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Edited Transcript of STAY earnings conference call or presentation 27-Apr-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Extended Stay America Inc Earnings Call

Charlotte May 1, 2017 (Thomson StreetEvents) -- Edited Transcript of Extended Stay America Inc earnings conference call or presentation Thursday, April 27, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gerardo I. Lopez

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

* James G. Alderman

Extended Stay America, Inc. - Chief Asset Merchant and EVP

* Jonathan S. Halkyard

Extended Stay America, Inc. - CFO

* Robert Ballew

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Conference Call Participants

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* Anthony Franklin Powell

Barclays PLC, Research Division - Research Analyst

* Bennett Smedes Rose

Citigroup Inc, Research Division - Director and Analyst

* Brandt Antoine Montour

JP Morgan Chase & Co, Research Division - Analyst

* Chris Jon Woronka

Deutsche Bank AG, Research Division - Research Analyst

* Harry Croyle Curtis

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

* Michael Joseph Bellisario

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

* Shaun Clisby Kelley

BofA Merrill Lynch, Research Division - MD

* Stephen White Grambling

Goldman Sachs Group Inc., Research Division - Equity Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the Extended Stay America First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rob Ballew, Investor Relations for Extended Stay America. Please go ahead, sir.

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Robert Ballew, [2]

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Good morning, and welcome to Extended Stay America's First Quarter 2017 Conference Call. Both the first quarter earnings release and an accompanying presentation are available on the Investor Relations portion of our website at esa.com, which you can access directly at www.aboutstay.com.

Joining me on the call today are Gerry Lopez, Chief Executive Officer; Jonathan Halkyard, Chief Financial Officer; Jim Alderman, Chief Asset Merchant; and Tom Bardenett, Chief Operating Officer. After prepared remarks by Gerry and Jonathan, there will be a question-and-answer session.

Before we begin today, I'd like to remind you that some of our discussions will contain forward-looking statements, including a discussion of our 2017 outlook. Actual results may differ materially from those indicated in the forward-looking statements. Forward-looking statements made today speak only as of today. The factors that could cause actual results to differ from those implied by the forward-looking statements are discussed in our Form 10-K filed with the SEC on February 28, 2017.

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

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [3]

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Thanks, Rob, and good morning, everyone. Thank you for joining us to discuss our first quarter 2017 results. If you had a chance to glance at our release from earlier today, by now you know we got off to a solid start this year. RevPAR was up 2.1% for the quarter, slightly above the top end of our guidance, driven by a strong March, continued our performance in our South division and a resurgence in the North.

All in all, we saw a number of markets around or above double-digit growth, from Minneapolis to the Carolina, to Jacksonville, Florida, to Denver, to Seattle. These helped offset weakness in the Bay Area and L.A. We are pleased by the 2.1% improvement, because it overlaps a very strong 5% RevPAR growth a year ago for a combined 7.1% RevPAR growth over the 2 years. As RevPAR was increasing, our field teams kept a tight lid on expenses and delivered for the second quarter in a row, triple-digit flow-through.

Across all controllable and significant line items to the P&L, our operators excelled. This highlights that even in a quarter with lower RevPAR growth than we are used to seeing and even when we lose a day of revenue in a quarter, we have the flexibility to expand margins. Thanks to our lean operating model and our triangle teams focused on execution, down to the individual property level.

Combined, the RevPAR performance and tight cost controls helped Q1 adjusted EBITDA come in at $129.6 million or $2.6 million above the top end of our guidance, 5.5% over last year. Adjusted FFO kept pace, actually did a bit better, growing 6.8% over 2016.

As all of you know, a strong free cash flow is integral to the Extended Stay investment thesis, and we are delivering against it. Now to be clear, we think that when you pair up first, our Q1 operating performance; with two, our long-dated low interest expense; and third, our reduced CapEx needs as renovations draw to a close, the free cash flow story is compelling, indeed, very compelling. Our Board agrees, and this morning, we raised our quarterly dividend by more than 10% to $0.21 per paired share, making it the third time in our 3 years as a public company, that we've raised dividend.

Add to it, our share repurchase program, 11 million shares retired in the last 14 months were roughly 5% of our shares outstanding. And I think you'll agree that capital returns to shareholders is not just a promise made but a promise kept at Extended Stay.

Turning to ESA 2.0. Happy to report progress continues the pace. In fact, now that renovations are wrapping up and as part of the plan that we laid last June, work against ESA 2.0 is beginning to accelerate. In the last couple of months, we've begun to build teams in asset management, development, and franchises, all reporting to Jim Alderman, now 4 months into his tenure at ESA.

Jim and his crew have already signed 5 letters of intent or purchase sale agreements for a land to build our next new prototype hotel. We expect to begin construction of 1 or 2 sites, perhaps as early as Q4 of this year and ramp up in 2018 and '19. We expect to begin franchise sales in the second quarter of this year.

As we've said before, we believe our franchise and program fees to be very competitive, and we expect our FDD and franchise agreement to be simpler to understand than the forms used by many of our competitors. The construction prototype designs that have been finalized and model rooms in our Charlotte support center that are up and running. We look forward to a lively NYU Hospitality Conference in June, so that we can bring discussions with potential partners to the next level.

After the many inquiries and preliminary conversations that we've had in the last 9 months, we are very much looking forward to closing some deals later this year.

Now turning to asset divestures. We are on track to closing the 3 Canadian asset sales we've mentioned in earlier calls within the next few weeks. At current exchange rates, this is more than a $66 million transaction. Once it closes, we will continue to manage our sales for fairly short period. But either way, I anticipate our sales will leave our system by year's end.

