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Edited Transcript of STAY earnings conference call or presentation 26-Jul-18 12:30pm GMT

Q2 2018 Extended Stay America Inc Earnings Call

Charlotte Jul 27, 2018 (Thomson StreetEvents) -- Edited Transcript of Extended Stay America Inc earnings conference call or presentation Thursday, July 26, 2018 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian T. Nicholson

Extended Stay America, Inc. - CFO

* Jonathan S. Halkyard

Extended Stay America, Inc. - President, CEO & Director

* Robert Ballew

Extended Stay America, Inc. - VP of IR

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Conference Call Participants

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* Anthony Franklin Powell

Barclays Bank PLC, Research Division - Research Analyst

* Bennett Smedes Rose

Citigroup Inc, Research Division - Director and Analyst

* Chris Jon Woronka

Deutsche Bank AG, Research Division - Research Analyst

* David Brian Katz

Jefferies LLC, Research Division - MD and Senior Equity Analyst of Gaming, Lodging & Leisure

* Harry Croyle Curtis

Nomura Securities Co. Ltd., Research Division - MD and Senior Analyst

* Harry Croyle Curtis

Instinet, LLC, Research Division - Research Analyst

* Joseph Richard Greff

JP Morgan Chase & Co, Research Division - MD

* Michael Joseph Bellisario

Robert W. Baird & Co. Incorporated, Research Division - VP and Senior Research Analyst

* Shaun Clisby Kelley

BofA Merrill Lynch, Research Division - MD

* Thomas Glassbrooke Allen

Morgan Stanley, Research Division - Senior Analyst

* William H. Ketelhut

Goldman Sachs Group Inc., Research Division - Associate

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Presentation

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Operator [1]

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Greetings, and welcome to the Extended Stay America Second Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Rob Ballew, Investor Relations. You may begin.

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Robert Ballew, Extended Stay America, Inc. - VP of IR [2]

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Good morning, and welcome to Extended Stay America's Second Quarter 2018 Conference Call. Both the second quarter earnings release and accompanying presentation are available on the Investor Relations portion of our website at esa.com, which you can access directly at www.aboutstay.com.

Joining me on the call this morning is Jonathan Halkyard, Chief Executive Officer; and Brian Nicholson, Chief Financial Officer. After prepared remarks by Jonathan and Brian, there will be a question-and-answer session. Before we begin, I'd like to remind you that some of our discussions today will contain forward-looking statements, including the discussion of our 2018 outlook. Actual results may differ materially from those indicated in the forward-looking statements. Forward-looking statements made today speak only as of today. The factors that could cause actual results to differ from those implied by the forward-looking statements are discussed in our Form 10-K filed with the SEC on February 27, 2018.

In addition, on today's call, we will reference certain non-GAAP measures. More information regarding these non-GAAP measures, including reconciliations to the most comparable GAAP measures, are included in the earnings release in Form 10-Q filed yesterday evening with the SEC. With that, I will turn it over to Jonathan.

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [3]

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Thanks, Rob, and good morning, everyone. Thank you for joining us this morning to discuss our second quarter results. Before getting into the results themselves, I'd like to recognize and thank my 8,000 coworkers who once again delivered solid results for the quarter. Our shareholders know that we operate a very lean business. It's one of the reasons our margins lead the industry. But it also means that our associates at the hotel need to wear a lot of different hats in serving our guests. They do this well every day and I and the rest of us here at our corporate headquarters, which we now refer to as the HSC, the hotel support center, we appreciate what they do every day.

