Earnings Call Transcript - HLT Q1 2023

Operator, Operator

Good morning, and welcome to Hilton's First Quarter 2023 Earnings Conference Call. Please note that this event is being recorded. I would now like to turn the conference over to Brian Kucaj, Senior Director of Investor Relations. You may begin.

Brian Kucaj, Senior Director, Investor Relations

Thank you, Chad. Welcome to Hilton's First Quarter 2023 Earnings Call. Before we begin, we would like to remind you that our discussions this morning will include forward-looking statements. Actual results could differ materially from those indicated in the forward-looking statements, and forward-looking statements made today speak only to our expectations as of today. We undertake no obligation to update or revise these statements. For a discussion of some of the factors that could cause actual results to differ, please see the Risk Factors section of our most recently filed Form 10-K. In addition, we'll refer to certain non-GAAP financial measures on this call. You can find reconciliations of non-GAAP to GAAP financial measures discussed in today's call in our earnings press release and on our website at ir.hilton.com. This morning, Chris Nassetta, our President and Chief Executive Officer, will provide an overview of the current operating environment and the company's outlook. Kevin Jacobs, our Chief Financial Officer and President of Global Development, will then review our first quarter results and discuss our expectations for the year. Following their remarks, we will be happy to take your questions. With that, I'm pleased to turn the call over to Chris.

