Choice Hotels International, Inc. (CHH) Earnings Call Transcript & Summary

Welcome back, everybody. So now I have to make that tough transition from like weighing the rabbit hole on prediction markets to what's going on in the hotel space. But this is actually really exciting. So to my right is Dom Dragisich. Dom is President and Chief Executive Officer of Choice Hotels. But the real story here is that he was just appointed to this role within the last few weeks. So congratulations, Dom.

Thank you very much. I appreciate it. It's an honor to be here.

So we've had the chance to work together for a number of years in your prior life as CFO, and we kept touch even in between there. But I don't think everybody is quite as familiar with you.

So let's just walk through, if you wouldn't mind, a little bit of your background and bio because you don't trace all your roots back to the hotel industry either. And I'd love to just kind of walk through that and what's led up to to your current role?

I certainly have a diversified set of experiences, and I know we have a prior relationship. But first thing I want to do is just say week 2 on the job. So it's good to see everybody again. It's great to be back. I was the CFO of the company for about 7 years. So a lot of familiar faces in the room, really excited to see everybody and talk throughout the day. But first off, honored by the Board's confidence in me with this appointment, really excited about leading the company through its next chapter of growth. And I think that's going to be the theme, just really laser focus on execution and growth. But to your point, Shaun, I am not new to the industry, spent a little bit of time at Marriott, but had a diversified set of experiences before I got to Choice, actually focused on finance, operations, strategy, also had a little bit of telecom experience. We share a little bit of a background there. So I've been in the technology world for some time. But just before Choice, I actually was the CFO of a company called XO Communications, which was a unique opportunity. I actually was able to work directly with Carl Icahn and his team. It was a bit of a turnaround situation, turn around the company and had the opportunity to lead the company through its eventual acquisition by Verizon. And it was back in 2017, where I got the call from Choice to basically become the CFO. And at the time, the company was going through a bit of a transition period. Obviously, there were some white spaces that the company was entering, extended stay, growth in some of the more revenue-intense segments. And I had a front row seat to all of that. That was the reason I was brought into the company to really lead Choice through that phase of its growth. And we were very successful in doing that. I obviously was instrumental in some of the inorganic things, so the acquisition of Radisson, WoodSpring, et cetera but also really helped lead the organic growth in terms of this revenue intense strategy, which is very much becoming a both-and, which we can certainly get into. But the reality is 7 years into the job, I was able to then really have a 360 view where I led the operations for the company, led the strategy of the company, led growth, development brands. So you name it, I've kind of done it here at Choice Hotels. And so it's really an honor to be in this role. And candidly, all of those experiences gave me a front row seat to effectively what is core to our model, and that's the franchisee, right? At the end of the day, when the franchisee wins, we as a franchisor win. So everything that we're focused on is the unit economics for our franchisee. And candidly, when they're growing, we're growing. And I'm really proud of the growth under the leadership team that I've actually had the honor of working with. When I joined the company back in 2017, we were a $295 million adjusted EBITDA business. Today, the guidance that we issued in Q2 implied about a $643 million adjusted EBITDA business. So pretty tremendous growth over a 9-year period of time. Just really excited to lead the company during this next phase of growth.

So when we think about presidents or executives, we always think about that first 100 days, right? And you said it yourself, you're first 2 weeks in. So what does that first 100 days look like for you? I mean, because you are coming from that internal seat, it's not like you don't know what some of the priorities of the business are, but you now have the ability to start to put some of your plans into action. So give us a little bit of a teaser of like what are some of your first initial things that you're working on?