This was an important quarter for us. First off, we made meaningful progress in executing our growth strategy, having grown our own hotel pipeline and having received our inaugural franchise applications. Our pipeline now stands at over 4,200 rooms and growing. Next, we saw a double-digit growth in adjusted Paired Share income per diluted Paired Share and adjusted FFO per diluted Paired Share during the quarter. And finally, between our dividend and share repurchase activity, we returned approximately $75 million to our shareholders during the quarter. Our second quarter system-wide RevPAR growth slowed a bit from the pace in the first quarter, and was up 1.6%. The slowdown in RevPAR growth as compared to the first quarter was not unanticipated, and was primarily due to a reduction in business related to the hurricanes in Florida and Houston last fall. Our internal research shows that our competitive set underperformed the industry and the economy chain scale during the second quarter, as our specific submarkets underperformed relative to the national average. The results are stronger when looking at the absolute RevPAR growth of our owned portfolio, which grew 2.4% during the quarter, driven by the higher levels of performance of our retained portfolio as compared to those we have sold. Strengths in the quarter in our San Francisco, Florida, Houston and Philadelphia markets were partially offset by weakness in Austin, Dallas, Boston and LA. It is gratifying to see the San Francisco area business rebound during the quarter. The mix of business across the system is moving in the right direction as well, with our revenue from 30 plus-day length of stay customers and those are coming through our proprietary distribution channels growing during the quarter. Weekly guests were down slightly in the quarter and shorter-stay customers with most of those coming through the OTA channel grew as well, though at a slower pace than in the first quarter. As usual, we had solid expense control at the property level. Excluding payroll and reservation expense, which both track revenue, remaining property level expenses in total actually declined in the second quarter. We've made progress in further standardization of operating practices across the system, and we have found new opportunities for leverage procurement here at the HSC. As such, we were able to nearly maintain margins at our property levels during the quarter at industry-leading 56.4%, down just slightly over the prior year.

Our cost structure also reflected our active targeting of core Extended Stay guests. They come with higher, more stable margins than transient business. Adjusted EBITDA during the quarter was $167.3 million. Our strong margins and share repurchase activity combined with a lower tax rate and lower depreciation expense led to double-digit percentage increases in both adjusted Paired Share income per diluted Paired Share and adjusted FFO per diluted Paired Share for both the second quarter and for the entire first half of 2018. We continued the strong pace of share repurchases in the second quarter, repurchasing nearly $33 million of shares in the quarter. Combined with repurchases in the first quarter and our dividends paid year to date, we've returned approximately $150 million to paired shareholders in the first half of 2018. On an annualized basis, that represents a more than 7% return of capital to shareholder in a year, based on recent market capitalization. Because of our asset sales and, as planned, our more modest capital spending in recent quarters, we have over $225 million of cash on our balance sheet, a portion of which could be deployed toward repurchases in the future. We believe our shares remain attractively valued and with our ability to arbitrage the free cash flow multiple on noncore asset sales, with the implied yield of our shares, we expect to continue to be buyers of our company's stock at these levels. Additionally, we would see any dip in the share price to be an excellent repurchase opportunity.

Since our first quarter call, we've made significant progress in our long-term growth strategy. Recall that 2 years ago, we introduced our growth strategy, ESA 2.0. That strategy included our -- growing our portfolio through new development and franchise sales, improvement of the owned portfolio through selling and refranchising lower ADR hotels and targeting renovation capital to improve the quality and performance of the owned portfolio. During the second quarter, we took steps to deliver on all 3 fronts.

This quarter, we approved our first 4 franchise applications independent of asset sales. As of this morning, we have purchased 4 sites and have another 11 sites under option. By the end of the year, we expect to have closed on at least 6 of those optioned sites in addition to the 4 we've already purchased. In a few weeks, we'll break ground at the first site for a hotel that should open in 2019, and we expect to have at least 4 sites under construction by the end of the year. In the second quarter, we purchased a hotel just outside of Charlotte near our headquarters, which we have since converted to an Extended Stay America. We expect to purchase another hotel for conversion in the southeast in the next 3 months as well. So in the case of these first 2 conversion hotels, we are buying 2 effectively brand-new hotels at attractive multiples with a similar design to our prototype in markets we were already targeting for new constructions. These purchases will also allow us to reduce or eliminate a significant portion of the cash tax impact from recent asset dispositions. In the last 3 months, we've signed purchase and sale agreements with 3 separate investment groups to sell and refranchise 46 of our hotels. Following customary due diligence, we expect to close on these three portfolios in the next several months, at which time the buyers will collectively commit to build or convert an additional 15 Extended Stay America hotels. When completed, this set of transactions will bring the total number of sold and refranchised hotels to 71, approximately halfway to our goal of 150 by the end of 2021.

So what does all of this mean in terms of our new hotel and franchise pipeline? Combining the new franchise commitments from the buyers of our 71 hotels already closed or under contract, with our own development and other franchising activities, we expect to have a pipeline of approximately 50 hotels by the end of this year. And finally, as we highlighted it at Investor Day about 2 years ago, we plan to return to a 7-year renovation cycle beginning around the end of this year. This project will be quite different from that which we undertook from 2011 to 2017. First, we'll renovate only approximately 450 hotels that we expect to retain, and we will do so over a 7-year time period. We will renovate not with a one-size-fits-all approach, but with 4 different renovation tiers determined by the return potential of each hotel. We expect to commence with the program in the fourth quarter this year.

