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

Q1 2012 Earnings Call

May 10, 2012 9:00 p.m. EDT

Executives

Kelvin Lau – IR Director

David Sun – CEO

Huiping Yan – CFO

Analysts

Justin Kwok – Goldman Sachs

Ella Ji – Oppenheimer & Co.

Billy Ng – Bank of America

Lin He – Morgan Stanley

Adam Krejcik – Roth Capital Partners

Vivian Hao – Deutsche Bank

Fawne Jiang – Brean Murray

Jamie Zhou – Macquarie

Chenyi Lu – Cowen & Co.

Tian Hou – T.H. Capital

Operator

Ladies and gentlemen, thank you for standing by for Home Inns’ first 2012 earnings conference call.

At this time all participants are in a listen-only mode. After management’s prepared remarks, there will be a question-and-answer session. Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to hand the call over to your host for today’s conference, Kelvin Lau, Home Inns’ Investor Relations Director.

Kelvin Lau

Hello, everybody, and welcome to our earnings conference call. Our first quarter 2012 earnings results were released earlier and now available on the company’s website.

With us today is David Sun, our CEO, Huiping Yan, our CFO, who will be further discussing our performance for the past quarter. After the 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 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 conference call will be available on Home Inns Investor Relations website at english.homeinns.com.

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

David Sun

Hello, everyone, and thank you for joining us today to discuss our first quarter results. Our core Home Inns operational performance was stable and Motel 168 integration continued to generate positive results despite a tough market environment and similarly low travel volume in the first quarter of 2012.

We reported total revenue of RMB1.26 billion for the first quarter, which is slightly above our guidance. This 66% revenue growth included consolidated first quarter results from Motel 168 that we acquired on September 30, 2011. Excluding Motel 168, our core business generated revenue growth of 23% organic growth. This was mainly result from new unit growth while performance from our mature hotel group remained stable.

Most specifically, 716 hotels that were in operation for at least 18 months during the first quarter gained 1.3% in RevPAR on the same hotels base year over year. As of March 31, 2012, nearly 30% of total of 1,168 Home Inns hotels were located in the third-tier cities and below, where overall ADR are meaningfully low in general than upscale cities market. These low-tier cities are still on their way to achieve full economic expansion even with our unique geographic diversity [inaudible] average daily rates flat at RMB165 year over year and combined with an occupancy rate of 84.4% compared with 85.1% in the same period of 2011. We generated RevPAR of RMB149 compared to RMB150 a year ago. These operating results are reasonable [sound] and within our expectations for the first quarter.

Occupancy rate at Motel 168 was 17.4%, down from 73.5% in the previous quarter. ADR grew 3% to RMB158 from RMB154 in the fourth quarter of last year. The resulting RevPAR of RMB111 compared to RMB113 last quarter was in line with our expectations. During the first quarter, we further reduced the scale of food and beverage operations as Motel 168 by 10% from last quarter, but still achieved total RMB327 million of revenues, which was at the high end of our guidance in the fourth quarter.

Six months into integration, we focus our efforts on implementing effective sales and market initiatives, facility upgrades for enhanced customer experience, and a personnel training and motivation to drive performance improvement. The results of these efforts continue to be encouraging.

For the month of April, Motel 168 portfolio achieved RevPAR of RMB140, with 85% of occupancy rate and ADR of RMB165. Motel 168 is a significant investment we made for the future of our company. We are very pleased with the integration results so far, and we expect to achieved 80% or higher occupancy rate on a full-year basis.

Furthermore, we have begun building a developed pipeline for Motel 168 and at end of the first quarter, we had five leased-and-operated hotels and 21 franchised-and-managed hotels contracted and under construction. Given the integration results, we are confident in the future development of the Motel 168 brand and its contribution of the company.

Now, let’s turn our attention to profitability. Excluding Motel 168, underlying operation margin for core Home Inns including Yitel hotels was 4.7% compared 7.9% in the first quarter of 2011. There are two key factors impacting operating margins.

First, dilutions from 80 leased-and-operated hotels including three Yitel hotels that were in operation for six months or less during the quarter impacted the overall margin rates by approximately 5 percentage points. These hotels contributed limited revenue yet incur full operation cost. Our new hotels are ramping within [our expectations] and are expected to continue doing so in a stable growth environment. The new hotels’ dilutive impact will continue to diminish as we steadily expand our portfolio base and attain healthy mix going forward.

The second factor impacting margin was the personnel cost increase at a pace faster than the revenue growth in the first quarter of 2012. Labor cost increase were well-anticipated, however, still within our previous estimated 5% to 10% on a per room night sold base for the year. We continue to proactively implement productivity programs and systematical adjustments underway to keep this cost increase in check. As overall market resume [inaudible] with steady growth, we expect that a low single digit room rate increase [would] absorb cost inflations and protect our overall margins. Meanwhile, we will continue to seize [inaudible] and event-driven pricing opportunities to offset the cost pressure.

For Motel 168, excluding one-time integration expense, operating cost decreased 4% from the fourth quarter of 2011. We are on the right track to stabilize and align the operating cost structure of Motel 168 with that of core Home Inns. With continued top line improvements, Motel 168 is expected to achieve positive net income within the next 12 months and become EPS accretive to the growth.

We can now talk about the margin results, talking about positive margin leads coming from [mix shift] for franchised hotels. With our allocated corporate overhead costs, franchised hotels as a group incur limited direct costs and contribute significant to our overall profit. With our operating track record and a strong brand and a well-run franchise programs, we expect our normalized operating margin to continue to expand as we gradually increase franchise mix from the current 53% to 60% or more in next five years.

