Home Inns Q3 2009 Earnings Call Transcript

Home Inns & Hotels Management Inc. (HMIN)

Q3 2009 Earnings Call

November 9, 2009 8:00 pm ET

Executives

Ethan Ruan - Investor Relations Manager

David Sun - Chief Executive Officer, Director

May Wu - Chief Financial Officer

Analysts

Jeff Hugh - Green River Investment

Ming Zhao - Susquehanna Investment Group

Lin Ho - Morgan Stanley

Eddie Leung - Banc of America

Wendy Wong - RBF

Justin Quark - Goldman Sachs

Presentation

Operator

Hello and thank you for standing by for Home Inns’ 2009 third quarter earnings conference call. (Operator Instructions) I would now like to turn the meeting over to your host for today’s conference, Ethan Ruan, Home Inns' Investor Relations Manager.

Ethan Ruan

Hello, everyone and welcome to our earnings conference call for the third quarter of 2009. Our third quarter earnings results were released earlier and are available on the company’s website. With us today is David Sun, our Chief Executive Officer; and May Wu, our Chief Financial Officer, who will be further discussing our performance for the past quarter. After their prepared remarks, David and May will be available to answer your questions.

Before we continue, please note that the discussion today will include forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our filings with the SEC. Home Inns does not undertake any obligation to update any forward-looking statements except as required under applicable law.

As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on Home Inns' investor relations website at english.homeinns.com.

I will now turn the call over to our CEO, David Sun.

David Sun

Hello, everyone and thank you for your interest and your participation in our third quarter conference call. We are pleased to report another strong quarter with total revenues exceeding our guidance and reaching RMB727.4 million, an increase of 37.9% year over year and up significantly from the RMB642 million we recorded last quarter.

A renewal in domestic business travel helped drive this revenue increase, as the steady growth of our hotel chain across China. I am particularly pleased that this revenue growth did not come at the expense of our borderline performance [inaudible]. Our adjusted income from operations reached RMB115.6 million for the quarter, compared to RMB48.4 million last year and RMB74.1 million in the previous quarter. This 139% year-over-year increase and 56% sequential increase in operating income is directly related to our high revenues and careful measurement of our business model and a responsible growth strategy.

One year ago, the economic situation in China resulted in Home Inns facing a number of challenges that were unprecedented in their intensity and scope. At that time, we quickly and effectively put in place strategies that we believe would allow Home Inns to not only endure the difficult economic climate but in fact take advantage of opportunities and be positioned to benefit up and improvement of the micro trends in China. Over the second quarter, we saw the first positive impact of our performance on the financial results and I am pleased to note that the momentum has continued and that in the third quarter, we have again reported improved results, due not only to the recovery of the Chinese economy but the hard work and vision of our company.

On the basis of our refined growth strategy, during the third quarter we opened 36 net new hotels, including eight net leased and operated hotels and 26 franchise and managed hotels. The opening of 28 new Home Inns franchise hotels is testament to the strength of our Home Inns brand. As we continue to expand into the new region and demonstrate the quality of our brand, we expect our franchising success to continue, as potential franchisees are attracted by our ability to offer a profitable and reliable business model. In fact, there is renewed and accelerated interest in our franchising opportunity. As our performance continues to improve, we are becoming more confident regarding a gradually re-acceleration of our expansion plan for both the leased and operated hotels and franchise and M hotels.

This confidence stemmed from our operational performance during the quarter. For the first time this year, we have achieved a REVPAR level that is above that of 2008. REVPAR for the quarter recovered to RMB157, up from RMB155 in the same period a year ago and compared with RMB148 in the second quarter. This performance was driven by the strong occupancy rate during the quarter, which stood at 97%, compared with 86% in the same period a year ago and 92% last quarter.

While the improvement was driven to an intent by a more favorable travel environment, the low proportion of new hotels in the portfolio also has [inaudible] our occupancy rate upwards. On a sequential basis, seasonality also played a slight [favorable role].

The improvement in our strong occupancy rate was balanced by the expected decline in our average daily rate compared to last year. The ADR decline year over year resulted from Home Inns continuing to open more hotels in the low tier cities as well as the one-time comparison to the high Olympic pricing we saw in Beijing a year ago in August. Sequentially, our ADR was relatively stable compared to the previous quarter.

Our mature hotels demonstrate their ability to perform steady. REVPAR for those hotels in operation for at least 18 months was RMB169 for the third quarter of 2009, flat when compared to the how the group of hotels performance for the same period in 2008. This stabilization in mature hotel performance is welcome news following three quarters of decline in like-for-like comparisons. And we believe that their performance will continue to benefit in the entire Home Inns organization as the percentage of mature hotels continues to increase across China.

