F-1/A 1 h03703a2fv1za.htm F-1/A fv1za
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As filed with the Securities and Exchange Commission on March 15, 2010
Registration No. 333-165247
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
AMENDMENT NO. 2
TO
FORM F-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
 
 
China Lodging Group, Limited
(Exact Name of Registrant as Specified in Its Charter)
Not Applicable
(Translation of registrant’s name into English)
 
         
Cayman Islands
  7011   Not Applicable
(State or other jurisdiction of
incorporation or organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)
 
5th Floor, Block 57, No. 461 Hongcao Road
Xuhui District
Shanghai 200233
People’s Republic of China
(86) 21 5153-9477
(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices)
 
 
CT Corporation System
111 Eighth Avenue, 13th Floor
New York, New York 10011
(212) 604-1666
(Name, address, including zip code and telephone number, including area code, of agent for service)
 
 
Copies to:
     
Howard Zhang, Esq.
Davis Polk & Wardwell LLP
26/F, Twin Towers (West)
B12 Jian Guo Men Wai Avenue, Chaoyang District
Beijing 100022, China
(86) 10-8567-5000
  Chris K.H. Lin, Esq.
Simpson Thacher & Bartlett LLP
35/F, ICBC Tower
3 Garden Road
Central, Hong Kong
(852) 2514-7600
 
 
Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. o
If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o           
If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o           
If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o           
 
 
CALCULATION OF REGISTRATION FEE
 
 
                         
Title of each class of
    Amount to be
    Proposed maximum offering
    Proposed maximum
    Amount of
securities to be registered     registered(1)(2)     price per ordinary share(1)     aggregate offering price(1)     registration fee
Ordinary shares, par value US$0.0001 per share(3)
    41,400,000     US$3.0625     US$126,787,500     US$9,040(4)
                         
(1)  Estimated solely for the purpose of computing the amount of registration fee in accordance with Rule 457(a) under the Securities Act of 1933, as amended.
(2)  Includes (a) ordinary shares represented by American depositary shares initially offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first bona fide offered to the public, and (b) ordinary shares represented by American depositary shares that are issuable upon the exercise of the underwriters’ over-allotment option to purchase additional shares. These ordinary shares are not being registered for the purposes of sales outside the United States.
(3)  American depositary shares issuable upon deposit of the ordinary shares registered hereby will be registered pursuant to a separate registration statement on Form F-6 (Registration No. 333-165402). Each American depositary share represents four ordinary shares.
(4)  Previously paid.
 
 
 
The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.
 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where such offer or sale is not permitted.
 
Subject to completion, dated March 15, 2010
 
9,000,000 American Depositary Shares
 
(HANTING HOTEL GROUP LOGO)
China Lodging Group, Limited
 
Representing 36,000,000 Ordinary Shares
 
 
 
This is our initial public offering. We are offering 9,000,000 American depositary shares, or ADSs, each representing four of our ordinary shares, par value US$0.0001 per share. No public market currently exists for our ordinary shares or ADSs.
 
 
We currently anticipate the initial public offering price of our ADSs to be between US$10.25 and US$12.25 per ADS. We have applied to have our ADSs listed on the NASDAQ Global Market under the symbol “HTHT.”
 
 
Investing in our ADSs involves a high degree of risk. See “Risk Factors” beginning on page 13.
 
 
                 
    Per ADS   Total
 
Public offering price
  US$               US$            
Underwriting discount
  US$               US$            
Proceeds, before expenses, to us
  US$               US$            
 
 
We have granted the underwriters a 30-day option to purchase up to 1,350,000 additional ADSs from us at the initial public offering price less the underwriting discount and commission.
 
 
Delivery of our ADSs will be made on or about          , 2010.
 
 
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.
 
 
 
Goldman Sachs Morgan Stanley
 
Oppenheimer & Co.
 
The date of this prospectus is               , 2010.


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Your home on the journey 39 cities 236 hotels 6,181 staff 38,360 Rooms 1,505,442 Hanting Club Members HANTING SEASONS HOTEL HENATING EXPRES HANTING

 


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No.1No.1No.1OccupancyRevPARGrowth1 1 2 Capturing a Wide Spectrum of Market Opportunities In 2008 and for the first half of 2009, among economy hotel chains in China with over 100 hotels or at least 10,000 hotel rooms, according to the October 2009 Inntie Report. In terms of the number of hotel rooms, in 2008 and for the first half of 2009, among economy hotel chains in China with over 100 hotels or at least 10,000 hotel rooms, according to the October 2009 Inntie Report. 1 2 No.1No.1No.1OccupancyRevPARGrowth1 1 2 Capturing a Wide Spectrum of Market Opportunities In 2008 and for the first half of 2009, among economy hotel chains in China with over 100 hotels or at least 10,000 hotel rooms, according to the October 2009 Inntie Report. In terms of the number of hotel rooms, in 2008 and for the first half of 2009, among economy hotel chains in China with over 100 hotels or at least 10,000 hotel rooms, according to the October 2009 Inntie Report. 1 2

 


 

 
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 EX-23.1
 
 
You should rely only on the information contained in this prospectus or in any free writing prospectus filed with the Securities and Exchange Commission in connection with this offering. Neither we nor the underwriters have authorized anyone to provide you with additional information or information different from that contained in this prospectus or in any free writing prospectus. We are offering to sell, and seeking offers to buy, ADSs only in jurisdictions where offers and sales are permitted. The information contained in this prospectus or in any free writing prospectus is accurate only as of its date, regardless of the time of delivery of this prospectus or of any sale of ADSs.
 
We have not taken any action to permit a public offering of the ADSs outside the United States or to permit the possession or distribution of this prospectus outside the United States. Persons outside the United States who came into possession of this prospectus must inform themselves about and observe any restrictions relating to the offering of the ADSs and the distribution of this prospectus outside of the United States.
 
Until          , 2010 (the 25th day after the date of this prospectus), all dealers that buy, sell or trade ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.


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CONVENTIONS THAT APPLY TO THIS PROSPECTUS
 
Unless otherwise indicated, references in this prospectus to:
 
  •     “ADRs” are to the American depositary receipts that may evidence our ADSs;
 
  •     “ADSs” are to our American depositary shares, each representing four ordinary shares;
 
  •     “China” or the “PRC” are to the People’s Republic of China, excluding, for purposes of this prospectus, Hong Kong, Macau and Taiwan;
 
  •     “Ordinary shares” are to our ordinary shares, par value US$0.0001 per share;
 
  •     “Series A preferred shares” are to our Series A convertible preferred shares, par value US$0.0001 per share;
 
  •     “Series B preferred shares” are to our Series B convertible redeemable preferred shares, par value US$0.0001 per share;
 
  •     “RMB” and “Renminbi” are to the legal currency of China;
 
  •     “US$,” “U.S. dollars,” “$,” and “dollars” are to the legal currency of the United States; and
 
  •     “we,” “us,” “our company,” “our,” and “HanTing” refer to China Lodging Group, Limited, a Cayman Islands company, and its predecessor entities and subsidiaries.
 
This prospectus contains translations of RMB amounts into U.S. dollars at specific rates solely for the convenience of the reader, and unless otherwise indicated, conversions of RMB into U.S. dollars in this prospectus are based on the exchange rate set forth in the H.10 weekly statistical release of the Federal Reserve Bank of New York, or the exchange rate, on December 31, 2009. We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, or at all. The PRC government imposes controls over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. See “Risk Factors — Risks Related to Doing Business in China — Governmental control of currency conversion may limit our ability to pay dividends in foreign currencies to our shareholders and therefore adversely affect the value of your investment” and “Risk Factors — Risks Related to Doing Business in China — Fluctuation in the value of the Renminbi may have a material adverse effect on your investment” for discussions of the effects of fluctuating exchange rates and currency control on the value of our ADSs. On March 8, 2010, the exchange rate was RMB6.8263 to US$1.00.
 
This prospectus contains statistical data that we obtained from various government and private publications. We have not independently verified the data in these reports. Statistical data in these publications also include projections based on a number of assumptions. If any one or more of the assumptions underlying the statistical data turns out to be incorrect, actual results may differ from the projections based on these assumptions. In particular, this prospectus contains statistical data extracted from two reports issued by Shanghai Inntie Hotel Management Consultant Co., Ltd., a PRC consulting and market research firm specializing in economy hotel business in the PRC. One report, publicly issued in March 2009, is titled Analysis of Economy Hotel Customers’ Future Demands, which we refer to as the March 2009 Inntie Report in this prospectus. The other report, issued in October 2009 and subsequently amended, is titled Analysis of Competition among Economy Hotel Chains in China, which we refer to as the October 2009 Inntie Report in this prospectus. The October 2009 Inntie Report was commissioned by us for a fee that is more than nominal. Furthermore, this prospectus contains a ranking of China’s top 20 cities, as measured by gross regional product in 2007, issued by the National Bureau of Statistics of China.


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PROSPECTUS SUMMARY
 
This summary highlights selected information appearing elsewhere in this prospectus. This summary may not contain all of the information you should consider before investing in our ADSs. You should carefully read this prospectus, including our financial statements and related notes beginning on page F-1, and the registration statement of which this prospectus is a part in their entirety before investing in our ADSs, especially the risks of investing in our ADSs, which we discuss under “Risk Factors.”
 
Overview
 
We operate a leading economy hotel chain in China. According to the October 2009 Inntie Report, we achieved the highest revenues generated per available room, or RevPAR, and the highest occupancy rate in 2008 and for the first half of 2009, and the highest growth rate in terms of the number of hotel rooms during the period from January 1, 2007 to June 30, 2009, in each case among economy hotel chains in China with over 100 hotels or at least 10,000 hotel rooms.
 
We mainly utilize a lease-and-operate model, under which we directly operate hotels that are typically located in prime locations of selected cities. We also employ a franchise-and-manage model, under which we manage franchised hotels, to expand our network coverage. We apply a consistent standard and platform across all of our hotels. As of December 31, 2009, we had 173 leased-and-operated hotels and 63 franchised-and-managed hotels. In addition, as of the same date, we had 21 leased-and-operated hotels and 123 franchised-and-managed hotels under development.
 
We offer three hotel products that are designed to target distinct groups of customers. Our flagship product, HanTing Express Hotel, targets knowledge workers and value-conscious travelers. Our premium product, HanTing Seasons Hotel, targets mid-level corporate managers and owners of small and medium enterprises, and our budget product, HanTing Hi Inn, serves budget-constrained travelers. As a result of our customer-oriented approach, we have developed strong brand recognition and a loyal customer base. We have received multiple awards, including “Most Favored Economy Hotel in 2008” by Traveler Magazine and “Most Suitable Economy Hotel for Business Travelers” by Qunar.com, one of the leading online travel search engines in China, in 2008. In 2009, approximately 68% of our room nights were sold to members of HanTing Club, our loyalty program.
 
Our operation commenced with mid-scale limited service hotels and commercial property development and management in 2005. We began migrating to our current business of operating and managing a multiple-product economy hotel chain in 2007. Our total revenues grew from RMB249.4 million in 2007 to RMB1,333.9 million in 2009. We incurred net losses attributable to our company of RMB111.6 million and RMB136.2 million in 2007 and 2008, respectively. We had net income attributable to our company of RMB42.5 million in 2009.
 
Industry Background
 
The lodging industry in China consists of upscale luxury hotels such as four and five star hotels and other accommodations such as one, two and three star hotels and guest houses. The industry grew from approximately 237,800 hotels in 2003 to approximately 315,900 hotels in 2008, and 20.1 million rooms in 2003 to 27.3 million rooms in 2008, according to Euromonitor International.
 
The economy hotel industry in China, in particular the branded economy hotel chains, is at an early stage of development and presents tremendous growth opportunities. We believe that a number of key factors will continue to drive the strong growth of branded economy hotel chains:
 
  •     China’s robust economic growth which drives overall travel and tourism industry;
 
  •     increasing domestic business travel, particularly with the growing importance of small and medium enterprises;


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  •     rapidly growing domestic leisure travel as a result of higher disposable income and changing lifestyle;
 
  •     increasing attractiveness of branded economy hotel chains; and
 
  •     emerging segmentation within the economy hotel industry.
 
Our Competitive Strengths
 
We believe that the following strengths differentiate us from our competitors and have enabled us to capture a leading position in the rapidly growing economy hotel industry in China:
 
  •     we have established a premium brand and achieved the highest RevPAR and occupancy rate in 2008 and for the first half of 2009, according to the October 2009 Inntie Report;
 
  •     we have successfully established a portfolio of diversified products;
 
  •     we have adopted a disciplined return-driven development model with a proven track record;
 
  •     we have been able to achieve operational efficiency while improving productivity;
 
  •     we have an efficient and scalable operating system supported by advanced technology platform; and
 
  •     we have an experienced management team supported by a well-trained workforce.
 
Our Strategies
 
Our vision is to become one of the leading hotel groups in China. We intend to achieve this goal through the following strategies:
 
  •     enhance our market leadership through prudent return-driven network expansion;
 
  •     meet evolving market demand through product diversification and customer segmentation;
 
  •     further enhance our brand recognition and expand our customer base by leveraging our loyalty program;
 
  •     continue to invest in human capital to support future growth; and
 
  •     continue to implement cost control measures to enhance our profitability.
 
Summary of Risk Factors
 
Investing in our ADSs involves a high degree of risk. You should consider carefully the risks and uncertainties summarized below, the risks described under “Risk Factors,” beginning on page 13, the other information contained in this prospectus before you decide whether to purchase our ADSs.
 
  •     Our operating results are subject to conditions affecting the lodging industry in general, which include, among other things, changes and volatility in general economic conditions, competition, and local market conditions.
 
  •     Our limited operating history makes it difficult to evaluate our future prospects and results of operations.
 
  •     We incurred net losses attributable to our company of RMB111.6 million and RMB136.2 million in 2007 and 2008, respectively, and may incur losses in the future.
 
  •     We may not be able to manage our planned growth.
 
  •     We may not be able to identify additional hotel properties for lease that satisfy our return threshold and achieve the expected economic returns on our leased-and-operated hotels.


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  •     Our legal right to lease certain properties could be challenged by property owners or other third parties or subject to government regulation.
 
  •     Any failure to comply with land- and property-related PRC laws and regulations may negatively affect our ability to operate our hotels and we may suffer significant losses as a result.
 
  •     Our success could be adversely affected by the performance of our franchised-and-managed hotels.
 
  •     We may not be able to maintain and enhance the attractiveness of our hotels and our reputation.
 
  •     As we operate as a holding company, any limitation on the ability of our subsidiaries to make payments to us could have a material adverse effect on our ability to conduct our business.
 
  •     Rapid urbanization and changes in zoning and urban planning in China may cause our leased properties to be demolished, removed or otherwise affected.
 
Corporate Structure and History
 
The following diagram illustrates our corporate and ownership structure, the place of formation and the ownership interests of our subsidiaries as of the date of this prospectus.
 
(FLOW CHART)
 
 
(1) Winner Crown Holdings Limited, or Winner Crown, is a British Virgin Islands company wholly owned by Sherman Holdings Limited, a Bahamas company, which is in turn wholly owned by Credit Suisse Trust Limited, or CS Trustee. CS Trustee acts as trustee of the Ji Family Trust, of which Mr. Qi Ji, our founder and executive chairman, and his family members, are the beneficiaries. Mr. Ji is the sole director of Winner Crown and beneficially owns approximately 60.2% of our total outstanding ordinary shares on an as-converted basis, including a certain number of shares that are held by East Leader International Limited (see footnote (2) below), over which Mr. Ji has voting power pursuant to certain powers of attorney.


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(2) East Leader International Limited, or East Leader, is a British Virgin Islands company wholly owned by Perfect Will Holdings Limited, a British Virgin Islands company, which is in turn wholly owned by Bank Sarasin Nominees (CI) Limited, as nominee for Sarasin Trust Company Guernsey Limited, or Sarasin Trust. Sarasin Trust acts as trustee of the Tanya Trust, of which Ms. Tongtong Zhao, a co-founder of our company, and her family members, are the beneficiaries. Ms. Zhao is the sole director of East Leader and beneficially owns approximately 20.2% of our total outstanding ordinary shares on an as-converted basis.
 
(3) The Chengwei Funds include (i) Chengwei Partners, L.P., (ii) Chengwei Ventures Evergreen Fund, L.P. and (iii) Chengwei Ventures Evergreen Advisors Fund, LLC. Chengwei Partners, L.P. is an exempted limited partnership incorporated in the Cayman Islands. Chengwei Ventures Evergreen Fund, L.P. is an exempted limited partnership incorporated in the Cayman Islands. Chengwei Ventures Evergreen Advisors Fund, LLC is an exempted limited liability corporation incorporated in the Cayman Islands. Chengwei Ventures Evergreen Management, LLC, a Cayman Islands exempted limited liability company, is the general partner of Chengwei Partners, L.P. and Chengwei Ventures Evergreen Fund, L.P., as well as the managing member of Chengwei Ventures Evergreen Advisors Fund, LLC.
 
(4) CDH Courtyard Limited is a British Virgin Islands company.
 
(5) The IDG Funds include (i) IDG-Accel China Growth Fund L.P., (ii) IDG-Accel China Growth Fund-A L.P. and (iii) IDG-Accel China Investors L.P. Each of the IDG Funds is an exempted limited partnership incorporated in the Cayman Islands. IDG-Accel China Growth Fund GP Associates Ltd., a Cayman Islands limited company, is the general partner of IDG-Accel China Growth Fund Associates L.P., a Cayman Islands limited partnership, which in turn is the general partner of IDG-Accel China Growth Fund L.P. and IDG-Accel China Growth Fund-A L.P. Each of the two directors of IDG-Accel China Growth Fund GP Associates Ltd., Mr. Patrick J. McGovern and Mr. Quan Zhou, owns 50% of IDG-Accel China Growth Fund GP Associates Ltd.’s voting shares. IDG-Accel China Investors Associates Ltd., a Cayman Islands limited company, is the general partner of IDG-Accel China Investors L.P. Mr. James Breyer is the sole shareholder and one of the two directors of IDG-Accel China Investors Associates Ltd. Mr. Quan Zhou is the other director of IDG-Accel China Investors Associates Ltd.
 
(6) The Northern Light Funds include (i) Northern Light Venture Fund, L.P., (ii) Northern Light Partners Fund, L.P., and (iii) Northern Light Strategic Fund, L.P. Each of the Northern Light Funds is an exempted limited partnership incorporated in the Cayman Islands. Northern Light Venture Capital Limited, a Cayman Islands exempted limited liability company, is the general partner of Northern Light Partners, L.P., a Cayman Islands limited partnership, which in turn is the general partner of the Northern Light Funds.
 
(7) Pinpoint Capital 2006 A Limited is a British Virgin Islands company.
 
(8) Formerly known as Lishan Senbao (Shanghai) Investment Management Co., Ltd.


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The following diagram illustrates our corporate and ownership structure, the place of formation and the ownership interests of our subsidiaries immediately after the completion of this offering and the purchase of shares by Ctrip from us and certain of our shareholders, assuming that the underwriters do not exercise their over-allotment option.
 
(FLOW CHART)
 
Powerhill Holdings Limited, or Powerhill, was incorporated in accordance with the laws of the British Virgin Islands in December 2003, and commenced operation with mid-scale limited service hotels and commercial property development and management in 2005. Powerhill conducted its operations through three wholly owned subsidiaries in the PRC, namely Shanghai HanTing Hotel Management Group, Ltd., or Shanghai HanTing, HanTing Xingkong (Shanghai) Hotel Management Co., Ltd., or HanTing Xingkong, and Lishan Property (Suzhou) Co., Ltd., or Suzhou Property. In August 2006, Suzhou Property transferred its equity interests in three leased-and-operated hotels to Shanghai HanTing in exchange for Shanghai HanTing’s equity interest in Shanghai Shuyu Co., Ltd., which was primarily engaged in the business of sub-leasing and managing real estate properties in technology parks.
 
China Lodging Group, Limited, or China Lodging, was incorporated in the Cayman Islands in January 2007. In February 2007, Powerhill transferred all of its ownership interests in HanTing Xingkong and Shanghai HanTing to China Lodging in exchange for preferred shares of China Lodging. After such exchange, each of HanTing Xingkong and Shanghai HanTing became a wholly owned subsidiary of China Lodging. In addition, in February 2007, Powerhill and its subsidiary, Suzhou Property, were spun off in the form of a dividend distribution to the shareholders.
 
In 2007, China Lodging began migrating to our current business of operating and managing an economy hotel chain. We first launched our flagship product, HanTing Express Hotel, which targets knowledge workers and value-conscious travelers. In the same year, we introduced our premium product, HanTing Hotel, which was subsequently rebranded as HanTing Seasons Hotel. In 2008, we launched our budget product, HanTing Hi Inn. In April 2007, China Lodging acquired Yiju (Shanghai) Hotel Management Co., Ltd. from Crystal Water Investment Holdings Limited, a British Virgin Islands company wholly owned by Mr. John Jiong Wu, a co-founder of our company. In January 2008, China Lodging incorporated HanTing (Tianjin) Investment Consulting Co., Ltd. in China and in October 2008, established China Lodging Holdings (HK) Limited in Hong Kong, under which HanTing Technology (Suzhou) Co., Ltd. was subsequently established in China in December 2008.


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Corporate Information
 
Our principal executive offices are located at 5th Floor, Block 57, No. 461 Hongcao Road, Xuhui District, Shanghai 200233, People’s Republic of China. Our telephone number at this address is +86 (21) 5153-9477. Our registered office in the Cayman Islands is located at the offices of Cricket Square, Hutchins Drive, P.O. Box 2681, Grand Cayman, KY1-1111, Cayman Islands. Our agent for service of process in the United States is CT Corporation System, located at 111 Eighth Avenue, 13th Floor, New York, New York 10011.
 
Investors should contact us for any inquiries through the address and telephone number of our principal executive offices. Our website is http://www.htinns.com. The information contained on our website is not a part of this prospectus.


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THE OFFERING
 
Total ADSs offered by us 9,000,000 ADSs
 
Price per ADS We currently estimate that the initial public offering price will be between US$10.25 and US$12.25 per ADS.
 
Over-allotment option We have granted the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase an additional 1,350,000 ADSs to cover over-allotments.
 
The ADSs Each ADS represents four ordinary shares. The depositary will hold the shares underlying your ADSs and you will have rights as provided in the deposit agreement.
 
We do not expect to pay dividends in the foreseeable future. If, however, we declare dividends on our ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our ordinary shares, after deducting its fees and expenses in accordance with the terms set forth in the deposit agreement.
 
You may surrender your ADSs to the depositary to be cancelled in exchange for ordinary shares. The depositary will charge you fees for any cancellation.
 
We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs, you agree to be bound by the deposit agreement as amended.
 
To better understand the terms of the ADSs, you should carefully read the “Description of American Depositary Shares” section of this prospectus. You should also read the deposit agreement, which is filed as an exhibit to the registration statement that includes this prospectus.
 
ADSs outstanding immediately after this offering
9,000,000 ADSs (or 10,350,000 ADSs if the underwriters exercise the over-allotment option in full).
 
Ordinary shares outstanding immediately after this offering
235,618,079 ordinary shares (or 241,018,079 ordinary shares if the underwriters exercise the over-allotment option in full).
 
Use of proceeds We anticipate using approximately 90% of the net proceeds of this offering for our hotel network expansion purposes and the remaining amount for general corporate purposes. See “Use of Proceeds” for more information.
 
Listing We have applied to have our ADSs listed on the NASDAQ Global Market.
 
Proposed NASDAQ symbol
HTHT
 
Depositary Citibank, N.A.
 