On the development front, we opened 59 new hotels this quarter, including five new leased-and-operated hotels and 54 new franchised-and-managed hotels. Six hotels include one leased-and-operated hotel and five franchised-and-managed hotels will close during the quarter mainly due to the city re-zoning, expiration and termination of the franchise agreements. At the end of the first quarter we had a robust pipeline of 218 hotels contracted or under construction, of which 72 were leased-and-operated hotels and 146 were franchised-and-managed hotels. For the full year of 2012, we are on track to open 330 to 360 new hotels.

As of March 31, 2012, the Home Inns brand had 5.7 million active non-corporate members, representing a 44.6% increase from 3.9 million as of March 31 last year. Combined with unique active non-corporate members from Motel 168, the company had 7.9 million unique active non-corporate members, 53.4% of room nights were sold to active non-corporate members who -- representing consistent increasing at a stable customer base.

In summary, based on current operations and result of Motel 168 integration so far, we are optimistic about the full-year outlook. As Home Inns enter its 11 years of operation, we believe our investment and focus on [sound strategy and] execution will continue to provide a solid base for substantial profitability growth.

With that, let me turn the call to Huiping.

Huiping Yan

Thank you, David, and hello to everyone on the call. I'm pleased to discuss our first quarter 2012 results, and then we’ll provide guidance for the second quarter of 2012. As I take you through the numbers, please note that I will only speak in RMB terms unless specifically mentioned.

For the first quarter of 2012, Home Inns total revenues were RMB1.26 billion, increasing 66% year over year. Excluding Motel 168, total revenues for the first quarter of 2012 were RMB928.4 million, an increase of 22.7% year over year. We will continue to provide certain financial data separately for Motel 168 in our earnings release for the purpose of providing more information to our investors during Motel 168’s integration period.

Total revenues for leased-and-operated hotels for the first quarter of 2012 were RMB1.13 billion, representing a 64.1% increase year over year and a 4.5% decrease sequentially. Excluding Motel 168, total revenues from leased-and-operated hotels for the first quarter of 2012 were RMB816.1 million, an increase of 18.7% year over year and a decrease of 1.7% sequentially. The year-over-year organic revenue increase were mainly driven by a greater number of hotels in operation and better RevPAR at mature hotels, defined as hotels in operation for 18 months or longer. The sequential decrease was mainly due to seasonality.

Total revenues for franchised-and-managed hotels for the first quarter of 2012 were RMB127.9 million, representing an 84.6% increase year over year and a 0.7% decrease sequentially. Excluding Motel 168, total revenues from franchised-and-managed hotels for the first quarter of 2012 were RMB112.3 million, an increase of 62.2% year over year and a decrease of 0.1% sequentially. Excluding Motel 168, year-over-year increase in revenues from franchised-and-managed hotels for the first quarter were mainly driven by increase in units as well as -- and the sequential decrease was mainly due to seasonality.

Total operating costs and expenses for the first quarter of 2012 were RMB1.22 billion. Total operating costs and expenses excluding share-based compensation expenses and integration charges were RMB1.17 billion for the first quarter. Excluding Motel 168, total operating costs and expenses excluding share-based compensation were RMB828.7 million.

For the first quarter of 2012, total leased-and-operated hotel costs were RMB1.1 billion or 97.3% of the leased-and-operated hotel revenues. Excluding Motel 168, total leased-and-operated hotel costs excluding share-based compensation expenses for the first quarter were RMB755.6 million or 92.8% of leased-and-operated hotel revenues, compared to RMB86.2% for the same quarter in 2011 and 85.3% for previous quarter. The year-over-year increase in leased-and-operated hotel costs as a percentage of leased-and-operated hotel revenues was mainly due to a higher pre-opening cost of RMB19.8 million for hotels under construction, higher mix of hotels who are reaching maturity where revenue were lagging behind costs, as well as increasing hotel labor costs. The sequential increase was mainly driven by seasonality.

Personnel costs of franchised-and-managed hotels for the first quarter of 2012 were RMB22.6 million, representing 17.7% of franchised-and-managed hotels revenues. Excluding Motel 168, personnel costs of franchised-and-managed hotel excluding share-based compensation expenses for the first quarter of 2012 were RMB16.8 million or 14.9% of the franchised-and-managed hotel revenue. This year-over-year increase was in line with the increase in the total number of franchised-and-managed hotels.

Sales and marketing expenses for the first quarter of 2012 were RMB18.2 million, representing 1.4% of total revenue compared to RMB10 million or 1.3% of total revenue in the same period of 2011. Excluding Motel 168, sales and marketing expenses excluding share-based compensation expenses for the quarter were RMB14.5 million, representing 1.6% of total revenue compared to 1.3% in the first quarter of 2011. This increase in sales and marketing expenses as a percentage of total revenue year over year was mainly due to a higher spending on sales and marketing programs in order to promote Home Inns’ online presence as well as enhancing our customer service programs.

General and administrative expenses excluding share-based compensation expenses and integration charges were RMB52.3 million or 4.2% of total revenues compared to that of 4.7% of total revenue in the same quarter of 2011 and 4.7% in the fourth quarter of 2011. Excluding Motel 168, general and administrative expenses excluding share-based compensation were RMB41.9 million or 4.5% of total revenues compared to 4.7% in the first quarter of 2011 and 5.6% in the previous quarter. The above resulted in a loss from operations for the first quarter of 2012 of RMB36.9 million.

