Earnings Call Transcript - HLT Q2 2024

Operator, Operator

Good morning and welcome to the Hilton Second Quarter 2024 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Jill Chapman, Senior Vice President, Head of Development Operations and Investor Relations. You may begin.

Jill Chapman, Senior Vice President, Head of Development Operations and Investor Relations

Thank you, Chad. Welcome to Hilton’s second quarter 2024 earnings call. Before we begin, we would like to remind you that our discussions this morning will include forward-looking statements. Actual results could differ materially from those indicated in the forward-looking statements and forward-looking statements made today speak only to our expectations as of today. We undertake no obligation to update or revise these statements. For a discussion of some of the risk factors that could cause actual results to differ, please see the Risk Factors section of our most recently filed Form 10-K. In addition, we will refer to certain non-GAAP financial measures on this call. You can find reconciliations of non-GAAP to GAAP financial measures discussed in today’s call in our earnings press release and on our website at ir.hilton.com. This morning, Chris Nassetta, our President and Chief Executive Officer, will provide an overview of the current operating environment and the company’s outlook. Kevin Jacobs, our Chief Financial Officer and President, Global Development, will then review our second quarter results and discuss our expectations for the year. Following their remarks, we will be happy to take your questions. With that, I am pleased to turn the call over to Chris.

Christopher Nassetta, President and Chief Executive Officer

Thank you, Jill. Good morning, everyone, and thanks for joining us today. We are pleased to report strong second quarter results with RevPAR growth driving adjusted EBITDA and adjusted EPS above the high end of our guidance. We continued to execute on our successful development strategy, and in July our system surpassed 8,000 hotels globally. Our newly acquired brands and recent strategic partnerships will help us build even more loyalty with guests, further enhancing our network effect and increasing our industry-leading RevPAR premiums. Coupled with our asset-light fee-based business model, we are well-positioned to continue producing significant free cash flow and driving meaningful shareholder returns in the quarter. In the quarter, system-wide RevPAR increased 3.5% year-over-year, above the midpoint of guidance due to robust group performance, continued recovery in business transient, and easier holiday comparisons. Transient RevPAR grew 2% year-over-year, with increases in both business and leisure demand. RevPAR across large corporates rose 5% in the quarter, driven by strong trends across most industries, including notable recovery in technology. Leisure transient RevPAR continued to exceed prior peaks, supported by solid summer travel demand, particularly in international markets. Group RevPAR rose more than 10% year-over-year, led by strong demand for corporate and social meetings and events, and booking windows continued to lengthen. For the full year, group position is up 10% over last year, with position up mid-teens over the next several years. We expect full-year system-wide RevPAR to increase 2% to 3%, driven by positive growth across all major segments and regions. We tempered the high end of our expectations versus prior guidance due to softer trends in certain international markets and normalizing leisure growth more broadly. With continued strength in group and steady recovery in business transient, we expect higher-end chain scales to continue to outperform. Turning to development in the quarter, we opened 165 hotels totaling more than 22,000 rooms and achieved net unit growth of 6.2%. We marked several milestones in the quarter, including the opening of our 6,000th hotel in North America, and we surpassed 75,000 Home2 Suites rooms globally. We also opened seven new resort properties in Europe, including the debut of Curio in Croatia and DoubleTree in Malta. We welcomed Graduate Hotels and NoMad into our family of brands during the quarter, providing further opportunities to deliver exceptional guest experiences and accelerate our expansion in the fast-growing lifestyle segment. Demand for lifestyle products continues to increase as guests seek unique experiences in sought-after destinations around the world. In the last year, we have expanded our lifestyle offerings by more than 30%, fueled largely by growth in Curio, Tapestry, and the recent acquisition of Graduate. With roughly 400 lifestyle properties today and hundreds more in the pipeline, we are well-positioned for substantial growth over the next several years. Conversions accounted for roughly half of openings in the quarter, driven by the addition of Graduate and the continued strength from DoubleTree and Spark. In the quarter, Spark opened 27 hotels, more than doubling its existing supply. The brand also celebrated its debut in Europe with the opening of Spark by Hilton London Romford, just nine months after the first property opened in the U.S. The opening marks the start of an exciting journey for Spark to redefine the premium economy segment in Europe, with further launches of the brand across Continental Europe expected in the coming months. In the quarter, we signed 63,000 rooms, increasing our pipeline to approximately 508,000 rooms, which is up 8% from last quarter and 15% year-over-year, with notable strength across the EMEA and APAC regions. In particular, Hilton Garden Inn continued to gain tremendous traction with year-to-date signings up nearly 90% across 20 different countries. Overall, conversions accounted for over half of the signings in the quarter, driven by additions from our acquisitions and partnerships. Excluding acquisitions and partnerships, conversions accounted for 25% of signings in the quarter, largely driven by continued momentum with Curio, Tapestry, and DoubleTree. System-wide construction starts in the quarter were up 160% versus last year and up 37% excluding acquisitions and partnerships. With meaningful growth across both the U.S. and international markets, we remain on track to exceed prior peak levels of starts by year-end. Approximately half of our pipeline is under construction, and we continue to have more rooms under construction than any other hotel company, accounting for more than 20% of industry share and nearly four times our existing share of supply. We've seen tremendous interest from owners through our exclusive agreement with Small Luxury Hotels of the World. With the pace of initial property signups far exceeding our expectations under our strategic partnership, we added nearly 300 boutique luxury properties to our system in July, with an additional 100 properties expected to join later this year. Adding these unique properties to our network is highly complementary to our existing luxury portfolio and significantly increases our luxury offerings for guests around the world without any capital commitment. During the quarter, the first AutoCamp properties were added to our platforms. Each AutoCamp location provides a unique opportunity for guests to immerse themselves in nature without sacrificing the comforts of high-end accommodations. These exclusive agreements with SLH and AutoCamp provide Honors members with new and exciting ways to earn and redeem points while broadening and enhancing our network effect. As a result of our strong pipeline, recent tuck-in acquisitions, and strategic partnerships, we now expect net unit growth of 7% to 7.5% for the full year. We are also proud to continue to be recognized for our industry-leading brands and culture. Brand finance recently ranked Hilton as the most valuable hotel brand for the ninth consecutive year, claiming nine of the top 50 hotel brand spots. Additionally, Hilton was recently named the top workplace in the U.S. for millennials by Great Place to Work and Fortune for the seventh consecutive year. Since 2016, we have received over 540 recognitions as a Great Place to Work across more than 60 countries, and we remain the number one great place to work in the world and the United States. We're very happy with our second quarter results, development milestones, and brand and commercial enhancements, which we think demonstrate the continued strength of our business model. Now I'm going to turn the call over to Kevin for a few more details on the results in the quarter and our expectations for the year.

