Aug 8, 2014
Executives
Stephen Joyce – President and Chief Executive Officer David White – Chief Financial Officer
Analysts
Amanda Bryant – Barclays Capital, Inc. Robin Farley – UBS David Loeb – Robert W.
Baird & Co. Jeff Donnelly – Wells Fargo Securities, LLC
Operator
Ladies and gentlemen, thank you for standing by. Good morning and welcome to the Choice Hotels International Second Quarter 2014 Earnings Conference Call.
At this time, all lines are in a listen-only mode. Later, there will be a question-and-answer session and further instructions will be given at that time.
As a reminder, today's call is being recorded. During the course of this conference call, certain predictive or forward-looking statements will be used to assist you in understanding the company and its results, which 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 believes, expects, anticipates, foresees, forecasts, estimates or other words or phrases of similar import. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements.
Please consult the company's 10 Form – I'm sorry, 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 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 a part of our second quarter 2014 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.
Stephen Joyce
Thank you very much. Well, good morning.
Welcome to Choice Hotels' earnings conference call. With me as always is David White, our Chief Financial Officer.
This morning we are going to update you on our performance for the second quarter of 2014 and I am pleased to say that the results are even stronger than we expected. I'll talk about our top-line results and business highlights and then Dave is going to walk you through the numbers in more detail.
Dave will also briefly review a change we announced earlier in this week regarding the timing of our revenue recognition for our royalty marketing and reservations fees, in case there are any questions on that. On the business front, the results this quarter are very strong.
We expect – we exceeded our expectations on the key metrics and criteria that we measure. There are several factors contributing to this continued growth of our lodging business this quarter.
A number of hotels in our domestic – the number of hotels in our domestic franchise system grew by nearly 2% and domestic system-wide revenue per available room increased 7.6% in the second quarter of 2014. Primarily as a result of these two metrics, franchising revenues increased 8%, led by growth of domestic royalty fees, which increased 7%.
Our strong revenue performance flowed through to the bottom line as we achieved a 12% increase in second net income from continuing operations as a result of revenue growth, combined with our continued discipline cost management. Based on these results, we are quite with our performance.
In addition to our strong numbers, we recently announced some other exciting news. In July, Choice Hotels was named to the Forbes' world's most innovative growth companies list.
We are the only major multi-brand hotel company to make that list. We believe, this is in part attributed to our innovative distribution approaches and our proprietary technologies.
Right after we were recognized by Forbes for innovation, we announced another new initiative. Couple of weeks ago, we unveiled a partnership with Ford Motor Company in which we will become the first hotel company to offer drivers of select Ford vehicles the ability to search for and make hotel reservations hands-free without taking their hands off the steering wheel.
Choice's innovation also led to our latest summer contest VacayGoneCrayCray to help us connect with millennials and new audiences, we partnered with YouTube sensations Rhett & Link. They signed on to reenact examples of vacations gone wrong, submitted by viewers of their morning show and travelers from across the U.S.
A new music video about the contest earned a spot as one of YouTube's top five trending videos during the week of July 21, which now has nearly 3 million views. Moving on to development, we executed 125 new domestic hotel franchise contracts in the second quarter, which is a 20% increase compared with the same quarter last year.
This is a result of both strong conversion deals and increasing new construction activity. New construction continues to pick-up as the financing environment improves.
We more than doubled our new construction franchise agreements with 29 new construction franchise agreements this quarter compared to 14 new agreements in the second quarter of last year. We've also had some significant openings on the new construction front like the opening of our Washington D.C.
Cambria Hotels and Suites that aligns closely with our strategic focus on opening Cambrias in major urban markets. As for conversions, we had 96 conversion deals this quarter.
We're particularly pleased with some important conversions and key destinations for the Ascend Hotel Collection such as Dallas, Texas and Biloxi, Mississippi. Additionally, we have signed new Ascend deals across multiple boroughs in New York City, proving again that this concept is very attractive to independent hoteliers.