Sure. First thing I'd say is the core of who we are as a company, that's not changing. There is going to be a little bit of a returning to our roots theme that you're probably going to hear throughout this conversation. But really, it comes down to that franchising business model. It's really being that asset-light franchisor. And again, when our franchisees win, we win. And so laser focused on unit level economics for our franchisees and really leveraging what we classify as a best-in-class conversion engine. And really, that has been the catalyst for our growth this year. And in the supply-constrained environment, we see that continuing to be the catalyst for our growth in the foreseeable future. But when you think about -- and I'll just kind of peek behind the curtain a little bit, what I've told our associates internally, I'm laser-focused on 3 things. And you're going to see kind of a maniacal focus on execution, which is mission-critical, but there's really 3 buckets. It's culture, it's execution and it's long-term strategy. And so as it pertains to the culture, really bringing in a sense of urgency in the role that I'm sitting in today a renewed energy. I think you heard it on the Q2 call, a transparent approach, frankly. I think it's really important to own where we may be falling short and to really lean in where our strengths are. And so that's my commitment to the investor community. That's my commitment to you as an analyst to continue to have that transparency in the sense of urgency. I think from an execution perspective, there's really 3 priorities. And that's my #1 priority is net rooms growth. And specifically in the U.S., our investors have asked for this time and time again, we are delivering momentum in that category, and we're going to continue to do so. I've already talked about unit level economics. And the third really is doing all this in a capital-light fashion. And I think throughout my tenure, we've actually put the balance sheet to work for acquisitions, for development and whatnot, but you're actually seeing us becoming a net recycler of that capital. So that's going to continue to be a huge focus for me and really returning to our roots from a capital-light perspective. And then the last bucket, like I said, it's really around the long-term strategy. And I think the bridge there is a lot of what you heard on the Q2 call as well. It's really our commercial engine. I think that this is an area where we've really leaned in on the investments that we've made over the last 2 years just with regards to a guest data platform, an RFP tool, a new loyalty program, a loyalty tool itself. A few things we'll probably talk about throughout the day today, but that really is the bridge in terms of us becoming a much more consumer-centric organization that is really AI-enabled. I think we can't have a conversation without talking AI, but I won't get into that just yet. But it's on the list. Great. But really, as you think about that evolution, where we've really fallen a little bit short, frankly, it's relative RevPAR performance. And so the investments that we've made over the last 2 years are really going to help us fuel the growth in the future in terms of heads and beds in that same-store sales growth. And so we're feeling good about where we are. Those are going to continue to be my top 3 priorities, and I'm really excited about the opportunities ahead.

So we've talked about, I think, 2 variables in particular, and so we may have already touched on this, but let's go that layer deeper. When we think about the investment community, these are algorithmic businesses as we've discussed plenty, and they're not that hard, right? We've got RevPAR and same-store growth. We've got rooms growth. We've got royalty rate. We've got an ancillary fee bucket because it has become more important to the industry. Which of the KPIs, though, do we want to associate with you right now, kind of like when we're looking back and we're like, we've talked about net rooms and a little bit falling behind on RevPAR. RevPAR is harder to be a controllable. So like let's -- which one or both those North Stars, what's going to be the North Star for your leadership?

Yes. I think you hit the nail on the head. It's a very simple business model. Obviously, over the last couple of years, there's been a little bit of noise with regards to the acquisitions and like I said, the development and whatnot. At the end of the day, my #1 priority is net rooms growth. And so the algorithm is simple. It's net rooms growth, RevPAR, effective royalty rate, those non-RevPAR fees, the ancillaries and then our international growth, which is about $50 million in terms of international. So that can continue to be a driver for the business. But I said them in order, right? My #1 priority continues to be net rooms growth. We're very encouraged by the progress that we're making. You continue to see sequential improvements, and you saw global rooms growth really accelerate in Q2. The U.S., in particular, is much more revenue intense, so to speak. And so from that perspective, my focus is really around just getting that U.S. rooms growth back to positive. We're feeling very good about the fact that openings were up about 30% in Q2. The development environment with franchise agreements were up about 30%. We're opening these hotels faster. The role that I was in even prior to the CEO seat, that's where my focus was. It was really on that operational variable. I think from a RevPAR perspective, you're right. You can't control the broader macro, but you can control really maintaining your fair share. And that's really where those commercial investments that we've made will allow us to get back to our fair share. And obviously, the goal is not just to get to fair share, but it's to eventually take share. And so RevPAR is the second key factor. And then effective royalty rate as you continue to drive franchisee profitability, revenue, lower costs and then obviously give them better tools. The effective royalty rate is the willingness to pay from our franchisees increases. And so you have seen that as a tailwind for us, 7 to 9 basis points is what we guided to for the year. And so those are -- those 3 metrics are the core revenue metrics and then obviously, the ancillaries and international growth. And we'll continue to provide transparency on that international line item as well.

