Yeah, hope itcontinues

FeliciaHendricks - Lehman Brothers

Yeah. Since yourbusiness is based on unit growth I do too. So, just getting to your guidance, Ithink there’s a little bit of a difference when you re-look at the RevPAR percentagechanges between what we’re looking at and the guidance that you’re giving justbecause we don't have the same store numbers including the Suburban acquisitionlast year. I was wondering if you could just give us those numbers for thefourth quarter and full year last year?

Dave White

Full year RevPARincluding suburban in ’06 was $40.13. And fourth quarter including Suburban was$39.70

FeliciaHendricks - Lehman Brothers

And then justfinally, what was the share count at the end of your quarter?

Dave White

I don't have thatright here in front of me. Let me track that down and before we end the callI’ll give you that.

Operator

And our nextquestion then comes form the line of Joseph Greff with Bear Stearns.

Joseph Greff -Bear Stearns

How sustainable is5% net domestic unit growth. I mean, given the pipeline, and the progressyou’re making with some of the brands, is that something that you think issustainable for next couple of years?

Or what it is atwo-year sustainable unit growth rate and I guess how different is it one aproperty basis versus a rooms basis?

CharlesLedsinger

We usuallytargeted sort of four to five unit growth. And, I think that that probablytranslates into somewhere between 3.5 to 4.5 on rooms growth. For us unitgrowth is important, I mean units are important because you get paid fees whenyou sell a new franchise, you get paid fees when a franchise sells that’s a re-licensingfee, that’s not by rooms, that’s by units.

So there is fairamount of income that gets generated by unit growth. We get fees whether thehotel opens or not. So, now we don’t like to do that, because, obviously ittakes up space and it takes up time. But if you look at our revenue generation,there is a fair amount of fees that are generated through those sales of newunits.

Rooms of courseare what pay the royalties so over time that’s an obviously important part too.But they’re both important. I’d say that, probably four to five and then onrooms probably a little bit less, just because the mix of properties goingforward is a little different than the historical mix has been.

But we have Cambriacoming on, which is our bigger units. And so that will have a kind of a mitigatingimpact. That’s still small in the whole scheme of things.

Joseph Greff -Bear Stearns

Got you. And then,one final question, David, with respect to next year, I know you don’t providea guidance, do you think the level of, what we would characterize as capitalinvestments or CapEx for next year is consistent with what you’re doing thisyear or should that go up or should that go down and what are the driversthere?

Dave White

We haven’t reallygone through all of our planning at this point, included that with our Board,so I’m a little hesitant to provide any kind of guidance like that at thispoint. But we are middle of December this year hosting an investor day wherewe’re presently planning to talk about ’08 expectations.

CharlesLedsinger

And just to answerthat question on the quarter-end share count we were at 62.8 million sharesoutstanding and that’s before any type of dilution factor for options.

Operator

 (Operator Instructions). We now go a questionfrom the line of Jeff Donnelly, with Wachovia Securities.

Jeff Donnelly -Wachovia Securities

Good morning guys.Marriott told us on its earning call that re-licensing fees could besignificantly lower than previously expected as pure transactions in the marketplacewere dropping the ability to capture those fees, what’s your take on that, is thatsomething you expect to see in your portfolio?

Dave White

We had a strongthird quarter from a re-licensing prospective and we will put those details aswe always do in our 10-Q here in a week or so. Q3 was strong and I think that alsoties into Chuck’s earlier comments about credit availability; I mean, there’sliquidity there to get these transactions closed and I’m not seen anything elsethat would cause me at this point to have any concern in that area.

Jeff Donnelly -Wachovia Securities

And just a followup on some of your earlier questions on your pipeline; Chuck, you touched onthis in one of your comments, that there’s a chance that maybe your completionor deliveries will perhaps slow a little bit in your pipeline simply becauseconstruction periods are taking a little longer.

Do you have anestimate how much longer that is taking so we can have a sense of maybe howyour room completions change over the next 24 months?

Dave White

That’s not unique toChoice, that’s applicable to really the entire industry. Six months is tacked ona new construction project over the past year or two just with all the thingsyou have to go through to get a hotel open.