Income from operations excluding share-based compensation expense and integration costs for the first quarter of 2012 of RMB9.7 million or 0.8% of total revenues. Excluding Motel 168, income from operations excluding share-based compensation expenses for the first quarter 2012 was RMB43.2 million or 4.7% of total revenues, compared to that of RMB60 million or 7.9% of total revenues in the same period of 2011 and 89.3% or 9.5% -- sorry, RMB89.3 million or 9.5% of total revenues in the fourth quarter 2011.

For the first quarter of 2012, adjusted EBITDA was RMB165.9 million. Excluding Motel 168, adjusted EBITDA was RMB163.4 million compared to RMB152.5 million in the same period of 2011.

Adjusted net loss attributable to Home Inns shareholders was RMB24.6 million for the first quarter of 2012. Excluding Motel 168, adjusted net income attributable to Home Inns shareholders were RMB3.6 million compared to RMB47.5 million from the same period in 2011 and RMB35.2 million for the fourth quarter of 2011.

Adjusted diluted losses per ADS for the first quarter of 2012 were RMB0.64 or USD0.09. Excluding Motel 168, adjusted diluted earnings per ADS were RMB0.08 or USD0.01.

During the first quarter, the company generated a net operating cash flow of RMB30.8 million compared to RMB65.4 million in the same quarter 2011. Capitalized expenditures for the first quarter were RMB170.3 million and related cash paid for capital expenditures during the quarter RMB229.8 million.

As of March 31, 2012, Home Inns had cash and cash equivalent of RMB1.15 billion. The outstanding balance of its convertible bonds issued in 2007 was RMB113.2 million including principal and accrued interest. Outstanding balance of financial liability measured at fair value [arose] from the convertible note issued in December 2010 was RMB1.01 billion and the balance of US dollar denominated four-year term loan was RMB1.51 billion.

Moving on to our outlook for the second quarter of 2012, for the full year, we believe market conditions will remain stable, and we’re confident in our ability to deliver consistent revenue growth and effectively manage cost. With that said, we are on track with our original plan for the year and are reaffirming our previously provided expectation.

The company continues to expect total revenues for the group for the year to be in the range of RMB5,816 million to RMB5,910 million, representing growth of 46.9% to 49.3% year over year. Total revenues for the group in the second quarter of 2012 are expected to be in the range of RMB1,430 million to RMB1,460 million. Total revenues for Motel 168 brand in the second quarter of 2012 are expected to be in the range of RMB390 million to RMB400 million. Excluding Motel 168, total revenues in the second quarter of 2012 are expected to be in the range of RMB1,040 million to RMB1,060 million. These forecasts reflect our current and preliminary view which is subject to change.

Now let’s open the call to questions. Operator, please?

Question-and-Answer Session

Operator

(Operator Instructions).

Your first question comes from the line of Justin Kwok from Goldman Sachs. Please ask your question.

Justin Kwok – Goldman Sachs

Good morning. Thanks for taking my question. I have two separate questions, one on the RevPAR and the other one on Motel.

[inaudible] on the RevPAR we saw a 1.3% increase year over year mature hotel basis. I just want to get more understanding on how this percentage, are you seeing any geographical divergence on this number or is it across the board what you're seeing on the trend for this? And looking into the few months into second quarter, what are you seeing on the pick-up, especially on the [room rate] side. That’s my first question. Thank you.

Huiping Yan

Sure. Thank you, Justin. For the first question, the 1.3% increase on a mature hotel basis is really in view of the overall diverse span of our mature hotel portfolio. There are certain pockets of the market that are experiencing challenges and then there are also other markets that are still exhibiting very strong increases. So, on a combined basis, we are seeing a 1.3% increase, which still is a sound -- is a good representation of a still reasonable, stale market environment.

Justin Kwok – Goldman Sachs

Just a follow-up on that, as you said, some of the markets may be more challenging than the others, is it more likely because of the macro cyclicality that you're seeing or is it -- or it has been the case ever since you have entered into these cities?

Huiping Yan

It’s largely due to the overall process in the market. And certainly our presence in the lower-tier markets does impact. However, for mature hotels, once they reach 18 months and higher, it’s very similar between the upper-tier cities and lower-tier cities for their performance.

Justin Kwok – Goldman Sachs

Thank you. And the second question is on Motel side, as I look at your breakdown on the portfolio, RevPAR for Motel, it was interesting to see that room rate is actually moving up on -- even on a sequential basis in the first quarter. So, what kind of pricing adjustment have you made into the portfolio in order to achieve that? And what’s your outlook for the pricing differential between Motal and Home Inns brand going forward? And in particular, as you have rationalized a lot of the food and beverage costs on the Motel side, how would it impact on the pricing or how would it impact on the revenue mix between the rooms and [RMB] for the Motel brand? Thank you.

Huiping Yan

Sure. Thank you. First of all, it is indeed our intention to adjust Motel 168 ADR up as we increase occupancy rate. And so far the integration results allow us to adjust the price. In the initial period, we bring some promotions to our guests in order for them to come in and experience really enhanced motel facilities, enhance -- creating [inaudible] enhancing the foot traffic. And so far we are seeing that the opportunity is there for us to adjust the price up even just from the previous quarter. And particularly in April, the ADR is up fairly significantly.

Going forward we do want to continue to hold the ADR level for Motel 168 at the level we achieved in April, as you understand that April is relatively a reasonable month during the year. And from there on, the focus will continue to be on occupancy rate. And for the longer term, once we concluded the integration, we do believe that Motel 168 rates will be at about 10% or 15% higher than the equivalent of Home Inns location, and that is specifically with regards to new motel locations.

