Extended Stay America, Inc.
Q3 2018 Earnings Call Transcript

Published: 4 Nov 2018

[Operator:]

Greetings, and welcome to Extended Stay America's Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only. A 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 your host, Robert Ballew, Head of Investor Relations. Thank you. You may begin.

[Robert Ballew:]

Good morning, and welcome to Extended Stay America's third quarter 2018 conference call. Both the third 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 this morning, I'd like to remind you, some of our discussions today will contain forward-looking statements, including a 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 will turn it over to Jonathan.

[Jonathan Halkyard:]

Thanks, Rob and good morning, everyone. Thank you for joining us this morning to discuss our third quarter results. Before we get into the results for our third quarter, I'd like to thank all of our talented associates here at Extended Stay America for their hard work and dedication in delivering yet another strong set of results this quarter. Their efforts were marked by caring for our guests and a commitment to our mission, and in the midst of Hurricanes Florence and Michael, even examples of selflessness and heroism. I am proud to call them my colleagues. It's hard to believe that this is my fourth earnings call as CEO and that the end of 2018 is in sight. During my first call as CEO back in February, I laid out the key tenets of our operating and capital allocation strategy. A strategy that recognized and capitalized on our unique product offering appealing industry segment, cash generative ability and talented management team. Our experience and results this quarter demonstrated, yet again, the efficacy of that strategy. Our primary priority and purpose is to serve our core guests, which are guests staying five nights or longer, generally a week to a few months. Our core guests are primarily traveling for business, working on temporary projects, attending trainings, preparing for relocation and so on. This is a very attractive guest profile, one that is marked by long reliable stays, self-sufficiency and value consciousness. This segment is growing for reasons driven by changes in our macro-economy and is currently underserved in the lodging space. Indeed, these guests make up 22% of U.S. hotel demand, yet only 9% of hotel rooms in the U.S. are Extended Stay rooms. And serving them provides ESA with high occupancy and high margins, while affording these guests an appealing nightly rates. Our Company's done this for over 20 years with a portfolio built through development and acquisition. In late 2011, we commenced a five-year renovation and re-branding project for the entire portfolio, which we completed in early 2017 with strong returns on the investment. Then two years ago, we declared a goal to improve our portfolio and business model in three ways to create shareholder value

[Brian Nicholson:]