So let's talk about this net rooms growth kind of turnaround, right? If that's going to be the North Star. And I think it's really important for Choice. There was a period in there, and this is where you and I were interacting quite a bit actually was around the revenue intense net unit growth strategy. And that was a hard one for Wall Street, right? We didn't have a major problem with it because analytically, we found that sort of everything you were doing actually backed up. But the bottom line was that aggregate room count was declining for Choice for a period of probably close to 2 years, while you were turning out some lower value units and you were bringing in higher value ones where you were able to even replace maybe catchment areas or AOPs with brands that you would have liked to have had there, but you couldn't before. But that's also been rolled off for probably more than a year, probably closer to 2 at this point. So what's been driving the turnaround that you saw in the second quarter? Because I think what's kind of gotten us back to a little glimmer of growth? And again, appreciating that there's plenty of white space or room to maybe improve that metric further. But walk us through the journey of where were we with the RING strategy and then kind of where do you think we are right now? What's driven that change?

Yes. So the RING strategy, revenue intense unit growth is kind of where we were 3, 4, 5 years ago and continue to be today. And so the product that we're bringing into the system continues to be a higher revenue per unit. So you're seeing more product in mid-scale, upper mid-scale, extended stay, upscale and less product coming in economy, specifically economy transient. So that's going to continue to be an important driver for earnings growth for years to come. The reality is we're over the biggest kind of what I would call the kind of the cliff of termination, so to speak, as it pertains to exiting some of that underperforming product out of the portfolio, lower quality, which has really been a nice tailwind for just the overall portfolio for us as well in terms of guest reviews and those types of things. And so we made the best decision for the time in terms of really turning around the Comfort brand, really leaning in on that revenue-intense strategy. But where we are today, there's no reason why this can't be a both-and. And that's really as it pertains to that franchisee success system that I think is the leading franchisee success system in the industry. We have a right to win in economy and lower mid-scale as well. So yes, we want to bring in higher-quality product, but that's really where you're seeing the focus. That's where you've seen kind of my focus over the last 2 years in that operational, like I said, and there's 2 sides of that, right? The net rooms growth has been driven by openings. Like I said, openings in Q2 were up about 30%. All of that has really been driven by 2 factors: the conversion engine and then on the new construction side, extended stay. Those have really been the bread and butter. 90% of our openings this year are expected to be conversions. We have a proven conversion engine. And the flip side of it is you've actually seen terminations significantly decline year-over-year. We're focusing people, process and systems on this. Obviously, like I said, we got over the biggest cliff. But the reality is our exits are down about 50% year-over-year as well. So you can do the math. Obviously, that's going to be a nice tailwind for us. It actually led to our increasing our net rooms growth guidance for the year as well. And just given the concentration of our portfolio in the U.S., that implies that we were increasing our U.S. rooms growth guidance as well.

I think the retention metric in particular, we do see just natural levels of higher churn at the lower -- as we kind of move down the chain scale ladder a little bit. But it's a hard one for us on Wall Street to pin down. So it seems like some of the work you've been doing has been behind the scenes we may just starting to see a little bit of the fruit there. But can you help us unpack or how would we gain confidence in this moving forward? Meaning, have we taken a brand-by-brand approach where we kind of called what we needed to cull and we're going to see that kind of move through? Again, we know the comfort initiative, but maybe since then, it hasn't been as clear. What's the right way to just gauge and make sure that what we're not seeing is the one place where it would be dangerous would be if we saw a change in brand standards just to keep -- just move the pendulum just to allow more to stay in the system for longer.

