Extended Stay America, Inc.
Q3 2017 Earnings Call Transcript

Published: 11 Nov 2017

[Operator:]

Greetings, and welcome to the Extended Stay America Third Quarter 2017 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce, Rob Ballew, Investor Relations. Please go ahead, sir.

[Robert Ballew:]

Good morning, and welcome to Extended Stay America's Third Quarter 2017 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 are Gerry Lopez, Chief Executive Officer; and Jonathan Halkyard, Chief Financial Officer. After prepared remarks by Gerry and Jonathan, there will be a question-and-answer session. Before we begin today, I'd like to remind you that some of our discussions will contain forward-looking statements, including a discussion of our 2017 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 28, 2017. In addition, on today's call, we will reference certain non-GAAP measures. More information regarding these non-GAAP measures, including reconciliations to the comparable GAAP measures are included in the earnings release and Form 10-Q filed with the SEC this morning.

[Gerardo Lopez:]

Thanks, Rob, and good morning, everyone. Thank you for joining us to discuss our third quarter 2017 results, which as you saw, in the release this morning, are a mixed bag. While most of our 625 hotel portfolio performing in line with expectations, a handful of markets were driving our overall numbers during the quarter, markets which have all been highlighted by our peers. And as you've heard from others, negatively impacting RevPAR during the quarter were the 4th of July dayshift, the Jewish holiday shift in September and cycling the DNC and RNC conventions last year, which collectively had a negative impact on RevPAR growth of about 70 basis points. On the other hand, hurricanes Irma and Harvey had a modest lift to our third quarter revenue of between 0.5 percentage points to 1 percentage point. In spite of the storms, leisure travel continues to be a bright spot for us, although growing a bit slower than earlier in the year. Corporate travel on the other hand remains soft. Unlike many of our peers, we own and operate all of our assets and can react more quickly to performance issues in our portfolio. As you would expect, we have done and are doing a number of things to attack the revenue softness. First, we've made a couple of key personnel changes, Simon Mendy, formerly VP or Senior VP of ops for a best-performing southern division and an 18 year veteran of the company has been named Executive VP of Operations and will oversee all of the company's nationwide operations. Simon brings to our C-suite an insider's operator knowledge of our cost structure that we've never quite had before at the senior most levels in the company. In parallel, Tom Buoy, formerly Executive VP of revenue management has been named Executive VP of revenue. In this new position, Tom will be responsible for all revenue generation including revenue management, call center and all sales activities. We believe this single senior-level focus on revenue, combined with a seasoned ESA hand on operations and expense control, will work much better for us going forward. Further, we've already realigned several key sales and operations resources against markets with higher ADRs and richer opportunities with a specific focus on driving occupancy. ADR, you see, even in these markets, has not been an issue. We have been redeploying CapEx into these markets so that we can continue updating our properties. All the areas in the company are performing well. Expenses, although modestly high during the quarter, were in line with our expectations and cycling a very tough comp from last year when we put in place a long list of cost measures, many of which were one-time in nature. To give you some context on a year-to-date basis, expenses are roughly flat versus prior. In fact, during the 9 months of 2017, our hotel operating margins have expanded by 60 basis points compared to 2016. Our capital investments are working with a roughly 130 most recently renovated hotels seeing RevPAR growth of nearly 12% on strong occupancy and ADR gains. Our balance sheet continues to improve with us delevering again in the quarter on the back of our strong free cash flow, while continuing to return capital to shareholders. Our teams performed very well in the face of 2 devastating storms in Texas and Florida, and we're very proud of and grateful for them. They executed a quick turnaround to get all of our about 60 Houston and Florida storm affected hotels open and ready for business. Occupancy has increased in these markets, as we fill these hotels with people displaced by the storms and others rushing in to help. Moving now to ESA 2.0. No surprise, our work on this strategic initiative continues to move forward. As we mentioned last quarter, there are three works, three very specific work streams we are executing against inside of 2.0. Let me update you on all three, first, asset sales. This month, we signed an agreement to sell 25 hotels to a single buyer. The agreement is subject to numerous conditions and has not yet gone hard, so we're not comfortable sharing a lot of details, but we'll do so in our next earnings call as the deal closes as planned in the next few months. That said, we can share with you that the deal terms are generally consistent with the strategy we announced at our 2016 Investor Day, that is, most of the hotels are in non-strategic secondary and tertiary markets with average RevPAR levels 20% below our portfolio average. Most are being sold at multiples around what we highlighted at Investor Day and currently reflected in our IR materials. One change is that we will continue to manage these hotels, all but one of them, under the Extended Stay America brand. Now beyond this 25-hotel deal, we've also signed a sale agreement for a single additional hotel for just over $16 million or 12x adjusted EBITDA, a transaction that we will expect to close in the next few months. Additionally, and beyond those 2 transactions, we're engaging 15 different brokerage firms and agencies to sell a significant number of hotels over the next 18 months. On those you can expect us to follow the same general approach we've used in the past. Tweaking where necessary to improve deal economics and drive shareholder value. All of this is consistent with commitments we made at our Investor Day last year. On the second work stream, franchising. The buyer of 25 hotels I mentioned a moment ago will agree to develop 15 additional franchise hotels, potentially bringing the ESA total properties up to 40. Not to sound like a broken record, but this approach is consistent with what we said on our Investor Day, where we will sell a group of hotels and then have the buyer continue to grow with the brand. We're excited to kick off our franchising program in this fashion. Additionally, beyond this one buyer, we're currently negotiating with 15 other firms to build new Extended Stay America hotels or convert existing hotels to the ESA brand. By the way conversions of existing hotels into our brand is one of those tweaks I talked about a moment ago. While we originally did not envision them as an option to grow our footprint, truth is attractive opportunities do exist and we intend to capitalize on them or with franchisees and as owned and operated hotels. Owned and operated hotels -- owner-operated hotel development is the third work stream and we continue to push ahead there as well. We just completed our first land purchase for a location in the Phoenix suburb, and currently have 2 other sites in the contract at various stages of due diligence with seven LOIs signed as well. We expect to break ground in the first site in the next few months. Over the next few quarters, you can expect to hear progress reports on all 3 of these work streams. Now let me turn the call over to Jonathan to give you more detail on our financial results and provide commentary on our Q4 and full-year 2017 outlook. Jonathan?

