Extended Stay America, Inc.
Q3 2016 Earnings Call Transcript

Published: 25 Oct 2016

[Operator:]

Greetings and welcome to the Extended Stay America Third Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Robert Ballew, Senior Director of Investor Relations. Thank you, Mr. Ballew. You may begin.

[Robert Ballew:]

Good morning and welcome to the Extended Stay America’s third quarter 2016 conference call. There is a third quarter earnings release and an accompanying presentation, are available on the Investor Relations portion on our website at esa.com, which you can access directly at aboutstay.com. Joining me on the call today are Gerry Lopez, Chief Executive Officer; Jonathan Halkyard, Chief Financial Officer; and Tom Bardenett, Chief Operating Officer. After prepared remarks by Gerry and Jonathan, there will be a question-and-answer session. Before we begin, I would like to remind you that some of our discussions today will contain forward-looking statements, including a discussion of our 2016 outlook. Actual results may differ materially from those indicated in the forward-looking statements. Forward-looking statements made to-date 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 23, 2016 and in our other filings with the SEC, including our Form 10-Q filed this morning. In addition on today’s call, we will reference certain non-GAAP financial measures. More information regarding these non-GAAP financial measures, including reconciliations to the most comparable GAAP measures are included in the earnings release and Form 10-Q filed this morning with the SEC. Also importantly, please note that unless otherwise stated all results commented on this call reflect comparable hotel operating results. And with that, I will turn it over to Gerry.

[Gerry Lopez:]

Thanks, Rob and thank you everyone for joining us this morning to discuss our third quarter 2016 results. As you can all accurately guess, we are pleased with our overall Q3 performance and are happy to build on what has been a strong record of growth dating back to 2010. In this quarter, our best in 2016, we set new RevPAR and adjusted EBITDA records for Extended Stay America. RevPAR came in at $54.65, a 3.7% increase over prior and our highest ever which helps your adjusted EBITDA to $185.7 million, our highest quarterly number ever. We were able to do this, because our team continued to execute on the strategic initiatives that you all know very well by now

[Jonathan Halkyard:]