Thank you, Jonathan. We were pleased to outperform all of our peer groups on RevPAR performance this quarter as comparable system-wide RevPAR in the third quarter increased 1.9% compared to the prior year, aided by a 110 basis point increase in occupancy and a 50 basis point increase in average daily rate, or ADR. The third quarter was impacted by the July 4th holiday, which fell on a Wednesday this year, discouraging business travel, and which had a negative, approximately 30 basis point impact on the quarter. Also affecting our RevPAR growth in September was the beginning of cycling on business we received from Hurricanes Irma and Harvey last year. Excluding both the impact of cycling the hurricanes and the July 4th timing, our comparable system-wide RevPAR growth during the third quarter would've been approximately 3%. Hurricane Florence did not have a significant impact on our business during the quarter. In addition, we outperformed our own comp set by more than 2% during the quarter. During the third quarter, comparable company-owned RevPAR increased 2.0%, while absolute company-owned RevPAR increased 2.7%, reflecting the improved remaining portfolio quality from non-core dispositions. For the first nine months of 2018, comparable system-wide RevPAR increased 2.3%. Revenue in the third quarter increased for both nightly guests and Extended Stay guests, with a bit more revenue growth coming from our longer-stay guests staying 30 nights or more. This quarter, most of our revenue growth came from our own website, esa.com, as well as our OTA partners. While our OTA business is still growing, the growth rate from this channel is down meaningfully compared to recent years and we expected to be fairly steady or even to decline going forward. Hotel operating margin declined 170 basis points in the third quarter to 55.5%, in line with our expectations. Increased payroll, reservation, maintenance and marketing expense led to the decline in hotel operating margin during the quarter. We expect the expense growth percentage to slow in the fourth quarter and to slow further going into 2019 to be more in line with normalized inflation. For the first nine months of 2018, hotel operating margin dipped 90 basis points to 54.8%. Corporate overhead expense, excluding share-based compensation and transaction costs, declined to 2.7%, to $20.3 million, during the third quarter. Our adjusted EBITDA in the third quarter was $173.7 million. Adjusted EBITDA during the quarter was impacted by the lost contribution of approximately $5.7 million from hotel dispositions in 2017 and 2018. Adjusted EBITDA for the first nine months of 2018 was $473.2 million, reflecting the lost contribution of approximately $13.9 million from recent hotel dispositions. Interest expense during the quarter decreased by $0.6 million, to $31.0 million, due to less outstanding debt and a decline in our LIBOR spread in our term loan, partially offset by the increase in LIBOR rates. Income taxes decreased $5.3 million, to $15 million, during the quarter, driven by a lower effective tax rate, partially offset by an increase in pre-tax income. For the first nine months of 2018, income taxes decreased $5.5 million, to $35.2 million. Adjusted FFO per diluted Paired Share increased 7.5% in the third quarter to $0.61 compared to $0.57 in the same period in 2017. The increase was driven by a lower tax rate and reduction in share count from Paired Share repurchases. For the first nine months of 2018, adjusted FFO per diluted Paired Share increased 11.2% to $1.60 compared to the same period last year. Net income during the third quarter increased 14.3% to $75.7 million, driven by increased revenue, lower depreciation expense, a lower effective tax rate and a gain on asset dispositions. For the first nine months of 2018, net income increased 30.5% driven by lower depreciation expense, lower income tax expense and a $41.6 million gain on asset dispositions, offset by a $43.6 million impairment charge earlier in 2018. Adjusted Paired Share income per diluted Paired Share in the third quarter increased 11.5% to $0.39 per diluted Paired Share from $0.35 in the same period last year. The increase was primarily due to a lower tax rate, lower depreciation expense and a lower share count from Paired Share repurchases. For the first nine31/10/2018 Tea & Snacks evening 80 months of 2018, adjusted Paired Share income per diluted Paired Share increased 15.7% to $0.94 compared to $0.81 in the same period in 2017. We ended the third quarter with our net debt to trailing 12-month adjusted EBITDA on a pro forma of 567 hotels basis at 3.6x, a decrease from the 3.8x at the end of the second quarter, as our total cash balance increased $159 million during the quarter to $386.6 million. The increase in our cash balance was driven by strong free cash flow during the quarter as well as gross proceeds of approximately $125 million from asset dispositions, which included prepaid franchise applications and development fees. Gross debt outstanding was $2.52 billion in line with the prior quarter. We are pleased 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. As Jonathan mentioned, this was just recently recognized by Moody's, who upgraded the rating on our debt in late October. Capital expenditures in the third quarter were $57.8 million, including $22.4 million for a hotel purchase and conversion, land acquisitions and other ESA 2.0 costs. During the quarter, we purchased one new hotel near completion, which we expect to open this week, and five additional sites for on-balance sheet development, bringing our total pipeline for on-balance sheet development to 18 hotels. We've broken ground on our first two sites and expect to break ground on two additional sites by the end of 2018. For the first nine months of 2018, capital expenditures have totaled $147.5 million. Yesterday, the Boards of Directors of Extended Stay America, Inc. and ESH Hospitality, Inc. declared a combined cash dividend of $0.22 per Paired Share, payable on November 29, 2018, to shareholders of record as of November 15, 2018. Our dividend yield is over 5% of recent trading prices, which is higher than other lodging C-corps. During the third quarter, we repurchased approximately 0.6 million Paired Shares for $11.7 million. Including purchases made quarter-to-date, we have repurchased approximately $84 million in Paired Shares year-to-date, or approximately 2.3% of Paired Shares outstanding. Our share repurchase authorization remaining is significant at over $110 million. As Jonathan mentioned earlier, we were pleased with the progress we made during the quarter on ESA 2.0, which was led by two portfolio sales to strong partners for a gross total of approximately $125 million, reflecting a 17.8x pro forma free cash flow multiple. Given our shares traded at pro forma free cash flow multiple of approximately 10x, we think this arbitrage represents a great deal for our shareholders. Additionally, progress with the third buyer of our three previously announced deals continues to move along well, with deposits that went hard in October. We expect to close on the sale of those 14 hotels in November, which would bring our total number of asset dispositions in 2018 to 72 hotels, roughly half our commitment by 2021. All but one of those 72 hotels are expected to stay in the system as ESA-branded hotels under franchiser management agreements. And each portfolio sale came with or is expected to come with commitments for additional ESA units in the near future. While cash is fungible, we expect our priorities for our operating cash flow and gross proceeds from asset portfolio dispositions to be used for capital investments and to newbuilds and renovations, share repurchases, debt retirement and continued strengthening of our balance sheet. Looking to the fourth quarter of 2018, we expect comparable system-wide RevPAR growth will be between 0 and positive 2%. Our fourth quarter outlook reflects an approximately 2% drag from cycling the hurricanes in 2017, and an approximately 50 to 100 basis point hit, expected from renovation disruption activity during the quarter. We expect adjusted EBITDA between $123 million and $130 million during the fourth quarter. We do not expect any meaningful impact to fourth quarter revenue or expenses from Hurricanes Florida – Florence or Michael. Although there will be some minor capital expenditures, most of which is reimbursable. For the full year 2018, we now expect comparable system-wide RevPAR growth of 1.75% to 2.25% and adjusted EBITDA of $596 million to $603 million. These reflect both our third quarter actual results, updated outlook for the fourth quarter, 32 asset dispositions in late September and expected 14 further dispositions in November or approximately $4.5 million in lost contribution from these dispositions. Both of these are a slight increase at the midpoint of guidance after adjusting for asset dispositions. We are bringing up the bottom end of our capital expenditure guidance to $215 million while maintaining the top end at $235 million, reflecting our faster than previously expected progress on land purchases for ESA 2.0 hotel builds and an expected $35 million to $40 million spent on renovations during the fourth quarter, including some pre-buys for FF&E for Q1 2019 renovations. Most of the first phases of hotel renovations are in higher ADR markets that have not had a renovation in seven years. They were predominantly received a higher CapEx per key premium or premium plus renovation packages compared to our lifecycle basic refresh renovation. We expect our annual interest expense to be approximately $128 million, slightly lower than prior guidance of $130 million. We expect adjusted Paired Share income per diluted Paired Share at between $1.10 and $1.14 per Paired Share, representing approximately 10% to 15% growth compared to 2017, an increase from our prior guidance at the midpoint of approximately 1%. 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 8% to 9.5% of our recent market capitalization. Now I'll turn it back to Jonathan for final remarks before Q&A. Jonathan?