Our second quarter 2018 earnings presentation available on our IR website has some additional highlights of the upcoming program, and we believe our shareholders will receive strong returns from these capital investments.

I'd just like to close with a few comments about our corporate structure. Over the past several months, many investors, and some in the equity research community, have inquired about the potential for Extended Stay America to revisit its corporate structure as a means to increase shareholder value. Indeed, a number of research analysts on the call this morning have modeled the company on this basis, using recent transactions and trading multiples to support various valuation analyses of our company under an opco-propco structure or some other method of separating the C corporation from the REIT. We welcome the analysts' approach, as we believe it highlights the intrinsic value of our company as compared with other lodging companies. This morning, I want our shareholders to know that we continue to evaluate the merits of alternatives to our current corporate structure. And notwithstanding our considerable progress in executing the ESA 2.0 strategy as outlined in my remarks this morning, we have preserved all optionality with respect to any structural alternatives that our board may consider in the future. I'll now turn the call over to Brian to discuss our financial results further, give an update on our 2018 outlook and discuss some of his priorities for the next year as ESA's new CFO. Brian?

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Brian T. Nicholson, Extended Stay America, Inc. - CFO [4]

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Thank you, Jonathan. Before I begin, I'd first like to thank you, thank the team here at Extended Stay America and the Boards of Directors of ESA and ESH Hospitality for the opportunity to return to Extended Stay America as Chief Financial Officer. It's an exciting time at our companies, and I am very pleased at the chance to contribute. I'd also like to take a moment to thank David Clarkson for his excellent work as interim CFO these last several months, and for his continuing service to the company. Since this is my first earnings call as CFO of Extended Stay America, I'd like to touch briefly on a handful of my key goals in the role for the next year or so before I jump into more details on our results.

First, I plan to work to ensure the finance team is partnered as effectively as possible with operations to help improve consistency of execution at our hotels. Second, I'll partner with our development team to help build solid processes and sound oversight for our franchise and on-balance sheet development for new hotels and conversions. And last, I plan to contribute to explore avenues to grow shareholder value, and to continue to be as communicative with investors as possible about progress against this and other company initiatives.

Turning to our results, comparable system-wide RevPAR in the second quarter increased 1.6% compared to the prior year. With a 3.4% increase in ADR, being partially offset by a 130 basis point decline in occupancy. April and June RevPAR growth was pulled down by a bit of a soft May. And while still growing RevPAR, we did have significantly less Hurricane-related business in the second quarter of 2018 than in the prior quarter, accounting for the entire drop in RevPAR growth compared to the first quarter. We also had less renovation tailwind in the second quarter compared to the prior 2 quarters. Comparable company-owned RevPAR increased 1.7%, while absolute company-owned RevPAR increased 2.4%, reflecting the improved remaining portfolio quality from noncore dispositions.

For the first half of 2018, comparable system-wide RevPAR increased 2.6%. Revenue in the second quarter increased for both nightly guests and Extended Stay guests, with slightly more revenue growth coming from shorter-stay guests as expected during the leisure travel months in summer. Hotel operating margins declined 30 basis points in the second quarter to 56.4%. Increased payroll and reservation expense led to the slight decline in hotel operating margin during the quarter.

All other hotel expense items, collectively, saw a decrease of 0.5% on a comparable company-owned basis during the second quarter compared to the prior year, highlighting our efforts to contain costs and offset pressure from key inflation risk items. For the first 6 months of 2018, hotel operating margin dipped 30 basis points to 54.5%.

Corporate overhead expense excluding share-based compensation and transaction costs increased 4.2% to $22.1 million during the second quarter, reflecting reimbursable management and franchise-related expenses during the quarter, which does not affect our adjusted EBITDA on a net basis. Our adjusted EBITDA in the quarter was $167.3 million, in line with our expectations. Adjusted EBITDA during the quarter was impacted by the lost contribution of approximately $6 million from hotel dispositions in 2017 and 2018. Adjusted EBITDA for the first 6 months of 2018 was $299.5 million. Interest expense during the quarter increased by $0.7 million to $32.4 million, driven by a $1.2 million charge in transaction fees, partially offset by a lower spread to LIBOR due to term loan repricing activity since the beginning of 2018. Income taxes decreased $1.5 million to $14.4 million during the quarter, driven by a lower effective tax rate, partially offset by an increase in pretax income and other income tax expense related to winding down our Canadian subsidiary.