Thank you, Gerry and good morning everybody. Our performance in the third quarter was strong. Our revenue grew 3.9% at the top of our guidance range to $354.5 million. Revenue growth for the first nine months of 2016 was 4.4% to $974.9 million. RevPAR increased 3.7% in the third quarter to $54.65, driven by ADR growth of 2.4% and an occupancy increase of 100 basis points. The increase in occupancy was partially aided by a decrease in rooms under renovation compared to the third quarter of last year. RevPAR growth for the first nine months of 2016 was 3.9%, driven by an ADR increase of 4%. Our renovated properties saw RevPAR growth of 4.5% during the third quarter, driven by ADR growth of 1.8% and an occupancy improvement of 210 basis points. During the quarter, we completed 17 hotel renovations, bringing our total number of renovated hotels to 547. We remain on track to complete our renovation program in early 2017. Our non-renovated properties, which were fewer than 10% of our hotels during the quarter, grew 0.8% with ADR growing 2% and occupancy declining 90 basis points. Now please note this is the last time that we will breakout un-renovated property performance. Due to the extremely small number of hotels in this category in the fourth quarter and we expect that none of them in the first quarter of 2017. As expected, our hotels that were under renovation during the quarter saw a RevPAR decline of 6.8%, driven by a nearly 10-point drop in occupancy due to room displacement. Excluding hotels under renovation during the quarter, our RevPAR increased 4.3%. Hotel operating margins expanded 150 basis points in the third quarter to 58.4%. The increase in hotel operating margin was driven by revenue growth, expense controls, a decrease in utility costs and a decrease in maintenance expense. This was partially offset by higher employee benefit expenses and an increase in real estate taxes. For the first nine months of 2016, our hotel operating margins declined slightly 30 basis points to 55.1%. Corporate overhead expenses, excluding non-cash share based compensation and secondary costs, decreased 1% to $21.2 million in the third quarter. Adjusted EBITDA increased 7.4% in the third quarter to $185.7 million, a new quarterly record for us and above the top end of our guidance range. The growth in EBITDA was due to the strong revenue growth and are beginning to roll over the cost of initiatives put in place during the third quarter of 2015, such as our expanded corporate sales team. For the first nine months of 2016, adjusted EBITDA increased 4.7% to $473.2 million. Interest expense during the quarter was $48.7 million, compared to $35.2 million in the third quarter last year. Interest expense this quarter though included $14.1 million due to debt extinguishment costs which is related to our refinancing activity during the quarter, over 90% of which was non-cash. For the first nine months of 2016, interest expense was $131.5 million, compared to $101.2 million for the same period in 2015. The increase in interest expense year-to-date is primarily due to debt extinguishment expense related to our refinancing activity in both the first and third quarter. Our effective tax rate for the quarter was 21.8% and was 16.4% for the first nine months of the year. Net income for the third quarter decreased 2% to $57.1 million due to higher depreciation expense from renovation, higher interest expense and loss contributions from the 53 hotels we sold last December. Net income for the first nine months of 2016 was $133.2 million. Our adjusted paired share income per paired share for the third quarter was $0.36, compared to $0.33 in the same quarter last year. Adjusted paired share income increased 7.3% to $71.5 million. Adjusted paired share income per paired share for the first nine month of 2016 was $0.79 and adjusted paired share income was $160.3 million, compared to $163.8 million in the same period last year. Adjustments to paired share income are detailed in this morning’s release. Capital expenditures for the third quarter totaled $56.5 million, including $23.9 million on renovation and $28.9 million in maintenance capital. Capital expenditures for the first nine months of 2016 totaled $166.5 million. During the third quarter, the company repurchased approximately 600,000 paired shares for $9.2 million and since the end of the quarter, purchased 1.59 million shares in the secondary offering for $27.6 million. Including that offering, the company has repurchased approximately $6.6 million paired shares this year for $97.2 million and has a remaining authorization as of yesterday of $102.8 million. These repurchases will provide a nice tailwind to both earnings per share and free cash flow per share in the coming quarter. We ended the third quarter with total cash of $171.4 million comprised of $149.8 million in unrestricted cash and $21.6 million of restricted cash. During the third quarter, we completed the refinancing of our balance sheet, a process we began in May of 2015. This quarter, we paid off the balance of our mortgage debt with a new $1.3 billion, 7-year term loan B and cash on hand. Total debt outstanding is now approximately $2.65 billion and our weighted average cost of debt is 4.6% with an average maturity of 7.8 years. Our debt structure is now low cost, long-dated and extremely flexible for current and future needs. Net debt was approximately $2.47 billion at the end of the quarter and net debt to trailing 12 months adjusted EBITDA of our comparable hotels decreased to 4.2x and expect to reduce this metric to approximately 3.5x by the end of 2018. This morning, the Board of Directors of Extended Stay America Inc. and ESH Hospitality Inc. declared a cash distribution totaling $0.19 per Paired Share for the third quarter 2016. These distributions include $0.03 per ESH Hospitality in Class A and Class B common share and $0.16 per Extended Stay America common share. These distributions are payable on November 22, 2016 to shareholders of record as of November 8, 2016. As a reminder, ESH Hospitality, Inc. expects to distribute approximately 100% of its taxable income. Looking to the full year of 2016, we now expect total revenue of $1.261 billion to $1.267 billion, representing comparable hotel revenue growth of approximately 3.6% to 4.1%. We expect $601 million to $606 million in adjusted EBITDA this year, representing 4.7% to 5.6% growth over comparable hotel results last year. We expect approximately 60% property flow-through for the full year of 2016, with an expansion of our hotel operating margin. We expect capital expenditures for the year to total $220 million to $235 million. This is a reduction at the midpoint of $22.5 million from our prior CapEx guidance. This is due to the final phase of renovations coming in approximately $12 million under budget. And because my boss is here, I want to say that again – $12 million under budget. And approximately $10 million of that renovation capital is now expected to occur in the first quarter of 2017 rather than the fourth quarter of 2016. For the fourth quarter of 2016, we expect total revenue of $286 million to $292 million, which represents growth of approximately 1% to 3% over comparable hotel revenue in the fourth quarter of 2015. We expect adjusted EBITDA of $128 million to $133 million during the fourth quarter representing 4.6% to 8.7% adjusted EBITDA growth. Lastly, Extended Stay America will be participating at several upcoming investor events. On November 9, we will be attending the Deutsche Bank Gaming and Lodging Conference in New York. We will be attending the MKM Entertainment Leisure & Consumer Conference on November 17 in New York City. We will be attending the Bank of America Leveraged Finance Conference on November 29 in Boca Raton. And on December 6, we will be attending the Barclays Gaming & Lodging Conference in New York. Rob, let’s now go to questions.

[Robert Ballew:]

Before we begin the question-and-answer session, I would like to ask everyone to limit their questions to one, with one follow-up in order to try to accommodate everyone in the queue. Operator, we will now go to questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Harry Curtis with Nomura. Please proceed with your question.

[Harry Curtis:]

Hi, good morning. The first question that I have is given the valuation differential between the hotels that you have recently sold and where your stock is, which according to your numbers is sub 8x next year’s EBITDA, does it make sense to keep selling hotels at premium prices until the market wakes up?