[Jonathan Halkyard:]

Thanks, Brian. Some industry observers recently had worried about some recent headline RevPAR weakness from Smith Travel Research reports. It is true that the hurricane impact will be a drag on fourth quarter and first quarter results for us and for the industry, many of us have mentioned that fact many times this year. However, the underlying RevPAR environment has not changed. If anything, it's improved in recent months. For example, for Extended Stay America in September, RevPAR growth outside of Houston and South Florida was 3%. In October, our RevPAR growth outside the hurricane markets is approximately 5%. Each of these months represents an acceleration from the first half of the year. We think the underlying fundamentals of the economy and our proven track record of execution continue to point to solid fundamentals for Extended Stay America. Operator, let's now go to questions.

[Operator:]

[Operator Instructions] Our first question is from Harry Curtis with Instinet. Please proceed with your question.

[Harry Curtis:]

Hey. Good morning, everyone. Jonathan, let me ask you – just start with the hotels that are left to sell. And is that roughly 80 still in the pipeline left to sell? And what I wanted to get at is looking ahead, are you planning on selling more? I'm trying to get an idea of whether – to what degree you would be selling kind of the hotels that are generating more EBITDA than the ones that you're selling today? To what extent do you just cut it off and say, all right, we've sold enough?

[Jonathan Halkyard:]

Good morning, Harry. Thanks for the question. You're correct in that having sold now roughly 70 hotels, and that includes, of course, the 14 that we expect to close in a couple of weeks. That's about halfway to the goal that we established a couple years ago, and we still feel that, that is the appropriate number of hotels, roughly 150. So that would leave about 80 left. To put some parameters around it, the EBITDA of the hotels that we have sold thus far, are kind of between $300,000 and $700,000 a year. And if you take all of the hotels that we don't plan on selling, they average around $1.3 million per year in EBITDA. And I would expect, first of all, that number of 80 that is the correct number to use at this point. I would not expect that we'll complete all of those during 2019 and they will be of the same general size in terms of revenue and earnings production of those that we have sold already, so in the kind of $300,000 to $700,000 range. And I'll just conclude by saying that the interest has been very high for the hotels that we have sold thus far. And I'm very optimistic that we'll be able to transact on similar terms and similar multiples with similar commitments to franchising and ongoing development that we've been able to accomplish with the first 70.

[Harry Curtis:]

Have you, again, beyond this, if you're selling these hotels at roughly 18x free cash flow, if you sold some of your higher performing hotels, do you think you could get a higher multiple and, therefore, keep that spread, that positive spread, between buying stock back and selling hotels? I'm just wondering if it makes sense to go deeper into the strategy.

[Jonathan Halkyard:]

Well, it could but the – what the countervailing argument is, is that those hotels, which currently generate higher levels of revenue and earnings are also – they provide us with strong potential returns for additional improvement in their operations and capital investment. So there are some higher-earning hotels that are included in these portfolios, not many and usually for reasons of geographic concentration. But as a general matter, we think that it's better for shareholders to retain those Extended Stay America hotels, which have higher levels of ADR, RevPAR, margin and cash flow, because many of those represent, we think, attractive opportunities for investment in the future.

[Harry Curtis:]

Okay. Thanks for that. And then I wanted to move on to my second topic, which is, could you give us an update on your current thinking on the opco propco status?

