Choice Hotels International Inc

NYSE:CHH

Earnings Call Transcript 2018-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. Good morning, and welcome to the Choice Hotels International Second 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 subsequently 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 2018 earnings press release, which is posted to our website at choicehotels.com under the Investor Relations section.

With that being said, I would now like to introduce Pat Pacious, President and Chief Executive Officer of Choice Hotels International Incorporated. Please go ahead, sir.

[Pat Pacious, President and Chief Executive Officer]

Thank you. Good morning, and welcome to Choice Hotels 2018 Second Quarter Earnings Conference Call. Joining me this morning is Dominic Dragisich, our Chief Financial Officer. After a strong first quarter, our second quarter performance delivered more positive news. For the second quarter of 2018, we experienced robust growth, highlighted by adjusted EBITDA growth of 20% versus the second quarter of 2017, and adjusted diluted earnings per share growth of 48% versus the second quarter of 2017.

As a result, we exceeded the high end of our previously reported earnings per share guidance by $0.08 and have raised our full year adjusted EBITDA and earnings per share guidance by $2.5 million and $0.08, respectively, at their midpoints. These results are proof that our long-term strategy of investing in our brands is working.

Our overall financial strength results from our ability to continue to deliver a strong and proven value proposition to our franchisees. This is exemplified by continued growth of our effective royalty rate. We attribute this growth to our ability to improve franchise agreement contract terms and offer limited royalty rate discounts over the last two years. These are clear indications that franchisees increasingly value Choice Hotels' brands.

In addition to the increasing value owners place in joining the Choice Hotels family, they are also staying with us for the long term. Our franchisees are, on average, signing 20-year contracts with us. We have a best-in-class voluntary franchisee retention rate of 99%. We also know that our owners are satisfied with Choice because they keep coming back. Half of the new franchise agreements signed through June 30 of this year are with existing or returning owners. Our franchisee base is also highly energized.

We had record attendance at our 2018 convention in May, and hotel owners rated it the most effective convention in its 64-year history. A consistent theme throughout the convention was how Choice and our owners share a mutual foundation of engagement and respect. We remain committed to deepening this positive relationship.

This morning, I’d like to talk to you about three things. First, our growing development pipeline. Next, I’ll provide an update on our successful loyalty program, Choice Privileges. And finally, I’ll close with an update on our brand performance by segment. Let me start with the health of our development pipeline. Here are the development highlights from the second quarter. Increases are from the same period of the prior year. We awarded 188 new domestic franchise agreements, an increase of 7%, and our new construction domestic franchise agreements increased 36%. We are especially pleased with where we are halfway through the year. As of June 30, our total domestic pipeline of executed franchise agreements increased to 950 hotels, which represents 32% growth from June 30, 2017. And our first half domestic development results exceeded our 2017 performance by 10%.

For the full year, we expect to exceed 2017’s full year performance, which was our best development year since 2007. Hotel owners choose us because we understand their business, provide resources to help them drive top line revenue and know how to successfully grow together in both the short and the long term. Choice proprietary revenue contribution delivered to our hotels continues to grow, and for the first half of the year, reached 62%, up by nearly 100 basis points year-over-year after significant growth in 2017.

Key to our efforts to drive direct bookings to our hotels is our Choice Privileges guest loyalty program, which has been rated number one in USA Today’s Best Readers Choice Award for the past two years.

And last week, Choice Privileges was named a Best Travel Rewards Program by U.S. News & World Report, its third year in a row making this list. We continue to enroll new loyalty member numbers at an increasing pace. Through the end of June, we added 2.5 million members, allowing us to surpass the 37 million member mark.

Today, we have more multi-stay active members than we had all active customers three years ago before the program’s relaunch. Plus, 91% of our loyalty members are U.S. based, and we expect these travelers to continue to stay in our nearly 5,800 domestic hotels. The growth and success of the Choice Privileges program is a result of constant fine-tuning to ensure we are meeting member expectations. This includes actively listening to what our customers want.

Recently added benefits include making free nights even easier to achieve, allowing all of our members to book free nights 100 days out, relaunching the popular points plus cash feature, allowing guests to redeem points towards their stay and pay the difference in cash, and partnering with Avis to give our platinum and diamond members reciprocity benefits with the car rental provider. Thanks to all these efforts, Choice Privileges' member satisfaction is at an all-time high.