[Jonathan Halkyard:]

Thanks, Gerry. Our third quarter results were affected by some revenue challenges, while other aspects of the business delivered consistent results. And these include expense management and returns on capital investments. Additionally, our industry-leading hotel margins of over 57% and a low tax rate of 23.5% allowed strong free cash flow growth and a reduction in our leverage ratio this quarter, all while continuing to return capital to shareholders. Comparable RevPAR in the third quarter picked up slightly to $54.55 compared to the prior year, with a 0.4% increase in ADR being offset by a 40 basis point decline in occupancy. The decline in occupancy was driven by weakness in Philadelphia, Northern and Southern California, Chicago and DC, and partially offset by an approximately 50 basis point lift from fewer rooms displaced from renovation and stronger demand in Houston and Florida post the hurricanes. With respect to ADR, this quarter we had an increase in net bookings from our OTA partners compared to the prior year, which reduced our ADR and RevPAR growth rates for the quarter by approximately 40 basis points. Remember, when a guest pays an OTA partner directly for a stay at ESA rather than paying at the hotel, the ADR and expense is the net amount rather than the gross amount. This does not affect our earnings, but it does reduce both revenue and expenses. Recently renovated hotels saw RevPAR growth of approximately 12%, adding more than 1 percentage point to our RevPAR growth during the quarter. Our 1- to 6-night revenue grew 3% in the quarter reflecting strong leisure demand, offsetting a 4% revenue decline from our guests staying from a week to a month, and that reflects some softness in corporate travel. Hotel operating margins declined 120 basis points, but still led the industry at 57.2%. Increases to labor cost, property taxes and maintenance expenses were partially offset by a reduction in utility and insurance expense, with total expenses coming in line with our expectation. We saw approximately $300,000 in expenses during the quarter from the post hurricane maintenance efforts, and we anticipate about the same amount in the fourth quarter mainly for landscaping. So for the first 9 months of 2017, comparable RevPAR increased 1.5% driven by a 100 basis point improvement in occupancy and a 30 basis point increase in ADR. For the 9 months of 2017, our operating margins have expanded 60 basis points to 55.7% on 97% property level flow-through on a comparable hotel basis, highlighting our effectiveness at keeping a tight control on expenses. Corporate overhead expense excluding share-based compensation and transaction cost declined 1.6% to $20.8 million during the third quarter, even as we invest in staffing our 2.0 programs. Our adjusted EBITDA in the third quarter was $180.3 million, below our range due to lower revenue than anticipated. Adjusted EBITDA declined 2.9% in part due to the lost contribution of about $2 million from the hotels that we sold in May of this year. For the first 9 months of 2017, adjusted EBITDA increased 2% to $482.7 million or a 2.9% increase on a comparable-hotel basis. Adjusted FFO per diluted Paired Share increased 2.3% in the third quarter to $0.57 per diluted Paired Share, driven by lower interest expense and fewer Paired Shares outstanding, partially offset by a higher tax rate. For the first 9 months of 2017, adjusted FFO per diluted Paired Share increased 4.6% to $1.44 per diluted Paired Share compared to $1.38 last year. Net income during the third quarter increased 16.1% to $66.3 million driven by lower interest expense from both the lower absolute level of interest, as well as a one time costs last year during the quarter from refinancing costs associated with our term loan B, and that was partially offset by an increase in income tax expense. Income taxes increased due to both higher pre-tax income as well as an increase in the rate associated with a one-time favorability last year from the PATH Act. Net income for the first 9 months of 2017 dipped 0.9% due primarily to an increase in income tax expense as well as higher non-cash impairment expense and partially offset by lower interest expense. Adjusted Paired Share income per diluted Paired Share in the third quarter dipped slightly to $0.35 per diluted Paired Share from $0.36 in the same period last year. The decline was due primarily to an increase in income taxes and lost contribution from asset sales in May of this year. Adjusted Paired Share income per diluted Paired Share for the first 9 months of the year increased 1.9% to $0.81 per diluted Paired Share compared to $0.79 in the comparable period last year. As a reminder, last year's adjusted Paired Share income benefited significantly from a one-time income tax adjustment from the PATH Act. We continue to make progress on improving our balance sheet and our free cash flow. This quarter, our net debt to trailing 12-month adjusted EBITDA declined to 3.9 times from 4 times last quarter, driven by a $60 million increase in cash to $138 million, and a slight decrease in debt outstanding. This was due to our strong free cash flow during the third quarter from lower capital expenditures, lower interest expense and strong operating margins. Gross debt outstanding was $2.59 billion compared to $2.65 billion a year ago, with a weighted average interest rate of 4.5% and an average of 6.6 years to maturity at the end of the quarter. That's quite a change from just 2 years ago when we had gross debt of $2.82 billion, a leverage ratio of 4.3x and approximately $15 million higher annualized interest expense. I'm very proud of the progress that we've made in delevering the company and improving our balance sheet. Capital expenditures in the third quarter were $39.8 million due to very limited renovation spend. We did, however, spend about $5 million on capital expenditures during the quarter related to flood damage and hurricane damage. For the first 9 months of 2017, we've spent $133 million in CapEx. This morning, the Boards of Directors of Extended Stay America and ESH Hospitality declared a combined cash dividend of $0.21 per Paired Share, payable on December 5, 2017 to shareholders of record as of November 21, 2017. This represents a strong and attractive annualized yield of over 4% at recent share prices. During the quarter, we repurchased approximately 250,000 Paired Shares for $4.8 million. For the first 9 months of 2017, we repurchased $3.4 million Paired Shares for $58.8 million. With our share repurchase authorization remaining at about $101.4 million, we have plenty of dry powder for opportunistic purchases. Looking to the fourth quarter, we expect comparable RevPAR growth between 0% and 2%, and that includes October RevPAR growth of 1.8%. We expect adjusted EBITDA for the quarter between $127 million and $132 million. Now that's below the fourth quarter of 2016 due to a tough expense comp last year as well as some favorable real estate tax outcomes last year. And here, a 2-year stack is instructive. Compared to the fourth quarter of 2015, our fourth quarter guidance represents 10% comparable EBITDA growth on approximately 60% flow-through at the midpoint of our range. For 2017, we now expect comparable RevPAR growth of 1% to 1.5%. We expect adjusted EBITDA of $610 million to $615 million. We're narrowing our CapEx guidance to $163 million to $178 million, which represents an increase of approximately $10 million in capital expenditures compared to 2016 for insurable events such as hurricanes and floods. We expect to recover $67 million of that capital in 2018. We're maintaining our annual interest expense guidance of $130 million. I'll now hand the call back over to Gerry for a brief statement before opening up for Q&A.

