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

Q2 2012 Earnings Call

August 9, 2012 9:00 p.m. ET

Executives

Kelvin Lau - IR Director

David Sun - Chief Executive Officer

Huiping Yan - Chief Financial Officer

Analysts

Jamie Zhou - Macquarie

Chenyi Lu - Cowen & Company

Ella Ji - Oppenheimer

Grace Lam - Citi

Billy Ng - Bank of America Merrill Lynch

Adam Krejcik - ROTH Capital Partners

Justin Kwok - Goldman Sachs

Kelvin Lau

Hello, everyone, and welcome to our earnings conference call. Our second quarter 2012 earnings results were released earlier and are available on the company’s website. With us today is David Sun, our Chief Executive Officer; and Huiping Yan, our Chief Financial Officer, 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 U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our 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 second quarter 2012 results. Since the first quarter of 2011, overall Chinese market experienced low growth post Chinese New Year holiday season. Previously, manufacturing and export dependent geographic [areas] continued to showing unfavorable year-over-year comparison and overall micro economy continued to be weak with no clear sign to recovery.

Facing such deceleration in the operating environment, the company was able to achieve solid overall performance with double-digit organic revenue growth, continued positive integration results at Motel 168, and increased productivity gain on [second] quarter cost. Total revenues for the second quarter increased 60.2% year-over-year to RMB 1.4 billion, including revenues of RMB 377.4 million from Motel 168. Excluding Motel 168, our core business revenues 18.5% to RMB 1.1 billion at the high end of our guidance.

Despite market softness, occupancy rates was still healthy at 92.1% compared with 94% in the same quarter last year. RevPAR of RMB 157 this quarter compared with RMB 153 in the same quarter last year was consistent with changes in market conditions. It is worth to emphasize that 790 mature hotels under Home Inns and Yitel brands that have been in operation for at least 18 months, maintain the same RevPAR of RMB 168 as that in the second quarter last year. This reflects the strength of our core business portfolio to weather economic downturns and their potential of resilient growth when the market rebounds.

Secondly, what was also encouraging was that our three Yitel brand hotels that opened in the second half of 2011 are tracking positive ramp up performance quarter-over-quarter and contributing to our total top line growth meaningfully. This adds validation to our product design and market position of this upscale brand and it confirms that effectiveness of our motel brand strategy.

Total revenues for Motel 168 came below our previous guidance due to worse than expected market conditions and accelerated overhaul of the food and beverage operations. About 55% of Motel 168 lease-and-operated hotels are located in the Yangtze Delta region, including Jiangsu and Zhejiang province, with relatively more concentrated manufacturing and export dependability impacted by the overall structural form of the China economy.

Net of this fact however, Motel 168 continued to achieve improvement in occupancy rate without decreasing average daily rates. Second quarter occupancy rate for Motel 168 increased to 80.8% from 70.4% in the first quarter of 2012, and from 74.6% in the second quarter of 2011. Our integration efforts are generating positive results. Meanwhile, we furthered our initiatives to restructure Motel 168 food and beverage operations in the second quarter. Part of the room revenue growth was offset by the sharp reduction in food and beverage revenues. The immediate benefit of such initiative were reduced costs associated with an inefficiently stressful structure of food and beverage operations.

We are in the process of ramping a more profitable food and beverage in line with that of the Home Inns brand. On the development front, we opened a total of 103 new hotels, including 32 new lease-and-operate hotels and 71 new franchised-and-managed hotels, of which six were franchised-and-managed Motel 168 hotels. We are on track to open a total of 330 to 360 new hotels in 2012. At the end of second quarter, we have a robust pipeline of 240 fellow hotels contracted or under constructions. Of which, 75 were lease-and-operate hotels and 172 were franchise-and-managed hotels.

Since our rebuilding of development pipeline post-global financial crisis in 2009, we have built a strongest franchise hotel pipeline as of the end of second quarter. We are well prepared to further leverage our proven franchise management program and platforms to maximize our brand value. Franchising is an increasingly important component of our business.

