Executives
David Sun - CEO
May Wu – CFO
Angela Li - Investor Relations Manager
Analysts
Alex Xu - Brean Murray Carret & Co.
David Katz – Oppenheimer
Hao Hong - SIG
Elena Anderson - William Blair
Ying Wong - Lehman Brothers
Andy Patel – Regent Hotels
Marisa Ho - Credit Suisse
Brenda Lee - Merrill Lynch
Lynne Hi - Morgan Stanley
Home Inns & Hotels Management, Inc. (HMIN) Q4 2007 Earnings Call March 3, 2008 8:00 PM ET
Operator
Good evening, and thank you for standing by for Home Inns fourth quarter and full year 2007 earnings conference call. (Operator Instructions) I would now like to turn the meeting over to your host for today's conference, Angela Li, Home Inns' Investor Relations Manager.
Angela Li
Hello, everyone and welcome to Home Inns fourth quarter and full year 2007 earnings conference call. Our fourth quarter and full year earnings results were released earlier today and are available on the company's website as well as on news wire services. Today you will hear from David Sun, our Chief Executive Officer and May Wu, our Chief Financial Officer. After their remarks, David and May will be available to answer your questions.
Before we continue, please note that the discussion today will include forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today. A number of the 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 law.
As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on Home Inns Investor Relations website at english.HomeInns.com.
I will now turn the call over to our CEO, David Sun.
David Sun
Hi, everyone and thank you for joining us for Home Inns fourth quarter and full year 2007 earnings conference call. I am pleased with the strong results demonstrated by our core business during the fourth quarter and full year 2007.
Our total revenues for the quarter increased by 82.9% year over year to RMB 327.6 million and our full year revenues increased 71.5% to just over RMB 1billion. This result included revenues of RMB 19.8 million from our recent acquisitions of Top Star hotel chain, which we're including as of November 1 and which I will discuss at great length shortly.
Our overall revenue growth was directly tied to our consistent expansion. We made considerable progress during 2007 towards our goal of 1,000 hotels throughout China without significant erosion of our key operational indicators. During the year, we doubled the number of hotels and the rooms available. During the fourth quarter of 2007, not counting the Top Star acquisitions, we opened 40 new hotels, bringing the total number of new hotels open for the full year 2007 to 107 compared with 66 new hotels in 2006.
The 266 hotels currently in operation are located in 66 cities in China which is a significant increase from the 134 hotels in 39 cities at the end of 2006. Our expansion is continuing at an impressive rate, with an additional 78 leased and operated hotels and 37 franchised and banner hotels under development as of the end of 2007.
It is also important to note that our rapid growth is being carefully controlled and managed to ensure we are not sacrificing our key operational performance. We have been able to maintain a stable room rate and occupancy levels, and therefore RevPAR, despite a considerable increase of operations throughout China.
During 2007, we also executed on our acquisition strategy and added 26 hotels from Top Star. We took full operational control as of November 1st. Before Chinese New Year, in early February, we successfully completed the system integration and have implemented Home Inns’ policies and procedures and are beginning to see positive indications of progress.
However, given the time of integration, we were unable to realize a benefit from our initiatives before the end of the year and therefore the average occupancy rate at Top Star hotels was 56% during the fourth quarter, well below our core Home Inns portfolio average of 91.6%. Although the initial phase was challenging, we still believe that within a six to nine months timeframe we will begin to see operational performance that matches the level of our organic Home Inns hotels.
We will continue to expand our network both organically and potentially through acquisitions in order to provide a comfortable and consistent lodging experience to China verticals and the growing number of business and leisure travelers. This expansion will include the existing market as well as expansion into new markets, including additional low tier cities. Although the low tier cities may not offer the same margin and RevPAR as larger centers like Shanghai and Beijing, they remain essential for building our reputation and brand in the marketplace and will support the long-term growth of the company. In addition, targeted low-tier cities are usually less competitive markets than tier-1 cities and provide us an increased opportunity to gain early mover advantage.