[Gerry Lopez:]

Thank you, Harry, for the question. And on an opportunistic basis, we believe the answer is yes. It’s all a question of how does it fit into the broader strategy. The Investor Day strategy, the ESA 2.0, as we got it, that we unveiled back in June puts us on a path to do exactly that, take opportunities to sell some of these assets as those opportunities present themselves, raise cash, which we can use to return to shareholders, which we can use to delever and which we can use to fuel our construction program as we finish off on the drawings and the new prototypes. It’s all part of a greater strategy and it fits into where we think we need to go as a company. Yes, absolutely, it makes perfect sense. It’s a question of balance. If you don’t watch yourself, you will wind up liquidating the company and that’s clearly not our intention. But with 629 hotels in the portfolio, and as many opportunities as we see to expand into some markets where we are not even represented today, we think that this recycling this merchant idea makes better sense in the world for us and our guests.

[Harry Curtis:]

Very good. And I had one other quick question with respect to franchising you do mean deep relationships within the owner community, can you give us a sense of how you are developing those relationships? Is there any initial – do you have any initial sense of what the demand is for your brand?

[Gerry Lopez:]

Yes, nothing that we could quantify just yet, Harry. Step one is to have a team in place led by a person who has had that experience and who has some of those relationships. And that’s exactly what we are spread out to do by having Jim Alderman, which we announced last night. Importantly, it’s not just Jim, it’s the entire team. And even though Extended Stay has never franchised before, the fact of the matter is that sitting around the table in my office, there are folks such as Mike Fruin and Tom Bardenett who have that – who have those relationships over the 30 plus year career working in the industry. So, although the company has not engaged in franchising before, the executives sitting around the table in fact have. So, some of those relationships are going to be continuations of those that we have built over the years. And we will look to establish some new ones as well. We are pleased frankly by the response to the Investor Day that we had back in June even before we are actively soliciting for franchises, we have had any number of inbound calls, folks who are ready, willing, enable and eager to hear what our proposition is, who understand the economics just on calls like this and for obviously our quarterly filings and who are eager to learn more about it and understand which markets maybe available for them to develop. So, nothing that I could put numbers around yet, but on an informal basis, the team is building, the experience sits at the table and the early interest, are all positive news.

[Harry Curtis:]

Just as a quick follow-up, but kind of part two of that question, was at 85,000 to 90,000 the key, for the owners, how do you think that the ROIC is going to compare to other brands?

[Gerry Lopez:]

We are working on some of those details, Harry. What I would tell you is that our target is to provide a model that allows the owners to have low single-digit, un-levered cash and cash returns. We would – we are looking to position ourselves as a compliment to a portfolio of other hotels in any given owners existing business. So, if we were to be like this fixed income part of anyone’s personal security portfolio, that’s kind of we want to be, steady, somewhat countercyclical, high operating margin, simple to operate and simple contracts to understand and work with. So, we are looking to complement kind of the existing portfolio that people have. So, we think that low double-digit kind of cash and cash return is going to put us – is going to put us on a pretty favorable light with the franchise and investment community out there.

[Harry Curtis:]

That’s very helpful. Thanks very much.

[Gerry Lopez:]

You bet.

[Operator:]

Thank you. Our next question comes from the line of Anthony Powell with Barclays. Please proceed with your question.

[Anthony Powell:]

Hi, good morning guys. Good quarter. I have to ask about the fourth quarter guidance, revenue growth, 1 to 3 EBIT below run-rate this year. What do you think so far in October and how the customer statement is trending?

[Jonathan Halkyard:]

Anthony, thanks for that, we appreciate it. As far as the fourth quarter goes, I think it’s fair to say we have been a bit cautious in our revenue outlook. Sitting here on the 25 October, October so far has been very much like September in terms of RevPAR growth, which is rates have been around 4%. So we feel very good obviously going into the back half of – back two-thirds of the quarter, October being the largest month of the quarter. But we are a bit cautious just because of uncertainty around consumer confidence and also the election. And as we noted in the prepared comments, corporate demand has been a little bit soft now for several months and that’s an important part of our business, particularly as we get into the slower season. But it’s a bit of a cautious outlook, but one we feel very good about right now.

[Anthony Powell:]

Thanks. And as we look towards next year, what RevPAR growth generally do you need to meet whatever cost increases you have, I think the standard is 3%, but I am imagining maybe a bit lower for you guys, if you can comment on that, that will be great?

[Jonathan Halkyard:]

Yes. We see our costs increasing next year 2%. Our largest cost of course is labor, which we see increasing approximately 2%. We do think we can keep other costs down below 2%, other property type costs. We will be investing a bit in our development organization, which will cause our overhead cost to go up a little bit more than 2%, but we are of course finding offsets in other areas. So if we can grow our revenue above that amount, then we should be able to grow earnings at a healthy pace. And also I would add that it’s not just room revenue that we have the opportunity to grow, we referenced it in our prepared comments, but our other revenue grew in double-digits this past quarter. And we think that there continue to be opportunities to grow non-room rental revenues, which while very much smaller than our room revenues will contribute, we think to the bottom line. So that’s another opportunity for revenue growth next year.

[Anthony Powell:]

Great, that’s it for me. Thank you.

[Gerry Lopez:]

Thank you, Anthony.