I’ll now turn to an update on our brands. Beginning with our upscale brands. Through June 30, we awarded 26 upscale contracts for our Cambria and Ascend brands, which increased our pipeline for both brands by more than 3,300 domestic upscale rooms. The Cambria Hotels brand remains a true source of potential growth for Choice. In the second quarter, four Cambria Hotels celebrated grand openings, including two in the major markets of Philadelphia and Dallas.

Year-to-date, we’ve awarded 11 contracts that will bring the Cambria brand’s modern design and tailored amenities to more top RevPAR markets. We continue to focus on multiunit development to help grow the Cambria brand even more rapidly. In June, we announced an agreement with Stratus Development Partners to develop five Cambria Hotels, beginning with a 180-room new construction hotel in Santa Clara, California.

The second site in this five pack has already been identified in the greater San Francisco market, and we expect to execute this franchise agreement in the third quarter. We are pleased to add Stratus to our growing list of developers who are developing multiple Cambria Hotels across the nation. Stratus currently has three Cambria Hotels already under construction in Orlando, Florida, and in Napa and Sonoma counties in California.

This new agreement will expand the depth of our joint effort. Our collaboration with leading developers, combined with the $475 million in capital we have committed to help grow the brand, is driving results. New Cambria Hotels like New Orleans, Nashville and Philadelphia have all opened above our expectations. Cambria now has 39 hotels open and operating in key markets. Another 19 hotels are currently under construction and expected to open within the next 12 to 18 months.

Complementing our new construction upscale Cambria brand is the Ascend Hotel Collection, most of which are conversion properties. This allows us to grow our upscale portfolio rapidly, both in terms of units and rooms. From signing, the average Ascend Hotel opens its doors in just about 100 days

The Ascend Hotel Collection is the industry’s first soft brand from a major hotel company and remains the largest, with more properties than the next two competitors combined. Ascend has strengthened its presence in popular, high-barrier-to-entry markets. Year-to-date, we’ve awarded 15 new contracts to bring even more upscale hotels to the collection. In total, the Ascend brand now has 217 properties open worldwide, with nearly 60 hotels in the pipeline.

Our most recent additions include the brand’s first two all-inclusive properties located in the Dominican Republic. These resorts by Hodelpa further the Ascend Collection’s presence in high-demand leisure destinations. Both resorts are convenient to local airports and feature top-notch amenities, including private beaches and on-site dining. Another notable addition to the Ascend collection is the Elon Hotel and Spa, a Bluegreen Resorts in San Antonio, Texas.

The 165-room hotel is located in a serene drive-to resort location and offers upscale amenities, including a spa and a 12,000-square foot fitness center. In furtherance of our long-standing strategic alliance, the Ascend Hotel Collection has now welcomed 37 Bluegreen Resorts properties into its portfolio of independent hotels and resorts. Moving now to our mid-scale brands. Our long-term strategy of investing in our brands is clearly seen in our flagship upper mid-scale brand.

Comfort is undergoing a multiyear $2.5 billion transformation to renovate common spaces and update guest rooms, which we call Move to Modern. As the capstone of this transformation effort, we announced a new Comfort brand image in May. A hotel is only eligible to display the new logo on its building and across digital channels after it complete this move to modern renovations. The new logo on the outside of these properties signals to guests the changes on the inside. Owner reaction to the new logo has been resoundingly positive.

To date, more than 450 Comfort properties, more than 1/4 of the domestic brand portfolio are in the process of obtaining the new signage. This means we’re in the process of certifying that these hotels meet Move to Modern’s elevated standard for design and product. We expect that all Comfort properties across the United States will have completed their renovations by the end of 2019 and have updated their signage by the end of 2020.

Another key investment we’ve made in the Comfort transformation is making our revenue management service, Choice RM, a brand standard. We’re happy to report that the rollout of this service across the entire Comfort brand was completed ahead of schedule. Across all Choice brands, over 1,700 hotels have implemented Choice RM. Hotels are expected to see RevPAR lift after six months of actively using this service. We believe our investment in Comfort fortifies the long-term health of the brand. In the second quarter, 15 new Comfort hotels opened their doors in thriving U.S. markets, a rate of more than one per week.

The domestic pipeline is nearly 300 properties, 80% of which are new construction hotels. We expect to see our investments in the Comfort brand to pay off in accelerated RevPAR growth and openings in 2019 and beyond. Finally, a few words about our extended stay portfolio. The WoodSpring Suites economy extended stay brand continues to drive growth for Choice. Through June 30, we awarded 44 new WoodSpring franchise agreements. For 2018, we are on pace to significantly exceed the brand’s record for new franchise agreements awarded in a single year.