In Austin, the other transaction we previously called out for you, we now expect the entitlement process to take longer than anticipated, so the transaction will likely close in 2018. As this hotel is twice as profitable as our average property, we see this strictly as a timing matter, and think a revised time line may actually have the benefit of allowing us to plan for a 1031 transaction, thereby minimizing tax leakage.

Lastly, on divestitures. This quarter, we expect to sell an additional hotel, in the Northeast this time, for approximately 18x trailing 12 months EBITDA. This property has not been renovated. It would have been our last, and it is currently unbranded.

Looking now at the overall industry. Supply growth at economy and mid-scale continues to be muted at best, certainly below the industry's total. That industry total, by the way, we see hovering near its long-term rather reasonable average of about 2%.

While we and others are yet to see a big bump in corporate demand so far this year, we remain optimistic that improved business confidence, increases in corporate earnings and potential infrastructure investments will lead to increased demand over the medium term. Given the nature of projects being talked about, we at Extended Care are very well positioned to capture this potential volume and are, at the same time, insulated from the pressures that we see in the urban gateway markets.

Next, we continue to be cautiously optimistic, about the overall macro environment in 2017 and the immediate years beyond. Lower corporate taxes and infrastructure spending, whether public or private, spells projects, and projects are what fuel our best business.

Let me close by coming full circle to Extended Stay America. In the next few weeks, we will complete our renovation program, all 600-plus hotels. The project begun 5.5 years ago. We will then take what we think is an 18 months to 24 months break from renovations, while we ramp up ESA 2.0, selling, building, transacting and franchising assets. We can do this because we have a team that's built a business model, that is now optimized, resilient and enables our future. In that future, we will remain committed to focus on fundamentals with operating and financial, one enables the other. The free cash flow story is and will remain strong. And the return of capital to shareholders is not only a promise made but a promise kept.

Now let me turn the call over to Jonathan to give you more detail on our financial results, and provide commentary on our Q2 and full-year 2017 outlook. Jonathan?

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Jonathan S. Halkyard, Extended Stay America, Inc. - CFO [4]

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Thank you, Gerry. After a soft top line start to 2017, our revenue performance strengthened during the quarter. This, combined with our fiscal discipline throughout the quarter, enabled ESA to deliver strong results yet again. And we certainly want to thank all of our colleagues in operations, sales, revenue management, and here at the headquarters for making this happen.

RevPAR increased 2.1% in the first quarter to $45.76, slightly above the top end of our guidance range, driven by ADR growth of 0.8% and an occupancy increase of 90 basis points. The increase in occupancy was aided by roughly 25 basis points from a decrease in rooms under renovation, compared to the first quarter of last year. The increase in RevPAR in the first quarter came from increased demand of shorter staying guests from OTAs, more than offsetting small declines in our 30-plus night stay and corporate business. However, the increase in OTA revenue did not increase our commission costs for the quarter, as we were able to improve our acquisition costs in this channel.

Total revenues for the first quarter increased 1.2%, which includes the loss of a day from leap year last year, which impacted us in the quarter by about 1.1 percentage points. Room revenue increased 0.9%, while other hotel revenue increased by 17.2% in the first quarter or an incremental $800,000 in revenue. Other revenue per occupied room increased $0.17 compared to first quarter of 2016 to $1.18, and we believe there continue to be opportunities for significant growth in this category.

Hotel operating margin expanded 210 basis points in the first quarter to 52.5%, on 230% property level flow-through. During the quarter, we saw a decrease in amenity costs, maintenance expenses, reservation cost and utility expense. These declines were partially offset by higher labor cost, but overall, expenses per occupied room declined 3.3%. Corporate overhead expenses, excluding noncash share-based compensation in secondary costs, increased 4.9% to $23.2 million in the first quarter.

The increase in overhead was due to an increase in consulting and professional services. And adjusted EBITDA increased 5.5% in the first quarter to $129.6 million above the top end of our guidance range. Adjusted FFO for the quarter increased 6.8% to $68.7 million, compared to $64.3 million in the same period of 2016. Adjusted FFO per share increased 11.7% to $0.35. Net interest expense during the quarter was $33.6 million compared to $47 million in the first quarter of 2016.

During the first quarter, we booked a noncash impairment charge on asset sale held for sale of $12.4 million, primarily due to a decline in currency exchange rate of the Canadian dollar. Our income tax expense was $4.5 million compared to $2.9 million in the first quarter of 2016. Our effective tax rate for the first quarter was 21.8% compared to 16.4% in the same quarter last year. And net income for the first quarter increased by $1.3 million, or 8.9%, to $16.1 million with higher hotel operating profit and lower interest expense, partially offset by an increase in depreciation expense, the impairment charge I just mentioned, and higher taxes.

Adjusted paired share income increased 10.6% to $28.5 million. Our adjusted paired share income prepared share for the first quarter was $0.15, compared to $0.13 in the same quarter of 2016, an increase of 15.7%. Adjustments to paired share income are detailed in this morning's press release. Capital expenditures for the first quarter totaled $48.4 million, including $21 million in renovation and $25.1 million in maintenance capital.

During the quarter, we completed 24 hotel renovations, bringing our total number of renovated hotels to 608 at the end of the quarter. As Gerry mentioned earlier, we expect to have renovated all hotels within the next few weeks. This final stage, which we began in early 2016, we believe will ultimately come in roughly $15 million under budget, thanks to procurement savings and process improvements. In total, when completed, we will have invested approximately $628 million on 628 renovations. That's $1 million per hotel. I can actually do the math myself on that one, or roughly about $9,000 per key.