[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. Nice quarter. I want to ask you on the corporate and I think you mentioned that your room rates were still up in the third quarter and I think a lot of your peers are going to show something else, so that’s a good win there, I just want to ask kind of more broadly, where do you think you are on the terms of overall progress with corporate accounts and are you still winning a fair share as we head in next year, which obviously is a little bit questionable on the macro front?

[Gerry Lopez:]

I think the answer Chris is, we feel pretty good about where we stand on corporate accounts. We are somewhat disappointed by the fact that the growth on it slowed down to just 1.5%, I think it was 1.25%, so. But of course, we were overlapping a quarter a year ago when it grew by double-digits. In fact, it was the first of three quarters or four quarters in a row where we grew – where we grew by double-digits, so great progress over the last 12 months or so. You just look at it on quarter-by-quarter basis and the numbers are going to be a little bit more choppy. We are winning our fair share. Part of it is a balance between progress that we want to make in ADR versus what some corporate customers are willing to pay. But we think we are well positioned. The renovation program has been key in capturing that business and importantly retaining that business as more and more of our properties are now renovated. So the portfolio across a broader geography is now suitable or approved by the corporate accounts. So we are feeling pretty good about the corporate business. It’s a month in, month out because they are feeling some of the same uncertainties about their business that we are. And the good news for us is that our – the nature of our corporate business is not quite as volatile as it is for other folks. The longer stay corporate customer is more project based. Once that project begins, it tends to get finished. It’s a question of enough projects getting started. So, we are feeling okay about the corporate business. Wish it was stronger. I think everybody will say that. But we are winning our fair share of the account business and the bids that we go up against.

[Chris Woronka:]

Okay, that’s great color, Gerry. And then I want to ask you on the Austin transaction, it sounds like it might be an alternative use situation, but aside from that, as we look forward, can you guys give us a little color on maybe how many – do you have a lot more of these sale transactions kind of in the works and how far down the road you might be on some of them?

[Gerry Lopez:]

Right now, there are really, beyond Austin and Canada, no other similar transactions that are kind of underway or in the work to this day. However, as we indicated back in June, we believe there are probably 10 to 15 situations like this in our company, kind of like the Austin situation where either the real estate underlying the hotel or a portion of the real estate adjacent to our hotel which is excess could be monetized in a way that really adds value for shareholders. So there are others on the list, but at this time, none that are at any advanced stage like Austin of course.

[Chris Woronka:]

Okay, very good. Thanks guys.

[Gerry Lopez:]

Thank you.

[Operator:]

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

[Smedes Rose:]

Hi. Thank you. Gerry, I think I heard you say that returns to owners or potential owners who franchised would be in the low single-digit level, but I think previously, you guys have talked about more of like 11% to 12% return, so I just wanted to ask if these are – those are different measurements that you were talking about or maybe you just can provide a little more color there?

[Gerry Lopez:]

I am sorry Smedes, I might have said low single. I meant to say low double. And I might have said low single and then corrected myself. It’s low double, to be absolutely clear. With pro forma, we are working on the final design. And of course, the cost of alignment has got a lot to do with it, etcetera. But our intention is to provide prospective owners with low double-digit cash and cash returns on un-levered, as an opening proposition for the new prototype.

[Smedes Rose:]

Okay, thank you. I appreciate the clarity. The other thing I wanted to ask you, it looks like the mix in terms of the channels, continues to shift to OTAs and away from your proprietary channels and I just kind of – is that kind of related to the corporate weakness that you said you have been seeing and is there – what kind of margin opportunity is there on that line if you can move away from the OTAs into your proprietary…?

[Gerry Lopez:]

Yes. That’s a great question. And just a couple of comments on the whole OTA piece of business. For us, it’s now about 20% give or take a couple of points, either way in any given month or quarter, but it’s about, call it a fifth of our business model, that’s in fact, yes it has been growing. Now, the way that we use OTAs is perhaps somewhat different that some of our peers that are out there. The vast majority, over 85% of the OTA business that we book, we actually build it in a couple of days of arrival. Those are rooms, given the length of stay, characteristics of our guest, those are rooms that otherwise would go unused. In our marketing scheme, we don’t have any mass medium advertising, we don’t do final for March madness, kind of advertising. In fact, the OTA channel is very much our advertising channel as well as a distribution channel. So if you were to think of expanded commission rate that everybody pays to an OTA and then you layer in whether it’s 4, 5, 6 some other mid single-digit number for marketing costs on top of that, that’s perhaps the way to look at it for someone else. For us, that commission rate that we pay is indeed the distribution fee and the marketing expense of capturing that business for those rooms that otherwise, given that it’s only a couple of days before people do the book, in a couple of days people will show up, otherwise those rooms will go unused. For us, it works really well to manage the OTAs like that. And then there is the final – the final stock is that the ADR that we are able to capture in that manner, even after paying the commission it’s still pretty favorable to our overall system wide ADR. So the combination of all of those, the fact that the ADR, even after commissions are still pretty favorable and in fact above some of the business that we can get. The fact that we use the OTA not only for distribution, but for marketing, the fact that it’s getting booked literally within two days of arrival, you take it all well altogether. And we are feeling pretty good about the productivity out of that distribution channel for our business, for our stake. And nothing better to reflect it on the quarter that we just had, where we are managing not only the property direct, it’s in a more efficient basis through central reservations and the one – and the activities at the hotel level, but they are also supplementing that with the OTAs. The mix is proving to work pretty well. The underlying enabler for it all is the RMS system that we put in place last year. As that system is – we continue to learn how to use it and it continues to learn about our guest behaviors, our guest patterns, it just becomes much more effective. That’s why we can use the OTAs in the way that we have. The RMS supports our people in the field as to when to release those rooms and when to hold them back. We are fairly happy with the way that it’s all come together and it is working. We learned more about it every week, certainly with every compression event in every market out there. There is learnings to be had, but the combination has worked out fairly well for us.