Our expectation that existing Choice franchisees would be attracted to this new brand is being realized, and we are seeing significant interest from new institutional capital to develop multiple hotels. Also fueling our growth in the extended stay segment is our mid-scale MainStay Suites brand. New franchise agreements for MainStay increased 27% through June 30 year-over-year. In addition to executing on the right strategy, we’re also benefiting from positive macroeconomic trends.

In this period of continuing and strengthening economic growth, we see room yet to run because unemployment remained low at 3.9% in July, consumer spending is up, consumer confidence remains high, and interest rates are holding. Additionally, tax reform is creating the expectation for a favorable business climate for the foreseeable future. This is particularly evident for the hotel sector. Furthermore, we believe the promise of tax reform has yet to be fully realized across the industry. As that occurs, we expect an ongoing positive impact on leisure travel in 2019 and beyond. In closing, investing in our brands is paying off.

This is demonstrated by our strong key financial results, both top line and bottom line; our robust development results across all of our segments, which are on track to surpass 2017’s full year performance, our best development year since 2007; and our powerful franchisee base. We are pleased with our performance, and look forward to a successful second half of the year. I’d now like to turn it over to our CFO, Dom Dragisich, who will share more specifics on our financial results.

[Dominic Dragisich, Chief Financial Officer]

Thanks, Pat, and good morning, everyone. We are very pleased with our second quarter financial results, which again exceeded our expectations and continued to build upon our robust first quarter performance. Lodging fundamentals remain strong, and our brands continue to perform for hotel owners. As a result, we continue to grow, invest in our business and return capital to shareholders.

The continued strength in our operating performance, our low leverage levels and tax reforms have allowed us to expand our business in three major ways. Our acquisition of the WoodSpring Suites brand in the first quarter of 2018, best-in-class tools, technology and programs that we provide to our franchisees and customers, and as Pat highlighted, continued investment in our well-segmented brand portfolio, including the growth of Cambria, the transformation of Comfort and other key brand investments.

Our significant cash flows allow us to both reinvest in our core business and return excess capital to our shareholders. In addition to our quarterly dividend, we repurchased an additional $29 million of our common stock in the second quarter. We have now repurchased over $70 million of Choice stock in 2018. We believe the strength of our business model, the positive economic environment and our runway for future growth will allow us to continue to execute on our capital allocation strategy. Now, let’s review our second quarter results and outlook in more detail.

Our second quarter financial performance was highlighted by revenue growth of 13% over the prior year and quarterly adjusted EBITDA of $94.3 million, a 20% increase over the same period of the prior year. Furthermore, we reported adjusted diluted earnings per share of $1.11, a 48% increase over the prior year quarter. As Pat mentioned, this adjusted diluted earnings per share performance exceeded the high end of our guidance by $0.08 per share. Our outperformance on our earnings per share guidance was driven by two factors: our core franchising operations, which exceeded the top end of our expectations by $0.03 per share; and a lower effective income tax rate for the quarter was approximately 20% compared to our initial forecast of 23%. This rate was primarily lower due to onetime tax benefits.

We are now forecasting our full year recurring tax rate to be 21% compared to our previous expectation of 22%. Our commitment to franchisee profitability continues to drive incremental revenues to hotels. As a result, our second quarter hotel franchising revenue increased 14% from the same period of the prior year to approximately $134.8 million. Our hotel franchising revenue growth was driven by our domestic royalty fees, which increased 13% to $97.6 million. The growth in our domestic royalties was fueled by the continued expansion of all three of our key domestic royalty levers.

Specifically, in the second quarter, domestic RevPAR increased 2.7%, driven by continued improvement in both occupancy and average daily rates, domestic units increased by 6.5%, and our domestic effective loyalty rate increased 15 basis points over the same period of the prior year. We believe our continued focus on increasing the number of customers booking directly with us and providing resources to help our franchisees optimize pricing will allow us to continue to grow these key metrics for the remainder of 2018 and beyond.

Now, we’ll share more detail about the drivers of our domestic RevPAR performance. We are particularly impressed with the performance of our extended stay brands, whose segment continued to perform exceptionally well. Our second quarter growth was led by our MainStay and WoodSpring brands, which beat their competitive segments by posting second quarter RevPAR increases of 14% and 9%, respectively.

