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Home Inns & Hotels Management Inc. (NASDAQ:HMIN)

Q3 2013 Earnings Conference Call

November 14, 2013 8:00 p.m. ET

Executives

Johnny Wang – IR Director

David Sun – Chief Executive Officer

Huiping Yan – Chief Financial Officer

Analysts

Ella Ji – Oppenheimer

[Bailey Yu] – Goldman Sachs

Billy Ng – Bank of America-Merrill Lynch

Lin He – Morgan Stanley

[Cyrus Ng] – Deutsche Bank

Long Lin – Brean Capital

Operator

Ladies and gentlemen, thank you for standing by for the Home Inns Group's Third Quarter 2013 Earnings Conference Call.

(Operator Instructions).

I'd now like to turn the call over to your host for today's conference, Johnny Wang, Home Inns Group's Investor Relations Director.

Johnny Wang

Thank you, [Sarah]. Hello everybody and welcome to our earnings conference call. Our third quarter 2013 earnings results were released earlier and are available on the company’s website. In addition, we have posted a slideshow presentation on our website which you can download and use to follow along with today's call.

With us today is David Sun, our Chief Executive Officer, and Huiping Yan, our Chief Financial Officer, who will be discussing our performances for the past quarter and outlook for the rest of the year. After their prepared remarks, David and Huiping 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 US 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 public filings with the SEC. Home Inns Group 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 Group's Investor Relations website at english.homeinns.com.

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

David Sun

Thank you, Johnny. Hello everyone and thank you for joining us today to discuss our third quarter 2013 results.

We delivered stable overall performance and a solid margin expansion for the third quarter of 2013. In summary, we met our revenue expectations for the Group with RMB1.74 billion in gross sales. Mature hotels maintained a stable performance, achieving 92.1% occupancy. Occupancy rates for Motel 168 reached above 85% for the quarter and we saw improving trends continue for both operating metrics and the bottom line results.

Performance targets are substantially met as our conclude Motel 168 integration this quarter. We are excited about the healthy growth momentum and the quality operations of our franchised business. It enabled us to achieve strong network expansion with net capital investment and steady margin expansion.

In addition to increasing franchised and managed revenue mix and additive contributions from Motel 168 operations, other drivers for our margin improvements such as cost control, operating efficiency and productivity enhancement initiatives are effective in improving profitability and strengthened cash generation. We're again 2.2 percentage points in adjusted EBITDA margin for the quarter and we are expected to achieve free cash flow positive on a full year basis.

Our strategies are sound and our execution is solid. With a stable and gradually improving macro environment, we are on track to maintain scale leadership and achieving profitable growth and returning increasing value to our shareholders.

Let's take a more detailed look at our operational results. Group occupancy rate decreased to 89.4% from 90.3% and ADR decreased slightly year over year to RMB173 from RMB174, resulting in decrease in RevPAR by 1.9% to RMB154 from RMB157 a year ago. This set of results was in line with overall industry performance, taking into consideration the market conditions and the geographic profile. Sequentially, RevPAR increased 6.2%, which was better compared to the peer performance.

There were 1,465 hotels in operation for at least 18 months in the quarter. These mature hotels maintained a flat ADR year over year at RMB175. RevPAR was down 0.6% year over year, driven by 0.6 percentage points decline in occupancy rates from 92.7% to 92.1%. 1,143 of the 1,465 mature hotels were Home Inns and Yitel hotels. While ADR was held flat at RMB179 year over year, occupancy rates decreased to 94% from 95.8% for the quarter, resulting in a RMB3 decrease in RevPAR from a year ago.

We believe that about 90% occupancy while maintaining ADR indicating a stable operating environment, healthy demand, and a reasonable level of competition during the [ramped] supply growth. Even so, it is not reasonable to expect above 90% occupancy rate to last forever as new supplies rush into the market.

We saw opportunity in enhanced value proposition in our existing product and service. Many of our high-performance hotels are in need to modernization after receiving millions of cash over the past decade. We plan to maintain the total amount of annual capital investment at RMB1.1 billion to RMB1.2 billion and which decreased in leased and operated hotels investments.

A proportion of the capital investment will go towards mature hotels. We have launched our utilization program last quarter and have received positive guest feedback and operational results. Over the next 18 to 24 months, about 400 of our early vintage hotels will go through the necessary upgrades. Together with continued repair and maintenance program, our hotels will keep providing value to our guests and the company is well-prepared to capture the next stage of growth potential of China economy.

