Extended Stay America, Inc.
Q2 2018 Earnings Call Transcript

Published: 26 Jul 2018

[Operator:]

Greetings and welcome to the Extended Stay America Second 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. It is now my pleasure to introduce your host Mr. Rob Ballew, Investor Relations. Thank you. You may begin.

[Robert Ballew:]

Good morning and welcome to Extended Stay America's second quarter 2018 conference call. Both the second 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 Brian Nicholson, Chief Financial Officer. After prepared remarks by Jonathan and Brian, there will be a question-and-answer session. Before we begin, I'd like to remind you that some of our discussions today will contain 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. Thank you for joining us this morning to discuss our second quarter results. Before getting into the results themselves I like to recognize and thank my 8,000 co-workers, who once again delivered solid results for the quarter. Our shareholders know that we operate a very lean business. It is one of the reasons our margins lead the industry, but it also means that our associates at the hotel need to wear a lot of different hats in serving our guests. They do this well every day, and I and the rest of us here at our corporate headquarters, which we now refer to as the HSC, the Hotel Support Center, we appreciate what they do every day. This was an important quarter for us. First off we made meaningful progress in executing our growth strategy. Having grown our owned hotel pipeline and having received our inaugural franchise applications. Our pipeline now stands at over 4200 rooms and growing. Next we saw double-digit growth in adjusted paired share income per diluted paired share and adjusted FFO per diluted paired share during the quarter. And finally between our dividend and share repurchase activity we returned approximately $75 million to our shareholders during the quarter. Our second-quarter system-wide RevPAR growth slowed a bit from the pace in the first quarter and was up 1.6%. The slowdown in RevPAR growth as compared to the first quarter was not unanticipated and was primarily due to a reduction in business related to the hurricanes in Florida and Houston last fall. Our internal research shows that our competitive set underperformed the industry and the economy chain scale during the second quarter as our specific sub-markets underperformed relative to the national average. The results are stronger when looking at the absolute RevPAR growth of our own portfolio, which grew 2.4% during the quarter driven by the higher levels of performance of our retained portfolio as compared to those we have sold. Strength in the quarter in our San Francisco, Florida, Houston and Philadelphia markets were partially offset by weakness in Austin, Dallas, Boston and LA. It is gratifying to see the San Francisco area business rebound during the quarter. The mix of business across the system is moving in the right direction as well with our revenue from 30 plus day length of stay customers and those coming through our proprietary distribution channels growing during the quarter. Weekly guests were down slightly in the quarter and shorter stay customers with most of those coming through the OTA channel grew as well though at a slower pace than in the first quarter. As usual, we had solid expense control at the property level. Excluding payroll and reservation expense, which both track revenue, remaining property level expenses total actually declined in the second quarter. We made progress in further standardization of operating practices across the system and we have found new opportunities for leverage procurement here at the HSC. As such, we were able to nearly maintain margins at our property levels during the quarter at industry-leading 56.4%, down just slightly over the prior year. Our cost structure also reflected our active targeting of core extended stay guests. They come with higher, more stable margins and transient business. Adjusted EBITDA during the quarter was $167.3 million. Our strong margins and share repurchase activity combined with the lower tax rate and lower depreciation expense led to double-digit percentage increases in both adjusted paired share income per diluted paired share and adjusted FFO per diluted paired share for both the second quarter and for the entire first half of 2018. We continued the strong pace of share repurchases in the second quarter repurchasing nearly $33 million of shares in the quarter. Combined with repurchases in the first-quarter and our dividends paid year-to-date, we have returned approximately $150 million to paired shareholders in the first half of 2018. On an annualized basis that represents more than 7% return of capital to shareholders in a year based on recent capital market capitalization. Because of our asset sales and as planned our more modest capital spending in recent quarters we have over $225 million of cash on our balance sheet, a portion of which could be deployed towards repurchases in the future. We believe our shares remain attractive valued and with our ability to arbitrage the free cash flow multiple on non-core asset sales with the implied yield of our shares, we expect to continue to be buyers of our company stock at these levels. Additionally, we would see any dip in the share price to be an excellent repurchase opportunity. Since our first quarter call we made significant progress in our long-term growth strategy. Recall that two years ago we introduced our growth strategy ESA 2.0. That strategy included growing our portfolio through new development and franchise sales, improvement of the owned portfolio through selling and refranchising lower ADR hotels, and targeting renovation capital to improve the quality and performance of the owned portfolio. During the second quarter, we took steps to deliver on all three fronts. This quarter, we approved our first four franchise applications independent of asset sales. As of this morning, we have purchased four sites and have another 11 sites under option. By the end of the year we expect to have closed on at least six of those option sites in addition to the four we have already purchased. In a few weeks, we will break ground at the first site for a hotel that should open in 2019, and we expect to have at least four sites under construction by the end of the year. In the second quarter, we purchased a hotel just outside of Charlotte near our headquarters, which we have since converted to an Extended Stay America. We expect to purchase another hotel for conversion in the Southeast in the next three months as well. So in the case of these first two conversion hotels we are buying two effectively brand new hotels at attractive multiples with similar designs to our prototype in markets we were already targeting for new construction. These purchases will also allow us to reduce or eliminate a significant portion of the cash tax impact from recent asset dispositions. In the last three months, we have signed purchase and sale agreements with three separate investment groups to sell and refranchise 46 of our hotels. Following customary due diligence, we expect to close on these three portfolios in the next several months at which time the buyers will collectively commit to build or convert an additional 15 Extended Stay America hotels. When completed, this set of transactions will bring the total number of sold and refranchised hotels to 71; approximately halfway to our goal of 150 by the end of 2021. So what does all of this mean in terms of our new hotel and franchise pipeline? Combining the new franchise commitments from the buyers of our 71 hotels already closed or under contract with our own development and other franchising activities we expect to have a pipeline of approximately 50 hotels by the end of this year. And finally, as we highlighted at that investor day about two years ago, we plan to return to a seven-year renovation cycle beginning around the end of this year. This project will be quite different from that which we undertook from 2011 to 2017. First, we will renovate only approximately 450 hotels that we expect to retain and we will do so over a seven-year time period. We will renovate not with a one-size-fits-all approach but with four different renovation tiers determined by the return potential of each hotel. We expect to commence with the program in the fourth quarter this year. Our second quarter 2018 earnings presentation available on our IR website has some additional highlights of the upcoming program, and we believe our shareholders will receive strong returns from these capital investments. I just like to close with a few comments about our corporate structure. Over the past several months many investors and some in the equity research community have enquired about the potential for Extended Stay America to revisit its corporate structure as a means to increase shareholder value. Indeed a number of research analysts on the call this morning have modeled the company on this basis using recent transactions and trading multiples to support various valuation analyses of our company under an opco/propco structure or some other method of separating the C-corporation from the REIT. We welcome the analysts’ approach as we believe it highlights the intrinsic value of our company as with other lodging companies. This morning I want our shareholders to know that we continue to evaluate the merits of alternatives to our current corporate structure and notwithstanding our considerable progress in executing the ESA 2.0 strategy as outlined in my remarks this morning we have preserved all optionality with respect to any structural alternatives that our board may consider in the future. I'll now turn the call over to Brian to discuss our financial results further, give an update on our 2018 outlook and discuss some of his priorities for the next year as ESA’s new CFO. Brian?

