Good morning, and welcome to the Choice Hotels International Third Quarter 2018 Earnings Conference Call. [Operator Instructions] 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. Actual results may differ materially from those indicated in forward-looking statements, and you should consult the company's Form 10-K for the year ended December 31, 2017, and the Company's other SEC filings for information about important risk factors affecting the company that you should consider. These forward-looking statements speak as of today's date, and we undertake no obligation to publicly update them 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 the third quarter 2018 earnings press release, which is posted on our website at choicehotels.com under the Investor Relations section. With that said, I would like to introduce Pat Pacious, President and Chief Executive Officer of Choice Hotels International, Inc. Please go ahead, sir.

Thank you. Good morning, and welcome to Choice Hotels Third Quarter 2018 Earnings Conference Call. Joining me this morning is Dominic Dragisich, our Chief Financial Officer. We're pleased to report another quarter of excellent performance, highlighted by reported diluted earnings per share, adjusted for special items, of $1.24, a 31% year-over-year increase. Our third quarter adjusted EBITDA exceeded our expectations with an 11% year-over-year increase, and our adjusted diluted earnings per share results exceeded the top end of our previous guidance by $0.07 per share. Our effective royalty rate also continued its impressive growth trajectory with a 12 basis point increase over the third quarter of 2017. Plus, our system size growth continues to meet our expectations. While our domestic RevPAR performance was lower than our previous guidance, this was driven by short-term and onetime impacts, which Dom will cover in more detail. We expect RevPAR growth to bounce back in the fourth quarter and have already seen a 2% year-over-year increase for the month of October. Based on our strong third quarter performance and fourth quarter outlook, we are pleased to announce that we have raised our full year adjusted EBITDA guidance by $1.5 million at the midpoint and raised adjusted earnings per share guidance by $0.09 at the midpoint. These strong financial results lay a solid foundation for continued future growth. It's been a year since my first earnings call with you as President and CEO. And in reflecting on the past year, I thought about what sets us apart and what makes us successful. First, we are strengthening our well-segmented and proven family of brands in a number of ways, from launching a new mid-scale brand extension to transforming our largest brand, to growing in both the upscale and extended-stay segments. Second, we're having incredible success as…

Thanks, Pat, and good morning, everyone. As Pat mentioned, we are very pleased with our third quarter results. As Pat mentioned, we are very pleased with our third quarter results. Today's release marks the third quarter this year where our financial performance has exceeded our expectations. We attribute this strong performance to our franchise business model, which provides multiple levers to drive revenue; our investments in and ongoing strength of our mid-scale and economy brand portfolio; our continued expansion of upscale segments with both the Ascend and Cambria brands; and our relentless focus on franchisee profitability. Choice's business model provides multiple levers to drive top line revenue growth. This includes expanding the number of franchised hotels in our system, increasing same-store sales, improving the pricing of our franchise contracts or a combination of all three. While the third quarter RevPAR results were below our expectations due to isolated occurrences like weather and calendar events, we continue to increase top line revenue by attracting new developers and adding new hotels to our portfolio, significantly expanding the royalty rates earned from our franchisees and increasing other revenue streams through offerings within our platform. Bold initiatives like a state-of-the-art new central reservation system, the Comfort transformation, new brands and our award-winning loyalty program continue to deliver strong quarterly and long-term results. Now let's review our third quarter results and outlook in more detail. Our third quarter financial performance was highlighted by revenue growth of 8% over the prior year period and quarterly adjusted EBITDA growth of 11% over the same period of the prior year to $103.6 million. We reported adjusted diluted earnings per share of $1.24, a 31% increase over the prior year quarter. As Pat mentioned, this performance exceeded the high end of our guidance by $0.07 per share. This earnings…

[Operator Instructions] And the first question comes from David Katz with Jefferies. You are live.

I wanted to just ask about indications for 2019 in any qualitative way. I know we're not up to the guidance process yet. But frankly, given how pressured kind of the industry has been, I think it might be helpful to get a sense there.

Yes, I think when we look at where the industry is being forecast for our chain scale, David, it's probably a little bit north of 2%, 2.2%, sort of on average, and we would expect to sort of perform in line with that. The qualitative thing that we've been talking about, which is the Comfort transformation, you got to think about that impact on it. And we'll have a better lens in that when we talk to you all in February as to sort of what the impact is going to look like in 2019. The way to think about the Comfort transformation is really there's about a third of the brand that's already done the Move to Modern. There's a third that's involved in it right now and a third that's yet to begin. And we do expect sort of that tipping point where the sort of a headwind of renovations will be replaced by a tailwind of better-performing properties at a certain point in 2019. So we'll have a better sense of that when we get to February, but I would expect our brands to perform basically in line with industry.

