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Home Inns (NASDAQ:HMIN)

Q3 2007 Earnings Call

November 21, 2007 8:00 pm ET

Executives

David Sun - CEO

May Wu – CFO

Analysts

Maria Schlavin - CIBC World Markets

Lynne Hi - Morgan Stanley

Chris Woronka - Deutsche Bank

Alex Xu - Brean Murray Carret & Co

Marisa Ho - Credit Suisse

Brenda Lee - Merrill Lynch

Keith Yeung - Merrill Lynch

Mickey Strauss - Strauss Asset Management

Robin Yang - Jayhawk Capital Management

Ho Hong - FIG

Operator

Welcome to the Home Inns third quarter 2007 earnings conferencecall. (Operator Instructions) I wouldnow like to turn the meeting over to your host for today’s conference, Ms. AngelaLi, Home Inns Investor Relations Manager. Please proceed, ma’am.

Angela Li

Thanks, Bill. Hello,everyone and welcome to Home Inns third quarter 2007 earnings conference call.Our third quarter earnings results were released earlier today and areavailable on the company’s website as well as on news wire services.

Today you will hear from David Sun, our Chief ExecutiveOfficer, and May Wu, our Chief Financial Officer. After their remarks, Davidand May will be available to answer your questions.

To start, please note that the discussion today will includeforward-looking statements made under the Safe Harbor provisions of the U.S.Private Securities Litigation Reform Act of 1995. Forward-looking statementsinvolve inherent risks and uncertainties; as such, our results may bematerially different from the views expressed today.

A number of potential risks and uncertainties are outlinedin our public filings with the SEC. HomeInns does not undertake any obligation to update any forward-looking statements,except as required under applicable laws.

As a reminder, this conference is being recorded. In addition, a webcast of this conferencecall 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

Hi, everyone. Thanksfor joining us to discuss Home Inns’ third quarter results for 2007. With me today is May Wu, our Chief FinancialOfficer.

We are pleased to report solid third quarter results, as wecontinued to experience strength in our business and execute on ourstrategies. The third quarter ended withtotal revenues of over RMB 266.4 million, reflecting a 66.1% increase year overyear.

Our income from operations, excluding share-basedcompensation, increased 55.1% compared with that of 2006. Our EBITDA, excludingthe impact of foreign exchange losses and share-based compensation, increased56% year over year.

We continue the rapid expansion of our nationwide network ofhotels to 37 cities, with 201 hotels in operation. At the same time, we continue to maintain ourhigh occupancy, stable RevPAR and profitability even as we enter more secondtier cities.

During the quarter, we opened 26 new leased and operatedhotels and four franchised and managed hotels. At end of the quarter, we 69 leased and operated hotels and 27 franchisedand managed hotels under development, providing a solid pipeline for us tocontinue to expand our hotel network according to our strategy in the comingquarters.

We continue to maintain leadership in China’secono hotel industry in terms of geographiccoverage, total revenue, total member hotels opened, and total hotel rooms. Infact, we believe we have lengthened the difference between ourselves and thenext largest player.

Our product is well-positioned in the market and we executedeffectively, as evidenced by our 95% occupancy rate and RMB 174 RevPAR. Those were slightly higher than the same quartera year ago.

We continue to see opportunities for us to grow with themarket, as well as taking market share, as we have demonstrated. We are especially encouraged by the opportunitieswe see in the significantly under-penetrated second tier cities.

We continue to expand our member network which reached morethan 419,000 active members at the end of the quarter who contribute more than50% of room nights. At the end of lastquarter, the active members were 337,000 and contributed to 51% of total room nights.

So in summary, we have executed effectively along a clearpath and are committed to continue to do so. As the industry leader with strong brand recognition, we will continueto target the right customer segments and also a consistent and quality productin convenient locations at a reasonable price.

Furthermore, we announced recently that we have agreed toacquire the Top Star hotel chain which consists of 26 econo hotels in 18 citiesin China. This is a significant move for Home Inns. By doing so, we are solidifying ourleadership position in China’secono hotel market and benefiting our ability to grow rapidly through bothacquisitions and organic growth.

With that, I will turn the call over to May Wu, our CFO, to walkyou through the financials.

May Wu

Thank you, David and hello to everyone on the call. I will now take you through the key financialhighlights. Please note that certainfigures I will talk about are non-GAAP, including EBITDA and some measuresexcluding share-based compensation expenses. You can find a reconciliation ofthese figures in the financial tables at the end of our press release. Also, all figures that are mentioned will beRMB unless I say otherwise.

We completed the quarter with total revenue of RMB 266.4 million,representing growth of 66.1% year over year. Total revenue from leased and operated hotels for the third quarter wereRMB 254.2 million, representing a 66.2% increase year-over-year.