I would also like to emphasize that every market expansion needs to meet our criteria for strong growth, population density and return on our investment and therefore should enable us to further leverage our core operational infrastructure and expand our brand nationwide.
Given this rapid anticipated growth, Mr. Jason Zong, our former Senior Vice President of Operations was recently appointed our Chief Operating Officer. Mr. Zong brings more than ten years of consumer industry experience to the position, recently serving as Vice President of Operations for B&Q China, a subsidiary of KingFisher, the third largest home improvement retail group in the world. This makes him well-suited to manage the increased scale of our operations. The company's previous COO, Ms. Liang Rixin, assumed a new role of Chief Branding Officer, focusing on the improvement and development of Home Inns brand and products.
In summary, during the past year we have grown our revenue by 71% to over RMB 1 billion while doubling our hotel comps and reporting 2007 income from operations that was up significantly from 2006. We achieved this through maintaining operational indicators such as RevPAR that are critical to our business, while bringing the Home Inns level of quality and service to 66 cities across China, many of them underpenetrated markets in low cities.
Additionally, while we experienced some negative pressure from Top Star during the quarter, we are on track with regard to its integration over the coming quarters and we believe we will soon benefit from our efforts. I believe we achieved substantial progress during the year and that we are poised for further success in the coming year.
Now I will turn the call over to May Wu, our CFO, to walk you through the financials.
May Wu
Thank you, David and hello to everyone on the call. As David mentioned earlier, we delivered strong results in 2007 although we did experience some negative financial pressures in the fourth quarter, largely as a result of our integration of Top Star; some higher expenses given our expansion into lower tier cities; as well as an accelerated new hotel rollout schedule.
I'd like to walk you through the major contributors to our results and then add some context to some of our financial highlights. Please note that all of the figures I mention will be in RMB. As David mentioned, for the fourth quarter of 2007 we had total revenue of RMB 327.6 million representing an 82.9% increase year over year and a 23% increase sequentially. Excluding Top Star, total revenues were RMB 307.8 million, a 71.9% increase year over year and a 15.6% increase sequentially.
For the full year of 2007, Home Inns had total revenue of RMB 1 billion, a 71.5% increase year over year and if we exclude Top Star, our total revenues were RMB 989.5 million or a 68.1% increase year over year. This revenue growth was largely due to the increased number of Home Inns hotels in operation and our ability to expand without significantly impacting occupancy levels or our room rates.
Turning to our costs and expenses, as the number of our hotels we operate increases along with a number of new hotels under construction, our costs and expenses also increased. Total operating costs and expenses for the fourth quarter, excluding share-based compensation and restructuring costs for the acquisition of Top Star, were RMB 284.1 million. Excluding Top Star altogether, total operating costs and expenses without share-based compensation for the quarter was RMB 256.8 million, or 83.4% of total revenue. This compared to 81.4% in the same quarter of 2006 and 77.1% in the previous quarter.
The largest cost component was the leased and operated hotel costs. The sequential percentage increase was due to lower occupancy rates typically experienced in the fourth quarter; a higher mix of new hotels and a large development pipeline. We opened 40 leased and operated hotels in the fourth quarter and of the 26 new leased and operated hotels that we opened in the third quarter, 21 opened in September. We also had 78 leased and operated hotels under construction, a record number for us. That compared with 69 in the third quarter in 2007 and 28 at year end 2006.
On a year-over-year basis, we were also impacted by higher food costs as well as the increased mix of hotels in lower tier cities, which have lower margins. The other component of our expenses for the quarter was sales and marketing as well as G&A expenses which totaled RMB 41.6 million. G&A expenses also included RMB 1.3 million in amortization of convertible bond costs with RMB 6.7 million in expenses arising from Top Star.