Our membership program continued to strengthen. As of June 30, 2012, the Home Inns group had 9.2 million unique, active non-corporate members. Increase from 4.3 million as of June 30, 2011. 57.8% of room nights were sold to active non-corporate members during the second quarter of 2012. With our integrated member royalty program, our membership will continue to provide a stable revenue base across all our hotel rents.

Looking to the balance of the year, we realistically believe that the market condition will remain challenging yet generally stable at least through the end of 2012. We are reasonably confident in our ability to successfully navigate through the (inaudible) and deliver a stable performance. In addition, we remain vigilant on solid execution. We will continue to focus on what we can control, including Motel 168 integration plan and the cost control mechanism. Motel 168 integration plans is proceeding well and we are transitioning into phase II of the plan.

The foundation work in phase I enabled us to stabilize existing business and prompting operational best practices and arming our people with effective tools and the knowhow. With the sales and marketing platform established, membership program integrated, more than half of the properties completed upgraded, risk and rewards metrics put in to place, we expect phase II integration to be further result driven.

Regarding to cost control, we are limited in ability to increase in selling price systematically due to the soft market condition this year. To add to this challenge, particularly labor costs continue to rise. We have initiated cost control measures, including restructuring of the hotel level staffing which are expected to generate benefit in the second half of the year. Our corporate [capital cost] structure continued to be lean and efficient. We had the G&A as a percentage of gross revenue for the total group decrease year-over-year.

As we look beyond 2012, we firmly believe that long-term prospect of China’s travel and lodging market remains strong. The near-term focus on integration of our brands, balanced development in lease and franchise business model, strength of our operating efficiency and as the September profit grows, Home Inns group is very well positioned to maximize opportunities that do exist and deliver a solid shareholder value over the long-term.

With that I will turn the call to Huiping.

Huiping Yan

Thank you, David, and hello to everyone on the call. I am pleased to first discuss our second quarter results and I will then provide guidance for the third quarter. The company has consolidated Motel 168 operations and financial results since October 1, 2011. We are presenting consolidated group numbers in the main body of our earnings release, and business and financial figures exclusive of the Motel 168 are being presented separately in an appendix to the earnings release.

Further, Motel 168 standalone profit and loss information is separately stated in a spreadsheet attached to our earnings release which is available for download for our investors. On this call I will review group financial results as well as selective non-Motel 168 information to provide more context. As I take you through the numbers, please note I will only speak in RMB terms unless specifically mentioned.

For the second quarter total revenues for Home Inns group were RMB 1.45 billion, increasing 60.2% year-over-year. Excluding, Motel 168 total revenues were RMB 1.0726 billion, an increase of 18.5% year-over-year. Total revenues from lease-and operated hotels were RMB 1.3 billion representing a 60.7% increase year-over-year. Excluding Motel 168 total revenues for leased-and-operated hotels were RMB 940.5 million, an increase of 16.2% year-over-year. Total revenues from franchised-and-managed hotels were RMB 149.7 million representing a 55.9% increase year-over-year. Excluding Motel 168 total revenues from franchised-and-managed hotels were RMB 132 million, an increase of 37.5% year-over-year.

Total operating cost and expenses were RMB 1.24 billion. Total operating expenses excluding share-based compensation and integration costs were RMB 1.19 billion, representing 82.4% of total revenues compared with 76% for the same quarter a year ago and 93.2% for the first quarter of 2012. The year-over-year increase in this cost and expense ratio was mainly due to overall market condition and the inclusion of Motel 168 operations which is at a less efficient cost ratio.

Total leased-and-operated hotel costs excluding share-based compensation expenses and integration cost, were RMB 1.1 billion representing 84.3% of the leased-and-operated hotel revenues compared to 77.5% of leased-and-operated hotel revenues in the same period of 2011, and 95.8% in the first quarter of 2012. The increase in this cost ratio was mainly driven by overall soft market conditions and absence of systematic price increases, less efficient cost structure of Motel 168 consolidated this year, and increase in personal costs.

Excluding Motel 168, total leased-and-operated hotel cost excluding share-based compensation expenses was RMB 769.4 million, representing 81.8% of the leased-and-operated hotel revenues compared to the 77.5% for the same quarter in 2011. The year-over-year increase in its expense ratio was due to soft market condition and personal cost increases without system managed price increases to offset. Excluding share-based compensation expense, personal cost of franchised-and-managed hotels were RMB 30.3 million representing 20.2% of franchised-and-managed hotel revenues compared to 17% for the same quarter in 2011, and 16% for the first quarter of 2012.