And on the food and beverage side, certainly we have reduced proactively the scale of loss-making segment of the business, and we will be stabilizing that. So far the food and beverage as a percentage of the total Motel 168 revenue is around 5% from the previous 11% or 12% in the last -- in previous year. And with that said, as we continue to improve our top line revenue on the room revenue side, it will go to offset part of the reduction in the food and beverage side of the revenue.

Justin Kwok – Goldman Sachs

Thanks. Thanks for the explanation. And congratulations on a good quarter as well. Thank you.

Huiping Yan

Thank you.

Operator

Your next question comes from the line of Ella Ji from Oppenheimer. Please ask your question.

Ella Ji – Oppenheimer & Co.

Thank you. First of all, about Motel 168, I think the EBITDA margin for 1Q is less than 5%. So, how does compare to management’s original expectation?

Huiping Yan

Thank you. The 4.8% in our expectation, we do know that the first quarter is a low season and as we are still ramping its top line performances, at the same time also adjusting its costs basis. If you heard what we talked earlier, the operating cost decreased and it will continue to do so. So there are two equations or two factors going. On the top line we are increasing and on the bottom line we continue to manage, finding opportunities to control the costs and even reduce the costs. So, going forward for Motel 168, the EBITDA margin will [definitely] improve.

Ella Ji – Oppenheimer & Co.

Great. Thanks. And then you mentioned that higher personnel costs, you expect to offset that with opportunistic price increase. Just wonder when should we expect to see such offset to happen. Will it be as early as 2Q?

Huiping Yan

We believe the market -- the current market trend is progressingly stabilizing and perhaps improving. So in the second half of the year, we are hoping to achieve price increases. Typically, if I may further elaborate, our business model is that we will experience cost increases year over year as normal CPI increases in China. And as we are able to increase low single digit on our selling price, we are able to absorb the cost increases on the operational level. And that structure and approach is still intact. In the first quarter and particularly starting last quarter in 2011, we have experienced softness in the market price. So in our overall decision and strategy-making, we decided that it was not the opportune time to raise prices. So the systematic price increase that we typically get on a year-over-year basis was not there.

As David mentioned earlier, as we progress into the second half of the year, we are seeing potential seasonally-driven price opportunities, as well as event-driven price opportunities for us to aggressively achieve increases in prices and so as to offset the labor cost increases. And still, with the labor cost increases, is within our previously expected 5% to 10% on a per room night basis. So it’s still manageable.

Ella Ji – Oppenheimer & Co.

Thanks. That’s very helpful. And lastly, do you have any unused loan facilities, banking facilities?

Huiping Yan

Yes, we do. We have in our RMB loan facilities RMB800 million that we have not have been drawn and no immediate need to tap into. And specifically on the overall term loan in fact in April of this year, we’ve essentially reduced that term loan balance by approximately 40%. So, from a cash perspective, our business are very cash-generative. Not only we are able to fund our ongoing expansion requirement, we are aggressively de-leveraging as well, without tapping into the available credit line to us.

Ella Ji – Oppenheimer & Co.

Got it. Thank you. That’s very helpful.

Huiping Yan

Thank you, Ella.

Operator

Your next question comes from the line of Billy Ng from Bank of America. Please ask your question.

Billy Ng – Bank of America

Hi, good morning. Thanks for taking my questions. The first one is just some follow-up questions, I think the other is pretty serious [inaudible]. But just want to clarify, when you say like there may be some opportunistic room rate increase in the second half, what kind of magnitude we are talking about? Are you seeing the overall market demand dynamic or demand supply dynamic turns more favorable in the second half and let’s say which allow room rate increase by 3% plus or still around 1%, 2%, 3% that we are seeing right now?

Huiping Yan

Sure. Thank you, Billy. The seasonality factor is typical in our lodging business. In other words, in the travel seasons of August and September and even in October, when we have long holidays in China, those are the seasonally attractive timeframe for us to raise prices. And then historically, our mature hotels and also our mature markets have experienced these types of opportunities and then we’ve captured those.

From a range expectation perspective, from our current view looking into the second half of the year, the trend is getting better and we think at least around 3% or maybe slightly higher will be possible.

Billy Ng – Bank of America

Okay. So you are referring to year-over-year increase, right, 3%, 4%?

Huiping Yan

Correct.

Billy Ng – Bank of America

Yes. That’s great. And also looking back, for the last couple of quarters, the demand a bit soft relatively speaking, maybe it’s hard to differentiate that, what contributed to that. But do you get a sense whether it’s the overall demand for the economy hotels turned softer because of the economy or more because of the supply issue, that you have more hotels in your portfolio that makes raising price a bit more challenge? So, like which factor do you think is more dominant?

Huiping Yan

Sure, Billy, that’s a very good question. And in our analysis, what we are seeing for -- first of all, mature hotels, their occupancy rate is still fairly stable, so that is indicating to us that even though there are softness in the marketplace, for established market, their performances are still very stable. And again, looking at the occupancy rates, in other areas of the markets where we have lots of new supply coming into the plate when all of the top-branded economy hotel players aggressively adding new units, we do expect and we are seeing that [buy] and the demand is [inaudible] or in a certainly still very much demand-driven, but the supplies are being absorbed by the marketplace, so, hence, the occupancy reflected that slight temporary softness.