Christopher Nassetta, President and CEO

Thanks, Brian. Good morning, everyone, and thanks for joining us today. We're pleased to report that demand for travel remains strong, maintaining the trend that we saw in the back half of last year, which led to both our top and bottom line results finishing the quarter above the high end of our guidance. As we move forward, fundamentals remain strong, and we expect secular tailwinds to continue to support growth. Despite continued macroeconomic uncertainty, we're optimistic that the power of our network effect, our industry-leading RevPAR premiums, and our fee-based capital-light business model will continue to drive strong operating performance, unit growth, and meaningful cash flow, enabling us to return an increasing amount of capital to shareholders. In the first quarter, system-wide RevPAR grew 30% year-over-year and 8% compared to 2019. Rate continued to drive growth, up 11% compared to 2019, and system-wide occupancy reached 68%, up from the prior quarter and just 2 points shy of peak levels. Globally, all segments outperformed expectations, and the lifting of COVID restrictions in China drove significant recovery in demand across Asia Pacific throughout the quarter. As a result, RevPAR in the month of March exceeded 2019 levels across all regions and segments for the first time since the pandemic began. Given our strong results and positive momentum, we're raising both top and bottom line guidance for the full year, which Kevin will cover in more detail in just a few minutes. Turning to the segment details. Leisure trends remained strong throughout the quarter with RevPAR surpassing 2019 by approximately 15%, ahead of prior quarter performance. Strong leisure transient demand continued to drive rates up in the mid-teens above 2019 and occupancy fully recovered back to 2019 levels, driven by the surge in travel in Asia Pacific. Business transient also continued to improve with RevPAR up 4% from 2019, reflecting the resiliency of business travel, particularly for small and medium-sized businesses, which remained roughly 85% of our segment mix. Recovery in group remains robust with RevPAR finishing roughly in line with 2019 with steady improvement each month in the quarter and March exceeding 2019 by 5%. Demand for future bookings also remained strong with full year group position up 28% year-over-year and 3% versus 2019. Additionally, new group leads ended in the quarter 13% higher than 2019, an increase of 6 points compared to the prior quarter. Looking at the full year, based on the better-than-expected Q1 results, the accelerated demand across Asia, and continued positive momentum in group, we now expect full year system-wide top line growth between 8% and 11% versus 2022, assuming some slowdown in the back half of the year due to macroeconomic uncertainty, particularly in the U.S. Turning to development. In the first quarter, we opened 64 properties totaling over 9,000 rooms, celebrating several milestones, including the opening of our 500th hotel in China, our 100th addition to the Tapestry Collection, and the opening of the Canopy Toronto Yorkville, the Lifestyle brand's debut in Canada. We also opened 2 new Embassy Suite resort properties in Virginia Beach and Aruba, with the Aruba addition marking the brand's 10th international property. And after recently being ranked the #1 Hotel Franchise in Entrepreneur Magazine's Franchise 500 for a record-breaking 14th year in a row, Hampton by Hilton expanded its global presence to 37 countries with the brand's first property in Ecuador. While we expect to see some impact from the current financing environment, we are encouraged by the progress on the signings and starts front. We signed approximately 25,000 rooms during the quarter, growing our pipeline to a record 428,000 rooms, more than half of which are currently under construction. Signings in the quarter outpaced the prior year across all regions. And conversion signings in the quarter were 24% higher than the prior year, benefiting in part from the rollout of our newly launched brand, Spark by Hilton. The initial interest in Spark has been tremendous. We currently have more than 300 deals in various stages of negotiation, and our teams are working hard to deliver this exciting new premium economy conversion brand with hotels opening later this year. Hilton Garden Inn also continues to be an engine of global growth with 14 new signings across 6 countries in the quarter and over 60 working deals in 22 countries. Additionally, in April, we announced the signing of the Waldorf Astoria Jaipur, marking the debut of the brand in India and further demonstrating our commitment to expanding our world-class luxury brands across the globe. Construction starts for the quarter totaled over 19,000 rooms, up nearly 20% from the prior year, and starts in the U.S. were up more than 50% year-over-year. Our global under-construction pipeline is up 8% compared to March 2022. And per STR, we continue to lead the industry in total rooms under construction. Taking all this into account, we still expect to deliver net unit growth within our guidance range this year and remain confident in our ability to return to 6% to 7% net unit growth over the next couple of years. On the loyalty front, Hilton Honors grew to more than 158 million members, a 19% increase year-over-year and remains the fastest-growing hotel loyalty program. In the quarter, Hilton Honors members accounted for 62% of occupancy, an increase of 200 basis points year-over-year. Additionally, in an effort to further provide our loyal guests with an elevated wellness experience, in April, we announced the international expansion of our partnership with Peloton, bringing Peloton bikes to properties across the UK, Germany, Canada, and Puerto Rico, building on our existing partnership to make Peloton bikes available in all U.S. hotels. As one of the world's largest hospitality companies, we recognize Hilton has the responsibility to protect the planet and to support the communities we serve to ensure our hotel destinations remain vibrant and resilient for generations of travelers to come. In early April, we published our 2022 Travel with Purpose Report, outlining our latest progress towards our 2030 environmental, social and governance goals, including our efforts to reduce our environmental impact while creating engines of opportunity within our communities and preserving the beautiful destinations where we live, work and travel. We remain committed to driving responsible travel and tourism globally while furthering positive environmental and social impact and sound governance across our operations and our communities. All of our success would not be possible without the dedicated efforts of our talented team, and we continue to be recognized for our remarkable workplace culture. Recently, Great Place to Work and Fortune ranked Hilton the #2 workplace in the U.S., our eighth consecutive year on the list, and once again, the top-ranked hospitality company, an accomplishment I'm truly proud of. Overall, despite macroeconomic uncertainty, we believe that our world-class brands, dedicated team members, and resilient business model have us incredibly well positioned for the future. Now I'll turn the call over to Kevin for a few more details on the quarter and our expectations for the full year.