Home Inns opened 26 new leased and operated hotels during thethird quarter of 2007. Total revenuefrom franchised and managed hotels in the third quarter were RMB 12.2 million,representing a 64.7% increase year over year. We opened four new franchised and managed hotels during thequarter. Franchised and managed hotelsrepresented 29% of total hotel count at the end of this quarter compared with27% at the same time last year and 32% last quarter.

Occupancy rates for the entire Home Inns hotel chain was 95%in the third quarter compared with 94% in the same period in 2006 and 95% inthe previous quarter. RevPAR in thethird quarter was RMB 174 compared with RevPAR of RMB 172 in the same period in 2006 and RMB174 in theprevious quarter. We are pleased thateven with the increased penetration into second-tier cities and a high mix ofnew hotels in our hotel chain, there is year-over-year increase in occupancyrate and RevPAR.

Total operating costs and expenses for the third quarterwere RMB 211.2 million. Total operatingcosts and expenses, excluding share-based compensation expenses non-GAAP forthe third quarter were RMB 207 million or 77.7% of total revenues. That compares to 76.7% in the third quarterof 2006 and 75.1% in the previous quarter. Let me discuss the contributingfactors that caused this fluctuation.

There are three components of our operating expenses. First, leased and operated hotel costs. Total leased and operated hotel costs were RMB180.9 million, representing 71.2% of the leased and operated hotelrevenue. Total leased and operated hotelcosts represented 68.9% of the leased and operated hotel revenue for the samequarter in 2006 and 69.8% for the previous quarter.

The increase in percentage compared to the previous quarterwas primarily related to the increase in rents and utility costs as a percentageof leased and operated hotel revenue. This is due to the large number of hotels under construction. Asrequired under US GAAP, we account for rent and expenses as our costs oncelease contracts become effective, even though in most cases we receive a rent-freeperiod of a few months during the construction stage.

The increase in percentage compared to the third quarter of2006 was primarily due to two factors:

(1) Higherdepreciation costs as a percentage of leased and operated hotel revenues;

(2) Lowerfood and beverage margin resulting from the rapid increase in food costs.

The higher depreciation cost as a percentage of leased andoperated hotel revenues were the result of an increase in mix of hotels insecond-tier cities because in these cities, we achieved lower revenue per hotel,while construction costs were similar across all cities.

Third let me talk about selling and marketing expenses. Selling and marketing expenses were RMB 6.5million, an increase of 93.4% year over year and 44.1% sequentially. The increase were primarily attributable tomore advertising and marketing activities as Home Inns continued to promote itsbrand and enter new geographic markets. Overall, sales and marketing expenses represented only 2.4% of totalrevenues.

Lastly, G&A expenses. G&A expenses were RMB 24 million. G&A expenses, excluding share-based compensation, non-GAAP, were RMB19.7 million or 7.4% of total revenues. That compared with 9% of total revenue in the same period of 2006 and7.5% in the previous quarter. Thedecrease in percentage this year versus the same period last year is the resultof our operating leverage as the revenue base grew.

Income from operations for the quarter were RMB 39.5million. Income from operations,excluding share based compensation expenses, non-GAAP, were RMB 43.8 million or16.4% of total revenue. That comparedwith 17.6% in the same period of 2006 and 18% in the previous quarter.

The decrease in operating margin from the same period lastyear was caused by higher leased and operated hotel costs as a percentage of leasedand operated hotel revenue as described previously.

EBITDA for the third quarter was RMB 52.1 million. Excludingforeign exchanges losses and share-based compensation expenses, adjusted EBITDAwas RMB 66.6 million an increase of 56%year over year and 8.1% from the previous quarter.

Net income for the quarter was RMB 25.3 million andexcluding forex loss and share-based compensation, net income would be RMB 39.8million, up 76.8% year over year.

Basic and diluted earnings per share amounted to RMB 0.36 or$0.05 and RMB 0.35 or $0.05, respectively. Basic and diluted earnings per ADS were RMB 0.73 or $0.10 US and RMB 0.70 or $0.09 US respectively.

Excluding foreign exchanges losses and share-basedcompensation, adjusted basic and diluted earnings per share are RMB 0.57 or $0.08and RMB 0.55 or $0.07 respectively. Adjusted basic and dilutive earnings per ADS would be RMB 1.15 or $0.15US and RMB 1.10 RMB or $0.15 respectively.

Net operating cash flow for the third quarter was RMB 72.5million or $9.7 million. Capitalexpenditures for the third quarter were RMB 171.6 million or $22.9million.

As of September 30, 2007 Home Inns had cash and cash equivalents of RMB 453.7 millionor $60.4 million and restricted cash of RMB 238.8 million or $31.9 million US.

We completed the acquisition of the 4.412% stake in ourmajority held subsidiary, Home Inns & Hotels Beijing, Ltd in July of 2007.We paid total consideration of RMB 60 million, as well as 441,669 ordinaryshares of Home Inns.