In the lower-tiered cities particularly, what we are seeing, particularly for Home Inns, since we added a lot of the new hotels in the lower-tiered cities, when there is an overall macro condition that is soft or not relatively as strong, the ramp-up is relatively slower, even still within our overall experience range of ramp-up but still relatively slower. So it’s also reflected in the occupancy rate. So, all in all, we believe that the macro environment together with the new supplies coming into the marketplace, the overall market dynamic is slightly shifting, but certainly not to a point that it’s going to be soft. It’s our belief that the economy hotel market will continue to grow, far from saturation.

Billy Ng – Bank of America

So, just basically can I read it as like the supply/demand dynamic should be better in the second half than the first half?

Huiping Yan

Yes.

Billy Ng – Bank of America

Okay. Just one last question. We noticed like in the announcement there are six hotels during the -- were being closed down during the quarter, either terminate because re-zoning or lease expiring. So, still a small number, but I think if I recall correctly still the highest ever for six hotels closing down in a quarter. Is that a trend that we should start concern a little or how should we read it?

Huiping Yan

Well, first of all, I think in the grand scheme of things, with over 1,000 hotels to 1,200 and also as leases, early leases naturally expire, we should start seeing here and there a few hotel closure. And specifically for this quarter, the franchise hotel as well as the leased-and-operated hotel closure were continuously big, mainly resulting from the city [inaudible] as we know that the overall Chinese market and China is going through a renovation, there are a lot of city planning taking place. And our exposure and our geographic print in the marketplace make it reasonable for us to see a few here and there. It’s very still, I think based on our history, that because of the core performances or [inaudible] them out because of the managing -- franchised-and-managed hotel relationship, it’s not the case.

Billy Ng – Bank of America

And so just one follow-up on that, so, like you said, re-zoning, will the company get enough compensation for being forced to close down the hotel, or usually you need to get the charge on that, or how does that work normally?

Huiping Yan

Yeah. First of all, typically we anticipate this type of normal happening in China due to development and expansion of cities. We built into our legal contract to have a clause where we will be compensated by the government bureau handling the re-zoning and redirecting of the hotels. So, most the cases we’ve received reimbursement or compensation for our losses.

Billy Ng – Bank of America

Thanks.

Huiping Yan

Thank you.

Operator

Your next question comes from the line of Lin He from Morgan Stanley. Please ask your question.

Lin He – Morgan Stanley

Hi, good morning. Thanks for taking my question.

First of all, a follow-up, the 1.3% RevPAR growth for mature hotels, can you give us an update on more recent trends, for example, in April, May, how does that trend look like? Do you see an improvement on that?

And then second question is on integration costs. I think you incurred about 25 million in total integration costs in the quarter. Can you remind us roughly how much you need to incur in Q2 or Q3? Thank you.

Huiping Yan

Thank you, Lin. First of all, the 1.3% increase is, if you break it down, you can see that mostly it’s coming from the ADR increases that we did from last year. And occupancy rate is somewhat flat. And in our current operations, we are seeing also similar level of increases. Nothing greater than the 1.3% but somewhere around low single digit 1% or 2%.

And for the Motel 168 integration costs, the overall budget as build into our pro forma model was USD20 million to USD25 million, and currently we are looking at somewhere USD20 million as opposed to the full USD25 million. The spending in the second quarter continues to be largely associated with the hotel level upgrades and renovation of the facilities. We expect to continue to spend and conclude those programs largely in second quarter, and there might be a slight remaining portion in the third quarter.

Lin He – Morgan Stanley

Okay. So, we should expect that the remaining of that USD20 million will be -- most of them will be incurred in Q2, right?

Huiping Yan

Yeah, Q2 and then remaining in the Q3.

Lin He – Morgan Stanley

Okay. Got you. Thank you.

Huiping Yan

Thank you.

Operator

Your next question comes from the line Adam Krejcik from Roth Capital Partners. Please ask your question.

Adam Krejcik – Roth Capital Partners

Yeah, hi, everyone. A couple of questions. First, is it possible to kind of get any sense for Motel 168’s performance on a year-over-year basis? So, you know, the occupancy versus Q1 of this year -- of last year and then ADR as well?

Huiping Yan

Sure. We can give you a general guidance on -- or sense of the performance, because Motel 168 accounting for its operating metrics are somewhat different from Home Inns. For example, we talked about in previous quarters that we included the food and beverage -- the breakfast was included in their RevPAR or in their ADR, and also there are some commission charges that were not taken out of the RevPAR or the ADR. So, it’s hard for us to specifically give you a year-over-year, but we have focused our attention on the occupancy rate which is very much clean and straightforward. The occupancy rate increases are reasonably high. As we went into the acquisition, the occupancy rate were 65% to 70% at best. And so far, we, in April, have achieved 85, and we expect to have a full year occupancy rate to be at 80% or perhaps higher. So that will give you an indication of the revenue increases.

Now, bear in mind that we are adjusting down, excluding beverage businesses, to be smaller scale as a percentage of the total revenue. So, in other words, some of the revenue increases will be offset by the food and beverage reduction.

Adam Krejcik – Roth Capital Partners

Got it. And just to confirm, you said earlier that total operating costs related to Motel 168 in this quarter was lower in absolute terms or as a percent of revenue?

Huiping Yan

Was lower in absolute terms. And then the reason we looked at it as absolute terms is the hotel level operating costs are fairly much fixed with the biggest items being rent and personnel costs. And some of the other costs such as food and beverage that’s associated with the reduction of the overall beverage business also declined. And in that sense, we are looking at the absolute dollar amount.

Now, as a percentage of the revenue, certainly is another deal that we typically look at. Cost structures, however, because of the revenue, it’s still increasing and it’s not as meaningful as we look at as a percentage of total revenue.