During the first quarter, the company repurchased and retired approximately $1.4 million paired shares for $23.1 million. Since commencing the repurchase program about a year ago, the company has repurchased and retired approximately $11 million paired shares at an average cost of $15.07 per paired share for $166.2 million. These repurchases represent over 5% of the shares outstanding at the beginning of 2016 and should provide a nice boost to earnings, free cash flow and adjusted FFO per share in 2017.

We ended the quarter with unrestricted cash of $64.8 million. Total debt outstanding, including unamortized deferred financing costs, was approximately $2.6 billion with a weighted average maturity of 7.3 years. We completed our term loan repricing in the first quarter, and our weighted average cost of debt is now approximately 4.4% with roughly 2/3 fixed and 1/3 floating interest rate. Our debt structure is low cost, long dated and flexible. Net debt to trailing 12-month adjusted EBITDA was 4.1x. We expect to reduce this metric to approximately 3.5x by the end of 2018.

This morning, the Board of Directors of Extended Stay America and ESH Hospitality approved a 10.5% increase in our quarterly distribution to $0.21 per paired shares. This marks the third year in a row, as a public company we have increased our dividend by over 10%, highlighting our commitment to shareholder return and confidence in our ability to deliver free cash flow. These distributions, includes $0.14 per ESH Hospitality Class A and Class B common share, and $0.07 per Extended Stay America common share. The distributions are payable on May 25, 2017, to shareholders of record as of May 11, 2017. As a reminder, ESH Hospitality expects to distribute approximately 100% of its taxable income.

We get many questions about our capital allocation. And I believe this quarter has provided a really strong case study in that regard. ESA's free cash flow of over $120 million during the quarter allowed the company to invest $48 million in CapEx, paid $37.5 million in dividends to paired shareholders, repurchased $23 million in stock and reduced our debt outstanding by approximately $13 million.

Let's talk about guidance. We are increasing our outlook for total revenues and adjusted EBITDA to -- for 2017. We expect total revenues of $1.285 billion to $1.31 billion on RevPAR growth of 1.5% to 3.5% and between $625 million to $640 million in adjusted EBITDA. We still expect a tax rate between 23% and 24%. We expect net interest expense of approximately $130 million, with net cash interest expense of approximately $120 million. We expect capital expenditures for 2017 to total $150 million to $180 million, which includes $30 million to $40 million in renovation capital and $10 million to $20 million in land acquisitions and development capital.

Our 2017 outlook does not reflect pending asset disposition. If these pending dispositions are complete in the second quarter, as we expect, it would lower our expectations for 2017 revenue by $7 million to $8 million, and adjusted EBITDA by $3 million to $3.5 million, but would have minimal impact, if any, on RevPAR.

For the second quarter of 2017, we are forecasting an acceleration of revenue growth compared to the first quarter and continued strong earnings growth. We expect RevPAR growth of 2% to 4% and adjusted EBITDA of between $170 million and $175 million, representing growth of approximately 3.5% to 6.5%. This outlook for the second quarter reflects the negative impact of Easter shifting into April and a benefit from lower renovation disruption beginning in May that will continue into the first half of 2018. There should be minimal impact on operating results from asset disposition in the second quarter.

Operator, 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 today is coming from Anthony Powell from Barclays.

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

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Just a question on your customer mix. You mentioned that your OTA business was up, corporate was down. Did that change throughout the quarter, meaning, did you see more corporate business in March than in January?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [3]

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Not really, Anthony. It was fairly consistent, year started soft, somewhat more driven by kind of the way that the holidays fell and the corporate business not really waking up, due to the fact that it was a new year until the middle of the month. But at the end of -- by the end of the quarter, there was no -- other than that one anomaly to start the year. There wasn't really any significant huge shifts that we noticed based on 1 month versus the other and one channel versus the other. It was a fairly consistent build of business. And then March was really a great month for us, and that trend has kind to continued, so that's where you see the guidance laying out the way that it did. So -- but it was -- overall, the patterns of business and the sources of business did not really shift in any significant way once you start looking at 3- and 4-week blocks rather than individual base.

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

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Got it. And so I guess your RevPAR guidance increased to 50 basis points, is that due to, I guess, stronger kind of OTA results? Or do you anticipate a more corporate demand later on in the year?

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Jonathan S. Halkyard, Extended Stay America, Inc. - CFO [5]

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Anthony, it's Jonathan. It really reflects the fact that our revenue performance has been accelerating through the first quarter, and we've seen that continue into April. So it's a modest increase in the overall RevPAR growth guidance for the year, but it really just reflects the trends we are seeing over the last 60 days and what we are seeing in the coming 60 days. Plus, of course, our confident around the conclusion of the renovation program and the performance of those newly renovated hotels.

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Operator [6]

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Our next question today is coming from Chris Woronka from Deutsche Bank.