So, for us, a hotelcan open as quickly as 12-13 months and can take much longer than that too. It’shard to generalize but as Chuck talked about, our expectations still remainstrong for these brands over time.

Jeff Donnelly -Wachovia Securities

Do you haveinternational royalty fees for the quarter?

Dave White

I don’t have thoseright here in front me but we would put those in our Q, which we are going tofile here in the next week or so.

Operator

We have a questionthen from the line of Michael Millman with Soleil-Millman Research.

Michael Millman- Soleil-Millman Research

Several questions,can you talk about why, fourth quarter RevPAR seems to be well below the thirdquarter gain and whether that has to do with last year’s acquisitions or isthere something else involved?

CharlesLedsinger

Well, I think seasonalityhas something to do with it. But we had a very strong third quarter. And we’vesaid all along, I think for the year, we’re sort of in-line with where we saidwe’re going to be for the year and our expectations that that’s about where we’regoing to end up.

It’s a little bitmore based on what the industry prognosticators are saying and as opposed toclear visibility that we have in our business per se. So we try to look at whatour historic performance is, vis-à-vis the industry and then look and see ifthere is any thing else unusual in the business, which there is not, or anytrends that we’re seeing.

So, we’re sayingwe’re going to hit the year number and David if you have any further insight.

Dave White

Yeah, just lookingat the PwC and STR publication recently, as well as lot of the others in theindustry, I mean, it doesn’t seem inconsistent with what some of the otherhotel companies have put out there and certainly not inconsistent with what PwCand STR are expecting in terms of Q4, a slight deceleration industry-wide inRevPAR.

Michael Millman- Soleil-Millman Research

I asked because, itjust seems that your third quarter RevPAR was much higher than you had guidedand your fourth quarter now looks like it’s much lower than you had guided backa couple of months ago.

Dave White

But Michael, onQ4, I mean, I think in our second quarter call, we had guided a Q3 RevPAR of 4.5and on the call we talked about Q4 being in the mid-fours to get us to four forthe full year.

We’ve been prettyconsistently saying 4% RevPAR I think since the beginning of the year; you’dhave to go back to the first quarter release. But I think we’ve been at 4% for2007 all year and in the most recent call, we guided to mid-fours in the fourthquarter.

So we’re not reallythat different where we thought we were last time we had this last call.

Michael Millman- Soleil-Millman Research

Okay, on themid-scale, the occupancy was up 50 basis points. How long do you think you cancontinue to get ADRs of five plus with under 1% occupancy increases? What’s thesustainability there?

Dave White

Well, I think thattrend is pretty much what everybody’s seen is that occupancy has been modestlyincreasing to flat. The forecast for next year actually occupancies to be down alittle bit.

So I think to theextent that we exhibit the same trends as the industry does and I would expectthat would be sustainable the same way. I mean, I don’t think we’re going tosee big differentiation from what the rest of the industry in our segments isseeing.

Michael Millman- Soleil-Millman Research

No I recognizethat’s industry, I was just wondering if you were concerned aboutsustainability of industry getting rate without …?

Dave White

I see what you’re saying.Well yes; I mean, ideally you’d love to have occupancy increasing as well asrate. But I think that the rate differential tends to be more supply driven. Sosupply on RevPARs, supply stays in levels where we’ve seen it.

You’ll probablystill be able to drive it through rate; those won’t last forever probably. So,hopefully the economy cooperates, and we’re able to continue to push that ratebut I think it’s a cyclical business that I think right now is still seeinglots of pricing power and then hopefully that’ll continue.

What you’re seeingnow, is probably, we’ve still got a little bit more demand than we have supplycoming into the markets. So we’re seeing that positive RevPAR and positivepricing power.

Michael Millman- Soleil-Millman Research

And the West Coastfires, is this looking like a mini-Katrina, in terms of the hotel business?

CharlesLedsinger

I don’t know theanswer to that, that’s a good question. I’m sure there is many people displacedand there is going to have to be homes rebuilt. Whether it is to the extentthat there was in New Orleans, I just don’t know the answer to that. Icertainly think that it will have an impact on the business.

Operator

I’m showing nofurther questions in queue.

CharlesLedsinger

Okay. Well, thankyou very much.

Operator

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