[Brian Nicholson:]

Thank you, Jonathan. Before I begin I would first like to thank you, thank the team here at Extended Stay America and the boards of directors of ESA and ESA Hospitality for the opportunity to return to Extended Stay America as Chief Financial Officer. It is an exciting time at our companies and I'm very pleased at the chance to contribute. I would also like to take a moment to thank David Clarkson for his excellent work as interim CFO these last several months, and for his continuing service to the company. Since this is my first earnings call as CFO of Extended Stay America I would like to touch briefly on a handful of my key goals in the role for the next year or so before I jump into more details on our results. First I plan to work to ensure the finance team is partnered as effectively as possible with operations to help improve consistency of execution at our hotels. Second, I will partner with our development team to help build solid processes and sound oversight for our franchise and on balance sheet development for new hotels and conversions. And last, I plan to contribute to explore avenues to grow shareholder value and to continue to be as communicative with investors as possible about progress against this and other company initiatives. Turning to our results, comparable system-wide RevPAR in the second quarter increased 1.6% compared to the prior year with a 3.4% increase in ADR being partially offset by 130 basis point decline in occupancy. April and June RevPAR growth was pulled down by a bit of a soft May, and while still growing RevPAR, we did have significantly less hurricane-related business in the second quarter of 2018 than in the prior quarter accounting for the entire drop in RevPAR growth compared to the first quarter. We also had less renovation tailwind in the second quarter compared to the prior two quarters. Comparable company-owned RevPAR increased 1.7% while absolute company-owned RevPAR increased 2.4% reflecting the improved remaining portfolio quality from non-core dispositions. For the first half of 2018 comparable system-wide RevPAR increased 2.6%. Revenue in the second quarter increased for both nightly guests and Extended Stay guests with slightly more revenue growth coming from shorter stay guests as expected during the leisure travel months in summer. Hotel operating margins declined 30 basis points in the second quarter to 56.4%. Increased payroll and reservation expense led to the slight decline in hotel operating margin during the quarter. All other hotel expense items collectively saw a decrease of 0.5% on a comparable company-owned basis during the second quarter compared to the prior year highlighting our efforts to contain costs and offset pressure from key inflation risk items. For the first six months of 2018, hotel operating margin dipped 30 basis points to 54.5%. Corporate overhead expense excluding share-based compensation and transaction costs increased 4.2% to $22.1 million during the second quarter, reflecting reimbursable management and franchise related expenses during the quarter, which does not affect our adjusted EBITDA on a net basis. Our adjusted EBITDA in the quarter was $167.3 million in line with our expectations. Adjusted EBITDA during the quarter was impacted by the lost contribution of approximately $6 million from hotel dispositions in 2017 and 2018. Adjusted EBITDA for the first six months of 2018 was $299.5 million. Interest expense during the quarter increased by $0.7 million to $32.4 million driven by a $1.2 million charge in transaction fees partially offset by a lower spread to LIBOR due to term loan repricing activity since the beginning of 2017. Income taxes decreased $1.5 million to $14.4 million during the quarter driven by a lower effective tax rate partially offset by an increase in pre-tax income and other income tax expense related to winding down our Canadian subsidiary. Adjusted FFO per diluted paired share increased 10% in the second quarter to $0.58 per diluted paired share compared to $0.53 per diluted paired share in the same period in 2017. The increase was driven by a lower tax rate and a reduction in share count from paired share repurchases. For the first six months of 2018 adjusted FFO per diluted paired share increased 13.4% to $1 compared to the same period last year. Net income during the second quarter increased 31.9% to $65.6 million driven by a reduction in expenses related to sold assets, lower depreciation expense, no impairment charges compared to $7.9 million a year ago and a lower effective tax rate. For the first half of 2018 net income increased 46.9% with a large gain on asset dispositions mostly offsetting a $43.6 million impairment charge during the first quarter of 2018 combined with an increase in revenue, lower depreciation and a lower effective tax