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Chris Jon Woronka, Deutsche Bank AG, Research Division - Research Analyst [7]

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Gerry, you mentioned the lower distribution costs in the quarter despite more OTA business. Can you maybe elaborate a little bit more on that? And just what's your outlook for that going forward? Is that the trend that we would expect to continue?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [8]

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Yes, I think it's a trend that you can expect will continue in a way that we saw in the first quarter. It's being driven by some of the -- some accounting changes in the way that the difference is showing up, in the hotels whether it is net pay at the hotel, whether it is being handled through the Web. It is also the product of pretty concerted, pretty significant effort by our revenue management and our marketing teams in working with the OTAs. But for us, as opposed to perhaps a lot of the other players in the industry, OTA is our friend. The revenue management system and the discipline that we've installed over the last 1.5 year now have allowed us to be very nimble. On a property-by-property basis, we can allow the OTA business to fill in blanks and to filling blocks of rooms that otherwise would have gone unused. And the pricing of that OTA business winds up even after commissions paid and et cetera, winds up being net accretive to us, to our P&L, particularly when you think of the OTA not just as a distribution channel but as a marketing channel as well. In many cases, for these guests that they come to us through that distribution channel, this is the first time they have stayed at one of our hotels. So it winds up being both marketing and distribution. When you consider that, the OTA channel for us winds up being number one, very efficient and number two, very accretive. So we kind of welcome that business, and our marketing activity reflects it. And they know it, and we know it, and the guests know it, and it works out for all of us.

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Chris Jon Woronka, Deutsche Bank AG, Research Division - Research Analyst [9]

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That's great color. And then on the ESA 2.0, I guess, you have some moving pieces coming down later this year with few asset sales and maybe starting into develop a few hotels. How should we think about the pacing of that, heading into the next year and beyond, in terms of your initial franchise sales?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [10]

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I think that the pacing that you can kind of bake in a little bit is that we will file an FDD later on this quarter, we will then at the NYU Conference in early June, really sit down and begin having [substance] conversations with any number of partners with whom we've had preliminary conversations for the last 9 months. You'll see us do some franchising deals we anticipate in the second half of the year, likely that, that will be back-end loaded just because of the time that it takes to do some of these things. You will see us, in parallel to the franchising, also acquire 1 or 2 pieces of land and perhaps even begin construction. That's perhaps the easiest part of it all, because construction requires permits and every jurisdiction out there have different requirements for that. But certainly the land purchases, you can anticipate a couple of those. So this schedule, that I just laid out, it's a schedule that we discussed last June. The big hurdles where the wrap up of the renovation program, we are literally within weeks of doing that, then just staffing up with the teams, we have now done that. The capital is ample and has been allocated and preapproved by the board, so we are ready to go there. The FDD filing of it is a prerequisite. Frankly, it's been ready to go. We've been waiting for the team to be staffed, so that the people who are going to be selling their franchises have some ownership of the product that they are going to be presenting to partners. So all of these things are now beginning to intersect, and we think that the pace, which has been mostly in background work, the last, call it, 6, 9 months, now the next 6 to 9 months begins to accelerate and begins to be real and pay -- bear some fruit. I think that the true impact will begin to show up, frankly, in '18. This year is still going to be a lot of early on work in onesies and twosies. And it's really into '18 and '19 that you'll see us then start doing some work on bulk deals. That's the way it looks at the moment. Now Jim Alderman is here with us. Jim, anything you would add or correct me or -- keep me honest.

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James G. Alderman, Extended Stay America, Inc. - Chief Asset Merchant and EVP [11]

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Well, I don't ever correct the boss, that's is what I do. I do -- I will build on, really, what is an amazing amount of (inaudible), that's really unaided awareness that we're getting out of the franchiser and investor community. I wouldn't necessarily say it's all 100% franchise interest. There a lot of people who simply look at the margins that we operate in and have approach us in making decisions to want to build some of these on our own and even potentially have us manage them, which is a little bit of a twist, but we are the experts of this. And I think that -- those 2 efforts combined, we feel good about the Investor Day information that was last June and feel good about really hitting the goals that are in that.

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [12]

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Does that answer your question, Chris?

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Chris Jon Woronka, Deutsche Bank AG, Research Division - Research Analyst [13]

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Yes, that's great.

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Operator [14]

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Your next question today is coming from Shaun Kelley from Bank of America.

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [15]

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And I apologize I missed maybe a couple of the prepared remarks. So I'm hopeful I'm not making you repeat anything. But Gerry, just looking at the hotel operating expenses, I know you called out some changes in your kind of channel mix that may have impacted things. But what's the single biggest bucket of what kind of drove the operating expense decline at the hotel level in the quarter?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [16]

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The 2 biggest buckets, no surprise, are labor and maintenance. Our operators, and that's what we called out in the prepared remarks, both Jonathan and I did, have really excelled at keeping a lid on costs, being very efficient with the per-occupied room cost across the entire operation, being very efficient on the overtime hours and so on and being very good and very proactive about staffing the hotel to the anticipated load that the hotel is going to face. That's one of the benefit of this revenue management system that we rarely talk about and that is you can predict the low, couple 3 days out, half a week, a week out and that allows for your staffing level to really match your load a lot closer, and that allows our operators to really keep a tight lid on cost. The maintenance has also been pretty good. A lot of it having to do with the fact that, of course, the vast majority of the hotels are now being recently renovated, some of the older ones, perhaps 4 or 5 years. But the bulk of hotels were renovated a year or 2 ago, and of course, the renovated hotels requires somewhat lessening. Those were really the 2 stars. Jonathan, am I leaving anything out?