I’d also like to mention a recent business development. Wehave agreed in October 2007 to acquire the Top Star hotel chain, which consistsof 26 economy hotels with approximately 4,200 rooms across 18 cities in China.Our consideration for the acquisition will consist of the assumption ofapproximately RMB 172 million in debt; the issuance of up to 655,831 Home Innsordinary shares, which equals 327,916 of Home Inns’ American depository shares.

There will also be a cash payment of up to RMB 88 million,if all conditions and targets are met by Top Star. We have taken control of the operations ofthe Top Star hotels on November 1, 2007, and the closing of the acquisition is expected to occuraround the end of 2007.

Top Star was established in 2005, and now is a popular economyhotel brand among domestic business and leisure travelers in China. The addition of these hotels will allow ourhotel chain to further expand to more than 320 hotels in more than 80 cities,and to leverage both Home Inns and Top Star customer bases.

Now let provide you with our guidance for the fourth quarterof 2007. We expect our total revenue inthe fourth quarter of 2007 to be in the range from RMB 320 million, or $42.7million to RMB 335 million or $44.7 million, including revenue from the TopStar hotels beginning November 1, 2007. I want to emphasize that this forecastreflects only the current and preliminary view, which is subject tochange.

Now let me turn the call back to David for his closingremarks.

David Sun

Thank you, May. Onceagain, thank you for partaking in our third quarter conference call. We would behappy to take your questions.

Question-and-AnswerSession

Our first question comes from the line Maria Schlavin - CIBCWorld Markets.

Maria Schlavin - CIBCWorld Markets

I just have a question about the Top Star deal. How many other companies the size of Top Starare there in your universe that you may potentially want to acquire?

David Sun

In recently published hotel positions, Top Star was on the8th position so we did have another eight players that have over 20 hotels inthe market.

May Wu

I want to just add on to David’s answer. Top Star was the8th largest on the list in the economy hotel chain segment. What we see isthere are a handful of hotel chains in the 15 to 25 hotel size.

Maria Schlavin - CIBCWorld Markets

Of the eight that are in the top eight, you are obviouslyone of them and then I’m sure there are a couple of other competitors that arelarger, so they wouldn’t necessarily be of that same size?

May Wu

That’s correct. The top five I would say are larger than 30hotels and then after that there are six, seven hotel chains in the 15 to 25hotels, throughout their entire chain.

Operator

Your next question comes from Lynne Hi - MorganStanley.

Lynne Hi - MorganStanley

My question is regarding the rent costs. I noticed in the news release that youmentioned there is an increase in rents and utility costs as a percentage ofrevenue, and a part of the reason is the larger number of hotels under construction.

My question is, have you seen rent costs increase from somenewly signed contracts compare to the contracts you signed before in the samearea?

David Sun

So far we only signed the Shanghai,Beijing, or Guangdong,those bigger cities that we find the rental of the property would be increasedby a big percent. But in the second-tiercities and third-tier cities we feel still very reasonable for rental.

Lynne Hi - MorganStanley

My second question is about Top Star. You said that you would start to include therevenue of Top Star since November. Buthow about the balance sheet, when will you start to consolidate the balancesheet?

May Wu

We will also be consolidating the balance sheet starting inthe fourth quarter. We have alreadytaken control of the Top Star operations. The fourth quarter results will include both Top Star and Home Innsexisting hotel chain operations and performance.

Operator

Your next question comes from Ho Hung - SIG.

Ho Hung - SIG

I just have a very quick question. I noticed recently you and David had beentalking about reaching 1,000 hotels in the next couple of years and alsotalking about overseas expansion. I’mwondering whether you can take the opportunity to give us more color on that?

David Sun

It is our internal objective, we plan to have our internalbusiness plan in the next three or four years we want to do a hotel chain up to1,000 hotels. I think by continuing to grow effectively toexecute our business strategy and business plan and improve our delivery, our commitmentby the year after we do an IPO and also adding more capacity while the companygrows. This is a target and we plan toreach that.

May Wu

We set our internal target based on a few things. One is our market analysis has indicated tous that just looking at 100 or so target cities that we have come up with, wethink we can comfortably accommodate about 1,000 hotels in all these markets.

From an internal management perspective, last year in 2006we added 66 hotels and this year we are on track to add about 100 hotels so wewill continue to expand our capacity to develop and manage new hotels in theyears to come. We’re confident that we will be able to do so.

With the marketplace and our internal execution capability,we’ve set this goal of reaching 1,000 hotels in the next few years and we will striveto continue to execute our business plan.

With regard to overseas expansion, that’s more of a thoughtin the incubating stage. We see some ofour customers increasingly traveling overseas and we think there may beopportunities for us to leverage on our brand over time. It is one of the many business initiatives that wehave under development; it’s not a near term focus at this time.

Ho Hung - SIG

The 1,000 hotel target, that is including acquisitions such as the Top Staracquisition that you did recently, right?