Lock-up We, our directors and executive officers, Ctrip.com International, Ltd., or Ctrip, and all of our existing shareholders as well as option holders under our Amended and Restated 2007 Global Share Plan and Amended and Restated 2008 Global Share Plan have agreed


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with the underwriters for a period of 180 days after the date of this prospectus not to sell, transfer or otherwise dispose of, and not to announce an intention to sell, transfer or otherwise dispose of any ADSs, ordinary shares or similar securities. See “Underwriting” for more information.
 
Reserved ADSs At our request, the underwriters have reserved for sale, at the initial public offering price, up to an aggregate of 585,000 ADSs, to our directors, officers, employees, business associates and related persons through a directed share program.
 
Risk factors See “Risk Factors” and other information included in this prospectus for a discussion of risks you should carefully consider before investing in the ADSs.
 
Unless otherwise indicated, all information in this prospectus:
 
  •     excludes 2,168,848 ordinary shares issuable upon the exercise of stock options issued under our Amended and Restated 2007 Global Share Plan that are outstanding as of the date of this prospectus;
 
  •     excludes 5,876,085 ordinary shares issuable upon the exercise of stock options issued under our Amended and Restated 2008 Global Share Plan that are outstanding as of the date of this prospectus;
 
  •     excludes 2,385,470 ordinary shares issuable upon the exercise of stock options issued under our Amended and Restated 2009 Share Incentive Plan that are outstanding as of the date of this prospectus;
 
  •     assumes that the underwriters do not exercise their over-allotment option to purchase additional ADSs;
 
Subject to the completion of this offering, Ctrip has agreed to purchase 7,202,482 ordinary shares from us and 11,646,964 ordinary shares from certain of our shareholders. See “Related Party Transactions — Transactions with Ctrip.” Unless otherwise indicated, all information in this prospectus:
 
  •     assumes that Ctrip acquires 7,202,482 ordinary shares from us at a price equal to the initial public offering price per ordinary share; and
 
  •     excludes the additional ordinary shares Ctrip may acquire from us if (i) the underwriters exercise their over-allotment option to purchase additional ADSs or (ii) we increase the total number of ADSs to be issued in this offering.


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SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
 
The following summary consolidated statements of operations and balance sheet data as of and for the years ended December 31, 2007, 2008 and 2009 have been derived from our audited consolidated financial statements which are included elsewhere in this prospectus. The summary consolidated financial information for those periods and as of those dates should be read in conjunction with those statements and the accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on page 44.
 
                                 
    Year Ended December 31,  
    2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands, except per share and per ADS data)  
 
Summary Consolidated Statements of Operations Data:
                               
Revenues:
                               
Leased-and-operated hotels
    248,199       797,815       1,288,898       188,825  
Franchised-and-managed hotels
    1,210       12,039       44,965       6,587  
                                 
Total revenues
    249,409       809,854       1,333,863       195,412  
Less: Business tax and related taxes
    (14,103 )     (45,605 )     (73,672 )     (10,793 )
                                 
Net revenues
    235,306       764,249       1,260,191       184,619  
                                 
Operating costs and expenses(1):
                               
Hotel operating costs
    (228,362 )     (687,364 )     (1,004,472 )     (147,156 )
Selling and marketing expenses
    (17,581 )     (40,810 )     (57,818 )     (8,470 )
General and administrative expenses
    (65,653 )     (81,665 )     (83,666 )     (12,257 )
Pre-opening expenses
    (61,020 )     (108,062 )     (37,821 )     (5,541 )
Total operating costs and expenses
    (372,616 )     (917,901 )     (1,183,777 )     (173,424 )
Income (loss) from operations
    (137,310 )     (153,652 )     76,414       11,195  
                                 
Income (loss) before income taxes
    (131,001 )     (156,463 )     69,438       10,173  
                                 
Net income (loss)
    (113,739 )     (132,583 )     51,448       7,537  
Less: net income (loss) attributable to noncontrolling interest
    (2,116 )     3,579       8,903       1,304  
                                 
Net income (loss) attributable to China Lodging Group, Limited
    (111,623 )     (136,162 )     42,545       6,233  
                                 
Net earnings (loss) per share:
                               
Basic
    (2.85 )     (2.52 )     0.24       0.03  
Diluted
    (2.85 )     (2.52 )     0.23       0.03  
Net earnings (loss) per ADS(2):
                               
Basic
    (11.41 )     (10.07 )     0.95       0.14  
Diluted
    (11.41 )     (10.07 )     0.93       0.14  
Weighted average number of shares used in computation:
                               
Basic
    45,248       54,071       57,562       57,562  
Diluted
    45,248       54,071       183,632       183,632  
Pro forma net earnings per share(3) — unaudited:
                               
Basic
                    0.24       0.03  
Diluted
                    0.23       0.03  
Pro forma net earnings per ADS — unaudited:
                               
Basic
                    0.95       0.14  
Diluted
                    0.93       0.14  
Weighted average number of shares used in computation — unaudited:
                               
Basic
                    179,621       179,621  
Diluted
                    183,632       183,632  
 
Note: (1)  Include share-based compensation expenses as follows:
 


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    Year Ended December 31,  
    2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands)  
 
Share-based compensation expenses
      14,785         4,815         7,955       1,165  
 
   (2)  Each ADS represents four ordinary shares.
 
   (3)  Pro forma basic and diluted earnings (loss) per ordinary share is computed by dividing income (loss) attributable to holders of ordinary shares by the weighted average number of ordinary shares outstanding for the year plus the number of ordinary shares resulting from the assumed conversion of the outstanding convertible preferred shares upon the closing of the planned initial public offering.
 
The following table presents a summary of our consolidated balance sheet data as of December 31, 2007, 2008 and 2009:
 
  •     on an actual basis;
 
  •     on a pro forma basis as of December 31, 2009 to give effect to (i) the automatic conversion of all of our outstanding Series A preferred shares into 44,000,000 ordinary shares, at a conversion ratio of one Series A preferred share to one ordinary share; and (ii) the automatic conversion of all of our outstanding Series B preferred shares into 78,058,919 ordinary shares, at a conversion ratio of one Series B preferred share to one ordinary share; and
 
  •     on a pro forma as adjusted basis as of December 31, 2009 to further reflect (i) the issuance of 1,700,000 ordinary shares upon exercise of warrants at US$1.54 per share in February 2010; (ii) the issuance of 7,708,665 ordinary shares upon exercise of options for total consideration of US$6,021,365 in March 2010; (iii) the issuance of 7,202,482 ordinary shares to Ctrip.com International, Ltd. assuming an initial public offering price of US$11.25 per ADS, the midpoint of the estimated range; (iv) the issuance and sale of 36,000,000 ordinary shares in the form of ADSs by us in this offering, assuming an initial public offering price of US$11.25 per ADS, the midpoint of the estimated range of the initial public offering price, after deducting estimated underwriting discounts and commissions and offering expenses payable by us and assuming no exercise of the underwriters’ over-allotment option. A US$1.00 increase (decrease) in the assumed initial public offering price of US$11.25 per ADS, the midpoint of the estimated range of the initial public offering price, would increase (decrease) the amounts representing cash and cash equivalents, total assets and total equity (deficit) by US$10.2 million.
 
                                                                 
    As of December 31,  
    2007     2008     2009  
                            Pro Forma
 
    Actual     Actual     Actual     Pro Forma     As Adjusted  
                            (unaudited)     (unaudited)  
    (RMB)     (RMB)     (RMB)     (US$)     (RMB)     (US$)     (RMB)     (US$)  
    (in thousands)  
 
                                                                 
Cash and cash equivalents
    173,636       183,246       270,587       39,641       270,587       39,641       1,094,225       160,304  
Restricted cash
    23,650       5,597       500       73       500       73       500       73  
Property and equipment, net
    465,186       957,407       1,028,267       150,642       1,028,267       150,642       1,028,267       150,642  
Total assets
    836,045       1,432,940       1,581,131       231,637       1,581,131       231,637       2,404,769       352,300  
Long-term debt
    -       27,500       80,000       11,720       80,000       11,720       80,000       11,720  
Deferred rent
    46,084       138,207       174,775       25,605       174,775       25,605       174,775       25,605  
Total liabilities
    293,062       665,378       678,875       99,456       678,875       99,456       678,875       99,456  
Mezzanine equity
    437,829       796,803       796,803       116,732       -       -       -       -  
Total equity (deficit)
    105,154       (29,241 )     105,453       15,449       902,257       132,181       1,725,895       252,844  

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The following tables present certain unaudited financial data and selected operating data as of and for the years ended December 31, 2007, 2008 and 2009:
 
                                 
    Year Ended December 31,  
    2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands)  
 
Non-GAAP Financial Data
                               
EBITDA(1)
    (95,983 )     (67,957 )     214,893       31,482  
EBITDA from Operating Hotels(1)
    (34,963 )     40,105       252,714       37,023  
 
 
(1) We believe that earnings before interest expense, tax expense (benefit) and depreciation and amortization, or EBITDA, is a useful financial metric to assess our operating and financial performance before the impact of investing and financing transactions and income taxes. Given the significant investments that we have made in leasehold improvements, depreciation and amortization expense comprises a significant portion of our cost structure. In addition, we believe that EBITDA is widely used by other companies in the lodging industry and may be used by investors as a measure of our financial performance. We believe that EBITDA will provide investors with a useful tool for comparability between periods because it eliminates depreciation and amortization expense attributable to capital expenditures. We also use EBITDA from Operating Hotels, which is defined as EBITDA before pre-opening expenses, to assess operating results of the hotels in operation. We believe that the exclusion of pre-opening expenses, a portion of which is non-cash rental expenses, helps facilitate year-on-year comparison of our results of operations as the number of hotels in the development stage may vary significantly from year to year. Therefore, we believe EBITDA from Operating Hotels more closely reflects the performance of hotels currently in operation. Our calculation of EBITDA and EBITDA from Operating Hotels does not deduct interest income, which was RMB1.2 million, RMB3.8 million and RMB1.9 million in 2007, 2008, and 2009, respectively. The presentation of EBITDA and EBITDA from Operating Hotels should not be construed as an indication that our future results will be unaffected by other charges and gains we consider to be outside the ordinary course of our business.
 
The uses of EBITDA and EBITDA from Operating Hotels have certain limitations. Depreciation and amortization expense for various long-term assets, income tax and interest expense have been and will be incurred and are not reflected in the presentation of EBITDA. Pre-opening expenses have been and will be incurred and are not reflected in the presentation of EBITDA from Operating Hotels. Each of these items should also be considered in the overall evaluation of our results. Additionally, EBITDA or EBITDA from Operating Hotels does not consider capital expenditures and other investing activities and should not be considered as a measure of our liquidity. We compensate for these limitations by providing the relevant disclosure of our depreciation and amortization, interest expense, income tax expense, pre-opening expenses, capital expenditures and other relevant items both in our reconciliations to the financial measures under accounting principles generally accepted in the United States, or U.S. GAAP, and in our consolidated financial statements, all of which should be considered when evaluating our performance.
 
The terms EBITDA and EBITDA from Operating Hotels are not defined under U.S. GAAP, and neither EBITDA nor EBITDA from Operating Hotels is a measure of net income, operating income, operating performance or liquidity presented in accordance with U.S. GAAP. When assessing our operating and financial performance, you should not consider this data in isolation or as a substitute for our net income, operating income or any other operating performance measure that is calculated in accordance with U.S. GAAP. In addition, our EBITDA or EBITDA from Operating Hotels may not be comparable to EBITDA or EBITDA from Operating Hotels or similarly titled measures utilized by other companies since such other companies may not calculate EBITDA or EBITDA from Operating Hotels in the same manner as we do.


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A reconciliation of EBITDA and EBITDA from Operating Hotels to net income (loss), which is the most directly comparable U.S. GAAP measure, is provided below:
 
                                 
    Year Ended December 31,  
    2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands)  
 
Net income (loss) attributable to our company
    (111,623 )     (136,162 )     42,545       6,233  
Interest expense
    -       1,249       8,787       1,287  
Tax expense (benefit)
    (17,262 )     (23,880 )     17,990       2,636  
Depreciation and amortization
    32,902       90,836       145,571       21,326  
                                 
EBITDA (Non-GAAP)
    (95,983 )     (67,957 )     214,893       31,482  
Pre-opening expenses
    61,020       108,062       37,821       5,541  
                                 
EBITDA from Operating Hotels (Non-GAAP)
    (34,963 )     40,105       252,714       37,023  
                                 
 
                         
    As of December 31,
    2007   2008   2009
 
Selected Operating Data:
                       
Total hotels in operation
    67       167       236  
Leased-and-operated hotels
    62       145       173  
Franchised-and-managed hotels
    5       22       63  
Total hotel rooms in operation
    8,089       21,033       28,360  
Leased-and-operated hotels
    7,583       18,414       21,658  
Franchised-and-managed hotels
    506       2,619       6,702  
Number of cities
    23       35       39  
 
The following table sets forth the status of our hotels under development as of December 31, 2009.
 
                         
    Pre-conversion
    Conversion
       
    Period(1)     Period(2)     Total  
 
Leased-and-operated hotels
    8       13       21  
Franchised-and-managed hotels
    31       92       123  
                         
Total
    39       105       144  
 
 
(1)  Includes hotels for which we have entered into binding leases or franchise-and-management agreements but of which the property has not been delivered by the respective lessors or managed hotel owners, as the case may be. The majority of these hotels are expected to commence operations by June 30, 2011.
(2)  Includes hotels for which we have commenced conversion activities but that have not yet commenced operations. The majority of these hotels are expected to commence operations by December 31, 2010.
 
                         
    Year Ended December 31,
    2007   2008   2009
 
Occupancy rate (as a percentage)
                       
Leased-and-operated hotels
    85       89       94  
Franchised-and-managed hotels
    82       74       91  
Total hotels in operation
    85       87       94  
Average daily room rate (in RMB)
                       
Leased-and-operated hotels
    181       178       174  
Franchised-and-managed hotels
    176       180       172  
Total hotels in operation
    181       178       174  
RevPAR (in RMB)
                       
Leased-and-operated hotels
    154       158       165  
Franchised-and-managed hotels
    145       132       156  
Total hotels in operation
    154       156       163  


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RISK FACTORS
 
Investing in our ADSs involves a high degree of risk. You should carefully consider the risks described below with all of the other information included in this prospectus before deciding to invest in our ADSs. We believe the risks and uncertainties described below represent all the material risks known to us that are related to our business and this offering.
 
If any of the following risks actually occur, they may harm our business, financial condition and results of operations. In this event, the market price of our ADSs could decline and you could lose some or all of your investment.
 
This prospectus also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially and in adverse ways from those anticipated in these forward-looking statements as a result of certain factors, including the risks we face as described below and elsewhere in this prospectus.
 
Risks Related to Our Business
 
Our operating results are subject to conditions affecting the lodging industry in general and our return-driven development model is subject to certain risks.
 
Our operating results are subject to conditions typically affecting the lodging industry, which include:
 
  •     changes and volatility in general economic conditions;
 
  •     our ability to maintain or increase sales to existing customers and attract new customers;
 
  •     competition from other hotels;
 
  •     natural disasters or travelers’ fears of exposure to contagious diseases and social unrest;
 
  •     seasonality of our business;
 
  •     changes in travel patterns or in the desirability of particular locations;
 
  •     increases in operating costs and expenses due to inflation and other factors;
 
  •     local market conditions such as an oversupply of, or a reduction in demand for, hotel rooms;
 
  •     the quality and performance of managers and other employees of our hotels;
 
  •     the availability and cost of capital to allow us and our franchisees to fund construction and renovation of, and make other investments in, our hotels; and
 
  •     the possibility that leased properties may be subject to challenges as to their compliance with the relevant government regulations.
 
In addition, our return-driven development model is subject to the following risks:
 
  •     we may not be able to successfully identify additional hotel properties for lease that satisfy our return threshold and we may not be able to achieve the expected economic returns on our leased-and-operated hotels;
 
  •     we may not be able to control our costs effectively as anticipated; and
 
  •     our limited operating history makes it difficult to evaluate our future prospects and results of operations.
 
Changes in any of the conditions typically affecting the lodging industry in general and the materialization of any risks applicable to our return-driven development model could adversely affect our occupancy rates, average daily rates and revenues generated per available room, or RevPAR, or otherwise adversely affect our results of operations and financial condition.


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Our business is sensitive to global or regional economic crises. A severe or prolonged downturn in the global or Chinese economy could materially and adversely affect our revenues and results of operations.
 
The recent global financial crisis and economic recession have been unprecedented and challenging. Uncertainty in credit availability, rising unemployment and sluggish corporate operating and earning performance in most major economies have continued in 2009. Capital market volatility remains at high levels, as a result of investors’ continued concerns about the systemic impact of potential long-term and wide-spread recession, energy costs, geopolitical issues, the availability and cost of credit, and the housing and mortgage markets. The weak economic outlook has negatively affected business and consumer confidence and contributed to slowdowns in most industries around the world.
 
A limited number of our hotels are located in cities where the local economy heavily depends upon international trade, such as Wuxi, Suzhou, and Ningbo. In 2009, the operation and financial performance of our hotels in these cities were adversely affected as a result of the negative impact of the global financial crisis on the economic conditions of these cities. Although there have been signs of recovery, there are still great uncertainties regarding economic conditions and the demand for economy hotels in China. Such uncertainties may adversely impact our results of operations. Continued turbulence in the international markets may also adversely affect our liquidity and financial condition, including our ability to access capital markets to meet our liquidity needs.
 
The lodging industry in China is highly competitive, and if we are unable to compete successfully, our financial condition and results of operations may be harmed.
 
The lodging industry in China is highly competitive. We compete primarily with other economy hotel chains as well as various local lodging facilities where the competition is mainly based on location, room rates, brand recognition, the quality of the accommodations and service levels. We also compete with two and three star hotels, as we offer rooms with amenities comparable to many of those hotels while maintaining competitive pricing. In addition, we may face competition from new entrants in the economy hotel segment in China. Furthermore, we compete with all other hotels for guests in each market in which we operate, as our typical business customers and leisure travelers may change their travel, spending and consumption patterns and choose hotels in different segments. New and existing competitors may offer more competitive rates, greater convenience, services or amenities or superior facilities, which could attract customers away from our hotels, resulting in a decrease in occupancy and average daily rates for our hotels. Any of these factors may have an adverse effect on our competitive position, results of operations and financial condition.
 
Our financial and operating performance may be adversely affected by epidemics, natural disasters and other catastrophes.
 
Our financial and operating performance may be adversely affected by epidemics, natural disasters and other catastrophes, particularly in locations where we operate a large number of hotels.
 
Our business could be materially and adversely affected by the outbreak of swine influenza, avian influenza, severe acute respiratory syndrome, or SARS, or other epidemics. In April 2009, reports surfaced regarding occurrences of swine influenza and fears of a global pandemic. Cases of swine influenza were later confirmed in numerous countries, including China and other parts of Asia. In 2005 and 2006, there were reports on the occurrences of avian influenza in various parts of China, including a few confirmed human cases and deaths. In early 2003, several economies in Asia, including China, were affected by the outbreak of SARS. During May and June of 2003, many businesses in China were closed by the PRC government to prevent transmission of SARS. Any prolonged recurrence of such contagious disease or other adverse public health developments in China may have a material and adverse effect on our business operations. For example, if any of our employees or customers is suspected of having contracted any contagious disease while he or she has worked or stayed in our hotels, we may under certain circumstances be required to quarantine our employees that are affected and the affected areas of our premises. Losses caused by epidemics, natural disasters and other catastrophes, including earthquakes or typhoons, are either uninsurable or too expensive to justify insuring against in China. In the event an uninsured loss or a loss in excess of insured limits occurs, we


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could lose all or a portion of the capital we have invested in a hotel, as well as the anticipated future revenues from the hotel. In that event, we might nevertheless remain obligated for any financial commitments related to the hotel.
 
Similarly, war (including the potential of war), terrorist activity (including threats of terrorist activity), social unrest and heightened travel security measures instituted in response, travel-related accidents, as well as geopolitical uncertainty and international conflict, will affect travel and may in turn have a material adverse effect on our business and results of operations. In addition, we may not be adequately prepared in contingency planning or recovery capability in relation to a major incident or crisis, and as a result, our operational continuity may be adversely and materially affected and our reputation may be harmed.
 
Seasonality of our business may cause fluctuations in our revenues, cause our ADS price to decline, and adversely affect our profitability
 
The lodging industry is subject to fluctuations in revenues due to seasonality. The seasonality of our business may cause fluctuations in our quarterly operating results. Generally, the first quarter, in which both the New Year and Spring Festival holidays fall, accounts for a lower percentage of our annual revenues than other quarters of the year. Therefore, you should not rely on our operating results for prior quarters as an indication of our results in any future period. As our revenues may vary from quarter to quarter, our business is difficult to predict and our quarterly results could fall below investor expectations, which could cause our ADS price to decline. Furthermore, although it typically takes our new hotels three to six months to ramp up, the ramp-up process of some of our hotels can be delayed due to seasonality, which may negatively affect our revenues and profitability.
 
Our limited operating history makes it difficult to evaluate our future prospects and results of operations.
 
Our operation commenced, through Powerhill Holdings Limited, with mid-scale limited service hotels and commercial property development and management in 2005, and we began migrating to our current business of operating and managing a multiple-product economy hotel chain in 2007. See “Prospectus Summary — Corporate Structure and History.” Accordingly, you should consider our future prospects in light of the risks and challenges encountered by a company with a limited operating history. These risks and challenges include:
 
  •     the uncertainties associated with our ability to continue our growth while trying to achieve and maintain our profitability;
 
  •     preserving our competitive position in the economy hotel segment of the lodging industry in China;
 
  •     offering innovative products to attract recurring and new customers;
 
  •     implementing our strategy and modifying it from time to time to respond effectively to competition and changes in customer preferences and needs;
 
  •     increasing awareness of our brand and products and continuing to develop customer loyalty; and
 
  •     attracting, training, retaining and motivating qualified personnel.
 
If we are unsuccessful in addressing any of these risks or challenges, our business may be materially and adversely affected.
 
We have incurred losses in the past and may incur losses in the future.
 
We incurred net losses attributable to our company of RMB111.6 million and RMB136.2 million in 2007 and 2008, respectively. Although we had net income attributable to our company of RMB42.5 million in 2009, we had an accumulated deficit of RMB245.5 million as of December 31, 2009. As we expect our costs to increase as we continue to expand our business and operations, we may incur losses in the future. We cannot assure you that we will achieve or sustain profitability in the future.


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Our newly opened leased-and-operated hotels typically incur significant pre-opening expenses at their development stage and generate relatively low revenues at their ramp-up stage, which may have a significant negative impact on our financial performance.
 
We mainly utilize a lease-and-operate model, under which the operation of each hotel goes through three stages: development, ramp-up and mature operations. During the development stage, leased-and-operated hotels generally incur pre-opening expenses ranging from approximately RMB1.0 to RMB2.0 million per hotel. During the ramp-up stage, when the occupancy rate is relatively low, revenues generated by these hotels may be insufficient to cover their operating costs, which are relatively fixed in nature. As a result, these newly opened leased-and-operated hotels may not achieve profitability until they reach mature operations. As we continue to expand our leased-and-operated hotel portfolio, the significant pre-opening expenses incurred during the development stage and the relatively low revenues during the ramp-up stage of our newly opened leased-and-operated hotels may have a significant negative impact on our financial performance.
 
Our costs and expenses may remain constant or increase even if our revenues decline, which would adversely affect our net margins and results of operations.
 
A significant portion of our operating costs, including rent and employee base salaries, is fixed. Accordingly, a decrease in revenues could result in a disproportionately higher decrease in our earnings because our operating costs and expenses are unlikely to decrease proportionately. For example, the New Year and Spring Festival holiday periods generally account for a lower portion of our annual revenues than other periods, but our expenses do not vary as significantly with changes in occupancy and revenues as we need to continue to pay rent and salary, make regular repairs, maintenance and renovations and invest in other capital improvements throughout the year to maintain the attractiveness of our hotels. Furthermore, our property development and renovation costs may increase as a result of an increase in the cost of materials. However, we have limited ability to pass increased costs to customers through room rate increases. Therefore, our costs and expenses may remain constant or increase even if our revenues decline, which would adversely affect our net margins and results of operations.
 