Kevin Jacobs, Chief Financial Officer and President, Global Development

Thanks, Chris, and good morning, everyone. During the quarter, system-wide RevPAR grew 3.5% versus the prior year on a comparable and currency-neutral basis. Growth was largely driven by strong international performance and continued recovery. Adjusted EBITDA was $917 million in the second quarter, up 13% year-over-year, and exceeding the high end of our guidance range. Our performance was driven by better-than-expected fee growth, largely due to better-than-expected U.S. RevPAR performance and some timing items. Management franchise fees grew 10% year-over-year. For the quarter, diluted earnings per share, adjusted for special items, was $1.91. Turning to our regional performance, second quarter comparable U.S. RevPAR was up 3%, driven by strong group performance, particularly in urban markets. In the Americas outside the U.S., second quarter RevPAR increased 7% year-over-year, driven by strong results in leisure markets. In Europe, RevPAR grew 7% year-over-year with solid performance across all segments and continued strength from international inbound travel. In the Middle East and Africa region, RevPAR increased 11% year-over-year with growth in both rate and occupancy led by strong group and leisure performance. In the Asia Pacific region, second quarter RevPAR was up 1% year-over-year. RevPAR in APAC ex-China increased 11%, led by continued strength in Japan and Korea. China RevPAR declined 5% in the quarter with difficult year-over-year domestic travel comparisons and limited international inbound travel negatively affecting results, which weighed on RevPAR results for the region but accounts for less than 3% of overall fees. Turning to development, we ended the quarter with approximately 508,000 rooms in our pipeline, up 15% year-over-year, with approximately 60% of those rooms located outside the U.S. and nearly half of them under construction. For the full year, we expect net unit growth of 7% to 7.5%. Moving to guidance. For the third quarter, we expect system-wide RevPAR growth of 2% to 3% year-over-year. We expect adjusted EBITDA of between $875 million and $890 million and diluted EPS, adjusted for special items to be between $1.80 and $1.85. For full-year 2024, we expect RevPAR growth of 2% to 3%. We forecast adjusted EBITDA of between $3.375 billion and $3.405 billion. We are bringing down the high end of our guidance to reflect slightly lower RevPAR growth expectations and FX movements. We forecast diluted EPS adjusted for special items of between $6.93 and $7.03. Please note that our guidance ranges do not incorporate further share repurchases. Moving on to capital return, we paid a cash dividend of $0.15 per share during the second quarter for a total of $37 million. Our board also authorized a quarterly dividend of $0.15 per share in the third quarter. Year-to-date, we have returned nearly $1.8 billion to shareholders in the form of buybacks and dividends, and for the full year, we expect to return approximately $3 billion. Further details on our second quarter results can be found in the earnings release we issued earlier this morning. This completes our prepared remarks. We would now like to open the line for any questions you may have. We would like to speak with as many of you as possible, so we ask that you limit yourself to one question. Chad, can we have our first question?

Operator, Operator

Thank you. The first question will be from Joe Greff with JPMorgan. Please go ahead.