rate. Adjusted paired share income per diluted paired share in the second quarter increased 11.7% to $0.35 per diluted paired share from $0.31 in the same period last year. The increase was largely due to a lower tax rate, lower depreciation, and lower share count from paired share repurchases. For the first half of 2018, adjusted paired share income per diluted paired share increased 18.8% to $0.54 compared to $0.46 in the same period in 2017. We ended the quarter with our net debt to trailing 12-month adjusted EBITDA on a comparable basis at 3.8 times, a slight increase from the 3.7 times at the end of the first quarter due to capital returns and an increase in ESA 2.0 CapEx, including the purchase of a hotel during the quarter for conversion. Gross debt outstanding was $2.52 billion compared to $2.53 billion at the end of the first quarter 2018. We are pleased that we've been able to reduce leverage over the past several years and reduce our term loan spread to LIBOR, which is a reflection of both our prudent financial policy and our high free cash flow business model. We finished the quarter with approximately $227 million in restricted and unrestricted cash. Roughly half of our restricted cash is expected to be used for 1031 exchanges for land and hotel purchases in the second half of 2018. Capital expenditures in the second quarter were $56.2 million, including $14.6 million for our hotel purchase and conversion, land acquisition and other ESA 2.0 costs, $3.8 million related to insurable events, and $14.9 million in IT CapEx. For the first half of 2018, capital expenditures totaled $89.7 million. 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 August 23, 2018 to shareholders of record as of August 9, 2018. Our dividend yield is approximately 4.0% at recent trading prices. During the second quarter, we repurchased approximately 1.6 million paired shares for $32.8 million. Since the end of the second quarter and as of this morning we have repurchased an additional 0.1 million paired shares for approximately $1.8 million. Including those repurchases, we have repurchased approximately $70 million in paired shares year-to-date or nearly 2% of paired shares outstanding. With our share repurchase authorization remaining at over $125 million, we have plenty of dry powder for purchases and we believe our shares remain attractively priced. Looking to the third quarter of 2018, we expect comparable system-wide RevPAR will increase by 1% to 3%. We expect adjusted EBITDA between $170 million and $176 million. For the full-year 2018, we now expect comparable system-wide RevPAR growth of 1.0% to 2.75% and adjusted EBITDA of $595 million to $610 million. Our updated full year RevPAR growth and adjusted EBITDA expectations have now been adjusted to include some renovation disruption in the fourth quarter as we begin our next cyclical renovation program in November. And it also continues to include expectations related to cycling over immediate hurricane related disruption, as well as post-storm increases in demand last year. Additionally our adjusted EBITDA outlook does not reflect additional sales as the impact will depend on the timing of closing and the number of hotels sold. We do not expect additional asset sales to impact comparable system-wide RevPAR growth materially. We are maintaining capital expenditure guidance of $205 million to $235 million reflecting our expectations to return to renovations in the fourth quarter with $30 million $45 million in renovation CapEx including some FF&E and pre-buys for our first quarter 2019 renovations. This will be partially offset by expected lower maintenance CapEx and lower ESA 2.0 CapEx. The amount of renovation CapEx could be higher or lower depending on timing in the last few weeks of the year. We are pre-buying more than normal in order to allow us to renovate key hotels in the lower occupancy months in the first quarter of 2019. Most of the first couple of phases of our hotels are in our hire ADR markets that haven't had a renovation in about seven years and will receive a premium or premium plus renovation as outlined in our earnings presentation. We continue to expect our annual interest expense to be approximately $130 million. We expect adjusted paired share income per paired share between $1.07 and $1.15 per paired share representing approximately 8% to 15% growth in 2018, a $0.02 increase from our prior guidance at the midpoint due to lower depreciation expense, lower loss on disposal expense, and additional paired share repurchases partially offset by a reduction in our adjusted EBITDA outlook. Through our dividends and share repurchases we continue to expect a return between $260 million and $300 million this year to our shareholders which represents roughly 7% of our market capitalization. Let's now go to questions.