We may not be able to manage our planned growth, which could adversely affect our operating results.
 
Our hotel chain has been growing rapidly since we began migrating to our current business of operating and managing a multiple-product economy hotel chain in 2007. We increased the number of our hotels in operation in China from 26 hotels as of January 1, 2007 to 236 hotels as of December 31, 2009, and we intend to continue to develop and operate additional hotels in different geographic locations in China. This expansion has placed, and will continue to place, substantial demands on our managerial, operational, technological and other resources. Our planned expansion will also require us to maintain the consistency of our products and the quality of our services to ensure that our business does not suffer as a result of any deviations, whether actual or perceived. In order to manage and support our growth, we must continue to improve our existing operational, administrative and technological systems and our financial and management controls, and recruit, train and retain qualified hotel management personnel as well as other administrative and sales and marketing personnel, particularly as we expand into new markets. We cannot assure you that we will be able to effectively and efficiently manage the growth of our operations, recruit and retain qualified personnel and integrate new hotels into our operations. Any failure to effectively and efficiently manage our expansion may materially and adversely affect our ability to capitalize on new business opportunities, which in turn may have a material adverse effect on our results of operations.
 
Expansion into new markets may present operating and marketing challenges that are different from those we currently encounter in our existing markets. In addition, our expansion within existing markets may cannibalize our existing hotels in those markets and, as a result, negatively affect our overall results of operations. Furthermore, in cities where the markets reach saturation, we may be unable to identify or lease additional properties in those cities or in commercially desirable locations within those cities. When the number of economy hotels reaches saturation in any particular city, we may be forced to lower our room rates to attract customers and remain competitive in those markets, which could hamper our ability to increase RevPAR or generate higher levels of revenues over time. Our inability to anticipate the changing demands that


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expanding operations will impose on our management and information and operational systems, or our failure to quickly adapt our systems and procedures to the new markets, could result in losses of revenues and increases in expenses or otherwise harm our results of operations and financial condition.
 
We may not be able to successfully identify, secure and develop in a timely fashion additional hotel properties.
 
We plan to open more hotels to further grow our business. Under our lease-and-operate model, we may not be successful in identifying and leasing additional hotel properties at desirable locations and on commercially reasonable terms or at all. We may also incur costs in connection with evaluating hotel properties and negotiating with property owners, including properties that we are subsequently unable to lease. In addition, we may not be able to develop additional hotel properties on a timely basis due to construction delays. If we fail to successfully identify, secure or develop in a timely fashion additional hotel properties, our ability to execute our growth strategy could be impaired and our business and prospects may be materially and adversely affected.
 
Future acquisitions may have an adverse effect on our ability to manage our business and harm our results of operations and financial condition.
 
If we are presented with appropriate opportunities, we may acquire businesses or assets that are complementary to our business. Future acquisitions would expose us to potential risks, including risks associated with unforeseen or hidden liabilities, risks that acquired hotels will not achieve anticipated performance levels, diversion of management attention and resources from our existing business, difficulty in integrating the acquired businesses with our existing operational infrastructure, and inability to generate sufficient revenues to offset the costs and expenses of acquisitions. Any difficulties encountered in the acquisition and integration process may have an adverse effect on our ability to manage our business and harm our results of operations and financial condition.
 
Our legal right to lease certain properties could be challenged by property owners or other third parties or subject to government regulation.
 
We do not hold any land use rights with respect to the land on which our hotels are located nor do we own any of the hotel properties we operate. Instead, a substantial part of our business model relies on leases with third parties who either own or lease the properties from the ultimate property owner. We also grant franchises to hotel operators who may or may not own the hotel properties. We cannot assure you that the land use rights and other property rights with respect to properties we currently lease or franchise for our existing hotels will not be challenged. For example, as of December 31, 2009, our lessors failed to provide the property ownership certificates and/or the land use rights certificates for 46 properties that we lease for our hotel operations. While we have performed our due diligence to verify the rights of our lessors to lease such properties, we cannot assure you that our rights under those leases will not be challenged by other parties including government authorities.
 
Under PRC laws, all lease agreements are required to be registered with the local housing bureau. While the majority of our standard lease agreements require the lessors to make such registration, most of our leases have not been registered as required, which may expose both our lessors and us to potential monetary fines. Some of our rights under the unregistered leases may also be subordinated to the rights of other interested third parties. In addition, in several instances where our immediate lessors are not the ultimate owners of hotel properties, no consents or permits were obtained from the owners, the primary lease holders or competent government authorities, as applicable, for the subleases of the hotel properties to us, which could potentially invalidate our leases or result in the renegotiation of such leases that leads to terms less favorable to us. Some of the properties we lease from third parties were also subject to mortgages at the time the leases were signed. Where consent to the lease was not obtained from the mortgage holder in such circumstances, the lease may not be binding on the transferee of the property if the mortgage holder forecloses on the mortgage and transfer the property. Moreover, we cannot assure you that the property ownership or leasehold in connection with our franchised-and-managed hotels will not be subject to similar third-party challenges.


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Any challenge to our legal rights to the properties used for our hotel operations, if successful, could impair the development or operations of our hotels in such properties. We are also subject to the risk of potential disputes with property owners or third parties who otherwise have rights to or interests in our hotel properties. Such disputes, whether resolved in our favor or not, may divert management’s attention, harm our reputation or otherwise disrupt our business.
 
Any failure to comply with land- and property-related PRC laws and regulations may negatively affect our ability to operate our hotels and we may suffer significant losses as a result.
 
Our lessors are required to comply with various land- and property-related laws and regulations to enable them to lease effective titles of their properties for our hotel use. For example, properties used for hotel operations and the underlying land should be approved for commercial use purposes by competent government authorities. In addition, before any properties located on state-owned land with allocated or leased land use rights or on land owned by collective organizations may be leased to third parties, lessors should obtain appropriate approvals from the competent government authorities. As of December 31, 2009, the lessors of approximately half of our executed lease agreements did not obtain the required governmental approvals. Such failure may subject the lessors or us to monetary fines or other penalties and may lead to the invalidation or termination of our leases by competent government authorities, and therefore may adversely affect our ability to operate our leased-and-operated hotels. We have started to negotiate with our other existing and new lessors and ask them to indemnify us against our losses resulting from their non-compliance, but we cannot assure you that we will be successful in this regard. While many of our lessors have agreed to indemnify us against our losses resulting from their failure to obtain the required approvals, we cannot assure you that we will be able to successfully enforce such indemnification obligations against our lessors. As a result, we may suffer significant losses resulting from our lessors’ failure to obtain required approvals to the extent that we could not be fully indemnified by our lessors.
 
Our success could be adversely affected by the performance of our franchised-and-managed hotels.
 
Our success could be adversely affected by the performance of our franchised-and-managed hotels, over which we have lesser control compared to our leased-and-operated hotels. As of December 31, 2009, we franchised and managed approximately 27% of our hotels, and we plan to further increase the number of franchised-and-managed hotels to increase our national presence in China. Our franchisees may not be able to develop hotel properties on a timely basis, which could adversely affect our growth strategy and may impact our ability to collect fees from them on a timely basis. Furthermore, given that our franchisees are typically responsible for the costs of developing and operating the hotels, including renovating the hotels to our standards, and all of the operating expenses, the quality of our franchised-and-managed hotel operations may be diminished by factors beyond our control and franchisees may not successfully operate hotels in a manner consistent with our standards and requirements. While we ultimately can take action to terminate franchisees that do not comply with the terms of our franchise-and-management agreements, we may not be able to identify problems and make timely responses and, as a result, our image and reputation may suffer, which may have a material adverse effect on our results of operations.
 
We may not be able to successfully compete for franchise-and-management agreements and, as a result, we may not be able to achieve our planned growth.
 
Our growth strategy includes expanding through franchising. We believe that our ability to compete for franchise-and-management agreements primarily depends on our brand recognition and reputation, the results of our overall operations in general and the success of the hotels that we currently franchise. Other competitive factors for franchise-and-management agreements include marketing support, capacity of the central reservation channel and the ability to operate hotels cost-effectively. The terms of any new franchise-and-management agreements that we obtain also depend on the terms that our competitors offer for those agreements. In addition, if the availability of suitable locations for new properties decreases, or governmental planning or other local regulations change, the supply of suitable properties for our franchise-and-manage model could be diminished. If the hotels that we franchise perform less successfully than those of our


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competitors, if we are unable to offer terms as favorable as those offered by our competitors or if the availability of suitable properties is limited, we may not be able to compete effectively for new franchise agreements. As a result, we may not be able to achieve our planned growth and our business and results of operations may be materially and adversely affected.
 
If we are unable to access funds to maintain our hotels’ condition and appearance, or if our franchisees fail to make investments necessary to maintain or improve their properties, the attractiveness of our hotels and our reputation could suffer and our hotel occupancy rates may decline.
 
In order to maintain our hotels’ condition and appearance, ongoing renovations and other leasehold improvements, including periodic replacement of furniture, fixtures and equipment, are required. In particular, we franchise and manage properties leased or owned by franchisees under the terms of franchise-and-management agreements, substantially all of which require our franchisees to comply with standards that are essential to maintaining the relevant product integrity and our reputation. We depend on our franchisees to comply with these requirements by maintaining and improving properties through investments, including investments in furniture, fixtures, amenities and personnel.
 
Such investments and expenditures require ongoing fundings and, to the extent we or our franchisees cannot fund these expenditures from our existing cash or cash flow generated from operations, we or our franchisees must borrow or raise capital through financing. We or our franchisees may not be able to access capital and our franchisees may be unwilling to spend available capital when necessary, even if required by the terms of our franchise-and-management agreements. If we or our franchisees fail to make investments necessary to maintain or improve the properties, our hotel’s attractiveness and reputation could suffer, we could lose market share to our competitors and our hotel occupancy rates and RevPAR may decline.
 
Our leases could be terminated early, we may not be able to renew our existing leases on commercially reasonable terms and our rents could increase substantially in the future, which could materially and adversely affect our operations.
 
The lease agreements between our lessors and us typically provide, among other things, that the leases could be terminated under certain legal or factual conditions. If our leases were terminated, we would have to relocate our operations to other properties. We may not be able to generate revenues out of such leases and may incur additional costs in restoring such properties. Furthermore, we may have to pay losses and damages and incur other liabilities to our customers due to our default under our contracts and we may not be able to operate in such properties. As a result, our business, results of operations and financial condition could be materially and adversely affected.
 
We plan to renew our existing leases upon expiration. We cannot assure you, however, that we will be able to retain our leases on satisfactory terms, or at all. In particular, as some of our leases will expire in the next several years and rents must be re-negotiated, we may experience an increase in our rent payments and cost of revenues. If we fail to retain our leases or if a significant number of our existing leases are not renewed on satisfactory terms upon expiration, our costs may increase in the future. If we are unable to pass the increased costs on to our customers through room rate increases, our operating margins and earnings could decrease and our results of operations could be materially and adversely affected.
 
Interruption or failure of our information systems could impair our ability to effectively provide our services, which could damage our reputation.
 
Our ability to provide consistent and high-quality services and to monitor our operations on a real-time basis throughout our hotel chain depends on the continued operation of our information technology systems, including our web property management, central reservation and customer relationship management systems. Any damage to or failure of our systems could interrupt our inventory management, affect the manner of our services in terms of efficiency, consistency and quality, and reduce our customer satisfaction.
 
Our technology platform plays a central role in our management of inventory, revenues, loyalty program and franchisees. Furthermore, we also rely on our website and call center to facilitate customer


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reservations. Our systems remain vulnerable to damage or interruption as a result of power loss, telecommunications failures, operations relying on the system such as reservation and billing will have to be conducted off-line or manually, and computer viruses, fires, floods, earthquakes, interruptions in access to our toll-free numbers, hacking or other attempts to harm our systems, and other similar events. Some of our systems are not fully redundant, and our disaster recovery planning does not account for all possible scenarios. Furthermore, our systems and technologies, including our website and database, could contain undetected errors or “bugs” that could adversely affect their performance, or could become outdated and we may not be able to replace or introduce upgraded systems as quickly as our competitors or within budgeted costs for such upgrades. If we experience system failures, our quality of services, customer satisfaction, and operational efficiency could be severely harmed, which could also adversely affect our reputation.
 
Failure to maintain the integrity of internal or customer data could result in harm to our reputation or subject us to costs, liabilities, fines or lawsuits.
 
Our business involves collecting and retaining large volumes of internal and customer data, including credit card numbers and other personal information as our various information technology systems enter, process, summarize and report such data. We also maintain information about various aspects of our business operations as well as our employees. The integrity and protection of our customer, employee and company data is critical to our business. Our customers and employees expect that we will adequately protect their personal information, and the regulations applicable to security and privacy are becoming increasingly important in China. A theft, loss, fraudulent or unlawful use of customer, employee or company data could harm our reputation or result in remedial and other costs, liabilities, fines or lawsuits.
 
If the value of our products or image diminishes, it could have a material and adverse effect on our business and results of operations.
 
We offer three hotel products that are designed to target distinct groups of customers. Our continued success in maintaining and enhancing our brand and image depends, to a large extent, on our ability to satisfy customer needs by further developing and maintaining our innovative and distinctive products and maintaining consistent quality of services across our hotel chain, as well as our ability to respond to competitive pressures. If we are unable to do so, our occupancy rates may decline, which could in turn adversely affect our results of operations. Our business may also be adversely affected if our public image or reputation were to be diminished by the operations of any of our hotels, whether due to unsatisfactory service, accidents or otherwise. If the value of our products or image is diminished or if our products do not continue to be attractive to customers, our business and results of operations may be materially and adversely affected.
 
Failure to protect our trademarks and other intellectual property rights could have a negative impact on our brand and adversely affect our business.
 
The success of our business depends in part upon our continued ability to use our brands, trade names and trademarks to increase brand awareness and to further develop our products. The unauthorized reproduction of our trademarks could diminish the value of our brand and its market acceptance, competitive advantages or goodwill. In addition, our proprietary information and operational systems, which have not been patented, copyrighted or otherwise registered as our intellectual property, are a key component of our competitive advantage and our growth strategy. As of December 31, 2009, we had 31 trademark applications under review by the authority. Furthermore, we may be subject to claims that we have infringed the intellectual property rights of others. For example, two PRC companies had raised objections to our application of certain trademarks, which, if supported by the relevant authorities, would affect our ability to register and use such trademarks.
 
Monitoring and preventing the unauthorized use of our intellectual property is difficult. The measures we take to protect our brands, trade names, trademarks and other intellectual property rights may not be adequate to prevent their unauthorized use by third parties. Furthermore, the application of laws governing intellectual property rights in China and abroad is evolving and could involve substantial risks to us. In particular, the laws and enforcement procedures in the PRC are uncertain and do not protect intellectual


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property rights to the same extent as do the laws and enforcement procedures in the United States and other developed countries. If we are unable to adequately protect our brands, trade names, trademarks and other intellectual property rights, we may lose these rights and our business may suffer materially.
 
If we are not able to retain, hire and train qualified managerial and other employees, our business may be materially and adversely affected.
 
Our managerial and other employees manage our hotels and interact with our customers on a daily basis. They are critical to maintaining the quality and consistency of our services as well as our established brands and reputation. In general, employee turnover, especially those in lower-level positions, is relatively high in the lodging industry. As a result, it is important for us to retain as well as attract qualified managerial and other employees who are experienced in lodging or other consumer-service industries. There is a limited supply of such qualified individuals in some of the cities in China where we have operations and other cities into which we intend to expand. In addition, we need to hire and train qualified managerial and other employees on a timely basis to keep pace with our rapid growth while maintaining consistent quality of services across our hotels in various geographic locations. We must also provide continuous training to our managerial and other employees so that they have up-to-date knowledge of various aspects of our hotel operations and can meet our demand for high-quality services. If we fail to do so, the quality of our services may decrease, which in turn, may have a material and adverse effect on our products and our business.
 
Our current employment practices may be adversely impacted under the labor contract law of the PRC.
 
The PRC National People’s Congress promulgated a labor contract law which became effective on January 1, 2008. The labor contract law imposes requirements concerning, among others, the execution of written contracts between employers and employees, the time limits for probationary periods, and the length of fixed-term employment contracts. Due to its limited history and the lack of clear implementation rules, it is uncertain how this labor contract law will impact our current employment practices. We cannot assure you that our employment practices do not, or will not, violate this labor contract law. If we are subject to severe penalties or incur significant legal fees in connection with labor law disputes or investigations, our business, financial condition and results of operations may be adversely affected. In addition, a significant number of our employees are contracted through a third-party human resources company, which is responsible for managing, among others, payrolls, social insurance contributions and local residency permits of these employees. We may not be able to continue this practice under this labor contract law, which would increase our human resources administration expenses. We may also be held jointly liable under this labor contract law if the human resources company fails to pay such employees their wages and other benefits.
 
Failure to retain our management team could harm our business.
 
We place substantial reliance on the experience and the institutional knowledge of members of our current management team. Mr. Qi Ji, our founder and executive chairman, and other members of the management team are particularly important to our future success due to their substantial experiences in lodging and other consumer-service industries. Finding suitable replacements for Mr. Qi Ji and other members of our management team could be difficult, and competition for such personnel of similar experience is intense. The loss of the services of one or more members of our management team due to their departures or otherwise could hinder our ability to effectively manage our business and implement our growth strategies.
 
We are subject to various franchise, hotel industry, construction, hygiene, safety and environmental laws and regulations that may subject us to liability.
 
Our business is subject to various compliance and operational requirements under PRC laws. For example, we are required to obtain the approval from, and file initial and annual reports with, the PRC Ministry of Commerce, or the MOC, to engage in the hotel franchising business. In addition, each of our hotels is required to obtain a special industry license issued by the local public security bureau, and to comply with license requirements and laws and regulations with respect to construction permit, fire prevention, public area hygiene, food hygiene, public safety and environmental protection. See “Regulation — Regulations on


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Hotel Operation.” Furthermore, new regulations may be adopted in the future to increase our compliance efforts at significant costs. Certain of our hotels are not in full compliance with all of the applicable requirements. Such failure to comply with applicable construction permit, environmental, health and safety laws and regulations related to our business and hotel operation may subject us to potentially significant monetary damages and fines or the suspension of operations and development activities of our company or related hotels.
 
The growth of third-party online and other hotel reservation intermediaries and travel consolidators may adversely affect our margins and profitability.
 
Some of our hotel rooms are booked through third-party online and other hotel reservation intermediaries and consolidators to whom we pay commissions for such services. They may be able to negotiate higher commissions, reduced room rates, or other significant concessions from us. We believe that such intermediaries and consolidators would attempt to develop and increase customer loyalty toward their reservation systems rather than ours. As a result, the growth and increasing importance of these travel intermediaries and consolidators may adversely affect our ability to control the supply and price of our room inventory, which would in turn adversely affect our margins and profitability.
 
Our limited insurance coverage may expose us to losses, which may have a material adverse effect on our reputation, business, financial condition and results of operations.
 
We carry all mandatory and certain optional commercial insurance, including property, construction, third-party liability and public liability insurance for our leased-and-operated hotel operations. We also require our lessors and franchisees to purchase customary insurance policies. Although we are able to require our franchisees to obtain the requisite insurance coverage through our franchisees management, we cannot guarantee that our lessors will adhere to such requirements. In particular, there are inherent risks of accidents or injuries in hotels. One or more accidents or injuries at any of our hotels could adversely affect our safety reputation among customers and potential customers, decrease our overall occupancy rates and increase our costs by requiring us to take additional measures to make our safety precautions even more visible and effective. In the future, we may be unable to renew our insurance policies or obtain new insurance policies without increases in cost or decreases in coverage levels. We may also encounter disputes with insurance providers regarding payments of claims that we believe are covered under our policies. Furthermore, if we are held liable for amounts and claims exceeding the limits of our insurance coverage or outside the scope of our insurance coverage, our reputation, business, financial condition and results of operations may be materially and adversely affected.
 
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud.
 
Upon completion of this initial public offering, we will become a public company in the United States subject to the Sarbanes-Oxley Act. Section 404 of the Sarbanes-Oxley Act, or Section 404, will require that we include a report from management on our internal control over financial reporting in our annual report on Form 20-F beginning with our annual report for the fiscal year ending December 31, 2011. In addition, our independent registered public accounting firm must report on the effectiveness of our internal control over financial reporting. Our management or our independent registered public accounting firm may conclude that our internal controls are not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may issue a report that is qualified if it is not satisfied with our internal controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. Either of these possible outcomes could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our reporting processes, which could materially and adversely affect the trading price of our ADSs.
 
In addition, our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future. Prior to this offering,


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we have been a private company with limited accounting personnel and other resources with which to address our internal control over financial reporting. As required by our agreement with our private investors, we prepared financial statements under accounting principles generally accepted in the United States, or U.S. GAAP, as of and for the two years ended December 31, 2007. As we did not have adequate accounting expertise in U.S. GAAP at the time when we prepared such financial statements, we have recently restated such financial statements. In connection with the audit of our consolidated financial statements as of and for the year ended December 31, 2009, a material weakness and certain control deficiencies of our company have been identified. The material weakness identified is related to our failure to accurately account for complex transactions and to monitor and apply new and emerging U.S. GAAP. We may identify additional control deficiencies as a result of the assessment process we will undertake in compliance with Section 404. We plan to remedy any identified control deficiencies before the deadline imposed by the requirements of Section 404, but we may be unable to do so. Our failure to establish and maintain an effective system of internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial reporting processes, which in turn could harm our business and negatively impact the trading price of our ADSs.
 
We will incur increased costs as a result of becoming a public company, which may adversely affect our profitability.
 
Our profitability may be affected as a result of our becoming a public company. We anticipate incurring a significantly greater amount of legal, accounting and other expenses than we did as a private company, including costs associated with our public company reporting requirements and investor relations activities, independent registered public accounting firm fees, registrar and transfer agent fees, incremental director and officer liability insurance costs, and director compensation. In addition, the Sarbanes-Oxley Act, as well as new rules subsequently implemented by the Securities and Exchange Commission and the NASDAQ Global Market, have required changes in corporate governance practices of public companies. We expect these new rules and regulations to increase our legal, accounting and financial compliance costs and to make certain corporate activities more time-consuming and costly. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs, which may adversely affect our profitability.
 
We, our directors, management and employees may be subject to certain risks related to legal proceedings filed by or against us, and adverse results may harm our business.
 
We cannot predict with certainty the cost of defense, the cost of prosecution or the ultimate outcome of litigation and other proceedings filed by or against us, our directors, management or employees, including remedies or damage awards, and adverse results in such litigation and other proceedings may harm our business or reputation. Such litigation and other proceedings may include, but are not limited to, actions relating to intellectual property, commercial arrangements, employment, non-competition and labor law, fiduciary duties, personal injury, death, property damage or other harm resulting from acts or omissions by individuals or entities outside of our control, including franchisees and third-party property owners. In the case of intellectual property litigation and proceedings, adverse outcomes could include the cancellation, invalidation or other loss of material intellectual property rights used in our business and injunctions prohibiting our use of business processes or technology that is subject to third-party patents or other third-party intellectual property rights.
 
We generally are not liable for the willful actions of our franchisees and property owners; however, there is no assurance that we would be insulated from liability in all cases.


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Risks Related to Doing Business in China
 
Adverse changes in economic and political policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.
 