Joe Greff, Analyst

Good morning, guys. Thanks for taking my question. I was hoping you could give us a little bit more detail, obviously on the net rooms growth side of things. Chris and Kevin, clearly going to 7% to 7.5% is obviously a very good thing. Can you talk about what's added versus a quarter ago, with particular attention with SLS and some of the newly acquired brands, as well as maybe what's different on a sort of organic same-brand basis versus a quarter ago?

Christopher Nassetta, President and Chief Executive Officer

Yes, I'd be happy to. I think the way to think about it is what's being added essentially is Graduate. I mean, if you look at our prior guidance, we had incorporated a guesstimate on what we would do for SLH. We are doing better than that. And so I think in the end that's going to probably be about a point and a half of NUG, Graduate, which we said would be separate and apart is about a half a point. And so I think if you sort of unwind all that and compare it against prior guidance, the organic is slightly less, but has 100% to do with some things that are just moving from the fourth quarter into the first quarter of next year. But as I was, as I said in my comments, in terms of feeling good about what's going on the development side, I mean, for the full year, we're going to hit historically high levels on signings. We're going to hit historically high levels on starts. And that is both of those, excluding any sort of partnerships or acquisitions. And obviously that's been translating into very good results. We feel very good about the momentum into next year. Most everybody was at our investor day in the spring, where we articulated a sort of algorithm story of 6% to 7% organically. And we feel very, very good about being able to deliver on that. Obviously, this year is going to be above the higher end of that because of some of the inorganic things. But if we fast-forward to next year, our expectation certainly is organically. We will be solidly in that range just given the signings, the starts, and looking at how that's going to play out in the next couple of years.

Joe Greff, Analyst

Thank you.

Operator, Operator

And the next question will be from Carlo Santarelli from Deutsche Bank. Please go ahead.

Carlo Santarelli, Analyst

Hey Chris, I think you addressed most of what I was going to ask, but at the end of your remarks there, you did talk about organic growth and the outline you laid out at the analyst day. When you think about contract acquisition spend over the next several years and acknowledging kind of that 6% net unit growth range. Should we be thinking something similar to what you've been spending in terms of contract acquisition spend this year to date, last, etc.?

Christopher Nassetta, President and Chief Executive Officer

Yes. Well, last year was elevated because of a few very specific deals, which we've noted over the last couple of calls. This year will moderate and be lower than last year. And I think on a go-forward basis, I'd look at the next year as sort of being comparable to where we'll end up this year. We're not really seeing any material difference. Notwithstanding a lot of noise in the market, I think in the quarter. Kevin helped me. Our key money percentage of deals in the second quarter was like 7% or 8%. Overall key money is still less than 10%. So 90 plus percent, fully free of any form of incentive. And we haven't really seen those stats really move around a whole lot. Again, we had an elevated year or two coming out of COVID because we got some really cool opportunities on some very big super high-end luxury and sort of resort convention-type assets. And we took advantage of that. But we're getting back to more normalized levels, which again will be lower than last year, this year. And I think we'll continue at that kind of level over the next two or three years.

Carlo Santarelli, Analyst

Great. Thanks. And then you mentioned group pace plus ten for this year. And the outlook for the next few years you mentioned was mid-teens. In terms of 2025, 2026, what kind of percentage of your expected group room nights is on the books at present for 2025?

Christopher Nassetta, President and Chief Executive Officer

I don’t have the exact number in my head, but I would guess at this point for 2025, it's probably 40% to 50%. And for 2026, it's probably a quarter, something like that. By the end of the year, we'll be for 2025, we'll probably cross over at 60% to 70%. Those would be sort of the typical numbers. And group is sort of getting back to pre-COVID typical levels. Like, even if you look in the second quarter group mix, it was pretty much at where we were pre-COVID. I mean, of overall mix in Q2 was 20%, which is exactly what it was, pre-COVID. So it's sort of, Group it's taken a while because of the long lead nature of it and planning and all that goes into it, particularly with the larger groups and the citywides. But that's sort of now hitting on all cylinders and normalizing. So, yes, I would think it would be in those percentages. So I think it's a very good indicator if we sit around this very table with all of our senior team, including head of sales and his team, and they feel very good. They're not. There's no sense of slowing on demand and pricing, and the group demand, pricing, and overall attitude in that segment remains quite good, quite strong. And as I mentioned in the comments, the booking window is extending. I mean, our overall booking window extended in the quarter. And at this point, pretty much the booking window is back to, obviously got super short during COVID but it's pretty much now back to normalized level extended in the second quarter and pretty much got us back to pre-COVID levels. The Group booking window continues to extend just because people have to go further out. There's just not enough space available for their needs.

Carlo Santarelli, Analyst

Perfect. Thank you very much.

Operator, Operator

And the next question is from Shaun Kelley with Bank of America, Merrill Lynch. Please go ahead.

Shaun Kelley, Analyst

Hi. Good morning, everyone. Thanks for taking my question.

Christopher Nassetta, President and Chief Executive Officer

Good morning, Shaun.