In addition, our upscale brands, Cambria and Ascend, posted second quarter RevPAR gains of 5.7% and 8.3%, respectively, significantly higher than the 2.8% increase reported for the upscale segment by STR Global. As Pat mentioned, our multiyear project to transform the Comfort brand via Move to Modern is well underway. The response to our new logo and brand image has been so positive that many of our franchisees have accelerated the pace of adopting the Move to Modern package and are currently completing their renovations. While in the short term, the acceleration of the Comfort room renovations has negatively impacted RevPAR for the Comfort brand by approximately 70 basis points during the second quarter, we believe this initiative is a significant positive for the brand’s long-term performance.

For the third quarter, we expect our domestic RevPAR growth to range between flat and 1.5%. This third quarter RevPAR guidance is based on the short-term Move to Modern impacts as well as the tougher comparable results due to the solar eclipse and hurricane activity that occurred in the third quarter of 2017. We also expect our 2018 full year domestic system-wide RevPAR growth to range from 1.5% to 3%, driven by the same factors.

We estimate that approximately 1/3 of our Comfort hotels will complete their Move to Modern renovations by the end of the year and expect the impacts from the program to be a net positive for 2019 RevPAR. The second revenue lever, unit and room growth, experienced another strong quarter. The number of units and rooms in our domestic system increased 6.5% and 8.8%, respectively.

Our unit growth is fueled by the WoodSpring acquisition and our quality brand, which saw a 6% increase in the number of units over the prior year. Quality, which is approaching 1,600 domestic hotels, is valued by developers for its strong performance and brand awareness in the mid-scale segment.

Our MainStay brand is capitalizing on the robust demand for extended stay product and increased its unit count by nearly 9%. We expect the MainStay brand to continue to experience strong growth in the next several years, as there is renewed interest in our extended stay portfolio, thanks to the WoodSpring acquisition and more favorable consumer demand trends.

Our steadfast focus on franchisee profitability is paying off. During the second quarter, we awarded 188 new domestic franchise contracts, a 7% increase from the second quarter of 2017. Through June 30, the number of newly awarded domestic franchise agreements increased 10% to reach 310, second only to the company record set in 2008. This growth is even more impressive given the strong performance in the first half of 2017, where franchise agreements increased 30% over the 2016 comparable period.

In addition to our system size growing, it’s getting younger. We are particularly pleased with the increase in new construction domestic franchise agreements, which increased 36% for the second quarter and 51% for the first half over the comparable period of prior year. As of June 30, our overall domestic pipeline also increased 32% over the prior period to 950 hotels. This represents an increase of approximately 22,000 rooms.

This robust pipeline is expected to fuel both short and long-term domestic unit growth. Specifically, our conversion pipeline at midyear was 26% higher than the same time period of the prior year, and we expect these conversion hotels to open within the next three to six months.

Our new construction pipeline has grown 34% as of June 30 and will be a catalyst for our long-term unit, rooms and RevPAR growth. In fact, we expect 50 ground breaks this year alone from our WoodSpring Suites brand. In addition to the robust Comfort new construction pipeline that Pat highlighted, our new construction Sleep Inn brand now has 138 hotels in its pipeline, an increase of 13% over the same period of the prior year.

For full year 2018, we are maintaining our domestic unit growth guidance and expected to range between 7% and 8%. We also expect both unit and room growth, excluding the onetime increase due to the WoodSpring acquisition, to accelerate in 2019 when the Comfort brand family is also expected to return to net unit growth.

The third and final revenue lever is royalty rate growth, which continued to be driven by the pricing of our franchise agreements. As Pat mentioned, our domestic effective royalty rates continue to expand, increasing by 15 basis points in the second quarter compared to the same period of the prior year. This growth was higher than expected. Therefore, we are increasing our full year guidance by 4 basis points at the top end and 2 basis points at the bottom end of our guidance, and now expect our effective royalty rate growth to range between 11 and 14 basis points.

The combination of our world-class franchise development team, strong brands, robust distribution channels and cutting-edge technology platform should allow us to continue to strengthen our value proposition and improve pricing even further. As you’ve heard, the impressive second quarter and first half performance of our three key levers resulted in substantial top line franchising revenue growth.