Specifically about Motel 168, the top line results came in within guidance, with RevPAR increasing 3.7% year over year to RMB139. Occupancy rate increased to 85.1% from 82.7% year over year and ADR increased to RMB163 from RMB162 a year ago. Mature Motel 168 hotels gained full RMB in RevPAR year over year due to increase in occupancy to reach 86.5% from 83.9% same period last year. The integration of Motel 168 span across the persistent period of economy weakness. Yet we focus our [primary] approach and have successfully turned the business around. We believe the improvement trend will continue for Motel 168 brand even after we conclude integration by the end of this quarter because of further operational effectiveness expected and the acquired hotels, as well as new Motel 168 hotels which will energize the entire brand portfolio.

On the subject of franchise operations, we continue to see our strong brand, well-established and successfully run franchise programs attracting quality investments seeking stable return. As of the end of the quarter, franchised and managed hotels represented nearly 60% of our total hotels in operation, and over 77% of the pipeline are franchise and management contracts.

For [our channel] operation, it is crucial to balance quantity and quality. This is even more important for the rapidly expanding franchise operation, from the front-end marketing and promotion to prospecting, from a potential screen and contract drafting, from the preopening activities to operation commencement, from daily operation [indiscernible] to ongoing franchise relationship management, our track record and continued business have won us loyalty, and confident from existing and new franchise [partnerships].

Franchise [interests] are rising for our midscale brand Yitel hotels. The strong performance of existing Yitel hotels added to our confidence and conviction that Yitel is a meaningfully differentiated product catered towards midscale business and leisure customers who are seeking quality at a competitive price is the basis of Yitel's brand value. Further even the operations experience, we are ready to advance franchised development as well as other forms of business model where we accelerate the pace of growth of Yitel hotels.

Half of our Yitel hotels in pipeline as of the end of the quarter was now leased and operated. Healthy development of franchised operations rely greatly on the frequent guest programs. We will continue to actively manage our frequent guest program to capitalize on our increasing brand value. As of September 30, 2013, our frequent guest program had reached a record high of 15.6 million unique active non-corporate members, up from 14.3 million as of June 30, 2013 and increased 47% compared to 10.6 million in the same period of 2012.

Now let's talk about development. Overall we opened 107 new hotels in the quarter, including 22 leased and operated hotels and 85 franchised and managed hotels. We'll remain disciplined in our new hotels development practice and we're focused on franchised business model to achieve capital efficiency and profitability expansion. In addition, upon conclusion of Motel 168 integration, we will strategically place Motel 168 as a brand to -- as a brand of choice to further penetrate existing markets where the Home Inn brand has well established.

As the company has reached a stage of steady unit growth, stabilizing revenue increase and the consistent margin expansions, and with the development of China's economy and increasing demand for lodging product and services, we see opportunities for us to expand our horizon internationally as well as explore other adjacent areas where our core competencies of consolidating resource and managing lodging product and service can further the vitality of our business. We have begun the groundwork for overseas expansion, starting with Southeast Asia market. And our leisure market focused service offering such as management contract model has already been proven in strategic leisure markets such as Hainan Island.

In addition, we are finalizing our corporate branding study, taking to consideration long-term strategic vision of our company, existing and future brand and portfolios which their core value are formalized and streamlined to form integrated and consistent platform with our product and services. Operations and management can synchronize and be effective as a whole.

We look forward to share with you our results for these corporate initiatives in the near future. Looking ahead to the balance of 2013, we are confident of achieving our previously set new hotels opening plan and revenues goals for the year -- for the year, even at stable macro environment.

In conclusion, we remain positive about the long-term opportunities in both the China travel industry and our own business, [followed] by improving external economic indicators and a stable underlying performance of our hotels, we are hopeful to see a gradual strengthening of our overall -- of the overall market in the second half of 2014 and onwards. We aim to build an enterprise of long-term growth and profitability that will consistently create added value for our customers and our shareholders.

Now, let me turn the call over to Huiping who will walk us through the financials at third quarter 2013 in more detail, and go over our outlook as well. Huiping.

Huiping Yan

Thank you, David. And hello to everyone on the call. I'm pleased to first discuss our third quarter results and will then provide our guidance for the remainder of 2013.

Motel 168's operation has been integrated under the group. For operating management and measurement purposes since this acquisition in 2011, we provided separate financial data for Motel 168 through the end of 2012 and provided operating metrics and revenue data for 2013. As we conclude our integration by the end of the third quarter 2013, we will no longer provider separate information in future reporting periods.

In addition, in this call, as I take you through the numbers, non-GAAP or adjusted measures used throughout the presentation reflect results exclusive of certain income and expense items which in management's view better reflect the underlying business operations and results. I will also only speak in RMB terms as it comes to numbers, except specifically noted.

Now let's talk about revenue. We delivered steady revenue growth and met our target for the quarter of 2013. Total revenues for Home Inns Group were RMB1.74 billion, increasing 8.8% year over year. Revenue for Motel 168 were RMB429.1 million for the quarter, increasing 7.6% year over year.