We conduct substantially all of our business operations in China. As the lodging industry is highly sensitive to business and personal discretionary spending levels, it tends to decline during general economic downturns. Accordingly, our results of operations, financial condition and prospects are subject to a significant degree to economic developments in China. China’s economy differs from the economies of most developed countries in many respects, including with respect to the amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While the PRC economy has experienced significant growth in the past 30 years, growth has been uneven across different regions and among various economic sectors of China. The PRC government has implemented various measures to encourage economic development and guide the allocation of resources. While some of these measures benefit the overall PRC economy, they may also have a negative effect on us. For example, our results of operations and financial condition may be adversely affected by government control over capital investments or changes in environmental, health, labor or tax regulations that are applicable to us.
 
The PRC government also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Certain measures adopted by the PRC government, such as changes of the People’s Bank of China, or the PBOC’s statutory deposit reserve ratio and lending guideline imposed on commercial banks, may restrict loans to certain industries. These actions, as well as future actions and policies of the PRC government, could materially affect our liquidity and access to capital and our ability to operate our business.
 
Uncertainties with respect to the Chinese legal system could limit the legal protections available to us and our investors and have a material adverse effect on our business and results of operations.
 
The PRC legal system is a civil law system based on written statutes. Unlike in common law systems, prior court decisions may be cited for reference but have limited precedential value. Since the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involves uncertainties, which may limit legal protections available to us. For example, we may have to resort to administrative and court proceedings to enforce the legal protection that we enjoy either by law or contract. However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult than in more developed legal systems to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy. These uncertainties may impede our ability to enforce the contracts we have entered into. In addition, such uncertainties, including the inability to enforce our contracts, could materially and adversely affect our business and operations. Accordingly, we cannot predict the effect of future developments in the PRC legal system, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, or the preemption of local regulations by national laws. These uncertainties could limit the legal protections available to us and other foreign investors, including you. In addition, any litigation in China may be protracted and result in substantial costs and diversion of our resources and management attention.
 
Rapid urbanization and changes in zoning and urban planning in China may cause our leased properties to be demolished, removed or otherwise affected.
 
China is undergoing a rapid urbanization process, and zoning requirements and other governmental mandates with respect to urban planning of a particular area may change from time to time. When there is a change in zoning requirements or other governmental mandates with respect to the areas where our hotels are located, the affected hotels may need to be demolished or removed. As a result, we may have to relocate our hotels to other locations. We have experienced such demolition and relocation in the past and we may encounter additional demolition and relocation cases in the future. For example, in 2009 we were obligated to


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demolish one leased-and-operated hotel due to local government zoning requirements and, as a result, wrote off property and equipment of RMB3.7 million, favorable lease agreements of RMB0.4 million and goodwill of RMB1.1 million and recognized an impairment loss of RMB1.9 million net of cash received of RMB3.3 million. In addition, in 2009 we were notified by local government authorities that we may have to demolish two additional leased-and-operated hotels due to local zoning requirements. We cannot assure you that similar demolitions or interruptions of our hotel operations due to zoning or other local regulations will not occur in the future. Any such further demolition and relocation could cause us to lose primary locations for our hotels and we may not be able to achieve comparable operation results following the relocations. While we may be reimbursed for such demolition and relocation, we cannot assure you that the reimbursement, as determined by the relevant government authorities, will be sufficient to cover our direct and indirect losses. Accordingly, our business, results of operations and financial condition could be adversely affected.
 
Governmental control of currency conversion may limit our ability to pay dividends in foreign currencies to our shareholders and therefore adversely affect the value of your investment.
 
The PRC government imposes controls on the convertibility of RMB into foreign currencies and, in certain cases, the remittance of currency out of China. See “Regulation — Regulations on Foreign Currency Exchange” for discussions of the principal regulations and rules governing foreign currency exchange in China. We receive substantially all of our revenues in RMB. For most capital account items, approval from appropriate government authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs, which would adversely affect the value of your investment.
 
Fluctuation in the value of the Renminbi may have a material adverse effect on your investment.
 
The value of the Renminbi against the U.S. dollar, Euro and other currencies is affected by, among other things, changes in China’s political and economic conditions and China’s foreign exchange policies.
 
Our revenues and costs are mostly denominated in the Renminbi, and a significant portion of our financial assets are also denominated in the Renminbi. We rely substantially on dividends paid to us by our operating subsidiaries in China. Any significant depreciation of the Renminbi against the U.S. dollar may have a material adverse effect on our revenues, and the value of, and any dividends payable on, our ADSs and common shares. If we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our common shares or for other business purposes, depreciation of the Renminbi against the U.S. dollar would reduce the U.S. dollar amount available to us. On the other hand, to the extent that we need to convert U.S. dollars, including the net proceeds we will receive from this offering, into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Quantitative and Qualitative Disclosure about Market Risk — Foreign Exchange Risk” for discussions of our exposure to foreign currency risks. In summary, fluctuation in the value of the Renminbi in either direction could have a material adverse effect on the value of our company and the value of your investment.


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The approval of the China Securities Regulatory Commission, or the CSRC, may be required in connection with this offering under a recently adopted PRC regulation; any requirement to obtain prior CSRC approval could delay this offering and a failure to obtain this approval, if required, could have a material adverse effect on our business, operating results, reputation and trading price of our ADSs, and may also create uncertainties for this offering; the regulation also establishes more complex procedures for acquisitions conducted by foreign investors which could make it more difficult to pursue growth through acquisitions.
 
In 2006, six PRC regulatory agencies jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rule. See “Regulation — Regulations on Overseas Listing.” While the application of the New M&A Rule remains unclear, we believe, based on the advice of our PRC counsel, that CSRC approval is not required in the context of this offering because we established our PRC subsidiaries by means of direct investment other than by merger or acquisition of domestic companies, and we started to operate our business in the PRC through foreign invested enterprises before September 8, 2006, the effective date of the New M&A Rule. However, we cannot assure you that the relevant PRC government agency, including the CSRC, would reach the same conclusion as our PRC counsel. If the CSRC or other PRC regulatory body subsequently determines that we need to obtain the CSRC’s approval for this offering, we may face sanctions by the CSRC or other PRC regulatory agencies, which could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as this offering and the trading price of our ADSs.
 
The New M&A Rule also established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex. For example, we are in the process of acquiring the noncontrolling interest in an existing subsidiary. We issued a warrant to one of the individual shareholders, who is a party not affiliated with us, of this selling joint venture partner and we cannot guarantee such arrangement would not trigger the approval requirement under the New M&A Rule. If relevant PRC government authorities deem such arrangement to be a transaction subject to the New M&A Rule and we do not seek such approval, we could be subject to administrative fines and other penalties from relevant PRC authorities, may be required to obtain approval for such transactions from the MOC and/or the CSRC and could be required to divest these subsidiaries, in which case we would lose the benefit of the revenues from hotels operated by such entities. There are no specific provisions of fines or penalties for such violations under current PRC laws and regulations and so the penalties we may suffer are uncertain.
 
In the future, we may grow our business in part by acquiring complementary businesses, although we do not have any plans to do so at this time. Complying with the requirements of the New M&A Rule to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from the MOC, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.
 
Recent PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders to personal liability and limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us, or otherwise adversely affect us.
 
In October 2005, the State Administration of Foreign Exchange, or the SAFE, promulgated Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Corporate Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles, or Circular 75, which requires PRC residents who use assets or equity interests in their PRC entities as capital contributions to establish offshore companies or inject assets or equity interests in their PRC entities into offshore companies to register with local SAFE branches. See “Regulation — Regulations on Offshore Financing” for discussions of the registration requirements and the relevant penalties.
 
We attempt to comply, and attempt to ensure that our shareholders and beneficial owners of our shares who are subject to these rules comply, with the relevant requirements. We noticed two of our minority shareholders who hold in the aggregate less than 1% of our total outstanding shares have not completed the required registration procedures and we have requested them to complete the required procedures. The two shareholders are preparing their applications, but we are not sure if they will complete the registration procedures on a timely basis or at all.


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We cannot provide any assurance that our other shareholders and beneficial owners of our shares who are PRC residents have complied or will comply with the requirements imposed by Circular 75 or other related rules either. Any failure by any of our shareholders and beneficial owners of our shares who are PRC domestic residents to comply with relevant requirements under this regulation could subject us to fines or sanctions imposed by the PRC government, including restrictions on our relevant subsidiary’s ability to pay dividends or make distributions to us and our ability to increase our investment in China.
 
We rely principally on dividends and other distributions on equity paid by our subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our subsidiaries to make payments to us could have a material adverse effect on our ability to conduct our business.
 
We are a holding company, and we rely principally on dividends from our subsidiaries in China for our cash requirements, including any debt we may incur. Current PRC regulations permit our subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, each of our subsidiaries in China are required to set aside a certain amount of its after-tax profits each year, if any, to fund certain statutory reserves. These reserves are not distributable as cash dividends. As of December 31, 2009, a total of RMB3.1 million was not distributable in the form of dividends to us due to these PRC regulations. Furthermore, if our subsidiaries in China incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us. The inability of our subsidiaries to distribute dividends or other payments to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends, or otherwise fund and conduct our business.
 
PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from using the proceeds of this offering to make loans or additional capital contributions to our PRC operating subsidiaries.
 
In utilizing the proceeds of this offering in the manner described in “Use of Proceeds,” as an offshore holding company of our PRC operating subsidiaries, we may make loans to our PRC subsidiaries, or we may make additional capital contributions to our PRC subsidiaries. Any loans to our PRC subsidiaries are subject to PRC regulations. For example, loans by us to our subsidiaries in China, which are foreign-invested enterprises, to finance their activities cannot exceed statutory limits and are required to be registered with the SAFE.
 
We may also decide to finance our subsidiaries by means of capital contributions. These capital contributions must be approved by the MOC or its local counterparts. We cannot assure you that we will be able to obtain these government approvals on a timely basis, if at all, with respect to future capital contributions by us to our subsidiaries. If we fail to receive such approvals, our ability to use the proceeds of this offering and to capitalize our PRC operations may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our business.
 
All employee participants in our share incentive plans who are PRC citizens may be required to register with the SAFE. We may also face regulatory uncertainties that could restrict our ability to adopt additional share incentive plans for our directors and employees under PRC law.
 
In 2006, the PBOC promulgated the Measure for the Administration of Individual Foreign Exchange, and in 2007, the SAFE promulgated the accompanying implementing rules. These regulations require PRC citizens who have been granted shares or share options by an overseas listed company to register with the SAFE and complete certain other procedures related to the share option or share incentive plan. Our PRC citizen employees who have been granted share options, or PRC optionees, will be subject to these regulations upon the listing of our ADSs on the NASDAQ Global Market. If we or our PRC optionees fail to comply with these regulations, we or our PRC optionees may be subject to fines and legal or administrative sanctions.
 
In addition, in 2007, the SAFE issued the Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Option Plan or Stock Option Plan of An Overseas Listed Company, or Circular 78, which requires PRC employee participants to register with the SAFE and to comply


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with a series of other requirements. See “Regulation — Regulations on Foreign Currency Exchange.” We cannot predict whether the SAFE will continue to enforce this circular or adopt additional or different requirements with respect to equity compensation plans or incentive plans. If it is determined that our Amended and Restated 2007 Global Share Plan, Amended and Restated 2008 Global Share Plan or Amended and Restated 2009 Share Incentive Plan is subject to Circular 78, failure to comply with such provisions may subject us and the participants of our share incentive plans who are PRC citizens to fines and legal sanctions and may prevent us from further granting options under our share incentive plans to our employees. Such events could adversely affect our business operations.
 
It is unclear whether we will be considered as a PRC “resident enterprise” under the new EIT law, and depending on the determination of our PRC “resident enterprise” status, dividends paid to us by our PRC subsidiaries may be subject to PRC withholding tax, we may be subject to 25% PRC income tax on our worldwide income, and holders of our ADSs or ordinary shares may be subject to PRC withholding tax on dividends paid by us and gains realized on their transfer of our ADSs or ordinary shares.
 
In 2007, the PRC National People’s Congress passed the Enterprise Income Tax Law, and the PRC State Council subsequently issued the Implementation Regulations of the Enterprise Income Tax Law. The Enterprise Income Tax Law and its Implementation Regulations, or the new EIT Law, provides that enterprises established outside of China whose “de facto management bodies” are located in China are considered “resident enterprises.” Currently, there are no detailed rules or precedents governing the procedures and specific criteria for determining “de facto management body” and it is still unclear if the PRC tax authorities would determine that we should be classified as a PRC “resident enterprise.”
 
Under the new EIT Law, dividends paid to us by our subsidiaries in China may be subject to a 10% withholding tax if we are considered a “non-resident enterprise.” If we are treated as a PRC “resident enterprise,” we will be subject to PRC income tax on our worldwide income at the 25% uniform tax rate, which could have an impact on our effective tax rate and an adverse effect on our net income and results of operations, although dividends distributed from our PRC subsidiaries to us could be exempt from the PRC dividend withholding tax, since such income is exempted under the new EIT Law to a PRC resident recipient. If we are required under the new EIT Law to pay income tax on any dividends we receive from our subsidiaries, our income tax expenses will increase and the amount of dividends, if any, we may pay to our shareholders and ADS holders may be materially and adversely affected. In addition, dividends we pay with respect to our ADSs or ordinary shares and the gains realized from the transfer of our ADSs or ordinary shares may be considered as income derived from sources within the PRC and be subject to PRC withholding tax.
 
Furthermore, if we are considered as a PRC “resident enterprise” and dividends we pay with respect to our ADSs or ordinary shares and the gains realized from the transfer of our ADSs or ordinary shares are considered income derived from sources within the PRC by relevant competent PRC tax authorities, such gains earned by non-resident individuals may also be subject to PRC withholding tax. See “Taxation — PRC Taxation.”
 
Risks Related to This Offering
 
There has been no public market for our ordinary shares or ADSs prior to this offering, and you may not be able to resell our ADSs at or above the price you paid, or at all.
 
Prior to this initial public offering, there has been no public market for our ordinary shares or ADSs. We have applied to have our ADSs listed on the NASDAQ Global Market. Our ordinary shares will not be listed or quoted for trading on any exchange. If an active trading market for our ADSs does not develop after this offering, the market price and liquidity of our ADSs will be materially and adversely affected.
 
The initial public offering price for our ADSs will be determined by negotiations between us and the representatives of the underwriters and may bear no relationship to the market price for our ADSs after the initial public offering. We cannot assure you that an active trading market for our ADSs will develop or that the market price of our ADSs will not decline below the initial public offering price.
 
Furthermore, Ctrip.com International, Ltd., or Ctrip, has indicated to us that it may also consider placing an order to purchase ADSs in this offering at the initial public offering price. If such an order is placed, neither we


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nor the underwriters are under any obligation or commitment to allocate any of the ADSs offered in this offering to Ctrip. Any ADSs issued and sold to Ctrip will be on the same terms as the other ADSs being offered in this offering except that those ADSs will be subject to lock up of 180 days pursuant to the terms of a lock up agreement between Ctrip and the underwriters in conjunction with the private placement of our ordinary shares. If Ctrip purchases ADSs in the public offering, the public float of our ADSs, prior to the expiration of Ctrip’s lock up agreement, will be decreased by the number of ADSs we sell to Ctrip in the public offering. See “Related Party Transactions — Transactions with Ctrip.”
 
The market price for our ADSs may be volatile.
 
The market price for our ADSs may be volatile and subject to wide fluctuations in response to factors including the following:
 
  •     actual or anticipated fluctuations in our quarterly operating results;
 
  •     changes in financial estimates by securities research analysts;
 
  •     conditions in the travel and lodging industries;
 
  •     changes in the economic performance or market valuations of other lodging companies;
 
  •     announcements by us or our competitors of new products, acquisitions, strategic partnerships, joint ventures or capital commitments;
 
  •     addition or departure of key personnel;
 
  •     fluctuations of exchange rates between the RMB and U.S. dollar or other foreign currencies;
 
  •     potential litigation or administrative investigations;
 
  •     release of lock-up or other transfer restrictions on our outstanding ADSs or ordinary shares or sales of additional ADSs; and
 
  •     general economic or political conditions in China.
 
In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our ADSs.
 
Because the initial public offering price is substantially higher than our net tangible book value per share, you will incur immediate and substantial dilution.
 
The initial public offering price per ADS is substantially higher than the net tangible book value per ADS prior to the offering. Accordingly, if you purchase our ADSs in this offering and assuming no exercise of the underwriters’ over-allotment option, you will incur immediate dilution of approximately US$7.05 in the net tangible book value per ADS from the price you pay for our ADSs, representing the difference between:
 
  •     the assumed initial public offering price of US$11.25 per ADS (the midpoint of the estimated initial public offering price range set forth on the front cover of this prospectus), and
 
  •     the pro forma as adjusted net tangible book value per ADS of US$4.20 as of December 31, 2009, assuming the automatic conversion of our outstanding Series A and Series B preferred shares into ordinary shares and after giving effect to this offering.
 
You may find additional information in the section entitled “Dilution” in this prospectus. If we issue additional ADSs in the future, you may experience further dilution. In addition, you may experience further dilution to the extent that ordinary shares are issued upon the exercise of stock options. Substantially all of the ordinary shares issuable upon the exercise of our currently outstanding stock options will be issued at a purchase price on a per ADS basis that is less than the initial public offering price per ADS in this offering.


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We may need additional capital, and the sale of additional ADSs or other equity securities could result in additional dilution to our shareholders and the incurrence of additional indebtedness could increase our debt service obligations.
 
We believe that our current cash and cash equivalents, anticipated cash flow from operations and the proceeds from this offering will be sufficient to meet our anticipated cash needs for the foreseeable future. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity and equity-linked securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all, particularly in light of the current global economic crisis.
 
Future sales or issuances, or perceived future sales or issuances, of substantial amounts of our ordinary shares or ADSs could adversely affect the price of our ADSs.
 
If our existing shareholders sell, or are perceived as intending to sell, substantial amounts of our ordinary shares or ADSs, including those issued upon the exercise of our outstanding stock options, following this offering, the market price of our ADSs could fall. Such sales, or perceived potential sales, by our existing shareholders might make it more difficult for us to issue new equity or equity-related securities in the future at a time and place we deem appropriate. The ADSs offered in this offering will be eligible for immediate resale in the public market without restrictions, and shares held by our existing shareholders may also be sold in the public market in the future subject to the restrictions contained in Rule 144 and Rule 701 under the Securities Act and the applicable lock-up agreements. If any existing shareholder or shareholders sell a substantial amount of ordinary shares after the expiration of the lock-up period, the prevailing market price for our ADSs could be adversely affected. See “Shares Eligible for Future Sale” and “Underwriting” for additional information regarding resale restrictions.
 
In addition, certain of our shareholders or their transferees and assignees will have the right to cause us to register the sale of their shares under the Securities Act upon the occurrence of certain circumstances. See “Description of Share Capital — Registration Rights.” Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration. Sales of these registered shares in the public market could cause the price of our ADSs to decline.
 
As our founder and co-founders collectively hold a controlling interest in us, they have significant influence over our management and their interests may not be aligned with our interests or the interests of our other shareholders.
 
Currently, our founder, Mr. Qi Ji, who is also our executive chairman, and our co-founders, Ms. Tongtong Zhao and Mr. John Jiong Wu, beneficially own approximately 60.2%, 20.2% and 5.0%, respectively, of our outstanding ordinary shares on an as-converted basis. See “Principal Shareholders.” Upon completion of this offering, Mr. Qi Ji, Ms. Tongtong Zhao and Mr. John Jiong Wu will beneficially own approximately 49.1%, 16.5% and 4.1%, respectively, of our outstanding ordinary shares if the underwriters do not exercise their over-allotment option or 48.0%, 16.1% and 4.0%, respectively, if the underwriters exercise their over-allotment option in full. The interests of these shareholders may conflict with the interests of our other shareholders. Our founder and co-founders have significant influence over us, including on matters relating to mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. This concentration of ownership may discourage, delay or prevent a change in control of us, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of us or of our assets and might reduce the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders, including those who purchase ADSs in this offering.


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You may not have the same voting rights as the holders of our ordinary shares and may not receive voting materials in time to be able to exercise your right to vote.
 
Except as described in this prospectus and in the deposit agreement, holders of our ADSs will not be able to exercise voting rights attaching to the shares evidenced by our ADSs on an individual basis. Holders of our ADSs will appoint the depositary or its nominee as their representative to exercise the voting rights attaching to the shares represented by the ADSs. You may not receive voting materials in time to instruct the depositary to vote, and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote.
 
You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.
 
We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act of 1933, as amended, or exempt from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of our ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.
 
You may be subject to limitations on transfer of your ADSs.
 
Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.
 
As a foreign private issuer, we are permitted to, and we will, rely on exemptions from certain NASDAQ corporate governance standards applicable to U.S. issuers, including the requirement regarding the implementation of a nominating committee. This may afford less protection to holders of our ordinary shares and ADSs.
 
The NASDAQ Marketplace Rules in general require listed companies to have, among other things, a nominating committee consisting solely of independent directors. As a foreign private issuer, we are permitted to, and we will, follow home country corporate governance practices instead of certain requirements of the NASDAQ Marketplace Rules, including, among others, the implementation of a nominating committee. The corporate governance practice in our home country, the Cayman Islands, does not require the implementation of a nominating committee. We currently intend to rely upon the relevant home country exemption in lieu of the nominating committee. As a result, the level of independent oversight over management of our company may afford less protection to holders of our ordinary shares and ADSs.
 
Our articles of association contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our ordinary shares and ADSs.
 
Our new amended and restated articles of association that will become effective upon the completion of this offering contain provisions limiting the ability of others to acquire control of our company or cause us to enter into change-of-control transactions. These provisions could have the effect of depriving our shareholders of opportunities to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction.


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For example, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares, in the form of ADSs or otherwise. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may decline and the voting and other rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.
 
You may face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited, because we are incorporated under Cayman Islands law, conduct substantially all of our operations in China and the majority of our officers reside outside the United States.
 
We are incorporated in the Cayman Islands, and conduct substantially all of our operations in China through our wholly owned subsidiaries in China. Most of our officers reside outside the United States and some or all of the assets of those persons are located outside of the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the Cayman Islands or in China in the event that you believe that your rights have been infringed under the securities laws or otherwise. Even if you are successful in bringing an action of this kind outside the Cayman Islands or China, the laws of the Cayman Islands and of the PRC may render you unable to effect service of process upon, or to enforce a judgment against our assets or the assets of our directors and officers. There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits. A judgment of a court of another jurisdiction may be reciprocally recognized or enforced if the jurisdiction has a treaty with China or if judgments of the PRC courts have been recognized before in that jurisdiction, subject to the satisfaction of other requirements. However, China does not have treaties providing for the reciprocal enforcement of judgments of courts with Japan, the United Kingdom, the United States and most other Western countries. For more information regarding the relevant laws of the Cayman Islands and the PRC, see “Enforceability of Civil Liabilities.”
 
Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law (2009 Revision) and the common law of the Cayman Islands. The rights of shareholders to take legal action against our directors and us, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws as compared to the United States, and provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.
 
As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.
 
Our management will have considerable discretion as to the use of the net proceeds from this offering.
 
Our management will have considerable discretion in the application of the net proceeds received by us. You will not have the opportunity, as part of your investment decision, to assess whether proceeds are being used appropriately. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. The net proceeds received by us may be used for corporate purposes that do not improve our efforts to maintain profitability or increase our share price. The net proceeds from this offering may be placed in investments that do not produce income or that lose value.


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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This prospectus contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to us. The forward-looking statements are contained principally in, but not limited to, the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” These statements relate to future events or to our future financial performance and involve known and unknown risks, uncertainties, and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Forward-looking statements include, but are not limited to, statements about:
 
  •     our anticipated growth strategies, including developing new hotels at desirable locations in a timely and cost-effective manner;
 
  •     our future business development, results of operations and financial condition;
 
  •     expected changes in our revenues and certain cost or expense items;
 
  •     our ability to attract customers and leverage our brand; and
 
  •     trends and competition in the lodging industry.
 