This year-over-year increase in the expense ratio was mainly due to Motel 168 with relatively lower franchised-and-managed hotel revenue base. The sequential increase in this ratio was also resulting from base pay adjustment and performance bonus accruals in Motel 168, in order to align its cost structure with rest of the group. Excluding Motel 168, increasing in franchised-and-managed hotel personal cost year-over-year are in line with increase in the number of franchised-and-managed hotel numbers.

Excluding share-based compensation expense and integration cost, sales and marketing expenses were RMB 15.1 million, representing 1% of total revenues compared to 1.4% of total revenues in the first quarter of 2012. General and administrative expenses excluding share-based compensation expenses and integration cost were RMB 53.1 million or 3.7% of total revenue compared to that of 5.1% of total revenue in the same quarter of 2011, and 4.2% in the first quarter of 2012. The company continues to benefit from economies of scale. The above resulted in an income from operations excluding share-based compensation expenses and integration costs of RMB 170.4 million or 11.8% of total revenues, compared to RMB 158.8 million or 17.5% of total revenues in the same period of 2011, and RMB 9.7 million or 0.8% of total revenue in the first quarter of 2012.

The year-over-year increase in the ratio of income from operations over total revenues was mainly caused by higher cost ratio in Motel 168 and an increase in personal cost while relatively soft market conditions were not conducive for systematic selling price increases, which would otherwise offset costs inflations. The sequential decrease in its ratio was mainly due to seasonality. Adjusted EBITDA was RMB 331.6 million or 22.9% of total revenues compared to RMB 165.9 million or 13.2% of total revenues in the first quarter of 2012, of which number Motel 168 was not included then.

Excluding Motel 168, adjusted EBITDA was RMB 274.3 million or 25.6% of total revenue compared to RMB 247.5 million in the same period of 2011 or 27.3% of total revenues in the second quarter of 2011. Adjusted net income attributable to Home Inns group shareholders was RMB 108.5 million for the second quarter, which included an adjusted net income from Motel 168 of RMB 8.2 million. Adjusted diluted earnings per ADS for the second quarter of 2012 were RMB 2.17 yuan or $0.34 in U.S. dollars.

During the second quarter the company generated a net operating cash flow of RMB 259.3 million compared to RMB 254.3 million in the same quarter 2011. Capitalized expenditures for the second quarter were RMB 224.5 million and related cash paid for capital expenditures during the quarter was RMB 134.5 million. As of June 30, 2012, Home Inns group had cash and cash equivalent of RMB 1.01 billion. The outstanding balance of its convertible bonds issued in 2007 was RMB 113.3 million, including principal and accrued interest.

Outstanding balance of long-term financial liability measured at fair value arose of from the convertible bonds issuance in 2010 December was RMB 997.7 million. The balance of U.S. dollar denominated four-year term loan facility decreased to RMB 917.1 million as the company had paid down US$95 million during the second quarter of 2012.

Now moving on to our outlook. As David mentioned earlier, while we do not anticipate a meaningful improvement in the overall market, we expect market conditions to remain relatively stable. Further taking into consideration of Motel 168’s current performance trend in light of the prevailing market conditions, we are revising our full year revenue guidance for Motel 168. Revenue guidance for the full year excluding Motel 168 remains unchanged.

For the full year, total revenue for Home Inns group are expected to be in the range of RMB 5715 million to RMB 5810 million. Previously guided total revenues for Home Inns group were in the range of RMB 5815 million to RMB 5910 million. Total revenues for the Motel 168 brand for the full year are expected to be in the range of RMB 1475 million to RMB 1500 million. Previously guidance total revenues for Motel 168 were in the range of RMB 1575 million to RMB 1600 million. Excluding Motel 168, total revenues for the full year of 2012 remain unchanged to be in the range of RMB 4240 million to RMB 4310 million.