[Smedes Rose:]

Okay, thank you. And then can I just ask just one final, Jonathan, with these asset sales, does that trigger any kind of gain that would need to be distributed to shareholders through the readers, is that not an issue on the required distribution?

[Jonathan Halkyard:]

Well, it would not be required distribution. We could distribute the amount of the gain in order to reduce the taxes payable on the gain, but it’s not a requirement.

[Smedes Rose:]

Okay, thank you.

[Operator:]

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

[Shaun Kelley:]

Hey, good morning guys. Gerry, I think during the quarter you mentioned obviously the recent hiring of Jim Alderman. It sounds like a great addition, but you also lost I think one of your top marketing guys in Tom Seddon. Could you talk about sort of any impact you may have in plans to either sell that role or sort of pivot the business and focus on different priorities?

[Gerry Lopez:]

Nothing specific that we are in a position to share, Tom’s responsibility, we appreciate Tom, he did tremendous work for us and his skill set was critical to the success that we enjoy. Even today we miss him everyday. His impact to the industry and his personality are missed by all of us. The reality is that one of his strongest skills and his best legacy is the team that he left behind. So, we validated Tom Buoy to take over some of the marketing responsibilities. He has been with us more than 5 years and he has been in charge of our revenue management system. He now also has marketing responsibilities. And the sales function falls now under our Chief Operating Officer. So, we were able to, as a result of Tom building such a good team, we were able to distribute the responsibilities and then create some room at the officer level for then Jim Alderman to join us in this new critical job we call Chief Asset Merchant. So, no specific plans at the moment. The responsibilities have been distributed, all being attended to. Tom will be missed, but the legacy of a true leader is building a great team and he did exactly that.

[Shaun Kelley:]

Great, that’s very clear. And then my second question would just be to help us kind of think through the renovation lifecycle here as things begin to wind down for next year, so sort of the specifics are how much of a tailwind do you think renovations are lapping disruption from last year were into this quarter or will be to 2016? And can you give us any sense of how much or when you think that will start to roll off in 2017?

[Jonathan Halkyard:]

Hey, Shaun. It’s Jonathan. Probably about – the benefit this quarter was probably about 60 basis points and that’s because of the reduction of the amount of renovation this year as compared to the third quarter last year and it will be a little bit less than that in the fourth quarter. And then even less still in the first and second quarter and yet there was – but there will still be a benefit, a year-over-year benefit in the first and second quarter of 2017 probably on the order of 20 or 30 basis points. And then we will be done as we indicated. And we are counting on the continued success of the renovated hotels that we have done this year and early next year to really help us as we conclude 2017 and even into 2018.

[Shaun Kelley:]

And so Jonathan to kind of think through the – there was 60 basis points or so in this quarter, it still seems like you probably would outperform your relative chain-scale even without that kind of displacement benefit. Is that fair to say?

[Jonathan Halkyard:]

Yes, yes. Yes, I think that’s fair to say. Yes.

[Shaun Kelley:]

Okay, great. Thank you very much.

[Gerry Lopez:]

Thank you, Shaun.

[Operator:]

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

[Thomas Allen:]

Hey, good morning. I remember last quarter there was some noise in the RevPAR numbers just around geographic mix when we looked at renovated versus un-renovated hotels. Can you just give us some more color on how different geographies performed? I know oil markets aren’t a big segment for you, but for example, can you give us that performance than this general other market segment?