Adam Krejcik – Roth Capital Partners

Okay.

Huiping Yan

And we certainly expect the percentage of -- the cost as a percentage of revenues continue to decline as we improve the top line.

Adam Krejcik – Roth Capital Partners

And what’s your expectations now for the full year blended EBITDA for 168?

Huiping Yan

Sure. 168, as we started to look at this business, it’s EBITDA, adjusted EBITDA of 13% or along that. And we expect to go into 8% to 10% -- we expect to achieve 8% to 10% revenue increases for 2012. And with that, largely the cost is already in place, particularly the rental cost is already there. So, the top line increases should translate into improvements on the bottom line, and we are expecting somewhere between 2% to 4% percentage points increases before the integration costs. So, the 13% is on an overall basis that we are looking at.

Adam Krejcik – Roth Capital Partners

Okay. So that non-GAAP integration cost is an expense that come on the Motel 168 operating cost line?

Huiping Yan

Yes, it will be included.

Adam Krejcik – Roth Capital Partners

Okay. And then, just two housekeeping questions, what was total pre-opening expenses in Q1? And then also, looking at your cash flows, it seems like operating cash flow as a percent of EBITDA was a little bit lighter than -- or softer than your typical run rate. Was that seasonal factors?

And then CapEx seemed abnormally high based on the number of hotels in your pipeline and openings. So, just any clarity there would be great.

Huiping Yan

Yes. Let me first answer that CapEx question. The CapEx -- the operating cash flow this quarter as well as the CapEx spending is seasonally driven. Typically we have the Chinese New Year timeframe or even before that, we settle a lot of the construction payables. So, the CapEx cash outlay is relatively higher. The CapEx on an accrual basis is also related to a significant number of hotels under conversion that are in our pipeline to be opened in the second quarter. And from the overall cash performances of the business, it’s still largely in line with our expectation. As we talked about earlier, it will be sufficient to fund our ongoing growth.

The first question you had is on the pre-opening expenses. For this quarter we had RMB19.8 million including pre-opening expenses on Motel 168 in the first quarter.

Adam Krejcik – Roth Capital Partners

Great. Thank you very much, Huiping.

Huiping Yan

Thank you.

Operator

Your next question comes from the line of Vivian Hao from Deutsche Bank. Please ask your question.

Vivian Hao – Deutsche Bank

Hi, Huiping. Thank you for taking my question.

Huiping Yan

Hi, Vivian.

Vivian Hao – Deutsche Bank

Hi. Could you please give us -- elaborate a little bit more on your lower-tiered new market entry strategy? Have you -- have the management been [inaudible] the model in terms of the franchisees versus operating hotels? And also probably a geographic breakout of your current portfolio for the up-tier cities versus the lower-tier cities?

Huiping Yan

Sure, Vivian. Certainly from a strategic perspective, we are really the first one going into expanding our presence into the lower-tier cities. It is recognized by our management as well as supported by the fact that Chinese economy is expanding more inlands and towards western part away from the tier 1 cities or [inaudible] city areas. The urbanization will continue for the next 10 to 15 years to reach 60% or so from the current 40% by government estimates. That would mean that the urban cities are up and coming.

They will provide similar opportunity or growth as what we had previously experienced in the first-tier cities when we first started our business in 2002. We were able to secure many attractive leases and we are able to benefit from the low escalation, the least rate in economic growth and expanding environment. And we hope to create that in the second tier or even the low cities. In fact, we’ve started doing that in 2007, and so far we have in our total portfolio about close to 30% in the lower-tier cities, meaning in the third-tier cities or even below. And that presence allowed us to prepare for capturing those economic expansion and the potential growth in the lower-tier cities.

From an operating economic perspective, we also did our homework because, overall, we maintained the unit level economics compared to the upper-tier cities. We all know that the lower-tiered cities’ ADR are relatively lower, in some cases significantly lower, 20% to even 30% lower than the upper-tier cities. And that, coupled with, however, costs in the lower-tiered cities, including rental and personnel being also relatively lower, we are able to generate still similar return on investment, even when we go into the lower-tier cities.

Vivian Hao – Deutsche Bank

Right.

Huiping Yan

And currently, what we are seeing is that the ramp-up in the lower-tier cities and the ramp-up in the upper-tier cities are normal. In other words, as hotels ramp up in the lower-tier cities, reaching maturity, those performances are fairly stable and we are in a very good position to enjoy the economic boom in the lower-tier cities as they develop.

Currently we have less than 20% of the total portfolio located in the first-tier cities. However, that is still an economic stronghold for us. We are benefiting significantly from those early leases that we signed, and we hope to continue to grow in up-tier cities including first-tier cities, but largely so more with the franchise hotels, continue balanced growth across the different markets of China.

Vivian Hao – Deutsche Bank

Sure. Just one follow-up on this, so, it looks like the slower ramp-up of the lower-tier city new portfolios should be persistent. Should we expect this ramp-up period like normal?

Huiping Yan

Yes. Our normal ramp-up period on average is six months. In some cases, of course, the extreme would be three months or even shorter. In the lower-tier cities, even with what we are seeing in the past couple of quarters where the macro conditions were soft, it’s still within our normal ramp-up range, the highest being nine months. So, as we mentioned, once the ramp-up is concluded, those hotels perform very similarly to the hotels located in upper-tier cities.

Vivian Hao – Deutsche Bank

Okay. One more question. So, in terms of the -- because I think the Motel integration has taken quite a lot of management attention and also resources. Do you see that your own portfolio gets downside, I mean, massive impact because of the resources [depriving] integration of Motel 168?