Shaun Kelley, Analyst

Morning, Chris. So, wanted to maybe just go high-level and get a few of your views on the latest on the consumer engineering, maybe the broader macro. Obviously, a lot of cross currents out there. I think what we continue to see repeatedly is some softness in leisure at the margin in the U.S., contrasting that with the fairly solid corporate environment. But behaviorally, what caught your eye just operationally through the quarter as we got into maybe the summer travel season. What do you think is changing at the margin? Thanks.

Christopher Nassetta, President and Chief Executive Officer

Yes, a great question. And obviously we spent a lot of time talking to people and looking at a lot of data in our business. Let me do it maybe through the lens of walking around the world a little bit to talk about what's going on. So starting with maybe I'll finish at home, start with Asia Pacific. Asia Pacific, as you heard in Kevin's commentary, is sort of a tale of two cities, China and then APAC ex-China. So in China, I think Kevin covered it nicely. In China, there is actually a very significant amount of travel going on. We do expect to end the year sort of down probably circa 5%. But what's going on in China is obviously they have economic issues, so their economy is slow, but really the travel business is still quite robust. But what's happening is they've opened up a lot of corridors for inter Asia travel that is visa-free. And Chinese travelers love to travel and they're getting out of China and they're going around, and there's just not enough inbound travel yet into China. There's not enough flights from Europe and the U.S. and other parts of the world to compensate for that, and that's going to take time. I mean, I was there during the quarter at a U.S.-China travel summit that the State Department sponsored with their equivalent, and we were talking about how we're going to stimulate more travel and more flights. And by the way, the flights have tripled or quadrupled, even since then. So, I mean, there is progress, but it's still going to take some time. So I think, China is a complex story, but that's what's going on. People, travel in aggregate, similar to where it was sort of not better or worse, but more people leaving, not enough coming in. I suspect over the next year or two we will get to a different place. Hopefully, their economy will start to pick up, but you'll have a lot more inbound travel. The rest of Asia Pacific is quite strong, particularly led by Korea and Japan. And we haven't seen any real signs of weakening in those markets. And I should say India, for that matter. No real signs of weakening. And those are the real APAC ex-China markets that are driving performance. And then coming to EMEA, again, sort of a bit of a tale to cities. The Middle East remains quite strong pretty much across the board. Europe, I would say, is still very, very strong in an absolute sense, but a touch weaker than what we had seen a quarter ago, led by what you're talking, implied in your question, which is some of the leisure business. Again, you're still at the high end of high single-digits year-over-year growth. So, it's not like it's a bad story. It's just a little it's come off just a little bit. And then coming, coming, I could keep lots of other places in the world, but these are the big markets. It’s coming home to the U.S. is exactly what's implied and sort of what you would guess from what I've already said. If you break apart the segments, Group is still raging, business transient is still grinding up, not at a rapid pace, but still grinding up. Both of those segments maintaining great pricing power. And then leisure transient has been normalizing because we're just getting back to a more normal life. And it was at very elevated levels, particularly on weekends, but broadly, and so we continue to see sort of normalization there. And the consumer, if you break it apart, and sort of segments in the lower sort of half of consumers, maybe even the lower three quarters. I mean, you can read the data is all out there. They had bank accounts and checking accounts full of money coming out of COVID. They've spent all that money. They're now borrowing more. And so, they have less available, less disposable income and capacity to do anything, including travel. You go up to the upper echelons and people still have pretty fat bank accounts and checking accounts and wherewithal. And so, what the impact of that is, some continued normalization on leisure transient. And the reason I use normalization is not to be cute. I mean, for the full year, if you look at it, we think we will globally see growth in all segments. I said that quickly in my prepared comments. It'll be very, very low in leisure transient but positive a little bit, higher on business transient, and then very, very strong for the reasons I've described on meetings and events. So, it is not, at least in our world and what we have seen year-to-date and what we expect for the rest of the year, it's not cratering in any way. It's just soft. It's definitely softening for the reasons I described.

Shaun Kelley, Analyst

Thank you so much.

Operator, Operator

And the next question is from Stephen Grambling from Morgan Stanley. Please go ahead.

Stephen Grambling, Analyst

Hi, thanks. We'd love to hear some incremental detail on effectively the non-RevPAR related fees, both within the management and franchise fees, as well as the other revenue line, as we just think about how the outlook has changed and any puts and takes to think about not only this year but maybe longer term.

Kevin Jacobs, Chief Financial Officer and President, Global Development

Yes, Stephen. The non-RevPAR-driven fees performed better than expected. We experienced strong core fee growth this quarter according to our algorithm, but the non-RevPAR-driven fees surpassed those expectations in the first half of the year. Some of this is related to timing as we progress through the quarters of this year. However, in the long run, all segments of the business, including license fees, other income, and additional revenue streams discussed at our Investor Day, should continue to grow at or above the algorithm over time. While there are some timing issues this year, it should ultimately contribute positively to the overall algorithm.

Stephen Grambling, Analyst

And just to clarify, are the timing issues just related to deals that were struck partnerships that were struck or just lapping over changes in terms?