[Gerardo Lopez:]

Thanks, Jonathan. We expect 2018 to be a pivotal year for Extended Stay America, with ESA 2.0 to be at the very forefront. While it's too early to give an outlook on operating metrics for the next year, we can tell you that one, we plan to sell a significant number of hotels, most of which would be re-franchised. Two, we will continue to move forward on owned and operated hotels using our own balance sheet for development. And three, we will repurchase shares when opportunities present themselves and continue to delever our balance sheet. This is the plan that we've outlined for you in the past, in which we'll continue to deliver against. Operator, let's now go to questions.

[Operator:]

Thank you. [Operator Instructions] Our first question today is coming from Harry Curtis from Instinet. Your line is now live.

[Harry Curtis:]

Hey, good morning. Gerry, quick question on your use of the words or the phrase, selling a number, a significant number of hotels. And I guess, my question is, can you put a little more color on that, what inning are we in as far as your longer-term strategy of selling hotels?

[Gerardo Lopez:]

Good morning, Harry. We're in the early innings. As you know, we announced the program in '16 we really began in '17, that's after the Crossland sale, which included the brand and everything else. And we've been very impressed and frankly, the idea of selling hotels has been warmly received. We've been negotiating as we've indicated in the prior calls with a number of parties. The game, again, I've to use your analogy of innings, I would characterize as first or second inning, a lot of opportunities ahead of us. There's any - there are any number of buyers with any number of objectives and we're negotiating across the spectrum. Some are strictly as is the case with this first set, financial buyers looking for yields. Some are operators looking to expand their footprint and diversify their portfolio of brands. None of these are 1C, 2Cs. None of these are new entrants into the market. We are pleased that the negotiations, frankly, the number of hotels range from just about half a dozen to, in this case, a couple of dozen,, and then some deals in the Q that are even beyond that. People have latched onto idea of owning a market and owning the flag in a market or two or three and then having the development rights for those markets, which was one of the basic tenants for the way that we were going about things. They are attracted to the proposition, not only for some of the financial, obviously, the benefits of the brand and the margin at which we operate, but also that exclusivity in the market. And frankly, some of the flexibility that we have shown both in terms of the fee structures and the way that we're packing or approaching the whole standards question. So it presents all in all a pretty compelling package for investors and operators, and it's a question of due diligence, it takes time, lining up of financing, which is plenty available as you know. And things are coming along. It's hard to, as you know Harry, in these things, predict exactly what will happen and when. But sales like the one that we made reference to this morning and the 2 dozen sites will not be unusual coming into 2018, some will be smaller others will be larger as well.

[Harry Curtis:]

Okay. But going back to that. First part of my question is, of the over 600 hotels that you've got, is there some target that you have in mind to dispose of in the next couple of years?

[Gerardo Lopez:]

Most definitely about a hundred a quarter, hundred and fifty, those numbers go back to the plan that we announced in June of 2016. That target hasn't changed. If anything, we thought that it may take 4 or 5 years, Harry, it may only take a couple. So the timeline may be accelerated. The number of hotels, the target, the number of hotels remains about the same.

[Harry Curtis:]

And is there a line in the sand on the multiples that you're going to take? Is it -- do you need to see a double-digit multiple on trailing EBITDA before you'll consider it?

[Gerardo Lopez:]

Very asset dependent, some of the hotels, particularly as we've tiered our portfolio into the 5 different tiers that we've explained in the past, some of the lower RevPAR hotels, no, we're not expecting to see double-digits at all. In fact, most of our performance in the IR materials and some of the numbers that we've released to the public assumes a single digit, 9, I believe to be the multiple that we will use now, again, extremely asset dependent. You've seen those advertise or announce rather, the sale of some individual, very specific assets often we've talked about in the past. We just talked about 1 today in the mountain market, in Denver, specifically. And you'll see those very specific locations come out at 12 or 13. That's great for that specific hotel. When you start cutting across portfolios, whether it's 6, 8, 10 or 24, 25 hotels, a different ballgame because the mix of hotel RevPAR then changes. So it's really specific to which individual property. On average, the line in the sand, to use your words, really it's about the shareholder value that can be unlocked in the transaction, it's really - we're not dogmatic or holding fast to some imaginary standard or another. Every transaction stands on its own two feet. Every asset stands on its own two feet.