On the new hotels, those which were open for less than 18 months and mostly in the second and third tier cities, also show a better ramp-up pattern compared with how similar hotels performance during the same period a year ago. Overall, our performance this quarter is a result of a year of discipline, hard work, be rewarded by an improving economy, as well as the overall success of expansion strategy we pursued over the past few years. This strategy includes establishing a nationwide footprint and achieved a balanced mix of leased and operated hotels and franchise managed hotels. With this balanced revenue mix and overall good performance of our hotels across all city tiers, the recovery in our REVPAR level has also reached an inflection point in our margin. Even if we adjust for the favorable impact from low pre-opening costs, we have still seen our operating margin on the rise this quarter compared to a year ago. Given these factors, and our overall operating metrics, we are now looking a bit carefully and with caution at a reacceleration of our expansion plan. Looking forward, we anticipate growth at a fast pace than we have [allowed] for 2009. At the same time, please be assured that of the highest importance for us, to us is that we proceed while ensuring success and profitability over the coming years.

Now I will turn the call over to May Wu, our CFO, to walk us through the financials. May.

May Wu

Thank you, David. As I take you through the figures more closely, please note that I will only use RMB numbers. The U.S. dollar figures can be found in the press release.

As David already discussed, our revenues for the quarter increased almost 38% year over year to $727.4 million, exceeding the high-end of our guidance of $705 million. Total revenues from leased and operated hotels were $685.7 million, which represented 37.3% increase year over year, primarily due to a larger leased and operated hotel portfolio and to a lesser extent improved overall REVPAR. The 12.6% increase we saw sequentially can be attributable to a greater number of hotels, as well as continued improvement in REVPAR, both due to economic recovery and favorable seasonality.

Revenues from franchised and managed hotels were RMB41.6 million, which represented a 49.2% increase year over year and a 26.5% increase sequentially. Revenues from franchise and managed hotels for the quarter were impacted by the same factors that impacted our leased and operated hotels. In addition, the significant number of new franchise and managed hotels open during the quarter also led to higher initial franchise fees. Home Inns opened a net of 28 new franchise and managed hotels during the third quarter of 2009.

Total operating costs and expenses excluding share-based compensation for the quarter were $568 million, or 78.1% of total revenues, representing a 26.8% increase year over year and a 7.5% increase sequentially. Those rates of increase were lower compared with our revenue growth rate leading to margin improvement.

Now let’s take a look at those costs in more detail. After operating costs and expenses excluding share-based compensation, leased and operated hotel costs were RMB521.6 million, or 76.1% of leased and operated hotel revenues, down from the 81.4% in the same quarter of 2008 and 79.8% last quarter. The decline from 2008 was due to lower pre-opening expenses as hotels under construction fell while the sequential improvement was driven by a stable cost base being matched with improving REVPAR and hence revenues per hotel.

Pre-opening costs were RMB32.6 million in the third quarter of 2008, RMB10.2 million last quarter and RMB4.6 million in the current quarter.

Sales and marketing expenses were RMB7.2 million for the third quarter of 2009, a decline of 3.1% year over year and an increase of 36.9% sequentially. The decrease year over year was due to a less aggressive marketing plan in 2009 and a sequential increase was due to certain planned marketing activities during the quarter, following lower marketing spend in the second quarter.

General and administrative expenses were RMB46.9 million for the quarter and excluding share-based compensation, this [inaudible] RMB39.2 million, or just 5.4% of total revenue for the quarter, which is below the 6.5% of total revenue last year and 5.8% in the previous quarter. The improvement in the ratio of G&A expenses to total revenue reflects the cost of operational leverage that is being achieved with an expanding revenue base.

Net of the above mentioned expenses, as well as business tax of RMB43.8 million, income from operations for the quarter reached RMB107.9 million, or RMB115.6 million when excluding share-based compensation expenses. This is a notable improvement compared to the RMB74.1 million in the previous quarter and more than double the RMB48.4 million for the third quarter of 2008.

Our adjusted operating margin improved to 15.9% compared with 9.2% a year ago and 11.5% last quarter, largely due to reduced pre-opening expenses. In fact, this is the first quarter since the economic downturn and indeed the first since we wrote our lower tier city expansion activities on the full scale that we achieved improved operating margins, even if adjusted for the impact of pre-opening expenses. This is the result of improved performance of our leased and operated hotels, increased franchise revenue mix, and cost of leverage on our SG&A.

We are especially pleased that in this quarter, we saw good REVPAR results across the range of our hotel chain. Our mature hotels, those that are at least 18 months old and mostly in first-tier cities, had flat like-for-like REVPAR while our younger hotels, which are mostly located in second and third tier cities, also ramped up nicely, resulting in our overall REVPAR improvement.