Huiping Yan

Sure. Certainly we put a lot of attention on Motel 168’s acquisition and integration, because we want to protect the value that we expect to achieve through this integration. But let me put it in this way. The core Home Inns business have been operating for many, many years. We have a very sound operating structure, management structure from district level all the way down to the cities level. The operational knowhow is ingrained or integrated in the day-to-day of the operations. So it really takes less attention compared to earlier years where we were building the business, building the franchise [inaudible] and so on and so forth.

So, the Home Inns side of the business are operating with a very healthy pace and healthy rhythm. And from a management perspective, we have put in key operators with seasonal experiences in Motel 168 to support the integration. And those key management structures are already in place. So, again, the focus from the management at the total group level is more strategic, more focusing on the milestone achievement of Motel 168. And I'm not denying that it takes attention, but it’s not taking away from our very successfully-run core business.

Vivian Hao – Deutsche Bank

Okay. Thank you. Very helpful.

Huiping Yan

Thank you.

Operator

Your next question comes from the line of Fawne Jiang from Brean Murray. Please ask your question.

Fawne Jiang – Brean Murray

Good morning, Huiping and David. Thank you for taking my question.

Huiping Yan

Hi, Fawne.

Fawne Jiang – Brean Murray

Actually, most of my question got answered -- got asked by previous analysts. I guess, one question I do have is regarding the cost saving on the Motel 168 side. You basically mentioned the company is taking measures to control costs. Just wonder, from your perspective, which are the main areas you potentially see room for improvement overall?

Huiping Yan

Sure, Fawne. First of all, when we look at Motel 168’s acquisition, we are seeing more of the sales synergy as opposed to cost synergy. So, in other words, it’s a performance improvement top line revenue synergy story as opposed to a cost story. In various discussions we’ve mentioned that Motel 168’s cost structure is not complete, for example, if development teams, there are no or little activity in the leased-and-operated hotel development pipeline, so we are rebuilding that organization. And the legal side of the business, because of no need to review contracts, lease contracts, we’re very thinly staffed. So, as from the area of compliance, to be a public company there needs to be SOX compliance and with sound internal control.

Now with all this said, while we are adding some costs, the overall integration of the support function, including finance, including HR, as well as IT program, all are getting synergies to a reasonable extent. The membership that are being integrated between Motel existing members and Home Inns, as well as the customer relationship programs, all have pluses and minuses in terms of cost.

So, going forward, we will continue to look at the cost structure of Motel 168. As we again improve the top line, we are very confident that the cost structure, we’re getting more leverage on an overall scale basis.

And the one point also to add, that in the second -- in the first quarter, we are seeing the operating cost reduction, it’s also contributed by the reduction in the food and beverage business where the associated costs were also lower.

Fawne Jiang – Brean Murray

Got it. Thanks very much, Huiping. It’s helpful.

Huiping Yan

Thank you, Fawne.

Operator

The next one comes from Jamie Zhou from Macquarie. Please ask your question.

Jamie Zhou – Macquarie

Hi, Huiping and David. Thank you for taking my question. I have a few follow-ups to earlier question asked. One is on Motel 168’s occupancy ramp-up. The company, you guys have said in the past that the problem with Motel’s low occupancy has to do with the large size, irregular size of the hotels itself, some of the rooms were -- some of the hotels have up to 400 rooms. And also it was said earlier that you guys are looking at downsizing some of the hotels to reduce the room supply to ramp up the occupancy.

Now my question here is whether the 80% overall occupancy target for Motel this year has factored in some of that downsizing of the oversized hotels. That’s my first question.

Huiping Yan

Thank you, Jamie. Yes, it is correct that Motel 168 has bigger scale on average hotels. And the occupancy rate that we are currently achieving are with its existing scale of hotels. And then we hope to continue to improve this occupancy rate and achieve 80% or even higher on a full-year basis. We did start with a few pilot programs on scaling down on specifically multi-brand operation of existing large units of Motel hotels, and we should soon see the results, positive or not positive.

One point to add is that Motel 168 location, and particularly those in Shanghai and Yangtze Delta regions, are very favorable in -- during certain period of the year, particularly with regards to leisure travel. Those large number of units actually benefit because they have more rooms to sell, as opposed to a limited number of rooms at core Home Inns brand or other similar brands with 100 to 120 rooms in average. So there are pluses and minuses.

What we are looking at currently is very closely monitor the overall performance, and as occupancy rates climb and as our pilot programs continue to [expand], once it’s successful, we should see the overall occupancy rate improve. And in some cases, we might not reduce the size due to its attractive available inventory in that particular market. I hope that answers your question.

Jamie Zhou – Macquarie

Great. That’s very helpful. Thank you, Huiping. And another quick follow-up, as to the five closed franchised hotels during the quarter, most of them are due to re-zoning, but also you did also mention that some of them were due to expiration and termination of the franchise agreement. I just want to get a bit more color on how many of the franchised hotels were due to termination of the agreement, and whether they were due to non-compliance reasons, or any color would be great. Thanks.

Huiping Yan

Yes. In those franchised hotels that were closed, one of them were because it’s non-compliant.

Jamie Zhou – Macquarie

Just one out of five.

Huiping Yan

Yes, just one.

Jamie Zhou – Macquarie

And the other four were related to re-zoning reasons?

Huiping Yan

Yeah, the other ones were all due to re-zoning, and there’s one also, the owner decided to reinvest in the facility to turn into other operation.

