Extended Stay America, Inc.
Q1 2018 Earnings Call Transcript

Published: 27 Apr 2018

[Operator:]

Greetings. Welcome to Extended Stay America First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to Robert Ballew, Investor Relations. Please go ahead, sir.

[Robert Ballew:]

Good morning and welcome to Extended Stay America's first quarter 2018 conference call. Both the first quarter earnings release and an accompanying presentation are available on the Investor Relations portion of our website at esa.com, which you can access directly at www.aboutstay.com. Joining me on the call this morning are Jonathan Halkyard, Chief Executive Officer; and David Clarkson, Acting Chief Financial Officer. After prepared remarks by Jonathan and David, there will be a question-and-answer session. Before we begin, I'd like to remind you that some of our discussions will include forward-looking statements, including the discussion of our 2018 outlook. Actual results may differ materially from those indicated in the forward-looking statements. Forward-looking statements made today speak only as of today. The factors that could cause actual results to differ from those implied by the forward-looking statements are discussed in our Form 10-K filed with the SEC on February 27, 2018. In addition, on today's call, we will reference certain non-GAAP measures. More information regarding these non-GAAP measures, including reconciliations to the most comparable GAAP measures are included in the earnings release and Form 10-Q filed yesterday evening with the SEC. With that, I'll turn it over to Jonathan.

[Jonathan Halkyard:]