In addition, we continue to prudently manage SG&A costs. As a result, our adjusted hotel franchising EBITDA increased 18% from the prior year second quarter. In addition, we were able to improve our adjusted hotel franchising margins by nearly 100 basis points in the second quarter to 68.2%. Before we open it up to questions, I’d like to comment on our outlook for the remainder of the year. Similar to the guidance we provided in May, our adjusted EBITDA, adjusted net income and adjusted earnings per share forecasts presented in the outlook section of our release were prepared utilizing the new revenue recognition standard and include the impacts of the WoodSpring acquisition.

However, the outlook excludes the impact of onetime integration and acquisition-related costs as well as the impact of net surpluses or deficits generated by marketing and reservation activities. Based on our second quarter results and the outlook for the remainder of the year, we are increasing both our full year adjusted EBITDA and adjusted earnings per share forecasts.

We now expect our adjusted EBITDA to range between $333 million and $339 million, and our adjusted hotel franchising EBITDA to range between $337 million and $343 million. In addition, we are increasing our guidance for adjusted diluted earnings per share to range between $ 3.71 to $3.77 per share.

Our guidance for our non-hotel franchising operations is being maintained, with net reductions and EBITDA expected to be between $3 million and $5 million. And we expect our adjusted diluted earnings per share for the third quarter to range from $0.13 to $2.17 per share.

In summary, we are very pleased with our strong second quarter. Our results show that our strategy is working. We are optimistic that the strong labor market, consumer confidence and lodging supply dynamics will provide a positive background against which to maintain our momentum and growth of our key royalty levers, franchise development results and overall financial performance.

At this time, Pat and I would be happy to answer any questions.

[Operator]

[Operator Instructions] The first question comes from the line of Thomas Allen with Morgan Stanley. please go ahead.

[Thomas Allen, Morgan Stanley]

Yes, good morning. Your procurement services in the quarter were really strong, up 24% year-over-year. Can you just talk a little bit about what’s driving that? Is it sustainable? And what kind of margins you’re driving in that business? Thank you.

[Pat Pacious, President and Chief Executive Officer]

Let me start with that, Tom. So really two key things are driving it. One is the volume of transactions or the procurement services team is going up, so there’s a lot more just volume going through our existing vendor agreements. And secondly is, last year, at the tail end of the year, we renegotiated our agreement with Bluegreen, which was sort of coming to the end of its 1st-year – first 5-year term, and we renewed that agreement, which, again, is providing a significant value to both Bluegreen and the Choice Hotels. So those are really the sort of two key drivers on the procurement services front.

[Dominic Dragisich, Chief Financial Officer]

Yes. I think that’s exactly right. We continue to expand other qualified vendor relationships as part of the program, and I think the other big driver just in the core business as well is just the increase in unit growth that you’re continuing to see. And as you tuck in other inorganic acquisitions like WoodSpring, you continue to further accelerate that procurement services revenue. Over the long term, you expect it to at least grow in line with our franchising revenues, if not, continue to outpace slightly due to the fact that we’re just continuing to strengthen some of those relationships.

[Thomas Allen, Morgan Stanley]

So should we imply that as you continue to outperform the other revenue line items kind of through the end of the year [be it] Bluegreen?

[Dominic Dragisich, Chief Financial Officer]

In the short term, outperformance. I think long term, we’re closer to franchising revenues.

[Thomas Allen, Morgan Stanley]

All right. And then just my follow-up. Based off of my math on the midpoints of your guidance range is you’re kind of implying fourth quarter RevPAR growth a little above 2%, but you can have a massive range there. How are you thinking about fourth quarter RevPAR growth, its helpful thank you.

[Dominic Dragisich, Chief Financial Officer]

So the way to think about fourth quarter RevPAR growth, I mean, the third quarter is the toughest comp that we have for the year obviously, and the two major impacts, obviously, it’s the eclipse. You also have the hurricane tailwinds that happened in the third quarter of last year. I think in the fourth quarter, we do expect to see acceleration, obviously, from what we’ll experience obviously in the third quarter. Two primary reasons for that. You also have the removal of the eclipse impact in the fourth quarter, and then you started to see some of those hurricane benefits dissipate in the fourth quarter as well. When you normalize for all of the calendar shifts and when you normalize for some of those hurricane tailwinds that we saw last year, you’re right around that 2% to 2.5% or so, which is what you implied in your question.

[Thomas Allen, Morgan Stanley]

Alright thank you.