Adjusted FFO per diluted Paired Share increased 10% in the second quarter to $0.58 per diluted Paired Share compared to $0.53 per diluted Paired Share in the same period in 2017. The increase was driven by a lower tax rate and a reduction in share count from Paired Share repurchases. For the first 6 months of 2018, adjusted FFO per diluted Paired Share increased 13.4% to $1 compared to the same period last year. Net income during the second quarter increased 31.9% to $65.6 million, driven by a reduction in expenses related to sold assets, lower depreciation expense, no impairment charges compared to $7.9 million a year ago and a lower effective tax rate.

For the first half of 2018, net income increased 46.9% for with a large gain on asset dispositions mostly offsetting a $43.6 million impairment charge during the first quarter of 2018, combined with an increase in revenue, lower depreciation and a lower effective tax rate. Adjusted Paired Share income per diluted Paired Share in the second quarter increased 11.7% to $0.35 per diluted Paired Share from $0.31 in the same period last year. The increase was largely due to a lower tax rate, lower depreciation and lower share count from Paired Share repurchases.

For the first half of 2018, adjusted Paired Share income per diluted Paired Share increased 18.8% to $0.54 compared to $0.46 in the same period in 2017. We ended the quarter with our net debt to trailing 12-month adjusted EBITDA on a comparable basis at 3.8x, a slight increase from 3.7x at the end of the first quarter due to capital returns and an increase in ESA 2.0 CapEx, including the purchase of a hotel during the quarter for conversion.

Gross debt outstanding was $2.52 billion compared to $2.53 billion at the end of the first quarter 2018. We are pleased that we've been able to reduce leverage over the past several years and reduce our term loan spread to LIBOR, which is a reflection of both our prudent financial policy and our high free cash flow business model. We finished the quarter with approximately $227 million in restricted and unrestricted cash. Roughly half our restricted cash is expected to be used for 1031 exchanges for land and hotel purchases in the second half of 2018. Capital expenditures in the second quarter were $56.2 million, including $14.6 million for a hotel purchase and conversion, land acquisition and other ESA 2.0 costs, $3.8 million related to insurable events and $14.9 million in IT CapEx. For the first half of 2018, capital expenditures totaled $89.7 million. Yesterday, the Boards of Directors of Extended Stay America, Inc, and ESH Hospitality, Inc., declared a combined cash dividend of $0.22 per Paired Share payable on August 23, 2018 to shareholders of record as of August 9, 2018. Our dividend yield is approximately 4.0% at recent trading prices.

During the second quarter, we repurchased approximately 1.6 million paired shares for $32.8 million. Since the end of the second quarter and as of this morning, we've repurchased an additional 0.1 million paired shares for approximately $1.8 million. Including those repurchases, we have repurchased approximately $70 million in paired shares year-to-date or nearly 2% of paired shares outstanding. With our share repurchase authorization remaining at over $125 million, we have plenty of dry powder for purchases, and we believe our shares remain attractively priced. Looking to the third quarter of 2018, we expect comparable system-wide RevPAR will increase by 1% to 3%. We expect an adjusted EBITDA between $170 million and $176 million. For the full year 2018, we now expect comparable system-wide RevPAR growth of 1.0% to 2.75% and adjusted EBITDA of $595 million to $610 million. Our updated full-year RevPAR growth and adjusted EBITDA expectations have now been adjusted to include some renovation disruption in the fourth quarter as we begin our next cyclical renovation program in November. And it also continues to include expectations related to cycling over immediate hurricane-related disruption as well as post-storm increases in demand last year. Additionally, our adjusted EBITDA outlook does not reflect additional sales as the impact will depend on the timing of closing and the number of hotels sold. We do not expect additional asset sales to impact comparable system-wide RevPAR growth materially. We are maintaining capital expenditure guidance of $205 million to $235 million, reflecting our expectations to return to renovations in the fourth quarter, with $30 million to $40 million in renovation CapEx, including some FF&E prebuys for our first quarter 2019 renovations. This will be partially offset by expected lower maintenance CapEx and lower ESA 2.0 CapEx. The amount of renovation CapEx could be higher or lower depending on timing in the last few weeks of the year. We are prebuying more than normal in order to allow us to renovate key hotels in the lower occupancy months in the first quarter of 2019. Most of the first couple of phases of our -- of hotels are in our higher ADR market that haven't had a renovation in about 7 years, and will receive a premium or premium plus renovation as outlined in our earnings presentation. We continue to expect our annual interest expense to be approximately $130 million. We expect adjusted Paired Share income per Paired Share between $1.07 and $1.15 per Paired Share, representing approximately 8% to 15% growth in 2018, a $0.02 increase from our prior guidance at the midpoint due to lower depreciation expense, lower loss on disposal expense and additional Paired Share repurchases, partially offset by a reduction in our adjusted EBITDA outlook. Through our dividends and share repurchases, we continue to expect to return between $260 million and $300 million this year to our shareholders, which represents roughly 7% of our market capitalization. Let's now go to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Anthony Powell with Barclays.