In some cases, you can identify forward-looking statements by terms such as “may,” “could,” “will,” “should,” “would,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “project” or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions. You should not place undue reliance on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which are, in some cases, beyond our control and which could materially affect results. Factors that may cause actual results to differ materially from current expectations include, among other things, those listed under the heading “Risk Factors” and elsewhere in this prospectus. If one or more of these risks or uncertainties occur, or if our underlying assumptions prove to be incorrect, actual events or results may vary significantly from those implied or projected by the forward-looking statements. No forward-looking statement is a guarantee of future performance.
 
The forward-looking statements made in this prospectus relate only to events or information as of the date on which the statements are made in this prospectus. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statements are made or to reflect the occurrence of unanticipated events.


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USE OF PROCEEDS
 
Based upon an assumed initial offering price of US$11.25 per ADS (the midpoint of the estimated initial public offering price range shown on the front cover of this prospectus), we estimate that we will receive net proceeds from this offering of approximately US$91.8 million after deducting underwriting discounts and commissions and the estimated offering expenses payable by us. Based on the same assumption, we estimate that we will receive net proceeds from our sale of shares to Ctrip of approximately US$20.2 million. A US$1.00 increase (decrease) in the assumed initial offering price would increase (decrease) the net proceeds to us from this offering by US$10.2 million after deducting underwriting discounts and commissions and the estimated offering expenses payable by us.
 
As of the date of this prospectus, we have not allocated any specific portion of the net proceeds of this offering for any particular purpose. We anticipate using approximately 90% of the net proceeds of this offering for our hotel network expansion purposes and the remaining amount for general corporate purposes.
 
In utilizing the proceeds of this offering, we may make loans to our subsidiary or we may make additional capital contributions to these entities.
 
The foregoing represents our current intentions with respect of the use and allocation of the net proceeds of this offering based upon our present plans and business conditions, but our management will have significant flexibility and discretion in applying the net proceeds of this offering. The occurrence of unforeseen events or changed business conditions may result in application of the proceeds of this offering in a manner other than as described in this prospectus.
 
Pending use of the net proceeds, we intend to invest our net proceeds in short-term, interest bearing debt instruments or bank deposits.


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DIVIDEND POLICY
 
We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business. We had never declared or paid dividends prior to December 31, 2009 and we do not have any plan to declare or pay any dividends in the near future.
 
Our board of directors has complete discretion in deciding whether to distribute dividends. Even if our board of directors decides to pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors.
 
If we pay any dividends, our ADS holders will be entitled to such dividends to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.
 
We are a holding company with no material operations of our own. We conduct our operations primarily through our subsidiaries in China. As a result, our ability to pay dividends and to finance any debt we may incur depends upon dividends paid to us by our subsidiaries. If our subsidiaries or any newly formed subsidiaries incur debt on their own behalf in the future, the instruments governing their debt may restrict their ability to pay dividends to us. In addition, our subsidiaries are permitted to pay dividends to us only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Pursuant to laws applicable to entities incorporated in the PRC, our subsidiaries in the PRC must make appropriations from after-tax profit to non-distributable reserve funds. These reserve funds include one or more of the following: (i) a general reserve, (ii) an enterprise expansion fund and (iii) a staff bonus and welfare fund. Subject to certain cumulative limits, the general reserve fund requires an annual appropriation of 10% of after-tax profit (as determined under accounting principles generally accepted in the PRC at each year-end); the other fund appropriations are at the subsidiaries’ discretion. These reserve funds can only be used for specific purposes of enterprise expansion, staff bonus and welfare, and are not distributable as cash dividends.


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CAPITALIZATION
 
The following table sets forth our total capitalization as of December 31, 2009:
 
  •     on an actual basis;
 
  •     on a pro forma basis to give effect to (i) the automatic conversion of all of our outstanding Series A preferred shares into 44,000,000 ordinary shares, at a conversion ratio of one Series A preferred share to one ordinary share; and (ii) the automatic conversion of all of our outstanding Series B preferred shares into 78,058,919 ordinary shares, at a conversion ratio of one Series B preferred share to one ordinary share;
 
  •     on a pro forma as adjusted basis to further reflect (i) the issuance of 1,700,000 ordinary shares upon exercise of warrants at US$1.54 per share in February 2010; (ii) the issuance of 7,708,665 ordinary shares upon exercise of options for total consideration of US$6,021,365 in March 2010; (iii) the issuance of 7,202,482 ordinary shares to Ctrip.com International, Ltd. at the midpoint of the estimated range of the initial public offering price of US$11.25 per ADS; and (iv) the issuance and sale of 36,000,000 ordinary shares in the form of ADSs by us in this offering, assuming an initial public offering price of US$11.25 per ADS, the midpoint of the estimated range of the initial public offering price, after deducting estimated underwriting discounts and commissions and offering expenses payable by us and assuming no exercise of the underwriters’ over-allotment option.
 
You should read this table together with our consolidated financial statements, the related notes included elsewhere in this prospectus and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
                                                 
    As of December 31, 2009  
                Pro Forma
 
    Actual     Pro Forma     As Adjusted  
                (unaudited)     (unaudited)  
    (RMB)     (US$)     (RMB)     (US$)     (RMB)     (US$)  
    (in thousands, except share data)  
 
Long-term debt (secured)
    80,000       11,720       80,000       11,720       80,000       11,720  
Mezzanine equity:
                                               
Series B convertible redeemable preferred shares (US$0.0001 par value per share, 106,000,000 shares authorized, 78,058,919 issued and outstanding).
    796,803       116,732       -       -       -       -  
Equity:
                                               
Ordinary shares (US$0.001 par value per share, 300,000,000 shares authorized, 60,948,013 shares issued and outstanding on an actual basis, 183,006,932 shares issued and outstanding on a pro forma basis and 235,618,079 shares issued and outstanding on a pro forma as adjusted basis as of December 31, 2009)
    46       7       125       18       161       24  
Series A convertible preferred shares (US$0.0001 par value per share, 44,000,000 shares authorized, issued and outstanding)
    34       5       -       -                  
Additional paid-in capital
    351,994       51,567       1,148,753       168,293       1,972,355       288,950  
Accumulated deficit
    (245,457 )     (35,960 )     (245,457 )     (35,960 )     (245,457 )     (35,960 )
Accumulated other comprehensive loss
    (12,529 )     (1,835 )     (12,529 )     (1,835 )     (12,529 )     (1,835 )
Noncontrolling interest
    11,365       1,665       11,365       1,665       11,365       1,665  
                                                 
Total equity(1)
    105,453       15,449       902,257       132,181       1,725,895       252,844  
                                                 
Total long-term debt, mezzanine equity and equity(1)
    982,256       143,901       982,257       143,901       1,805,895       264,564  
                                                 
 
(1)  Assuming the number of ADSs offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting estimated underwriting discounts and commissions and offering expenses payable by us, a US$1.00 increase (decrease) in the assumed initial public offering price of US$11.25 would increase (decrease) each of additional paid-in capital and total equity by US$10.2 million.


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DILUTION
 
If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the pro forma net tangible book value per ordinary share.
 
Our net tangible book value as of December 31, 2009 was approximately US$126.5 million, or approximately US$2.08 per ordinary share or US$8.30 per ADS. Net tangible book value represents the amount of our total consolidated assets, less the amount of our total consolidated liabilities, intangible assets and goodwill. Dilution is determined by subtracting pro forma as adjusted net tangible book value per ordinary share or per ADS, after giving effect to (i) the conversion of Series A and Series B preferred shares; (ii) the issuance of 1,700,000 ordinary shares upon exercise of warrants in February 2010; (iii) the issuance of 7,708,665 ordinary shares upon exercise of options in March 2010; (iv) the issuance of 7,202,482 ordinary shares to Ctrip.com International, Ltd., or Ctrip, assuming an initial public offering price of $11.25 per ADS, the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus; and (v) the proceeds from this offering after deducting estimated underwriting discounts and commissions and offering expenses payable by us, from the assumed initial public offering price per ordinary share or per ADS, respectively, which is the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus.
 
Without taking into account any other changes in net tangible book value after December 31, 2009, other than to give effect to the conversion of Series A and Series B preferred shares, the issuance of 1,700,000 ordinary shares upon exercise of warrants, the issuance of 7,708,665 ordinary shares upon exercise of options and the issuance of 7,202,482 ordinary shares to Ctrip, our sale of the ADSs offered in this offering at the initial public offering price of US$11.25 per ADS, the midpoint of the estimated range of the initial public offering price, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value at December 31, 2009, would have been US$247.2 million, or US$1.05 per ordinary share, and US$4.20 per ADS. This represents an immediate increase in pro forma as adjusted net tangible book value of US$0.36 per ordinary share and US$1.44 per ADS, to the existing shareholders and an immediate dilution in net tangible book value of US$1.76 per ordinary share and US$7.05 per ADS, to new investors purchasing ADSs in this offering and Ctrip.
 
The following table illustrates such dilution:
 
                 
    Per Ordinary
       
    Share     Per ADS  
 
Assumed initial public offering price
  US$ 2.81     US$ 11.25  
Net tangible book value as of December 31, 2009
    2.08       8.30  
Pro forma net tangible book value
    0.69       2.76  
Pro forma as adjusted net tangible book value
    1.05       4.20  
                 
Increase in pro forma as adjusted net tangible book value
    0.36       1.44  
                 
Dilution in pro forma as adjusted net tangible book value to new investors in this offering and Ctrip
    1.76       7.05  
                 


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The following table summarizes on the pro forma as adjusted basis described above, as of December 31, 2009, the differences between existing shareholders and the new investors with respect to the number of ordinary shares (in the form of ADSs or shares) purchased from us, the total consideration paid and the average price per ordinary share/ADS paid before deducting estimated underwriting discounts and commissions and the estimated offering expenses. The total number of ordinary shares does not include ordinary shares underlying the ADSs issuable upon the exercise of the over-allotment option granted to the underwriters.
 
                                                 
    Ordinary Shares
    Total
    Average Price
       
    Purchased     Consideration     Per Ordinary
    Average Price
 
    Number     Percent     Amount     Percent     Share(1)     Per ADS(1)  
 
Existing shareholders
    192,415,597       81.7 %   US$ 176,516,182       59.2 %   US$ 0.92     US$ 3.67  
New investors and Ctrip
    43,202,482       18.3       121,506,982       40.8       2.81       11.25  
                                                 
Total
    235,618,079       100.0 %   US$ 298,023,164       100.0 %                
                                                 
 
 
(1) Assumes an initial public offering price of US$11.25 per ADS, the midpoint of the estimated range of the initial public offering price, the automatic conversion of all of our outstanding 44,000,000 Series A preferred shares and 78,058,919 Series B preferred shares into ordinary shares upon the completion of this offering, the issuance of 1,700,000 ordinary shares upon exercise of warrants, the issuance of 7,708,665 ordinary shares upon exercise of options and the issuance of 7,202,482 ordinary shares to Ctrip.
 
A US$1.00 increase (decrease) in the assumed initial public offering price of US$11.25 per ADS would increase (decrease) our pro forma as adjusted net tangible book value by US$10.2 million, or by US$0.04 per ordinary share and US$0.17 per ADS, and the dilution in pro forma as adjusted net tangible book value to new investors in this offering and Ctrip by US$0.21 per ordinary share and US$0.83 per ADS, assuming no change to the number of ADSs offered by us as set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and offering expenses payable by us.
 
The pro forma as adjusted information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.
 
The preceding discussion and tables assume no exercise of options to purchase ordinary shares outstanding as of December 31, 2009 except 7,708,665 ordinary shares issued upon exercise of option in March 2010. As of March 12, 2010, there were 10,430,403 shares issuable upon exercise of options to purchase ordinary shares. To the extent outstanding options are exercised, new investors will experience further dilution.


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EXCHANGE RATE INFORMATION
 
Our reporting and financial statements are expressed in the U.S. dollar, which is our functional and reporting currency. Substantially all of the revenues and expenses of our consolidated operating subsidiaries, however, are denominated in RMB. This prospectus contains translations of RMB amounts into U.S. dollars at specific rates solely for the convenience of the reader. For all dates and periods through December 31, 2008, conversions of Renminbi into U.S. dollars are based on the noon buying rate in The City of New York for cable transfers of Renminbi as certified for customs purposes by the Federal Reserve Bank of New York. For January 1, 2009 and all later dates and periods, the exchange rate refers to the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board. Unless otherwise indicated, conversions of RMB into U.S. dollars in this prospectus are based on the exchange rate on December 31, 2009. We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. On March 8, 2010, the daily exchange rate reported by the Federal Reserve Board was RMB6.8263 to US$1.00.
 
The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you.
 
                                 
    Noon Buying Rate
Period   Period End   Average(1)   Low   High
    (RMB per US$1.00)
 
2005
    8.0702       8.1826       8.2765       8.0702  
2006
    7.8041       7.9579       8.0702       7.8041  
2007
    7.2946       7.6058       7.8172       7.2946  
2008
    6.8225       6.9477       7.2946       6.7800  
2009
    6.8259       6.8307       6.8470       6.8176  
2009
                               
September
    6.8262       6.8277       6.8303       6.8247  
October
    6.8264       6.8267       6.8292       6.8248  
November
    6.8265       6.8271       6.8300       6.8255  
December
    6.8259       6.8275       6.8299       6.8244  
2010
                               
January
    6.8268       6.8269       6.8295       6.8258  
February
    6.8258       6.8285       6.8330       6.8258  
March (through March 8)
    6.8263       6.8261       6.8265       6.8258  
 
(1)  Averages for a period are calculated by using the average of the exchange rates at the end of each month during the period. Monthly averages are calculated by using the average of the daily rates during the relevant period.


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ENFORCEABILITY OF CIVIL LIABILITIES
 
We were incorporated in the Cayman Islands in order to enjoy certain benefits, such as political and economic stability, an effective judicial system, a favorable tax system, the absence of exchange control or currency restrictions, and the availability of professional and support services. Certain disadvantages, however, accompany incorporation in the Cayman Islands. These disadvantages include a less developed body of Cayman Islands securities laws that provide significantly less protection to investors as compared to the laws of the United States, and the potential lack of standing by Cayman Islands companies to sue in the federal courts of the United States.
 
Our organizational documents do not contain provisions requiring that disputes, including those arising under the securities laws of the United States, between us, our officers, directors and shareholders, be arbitrated.
 
Substantially all of our operations are conducted in China, and substantially all of our assets are located in China. A majority of our officers are nationals or residents of jurisdictions other than the United States and a substantial portion of their assets are located outside the United States. As a result, it may be difficult for a shareholder to effect service of process within the United States upon these persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States.
 
We have appointed CT Corporation System as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.
 
Conyers Dill & Pearman, our special Cayman Islands counsel, and Jun He Law Offices, our special PRC counsel, have advised us that there is uncertainty as to whether the courts of the Cayman Islands and China, respectively, would:
 
  •     recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or
 
  •     entertain original actions brought in each respective jurisdiction against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.
 
Conyers Dill & Pearman has advised us that a final and conclusive judgment in the federal or state courts of the United States under which a sum of money is payable, other than a sum payable in respect of taxes, fines, penalties or similar charges, may be subject to enforcement proceedings as a debt in the courts of the Cayman Islands under the common law doctrine of obligation. However, Conyers Dill & Pearman has advised us that it is uncertain whether a U.S. court judgment based on the civil liability provisions of the U.S. federal securities laws would be enforceable in the Cayman Islands because a Cayman Islands court may determine that such judgment is in the nature of a “penalty” and therefore not subject to enforcement proceedings as a debt.
 
Jun He Law Offices has further advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other agreements with the United States that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC laws or national sovereignty, security or public interest. As a result, it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.


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SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
 
The following summary consolidated statements of operations and balance sheet data as of and for the years ended December 31, 2007, 2008 and 2009 have been derived from our audited consolidated financial statements which are included elsewhere in this prospectus. Our statement of operations and balance sheet data as of and for the year ended December 31, 2006 are unaudited.
 
We have not included financial information for the year ended December 31, 2005, as such information is not available on a basis that is consistent with the consolidated financial information for the years ended December 31, 2006, 2007, 2008 and 2009. Our operation commenced, through Powerhill Holdings Limited, or Powerhill, with mid-scale limited service hotels and commercial property development and management in 2005. See “Prospectus Summary — Corporate Structure and History.” We began migrating to our current business of operating and managing a multiple-product economy hotel chain in 2007. In light of the change in our business model and our significant growth since 2007, we believe that the financial data for the year ended December 31, 2005 would not be meaningful to investors. Furthermore, the preparation of the 2005 financial information would require the accounting records of Powerhill’s subsidiary, Lishan Property (Suzhou) Co., Ltd., or Suzhou Property, and its subsidiary, Shanghai Shuyu Co., Ltd., or Shuyu. Historically, limited unconsolidated financial statements have been prepared for Suzhou Property and Shuyu under PRC accounting standards for internal purposes and only to support tax return information filed with the PRC tax authorities. Due to the long-dated nature of the 2005 accounting records of these two entities and the lack of accounting personnel at our company and Powerhill who are familiar with the preparation of such accounting records, our consolidated financial statements for the year ended December 31, 2005 cannot be provided on a U.S. GAAP basis or home-country GAAP basis without unreasonable effort or expense. We do not believe that the omission of selected financial data for 2005 would have a material impact on a reader’s understanding of our financial results and condition, or related trends.
 
The following selected historical consolidated financial and operating data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited financial statements and the related notes included elsewhere in this prospectus. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods.
 
                                         
    Year Ended December 31,  
    2006     2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands, except per share and per ADS data)  
 
Summary Consolidated Statements of Operations Data:
                                       
Net revenues
    54,031       235,306       764,249       1,260,191       184,619  
Operating costs and expenses(1)
    (94,069 )     (372,616 )     (917,901 )     (1,183,777 )     (173,424 )
Income (loss) from operations
    (40,038 )     (137,310 )     (153,652 )     76,414       11,195  
Income (loss) before income taxes
    (36,623 )     (131,001 )     (156,463 )     69,438       10,173  
Net income (loss)
    (29,954 )     (113,739 )     (132,583 )     51,448       7,537  
Less: net income (loss) attributable to noncontrolling interest
    (425 )     (2,116 )     3,579       8,903       1,304  
                                         
Net income (loss) attributable to China Lodging Group, Limited
    (29,529 )     (111,623 )     (136,162 )     42,545       6,233  
                                         
Net earnings (loss) per share:
                                       
Basic
                 (2.85 )     (2.52 )     0.24       0.03  
Diluted
                 (2.85 )     (2.52 )     0.23       0.03  
Net earnings (loss) per ADS(2):
                                       
Basic
                 (11.41 )     (10.07 )     0.95       0.14  
Diluted
                 (11.41 )     (10.07 )     0.93       0.14  
Weighted average number of shares used in computation:
                                       
Basic
                 45,248       54,071       57,562       57.562  
Diluted
                 45,248       54,071       183,632       183,632  
Pro forma earnings per share(3) — unaudited:
                                       
Basic
                                 0.24       0.03  
Diluted
                                 0.23       0.03  
Pro forma earnings per ADS — unaudited:
                                       
Basic
                                 0.95       0.14  
Diluted
                                 0.93       0.14  


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    Year Ended December 31,  
    2006     2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands, except per share and per ADS data)  
 
Weighted average number of shares used in computation — unaudited:
                                       
Basic
                                 179,621       179,621  
Diluted
                                 183,632       183,632  
 
 
Note: (1)  Include share-based compensation expenses as follows:
 
                                 
    Year Ended December 31,  
    2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands)  
 
Share-based compensation expenses
      14,785         4,815         7,955       1,165  
 
   (2)  Each ADS represents four ordinary shares.
 
   (3)  Pro forma basic and diluted earnings (loss) per ordinary share is computed by dividing income (loss) attributable to holders of ordinary shares by the weighted average number of ordinary shares outstanding for the year plus the number of ordinary shares resulting from the assumed conversion of the outstanding convertible preferred shares upon the closing of the planned initial public offering.
 
The following table presents a summary of our consolidated balance sheet data as of December 31, 2006, 2007, 2008 and 2009:
 
  •     on an actual basis;
 
  •     on a pro forma basis as of December 31, 2009 to give effect to (i) the automatic conversion of all of our outstanding Series A preferred shares into 44,000,000 ordinary shares, at a conversion ratio of one Series A preferred share to one ordinary share; and (ii) the automatic conversion of all of our outstanding Series B preferred shares into 78,058,919 ordinary shares, at a conversion ratio of one Series B preferred share to one ordinary share; and
 
  •     on a pro forma as adjusted basis as of December 31, 2009 to further reflect (i) the issuance of 1,700,000 ordinary shares upon exercise of warrants at US$1.54 per share in February 2010; (ii) the issuance of 7,708,665 ordinary shares upon exercise of options for total consideration of US$6,021,365 in March 2010; (iii) the issuance of 7,202,482 ordinary shares to Ctrip at the midpoint of the estimated initial public offering price range; and (iv) the issuance and sale of 36,000,000 ordinary shares in the form of ADSs by us in this offering, assuming an initial public offering price of US$11.25 per ADS, the midpoint of the estimated range of the initial public offering price, after deducting estimated underwriting discounts and commissions and offering expenses payable by us and assuming no exercise of the underwriters’ over-allotment option. A US$1.00 increase (decrease) in the assumed initial public offering price of US$11.25 per ADS, the midpoint of the estimated range of the initial public offering price, would increase (decrease) the amounts representing cash and cash equivalents, total assets and total equity (deficit) by US$10.2 million.
 

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    As at December 31,  
    2006     2007     2008     2009     2009     2009  
                                  Pro Forma
 
    Actual     Actual     Actual     Actual     Pro Forma     As Adjusted  
                                  (unaudited)     (unaudited)  
    (RMB)     (RMB)     (RMB)     (RMB)     (US$)     (RMB)     (US$)     (RMB)     (US$)  
    (in thousands)  
 
Cash and cash equivalents
    33,272       173,636       183,246       270,587       39,641       270,587       39,641       1,094,225       160,304  
Restricted cash
    27,330       23,650       5,597       500       73       500       73       500       73  
Property and equipment, net
    159,216       465,186       957,407       1,028,267       150,642       1,028,267       150,642       1,028,767       150,642  
Total assets
    280,593       836,045       1,432,940       1,581,131       231,637       1,581,131       231,637       2,404,769       352,300  
Long-term debt
    -       -       27,500       80,000       11,720       80,000       11,720       80,000       11,720  
Deferred rent
    6,028       46,084       138,207       174,775       25,605       174,775       25,605       174,775       25,605  
Total liabilities
    175,382       293,062       665,378       678,875       99,456       678,875       99,456       678,875       99,456  
Mezzanine equity
    -       437,829       796,803       796,803       116,732       -       -       -       -  
Total equity (deficit)
    105,211       105,154       (29,241 )     105,453       15,449       902,257       132,181       1,725,895       252,844  
 
The following table presents a summary of our consolidated statements of cash flow for the years ended December 31, 2007, 2008 and 2009:
 
                                 
    Year Ended December 31,  
    2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands)  
 
Summary Consolidated Statement of Cash Flow Data:
                               
Net cash provided by (used in) operating activities
    (68,254 )     (13,738 )     296,340       43,414  
Net cash used in investing activities
    (284,014 )     (451,589 )     (256,027 )     (37,508 )
Net cash provided by financing activities
    499,307       482,479       47,064       6,895  

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section entitled “Selected Consolidated Financial Data” and our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.
 
Overview
 
We operate a leading economy hotel chain in China. According to the October 2009 Inntie Report, we achieved the highest revenues generated per available room, or RevPAR, and the highest occupancy rate in 2008 and for the first half of 2009, and the highest growth rate in terms of the number of hotel rooms during the period from January 1, 2007 to June 30, 2009, in each case among economy hotel chains in China with over 100 hotels or at least 10,000 hotel rooms.
 