Jamie Zhou – Macquarie

Okay. Great. Thanks. That’s all my questions. Thank you.

Huiping Yan

Thank you, Jamie.

Operator

Your next question comes from the line of Chenyi Lu from Cowen & Co. Please ask your question.

Chenyi Lu – Cowen & Co.

Great. Thank you. I just have two questions. Regarding the sales and marketing expense, excluding Motel 168, the first quarter was actually, was a little behind, and I believe it’s obviously because of the economy, growth slowed down, the company put out more sales and marketing efforts. So, can you give us a view of your sales and marketing expense going for -- throughout the other quarters of 2012?

Huiping Yan

Thank you for your question. The sales and marketing expenses, we, as a company, we do not conduct significant company-level campaign in addressing after-market or in order to promote our business. The spending are kept at below 1.5% or around 1.5% of the total revenue as a budget. And those are specifically related to brand promotion, to our online presence, our customer service, and those related programs that are indeed having reasonable return on the investment.

The key marketing efforts that are expected are really at the hotel level, and they are very much inexpensive. We’re just passing out flyers, visiting the local businesses who make bookings for their visitors, and provide limited promotions. So, those expenses, together with the headquarter programs, are kept at a low percentage, 1.5% of the total revenue. And that is the overall philosophy of our management of the business.

Chenyi Lu – Cowen & Co.

So, basically, for sales and marketing, so you expect to be 1.5% going forward as the Home Inns neighbor, excluding the Motel 168.

Huiping Yan

Correct.

Chenyi Lu – Cowen & Co.

Okay. So, my next question, regarding the G&A, again try to exclude Motel 168 because a lot of people ask about Motel 168. We’re seeing some economy of scale improvement, so, do you expect continue to improve on current level for the 2012? Thank you. That will be all.

Huiping Yan

Sure. We have achieved significant leverage on our headquarter G&A cost. And as we include -- sorry, your question is without Motel 168. As we go forward expanding the top line, we will continue to control the headquarter costs and maintain the productivity level or even improve productivity level at the G&A side.

Now, if I may comment on including Motel 168, that Motel 168 business are going to improve and grow. So with that joining the overall group, we will again see leverage on the scale because our support system largely are integrated and they should start to gain productivity similar to what we’ve done with Home Inns.

Chenyi Lu – Cowen & Co.

Great. Thank you.

Huiping Yan

Thank you.

Operator

Your next question comes from the line of Tian Hou from T.H. Capital. Please ask your question.

Tian Hou – T.H. Capital

Hi, Huiping. I just have one question. As we look at your company and your peers, everybody has had a target for this year to open leased-and-operated hotel in above 120. So, if we look at a couple of years ago, like 2009, three of you together total opened is 122. So, now three of you together this year target is 330 and above. So, how do you see the company cushion in this area among you and your peers? How difficult is it to accomplish the goal?

Huiping Yan

Sure. First of all, I think the overall market is -- we are seeing maturity in the understanding about the franchise model and also budget hotel model itself are better understood by investors. The growth of -- or the increase in the proportion of franchised businesses is also relative to the readiness of the programs that we’ve established for running it as efficiently as possible.

Now, with that in mind, we believe that the brand awareness and the geographic presence of the brand makes a significant difference in a franchisee’s decision on selecting which brand to go. Now, the quality of return on their investment is the most important factor that a franchisee considers.

And there are some specific statistics. In our business, we have continued new franchisee joining the programs. We also have repeat or franchisees who opened the second, the third or even the fifth, or more, with successful experience in the franchise programs. There is a 38% concentration of franchisees operating two or more franchise hotels. And it is in our experience that the demand is very strong on the franchise part of the business, and that is why we are seeing a very strong pipeline as well or application, number of application, as well for franchise business. And we believe that the overall market demand is still there. So, for all the top players including our competitors, are going to continue to find qualified franchise, and the key is to improve and continue to provide sound return for our franchisee.

There is a [big] difference in our strategy compared to other competitors that once we are in or when we are exploring and opening new markets, particularly in the third-tier cities, Home Inns typically open with leased-and-operated hotels to take full control and full responsibility of the management of the hotel in order to understand the risk and establish successful practices before we introduce franchise model. And this is our commitment to our franchisees. And that is also very well understood and appreciated by our franchisee.

Tian Hou – T.H. Capital

That’s very helpful. So, Huiping, this is from a franchised hotel front, what about on the leased-and-operated hotel?

Huiping Yan

Sure. In the leased-and-operated hotels, the supply, yes, is reducing, but the fact that we are opening in lower-tier cities, we are expanding our footprint in the lower-tier cities, which are the future economic powerhouses of China, we have not seen or have not been deterred because of the lack of opportunities and continued leased-and-operated hotels. It’s more from a cost consideration perspective that we are opening relative to the leased-and-operated hotels in the upper-tier cities because those markets’ rental costs are becoming more and more prohibitive for us to continue to run a budget hotel and expect the same return on investments.

Tian Hou – T.H. Capital

That’s very helpful. Thank you.

Huiping Yan

Thank you.

Ladies and gentlemen, thank you very much for your question. I believe the time is up. And we again want to provide as much information as possible for you to understand an ever-so-complex business even with Motel 168. And we are very pleased with the integration results that we achieved so far, and we continue to focus on the underlying operations of our core business including Yitel development. And we are really looking forward into the second quarter and the rest of the year and we look forward to have discussions with you on a continued basis. Thank you very much.

Operator

Ladies and gentlemen, that does conclude our conference call today. Thank you for participating. You may now disconnect.

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