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Jonathan S. Halkyard, Extended Stay America, Inc. - CFO [17]

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Well, I do want to point out that everybody on the call probably remembers that in the fourth quarter we had a very strong performance on the cost side as well. Now there were a couple of items that were a bit unusual in the fourth quarter, and we called those out. This quarter was different. This quarter was just solid cost performance across the board, and I think not only from the diligence to the operator but benefiting from some investments that we've made. People don't appreciate all the time that the second or third largest cost category in our P&L is facility. Well, we've been allocating capital over the last couple of years in our heating/cooling units as well as our bathroom fixtures, and we are really -- we've seen the benefit of that in our utility cost, which isn't that sexy, but it makes a big difference in our margin. So this is probably the best cost performance we've had this quarter since I've been at the company, and that's one of the reasons we also have the confidence to improve our adjusted EBITDA guidance for the year.

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [18]

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And Jonathan -- I mean, to follow up on that, I think that's really impressive and appreciate the clarity. I guess, so the follow-up in -- like, this doesn't sound like it was simply a response to what relative year last few quarters has been, like, a little bit of a softer absolute RevPAR number. This isn't like -- this is more operational day-to-day, blocking and tackling. Am I off on that? Or is that a fair characterization?

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Jonathan S. Halkyard, Extended Stay America, Inc. - CFO [19]

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That's exactly right.

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [20]

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Okay. Great. And then my other question would just be -- and again sorry, if you gave this one, but what would be the cadence of capital spending, especially on the gross side, now that the renovations are kind of going down? Could you just give us either an update? Or what -- how you are expecting growth CapEx, in particular to trying across the year?

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Jonathan S. Halkyard, Extended Stay America, Inc. - CFO [21]

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Well, I'll give you a cadence for CapEx across the year and then I'll invite maybe Gerry or Jim to comment on growth. I interpret your question to be around, what we call, the ESA 2.0. We've spent almost $50 million of CapEx this quarter, which was a heavy amount of spending with the renovation program. That will decline in the second quarter and decline further in the third and the fourth quarter, as we, of course, complete the renovation program. And our CapEx guidance for the year does include some money for, essentially, real estate acquisitions. But the timing of that is difficult to forecast at this point. But there won't -- I don't expect there will be any meaningful growth CapEx until the third or the fourth quarter at the earliest.

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [22]

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That's right. We were in conversations with -- at 5 different sites in 4 different states, and now you're in that phase where you negotiated for the land and et cetera, et cetera. I would anticipate it'll be definitely not even third quarter before we are laying out some hard cash for some of the dirt. And then depending on permitting, whether or not that will then be followed up by some construction -- startup of a construction money, but it will definitely be back-end weighted, third and fourth quarter weighted. None of these amounts will be huge, certainly none of these amounts in total will equal -- for example, what we've been spending on the renovation front over any given quarter over the last 5 years. It will be significantly lower than that.

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Jonathan S. Halkyard, Extended Stay America, Inc. - CFO [23]

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Our guidance, Shaun, for the year in CapEx includes $10 million to $20 million of this growth capital. I'm still comfortable with that range. And if we update it at all, I can't imagine we would do that until our third quarter call.

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Shaun Clisby Kelley, BofA Merrill Lynch, Research Division - MD [24]

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Great. And $90 million to $100 million is still a good number on the maintenance side?

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Jonathan S. Halkyard, Extended Stay America, Inc. - CFO [25]

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Yes.

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [26]

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Yes.

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Operator [27]

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Our next question today is coming from Harry Curtis from Instinet.

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [28]

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Harry?

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Operator [29]

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Our next question is coming from Stephen Grambling from Goldman Sachs.

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Stephen White Grambling, Goldman Sachs Group Inc., Research Division - Equity Analyst [30]

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I may have missed this at the start, but now that you lapped the first full year with a centralized sales team and the initial gains in corporate accounts, what are some of the kind of key learnings and any adjustments you're thinking about to build on those initial benefits?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [31]

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Number one, how efficient they can be in bringing the business. And the way that we've had that group organized really breaks in through 3 different tiers. One, one tier of tax addresses the corporate opportunity with big national players. There is a second team which is really where the bulk of people sit and the team that really has to drum up the business at the local level. In difference to other people in our space, we don't have sales folks associated with each individual hotel, we'd rather have them by market. And that's part of our operating model and that's part of the efficiency, that's part of what we call a triangle team. And then the third piece, the third layer, sits here in our Charlotte headquarters, and they are an outbound call center, and they also support the field guys when we have to make bulk reservations and the like. The real secret to the secret sauce to our success has been in that structure, where we have specialists and it's a small group, couple of dozen, calling in those big national accounts, where the requirements and the needs of that group are vastly different, because they are spread, literally, spread all over the country, transportation companies and the like, where they have drivers or maintenance folks that are all over the states, okay? That is a very different set of characteristics than the folks at the local level, who are much more project-based, who are looking for rooms on a 2-, 3-, 4-, 5-month basis, because they have some work to do, whether it's a construction project or an IT project. And those, by the way, are 2 out of the top 3 verticals that we focus on, which has been the other key to our successes. We've learned and declared that construction, IT, and health care are the 3 top verticals that we focus on. Because when we do that, we learn that their stays tend to average a month and beyond and that is our sweet spot. When we get people in our hotel that are looking for 2 to 4 -- 2 weeks to 2 months, couple of months, 4 months, that's really the sweet spot -- the package, the value package that we present to that guest and the profitability for us of that guest is really the intersection that has allowed us to drive some of the results that you saw last quarter and this quarter. So there's been a lot of learning. We'll continue to optimize that group. They have responded great. The demand -- the industry demand for that corporate business has remained flat, but we believe that we made some significant inroads, and frankly, we see nothing but upside coming from that side of the business.