[Harry Curtis:]

But the blended average, you mentioned the lower end hotels nine times and the higher end at 12 times or more. Is it reasonable to assume on a portfolio basis in the next year or two, that at least you can get around 10 times?

[Gerardo Lopez:]

Hard to say. I want to keep - we're going to keep some of the better higher producing markets. I'm really reluctant, Harry, to predict the couple of years out. I think the best -- I'm going to default into the best indicator of future performance is past performance and we sold in the last two years. If you've - I date myself all the way back to Crosslands, we've never sold hotels in any kind of transaction that was not accretive to our shareholder value. So I think it's very going to be very situation-specific. Two years out, it's tough to predict. But I think you see us apply some discipline to the way that we're approaching this work. And I think it's reasonable to expect we will continue to apply that discipline without giving you a hard set cast and concrete number that may fluctuate based on the market and may fluctuate based on the location.

[Harry Curtis:]

Okay. And I promise, this will be my last.

[Gerardo Lopez:]

No. Now don't over promise and under deliver, Harry.

[Harry Curtis:]

I know, I know. I'm always - I'm good at under delivering. So it's just - it's the spread really that we're all interested in between what you can repurchase your stock at and what you are netting from your asset sales. So if you could address that spread.

[Jonathan Halkyard:]

I'll address that, Harry, its Jonathan. I think, an important point in thinking about the prices at which we sell some of these assets is that the lower ADR assets achieve clearly lower property level EBITDA. So we're talking about assets when we talk about our lower tiers that generate anywhere from $400,000, $600,000 or $700,000 annually on property level EBITDA that compares with $1 million across the system and many hotels at the upper tiers, which are closer to $2 million or $2.5 million. At the same time, those properties consume about the same level of maintenance capital investment every year, call it $150,000 or so, so across the system. So on a free cash-flow basis, these lower-level, lower tier properties are going to generate very strong multiples for us. And so when we think about deploying those proceeds towards share repurchases, I'm confident that even if we are to sell some of these lower-tier assets at, say, a 9 times multiple, that using those proceeds and I should say 9 times EBITDA multiple, a much higher multiple for cash flow, that re-deploying those proceeds towards share purchases or even debt retirements is going to be accretive for shareholders. That's the way that we've thought about it. And you can be sure that when we announce these deals, we'll call out what the free cash flow multiple is as well as our intended use of those proceeds.

[Gerardo Lopez:]

Does that answer your question, Harry?

[Harry Curtis:]

It does, and I apologize for drilling down. But we wanted it clarified. Thanks…

[Gerardo Lopez:]

No problem. Appreciate the question, good questions. Very good questions.

[Operator:]

Thank you. Our next question today is coming from Anthony Powell from Barclays. Your line is now live.

[Anthony Powell:]

Hi. Good morning, guys. Sticking with ESA 2.0, you mentioned that you'll be managing the 25 hotels you could potentially sell to a single buyer. Are the economics in management, managing these hotels are materially different than the franchise which you envision? Then are you seeing more interest in the management structure than you expected?

[Gerardo Lopez:]

Good question, Anthony. We originally drew up the plan to sell the hotels and run them strictly as a franchise. We've been approached over the last few months by financial buyers, who were strictly interested in the returns and the yields from the investment, the old put good money to work who did not have a management structure to bring to bear. So we've stepped into the void and have agreed to manage them for, for a management fee on top of the franchise and royalty fees. So it works all the way around. It was an opportunistic move on our part. We'd not anticipated doing that, but we have owned these properties on average for 18 years. We know them well. We have personnel in place, a lot of the come with operational density that we like because it helps us keep a lid on cost. So the economics change as a result of a sale of the asset. But as we work through the performance with the fee streams and a management fee on top of that, things are attractive enough for us to want to engage in a transaction, even though it does have somewhat of a different twist than we had originally anticipated. Does that get at your question? I want to make sure I'm being responsive.

[Anthony Powell:]

Yeah. I guess, I'm just saying, what's the incremental fee, I guess, you get and what is the management fee above and beyond the franchise royalty that you were expecting?

[Gerardo Lopez:]

We've advertised into - in out FDD, a 5 and 5 program, 5% for the royalty and 5% for the program fees. Beyond that, we're really now getting into some of the management fees are going to be above that. So if I were to say though that, for this - as we call it manchise [ph] agreements, where we're managing a franchise in somewhat we have. There's an incremental beyond the 5% and 5% fee that we are charging for that. It's not inconsistent, Anthony, with what you would see in the marketplace by other management companies.

[Anthony Powell:]

And moving on to the quarter. Obviously, corporate demand has been weak for a number of quarters. The renovations and the corporate sales teams were, the attempt is to kind of get into that market a bit more. What industries have been tougher to crack than you expected, what industries particularly on the West Coast? And where are you redeploying these efforts that you mentioned in your prepared remarks that generate some more RevPAR growth?

[Gerardo Lopez:]

The truth, Anthony, is that as we've looked at the different challenges that we face across the country, more than verticals, the issues are really geographic. It's really a handful of market. A couple were expected, primarily those that were overlapping, the political conventions over a year ago. California has been a soft spot for a while for us, for a couple or 3 quarters. And that's where we've relocated or reallocated, I should say, some of the sales resources and some of the capital and some of the attention that we've been talking in the past. So there's no specific industry that is lagging more than any other across the country than anything else. It's really for us, it's really a geographic issue, and it is limited to those handful of markets. Now those handful of markets for us are very critical. Northern and Southern California are by far our highest ADR markets, on average two time, three time , with two time what the system would be and three times with some of the other mega cities in the U.S. would be. So weakness in those two have outsized impact relative to the system. So there's no vertical. So much of its geographic weakness that is driving the softness.