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Anthony Franklin Powell, Barclays Bank PLC, Research Division - Research Analyst [2]

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Brian, welcome to the call. I had a question about RevPAR growth overall. You mentioned that the economy Extended Stay comps had underperformed the industry. How do you think your hotels in your segment should perform relative to the industry over the medium term? Do you think you can start performing in line once the hurricane comps go away or is there just more demand growth in other segments right now?

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Brian T. Nicholson, Extended Stay America, Inc. - CFO [3]

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

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Anthony Franklin Powell, Barclays Bank PLC, Research Division - Research Analyst [4]

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All right. Just following up on that. So what's the -- especially as you are starting a renovation program next year, which could be disruptive, what kind of RevPAR growth should we be expecting for your portfolio over, say, the next couple of years? Are we talking 0% to 2%? I know it's less important now given the ESA 2.0, but it's important to kind of help us model things moving forward.

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [5]

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

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Anthony Franklin Powell, Barclays Bank PLC, Research Division - Research Analyst [6]

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

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [7]

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

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Operator [8]

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Our next question comes from Harry Curtis with Nomura Instinet.

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Harry Croyle Curtis, Nomura Securities Co. Ltd., Research Division - MD and Senior Analyst [9]

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Wanted -- I had 2 questions. Jonathan, you mentioned the target of 50 hotels or a pipeline of 50 by the end of the year. If you could give us some sense of visibility and from the perspective of the developer, what are the expected ROICs on these new hotels? And how does that compare to other options in that competitive set?

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [10]

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

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Harry Croyle Curtis, Nomura Securities Co. Ltd., Research Division - MD and Senior Analyst [11]

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

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [12]

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Yes, I think -- I'll comment, I guess, briefly around the thinking. It comes down to really 2 factors. One is, of course, the performance of the business and what -- to what extent any corporate structure that the company has actually influences its performance and ability to deliver free cash flow? And that's not just operating performance but that's things like taxes and the rest. And then how will the equity market value that performance? And so those are, broadly speaking, kind of the 2 factors that we consider -- and it's not just around any kind of structural changes, the same kind of approach could be applied to thoughts around strategic M&A or other types of capital allocation. In terms of -- and that's a process that we always go through, of course. And in terms of -- I don't know -- I don't recall how you phrased the kind of what has to happen. There's certainly no -- there's no bright line but I -- but we recently know that there has been some focus on this, we get questions from our shareholders from time to time on this. And as I mentioned, of course, a number of folks in the equity research community have commented on this so we just thought it was important to kind of state the way that we're looking at it.

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Harry Croyle Curtis, Nomura Securities Co. Ltd., Research Division - MD and Senior Analyst [13]

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

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [14]

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

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Operator [15]

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

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Chris Jon Woronka, Deutsche Bank AG, Research Division - Research Analyst [16]

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

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Brian T. Nicholson, Extended Stay America, Inc. - CFO [17]

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Yes, Chris, I'll take that and Jonathan may want to jump in. As we look at the data, the softness in May was not something that was driven by a particular geography or set of geographies. It was not driven by a particular industry or demand driver. We just saw sort of generalized softness really beginning at the end April, persisting through May and then sort of strength regaining through June. And I just -- I hesitate to speculate on whether there could be larger factors, macroeconomic or other factors, that might have contributed there. July, I think, as everyone knows, started with some difficulty and with some headwind, the 4th of July holiday on a Wednesday sort of interfered with business travel that first whole week of July. But since then, we've seen decent strength in July and we compare pretty favorably to the industry and to the economy segment at least with the information we've seen so far.