And then I think from a units and effective royalty rate perspective, David, we talked about where we're anticipating ex WoodSpring somewhere in that 3% unit growth range. We do expect that to accelerate into 2019, and we expect our effective royalty rate to continue to accelerate as well, not necessarily accelerate over and above the double digits that you're seeing this year, but certainly in line with historicals call that mid-single-digit range.

And just to follow that up, I think you may have indicated that opening pace is accelerating. I wanted to make sure I heard correctly. And just talk about what the forces are that are driving that. I suppose the devil's advocate might suggest with commodities and labor getting a bit more expensive and interest rate -- cost of money getting a bit more expensive, that sounds counterintuitive to me.

Well, I think it's twofold. One the conversions are easier to obviously get done and open that pace more quickly. If you look at our Ascend collection, the average day from awarding the contract to opening the hotel is about 100 days. So we have some brands that the pace with which we can literally get a contract award and get the hotel open in a very short time frame. We're seeing growth in those brands as well. And I think we've been building our new construction pipeline. Dom talked about that starting to accelerate as well. And so that's starting to have an impact as well. As we think about the Comfort turnaround, a lot of that started several years ago with exiting older products in the brand which opened up markets, which then led to new contracts being awarded over the last couple of years. We're now starting to see those types of hotels come online.

And the next question comes from Shaun Kelley with Bank of America.

Maybe just to stick with David's point on the unit growth pipeline, I mean, maybe to say it more concretely completely, we've actually heard some of the like larger U.S. brand companies starting to talk about a plateau in their U.S. development side and possibly maybe even modest declines when we look at the supply outlook across '19 and '20. It doesn't really appear that you guys are seeing that activity. So just kind of -- could you elaborate just a little bit more on maybe specifically what you're seeing on the interest level for developers and what's allowing them to build or develop Choice properties at this point in the cycle when other guys are struggling to grow.

I think -- I'll talk about it at the brand level, and then Dom can sort of follow in. When you think about what we've done with Comfort Inn, we created a number of markets in this transformation. So we actually shrunk demand, if you go back and look at it, say, five years ago. That created a lot of open markets for our brand that's in very high demand. And so I do think that at this point, where we are in that brand strategy, we're seeing a lot of demand for that and in particularly new construction Comfort Inns. I also think when you think about the brand that we acquired, WoodSpring, that is just a brand that once we brought it on to our platform, exposed it to our current franchisee base, it's really increased the interest, not just in WoodSpring but in the extended-stay segment as well. So both MainStay and suburban are seeing accelerated even beyond our expectations we have at the beginning of the year because there's a renewed interest within our development community for our extended-stay product on the Choice platform. And then obviously, the Cambria and Ascend collection, both of those are upscale opportunities where you look at the number of rooms we have, 20,000 rooms in the U.S., there's a huge number of markets for upscale products on the Choice platform that are available. So I think it's just not just there's developer interest in our brands, but also the opportunity and the brands we're growing into the new segments, that's really attracting the type of development results that we're seeing.

Yes, Shaun, I would say for Comfort specifically, if you think about the new construction pipeline growing as dramatically as it had in the last couple of years and call it the 1 to 2-year time line for construction, we've had more than 120 new ground-breaks this year alone for Comfort, which is about 40% ahead of where we were last year for that particular brand. And I think just more on a macro basis, if you think about the profile of our franchisee and kind of call it that mid-scale space, where they're financing these projects, 50% equity upfront and only going out and raising 50% debt, easier to not run into snags in terms of rising interest rates and some of the tightening that you may see from a loan-to-cost perspective. So we're continuing to see acceleration on that side as well.

And then just 1 or 2 RevPAR questions, if I could. The -- if you could just in the quarter try and quantify for us, if you could, what you think how -- what you think the impact from that Comfort renovation specifically was. And then as we look out to the fourth quarter, most people are pointing us to think that October is going to be the best month of the quarter. And I hate to subsegment your guidance. But if we look at the 2% you said for October, is that your expectation that things can stay there to kind of stick within your guidance range? Or do you expect that to slow at all?

