Choice Hotels International, Inc.

Ladies and gentlemen, thank you for standing by. Welcome to Choice Hotels International's second quarter 2020 earnings call. At this time, all lines are in a listen-only mode. I will now turn the conference over to Allie Summers, Investor Relations Director for Choice Hotels.

Good morning, and thank you for joining us today. Before we begin, we would like to remind you that during 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 forms 10-Q, 10-K and other SEC filings for information about important risk factors affecting the company that you should consider. Moreover, we would like to acknowledge that there continues to be significant uncertainty as to the duration and severity of the impact of the COVID-19 pandemic on our occupancy levels and future results. 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 second quarter 2020 earnings press release, which is posted on our website at choicehotels.com under the investor relations section. This morning, Pat Patience, our President and Chief Executive Officer, and Dom Dragovic, our Chief Financial Officer, will speak to our second quarter and year-to-date operating results and financial performance. They'll be joined by Scott Oaksmith, Senior Vice President, Real Estate and Finance. Following Pat and Dom's remarks, we'll be glad to take your questions. And with that, I'll turn the call over to Pat.

Thanks, Ali, and good morning, everyone. We appreciate you taking the time to join us and hope that you and your families are well and healthy. I'd like to begin by acknowledging the truly remarkable efforts throughout the first half of the year of our franchisee small business owners and their hotel staff, as well as Choice Associates around the globe. Thank you for all you've done for guests and the communities you've touched. This quarter has been marked by unprecedented events, and the velocity of change has never been greater. As you'll hear today, we outperformed the competition in the second quarter on several fronts. The year-over-year change in our domestic system-wide REVPAR of negative 49.6% outperformed the overall industry by over 20 percentage points. and exceeded the primary chain scale segments in which we compete, as reported by STR, by 7 percentage points. And as you can see in Exhibit 7 of our press release, our domestic system-wide occupancy rates surpassed the industry by an average 570 basis points per week since the onset of the pandemic in mid-March through July 25th. We're pleased that these trends continued through July. For the past 20 weeks through July 25th, we continued to observe material REVPAR share gains against the competition. In the second quarter, all of our economy, extended stay, and select service brands achieved material REVPAR index gains versus their local competitors. with the Comfort Family, Ascend Hotel Collection, and Extended Stay Portfolio, each experiencing share gains of over 10 percentage points. Domestic system-wide daily occupancy levels surpassed 60 percent last Saturday, and over half of our domestic hotels experienced occupancy levels north of 50 percent during the last week of July. At the same time, our development results provide even further cause for optimism. In the first half of the year, we awarded over 150 new domestic franchise agreements. Over 80% of the agreements were signed since the middle of March. And two-thirds of the agreements sold in the first half of the year were for conversion hotels, which are expected to open more quickly than our new construction projects. In addition, we maintained our development momentum with 33 new agreements signed in the month of July alone. This morning, I'd like to highlight three areas. First, the factors that are driving our performance against competitors and position us well for the second half of the year. Second, the close and unique partnership we have with our franchisees. And finally, our thoughts on the road ahead. There are several factors contributing to our outperformance of the industry averages in the second quarter. First is our strength in leisure travel, which has climbed in recent months, and currently represents over 80% of consumed room nights system-wide. In fact, the proportion of arrivals from our leisure guests increased by more than a third in June as compared to the levels seen in late March. We're proud of our reputation as the hotel company families turn to for vacations and road trips. Our ability to appeal to these guests has proven to be a competitive advantage since the onset of the pandemic, as leisure travel continues to lead the recovery. This summer, the more than 2,000 domestic hotels in our system near beach locations and national parks offered attractive destinations for travelers looking to practice outdoor social distancing. Contributing to our ability to appeal to leisure travelers is our geographic footprint. Our hotels are located in the right markets to capture growing demand from travelers who increasingly are choosing to drive to their destinations instead of flying. We're well positioned given that we have more than 4,000 hotels across the country located within one mile of an interstate exit. In June, one-fourth of our revenue came from customers who traveled less than 25 miles to a hotel, a sign that more guests just want to get out of the house while staying closer to home. We expect that our strong presence in drive-to locations will lead to continued outsized performance as gas prices remain low and travelers feel safest in their own cars. This provided the basis for our new multimedia ad campaign On the Road Again, the first to launch from a major hotel company since the pandemic began. Throughout the second quarter, we observed significant monthly increases in our proprietary contribution, which we believe was supported by the campaign. More specifically, from May to June, our website contribution increased by 370 basis points and our loyalty contribution increased by 460 basis points. While our hotels attract a higher proportion of leisure travelers and are not reliant on group business from meetings and conventions, we've seen both a gain in market share and a steady week-over-week increase in the volume of business traveler room nights since a low in early April. This is