Thanks, Rob, and good morning, everyone. Thanks for joining us to discuss our first quarter 2018 results and updates on our growth strategy. I'd like to just start by thanking my 8,000 co-workers for delivering strong results during the quarter. The folks on the front lines in our hotels, in sales, revenue management and development all delivered on their commitments this quarter. It's what you, our shareholders expect from us and what we expect from ourselves. And the first quarter of 2018, was an important and successful one for our company, not only did we once again post strong RevPAR growth and margins in the core business, but we advanced our growth strategy, returned capital to shareholders, de-levered our balance sheet, bolstered our Board of Directors, and made a key addition to our management team, not a bad start to the year. Let me spend a few minutes on each of these accomplishments. It's only been a couple of months since our last call, but the strong trends we saw in the fourth quarter and early 2018 carried into March, as we finished the quarter with comparable system-wide RevPAR growth of 3.7%, with the month of March showing some of the strongest RevPAR growth seen in many months. Our company-owned hotels grew RevPAR 4.7% in total reflecting both strong same-store sales results as well as an improvement in our owned portfolio operating metrics as a result of non-core asset dispositions over the last year. We generated adjusted EBITDA of $132.2 million representing an increase of 3.8% on a comparable basis. Revenue growth came from a strong performance in the South, particularly in Florida and Houston, as well as improvements in our North division. Our Bay Area results during the quarter were a bit softer but in line with the industry, while we also saw improvements in the Philadelphia and Chicago markets. Revenue growth was driven by strong increases in average daily rate particularly among our core Extended Stay guests, where we saw revenue growth of approximately 4.5% driven by increased revenue from our monthly business. As I mentioned on our last call, our goal is to grow that business and while I'm pleased with the trends to start the year, I'm not yet satisfied as I remain convinced there giving greater growth potential for us in this segment. The increase in adjusted EBITDA combined with a lower tax rate, lower depreciation expense, and reduced interest expense, led to double-digit increases in both adjusted paired share income and adjusted FFO per paired share in the first quarter. Against the strong operational and free cash flow backdrop, yesterday, our Boards of Directors approved an increase in our dividend to $0.22 per paired share, a 4.8% increase. This marks the fourth straight year since the company went public that we have raised our dividend despite having sold a significant number of hotels, more than 80 in fact. We believe our dividend is an important component of our overall capital allocation and as our free cash flow and free cash flow per paired share increase we expect to have the capacity for further increases in the future. Speaking of capital returns we accelerated the pace of our share repurchases thus far in 2018. As of this morning, we have repurchased approximately $50 million in paired shares year to-date. We believe our shares remain very attractively valued and with our ability to arbitrage the free cash flow multiple on non-core hotel sales with the implied yield of our shares, I expect that we will continue to be strong buyers of our company's stock at these levels. It's important to note that over the past 18 months we've advised our shareholders that with the completion of our portfolio-wide renovation project last May, we would scale down our capital investment levels, return capital to shareholders, and reduce our financial leverage. We have done that. In addition to the capital returns I just mentioned this quarter we retired debt de-levering to 3.7 times trailing 12-month pro forma adjusted EBITDA. But we are still investing in the business with the first quarter bringing an increase in our IT and development CapEx both of which are future growth drivers for the company. In the brief time since our last call, we have made more progress on our ESA 2.0 growth strategy. In addition to the previously announced 25 hotel asset sale in February, we also completed the sale of our Downtown Austin hotel for approximately $45 million in March. These 26 hotels were sold at a blended free cash flow multiple of approximately 17 times highlighting yet again the strong multiple arbitrage available to us through share repurchases and new hotel build. Meanwhile, we are actively engaged in negotiations to sell up to 45 additional hotels this year, using the same general framework of selling assets, obtaining franchise agreements in return, and securing owner commitments to develop or convert new Extended Stay America hotel. We are targeting to complete these sales in 2018 which would place us about halfway towards our objective of a 150 hotel asset sales by the end of 2021 well ahead of our expected pace. And we expect to break ground on our first new hotel development construction project in 11 years this summer and expect to open in 2019. As of this morning we have purchased three land sites and expect to purchase another five to eight sites this year. We are near completion of the re-costing effort on the 2.0 prototype and I am confident that the construction costs will fall between $70,000 and $75,000 per key. And while we don't see ourselves as an acquirer of other hotel brands in the near future, we do see opportunities for conversions from time-to-time. In fact we are under contracted by two Extended Stay hotel for a combined $25 million, one recently completed hotel, and another nearly completed. After closing, we will convert these hotels to Extended Stay America and link them to our sales and distribution network. We expect those transactions to occur in the second and third quarter. We strengthened our already estimable Board of Directors this quarter with the addition of Ellen Keszler and Bruce Haase. Ellen Joined the ESA Board in February and brings to us a wealth of experience in digital travel, distribution, and revenue management. For years at Travelocity and Sabre will bring invaluable expertise to us. Bruce joined the ESH Board at the end of March, a hospitality industry veteran, Bruce's great success in building Wood Springs franchise business is directly relevant to our ambitions in this area. I know that our shareholders will be well served by Bruce and Ellen and I join my co-workers in welcoming them to ESA. And as I'm sure you've seen we just announced the appointment of Brian Nicholson as CFO of Extended Stay America. This is a return to ESA for Brian. When I joined the company almost five years ago, Brian was our Vice President of Financial Planning & Analysis and when I was CFO, he was my top Lieutenant. Brian left ESA in 2015 and over the last few years has been the CFO of Driven Brands and the CFO and Interim CEO of The Fresh Market, a grocer with approximately 170 stores. We're all thrilled to welcome Brian back to ESA and I want to thank David Clarkson for his outstanding work as Acting CFO. I think you would all agree that we have not missed a beat with David in the chair. I'm honored to have such a strong and deep leadership team and one that will be strengthened with Brian's addition. Last quarter, I spent a few minutes talking about our segment and why I was so enthusiastic about the economic opportunity associated with it. This morning, I'd like to discuss briefly some important topics that sometimes are overlooked, specifically our efforts around energy conservation of sustainability and our commitment to the community. Since 2012, Extended Stay America has invested significant amounts of CapEx to reduce our energy and water usage to the benefit of the environment and our shareholders. Compared to 2012 usage rates, in 2017, the company saved more than 400 million gallons of water, over 30 million kilowatt hours electricity and more than 60 million BTUs of natural gas. In fact, our total utility cost per occupied room is down versus 2011 despite six years of cost inflation and we expect to reduce our utility usage again in 2018. Given our lean operating model, utility expense is one of our most significant expense items. We have been equally responsible in our renovation program. During our previous rate phase of renovations, we were able to keep over 25 million cubic feet of materials out of landfills through our recycling efforts and we intend to be just as diligent with our new development and future renovation. Since 2013, we have partnered with the American Cancer Society to provide lodging support to patients and caregivers that need to travel for lifesaving treatments away from home. We've donated over 120,000 free or deeply discounted hotel rooms since then helping over 15,000 patients and their families save more than $5 million in lodging expense highlighting our commitment to improve the lives of our guests and our employees. Our mission is to care for people who are building a better future for themselves and their family. This is for guests and my co-workers of core, but it's also for the communities in which we operate. Let me close with a couple of comments and observations on our operating environment. Two weeks ago, I spent a week with our operations leadership at several locations across the country. They and therefore I am optimistic about the general level of demand from our guests. We're encouraged by demand for construction, training, transportation, and other projects for the next couple of quarters and we continue to find the supply and demand balance favorable for us with overall industry supply growth moderate and supply at our price point expected to be less than half that of the industry. I'll now turn the call over to David to discuss our financial results further and give an update on our 2018 outlook. David?