[Anthony Powell:]

And on the redeployment of assets and attention. What specifically are you trying to do there? What targets are you trying to reach? What customers are you trying to gain?

[Gerardo Lopez:]

Driving occ [ph] We're looking to drive occupancy. Our ADR is holding steady and well. The weakness has come primarily from occupancy and what we're talking about is redeploying sales folks into some of these weaker markets, also driving up our operations, our in-hotel execution. The markets, as you look across the entire landscape of lodging companies and REITs, a lot of folks have had weakness in the very same markets, that's the operating environment that we're in. But we think that we have opportunities, particularly, when it comes to driving occupancy into some of these hotels and particularly when it comes to improving the guest experience into some of these hotels. So we're looking to address them very, very specifically on a market-by-market basis.

[Anthony Powell:]

Last of my five questions, I guess. So in San Francisco, Northern California, do you expect to get any lift from Moscone, kind of anniversarying your coming back online?

[Gerardo Lopez:]

Some, understanding though that our hotels are not urban, we're more out in the suburbs. But of course, something like Moscone drives market wide, city wide compression. So yes, we expect to get some benefit from it, understanding that we're not located two blocks away. Our hotels are further down the Peninsula and on the other side of the Bay. But clearly, in that market, while compression will help us, but we're not going to be the beneficiary. So Moscone coming back online, and all of a sudden having hotels that might have been running at 15% or 20% occupancy, now driving 60% occupancy. Our hotels around 70%-some-odd, and we see some of the spill over. So we're indirect beneficiaries, not direct beneficiaries.

[Anthony Powell:]

Thanks for all the detail. I appreciate it.

[Gerardo Lopez:]

You bet.

[Operator:]

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

[Shaun Kelley:]

Hi, guys. Good morning. I just wanted to stick with the softness in the core business. So Gerry, maybe if we just dig in a little further. As you talked about it in the prepared remarks, I think it was mentioned that, you're still seeing renovation lift at some of the hotels, and that would have added about 1 point. So it implies that the core business would have been negative 1. And then if we actually kid of dig a little further, you got some benefit from the hurricanes. So it does imply that the core business is trending probably worse than negative 1, if we strip out everything that's going on here. So like - is that a run rate that is going to continue and/or like how much? And how quickly do you think some of the initiatives you talked about in the sales side can start to turn the corner on that softness,, because it's pretty material relative to what we're seeing out of the industry and the peers.

[Gerardo Lopez:]

So we don't see what you're seeing. And maybe it is because we look at it on a more on a market-by-market basis. If I was to just strip out those, the 5 markets that we've had issues in, in the West, primarily driven by execution. In the East, primarily driven by the convention overlap and so on. The balance of the portfolio was up, had RevPAR, positive RevPAR of 2.1%. So to paint the entire portfolio or the entire business with a broad brush that says, oh wow, the core business is soft. I don't know - we don't think of it that way. We think of it as having specific execution issues in specific markets and then some of them overlap and why not. But when we see strength, the way that the balance of the portfolio have had, we don't generalize across the entire 625 hotel portfolio based on what a handful of markets may be doing over a handful of weeks. Now the hurricane issue, it hasn't come up yet, but you kind of came at it a little bit on the side. So yes, we have some benefit from the hurricanes. The reality of the matter is, for us, the hurricanes are kind of a mixed blessing. On the one hand, yes, we benefit from their impact. On the other hand, we don't turn the house over the way that some of the shorter length of stay chains and some of the more transient hotels do. So yes, the hurricanes gain and they've helped our Texas and our Florida business. But our business in the South and the Southeastern Florida specifically was doing really well before the hurricane. So it's doing a little bit better now, but it was doing really well before. The last piece, Shaun, that I will throw out is when I look at it on a month-on-month basis rather than on a year-on-year basis, July was not great, was a negative RevPAR month for us. But August was essentially flat. September came up to above 1. And October, as Jonathan indicated in the remarks, it's running at just under 2. So to look at this handful of markets, to look at a handful of weeks and use the results from those very specific markets and weeks to characterize the performance of the entire portfolio, that's not, I'm not prepared to go there. The data just doesn't support it.

[Shaun Kelley:]

Okay. And well then help us reconcile that with the guidance. Because the 4Q guidance suggests that -- maybe we're off on our math a little bit, but basically relative to the Delta and 3Q, at least to the Street. I can't remember if you provide quarterly guidance. But relative to Delta for the Street, it's sort of implying that there will be a continuation of trend, meaning, you missed this quarter by $6 million, you're going to miss next quarter by $6 million. So if these are really calendar issues and you're really comfortable with the trajectory, why the reduction in the 4Q outlook?

[Jonathan Halkyard:]

Shaun, it's Jonathan. Our 4Q outlook is 0% to 2% RevPAR, while we're sitting here at the end of, at least, at the end of October, right about the top end of that range. That's typically what we like to do. We like to have guidance that we - where we're comfortable towards the top end of the range. I think it's important though to note that our results, out in the West Coast particularly, which really weren't affected by calendar issues so much, such as the conventions, our results in the West were unacceptable this quarter. And we are taking - we've taken immediate action to address those results both in terms of management as well as sales deployment. So we expect those efforts to have an effect on our results, but it's going to take a little bit of time to turn around. We're encouraged by what we're seeing in October and early November. But because these hotels out there run at ADRs, which are at such a premium to our system average, shortfalls there are really difficult to recover with growth elsewhere in the portfolio, which we're seeing as Gerry noted. So I guess, our fourth quarter guidance does contain a bit of conservatism in terms of the revenue guide. But I'm comfortable with that conservatism given what we saw develop in the third quarter. And then in terms of adjusted EBITDA for the fourth quarter, I think, everybody has expected all year long because of some favorable expense items that we had in the fourth quarter last year, which we enumerated in our call back in February. Everybody, in fact our own budget contained an EBITDA decline because of comping over those expensive favorabilities last year, which is why I called out the kind of a 2-year stack, something I'm always reluctant to do, but I think it actually means -- is meaningful in this case.