For the full year, total operating expenses, excluding share-based compensation and restructuring costs for the acquisition of Top Star were RMB 822.7 million. Without Top Star, total operating expenses excluding share-based compensation were at RMB 795.4 million or 80.4% of total revenue. That compared with 78.8% in the previous year. Factors that drove this percentage increase were similar to those I just mentioned above.
Sales and marketing, along with G&A costs for the year, were largely in line with expectations. For the full year, we had RMB 19.6 million in sales and marketing expenses and RMB 99 million in G&A.
Although we saw strong revenue growth for the quarter, due to the increased costs associated with Top Star and our construction plan we saw a year-over-year decline in income from operations from RMB 20.1 million to RMB 13.9 million. However, if we exclude Top Star we saw strong growth from our organic business with quarterly income from operations of RMB 27.1 million. This represents a 34.5% year-over-year increase.
For the full year, we reported RMB 126.4 million in operating income without share-based compensation and restructuring costs for the acquisition of Top Star, compared to RMB 90.9 million in 2006. Excluding Top Star, income from operations without share-based compensation was RMB 134.9 million and this represents a year-over-year increase of 48.4%.
I would like to provide some color on the margin reductions that we experienced. Although we have been successful in maintaining stable pricing and occupancy, our increased presence into lower tier cities results, in general, to lower room rates and hence revenues generated from that hotel. Although costs are lower as well, the cost reduction is usually not proportional compared to revenue, especially with regard to utilities and employee costs.
Additionally, at a cost of RMB 6 million to RMB 7 million to refurbish a hotel regardless of location, meaning the lower room rates in the lower tier cities translates to higher depreciation as a percentage of revenue. We expect this trend to continue through 2008 as we will remain focused on increased penetration into lower tier cities without yet benefiting from improving SG&A substantially.
However, we do expect this impact will be reduced in 2009 as the shift will be much less severe compared to 2007 and 2008. In addition, we should start to see SG&A leverage beginning at that point.
Overall these factors, in addition to foreign exchange losses, resulted in our reporting a net loss for the quarter of RMB 15.2 million. Excluding foreign exchange losses, share-based compensation expenses and restructuring costs for the acquisition of Top Star, we reported adjusted net income of RMB 18.1 million. Excluding Top Star altogether, our adjusted net income was RMB 26.6 million. That's an increase of 37.5% year over year.
For the full year of 2007, net income was RMB 35.8 million. Excluding foreign exchange losses, share-based compensation, non-recurring charges and the impact of Top Star, our adjusted net income was RMB 114.8 million. Excluding Top Star altogether, net income was RMB 123.3 million. This demonstrates impressive growth compared to the RMB 70.2 million in net income for 2006 or a 75.7% growth year over year.
As of December 31, 2007 Home Inns had cash and cash equivalents of RMB 1.56 billion. We also had convertible bonds of RMB 1.1 billion. We generated strong net operating cash flow from our business, which was RMB 48.1 million for the fourth quarter of 2007 and RMB 215 million for the year.
Now let me provide you with our guidance for our first quarter as well as the full year of 2008. Taking into account the serious snowstorm which impacted operations for approximately a three-week period, our sequential growth leads us to expect our total revenue in the first quarter of 2008 will be in the range of RMB 330 million to RMB 350 million. For the full year of 2008, our total revenues are expected to grow 70% to 80% over year 2007. This forecast reflects Home Inns current and preliminary view which is subject to change.
On the margin side, as we maintain our rapid growth, we expect to experience a similar impact from new hotels and additional dilution due to the increased mix of hotels in the lower tier cities in the same magnitude as we experienced in 2007. Let me be clear that while we are not pleased by these circumstances, we are not at all concerned for our long-term performance as we understand the reasons and are taking steps to minimize the impact of these factors. We also believe this impact will be less significant in 2009 as our mix in lower tier cities stabilizes and we start to realize SG&A leverage. In addition, some of these costs, especially on the new hotel front, reflect our investment in our strategy as we continue to expand into underdeveloped markets.