[David Clarkson:]

Thank you, Jonathan. We were pleased with our strong top-line performance in the quarter and that our revenue growth came primarily from our core longer-term guests. Comparable system-wide RevPAR in the first quarter increased 3.7% compared to the prior year with a 4% increase in ADR being partially offset by 20 basis point decline in occupancy. The decline in occupancy was caused by the Easter timing shift which we estimated will add a negative 40 basis point impact during the quarter. Comparable company-owned RevPAR increased 3.8% driven by a 4% increase in ADR partially offset by 20 basis points decline in occupancy. Our absolute level of company-owned RevPAR increased 4.7% during the first quarter reflecting strong overall RevPAR growth and our improved asset quality from non-core dispositions. Revenue in the quarter increased for both nightly guests and Extended Stay guests but grew more quickly for our Extended Stay guests. This was particularly true in markets impacted by storm activity both from the Hurricanes in 2017 and the winter storms in 2018. Our hotels are well suited for both displaced homeowners and the demand resulting from post storm rebuilding activities. Hotel operating margins declined 30 basis points in the first quarter to 52.2%. The increased payroll expense, property taxes, and commission expense led to the slight decline in hotel operating margins for the quarter. Corporate overhead expense excluding share-based compensation and transaction costs dipped 1.7% to $22.8 million during the quarter. Our adjusted EBITDA in the quarter was $132.2 million above the top end of our range due to higher than anticipated revenue in March. Adjusted EBITDA increased 2% even with the loss contribution during the quarter of approximately $2.3 million from the hotels sold in 2017 and 2018. Income taxes increased $1.3 million to $5.8 million during the quarter driven by higher pre-tax income that was partially offset by decrease in our effective tax rate due to the recent tax reform bill. Adjusted FFO per diluted paired share increased 18.2% in the first quarter to $0.42 per diluted paired share compared to $0.35 per diluted paired share in the same period in 2017. The increase was driven by a lower tax rate and increase in adjusted EBITDA, lower net interest expense, and a reduction in share count from paired share repurchases. Net income during the quarter increased 94% to $31.1 million driven by increased revenue, a gain on asset sales, a lower effective tax rate, and a lower depreciation expense, partially offset by an increase in impairment charges. The elevated impairment charges this quarter relate primarily to the hotels for which we are in the process of negotiating sale agreements. These hotels have levels of RevPAR and cash flow well below our company average. On the flip side, we recognize the $38 million gain from the sales of our Downtown Austin Texas Hotel and the 25 hotel portfolio each of which we completed during the quarter. Adjusted paired share income per diluted paired share in the first quarter increased 33.5% to $0.19 per diluted paired share from $0.15 in the same period last year. The increase was due to a lower tax rate, lower depreciation, increased revenue, and lower share count from paired share repurchases. We ended the quarter with our net debt to trailing 12-months adjusted EBITDA on a 598 hotel basis at 3.7 times down from 3.9 times on a 625 hotel basis at the end of 2017. Gross debt outstanding was $2.53 billion compared to $2.59 billion at the end of the fourth quarter as we retired over $60 million of floating interest rate debt during the quarter. We are pleased with the extent to which we've been able to reduce leverage over the past several years which is a reflection of both our prudent financial policy and our high free cash flow business model. We finished the quarter with approximately $249 million in restricted and unrestricted cash up significantly from year-end 2017 with higher cash from operations and after the sale proceeds being partially offset by debt retirement and an increased pace of share repurchases. Approximately two-thirds of the restricted cash is associated with 10/31 exchanges from the sale of our Denver Tech Center Hotel in December and the Austin Hotel sold in March. We expect to use most of the proceeds from those two hotels for conversions and land purchases in order to minimize our taxes. Gross proceeds from asset sales during the quarter including franchise application fees were approximately $159 million for 26 hotels with an average sale multiple of nearly 17 times pro forma free cash flow. As Jonathan highlighted, this strong free cash flow multiple sale allows us to arbitrage the share repurchases and new hotel builds with a much higher free cash flow yield. We expect to continue to take advantage of this arbitrage, while our shares remain undervalued with proceeds from future asset sales. Capital expenditures in the first quarter were $33.6 million including $4.2 million for land acquisition and other ESA 2.0 costs, $10.5 million in IT CapEx, and approximately $2.2 million on CapEx related to flood and hurricane damage in 2017. Yesterday, the Boards of Directors of Extended Stay America, Inc. and ESA Hospitality, Inc. declared a combined cash dividend of $0.22 per paired share payable on May 25, 2018 to shareholders of record as of May 11, 2018. This represents a 4.8% increase despite having sold 31 hotels in the last year and the expectation of future asset sales as we remain confident we can continue to grow free cash flow per share. Our dividend yield is now 4.4% at recent trading prices. During the first quarter, we repurchased approximately 1.8 million paired share for $35.2 million. Since the end of the first quarter and as of this morning we have repurchased an additional 0.8 million paired shares for $15.1 million representing approximately $50 million in repurchases in the first four months or 1.3% of our outstanding paired shares. With our share repurchase authorization remaining now at over $145 million, we have plenty of dry powder for purchases and believe our shares remain very attractively priced. Looking at the second quarter of 2018, we expect comparable system-wide RevPAR will increase by 1% to 3%. We expect adjusted EBITDA between $164 million and $170 million. For the full-year 2018, we continue to expect comparable system-wide RevPAR growth of 1% to 3% and adjusted EBITDA of $600 million to $620 million. We expect the loss contribution from the Austin Hotel sales will be roughly offset by the expected contribution of the two conversion purchases. Our adjusted EBITDA outlook does not reflect expected additional sales as the impact will depend on timing of closing and the quantity of hotels sold. We are increasing our capital expenditure guidance to $205 million to $235 million reflecting an additional $25 million in capital to purchase the previously mentioned two hotels for conversion. These purchases we expect will be completed using a 10/31 exchange from the Denver Tech Center in Austin Hotel sales saving the company approximately $3 million to $4 million in taxes. So remainder of our capital expenditure assumptions are consistent with the outlook we provided in February. We continue to expect our annual interest expense to be approximately $130 million in line with last year as our refinancing activity in 2017 and modest debt retirements should offset increases in LIBOR. This morning, we also introduced two new annual guidance metrics. The first is adjusted paired share income per paired share which we expect will be between $1.04 and $1.14 per paired share excluding the impact of any additional share repurchases. We've had many requests to guide to this metric and we believe for this year, and in 2019, will better reflect the health of the company than absolute adjusted EBITDA as we go through this portfolio transformation with asset sales. The second metric is our expected return of capital to paired shareholders which is another common request. Through our dividends and share repurchases, we expect to return between $216 million to $300 million this year to our paired shareholders which represents roughly 7% to 8% of our market capitalization. Operator, let's now go to questions.