Our revenue guidance for the third quarter of 2012. The Home Inns group expects its total revenue from the third quarter of 2012 to be in the range of RMB 1545 million to RMB 1575 million. Total revenues for Motel 168 brand in the third quarter are expected to be in the range of RMB 390 million to RMB 400 million. Excluding Motel 168 total revenues in the third quarter of 2012 are expected to be in the range of RMB 1155 million to RMB 1175 million. These forecasts reflect Home Inns group’s current preliminary review which is subject to change.

Now I would like to open the call to questions. Operator, please.

Question-and-Answer Session

Operator

(Operator Instructions) And the first question comes from the line of Jamie Zhou calling from Macquarie Securities. Please ask your question.

Jamie Zhou - Macquarie

My first question is on the Motel ADR. I see that your Motel ADR did not see a sequential quarter-on-quarter increase in the second quarter. I am wondering if you are planning to increase ADR slightly having been through the summer season or have you already done that? That’s my first question. Thanks.

Huiping Yan

Thank you. As you can see that, Jamie, our occupancy rate continues to increase and our focus in integration is initially to continue to boost the occupancy rate increases. We intend to at minimum maintain the current level of ADR and we will watch very closely how the price level impacts occupancy rate. So again, the expectation is to maintain current level of ADR while we drive further increases in our occupancy rates.

Jamie Zhou - Macquarie

So if I remember correctly, back in Q4 of last year, you did tell -- you mentioned that you intend to keep the ADR under discount for about six months. That’s from Q4 last year to Q1 of this year. Is there a change in the duration strategy?

Huiping Yan

Sure. Actually when we were in the first stage of integration, we did adjust the ADR down while we are implementing all of the integration initiative. Again, the focus is to bring people and to built for traffic. And so therefore that’s what we did. And then since then our ADR has been gradually climbing as we continue to improve the occupancy rate. The discount is in relationship to the overall performance of Motel 168 in the past where the occupancy rate and the ADR relationship were unreasonable. So as we continue to integrate the business, there will be much more efficiency between the two metrics. And eventually once we conclude the integration of Motel 168, the existing portfolios ADR level should return normal as a relationship to our core Home Inns business.

The new portfolio that we will establish from Motel 168 will add a price premium given its better outfit of the hotel as well as the scale efficiency.

Jamie Zhou - Macquarie

Okay. Understood. Thank you. My second question is on the integration expense. I noticed that there was another RMB 25 million recorded in the second quarter. First, I would like to confirm, that’s coming out of the general and administrative expense, right?

Huiping Yan

There were two parts. One part of it is inside large portion of our integration costs associated with the hotel level property upgrades and revalidation. So it is charged to the hotel operating cost net income the line of others. And there is a small portion charged to the G&A.

Jamie Zhou - Macquarie

Okay. Are we still looking for another RMB 13 million to be spent in the remainder of 2012?

Huiping Yan

That’s correct.

Jamie Zhou - Macquarie

Okay. Thank you. My last question is on competition. As Home Inns is seeing increased competition coming from smaller competitors, particularly given the rounds of private equity fund raising for few of your smaller competitors such as (inaudible) over the last quarter. Can you just give us some color on the competition front? Thank you.

Huiping Yan

Sure. One of the statistics that we look very closely is how much of our revenue is contributed by our membership. So in this case while the regional small players are receiving equity funding and perhaps increased their operational focus, the larger scale of Home Inns still has a advantage -- lots of advantages. As I mentioned in the earlier statistics that 58% of our room nights were sold to members. And I think this goes back to the selling point of the attractiveness of a budget hotel when consistent quality of the product are expected by our customers. So we still believe, Home Inns, with its large scale and geographic diversity will have great advantage over the small operators.

Jamie Zhou - Macquarie

Okay. I see. Just follow up to that. Now that you said in our announcement that you are still looking for an opportunity to raise your ADR for the core Home Inns hotel. Is competition effecting your ability to raise on that front in addition to the macro economy headwind?

Huiping Yan

First of all, this year due to the market condition we were not able to push through systematic price increases. Many of the markets are impacted by overall economy restructure in China and so far we still not see clear sign of recovery, hence right now we are not expecting to have any meaningful ADR increases. Going into the third quarter, we are expecting slight benefit from the seasonality improvements and we will maximize the price opportunities where we can. So we do expect to at minimum maintain our current level of ADR and then take opportunities when they present.