David Sun

Yes you are right.

May Wu

At this time, yes, it will include the Top Star acquisitionand for the future in our plans we are comfortable that we will be able toreach that size without any additional acquisitions.

In the event any other acquisitions materialize then we willadjust our plan accordingly. What anacquisition will bring us is the existing properties and save a lot of upfrontwork and in some cases, it may also bring us some very attractive leases. Itwill also, once we take it over, it will require the same kind of management attentionto these acquisitions.

In our plan, we do not need any additional acquisitions toreach our goal; but in any event that we do any acquisitions, we may adjust ourorganic growth plan accordingly.

Ho Hung - SIG

So you are saying the 1,000 hotels are all organic growth?

May Wu

It can be.

Ho Hung - SIG

I remember at one stage you mentioned that your existinginformation systems can support up to 800 hotels in your entire Home Inns system. I’m just wondering when you get to hotelsnumber that are much larger than 800, I’mwondering whether you require significant CapEx to upgrade your IT systems?

May Wu

Currently we still only have 200-plus hotels, so we’re veryfar away from the 800 number. But at the same time, we have already started tostudy the technology requirements, because we have already set our internalgoal to reach 1,000 hotels and we think at this time it will be a gradualprocess for us to strengthen our technology platform. So you are not likely to see a substantial one-timeCapEx, like say when we are at almost 800 hotels. It will be a gradual process.

Ho Hung - SIG

Right, that’s great to hear. Recently, I noticed that Home Inns also mentioned you are havingmembership rooms in Beijing duringthe Olympics for $1,000 a night. I’m wondering for those two weeks, how muchpositive impact should we be expecting from the Olympics?

David Sun

Yes, in this stage we only say that the Olympic Games, inthe 20 days of the period, we do have a good positive impact for the OlympicGames because we did the pricing, we raised it about four times, as I recall, fromthe original price. So I think that’sthe positive impact. But we did a studyon that because we don’t know yet about the before/after Olympics, how much itwill impact the Beijing hotels. So we still study.

Operator

Your next question comes from Chris Woronka - DeutscheBank.

Chris Woronka -Deutsche Bank

I have a question on the occupancy for the quarter. What you had preannounced last month was alittle bit stronger than we had been looking for. We know you’re runningbasically 100% already in the tier-one, sohave you seen some better than expected demand growth in the tier-two markets?

David Sun

Yes, if you look at occupancy performance from this year andlast year and also last quarter, we believe we have already well-managed ourperformance in the second-tier cities. It is a little bit of a slow comebackfor the performance in the second-tier cities, but the opposite reach, theperformance, they are not much different between first-tier cities and second-tier cities.

May Wu

Chris, I just wanted to give you a little morespecifics. With the operationalstatistic that we reported for the third quarter of 2007, about 72% of ourhotels are in second tier cities versus about 64% a year ago. So even with the increase in mix change westill see very healthy occupancy and RevPAR. We are seeing our strategy and our expectations in second-tier citiesare being met.

Chris Woronka -Deutsche Bank

On the unit growth, can you talk a little bit about ifyou’re still on track to open 100 hotels full year 2007, how do the openingslook in the fourth quarter? Will they bestaggered towards the end of the quarter or middle? Anything unusual this quarter versus thefourth quarter of 2006?

May Wu

No, I think the pattern is fairly similar versus fourthquarter of last year. The other thingthat we think we are seeing, if you think about the last two quarters of 2006 a majority of the new hotelopenings were concentrated in the last two quarters of 2006; while in this yearit’s more evenly distributed in Q2, Q3 and Q4. What that means is that in Q4, the impact from new hotels will beslightly less significant compared to 4Q06.

An offsetting factor may be that we have even more hotelsunder development in Q4 percentage-wise compared to fourth quarter of ‘06. These are the two offsetting factors if you wantto think about margin. But overall,other than that there’s nothing extraordinary.

Chris Woronka -Deutsche Bank

Could you just remind me if you have the number in front ofyou, how many hotels did you have under development at this same time lastyear? Was it at the beginning of fourth?When you reported the third quarter it was less than the 96 you have now.

May Wu

At the end of the third quarter we had 33 leased andoperated hotels under development and we have 23 franchise and managed hotelsunder development. So 56 under development at the end of Q3 of last year versusthe 96 in Q3 ofthis year.

Chris Woronka -Deutsche Bank

Those 96 hotels are probably spread out over the next six tonine months. Is that basicallyright? You would obviously add some morelater this quarter and early next that would probably still open in 2008?

May Wu

That is correct. Partof them will open in the fourth quarter and some will open in the firstquarter, but there will still be some remaining that will open in the secondquarter, due to the Chinese New Year time in the first quarter when we had tostop construction.

Operator

Your next question comes from Alex Xu - Brean Murray Carret& Co.