[Operator:]

Thank you. Before we begin the question and answer session I'd like to ask everyone to limit their questions to one and one follow-up in order to try to accommodate everyone in the queue. [Operator Instructions]. One moment please while we pull for questions. Our first question comes from the line of Anthony Powell with Barclays. Please proceed with your question.

[Anthony Powell:]

Hello. Good morning everyone. And Brian welcome to the call.

[Brian Nicholson:]

Thanks Anthony.

[Anthony Powell:]

I had a question about RevPAR growth overall you mentioned that the economy extended stay constant under reform of the industry. How many of you think the hotels in your segment should perform relative to the industry over the medium term? Do you think you can start performing in line once the hurricane comps go away or is there just more demand growth in other segments right now?

[Brian Nicholson:]

Anthony my sense is that there has been more demand growth in other segments right now. I don't know that I really want I want to try to explain the growth in the economy segment as a whole, but we have obviously we well there's no perfect analog for our business in the segments that start tracks. We do feel like the economy segment is a little closer to us than any of the others and while we're a little better than the worse we feel better especially recently about how we've done relative to the economy segment. And feel like the economy segment is picking up some strength relative to others.

[Anthony Powell:]

All right. So following up in that so let's say especially just starting renovation programs next year was going to be disruptive what kind of RevPAR growth should we be expecting for your portfolio over the next couple years? I assume zero to two yes I know it's not important now giving the ESA 2.0 but it's important to kind of help us model things going forward?

[Jonathan Halkyard:]

Hey, Anthony it's Jonathan, I'll be reluctant to provide kind of RevPAR estimate over the next several years, I will say the following though that this renovation program while we do think it will introduce some disruption in the fourth quarter. We think it's going to be a nice tailwind for us in the next several years as we get more of our hotels benefiting from this capital investment. Secondly we still believe very strongly in the demand for a core extended stay guests and that there is not a great deal of supply being put against extended stay guests and meanwhile we continue to improve our capabilities around sales and revenue management for these longer-term customers and we think that that represents an attractive opportunity for us over the next several years and that should provide us the opportunity to continue to grow RevPAR.

[Anthony Powell:]

Okay. Thanks and just in terms of ESA 2.0 in the structure it seems like you've been selling a lot of the lower tier hotels and it looks like the hotels you're building in kind of high-growth markets. As you look towards maybe splitting up or a new structure what kind of owned asset base do you expect to have going forward in terms of either RevPAR, total RevPAR asset quality locations where you trying to go in terms of your owned asset based overtime?

[Jonathan Halkyard:]

Well, we are first of all in terms of the hotels that we are going to be developing or that our new franchisees will be developing these are going to be in markets and hotels that provide higher levels of ADR and RevPAR than our current portfolio. We now are around $65 or so ADR in the portfolio and many of these hotels are going to be in the kind of $80 to $90 RevPAR or I’m sorry ADR level. As we go forward disposing our lower ADR hotels and developing new hotels like I just described, I mean, these are going to be in markets that have key extended state demand drivers. Construction and medical and IT and the other industries that really drive our business. Where we’re finding right now, many of these opportunities are going to be in markets like Florida, the Carolina’s, Texas and the Arizona and the Mountain West to pick a few.

[Anthony Powell:]

All right, thank you, appreciate it.

[Jonathan Halkyard:]

Thanks, Anthony.

[Operator:]

Thank you. Our next question comes from Harry Curtis with Nomura Instinet. Please with your question.

[Harry Curtis:]

Good morning, everyone. I wanted I have two questions. Jonathan, you mentioned the target of 50 hotels or a pipeline of 50 by the end of the year. If you could give us some sense of visibility and from the perspective of the developer, what are the expected ROICs on these new hotels and how does that compare to other options in that competitive set?

[Jonathan Halkyard:]

Sure, good morning, Harry. In terms of the ROIC that we are seeing from the hotels that we’re looking to develop on our own account and for those that we believe that our developers are seeing, they are kind of in the low double digit unlevered returns, kind of a 11% 14% is what we are seeing and what we believe the developers are seeing as well.