Total revenues from leased and operated hotels for the third quarter were RMB1.54 billion, representing a 7.2% increase year over year. Revenues from franchised and managed hotels for the third quarter were RMB204.1 million, an increase of 22.5% year over year. These year-over-year increases in revenue were mainly driven by a volume increase in terms of the number of hotels in operation.

With respect to the operating costs and expenses, the company continues to focus on productivity measures and effective cost management that has a lasting effect in order to address rising costs in operation such as personnel costs and utility costs. Total operating costs and expenses were RMB1.41 billion for the third quarter or 80.9% of total revenues, compared to 84.4% in the same period of 2012. Non-GAAP total operating costs and expenses for the quarter were RMB1.38 billion or 79.5% of total revenue, compared to 81.6% in the same period a year ago. These decreases in both GAAP and non-GAAP expense as a percentage of total revenue resulted from continued benefits from hotel level workforce efficiency gain and ongoing cost control focuses.

Total leased and operated hotel costs were RMB1.24 billion or 71.4% of the total revenue, down from 75.9% for the third quarter of 2012. Non-GAAP leased and operated hotel costs of the quarter were RMB1.24 billion or 80.6% of the total leased and operated hotel revenue, compared to 82.9% in the same period a year ago.

The year-over-year decrease in these expense ratios were mainly due to headcount reduction of hotel staff, rationalization of food and beverage operations, and continued cost control on consumables and other leased and operated hotel operating expenses. Preopening costs included in the leased and operated hotels were RMB18.1 million for the quarter compared to RMB28.8 million in the third quarter of 2012.

Personnel costs of franchised and managed hotels for the third quarter were RMB54.1 million, an increase of 20% over last year. The equivalent non-GAAP measure was RMB51.4 million, an increase of 21% year over year. Both increases for GAAP and non-GAAP measures are below the rate of increase of franchised and managed hotel revenues in the third quarter, indicating leverage as our franchised [DMs] developed multi-hotel management capabilities.

Sales and marketing expenses for the third quarter were RMB24.2 million for GAAP and RMB23.9 million for non-GAAP measures. Sales and marketing expenses were controlled as a percentage of revenue, which represented 1.4% of total revenue for the third quarter of this year, compared to 1.1% in the same period of 2012. The increase in the spending included corporate branding study and charitable sponsorship during the third quarter of 2013. They were non-recurring in nature.

General and administrative expenses were RMB86.8 million or 5.0% of total revenue, compared with RMB77.9 million or 4.9% for the same period a year ago. The non-GAAP results of G&A expenses were RMB70.3 million or 4.0% of total revenues for the third quarter, compared to 3.6% for 2012. General and administrative expenses as a percentage of total revenue remained relatively stable. Excluding a catch-up bonus accrual in the third quarter, the increase in G&A expenses were also in line with total revenue increases.

The above discussed income and expense items resulted in income from operation of RMB226.9 million or 13.0% margin rate for GAAP and RMB251.1 million and 14.4% margin rate for non-GAAP measures. The respective increases in margin rate of 3.4 percentage points and 1.6 percentage points for GAAP and non-GAAP results were mainly driven by increase of higher margin revenue from franchised and managed hotels, improvements in Motel 168 operations, and a positive contribution to the Group, and better expense ratio at leased and operated hotels that we just discussed.

EBITDA, which is a non-GAAP measure, was RMB374.7 million for the quarter, a margin rate of 21.5%, compared to RMB283.5 million or 17.7% of total revenue a year ago. Adjusted EBITDA, again a non-GAAP measure, for the third quarter, was RMB447.6 million or 25.7% of total revenues, compared to RMB375.5 million or 23.5% of total revenues in the same period of 2012. Net income attributable to shareholders for the quarter was RMB108 million, increased 220% from RMB33.7 million a year ago.

Adjusted net income attributable to shareholders was RMB180.9 million for the third quarter compared to adjusted net income of RMB135.8 million in the same period of 2012. Diluted earnings per ADS were RMB2.31 or $0.38. Adjusted diluted earnings per ADS for the third quarter were RMB3.7 or $0.61.

Now talking about our cash situation. In the third quarter of 2013 the company generated a net operating cash flow of RMB456.9 million compared to RMB239.9 million in the same period of 2012. Capitalized expenditures for the third quarter were RMB214.2 million, while related cash paid for capital expenditures during the quarter was RMB198.3 million.

As of September 30, 2013, Home Inns Group had cash and cash equivalents of RMB1.04 billion. The outstanding balance of convertible notes issued in 2010 measured at fair market value was RMB1.1 billion. The outstanding balance of the US dollar denominated three-year term loan was RMB719.3 million.

Now turning to our outlook. As Dave had mentioned earlier, we remain on track to meet our previous provided new hotel openings as well as revenue expectations, for which I will not be specific in numbers, allowing the time for the following summary.

