Extended Stay America, Inc.
Q4 2017 Earnings Call Transcript

Published: 27 Feb 2018

[Operator:]

Greetings and welcome to Extended Stay America fourth quarter 2017 earnings 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. I would now like to turn the conference over to your host, Robert Ballew.

[Robert Ballew:]

Good morning and welcome to Extended Stay America's fourth quarter 2017 conference call. Both the fourth quarter earnings release and an accompanying presentation are available on the investor relations portion of our website esa.com, which you can access directly at www.aboutstay.com. Joining me on the call this morning are Jonathan Halkyard, Chief Executive Officer, and David Clarkson, Acting Chief Financial Officer. After prepared remarks by Jonathan and David, there will be a question-and-answer session. Before we begin today, I'd like to remind you that some of our discussions will contain forward-looking statements, including the discussion of our 2018 outlook. Actual results may differ materially from those indicated in the forward-looking statements. Forward-looking statements made today speak only as of today. The factors that could cause actual results to differ from those implied by the forward-looking statements are discussed in our Form 10-K filed with the SEC this morning. In addition, on today's call, we will reference certain non-GAAP measures. More information regarding these non-GAAP measures, including reconciliations to the most comparable GAAP measures are included in the earnings release and Form 10-K filed this morning with the SEC. With that, I'll turn it over to Jonathan.

[Jonathan Halkyard:]