thanks to the profile of our core business travelers who've been on the road these past months, including first responders, medical and other essential workers, government, trucking, logistics, and construction workers. We're also capturing a larger share of consumer demand, which is the second factor contributing to our outperformance in the second quarter. Not only are we gaining new customers who are attracted by our well-known brands, and the ability to drive to our hotels. But the average number of stays per guest has also increased during the second quarter relative to 2019. We're also benefiting from our key customers. Choice Privileges Diamond Elite members spent more at our hotels in July as compared to July of last year. Our award-winning loyalty program is now 46 million members strong and enrollments continue to grow. Our long-term strategy is not just to grow brands in the right markets, but also to grow the right brands in the right segments. The focus of our strategic investments has been concentrated on the more revenue-intense mid-scale, extended stay, and upscale segments, and it's paying off. In the second quarter, we achieved a 2.3% aggregate increase in units and a 3.7% increase in rooms across these three target segments, despite the challenging environment. I'd like to briefly highlight the brand's driving success in each. First is mid-scale, the segment where our company was founded and where we are a leader. One in four mid-scale hotels in the US is a Choice Hotels brand. Our upper mid-scale and mid-scale brands represent two-thirds of our total domestic portfolio. Comfort's $2.5 billion system-wide renovation has positioned our flagship brand extremely well to weather this storm, attracting both travelers and hotel developers looking for a trusted brand to deliver proven value. This is already bearing out. In addition to the REVPAR index gains against their local competitors of 13 percentage points in the second quarter, the Comfort brand family experienced a REVPAR change that was over nine percentage points higher than the upper mid-scale change scale. Comfort hotels that completed their renovations by the end of 2019 experienced even stronger REVPAR and saw a significant advantage in REVPAR index gains of nearly 16 percentage points versus their local competitors. Comfort now represents over a quarter of our total domestic pipeline, which will fuel revenue intense growth for years to come. The next segment in which we targeted our strategic investments is extended stay, where our well-positioned brands afforded us a competitive advantage with industry-leading performance. Between the onset of the pandemic in mid-March through the end of the second quarter, our portfolio of 414 extended stay hotels grew 8% year over year and achieved average occupancy rates of 66% nearly double the industry average. Leading the way was our WoodSpring Suites brand with an average occupancy rate of 69% in the second quarter, beating the overall industry by nearly 36 percentage points. WoodSpring Suites' occupancy levels have remained above 70% since mid-May, and in the last week of July, returned to occupancy rates consistent with 2019 levels. Savvy developers looking to drive returns in practically any economic environment know that demand for extended stay lodging outpaces industry supply by 2 to 1, which contributed to the 8% year-over-year increase in our extended stay pipeline in the second quarter. We're very optimistic about the growth potential of our extended stay portfolio including our dual-brand sleep mainstay concept and our new EverHome Suites brand. As for the upscale segment, our portfolio achieved impressive year-over-year growth in the second quarter, including a 37% increase in room count, outperformance in RevPar change of over 7 percentage points versus the upscale segment, and RevPar share gains against local competitors. Contributing to our success is our proven conversion engine, which allows us to drive unit growth through down cycles. For example, the Ascend Hotel Collection was launched in 2008 during the Great Recession and is now the industry's largest soft brand with over 370 hotels around the globe. We see significant opportunity for the Ascend Hotel Collection as we recover from the crisis due to the brand's low capital requirements for entry and strong value proposition for owners driven by reduced customer acquisition costs. Our upscale Cambria Hotels brand benefits from strong leisure travel demand thanks to being affiliated with our system. The brand's developer interest remains high, and in fact, The number of contracts we awarded in the first half of the year is in line with last year's results, proof that the brand's value proposition is resonating. Ultimately, what sets Choice apart is not that we're the only lodging company with a primarily franchise-only business model. It's who our owners are. Ninety percent of our hotels qualify as small businesses. I meet regularly with these entrepreneurs, many of whom have overcome a lot to build a legacy for their families. For them, their Choice brand hotel is more than an investment. It's their livelihood. A soft year can make or break their ability to afford their child's college tuition. Therefore, their wholehearted commitment to the success of their business is unparalleled and differentiates Choice Hotel's partnership with our franchisees. Our typical franchisee is an owner-operator with one hotel financed with low overall debt levels and a flexible operating model that allows owners to scale back staffing and service levels to reduce expenses, critical elements during down cycles. Even in April, amid the worst week of the crisis in the industry, over 90% of our domestic hotels remained open, demonstrating the tenacity and resilience of our ownership base. Today, we're proud to say nearly 100% of our domestic hotels are open. In addition, we continue to see increased openings in our international portfolio, where 96% of our hotels are open and operating as of the end of July. We're proud to have earned the trust of so many small business owners by demonstrating consistently over more than eight decades in business that we treat our franchisees investment just as seriously as we do our own capital, and more recently, by providing the