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Edited Transcript of RLH earnings conference call or presentation 8-Nov-19 2:00pm GMT

Q3 2019 Red Lion Hotels Corp Earnings Call

Spokane Nov 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Red Lion Hotels Corp earnings conference call or presentation Friday, November 8, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Julie A. Shiflett

Red Lion Hotels Corporation - Executive VP, CFO & Treasurer

* Nathan M. Troup

Red Lion Hotels Corporation - Senior VP & CAO

* Robert George Wolfe

Red Lion Hotels Corporation - Independent Chairman of the Board

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Conference Call Participants

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* Alex Joseph Fuhrman

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Brian H. Dobson

Nomura Securities Co. Ltd., Research Division - VP of Lodging REITs

* Eric Christian Wold

B. Riley FBR, Inc., Research Division - Senior Equity Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the RLHC Third Quarter 2019 Earnings Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Nate Troup. Thank you, sir. You may begin.

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Nathan M. Troup, Red Lion Hotels Corporation - Senior VP & CAO [2]

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Thank you. Welcome to RLH Corporation's third quarter earnings call. With us today are Bob Wolfe, Chairman of the Board; Jake Brace, Board Member; and Julie Shiflett, EVP and Chief Financial Officer.

Before we get started, I want to remind you that the company's remarks today contain forward-looking information that is subject to a number of risk factors that may cause actual results to differ materially from those expressed or implied. For a discussion of important risk factors, please see our most recent Form 10-K and subsequent reports filed with the SEC. Our Form 10-K and other filings are available on our website, rlhco.com, in the Investor Relations section or through the SEC website at sec.gov. These forward-looking statements speak as of today, and we undertake no obligation to publicly update them to reflect subsequent events or circumstances.

The company will also be referring to a number of non-GAAP measures. The reconciliation of these measures to their comparable GAAP measure is provided in the tables of our press release. That release is also available on the Investor Relations section of our website.

I will now turn the call over to Bob.

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Robert George Wolfe, Red Lion Hotels Corporation - Independent Chairman of the Board [3]

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Good morning. Thank you for joining our call today. I'm Bob Wolfe, Chairman of RLH Corporation. I'm joining Julie Shiflett, the company's Chief Financial Officer this morning to review the company's third quarter results and briefly discuss management changes at RLH.

Yesterday, the Board accepted Greg Mount's resignation. He will also be stepping off the Board. These changes are effective immediately. We acknowledge and share in our shareholders' frustration regarding the lack of progress growing the core franchise business, along with elevated franchise terminations and weak performance of owned hotels. The Board understands the need for action to be taken. That starts with the change in the company's leadership. The first step was making changes to the Board over the last 6 months, and now it has acted decisively and thoughtfully with the changes announced today.

Furthermore, The Board has appointed a search committee with Jake Brace, an independent director of the company's Board as the Committee Chair. The Board has also tasked Mr. Brace, to be its liaison between the Board and management regarding day-to-day matters. Until the company appoints a chief executive officer, the management committee will oversee the operations of the company and will report to the Board through Jake as liaison. The members of the management committee include Gary Sims, Chief Operating Officer; Julie Shiflett, Chief Financial Officer; and Thomas McKeirnan, General Counsel.

The members of the management committee and the Board are laser-focused on delivering superior value and service to our franchisees to stem the pace of terminations, restructuring franchise sales efforts to accelerate franchise growth and rightsizing the cost structure of the business to reflect RLH's current size, revenue and profitability requirements. The asset sales in the past few years are largely complete. The company now needs to put all its effort into building around a strong business proposition for its franchisees and delivering value to shareholders. The change we've begun will take time to implement. We greatly appreciate your support as we turn RLH into a fast-growing hotel franchise company and identify a CEO that can effectuate strategic and tactical moves needed to drive our growth.

I will now turn the call over to Julie who will walk through the company's third quarter results and revised 2019 outlook.

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [4]

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Thanks, Bob.

RLH Corporation reported a net loss for the third quarter of 2019 of $3.5 million or $0.14 per share as compared to net income of $8.9 million or $0.35 per diluted share in the prior year period. The change is primarily due to prior year gains on the hotel sales that did not recur in the current year, softer current-year performance of our hotel segment, a $5.4 million impairment charge on our owned hotel in Washington, D.C. and increased bad debt expense and collection costs, partially offset by higher franchise profits and reductions in selling, general, administrative and other expenses, primarily due to compensation reductions.