We mainly utilize a lease-and-operate model, under which we directly operate hotels that are typically located in prime locations of selected cities. We also employ a franchise-and-manage model, under which we manage franchised hotels, to expand our network coverage. We apply a consistent standard and platform across all of our hotels. As of December 31, 2009, we had 173 leased-and-operated hotels and 63 franchised-and-managed hotels. In addition, as of the same date, we had 21 leased-and-operated hotels and 123 franchised-and-managed hotels under development.
 
We offer three hotel products that are designed to target distinct groups of customers. Our flagship product, HanTing Express Hotel, targets knowledge workers and value-conscious travelers. Our premium product, HanTing Seasons Hotel, targets mid-level corporate managers and owners of small and medium enterprises, and our budget product, HanTing Hi Inn, serves budget-constrained travelers. As a result of our customer-oriented approach, we have developed strong brand recognition and a loyal customer base. We have received multiple awards, including “Most Favored Economy Hotel in 2008” by Traveler Magazine and “Most Suitable Economy Hotel for Business Travelers” by Qunar.com, one of the leading online travel search engines in China, in 2008. In 2009, approximately 68% of our room nights were sold to members of HanTing Club, our loyalty program.
 
Our operation commenced with mid-scale limited service hotels and commercial property development and management in 2005. We began migrating to our current business of operating and managing a multiple-product economy hotel chain in 2007. Our total revenues grew from RMB249.4 million in 2007 to RMB1,333.9 million in 2009. We incurred net losses attributable to our company of RMB111.6 million and RMB136.2 million in 2007 and 2008, respectively. We had net income attributable to our company of RMB42.5 million in 2009.
 
Factors Affecting Our Results of Operations
 
              General factors affecting our results of operations
 
Our results of operations are subject to general economic conditions and conditions affecting the lodging industry in general, which include, among others:
 
  •     Changes in the national, regional or local economic conditions in China.  Our financial performance depends upon the demand for our products, which is closely linked to the general economy and sensitive to business and individual discretionary spending levels in China. While the lodging industry in China has benefited from the significant growth experienced by the PRC economy in recent years, the recent global financial crisis and economic slowdown in 2008 and 2009 have negatively affected business and consumer confidence and contributed to slowdowns


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  in most industries, including the lodging industry. Despite signs of recoveries, there remain uncertainties regarding the general economic conditions and demand for our products. Our costs and expenses may also be affected by China’s inflation level. We may not be able to pass on the increased costs to our customers. Other macro-economic factors beyond our control may also affect our results of operations. For example, any prolonged recurrence of contagious diseases, social instability or significant natural disasters may have a negative impact on the demand for our products.
 
  •     PRC government policies and regulations.  Our future business and results of operations could be significantly affected by PRC government policies and regulations, particularly those that relate to zoning and licensing.
 
China is undergoing a rapid urbanization process, and zoning requirements and other governmental mandates with respect to urban planning of a particular area may change from time to time. When there is a change in zoning requirements or other governmental mandates with respect to the areas where our hotels are located, the affected hotels may need to be demolished or removed. While we may be reimbursed for such demolition and relocation, the reimbursement, as determined by the relevant government authorities, may not be sufficient to cover our direct and indirect losses. See “Risk Factors — Risks Related to Doing Business in China — Rapid urbanization and changes in zoning and urban planning in China may cause our leased properties to be demolished, removed or otherwise affected.”
 
Our business is also subject to various compliance and operational requirements under PRC laws. In particular, each of our hotels is required to obtain a special industry license issued by the local public security bureau, and to comply with license requirements and laws and regulations with respect to construction permit, fire prevention, public area hygiene, food hygiene, public safety and environmental protection. Any changes to the existing laws and regulations in the future may increase our compliance efforts at significant cost. See “Regulation — Regulations on Hotel Operation.”
 
  •     Competition.  The lodging industry in China is highly competitive. We compete primarily with other economy hotel chains as well as various local lodging facilities. Competition among economy hotels in China is primarily based on location, room rates, brand recognition, the quality of the accommodations and service levels.
 
  •     Access to capital.  The lodging industry is a capital intensive business that requires significant amounts of capital expenditures to develop, maintain and improve hotel properties. Access to the capital that we or our franchisees need to finance the development of new hotels or to maintain and improve existing hotels is critical to the continued growth of our business.
 
  •     Seasonality and special events.  The lodging industry is subject to fluctuations in revenues due to seasonality. Generally, the first quarter, in which both the New Year and Spring Festival holidays fall, accounts for a lower percentage of our annual revenues than other quarters of the year. In addition, certain special events, such as the China Import and Export Fair held twice a year in Guangzhou and the upcoming World Expo in Shanghai in 2010, may increase the demand for our hotels as such special events may attract travelers into and within the regions in China where we operate hotels.
 
              Specific factors affecting our results of operations
 
While our business is affected by factors relating to general economic conditions and the lodging industry in China, we believe that our results of operations are also affected by company-specific factors, including, among others:
 
  •     The total number of hotels and hotel rooms in our hotel network.  Our revenues largely depend on the size of our hotel network. Furthermore, we believe the expanded geographic coverage of our hotel network will enhance our brand recognition. Whether we can successfully increase the


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  number of hotels and hotel rooms in our hotel chain is largely affected by our ability to effectively identify and lease or franchise additional hotel properties at desirable locations on commercially favorable terms and the availability of funding to make necessary capital investments to open these new hotels.
 
  •     The fixed-cost nature of our business.  A significant portion of our operating costs and expenses, including rent and base salary, is relatively fixed. As a result, an increase in our revenues achieved through higher RevPAR generally will result in higher profitability. Vice versa, a decrease in our revenues could result in a disproportionately larger decrease in our earnings because our operating costs and expenses are unlikely to decrease proportionately.
 
  •     The mix of leased-and-operated hotels and franchised-and-managed hotels in our hotel portfolio.  The mix of leased-and-operated hotels and franchised-and-managed hotels in our hotel portfolio affects our results of operations in a given period. Our leased-and-operated hotels have been and will continue to be the main contributor to our revenues. Under the lease-and-operate model, while each hotel incurs certain upfront development costs and pre-opening expenses, we generally expect more revenues and profit contribution once a hotel’s operations mature. Under the franchise-and-manage model, we generate revenues from fees we charge to each franchised-and-managed hotel while a franchisee bears substantially all the capital expenditures, pre-opening and operational expenses. As such, our franchise-and-manage model enables us to quickly expand our network through franchisees without incurring significant capital expenditures or expenses. We intend to increase the percentage of franchised-and-managed hotels in our hotel portfolio to expand our geographic presence and diversify our revenue mix.
 
  •     The proportion of mature hotels in our leased-and-operated hotel portfolio.  Generally, the operation of each leased-and-operated hotel goes through three stages: development, ramp-up and mature operations. During the development stage, leased-and-operated hotels generally incur pre-opening expenses ranging from approximately RMB1.0 to RMB2.0 million per hotel. During the ramp-up stage, when the occupancy rate is relatively low, revenues generated by these hotels may be insufficient to cover their operating costs, which are relatively fixed in nature. The pre-opening expenses incurred during the development stage and the lower profitability during the ramp-up stage for leased-and-operated hotels may have a significant negative impact on our financial performance. It typically takes our hotels three to six months to ramp up, which may be affected by factors such as seasonality and location. We define mature leased-and-operated hotels as those that have been in operation for more than six months.
 
As a result of our rapid expansion, a significant number of our leased-and-operated hotels were in the development and ramp-up stages in 2007 and 2008. The table below illustrates the openings of our leased-and-operated hotels in 2007, 2008 and 2009.
 
                         
    2007     2008     2009  
 
Leased-and-operated Hotels
                       
Number of hotels as of January 1,
    24       62       145  
Number of newly-opened hotels within the year
    38       83       28  
Newly-opened hotels within the year as a percentage of hotels as of January 1,
    158 %     134 %     19 %
 
We track the performance of our leased-and-operated hotels by comparing hotel income (loss), which is the difference between net revenues and hotel operating costs, of our new hotels and mature hotels. Calculated on a monthly rolling basis, taking into account the total number of new and mature hotels in any particular month, hotel loss directly attributable to new leased-and-operated hotels was RMB16 million, RMB27 million and RMB21 million in 2007, 2008 and 2009, respectively, while hotel income directly attributable to mature leased-and-operated hotels


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was RMB22 million, RMB94 million and RMB238 million in 2007, 2008 and 2009, respectively, as illustrated in the table below.
 
                         
    Year Ended
 
    December 31,  
    2007     2008     2009  
    (RMB in millions, except RevPAR and percentages)  
 
Mature Leased-and-operated Hotels
                       
RevPAR (in RMB)
      147       171       169  
Net Revenues
    174       491       1,080  
Hotel Operating Costs
    151       398       841  
Hotel Income Directly Attributable to Mature Leased-and-operated Hotels
    22       94       238  
Hotel Income as a Percentage of Net Revenues
    13 %     19 %     22 %
New Leased-and-operated Hotels
                       
RevPAR (in RMB)
    112       116       124  
Net Revenues
    61       262       138  
Hotel Operating Costs
    77       288       159  
Hotel Loss Directly Attributable to New Leased-and-operated Hotels
    (16 )     (27 )     (21 )
Hotel Loss as a Percentage of Net Revenues
    (26 )%     (10 )%     (15 )%
 
We plan to continue to expand our leased-and-operated hotel portfolio. However, we expect the proportion of mature leased-and-operated hotels in our hotel network to increase due to the enlarged base of mature leased-and-operated hotels, which we believe will have a positive effect on our results of operations.
 
Key Performance Indicators
 
We utilize a set of non-financial and financial key performance indicators which our senior management reviews frequently. The review of these indicators facilitates timely evaluation of the performance of our business and effective communication of results and key decisions, allowing our business to react promptly to changing customer demands and market conditions.
 
Our non-financial key performance indicators consist of the increase in the total number of hotels and hotel rooms in our hotel chain as well as RevPAR achieved by our leased-and-operated hotels. RevPAR is a commonly used operating measure in the lodging industry and is defined as the product of average occupancy rates and average daily rates achieved. Occupancy rates of our hotels mainly depend on the locations of our hotels, product and service offering, the effectiveness of our sales and brand promotion efforts, our ability to effectively manage hotel reservations, the performance of managerial and other employees of our hotels, as well as our ability to respond to competitive pressure. We set the room rates of our hotels primarily based on the location of a hotel, room rates charged by our competitors within the same locality, and our relative brand and product strength in the city or city cluster.
 
Our financial key performance indicators consist of our revenues, costs and expenses, which are discussed in greater details in the following paragraphs. In addition, we use earnings before interest expense, tax expense (benefit) and depreciation and amortization, or EBITDA, a non-GAAP financial measure, as a key financial performance indicator to assess our results of operations before the impact of investing and financing transactions and income taxes. Given the significant investments that we have made in leasehold improvements, depreciation and amortization expense comprises a significant portion of our cost structure. We believe that EBITDA is widely used by other companies in the lodging industry and may be used by investors as a measure of our financial performance. We also use EBITDA from Operating Hotels, another non-GAAP measure, which is defined as EBITDA before pre-opening expenses, to assess operating results of the hotels in operation. We believe that the exclusion of pre-opening expenses, a portion of which is non-cash rental expenses, helps facilitate period-on-period comparison of our results of operations as the number of hotels in


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the development stage may vary significantly from year to year. See “ — Results of Operations” for a reconciliation of EBITDA and EBITDA from Operating Hotels to net income (loss).
 
Revenues.  We primarily derive our revenues from operations of our leased-and-operated hotels and franchise and service fees from our franchised-and-managed hotels. Our revenues are subject to a business tax of 5% and other related taxes. The following table sets forth the revenues generated by our leased-and-operated hotels and franchised-and-managed hotels, both in absolute amount and as a percentage of total revenues for the periods indicated.
 
                                                         
    Year Ended December 31,  
    2007     2008     2009  
    (RMB)     %     (RMB)     %     (RMB)     (US$)     %  
    (in thousands except percentages)  
 
Revenues:
                                                       
Leased-and-operated hotels
    248,199       99.5       797,815       98.5       1,288,898       188,825       96.6  
Franchised-and-managed hotels
    1,210       0.5       12,039       1.5       44,965       6,587       3.4  
                                                         
Total revenues
    249,409       100.0       809,854       100.0       1,333,863       195,412       100.0  
Less: Business tax and related taxes
    (14,103 )     (5.7 )     (45,605 )     (5.6 )     (73,672 )     (10,793 )     (5.5 )
                                                         
Net revenues
    235,306       94.3       764,249       94.4       1,260,191       184,619       94.5  
                                                         
 
  •     Leased-and-operated Hotels.  In 2008, we generated revenues of RMB797.8 million from our leased-and-operated hotels, which accounted for 98.5% of our total revenues for the year. In 2009, we generated revenues of RMB1,288.9 million from our leased-and-operated hotels, which accounted for 96.6% of our total revenues for the year. We expect that revenues from our leased-and-operated hotels will continue to constitute a substantial majority of our total revenues in the foreseeable future. As of December 31, 2009, we had 21 leased-and-operated hotels under development.
 
For our leased-and-operated hotels, we lease properties from real estate owners or lessors and we are responsible for hotel development and customization to conform to our standards, as well as for repairs and maintenance and operating costs and expenses of properties over the term of the lease. We are also responsible for all aspects of hotel operations and management, including hiring, training and supervising the hotel managers and employees required to operate our hotels and purchasing supplies. Our typical lease term ranges from ten to 20 years. We typically enjoy an initial three- to six-month rent-free period. We generally pay fixed rent on a monthly or quarterly basis for the first three or five years of the lease term, after which we are generally subject to a 3% to 5% increase every three to five years.
 
Our revenues generated from leased-and-operated hotels are significantly affected by the following operating measures:
 
  •     the total number of leased-and-operated hotels in our hotel chain;
 
  •     the total number of leased-and-operated hotel rooms in our hotel chain; and
 
  •     RevPAR achieved by our leased-and-operated hotels, which represents the product of average daily rates and occupancy rates.
 
The future growth of revenues generated from our leased-and-operated hotels will depend significantly upon our ability to expand our hotel chain into new locations in China and maintain and further increase occupancy rates and average daily rates at existing hotels. As of December 31, 2009, we had entered into binding contracts with lessors of 21 properties for our leased-and-operated hotels which are currently under development. We intend to fund this planned expansion with our operating cash flow and our cash balance.


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  •     Franchised-and-managed Hotels.  In 2008, we generated revenues of RMB12.0 million from our franchised-and-managed hotels, which accounted for 1.5% of our total revenues for the year. In 2009, we generated revenues of RMB45.0 million from our franchised-and-managed hotels, which accounted for 3.4% of our total revenues for the year. We expect that revenues from our franchised-and-managed hotels will increase in the foreseeable future as we add more franchised-and-managed hotels in our hotel chain. We also expect the number of our franchised-and-managed hotels as a percentage of the total number of hotels in our network to increase. As of December 31, 2009, we had 123 franchised-and-managed hotels under development.
 
We select franchisees who are property owners, existing hotel operators or hotel investors. We directly manage our franchised-and-managed hotels and impose the same standards for all franchised-and-managed hotels to ensure product quality and consistency across our hotel network. Management services we provide to our franchisees generally include hiring, appointing and training hotel managers, managing reservations, providing sales and marketing support, conducting quality assurance inspections and providing other operational support and information. Our franchisees are typically responsible for the costs of developing and operating the hotels, including renovating the hotels according to our standards, and all of the operating expenses. We believe our franchise-and-manage model has enabled us to quickly and effectively expand our geographical coverage and market share in a less capital-intensive manner through leveraging the local knowledge and relationships of our franchisees and the properties that they may own which are suitable for hotel business.
 
Our franchise-and-management agreements typically run for an initial term of eight years. We collect fees from our franchisees and do not bear loss, if any, incurred by our franchisees. Our franchisees are generally required to pay us a one-time franchise-and-management fee ranging between RMB100,000 and RMB300,000. They are also responsible for all costs and expenses related to hotel construction and refurbishing. In general, we charge a monthly franchise-and-management fee of approximately 5% of the total revenues generated by each franchised-and-managed hotel. Beginning in 2009, we launched an alternative performance-based fee scheme to provide franchisees with an additional choice. We also collect from franchisees a reservation fee on a per-room-night basis for using our central reservation system and a membership registration fee to service customers who join our HanTing Club loyalty program at the franchised-and-managed hotels. Furthermore, we employ and appoint hotel managers for the franchised-and-managed hotels and charge the franchisees a monthly fee for the service. Therefore, our revenues from franchised-and-managed hotels are primarily affected by the number and the revenues of franchised-and-managed hotels.


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Operating Costs and Expenses.  Our operating costs and expenses consist of costs for hotel operation, selling and marketing expenses, general and administrative expenses and pre-opening expenses. The following table sets forth the components of our operating costs and expenses, both in absolute amount and as a percentage of total revenues for the periods indicated.
 
                                                                                 
    Year Ended December 31,                    
    2007     2008     2009                    
    (RMB)     %     (RMB)     %     (RMB)     (US$)     %                    
    (in thousands except percentages)  
 
Total revenues
    249,409       100.0       809,854       100.0       1,333,863       195,412       100.0                          
Less: Business tax and related taxes
    (14,103 )     (5.7 )     (45,605 )     (5.6 )     (73,672 )     (10,793 )     (5.5 )                        
                                                                                 
Net revenues
    235,306       94.3       764,249       94.4       1,260,191       184,619       94.5                          
                                                                                 
Operating costs and expenses
                                                                               
Hotel operating costs:
                                                                               
Rents and utilities
    (112,787 )     (45.2 )     (322,809 )     (39.9 )     (508,579 )     (74,507 )     (38.1 )                        
Personnel costs
    (34,411 )     (13.8 )     (137,231 )     (16.9 )     (169,248 )     (24,795 )     (12.7 )                        
Depreciation and amortization
    (33,234 )     (13.3 )     (92,838 )     (11.5 )     (141,600 )     (20,744 )     (10.6 )                        
Consumables, food and beverage
    (35,597 )     (14.3 )     (82,662 )     (10.2 )     (119,056 )     (17,442 )     (8.9 )                        
Others
    (12,333 )     (5.0 )     (51,824 )     (6.4 )     (65,989 )     (9,668 )     (5.0 )                        
                                                                                 
Total hotel operating costs
    (228,362 )     (91.6 )     (687,364 )     (84.9 )     (1,004,472 )     (147,156 )     (75.3 )                        
Selling and marketing expenses
    (17,581 )     (7.0 )     (40,810 )     (5.0 )     (57,818 )     (8,470 )     (4.3 )                        
General and administrative expenses
    (65,653 )     (26.3 )     (81,665 )     (10.1 )     (83,666 )     (12,257 )     (6.3 )                        
Pre-opening expenses
    (61,020 )     (24.5 )     (108,062 )     (13.3 )     (37,821 )     (5,541 )     (2.8 )                        
                                                                                 
Total operating costs and expenses
    (372,616 )     (149.4 )     (917,901 )     (113.3 )     (1,183,777 )     (173,424 )     (88.7 )                        
                                                                                 
 
  •     Hotel operating costs.  Our hotel operating costs consist of costs and expenses directly attributable to the operation of our leased-and-operated and franchised-and-managed hotels. Leased-and-operated hotel operating costs primarily include rental payments and utility costs for hotel properties, compensation and benefits for our hotel-based employees, costs of hotel room consumable products and depreciation and amortization of leasehold improvements. Franchised-and-managed hotel operating costs primarily include compensation and benefits for franchised-and-managed hotel managers and other limited number of employees directly hired by us, which are recouped by us in the form of monthly service fees. We anticipate that our hotel operating costs will increase as we continue to open new hotels. However, we anticipate that our hotel operating costs as a percentage of our total revenues will decrease in general primarily due to (i) the enlarged base of relatively mature hotels in our leased-and-operated hotel portfolio and (ii) the relatively fixed nature of a significant portion of our operating costs and expenses.
 
  •     Selling and marketing expenses.  Our selling and marketing expenses consist primarily of commissions to travel intermediaries, expenses for marketing programs and materials, bank fees for processing bank card payments, and compensation and benefits for our sales and marketing personnel, including personnel at our centralized reservation center. We expect that our selling and marketing expenses will increase as our sales increase and as we further expand into new geographic locations and promote our brand.
 
  •     General and administrative expenses.  Our general and administrative expenses consist primarily of compensation and benefits for our corporate and regional office employees and other employees who are not sales and marketing or hotel-based employees, travel and communication expenses of our general and administrative staff, costs of third-party professional services, and office expenses for corporate and regional office. We expect that our general and administrative expenses will increase in the near term as we hire additional personnel and incur additional costs in connection with the expansion of our business and with being a public company, including costs of enhancing our internal controls.
 
  •     Pre-opening expenses.  Our pre-opening expenses consist primarily of rents, personnel cost, and other miscellaneous expenses incurred prior to the opening of a new leased-and-operated hotel.


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  Our pre-opening expenses are largely determined by the number of pre-opening hotels in the pipeline and the rental fees incurred during the development stage. Landlords typically offer a three- to six-months rent-free period at the beginning of the lease. Nevertheless, rental is booked during this period on a straight-line basis. Therefore, a portion of pre-opening expenses is non-cash rental expenses. The following table sets forth the components of our pre-opening expenses for the periods indicated.
 
                                 
    Year Ended December 31,  
    2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands)  
 
Rents
    41,515       77,764       29,907       4,381  
Personnel cost
    11,585       16,402       3,584       526  
Others
    7,920       13,896       4,330       634  
                                 
Total pre-opening expenses
    61,020       108,062       37,821       5,541  
                                 
 
Our hotel operating costs, selling and marketing expenses and general and administrative expenses include share-based compensation expenses. The following table sets forth the allocation of our share-based compensation expenses, both in absolute amount and as a percentage of total share-based compensation expenses, among the cost and expense items set forth below.
 
                                                         
    Year Ended December 31,  
    2007     2008     2009  
    (RMB)     (%)     (RMB)     (%)     (RMB)     (US$)     (%)  
    (in thousands except percentages)  
 
Hotel operating costs
    24       0.2       116       2.4       523       77       6.6  
Selling and marketing expenses
    107       0.7       178       3.7       465       67       5.8  
General and administrative expenses
    14,654       99.1       4,521       93.9       6,967       1,021       87.6  
                                                         
Total share-based compensation expenses
    14,785       100.0       4,815       100.0       7,955       1,165       100.0  
                                                         
 
We adopted our 2007 Global Share Plan and 2008 Global Share Plan in February and June 2007, respectively, expanded the 2008 Global Share Plan in October 2008, and adopted the 2009 Share Incentive Plan in September 2009. We have granted options to purchase 11,909,540, 1,948,370, 6,305,975 and 172,595 of our ordinary shares in 2007, 2008, 2009 and for the first two months of 2010, respectively. We recognized share-based compensation as compensation expenses in the statement of operations based on the fair value of equity awards on the date of the grant, with the compensation expenses recognized over the period in which the recipient is required to provide service to us in exchange for the equity award. The share-based compensation expenses have been categorized as either hotel operating costs, general and administrative expenses, or selling and marketing expenses, depending on the job functions of the grantees.
 
On June 20, 2007, we issued 7,840,001 ordinary shares and a detachable warrant for the purchase of up to 4,704,001 Series B preferred shares at US$1.27551 per share, or the founder warrant, to Winner Crown Holdings Limited, or Winner Crown, for a promissory note of RMB76,185,973. The promissory note was interest free, had a term of four months and was collateralized solely by the ordinary shares. We recorded the fair value of the founder warrant of RMB6,593,655 as a liability in the consolidated balance sheets on the grant date, as such warrant was convertible into mezzanine equity securities, and a corresponding compensation charge given that the founder warrant was not subject to forfeiture upon failure to pay the promissory note.
 