Thanks, Rob. And good morning, everyone. And thank you for joining us to discuss our fourth quarter and full-year 2017 results. Before getting started with the review of our results, I'd like to join all of my colleagues in thanking Gerry Lopez for his leadership and service to ESA. We all enjoyed working with him very much and will miss him and we wish him well in his future endeavors. I would also like to take a moment and thank all of my fellow associates at ESA for delivering strong results during the fourth quarter and working hard to set us up for a successful year in 2018. We came out of the third quarter with some challenges and I'm proud to say that we met those head-on. We could not have done it without the dedication and hard work of our roughly 8,000 associates across the nation. As I reflect on the last few months, first, in anticipation of assuming the CEO position and more recently having actually assumed it, I'm reminded of the reasons I joined this company so enthusiastically just over four years ago. First, this segment of the market, the extended-stay segment is underserved. Only 8% of the US hotel industry room supply is extended-stay product, but this segment makes up approximately 22% of US hotel demand. Moreover, the majority of this demand exists at our price point. Tens of millions of room nights of demand for stays greater than seven nights are presently staying at traditional hotels and at price points between $50 and $100 per night. This customer, the guest who is staying from a few weeks to a few months, generally traveling on business, self-sufficient and value conscious, is our core customer and we believe they are underserved by traditional hotels. We believe this fundamental dynamic provides an attractive opportunity to grow our revenue profitably and grow our footprint. And we believe demand for extended-stay product will continue to grow. This is due to fundamental changes in the way Americans are living and working. Our employers demand increasing mobility while we increasingly value stability in our living circumstances. This has led to an increase in workers traveling often for extended periods of time to meet their employment obligations. We also benefit from increased aggregate demand caused by stimulative economic policy. Our product is ideally suited, for example, to accommodate people working on infrastructure projects and we believe we are poised to benefit from any potential bill targeting infrastructure over the next few years. At the same time, at our price point, there continues to be limited supply growth expectations over the next few years as the larger C-corps focused on upper midscale and upscale hotels. Secondly, our operating model and capital structure are tailor-made for this customer segment. Our simple operating model, when applied against the extended-stay customers, present our shareholders with our most attractive economics. And the feeling is mutual. Because our product is so relevant to the core extended-stay guest, meeting their desire for self-sufficiency at an attractive price, they reward us with a net promoter score that is five times higher than that received from our transient guests. Our operating model, which combines low fixed and variable costs with wide geographic diversification, taken together with our long-dated and low-cost capital structure, provides significant free cash flow generation for shareholders. And over the past two years, we have demonstrated a shareholder first capital return policy and returned over $560 million to shareholders during that time period or almost $3 per paired share. Additionally, tax reform will reduce our cash taxes by more than $20 million this year, further enhancing our ability to return capital to shareholders. And finally, I am reminded of our company's mission. ESA exists for people who are building a better future for themselves and their families. It's a noble mission and one we all take very seriously here. We believe in this mission not only for the ways in which ESA provides career growth for its employees, but more importantly for how we provide a home away from home for our customers. Nowhere was that more evident than in the way that we serve customers during the fourth quarter in the wake of Hurricanes Irma and Harvey. The aftermath of these storms contributed favorably to our financial results this past quarter as we were able to accommodate displaced residents for a short period of time, followed by longer stays from insurance adjusters, relief workers and now construction workers. Some will call these results unusual, but – for us – they are business as usual and we take great pride in it. Let's get into the fourth quarter results in more detail. As you saw from our release this morning, we had a strong finish to 2017 and a solid year overall. Fourth quarter RevPAR growth and adjusted EBITDA both finished above our initial guidance in November as well as our updated guidance in mid-December. We limited expense growth despite cycling some one-time expense benefits in the fourth quarter of 2016 with property level expenses up only 1.9% from two years ago on a comparable basis. And for the full year of 2017, property level expenses grew only 1.2% compared to 2016. Results from our hotels on the West Coast improved from the third quarter. Many of you know from our third quarter, as well as subsequent discussions, that we faced a number of sales and operational challenges in the region last year. Our remedial efforts began midway through the third quarter and continue to this day. My first trip as CEO was to the West Coast for three days to visit with our regional managers, property operating teams and sales force. I'm pleased to see improved results and have full confidence in our operating and revenue teams as they work to improve the results further. We're making progress and the work continues. During the fourth quarter, we made additional progress in monetizing the real estate portfolio to generate capital returns for shareholders, improve the owned portfolio and build our franchise base. We sold one property in Denver during December for $16 million or 13 times trailing 12-month adjusted EBITDA and 18 times pro forma trailing free cash flow. Just this morning, we announced the closure of the sale and re-franchising of the 25-hotel portfolio we announced in November for a gross amount of $114 million including application fees. This represents a very strong free cash flow multiple in excess of where the company trades in the market and has created an attractive fee stream for the company. It is important to note that the capital required to maintain our hotels was fairly consistent throughout the portfolio, while the adjusted EBITDA per hotel ranges from $400,000 to over $4 million. This creates attractive free cash flow multiple arbitrages even at somewhat lower EBITDA multiples for our lower ADR hotels. The buyer of the 25-hotel portfolio has signed an agreement to build or convert 15 additional Extended Stay America hotels over the next few years. And we expect to close the previously announced sale of one of our Austin, Texas hotels in March for approximately $45 million, an attractive free cash flow multiple to say the least. These three transactions, closing within 90 days of each other, provide approximately $175 million in proceeds to shareholders at attractive free cash flow multiples. Shedding these assets, which together are at lower ADRs than our system average, improves the quality of our owned portfolio. More importantly, these sales allow us to reinvest those proceeds in higher-yielding returns, such as new hotel builds, freeing up additional cash for share repurchases. In fact, our Board of Directors just this morning increased our share repurchase authorization by $100 million. We expect to announce additional asset sales in the coming quarters, most of which we believe will have development agreements included. For our owned balance sheet development, we recently completed the purchase of our second piece of land and will shortly be concluding due diligence and closing on an additional three sites. By the end of the year, I expect we will have acquired 8 to 10 development sites. We expect to break ground in the second quarter of the first two locations and complete constructions of these new ESA hotels in the first half of 2019. We are also looking at a small handful of conversion opportunities as well. This being my first earnings call as CEO, I would like to conclude my prepared remarks with a brief summary of my priorities for this year. First, I plan a renewed focus on our core customer – value conscious business travelers staying a week to a couple of months that will lead to a reinvigoration of our RevPAR growth. Our operating model is perfectly suited to these guests and we will do very well on the top and bottom line if we continue to serve their needs. Having been COO of this company and with the full confidence in our operating team, I will focus on the guest experience, continue process improvements, keep expense growth in line and generally stick to our knitting. Secondly, I intend to simplify our own internal processes in order to streamline our operations, improve our productivity and fuel our organic growth and development. The company's growth in recent years has increased complexity and, at times, slowed our decision-making. I intend to reverse that and have convened an internal working team to address this and identify opportunities for improvement. We know how to do this. I led a similar exercise at Caesars Entertainment a few years ago and my current team here is made up of exceptional professionals, deep in industry and functional knowledge and terrific leaders of people. I've given Jim Alderman, our development chief, and his team the task to review critically the construction cost of our new prototype and determine ways to reduce this cost, while delivering a product that is relevant to, and anticipatory of, the needs of our core customer. A lower-cost prototype will allow expansion into a larger number of markets and provide improved financial returns to our franchise partners and ourselves. That work is already underway, and we expect to complete it in the next couple of months. I do not expect any delay in construction activity as a result of this project. Finally, we will pick up the pace on franchising. To accomplish that, in addition to a lower buildout cost to improve returns, we will target smaller franchisees and investors in addition to the larger targets that we've been cultivating over the last year. Now, today was a big day for us as we welcome the first 25 franchisees into your system, but we're just getting started. We will be expanding the franchise team to cover an increased response from our broadened strategy. We expect to execute between 10 and 20 franchise deals in 2018 in addition to the commitments from asset buyers for additional franchise deals codified in their development agreements with us. And looking to this year, I believe the underlying funnel of demand is as strong as any point in the last year. The corporate travel guest appears to be moderately picking up the pace and the leisure consumer remains strong. Supply growth continues to be well in control and, at our price point, remains well below the industry. Our investment priorities for 2018 include share repurchases, capital and personnel for ESA 2.0 and investments in technology to enable more expansive guest services, which will drive incremental hotel revenue. These technology initiatives specifically are very exciting for us and I look forward to updating you with our progress in future quarters. I'll now turn the call over to David to give you more detail on our quarter four financial results and provide commentary on Q1 and the full year 2018 outlook. David?