[Operator]

The next question comes from the line of Robin Farley with UBS. Please go ahead.

[Robin Farley, UBS]

I wanted to clarify because I think your previous guidance has not included WoodSpring and now it does on both the not included WoodSpring and now it does on both the RevPAR and royalty rate. On the RevPAR front, it looks like RevPAR is lower, including WoodSpring. I don’t know if that’s just Choice – I’m sorry, the Comfort renovations that you talked about if that’s sort of making it maybe lower? And then also on the royalty rate. Backing out WoodSpring, is the royalty rate on the existing business going down maybe a basis point or two? It could just be a rounding errors so if you could just clarify.Thanks.

[Dominic Dragisich, Chief Financial Officer]

Yes, Robin, it’s a good point. You saw a slightly higher impact of WoodSpring in Q1 because of 13.5% RevPAR growth that the brand had from a RevPAR perspective. When you take a look at the RevPAR this quarter, it was 2.7%. When you remove the impact, when you remove WoodSpring, it would have been about 2.6%, so about 10 basis points. For the full year, the impact would be right around that, call it 10 to 20 basis points or so. So obviously, not a very material impact on the full year. So we did consolidated as part of our guidance for the year. And when you take a look at the effective royalty rate, up about 15 basis points, WoodSpring had about a two basis point impact on that. So call it about up 13 or so for this quarter. For the full year, it’s right around that as well, about a two basis point lift.

[Robin Farley, UBS]

So is the lower RevPAR, is it the Comfort brand renovations? Or is that – or is there anything else there impacting.

[Dominic Dragisich, Chief Financial Officer]

It’s a big driver, about 70 basis points in quarter for the Comfort brand portfolio, which is somewhere just south of 50% of our overall revenue, so you can back out the impact there. And then we expect that to continue in Q2 and Q4. We expect the move to modern upgrades to be a net positive for RevPAR in 2019 and beyond, as we discussed in our prepared remarks.

[Robin Farley, UBS]

Okay great thank you.

[Dominic Dragisich, Chief Financial Officer]

Thank you.

[Operator]

The next question comes from the line of David Katz with Jefferies. Please go ahead.

[David Katz, Jefferies]

I wanted to just delve a little deeper into WoodSpring and that as a segment. Obviously, there’s some good initial gains there in both performance and development. Is that an underexplored segment of the business that is now sort of getting on our radar in part because of WoodSpring? Has it been fragmented or segmented across the country? What’s going on in that segment?

[Pat Pacious, President and Chief Executive Officer]

I think when you look at the economy segment, David, in general, the growth in the economy segment is coming from the economy extended stay segment, and WoodSpring is a key driver of that. So when you look at the STR data, you look at the data from highland that looks at that segment, a lot of the growth is coming from the economy extended stay segment and a lot of that growth is coming from WoodSpring.

What WoodSpring is, I mean, you have to think about it in a couple of terms. One, the hotels we’re building are 122- room hotels. So these are not your sort of – when you look at the average room count on an economy hotel, they’re much smaller than that. So first piece is they’re larger hotels. Secondly, they’re running at about 80% occupancy.

And thirdly, these are all new construction full fee, meaning no discounting on the royalty rate side of the house. So we’re very excited by the performance of the hotels once they get in our system. And as you mentioned, we’re really excited about the development prospects, both with existing WoodSpring developers, Choice developers who are now building WoodSpring, and as I mentioned, the interest of additional institutional capital that’s looking to come in and do not one or two hotels, but do 20 hotels.

So all of those are significant positives for us as a business. And that segment, I think, is something that maybe a lot of people in the industry haven’t really focused on, but it’s a key driver of growth for us, both on the unit side, and as Dom mentioned, on the RevPAR side.

[David Katz, Jefferies]

And I wanted to – at the other end of the spectrum or your spectrum is Cambria. And we’ve seen quite a few announcements that you’ve made. Have you told us how many Cambrias there are in the pipeline? And what we can reasonably expect in the next year or two?

[Pat Pacious, President and Chief Executive Officer]

Yes. So we’re expecting to sort of cross the 50 open hotels, really, at this time next year, probably by the end of that in the second quarter of 2019. I think total pipeline is close to 90 hotels, somewhere in that – 80 hotels, David. So the growth of that brand and our confidence level that we’re going to get, act to critical mass, and ultimately, as we talked on previous calls, have to use less capital to incent the brand. We’re well on our way to doing that. So we’re at 39 open today. We’ll be crossing the 50 threshold by this point next year. We have 19 under construction, so we feel really good about the opening space in 2019 and beyond.