Kevin Jacobs, Chief Financial Officer and President, Global Development

Thanks, Chris, and good morning, everyone. During the quarter, system-wide RevPAR grew 30% versus the prior year on a comparable and currency-neutral basis and increased 8% compared to 2019. Growth was driven by strong demand in APAC as well as continued strength in leisure and steady recovery in business transient and group travel. Adjusted EBITDA was $641 million in the first quarter, up 43% year-over-year and exceeding the high end of our guidance range. Outperformance was driven by better-than-expected fee growth across all regions as well as strong performance in Europe and Japan benefiting our ownership portfolio. Management and franchise fees grew 30% year-over-year, driven by continued RevPAR improvement. Continued good cost discipline further benefited results. For the quarter, diluted earnings per share adjusted for special items was $1.24, increasing 75% year-over-year and exceeding the high end of our guidance range. Turning to our regional performance. First quarter comparable U.S. RevPAR grew 21% year-over-year with performance continuing to be led by strong leisure demand. Both business transient and group RevPAR finished above 2019 peak levels for the second consecutive quarter, driven by strong rate growth. In the Americas outside the U.S., first quarter RevPAR increased 56% year-over-year and 35% versus 2019. Performance was driven by strong leisure demand at resort properties where RevPAR was up over 60% compared to peak levels. In Europe, RevPAR grew 68% year-over-year and was 13% higher than 2019. Performance benefited from continued strength in leisure demand and recovery in international inbound travel, particularly from the U.S. In the Middle East and Africa region, RevPAR increased 32% year-over-year and 42% versus 2019, led by strong rate growth and group demand. In the Asia Pacific region, first quarter RevPAR was up 91% year-over-year and down only 4% versus 2019. RevPAR in China was down 5% compared to 2019, 32 points better than the prior quarter as demand recovery accelerated due to the lifting of COVID restrictions. The rest of the Asia Pacific region also saw a significant improvement with RevPAR, excluding China, up 19% versus 2019, representing an 11-point improvement versus the prior quarter. Turning to development. Our pipeline grew year-over-year and sequentially and now totals 428,000 rooms with nearly 60% located outside the U.S. and over half under construction. Looking at the full year, despite the near-term macroeconomic uncertainty, we still expect net unit growth between 5% and 5.5%. Moving to guidance. For the second quarter, we expect system-wide RevPAR growth to be between 10% and 12% year-over-year. We expect adjusted EBITDA of between $770 million and $790 million and diluted EPS adjusted for special items to be between $1.54 and $1.59. For the full year 2023, we expect RevPAR growth of between 8% and 11%. We forecast adjusted EBITDA of between $2.875 billion and $2.95 billion. We forecast diluted EPS adjusted for special items of between $5.68 and $5.88. Please note that our guidance ranges do not incorporate future share repurchases. Moving on to capital return. We paid a cash dividend of $0.15 per share during the first quarter for a total of $41 million. Our Board also authorized a quarterly dividend of $0.15 per share in the second quarter. Year-to-date, we have returned more than $600 million to shareholders in the form of buybacks and dividends, and we expect to return between $1.8 billion and $2.2 billion for the full year. Further details on our first quarter results can be found in the earnings release we issued earlier this morning. This completes our prepared remarks. We would now like to open the line for any questions you may have. We would like to speak with as many of you as possible, so we ask that you limit yourself to one question, please. Chad, can we have our first question?

Operator, Operator

And the first question is from Carlo Santarelli from Deutsche Bank.

Carlo Santarelli, Analyst

Chris, just in terms of the way you guys are thinking about the year, your guidance, obviously, from a RevPAR perspective, up about 350 basis points at the midpoint. First quarter obviously contributes some of that lift. You guys spoke to a tougher macroeconomic situation in the second half of the year on your fourth quarter call. How much has your outlook on the second half changed as obviously, you get some contribution from the first quarter, you have a lot of visibility in the second quarter? Just trying to understand within the context of that guidance if you've had any kind of change or pushing out of when you guys believe or when you're interpreting the macroeconomic conditions will toughen.

Christopher Nassetta, President and CEO

That's a great question. I mentioned macroeconomic uncertainty for a reason, as we are in an unpredictable environment. As reflected in our numbers and prepared comments, we're seeing strong performance across all segments. The leisure sector remains robust, and business travel demand and pricing have returned to pre-pandemic levels. The group travel segment is progressing, albeit at a slower pace, but I believe it will recover in the second half of the year with a high level of confidence. Importantly, we’re not observing any signs of declining demand. There is significant momentum. Every Monday, I meet with my executive team, representing all regions, and I always ask if they're seeing any issues with demand. The answer continues to be no. However, we acknowledge the inflation challenges in the U.S. and other parts of the world. Inflation is being managed and is in the process of normalizing, particularly here, although it hasn't fully resolved. The Federal Reserve has committed to addressing this, and I trust they will. I anticipate that the broader economic conditions will slow, which could eventually impact us. However, we haven’t felt this impact yet for a couple of reasons: first, there remains pent-up demand; second, spending patterns are shifting, with consumers prioritizing experiences over material goods. International travel is also on the rise, especially with China's reopening, though it's not back to previous levels yet. Supply in the industry is historically low and likely to remain so, which positively affects our position since we capture more than our fair share of supply. The fundamentals of supply and demand in our business remain strong. That said, I do expect a slowdown. Reflecting on how I feel compared to a quarter ago, I would say I have a greater sense of resilience in the economy, and inflation appears to be under control. My confidence in the Federal Reserve’s ability to manage this situation effectively has improved. I believe we may see a slowdown or a modest recession rather than a severe downturn. After a quarter of results and understanding the current half of the year better, I have increased confidence. That’s why we’ve raised our guidance for both revenue and profits, as I see enough momentum. The economy feels resilient, and I have more faith in the Fed to handle things without significant disruptions. While we do believe there will be a slowdown, possibly later in the third quarter moving into the fourth quarter, I think there’s a chance it could extend into next year due to the overall consumer strength. We've incorporated expectations of some slowdown in our guidance for the second half of the year, acknowledging that we still face uncertainty.