[David Clarkson:]

Thank you, Jonathan. We were pleased with our strong finish in the fourth quarter. Comparable hotel RevPAR in the fourth quarter increased 3.3% compared to the prior-year, with the 4.7% increase in ADR being partially offset by a 100-basis point decline in occupancy. We have had sequential improvement in RevPAR growth each month since July, driven by improvements in Florida, Texas and the Bay Area and by strong increases in ADR. Revenue in the quarter increased for both nightly guests and extended stay guests. Recently renovated hotels have continued to perform well and have had RevPAR growth of 15% in the quarter. For 2017, comparable hotel RevPAR increased 1.9%, driven by a 50-basis point improvement in occupancy and a 1.3% increase in ADR. Hotel operating margins declined 210 basis points during the quarter to 53%. Increases in property taxes, driven by one-time favorable expenses last year that we've highlighted on prior calls, and increased payroll expense led to the decline in hotel operating margin. For 2017, our operating margins dipped 10 basis points to 55% on hotel operating expense growth excluding loss on disposal of assets of 1.2%. Corporate overhead expense, excluding share-based compensation and transaction costs, increased by 0.6% to $20.6 million during the fourth quarter. Our adjusted EBITDA in the fourth quarter was $140.2 million, well above the top end of our range due to higher revenue and strong expense control. Adjusted EBITDA declined 1.6% in part due to lost contribution of approximately $1 million from the hotels sold in 2017 and cycling a number of favorable expense items during the fourth quarter last year that we had previously highlighted including property taxes. For 2017, adjusted EBITDA increased 1.2% to $622.9 million. Adjusted FFO per diluted paired share dipped 2.2% in the fourth quarter to $0.40 per diluted paired share, driven by a higher tax rate. For 2017, adjusted FFO per diluted paired share increased 3% to $1.84 per diluted paired share compared to $1.79 last year. Net income during the fourth quarter increased 33.2% to $40.2 million, driven by increased revenue, a gain on asset sale and lower operating expenses, partially offset by an increase in income tax expense. Income taxes increase due primarily to higher pretax income as well as an approximately $4.1 million provisional income tax expense during the fourth quarter related to the Tax Cut and Jobs Act passed by Congress at the end of 2017. Net income for the year increased 5.4% due to increased revenue, gain on asset sales and lower interest expense, partially offset by increased impairment charges and higher income tax expense. Adjusted paired share income per diluted paired share in the fourth quarter dipped slightly to $0.19 per diluted paired share from $0.20 in the same period last year. The decline was due to an increase in income taxes. The increase in our income tax rate reduced our paired share income per diluted paired share by approximately $0.03 in the quarter. Adjusted paired share income per diluted paired share for the year increased to $1 per diluted paired share compared to $0.99 in the comparable period last year. The increase in our income tax rate reduced our paired share income per diluted paired share by approximately $0.09 in 2017. We ended the year with our net debt to trailing 12-month adjusted EBITDA at 3.9 times, in line with the end of the third quarter and down from 4.2 times at the end of 2016. Gross debt outstanding was $2.59 billion compared to $2.66 billion a year ago. We feel very good about our balance sheet. Our nearest maturity is in 2023, two-thirds of our debt is fixed rate and our weighted average interest rate is 4.5%. Capital expenditures in the fourth quarter were $33.5 million, including approximately $2.4 million on capital expenditures related to flood and hurricane damage. For the full year 2017, we spent $166.4 million in capital expenditures, including $33.1 million on renovations and $11.9 million on insurable events. This morning, the boards of directors of Extended Stay America, Inc. and ESH Hospitality, Inc. declared a combined cash dividend of $0.21 per paired share payable on March 27, 2018 to shareholders of record as of March 13, 2018. During the fourth quarter, we repurchased approximately 200,000 paired shares for $3.5 million. For the full year, we repurchased 3.6 million paired shares for $62.3 million. And so far, in 2018, we have repurchased approximately 1.1 million shares for roughly $20.6 million. This morning, our boards of directors approved an increase in our paired share authorization by an additional $100 million. With our share repurchase authorization remaining now at over $175 million, we have plenty of dry powder for purchases and believe our shares remain very attractively priced. Looking ahead to the first quarter of 2018, we expect comparable RevPAR will increase by 1% to 3%, which includes January RevPAR growth of 4.1% and an expected negative 50 basis points to 75 basis point impact to the quarter from the Easter date shift. We expect adjusted EBITDA between $124 million and $130 million compared to $126 million on a comparable hotel basis a year ago. For 2018, we expect comparable RevPAR will increase by 1% to 3%. We expect adjusted EBITDA of $600 million to $620 million. This adjusted EBITDA outlook includes an approximate $16 million in lost net contribution from the asset sales in 2017, and thus far in early 2018. Our capital expenditure guidance is $180 million to $210 million. This represents an increase from 2017 levels for two reasons. First, as we expect to continue to build our pipeline and accelerate our new hotel development by spending $40 million to $60 million this year on the purchase of 8 to 10 new sites and commencement of construction during the year on about half of those sites. The second is that we are making some important technology investments in our hotels, including a new property management system, improved Wi-Fi for our guests and the ability to offer television streaming capabilities. We think these investments will enable our hotel level associates to operate more efficiently and effectively and improve our guest experience, while also increasing our ancillary revenue. These IT investments will amount to $30 million to $40 million during the year. Our capital expenditure guidance currently does not include renovation CapEx this year. It is possible we will begin the next renovation program late in 2018 and we expect to be able to share additional detail with you in future quarters on potential timing and scope. We expect our annual interest expense to be approximately $130 million this year, in line with 2017 as our refinancing activity in 2017 should offset increases in LIBOR. Operator, let's now go to questions.