Now, let me turn the call back to David for his closing remarks.
David Sun
Thank you, May. I believe that the performance we have demonstrated over the past year validates our strategy and consistent growth and illustrates that we are able to sustain our nationwide expansion. Although our margins were impacted slightly due to the acquisition of Top Star and the roll out of new hotels in lower tier cities, we believe that these are necessary steps for us to take in order to maintain our long-term growth. I believe this strategy will be further validated over the coming quarters as Top Star demonstrated high occupancy and RevPAR during the integration process.
I believe delivering a consistent product and high quality service across our hotel chain is just as important as an aggressive expansion strategy. This consistency means our customer will continue to see Home Inns as a brand they can trust. We believe that by continuing to target the right customer segments and by offering our products in convenient locations and at a reasonable price we will maintain our customer loyalty well into future.
Once again, thank you for participating in our fourth quarter earning conference call. Now we’ll be happy to take any of your questions. Thank you.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from Alex Xu - Brean Murray Carret & Co.
Alex Xu - Brean Murray Carret & Co.
First of all, you have a RMB 4.6 million restructuring charge during the quarter. Can you give us a little bit of color in terms of what these charges are related to? Are they personnel-related or you some facility or something like that?
May Wu
The RMB 4.6 million restructuring charges are all pertaining to the integration of Top Star. That included about RMB 500,000 severance payments for personnel realignment and the remainder, by and large, are write off of intangible assets such as the software that Top Star was previously using which is of no value to us going forward.
Alex Xu - Brean Murray Carret & Co.
In terms of integration, have you already finished the IT part of the integration as well as the personnel training, that sourcing?
David Sun
Yes, we take over all operations from November 1 and the system integration had been completed before the Chinese New Year in early February. Also, the new management team, the operational procedure and the service standards have already been implemented in the Top Star hotels before the Chinese New Year.
Alex Xu - Brean Murray Carret & Co.
What will it take, say from this point on, to let's say three, four, five months later to bring Top Star to your satisfied operations level? Will you need to do a lot of marketing to promote the Top Star brand or just put the right people in the right place to run the hotel more efficiently?
David Sun
I think mostly we put the right people in the right position and also strongly implemented our Home Inns operational procedure and service standard; also we put the customer platform link with Top Star hotels. So I think by this effort we have received some positive change come out after Chinese New Year so we believe by another three to six months we are able to bring the Top Star hotels to the normal Home Inns hotel level.
Alex Xu - Brean Murray Carret & Co.
My last question is going forward, can you walk us through a little bit regarding how you look at the 2008 RevPAR trend compared to year over year in 2007?
May Wu
Looking to 2008, as we mentioned, entering into lower tier cities remains an important part of our strategy. Because of that, we do not expect RevPAR pick up on a year-over-year basis in 2008 versus 2007. We may experience a 3% to 4% type of RevPAR decrease on a year-over-year basis is how we see it right now. But we may end up doing a little better than that but given the city mix that we plan to enter we are planning on a 3% to 4% RevPAR decrease on a year-over-year basis.
Alex Xu - Brean Murray Carret & Co.
That is not considering the impact from the first quarter and the second quarter or the Top Star impact, as well as maybe the September quarter, the Olympics, impact? Is that right?
May Wu
I think those two factors will by and large offset each other, taking into account those factors. On a full-year basis, I think the 3% to 4% RevPAR decrease on a combined basis is what we are expecting but how it will play out will obviously be different from each quarter. In the first half of the year, we will be impacted by Top Star still ramping up and that impact will be neutralized in the third quarter as we expect Top Star to reach Home Inns core portfolio level. On top of that, we may experience some positive impact from the Olympics.
Also in the first quarter the impact may be slightly larger given the snowstorm.
Operator
Your next question comes from David Katz - Oppenheimer.