The company is well-positioned for the future growth. Specifically if we look at our like-for-like comparison for the fourth quarter, the trend has been positive. And if the market remains stable and gradually improving, 2014 should be a relatively positive year for Home Inns. And going forward 2014, we have an increasing optimism regarding our performances, specifically on margin. Continued trend of expansion is to be expected given the drivers underlying the expansion. Leased and operated hotels mix increase will help natural margin lift. And the note to that is we will continue focused on the franchised hotels quality of management in order to balance the quantity and the quality.

Two, Motel 168, its positive results from the integration has provided high confidence in our ability to consolidate resources and execute carefully planned strategies and [attacks]. Better performance are expected for Motel 168 even beyond its integration. And particularly so exciting for Home Inns is the Motel 168's location largely around Shanghai and Yangtze Delta regions will greatly benefit from the expected opening of World Disney in Shanghai.

Further for Yitel, the operational results as well as the experience that we've accumulated have increased our conviction and our outlook for the great potential of Yitel as the midscale market continue to open and continue to attract customers. Yitel product is specifically designed to be differentiated from that of the Home Inns economy hotels, therefore the customer feedback as well as the market positioning and also future pricing opportunities are quite positive in our view.

In 2014 we expect to increase the level of opening for Yitel. And with a steady and controlled pace in managing the quality as well as the number, we are expecting to deploy multi-business model for Yitel development in order to accelerate the pace as well as managing the quality and the output.

As David mentioned that we are looking into developing new markets overseas, and that is a natural outcome as our customers heading overseas. As we all know, the statistics has indicated an increasing volume going overseas, and hence, our initial market work and research will be focused on Southeast Asia. And the model that we plan to deploy are more on a collaboration or cooperation basis in order to limit investment and also risk exposure.

For 2014 we expect to open no less than 450 hotels in total. Eighty-five percent or more of these hotels will be franchised model.

So in summary, the company is in great shape. The margin expansion will continue and our continued focus and steady execution of our sound strategies is the pace and the rhythm of our business.

So with that, I will turn the call over to you for Q&A.

Operator please?

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we'll now begin the question-and-answer session. (Operator Instructions).

Our first question today comes from the line of Ella Ji of Oppenheimer. Please ask your question.

Ella Ji – Oppenheimer

Thank you. Good morning. Thank you for taking my questions.

I want to start by asking you the recent market situation and what's your anticipated RevPAR performance in the fourth quarter.

Huiping Yan

Sure. Thank you, Ella.

As we know that the third quarter, particularly July and August, performance year over year were all positive. And then with the, certainly, the September timing of the holidays, they were down year over year. And that is consistent towards -- to -- as it compared to the rest of the performance in the marketplace.

And what we saw in October and November so far, the performances are also positive year over year. Together with the indices that are out there in the marketplace, the signal is that the economy is at least stabilizing and also potentially could gradually improve.

For the fourth quarter, we are quite optimistic that we'll be positive year-over-year gain, even though it might be small, but it's a quite confidence boost for the overall operation as well as the expectation coming from the market. Ella?

Ella Ji – Oppenheimer

Yes, that's good to know. And then next I want to ask your, you know, you said in 2014 no more than 450 hotels opening. How many, within that, how many will be Yitels and Motel 168?

Huiping Yan

So far we have rough plan. Certainly this is not the guidance specifically. We will be providing the guidance in the next call.

For Yitel we currently plan to have around 20 new Yitel opening. And for the leased and operated hotels, of course it's only about 15% of the total. Between Home Inns and Motel 168, as we mentioned that we will strategically place Motel 168 as the brand of choice as we further penetrate selected markets where Home Inns has already established its presence. And this is again one of our advantage due to the multiple brand that's available to us. And also the product differentiation amongst the economy brands for its look and feel and also the customer base, we're able to use a second economy brand to capture a greater segment of the market.

Ella Ji – Oppenheimer

Could I -- I just want to follow up with your comments that, you know, can you just elaborate a little more why you want to place 168 as a second choice? And do you think there may be some chances of cannibalization with the existing Home Inn hotels?

Huiping Yan

A very good question, and let me elaborate. In the target markets where we have some quite well-established Home Inns, the density is starting to increase. For example, in the first-tier cities, the distance between the hotels could be as close as a kilometer or even closer. And certainly when we look at the occupancy rate, it's still quite high, but we don't want to, as you mentioned, get into a cannibalization stage.

Now in a way, the competition and cannibalization is a kind of relationship that we want to properly manage. With multi-brand availability to us, in practice we've seen that there are hotels located right next to each other. And because it is a slightly different look and feel, for example, for our Motel 168 products it is more trendy and it attracts more of the younger generation, younger crowd, and it has somewhat of a more leisure tendency.