[Operator:]

[Operator Instructions]. Our first question comes from the line of Harry Curtis from Instinet, LLC. Please proceed with your question.

[Harry Curtis:]

Hey, good morning, everybody. Two quick questions. Jonathan, can you discuss in a little greater detail the fixing of the customer service issues in California, particularly as it relates to a tighter labor market. What I'm interested in is your point of view on the risk of running into these service issues again, given the tight labor market.

[Jonathan Halkyard:]

Sure. And good morning, Harry. Really, the ability for us to deliver consistent service in California has been somewhat related to labor issues, but not entirely. Clearly, it is a tight labor market, but we also have a very lean labor model. We also have a number of hotels out there that are in close proximity to one another. So, one of the things that we've been doing better out on the West Coast is our hotels have been more adept at sharing employees, particular housekeepers, and do more limited extent than our maintenance personnel. Because of our lean labor model, we haven't always been able to offer full-time hours to many employees, but by combining staff between several of our hotels, we've been able to do that. And that enables us to retain our employees more effectively. And the longer our folks have been with us, the more effective they are at doing their jobs in providing clean, safe rooms to all of our guests. So, as I noted in my prepared comments, the work continues here. But I think one area that we've seen some progress is just more effective scheduling and staffing of our folks out in the West Coast.

[Harry Curtis:]

Very good. And the second question related to your comments about asset sales that you would likely see additional asset sales. Can you discuss the level of, or the appetite, from buyers' perspective? Has there been an increase in demand and what does the typical buyer profile look like?