[Gerry Lopez:]

Yes, I’ll start it, Thomas and Jonathan will kick me on. The southern – what we call our Southern division, which is essentially the Southeast and cutting across into Texas, has been our strongest performer all year for all three quarters. The Southeast specifically continues to do really well. Yes, sure. Houston, the oil market in Houston has been obviously a drag, but the balance of the State of Texas has actually been pretty good. In fact, the plus number in Dallas and the minus number in Houston are almost exact matches for one another, plus 18 and change, minus 18 and change, right? So in spite of that that division when balanced out across the balance of the geographies continues to do well. The west rebounded nicely in Q3. A lot of that is project-driven IT kind of work. We are happy to see the Bay Area come back strong. The softest market for us has been, besides the oil patch specifics has been the north and that’s very much linked to some work that we had, some project-specific work that we had a year ago that was one-off and we haven’t captured replacement business this year. All-in-all, no surprises, the trends, the geography trends have been pretty steady for the last three or four quarters. There are macro factors affecting those geographies and then some specific hotel-to-hotel project stuff, but there is nothing fundamentally changing that you haven’t seen across SDR or some of our peer set. Jonathan any other color on the geography?

[Jonathan Halkyard:]

No.

[Gerry Lopez:]

Does that help you, Thomas? Is that…

[Thomas Allen:]

Yes, no, that’s great. That was very helpful. And then just as my follow-up question, you touched on this a bit earlier, but during your Investor Day, Austin was one of the markets you highlighted. And at that time you talked about how – there were a couple of developers that were interested. And you also laid out two options, one, where you start out right for a higher multiple and the other way you entered an agreement for another Extended Stay hotel. It sounded like you went for the higher multiple, but can you just talk about some of the discussions in a little bit more detail? Thank you.

[Gerry Lopez:]

Sure. Happy to give you some color. Indeed, we went for the higher multiple. The use is not going to be an Extended Stay hotel, it will be a 40-plus storey tower that will have office and residential and retail and everything else. This is a prime block in Downtown Austin. We don’t have many urban hotels like this one was. We can frankly the way that we thought about it is, gee, it’s 100 and some odd key hotel. Very good performer, by the way, but with the proceeds of that sale, if you wanted to think of very simplistic terms, you can get 3 other hotels in Austin built and capture 300 plus rooms, 330, 360 rooms replacing the 120 keys that you have downtown and one that’s generating 2.5x of EBITDA from the one transaction. So for us, it became very evident very quickly that in an opportunistic basis this is not something that we would turn down. We had meetings with any number of developers that they want to group that has a lot of experience with multi-use in Austin. The Austin people, they are not flying in from out of town to get this done. And we look forward to their success.

[Thomas Allen:]

Makes a lot of sense. Thank you.

[Gerry Lopez:]

You bet.

[Operator:]

Thank you. Our next question comes from the line of Joseph Greff with JPMorgan. Please proceed with your question.

[Joseph Greff:]

Good morning, everybody. Jonathan, can you help us out with how you are thinking about the 2017 CapEx and investment spend?

[Jonathan Halkyard:]

CapEx and what?

[Joseph Greff:]

Other investment spend related to, yes, ESA 2.0.

[Jonathan Halkyard:]

Sure. Yes, we are in, actually, in the final strokes of our 2017 budget now and we will be providing guidance for 2017 during our fourth quarter call as we typically do. But in broad stroke, we are planning maintenance capital of approximately $90 million to $100 million, which is a bit below what we have spent – what we will have spent this year and in 2015. And then our capital associated with the renovation program will be between $30 million and $40 million. That was going to be lower, but as I mentioned in the prepared remarks, it’s about $10 million that we had thought we would spend this year, which is sliding into January, so about $35 million. And then we typically have corporate and IT capital. And I think the amount that is still I think subject to some variability would be the extent to which we invest in real estate or even in the beginning of our prototype, our first hotel or two hotels, which to the extent we spend capital in 2017 on that will more likely be much later in the year and probably not a lot of money. So against our guidance of 2016 CapEx of over $200 million next year is going to be – is going to be a reduction compared to that amount, which is one of the reasons why we are really expecting very healthy free cash flow next year.

[Joseph Greff:]

Got it. And then what implies to the 4Q is that guidance that does not take into account asset sales?

[Jonathan Halkyard:]

Yes. You are talking about the 4Q operating guidance, revenue and EBITDA?

[Joseph Greff:]

Correct.

[Jonathan Halkyard:]

Yes. It does not take into account any of the asset sales. No.

[Joseph Greff:]

Okay. But those assets are not being depreciated it looks like and what implies to the 4Q?

[Jonathan Halkyard:]

I believe we still have those assets being depreciated in the 4Q, in the fourth quarter for the purposes of our guidance at this point.

[Joseph Greff:]

Great.

[Gerry Lopez:]

We will be operating the assets in the fourth quarter. Was there anything else Joe?

[Joseph Greff:]

I am all set. Thanks.

[Gerry Lopez:]

Okay. Thanks.

[Jonathan Halkyard:]

Thanks Joe.