Carlo Santarelli, Analyst

Thank you, Chris. I have a quick follow-up. During the period, managed franchise RevPAR was 29%, and unit growth for franchises was 4.4%. Franchise fees increased by about 23%. I assume that's related to a comparison issue with some additional non-RevPAR fees from the first quarter of 2022?

Christopher Nassetta, President and CEO

Correct. The way to view those figures is that they are normalizing in growth rates, exceeding both algorithm growth and typical growth on a same-store basis. However, due to Omicron, we experienced an exceptionally high fee growth rate in the first quarter. Looking at the intermediate to longer term, we believe that all ancillary license fees and similar revenue streams will grow at a rate better than our usual algorithm growth. There is some year-over-year normalization occurring due to the impact of Omicron.

Kevin Jacobs, Chief Financial Officer and President, Global Development

And a little bit of mix as well, so the franchise business is a little more concentrated in the U.S. where RevPAR growth has not been as robust as outside the U.S.

Operator, Operator

And the next question is from Joe Greff from JPMorgan.

Joseph Greff, Analyst

Chris, I'd love to hear your views on and your understanding of what developers are feeling right now, just given changes in the credit markets and the banking environment, particularly with maybe limited service developers that are more reliant on regional banks for financing. Are they requesting more capital help from you guys? Do you think maybe they're pulling forward some deals maybe in an effort to circumvent future tightening? Can you talk about what your expectation is for maybe pipeline growth for the balance of the year? And then I have a follow-up.

Christopher Nassetta, President and CEO

It's still early, and we've been conversing with many in our ownership community regarding the banking issues that have emerged. Feedback varies widely; some have not seen much of an impact and are still securing financing, as evident from our rising numbers in U.S. starts. Some of that activity occurred before the regional banking challenges, while some was after. The top owners with strong relationships are still closing deals, which is enhancing our market share in a more challenging environment. Conversely, there are also those struggling to find funding, and others who indicate their banks are assuring them support but need around three months to assess the situation. It’s too soon to draw firm conclusions. Objectively, the Federal Reserve seems to be managing the situation reasonably well, aiming to prevent a widespread crisis among regional banks. Overall, we seem to be in a decent position. However, the net result in the near term will likely be reduced credit availability. We expect to capture more than our fair share because our brands perform well, which typically increases our market share when financing conditions tighten. Nonetheless, it's difficult to believe there won’t be some impact, although it hasn’t yet manifested; it didn’t appear in the first quarter. We expect our pipeline will continue to grow this year, but the critical question will be how well we convert those projects under construction. The first quarter was very strong, but the conversion process is likely to become more challenging as time goes on. On a positive note, when financing toughens, our market share tends to increase. The development pace in China may be slow now, but it's picking up, and I believe it will significantly contribute next year. Conversions remain a priority, and we anticipate a considerable increase in their percentage of overall deliveries this year, assisted by our Spark initiative, which offers low-cost entry with minimal reliance on the banking sector. That was not the primary reason for launching Spark; our focus was on enhancing service and expanding our network. Nevertheless, the timing has turned out to be quite advantageous. While it may not have a substantial impact this year, I foresee significant contributions starting next year and beyond. Ultimately, what’s happening in the banking sector is expected to affect limited-service operations, which rely heavily on regional and local bank financing. They will scale back, but most will navigate through this, resulting in less credit and some slowdown in the industry.

Joseph Greff, Analyst

Great. Thank you for that, Chris. And just my follow-up question is this, the system-wide RevPAR is flat, which is sort of what's baked into the second half guidance. But if we just think about it for the intermediate term, not that you're guiding to anything beyond the second half, do you think fee growth can be in excess of RevPAR growth, just given the rooms growth in the last few years?