I couldn't agree with you more, and this is where kind of the both-and strategy comes into play because we need to continue to be revenue intense, but at the same time, we have the right to win with Econo Lodge, with Rodeway, some of our lower mid-scale brands as well. And so we're going to continue to do that, right? And I think what it comes down to, it goes back to, again, unit level economics. If you're performing and your franchisees are making money, they're staying in your system. And so we have obviously continued to drive profitability at the lower end of the chain scales as well with some of the programs and the tools and everything that we're rolling out to the select service lower mid-scale and economy players as well as up the chain scale. So that has been one of the reasons why you've seen that. The other is we've lapped a few of those initiatives that we talked about, the Comfort cleanup. So we're back to kind of standard termination rates with the Comfort brand, which obviously is our largest brand and our biggest revenue contributor. So that's no longer going to be a headwind. But really, this comes down to also just the way that we operate operationally, right? And so what we were able to do is put, like I said, our best people. We've got systems and we've got the data to allow us to get in front of that owner sooner, right? If you see an expiration coming up or if you see a window coming up, what is it that we have to do to ensure that they're satisfied? What is it that we have to do in terms of being able to retain them in our system, not at all cost right? But at the same time, making sure that we have that relationship, and we're getting in front of it. The reality is when you take a look at the termination side, we expected and this is what we guided to about a 250 basis point improvement in our retention rate this year. What that reflects is back to effectively where we were historically. So I think that we had a little bit of a wave of terminations over the last 2, 3, 4 years. But now what you're starting to see, again, a return to where we were historically, and we believe that we're going to be able to sustain that churn rate in the foreseeable future.

So walk us through then the medium to long term. We're going to -- we'll put this comfortably under the -- not guidance, but what would be the aspirational goal or possibility of where net rooms growth could get to? And like again, this is going to be something that's going to move over time. I can't just keep you staring [indiscernible] what's about to be said. But yes, just help us steer the boat here a little bit. I mean we -- the background is we know what the industry is achieving. We know what all the peers are doing. These are all publicly traded companies. And so we know the metrics that are out there. But what's reasonable for choice acknowledging that your churn rates are yours and your brands may be at a different part of your life cycle.

Yes. I mean, I'm not going to issue any sort of guidance, [indiscernible], so don't worry about that. But when you take a look at just the algo, I mean, what I'll talk about is historically speaking, this is a business that's grown 2%, 3%, 4% from a net rooms growth perspective. Obviously, the revenue intense strategy doesn't necessarily require us to get back to 4% plus or whatever it might be. But when you take a look at the implied guidance for this year, 1.5% is effectively what we guided. We talked about in Q2, we felt very good about where we were, and that's the reason why we raised the guidance. So again, we expect to see -- you saw sequential improvement from Q4 to Q1. You saw sequential improvement from Q1 to Q2. We expect to continue to see sequential improvement. And candidly, we believe that there's momentum in the business to certainly sustain that. And ideally, you would get back to those historical rates over the mid-to-long term.

Great. And you brought up a few times, and I think it's super important, the dynamic around franchisee health sort of so goes the franchisee, that retention rate is going to move very naturally with if they're having a great experience, they're going to stay in the system for longer, right, which is sort of the output of the function. This is actually -- this topic has become a bigger topic across the broad industry. So it's been a little less so at your chain scale, but I imagine it's being held across the industry. The truth is we know what owners have been up against, right? There was a very low ADR inflation environment, '17 and '19. There was COVID where it was just pure survival and then maybe a quick hockey stick ramp, but after that, sustained levels of high unit cost inflation, which just makes it hard, right? It's hard to grow revenues faster than costs. Put all that together, and franchisees are feeling it after 8, 9, 10 years of mostly headwind. So what can you do on that side to kind of return back to them some of those things? What are they asking for? And what do you -- walk us through a couple of the initiatives that you're starting to feel good about that are helping franchisees at that most basic level of saying, look, choice, we're paying you like here's what we wanted to see on our margins to make this a symbiotic relationship.