necessary support to help them weather this crisis. For example, we redeployed associates from across the company to help franchisee facing teams contact owners from every hotel in the system, resulting in nearly 25,000 individual consultations. We've also remained active in our advocacy efforts at the federal level to secure relief for franchise businesses as the economy reopens. We hope that the Congress will be able to vote soon on an agreement on critical economic relief and stimulus. I've met recently with the leaders in the administration and the Congress and just yesterday with Speaker Nancy Pelosi to ensure that relief for small business is front and center in their discussions. We continue to leverage our award-winning Choice University online learning platform to educate our owners on the various federal programs as they come online and share best practices around reducing their operating expenses. A few weeks ago, Choice Hotels was ranked the number one organization for excellence in learning development by the Learning 100 Awards. We're honored to have been the only lodging company on the list and surpassed companies like FedEx and the Khan Academy. In addition to a targeted and strategic fee deferral program, we sought to help further improve our owners' profitability by optimizing the operating efficiency of their hotels. While this has been one of our core focuses for years, the pandemic has further accelerated some of our efforts. For example, we've rolled out offerings like grab-and-go breakfast, housekeeping on demand, and contactless check-in that not only keep pace with rapidly changing guest expectations and enhance the safety of travelers and on-property associates, but also lower franchisees' total cost of ownership. Two key metrics tell us that we're living up to our promise as a franchisor to help small business owners be in business for themselves, but not by themselves. First, over half of the new franchise contracts awarded in the second quarter were with existing or returning owners, which means we're providing an attractive value proposition to those who know us well and those new to Choice Hotels. And second, We maintain an industry-leading voluntary franchisee retention rate of 98%, of which we are extremely proud. I'd now like to share a few words about our people and our corporate culture. At Choice Hotels, we are committed to our values, reflected in our brand promise of making every associate, partner, and guest feel welcome, wanted, and respected. Part of how we deliver on this commitment is by weaving deliberate diversity and inclusion initiatives throughout all levels of the enterprise. For over 15 years, our board of directors has had a diversity committee specifically aimed at advancing a culture that values diversity and inclusion. We also have a long history of enhancing the diversity of our ownership base by supporting minority and veteran entrepreneurs and providing best-in-class resources that hotel owners need to drive these values throughout their organizations. As the national conversation about race has unfolded, we've initiated a series of actions that brought us together as a community to have courageous conversations, listen, learn, and support one another. These efforts will be outlined in our updated ESG report this coming fall. I'm proud to say that our culture of diversity, equity, and inclusion is being recognized. We recently have been named one of the best employers for diversity by Forbes, the best place to work for LGBTQ equality by the Human Rights Campaign for the eighth consecutive year, and one of the best places to work for people with disabilities, earning a perfect score on the Disability Equality Index. I'm also deeply honored to have been named one of the best CEOs for women employees by Comparably. Before handing it off to Dom, I'd like to share a few words about the road ahead, both for our company and the industry. As for the economic and industry outlook, we are planning for the recovery to continue to be sporadic and regional. Even if an increased wave of the pandemic were to return in the fall, There are several factors we believe would mitigate the impact on our business and that we are closely monitoring. First is the duration and scope of any travel restrictions. We seem to be getting geographically narrower and localized as the pandemic wears on. Importantly, 96% of our portfolio is comprised of select service hotels that do not have bars or restaurants. which have been a particular focus of restrictions across the country. The degree to which the virus spreads will depend in part on our collective adoption of best practices around hand hygiene, social distancing, and personal protective equipment. This brings me to the second factor we're monitoring, consumer behavior. As for consumers having the means to travel, We are optimistic that additional government assistance and stimulus funding currently under debate will, once passed, help get Americans back on the road again. Our commitment to clean initiative is aimed at boosting consumer confidence to travel by building on our existing dedication to cleanliness. As part of commitment to clean, we made the decision to require guests to wear face coverings in hotel common areas as an important and simple step everyone can take to help protect the safety of guests and franchise hotel employees by slowing the transmission of COVID-19. As a member of the American Hotel and Lodging Association's Safe Stay Advisory Council, Choice Hotels stands united with the industry in adopting the guidelines outlined in the Safe Stay Guest Checklist, including the required use of face coverings in common areas. In closing, the strengths of our company outlined today are all underpinned by our disciplined management team, many of whom have experience leading the company through previous down cycles, something I've been thinking a lot about as I mark my 15th year at Choice. Our long-term view, proven brands, and compelling franchisee value proposition will help us not only emerge from the crisis in a position of strength, But we expect to continue to capture an outside share of demand while building on our partnership with our small business hotel owners. With that, I'll hand it over to our Chief Financial Officer, Dom.