Our strategy of continued expansion into all geographic regions and tiers of cities is being proven to be a profitable one and one which we are executing successfully.

Our adjusted EBITDA for the quarter reached RMB191 million, up 86.4% year over year and 28.1% sequentially. We generated substantial operating cash flow of RMB231 million for the quarter and for the first nine months of 2009, we have generated a total of RMB466.1 million in operating cash flow.

Net income for the third quarter was RMB86.7 million, which included a small gain of RMB4.3 million from repurchase of unconvertible bonds. Excluding this, for-ex loss and share-based compensation expenses were reported in adjusted net income for the quarter of RMB90.2 million, resulting in adjusted diluted earnings per ADS of RMB2.15 or $0.31.

At the end of the quarter, we are net cash positive with cash and cash equivalents of RMB755.4 million, and our convertible bond balance stands at RMB437.9 million.

As we look to finish 2009, our outlook for the fourth quarter of 2009 is a revenue range of RMB675 million to RMB695 million, based on the stabilization trends we are currently seeing while taking into account our moderate new hotel addition pace and a slower seasonal pattern in the fourth quarter.

We now expect our total revenue for the full year of 2009 to grow between 37% to 39% over 2008, up from the guidance of 33% to 35% year over year we announced during last quarter’s earnings call in August.

We are pleased with our progress and we look forward to updating you again soon.

David.

David Sun

Thank you, May. Home Inns remains the economy hotel leader in China and we have shown our ability and achieved strong results despite challenging conditions by making decision that balance in short-term realized with our long-term goal. Thank you for your attention and we are happy to answer all of your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Jeff Hugh with Green River Investment.

Jeff Hugh - Green River Investment

I have a question -- how many hotels do you think you will open in 2010 and how many will be franchise and how many will be leased and operated?

David Sun

Thank you for your question. In this stage, we plan to have about 180 to 200 new hotels open in 2010 that will be at least 60% is franchise hotels. Thank you.

Jeff Hugh - Green River Investment

Can I ask another question? I noticed that your mature hotel in third quarter REVPAR is the same as last quarter but your occupancy rate, overall occupancy rate is much higher, is higher than last quarter. So do you decrease some ADR for mature hotels in third quarter?

David Sun

No, actually we don’t -- we haven’t done the pricing adjustment in the third quarter. Actually, in the beginning of the year because of the economic conditions, we do review all the pricing in the whole company and we do selectively to reduce some pricing in the first cities, all cities.

Jeff Hugh - Green River Investment

Thank you very much.

Operator

Our next question is from Ming Zhao with SIG.

Ming Zhao - Susquehanna Investment Group

Thank you for taking my questions. Just two quick questions -- May, can I ask you why 4Q guidance shows some sequential decline in revenue? Is there anything to do with the swine flu consideration? And the second question is can you update us about the income tax rate going forward, what we should be looking at. Thank you.

May Wu

Sure. With regard to the fourth quarter revenue, we are glad you asked this question. Actually, as I mentioned, our guidance is based on a more moderate hotel opening schedule this year compared to previous years, while taking into account seasonality. As you may know, the second and third quarter are our strongest quarters, with the first quarter being the weakest but fourth quarter would be on a same -- on a apples-to-apples basis we do expect a sequential decline in REVPAR in our hotels. In the previous years, this is normally made up by the large number of new hotel openings that went into the portfolio; however, this year given our more moderate hotel development plan, the new hotels that will go into the portfolio as well as the new hotels we opened in the last two quarters that is ramping up, the revenue from this source is not sufficient to offset the seasonality. So this is the reason for the sequential decline. But we are not seeing any impact by the swine flu in China at this time.

With regard to the tax rate, you need to make a few adjustments when calculating our tax rate. For example, gains and losses associated with convertible bond repurchase as well as forex loss are not tax deductible. Share-based compensation expense is not tax deductible. After adjusting for these factors, our tax rate on a full-year basis should be in the 23% to 24% range.

Ming Zhao - Susquehanna Investment Group

Thank you. Very helpful.

Operator

Our next question is from the line of Lin Ho with Morgan Stanley.

Lin Ho - Morgan Stanley

Congratulations on the great quarter. I also have one question -- can you update us on the performance of H hotels in this quarter regarding the ADR and occupancy rate?

May Wu

Although we do not break out the exact performance of the H hotel, what we could report to you is that the H hotel continued to improve a bit gradually. Again, as we mentioned this is a -- this is the first hotel that is a prototype in a slightly high-end range and we are still tweaking the models and learning from our operational experience. I would say though we are pleased that H hotel finally reached EBITDA break even in the third quarter but we still have a lot of work to do and we have no immediate plan to roll it out.