[Shaun Kelley:]

Thanks, Jonathan. My last question would be just, as we think about the -- just maybe to say differently or say it out loud, for the guidance here, does this build in any of the course correction initiatives you've taken or is this more of a run rate of where you guys were at least in those California, or those weaker markets through the third quarter? And then more importantly, do you think you can have this whole thing course corrected by '18? Or could there be some impact in '18 too as we're just trying to figure out -- and figure out what works in those markets?

[Jonathan Halkyard:]

It incorporates what we've been seeing through the first 5 weeks of the fourth quarter, that's for sure. But it's a 200 basis point range on our RevPAR guidance, which is what we typically provide. And of course, provides for some variabilities in outcomes given how kind of late our booking window is. So yes, it certainly incorporates some anticipated improvement in these markets. It will be solved in 2018. It has to be, because again, we're not accustomed to underperforming like this in these markets. We haven't missed a quarter in 3 years, and it's not something we intend to do again. So we need to fix this, that's for sure.

[Gerardo Lopez:]

And the issues, Shaun, to be clear, as we've indicated a couple of times this morning, are not systemic or endemic to the entire portfolio. They're localized, they're specific. We've already begun to address them by taking steps to address them. So it's not that the actions required spread over 625 properties in 44 states. They're much more specific than that. That allows us to take a quicker action. So it's not -- there's not a lot of mystery to it.

[Shaun Kelley:]

Thank you very much.

[Gerardo Lopez:]

You bet.

[Operator:]

Thank you. Our next question today is coming from Chad Beynon from Macquarie Group. Please proceed with your question.

[Chad Beynon:]

Hi, good morning. Thanks for taking my question. I noticed in the Q that the asset sales that we're talking about, the 26 assets, it looks like the sales price is $129 million, just a couple of points of clarification on that. One, can you talk about any tax leakage or kind of cost basis on that? And then secondly, on that, if there is a non-refundable deposit? Just some more color on that just because it was in the Q?

[Gerardo Lopez:]

Yes. Other than to say, Chad, that there's a tax leakage, we don't want to get into a lot of specifics on the deals until things begin to -- until they close. So not a lot of tax leakage on the deals in the cross section of the portfolio as we indicated. So it does bend towards the tiers 4 and 5, so our lowest performing RevPARs on average. These are assets that are about 20% in RevPAR, below the balance of the hotels, which is exactly the kind of target property that we wanted to package for sale. So we - until the thing goes hard and it closes, we're reluctant to say too much. But to answer your question specifically, very little tax leakage involved in this deal.

[Chad Beynon:]

Okay. My follow-up unrelated is around corporate negotiation season. I know this was kind of a core pillar of the company's growth and kind of the change in mix. Anything you can help us with in terms of thinking about how corporate negotiation season has gone, now that all of your assets have now been completely re-branded and refreshed, anything there would be helpful?

[Gerardo Lopez:]

So early in the season, it's still only early November, we're looking to be about 2 points better into '18 than our current run rate. As I indicated in the prepared remarks and even in a couple of the answers, ADR hasn't really been our issue, so much as is been. So rate holding steady, not anticipating any huge difficulties or anything else on the corporate negotiated front. In fact, to the point of your question, the fact that all of the hotels are now renovated, has worked well for us and we're in a pretty good place with our big national accounts and looking for that to continue, particularly as we ramp up in some of the training on our hotels with the new moves, the personnel moves that we put in place. So in fact, we're looking forward to the conclusion of the negotiation season on that front.

[Chad Beynon:]

Okay. Thank you very much.

[Gerardo Lopez:]

You bet.

[Operator:]

Thank you. Our next question is coming from Michael Bellisario from Robert W. Baird. Please proceed with your question.

[Michael Bellisario:]

Good morning, guys.

[Gerardo Lopez:]

Morning.

[Michael Bellisario:]

Just wanted to dig into the RevPAR underperformance a little bit more. Can you maybe break out in the quarter, how much of the underperformance was on the occupancy side and how much was ADR? And then are you seeing any impact from your new mid scale supply coming online in your markets?

[Jonathan Halkyard:]

Yes. The underperformance that we saw in the third quarter was more due to rate than to occupancy. However, as we went through the quarter, we were able to close that rate underperformance really due to some pretty terrific effort on the part of our operators and our revenue managers. But I would say it was mostly due to rate. And then, I would not point to any real impact from increases in supply to our performance in the third quarter or as it relates to our forecast for the fourth quarter.

[Michael Bellisario:]

Got it, that's helpful. And then on the asset sale front. Are there any renovation requirements sort of a new buyer pip that a purchaser would have to complete that might be kind of an added qualitative benefit for you guys?

[Gerardo Lopez:]

Yes. Well, the answer is yes. Obviously, as they take ownership of the assets, when the next wave of asset renovation comes in, that will be their responsibility because although all of the assets have been renovated in this last cycle that we just concluded. That depends on the asset, depending on the market, depending on when renovation was completed. The timeline for that next wave of investment may not occur for a year to 5 -- to 5 years out. We began this process 6 years ago, 5 years ago. So depending on which assets you're getting, it may be 5 years before you have to come back for the next renovation because this particular sale that we've discussed this morning, it's in those tier 4 and tier 5s with the lower RevPARs. Those were also the last wave of assets that were renovated. So the next pip on them, if you would, is really not due for another 4 or 5 years, again asset specific. We think that their assets are in a 6, 7 year pip cycle. So if you're buying something that was just renovated in the last year or 2, you got 4 or 5 ahead of you, and that indeed is attractive to these potential buyers.