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Chris Jon Woronka, Deutsche Bank AG, Research Division - Research Analyst [18]

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

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [19]

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

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Operator [20]

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Our next question comes from Shaun Kelley with Bank of America.

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [21]

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Jonathan, to go back to sort of the strategic comment and I totally appreciate that this is difficult to do on a, sort of, public earnings call. But just to say it kind of or think about it more broadly, is there either a goalpost or somewhere you want to get on maybe the refranchising or the ESA 2.0 or into some of these renos before you think there might be an optimal time for Extended Stay to look more aggressively at some of these -- some sort of other corporate structure? Or do you think it's something you can do in parallel and not necessarily disrupt a lot of the other initiatives you have going on?

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [22]

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

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [23]

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No, I think that make sense. And then the follow-up would be since you mentioned the pipeline and some of the values that, that may create or be important to. So can you just give us a little bit of a bridge on -- I think as you've laid it out in the release, which is pretty clear, you -- the way you're analyzing here you have 26 hotels in a pipeline today, you said 50 by the end of the year. So what's the component to bridge from the 26 to the 50? Is that new individual contracts? Are these coming from the existing recycling people? Is that coming from your own build? What's going to be the buildup to get you from 26 to 50?

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [24]

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Okay, Shaun, I'm going to give this a try but invite Brian to comment as well if I don't get it exactly right. So we have a -- it starts with the 15 hotels that -- from the transaction that we completed earlier this year. That buyer has committed to build and/or convert an additional 15 Extended Stay America hotels. We presently have 15 hotels in the pipeline for our owned development. We have another 4 franchised applications, so these are franchisees, who are going to build new Extended Stay America hotels, but have not acquired any hotels from us. So that brings us up to 34. And then the buyers of the 46 hotels that we currently have under contract are together, collectively, committing to build an additional 15 Extended Stay America hotels. So that brings us to 49. Now we also believe that will -- that Jim Alderman and his team will be successful in selling additional franchisees over the next 6 months and so that will be even past that 50 or 49 hotel pipeline. Does that make sense?

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [25]

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Yes, it makes perfect sense. I am super clear.

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Operator [26]

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Our next question comes from David Katz with Jefferies.

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David Brian Katz, Jefferies LLC, Research Division - MD and Senior Equity Analyst of Gaming, Lodging & Leisure [27]

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I wanted to just ask when we look at the strategy going forward of selling hotels in bunches. How are you thinking about the balance between using the (inaudible) capital to improve those hotels to -- presumably to get a better price with the notion of selling them ahead of renovation, I mean someone else using their capital into the renovation rather than the company's, which could conceivably accelerate the process. I recognize there's a balance in there and everyone may be different. But just thinking about the pace of the process here.

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [28]

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

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Brian T. Nicholson, Extended Stay America, Inc. - CFO [29]

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

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David Brian Katz, Jefferies LLC, Research Division - MD and Senior Equity Analyst of Gaming, Lodging & Leisure [30]

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

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [31]

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

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Operator [32]

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Our next question comes from Joe Greff with JPMorgan.

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Joseph Richard Greff, JP Morgan Chase & Co, Research Division - MD [33]

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Most of my questions have been asked and answered, but I do have one more with respect, Jonathan, to your comments on you and the board continuing to evaluate the narrative of corporate structure. I guess how are you thinking about the timing of reaching a conclusion on potentially new corporate structure? And I gather if the stock valuation goes from its present 10x multiple to something close to peers, your incentive is lessened in doing that. If the cost of doing a different corporate structure is prohibitive or can't be borne by a third party like in the case of La Quinta, you probably would have less intent to do it. So what's the -- sort of, the timetable for you all in, sort of, reaching a conclusion since it is, I guess, the evaluation of corporate structure is independent of continued progress on the various 2.0 initiatives, and that's all for me.

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [34]

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

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Operator [35]

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Our next question comes from Thomas Allen with Morgan Stanley.

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Thomas Glassbrooke Allen, Morgan Stanley, Research Division - Senior Analyst [36]

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Following on to same path of corporate structuring questions. If you were to pursue an opco-propco structure, how would you think about tax [flakage]? It's obviously a little different given your ready structure of the Paired Share rate?