[Operator:]

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions]. Thank you. Our first question today comes from the line of Harry Curtis with Instinet. Please proceed with your question.

[Harry Curtis:]

Hey good morning everyone. I had two quick questions. Jonathan, your first quarter RevPAR was exceptional particularly considering the calendar shift, but you've kept your annual guidance for RevPAR at 1% to 3%. Can you walk us through how you see the balance of the year shaping up? Do you think that that the 1% to 3% is just being conservative or are there some challenges that we should be aware of?

[JonathanHalkyard:]

Good morning, Harry, and thanks for the question. I will address that. I'll certainly invite David to add color if he wants to. We did have a strong start to the year, to the quarter, particularly as you noted the calendar shift in March hurt us a little bit with Easter. April is -- April has been a pretty good month with about 3% RevPAR growth as of this morning. A couple of reasons. First of all it probably is a bit conservative really for a couple of reasons. One is it is early in the year. I believe we have made adjustments once maybe twice this early in the year to our annual guidance, but it's typically been our practice unless something really unusual has happened to begin to look at the annual RevPAR guidance in our second quarter results and that's because while we do have larger customers that where we have visibility several months out much of our business does book in the last 30 or 60 days. In terms of how things play out for the remainder of the year, I do believe in the third quarter, the comp is probably a little bit easier for us, in the fourth quarter it's probably a bit more difficult mainly because we had a very strong fourth quarter aided in part by the storms that occurred in the business that we get as a result of that. But the main reason is it's just still early in the year, but hopefully our shareholders understand that we feel -- we do feel confident about the operating environment for the remainder of the year.

[Harry Curtis:]

That's helpful. And my second question is in your remarks you talked about a lift in IT CapEx and can you walk us through is this an opportunity to cut -- really eventually cut costs or is it a revenue enhancement opportunity, what is the overall strategy?

[Jonathan Halkyard:]

It is mainly a revenue enhancement opportunity for us. There's two component to our IT, the majority of our IT spend this year, and it is an elevated IT CapEx spend compared with what we've done in the past and what we intend to do in the future. The two components are first of all, a higher bandwidth backbone in our properties themselves primarily to enable casting video entertainment in our rooms for our guests which they pay for through buy-up fees on higher in room Wi-Fi bandwidth. Many of our guests are now bringing their own devices of course into the hotel rooms and they're looking to cast off those devices as opposed to watch traditional kind of linear cable channels. And the second is the supporting investment which is HDTVs in many of our rooms that of course are related to that first initiative. With over 60,000 rooms that's a lot of TVs we're not replacing all of them; we’re doing it really in the markets where we think the opportunity is there. But that that will enable us to drive additional Wi-Fi buy-up revenue which is one of our largest and fastest growing on room revenue streams. And then, finally, we are looking to replace our property management system later in the year. This is the systems that our front desk agents use to check-in and check-out guests, it will be a much more intuitive system for our staff to use and will enable future innovations at our hotels such as mobile check-in and check-out and even mobile room keys for keys using their mobile devices.