Jamie Zhou - Macquarie

But so far it has not happened in third quarter to date?

Huiping Yan

Very limited opportunities.

Operator

And the next question comes from the line of Chenyi Lu calling from Cowen & Company. Please ask your question.

Chenyi Lu - Cowen & Company

Regarding the -- you guys lowered your revenue guidance for this year. Can you guys give us a view as adjusted EBITDA margin, what we should look for the remaining of 2012? That would be great. Thank you.

Huiping Yan

Sure. I will give a more directional suggestion. Motel 168 on a adjusted basis achieved 3.7% negative EBITDA margin in the first quarter of this year. And in the second quarter of this year it achieved an EBITDA margin of 7.9% and on adjusted basis, 15.2%. Now these improvements are as a result of various things, mainly the overhauling of our food and beverage which eliminated a lot of the food and beverage of a non-profitable segment of the business. And also the occupancy rate increases does drive revenue, room revenue growth sequentially and compared to last quarter of 2011.

So with that said, we will continue to push for the increases in the occupancy rate, hence improve room revenue with what we had described earlier. So that because of the impact of the overall market, the net results of the increases will be somewhat subdued or offset. And we do see a potential for continued slight improvement in the margin rate so we are cautiously optimistic at this point.

Chenyi Lu - Cowen & Company

So given the integration we see on Motel 168, do you expect your margin, adjusted EBITDA margin will be flat into 2012 and see a improvement in 2013.

Huiping Yan

It is hard to pinpoint where the bottom of the market is. The current view is that the rest for the year would probably be benign, I think is the best way I can describe it. It’s probably similar and with no major improvements. And then we are looking to potentially slight lift in the third quarter due to seasonality, but then there are more uncertainties that we cannot see into the fourth quarter perhaps.

So looking beyond 2012, however, we do believe that with a stable six months of the market conditions, the likelihood of a recovery is better or higher in 2013. And our business will continue to maintain its operating structure and business efficiencies. And we continue to focus on the execution. The fundamentals are still in place. So we are confident that looking beyond 2012, our operations in business results will improve from them.

Operator

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

Ella Ji - Oppenheimer

Thanks. Huiping, I want to discuss further with you regarding margins performance in the second quarter. The margins for Home Inns Hotels was 25.6% in 2Q. It’s quite a big increase from 1Q. Although you have -- you still have some diluted from new hotels. So I am just wondering if there is any one-time benefit for that margin -- for that big margin increase.

Huiping Yan

This improvement really comes from two parts that I would point to you, Ella. One is that, from a revenue perspective, we do have a meaningful increase compared to the first quarter. And also the cost structure as a percentage of revenue improved slightly. And then second point is in the G&A leverage. On both front of Motel 168 and Home Inns you can see that the number is reflecting the G&A leverage. So we do see that the underlying business operational profitability is quite sound.

Now there are no onetime adjustments. There was a onetime adjustment in 2011 second quarter on the sales and marketing front. But excluding that we do see that the business is showing underlying strength in holding the ground. With regard to profitability of course we should talk about the cost structure of the leased-and-operated hotels. We mentioned that the personal costs are increasing. However, it is again still within our previous expected range of 5% to 10% on a per unit sold basis. And again as David alluded to earlier that we have implemented a hotel staffing structure and it will show more benefit in the second half through the year.

So we do believe that underlying core Home Inns business has very strong profit potential. And as the market resumes, revenue will improve and then the cost expense ratio will also follow in improvements.

Ella Ji - Oppenheimer

Right great. So it sounded like the margins, you will be hold this margin level if we assume the market situation is also stable from this level.

Huiping Yan

Yes, correct. And if I may just give you some more of the statistics. The 790 hotels that were mature over 18 months, they represent over 62%-63% of our total portfolio. And that is a very sound business base. And that is what we say that our cost structure, our profitability potential is still quite strong.