Kevin Jacobs, Chief Financial Officer and President, Global Development

Not on partnerships or deals just a little bit of comparability year-over-year and just a little bit of strength in the early part of the year in some of those parts of the business.

Operator, Operator

Thank you. And the next question will be from David Katz with Jefferies. Please go ahead.

David Katz, Analyst

Hi, good morning, everyone. Thanks for taking my question. And it's perfectly suited because I wanted to follow on to the prior one, which is related to non-RevPAR fees. Can you talk a bit about your ability to affect or influence that growth meaning is there just more resource toward identifying and executing on those opportunities? Or is the world just evolving in a way that's sort of driving that growth on your behalf which benefits from your scale?

Christopher Nassetta, President and Chief Executive Officer

Yes. I believe that nothing is beyond our ability to influence, although the broader macro factors are something we can discuss later. There are many strategies we can implement without going into too much detail. For instance, you can see some of our initiatives related to our American Express co-brand cards, where we are working to reintroduce cards and modify their benefits. As Kevin mentioned, we are continuously communicating with our third-party partners to maximize the effectiveness of these cards. We have a significant role in these partnerships, with many contractual rights in place. Our long-standing collaboration with American Express is especially important, as it benefits both parties to ensure optimal performance. We have dedicated teams working hard every day to find ways to modify customer offers to encourage more sign-ups for co-branded cards and enhance spending. We maintain active discussions with partners like Hilton Grand Vacations, particularly regarding the value proposition. Our involvement in the Bluegreen and Diamond acquisitions demonstrates our commitment to shaping better outcomes by creating new brands in that area. In summary, we leave nothing to chance. We are actively engaged with our rights and strong partnerships, constantly seeking ways to refine our programs and adjust customer offers for improved results.

David Katz, Analyst

Super helpful. Lots more in this. Thanks very much.

Operator, Operator

Thank you. And the next question is from Robin Farley with UBS. Please go ahead.

Robin Farley, Analyst

Thanks for the opportunity. I wanted to revisit the unit growth guidance for next year. It appears that you have approximately 30% more rooms under construction compared to 2019, if my calculations are accurate. So, it doesn't seem like you necessarily need to speed up conversions, although others have mentioned that possibility. Could you share your thoughts on the current conversion landscape? Are there factors that might lead to an increase in that area in 2025?

Christopher Nassetta, President and Chief Executive Officer

Yes. I mean I agree. That's why I feel good about being in the 6% to 7% range. I mean, effectively, if you take out all the partnerships and everything, it is by being solidly in that range, it is accelerating. So it is organically reflective of the strength conversions, we do think are accelerating. I mean, for the full year, we're going to have conversions over 50%. But again, that's in part driven by partnerships, acquisition, and partnership. If you strip all of that stuff out, conversions are going to go from like 30% to just under 40%. So we are having great success in conversions. We believe strongly that has everything to do with the strength of our brands and the strength of our commercial engines driving better outcomes for our owners. And so we are getting a hugely disproportionate share of conversions. And if we do our job, which we intend to do, we think that will continue. So being solidly in 6% to 7% next year, it is reflective of the benefit of the acceleration we're seeing in signing starts, conversions, all of that baked in. It's obviously a little bit early in that it's August to give a tighter range. But as we get closer to it, we will, but we feel very comfortable being solidly in that range.

Robin Farley, Analyst

Great. It's very helpful. And then if I could, just one clarification. Kevin's comments on the timing of fee growth mentioned that the first half outperformed, and the idea that this trend will be sustained over time. Does this imply that the full year will follow the same algorithm, or should I be thinking that the second half might be slightly below the algorithm while the full year aligns with that comment?

Christopher Nassetta, President and Chief Executive Officer

Yes. Our guidance reflects that. In the first half of the year, EBITDA growth will be stronger due to timing issues discussed by Kevin. As a result, it will be lower in the latter half. However, for the entire year, we expect it to be around 10% growth. It's worth noting that, despite my desire to control everything, we cannot influence the macroeconomic environment, which is showing slight signs of weakening. While this has influenced us to lower the top of our RevPAR guidance and adjust our EBITDA guidance slightly downward, much of that adjustment was due to foreign exchange changes. Excluding those changes, our EBITDA has remained relatively stable. Even with RevPAR declining, our unit growth midpoint is increasing, keeping our overall projections consistent. We earlier stated our aim for approximately 10% EBITDA growth, and even in this somewhat soft macro environment, we are on track to meet that goal due to our effective development strategy. This not only highlights the resilience of our core business and model but also acknowledges the successful execution of our development plans led by Kevin.

Robin Farley, Analyst

Great. Perfect, thank you.

Operator, Operator

And the next question is from Smedes Rose with Citi. Please go ahead.

Smedes Rose, Analyst

Hi, thanks. Just I guess to follow up on the growth outlook a little bit. Just looking at sort of the implied RevPAR ranges at kind of one and change to three and change through the back half of the year. I mean, is the higher end just a reflection of maybe what happens with the U.S. economic growth? Or is there something else in particular that you think could drive you towards the higher end of that implied outlook?