For Home Inns, it continues to attract more of the business traveler. It has a laid-back and home away from home feeling. So with those advantages that we consider the density of the existing portfolio and also looking at the opportunity that still exists in those markets, that we could further penetrate, i.e. introducing new supplies, with a different brand, with a different brand, even though Motel 168 was acquired, but it has already established its recognition in the marketplace and also the operation has been about normal and on par with that of the Home Inns, so we believe the confidence is there to introduce the Motel 168 product as a choice to, one, solve a potential cannibalization issue and further develop the brand.

Ella Ji – Oppenheimer

That's very helpful. Thank you. I'll get back to the queue.

Huiping Yan

Thank you, Ella.

Operator

Our next question comes from the line of [Bailey Yu] of Goldman Sachs. Please ask your question.

[Bailey Yu] – Goldman Sachs

Hi, good morning. Congratulations on the good results. I have two questions.

One is on Motel 168, can you elaborate a little bit more on your expectations for Motel? I know that you said it has turned EPS positive. How about EBITDA margin and how is your expectations for next year compared to your previous target?

Huiping Yan

Okay, first question. So, Motel 168, we do have a -- we did have a pro forma target when we acquired the Motel 168. And I reiterate, it was 85% occupancy rate and RMB135 RevPAR on a full year basis for 2013. We are in range in reaching those targets.

Given the market environment and also looking at the positive outperformance of market by Motel 168, we believe that the substantial meeting of the expectation of our integration is indeed taking place. So going forward, now as we conclude all the specific integration tasks in -- by the end of the third quarter, the operations will continue to improve its operating efficiencies as we further integrate total operating rhythm, the effectiveness of the management, the marketing, sales and marketing, all those aspects, for a large portfolio to continue to integrate. And that is to be expected.

Now that is regarding, what I just said, is regarding the existing portfolio. The more exciting part is the fact that we are seeing opportunity to further develop Motel 168 brand itself. Related to the question that I just answered to Ella, the expansion of economy hotels, we will look to Motel 168 strategically as the brand of choice.

The new format of Motel 168 in its size, in its operation, is very similar to that of the core Home Inns brand. In addition, because of its trendiness and also the design element that were built into the product itself, we are able to position Motel 168 at a slightly higher ADR position. So with that, as we see the gap between Motel 168 -- acquired portfolio performances narrowing to that of Home Inns and the additive new Motel 168 that will be introduced into the total portfolio, and that's what David had mentioned, the energizing effect of new blood, so to speak, introduced into the portfolio will in total help improve the entire performance results of Motel 168.

And as I briefly touched upon earlier in the summary, Motel 168's location is not replicable and the location quite concentrated in Shanghai and Yangtze Delta region as we look forward to the Disney open, there are some unofficial estimates showing that it could be a 70 million flow each year. And that is equivalent of the World Expo.

Now we all had an experience to reference to during World Expo, the premium that we are able to get from the event was very additive and a great contribution to our total portfolio, and specifically on the margin side. So we are quite excited about the fact that we have successfully concluded Motel 168. And in 2014 we'll continue to improve its efficiency, ready to receive added benefits coming from the World Disney.

So owing that, I believe that the outlook for Motel 168 is quite positive and not just in 2014 but beyond. [Bailey].

[Bailey Yu] – Goldman Sachs

Thank you for that. I just have one follow-up and that is, you mentioned that you would expect a high ADR and Motel has already achieved 85% occupancy this quarter. Would you mind giving a little bit of your thinking on whether occupancy will further improve? And as well as the margin that was achieved this quarter.

Huiping Yan

Sure. Now again we want to look at the Motel 168 portfolio in two parts. The existing part of the -- or the acquisition portfolio of Motel 168 has reached above 85% occupancy rate as I mentioned in the call earlier. David mentioned in the call earlier, the matured Motel 168 has reached 86% occupancy rate. And the performance of the new Motel 168 hotels, their occupancy rate were 85% plus and 90% as they ramp up, just like that of a Home Inns core hotel.

So with that, we think gradually Motel 168 occupancy rate as well as ADR will trail and improve on a go-forward basis. Eighty-five percent and up and getting closer to 88%, 87%, that's all possible.

Now when I say it's all possible, is again looking at the supply and demand relationship in the marketplace. We don't expect 95% occupancy rate to last as the market receives more supply. But certainly the trend of Motel 168 RevPAR improvements are going to be there for the next two to three years.

[Bailey Yu] – Goldman Sachs

Sure. And my second question is on the special project expenses that was included in sales and marketing. Can you quantify how much that was? And any specific potential impact that we will see from the corporate initiatives that David mentioned earlier in the call?