Yes. So it certainly has been a headline, especially as of late. It all comes back to -- you've got to look at it as a basket of goods, a basket of services that you're provided and ultimately, the overall franchisee profitability. That's where it starts. And so at the end of the day, fees, et cetera, are one component of that. I'm not going to sugarcoat it. The franchisees are pinched right now. Insurance, labor, property taxes, interest rates, the cost of financing has certainly increased over the last couple of years as well. And so everything that we're doing, and this is a company that has an 85-year history working hand-in-hand with small business owners. And I think that's where it starts, right? And how do you ensure that you're giving the franchisee what it is that they need to run a profitable business. And so we think about it, there's 3 levers. Again, very simple business model. We're driving top line revenue. And so all the things that I talked about from a commercial perspective, that's the key there is making sure that we're continuing to gain share in that regard. We're lowering their costs, and then we're giving them tools to operate their businesses more efficiently. And we can certainly talk about each of the 3. But it's not just about the cost to operate as well. It's the cost to enter the system. And so a lot of what we've been focused on is how do we ensure that we're driving our FF&E cost down? How do we ensure that we're driving cost to convert, cost to build. And so what you've seen is several initiatives that we've led over the last couple of years that has driven our prototype costs down by about 25%. You've actually seen FF&E reduced by about 20% as well. A lot of the headlines is really around fee relief, right? And so this isn't something new to Choice. Interestingly enough, for the last several years, not last quarter, a couple of quarters, we have actually tied fee reductions to guest review scores from a loyalty cost perspective, from an overall fees perspective as well, especially in the lower end of the chain scales where they are particularly pinched just given the pressure on ADR as well. So again, this is a holistic view of that franchisee profitability, and we're not new to this game. It's been 85 years, and we're really proud of where our franchisees are. Granted, there's still some headwinds. And frankly, supply is going to be less than 1%. So a lot of this is really centered around the cost to convert more so than the cost to build. And the faster we can get those owners cash flowing, the better it's going to be. So a lot of our focus has also been on accelerating the time from signing to getting that franchise open. And so we've actually been able to compress that by about a month as well, which has also been net favorable to the cash flow of a lot of these owners that are ramping.

And you mentioned fee relief, which is, again, it's one component of a complex matrix of what an owner is working through, but it's an important one, right, when they are looking at their P&L and scrutinizing every line item more than they arguably ever have, right? Can you help us put it in perspective? Again, some of these initiatives sound like they've been in place. It is not new that what you're doing. But what's kind of in play here? Because this is something that is becoming a little bit more of a discussion point across the industry, whether it's directional magnitude or kind of like what are you able to do in incent? And then how are you able to fund it, right? Is it really just efficiencies through some of the system fund and some of the different kind of fees that they're paying external, obviously, to the royalty rate that are ultimately being charged?

Well, so I think broadly speaking, when you think about the model, all-in fees for any franchisor is 10% when you think about the royalty rate and the system fund. I think the one that has gotten the most attention lately has been on the loyalty side, right? And so we've talked about a lot of the brand companies talking about loyalty in terms of who ultimately wins. And ultimately, if it's driving heads and beds, that's the goal here is really driving that top line. But that's where one of the focus areas has always been for Choice Hotels. But we want to tie that relief to an outcome. And to me, it's not just giving relief for the sake of relief. If you drive a certain guest review score above a threshold, which obviously is the most closely correlated metric to RevPAR index, we're going to give you some relief because why? We're going to be able to make it up basically and both of the parties win, the franchisee and the franchisor. So again, that's one of the areas where you've seen the fee relief. The other is just, like I said, in the economy segment in particular, where, obviously, if they have an LTR score above a certain amount, which is our likelihood to recommend score, we would give that relief as well. So you'll see that come off of that overall 10%. It's a smaller component of it, but the reality is it goes back to do you have the ability to drive other SG&A down for that franchisee as well from an automation perspective, et cetera. So broadly speaking, because of the rising cost and some of the other P&L items, the franchisee fee has become a smaller percentage of the overall cost picture. So the key here is how do we actually go target reducing their cost to operate through those other P&L items.

We'll come back to that in a minute, but I want to -- like one last area on sort of the rooms development picture is we've started to hear some competitive buzz about just more investment spending in the landscape, more key money that's being commanded potentially like lower chain scale and price points, right? I think all of this is a pretty natural outgrowth of 4, 5 years now straight of materially below long-term average supply growth. So we're all competing over a smaller and smaller pie and all looking for ways to get kind of involved in that. What's your perspective just on the topic overall? Are you seeing that money trickle down to your price point? And then you're in a very different phase of where you might be on key money, which is you put a lot into some new brands and starting to actually maybe recycle a piece of that. So talk about those 2 different balancing. What are you seeing in the industry? And then kind of how is this translating to Choice's kind of budgeting and thought process?