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Stephen White Grambling, Goldman Sachs Group Inc., Research Division - Equity Analyst [32]

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Great. And then as you've gotten through or getting towards the end of the initial renovations here, how wide is the performance in RevPAR index across the portfolio now? And if you have any outliers, what's kind of the typical driver in that?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [33]

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When you say -- help me a little bit, when you say how wide, what do you mean by how wide is it?

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Stephen White Grambling, Goldman Sachs Group Inc., Research Division - Equity Analyst [34]

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So do you still have a handful of underperforming properties? And where would that in RevPAR index be relative to your average? And just trying to think about getting that up?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [35]

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Got it. No, we do. I wouldn't call them underperforming, Stephen, for the simple reason that we reflect the market. No single one of our 629 hotels is anything but profitable. All of the properties run in the black. Well, we do see a wide gap on is, for example, the ADR that we're able to charge in a market like, say, Kansas City, St. Louis, Indianapolis versus the ADRs that we can get out of the Bay Area, East Bay, West Bay or in L.A., for example. It would almost lead you to believe -- if you were to look at those 2 in isolation, say, the Midwest versus the West Coast. You'd almost think you're looking at 2 different companies. Okay, because the ADR gap can sometimes be almost twice, not quite, but almost twice. But that's not a reflection of anything but the market that they're located in. Everything is more expensive in San Francisco, no surprise. And our hotels reflect the individual marketplace more than they reflect any other set of characteristics. It is not the only thing that comes into play, but it's largely driven by the individual marketplace. There is nothing -- when we look at the performance across the board, of all the hotels, there is nothing in looking at the differences that cannot be explained first and foremost by the location of the hotel.

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Stephen White Grambling, Goldman Sachs Group Inc., Research Division - Equity Analyst [36]

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Right. I guess most of what you just described is just geographical differences. But if you look at the RevPar index specifically, there is no difference then across the board?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [37]

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None that couldn't be 90-plus percent explained by the site, by location of the hotel. In some cities, you may see differences between the airport and suburban demand center, corporate office park or something like that. But mostly, what you'll see is lower RevPAR in the Midwest and higher numbers in either of the coasts, but certainly the East and West Bay and L.A. will have the higher RevPAR numbers. It's not unusual for us to have a hotel in the East or the West Bay, where the RevPAR will be a 3-digit number versus in the Midwest where it will be in the 40s.

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Operator [38]

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Our next question today is coming from Harry Curtis from Instinet.

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Harry Croyle Curtis, Nomura Securities Co. Ltd., Research Division - MD and Senior Analyst [39]

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So the first question is related to the 5 LOIs that you've got. Do you have a sense of what kind of RevPAR index premiums these might need to generate to spur developer interest? And as you try and do deals, franchising deals, what kind of returns do you think these new hotels are likely to generate that will pique their interest? And then the last question is, what are the features of these new developments that are maybe slightly different or more appealing to developers versus the bulk of your portfolio?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [40]

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Yes, so let me try and take them in reverse order. The appeal, we think, is going to be driven by a very much proven time-tested business model, where our margins are such that, that's what we are learning and we have learned over the last 9 months attracts the developer's interest, right? That it's not a brand-new brand, that people don't already know, in fact, the brand has been around 20 years, that is not a business model that is trying to be cute or edgy or appealing to a very narrow segment of the audience, it's not, that it's a chain scale that, by and large, has gotten forgotten by a lot of the other development work and a lot of the other brand work that the people are doing across the industry. So that combination, that brew, has held appeal, right? The fact that it's a proven brand, that it's a good business model, that the margins are so ample. It's what's piqued people interest which prompted a lot of the conversations, a lot of the phone calls that we've received. People get it, people get the fact that the hotel doesn't have to be in, what I call, the intersection of Oak and Main that people -- people get the fact that our customer base will drive an extra traffic light or 2 in order to get the kind of rate that we proposed, particularly when we bulk that right up for Extended Stays of a couple of weeks or a couple of months. So that's what we are finding is kind of the base, the fundamental appeal. When it comes to the returns, we've seen and the work that we've done goes back to the presentation that we put together and showed everyone last June. We pro-forma it at that time in the low double digits unlevered. We have seen nothing in the 9 months and the work that we've done on design, some of the preliminary conversations that we've had on land, some of the conversations we've had with potential partners that will lead us to believe that the assumptions made a year ago were incorrect anyway. So we don't want to get into business of predicting returns. Every situation is going to be different. But nothing that we've learned dissuades us from the assumptions that we made 9 months ago for that June presentation. So feeling pretty good about ESA 2.0 and the direction in which it's headed. We've had a lot of, frankly, a lot of inquires, folks that want to get into the brand and are anxious to do so. So very -- continued to be very, very encouraging. Then as I've said in the prepared remarks, Harry, anxious to get -- do some deals. It's nice -- it's been nice to have all of the conversations and the chit-chat. We want to get going on some of these things. And the time to do so is now fast approaching. Did I answer all of your questions? Or did I leave anything out?

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Harry Croyle Curtis, Nomura Securities Co. Ltd., Research Division - MD and Senior Analyst [41]

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That answered the bulk of it. I guess the follow-up would be, do you have any sense of how the low double-digit expected return compares to a developer looking at, say, developing a Residence Inn or a Home2?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [42]

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I'm going to let Jim give you some sense of that, because we've actually been doing some work on that. Jim?