Thanks, Pat, and hello, everyone. Choice continues to benefit from our resilient, primarily asset-light, franchise-focused business model. which has historically delivered stable returns throughout economic cycles and provides a degree of cushion from market risks. Today, I will provide some additional color around our second quarter results and share updates regarding our cost management efforts, balance sheet and liquidity, as well as our approach to capital allocation. I'll close with our thoughts on the outlook for the road ahead. For the second quarter 2020, total revenues excluding marketing and reservation system fees were $72.1 million, adjusted EBITDA totaled $41.1 million, and adjusted earnings per share were 13 cents. Due to the COVID-19 pandemic and its subsequent impact on the travel industry, our domestic rev par for the second quarter declined 49.6% for the full system and 48.6% for comparable properties over the same period of the prior year. As shown in Exhibit 7 of our press release, the trough in our domestic system-wide occupancy rate occurred in early April at 28% compared to the overall industry rate of 21%. Occupancy rates have been steadily climbing since that time, reaching 50% at the end of June and exceeding 60% this past weekend. In addition, our year-over-year outperformance versus the competition continued through July. Since the beginning of March, nearly two-thirds of our RevPAR decline was attributed to occupancy and only about a third to rates. Throughout the pandemic, our revenue management experts have been advising our franchisees on the best use of the tools we provide to maximize their pricing strategies. As a result of these efforts, our ADR index was up 3.6 percentage points against local competitors in the second quarter. Despite the challenging environment, we increased the number of our domestic hotels by 0.6% and rooms by 2% year over year. Across our more revenue-intense brands in the upscale, mid-scale, and extended stay segments, we grew the number of hotels by 2.3% and rooms by 3.7% year over year. We are particularly pleased to report that our flagship comfort brand family continue to experience positive unit and room growth following its recent transformation. We are also happy with the company's performance related to our effective royalty rate, which reaffirms that developers continue to choose our brands as they seek to boost the value of their hotels and recognize our unwavering commitment to maximize the return on investment. Thanks to our investments in technology and proprietary franchisee-facing tools, during this crisis, we were able to deliver new guests to our franchise hotels to drive occupancy levels while helping our owners improve the operating efficiency of their hotels and lower their total cost of ownership. Our domestic effective royalty rate increased 10 basis points in the second quarter versus the same period of the prior year to 4.94%. This is driven by the attractive value proposition we provide to franchisees, their continued desire to be affiliated with our strong brands and our current pipeline. As the current period of low travel demand and occupancy wears on, we anticipate that new owners will seek the shelter of a large proven franchisor that delivers strong top line revenues to their hotel. Therefore, despite the softer revenue environment, we expect to observe continued growth of this lever for the remainder of the year. Choice entered the crisis with a strong balance sheet due to our prudent capital allocation strategy. We also took a strategic approach in adopting mitigation efforts to alleviate the impact of the pandemic on our business. Every action the company has taken since the beginning of the crisis was aimed at improving our cash position, bolstering liquidity, reducing discretionary costs, and exercising discipline around capital allocation. Our financial position and liquidity allowed us to take a strategic, measured approach to cost management by adjusting to a lower consumer demand environment. Previously, we announced mitigation efforts in response to COVID-19 that were expected to result in SG&A cost savings of nearly 25% in 2020. Today, we are on track to achieve this target and also expect to maintain a run rate of SG&A cost savings of at least 15% in 2021 and beyond. We have also lowered our maintenance capital expenditures, which have historically been below $35 million by 20%. We expect these actions will better align our cost structure in the post-pandemic environment. While our cash and liquidity profile remains exceptionally strong, we have continued to take actions to further bolster that strength, which we believe will allow us to not only weather the impacts of the pandemic, but improve our long-term financial and competitive position. In July, we issued $450 million in new senior unsecured notes, which allowed us to both refinance a portion of our existing senior notes offering due in 2022 and repay our previously announced 364-day $250 million term loan. This new 10-year senior note offering allowed us to extend our near-term debt maturities to 2031 and capitalize on favorable credit markets to significantly reduce the effective cost of our borrowings. The offering was oversubscribed by nine times, a powerful endorsement of our business model and its performance, as well as the stewardship of the company's resources amid turbulent times. As of the end of June 2020, the company has over $725 million in cash and available borrowing capacity through its revolving credit facility and has maintained a consistent liquidity position over the last three months. In fact, despite the worst impact of the pandemic being incurred during the second quarter, the company's net debt only increased approximately $31 million, much lower than we initially expected. We continue to believe that our current liquidity position is more than adequate to weather the current environment, and today our gross debt to EBITDA leverage levels remain well within our target range of three to four times. Our historic, prudent, and disciplined approach to capital allocation has been instrumental in our ability to successfully navigate the current crisis. We will continue to follow the same approach and ensure our level of investment activity is aligned with the current environment. Most importantly, we will always look for organic growth opportunities to invest strategically in our business. Based on our strong organic growth track record, we believe these internal investments will continue to drive attractive returns for years to come. We will be evaluating other investments and capital return opportunities in the context of developing market conditions and our overall capital allocation strategies. Now I will close with some thoughts on what lies ahead. The ultimate and precise impact of the pandemic on our business for the remainder of 2020 and beyond remains largely unknown, as is the exact trajectory of our industry's recovery. While we are not issuing formal guidance today, we currently expect that COVID-19 will have a less significant impact on our third quarter performance results based on the continued weekly trend of travel growth predominantly stemming from leisure transient guests driving to their destinations. We will continue to evaluate the impact of COVID-19 across the business and will provide further updates in November during our next earnings call. I would like to close by saying that we are optimistic about Choices prospects. And while we are not immune to the pressures faced by the industry, we believe that our long-term focus prudent and disciplined capital allocation strategy and the targeted actions we have undertaken since the onset of the crisis will allow us to continue to capitalize on opportunities during the recovery. At this time, Pat and I would be happy to answer any questions. Operator?