[Jonathan Halkyard:]

Well, there has been pretty strong demand to look at our assets and we've been selective in the types of deals that we would do. Selective not only in terms of the price, but also the partners that we're going to work with and their commitment to grow our network with additional sites after they buy our site. So, I think Three Wall is a perfect example of this. Not only were we able to get a fair price for these assets from our shareholders, but we'll have a great partner who we expect will continue to build new Extended Stay hotels. So, there has been strong demand. We have narrowed that down. We do have a number of potential transactions that are right now at various stages of negotiation. They have a similar flavor to the Three Wall transaction both in terms of the number of hotels, the types of markets and the commitment of these partners to develop additional Extended Stay hotels. You probably recall from our launch of the 2.0 strategy about a year-and-a-half ago that we indicated that we would potentially sell about 150 hotels and re-franchise them over a three-year period. So, let's say 50 per year. And I think at our present course and speed, I think that's still a very good assumption. We've completed the sale of 25 hotels now and I expect that there will be more this year, but there's not going to be 100 hotels in 2018 that will sell.

[Harry Curtis:]

Okay, got it. Thanks very much.

[Jonathan Halkyard:]

All right. Thanks, Harry.

[Operator:]

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

[Anthony Powell:]

Hi. Good morning, everyone. Jonathan, you mentioned the renewed focus on the core business customer. I know over the past few quarters, the OTA mix had increased. Is that mix something you want to reduce over time and how quickly do you think you can increase the business customer mix?

[Jonathan Halkyard:]

Good morning, Anthony, and thanks for that question. Clearly, our shorter-term transient guests have been increasing over the past several years and have contributed somewhat to our ADR growth and our RevPAR growth. But my view is that that process has probably reached its conclusion in terms of the growth of that customer segment. And that's because there is still a deep pool of demand from extended-stay customers, many of them part of our larger corporate accounts that I think our model is ideally suited to serve. We serve transient guests well, but the fact of the matter is, is that that's really not what we're built to serve. Our hotel themselves are staffing models, are not ultimately built serve a transient guest. And so, obviously, our ability to reduce that dependency on the transient guest of that business requires us to continue to build our base of demand from longer-term customers. I don't have any great ambition to reduce the number of transient guests, but I do think that we will not be depending as much on the growth of that in the future; and that, from a RevPAR perspective, we can continue to grow just by building the base business customer. In terms of how long it will take, I expect to make real progress on this this year. And it's a multifaceted approach. It starts with continued improvement in the effectiveness of our corporate sales force. I'm not worried in the least about our hotels' operational capability to service debt [ph]. It's something we already do exceptionally well. It's actually the transient guests which cause us to have to add complexity to our business model and do some unnatural acts for us in order to serve those transient guests. So, this is a big, big thing. It's no mystery why I listed it as my number one priority. It's something I talk about all the time to our internal team and it starts with really demand generation from corporate customers.

[Anthony Powell:]

Got it, thanks. In terms of your technology investments, you mentioned the new property management system, Wi-Fi, television streaming. Do any of these investments result in a higher level of OpEx going forward or do you think they can actually maybe even reduce OpEx in hotels?

[Jonathan Halkyard:]

I'm very excited about these technology investments and we mentioned them this quarter. And I expect to update our shareholders on our progress as we go through the year. I think that they have the potential ultimately to reduce our OpEx over time. Our customers are increasingly using technology, of course, in our rooms. They are increasingly using their mobile devices to make reservations for us. A key component of this technology investment plan is a new mobile app for the use of our customers. And I think that, as we go forward, not only does it have the potential to grow ancillary revenue through Wi-Fi bandwidth buy-ups at the site level, but also to reduce OpEx marginally.

[Anthony Powell:]

All right. That's it for me. Thank you.

[Jonathan Halkyard:]

All right. Thanks, Anthony.

[Operator:]

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

[Chris Woronka:]

Hey, good morning, guys. Jonathan, I want to ask you on the new prototype, the new lower cost to build prototype you mentioned. Is that something that can maybe eventually, I guess, evolve into having a – maybe a two-tiered kind of branding structure or something like that as you go further down the asset sale refranchising road and then the newbuild franchises?