Alex Xu - BreanMurray Carret & Co

I don’t know if you already mentioned Top Star. Can you just go over a little bit regardingTop Star’s impact on the December quarter, on the operational matrix side, particularlythe RevPAR, average grade and those on the margin side.

May Wu

Hi, Alex. For the fourth quarter, as we mentioned, we aretaking over the operation of Top Star starting November 1st and what we arefocusing on at this time is to integrate the Top Star chain into our entiresystem. The first step to do so is toconvert the system to become part of our entire systems platform including thefront end, the back end as well as the centralized reservations system.

While we are in the process of doing that we do expectcertain disruptions of business in selected hotels. There are 26 hotels in Top Star and we willmigrate these hotels onto our platform gradually, in stages. We expect that to take through to at leastthe end of the year.

We are expecting minimum revenue impact from Top Star in thefourth quarter and the guidance that we gave we are only counting on about a RMB15 million in revenue from Top Star. Wealso expect that the RevPAR of Top Star will be fairly low, but we are stillassessing what it will be because we just took over control of the Top Starhotel.

Alex Xu - BreanMurray Carret & Co

If we exclude Top Star what do you see on the RevPAR side ona year-over-year basis for your baseline business for the fourth quarter?

May Wu

Again, we are not seeing any change in the RevPAR pattern ona full year basis. We think it will be flat to down in the low single-digitrange. So basically no change in what wehave always been seeing in the existing Home Inns business, which we are verypleased with.

Alex Xu - BreanMurray Carret & Co

Regarding the 2008 Olympics, I noticed that some of yourhotels, your booking signage already started marketing the room rate, adifferent room rate for that period of time. How well accepted by your customer or by your potential customer interms of rate increase of that magnitude?

David Sun

Yes. I think that isa market issue. It is really we list ourprices according to the market, what we call movement because the governmenthas already given us guidance of the pricing and also the 2,000 or 3,000 or4,000 that have already listed their price and also some econo-hotels started to list their price.

So we are still value for money according to the marketguidance to lift the price. In thisstage, we think about four times or five times the original price, but we are stillclose to what the price is for the market and also what the feedback is fromthe customers. So far the feedback fromthe agents is still very, very positive.

Operator

Your next question comes from Marisa Ho - CreditSuisse.

Marisa Ho - CreditSuisse

I just have a very quick question on your expansiontargets. Based on your existing pipelineand the Top Star integration, you’reprobably going to get to somewhere around 300 or 350 hotels by the middle of2008. But you think there is a market and probably will have about 1,000properties in about three to four years time.

If you were to get to that target, it pretty well implies thatyou would have to accelerate your growth plan quite significantly from theroughly 100 hotels a year that you are opening right now, on a per-yearbasis. Do you actually see the accelerationalready happening in 2008 or do you think it will happen for the latter end ofthe four-year time horizon?

May Wu

We have already seen that acceleration. For example, the 96 hotels in the contract bythe end of the third quarter, that’s substantial, that’s more than a 60%increase year over year in terms of a pipeline. Again, for 2006 we only opened 66 hotels; this year we are opening about100. We are building up capacity fornext year to accelerate our growth.

Not necessarily we will be achieving a higher kind of topline growth, but we are planning on not very much different type of growthcompared to this year. We are still finalizing our plan for the next year, asfar as the next three to five years. Wewill provide more updates on our next year end conference call.

I think directionally we are planning on significant stepups of our internal development and new hotel room out capacity.

Marisa Ho - CreditSuisse

Excellent. It’sdefinitely moving in the right direction.

May Wu

One reason we’re doing that is we really see that the marketis ready for that. We see that our brandis being increasingly recognized, not only in the big cities but also allacross the region. We are seeing thelandlords are becoming more aware of the economy hotel concept and willing torelease property to economy hotel operators. We are the first in many of thecities that we entered, so we really want to capture this opportunity.

As David mentioned before, looking one year after we becamea public company we have executed on our plan fully and today our leadership positionis clearer than ever before and we intend to continue on that path.

Marisa Ho - CreditSuisse

Out of the expansion plan you have in mind, do you have anyplans to set up a second brand?

David Sun

Right now because the market is very, very big and we have alot of things to do, we are still very focused on the current Home Inns brandto expand and penetrate the market. We do study what is our customer base, theygradually upgrade their needs, but in the current stage we just study but havenot started to work on the detailed planning.

May Wu

With regard to a second brand or higher end products, again,is one of the many potential things we’re working on. But at this time, we don’t see the need forsuch a brand immediately. Whether or not we will launch a new name brand it woulddepend on many things, including management focus.

One thing we look at is if we look around we do not see anyvery successful, let’s say, slightly higher end brands that represents anyimpact to our business, therefore we are not in no hurry to do so, but we willexplore the possibilities.

Operator

Your next question comes from Brenda Lee - MerrillLynch.