[Harry Curtis:]

And will that system have any revenue management features functionality?

[Jonathan Halkyard:]

Not really, it'll be really be an interface for our guests and for our front desk agents.

[Operator:]

Our next question is from the line of Chris Woronka with Deutsche Bank. Please proceed with your question.

[Chris Woronka:]

Hey, good morning guys. Jonathan, wanted to ask you kind of where you stand on having franchisees starting up new hotels that maybe or not part of a group that is buying part of your owned portfolio, is that something that you see maybe accelerating or considering further?

[Jonathan Halkyard:]

Are you talking about franchisees who are kind of smaller groups or smaller entities?

[Chris Woronka:]

Yes but they're not necessarily buying any of your owned hotels. So they would be -- they would not have any other skin in the game beyond their first maybe Greenfield Extended Stay Hotel?

[Jonathan Halkyard:]

Yes, that is certainly an effort underway to introduce our brand to developers and franchisees who would develop new Extended Stay America hotels without buying portfolios from us. Certainly there has been a lot of interest from group to acquire our hotels and franchise them from us and then also develop new hotels and we've already closed one deal, we have three in process that we described during our remarks. So that -- there's probably, there's been more demand on that front than we've been willing to accommodate just on the straight franchisee front, that's an effort that is ongoing and I hope that we'll have results from that announcement in the coming quarters. But for now at this point, our franchisees have been those who have acquired hotels from us.

[Chris Woronka:]

Okay, great. And then also want to ask now it's a little bit further down the road any preliminary thoughts on how -- on the WoodSpring Choice acquisition and what impact if any that's having on your franchising or operations?

[Jonathan Halkyard:]

We don't see any impact on our franchising activities or our operations at this point from the Choice's acquisition of WoodSpring.

[Operator:]

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

[Anthony Powell:]

Hi good morning everyone. Jonathan you mentioned you wanted to grow your monthly stay guests. I think in prior years the company had focused more on growing the seven to 29 nine night guests. You talked more about the difference between those types of guests and why the monthly guests more attractive now?

[Jonathan Halkyard:]

Sure. Good morning, Anthony. Thanks for the question. The monthly guests has always been very attractive segment for us no doubt for so many reasons. One is that they bring to us if they're priced correctly which we do very well, they bring to us an EBITDA contribution that is equal to or better than any other customer segment. Those monthly guests who are business travelers staying with us from we call monthly guests but a few weeks to a few months typically come to us through corporate accounts, their retention rate, or loyalty rate can be very high and they come to us predominantly through our owned distribution channel. They also of course access our hotels in a way that really meets our lean operating model, monthly housekeeping or sorry weekly housekeeping and so on. They also, they regard our product very highly and provide for us very attractive social media reviews for other guests who are looking on to our hotels. So it is a customer segment for which our product is ideally suited and it's also one that our competitors are really not addressing and you're correct to point out Anthony that over the past couple of years we have increased the numbers and the revenues from our shorter stay guests and we've been predicting for some time and I commented back in February that we expected to really bend that curve back towards our longer stay guests and I was gratified to see that during this quarter we've made progress in that regard and that our monthly business contributed the majority of our growth in revenue to the business this quarter. So we will always have short-term guests, it’s an important part of our business mix, it's fills occupancy very close to the day of arrival but our operators and I want our shareholders to know that home for us is where the core customer, the Extended Stay customer who gives us very high service scores, who has high loyalty and provides us with terrific economics.

[Anthony Powell:]

Thanks. And on to the two hotel acquisitions, what about the real state of markets attracted you to those hotels and as you sell more blocks of assets should we expect you to use 10/31 proceeds to do the smaller deals on an ongoing basis?

[Jonathan Halkyard:]

Well these two hotels we mentioned, we are -- they are in attractive markets. We think the valuation and the return that are associated with them are going to be strong for us and frankly they're going to enable us to build a muscle around conversion and integration which is I think is going to be important for this company going forward. That being said, I don't think this is going to be a significant category of capital allocation in the future. I do think we'll continue to do acquisitions and conversions but it's probably somewhere in let's say 10 to 50 hotels potentially over the next several years. So it's not going to be a major effort, but we think particularly if this effort is successful I think it will be -- it will be a component of our expansion strategy.