[David Katz, Jefferies]

Perfect thank you very much.

[Pat Pacious, President and Chief Executive Officer]

Thank you.

[Operator]

The next question comes from the line of Jared Shojaian with Wolfe Research. Please go ahead.

[Jared Shojaian]

Pat, you cited a 99% retention rate with your owners. You talked about the long-term, 20- year contract. But when I look at your room exit historically, they’ve averaged 5% per year. So can you help me bridge that gap and understand the difference between some of those stats you’ve cited? And then, with the Comfort refresh winding down, how are you thinking about the right level of room exits going forward?

[Pat Pacious, President and Chief Executive Officer]

I think the way we look at terminations is some of them are terminations we force, meaning the hotel is not meeting the brand standards or it’s a strategic move like we’ve done with Comfort over the last several years, where those are brand-driven or Choice Hotels-driven terminations. When we talk about voluntary terminations, really there’s only – I mean, the 99% I mentioned means that only 1% of our franchisees are actually taking their routes and saying they’re going to go independent or maybe to a different brand.

So we look at that as a very key driver of the health of our brand and the attractiveness of our brands to our franchisee base. So that’s how we think about it. And I think if you go back and look historically on the overall terminations rate, much of that is us driving it because the owners aren’t willing to put the capital and to keep the brand up to the standards that we’re looking for, or it’s something similar to what we did with Comfort, where we are intentionally looking to move that brand up higher. And some of our owners who don’t want to stay in the brand, they may move to Comfort, they may move to a different brand of ours or move out of the system altogether.

[Jared Shojaian]

Okay, that’s helpful. Thank you. And then just switching gears here. I mean, can you give me a sense as to, on the international side, what percent of your rooms are direct versus masters? And one of your competitors is talking about the opportunity to grow the direct piece, and the subsequent positive effect that, that would have on the total system royalty. So I think for you, international is 20% of your rooms, but it’s still a very tiny percent of your revenue, presumably just because of the master franchise agreement. So can you talk a little bit about that opportunity going forward?

[Pat Pacious, President and Chief Executive Officer]

Yes. So if you look at our international portfolio, we can get you the exact number, Jerry, but I think it’s probably over 50% fall into that master franchisee category. So those are markets like Brazil or Japan or the Nordic countries where we have a master franchise agreement in place and great hotels. But to your point, they don’t drive the type of profitability that if we do, we’re in the direct markets. On the direct front, we’ve been executing a strategy.

If you look at our European footprint, really shrinking the number of hotels but growing the number of rooms. And so if you look at the exits we’ve had versus the adds we’ve had over the last really three years we’ve been executing this strategy, the goal was to go out of these sort of tertiary markets in Europe and move into more secondary and primary markets, one to drive the brand awareness higher, but two, also to drive the profitability of these hotels higher. So that’s kind of the strategy on the direct front.

Yes, I think we talked about on the previous calls some of the things we’re doing around the international business. Our alliance with Sercotel that we announced on the last call really helps us in an area that we don’t have capability wise, which is hotel management. And we’re beginning to see some opportunity there going to market with our brands and Sercotel’s management in certain parts of Europe that, I think, are really going to help us to grow the European footprint.

[Dominic Dragisich, Chief Financial Officer]

So Jared, Pat is right on. It’s about 60% of the total portfolio falls into that master. However, a good portion of that is also a JV that we have with can – not technically a master, we get slightly higher rates obviously there. Well over 50% of that is in the form of a JV, but about 60-40 in terms of master and direct. We’re continuing to see that direct proportion grow year-over-year and expect to do it going forward as well.

[Jared Shojaian]

All right. Thank you very much.

[Operator]

The next question comes from the line of Patrick Scholes with SunTrust. Please go ahead.

[Patrick Scholes, SunTrust]

Hi, good morning, thank you. A question for you. When I think back to the last cycle and when we saw an uptick in gas prices in 2018, Choice was the only hotel company at that time to call out the bet that gas prices were in fact hurting their business. With the recent uptick in gas prices, are you seeing any impact as of yet on your business? Thank you.