[Jonathan Halkyard:]

Sure. The management team and the board, we remain committed to growing the shareholder value by all means, and that certainly includes the improvement in our core business and growing our franchise business, as we just talked about, kind of monetizing our lower RevPAR hotels, investing in the own portfolio, repurchasing shares and so on. And we've made progress on all of these fronts and none of these activities precludes the pursuit of structural alternatives that the board might consider in the future. So actually, on the contrary, we think that what we've been doing, not only in the core business, but under the moniker of 2.0 actually serves to increase the value of our brand and of our real estate portfolio. We also think the company ought to be valued with that optionality in mind. That's the way we value the company and some of the observers of our company do the same, which we think ought to continue. So we remain committed to growing shareholder value and we continue to evaluate the merits of any alternatives to the corporate structure.

[Harry Curtis:]

Very good. And that was a very fine quarter. Thank you.

[Jonathan Halkyard:]

Thanks.

[Operator:]

Our next question is from Anthony Powell with Barclays. Please proceed with your question.

[Anthony Powell:]

Hi. Good morning, everyone. Given some of the recent equity market volatility, how do you evaluate a higher level of share buybacks in the near term versus on-balance sheet development efforts? And has the recent increase in construction costs changed any of your redevelopment plans?

[Brian Nicholson:]

Anthony, this is Brian. Thanks for the question. I think, as you may have noted, our pace of share buybacks had slowed in the third quarter. If you think about the third quarter, our weighted average purchase price and our weighted average closing price were within a nickel of each other in the high-20s, north of $20.80. It's a different world now. So obviously, share buybacks are more attractive to us today. But we're in a pretty good position. As Jonathan mentioned, we are able to sell hotels at free cash flow multiples in the high teens. We are able to repurchase shares at, call it, 10x free cash flow today. We are able to do newbuilds that, when stabilized, we're able to build those at about 7x to 9x free cash flow. So we have a good menu of options and, frankly, enough cash to pursue multiple options at once.

[Anthony Powell:]

Got it. Thanks. Could there be some upside to the capital turn guidance if you believe that the buyback opportunity's especially attractive, for the remaining of the year?

[Brian Nicholson:]

Good question. Certainly something that we'll continue to look at and monitor day by day. I'm frankly not excited about the prospect of a $16 share price through the remainder of the quarter. I don't think that's fair, given what we're doing and what we're producing, but we'll see what happens.

[Anthony Powell:]

Thanks. And, Jonathan, you mentioned that there was some acceleration and, I guess, core RevPAR trends from September to October relative to the first part of the year. Can you give us some more detail on that, what geographies or industries may have driven that higher RevPAR growth that you're seeing right now?

[Jonathan Halkyard:]

Sure, Anthony. Broadly speaking, California is one source of it. Southern California has been a bit better for us over the past couple of months than it was earlier in the year and those are just – those are large producers for us, those hotels in Southern California. Up in the Boston area, this incredibly unfortunate accident, the gas explosion that was in that market a month or so ago, it's these kinds of events where our company really can add value to both residents and first responders, and so that has driven quite a lot of business up in that New England area. And then finally I would add, I guess I'd add the Philadelphia mid-Atlantic region generally has been stronger for us in the last couple of months in its growth than it was earlier in the year. Brian, would you add anything to that list?

[Brian Nicholson:]

No. I think the Philadelphia, the Bay Area, those are areas that were relatively weak for us a year ago, but have been much stronger in the third quarter this year.

[Anthony Powell:]

Great. Thanks a lot.

[Brian Nicholson:]

Thank you.

[Operator:]

Our next question is from David Katz with Jefferies. Please proceed with your question.

[David Katz:]

Hi. I wanted to just ask about what you're seeing in the trenches as you go out to sell franchise contracts. As a single-brand entity with what appears, which is, obviously, a consolidating landscape, how do you pitch against that? And what have you seen, let's say, in the last quarter or so that enables you to be confident that you're going to get where you're headed?

[Jonathan Halkyard:]

We pitch the fundamentals of our business model, the strong returns, the simplicity of our business model, the margins, the ability to own a market through purchasing our hotels and then entering into a franchise agreement with us and a development agreement with us, and in the end an operating history of 17 years against over 600 of these hotels. So that has really been what's carried the day, is our experience, and the fact that this is what we do, operating Extended Stay America hotels in every geography in this country. We, I think, have communicated and demonstrated our discipline with respect to the capital costs associated with building these hotels. And the folks that we are dealing with who have entered into franchise agreements with us, these are experienced developers. They already – many of them are major select service owners. One of the largest franchisees of WoodSprings is involved with us and other smaller owner-operators. So all of that gives us a high degree of confidence in our ability to be successful in growing the franchise fee stream.