Owners are seeing the benefits that we bring to their hotels to our central reservation system, easy to use cloud-based property management system, and our new and innovative distribution channels. Turning to distribution, we were recently recognized as having the top mobile websites in the industry.
The Search Agency reviewed the 100 most visited mobile travel destination and accommodation sites, and named Choice Hotels and five of its brand's mobile sites as the top six best sites for customer mobile experience. That’s the top six, one through six out of the top 10.
Choice Hotels is a true leader in staying ahead of guest needs when it comes to making reservations via mobile technology. The revenue contribution of the central reservation system increased to 39.8% in the second quarter, up 280 basis points over the same time last year.
Choicehotels.com revenue increased more than 12% for the quarter and we recently achieved our first ever 7 million revenue day on this site. Bookings via our mobile applications continue to grow at a fast pace, and yielded an increase of 44% for the quarter compared to the same time last year.
Our award–winning loyalty program Choice Privileges has worldwide enrollments grow by over 1.3 million new members this year. We now have over 20 million members in this program.
Bottom line, our distribution strategy is working well. We're staying ahead of guest booking needs and we are leveraging our distribution channels to deliver an increasing number of customers to our franchisees hotels.
Changing gears a bit, I'll give you a brief update on SkyTouch Technology. SkyTouch has continued to sign new properties and is seeing growth in a pipeline of customers and a strong interest from potential customers.
The addition of sales directors and managers focused on specific market segments has supported these results. And at this time, SkyTouch has secured contracts for approximately 50 third-party hotels.
SkyTouch recently signed a development agreement with customers – with a customer representing more than 500 hotels. That development agreement covers requirements to meet their system needs, the development work and anticipated pilot will position us well for future growth with this customer.
SkyTouch is getting some great recognition and was recently featured on the cover of CIO review as one of the 20 most promising solution providers in the travel and hospitality business. SkyTouch also receives some great interest at the recent HiTEC Conference in LA where strong traffic was generated to SkyTouch booth, leading to a large number of new sales and partnership opportunities.
We are very pleased with the progress of SkyTouch and we remain excited about its potential impact on our future growth. Overall, we're quite pleased with our results this quarter, obviously.
We saw increases in earnings per share, franchising revenues, domestic royalty fees, and RevPAR, which all helped deliver strong results for our franchisees. Now, let me turn it over to Dave to share more detail on the financial results.
David White
Thanks, Steve. And as Steve mentioned and as we described in the Form 8-K filing earlier this week, we now record our royalty and certain marketing and reservation fee revenues in the current month in which the underlying gross room revenues are earned by our franchisees.
This is different than our historical practice, which was to record these on a one-month lag. And while we believe our historical practice was well understood by investors, this change was required to comply with Generally Accepted Accounting Principles.
The financials and related operating statistics for all periods, including the 2013 preliminarily restated results included with the press release we published this morning reflect this change. As we indicated in the press release, we plan to file restated quarterly financial statements for certain prior periods and revised annual statements as soon as administratively possible.
And until we complete these filings, additional information could become available, which could cause the company's current estimates to change. Turning to the results, as you may have read in this morning's press release, we reported diluted earnings per share of $0.60 for second quarter 2014, which represented 11% increase in the prior year.
EBITDA from franchising activities for the second quarter increased 12% over the same period of the prior year, due to an 8% increase in franchising revenues and a 270 basis point expansion of our franchising margins. The increase in our franchising revenues for the quarter was driven primarily by continued growth of the franchise system and strong domestic RevPAR performance.
In addition, the strong franchising revenue growth, we continued to demonstrate strong cost discipline as evidenced by our franchising SG&A expenses for the quarter increasing by less than 1%. As a result of the combination, the top line revenue growth and continued discipline in the cost management, our franchising margins expanded from 66.1% in the second quarter of 2013 to 68.8% in the current quarter.
Our domestic royalty revenues increased by approximately 7% to 71.2 million due to a combination of increases in RevPAR and in our system size, partially offset by a 6 basis point decline in our effective royalty rate. Domestic RevPAR growth for the quarter was approximately 7.6%.