David Katz - Oppenheimer
In going back through some of the transcripts from the last quarter and some of our recent calls -- and I apologize if you commented on this and we missed it -- but you were talking about potentially growing the system to 1,000 hotels over a certain period of time. That, I think, was an internal goal and it was a hot topic on the last conference call. How should we think about that goal one quarter later? Is that still something that's an internal goal that's out there? What kind of curve should we be modeling that on to the degree that you can help? Thanks.
David Sun
I think 1,000 hotels, that's our internal goal for the next three or four years to achieve that. Right now, we said by the end of 2011our target is to open 1,000 hotels in China, so that's an internal goal. Also I think we will be working very hard to put it in the detailed business plan.
May Wu
In terms of how we plan to reach that goal, we expect that in 2008 we plan to open 160 to 180 new hotels and that's substantially higher than the just above 100 hotel in 2007 that we opened without counting the acquisition of Top Star. We will certainly continue to ramp up that capacity, although probably in a less year-over-year increase type of pattern in 2009 and 2010. So with the current number of hotels, if you add 160 to 180 and then gradually throughout 2011.
David Katz - Oppenheimer
We're certainly not jumping to any conclusions about an acquisition after just one quarter, but obviously Top Star presented some issues in the quarter. Are they in line with what you expected with it? Is it a little bit more of a challenge than what you may have thought or is everything right on plan as expected?
David Sun
I think from operations-wise, it was a first experience to doing such scale of the integration, so we learned a lot of things. I think it's a lot of challenges expected by doing the project so I think operations-wise we are on track to learn a lot of things. I think we did expect all we experienced on that.
May Wu
On the financial side with the RMB 13 million loss that we encountered in the fourth quarter, by and large that was expected, given that we conducted a thorough due diligence of the company before we completed the acquisition. We are committed to turn the hotel around as quickly as possible. We expect, given the Chinese New Year, the seasonality and the snowstorm in the first quarter, Top Star will continue to be a loss generator in the first quarter but we expect that to ramp up gradually and again, we still have the six to nine month timeframe from the date of acquisition to ramp up Top Star Hotels to a satisfactory level.
David Katz - Oppenheimer
Do the goings on with Top Star preclude you from making another smaller acquisition if one presents itself? Or are there any out there? How's the landscape for that?
May Wu
When we look at an acquisition, we want to look at the location. We want to look at the value. The current integration of Top Star would not preclude us from making a small acquisition if we see the right fit. However, it's not likely that we're going to make another big acquisition until we fully integrate Top Star.
Operator
Your next question comes from Hao Hong - SIG
Hao Hong - SIG
Further on Top Star, I heard David said occupancy rates for Top Star are 56%. I remember when you made the acquisition in November you mentioned that the chain’s occupancy rate was about 60% to 70%. So now we're actually seeing occupancy rate going down. What would be the reason?
David Sun
Thanks for your question. I think the main reason is first due to the seasonality because on the last report we say that 60% is September and October. So that's 56% represents November and December. If you look at our core business, Home Inns third quarter is 97% occupancy, but fourth quarter is about 91% occupancy. So that's the normal seasonality trend, it is getting down to a little bit about Top Star hotels' occupancy.
The second reason maybe is a minor reason, the integration. We took full operation November 1. We are doing integration system and also the people and the process integration. So I think that will be a little bit impact of the service and also the operation in November and December.
Hao Hong - SIG
Just now you mentioned the RMB 4.6 million restructuring costs incurred in fourth quarter '07. I'm just wondering whether in the next two to three quarters whether you have any more restructuring costs to pay?
May Wu
We do not expect to experience any more restructuring charges pertaining to Top Start. We will be making some investments in terms of maintenance but that will be normal course of business.
Hao Hong - SIG
Final one on tax rate, I noticed that this quarter the tax rate is quite high; it's about 50%. I'm just wondering why?