[David Katz:]

Got it. I certainly agree that there aren't a lot of players in the economy extended stay as we've discovered. Given that scale is the mission and building scale and distribution is the mission, what updated thoughts do you have about consolidation, which could be increasingly hard on the buy side with your stock down here? But I suppose I'm asking about the other direction also. Has there been sort of any increased thought process around merger or otherwise that you can discuss?

[Jonathan Halkyard:]

Well, in terms of consolidation on the acquisition front, I think we may be active on that front, mainly in the conversion area. Brian mentioned that we have acquired two hotels in Charlotte and down in South Carolina that we're converting to Extended Stay America. And we believe that that's an opportunity that we will either continue to capitalize on or our franchise partners may bring us conversion opportunities. And we are open to both sets of opportunities. We think that, that could work well for us under the right circumstances. And in terms of the other side, I'm not sure how to answer that. There's really been no change on that front.

[David Katz:]

I wasn’t quite sure how to ask it either. Thank you very much.

[Operator:]

Our next question is from Thomas Allen with Morgan Stanley. Please proceed with your question.

[Thomas Allen:]

Hey. Good morning. Thanks for the color on how trends have been through in the beginning of the fourth quarter. I think one of the concerns among investors is just the supply environment for lower-tiered hotels. Could just talk about how you view it? Thank you.

[Brian Nicholson:]

Sure. There is new supply coming on...

[Jonathan Halkyard:]

First of all, I'm going to note an objection to the term lower-tiered hotels. But anyway...

[Brian Nicholson:]

I think that's fair. Certainly within our segment, our chain scales, there is more supply coming on. But, frankly, there appears to be plenty of business for that supply. We still exist in a market, in a country, where there is an awful lot of extended-stay demand in transient hotels, 8% to 9% of the supply in the country is purpose-built extended stay. Over 20% the stays in this country or room nights in this country are represented by stays of five nights or more. And then even as new supply comes on, an advantage to having had a fleet of over 600 hotels in every market in the country for a couple of decades now means that we have locations that are simply not replicable and are proud to have and glad to have that strategic advantage. Certainly, there's opportunity to grow. Certainly, especially, within high-growth markets like our home here in the Carolinas, Florida, Arizona, Texas, Colorado, there is plenty of growth that provides new opportunities for us as well as for others. But in the core markets where we operate, while there is supply coming on, we don't think that it's a meaningful negative impact.

[Thomas Allen:]

Perfect. Thank you. And then just a modeling question so that we're all in the same page. How should we think about the hotels you sold this year, the EBITDA impact in 2019 on a year-over-year basis? Thank you.

[Brian Nicholson:]

For the fourth quarter, we have estimated that number at about $4.5 million. Hence, we've got a few hotels that are with us for the part of the fourth quarter, but not all of the fourth quarter. When you take the full complement of hotels that we will have sold by the end of the year, the impact of 2019 on a year-over-year basis will be in the neighborhood of $20 million.

[Thomas Allen:]

Thank you.

[Operator:]

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

[Chris Woronka:]

Hey. Good morning, guys. I wanted to ask a little bit more about the unit growth pipeline. Pretty impressive growth since last quarter and you've talked pretty positively about the underlying opportunities for new owners including some of the ones you're doing on balance sheet. So I guess the question is, could we really see the pace of that continue to expand? I mean, we're not expecting 50% every quarter, of course, but compared to maybe your projections a year or two ago, do you think this is something that can gain more momentum?

[Brian Nicholson:]

Yes, thanks for the question, Chris. Obviously, we have seen a pretty good pickup in momentum. I'm not going to promise 50% growth quarter-to-quarter for any extended period of time. But I think the fact that we started with a very good partner, who acquired some of our assets and agreed to build more, really got things moving earlier this year. We have disclosed, as of the end of September, we had 34 hotels in the pipeline from third parties, 25 of those were related to asset sales and additional commitments from franchise groups who purchased those hotels. But whereas last quarter, we had a couple of franchisee groups who had committed to four hotels, independent of asset sales, at this point, we have five independent franchise groups representing a total of nine hotels and we think that as this engine gets rolling and as it's proven out, that will continue to grow.

[Chris Woronka:]

Okay. That’s helpful. And then I wanted to ask on the RevPAR performance. You guys, with the breakout, you now give us the 2.0% for the comparable owned versus the 1.9% for the system-wide, obviously a pretty small difference. But if you look back, maybe, would there be any trends in terms of the real estate that you're holding onto, the remaining hotels? Would you expect those to – are there going to be bigger performance gaps going forward in terms of outperformance, potentially by the hotels you are keeping? Or do you think they're going to perform roughly the same?