Our RevPAR growth was driven by a combination of both occupancy gains of about 280 basis points and a 2.9% increase in our average daily rates. We attribute the increase in occupancy rates in our overall RevPAR improvement to increased leisure travel, which we believe reflects the improving U.S.
economy, as well as declining unemployment rates. As a result of the trends we are seeing in the business and our year-to-date RevPAR performance through June, we now expect full-year RevPAR to range between 6.25% and 7.25%.
On the supply front, we were able to grow the number of hotels operating in our domestic franchise system by nearly 2% compared to June 30, 2013. On the franchise development front, we are pleased that the fundamentals that drive new hotel development and conversion opportunities are continuing to improve as both the RevPAR and financing environments continue to get better.
You can see the impact of this trend in our results for new construction franchise agreement executions which have essentially doubled year-to-date and for the second quarter compared to last year. We believe the industry is in the early stages of the supply growth part of the cycle which we expect to accelerate over the next several years.
During the second quarter 2014, we executed 125 new domestic franchise contracts, a 20% increase compared to a 104 during the second quarter of 2013. I'm pleased to report that this performance contributed to 16% increase in our pipeline of hotels under construction or waiting conversion or approved for development compared to a year ago.
And we continue to expect our 2014 franchise sales activity levels to exceed prior year levels. Now, I'll turn to our outlook for the remainder of 2014.
As always our outlook assumes no share repurchases under the company's share repurchase program and assumes the effective tax rate for continuing operations to be 30.7% for the third quarter and for full-year 2014. Our franchising activity guidance assumes that our RevPAR will increase approximately 6.5% for the third quarter and range between 6.25% and 7.25% for full-year 2014, clear acceleration from the outlook we published in April with our first quarter earnings release.
Our net domestic unit growth will increase between 1% and 2% and our effective royalty rate will decline by 4 basis points for the full-year. Based on these assumptions we are establishing guidance for full-year 2014 EBITDA from franchising activities to range between $231 million and $234 million.
As we mentioned in the release, more than three quarters of the increase in our EBITDA outlook at the midpoint compared to our April 28 outlook is due to our strong year-to-date actual performance through June and anticipated improved operating fundamentals and performance for the second-half of 2014. The remainder of the increase reflects the change in accounting for royalty fees, which I mentioned previously.
With regards to SkyTouch we are projecting reductions in EBITDA for full-year 2014 of approximately $20 million, compared to approximately $11.5 million in 2013. Our net EBITDA reduction outlook for SkyTouch is substantially unchanged from our previous outlook.
We now expect our third quarter 2014 diluted EPS to be $0.62, our full year 2014 diluted EPS to range between a $1.92 and a $1.96, and our consolidated EBITDA for full year 2014 to range between $211 million and $214 million. We are very pleased with our second quarter performance and believe we are extremely well positioned to continue our strong momentum for the remainder of the year.
And now, let me turn the call back over to Steve.
Stephen Joyce
Thanks, Dave. It's great to have a quarter with such strong results and the numbers Dave just reviewed speak for themselves.
We're also finally getting some cooperation from the economy. Economic figures continue to suggest an optimistic outlook for this year and future years to come.
In particular, the Conference Board's Consumer Confidence Index has been showing continued improvement and now it's at its highest point since 2007. On the jobs front, there has been strong employment gains of 200,000 a month recently and we like the types of positions that are growing fastest and those sectors that happen to share similar demographics with our customer base including job growth in IT, healthcare, education and the service industries.
So overall, we're quite pleased with the quarter, given the continued innovation at Choice, the recognition we've received and our performance which exceeds our expectations on all core criteria that we measure. This is a strong quarter.
We're optimistic about the rest of the year. Now, let me open it up to any questions you might have.
Operator
(Operator Instructions) We will pause momentarily to compile a list of questions. And your first question comes from the line of Felicia Hendrix with Barclays.
Please proceed.
Amanda Bryant – Barclays Capital, Inc.