No, 2%, we sort of guided to 1% to 3%. And so we do think 2% is sort of the midpoint, and October is there. We think we can maintain that as we get into November, December. So I think that -- we feel pretty comfortable about our Q4 guidance. Regarding the sort of Q3 RevPAR, we've looked a lot at sort of the impact that the renovations in the Comfort Hotels have impacted. We peg that at about 60 basis points sort of takeaway, if you look at it that way from the standpoint of so where the chain scale should have been. When you take rooms out of service at the level we're doing it for Comfort, it's probably about a 60 basis points decline on that front. The calendar shift is probably about a 20 basis points that Dom mentioned July 4 and some of the Jewish holiday shifts. And then really when you look at the hurricane impact, that's probably about 30 basis points. So we've -- that one is really hard to predict just because -- what's really interesting about these hurricanes is they aren't year-over-year the same thing. If you look at Hurricane Irma from last year, that hurricane actually was almost like the impact of two hurricanes because it approached the East Coast of Florida and created folks evacuating the East Coast. And it didn't hit it. If you remember, it swung around the peninsula and hit the West Coast of Florida. So we got sort of a lot of people moving from East interior and then from the West Coast interior. And you didn't have a similar-type hurricane this year. Florence had a long sort of weeklong -- people expecting a large hurricane to hit, and you ended up with a lot of evacuation zones. So hotels were closing way in advance of any hurricane impacts. And many of those hotels closed, and they ended up being outside the impact area. So the hurricanes are really hard to predict. And the final one, which is maybe unique to Choice, because of where our product sits, is the solar eclipse. We had Econo Lodges in the middle of Kentucky in the late August having three-night stay minimums with triple-digit ADRs because people were going to see the solar eclipse. And there's no way to predicate it because you don't sell tickets to a solar eclipse. People just sort of find out where the path is. So that one was probably unique because of the secondary and tertiary markets in the lodging space, where we had a lot of product. So I think when we look at those impacts, those are sort of the major components to it.

And the next question comes from Robin Farley with UBS.

This is Arpine in for Robin. Did your outlook for Q4 change at all versus what you were looking at a quarter ago? The implied range was quite wide, and it seems like midpoint barely changed, maybe only slightly lower in terms of what you're looking at today versus about three months ago?

I think the easiest way to explain it is if you think about the puts and takes from the beat in Q3 flowing into Q4. So we beat the midpoint of our EPS guidance by about $0.09 per share. A little over two third of that was operational. About one third of that was tax related. And so in Q4, you're picking up a little bit of additional tax benefit, which is why you see that tax rate in Q4 coming down a little bit. And we're investing about $1 million or $2 million more in Q4 for some of our R&D-like activities, et cetera. So long story short is we expect Q4 to come in line with expectations that we previously had, and we're flowing the beat through from Q3 to Q4.

I was start of more asking for RevPAR in terms of implied wide range. Do you feel that, that midpoint changed at all in terms of what you're looking at now versus a quarter ago?

Not the Q4 midpoint specifically, no. So it really is attributed to those onetime impacts that we saw in Q3. We're maintaining that, call, about 2%-ish trend that we had expected, if you normalize all of these onetime impacts as well.

And then the royalty rate is going up on clear basis, and Q3 was actually slightly ahead of our expectations. Could you break down sort of some of the drivers for acceleration next year and growth in terms of published rates and what's in the books? I know you outlined about mid-single-digit, right, versus sort of going back to double.

That's correct. So I mean -- so if you think about the mid-single-digit growth in 2019, a lot of it has to do with the tougher comps. And that's the reason why we guided where we guided for full year as well. Q4, in particular, is tough for comps because as your pricing increases, it's just tougher to overcome that. Now in terms of the drivers, a lot of it has to do with the -- what we had talked about in previous quarters, which is we increased the rack rate across our entire portfolio over the last 24 months a few times actually, which just shows the value proposition that we provide to our franchisees. We're continuing to see some of those burn offs from the discounts that we provided post-recession, post back in 2008, 2009. And so those are 2 of the drivers. And then the third is just when you see the success that we've had in the development environment, we just have to go to market with fewer discounts. And so those 3 drivers in particular have really been the catalyst behind the double-digit increase this year. We do anticipate continuing to benefit in the 2019, not quite to those double-digit rates, but probably somewhere, maybe even a little bit better than those historical, call it, mid- to low single digit.

And then one quick housekeeping. What is driving the nonhotel franchising loss higher versus the last time you guys guided?

So what we're doing, when you think about the company and the brand launches we're doing and expanding sort of the new product offering, things along the lines of vacation rental, our partnership we had with Bluegreen, there's a lot of additional R&D expense that we're providing that really is sort of showing up in those numbers. That's where things like new prototypes, that Clarion Pointe market research and those types of things that we have -- we do in order to identify new growth initiatives for the business, fall into that bucket.

And the next question comes from Gregory Miller with SunTrust Robinson Humphrey.

I'm on the line for Patrick Scholes. Just a question on Clarion Pointe. Since you mentioned that you're aiming for over 1,000 hotels and given that Clarion core brand has about 300 hotels globally and 166 domestically, I'm curious what drove the decision to choose Clarion's brand name as a brand extension versus choosing a new brand name. It seems like you feel the Clarion's brand is well recognized enough to create the brand extension. But could you elaborate on that rationale?