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [37]

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

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Brian T. Nicholson, Extended Stay America, Inc. - CFO [38]

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I think that's right.

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Thomas Glassbrooke Allen, Morgan Stanley, Research Division - Senior Analyst [39]

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Okay. And then just on the fundamentals quickly. Last earnings call, Jonathan, you suggested that your 2018 RevPAR guidance could be proven conservative. I guess what's changed since then that you've cut your guide slightly?

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [40]

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

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Brian T. Nicholson, Extended Stay America, Inc. - CFO [41]

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Yes, Thomas, I'd chime in a little bit there. First, recognizing that while we are, from a calendar perspective, maybe a little more than -- we are more than halfway through the year, I think some of the uncertainty that is, sort of, loaded into cycling on some of the hurricane and other activity from last year and, sort of, not knowing what's going to be coming this year. So we have more than half the year behind us, but probably more than half the year is an uncertainty ahead of us. That said, I think we do feel pretty good about where we are. If you look at the annual guidance and 1% to 3% that was given before, adjusted for about 0.25 point, we think about a percentage point of RevPAR in the fourth quarter, which translates to 0.25 point on the year, effectively adjusted for that we've taken up in the bottom end of the range by 0.25. So I guess that I'd leave it at that.

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Operator [42]

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Our next question comes from Smedes Rose with Citi.

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Bennett Smedes Rose, Citigroup Inc, Research Division - Director and Analyst [43]

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

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [44]

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

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Bennett Smedes Rose, Citigroup Inc, Research Division - Director and Analyst [45]

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Okay. But that higher expense line is, call it, $3.5 million or something. Is it fair to say that, that would continue going forward? Or do you see those more sort of one time-ish?

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [46]

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I think some are one time, like building some of this infrastructure that I referenced. And then some I think we can expect to ebb and flow over time, like the promotional mix of OTA expense, et cetera.

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Operator [47]

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

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Michael Joseph Bellisario, Robert W. Baird & Co. Incorporated, Research Division - VP and Senior Research Analyst [48]

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

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Brian T. Nicholson, Extended Stay America, Inc. - CFO [49]

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

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Michael Joseph Bellisario, Robert W. Baird & Co. Incorporated, Research Division - VP and Senior Research Analyst [50]

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

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [51]

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

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Operator [52]

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Our next question comes from Stephen Grambling with Goldman Sachs.

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William H. Ketelhut, Goldman Sachs Group Inc., Research Division - Associate [53]

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

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [54]

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Bill, full portfolio, what do you mean?

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William H. Ketelhut, Goldman Sachs Group Inc., Research Division - Associate [55]

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Or like kind of spinning off the propco and kind of a corporate structure adjustment.

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [56]

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Wow, I look at them as 2 completely different types of transactions. Certainly, there are costs associated with transacting assets on an individual basis that are -- there is scale benefit in transacting larger groups of hotels. This is why we have -- one of the reasons why we have entered into sale transactions in most cases that have been small portfolios of 15 to 25 hotels. And not only because of the lower costs associated with doing those, but also because buyers of a portfolio that size are the ones who are willing and able to commit to build additional hotels for us as franchisees. I consider any structural alternative that -- like the ones I described in my opening remarks to be really a whole different kettle of fish versus these types of portfolios that we have been disposing.

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Operator [57]

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Our final question comes from Anthony Powell with Barclays.

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Anthony Franklin Powell, Barclays Bank PLC, Research Division - Research Analyst [58]

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Just one follow-up from me. Could you describe the profile of the 4 franchisees that you signed up? Are they experienced hotel developers, are they other types of real estate developers, and why do you think they chose your product?

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [59]

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Yes, these are all large multiunit hotel developers. And their reasons are for -- are all slightly different, but I think, in general, they view ours as a proven model, a brand that really can grow and one that has just broad demand-supply dynamics, which are favorable for them as developers. They're also experienced in developing this type of products so they have a high degree of confidence in their ability to deliver the assets at the costs that we've described. So we're very optimistic, and I do believe that we're going to have additional signings like this in the next 6 months.

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Operator [60]

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

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Jonathan S. Halkyard, Extended Stay America, Inc. - President, CEO & Director [61]

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

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Operator [62]

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