[Harry Curtis:]

Okay. That’s an important consideration as you do consider the possibility of a restructuring and so that leads me to my second question is if you could give us your perspective and perhaps that at the board, what are the advantages and challenges of effecting us been and maybe what are some of the what has to happen from here going forward to make that decision?

[Jonathan Halkyard:]

Yes. I think, I mean I’ll comment I guess briefly around the thinking. It comes down to really kind of two factors. One is the course of the formants of the business and what to what extent any corporate structure that the company has actually influences its performance and ability to deliver free cash flow and that’s not just operating performance but that seems like taxes and the rest. And then how will the equity markets value that performance. And so, those are probably speaking kind of the two factors that we consider and it’s not just around any kind of structural changes, the same kind of approach could be applied to thoughts around strategic M&A or other types of capital allocation. In terms of -- and that’s a process that we always go through of course. And in terms of I don’t know kind of phrase it kind of what have to happen. There is certainly no, there is no bright line but I we certainly know that there has been some focus on this, we get questions from our shareholders from time-to-time on this as I mention of course a number of folks in the equity research community have commented on this. So, we just thought it was important to kind of state the way that we’re looking at it.

[Harry Curtis:]

I guess where I’m going with this is this has been an option for the company for a while. You seem to have a higher level of interest in it now, why now?

[Jonathan Halkyard:]

Well, it’s not that we have a higher level of interest necessarily but it has become a more frequent topic of questioning that the company has gotten. Clearly in the last couple of years there’s been a couple of transactions along the lines of this type whether it be Hilton or lucky to have course. And so, there are some different factors that we’ve been able to take a look at. But it’s mostly because it’s been more a topic of conversation and questioning from our shareholders and the equity research community that we thought it was important to make a statement.

[Harry Curtis:]

Okay, very good. Thanks, very much.

[Jonathan Halkyard:]

All right, thanks.

[Operator:]

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

[Chris Woronka:]

Hey, good morning guys. Appreciate the color I guess around the softness in May. Can you kind of maybe extrapolate that a little bit and talk about what happened in June and then if you care to give us a little bit of preview of July, I know the monthly number whip around a little bit but maybe what kind of trajectory you’re on currently?

[David Clarkson:]

Yes, Chris. I’ll take that and Jonathan may want to jump in. as we look at the data, the softness in May was not something that was driven by a particular geography or a set of geographies. It’s not driven by a particular industry or a demand driver. We just saw sort of generalized softness really beginning at the end of April persisting through May and then sort of strength regaining through June. And I hesitate to speculate on whether there could be larger factors macroeconomic or other factors that might have contributed there. July, I think as everyone knows, started with some difficultly and with some headwind e fourth of July holiday on a Wednesday sort of interfered with business travel at first whole week of July, but since then we've seen decent strength in July and we compare pretty favorably to the industry into the economy segments at least with the information we've seen so far.

[Chris Woronka:]

Okay. Appreciate that and then is we think about the, this next phase of renovations if I think back to the first round you did which I think started in what 2012 or something I remember you did the higher kind of or high RevPAR jet markets first which I understood to be maybe out west California. As we think about that this time around is it going to follow the same pattern in terms of you do the higher return projects first actually the best tailwinds are going to maybe come a year after though that kind of first batch is done. Is it going to be a similar trajectory to that?

[Jonathan Halkyard:]

It is going to be a similar trajectory Chris that we are generally starting with our higher ADR sites and they happen to be also the ones that have gone the longest period of time now without a renovation for the most part. I'm hopeful we're not going to have to wait a year. I mean just as in the last time we'll be able to get through these hotels in about 10 to 12 weeks max and then we expect we'll be seeing some benefit from those investments pretty shortly thereafter.

[Chris Woronka:]

Okay. Very good. Thanks guys.

[Jonathan Halkyard:]

Thanks Chris.

[Operator:]

Thank you. Our next question comes from Shaun Kelley with Bank of America. Please proceed with your question.

[Shaun Kelley:]

Hey. Good morning guys. Jonathan to go back to sort of the strategic comment and I totally appreciate that this is a difficult to do on a sort of public earnings call, but just to say it kind of or think about it more broadly on -- is there like a either a goal post where you want to get on maybe the re-franchising or in ESA 2.0 or into some of these renovations before you think there might be an optimal time for extended stay to look more aggressively at some of these operative - some sort of other corporate structure or do you think it's something you can do in parallel and not necessarily disrupt a lot of the other initiatives you have going on?