[Anthony Powell:]

Okay. And the deal size will be similar to the ones you've done like two hotels $25 million roughly or let’s say $12.5 million per hotel?

[Jonathan Halkyard:]

Yes, the acquisition cost of these hotels is roughly equal to what our build cost would be probably even a little bit less. We will spend a modest amount of capital in the conversion, these are Extended Stay Hotels. So the re-flagging will not be a significant capital investment at all. And so I look at these as really a way to accelerate our growth by buying hotels that are already -- already be constructed and yes, I think that the buys will be relatively small as opposed to large groups of hotels.

[Operator:]

The next question is from the line of Joe Greff with J.P. Morgan. Please proceed with your question.

[Joe Greff:]

Good morning everybody. With respect to this core longer-term guest focus, Jonathan, what percentage of room nights that these -- this segment account for the 1Q had about compared to a year ago and then where would you optimally like to get to from here?

[Jonathan Halkyard:]

Well together the weekly and monthly guests contributed about south 65% of revenue and that's about equal to what it was a year ago. And we have certain hotels in the system that will do 70% or 80% of that weekly and above levels of guests. We have certain hotels in the system that are in transient areas that will do 60% transient business. For example, maybe down in Fort Lauderdale near the Cruise Port as an example. So there is not one size fits all for the hotels, but broadly speaking I would expect to see our weekly and monthly guests grow probably over 70% maybe even 75% of our overall revenue and room night mix over time. So it’s again -- there will always be a meaningful piece of transient business in our system but we see deep pools of demand for Extended Stay customers amongst our corporate accounts that we don't see others addressing effectively in this mid-priced segment like we do. So that together with the merits I mentioned earlier -- to an earlier question is why we think this is an attractive segment.

[Joe Greff:]

Great. And then just a follow-up question on these additional potential asset sale fees 30 to 45 assets, is there much of a difference in asset quality in these assets versus the ones that you sold?

[Jonathan Halkyard:]

No, no these are like the ones that we sold in February, these represent what we call Tiers 4 and 5 out of our five tier scale. Generally they have RevPAR levels that are probably 25% below the system average. So they are in many ways similar to the portfolio we sold in February.

[Operator:]

Our next question is from the line of Chad Beynon with Macquarie Group. Please proceed with your question.

[Chad Beynon:]

Hi good morning. Thanks for taking my questions.

[Jonathan Halkyard:]

Hi, Chad.

[Chad Beynon:]

Good morning. You commented that you're still seeing some strength in Houston, Florida I think that's a couple of quarters of really accelerated growth obviously post the Hurricanes, are we kind of to the point now where this was just a regular business and maybe those markets should continue to be strong or is the benefits still coming from the post- hurricane just a little bit more color on that given your exposure to those markets? Thanks.

[Jonathan Halkyard:]

Sure, thanks Chad. It's interesting. I mean Houston was strong in the first quarter, but we also were comping over the Super Bowl which hurt that market a little bit as well and in Florida that that business accelerated in the first quarter versus the fourth quarter and some of our largest accounts in Florida and the fastest growing one have nothing to do with the hurricane. For example we do a large business with condominium units that are undergoing renovations themselves and they moved their residents into our hotels while they do those renovation. So there are many of these businesses in these areas which are quite strong which are unrelated to the storms. There still is business in these markets related to the storms. However but as I look at both Houston and Florida generally I'm -- we've been very happy with their performance, we have terrific leadership in those markets and we think that just a fundamental business environment there is going to be pretty good for us even as the storm effect does continue to wind down.

[Chad Beynon:]

Okay, great thanks. And then just going back to the asset sales that are under negotiation given that you're slightly ahead of schedule in terms of getting to the 150 and the multiples that you've sold assets at have been quite high. Could you kind of help us think about how careful you might be with these sales, does it make sense to sell to multiple buyers given maybe the difference in prices and how much urgency do you have in terms of completing the sale in 2018 or kind of waiting out for maybe higher prices just some more color on that would be helpful?

[Jonathan Halkyard:]

Yes, with the 45, up to 45 hotels that we described that we're working on right now beyond that there we do not have any real urgency to dispose of additional hotels. And there -- we don't need to do this we set out a five-year timeframe back in 2016 to complete these sale. And while we are ahead of pace I'm not moving that five-year time frame up at all. So we intend to get maximum value for our shareholders as we move through this process and we feel very good about the sale we accomplished in February, about the potential sale of these 45 hotels this year, but beyond that there's no real urgency to do more and we will stay with that five-year plan.

[Chad Beynon:]

Okay, thanks and congrats on the employment of Brian.