[Jonathan Halkyard:]

No. It will not result in a two-tiered brand structure. In fact, one of the reasons that I'm doing this is to avoid a two-tier brand structure. As we develop the new prototype, it became my view that the new prototype might've been overshooting our customers a little bit. Our customers are very self-sufficient. They're value conscious. And they will pay us well for these rooms, but they're not going to pay for things that they don't use. So, this is really an effort to make the new prototype entirely relevant to our core customer. It will certainly be an improvement, no doubt, but it will enable us to stay firmly within this mid-price extended-stay segment. At the same time, as we eventually go through our existing portfolio and renovate those rooms on our next phase, it'll make it more cost-effective for us to renovate the existing estate to a level that's commensurate with the newbuilds. So, that's the essential strategy and it will not result in any kind of two-tiered brand or any confusion amongst our guests.

[Chris Woronka:]

Okay, that's helpful. And then, I wanted to ask on infrastructure. I know we really have no idea what ultimately might happen, if anything. But the question is kind of, are you guys internally positioned if there is a bigger effort forthcoming at the federal level? Do you guys think you're ready to kind of go out and pursue some of the business that would come out of that, knowing it's a longer-term proposition. But do you think you're set up for that in terms of sales resources.

[Jonathan Halkyard:]

I absolutely do. I think one of the bright spots for our business up in the northeast over the past couple of years has been the Tappan Zee Bridge project, which served a couple of our hotels up there quite well. So, I think we're very well positioned for this business. And again, we really don't have any control over the pace or the types of investments that are going to be made, but we think our product is entirely relevant for those types of workers.

[Chris Woronka:]

Okay, very good. Thanks, Jonathan.

[Jonathan Halkyard:]

Thanks, Chris.

[Operator:]

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

[Joe Greff:]

Good morning, everybody. I have two questions. One, you mentioned the free cash flow multiple that you sold the 25 hotels for, was in excess of your current share price free cash multiple presently. Can you give us more specifics on the free cash flow that you arrive at for those 25 hotels, whether that's on a trailing basis or on a 2018 basis? And then, my second question relates to something you touched upon earlier, Jonathan, capital return and share buybacks. From here, as we look into 2018, and it's been a few years, how programmatic will these buybacks be? If I look at your EBITDA guidance and then your implied free cash flow guidance, your free cash flow guidance for this year is in excess of the current authorization and I think that'll only be enhanced with additional free cash flow enhancing asset sales. So, how do we think about that? Thank you.

[Jonathan Halkyard:]

Sure. Good questions. First of all, as I discussed, free cash flow multiples on the assets that we sold, that was using a trailing number and also not including the fee stream for management and franchising that will result from that sale. And it was about a 15.5 times trailing free cash flow multiple on that sale that we completed. As it relates to share repurchases going forward, that really depends more on the share price than it does on the financial resources available to the company. As you noted, our free cash flow generation this year is quite strong even before the proceeds we would expect from any future asset sales. Our share repurchase authorization at $175 million that's remaining, that's almost $1 a share of potential share repurchases for the remainder of the year. On top of our over $0.80 annual dividend rate, it's pretty healthy return of capital to shareholders this year if we were to exhaust that authorization. So, we certainly – we believe the shares are attractively priced right now. We believe that repurchasing those shares represents an appealing use of cash flow. And as we go forward during the year, we intend to continue to repurchase shares along as we believe that that's an attractive thing for us to do for shareholders.

[Joe Greff:]

Thank you.

[Operator:]

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

[Michael Bellisario:]

Good morning, guys.

[Jonathan Halkyard:]

Good morning.

[Michael Bellisario:]

Just wanted to go back to the topic of development returns. Have you been hearing from builders or developers in your conversations that the economics aren't attractive enough or is this kind of an internal decision that you've decided upon?

[Jonathan Halkyard:]

More an internal decision. It was driven by two factors. One, this notion of maintaining consistency in the brand and a product that is relevant to our customer base, which is, we believe, a very deep pool of demand and one we can continue to grow. And the second was to widen the aperture for potential markets where developers could build our sites and where we could build our sites at a lower capital cost. That would enable these hotels to earn an attractive return in lower ADR markets. So, one of my priorities, which I noted at the end of my prepared remarks, was to accelerate the pace of franchising. So, we have made good progress not only on the sale and re-franchising front, but also in developing interest amongst new franchisees, who would develop hotels on our behalf. But I want pickup that pace. And so, this strategy of reducing the capital cost associated with building our new hotels, I think, will just aid in that.

[Michael Bellisario:]

That's helpful. Kind of on the same lines with the IT investments, is that something potential franchisees or development partners, are they pushing for those upgrades too?