Ella Ji - Oppenheimer

Great. And then my second question is about the market trend. So I heard you said you expect market to be stable but could you just comment third quarter quarter-to-date, how does that compare to 2Q. I mean 2Q mature hotels RevPAR was flat. It’s below 1Q’s 1.3%. So, do you expect to see a possible negative comp in 3Q? And also given there is recently some very severe weather conditions in China, do you think there is any negative impact on your business?

Huiping Yan

Yeah, I think to simply put that we expect the performances to be stable. We are currently not detecting any trend of negative comp. The seasonality in the third quarter will help slightly.

Operator

And the next question comes from the line of Grace Lam calling from Citi. Please ask your question.

Grace Lam - Citi

I would like to ask, could you talk about like the different performance of regions, like regional different performance. Are you seeing any region or cities that are doing particularly strong.

Huiping Yan

Thank you, Grace, for your question. It is a very good question and it is how we look at Motel 168 business and the core Home Inns business differently. Motel 168 was highly concentrated, it’s locations are highly concentrated in the Yangtze Delta region area and the surrounding cities. Those areas largely were manufacturing and export businesses, textile, light industry. So those areas are more impacted than the rest of the country.

Now on the other hand for Home Inns business because of its diversity, it is indeed it’s strength in its ability to balance in its total portfolio. While those area of softness in the Yangtze Delta regions are present, the rest of the country such as northern part of China, Beijing, Changzhou, for example. Those areas are still quite relatively strong. So we are -- as a result, we described that the 790 mature hotels maintained their RevPAR year-over-year in an environment that we are in. That is as a result of our diversified portfolio.

Grace Lam - Citi

Thank you. May I have a second question? Could you give an update on your Yitel strategy? And also I thought that there is a one franchise hotel, will the charges be similar to other Home Inns hotels?

Huiping Yan

Sure. Thank you for your question. Yitel hotel, we have reported that the three that we opened in 2011 are ramping up according to our plan. And then this year, we have in operation currently four hotels, including one that was opened previously in 2008. The overall design of the Yitel product is in its final stage and the total group reached 80% occupancy rate in second quarter of this year. And that is an increase of around 65% than last year when it first started. So that’s why we are seeing that the brand itself, the product itself is being proven in the market place.

And in 2013, we plan to open another six and then by then Yitel will reach a reasonable scale and a stabled benchmark. We will deploy franchise and managed model both in Yitel when the time comes.

Operator

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

Billy Ng - Bank of America Merrill Lynch

I have three questions there. The first one, I just wonder, like in addition to the color of the geographical difference of the performance, can you tell us about in terms of tier 1, tier 2 cities versus tier 3, tier 4 cities. Do you still see tier 3, tier 4 cities in the second half will have more challenges to maintain the RevPAR or that has been reversed? That’s my first question.

Huiping Yan

Sure. We are not expecting the overall market condition to change substantially in the second half. You are correct that the tier one, tier two cities with its complex and sophisticated economic structure, it has better ability to weather the economic downturn. The third and fourth tier cities largely are still in its up and coming on its formation of a strong economy, does relatively show softer performances compared to tier one, tier two cities.

In the second half of 2012, we however don not expect sharp reversal or a further downturn of the overall market. And then third tier or fourth tier cities are of no exception.

Billy Ng - Bank of America Merrill Lynch

Thanks. And my second question is this, for the lowering guidance, what caused them? Is that more from, okay, the opening schedule, custom of the hotels or we see occupancy rates or room rates in softness. In general, how should we see, how should we read the lowering guidance number?

Huiping Yan

Sure. First of all, we lowered revenue guidance for Motel 168 only. And it’s driven by largely two reasons. One is that those highly concentrated locations of Motel 168 in regions that are more impacted by the overall market softness. We do not see, or we cannot see at this point any improvements in those markets. So therefore we lowered the revenue guidance for Motel 168 because our observation and assumption changed from beginning of the year.