[Jonathan Halkyard:]

Well, I think that Chris, I think that we'll continue to see just the overall RevPAR of the owned portfolio as compared to the owned portfolio in prior periods, that's going to – that gap will increase, because we are selling lower RevPAR assets, generally speaking. And if we're doing our job, then the assets that we retain will grow at a higher rate than the portfolio in general. Now the fact is also that the folks that we are selling these assets to are skilled operators with their own plans and potential investments in the hotels that we're selling and we are – I would expect and I'm certainly rooting for these hotels under their ownership to perform exceptionally well and as franchisors, we're committed to helping them do that. But kind of right out of the gate, I just think that the math will likely be that the RevPAR of the owned portfolio will – those growth numbers will increase.

[Chris Woronka:]

Okay, very good. Thanks.

[Jonathan Halkyard:]

All right.

[Operator:]

Our next question is from Joe Greff with JPMorgan. Please proceed with your question.

[Joseph Greff:]

Good morning, everybody. Three questions, two are relatively easy, straightforward. One, can you give us a sense or range, maybe you said this, I didn't catch it – of 2019 capital investments, if you could break that out between routine maintenance and non-routine, non-maintenance? Question number two, of the 4,216 rooms in this third-party type line, how many will open in 2019? And then the third question, Jonathan for you, to what extent is you're not prioritizing or prioritizing more the evaluation of an opco/propco split of function of lower industry equity valuations? Thanks.

[Brian Nicholson:]

Okay. Thanks, Joe. So I guess taking these in order or – actually let me change the order a little bit. First, on the hotels that we would expect to have opened in 2019, in terms of the owned hotels, we've broken ground on a couple, plan to break ground on a couple more before the end of the year. But the construction cycle is right about 12 months. So while we would expect to have some new hotels within our owned portfolio opened by the end of the year, the impact to our financial performance next year is going to be pretty modest. And I would expect the same for third party, while there is good third-party activity and they are moving ahead apace, again, it takes about 12 months to get a hotel built. So I wouldn't expect to see a lot of impact to 2019. In terms of 2019 capital, it is our plan and has been our practice in past years to provide full guidance on our operating plan as well as our capital plan for 2019 at our fourth quarter call, which will be coming up in February. I would tell you that the difference between where we've been, say over the course of the last year and where we would expect to go next year relates to the CapEx from our renovation program and then CapEx for newbuilds. But on the renovation program, just kind of some things to keep in mind, we're doing at least the 5,000 per key base level of renovation in all property, spread out over the course of about seven years. So you can expect that that renovation activity will probably result in CapEx of about $35 million to $40 million in 2019 and in subsequent years. In addition to that, there are the extra tiers of renovation. If you will that we are doing for return. And that level of renovation activity spread out over the course of the seven years is going to be somewhere in the neighborhood of $40 million, maybe a little north of that, and we would expect it to be somewhat higher in 2019. As I've commented earlier, a number of the hotels that have been – have gone the longest since the last renovation are hotels in markets where we do believe we have opportunity to renovate for return. Add to that though, you see we continue to put owned sites onto our pipeline. The entitlement process takes some time and we really don't have significant spend during the entitlement process. Typically, it's about six months, although it varies from location to location. And then once that time is over, we would expect to begin incurring CapEx and it's fairly smooth through the 12-month period at something like $1 million per location per month.

[Jonathan Halkyard:]

And Joe, on your final question, the equity performance of the companies in the lodging sector really hasn't had any impact on either prioritizing or de-prioritizing any evaluation of the Company's corporate structure.

[Joseph Greff:]

You think I'm correct in interpreting your comments or lack of comments today as a de-prioritizing of that evaluation?

[Jonathan Halkyard:]

No, I don't think that's correct.

[Joseph Greff:]

Okay, good. Thank you.

[Jonathan Halkyard:]

All right.

[Operator:]

Our next question is from Stephen Grambling with Goldman Sachs. Please proceed with your question.

[Stephen Grambling:]

Hey, thanks for taking the questions. Maybe if you can elaborate a little bit more on the actions that are enabling the pickup in esa.com bookings and I guess, what's the delta in distribution marketing costs between your website and the OTAs? And then, can you clarify whether you expect the growth rate of OTA bookings to decelerate or the mix itself to come down?

[Jonathan Halkyard:]

I'll make a brief comment on the first part of the question and then invite Brian to comment further. We have, I think, gotten quite a lot more better in the last year at evaluating our digital marketing spend and deploying it where it generates the greatest return, and that's due not only to our own team here, but that we use working with us on the outside in our digital search. Spending in that and we have increased that spending a bit over the last, really, three months, but even a little bit before that where we believe that it can drive an attractive return on that investment, and so that has in part, caused some of the better performance out of the esa.com channel. Brian, you want to add? Brian, you want to comment?