[Jonathan Halkyard:]

Our CIO has been pushing for those upgrades. He's here. I'm joking. No, it really hasn't come from the franchisees. This has been on our IT roadmap for about a year-and-a-half. And we've done the work you would expect in terms of our RFPing for potential providers, piloting this technology in a number of our sites and preparing for full rollout. These are large projects for us, not only because of their costs, but also because of the changes that involves here some of our people as well as, of course, the offering it provides our guests. So, this has been on the roadmap for a while. And then, this year and 2019 is when we're really going to be rolling it out.

[Michael Bellisario:]

Got it. That's good to hear. Thank you.

[Jonathan Halkyard:]

All right.

[Operator:]

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

[Shaun Kelley:]

Hi. Good morning, everyone. Jonathan, can you just give us an update on – thanks for the color on kind of the free cash flow multiples that you've done on the asset sale program so far. Could you give us a little color on just – if you think of the program of asset sales to date, kind of what's your blended average EBITDA multiple that you've reached so far on what you sold. I know the numbers individually and small groups have been kind of all over the map.

[Jonathan Halkyard:]

I don't have the exact number for the blended average, but we think it's probably around – I think it's around 17 times trailing free cash flow. So, that's including – just to recite what's behind us now, the Canada asset sales, the Denver Tech Center sale which we did in December and then the 25 assets to Three Wall Capital. And I would include in that also the Austin sale, which we expect to close potentially sometime this quarter. So, taken together, it's certainly better than 15.5 times and it might be 17 times. This is exactly the strategy that we announced a year-and-a-half ago. And it is a combination between what I would call monetizing real estate that is worth more as a non-extended-stay hotel, like Austin, for example, or Denver Tech Center and then others like Three Wall which are recycling capital, but maintaining these assets in the system through franchise agreements.

[Shaun Kelley:]

Great, thanks. And then, the other question on – it's come up on a lot of the REIT calls this year so far has been on cost inflation. So, if you could just tell us what you're experiencing on the ground, your ability to offset some of the wage and benefit pressure that's out there and sort of how – like, how nervous or how conservative do we need to be to think about kind of what could happen as the year progresses if inflation does start to pick up, particularly on earnings for – on the wage front?

[Jonathan Halkyard:]

We do have expectations of certain cost increases in our internal forecast and our guidance. They're mostly around labor. Now, it's important to note that labor constitutes only about 18% of our revenues, which I expect is lower than many other lodging competitors. So, given our cost structure, it's not as burdensome as it might be on others. But there are certain parts of the country where we expect wage inflation of kind of 4%, 5%, 6%. There are other parts of the country where we expect very little wage inflation. We are able to mitigate that through scheduling and staffing and just continuing to nail our labor supply as it relates to the demand that we have. But that is just – that is something that we face on the labor front. Other areas of the P&L, I can't think of any operating expense areas where we're really seeing much inflation. And again, it's because our cost structure is so lean. Our rooms cost, which includes all of our linens and our soaps and shampoo and breakfast and all of that, those consumables, are $1.50 per occupied room night. So, we just don't have the cost structure that many other consumer-facing companies and lodging companies have where this can really hurt us that much.

[Shaun Kelley:]

Thank you very much.

[Operator:]

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

[Thomas Allen:]

Hey, good morning. You used to give the breakout between – your distribution between proprietary channels, OTAs and other. Can you just give us an update on that? Where did 2017 shake out and kind of your updated thoughts on driving distribution? Thanks.

[Jonathan Halkyard:]

Sure. Thanks for that question. This is certainly an important topic for us. Just over 20% of our room nights are coming through the OTAs. A few percentage points are coming through opaque channels. And the rest, the vast majority, over 70% are coming through our proprietary channels, which include our website, our call center and just our hotels themselves where folks are renting rooms across the desk or extending their reservations. So, it is certainly our goal to drive – to continue to drive demand towards our proprietary channels where not only are they more cost-effective for us, but also we have the opportunity in those channels to engage our customers into our loyalty program and upsell them more effectively to other offerings that we have. Or to the extent that our hotels are fully occupied, which, fortunately, they often are, to move those customers to similarly situated hotels that could meet their needs. So, there's a lot of reasons why we want to continue to drive customers towards our proprietary channels. But during 2017, that distribution moved a little bit towards our OTA channels mostly because of growth of our shorter-term guests. And as I noted in my priorities, one of those is – the most important priority is to continue to drive demand from our core customers, which come to us through our proprietary channels which are lower cost.