We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Robin Farley from UBS. Please go ahead.

Great. I don't know if you addressed this in the opening remarks because I missed a couple of minutes, but I wanted to just follow up on the royalty rate. I know the release talked about a 10 basis point increase in the quarter. Can you talk about royalty rates on the new agreements you're signing? I'm just wondering if the current environment – I know after the last downturn, there were some kind of rate – rate reductions in the introductory years, things like that. So just wondering how the royalty rates are looking on the newly signed agreements. Thanks.

Thanks, Robin. So to the point that you made, yeah, the royalty rate was up about 10 basis points. And in previous conference calls, we had talked about the fact that that was really driven by the increase in RAC rates. Obviously, we had a very strong transaction environment over the course of the last couple of years, which allowed that royalty rate to be reset. Just really a testament to the strong value proposition. What I would say is in the future, probably continued growth. We said we would see continued growth throughout 2020 and that future growth would probably be more in line with our historical effective royalty rate growth of call it mid single digits. What we're seeing right now is maybe some slight discounting, at least in the shorter term that would burn off probably over the course of that 12 to 18 months anyway. But again, highly dependent on whether that transaction environment does return in 2021, 2022, et cetera, obviously driven by the REVPAR environment and some of the other factors as well. But we still do expect continued growth in that rate, at least for the remainder of this year, and probably in line with historicals beyond that.

Robin, I would just add that a significant amount of the new agreements we're selling in the second quarter were at brands where we haven't historically had to discount. And so, you know, those are brands like WoodSpring and Comfort as well has also been very strong from that perspective. So to Dom's point, if there is a discounting similar to the Great Recession, it's likely to be significantly less to what we had to do 10 years ago.

Okay, no, that's helpful. So you said there's some limited reductions in rate for the new agreements. That's more, that will affect the royalty rate next year being mid-single digit as opposed to the rate of increases you're seeing this year? Is that kind of when that comes into play?

Yeah, I think we'll all take a look at it. Yeah, we were already headed in that direction. And given the outsized impact of the existing contracts versus the new ones coming in, to Dom's point earlier, it is expected to return to historical levels.

Okay, great. Thank you very much.

Thank you. The next question comes from Sean Kelly from Bank of America. Please go ahead.

Hi. Good afternoon, everybody. Pat or Don, could you just give us a quick update on sort of the franchisee collection and health piece here? Just, you know, what percentage of franchisees were, you know, did elect for any sort of fee deferrals? How is the collection, you know, process proceeding as we move? you know, kind of from, you know, the darkest period here into, you know, kind of a more stable period. If you could just give us some stats or updates there, I think that'd be really helpful.

Sure. I think the, we spoke on the last call, you know, we were pretty much in the middle or close to what ended up being the end of a lot of those early conversations with regard to franchise fee deferrals. So the numbers we gave in the first quarter around the number of of hotels that that that took us up on that offer really hasn't changed. What's really been promising has been the significant performance we've had on the top line revenue to our franchisees in the month of May and June, in particular for the quarter and that's continued into July. So we're not having anywhere near those level of conversations that we were having back in in the April timeframe. Dom, you want to follow up? Sure.