Kevin Jacobs, Chief Financial Officer and President, Global Development

Yes, it suggests a 2% to 3% growth for both quarters. If you assess the current developments in the third quarter, it has been somewhat weaker. Moving into the fourth quarter, we expect that with the significant business travel months of October and early November, particularly in the U.S., there will be some improvement in RevPAR growth. This is also supported by our group position. It's important to note that approximately 70% of our revenue comes from the United States, so developments there will be influential. With the strength of our larger group hotels in urban markets and our expectations for increased business travel in early fourth quarter, we see this reflecting in our financial outlook.

Smedes Rose, Analyst

Thank you. Appreciate it.

Operator, Operator

And the next question is from Brandt Montour with Barclays. Please go ahead.

Brandt Montour, Analyst

Good morning, everybody. Thanks for taking my questions.

Christopher Nassetta, President and Chief Executive Officer

Good morning.

Brandt Montour, Analyst

Good morning. So Chris and Kevin, so implied in the fact that EBITDA, the guidance for the full year didn't really come down but you did cut RevPAR, we're left to assume that there's some incremental fees potentially from that extra NUG from SLH. Correct me if I'm wrong there. But the follow-on question is, if you could just remind us the economics of the SLH hotels and what you're implying to sort of accruing fees from them as we go through the rest of the year?

Christopher Nassetta, President and Chief Executive Officer

Yes, I think you are right. Part of it is the improvement in fees related to SLA, and part is the increase in non-RevPAR fees. To understand the economics of SLH, we receive standard fees similar to a typical franchise agreement, but we earn our fees based on the business we generate rather than on a percentage of total revenues. It's important to note that the average rate for these hotels is about 6 to 7 times our system-wide average rate. Overall, we feel very optimistic about the economics.

Brandt Montour, Analyst

Okay. That's super helpful. And then the follow-on question is just a clarification on some of your comments, Kevin, on the back half RevPAR I know U.S. is the big one, but U.S. and China may be taken separately, what are you implying for the back half on those two buckets versus the July run rate? Are you implying any reacceleration or sort of straight lining or what's qualitatively what you guys are thinking there?

Kevin Jacobs, Chief Financial Officer and President, Global Development

Yes, we haven't provided a July run rate yet. However, based on industry trends, it suggests an acceleration in the latter half of the year compared to July, if that's what you were specifically asking.

Christopher Nassetta, President and Chief Executive Officer

I believe that the acceleration mentioned by Kevin will be more evident in the fourth quarter. Looking at the third quarter, it seems we are experiencing a transition where leisure travel is down, and we don’t have as much business travel or events taking place. Therefore, when comparing the third quarter to the fourth, I expect the third quarter to be weaker while the fourth quarter will be significantly stronger for the reasons Kevin outlined. First, we anticipate a return to more typical levels of business travel, especially as we move past Labor Day. By October and November, we should see increased activity, and we have a solid group bookings that will contribute to a stronger fourth quarter compared to the third.

Brandt Montour, Analyst

Perfect. Thanks, everyone.

Operator, Operator

And the next question is from Patrick Scholes with Truist Securities. Please go ahead.

Patrick Scholes, Analyst

Hello, good morning, everyone.

Christopher Nassetta, President and Chief Executive Officer

Good morning.

Patrick Scholes, Analyst

Have you seen any impact on ADR growth or even customer demand from bundling the hotel rate and the resort or amenity fees into a single rate quote? Thank you.

Kevin Jacobs, Chief Financial Officer and President, Global Development

No, not yet. I think, look, it's sort of early days on sort of those changes. But I mean, really, in the end, that's about more transparency, and we do not see any impact to ADR. We have not seen any impact nor do we expect any from that change.

Patrick Scholes, Analyst

Okay. And a follow-up question may for Kevin. You folks have done exceptionally well with EBITDA margin expansion really far and away the best in my coverage universe since 2019. Any high-level thoughts about how much more room you have to go? Or how should we think about potential for EBITDA margin growth over the next several years. Thank you.

Kevin Jacobs, Chief Financial Officer and President, Global Development

Thank you for the question, Patrick. We appreciate it because we believe it's been a very positive narrative. We discussed this briefly during Investor Day, but for those who missed it or need a refresher, we anticipate an annual increase of 50 to 100 basis points in embedded margin growth as our business shifts, with all growth coming from the fee segment. These fees generate 100% margin and enhance the overall business margins. Coupled with effective cost control, which I think we've excelled at, our margins are now 1,000 basis points higher than they were before COVID, and we expect that trend to persist. While there may be fluctuations due to economic conditions and our performance relative to annual projections, generally expect about 50 to 100 basis points of embedded growth.

Christopher Nassetta, President and Chief Executive Officer

There will be years where certain areas perform better. This year is expected to be our strongest. Therefore, we anticipate an increase of over 100 basis points in EBITDA margin growth.