In the third quarter, adjusted EBITDA came in at $5.9 million as compared to $5.8 million in the same period last year. The improvement reflects the growth of adjusted EBITDA from the core franchise business, partially offset by a $400,000 decline in contribution from our owned hotels and $160,000 of EBITDA contribution from hotels that were sold in 2018 that did not recur in the current period. The third quarter results were negatively impacted by a deceleration in the travel industry and slowing demand in our hotels in both business and leisure travel, thereby, reducing our occupancy-based fees such as reservations and owned hotel revenues.

Our mid-scale and economy hotels experienced shorter booking windows compared to higher-scale hotels and are impacted more quickly than by declines in demand. In our owned hotels, we responded to these industry headwinds by reducing our operating costs. The year-over-year owned hotel performance net decline of $400,000 is primarily due to the cost of engaging third-party management for these hotels, which is an increase in expense over the prior year.

Adjusted EBITDA margin for the core franchise business was approximately 34% as compared to 40% in the year prior primarily due to bad debt from 1 large customer. During the third quarter, franchise revenue increased 7.2% to $16.2 million as compared to $15.1 million in the prior year. The improvement in our franchise revenue was a result of an increase in transaction fees and new programs for reputation management and guest satisfaction. These new programs, combined with the departure from the system of some lower-rated hotels, have improved our online reputation scores 2.8% year-to-date compared to the prior year, with the largest increases coming from our economy hotel brands, ABVI and CBVI, of 4.5%; and Knights Inn with an increase of 3%. These increases in fee revenue were partially offset by a $620,000 reduction in royalty fees and lower marketing fees, primarily due to the 176 terminated agreements year-to-date.

In the quarter, we signed 47 new franchise license agreements, bringing the total to 143 through the end of the third quarter. We've also signed another 17 agreements since the end of September. 10 of the agreements signed in the third quarter were for our mid-scale brands, which typically have royalty-fee escalators in the future years. 14 of our contracts in the quarter were also for new locations. We are maintaining our guidance range of 175 to 210 new contract signings for the year. The contracts for all new locations, mid-scale and economy, that were signed in the third quarter will have phased conversions and openings over the next 3 to 24 months. They will not have an impact on our 2019 revenue.

As I mentioned, our mid-scale contracts typically have openings in the 6 to 24 months after signing and contain future royalty increases, which allow our revenue to increase without needing to increase support costs. For instance, mid-scale contracts signed throughout 2019 contributed just $100,000 in 2019 royalty revenues and are expected to contribute approximately $500,000 of royalty revenue in 2020 and increase annually by 10% to 20% for the following 2 years. This royalty stream does not include marketing fees or additional incremental revenues that are generated from transactions or other franchise fees.

Franchise contracts that terminated in the quarter totaled 58 agreements, of which 51 were in the economy brands with all terminations totaling annualized royalty contribution of approximately $1.1 million. Year-to-date terminations are 176 agreements with 159 being in the economy brand. Annualized royalty revenue contribution of the terminated hotels is $3.1 million for those terminations year-to-date. We expect the level of terminations we are experiencing may persist through the first half of 2020. Over time, we anticipate we will settle into a more industry standard termination of around 10% on our economy brand hotels, offset by similar levels of new contract additions.

Also impacting our results was the financial challenges of 1 of our larger mid-scale hotel owners. This customer operates a portfolio of over 20 hotels, of which 10 hotel carry the RLH brands. We have accounts and notes receivable balances of roughly $7.2 million with this customer and have recognized a $750,000 bad debt charge in the quarter, which is reflected in our SG&A expense. Five of the hotels are still operating under RLH flags through agreements with lenders or the courts who are currently paying the ongoing franchise obligation. Two of the hotels have ceased operations, and the remaining 3 are continuing to operate under their franchise agreements. We have completed a thorough assessment of our exposure in these receivables. And at this time, we believe we have adequate collateral and guarantees to support the net receivable balance. This situation is fluid, and we are working closely with the customer and our attorneys to pursue and protect our financial interests. We anticipate that there will be further legal costs associated with this situation as it progresses.

In the quarter, SG&A expense increased about 1% year-over-year to $8.2 million. And the increase was primarily driven by bad debt expense and associated legal costs related to the mid-scale franchise customer I just discussed. This increase was partially offset by a reduction in operating expenses and a reduction in overall compensation expense, including payroll, variable compensation and stock compensation. Over 50% of our SG&A expense is related to selling and support of franchise agreements. Roughly 5% is related directly to Board compensation and publicly -- and public company-related costs. The remaining expense includes the corporate executive team and the administrative support functions of finance, accounting, human resources and IT.