Christopher Nassetta, President and CEO

Should be, yes. It should be mathematically, yes. The algorithm is, as you know, so the same-store plus unit growth. And we've been delivering on average even through COVID, 5-ish, maybe a tick over, even in an environment that is being impacted by some of the things I just described. We believe we'll continue to do that as we manage our way over the next couple of years back up to the 6% to 7%. And so even in a no-growth same-store environment, which is not certainly what we're experiencing now for the record, as you can see, but even in that environment, fees would continue to grow with unit growth.

Operator, Operator

And the next question is from Shaun Kelley from Bank of America.

Shaun Kelley, Analyst

Chris, I wanted to focus on the development activity, but let's discuss the longer-term outlook. Could you share your insights on how the situation unfolded during the global financial crisis? Specifically, I'd like to understand the impact of the three main drivers of domestic unit growth. This includes reliance on the financial system, the conversion activity with a promising pipeline of brands, and the international aspect. Can you provide insights on how these two areas might play out as we move into 2024 and 2025? How much could they contribute to achieving a mid-single-digit net unit growth target in various scenarios, especially considering potential challenges in financing and a tougher macro environment?

Christopher Nassetta, President and CEO

Yes, that's the right question. We do expect to see some impact, but we feel good about staying in the range you mentioned. We've maintained around 5 during the toughest downturns, including COVID, and believe we can continue to do so as things stabilize. Our strategy includes gaining market share, as our products perform better than others and we hold the top market share brands. While there may be less new construction locally, we will work hard to capture a larger portion of that market. We are well-positioned for conversions, especially compared to the Great Recession, with more options in terms of brands. The Spark initiative is particularly promising, as it offers a strong product at a competitive price point with minimal dependence on financing. While many conversions are tied to asset transactions where ownership changes, we will still pursue conversions that don't involve ownership changes, even though this adds some pressure. Spark will contribute to unit growth, with the potential for around 20,000 rooms. The conversion cost is significantly lower than that of new builds, which often require financing upwards of $10 million or more. It's important to note that the current banking situation in the U.S. is different from the global crisis experienced during the Great Recession. Although Europe has been somewhat affected, the focus remains on opportunities outside the U.S., with China expected to take a bit longer to rebound. However, we anticipate that growth in China will catch up in 2024 and 2025 as conditions improve. Our growth strategy will rely on conversions, international expansion, and increasing market share in the U.S. Additionally, we're preparing to launch a new brand in the extended-stay segment at a lower price point, which we expect to be cost-efficient to build. This initiative responds to requests from our ownership community and customers, and while it won't impact this year, we expect it will generate significant interest starting in late 2024 or early 2025. Our existing Home2 brand has shown incredible demand throughout COVID, and we believe this new brand will also resonate with customers, offering higher margins. As financing conditions improve, we are optimistic about reaching our net unit growth target of around 5, and eventually moving towards 6 to 7 over the next few years through a combination of the strategies we discussed.

Operator, Operator

And the next question is from Smedes Rose from Citi.

Smedes Rose, Analyst

I just wanted to ask you quickly on that extended-stay launch. We've seen a lot of products from different brands being launched to the extended-stay segment. And I was just curious, what do you think is driving so much interest from customers? And are they abandoning another segment of mid-scale? We don't get data or at least in our case, we don't get extended-stay data specifically. We just see the chain scale data. I'm just wondering what sort of shifts you're seeing within that, that it's leading so many people to launch into that sector.

Christopher Nassetta, President and CEO

We were already noticing a demand for workforce housing before COVID, as people sought more mobility in their lives and the ability to work from different locations without committing to a long-term lease. They wanted to avoid the hassles of signing a rental agreement and paying a one-year deposit. Even before the pandemic, demand was exceeding supply. When COVID occurred, it accelerated the trend toward mobility. While many are returning to the office, the environment has changed significantly. A larger portion of the workforce will be working remotely on a permanent basis, enjoying more flexibility throughout the week. As these changes continue, we see increasing demand amid limited supply, which strengthens the market fundamentals. Regarding our upcoming product, we’ve nearly completed the development and it represents a hybrid of apartment efficiency and hotel features, with a ratio leaning more towards apartment efficiency. There is a substantial unmet need for workforce housing, catering to individuals requiring temporary stays of 30 to 120 days. In contrast, most existing extended-stay brands cater to shorter stays of 5 to 10 days. This new offering addresses a different demand from various location types, and it complements our existing brands like Home2 and Homewood without being competitive. I didn’t mean to elaborate so much, but this initiative represents the potential for hundreds of hotels over time, not just 50 or 100. In 10 years, our presence will be comparable to that of Home2, with multiple locations because we believe the need is currently present and expanding. Many others are entering this market, but we have a proven track record of successfully launching brands and achieving scale, creating network effects within our offerings. Our system consistently delivers the highest market share in the industry. For owners considering building similar products elsewhere, they will recognize the strength of our system. Ultimately, consumers tend to gravitate toward products that meet their needs effectively, often resulting in higher margins and market share. We are poised to replicate our success in this new segment, and we have invested considerable effort into it. By the next time we meet, we hope to share updates on how many deals we have lined up.