May Wu
Yes, let me explain that. On paper you're right, the tax rate looks like it's over 50%, but if you take out share-based compensation as well as forex loss and other non-cash items, the tax rate is in the low 30% range which is still high compared to the previous quarters and abnormal considering our tax rate of a mid-20% range. This is because fourth quarter is the quarter where we make adjustments for all the deferred tax assessments, et cetera.
For example, if we had losses that are not tax deductible the adjustments tend to be all made in the fourth quarter as opposed to each quarter throughout the year. If we were to even out those losses into each of the four quarters, our tax rate would still be in the mid 20% range.
Hao Hong - SIG
On the restructuring costs of RMB 4.6 million you mentioned that most of it is just write-off of intangible software, so they're not cash costs?
May Wu
That's correct. Only about RMB 500,000 is cash costs.
Operator
Your next question comes from Elena Anderson - William Blair.
Elena Anderson - William Blair
May, I just wanted to clarify what you said about the EBITDA margin expectation for 2008 given your expansion into tier 2 cities. I think you said we should expect a similar magnitude of erosion in 2008. Could you clarify that? Did you mean in basis point terms?
May Wu
Sure. On a full-year basis if we were to look at Home Inns core business excluding Top Star, for full year 2007 our EBITDA margin was 25.7%. That compared to 23.4% for the full year of 2006. So it was a decrease of about 2%. We continue to expect 1% to 2% of margin erosion in 2008 versus 2007. So that's the type of magnitude that I mean.
Again, we expect that to stabilize starting in 2009 and in addition we will start to see SG&A leverage.
Elena Anderson - William Blair
I think I flip-flopped the numbers. 2007 is about 23.4% EBITDA margin?
May Wu
EBITDA margins for 2007 excluding Top Star was actually 25.7% which is slightly higher than 2006 but income from operations was only 13.6% in 2007 versus the 15.4% in 2006. So income from operations deteriorated about 1.8% in 2007 versus 2006. The EBITDA margin actually increased slightly.
The various reasons that caused that we can go through in more depth if you'd like, but in general we expect 1% to 2% margin decrease on a year-over-year basis, mostly on the operating income side, much less so on the EBITDA side as the depreciation pressure we have in second tier cities is not reflected on the EBITDA side.
Operator
Your next question comes from the line of Ying Wong - Lehman Brothers.
Ying Wong - Lehman Brothers
Just a follow-up question on the RevPAR trend. You earlier commented that you expect the RevPAR to drop by about 3% to 4% on a year-on-year basis. I was wondering on an organic basis what sort of RevPAR trend do you expect for the existing properties? Specifically, do you expect a different trend between tier 1 versus tier 2 cities? Thanks.
David Sun
Yes, I think for the existing hotels we expect the RevPAR will be maintained similar to levels of 2007 or make a slight improvement in 2008. In the tier 1 cities I think that's very similar in first tier cities and second tier cities in existing hotels level.
Ying Wong - Lehman Brothers
So you basically expect similar RevPAR growth for second tier cities and first tier cities?
David Sun
Yes.
Operator
Your next question comes from Andy Patel - Regent Hotels.
Andy Patel - Regent Hotels
My question is for RevPAR since it was not increased in 2007 compared to 2006, how do you expect the trend to be when you add more hotels to the portfolio? How do you expect to grow like that when there's no RevPAR growth? Normally with inflation and everything else and the cost going up, how do you expect to make money when you do that?
May Wu
As we mentioned, the RevPAR decrease was primarily caused by a mix change by our shifting into second tier cities. Although the margins in these cities are not as good as some of our early hotels in Shanghai and Beijing, they still represent extremely attractive opportunities. Our developments in those cities will meet our minimum 20% return on investment. We're confident about that.
Andy Patel - Regent Hotels
Then to follow up with that, with the 20% return on investment, I was looking and there was no mention for normally the way we analyze hotels is management fee of 4% and a replacement reserve of 3%; I don't see that on your statements here.
May Wu
All our leased and operated hotels are managed by ourselves so there is no management fee to any third party.