[Jonathan Halkyard:]

Thanks Shaun. I think it's a good question and it's well posed. There is no particular goal post or milestone with respect to our ESA 2.0 activities and growth strategy that would need to occur in order for us to consider any change to our structure. Our message really is twofold. The first is that our main interest is to increase shareholder value and just as we evaluate capital allocation decisions or M&A decisions or investment we of course consider the company's corporate structure in that light. The second is we're moving forward. We are ambitiously going after this ESA 2.0 strategy. We think we made a pretty significant progress this past quarter and well for the remainder of the year and importantly what we're doing in that regard which is building the value of our brand by bringing on new franchisees and growing the portfolio and improving the value of the owned portfolio through recycling capital selling lower ADR assets that attractive valuations investing on in new hotels that we think will drive an attractive return. We think both of those broad activities will make a lot of sense whether the company whatever structure the company pursues maintaining its current structure doing something different. So we're moving forward with the ESA 2.0 plans and we don't think in doing so frustrates any potential changes that the company might pursue and in fact might even make those more valuable.

[Shaun Kelley:]

I think that makes sense. Thank you for the candor and then the follow up would be yes you mentioned the pipeline and some of the values that may create or be important too. So can you just give us a little bit of the bridge on I think as you've laid it out in the release which is pretty clear the way you're analyzing here you have 26 hotels in a pipeline today you said 50 by the end of the year. So what's the kind of component to kind of bridge from the 26 to the 50? Is that, new individual contracts are these coming from, the existing recycling people is that coming from your own build like just what's going to be the build up to get you from 26 to 50?

[Jonathan Halkyard:]

Shaun, I'm going to give this a try but invite Brian to comment as well as if I don't get it exactly right. So we have a -- it starts with 15 hotels that from the transaction that we completed earlier in this year that buyer is committed to building or convert an additional 15 extended Stay America hotels. We presently have 15 hotels in the pipeline for our owned development. We have another four franchise applications. So these are franchisees who are going to build extended Stay America hotels but have not acquired any hotels from us. So that brings us up to 34 and then the buyers of the 46 hotels that we currently have under contract are together collectively committing to build an additional 15 extended Stay America hotels. So that brings us to 49. Now we also believe that will Jim Alderman and his team will be successful in selling additional franchisees over the next six months and so that will be even past that 50 or 49 hotel pipeline. Does that make sense?

[Shaun Kelley:]

Yes. It makes perfect sense. I am super clear. Thank you very much.

[Jonathan Halkyard:]

All right. Thanks Shaun.

[Operator:]

Thank you. Our next question comes from David Katz with Jefferies. Please proceed with your question.

[David Katz:]

Hi. Good morning. As well just second in appreciation for the candor. Well, I wanted to just ask when we look at the strategy going forward of selling hotels in bunches, how are you thinking about the balance between using the capital to improve those hotels to presumably to get a better price with is a notion of selling them ahead of renovation and someone else using their capital into the renovation rather than the companies which could conceivably accelerate the process. I recognize there's a balance in there and everyone may be different but just thinking about the pace of the process here.

[Jonathan Halkyard:]

Yes David, it was a little bit muffled but I think I got the question which is essentially how do we think about investing capital in those hotels that we are looking to sell as to not investing I guess taking renovation capital and those and instead deploying it elsewhere. We generally see stronger returns in capital that we invest to renovate those hotels in our hire ADR markets, and in those is markets where we see stronger extended stay demand drivers. And for that reason we would place a lower priority on investment in - capital investment in the lower ADR hotels and that that's the main reason why we would - we think it would we would be better stewards of our capital investment to invest that capital either in our higher ADR hotels or in new hotels themselves. Now, how our buyers or buyers of these hotels may have a different view and that’s fine; that’s what makes the market. So, but that’s generally the way we see it. I don’t know if Brian would have anything to add.

[Brian Nicholson:]

Yes. I’d probably allude to a point that’s been made earlier which was as we went through our prior renovation program, we tended to start with higher ADR hotels and move sort of then our own internal team scale. So, a lot of these properties that are candidates for sale had had more recent renovations than others. And so, that would be an additional reason why we would prefer to wipe. Our intent is not to focus capital on these properties. But again, that all becomes a negotiation as we work to get these deals done.

[David Katz:]

Great. And just one follow-up, from a developer perspective, when you go out to sell the brand, clearly the universe and the divide in the universe is widening between the very large scale systems and the single brand or smaller portfolios. As you grow out, either pitch your value proposition. Help us understand how you capture the deals against the likes of the much larger systems that have presumably a powerful pitch.

[Jonathan Halkyard:]

That why -- they certainly do have a powerful pitch. I think really what ultimately wins the day for us has been our focus on the Extended Stay customer, our model, not only our operating model and the margins associated with it but also our cost model for constructing these hotels which on our last call I indicated that we were close to nailing down our cost, our construction cost per room. And we had since validated that with hard bids in the construction market so that we can be at or under $75,000 a key for this hotel. But I think all of those items together are proven operating model or economical cost of build and our focus on this extended stay customer has ultimately enabled us to really to make some head way. And we really we sell the bottom-line to these developers not necessarily the topline and I think that’s the reason that we’re having some success.