[Operator:]

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

[Stephen Grambling:]

Hey, thanks. This is somewhat of a follow-up to Shaun’s earlier question on the contributions of some of your company-specific initiatives, as we look beyond the renovations to maybe rev management, the loyalty program, etcetera, how did these contribute to the top line performance in the quarter and how should we be thinking about the trajectory of these going forward? Thanks.

[Gerry Lopez:]

We don’t typically break out some of the specific contributions just because it’s kind of difficult to piece out the contributions for any specific initiatives. We can track the renovations and then from there it gets kind of easy. I can tell you that our loyalty program for example is up to 1.5 million members. We had about 160,000 in the third quarter. They now represent about a third of our business, that 1.5 million members. So we can track those kinds of statistics to attribute the growth from beyond that and try to attribute okay, so what – how much of our specific growth was driven by one or the other thing is kind of hard. We know that the RMS system, we try and gauge its contributions in a couple of different ways. And we have said all along and continue to believe based on that analysis about 1 point to 2 points RevPAR are driven by the RMS. But it’s hard to know whether how much of it is RMS versus the Extended Perks. We know the specifics, but when they all clash together, we are pleased to see it all contributing to the near 4% RevPAR growth and are happy with that rather than to piece a specific contribution and trying to break out the 4% RevPAR into any one component or the other.

[Stephen Grambling:]

And then in terms of, I guess a follow-up, how you are thinking about those building momentum into next year. And then if I maybe change gears a little bit, as you think about some of the initiatives you have around cost controls, can you just flush out what some of those are that are keeping your overall costs to maybe a lower level than it has been historically? Thanks.

[Gerry Lopez:]

Yes. They – what we did in the kind of in the middle of the year was kind of reset some of our infrastructure to where we expect to be lower RevPAR growth environment which is in fact what’s happened, right. And by lower RevPAR growth environment, we mean exactly what we are seeing, which is this 3% give or take right, as opposed to a 5% or a 6%. So what I mean by that is that we have looked at our entire infrastructure, the number of divisions that we have for example, are in field operations. So it used to be four, now it’s three. The number of district managers, it used to be close to 120, now it’s closer to 100. The expense control by those district managers it used to be closer to five or six, now it’s closer to seven or eight. So those are the kind of things that we are doing. We have invested a lot in training for example. So we have more qualified people leading the hotels. So therefore that allows us our supervisory scope to be somewhat one or two hotels greater than it used to be. When you own 629 hotels, one or two hotels increased scope for a district manager pretty quickly allows you to reduce the number of district managers by 12%. And that’s the kind of thing that we have done Stephen, is kind of adjust the infrastructure of the organization to a growth environment that is not going to be as aggressive as we might have anticipated 1 year or 2 years ago. And it’s worked quite well. Some of the initiatives that we put in place for the second half of the year, like the ones I just described are sustaining, meaning they will carry into 2017. And then there are other things that we have done that were more deferred or were one-time. Those we wouldn’t expect and when we are ready to discuss guidance into ‘17, we will piece those out so that the ones that are more infrastructure and fundamental in nature, that benefit will show up. And then the ones that were one-time of course, of course not. But it was not so much a cost program where we executed that allowed us – that enabled this kind of flow through. It was more of a reset to a different operating environment than we have been expecting and it’s worked quite well, so.

[Stephen Grambling:]

Good, that’s helpful. Thanks so much.

[Gerry Lopez:]

You bet.

[Operator:]

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

[David Loeb:]

Good morning gentlemen. Just a follow-up, first on Smedes’ question about the OTAs, you have hung your head on – I know a fifth of your business coming from OTAs, it’s obviously more short-term in nature, short stay and more volatile in a sputtering economy, does that give you any pause about your ability to fill those rooms in 2017?

[Gerry Lopez:]

Everything about 2017 gives us pause, David. I mean, there is uncertainty about where the consumer is going to go. There is uncertainty about the corporate account. There is any number of things that will give us pause. For us though, it’s a question of looking at the business as we present itself. And so long as we can manage the mix in a way that is accretive to our ADR and our RevPAR, we feel that we are doing the right thing and we feel good about it. So it’s not a question of gee we set out to build our OTA business so much as it is a question of the demand is presenting itself in such a way that OTA being a greater percent of our mix. There is no specific objective to get that business to any set amount of the mix. It’s rather a question of we want to keep the hotels busy and demand is presenting itself in that way, we take advantage of it. Was demand to present itself on a corporate basis, then the OTA business wouldn’t be where it is. So we balance it as we present it – as it presents itself. We try to generate the corporate business as longer term. Obviously, certainly, the project side of it is longer term. That’s not a week-to-week, that’s more like month-to-month and quarter-to-quarter. we are not about to turn down business, however, it gets generated on account of where it came to an OTA and the commission is attached to it, particularly you know that commission, the ADR is accretive to our results. So yes, we are comfortable with it. But we worry. Yes, I would say it’s definitely in the worry list as far as any number of other factors for ‘17.