The second part is we have accelerated our overhaul activities at Motel 168 for its food and beverage businesses. Through practice, through actually day to day, we realized that it is not a half-baked job that could be done in reducing half of the food and beverage. We believe it should be a surgical activity meaning we immediately reduce the food and beverage business sharply. And that sharp downturn, reducing the previous around 11% of the total revenue of food and beverages businesses to currently somewhere around 4% is a sharp decrease. So we plan to continue to do that and as we ramp up, or re-ramp the food and beverage business to be more similar as that of the core Home Inns and Yitel Home Inns business, we will take some time in the second half to replenish, so to speak, of the food and beverage revenue.

So with those two key considerations, we have lowered Motel 168 revenue. And then again, the total core Home Inns Yitel business revenue guidance stayed intact. You also asked about the development of Motel 168. While we are integrating Motel 168, we previously didn’t plan on a great effort in increasing the hotel openings. And that will come in 2013. This year we are looking at around six to seven leased-and-operated hotels opening from Motel 168 brand, and around 30 or so franchised Motel 168.

Billy Ng - Bank of America Merrill Lynch

Okay. Thanks. And the last question actually is just housekeeping. Several things, one is, can you tell us the opening schedule you just mentioned, Motel 168. How about the Home Inns franchise for the two, next two quarters in the second half with the opening schedule will be. And also what's the remaining integration cost for Motel 168? How should we forecast that for the next two quarters? And finally, just one thing exactly, we see a non-operating income about RMB 11.6 million. I just wonder, is that a recurring number and what is that basically?

Huiping Yan

Okay. Let me get your last question out of the way first. The non-operating income represents government subsidies and so far in the past we have been receiving government subsidies largely due to some of our effective tax structure of our business. Of course we cannot guarantee those government subsidies to continue forever. Now your first question about openings.....

Billy Ng - Bank of America Merrill Lynch

In the first quarter it has a fairly significant increase on that. So is that a going run rate we should use for the guidance?

Huiping Yan

There is no pattern or no set numbers to be expected on a go forward basis based on our overall operations, based on the various other factors that are not entirely within our control. The government’s fiscal conditions and all that will go into play. So therefore there is not a way of clearly forecasting it.

Billy Ng - Bank of America Merrill Lynch

I see. Thanks.

Huiping Yan

And so your first question is the opening schedule. In the first half of the year for leased-and-operated hotels we met our target and we typically plan 30% to 35% of the total leased-and-operated hotel openings. And we have achieved that. For the total year of 2012, excluding Motel 168 we are looking at somewhere around 100 leased-and-operated hotels and then 250 or so of the franchise hotels. In the rest of the year, the opening schedule will be fairly reasonable with perhaps about 52% or 60% in Q4 and then the rest in Q3.

Operator

And the next question comes from the line of Adam Krejcik calling from ROTH Capital Partners. Please ask your question.

Adam Krejcik - ROTH Capital Partners

A couple of questions. First going back to Motel 168. So just wanted to understand a little bit more about the occupancy rate. It picked up quite a bit sequentially but on the last conference call you said it’s averaging I think around 84% in the month of April. So must have declined a bit in May and June. So is that related to economic conditions, the macro environment? And then secondly, how are the plans, specific plans related to Motel 168 in terms of improving the occupancy rate. I think you mentioned one of the initiatives was making the hotel smaller, splitting them up. Can we get an update on that? And just kind of how you are thinking about the occupancy rate trend there for the rest of the year and I guess in the next year as well given the (inaudible)

Huiping Yan

Sure. Thank you, Adam. The sequential increases is partly helped by seasonality of course. In April we did achieve a high occupancy rate. Now April typically is a better month across the whole quarter. In May and June we again see the further impact of the economy and that impacted Motel 168 occupancy rate. So on a blended basis, it is at 80.8% for the total quarter.

The plans of our integration is that we did mention that we have concluded phase one. Phase one of putting in investment and putting in place our initiatives and operational foundations. The second stage would be leveraging on all these investments and platforms to be more results driven and then specifically the risk and award or performance based metrics are put in place. So people understood what it means, people understood the various items that we would manage so as to drive results. So we are putting all the efforts into really showing and seeing the improvements in the second phase. And with that the occupancy rate for Motel 168 is targeted to be at 80% on a full-year basis and perhaps even more for 2012.