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James G. Alderman, Extended Stay America, Inc. - Chief Asset Merchant and EVP [43]

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Yes. Harry, your initial part of your last question talks about index, and it's -- that's really misleading. It's kind of misleading for us, market-to-market, because it's really imperfect with our ability to get kind of perfect dataset in each of these individual markets. There's just not enough Extended Stay for us to reach out to. But as far as where we're targeting, where these things work, it's really an $80 to $85 ADR on this newbuilds, is the sweet spot and up. So to translate that into an index, it's certainly with index higher with this new product, but this is kind of transformational. And as far as our returns versus Residence Inn or Home2, it's really hard to say. They're -- we're really a different product type than they are. We have a much longer stay than both of those. Those are more of a -- they are both fantastic brands, but their room formats are a bit different and ours is truly targeted towards that long-term stay guest. I know theirs is set up that way, but if you would just look at their numbers, they are much more transient.

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [44]

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The average LoS, the average length of stay, Harry, even across some of the Extended State products by the majors will be 4 nights. So that's better than the 2 nights that they perhaps get in a transient business. But for us, in the mid-20s, 26-day length of stay, we really -- our [going to end] generation, and our brand really goes at a different consumer behavior, different guest behavior than those guys do. So it's tough sometimes to get to the right comp sets and so on. We operate in the higher end of economy, lower end of mid-scale. Most of those daily rates -- some of those Extended Stay products by the majors is going to be 1.5 to 2x our rate. A lot of them don't discount for the extended period for the Extended Stay, of course, that is our bread and butter. So it's just really winds up for the guest and his friend to make a decision. It almost winds up being apples and oranges. They are both fruits, but they taste different.

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Harry Croyle Curtis, Nomura Securities Co. Ltd., Research Division - MD and Senior Analyst [45]

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Yes, one would think that with your longer basis of stay, your labor costs are lower and your operating margins ought to be higher. So that, theoretically should be more appealing.

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Operator [46]

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Our next question is coming from Joseph Greff from JPMorgan.

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Brandt Antoine Montour, JP Morgan Chase & Co, Research Division - Analyst [47]

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This is actually Brandt Montour on for Joe. So I appreciate the color on near-term trends. And just looking at -- I think most of the industry are expecting some sequential deceleration due to the Easter shift. And I understand you had a tougher one Q1 comp, but can you just quantify what that Easter shift was for you in the 1Q? And what you are baking in Q2 guidance?

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Jonathan S. Halkyard, Extended Stay America, Inc. - CFO [48]

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We think the Easter shift was probably about 50 basis points.

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Brandt Antoine Montour, JP Morgan Chase & Co, Research Division - Analyst [49]

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Okay, great. And then regarding corporate transient, is it safe to assume that the acceleration you saw in 1Q was on the leisure side? And regarding corporate, what indicators do you guys track when trying to gauge how forward demand might -- may trend?

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Jonathan S. Halkyard, Extended Stay America, Inc. - CFO [50]

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When it comes to forward-look for corporate business, we really -- I mean, every Friday afternoon, we have a pretty significant download with all of our sales force around their lead generation as well as the booking trends, both out in the field and here in our centralized call centers, so -- and that is accompanied by a forecast kind of 30, 60, 90 days out from the sales force. So we look at environmental factors around what folks are saying about corporate demand. But since ours is so much project-driven, we really kind of do our own homework in that regard and try to build our forecast based upon what business we know is out in the market and our success at getting that.

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Operator [51]

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Your next question today is coming from Smedes Rose from Citi.

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Bennett Smedes Rose, Citigroup Inc, Research Division - Director and Analyst [52]

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I just wanted to ask a question on the development program. It sounds like you have a lot of interests so far from potential franchisers. Is there a point where you would scale back on your on balance sheet development, given better-than-expected demand from franchisers? Or do you feel like it's important to move ahead with that development pipeline?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [53]

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So a couple of perspectives on that. One is, we did a quite a bit of homework before we launched into this ESA 2.0. And part of that homework, part of the learning was, that the existing asset base could just about double across the geographies in which we operate. So we had 620-plus hotel base, the analysis show that we could have added another 600 hotels. Clearly, we're not going to do anything close to that, but it was reassuring and we've indicated a couple of times to know that, that demand exists out there and that we had ample room to grow. So that was kind of a point one then. Point 2 becomes a matter of balancing out our own balance sheet and kind of the great cash flow generation that each property can put up versus the fact that we just can't get to all of these opportunities. Even with 600 potential expansion, 600 site potential expansion -- even if you only wanted to do 2/3 of that, it's close, you are still not going to be able to get through all of the possibilities with your own capital quickly enough. So that's where the franchising really comes in. If we go back to the presentation last June, even then we were freely saying and admitting that we expect the bulk of the expansion, the unit count expansion, to come from the franchising side. That continues to be true to this day. We want to do something on our balance sheet, because we know that there are some great opportunities out there, because we know that the brand works. Frankly, the developers and the partners expect it that we will build the first couple of prototypes on our own bill, so that we can prove out the value engineering that looks great on paper actually works in real life. So that's the impetus behind the own balance sheet. That, and the fact that it generates great cash. Does that answer your question?