[Brian Nicholson:]

Yes, I think that's fair. In terms of OTA spend. The proportion of our business generated by OTAs has grown over the past several years. With Jonathan's strategic directive to focus more heavily on our core Extended Stay guest, we will see at least over time that the proportion of our overall revenue generated by shorter-term guests, and that's closely related to OTA activity, will decline. Now period-to-period, quarter-to-quarter, there may be some noise there depending on the nature of the activity, how much of the OTA spend is related to promotional versus non-promotional spend. But generally speaking, we believe that our OTA spend is plateauing and we'll begin to decline over time. And then an additional comment, maybe a little bit more color on what Jonathan just said. In addition to our digital marketing efforts, just this idea that the digital marketing efforts are geared toward producing a return, we are specifically looking at ways that digital marketing can more effectively drive traffic to esa.com and, frankly, drive Extended Stay demand to esa.com, which has met in a different kinds of digital spend, testing in what we're doing. But we think ultimately, this is going to pay dividends and that it will bring more traffic to our own channels and the right kind of traffic in terms of its desirability to us.

[Stephen Grambling:]

So I guess just a follow-up there, maybe I missed it. What's the stabilized spread in the cost of your direct channel versus OTAs?

[Brian Nicholson:]

Our website, if you set aside the costs of digital or the promotions to drive traffic to the website, our website is essentially free. We have some internal costs around that, but marginal cost of the booking on our website is basically free. Our OTA costs, similar to others in the industry, may be a little bit higher, run high teens on average. So obviously, it means a lot to us if we can drive more traffic to the website.

[Stephen Grambling:]

Great and then maybe one last clarification, just, I realize it's early for 2019 expectations, but as we think about some of the puts and takes this quarter and next quarter, whether it's some of the execution comparisons, the hurricanes and then also as you think about renovations, is there any reason to believe that 2019s RevPAR growth would be dramatically dissimilar than kind of the longer-term algorithm that you've laid out in the past?

[Jonathan Halkyard:]

I wouldn't think so. I mean, we will have, of course, renovations going on. But we'll have, as you noted, the normal puts and takes against prior year comps and we try not to get too granular in calling those out unless they're significant. But there's nothing in the business that I see that would cause it to be dramatically different and it's our goal to improve continuously in our execution and our marketing and sales activities, become more efficient at the corporate office here, at the Hotel Support Center, and always improve results.

[Stephen Grambling:]

Fair enough. Thanks so much.

[Jonathan Halkyard:]

Thanks.

[Operator:]

Our next question is from Smedes Rose with Citi.

[Smedes Rose:]

Hi, thanks. I wanted to ask you, I guess, kind of going into 2019, what sort of bump do you think you might achieve on margins sort of on a same-store basis just with the removal of these lower-margin hotels that you've sold? I don't know if you can help sort of quantify that or just kind of what the general impact should be on the kind of comparable basis?

[Brian Nicholson:]

I guess I can speak to that generally, Smedes. Thanks for the question. You're right, the hotels that we are selling and taking out of the system are significantly lower margin hotels, say 30s versus 50s. And so as we complete the sale of these hotels, it will have a positive impact and we would expect it to have a positive impact on our margins. At least in the short term, I think fourth quarter will look something like what we've seen in the past, maybe a slight improvement in terms of year-over-year margin change. But because of the activity that we're doing in terms of marketing and in terms of what we're – some of what we're seeing in payroll, while the sale of hotels will blunt the change in margin, it won't completely offset it. And would like to comment quickly on the payroll as well. This is – some of what's going on is just higher labor costs, but then I'd note that some of what's going on is an intentional, moving our part to slightly improve the full-time versus part-time mix at our hotels. We think that, that provides more stability. Ultimately, will provide a better guest experience and reduce some onboarding and other costs for us again, longer-term.

[Smedes Rose:]

Okay. And then you talked about your OTA a little bit. I was just wondering, can you just share what is the percent now of bookings that come through OTAs versus other channels?

[Brian Nicholson:]

That number is about 22% to 23% of our overall revenue.

[Smedes Rose:]

About 22% to 23% are coming through OTAs?

[Brian Nicholson:]

That's correct.

[Smedes Rose:]

All right. So has that changed meaningfully over the last year or...?

[Brian Nicholson:]

Not over the last year. No. It has grown over the course of the last five years up to last year. But this year, we basically plateau relative to last year.

[Smedes Rose:]

Gotcha, all right.

[Brian Nicholson:]

Thank you.

[Operator:]

[Operator Instructions] Our next question is from Michael Bellisario with Robert W. Baird.