[David Katz:]

Thanks, very much.

[Jonathan Halkyard:]

Thank you, David.

[Operator:]

Thank you. Our next question comes from Joe Greff with J.P. Morgan. Please proceed with your question.

[Joe Greff:]

Hello, everybody. Most of my questions has been answered but I do have one more with respect to Jonathan to your comments. On even it were continuing to evaluate the merits of corporate structure, I guess how are you thinking about the timing of reaching a conclusion on potentially a new corporate structure and I get this stocks evaluation goes from its present achieve 10 times multiple of this something close to peers. Your intent is less than doing that. If the cost of doing a different corporate structures prohibitive or can be borne by a third party like in the case of looking through, you probably would have less intent to do it. So, what’s sort of the timetable for you all and sort of reshoot pollution as since it is either the evaluation of corporate structure is independent of continued progress on the various 2.0 initiative. And that’s all for me, thank you.

[Jonathan Halkyard:]

Okay. Thanks, Joe. I am reluctant to really put any kind of timeline on this. I only want to assure our shareholders that it is a topic that we pay close attention too and has one that we and our board continue to value it not only in the context of valuation but also in terms of performance of the portfolio. So, I don’t imagine that a satisfactory answer for you. That’s the answer at this point.

[Joe Greff:]

Okay, thank you.

[Jonathan Halkyard:]

Thanks.

[Operator:]

Thank you. Our next question comes from Thomas Allen with Morgan Stanley. Please proceed with your question.

[Thomas Allen:]

Hi, good morning. Following down the same path of corporate structuring questions. If you were to pursue an opco propco structure, how would you think about tax REIT edge, it’s obviously a little different given your already structured the head share REIT? Thanks.

[David Clarkson:]

I would only say this, Thomas, that the fact that we are already a have a REIT as well as some see corporation makes the tax element of this question, considerably less complex that it might be for an entity to not have the REIT already in existence. Beyond that, I’d hesitate to speculate or quote any more specifics.

[Thomas Allen:]

I think that’s right. Okay, and then there’s some fundamentals quickly. Last earnings call, Jonathan, you suggested that your 2018 RevPAR guidance could be proven conservative. I guess, what’s changed since then that you’ve cut your guidance lately?

[Jonathan Halkyard:]

I will offer just one observation and then allow Brian to maybe talk a little bit about the balance of the year. It's when we had our last call, I did suggest that it was particularly in light of how we were coming out of April which if I recall was probably 3% or maybe even a little bit better RevPAR growth. As I noted in the remarks the second quarter RevPAR performance was influenced by the deceleration of the growth and some of these hurricane affected markets and some of that was difficult to forecast I think it's, but I think it's also true that our annual guidance has really changed only to account for some of this renovation impact later in the year and that are it's been generally consistent with what we described back in April, but I think it was probably mostly due to the -- to what we had seen in April versus what we then saw in May and June.

[Brian Nicholson:]

Yes, Thomas I'd chime in a little bit there. First recognizing that while we're from a calendar perspective maybe a little more than we are more than halfway through the year. I think some of the uncertainty that is sort of loaded into cycling on some of the hurricane and other activity from last year and sort of not knowing what's going to be coming this year. So we have more than half a year behind us but probably more than half the years of uncertainty ahead of us. That said I think we do feel pretty good about where we are. If you look at the annual guidance and the one to three that was given before adjusted for about a quarter point we think about a percentage point of RevPAR in the fourth quarter which translates to a quarter point on the year effectively adjusted for that we've taken up the bottom end of the range by a quarter. So I guess I'd leave it at that.

[Thomas Allen:]

Okay.

[Operator:]

Thank you. Our next question comes from Smedes Rose with Citi. Please proceed with your question.

[Smedes Rose:]

Hi, I just wanted to follow up on that on your guidance in the EBITDA reduction for the year. So is it fair to say most of it is related to incremental disruption that you would expect if you ramp up on your renovation program and how can we think about that following through into next year in terms of like maybe the percentage of rooms that you would expect to put under a heavier renovation than maybe we had modeled initially? Is there any kind of timeline we can think about there because I assume this is going to sort of follow through now into whatever we had been modeling?

[Brian Nicholson:]

Yes. Smedes and I'm going to speak in terms of midpoint here. The sort of the midpoint of our audacity with our guidance has come down by about 7.5 million. I would not blame all or even most of that on the renovations because if you look at sort of our performance on the margin and what we expect in terms of sales loss from that disruption it's really more like $3 million in EBITDA disruption if you will. The remainder of it is various expenses and I hesitate to call too much out. There are several of them but the bigger ones are somewhat higher franchising development infrastructure expense. Somewhat higher digital marketing and then some other various expenses that under normal circumstances you'd expect offsets and you wouldn't hear us calling these kinds of things out but we're seeing a number of these expenses all moving in the same direction and I thought it'd be prudent to recognize that as we offer guidance for the remainder of the year. So as we look forward to the impact of disruption over multiple years I would certainly not assign the EBITDA adjustment that we've made for this quarter and its entirety or frankly even half of it [to future years].