Good morning. This is Amanda for Felicia.
David White
Good morning, Amanda.
Amanda Bryant – Barclays Capital, Inc.
Good morning. Two things, first, could you go into how the accounting change impacted your expectations for the second-half of the year on a quarterly basis.
I guess, in particular, third quarter EPS guidance looks a little lighter than our expectation. And then just as a quick follow-up, your Ascend Collection RevPAR declined for the second quarter in a row.
Are those renovations – are there renovations or anything else going on, on those hotels in particular? Thank you.
David White
Great, thanks, Amanda. So let me take the first part of that question, around our expectations for the full year.
So basically, this one month lag shift had an impact on our full year less than a $1 million, when you think about it on an annual basis, at the royalty line for 2014 relative to our prior outlook. So, on an overall basis on an annual perspective it's less than $1 million impact to top-line revenues.
But when you at them at a quarterly basis because of the seasonality of the business, relative to the flow of the quarters in prior years, the first two quarters will now look stronger than they previously did, and the second two quarters of the year, the back two quarters of the year will look weaker. But net-net between the two quarters, between the first-half of the year and the second-half of the year on a full year basis they were just out to a pretty immaterial impact to the top-line.
On the Ascend side of things, basically, I think what you're seeing there, since the RevPAR declines, is really a function of the system growth and the fact that we don't report our RevPAR on a same store basis. So as we're growing the system percent depending upon where those hotels come into the – which markets they come into, their absolute RevPAR levels for the properties they were adding maybe in markets where for an up-scale hotel the absolute RevPAR is lower than the overall brand average.
That's the primary thing you see in there.
Stephen Joyce
Then the other thing that impacts that as well is as these properties come to us there is typically about a six-month ramp where we start really impacting our top-line performance and then we show, obviously, they must feel very positive RevPAR results coming from signing up for the system as a result of the high growth that we're seeing.
Amanda Bryant – Barclays Capital, Inc.
Understood. Thank you very much.
David White
No problem.
Operator
And your next question comes from the line of Avon Farley with UBS. Please proceed.
Robin Farley – UBS
That's probably me, it's Robin Farley. Two questions…
Stephen Joyce
Hi, Robin.
Robin Farley – UBS
Hi, the RevPAR increase for the year is obviously a significant uptick. And maybe not as much flow-through to the EBITDA increase in your full year guidance as we would have thought and I don't know if that – is that royalty rate issue or even if you could give a little color around that.
And then my second question is, what do you think just sort of qualitatively is kind of driving the midscale and economy segments of the industry overall to be outperforming the higher end? I'm just curious what thoughts you have on that.
David White
Okay. Thanks, Robin.
I'll take the first question. And basically, in addition to what I commented on, on the revenue side of things a minute ago about how that change in accounting impacts our full-year outlook.
On the cost side as I think about the back-half of the year on the SG&A line, there's probably at the midpoint about $1 million of timing items that we got the benefit of in the second quarter that will push into the third quarter. And then also with some incremental in your professional fees that we'll incur in the back-half of the year, (inaudible) planned as well as because the results are obviously stronger at the EBITDA and EPS levels than we previously anticipated.
Many of our variable compensation plans are tied to the improved performance. So you're seeing a shift upwards in the back-half of the year and the cost related to some of the variable compensation plans.
Some modest incremental professional fees and then the timing difference from Q2 to the back-half on the cost side of things that will…
Robin Farley – UBS
Okay. And the profession fees, is that related to SkyTouch or other than…
David White
It's just the general professional fees, not any specific SkyTouch related ones.
Stephen Joyce
So and then on the second part of your question, this is actually a fairly normal pattern that we've seen historically in the cycles, where the primary growth in the start of the cycle comes in urban markets and primarily benefits the upscale and upper upscale, they're also the ones least affected by downturns based on their education level and their travelling patterns. And now, what you're seeing is as the cycle progresses that's spreading rapidly into the other segments, that coupled with two important factors.