Moving on to marketing and reimbursable expense in the second quarter, we experienced roughly a 5% decline year-over-year due to lower transaction volumes and the lower overall hotel count. The quarter was highlighted by our ongoing progress in the effort to sell our company-operated hotel assets. As previously announced, we've entered into nonbinding agreements to sell our Atlanta, Washington, D.C., Salt Lake City and Anaheim hotels. These sales are anticipated to generate gross proceeds of approximately $85 million and net proceeds to the company of $32 million to $36 million after hotel debt repayments and joint venture distributions. We are working through due diligence items with the buyers and are working hard to get these closed by year-end, though some sales may move into Q1 of 2020. These 4 hotels contributed $5.1 million and $6.3 million of adjusted EBITDA for the 9 months ended September 30, 2019 and 2018, respectively, and $7.5 million of adjusted EBITDA for the full year of 2018. In revenue, they contributed $25.3 million and $26.2 million for the 9 months ended September 30, 2019 and 2018, respectively, and $33.8 million of revenue for the full year of 2018.

With respect to our balance sheet, as of September 30, 2019, we had approximately $55 million of indebtedness. We finished the quarter with cash and cash equivalents of roughly $21 million, including $7.3 million held by our joint ventures. Our net debt to trailing 12 months EBITDA for the second quarter was 2.6x.

Adjusted free cash flow for the first 9 months of 2019 was $3.8 million as compared to a deficit of $15.7 million for the same period last year. The year-over-year improvement is largely related to distributions to joint venture partners in the first 9 months of 2018 that did not recur in 2019.

To conclude our prepared remarks, we are revising our outlook for 2019 based on our performance in the third quarter, combined with industry trends and market conditions that are impacting our business. Selling, general and administrative and other expense guidance is being suspended, while management and the Board are reviewing improvements to our cost structure. Our current pace of terminations, coupled with the underperformance of our owned hotels, has prompted us to reevaluate our adjusted EBITDA outlook for 2019. As such, we are reducing our adjusted EBITDA guidance to a range of $11.5 million to $13.5 million from the prior $20.5 million to $22.5 million range. The reduction in our adjusted EBITDA guidance reflects our performance to date and our outlook for the fourth quarter.

As a reminder, the guidance does not include or contemplate the impact of additional hotel sales. As we close on our hotel sales, we will file an 8-K, and we will update our guidance for inter-quarter activities during the subsequent quarter's earnings call.

As I've previously mentioned, we are maintaining our guidance range of a 175 to 210 for our new franchise license agreements to be signed in the year. And the interest in our Canvas Integrated Systems is continuing. We expect to finish the year with 10 executed deals.

That concludes our prepared remarks, and we'll now open the call for questions from analysts regarding our third quarter financial results.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Eric Wold with B. Riley.

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Eric Christian Wold, B. Riley FBR, Inc., Research Division - Senior Equity Analyst [2]

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A few questions. I guess, one, can you just maybe walk us through, over the past 3 months, how this materialized in terms of the significant underperformance from the hotels versus the EBITDA guidance that you reaffirmed, 3x or twice and reaffirmed back in August? Maybe kind of walk through a time line if you have really how things deteriorate this much within just a short amount of time and without any kind of mid-quarter announcements or pre-announcements by the company.

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [3]

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Thanks for joining us today, Eric. What -- there were 2 areas that really impacted us, and it started late in the third quarter. And it was a deceleration in the market trends for, primarily, occupancy in our owned hotels and in our franchise portfolio. While in our economy segment, our ADR has remained strong compared to index. Occupancy has declined compared to our competitive set. And the same has happened in our mid-scale hotels. That impacts for mid-scale hotels, both royalty revenue, marketing revenue and our transaction fees. And for economy hotels, it really impacts our transaction fees and our owned hotels in the same way for hotel revenue. The majority of our hotels are located in tertiary, secondary markets. And so they get hit, and we see the impact on those much sooner than we would see on other hotel, other major markets. The mid-scale and economy booking window in the industry is 20 to 23 days, whereas luxury and upper upscale window is 33 to 38 days in advanced booking. So it -- the trends we see are -- happened very quickly. The opportunity for us is that, as we can grow our hotel portfolio into those larger markets, we will be less susceptible to those market trends.