Yeah, the only few things that I would add there, Sean, is when you take a look at how we did the fee deferral program, you know, Pat's opening remarks really covered this, but we were very strategic and surgical, but we were also very long-term focused in nature. We don't want their, you know, obviously the buyer's data, some of the other elements, you don't know if there's going to be another, you know, crunch in terms of where the franchisees are. So what we did is we deferred some portion of the entire yearly fee that would be recovered then in years two and three, rather than there being this cliff, so to speak. When you look at the quantitative impact, Sean, it's about, you know, we had talked about maybe a $10 to $20 million network in capital drag that would then be recovered, obviously, in years two and three. It's looking like it's going to be on the lower end of that, probably more like $10 to $15 million in terms of those fee deferrals. And that's really, you know, to Pat's point, driven by the strong occupancy that we're seeing, certainly higher than previous expectations there. And overall collections, I think what you're seeing is in the first quarter as well, we had talked about, you know, call it a two to three year runway. That was really based on $20 million cash burn. Our cash burn for the second quarter of this year was actually about half of that. It was about $10 million. Where we are today is a much better position than where we were throughout the second quarter as well. So we're really returning to a cash break-even, cash positive position as you continue to see these collections continue, these collection rates continue to increase, coupled with the stronger occupancy performance that you're seeing week over week.

That's great and super helpful. Thank you both. And then sort of the follow-up, but sticking with the same theme, would just be, you know, can you help us just translate as we think about this kind of you're now above 50% occupancy across the portfolio, which is, like you said, a huge bright spot as we kind of look at that relative to the industry. What does that translate into for, let's call it unit level economics for the franchisees? You also talked a little bit about your rate mix. Are we at a level where you think most of your franchisees are also cashflow positive? And then are we at a place where, and then how do you kind of think about that before and after debt service? I know I know it's a really broad question, but just maybe an indicative example or set of examples would be helpful.

Sure. I think we talked about this in the past. With debt service, for most of our hotels, if you're at that 30% occupancy level, you're able to break even. Today, probably about 15% of the portfolio is probably operating at that 30% level or below. So a good 85% is in that positive territory. You know, the debt service on our hotels is kind of interesting because, you know, the loan to cost on most of our hotels, it's about 50% equity and 50% debt. And so, you know, from the standpoint of the debt service in a mid-scale or an economy hotel is lower than it might be in other parts of the industry. So those are two key factors that I think have us feeling pretty good about the financial health of our franchisees. To Dom's point, the outperformance in the second quarter relative to where we thought we were going to perform on the top line revenue has significantly helped our owners. As you know, the summer months or the big months prefer a significant number of our hotels, so being able to get into that above break-even position in late April, early May, and then having a good three months of running at that level has got our franchisees in a much healthier position. I will say, and this is what we've been spending a lot of time focusing on, is with the CARES Act and the PPP program and all of those things that have been really a nice bridge for the industry and for our hotels to provide additional liquidity We are doing our best to advocate for continuation of those programs because as we're all seeing, and we've mentioned this before, the virus is sporadically popping up in places, which is leading to regional dips and valleys. And so having additional government relief programs that our franchisees can take advantage of if we have further hotspots in the back half of the year is going to be critically important. for our owners. But by and large, you know, Sean, I think the health of the franchisees is in a really strong position today relative to where we were back in the early part of April.

Thank you both.

Thank you. The next call is from Michael Bellisario from Baird. Please go ahead.

Good afternoon, everyone. Good afternoon, Michael. Patrick, just to follow up on that last question, and also on your conversation yesterday with the speaker, could you maybe just provide some specifics about what the franchisees are asking for, and I guess maybe why they need it specifically?

Sure. There are two things they want. One is liquidity, and the other is liability protection. And so a lot of the liquidity issues are obviously related to the use of PPP funds and the recapitalization of that program. Secondly, there's things that are in the tax code that could be really helpful for our industry around either CapEx or operating expenses relative to cleaning supplies, things that owners are going to have to do to adapt to the new environment. and there's a significant amount of things in the tax code that could be done to actually encourage, particularly business travel, to get consumers back on the road again. On the liability side of the house, this is something that is not just in the hotel space but across businesses, large and small, is to provide that safe harbor protection so you don't have – lawsuits that are literally putting the businesses that we've struggled so hard as a country to keep alive, putting them out of business over liability related to the pandemic. Business interruption insurance does not include pandemics. And so the small business owners and hotel owners around the country are not able to rely on that. And so there is this open liability issue. I spoke to the speaker about it. We had a great call with the industry last night with Senator Rubio, who's leading a lot of the small business efforts on the Senate side for the future relief bill here. And those are the two key issues. It's liquidity and liability that are the things that our owners are concerned about as we have figured out how to run a hotel business in the age of COVID. And our owners have been very successful doing that. despite the travel restrictions. I think the industry itself has proven to be an essential part of the functioning of the country with essential travelers and the like. So we're actually looking at the back half of the year if we do see more spikes. I think local jurisdictions, state governments, and business owners have all figured out how to work together to keep the hotels open, operating, at a good level of occupancy, so long as everybody does the right things, you know, wear your mask, socially distance, and wash your hands. And the hotel industry itself has stepped up significantly in our cleanliness standards. So all of those things, I think, are positives. But I would just go back to, you know, that liability protection and liquidity are the two key things that we're looking for out of the upcoming government legislations.