[Pat Pacious, President and Chief Executive Officer]

The answer to that Patrick is no. We’re not seeing any impact. I think in previous years, we’ve done some studies that really look that even when gas prices in real terms were getting close to $5 a gallon in some parts of the country, even at that – those high elevated rates, we didn’t see an impact to hotel demand. So yes, we’re not seeing anything at this point that’s indicating it’s at all hurting any demand.

[Patrick Scholes, SunTrust]

Okay, thank you. That’s it.

[Operator]

The next question comes from the line of Dan Wasiolek with Morningstar. Please proceed with your question.

[Dan Wasiolek, Morningstar]

Good morning guys, thanks for taking the question. So I believe last quarter, you guys had given guidance for net room growth 2018 excluding WoodSpring. Just wondering if there’s any change to that. And if you have any pipeline growth excluding WoodSpring that you’d be able to share for the quarter, what the growth was excluding that?

[Dominic Dragisich, Chief Financial Officer]

There’s not. When you exclude the impact of WoodSpring, we had guidance of 2.5% to 3.5% on our full year unit growth. We will be maintaining that. So at the midpoint, call it right at 2% or so. In terms of the pipeline, the pipeline was up about 32% with WoodSpring. If you remove WoodSpring from that equation, it was up about 18%.

[Dan Wasiolek, Morningstar]

Okay, very good, that’s it thanks.

[Operator]

The next question comes from the line of Carlo Santarelli with Deutsche Bank. Please proceed with your question.

[Carlo Santarelli, Deutsche Bank]

Yes, hey guys. Good morning. I was just wondering if you could quickly maybe just go through some of your capital allocation strategy here going forward, specifically kind of CapEx and other capital deployment needs. And how we should maybe think about as the leverage continues to kind of trend lower, where your heads are?

[Pat Pacious, President and Chief Executive Officer]

Sure. So I think if you look at our capital allocation strategy, and we’ve talked about this multiple times, but it’s about really investing back in our brands where it makes sense. If you look at the $475 million we have allocated for Cambria, today only about $280 million of that has actually helped. But we’re going to allocate capital really to projects that make sense for us on our core business and growing that.

Secondly, we’ll look at acquisitions, which we demonstrated this year with the acquisition of WoodSpring in segments that makes sense. We like to buy brands that are ready to scale and that are kind of the brands of tomorrow. So we’ll continue to do that. And then we have returned capital to shareholders when it makes sense to do so. And so I think if you look at that sort of strategy, that’s kind of been our strategy over the last, really, our history really since we’ve been a public company. Dom, do you have anything to add on it?

[Dominic Dragisich, Chief Financial Officer]

No, I would just say that any excess capital, we sit at about 2.4 times our leverage ratio, and we talked about that publicly. We want to be right around three to four times. So we are certainly underlevered at this point in time, and so I think we can continue to take a look at piling some of the capital back in the business in organic or share repurchases, and we do expect to continue share repurchases in Q2 as well.

[Dan Wasiolek, Morningstar]

Great, guys. And just quickly if you don’t mind, just a little housekeeping. What was the diluted share count at the – as of June 30 as opposed to the average just the end of period share count?

[Dominic Dragisich, Chief Financial Officer]

Right around $57 million.

[Dan Wasiolek, Morningstar]

Thank you.

[Pat Pacious, President and Chief Executive Officer]

Do we have any more questions?

[Operator]

Apologies. The next question comes from the line of Anthony Powell with Barclays. Please proceed with your question.

[Anthony Powell, Barclays]

Hi good morning. I have a follow-up on the capital allocation question. The buyback activity has been the highest really since really in 10 years or so. Could we expect this level of buybacks to continue on an ongoing basis, excluding any kind of larger acquisitions?

[Dominic Dragisich, Chief Financial Officer]

So I’ll just go back to Pat’s original comment, right? At the end of the day, we evaluate in terms of what opportunities we had internally, be it Cambria or another brand as well as inorganic activity. Like I said, I think you can continue to anticipate some buyback activity in Q3, and we’ll continue to monitor it in Q4 and beyond.

[Anthony Powell, Barclays]

All right, great thanks.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Pat Pacious for any closing remarks. Thank you.

[Pat Pacious, President and Chief Executive Officer]

Thank you. And thank you all for joining us today. As you can see, we have a lot to be excited about. Our long- term strategy of investing in our brands is paying off, as demonstrated by our strong key financials, robust development pipeline and powerful franchisee base. We’re pleased with our performance and look forward to a successful second half of the year. Have a great summer, and we will talk to you in the fall.

[Operator]

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