[Jonathan Halkyard:]

Thanks. Thanks very much, Chad.

[Operator:]

The next question is from the line of Thomas Allen with Morgan Stanley. Please proceed with your question.

[Thomas Allen:]

Hey good morning. So the mix of customers between longer and shorter stay was helpful. You used to also talk about the mix of distribution channels, can you just talk to how that's shifting. Thanks.

[Jonathan Halkyard:]

Sure and thanks a lot, Thomas. The -- one of the really important parts of our results in the first quarter was the fact that our owned distribution channels, so by that I mean our website, our call center, and our what we call property direct, which is folks coming into our hotels and booking rooms or people who are already with us extending their time with us that all of those owned distribution channels grew in the first quarter and we've been seeing some growth of course in OTAs over the past year-and-a-half and that grew as well in the first quarter but it didn't grow as fast as has been growing in the past. So all of this is important and expected when we strong growth out of our core customers or longer stay guest. They're the ones who book directly with us through the website or the call center or property direct.

[Operator:]

The next question is from the line of Shaun Kelley with Bank of America. Please proceed with your question.

[Shaun Kelley:]

Hey good morning guys. Jonathan I want to start I think you mentioned in the prepared remarks some of the progress you'd made on cost reengineering around the new prototype and the development side. Can you just talk a little bit more about that specifically, when I think you said $70,000 to $75,000 is a key type target range. That's definitely well below I think what we see developers really able to achieve out there particularly in today's market, so where are some of the key components that you're able to I guess optimize to able to bring that concept down.

[Jonathan Halkyard:]

Yes, thanks Shaun. I announced in February that effort to reduce the construction cost of our new units. A project which we actually began in early January and that is concluding right about now in the next two weeks. The primary sources of the cost reduction have been two. One is in the square footage of the room, I think three, one is in the square footage of the room, we reduced the square footage of the new rooms from what had been contemplated although I would add the redesigned prototype rooms are still of the same size or larger than those of our existing at stay. The second is in the -- in some of the fit and finish of the rooms themselves and actually I think this is a win-win and that what our developers and our architects have designed is not only a reduced cost but also increased durability in those, but the majority of the savings came from the square footage as is the case in any exercise like this. And the third I would add is that we're doing some work around some more innovative construction techniques that we think are going to be directly relevant to our type of products that have been used in multifamily and that's something that we will be testing over the next year, but that could add additional savings to our program.

[Shaun Kelley:]

Great, that's helpful. And then second question is just on you guys give a very detailed CapEx plan. Can you just remind us of how much kind of renovation capital is baked in for this year particularly as we look out to the later part of this year for possibly that next round of potential more targeted rental that you talked about in the past?

[David Clarkson:]

Sure, hey Shaun this is David. Yes, we've not baked in any renovation capital into our guidance at this point except for few million dollars for some testing. We're in the process now of determining what that renovation program will look like and what the timing will be. So to the extent there is spent in 2018 on that and there could be in the very latter part of Q4 we will provide an update likely on our next call. And so the CapEx changes that we did make the guidance related exclusively to that $25 million for the two hotels we expect to acquire.

[Shaun Kelley:]

Great. And as the -- is the plan still or could you give us some kind of view I know it's a little far out to probably even provide your own budget on this, but to the extent you mentioned IT CapEx possibly ramping down is that in the ballpark of what would be replaced by a more targeted rental capital or kind of how should we think about more like a long-term mix of CapEx?

[David Clarkson:]

Yes. When you think long-term in terms of renovation CapEx I'd point you back to our Investor Day presentation from almost two years ago but still sort of holds which is that we would expect to renovate our hotels generally every seven years. Our prior CapEx program was about 10,000 a key or next one we expect will be not uniform and cookie cutter and 10,000 a key across the portfolio some maybe 5,000 a key, some maybe 15,000 a key, so that's what we're in the process of figuring out. I think our Investor Day presentation sort of outlined an average of 12,000 a key across the portfolio again every seven years so that would be a place to start from a modeling perspective.

[Operator:]

Our next question is from the line of Smedes Rose with Citigroup. Please proceed with your question.

[Smedes Rose:]

Hi, thanks. I just wanted to ask you about the RevPAR on the same-store basis going up 3.7% in the first quarter but then the hotel operating margin declining by 30 basis points is there something in particular that was driving that decline I just sort of thought with a fairly fixed cost model you would have seen more margin expansion.