Got it. That's very helpful. And then just one more. I know you mentioned investment opportunities again on prior calls, but maybe can you provide an update on your latest thinking there? And are you starting to sharpen the pencil or at least think about offense anymore today versus 90 days ago?

Relative to M&A or investment back in our business? Within our business, I mean, I think We talked about the continued performance and interest in our Cambria brand. That has continued to drive interest. While we haven't done a lot on the Everhome side, the conversations that we're having with owners there are very, very, very positive. And our WoodSpring brand continues to grow as well without any capital involvement. Yeah, I think as we talked about on the M&A front and, you know, it's extremely hard for either a buyer or a seller today to underwrite an asset just given, you know, the expectations on what the future holds. So we are, while there's opportunities that may come down the pike right now, I think a lot of sellers are kind of waiting to see what happens with their assets.

The next question comes from Jared So J.N. from Wolf Research, please go ahead.

Hi, everybody. Thanks for taking my question. Hi, Jared. Can you talk about which brands specifically are driving the RevPAR index gains for you? Is that primarily extended stay brands, or are you seeing that really across the entire portfolio? And then do you think those gains are coming from independents specifically or other brands?

So it's across the portfolio, Jared. It's all of our limited service hotels. It's all of our upscale and our extended stay hotels and our economy hotels. The only brand is our Clarion brand, which is a meetings-based brand. I think there's about 175 of those. But all of the other brands, every single one of them has had significant red part index share gains. And it's coming from competitors. It's coming from independents alike. So when we say our local competitive set, these are not set by choice hotels. These are set by our consultation with our owners as to who they're truly competing with in their market for those price points. So it's a real strong signal to us that our owners are seeing share gains relative to other hotels on the same street corners.

Got it. Thank you. And I believe you mentioned the 98% voluntary owner retention, but can you tell us how a total owner exits have been trending year to date and how that compares to last year and prior years?

Yeah, so when you take a look at it, Jared, you know, the overall turn rate when you put, you know, involuntary and voluntary together, you know, the voluntary side of the house historically is about one to two percent involuntary, about three to four percent. And we're trending in line with that. But I think what you have to really look at is not all of those terminations and not all unit growth is created equal. So when you take a look at where the unit growth is coming from, I know in the past we've always talked about, you know, Cambria being three to four times more revenue intense than an average comfort. But really all of the terminations are really coming from that economy segment, which is why you saw the net unit growth in the economy segment in particular decline. But then when you look at three of the really key brands to help us as part of the recovery, Comfort, obviously, the transformed brand overall, it's about three times the royalty revenue as one of our economy brands. Ascend being a very big conversion engine for us. also about three times the royalty revenue. And then WoodSpring Suites, when you think about the multi-pack and the momentum that we have with that unit growth as well, it's about two times the royalty as one of those economy brands. And so it's really, you know, overall churn still very much in line with historical, but where it's coming from, we're very optimistic about how that's going to move us forward as part of the recovery.

Okay, thanks, Dom. And just one more, if I may. I think you said in June, a quarter of your revenue came from customers who traveled less than 25 miles away. I thought that was an interesting stat. Is that just mixed effect with Extended Stay outperforming everything right now, and Extended Stay tends to have more local visitation than some of the other chain scales? Or is there something else fundamentally different about consumer behavior right now where you are seeing more vacations and that sort of thing that are finding their way into your brands.

Yeah, I think, Jared, what we're seeing is a shift in consumer behavior. It's not really a brand-specific driver. You know, 25% is a significantly higher number than what we normally have, which is more in that sort of high single digits. But it's proof to us that, you know, it could be several things. One, you know, if a state is – is open to its own travelers, but it's not open to travelers from other states, people still want to get out and travel. And if it just means going, you know, to the next town over or if you're in Phoenix and going up to Flagstaff or, you know, staying within your own state, we're seeing a lot more interstate travel as opposed to intrastate travel. And I think that's, you know, significantly higher this summer than we've been used to seeing in prior years.

Okay. Thank you very much.

Next question comes from Patrick Scholes from Truist. Please go ahead. Good morning, everyone.

Good morning. As your net income continues to ramp up and recover here, I'm wondering about your thoughts regarding reinstating the dividend or part of it. And along with that, remind me, are you restricted by any covenants or other lending restrictions in that regard? Thank you.