Operator, Operator

And the next question is from Chad Beynon with Macquarie. Please go ahead.

Chad Beynon, Analyst

Good morning. Thanks for taking my question. I wanted to focus on conversions, which for you guys and a lot of your peers are just becoming a bigger component of net unit growth? And maybe said differently, a more predictable piece. So as you think about the net unit growth beyond in 2025 and 2026 and some of the new brands that you've rolled out, which are helping on conversions, should this lift just in terms of percentage of NUG. And how does the cycle play into that with rates coming down? Thanks.

Kevin Jacobs, Chief Financial Officer and President, Global Development

Yes, that's a great question. It's really a combination of factors. We've experienced years in the past where we enter a phase in the cycle where capital becomes more restricted and costly for new developments. During this phase, conversions typically become more prevalent because they are easier to finance; you already have a trading hotel that's generating cash flow. We are focusing on our lifestyle brands, which are more suited for conversions. For example, Spark is 100% a conversion brand. We are implementing strategies to boost our share of conversions. So it's both a cyclical phenomenon and a strategic initiative. Historically, there have been times when conversions played a larger role. This is such a time. Additionally, some of our strategic initiatives are somewhat semi-permanent, allowing us to capture more market share. Last year, we accounted for about 40% of conversion deals in the U.S., and we've surpassed that percentage this year. Our network effect, the RevPAR growth we generate, the strength of our brands, and our focused strategy should contribute positively to the company's long-term growth trajectory, making it more than just a cyclical trend, although the cyclical aspect is also significant.

Chad Beynon, Analyst

Thank you very much.

Operator, Operator

The next question is from Duane Pfennigwerth with Evercore ISI. Please go ahead.

Duane Pfennigwerth, Analyst

Hey, good morning. Thank you. Just on Spark, you mentioned 27 hotels. Any themes in terms of the brands or types of properties that are converting from and what the average investment by owners is? And then my follow-up on the 400 SLH, generally, where are they located? And any more detail you can offer about the profile of these properties coming in as well? Thank you.

Kevin Jacobs, Chief Financial Officer and President, Global Development

Yes, I'll address the first part regarding Spark. Everything is progressing as we anticipated. Over 95 percent of the hotels are affiliated with third-party brands. While I won’t specify which brands, it’s something people can deduce, and it aligns with our expectations. The investment from owners is coming in as projected. There have been slight increases in construction costs, as noted in the industry, but they remain within our expected ranges. Early performance indicators show that the RevPAR index for the hotels is quite strong, potentially even exceeding our expectations, which is generating momentum. For SLH, the breakdown is 60% in EMEA, 20% in the Americas, and 20% in Asia Pacific. These are defined as small luxury hotels, averaging between 45 to 50 rooms. As mentioned, these properties are unique and are situated in high-rated, high RevPAR markets. The number of sign-ups has been better than anticipated, and the profile of the properties is just as we expected when we initiated this initiative.

Duane Pfennigwerth, Analyst

Thank you.

Operator, Operator

And the next question is from Dan Politzer from Wells Fargo. Please go ahead.

Dan Politzer, Analyst

Hey, good morning, everyone. Thanks for taking my question. Just a quick one on China. I believe you said that China was 30% of overall fees. I assume that over indexes in terms of the incentive management fees. But how should we think about that relative to that line item? And maybe any guide guardrails for incentive management fees as we think about the rest of the year and as it relates to China.

Kevin Jacobs, Chief Financial Officer and President, Global Development

No, I think for China, it doesn't differ from our typical fee structure. If we manage, it's essentially based on a percentage of gross operating profit. So that's quite similar to our other international management agreements. We're also expanding our franchise business in China, which involves straightforward franchise fees, approximately 5%. Therefore, the fee structure in China aligns with our overall business. Regarding IMF, there are a few factors at play. This might not be precisely what you were asking, but we have some foreign exchange effects and a few contracts that shifted from management to franchise at similar economics. As a result, there's been a transition between different IMF segments. If you take those two elements and a few timing issues into account, IMF would show low double-digit growth for the year, slightly above our overall business performance, representing about 9% or 10% of fees. So not much significant activity there.

Dan Politzer, Analyst

Thank you. Helpful.

Operator, Operator

And our next question is from Richard Clarke with Bernstein. Please go ahead.

Richard Clarke, Analyst

Hi, good morning. Thanks for taking my questions. Just looking at some of the other regions like Middle East and Africa, Asia, ex-China, the ones that are really delivering the double-digit growth at the moment. Just your outlook for that for the second half. Can they keep that pace of momentum? Or are we going to sort of see a convergence of global RevPAR around your guidance number?

Christopher Nassetta, President and Chief Executive Officer

No, I think we feel good about the second half in those regions that are really performing at that level. As I was trying to say when I did my little around the world exercise, we do think there's softening in certain segments, in certain parts of the world for the reasons I described. But not we think APAC ex-China is going to have a very good second half of the year. We think Middle East Africa will as well in those two cases. And those are the two that are really at the highest levels of RevPAR performance.