On August 14, 2007, pursuant to arrangements between us and certain external third-party consultants, we issued 387,634 ordinary shares for certain services received on that date and recorded share-based compensation of RMB1,934,527 which represented the fair value of the ordinary shares on August 14, 2007 at RMB4.99 per share.


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Taxation
 
We are incorporated in the Cayman Islands. Under the current law of the Cayman Islands, we are not subject to income or capital gains tax. In addition, dividend payments are not subject to withholding tax in the Cayman Islands.
 
China Lodging Holdings (HK) Limited is subject to a profit tax at the rate of 16.5% on assessable profit determined under relevant Hong Kong tax regulations. To date, China Lodging Holdings (HK) Limited has not been required to pay profit tax as it had no assessable profit.
 
Prior to January 1, 2008, our PRC operating entities were governed by the Income Tax Law of the PRC for Enterprises with Foreign Investment and Foreign Enterprises and the Provisional Regulations of the PRC on Enterprises Income Tax, or the old EIT Laws. Pursuant to the old EIT Laws, PRC enterprises were generally subject to the enterprise income tax at a statutory rate of 33% (30% state income tax plus 3% local income tax). On March 16, 2007, the National People’s Congress, the Chinese legislature, passed the Enterprise Income Tax Law, and on December 6, 2007, the PRC State Council issued the Implementation Regulations of the Enterprise Income Tax Law, both of which became effective on January 1, 2008. The Enterprise Income Tax Law and its Implementation Regulations, or the new EIT Law, applies a uniform 25% enterprise income tax rate to both foreign-invested enterprises and domestic enterprises.
 
The new EIT Law imposes a withholding tax of 10% on dividends distributed by a foreign-invested enterprise to its immediate holding company outside of China, if such immediate holding company is considered a “non-resident enterprise” without any establishment or place within China or if the received dividends have no connection with the establishment or place of such immediate holding company within China, unless such immediate holding company’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement. Holding companies in Hong Kong, for example, are subject to a 5% withholding tax rate. The Cayman Islands, where we are incorporated, does not have such a tax treaty with China. Thus, dividends paid to us by our subsidiaries in China may be subject to the 10% withholding tax if we are considered a “non-resident enterprise” under the new EIT Law. See “Risk Factors — Risks Related to Doing Business in China — It is unclear whether we will be considered as a PRC ‘resident enterprise’ under the new EIT Law, and depending on the determination of our PRC ‘resident enterprise’ status, dividends paid to us by our PRC subsidiaries may be subject to PRC withholding tax, we may be subject to 25% PRC income tax on our worldwide income, and holders of our ADSs or ordinary shares may be subject to PRC withholding tax on dividends paid by us and gains realized on their transfer of our ADSs or ordinary shares.”
 
Critical Accounting Policies
 
We prepare financial statements in accordance with accounting principles generally accepted in the United States, or U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect the reported amounts of our assets and liabilities and the disclosure of our contingent assets and liabilities at the end of each fiscal period and the reported amounts of revenues and expenses during each fiscal period. We continue to evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and assumptions that we believe to be reasonable, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.
 
The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing our financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.


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Revenue Recognition
 
Our revenues are primarily derived from operations of leased-and-operated hotels administrated under the “HanTing” brand name, including the rental of rooms and food and beverage sales. Revenues are recognized when rooms are occupied and food and beverages are sold.
 
Our revenues from franchised-and-managed hotels are derived from franchise-and-management agreements where the franchisees are required to pay (i) an initial one-time franchise-and-management fee and (ii) an ongoing franchise-and-management fee based on a percentage of revenues, which amounts to approximately 5.0% of the room revenues of the franchised hotels, or variable percentage of the room revenues in accordance with the performance level of the individual franchisee on a monthly and/or calendar-quarterly basis. The one-time franchise-and-management fee, which is non-refundable, is recognized when the franchised hotel opens for business, and we have fulfilled all our commitments and obligations, including assistance to the franchisees in property design, leasehold improvement construction project management, systems installation, personnel recruiting and training. Ongoing franchise-and-management fees are recognized when the underlying service revenues are recognized by the franchisees’ operations. Other revenues generated from franchise-and-management agreements include a central reservation system usage fee and a monthly system maintenance and support fee which are recognized when services are provided.
 
We account for certain reimbursements (primarily salaries and related charges) mainly related to the hotels under the franchise program as revenues. Reimbursement revenues are recognized when the underlying reimbursable costs are incurred.
 
Membership revenues are earned on a straight-line basis over the estimated membership term which is estimated to be approximately three to five years dependent upon membership level. Membership life is estimated at the time the membership card is sold based on management’s industry experience and data accumulated by our company, including usage frequency and actual attrition. These estimates are updated regularly to reflect actual membership retention.
 
Long-Lived Assets
 
We evaluate the carrying value of our long-lived assets for impairment by comparing the expected undiscounted future cash flows of the assets to the net book value of the assets if certain trigger events occur, such as receiving government zoning notification. Inherent in reviewing the carrying amounts of the long-lived assets is the use of various estimates. First, our management must determine the usage of the asset. Impairment of an asset is more likely to be recognized where and to the extent our management decides that such asset may be disposed of or sold. Assets must be tested at the lowest level, generally the individual hotel, for which identifiable cash flows exist. If the expected undiscounted future cash flows are less than the net book value of the assets, the excess of the net book value over the estimated fair value is charged to current earnings. Fair value is based upon discounted cash flows of the assets at a rate deemed reasonable for the type of asset and prevailing market conditions, appraisals and, if appropriate, current estimated net sales proceeds from pending offers. Future cash flow estimates are, by their nature, subjective and actual results may differ materially from our estimates. If our ongoing estimates of future cash flows are not met, we may have to record additional impairment charges in future accounting periods. Our estimates of cash flow are based on the current regulatory, social and economic climates where we conduct our operations as well as recent operating information and budgets for our business. These estimates could be negatively impacted by changes in laws and regulations, economic downturns, or other events affecting various forms of travel and access to our hotels.
 
Goodwill Impairment
 
Goodwill is required to be tested for impairment at least annually or more frequently if events or changes in circumstances indicate that these assets might be impaired. If we determine that the carrying value of our goodwill has been impaired, the carrying value will be written down.


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To assess potential impairment of goodwill, we perform an assessment of the carrying value of each individual hotel at least on an annual basis or when events and changes in circumstances occur that would more likely than not reduce the fair value of each individual hotel below its carrying value. If the carrying value of an individual hotel exceeds its fair value, we would perform the second step in our assessment process and record an impairment loss to earnings to the extent the carrying amount of the individual hotel’s goodwill exceeds its implied fair value. We estimate the fair value of each individual hotel through internal analysis and external valuations, which utilize income and market valuation approaches through the application of capitalized earnings and discounted cash flow. These valuation techniques are based on a number of estimates and assumptions, including the projected future operating results of the individual hotel, appropriate discount rates and long-term growth rates. The significant assumptions regarding our future operating performance are revenue growth rates, discount rates and terminal values. If any of these assumptions changes, the estimated fair value of our individual hotel will change, which could affect the amount of goodwill impairment charges, if any. We have not recognized any impairment charge on goodwill for the periods presented. We are currently not aware of any impairment charge of the goodwill.
 
Customer Loyalty Program
 
HanTing Club is our customer loyalty program. Our members can earn points based on spending at our leased-and-operated and franchised-and-managed hotels and participating in certain marketing programs. Points can be redeemed for membership upgrades, room night awards and gifts within two years after the points are earned. Management determines the fair value of the future redemption obligation based on certain formulas which project the future point redemption behavior based on historical experience, including an estimate of points that will never be redeemed, and an estimate of the points that will eventually be redeemed as well as the cost to be incurred in conjunction with the point redemption. The actual expenditure may differ from the estimated liability recorded. Prior to February 28, 2009, we recorded estimated liabilities for all points earned by our customers as we did not have sufficient historical information to determine point forfeitures or breakage. Based on our accumulated knowledge on reward points redemption and expiration, we began to apply historical redemption rates in estimating the costs of points earned from March 1, 2009 onwards.
 
Income Taxes
 
The provision for income taxes has been determined using the asset and liability approach of accounting for income taxes. Under this approach, we recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and tax basis of assets and liabilities. A valuation allowance is required to reduce the carrying amounts of deferred tax assets if, based on the available evidence, it is more likely than not that such assets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed periodically based on a more-likely-than-not realization threshold. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carryforward periods, our experience with operating loss in the China economy hotel industry, tax planning strategy implemented and other tax planning alternatives. Prior to 2009, we had significant operating losses attributable to rapid expansion and related pre-opening costs incurred. As of December 31, 2007, 2008 and 2009, we had deferred tax assets generated from net loss carryforward before valuation allowance of RMB8.8 million, RMB61.1 million and RMB45.0 million, respectively. We expect many of our hotels that were put in operation in 2007, 2008 and 2009 will become mature and generate sufficient taxable profit to utilize the substantial portion of the net loss carryforward. If our operating results are less than currently projected and there is no objectively verifiable evidence to support the realization of our deferred tax asset, additional valuation allowance may be required to further reduce our deferred tax asset. The reduction of the deferred tax asset could increase our income tax expenses and have an adverse effect on our results of operations and tangible net worth in the period in which the allowance is recorded.
 
The provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the year. Our tax rate is based on expected income, statutory tax rates and tax


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planning opportunities available in the various jurisdictions in which we operate. For interim financial reporting, we estimate the annual tax rate based on projected taxable income for the full year and record a quarterly income tax provision in accordance with the anticipated annual rate. As the year progresses, we refine the estimates of the year’s taxable income as new information becomes available, including year-to-date financial results. This continual estimation process often results in a change to our expected effective tax rate for the year. When this occurs, we adjust the income tax provision during the quarter in which the change in estimate occurs so that the year-to-date provision reflects the expected annual tax rate. Significant judgment is required in determining our effective tax rate and in evaluating its tax positions.
 
We recognize a tax benefit associated with an uncertain tax position when, in our judgment, it is more likely than not that the position will be sustained upon examination by a taxing authority. For a tax position that meets the more-likely-than-not recognition threshold, we initially and subsequently measure the tax benefit as the largest amount that we judge to have a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority. Our liability associated with unrecognized tax benefits is adjusted periodically due to changing circumstances, such as the progress of tax audits, case law developments and new or emerging legislation. Such adjustments are recognized entirely in the period in which they are identified. Our effective tax rate includes the net impact of changes in the liability for unrecognized tax benefits and subsequent adjustments as considered appropriate by management. We classify interest and penalties recognized on the liability for unrecognized tax benefits as income tax expense.
 
Share-Based Compensation
 
We recognize share-based compensation in the statement of operations based on the fair value of equity awards on the date of the grant, with compensation expense recognized over the period in which the recipient is required to provide service to us in exchange for the equity award. The share-based compensation expenses have been categorized as either leased-and-operated hotel operating costs, general and administrative expenses or selling and marketing expenses, depending on the job functions of the grantees.
 
In determining the fair value of our ordinary shares in each of the grant date, we relied in part on valuation reports prepared by two independent valuers based on data we provided. These valuation reports provided us with guidelines in determining the fair value, but the determination was made by our management.
 
Determining the fair values of the ordinary shares requires making complex and subjective judgments regarding projected financial and operating results, our unique business risks, the liquidity of the ordinary shares and our operating history and prospects at the time of grant. Therefore, these fair values are inherently uncertain and highly subjective.
 
The assumptions used to derive the fair values of the ordinary shares include:
 
  •     no material changes in the existing political, legal, fiscal and economic conditions in China;
 
  •     no major changes in tax law in China or the tax rates applicable to our subsidiaries and consolidated affiliated entities in China;
 
  •     no material changes in the exchange rates and interest rates from the presently prevailing rates;
 
  •     availability of finance not a constraint on our future growth;
 
  •     our ability to retain competent management, key personnel and technical staff to support our ongoing operations; and
 
  •     no material deviation in market conditions from economic forecasts.
 
These assumptions are inherently uncertain. Different assumptions and judgments would affect our calculation of the fair value of the underlying ordinary shares for the options granted, and the valuation results and the amount of share-based compensation would also vary accordingly.


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The following table sets forth the options and ordinary shares issued to certain directors, officers and employees in 2009 and for the first two months of 2010:
 
                                                 
                    Midpoint of
       
            Purchase
  Fair Value of
  Estimated
       
    Ordinary
      Price/Exercise
  Ordinary
  Initial Public
  Intrinsic
  Type of
Grant Date   Shares   Options   Price   Shares   Offering Price   Value*   Valuation
 
January 1, 2009
    -       227,000     US$1.53   US$ 0.64     US$ 2.81       US$290,560     Retrospective
July 1, 2009
    -       110,000     US$1.53   US$ 1.36     US$ 2.81       US$140,800     Retrospective
August 3, 2009
    -       3,756,100     US$1.53   US$ 1.51     US$ 2.81       US$4,807,680     Retrospective
August 6, 2009
    1,982,509       -     US$1.80   US$ 1.51     US$ 2.81       US$2,002,334     Retrospective
October 1, 2009
    -       1,596,000     US$1.53   US$ 1.63     US$ 2.81       US$2,042,880     Retrospective
October 14, 2009
    -       16,875     US$1.53   US$ 1.63     US$ 2.81       US$21,600     Retrospective
November 20, 2009
    -       600,000     US$1.53   US$ 1.76     US$ 2.81       US$768,000     Retrospective
January 1, 2010
    -       118,000     US$1.53   US$ 2.23     US$ 2.81       US$151,040     Contemporaneous
February 5, 2010
    -       54,595     US$1.53   US$ 2.81     US$ 2.81       0     -**
 
 
*   Intrinsic value equals the difference between the midpoint of the estimated initial public offering price and the purchase price/exercise price of the ordinary shares/options, multiplied by the number of ordinary shares/options.
 
**  We used the midpoint of the estimated price range of this initial public offering as the fair value of our ordinary shares underlying the options granted on February 5, 2010 without separately performing a valuation in connection with these options as we believe the number of these options is insignificant.
 
Significant Factors, Assumptions, and Methodologies Used in Determining Fair Value
 
The procedures performed to determine the fair value of our ordinary shares were based on the income approach to estimate the aggregate equity value of our company at the relevant stock option grant dates. The market multiple approach was performed as well to substantiate the income approach result. We have used the option-pricing method to allocate the aggregate equity value to preferred and ordinary shares. This method involves making estimates of the anticipated timing of a potential liquidity event, such as a sale of our company or an initial public offering, and estimates of the volatility of our equity securities. The anticipated timing is based on the plans made by our board and management.
 
The income approach involves applying appropriate discount rates to estimate debt-free cash flows that are derived from forecasts of revenues and costs. The projections used for each valuation date were made based upon the expected outlook on our operating performance through the forecast periods. The assumptions underlying the estimates were consistent with our business plan.
 
Specifically, the future debt-free cash flows were determined by subtracting taxes, future capital spending and future changes in working capital from, and adding future depreciation and amortization to, EBIT. EBIT represents income (loss) plus interest expense and income tax provision, less interest income. The terminal or residual value at the end of the projection period was based on Gordon Growth Model with terminal growth rate assuming to be 3% for all the valuation dates. The resulting terminal value and interim debt-free cash flows were then discounted at a rate ranging from 13% to 15% for the respective valuation dates which was based on the weighted average cost of capital of comparable companies, as adjusted for the specific risk profile of our company. There is inherent uncertainty in these estimates. If different discount rates had been used, the valuations would have been different.
 
The market multiple approach was based on appropriate multiples, such as EV/EBITDA, at the valuation dates, and multiplying the relevant financial indicators to be representative of the performance of our company. The market multiples were obtained through the market comparison method, where several companies with their stock traded in the public market were selected for comparison purposes and used as a basis for choosing reasonable market multiples for our company.
 
On May 22, 2009 and August 6, 2009, we issued 3,375,635 and 783,734 ordinary shares, respectively, at a price of US$1.80 per share to certain third-party investors. We also issued 1,982,509 ordinary shares to


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Winner Crown at a price of US$1.80 per share on August 6, 2009. Winner Crown is a company wholly owned by Sherman Holdings Limited, a Bahamas company, which is in turn wholly owned by Credit Suisse Trust Limited, or CS Trustee. CS Trustee acts as trustee of the Ji Family Trust, of which Mr. Qi Ji, our founder and executive chairman, and his family members, are the beneficiaries. In late 2008, in response to the global financial crisis, we decided to raise financing to help strengthen our cash position and execute our strategic plans in 2009. On January 10, 2009, our board decided that the new issuance price should be US$1.80, a premium to US$1.53, the price of the preferred shares we issued in 2008. After the price was fixed, we closed the transaction in two separate tranches in May and August 2009. The price of US$1.80 per share was not set based on an income or market multiple approach. Instead, the price was set to alleviate the potential dilutive impact on our existing investors. In addition, the shares were not offered to a wide group of potential investors. Approximately 32% of the shares were purchased directly by a company controlled by Mr. Qi Ji with the rest purchased by his friends who, with a strong commitment to our company’s performance, believed that the long term growth prospect of our company warranted a premium to the price of our preferred shares. In addition, the number of the ordinary shares issued represented less than 3% of our total shares outstanding on a fully diluted basis at the time of their respective issuances. Lastly, we evaluated our implied equity value and our financial performance as of January 10, 2009, and the actual issuance dates in May and August 2009 against those of our most closely comparable competitor, which is a public company listed in the U.S., and concluded that the implied equity value for our company, based on US$1.80 per ordinary share, would be significantly higher than what an open market would accept at the respective time. Therefore, we concluded that the transaction price of US$1.80 per share did not reflect the fair value of our ordinary shares on the relevant issuance dates.
 
For the purpose of determining the estimated fair value of our share options, we believe expected volatility and estimated share price of our ordinary shares are the most sensitive assumptions since we were a privately held company at the date we granted our options. Changes in the volatility assumption and the estimated share price of our ordinary shares could significantly impact the estimated fair values of the options calculated by the binomial option pricing model. Expected volatility is estimated based upon the average stock price volatility of the comparable companies listed above over a period commensurate with the expected term of the options. When estimating expected volatility of the share price of a nonpublic entity, historical volatility of an “appropriate industry sector index” should be considered. As there is no sector index for the hotel business in the stock exchanges in the United States, the market where the company is applying for a listing, the pool of selected companies, with significant amount of their revenues obtained from the hotel business, is considered as a proxy for the industry sector and average volatility of the pool was used in the valuations. We believe that the average share price volatility of the guideline companies is a reasonable benchmark in estimating the expected volatility of our ordinary shares.
 
Determining the value of our share-based compensation expense in future periods requires the input of highly subjective assumptions, including estimated forfeitures and the price volatility of the underlying shares. We estimate our forfeitures of our shares based on past employee retention rates and our expectations of future retention rates, and we will prospectively revise our forfeiture rates based on actual history. Our share compensation charges may change based on changes to our actual forfeitures. Our actual share-based compensation expenses may be materially different from our current expectations.
 
Significant Factors Contributing to the Difference between Fair Value as of the Date of Each Grant
 
The increase in the fair value of our ordinary shares from US$0.64 per share as of January 1, 2009 to US$1.36 per share as of July 1, 2009 was attributable to the following significant factors and events:
 
  •     The prospect for the global economy became more optimistic and China’s economy showed robust growth since the second quarter of 2009. This was evidenced by a number of indicators, including a 14.9% annualized quarter-over-quarter gross domestic product, or GDP growth from the first quarter of 2009, according to a report issued by the People’s Bank of China on July 28, 2009, the expansion of the Purchasing Managers’ Index (PMI) and a significant increase in banking loans and investments.


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  •     We increased the number of our hotels in operation from 167 hotels as of January 1, 2009 to 200 hotels as of June 30, 2009. For the first time in our history, we were able to generate a quarterly profit. We generated a net income attributable to our company of RMB27.9 million in the three months ended June 30, 2009. We generated an operating cash in flow of RMB101.4 million for the six months ended June 30, 2009 compared to an operating cash outflow of RMB30.1 million for the six months ended June 30, 2008. The improved operating performance in the second quarter as well as the first half of 2009 contributed to the increase in our projections used in the July 2009 valuation.
 
  •     The improved profitability, among others, led us to increase the probability of an initial public offering in calculating the fair value of the ordinary shares from January 1, 2009 to June 30, 2009. In addition, we decreased the discount for lack of marketability from 25% as of January 1, 2009 to 19% as of June 30, 2009 given the increased likelihood of and proximity to an initial public offering.
 
  •     As a result of the above, inclusive of our ability to achieve or exceed our business plan, we decreased the overall discount rate by 1% from 14% as of January 1, 2009 to 13% as of June 30, 2009.
 
The fair value of our ordinary shares increased from US$1.36 per share as of July 1, 2009 to US$1.51 per share as of August 3, 2009, to US$1.63 per share as of October 1, 2009 and to US$1.76 as of November 20, 2009. Starting from July 2009, we started the preparation work for our initial public offering. As a result, we gradually increased the probability of our initial public offering in calculating the fair value of our ordinary shares. In addition, we further decreased the discount for lack of marketability given the increased likelihood of the proximity to our initial public offering.
 
The increase in the fair value of our ordinary shares from US$1.76 per share as of November 20, 2009 to US$2.23 per share as of January 1, 2010 was primarily attributable to the following significant factors and events:
 
  •     China’s economy continued to show robust growth during this period, which was evidenced by a number of indicators, including accelerating annualized quarter-over-quarter GDP growth in the last quarter of 2009 and the improving export figures.
 
  •     We have been able to successfully carry out our expansion plan by operating 20 more hotels in the three months ended December 31, 2009 as compared to the three months ended September 30, 2009.
 
  •     The cash flow generated from our operating activities during the six months ended December 31, 2009 has enabled us to accelerate our hotel expansion plan for 2010.
 
  •     We generated net income attributable to our company of RMB42.1 million for the six months ended December 31, 2009, exceeding the forecast we used to determine the fair value of our ordinary shares as of November 20, 2009. The improvement in profitability, among other things, led us to increase the projected total number of our new hotels.
 
  •     We increased the probability of our initial public offering and decreased the discount for lack of marketability in calculating the fair value of our ordinary shares given the progress we have achieved in the public offering preparation process.
 
The estimated offering price is US$11.25 per ADS (equivalent to US$2.81 per ordinary share), based on the mid-point of the estimated offering range. Factors contributing to an increase in the fair value of our


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ordinary shares from the appraised value of US$2.23 per share on January 1, 2010 to the estimated offering price of our ADSs include the following:
 
  •     the liquidity of our ordinary shares will increase following the consummation of this offering and the listing of our ADSs on the NASDAQ Global Market; and
 
  •     Ctrip.com International, Ltd., or Ctrip, one of the largest online travel services providers in China, has entered into an agreement with us to purchase certain of our shares at the initial public offering price, subject to the completion of this offering.
 
Selected Operating Data
 
The following table presents certain selected operating data of our company as of and for the dates and periods indicated. Our revenues have been and will continue to be significantly affected by these operating measures which are widely used in the lodging industry.
 
                         
    As of December 31,
    2007   2008   2009
 
Selected Operating Data:
                       
Total hotels in operation
    67       167       236  
Leased-and-operated hotels
    62       145       173  
Franchised-and-managed hotels
    5       22       63  
Total hotel rooms in operation
    8,089       21,033       28,360  
Leased-and-operated hotels
    7,583       18,414       21,658  
Franchised-and-managed hotels
    506       2,619       6,702  
Number of cities
    23       35       39  
 
                         
    Year Ended December 31,
    2007   2008   2009
 
Occupancy rate (as a percentage)
                       
Leased-and-operated hotels
    85       89       94  
Franchised-and-managed hotels
    82       74       91  
Total hotels in operation
    85       87       94  
Average daily room rate (in RMB)
                       
Leased-and-operated hotels
    181       178       174  
Franchised-and-managed hotels
    176       180       172  
Total hotels in operation
    181       178       174  
RevPAR (in RMB)
                       
Leased-and-operated hotels
    154       158       165  
Franchised-and-managed hotels
    145       132       156  
Total hotels in operation
    154       156       163  


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Results of Operations
 
The following table sets forth a summary of our consolidated results of operations, both in absolute amount and as a percentage of total revenues for the periods indicated. This information should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. We have grown rapidly since we began migrating to our current business of operating and managing a multiple-product economy hotel chain in 2007. Our limited operating history makes it difficult to predict our future operating results. We believe that the year-to-year comparison of operating results should not be relied upon as being indicative of future performance.
 