[Michael Bellisario:]

Got it, that's helpful. But I guess, my question was more about nothing has accelerated. It's still just the normal 6 to 7 year life cycle. That's kind of what you said, right?

[Gerardo Lopez:]

Correct.

[Michael Bellisario:]

Got it. And then just one last one from me kind of on the conversion front. You mentioned that the new wrinkle. Do you see yourself doing any of these types of deals? Or is this just for third-party capital to do?

[Gerardo Lopez:]

No. We see ourselves doing a few. The size of the opportunity is under review. It's more than a dozen and less than 5 dozen properties across the country that we think this could be in play for. We would not tackle all of those on our own. Frankly, the idea of doing some of these conversions was brought in to us by some of the potential franchisees that we've been talking to. We're likely to take down 1 or 2 ourselves to learn how to do it. And because the economics, as we've look at them, particularly in markets that we're already operating, are very attractive in taking a hotel that already has the kind of physical configuration that we need, meaning a kitchen. And taking it from a transient model to our Extended Stay model, the operating cost profile changes quite dramatically. Now, the ADR may change and some of the other dynamics may change as well. But with our cost structure into some of these properties we think - indeed we think that we can make them work. So we're likely to take down a couple ourselves to learn as our -- a couple of the franchisees who frankly brought it up and are eager to do it.

[Michael Bellisario:]

That’s helpful. Thank you.

[Gerardo Lopez:]

Yeah. You bet.

[Operator:]

Thank you. Next question is coming from Joe Greff from JPMorgan. Please proceed with your question.

[Joe Greff:]

Good morning, guys. A couple of quick ones here. Gerry, you mentioned you grew RevPAR 1.8% in October. If you strip out the holiday shift benefit as well as whatever hurricane benefits that you have, what did RevPAR grow by end quarter, in October rather?

[Jonathan Halkyard:]

I don't think we actually have that.

[Gerardo Lopez:]

Stripped out like that. No.

[Joe Greff:]

It's in positive growth territory or is it more flat to down?

[Gerardo Lopez:]

No. Definitely in positive growth territory. Again, the hurricane benefit, for us coming in, a, markets that were already performing well; b, given our format where we can -- the property just doesn't empty out of turnover on a transient basis. There is some, but it's not going to be the kind of benefit that has been attached to the whole hurricane phenomenon. So there's some unmistakable benefits to it, we haven't pieced that out for the month, we will for the quarter. But it's not the fact that we're back up to 1.8%, which is closer what we've been running all year, for the month of October, it's not because of 2 storms and 5 dozen hotels in 4 markets.

[Joe Greff:]

So you would characterize it as a 1.8% as a normal level that doesn't have a lot of benefits in it. Is that the fair characterization?

[Gerardo Lopez:]

No. That's not what I said. I said, that there's some -- there is clearly going to be some benefit from the hurricanes. We haven't pieced it out for the 1.8%, so I cannot give you a hard number on it. But I'm very reluctant to say that returning to a level of RevPAR growth consistent with what we've seen earlier in the year is due to two storms in four markets, that's what I'm saying.

[Joe Greff:]

If we assume 0% to 2% as a steady-state RevPAR growth trajectory for you, and we assume no asset sale so there aren't any mix issues. Where -- and you grow same-store adjusted EBITDA in that RevPAR growth range or is that not enough to offset OpEx increases?

[Gerardo Lopez:]

We should be able to flow through about two thirds of any RevPAR increases. Am I thinking about it in the right way? So...

[Jonathan Halkyard:]

With flat revenue growth, it's going to be hard for us to grow earnings, we'll have to cut costs.

[Gerardo Lopez:]

Right.

[Jonathan Halkyard:]

At 2%, we can grow earnings and as I think, Gerry mentioned, in the prepared remarks, through 9 months of this year, our operating expenses were flat.

[Gerardo Lopez:]

And margin expanded 60 basis points through 9 months?

[Jonathan Halkyard:]

But and that was with, I think through 9 months we had revenue -- RevPAR growth of 1.5% flat expense. So we had margin growth and adjusted EBITDA growth. I think it's - but it is, I think, mathematically correct that if we're at 0 RevPAR growth, it's going to be difficult for us to grow earnings. I'm pretty comfortable at the higher end of that range. We can continue to grow earnings.

[Joe Greff:]

And then my final question, Gerry, in your prepared comments, you mentioned the occupancy weakness in Philadelphia, Northern and Southern California, Chicago and Washington, D.C. Are any of the properties that you're trying to sell in these troublesome markets? And I guess, does that pose a risk for closing these asset sales that you referenced?

[Gerardo Lopez:]

Yes. More so in some of the markets in the East and in California. But yes, the hotels that we're trying to sell will cover some of those markets, absolutely.

[Joe Greff:]

Okay. Thank you very much.

[Gerardo Lopez:]

You bet.

[Operator:]

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

[Chris Woronka:]

Hey. Good morning, guys. Just wanted to ask you on kind of revisit the supply question a little bit. My question is more, when a new hotel does open up in one of your markets, whether it's an Extended Stay, mid-scale that you would consider comparable or maybe a non-Extended Stay hotel. How much kind of analytics are you guys doing to try to figure out if there really is any impact, just so that it doesn't take you by surprise down the road, I guess?