Andy Patel - Regent Hotels
What about the replacement reserve?
David Sun
The maintenance fee is already taken into account in the normal operating costs.
Operator
Your next question comes from Alex Xu - Brean Murray Carret & Co.
Alex Xu - Brean Murray Carret & Co.
I have a follow-up question on the pipeline. Obviously this quarter at the end of the December quarter you have a total of 115 hotels under development. If you look at the trend in 2007 basically almost a straight line up from 48 in first quarter, all the way to what we have in the December quarter. How are we suppose to model going forward in 2008? Do you see this pipeline topped off at a certain level, or do you continue to see the pipeline growing as we are moving along in 2008?
David Sun
Alex, I think given the currency capacity I think that would be what the number will very consistently be doing in the next two or three quarters. If we further improve or enhance our capacity from the development side I think that will be a little bit different.
May Wu
I want to add on that our goal is to open 160 to 180 hotels in 2008 and we already have 115 in the pipeline. So you can see that we have high visibility for our plans in 2008. What we are trying to do is to expedite our development process and to push the hotels to open early in the year rather than later in the year. So because of this magnitude you may see the pipeline number let's say go down slightly in the first quarter or second quarter. If there are more hotels open as opposed to remain in the pipeline. But in general the trend should continue.
Alex Xu - Brean Murray Carret & Co.
The next one is regarding your franchised hotel because there's some chatter in China regarding some of your competitors changing the franchise-fee structure. Can you remind us what your current fee structure is? Do you have any plan to adjust your structure based on what your competitors are doing?
David Sun
Right now the fee structure, we still maintain the same one-time entrance fee, about 3,000 per room. Also we charge 6% of revenue as a management fee and also the branding fee. We still maintain the same fee structure.
Regarding the market issues, we believe that the important thing is to provide the quality service and management to the franchisees. So in this moment we don't have any idea to changing the fee structure to respond to market competitors.
Operator
Your next question comes from Marisa Ho - Credit Suisse.
Marisa Ho - Credit Suisse
A follow-up on the tax rate. Do you have guidance for us on how the tax rate will look going into 2008 and also 2009?
May Wu
We expect the tax rate in 2008 to be in the low to mid 20% range if we were to exclude the non-cash costs. This reflects a decrease in the tax rate in China from 33% to 25% but also reflects as we continue to roll out rapidly new hotels there will be losses from which we will not be able to offset for some time until the hotels start to make profits. On a full-year basis we continue to expect low-20% up to mid-20% tax rate.
Marisa Ho - Credit Suisse
On the Top Star hotels going into first quarter 2008, do you have a rough guidance number for us? Is it going to be on a similar magnitude compared to the fourth quarter of 2007?
May Wu
First of all, we do not expect any further restructuring charges going forward. If we were to exclude that, the loss from Top Star was about RMB 9 million in the fourth quarter. We expect that to be lower in the first quarter. However, keeping in mind the first quarter given the impact of Chinese New Year and the recent snowstorms, it is still a slow quarter so we do not expect a significant loss reduction from the Top Star chain. But starting from the second quarter we expect minimal loss, if any.
Operator
Your next question comes from Brenda Lee - Merrill Lynch.
Brenda Lee - Merrill Lynch
Just one question regarding the effect of distribution of this directly managed and franchised hotel. What's the plan going forward for 2008 and 2009? Is there any possibility that you will actually be able to generate higher than expected cash flows because of the change of hotel distribution? When are we most likely to see you turn free cash flow positive? Thank you.
David Sun
Thank you, Brenda. Right now the franchising is still about the 30% range. We don't have plans to have a big change of the percent mix of the franchise. So going forward in 2008 and in 2009 we still would be about 30% to 35% of the franchise mix.
Brenda Lee - Merrill Lynch
In terms of free cash flow positive, we've always said that given our return on investment, as long as we are growing above our return on investment, we will need additional funding to support our growth. We are well funded at this time; as you see, we have RMB 1.56 billion on the balance sheet at the end of the year which will be sufficient to support our growth for the foreseeable future.