Sure. Let me first address the 1,000 hotels. 1,000 hotels is sort of the available market that we look at out there. So we had 100% market share, say, in the next five years, we would get 1,000 hotels. If you think about our market share in the mid-scale segment today, it's about 25%. So just as you're thinking about available market and then how many will Choice actually award contracts to and bring on to our system, it probably will not be in the 1,000. I'd love it to be, but in that sort of next three to five years, it's probably close to the, say, 250, 300 hotels is more likely. The reason for the use of the Clarion name is Clarion has one of the highest brand equities of our brands, of the 12 brands that we have. There is an aspirational concept or mind shift, if you think about in the mind of the consumer, and we wanted to leverage that. The second thing is that the Clarion hotel owners themselves also have additional product that doesn't have the full-service food and beverage options or meeting space. And so there was interest there from our current Clarion owners in doing additional product within the brand, just not having the food and beverage option and as much meeting space. So that was the reason behind picking a brand extension as opposed to a new brand, which really requires a lot more investment. And actually, when you're selling it to developers, there's really a question mark of is the consumer really going to know what brand X is. It takes years to build some brand equity. So leveraging that, we think gives us a real opportunity to accelerate the development. And with the early results, we believe that's starting to show up.

And could you elaborate a little bit on the geographic rollout in terms of urban, suburban, highway locations, what your intentions are?

For Clarion Pointe?

Correct, for Clarion Pointe.

Yes. It would probably be similar to our other mid-scale brands where it'll be primarily focused on secondary markets to begin with. That's where I think the initial hotel that we'll open will be in Gatlinburg, when you kind of think about those types of markets, but we do expect over time that will push into primary markets in a similar fashion that Clarion has.

And the next question comes from Alton Stump of Longbow Research.

Just wanted to ask, as you kind of think exceptionally about, of course, '19 builds accelerating, as far as the conversion versus new build rate, I would presume that conversions will be a higher percentage of your overall build. How much of that are you seeing players actually with cost going up, interest rates going up that may be some more opportunities for players that are looking to convert into a Choice hotel brand next year?

So with rising interest rates and some of the other headwinds I think that you see on new construction, so steel prices, those types of things, it's interesting because you hear that at sort of a headline level. But when I talk to our developers, they're not really experiencing that yet. And it's possible it is to come. I was with similar owners a couple of weeks back. And one of our developers suggested five Comfort Inns with us down in the Texas market. He's not having trouble finding construction crews and folks to get the hotels built. So it's not something I would just lay a broad blanket across. Your point, though, is well taken, which is in a market of rising interest rates and higher construction costs, you would expect to see more conversion opportunities versus new construction. I think the good news for us is the number of new construction hotels that are already underway because there's a lot of confidence that those are going to show up as open hotels as we move into '19 and 2020.

And then just a follow-up on the RevPAR front. I was just surprised to see it snapped back to 2% October given that -- I would assume that there are some headwinds year-over-year from the hurricane from last year. Of course, it's just 1 month of data, but can you give us some color, if you can, on what drove that pretty steep recovery versus what you put up in 3Q?

Yes, I think part of the October benefit is some of the hurricane sort of aftermath of the 2 that hit sort of in August and September here in the U.S. And I think the other part is some of the Move to Modern hotels are getting through their renovations. They're putting rooms back in service, and that's beginning to benefit us as well. As those rooms come back into service, we're seeing a pickup, too, in business demand as opposed to leisure. And as you think about Comfort Inn, the more hotel rooms we have open in Comfort Inn that helps because we're getting a lift in business now in addition to the leisure lift. Same thing is true for Cambria. That sort of lift in business transient is helping our Cambria and our Ascend brands as well our upscale brands. And on the other side of the house, in the WoodSpring side, that's also a brand that has a higher business to leisure mix than our other brands. So that's also what I think maybe sort of the positive drivers in October.

And as there are no more questions at the present time, I would like to hand the call to Pat Pacious for any closing comments.

Thank you. Thanks, everyone, for joining us today. As you can see, we have a lot to be excited about. Our strong financial metrics are laying a solid foundation for -- to continued growth. We excel at providing our owners with a proven brand portfolio and best-in-class franchisee resources that drive their profitability. This has resulted in greater demand to join the Choice system and put us in a path to set a new company development record. We're pleased with our third quarter and year-to-date performance, and we look forward to ending the year on a high note. So enjoy the upcoming holiday season, and we'll talk to you in the New Year.

Thank you. That concludes the conference call. Thank you for attending today's presentation. You may now disconnect your lines.