For our segments, both consumer confidence and employment are critically significant to our performance, particularly as it relates to employment, if you look at our performance over the years, a slight downtick, it's an exaggerated impact on the down side. But a slight uptick which is what we're seeing gets exaggerated impact on the upside as well.
So I think consumer confidence, the jobs growth that we're beginning to see, people sense that now is a good time. We did a survey early on of what our customers will do in the summer.
They were very bullish about the number of trips they were going to take and the amount of bookings that they were going to make with us. And so I think what you're seeing is that as the cycle progresses where the upscale brands tended to be benefitting the most from that upturn, you're now seeing it fully being born in the mid and upper economy segments that we operate in primarily.
And so we are seeing that, and what the nice thing is, we're also seeing that momentum holding. And so we're expecting a very strong back end of the year as well, and while we are not going to get into next year, it looks as if this run should continue for quite a while.
Robin Farley – UBS
Okay, that’s great. Thank you.
Operator
(Operator Instructions) And your next question comes from the line of David Loeb with Baird. Please proceed.
David Loeb – Robert W. Baird & Co.
It’s David Loeb for David. And it’s is Baird but you knew that.
Stephen Joyce
Good morning, David.
David Loeb – Robert W. Baird & Co.
Good morning. I just had a question about the accounting change.
So I gather this – this happened when you changed auditors. So the previous auditors found no material weakness, but the new auditors said this was a material weakness, is that correct?
Stephen Joyce
Well, no, I mean the – it’s the predecessor auditors that make the judgment call on the internal control side of things.
David Loeb – Robert W. Baird & Co.
So this is not the current auditors? David White So, basically, when we identified during the second quarter that we needed to adjust the accounting for the one-month lag.
We went back and had a discussion about that with our predecessor auditors, concluded we needed to restate certain quarters. But because the impact on annual periods is immaterial, we won't be required to restate the annual periods, although we will.
When you see our future filings, you will see them revised to reflect this is as an immaterial upward adjustment. And then it forces you to look at the internal control side of things with your predecessor auditor.
Stephen Joyce
And quite frankly, the practice of lagging a month came with the inception of the company. It wasn’t changed, because it seemed acceptable to everyone.
There was never any question, it is an accounting interpretation that it was a material weakness, those are the words that come from the literature. But it’s not as if the entire public and all the investors and everyone else that had ever been involved didn’t know that we accrued one-month in arrears.
And so quite frankly, I think this move helps us a lot, because now the comparables on a calendar year will be much easier. It won't be a differential point between our performance and others, which I think makes comparison easier.
So – and quite frankly, I've been through this before in a previous company that had a similar situation and also made that change. So my view is while you never want to have a discussion point around this with investor public, it’s easier not to do it, which is primarily why it wasn’t changed before.
This change makes a lot of sense, and so the timing seemed right to go ahead and do it and so we're doing it.
David Loeb – Robert W. Baird & Co.
Yes, Steve, I have to say, I think it’s a change for the better, I agree with you on that.
Stephen Joyce
Yes.
David Loeb – Robert W. Baird & Co.
And I guess, I also agree about material weaknesses, in the age of Sarbanes–Oxley that term is thrown around pretty loosely for things that seem pretty minor. I guess, David maybe you could just explain a little better about how it is that in the age of Sarbanes–Oxley, you could go this long without somebody bringing this to your attention earlier, that’s the part that I guess I was puzzled, because it seems like you’ve had the point of sale systems in place, where you get essentially instantaneous information on operations at your franchise properties?
David White
Yes, I think that you kind of hit it there. I mean, at the end of the day, this practice we believe, as Steve mentioned, I mean, it was initiated prior to us becoming a public company more than 17 years ago.
We think the reason it was initiated was because we used to be on a kind of a manual paper-based system by our franchisees where they report the gross room revenues to us through faxes basically. And there is inherent time lag in that process and given that and the seasonality of the lodging business, at that time when this policy was going to be established, we thought it was probably difficult to establish a reasonable estimate of monthly gross room revenues.