Brenda Lee - MerrillLynch

Congratulations on a good quarter. A few questions, more towardsthe macro side. Could you please share with us your insight about the currentdemand and the concentration of the hotel industry in Chinaat this moment?

Also, what is your outlook for RevPAR for both Home Inns andfor the industry as a whole in terms of the trend and the direction in the nearterm?

May Wu

Brenda, can you repeat the first part of your question?

Brenda Lee - MerrillLynch

I’d like to know more about the current supply/demandsituation? Number of rooms, et cetera.

May Wu

In terms of industry supply and demand?

Brenda Lee - MerrillLynch

Right.

David Sun

Although we have a lot of players coming to the economyhotel market, we see the total market still is huge because of China’seconomy, China’stravel industry and also what we call the branding and converting in the hotel industry. So if you look at 300,000 hotels all in China,most of them are not branding, they are still running quite low occupancy.

If we look at total market, the demand there is huge. Ithink it’s still a very huge market to develop for us.

Brenda Lee - MerrillLynch

Recently we read some industry surveys saying that there is apotential oversupply situation and may actually drive the government’sattention to actually regulate the industry. Could you please tell us what is theimpact of that?

David Sun

I think it’s not oversupply. The government thinks that because of the success of Home Inns, becauseof the market going so high, a lot of money getting in so for certain players, they are notpatient to be in the business. They arenot doing regularly, have not set the business in right track so it’s not a verystable business.

So the government thinks we need to organize the market muchbetter than today to try to encourage the branding hotel chains like Home Innsto set up the industry guidance or regulations for the whole of the market tohelp the total sector to develop and grow more healthy.

May Wu

I don’t think the government is regulating theindustry. It’s more the government istrying to help the entire industry to move in a more efficient and healthydirection, which is very good for the large players like us, like HomeInns. Also, again we think thedemand-supply situation is very healthy as illustrated by our healthyoperational performance.

Just as in any industry, there will always be marginalplayers who cannot achieve good performance. That is not an indication of theoverall healthiness of the industry at all.

Brenda Lee - MerrillLynch

Thank you, May. My next question is on the RevPAR trends forthe industry and for Home Inns?

David Sun

I think the RevPAR trend is this year versus last year,because we entered more and more second tier cities, in the third quarter weare a little bit down for the RevPAR and also the second quarter. But from thethird quarter, we are able to maintain the RevPAR even slightly higher thanlast year.

I think we are pretty much stable on operations in thesecond tier cities, so looking for the RevPAR trend in Home Inns trend-wise, Ithink we still maintain a quite stable RevPAR in the future.

Brenda Lee - MerrillLynch

And one phenomena we noticed is that many other hotels, yousee the increase in average room rate but for Home Inns, actually the averageroom rate is held relatively steady. Is that a strategic decision by thecompany to maintain the room rate to get market share, or is there something todo with the pricing power for the industry, for the economy hotel industry?

May Wu

I think what you see in terms of room rate increase is morein the [inaudible] hotel, especially the five star hotel category. Because inthat category, the turnaround time is long, so while the demand is growing veryquickly, some of the existing players have been raising rates.

In our segment, I think we need to look at the rapid growthof the industry. The [four star] hotel industry is growing capacity more inline with the total industry, or slightly higher. But in the economy hotelsegment, because it’s such a new industry, although we still represent a verysmall part of the lower tier pricing [margin outlet] segment, the growth ratefor the economy hotel segment is fairly fast.

In fact, we are not seeing any pricing increase in theeconomy hotel segment overall and we are priced already higher than a lot ofour competitors. And the reason -- as you see that our occupancy rate is veryhigh, so we can raise price if we choose to, but we think it’s a risky strategyto expand capacity in a 60%, 70% range and raise price at the same time.

So it is our choice to keep price stable in general,although in selective cities where we have a large presence, we have beenraising price in a single digit range.

Brenda Lee - MerrillLynch

Thanks. One more question regarding occupancy rates; may Iknow the formula for the company to calculate occupancy rate? Because in somehotels, they actually reserve a few rooms, say 10, 20 rooms, for just ashort-term stay. And when you are calculating the occupancy rate, the[inaudible] is actually smaller than the total number of rooms.

May Wu

We calculate occupancy rate based on the number of staysover the number of available rooms.

Brenda Lee - MerrillLynch

The number of available rooms includes those reserved for ashort stay, or --

May Wu

The short stays are accounted for as one stay. So in otherwords, some of our hotels could be running over 100% occupancy.

Brenda Lee - MerrillLynch

Okay. I see what you mean. Thank you.

Operator

Your next question comes from the line of Keith Yeung ofMerrill Lynch. Please proceed.

Keith Yeung - MerrillLynch

I have a couple of questions on the balance sheet. Could youexplain to us why it was quite a sharp jump in good will and intangible assets,year-on-year basis? And also, could you tell us what is the unfavorable leaseliability there?