Smedes Rose, Analyst

Can I ask a quick question? The difference in gross room additions in the first quarter seems wider than what we've observed before. Is this a seasonal trend, or was there something specific on the deletion side that you can highlight?

Kevin Jacobs, Chief Financial Officer and President, Global Development

No, removals are in line with what we typically see. We expect around 1% for the year. In terms of gross rooms, during the first quarter, gross room additions were lower while deletions remained relatively constant. That explains the difference.

Operator, Operator

And the next question is from Stephen Grambling from Morgan Stanley.

Stephen Grambling, Analyst

Maybe following up on some of your comments about the new brand launches, Spark and then it sounds like another one in the extended-stay. When you think about going into some of these lower-end chain scales, I think many of the peers often see higher attrition rates or deletion rates. What can you do to ensure that the attrition rates from your brands are more resilient long term? And have you seen any evidence of that from your current lower of chain scale brands such as Tru?

Christopher Nassetta, President and CEO

No, I mean, are you referring to losing hotels out of the system? Here’s the thing: what we do is significantly enhanced by delivering strong commercial performance. We have great brands that resonate with customers, effective loyalty programs, and products and services within those brands that truly connect with our audience. Ultimately, our commercial strategies yield the highest market share. If you consider brands like Tru or Hampton, I would estimate that nearly all the exits from those brands are by our decision. To my knowledge, there haven’t been any Trus that have exited since it's a relatively new brand; likely none at all. For Hampton, we choose to part ways with properties whose time has come, either due to their location or condition not meeting our standards. Thus, our attrition rate is very low. The reason for this low attrition is that our leading brands dominate their categories and capture a significant market share. As we develop Spark and our new extended-stay brand, it’s crucial that we get it right. We aim to achieve high market share and ensure that our product truly meets customer needs. Customers are not inclined to leave because our track record in the key categories is outstanding. When reviewing all our extended-stay brands—Home2, Homewood, Hampton, Tru—most of the attrition comes from our choices.

Stephen Grambling, Analyst

That's helpful context, and that's my one question.

Operator, Operator

The next question is from David Katz from Jefferies.

David Katz, Analyst

I wanted to just go back to Spark because obviously, a lot of enthusiasm and success and it's unlike things that you've done before. If we look at the makeup of the deals that you've put together, I'd love some color on what's in there. Are those independents that are looking for a brand? Are those switching from other brands for one reason or another? Are any of the hotels switching within your system into it that may have otherwise departed for one reason or another?

Christopher Nassetta, President and CEO

Yes. Regarding the 300, I would say almost all of them are coming from other brands in the economy sector, with only a small number related to us. There are a few hotels that we think will work for Spark even though they wouldn’t be suitable for Hampton, but that’s a very small amount. Most of the data points are tied to other brands in the economy space, and I have some of that information, but I'm not sharing it.

David Katz, Analyst

Fair enough and understood. My follow-up is when we look at the revenue intensity of adding in this category, how does that measure up with your other brands? Obviously, the upper upscale, a unit is generating more, right? But how does the fee structure and the revenue intensity of this measure up and add to your system?