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Eric Christian Wold, B. Riley FBR, Inc., Research Division - Senior Equity Analyst [4]

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Okay. So I'm still struggling here. It's almost a $10 million reduction in EBITDA from where you previously were, and you said a lot of these came up late in the third quarter. So maybe give us a sense of kind of what your internal budget was for EBITDA for Q3 and Q4 to see kind of how much really came out of Q3 versus Q4 would be helpful.

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [5]

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Yes. If you -- looking at our guidance and where we are right now and compared to the analyst expectations, you can see that a larger portion of this impact is in Q4 when you adjust Q3 for the $750,000 to $800,000 of expenses related to our 1 large customer. The majority of that -- a larger portion of that downward trend is impacting in Q4 as we see those trends carrying into the fourth quarter.

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Eric Christian Wold, B. Riley FBR, Inc., Research Division - Senior Equity Analyst [6]

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So if we look at -- if -- I know -- I appreciate you giving us the numbers for the 4 company -- the 4 hotels that are currently in the process of being sold. Maybe within that, call it, $12.5 million guidance at the midpoint, if you assume all 4 hotels are sold as well as the 2 remaining ones you expect to sell, what would be the adjusted EBITDA for the remaining company? That would be helpful in terms of gauging kind of what a value for a company is once those are gone.

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [7]

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Yes. I don't have the adjusted EBITDA for Olympia and Baltimore in front of me at this moment. But I really appreciate that insight, and we will look at getting additional guidance out on that.

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Eric Christian Wold, B. Riley FBR, Inc., Research Division - Senior Equity Analyst [8]

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Okay. Final question then for me. Of the 4 hotels currently in sale process, any issues underlying their performance? And is there any risk that something could derail those sales from coming out given what's happening with your other owned hotels?

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [9]

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The underperformance, because those hotels, we are forecasting them to be in the system through the end of the year. The majority of these sales, based on the current time line, are going to happen late in the fourth quarter. So the impact is going to before we have included them in our guidance for the full period. In terms of the sale process, they are still nonbinding agreements and we are continuing to work with our owners through due diligence and do not currently see anything that would prevent closing of those transactions.

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Operator [10]

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Our next question comes from the line of Brian Dobson with Nomura Instinet.

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Brian H. Dobson, Nomura Securities Co. Ltd., Research Division - VP of Lodging REITs [11]

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So just real quick on terminations and system growth. I guess related to this 1 large customer in the third quarter, do you have or can you identify now any other potential, I guess, threats of -- or rather, exposure to similar large customers that could potentially be in difficult financial circumstances?

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [12]

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That's a great question. Absent this owner, our portfolio of hotels is about 17% of the portfolio of our hotels that are owned by owners that have multiple hotels in our system. Most of the remainder of those are 1, 2 or 3 hotels, and they are in the economy segment versus the mid-scale segment. This is the only owner in the mid-scale segment that has multiple hotels with us at this time. Our mid-scale segment contributes about 1/3 of our royalty revenue. So if we had a current active economy owner with 2 or 3 hotels, it would not have a significant financial impact.

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Brian H. Dobson, Nomura Securities Co. Ltd., Research Division - VP of Lodging REITs [13]

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So I take it that the remainder of your ownership base is highly decentralized. Is that a fair statement?

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [14]

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Yes, it is.

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Brian H. Dobson, Nomura Securities Co. Ltd., Research Division - VP of Lodging REITs [15]

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Okay. And then excluding this event in the third quarter, which appears largely onetime in nature, what's your outlook for system growth in 2020 on an adjusted basis, if you had never had this large onetime event?

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [16]

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Yes, that's a great question also. And we are looking -- we typically give our 2020 guidance when we do our earnings release at the end of the year. Also, with the change in management and our focus on improving our relationship with our franchisees, accelerating our sales growth, reallocating resources, we will be looking to give that future guidance in the upcoming months.

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Brian H. Dobson, Nomura Securities Co. Ltd., Research Division - VP of Lodging REITs [17]

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But would it be fair to say that it would be probably in line with the system growth that you were looking for at the beginning of this year for this year, excluding the event?

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [18]

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I think the piece there, Brian, that is a mix is the other piece that we are really focused on, as Bob mentioned in his comments, is stemming the tide of the terminations. And so we have 2 competing factors there. We are focused on accelerating our franchise sales growth and stemming that termination tide. Both of those will impact the future royalty revenue. And we would want to -- when looking at what we were guiding for at the beginning of 2019, I think we need to take time and get that correct for 2020 before we announce that publicly.

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Brian H. Dobson, Nomura Securities Co. Ltd., Research Division - VP of Lodging REITs [19]

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Okay. Fair enough. So switching over to Canvas, how does the shift in management affect that aspect of the business? Are you as committed to it?