Yeah, Patrick, so we've basically said we're going to suspend the dividend through the end of the year and then sort of reevaluate depending on what happens in 2021 as we begin to get a fresher look into that year. I'm glad you brought that up because if you're looking at our sort of outlays during the second quarter, we really took a long-term view. The first thing we focused on was helping our franchisees through this A significant amount of the impact of that fee deferral and fee help was in the second quarter, and it's going to be a similar level in quarters three and four. Secondly, we had our workforce resizing that was done in the second quarter, and that was done to set us up for a lower demand environment that we expect to see in 2021 and beyond. And the third was the dividend, which had been approved prior to the onset of COVID-19. And that's about $12 million. So just as you're thinking about our cash position and you're thinking about the outlays and our cash burn, as Don mentioned, being basically about $10 million a month, putting the dividend back into place is something that we'll consider next year. But at this point, we've essentially said we're going to suspend it for the remainder of 2020.

The only thing I would add is there are no restrictions on paying those dividends, Patrick, just given the covenant package that we have in place.

Okay. Thank you, gentlemen.

Great. Thank you. Next question comes from Alton Stump from Longbow Research. Please go ahead. Great.

Thank you. Good afternoon. I just wanted to ask about the conversion rate. I know you mentioned, Pat, that it obviously upticks significantly over the course of the you know, up to curious, you know, what percentage into Q came from conversions versus new build, say versus this time last year.

Don, why don't you go for the give me a year over a year, you can but I'll just just on the it's, you know, the difference I think this time around, relative to past downturns is just our portfolio mix is a little bit different where we have stronger brands going into this downturn. We talked about them in the prepared remarks. If you look at Comfort and the Ascend collection in particular, we're able to do really strong hotel assets that convert into those brands. And those are brands that drive higher royalty to the system than the average brand. So that mix of conversion this time I think is going to be very – helpful with our strategy to be, as I keep saying, you know, in those more revenue-intensive segments and revenue-intensive locations.

Right. And when you take a look, Alton, at the historicals, about 60% of our openings have come from conversions. And to Pat's point on, you know, a more recessionary environment or a downturn environment, in the Great Recession, we actually saw that 80% to 90% of our openings actually came from conversions. So what you saw this year, it was slightly above historical, but especially over the course of the last two months in particular, as COVID has become more widespread, you've actually seen that number of conversions begin to tick up a little bit more than even that two thirds rate that you've seen historically speaking. And again, you know, when, you know, going back to the Ascend, you know, properties, you know, Comfort being bigger conversion engines for us now that that transformation is complete, we see more revenue intense conversions happening as well. So we're very, very optimistic about that.

That makes sense.

Very helpful. Thank you, Pat and Dom. Thank you. Next question comes from Robert Mullins from Gordon Haskett. Please go ahead. Good afternoon.

So CHOICE has clearly been a beneficiary of Drive 2 leisure demand over the past couple of months, but how should we think about demand heading into the fall and winter months? And any commentary around what you're doing to drive demand in the back half of the year would be very helpful.

Sure. I think, you know, Robert, it's going to depend on three things. It's going to depend on the stimulus. It's going to depend on schools. And it's going to depend on sports. So, you know, all three of those are unknowns at this point. I think a month from now we'll have a clearer idea on what comes out of the Congress and gets approved by the administration from the standpoint of additional help to help the industry recover from a travel perspective. I would say on the schools opening, it's interesting because as some of these schools have gone virtual, they're actually pushing their start dates later, which means you could have more of an extension of summer travel into September, or it could go the other way where schools are becoming, you know, starting earlier. It's going to be interesting to kind of see how that impacts overall travel. And then sports is a key driver as well. You know, what happens both at youth sports and the college sports level as well as you get into the later months of the year. And all of those at this point, I think, are unknowns. But they do have a potential if they go in the right direction to take our occupancy and REVPAR numbers and continue to move them in a direction that would outperform our expectations or they could have a deleterious effect on it in the opposite.

That's helpful. And then if I could just sneak in one more. So with all the heightened competitive activity around conversions, are you doing anything different than in the past to attract these types of deals?

So as I said in my remarks, we have a management team largely that was here during the last recession. And so there's a playbook around what we do with regard to shifting our sales and development pipeline more towards conversions. So we are prepared to do some of those things. It would probably be similar to what we've done during prior downturns. Great. Thank you very much.

And Robert, the only thing I would add is just in terms of the leisure trends and whatnot, we did post an investor presentation on our website that really highlights a lot of what you're seeing in terms of the drive-to locations, the mix of the portfolio, proximity to highways, et cetera. So you can see that on our investor relations website that we posted right at the beginning of this call as well. Thank you. Thank you.

There are no more questions in the queue. This concludes our question and answer session. I'd like to turn the conference back over to Pat Pacius, President and CEO, for any closing remarks.

Thank you, Operator, and thanks again, everyone, for your time. We're pleased with our ability to navigate the challenging first half of this year and to outperform the overall industry and the competition in the second quarter. So I hope you all will stay safe and healthy, and we'll talk to you all again in the fall. Have a great afternoon.

conference has now concluded. Thank you for attending today's presentation. You may now disconnect.