Christopher Nassetta, President and CEO

Yes. The fee structure is similar to other fee structures, but they are smaller and at a lower rate. We estimate the rate to be around $80 to $90, in contrast to the net Tru rate, which is in the $120s, with Hampton around $140. They are comparable in size, and many of the Trus and Hamptons have a lower average daily rate by design. Therefore, the per pound fees will be somewhat lower, especially compared to upper upscale businesses. It's essential to note that we aim to create a network effect. This represents a significant customer acquisition tool for us, as there are around 70 to 80 million travelers in this segment, half of whom are younger individuals who can only afford this pricing. While we serve some of them, we still have much room to grow. The opportunity lies in getting these customers engaged with our system early by providing the best product available in the economy space. Every hotel and customer-facing element must meet our standards, and we control access until those standards are met. Additionally, it's important to consider the infinite yield aspect. We bring in millions of new customers who will eventually upgrade and use our other products. Our brand has been built through hard work and successful negotiations, and while the per pound fees may seem lighter, we aren't incurring costs for them, which contributes to the infinite yield. We continue to develop these incremental fee streams. Just like someone might have questioned the potential of Hampton over 30 years ago when it started with a $50 rate and 100 to 120 rooms, the reality is that Hampton has become a multi-billion dollar value. The ultimate potential of Spark is even larger because it targets a bigger market share. We are very enthusiastic about it, as we believe it will drive not only new unit growth but also significantly enhance earnings as it develops, ultimately increasing the overall value of the company.

David Katz, Analyst

Sounds like no meaningful key money there either?

Kevin Jacobs, Chief Financial Officer and President, Global Development

Yes, I think David, just to add a bit, Chris covered it well. The capital intensity in our business is significantly higher at the upper end. As you progress up the chain scale, the deals become more competitive and require more capital. Additionally, from a revenue intensity perspective, as Chris pointed out, when we incorporate these lower fee per room hotels, the fee per room naturally decreases. However, when we project this over a long period, you'll find that the fees per room do not...

Christopher Nassetta, President and CEO

Keep going up.

Kevin Jacobs, Chief Financial Officer and President, Global Development

They continue to increase over time, and we are still growing at what we often refer to as an algorithm. If you consider same-store sales alongside NUG, the fees per room and the growth of those fees are maintaining that pace. Part of this is due to the non-RevPAR-driven fees that Chris mentioned earlier in the call, which we believe will keep growing at a rate that surpasses the algorithm. When you incorporate all of this into your model, it remains surprisingly steady and continues to grow.

Operator, Operator

The next question is from Robin Farley from UBS.

Robin Farley, Analyst

I wanted to ask a little bit about the business transient performance in the quarter. I know you talked about RevPAR being ahead of 2019 levels. But I wonder if you could give us a sense of where either occupancy or number of business transient nights in the quarter compared to Q1 of '19. It seemed like from kind of broader industry trends, that Q4 didn't show that much sequential improvement from Q3 in terms of that change versus 2019. And maybe you'll say, of course, it may not matter at all when you have RevPAR performance as strong as what you have. So I'm certainly not saying it's not a strong quarter, but I'm kind of curious what's going on with that business transient night piece event.

Christopher Nassetta, President and CEO

Yes. Globally, business transient improved from the fourth quarter to the first quarter, rising from approximately 1.03 to 1.04. Notably, the overall occupancy level in the first quarter has returned to or slightly exceeded its previous peak for the first time. This is a global figure, not just in the U.S. The reason for this trend, despite what you may be hearing, is quite straightforward: it's driven by small and medium-sized enterprises (SMEs). While larger corporate entities are cautious due to global uncertainties and may be limiting their travel, my interactions at a recent major customer event did not reflect this concern among big corporations. Year-over-year, they are traveling more, though perhaps not as much as they initially planned. However, SMEs, which constitute 85% of our business, are performing exceptionally well. Larger corporations have not returned to previous levels, and while they might recover gradually, they aren’t significantly cutting back on travel as they have already made substantial reductions. Instead, their spending seems to be stabilizing. We have intentionally shifted our business mix to prioritize SMEs, which are more resilient and fragmented. Business transient is doing well, and in the first quarter, both prices and volume were at or above previous levels, and this positive trend is continuing into the second quarter, although it is still early.

Robin Farley, Analyst

Okay, great. Very helpful. And then just the other question, kind of a small one is your distribution through OTAs, I have to imagine that as business transient is coming back, that your OTA distribution is moving down compared to last year, just given that leisure is not as big a percent of total.

Christopher Nassetta, President and CEO

It's normalizing. It's slightly elevated relative to pre-COVID but not much and has come down a bunch. And we expect probably by the end of the year, certainly into next, it will be normalized with where it was, which is where we want it to be.