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [20]

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That's a great question. We have a solid team that has worked on Canvas since the beginning and the inception. In addition to that core team led by Gary Sims who is our Chief Operating Officer, we have the Board's support in Canvas. But as I mentioned, we look at having approximately 10 contracts signed by the end of this year. And as we've said, this is still in a test phase, and we don't expect to see large growth or contribution from Canvas in 2020.

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Brian H. Dobson, Nomura Securities Co. Ltd., Research Division - VP of Lodging REITs [21]

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Great. And then a question as it pertains to the Board. Does the Board see this as a -- an HR event looking for a replacement for the CEO? Or do you see this more as a strategic review of the company on the whole?

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [22]

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I'm going to let -- I'm going to turn that question to Bob.

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Robert George Wolfe, Red Lion Hotels Corporation - Independent Chairman of the Board [23]

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Julie, I'll take it. Yes, Brian, it's Bob Wolfe. As you know, we have been on the asset-light path for some time, and we have successfully sold the majority of our rail property. And our direction is all about -- it's all franchised all the time. So we're looking for a leader that can help us to do the things that I mentioned and Julie reiterated, which is, in the first case, deliver superior value to our franchisees. We think we have a business model that is a great business proposition. So we need to get a sales force that will accelerate growth there. We need to take care of our current franchisees. And we need to control our costs, and we'll get a leader who will help us to do that.

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [24]

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And Brian, I rejoined the organization in January of 2019, and I rejoined because I really believe there is a great opportunity for financial growth. And with this management change, we will have additional opportunities to improve shareholder value and accelerate that growth. And I'm very excited about the future.

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Operator [25]

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Our next question comes from the line of Alex Fuhrman with Craig-Hallum.

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Alex Joseph Fuhrman, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [26]

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Was wondering if you could elaborate a little bit more on what was causing the churn in your franchisee base. Did you have a sense of, have owners been joining other systems that have terminated their agreements? And has the acceleration in that churn, did that start late in the quarter as well as you were seeing that your company-owned hotels were beginning to decline?

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [27]

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Alex, thanks for joining us again. In the trend piece, quarter 3 terminations are actually lower than quarter 3 2018 terminations. The terminations were much higher, though, in the first half of the year compared to the prior year. As we mentioned in Q2, the trend still holds similar for the economy hotels that the majority of those hotels are going independent, and the remainder are going to 1 or 2 handful of -- they're going 1 hotel to a different brand. No one brand is taking a substantial portion of those. There are a couple of things internally that are moving those terminations, and that is focusing on hotels that are not positively contributing to the brand or meeting their financial obligations. But in that vein, I think what's really great and important is what Bob mentioned in his comments, which are: we recognize there is opportunity in focusing on the contribution we delivered to the hotels and focusing on those franchise owners' satisfaction in how we are supporting them to be able to impact that termination rate in the future as well as impact and help support our accelerated franchise growth that the Board and management are both focused on.

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Alex Joseph Fuhrman, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [28]

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Okay. That makes sense. And then, just as far as the CEO search goes, can you give us a sense of how long that process is expected to take? And are you looking to move quickly there? Or is it really more about finding the right candidate? I'm just curious, with these sales ongoing and other assets that are likely to be sold, is there a sense of urgency to fill that position? Or is it really more about waiting for the right fit?

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Robert George Wolfe, Red Lion Hotels Corporation - Independent Chairman of the Board [29]

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Alex, it's Bob Wolfe again. We've got Jake Brace as the Chairman of our Search Committee, and we are focused on getting the right person. We don't see -- there's no fire drill, and we'll take our time. We'll do it right, and we're going to get a leader that can help us meet our objectives. So we have a lot of confidence in Gary and Julie and Tom and with Jake there helping on -- be our liaison on the day-to-day basis. We're well covered.

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Operator [30]

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We have reached the end of the question-and-answer session. Ms. Shiflett, I would now like to turn the floor back over to you for closing comments.

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Julie A. Shiflett, Red Lion Hotels Corporation - Executive VP, CFO & Treasurer [31]

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Great. I really want to thank everybody for attending our Q3 earnings call. And if you have any further questions related to the Q3 earnings or financial performance, please reach out to our Investor Relations contacts. Thanks, and have a great day.

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Operator [32]

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This concludes today's teleconference. A replay of today's conference will be available until November 22, 2019. You may access the replay by dialing (877) 660-6853 and entering conference ID 13695406. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.