Huiping Yan

Certainly. Now first of all, without specifically disclosing the amount of spending, if you look at our sales and marketing expense itself, it's capped at 1.1% or 1.4% of the total revenue. And it is within our annual budget as we look at the overall sales and marketing expenses. The special project itself, if I may elaborate a little bit more, we are at a stage of short-term forecast as well as long-term planning for the total company for the next five to ten years.

Looking at our brand, the core values of each of the brands, the positioning and the overall marketing strategy, as well as the operations behind all these core value proposition, are being studied through this special project. We not only had internal experts as well as external experts looking at this together to string -- to design the overall strategy for sales and marketing. And that's where the spending goes. David mentioned that we should be able to conclude this project by the end of this year, and at which time we'll have much more detail to share with you.

The impact really is -- the cost impact is very minimum. However, from the long-term growth perspective of the company, this study will focus our attention on the sales and marketing as well as the brand positioning and overall operations. So it's very difficult to quantify the significant benefit that we'll bring to our company.

[Bailey Yu] – Goldman Sachs

Thank you so much for the color. Thanks.

Huiping Yan

Sure. Thank you, [Bailey].

Operator

Our next question comes from the line of Billy Ng from Bank of America-Merrill Lynch. Please ask your question.

Billy Ng – Bank of America-Merrill Lynch

Hi. Good morning and, first, congratulations on the very solid results. And a couple of questions. First one actually is, I think, Huiping, you mentioned that your view or the company views on 2014 is pretty optimistic or pretty positive. I know it's a bit early, like -- but we just want to get a little bit more color on how we should approach 2014, first of all, in terms of top line, in terms of [RevPAR], what kind of trend we should see? Is that like the -- should we start expecting a healthy increase in the same-store or same-hotel RevPAR? And in terms of the bottom line, you also mentioned that you expect the margin expansion continue. And in this year, in 2013 we saw almost a 200-basis-point improvement. And you mentioned that there should be more room to do cost saving or economy of scale. But what kind of ballpark margin expansion we can expect on a fairly rough term?

Huiping Yan

Sure. The view on 2014 being positive is largely based on the Q4 performances, certainly third quarter's stable performance as well. And we look beyond just hotel industry. We look at the travel industry as a whole. The demand, the flow, the volume are all indicating a positive potential going into 2014.

Now the reason we said that in 2014 second half we should be seeing -- we should reasonably expect meaningful improvements is that considering our overall portfolio, we have seen that our overall portfolio is geographically diverse. It has a concentration in lower tiers and mid tiers, and limited in tier 1.

As we look at those layers of performances in the third quarter and the fourth quarter, we are seeing slightly positive improvements in the lower-tier city even than the first tier. But still the lower tier should catch up. They do lag behind. And if the market is stable going into 2014, we should be seeing overall trend of RevPAR expansion being a good opportunity. And the lower-tier city should also follow and improve certainly our current view.

And our approach to the overall RevPAR strategy is where the market has arrived or has recovered substantially, we should seek pricing opportunities, and particularly those cities that are stable with respect to the matured hotels, the like-for-like comparisons, while holding high occupancy rate, will be likely potential for the price improvement. Hence, RevPAR should expand.

For the lower-tier cities, we do believe there will be geographic [differences]. In certain areas lower-tier cities' improvements will be faster than other areas. So again our more detailed level management as opposed to a one-size-fits-all approach will come into play. We will focus on case by case if necessary to further seek pricing opportunities. Because again as we grow top line steadily, it's not going to outgrow the unit expansion because of the introduction of more franchised hotels.

The margin expansion and the quality of the operations will become our focus. And I'll give you a very specific example. A 1 percentage of occupancy rate could be two different types. One is overnight, one is hourly. Our business is learning to focus more on higher [calorie] occupancy rate. So in other words, the overnight rate will be much more valuable than the hourly rate.

Now as the economy improves, we should expect daily rates to pick up faster. So those are the types of opportunities and focus the headquarter and the think-tank should direct the overall business to gear towards.

And roughly speaking, the same hotel like-for-like improvements is to be expected. And given a more positive improvement in the second half, starting the busy season or the travel season, perhaps the normal pricing practice would resume, i.e. mid to low single-digit price increases, together with the cost control initiatives that will continue to be lowered out, we believe the margin expansion is to be expected. Now that is not to -- that is also in combination with the franchise lift that we will -- the franchise mix shift that will provide the lift that we believe will continue on for the next two to three years.

Billy Ng – Bank of America-Merrill Lynch

Thanks.

Huiping Yan

I hope that answers --

Billy Ng – Bank of America-Merrill Lynch

Just one follow-up, not exactly a follow-up question, but on the opening, you mentioned about 450 new hotels opening next year. I just wondered whether you guys have changed the strategy or would still stick with. Because among all the operators, Home Inns is more aggressive on opening in tier 3 and tier 4 cities. But now with the new initiative of being more aggressive on Motel 168, has that changed? And can you use Motel 168's to open more in tier 1, tier 2 cities, or you would still stick with like exploring or opening more in tier 3, tier 4 cities.