[David Clarkson:]

Sure, this is David again. So you're right our business model is fairly fixed in nature. So those expense increases are not necessarily the result of sort of higher than predicted revenue, say for some commission expense for OTAs which was up in part due to more volume coming through the OTAs and in part from the way people are booking through that channel some book growth, some for -- book net, and so that that difference created some incremental expense on our P&L. And payroll expenses were up about 5% in the quarter most of that the result of wage pressure primarily on the West Coast. So we are dealing with some increase in expenses which again not the result necessarily of increased revenue but we are seeing like others in hospitality and in retail. So those are some facts that we're dealing with.

[Smedes Rose:]

Okay. And then just as you identify more site for future development, is there sort of a ballpark of the number of hotels that you would be comfortable developing kind of on balance sheet at any one time that we sort would be thinking about?

[Jonathan Halkyard:]

Yes, I mean I think we're sort of ramping up to being able to do 10 to 15 new on balance sheet sites per year. We expect to break ground on five or so in the next three quarters or so but again in the process of ramping up to 10 to 15 a year on a go forward basis.

[Operator:]

Our next question is from the line of Michael Bellisario with Robert W. Baird. Please proceed with your question.

[Michael Bellisario:]

Good morning everyone. Just wanted to dig into Shaun development question a little more here may be what are you hearing from your partners on the development front regarding their target returns, how they think about returns and then also how they think about other brands maybe like True trying to playing your space and also trying to lower their development costs as well?

[Jonathan Halkyard:]

We really haven't heard anything from the developers around True competing with us. What we have heard is that they are -- they're enthusiastic about our efforts to reduce the cost of our hotels. They're confident in their ability to develop our hotels. They are enthusiastic about the fact that we have 600 of these hotels already operating and that the P&L is proven. And they're really buying into the notion that the bottom-line is more important than the top-line in terms of margins more important than RevPAR. They get that benefits of that operating model. So I think that -- the conversations with the developers have been very constructive. And the returns that they see in our model they believe not to speak for all of them, but at least in the discussions we've had more of the discussions have been around the model itself than the returns associated with them which we believe they think are quite adequate.

[Michael Bellisario:]

All right, that's helpful. And then just on the demand front maybe could you give us a little more detail on what you saw from the Business Travel -- Traveler during the quarter maybe how much was demand, how much was pricing uptake and then also what sectors did you see the strongest and weakest in the quarter.

[Jonathan Halkyard:]

Yes, we saw our corporate sales during the quarter were about equal with what they were in the first quarter of 2017. We see -- we're seeing demand that strong from construction and looking ahead to the second quarter that's clearly where as we query our top sales people and our regional sales people a lot of the demand is around the construction industry. So that's pretty much what we're seeing.

[Operator:]

The next question is from the line of Stephen Grambling with Goldman Sachs. Please proceed with your question.

[Stephen Grambling:]

Hey thanks. Two quick follow-ups. I guess first what exactly is changed to better target and grow that core a longer stay customer already and what still has to be done and second on the management franchise properties what are the initial learning's from these contracts and properties out of the gate and how should we think about additional infrastructure that still needs to be built out for you to support the planned growth?

[Jonathan Halkyard:]

On the first question, not a lot has changed other than really the direction that I and the rest of the senior leadership team has given to our sales force around targeting the longer stay customers from our business travelers. And on the margins really just a rededication towards our distribution channels particularly the website and the call center to make sure that we are getting all of the demand that is presenting itself through our proprietary channel. So additional investment in the call center to make sure that we are entering the phones quickly and that we’re converting that inbound call volume into reservations and innovation and improvements around the website for the same objective. So it really is just demand generation through our direct sales force for the most part and then optimizing and eliminating any friction on the distribution channels that serve those customers. And this is a process that will develop over time and our marketing investments are certainly going to be oriented more towards those longer stay guests because we think that that's the right thing for our business and our shareholders. In terms of your second question was about infrastructure or the kind of our experience with franchise and management out of the gate. It’s been a really a good couple of months for us since we brought on our first 25 franchisees. We have a pretty lean franchise services operation here with a leader taken for -- he is one of our best regional directors who is now leading our franchised services operation. Many of the other folks here are doing that as part of their existing roles within our company. Over time we will build out a proper franchise services organization but we’re deliberately slow paced on that simply because we want to make sure that we do it responsibly and as we do that over time, it’s not going to add a lot of expense to the organization and I -- not enough to even call out at this point in terms of any addition to G&A or anything like that.

[Operator:]

Thank you. We've reached the end of our question-and-answer session for today and I would like to turn the call back to Jonathan Halkyard for closing remarks.

[Jonathan Halkyard:]

Thanks, Rob, and thanks everybody for joining us on the call. We look forward to seeing many of you over the coming months as we engage in a number of Investor Events in May and June and I hope you will all join us in late July for our second quarter earnings call. Thanks very much.

[Operator:]

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.