Lin Ho - Morgan Stanley

All right, I see. Thank you.

Operator

Our next question is from the line of Eddie Leung with Banc of America.

Eddie Leung - Banc of America

Will you talk about the trend of the rental cost going forward? And do you see any pressure on rental cost? Thanks.

David Sun

Thank you for your question and for the rental, we seem to be very stable starting from the second half of 2008. Now although the economy is getting recovered, we still see the very stable rent in the domestic way. And also especially in the second or third-tier cities, we still see a very [inaudible] rental for our business.

Eddie Leung - Banc of America

Thank you.

Operator

(Operator Instructions) The next question comes from the line of Wendy Wong with RBF.

Wendy Wong - RBF

I just wondered if you have any plan to increase the pricing for those mature hotels in the top tier cities, especially if you see a strong rebound in the hotel demand in the past few quarters. Thanks.

David Sun

Thank you for your question and I think it is possible because if you look at 97% of occupancy, we do have ability to do that. I think it is -- as a company, we are balancing between the economic condition, especially in the beginning of this year. We did some adjustment for the pricing but after we saw the recovery of the economy and also the market condition, we do think about the adjustment of the pricing. And also for our strategy because we still are doing a very large expansion in this year and the next year, so we do a very conservative look at our pricing, especially in what we call the first tier cities, because we will be adding more units in the existing markets. But also if you look at the second or third-tier cities, not just first-tier cities, we believe that it is the opportunity in the near and -- short and near-term, we can see the pricing opportunity in there.

Wendy Wong - RBF

Thanks. I have one more follow-up actually regarding your relationship with CTRIP, since CTRIP took more than an 80% stake in Home Inns, have you increased any cooperation on the operation side?

David Sun

I think it is -- we are always doing what we call very independent, very fair business between us and CTRIP. Although they are the biggest investor in Home Inns, but they are -- it seems to be they are very financing purpose, so we are not doing a special deal with CTRIP, just doing some marketing connection between both parties. Thank you.

Operator

Our next question is from the line of Justin [Quark] with Goldman Sachs.

Justin Quark - Goldman Sachs

A follow-up question on the previous discussion regarding mature hotels, I just want to get a sense on the performance between the first tier cities and -- between first tiers and the second, third tier cities because I just want to see, do you see in the last two quarters any particular trends in terms of the ADR that you can achieve, and also the business mix, i.e. the mix between leisure and business customers between the two segments? That is my first question.

May Wu

I would say if you were to take a look at our mature hotels, our hotels that over 18 months old, in that portfolio still about half of those hotels are in first tier cities. Over the past two quarters, we saw a faster recovery in the second and third tier cities while continued stabilization in the first tier cities, so that’s the general trend we saw.

Justin Quark - Goldman Sachs

Thank you, and my second question is regarding your expansion plans -- you had mentioned that in 2010 you would like to achieve a 60% growth in terms of the -- sorry, 60% new hotel additions in the franchise segment. What is your overall target in terms of the split between these operated and franchise hotels for your overall portfolio? And do you mind explaining a bit on the rationale behind this split, if there is any [inaudible]? Thanks.

May Wu

Sure. As David mentioned, we -- our current plan, although we are still in the initial planning stage for 2010, our current plan is to open 180 to 200 hotels in 2010. This is a result of our continued experience in the economic recovery and based on our internal capability, as we did open over 200 hotels in 2008. So we are confident that we can achieve that.

Within the split, we are targeting at least 50% franchise and managed hotels and possibly 50% to 60%, and the rationale is two-fold. One is we want to pursue a balanced growth strategy. Our consideration is not only to expand but to expand with balance in preserving our margin and be self-funding going forward.

With that in mind, we have a limited number of leased and operated hotels that we want to open and we believe this would be the right strategy, given that we are already the market leader, we are in most of the markets that we want to be in, so we can manage to grow at a balanced pace.

On the franchise front, historically in our new hotels we’ve opened 30% to 40% franchise hotels while this year 2009, the franchise mix is over 50%, again taking into account a balance between growth and margin, as well as given the economic downturn. Going forward, the consideration continues to be that and in addition as we have already have a good presence in over 110 markets, we believe that those markets are ripe for us to continue to grow franchise hotels, so we will have a sufficient opportunity for us to grow the number of franchise hotels that may even exceed the number of leased and operated hotels. And as a matter of fact, we are seeing very strong demand in the franchisee community, given our proven profitability and performance.

Justin Quark - Goldman Sachs

Thank you.

Operator

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation. You may now disconnect.

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