Huiping Yan

Sure, a very good question. Since about at least three quarters ago, I should say that we've communicated the fact that we are -- we look at the overall geographic positioning of our business. We have established -- or well-established our presence in the lower-tier cities, including the third tier and below. And we've seen that as economies gradually stable in improving the mid-tier or the second tier or even tier 1 markets, again that presented opportunity to further penetration.

And that is consistent with our Motel 168 strategy, i.e. as a choice brand to further penetrate existing markets. So as other competitors or maybe other peers starting to further expand into lower tiers, we have a different strategy because we have already established our footprint in the lower-tier cities. We are pulling back and focusing on where the greater opportunity there is still exists in the tier 2 and some of the major strategic cities.

So the strategy really hasn't changed since we first talked about it about a year ago, that we are pooling our resources and reconcentrate and refocus the deployment of our development dollar as well as human resources, in focusing the areas where we find further penetration opportunities which are not, again, is not in the lower-tier cities.

Billy Ng – Bank of America-Merrill Lynch

Thanks. Just one last thing, do you have numbers like in terms of the opening 450, in terms of percentage, how many of them or how much is still in tier 1 and tier 2 cities for the 450 hotels opening next year?

Huiping Yan

Our current tier 1 city portfolio is 21% and tier 2 is about 40%. So we should maintain that percentage going forward. In other words, the first tier perhaps will be only 20% of our total expansion with the rest focused mainly on the tier 2.

Billy Ng – Bank of America-Merrill Lynch

Okay. Thanks. Our next question comes from the line of Lin He of Morgan Stanley. Please ask your question.

Lin He – Morgan Stanley

Good morning, David and Huiping and Johnny. Thanks for taking my question. First question is a follow-up on Ella's question earlier about the 4Q RevPAR trend. And I you just mentioned that the 4Q RevPAR trend looks positive right now. I just want to understand, how much is that to do with the strong trend, strong momentum we've seen during the Golden Week holiday, and what is the trend of the business travel you're seeing right now.

And secondly is a follow-up. David's comment about the actual CapEx on mature hotels, about 400 mature hotels you want to upgrade to maintain this level. Just want to understand, what is the roughly per hotel actual maintenance cost you're budgeting for. And is this initiative for your own portfolio of leased and operated hotels only or the franchised hotels going to participate in this program as well? And going forward, would you consider this necessary?

Huiping Yan

Okay, thank you. First part of the question, the 4Q performances, if you look at the October Golden holiday as well as so far in November, the trend has been positive. Now again it's not a significant increase. We're looking at somewhere around 1% improvement. The December timeframe, we historically seen December is somewhat down. So we expect at minimum as a base case the first -- the fourth quarter should be flattish with a potential improvement, particularly with regards to the like-for-like mature hotels, we should be seeing a positive RevPAR expansion, although it might not be significant.

Regarding the second part of the question, the 400 hotels that we currently plan to be going through the revitalization program in the next 18 to 24 months will not cause increase in the total CapEx deployment or CapEx investment. Part of the money is really coming from the overall RMB1.1 billion to RMB1.2 billion capital investment that we have expected to spend in 2013. And as you know that we have decrease in the total leased and operated hotel opening for this year and we continue to expect 85% of the total 450 will be franchised hotels, so the need for leased and operated hotel capital is diminishing.

While we maintain the 3% repair and maintenance spending which runs through our P&L, the CapEx that we needed for the revitalization of the earlier vintage hotels will again be coming from -- coming out of the RMB1.1 billion, RMB1.2 billion CapEx overall plan. On average, the [per single] vintage hotel revitalization [will cost] somewhere around RMB500,000 to RMB700,000. So that's again not a major investment but certainly is on our current plan and also few of the conversions or modernization that's already done. That should bring us great pricing opportunities as we provide a good facelift, so to speak, as well as some of the functionality improvements for our guests so that they should be able to willing and support a price increase.

Okay. And one more thing to mention about Golden Week, now Golden Week, during the Golden Week, the RevPAR performances were positive. Again the limitation of our total hotel is when there are huge volume flushing through the whole system, we could be running at 100% occupancy rate but yet we don't have any more to -- inventory to fill. So this is about managing everyone's expectation. As the Golden Week's momentum and also the volume, what's in the news, quite, quite positive and really exciting, in our business, because of the limited rooms or the limited inventory, we could only have so much to gain.

So Golden Week holiday is positive first of all for us, but it's not -- we shouldn't be expecting a significant add or addition to the total.

Operator

Our next question comes from the line of [Cyrus Ng] of Deutsche Bank. Please ask your question.