Operator
Your next question comes from Lynne Hi - Morgan Stanley.
Lynne Hi - Morgan Stanley
I have a couple questions, more on the cost side. First in terms of employee salary expenses, how much of a percentage increase do you expect to experience in 2008 and 2009 in terms of salary?
May Wu
In terms of compensation increase, as you see on a full year basis in 2007, personnel costs represented about 16% of our leased and operated hotel costs versus 15.5% in 2006. So percentage-wise there was a slight increase. But again, that's largely due to our expansion into lower tier cities. On an apples-to-apples basis, personnel costs by and large were stable as a percentage of hotel revenue, because a part of our hotel compensation structure is that the personnel costs will be linked to the profit of the hotels. We are experiencing a slightly higher personnel cost increase at a headquarter level given the increase of compensation for professional staff members. However, we are offsetting that, by and large, due to our increased scale.
Lynne Hi - Morgan Stanley
My second question is regarding the per hotel CapEx. From my point of view, I noticed that compared to some of your competitors the renovation and refurbishing at Home Inns is relatively simple. What's your plan on that? Do you have a plan to increase per hotel CapEx in the future?
David Sun
I think right now we are very good to maintain that CapEx investment by about 50,000 to 55,000 per room. We are very disciplined to try to highly control the investment. We're still looking for the product improvement and development. That's why our we have Liang Rixin as the Chief Branding Officer to be more focused on looking for the product improvement. I think that improvement does not mean we have to invest a lot of money. I think the way we look at it is what is the more efficient way and also how to meet the customer needs. So I think for the investment, CapEx-wise we still want to maintain the same level as 2007.
Operator
Your next question comes from the line of Hao Hong – SIG.
Hao Hong - SIG
On the room refurbishment cost which is about RMB 6.7 million per hotel, RMB 55,000 per room. The entire chain average cost is not specific to -- I'm just wondering why wouldn’t your second tier cities hotel opening costs be a bit cheaper?
May Wu
Because if you think about it we need property and we configure them to Home Inns standards. So a lot of the re-configuration we are not building the building from the ground up. So our refurbishment process is very standardized across all cities and the materials that we use are the same and we utilize centralized purchasing for all the hotel fixtures, et cetera. Therefore while we are able to utilize cost savings because of that and at the same time the costs are the same across the board. With regard to labor costs, construction labor is very mobile so the teams go everywhere and they charge similar rates in all cities.
David Sun
That's a good question. I think from company-wide we set up the project to see any opportunity to see the investment savings in second tier cities. Because of the pressure on depreciation in second tier, third tier, low tier cities. We have already set a project to study on that, but at this time we still maintain the same investment in all the cities.
Operator
Your final question comes from the line of Marisa Ho - Credit Suisse.
Marisa Ho - Credit Suisse
I just have a follow-up question to David’s comment earlier about the appointment of the Chief Branding Officer. Regarding your branding efforts going forward, are we talking about you actively looking at a new format or even a new brand to satisfy your customers' needs?
David Sun
For the company, we're really looking for any opportunity from the market. I think company-wide we're more focused on the customer needs in the market and what synergy we can make for our customer base. So we are studying the customer base, looking for their further needs, especially for our membership. So I think that we are studying that.
Marisa Ho - Credit Suisse
On that note can you give us an update on your membership situation and how much of your members currently account for your room nights in the fourth quarter?
May Wu
Our members have grown to over 500,000 and they continue to account for about 50% of our room nights and we're very pleased about that which is a similar pattern as the previous quarter.
Operator
There are no further questions at this time. I will now turn the call back over to management.
May Wu
Thank you, everyone for participating on our earnings call. Again, we are looking forward to another year of rapid expansion.
David Sun
If you have any questions you can further contact with May or myself or Angela.
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