[Thomas Allen:]

Helpful, thanks. And then, just in terms of occupancy, you had really strong ADR growth this quarter. But for the past two quarters, you've been seeing slight occupancy declines. Can you just remind us what's driving that? And then, how should we think about kind of occupancy versus your ADR growth for 2018? Thanks.

[Jonathan Halkyard:]

There hasn't been much of an occupancy change. Usually, occupancy declines will be the trade-off from more aggressiveness on rate. And so, we view those holistically and will accept lower occupancy when we believe that it's merited by more aggressive opportunities regarding rate and really that's what the dynamic was in the quarters that you described. Regarding 2018, we believe that our RevPAR growth will come – certainly, the majority, and perhaps exclusively from rate growth.

[Thomas Allen:]

All right. Thank you.

[Jonathan Halkyard:]

Thanks, Thomas.

[Operator:]

[Operator Instructions]. Our next question is from the line of Stephen Grambling from Goldman Sachs. Please proceed with your question.

[Stephen Grambling:]

Hey, good morning. Thanks. Two quick follow-ups. I guess, first, can you elaborate a bit more on what the biggest opportunities are to more effectively target and serve that core value and longer-stay customer. And given a lot of the more midscale extended stay product seems to be coming to market, have you seen any change in the discussions with corporate customers or otherwise as to what they may expect or need? Thanks.

[Jonathan Halkyard:]

Thanks for that question. It starts with our corporate sales force and calling on our corporate customers more effectively. And these customers are different. Some of them have travel managers who arrange travel for their entire companies. Others have travel managers that are assigned to find lodging for specific projects within those companies. So, it really comes down to our sales force, understanding the purchasing process at these businesses and calling more effectively on them. And that's done – a combination of local in-market sales professionals on our staff or centrally-located, typically in Charlotte, corporate account representatives who are calling on these larger companies. So, that's really where it comes from. It all needs to be supported by a consistent experience at the hotel level. But I'll tell you. We have terrific folks leading all of these functions. And they all understand that this customer is most important, the most profitable and the highest retention for us and the secret to our future success. On the second part of your question, we are certainly seeing some supply growth within our segment. But it is well below the supply growth that we're seeing in other price points in lodging. So, while competitive intrusion is always something that is a consideration, I don't view it as a particularly large issue at this point or one that's going to be an obstacle to our being successful with this core guest.

[Stephen Grambling:]

Great, thanks. And one other quick follow-up. And maybe I missed this. But given the large IT projects and ESA 2.0 spend embedded in your 2018 guidance, what is the appropriate run rate longer-term for CapEx as we think about maybe some of these one-time things smoothing out? Thanks.

[Jonathan Halkyard:]

Yeah. I would actually – I think that we will be providing updates on that in the future. And I think the main reason is, is that that level of longer-term CapEx depends not only on our asset sales and how the size of the portfolio changes in the coming years, but, more importantly, our pace of new development, which is – really would drive that CapEx number. As it relates to our regular way maintenance capital investment for the company as well as just our core IT investment, we expect that to be pretty stable. And I do not expect certainly annual IT investments, like we have guided for this year. I do expect that, even in 2019, will come down pretty dramatically. But the longer-term plan really is dependent upon our investment in new hotels. And I think as we go forward this year and build that pipeline, we'll be able to provide better guidance on what that looks like over the longer-term.

[Stephen Grambling:]

And so, the ESA 2.0 component, should that moderate or will that have a bigger ramp at least in the near term?

[Jonathan Halkyard:]

I would refer you to the plan that we indicated when we launched the 2.0 strategy, which is still operative around our development of that pipeline over a five-year time period and taken in conjunction with the company's free cash flow generation over the next five years. That's still a pretty good look at what we anticipate – how we anticipate this plan to rollout.

[Stephen Grambling:]

That's great. Thanks so much.

[Jonathan Halkyard:]

Okay, thank you.

[Operator:]

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

[Jonathan Halkyard:]

Thank you, Dana, and thank you everybody for joining us for our earnings call this morning. We appreciate your interest and support and we look forward to speaking with you again in late April when we discuss our first quarter 2018 results. Thanks, everybody.

[Operator:]

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