But you're right over time we developed electronic reporting capabilities to gather that franchise gross room revenue information and now we have it. So we can certainly make that estimate.
The company had not previously considered it to be material, because on an annual basis, it was – in our view clearly not material in the annual financial statements. And it doesn’t materially impact even on a quarterly basis, materially in our view they trending and the result of – it’s in this shift it’s more the seasonality of the business.
It’s tough, David, to say why now versus why it wasn’t identified in the past, but honestly, I'm not even sure if there's any benefit to be gained by having that conversation. It's kind of does what it does, we're fixing it.
We think it will be better from a comparative perspective going forward and that’s where we are.
David Loeb – Robert W. Baird & Co.
Totally fair and I agree. Thank you.
Stephen Joyce
Thank you.
Operator
And your next question comes from the line of Jeff Donnelly with Wells Fargo. Please proceed.
Jeff Donnelly – Wells Fargo Securities, LLC
Good morning, guys. I was…
Stephen Joyce
Good morning, Jeff.
Jeff Donnelly – Wells Fargo Securities, LLC
Considering SkyTouch I guess first question now, how does it fall in terms of the (inaudible) versus your original expectations?
Stephen Joyce
I would say pretty much on pace with what our expectation was. And then I would say in the pipeline, it’s probably stronger than we anticipated in terms of, particularly the larger opportunities that were in discussion on.
So we're pretty excited about where we are, that got to approve it and sign them. But the one signing of the 500 unit chain we think is encouraging.
The HiTEC Conference was particularly encouraging given the amount of interest and kind of buzz about the system, and we're getting a lot of looks from a lot of people. And so on the pipe side, it’s hard not to get enthusiastic about the discussions we are having.
But we've got to approve it by signing them up, and we think we are on good position to do that and we will continue report those results as well as the other thing that we're moving towards that we said in the past is, as we would like to give you guys more help in sort of modeling what the impact will be over the next couple of years. We're not quite ready to do that, because we don’t think we have sufficient information and sort of a sufficient booking pattern to be able to say, okay, we know it’s X, but there's – but we're getting closer to that and probably in the next several quarters, we will be able to do that for you.
Jeff Donnelly – Wells Fargo Securities, LLC
And it's actually one of my, maybe second question, maybe a statement, as I think (inaudible) performed a little bit this year, (inaudible) performed this year is, I suspect in large part due to – excuse me, SkyTouch, how it flows through your financials, but also that as you said, the lack of understanding or clarity around the future. Are you able to, Dave, maybe provide people of the sense of what you are ultimately going to commit there in terms of capital investments or maybe even a sense of what success looks like even if it’s a few years down the road?
Stephen Joyce
Yes. So, I'll just repeat what I said previously was, look, we believe while it is a venture that we hadn’t been in before.
We've been in this business for a long time, so it’s not a new business. We know exactly what we are spending and we are in the process of investing in what we think will be a profitable venture for us.
But I've also said and I'm holding to this that, if we don’t believe it’s going to be profitable in the next couple of years, we'll shut it down and go back to where we were or figure something else out. And so from a risk standpoint, yes, we're putting some money into it and sort of you should think it's sort of the levels we are currently putting it in, but we are not going to do that forever.
And if we don’t prove to ourselves relatively shortly, that this thing is going to go and be a significant contributor to the company then we will reverse our position, take it back in-house or figure out some other form that we think makes sense.
Jeff Donnelly – Wells Fargo Securities, LLC
Okay, that's great. Thank you very much.
Stephen Joyce
You bet.
David White
Thanks, Jeff.
Operator
There are no remaining questions at this time. I would like to turn the call over to Steve Joyce for any closing remarks.
Stephen Joyce
Okay. Well, that concludes our call for today.
Obviously, we're very excited about where we are and what's going on both in the industry and for Choice. As always, thanks for joining us and your interest in Choice and we'll look forward to talking to you next quarter.
Have a good day.
Operator
Ladies and gentlemen, that concludes today's conference. Thank you for your participation.
You may now disconnect. You all have a great day.