May Wu

Okay, the intangible assets came about from the acquisitionof Home Inns, of the 4.41% minority stake in Home Inns Beijing that wecompleted in July, because the acquisition price we take, which is RMB60million, as well as the issuance of 441,000 also ordinary shares, is substantiallylarger than the book value of Home Inns Beijing’s 4.41% stake. We had torecognize the difference in two categories, two major categories in the goodwill or intangible assets.

And in determining the intangible assets, it’s more of anaccounting exercise going through all the existing leases and allocating the4.41% to any difference between the -- what’s perceived market value of theleases versus the actual lease terms.

The unfavorable lease came about -- the whole thing is justkind of going -- because a lot of our leases -- because our buildings areunique, so there is -- when coming back with a market benchmark, there arecertain variations and we just had to choose some approximate in certainmarkets.

So that’s the evaluation results that came out and it wasconducted by a professional valuator.

Keith Yeung - MerrillLynch

And then, how will the policy on, the accounting policy onVOTP amortization?

May Wu

Intangible assets will be amortized over the remainder ofthe perceived life of the intangible assets. For example, if the [inaudible]releases, then it will be amortized over the length of the remaining leaseterms.

So good will, you understand, requires that we perform animpairment test on a periodic basis.

Keith Yeung - MerrillLynch

Thank you.

Operator

Your next question comes from the line of Mickey Strauss ofStrauss Asset Management. Please proceed.

Mickey Strauss -Strauss Asset Management

Two questions; in your thinking about the thousand hotels,how many will come from acquisitions? I’m trying to understand whether this ispart of your ongoing philosophy to make other acquisitions among those topeight or even below that, and if so, how many of the thousand hotels you haveplanned would come from acquisitions?

May Wu

For the moment, I think only 26 will come from acquisitions,which is the Top Star acquisition, plus I guess the three we acquired earlier.But in the longer term, the 1,000 hotel target is what we set out for ourselveseven without any acquisition. We can achieve that with our -- going forward, wecan achieve that on an organic basis.

That being said, it is our ongoing strategy to catch anyadditional acquisition opportunities and to execute on all our, to act on itwhen the appropriate opportunities come.

At this time, we think it’s likely that you can 15% or 20%of the future growth may come from acquisitions, but the timing and magnitudeof the acquisition will be uncertain. Although we think there will beopportunities, we’re not counting on it.

Mickey Strauss -Strauss Asset Management

So another way to say that is you really think you mighthave 1,200 hotels in three to four years time -- is that what you are saying?So 1,000 internally and another 15% to 20% from acquisitions?

May Wu

Our goal is to reach about 1,000 hotels. If there are goodacquisition opportunities, we will act on it and if acquisitions don’tmaterialize, we will just continue to roll out hotels ourselves.

Mickey Strauss -Strauss Asset Management

And then I wanted to just ask a shorter term question; isthere any --

David Sun

I think the acquisition won’t be the platform that if we dothe acquisition, if we do have opportunity to do an acquisition to expand ourbusiness, then we are accordingly to adjust our organic growth pattern, both ofthe -- and look at the [inaudible] capacity [at that time].

Mickey Strauss -Strauss Asset Management

And just a shorter term question; is there any seasonalitysuch that your fourth quarter would have an occupancy rate one way or theother, just because of seasonality?

David Sun

I think the occupancy and also the performance, the trend ofthe performance will be very similar like last year, so if we look at lastyear, it will be slightly down from third quarter to fourth quarter. I thinkthe trend will be the same because of a little bit of seasonality by the end ofthe year, and also the new store opens, a lot of new store opened by thirdquarter and fourth quarter will be the impact of the [inaudible] fourth quarterperformance.

May Wu

Just to add on that, starting in November and December, someof the cities with severe winter weather, we will see slightly down occupancybut the pattern will be similar to last year, so we are not expecting anythingextraordinary.

And then in terms of the similarities/differences betweenfourth quarter of this year versus last year, this year our new hotel openingswere more evenly distributed across second quarter, third quarter, and fourthquarter, versus last year it was more in the third and fourth quarter. So weexpect new hotel impact in the fourth quarter will be less compared to a yearago, but we also said on a separate note though we did expect that we will haveeven on a percentage, we will have even more hotels under development comparedto a year ago, which will result in some up-front costs.

Mickey Strauss -Strauss Asset Management

Okay. Thank you very much.

May Wu

But that will not impact the [inaudible].

Operator

Your next question comes from the line of Robin Yang ofJayhawk Capital Management. Please proceed.

Robin Yang - JayhawkCapital Management

I didn’t catch your answer to the Merrill Lynch analystquestion about to the unfavorable lease liability -- what is that?