[Jonathan Halkyard:]

I think just one comment on that, now that we have a high degree of confidence and the integrity of our pricing, because of our revenue management system and that we are pricing those shorter term stays appropriately on the OTA channels, I think the growth of the OTA channels is evidence that we are winning on that shelf. And when we do $78 in ADR to the OTA versus $60 – $78 on our short-term business versus $60 on our long-term business, if we can manage that occupancy appropriately, which we think we are doing, that’s – that short-term business is a very good piece of business for us, particularly in the high season, which is third quarter, as we get into low season, we are of course going to work at filling our rooms with more long-term corporate business, because we won’t have as much of the short-term demand, but I think it’s been exactly the right strategy for us.

[David Loeb:]

That’s a really good answer really from start to finish. Jonathan, when you mentioned the short-stay ADR, how does that short-stay ADR in total compared to the OTA ADR? Are those pretty close to each other?

[Jonathan Halkyard:]

Yes, they are going to be pretty close. I mean, our short-term business right now, one business is kind of 30 – low 30 [indiscernible] 20% right? So we are doing short businesses through our other channels, but it’s again when we can manage the occupancy and price it correctly, that’s a trade that we will do all day long so long as Gerry said the demand presents itself.

[David Loeb:]

Right. So, the $78 number is pretty close to what the OTA ADR?

[Jonathan Halkyard:]

Yes.

[David Loeb:]

And that’s growth that’s before commission right?

[Jonathan Halkyard:]

That’s correct.

[David Loeb:]

Okay. And one more something I don’t thank you have much worry about, clearly, Gerry, you stated very strongly that the stock price is attractive for share repurchase. I just wondered if you could comment a little more broadly in capital allocation about how aggressive you would consider being here and how you weigh balance sheet progress, asset sale proceeds against the share repurchase capacity and interest?

[Gerry Lopez:]

I am glad to hear you say that. The idea that our shares are undervalued came across strongly, because we meant it to come across strongly. Look, we are going to look at our capital allocation very carefully and thoughtfully, right? So, shareholder returns are going to be top of mind and are going to be leading the list on any discussion that regards capital. We are a dividend payer. We have increased dividend every year that we have been a dividend payer that we have been public. We expect to maintain that dividend or increase it. We do that transaction. Certainly, when we do the larger transactions as we did back in December, a portion of the proceeds of those transactions went right back to the shareholder. Now, cynically, well, gee, you are required to do some of that, because of the REIT structure and indeed that’s the case. But there is any number of ways that we could have redeployed that capital yet, returning it to the shareholders, whether in the dividend form or the share repurchase form, that’s going to be going to be topic one. We are still, moving on to number two, we are still 4.2 levered even though we repaid $170ish million in our debt. But as we restructured the balance sheet into more traditional cost demand type instruments, the opportunity to delever is going to present itself and we will take that. So, that’s never – that’s never far down the list. We will expect that some of the capital will be used not to what was renovation process, but when it comes to an end here in the first 3 months or so of ‘17, but then we will have new construction. So, we will be buying some land and putting up the first couple of three of the new prototypes. So, some of that, it won’t be as intense the use of capital as the renovations have been, because there just won’t be as many, but that use will fuel our future. So, we expect to be doing some of that as well. Those are going to be kind of what our focal points are for capital. I think David that what you have seen us do the last call it 1.5 year, perhaps 2, in terms of capital allocation is going to be consistent with what we are going to do over the next couple of years. The main difference being other renovation program comes to an end. And that has been a big use of funds and the new construction program that replaces it will not be as intense. I will not take – it will not kick into gear in nearly following the renovations either. So, we put 2017 in a pretty good place in terms of what our free cash flow looks like. Jonathan, did I leave any of the saving points out?

[Jonathan Halkyard:]

No.

[Gerry Lopez:]

Does that make sense, David? Does that answer your question?

[David Loeb:]

Yes, that’s great and it’s great on the long-term perspective. So just to zoom in on the short-term then, with call it roughly $100 million of proceeds coming in from asset sales and $100 million left on your authorization, that it sounds like you have the ability to complete that authorization without being overly concerned about the balance sheet given the long-term free cash flow terms. Is that fair?

[Gerry Lopez:]

Yes, that’s very fair.

[David Loeb:]

Great. Thank you.

[Gerry Lopez:]

We of course we put leverage targets out into the market. We are committed to meeting those targets. But leverage is also a function of duration as opposed in addition to the quantum of debt. And in that vein, we are really proud of how we have extended maturities on our debt over the past 1.5 years and we think that, that really helps the leverage picture as well.

[David Loeb:]

Perfect. Thank you.

[Gerry Lopez:]

Thank you.

[Operator:]

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

[Gerry Lopez:]

Thank you, Michelle and thank you everyone for joining us today. We are looking forward to finishing 2016 strong and then reporting back to you all our results in late February, early March. Thank you and have a great day.

[Operator:]

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