Operator, Operator

The next question is from Brandt Montour from Barclays.

Brandt Montour, Analyst

I was wondering if you could just dig in a little bit to the drivers of the conversion activity, taking Spark out of it. Chris, you mentioned potentially lower hotel transaction activity from financing headwinds putting pressure as well as financing being a headwind in and of itself for doing non-Spark hires and conversions. I guess could you stack that up against some of the maybe positive tailwinds, perhaps enforcement of brand standards across the industry, foresee more trade down or even more independents getting more nervous looking for brands? How do you look at all those factors on a net basis later into the year?

Kevin Jacobs, Chief Financial Officer and President, Global Development

Yes, outside of Spark as we've covered that, I think you've got a couple of factors. One is yes, in sort of an environment where people are expecting demand to soften, they tend to seek out brands more often, and obviously, they tend to seek out the stronger brand. So it's being driven by somewhat of demand for independent hotels converting to brands. And then I think the other factor is in an environment where credit's tighter, a cash-flowing hotel, right, so acquiring a hotel and that's already cash-flowing, it's easier to finance than new construction. So I think those are the two primary drivers. And then you think about some of the things that are going on around the world. But they're generally driven by transactions and generally in a softening demand environment, easier to finance and more demand for the branded systems.

Operator, Operator

The next question is from Bill Crow from Raymond James.

Bill Crow, Analyst

As we think about the change to your guidance for 2023, how much of that is driven by areas outside the U.S.? And has there really been any change or any positive change to U.S. expectations?

Kevin Jacobs, Chief Financial Officer and President, Global Development

Yes, Bill, what you're observing is a broad positive change across all regions. As Chris mentioned earlier in the call, this is primarily due to strong demand continuing into the second quarter. We are slightly raising our expectations for the second quarter and a bit for the third quarter as well. While we anticipate a slowdown in the latter half of the year, the outlook is improving in all regions, including the U.S.

Bill Crow, Analyst

A follow-up. I'm going to actually switch my follow-up, and I want to actually address something you just said, Chris, which is that large corporates seem to be flat in their demand. And I'm just curious whether this early in the recovery, and I know there are issues going on in tech and financial services in particular, but does this give credence to that argument that business travel never fully recovers?

Christopher Nassetta, President and CEO

I don’t think that’s the case. The evidence suggests otherwise. Business travel has already started to recover in the first quarter. For us, this means that as the environment stabilizes, there is potential growth in business travel. We’ve successfully shifted towards small and medium enterprises, and on a volume basis, we’re back to where we were. Although the rate base is higher, large corporations are still traveling, and they are not all the same. The impact is seen primarily in technology, banking, and consulting. Other major corporate sectors are growing but have been held back by these industries. As those sectors stabilize and start planning for the future and getting their sales teams back out, we can expect growth. In the next year or two, I believe that when the environment becomes more certain, business travel, in terms of both volume and price, will exceed previous peaks. I feel the same way about group business. The past three years haven’t just led to pent-up demand; they have reinforced the importance of in-person interaction for culture, collaboration, and innovation. I previously mentioned that once we get through this, the environment will resemble the past more than it currently does, and I still stand by that. The data supports this perspective. Looking at our business mix this quarter compared to pre-COVID, the major segments of business transient, leisure transient, and group are nearly the same. The only change is that leisure is slightly higher, while group is slightly lower, but overall, we’re close to pre-COVID levels. Group travel will take time to return, while leisure has been performing well. As we continue to attract high-rated groups, I expect our mix to improve. Therefore, I don’t see support for the argument that business travel won’t fully recover; the data contradicts that notion at this time.

Bill Crow, Analyst

Look forward to seeing you early next month.

Christopher Nassetta, President and CEO

Yes. Same.

Operator, Operator

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the call back to Chris Nassetta for any additional or closing remarks.

Christopher Nassetta, President and CEO

Thank you, Chad. Thanks, everyone, for your time today. These are interesting times marked by uncertainty. However, as you can see, we are very pleased with our performance in the first quarter and optimistic about the second quarter. In fact, we have a positive outlook for the entire year. We are staying vigilant about global developments, but we continue to perform well and deliver results, and most importantly, we are increasing our capital returns, which we will maintain. Thank you for your time, and we look forward to speaking with you after the quarter.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.