[Gerardo Lopez:]

We do the analytics down to the individual property level. That's the whole point of having the company structured the way that we have with this field-base triangle teams, we call them, where we have a revenue manager, an operator, i.e., the people running the hotel and then a salesperson. The revenue manager's job, frankly is, it's exactly that, is to understand the competitive dynamic for that - for each of the individual hotels that they have assigned to them. Comp set basis, whether its location comp set in a proximity or whether it is change scale or format comp set, meaning extended stay versus transient or economy versus mid-scale versus whatever else. The truth is, the supply growth that we're seeing, it's -- other than in some very selective instances where there are some economy-based extended stay properties that are popping up here and there in a very limited-scale basis. Most of the supply growth that we're seeing is coming at ADRs that are 1.5 times to 2.5 times our ADR. So yes, they do have a newer property. But on average, we're seeing nightly rates that are literally 150% of ours, 200% of ours. So it makes us - it allows us to maintain our competitive positioning at least for an intermediate amount of time. And then you still have to come back and consider what kind of amenities you're offering and what kind of guest experience you are representing to the guest. But yes, we look at it on a property-by-property basis, that's what our revenue managers do, comp set, index, nightly rates, weekly rates are set very much based on that analysis. The monthly rate incorporates not only that analysis, but frankly also apartment, multifamily housing rates from the surrounding area. So that's not something that a lot of people in the lodging -- in the hotel business do is we look at the other area of things. But you've got to remember, 40%, 46%, 48% of our businesses is longer than 30 days. So we're bumping up against multifamily and the other side as well. That's does not go unnoticed by our revenue managers either.

[Chris Woronka:]

Okay. I appreciate the color. And just a quick follow-up for me, if we can hit back to maybe some of the issues you addressed in the West. And I apologize if I missed it. But there wasn't any circumstances of people going to competitors or things like that, right? I mean, this is just kind of internal thing, you guys decided you need to make a change? It wasn't something of them being poached or anything like that?

[Gerardo Lopez:]

I'm sure there's some of that. I mean, it's hard for me to imagine that there aren't people out there making offers, this is a highly competitive industry, I would expect it. But we have not noticed, is kind of mass migration of people rejecting the Extended Stay proposition in favor of some other chain or some other format or some other hotel. The overall markets, for example, the Bay area, the overall market has been struggling. And we have been struggling right along with it. And when the Moscone Center comes back, the compression that, that will put on everybody will be first noticed and then hotels that's closer to downtown will benefit from it first and eventually we will as well. But no, there's no detectable mass migration or a mass exodus or anything like that, it's more location-by-location. And, yes, I'm sure there's highly competitive business. People cutting deals all the time, so are we, but it's not anything that I would characterize as poaching or nothing beyond the normal conduct of a competitive business.

[Chris Woronka:]

Okay. Thanks, Gerry.

[Gerardo Lopez:]

You bet.

[Operator:]

Thank you. We have time for one final question coming from Stephen Grambling from Goldman Sachs. Please proceed with your question.

[Stephen Grambling:]

Hey, thanks. Two quick follow-ups. First to Joe's operating leverage question. I guess looking beyond 4Q, can you provide a little more color on the puts and takes to operating costs in 2018 as renovations are lapsed versus anything you may be seeing on the rate front?

[Jonathan Halkyard:]

Sure. We don't provide guidance until February for our -- for 2018. But as we get into our process for planning, we do think that there's an opportunity for us to continue to drive down utilities expense, which probably not a lot of people talk about. But for us, really second to labor, is our largest property level expense. We put some capital against that over the past 3 years and it's really been paying dividends, so to speak. So we think that there's still opportunity there. And then on the wage front, it's kind of 2 things going on there. One is, in certain markets, we are seeing wage pressure, upward pressure, and we're going to have to deal with that. On the other hand, we still are getting better and better at driving down overtime expense, just doing more effective scheduling and staffing. We think that wages -- our wages will go up next year, wage expense probably 1% to 2%. But for us, in our model, that is a relatively small part of our overall cost. I think our wage cost per occupied room is about $10. So that's not the greatest cost increase for us. That's really all that is meaningful at this point. We obviously, always work hard to reduce our exposure to property tax increases, but those are the only ones that I would really call out.

[Stephen Grambling:]

Great. And then my second question is more of clarification on the earlier asset sale questions, I think from Harry and Chad. Is the math dictating your decision simply that the valuation on free cash flow to net after-tax proceeds will be a discount to your current trading otherwise you just won't do it?

[Jonathan Halkyard:]

There might still be circumstances in which we would do it, but those will probably be driven by factors other than the pure financial. So I don't want to draw that line in the sand. But that is financially, we're going to be looking at these transactions on a free cash flow multiple basis and I do expect that those will be accretive to shareholders.

[Gerardo Lopez:]

Yes. That's going to be the primary rule, Steven. We have some hotels that came to the flag as a result of acquisitions that are really in standalone markets - standalone situations where we just don't have the kind of density that we like to operate. Those are very few and very specific and in those circumstances, yes, we may let a hotel or two here or there in isolated markets go, but that's not going to be the rule. The free cash flow multiple as Jonathan outlined, it's really the guiding light for us when we make these decisions, particularly as we make them on a portfolio basis, as we sell, the half dozens, dozens and dozen and a half account of portfolios in specific markets. That's really the driving factor.

[Stephen Grambling:]

Fair enough. Thanks so much.

[Gerardo Lopez:]

You bet.

[Operator:]

Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for your further or closing comments.

[Gerardo Lopez:]

Thank you, Kevin. I want to thank everybody for taking the time this morning. Sorry that we run a little late, and we may not have gone through everyone's questions. But Jonathan, Rob, David Clarkson and I will all be out in various conferences over the next four weeks between now and the end of the year. We're looking forward to seeing all of you and meeting with our investors in the individual conferences. Thank you, again, for taking the time this morning.

[Operator:]

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day. We thank you for your participation today.