[Smedes Rose:]

Okay. But that higher expense line of call it three and three and a half million or something it's is it fair to say that that would continue going forward or do you see those as more sort of time-ish?

[Brian Nicholson:]

I think some at one time like building some of infrastructure that I referenced and then some I think we can expect to [indiscernible] and flow over time like the promotional mix of OTA expense etcetera.

[Smedes Rose:]

Okay. Thank you.

[Operator:]

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

[Michael Bellisario:]

Good morning. I just want to dig a little bit deeper into the 2Q softness. Any impact that maybe you can quantify or even saw just from your mix shift strategy that you're employing and then also maybe a little bit more detail into why occupancy you think was down in the quarter?

[Brian Nicholson:]

In terms of the mix shift strategy I think I characterize that more as just a broader emphasis on longer stay guests who while in somewhat lower ADRs are more profitable guests to us within our model. Yes, I think as we have outlined we did see increases in our shorter term guests. We did see increases in our 30-plus guests. I would not say that -- it would not be a fair characterization to say that we have attempted to migrate our guest mix toward longer stay and saw as a result a decline in short term guests because that just simply wasn't the case. We didn't see growth in the 0 to 6 category. Again as I mentioned before it was across channels. It was across geographies and it was primarily concentrated in a period of a handful of weeks.

[Michael Bellisario:]

That's helpful and then maybe provide your thoughts on backfilling the EVP-ops position and maybe could you provide some more details on that transition and anything related there to the 2Q performance?

[Jonathan Halkyard:]

It's Jonathan. I don't think there's anything in that transition that is related to 2Q performance. Victoria Plummer who is one of our senior vice presidents of operations in charge of the West, Victoria has assumed interim leadership of all of our operations and in the coming months we'll be looking to fill that role on a permanent basis, but as far as I'm concerned there has been absolutely no interruption or impact of our performance and Victoria's stepped in and done a terrific job leading the company.

[Michael Bellisario:]

Thank you.

[Jonathan Halkyard:]

Thanks.

[Operator:]

Thank you. Our next question comes from Stephen Grambling with Goldman Sachs. Please proceed with your question.

[Unidentified Analyst:]

Hi, this is Bill filling for Steven. I guess as you think about the corporate structure and asset sales can you provide some color on the friction costs of doing a sale of individual assets versus the full portfolio?

[Jonathan Halkyard:]

So, Bill full portfolio what do you mean?

[Unidentified Analyst:]

We're like kind of spinning off the prop-co and a kind of a corporate structure adjustment?

[Jonathan Halkyard:]

Well, I look at them as two completely different types of transactions. Certainly there are costs associated with transacting assets on an individual basis that are working there. There is scale benefit in transacting larger groups of hotels. This is why we have one of the reasons why we have entered into sale transactions in most cases that have been small portfolios of 15 to 25 hotels and not only because of the lower costs associated with doing those but also because buyers of a portfolio that size are the ones who are willing and able to commit to build additional hotels for us as franchisees. I consider any structural alternative that like the ones I described in my opening remarks to be really a whole different kettle of fish versus these types of portfolios that we have been disposing.

[Unidentified Analyst:]

Great. Thank you. That's it from me.

[Jonathan Halkyard:]

Okay. Thanks Bill.

[Operator:]

Thank you. Our final question comes from Anthony Powell with Barclays. Please proceed with your question.

[Anthony Powell:]

Hi, just one follow up for me could you describe the profile of before franchisees that you signed up are they experienced hotel developers or are they types real estate developers and why do you think they chose your product?

[Jonathan Halkyard:]

Yes. These are all large multi-unit hotel developers and their reasons are all slightly different, but I think in general they view ours as a proven model, a brand that really can grow and one that has just broad demand-supply dynamics which are favorable for them as developers. They are also experienced in developing this type of product. So they have a high degree of confidence in their ability to deliver the assets of the cost that we've described. So we're very optimistic and I do believe that we're going to have additional signings like this in the next six months.

[Anthony Powell:]

Great. Thank you.

[Jonathan Halkyard:]

Thanks Anthony.

[Operator:]

Thank you. There are no further questions at this time. I would like to turn the call back over to Mr. Halkyard for any closing remarks.

[Jonathan Halkyard:]

Thanks Michelle. I just want to close quickly by thanking all of our shareholders for their support and the research analysts on the call this morning for your thoughtful questions, and we're looking forward to getting back to work here and we will also look forward to updating you on our third quarter results which we now anticipate to be during a call in late October and with that I'll wish everybody a terrific day and a terrific rest of the week.

[Operator:]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.