[Cyrus Ng] – Deutsche Bank

Hi. Thanks for taking my question. Just a question on the expansion plan. I think in the near term, you're [indiscernible] focused on growing own portfolio, but I just wonder, what sector will you consider [indiscernible] in margin, in your price or in [indiscernible] in future?

Huiping Yan

Certainly the acquisition and M&A activity is a part of our corporate strategy on an ongoing basis. It's not something that we go out and seek for such opportunities. Now we do consider -- starting to see more and more scarce resources in terms of real estate. We do open and we are open to look at potential regional strategic acquisitions.

Now this is very different compared to Motel 168 acquisition. We'll be looking closely at self-development cost equation versus acquisition costs. And so those, we should be expecting here and there potential opportunity to rise. But that's certainly not the main focus of our growth. The main focus of our growth still at this stage is organic which will include consolidation of the existing resources that are out there.

[Cyrus Ng] – Deutsche Bank

Thank you. Thank you.

Operator

Our next question comes from the line of Long Lin of Brean Capital. Please ask your question.

Long Lin – Brean Capital

Hi, good morning. Thank you for taking my questions. I have two questions. My first question is regarding the personnel costs. In the quarter we see continued leverage in personnel costs. Can you give some color on how should we expect the personnel cost going forward?

Huiping Yan

Sure. Yes, we, first of all, have started to implement the personnel workforce effectiveness initiative since really last year in 2012. And on an ongoing basis, we continue to roll out initiatives in consolidating positions, eliminating certain functions, or having multi-functional capabilities. So our staff to room ratio has been consistently reducing.

Going forward for at least part of 2014, we expect the current initiatives that are in place should bring about benefits. As we mentioned in our last conference call that going forward, as we look to maintaining our services to our guests, other innovative solutions will be rolled out, such as IT solutioning, self-check-in, self-checkout, and those type of mechanisms should also help us further looking for opportunities to reduce human resource side of the cost equation.

Long Lin – Brean Capital

Okay, thank you. Second question is regarding the competition. Can you comment on the current competitive landscape in budget hotel sector? Have you seen any material change, in particular for franchised hotels? Also if you can share some like what percent of your new franchised hotels coming from repeat franchisees and what percent coming from like new franchisees.

Also the new openings for the franchise, you will have like 85% of the new openings will be franchised hotels next year. So just wondering, for these new openings, they will be what -- mainly in what regions? Thank you.

Huiping Yan

Okay, sure. About competition, naturally with more and more supply being introduced into the marketplace, competition is expected to rise. But as we look at our performances of the hotels, the occupancy rate is still 90% and above. So with that, we believe that the demand is still there in the marketplace and competition is sensible and manageable at this time. And we are of course watching very closely going forward in the next two to three years as we continue to expand our network where the supply and demand relationship goes, and we should adjust accordingly our development plan.

The franchised hotel currently we are seeing the pipeline increasing very solidly. A lot of our existing franchisees are bringing us more and more applications for new projects. Roughly about 40% of our new franchised contracts were coming from existing franchisees who have on average four or five, with the most 20 locations already established. And this is very much a vote of confidence. And the vote of confidence in our ability to run the program as well as deliver a maximized return to our franchise partners.

Another observation that we have recently is that some of the small existing hotels and also some of the small developers are also coming to Home Inns to jointly develop the hotel opportunities. So that is a new trend that we have observed. And it's also quite positive to our overall pipeline development for franchised hotel opening.

Of the 85% new hotels that we will add will be franchised hotels. Mostly it will be again in the first and the second tier. Again the franchise network was the network reach and also their relationship as well as flexibility in operational structure, we see that they are more advantaged in helping the overall brand expansion in the tier 1 and the tier 2 cities. So again mostly will be focused in tier 1 and tier 2 cities for all those franchised opportunities.

Operator

We have no further questions in queue, so I'll now hand the call back to Huiping Yan for any closing remarks.

Huiping Yan

Thank you everybody again for your time and interest in participating in today's call. If I may reiterate our outlook for 2014 is positive given stable performances. Our margin story will continue as the mechanism in place for margin expansion will continue for the foreseeable future. Motel 168 is going to be a strong growth engine not only on the top line, as well as margin performances improvements as they continue to further integrate operational efficiencies as well as future potential pricing opportunities as it compares to the existing core Home Inns.

Yitel hotels is the future of our business. We are very focused on developing this product and making it differentiated from the rest, and develop this brand in order to find opportunities for the three to four-star hotel market for consolidation in the future.

The new initiatives will prepare us for the near future as we expand our overall corporate horizon to follow our customers in seeking greater revenue as well as profitability enhancements of the total portfolio, hence, creating value for our shareholders.

With that, I will conclude today's call and I look forward to share with you on a go-forward basis. Thank you very much.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you so much for your attendance. You may all disconnect.

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