Richard Clarke, Analyst

And then maybe just a clarification. Maybe this is related to your previous comment, Kevin. But I noticed that think about 1,000 Waldorf Astoria rooms have left the system and about 300 Conrad. I guess that's probably Edinburgh and the New York one. But just any color around those hotels leaving the system and what it means for those brands.

Kevin Jacobs, Chief Financial Officer and President, Global Development

No, we had a few Waldorf properties that stayed in the system but were transformed into different brands. These hotels have been part of the Waldorf portfolio for a long time, dating back to when Waldorf was more of a collection brand than it is today. Aside from the one you mentioned in New York, the Waldorf properties that transitioned have remained in the system, with one becoming an LXR and two rebranded as Curios.

Christopher Nassetta, President and Chief Executive Officer

We encouraged this shift as part of our strategic goals for Waldorf. If you consider all the existing Waldorf properties and the new products being introduced, Waldorf is performing exceptionally well. The product offerings are outstanding, and the new products are exceeding expectations. However, like any long-standing brand, there are some elements that don't entirely align with our vision. The positive aspect is that with 24 brands, we can accommodate various options. While not everything will fit perfectly within Waldorf, those properties that have transitioned out are still excellent assets that simply didn't meet the Waldorf standards, but they do fit well within other brands.

Richard Clarke, Analyst

Makes sense. Thank you.

Operator, Operator

And the next question is from Kevin Kopelman with TD Cowen. Please go ahead.

Kevin Kopelman, Analyst

Thank you very much. I have a couple of quick questions. First, regarding your foreign exchange assumption, was that established before the U.S. dollar began to weaken on Friday? And secondly, could you provide information on pipeline approvals in the second quarter excluding Graduate? Thank you.

Kevin Jacobs, Chief Financial Officer and President, Global Development

Yes. The answer is no. Our forecast was established prior to Friday, but I don't believe Friday's movement will significantly impact the full year for foreign exchange. It did worsen a bit and became more of a headwind throughout the quarter, which influenced our guidance range for the full year. Now, could you repeat the second part of your question?

Kevin Kopelman, Analyst

The second one was just you had that huge approvals number. I think some of it was maybe incorporating graduate hotels, but I know underlying was also strong. If you could just give us pipeline approvals ex-Graduate.

Christopher Nassetta, President and Chief Executive Officer

We provided that information in the press.

Kevin Jacobs, Chief Financial Officer and President, Global Development

It's in the press release.

Christopher Nassetta, President and Chief Executive Officer

4,000 and change.

Kevin Jacobs, Chief Financial Officer and President, Global Development

And you’re right. It does incorporate both momentum in the existing brands and the new stuff. I'd say that's pretty strong.

Kevin Kopelman, Analyst

Thank you very much.

Operator, Operator

And the next question is from Conor Cunningham with Melius Research. Please go ahead.

Conor Cunningham, Analyst

Hi, everyone. Thank you. Just on the conversations with developers, I'm just curious on how that's changed over the past six months. I assume that there's a lot more comfortability around financing and credit availability. And then another one, just Airbnb called out booking presentation on just longer-term rentals. I mean, I realize your extended stay business is not exactly the same. But are you seeing any hesitancy on the longer but curve stuff in general? Thank you.

Kevin Jacobs, Chief Financial Officer and President, Global Development

Yes. No, the second part is easy. We're not. And I think I'm not going to comment on what Airbnb said, and you haven't had a ton of time to study what they said, but that's a very different business. The composition of their business, 90%, 95% leisure all long-term stay. So I'll let them comment on that part of the business. We're not seeing any changes. And Chris even talked about booking windows normalizing and things like that earlier in the call. So nothing there. And then sorry, the first part was... Yes, I would say they are mostly consistent. Developers remain optimistic about the future of travel, and overall capital seems to be a bit less expensive than it was, coming down from its peak. There is an expectation for further decreases, but the lending environment is more restrictive due to the macroeconomic concerns from the lending community. Despite this, there is still funding available for solid projects, which is why we are seeing an increase in our construction starts. We are gaining market share in situations where capital is tighter. We've mentioned this before: when the tide rises, everyone benefits, but when it recedes, the stronger brands that lenders trust and developers feel confident working with will capture more market share, and that is what we are witnessing.

Conor Cunningham, Analyst

Appreciate, thank you.

Operator, Operator

And ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Chris Nassetta for any additional or closing remarks.

Christopher Nassetta, President and Chief Executive Officer

Thank you, Chad, and thank you, as always, for spending an hour of your day with us. Obviously, we're super pleased to be able to deliver on second quarter, and we feel very good about our outlook for the full year, as I described, while the macro environment is a little bit weaker. Our development story is incrementally stronger, and the net result is pretty much our ability to deliver an algorithm, which we're excited about. We will look forward to catching up with you after the third quarter to give you the latest and greatest. And hope everybody enjoys what you can on the rest of summer. Take care, and thanks.

Operator, Operator

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