And looking forward in 2013 and into the rest of the integration phase, we are still tracking our previous plan. And to achieve EPS accretive sometime in 2013 and then for the full year of 2014. The split of the hotels, we have started the piloting program, there were two completed. One that was completed earlier in May are showing positive results. And with that we are planning in the second phase to identify more of such potential candidates in further breaking those large units down. And we are seeing that every possible opportunity improving the occupancy rate, even just 3 or 4 points, which mean quite a large positive impact on the bottom line. So therefore we would roll out more of such initiatives in the second half of the year. And in the cost associated with those splitting of the larger units is part of our integration budget.

Adam Krejcik - ROTH Capital Partners

Okay. Great. And then is there (inaudible) any trends. You have talked about locations, demographics, but are you noticing any trends in terms of leisure travel or fitness traveler being impacted, one, more or less from the macro environment.

Huiping Yan

Yes, definitely. The business volume is impacted more by the overall macro economy. The leisure travel as a whole is still quite healthy and then we do see that the leisure travel is picking up but it’s still at a percentage.

Adam Krejcik - ROTH Capital Partners

Okay. Great. And then my final question regard to your balance sheet. So you paid down some debt this quarter. Can you just talk about your plans in terms of debt reduction over the coming second half of the year into next year? And then you know I take that you remain comfortable with all your covenants and the leverage that you have right now with the free cash flow that you are going to generate? Or is there any other plans in terms of you needed to change your capital structure. Thank you.

Huiping Yan

The current gearing is still quite comfortable for us. In addition to the 95 million that we paid down in the second quarter in July, this year we paid further down of another 21 million. And that is as a result of balancing our overall cash generation and the development plan. The overall plan for 2013 is that we will continue to monitor the market condition and also balancing between leased-and-operated and the franchise hotel opening plan. So far there is no additional capital needs based on our -- compared to our previous cash flow plan. So as we generate more cash and as we continue to maintain within our covenants, we may continue to pay down the debt as we can. But, again, we need to balance between how we deploy our cash in growing the company and receiving or maximizing the return on investment compared to incurring interest cost on the term loans. So it’s a holistic approach, Adam.

Operator

And the next question comes from the line of Justin Kwok calling from Goldman Sachs. Please ask your question.

Justin Kwok - Goldman Sachs

I have a question on the medium-term development plan of the company. We got to the expansion in terms of the new opening and also different brands. With your comment earlier on, on the fact that you think it would largely be a stable year for this year and may potentially be stable for next year, whereas there is some geographical data in terms of the performance relative to country. Do you or will you be changing some of your expansion plan, for example leased-and-operated versus franchised-and-managed and also the way you are going to roll out your geographical coverage. I guess you are now already covering over 200 cities. So will you be, say focusing more back to the main cities where you have seen more stable performance. How should we look at the way you expand the portfolio in the one or two years to come? Thank you.

Huiping Yan

Yes, thank you. Very good, Justin. There are various factors that we are considering right now in planning our longer range or longer term. The franchise business platform is very well established and very well run. Brand recognition and return on investment track record for our franchises has been well regarded. And it’s reflected in our pipeline, I think 172 franchise pipeline indicates that the strong demand is there. Going into longer term we will be looking at focusing more on the franchise model as an increasing part of our business. About 65% to 70% of our new hotels maybe in the form of franchised model going forward.

As far as our geographic rebalancing we have established very strong presence in many of the key cities including tier one, tier two and some of the tier three. We believe that those are great leverage that we can have and continue to build on those platforms. So the next wave of expansion will be further penetration into those well established markets. While we will still have a reasonable level of expansion into new markets where longer-term growth potential exists. Hope that answers your question.

Operator

I would now like to hand the call back to the management team for closing.

Huiping Yan

Thank you, very much everybody for your questions. Again, all the financial information are available at our investor relations website and also if I may point out to you that we have added a document that addresses the current topic, such as VIE, corporate structures, our Motel 168 acquisition strategy and as well as integration plan, to provide more information. So feel free to visit our website. We will be going on a road show with Goldman Sachs in Hong Kong immediately after this earnings call next week. So I hope that you have contacted Goldman Sachs in securing a slot in speaking with us. And we look forward to talk to you more on a more frequent basis going forward. Thank you very much.

Operator

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

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