[Michael Bellisario:]

Good everyone. Just wanted to follow-up on the comments you made on the labor side. I guess, what's kind of the prior run rate, that growth rate, and then what do you think it goes to – after you improve the full time, part time mix that you mentioned?

[Brian Nicholson:]

Our labor costs had been up, call it, 4%-ish over the course of this year, and we would expect that – not that I really have a crystal ball on what's going to happen in terms of pay rates over the course of the next several years, but it would be our hope that we would bring that number up back to something more in line with general inflation. And then again, a benefit in the, call it, the marginal investment that we are making this year should be longer-term reduction in some training and other cost as we improve the tenure of the employees in our hotels. And ultimately, we would hope a better execution, better service levels and ultimately an impact on revenue.

[Michael Bellisario:]

Got it. Do those training costs, do those flow through G&A or those at the hotel operating expense level?

[Brian Nicholson:]

Those are hotel operating expense level.

[Michael Bellisario:]

That’s all from me. Thank you.

[Brian Nicholson:]

Thanks.

[Operator:]

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

[Chad Beynon:]

Hi, good morning In terms of hotel land acquisitions and some of the new franchise deals, do you have a preference toward, I guess, location characteristics, meaning suburban versus airport versus other? Or do you think your current mix is kind of the right mix that you want to have over the next five years or so?

[Jonathan Halkyard:]

Chad, I think the current mix is working quite well for us, when we evaluate new sites. There are several considerations, of course taken into account. Among the most important are the proximity to demand drivers for our business. Those include corporate office parks, hospitals and kind of general destinations where our core customers like to be proximate to. The second is concentration to our existing assets, where we would not be as enthusiastic about sites that are distant from our existing operations core. So there are other factors but those are probably the most important. And so there's no real change in strategy against the existing portfolio from where our new sites would be.

[Chad Beynon:]

Okay. And then with respect to the 80 assets that are still remaining to be sold over the next couple years, are these harder to package together in a portfolio, meaning should we expect for, I guess, more announcements with kind of fewer sales in each portfolio? Or is that false to assume that?

[Jonathan Halkyard:]

That would be false to assume that. We've already begun the process of looking at those – the collection of hotels which could become part of that group. And we believe that the portfolio sizes, which I think so far have ranged from 14 hotels to 25 hotels, is the right size for a number of reasons and we think we can accomplish that with our next phase.

[Chad Beynon:]

Okay, thank you very much. Appreciate it.

[Operator:]

And our final question is from Shaun Kelley with Bank of America. Please proceed.

[Shaun Kelley:]

Hey, good morning, guys. Just one for me which is, Jonathan, you talked about it at last quarter a little bit and I think you alluded to it a little bit here too, but just can you talk about your current mix of the business towards longer-stay versus shorter-stay guests? And how is that helping you navigate kind of the current operating environment that you guys see out there? And any changes you've made as a result of what you're kind of hearing back from the latest trends?

[Jonathan Halkyard:]

Thanks, Shaun. We have about 65% of our business and what I would call our core customers, which are those customers staying with us for a week or longer, and about 45% of our customers staying with us for a month or longer. And that has – having followed our company for a while, you knew that was declining for a bit, but for the last year, we've been growing that and we're doing that because those customers are one sort of whom our product makes a heck of a lot of sense and they are also our most profitable customers and they love us. They give us great social media reviews and they join our loyalty program and they repeat their visitation with us. So for all those reasons, we have really, under my watch, we have rededicated ourselves to that customer segment. And I think that, that sets us up very well to compete and hopefully outperform others in lodging because we are able to build that base of customers in our hotels. And then in the end, fill the occupancy with more transient guests, hopefully through our own proprietary channels. So we do typically outperform in the fourth quarter and the first quarter, and that's because we enjoyed a high occupancy associated with these core customers and that's why – one of the core reasons why I was particularly pleased to see that we did so actually in the third quarter, which is, in the past, a quarter where we have not performed at the growth rates of the industry generally, because we didn't have that transient demand. But because we did, I think it's evident that this strategy is working for us not only in the fourth quarter and the first quarter, but the year round as we hopefully get better and better at attracting and retaining that core longer-stay customer.

[Shaun Kelley:]

Great, thank you very much.

[Jonathan Halkyard:]

All right, thanks Shaun. End of Q&A

[Operator:]

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call over back over to Jonathan Halkyard for closing remarks.

[Jonathan Halkyard:]

Thank you, and thank you very much, everybody, for joining us this morning to talk about our third quarter results. We'll look forward to seeing you in the coming months or speaking with you in February when we talk about our fourth quarter and full-year 2018 results. Have a great day, everybody.

[Operator:]

Thank you. This concludes today's conference. You may disconnect your lines at this time and thank you for your participation.