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Bennett Smedes Rose, Citigroup Inc, Research Division - Director and Analyst [54]

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It does. And then I just wanted to do a quick follow-up. Would the Extended Stay help with the financing at all for potential franchisers? Or will they be responsible for putting together their own financing packages?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [55]

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We may. We haven't committed to doing so or not. Frankly, we -- to be honest with you, the folks that we've talked to are all self-financing. The fact is -- the stated objective was to deal with companies and players who are, a, already in the industry; b, have their own sources of capital; c, know how to run a hotel, even if they don't run an Extended Stay hotel and certainly not run it the way that we do, at least they know what hiring and retaining people is all about. And that's a reason that we wanted to do that. Now if we come across an opportunity where we may need to provide some financing or enter in some sort of deal, we remain flexible and our cash flow generation as we stated in the prepared remarks and as you know is such that it would allow for that. So not saying yes, not saying no. More saying like we'll have to look at the individual opportunity and see how it shapes up and -- it wouldn't prevent us from doing a deal, put it that way.

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Operator [56]

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Our next question today is coming from Michael Bellisario from Baird.

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Michael Joseph Bellisario, Robert W. Baird & Co. Incorporated, Research Division - VP and Senior Research Analyst [57]

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Just wanted to stick on the development topic. How are you selecting your sites? And then how does the new supply, maybe like the Uptown Suites brand, that looks like it's going to be a direct competitor of yours. How does that impact your thinking today, as you select those sites?

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James G. Alderman, Extended Stay America, Inc. - Chief Asset Merchant and EVP [58]

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The way that we are -- it's Jim Alderman. The way that we are looking at selecting sites is much -- taking a look at what our great factors of success are now. Where the business that we currently seem to gravitate towards and gravitate towards us is located. And certainly, we are looking at areas where we already have significant operational density. We are not going to be building in one-off places. So we look for operational density. We look for the construction client -- the construction activity. We look at the high growth state, the medical activity, the tech. In general, we are looking at infill and suburban locations in the major cities where you see most of the significant growth in the country. We are concentrated right now on the first 5. We are in 4 states. We are looking in Colorado and Texas and Arizona, but we have several things working in the Southeast corridor or even couple of things opportunistically in the Northeast. So we are not limiting out necessarily any markets, but I think you can easily correlate where we're concentrating with the highest growth GDP states and GDP metro areas.

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [59]

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Operational density matters, demand generators matter. Those are kind of like the threshold questions. Of course -- can the deals be done right, and is the purchase acquisition costs, the land acquisition cost going to be reasonable, is the construction crew available, of course, all of those things matter as well. But if there is strong demand generators and Jim underlined a couple of them, right. We know health care is a good demand generator for us, we know that a growing market with a lot of construction activity is going to be a good demand generator for us, we know tech centers are a good demand generators -- hey, that's going to work. And then we already are in that market with a number of other hotels for our operators. That's part of the secrets sauce, the ability to source talent and retain talent is significantly better in any market where you have an operating presence already. And that, at the end of the day, is a people business, people serving people. And if we have those characteristics and if the land can be bought at the right price, we're in.

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Michael Joseph Bellisario, Robert W. Baird & Co. Incorporated, Research Division - VP and Senior Research Analyst [60]

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Got it. And then any thoughts on that Uptown Suite brand introduction?

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James G. Alderman, Extended Stay America, Inc. - Chief Asset Merchant and EVP [61]

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So the first one is in North Carolina. So we're going to drive by and see it. Don't know much of about it. Looks like, yes, it's an interesting proposition. We'll learn more once we visit. Congratulations to those guys. They got a very successful business, and it looks good. We'll learn more once it's open and running, and we can drive by.

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Michael Joseph Bellisario, Robert W. Baird & Co. Incorporated, Research Division - VP and Senior Research Analyst [62]

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Got it. And then just one quick follow-up on the OTA topic. Can you just quantify what percentage of that OTA business of yours is that first-time stay guest that you mentioned? And maybe any conversion metrics upon subsequent stays? Whether they go to brand.com (sic) [aboutstay.com] to book or enroll in the Extended Perks per room?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [63]

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What percent -- about 90% or 95% of the OTA guest is the first-time stayer. We try to measure it, but it's mostly imprecise data, but it looks to be pretty significant first-time stayer.

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Operator [64]

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Your next question is coming from Anthony Powell from Barclays.

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Anthony Franklin Powell, Barclays PLC, Research Division - Research Analyst [65]

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It's a follow-up on the Uptown Suite's question. Obviously, you have a very attractive business model. What's your view on more competitors entering the space over time, as people look for more development opportunities?

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [66]

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We welcome the competition. Fair and square competition is always going to be good. It's going to make us better, it's going them better, the guest is going to be served better. And I've never been in an industry and I've been in my fair share where we better served guests, better-served customers didn't benefit all of the players in the business. It's good to see, frankly, the segment getting some attention. Most of the time the economy segment, the mid-scale segment, the extended stay segment is forgotten. And I understand it right. The glitzy, glamor development get all of the attention and the headlines and everything else. The fact of the matter is that it's in our end of the segment that the majority of people stay, and we have tremendous demand that we know is going unserved, right. I mean, 8% of the rooms, 20% of the demand, 22% of the demand is service in our chain scale. So it's all, frankly, to the extent that new development and new players bring our end of the business more in the limelight, more to put it in the forefront. Let's -- have at it. I think it's all good. The sites will sort themselves out. The competition will sort themselves out. The guests will make their selections. I like the fact that these players entering lends an air of institutional validation to what we are doing. And that I think serves us well, Anthony.

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Operator [67]

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

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Gerardo I. Lopez, Extended Stay America, Inc. - CEO, President and Director [68]

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Thank you, Kevin, and thank you, everyone, for joining us this morning. We look forward to visiting with you again in the many investor conferences that we're going to be present over the next few weeks, and certainly, when we report our second quarter results in early August. Have a good morning. Have a good day.

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Operator [69]

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