May Wu

The assessment of the -- when we assess the intangibleassets, part of the work is to perform an assessment on the leases that weresigned, and then we selected a benchmark for each market in order to assesswhether the existing leases are effective or favorable or unfavorable termsversus that. And some came out to be favorable and some came out to beunfavorable, but we don’t think -- first of all, it’s a very small amount.Secondly, we don’t read too much into it because it’s more of an accountingmeasurement and our leases are all -- our buildings are unique, so we justdon’t think that on an operational basis in reality, that really representsanything that -- we just don’t read too much into it. It’s an accountingexercise to assess the intangible asset part of the Home Inns Beijing minoritystake acquisition.

Robin Yang - JayhawkCapital Management

And how is that eventually going to flow through the incomestatement?

May Wu

It’s amortized over the term of the remainder of the leaseterm, so it’s about -- I think about [12 years] -- 15 years.

Robin Yang - JayhawkCapital Management

Okay, so that 533,000 is related to the Beijing Home Innsminority stake, going forward, when is your auditor going to assess theacquisition of Top Star and what is the likelihood that you are going to haveanother charge of unfavorable lease liability as it relates to Top Star?

May Wu

Actually, we will perform the Top Star intangible assets andgood will impact in the fourth quarter. But the unfavorable lease metric isactually not a charge. If you have a favorable lease, then that will beamortized over the term of the remainder of the lease. That will actuallyappear as a cost item on our income statement over time. An unfavorable leaseassessment actually offsets that partially.

So for example, in this quarter in our income statement, theP&L, we have some small intangible assets amortization expense that’sincluded in the expense line, resulting partially from the favorable lease andagain, the unfavorable lease part actually offsets that.

Robin Yang - JayhawkCapital Management

Okay, and my last question is related to your balance sheet,another balance sheet item, which is the other payable and the gross -- if youcombine the two, that number jumped from $17.2 million in the second quarter to$24.5 million in the third quarter. I’m just wondering what is in those lineitems that has jumped so much within one quarter.

May Wu

I’m sorry, which two line items?

Robin Yang - JayhawkCapital Management

The other -- on the balance sheet, on the liability side,there’s other payable and -- let’s see, that line items called other payableand accrual.

May Wu

Those more relate to the Sunshine acquisition. That leaserepresents the -- as you may recall, we acquired, we did a small acquisition,acquired three hotels and that, we’re still in the process of going through thefinal closing process of that, so the other payables represent the remainder ofconsideration, part of the remainder of consideration that we need to pay.

Robin Yang - JayhawkCapital Management

Okay. All right. Thank you.

Operator

Our last question comes as a follow-up from [Ho Hung] ofSIG. Please proceed.

Ho Hong - FIG

Four questions, specifically regarding the Top Star hotelcontribution to the fourth quarter. I remember during the conference theacquisition, you told us that there were 4,200 rooms, average room rate isabout $140, and occupancy rate is about 70% in the Top Star hotels. There are61 days in the fourth quarter that these hotels can make contributions to yourfinancial statement, so shouldn’t we expect $25 million instead of $15 millionfor the fourth quarter from Top Star? Are we being a bit conservative here?

May Wu

I think what we are planning on is that, as we mentioned, weare migrating the Top Star platform onto our Home Inns platform, so in theprocess of doing so, some hotels will experience business disruption for aperiod of time and that’s what we are planning on. We want to kind of the firststage of integrating these hotels is to really, in terms of the systemsintegration, the front end and on the back end, only if we complete thatsuccessfully, we can fire full cylinder in the future sales and profitabilityof these hotels. So it will take us a few months to complete this process, andin the process of doing so, we are planning actually lower performance in thehotels compared to how it was performing before.

And then actually in the fourth quarter, we may complete thesystems integration around the end of the year so in the fourth quarter, wewill be reporting still separately Home Inns results and Top Star results.

Ho Hong - FIG

That’s great, and just one last question on operating cashflow; I noticed that you disclosed operating cash flow for this quarter by$72.5 million, which is up substantially from the third quarter. But I don’tremember seeing the operating cash flow for the same period last year. Wouldyou be able to disclose that to us?

May Wu

Let me get back to you on that. It’s in one of ourpresentations but I don’t have it handy. Let me get back to you on that.

Ho Hong - FIG

Okay. Thank you.

May Wu

We have time for one more question.

Operator

We have no further questions in queue, Madam.

Angela Li

Are you still on the line?

Ho Hong - FIG

Yes.

May Wu

Okay, we will e-mail you the operating cash flow for thesame quarter last year.

Ho Hong - FIG

That’s great. Thank you.

David Sun

Again, thank you for joining us today. If you have anyfurther questions, please do not hesitate to contact myself, May, or any of ourinvestor relations representatives. Thank you very much.

Operator

Thank you very much, sir and thank you, ladies andgentlemen, for your participation in today’s conference call. This concludesyour presentation for today. You may now disconnect. Have a good day.

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Source: Home Inns Q3 2007 Earnings Call Transcript
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