                                                         
    For the Year Ended December 31,  
    2007     2008     2009  
    RMB     %     RMB     %     (RMB)     (US$)     %  
Consolidated Statement of Operations Data:   (in thousands except percentages)  
 
Revenues:
                                                       
Leased-and-operated hotels
    248,199       99.5       797,815       98.5       1,288,898       188,825       96.6  
Franchised-and-managed hotels
    1,210       0.5       12,039       1.5       44,965       6,587       3.4  
                                                         
Total revenues
    249,409       100.0       809,854       100.0       1,333,863       195,412       100.0  
                                                         
Less: Business tax and related taxes
    (14,103 )     (5.7 )     (45,605 )     (5.6 )     (73,672 )     (10,793 )     (5.5 )
                                                         
Net revenues
    235,306       94.3       764,249       94.4       1,260,191       184,619       94.5  
                                                         
Operating costs and expenses(1):
                                                       
Hotel operating costs
    (228,362 )     (91.6 )     (687,364 )     (84.9 )     (1,004,472 )     (147,156 )     (75.3 )
Selling and marketing expenses
    (17,581 )     (7.0 )     (40,810 )     (5.0 )     (57,818 )     (8,470 )     (4.3 )
General and administrative expenses
    (65,653 )     (26.3 )     (81,665 )     (10.2 )     (83,666 )     (12,257 )     (6.3 )
Pre-opening expenses
    (61,020 )     (24.5 )     (108,062 )     (13.3 )     (37,821 )     (5,541 )     (2.8 )
                                                         
Total operating costs and expenses
    372,616       149.4       917,901       113.4       1,183,777       173,424       88.7  
                                                         
Income (loss) from operations
    (137,310 )     (55.1 )     (153,652 )     (19.0 )     76,414       11,195       5.8  
Interest income
    1,219       0.5       3,786       0.5       1,871       274       0.1  
Interest expenses
    -       -       1,249       0.2       8,787       1,287       0.7  
Foreign exchange gain (loss)
    (145 )     (0.1 )     (13,884 )     (1.7 )     (60 )     (9 )     0.0  
Change in fair value of warrants
    5,235       2.2       8,536       1.1       -       -       -  
                                                         
Income (loss) before income taxes
    (131,001 )     (52.5 )     (156,463 )     (19.3 )     69,438       10,173       5.2  
Tax expense (benefit)
    (17,262 )     (6.9 )     (23,880 )     (2.9 )     17,990       2,636       1.3  
                                                         
Net income (loss)
    (113,739 )     (45.6 )     (132,583 )     (16.4 )     51,448       7,537       3.9  
Less: net income (loss) attributable to noncontrolling interest
    (2,116 )     (0.8 )     3,579       0.4       8,903       1,304       0.7  
                                                         
Net income (loss) attributable to China Lodging Group, Limited
    (111,623 )     (44.8 )     (136,162 )     (16.8 )     42,545       6,233       3.2  
                                                         
Deemed dividend on Series B convertible redeemable preferred shares
    (17,499 )     (7.0 )     -       -       -       -       -  
                                                         
Net income (loss) attributable to ordinary shareholders
    (129,122 )     (51.8 )     (136,162 )     (16.8 )     42,545       6,233       3.2  
                                                         
 
Note: (1)  Include share-based compensation expenses as follows:
 
                                 
    Year Ended December 31,  
    2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands)  
 
                                 
Share-based compensation expenses
      14,785         4,815       7,955       1,165  


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The following tables present certain unaudited financial data and selected operating data as of and for the years ended December 31, 2007, 2008 and 2009:
 
                                 
    For the Year Ended
 
    December 31,  
    2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands)  
 
Non-GAAP Financial Data
                               
EBITDA(1)
    (95,983 )     (67,957 )     214,893       31,482  
EBITDA from Operating Hotels(1)
    (34,963 )     40,105       252,714       37,023  
 
 
(1) We believe that EBITDA is a useful financial metric to assess our operating and financial performance before the impact of investing and financing transactions and income taxes. Given the significant investments that we have made in leasehold improvements, depreciation and amortization expense comprises a significant portion of our cost structure. In addition, we believe that EBITDA is widely used by other companies in the lodging industry and may be used by investors as a measure of our financial performance. We believe that EBITDA will provide investors with a useful tool for comparability between periods because it eliminates depreciation and amortization expense attributable to capital expenditures. We also use EBITDA from Operating Hotels, which is defined as EBITDA before pre-opening expenses, to assess operating results of the hotels in operation. We believe that the exclusion of pre-opening expenses, a portion of which is non-cash rental expenses, helps facilitate year-on-year comparison of our results of operations as the number of hotels in the development stage may vary significantly from year to year. Therefore, we believe EBITDA from Operating Hotels more closely reflects the performance capability of hotels currently in operation. Our calculation of EBITDA and EBITDA from Operating Hotels does not deduct interest income, which was RMB1.2 million, RMB3.8 million and RMB1.9 million in 2007, 2008, and 2009, respectively. The presentation of EBITDA and EBITDA from Operating Hotels should not be construed as an indication that our future results will be unaffected by other charges and gains we consider to be outside the ordinary course of our business.
 
The use of EBITDA and EBITDA from Operating Hotels has certain limitations. Depreciation and amortization expense for various long-term assets, income tax and interest expense have been and will be incurred and are not reflected in the presentation of EBITDA. Pre-opening expenses have been and will be incurred and are not reflected in the presentation of EBITDA from Operating Hotels. Each of these items should also be considered in the overall evaluation of our results. Additionally, EBITDA or EBITDA from Operating Hotels does not consider capital expenditures and other investing activities and should not be considered as a measure of our liquidity. We compensate for these limitations by providing the relevant disclosure of our depreciation and amortization, interest expense, income tax expense, pre-opening expenses, capital expenditures and other relevant items both in our reconciliations to the U.S. GAAP financial measures and in our consolidated financial statements, all of which should be considered when evaluating our performance.
 
The terms EBITDA and EBITDA from Operating Hotels are not defined under U.S. GAAP, and neither EBITDA nor EBITDA from Operating Hotels is a measure of net income, operating income, operating performance or liquidity presented in accordance with U.S. GAAP. When assessing our operating and financial performance, you should not consider this data in isolation or as a substitute for our net income, operating income or any other operating performance measure that is calculated in accordance with U.S. GAAP. In addition, our EBITDA or EBITDA from Operating Hotels may not be comparable to EBITDA or EBITDA from Operating Hotels or similarly titled measures utilized by other companies since such other companies may not calculate EBITDA or EBITDA from Operating Hotels in the same manner as we do.


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A reconciliation of EBITDA and EBITDA from Operating Hotels to net income (loss), which is the most directly comparable U.S. GAAP measure, is provided below:
 
                                 
    For the Year Ended December 31,  
    2007     2008     2009  
    (RMB)     (RMB)     (RMB)     (US$)  
    (in thousands)  
 
Net income (loss) attributable to our company
    (111,623 )     (136,162 )     42,545       6,233  
Interest expense
    -       1,249       8,787       1,287  
Tax expense (benefit)
    (17,262 )     (23,880 )     17,990       2,636  
Depreciation and amortization
    32,902       90,836       145,571       21,326  
                                 
EBITDA (Non-GAAP)
    (95,983 )     (67,957 )     214,893       31,482  
Pre-opening expenses
    61,020       108,062       37,821       5,541  
                                 
EBITDA from Operating Hotels (Non-GAAP)
    (34,963 )     40,105       252,714       37,023  
                                 
 
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
 
Revenues.  Our total revenues increased by 64.7% from RMB809.9 million in 2008 to RMB1,333.9 million in 2009.
 
  •     Leased-and-operated hotels.  Revenues from our leased-and-operated hotels increased by 61.6% from RMB797.8 million in 2008 to RMB1,288.9 million in 2009. This increase was primarily due to our continued expansion of leased-and-operated hotels from 145 hotels and 18,414 hotel rooms as of December 31, 2008 to 173 hotels and 21,658 hotel rooms as of December 31, 2009, and an increase in RevPAR. RevPAR for our leased-and-operated hotels increased from RMB158 in 2008 to RMB165 in 2009 due to an increase in occupancy rate of our leased-and-operated hotels from 89% in 2008 to 94% in 2009. The increase in this occupancy rate resulted primarily from the increased proportion of room nights in our mature leased-and-operated hotels, which have been in operation for more than six months, from 57% in 2008 to 85% in 2009. The average daily rate for our leased-and-operated hotels decreased from RMB178 in 2008 to RMB174 in 2009, primarily reflecting room rate decreases during the economic slowdown.
 
  •     Franchised-and-managed hotels.  Revenues from our franchised-and-managed hotels increased significantly from RMB12.0 million in 2008 to RMB45.0 million in 2009. This growth was primarily due to an increase in the number of franchised-and-managed hotels from 22 as of December 31, 2008 to 63 as of December 31, 2009, and an increase in RevPAR. RevPAR for our franchised-and-managed hotels increased from RMB132 in 2008 to RMB156 in 2009 driven by the increase in occupancy rate of our franchised-and-managed hotels from 74% in 2008 to 91% in 2009. The increase in this occupancy rate resulted primarily from the increased proportion of our franchised-and-managed hotels that are located in China’s economically more developed cities. The average daily rate for our franchised-and-managed hotels decreased from RMB180 in 2008 to RMB172 in 2009, primarily reflecting room rate decreases during the economic slowdown.
 
Operating Costs and Expenses.  Our total operating costs and expenses increased by 29% from RMB917.9 million in 2008 to RMB1,183.8 million in 2009. This increase resulted from increases in our hotel operating costs, selling and marketing expenses and general and administrative expenses, partially offset by a decrease in our pre-opening expenses.
 
  •     Hotel operating costs.  Our hotel operating costs increased by 46% from RMB687.4 million in 2008 to RMB1,004.5 million in 2009. This increase was primarily because of our substantial expansion of hotels from 167 hotels as of December 31, 2008 to 236 hotels as of December 31, 2009. Our hotel operating costs as a percentage of total revenues decreased from 84.9% in 2008 to 75.3% in 2009, primarily due to cost control of personnel costs, consumables, food and beverage and other hotel operating costs.


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  •     Selling and marketing expenses.  Our selling and marketing expenses increased by 42% from RMB40.8 million in 2008 to RMB57.8 million in 2009. This increase was primarily due to RMB9.5 million of additional expenses for marketing and promotional activities, RMB6.3 million of additional commissions to travel intermediaries, RMB5.7 million of additional compensation and benefits for our sales and marketing personnel, and RMB4.1 million of additional bank fees for processing bank card payments as we expanded our business. We recorded less expenses relating to our customer loyalty program in 2009 due to (i) an amendment to franchise-and-management agreements to discontinue reimbursing franchisees for free room nights provided in connection with point redemption; and (ii) the application of a point expiration rate in estimating the costs of our customer loyalty program. Our selling and marketing expenses as a percentage of total revenues decreased from 5.0% in 2008 to 4.3% in 2009.
 
  •     General and administrative expenses.  Our general and administrative expenses increased slightly from RMB81.7 million in 2008 to RMB83.7 million in 2009, primarily as a result of an increase in personnel costs, an increase in provision for contingent liabilities, and an increase in share-based compensation expenses, partially offset by a decrease of RMB9.2 million in professional service fees. Our general and administrative expenses as a percentage of total revenues decreased from 10.2% in 2008 to 6.3% in 2009.
 
  •     Pre-opening expenses.  Our pre-opening expenses decreased from RMB108.1 million in 2008 to RMB37.8 million in 2009, primarily due to a decrease in the number of newly opened leased-and-operated hotels from 83 in 2008 to 28 in 2009 in an effort to balance growth and profitability during the global economic downturn. Our pre-opening expenses as a percentage of total revenues decreased from 13.3% in 2008 to 2.8% in 2009.
 
Income (Loss) from Operations.  As a result of the foregoing, we had income from operations of RMB76.4 million in 2009 compared to a loss from operations of RMB153.7 million in 2008.
 
Interest Income (Expense), Net.  Our net interest expense was RMB6.9 million in 2009. Our interest income was RMB1.9 million in 2009, and our interest expense on our bank loans outstanding was RMB10.4 million, RMB1.6 million of which was capitalized in connection with leasehold improvements. We had net interest income of RMB2.5 million in 2008. Our interest income was RMB3.8 million in 2008, primarily on the proceeds from our Series B preferred shares, and our interest expense on our bank loans outstanding was RMB7.6 million, RMB6.3 million of which was capitalized in connection with leasehold improvements.
 
Foreign Exchange Gain (Loss).  Our foreign exchange loss decreased to RMB59,677 in 2009 from RMB13.9 million in 2008. The foreign exchange losses in 2009 and 2008 were primarily due to the devaluation against RMB of certain foreign currencies in which a portion of our cash was denominated.
 
Change of Fair Value of Warrants.  In relation to the outstanding warrants issued to purchase Series B preferred shares, we recorded mark-to-market fair value changes of RMB8.5 million and nil in 2008 and 2009, respectively. There was no outstanding warrant in 2008 and 2009.
 
Tax Expense (Benefit).  We had tax expenses of RMB18.0 million in 2009 compared to tax benefits of RMB23.9 million in 2008, which was primarily due to the fact that we generated operating income in 2009 compared to an operating loss in 2008. Our effective tax rate increased from 15.3% in 2008 to 25.9% in 2009, primarily due to an increase of RMB10.8 million in the valuation allowance for deferred tax assets in 2008 compared to a decrease of RMB1.6 million in such allowance in 2009.
 
Net Income Attributable to Noncontrolling Interest.  Net income attributable to noncontrolling interest represents joint venture partners’ share of our net income based on their equity interest in the leased-and-operated hotels owned by the joint ventures. Net income attributable to noncontrolling interest increased from RMB3.6 million in 2008 to RMB8.9 million in 2009, primarily due to increased profit from the joint ventures as the jointly owned hotels became mature.


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Net Income (Loss) Attributable to China Lodging Group, Limited.  As a result of the foregoing, we had net income attributable to China Lodging Group, Limited of RMB42.5 million in 2009 compared to net loss attributable to China Lodging Group, Limited of RMB136.2 million incurred in 2008.
 
EBITDA and EBITDA from Operating Hotels.  EBITDA (non-GAAP) was RMB214.9 million in 2009, compared with negative EBITDA of RMB68.0 million in 2008. This change was primarily due to (i) a net loss of RMB136.2 million in 2008 compared with net income of RMB42.5 million in 2009, (ii) an increase in depreciation and amortization from RMB90.8 million in 2008 to RMB145.6 million in 2009 primarily because of our substantial expansion of hotels from 167 hotels as of December 31, 2008 to 236 hotels as of December 31, 2009, and (iii) a decrease in pre-opening expenses from RMB108.1 million in 2008 to RMB37.8 million in 2009 as a result of a decrease in the number of newly-opened leased-and-operated hotels from 83 in 2008 to 28 in 2009 in an effort to balance growth and profitability during the global economic downturn. Excluding pre-opening expenses, EBITDA from Operating Hotels (non-GAAP) increased significantly from RMB40.1 million in 2008 to RMB252.7 million in 2009.
 
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
 
Revenues.  Our total revenues substantially increased from RMB249.4 million in 2007 to RMB809.9 million in 2008.
 
  •     Leased-and-operated hotels.  Revenues from our leased-and-operated hotels more than tripled from RMB248.2 million in 2007 to RMB797.8 million in 2008. This increase was primarily due to our substantial expansion of leased-and-operated hotels from 62 hotels and 7,583 hotel rooms, as of December 31, 2007 to 145 hotels and 18,414 hotel rooms as of December 31, 2008, and the increased proportion of mature leased-and-operated hotels, which have been in operation for more than six months, in our portfolio and an increase in RevPAR. RevPAR for our leased-and-operated hotels increased from RMB154 in 2007 to RMB158 in 2008 due to an increase in occupancy rate of our leased-and-operated hotels from 85% in 2007 to 89% in 2008. The average daily rate for our leased-and-operated hotels decreased from RMB181 in 2007 to RMB178 in 2008, primarily as a result of the decreased proportion of our leased-and-operated hotels that are located in China’s economically more developed cities.
 
  •     Franchised-and-managed hotels.  Revenues from our franchised-and-managed hotels substantially increased from RMB1.2 million in 2007 to RMB12.0 million in 2008. This growth was primarily due to our substantial expansion of franchised-and-managed hotels from five hotels as of December 31, 2007 to 22 hotels as of December 31, 2008, partially offset by a decrease in RevPAR for our franchised-and-managed hotels from RMB145 in 2007 to RMB132 in 2008.
 
Operating Costs and Expenses.  Our total operating costs and expenses increased from RMB372.6 million in 2007 to RMB917.9 million in 2008. This increase primarily resulted from the overall growth in our business.
 
  •     Hotel operating costs.  Our hotel operating costs increased from RMB228.4 million in 2007 to RMB687.4 million in 2008. This increase was primarily because of our substantial expansion from 67 hotels as of December 31, 2007 to 167 hotels as of December 31, 2008. Our hotel operating costs as a percentage of total revenues decreased from 91.6% in 2007 to 84.9% in 2008.
 
  •     Selling and marketing expenses.  Our selling and marketing expenses increased from RMB17.6 million in 2007 to RMB40.8 million in 2008, primarily due to RMB6.6 million of additional expenses for marketing and promotional activities, RMB5.0 million of additional bank fees for processing bank card payments, RMB4.2 million of additional personnel costs as we expanded our business and RMB2.3 million of additional commissions to travel intermediaries. Our selling and marketing expenses as a percentage of total revenues decreased from 7.0% in 2007 to 5.0% in 2008.


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  •     General and administrative expenses.  Our general and administrative expenses increased from RMB65.7 million in 2007 to RMB81.7 million in 2008. This increase was primarily due to an increase of RMB5.3 million in professional service fees and an increase of RMB5.2 million in travelling and other expenses as a result of wider geographic coverage and an increased number of hotels in our portfolio, partially offset by a decrease of RMB10.1 million in related share-based compensation expenses. Our general and administrative expenses as a percentage of total revenues decreased from 26.3% in 2007 to 10.2% in 2008.
 
  •     Pre-opening expenses.  Our pre-opening expenses increased from RMB61.0 million in 2007 to RMB108.1 million in 2008, primarily due to an increase in our rental costs as a result of an increase in the number of our newly opened leased-and-operated hotels from 38 in 2007 to 83 in 2008. Our pre-opening expenses as a percentage of total revenues decreased from 24.5% in 2007 to 13.3% in 2008.
 
Loss from Operations.  We had a loss from operations of RMB153.7 million in 2008 and a loss from operations of RMB137.3 million in 2007 as a cumulative result of the above factors, particularly the significant pre-opening expenses associated with our hotel chain expansion efforts.
 
Interest Income (Expenses), Net.  Our net interest income increased from RMB1.2 million in 2007 to RMB2.5 million in 2008, primarily due to increased interest income resulting from additional proceeds from the issuance of Series B preference shares to our founder and co-founders, partially offset by the increased interest expenses resulting from a higher amount of bank loans outstanding.
 
Foreign Exchange Loss.  We had a foreign exchange loss of RMB13.9 million in 2008 compared to a foreign exchange loss of RMB145,096 in 2007. The foreign exchange loss in 2008 was primarily due to the devaluation against RMB of certain foreign currencies in which a portion of our cash was denominated.
 
Change of Fair Value of Warrants.  In relation to the outstanding warrants to purchase Series B preferred shares, we recorded mark-to-market fair value changes of RMB8.5 million and RMB5.2 million in 2007 and 2008, respectively.
 
Tax Benefits.  We had tax benefits because of operating losses in 2007 and 2008. Tax benefits are computed on an individual legal entity basis. Our tax benefits increased from RMB17.3 million in 2007 to RMB23.9 million in 2008, primarily as a result of an increase in operating loss.
 
Net Income (Loss) Attributable to Noncontrolling Interest.  Net income (loss) attributable to noncontrolling interest represents joint venture partners’ share of our net income or loss based on their equity interest in the leased-and-operated hotels owned by the joint ventures. We recorded an allocation of net income attributable to noncontrolling interest of RMB3.6 million in 2008 because hotels owned by the joint ventures generated profit in aggregate in that year and an allocation of net loss attributable to noncontrolling interest of RMB2.1 million in 2007 because hotels owned by the joint ventures generated loss in aggregate in that year. The change of non-controlling interest from a loss in 2007 to a profit in 2008 resulted from the jointly owned hotels turning profitable when entering mature operations.
 
Net Loss Attributable to China Lodging Group, Limited.  As a result of the foregoing, we had net loss attributable to China Lodging Group, Limited of RMB136.2 million and RMB111.6 million in 2008 and 2007, respectively.
 
EBITDA and EBITDA from Operating Hotels.  We had negative EBITDA (non-GAAP) of RMB68.0 million in 2008, compared with negative EBITDA of RMB96.0 million in 2007. This change was primarily due to (i) a net loss of RMB136.2 million in 2008 compared with a net loss of RMB111.6 million in 2007, and (ii) an increase in depreciation and amortization from RMB32.9 million in 2007 to RMB90.8 million in 2008 primarily because of our substantial expansion of leased-and-operated hotels from 62 hotels as of December 31, 2007 to 145 hotels as of December 31, 2008. Excluding pre-opening expenses, EBITDA from Operating Hotels (non-GAAP) was RMB40.1 million in 2008 compared with negative EBITDA from Operating Hotels of RMB35.0 million in 2007, due to an increase in pre-opening expenses from RMB61.0 million in 2007 to RMB108.1 million in 2008 primarily because of an increase in our rental costs as


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a result of an increased number of our new leased-and-operated hotels in the pipeline from 38 in 2007 to 83 in 2008.
 
Our Selected Quarterly Results of Operations
 
The following table presents our selected unaudited quarterly results of operations for the eight quarters in the period ended December 31, 2009. This information should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. We have grown rapidly since we began migrating to our current business of operating and managing a multiple-product economy hotel chain in 2007. Our limited operating history makes it difficult to predict future operating results. We believe that the quarter-to-quarter comparison of operating results should not be relied upon as being indicative of future performance.
 
                                                                 
    For the Three Months Ended  
    March 31,
    June 30,
    September 31,
    December 31,
    March 31,
    June 30,
    September 31,
    December 31,
 
    2008     2008     2008     2008     2009     2009     2009     2009  
    (in RMB thousands)  
 
Consolidated Statement of Operations Data:
                                                               
Revenues:
                                                               
Leased-and-operated hotels
    127,856       179,467       223,943       266,549       262,482       321,528       349,788       355,100  
Franchised-and-managed hotels
    531       2,236       2,617       6,655       6,024       12,282       11,325       15,334  
Total Revenues
    128,387       181,703       226,560       273,204       268,506       333,810       361,113       370,434  
Less: Business tax and related taxes
    (7,282 )     (10,071 )     (12,379 )     (15,873 )     (14,970 )     (18,514 )     (20,004 )     (20,184 )
Net Revenues
    121,105       171,632       214,181       257,331       253,536       315,296       341,109       350,250  
Operating costs and expenses(1)
                                                               
Hotel operating costs
    (117,272 )     (142,466 )     (187,443 )     (240,183 )     (241,650 )     (239,090 )     (256,268 )     (267,464 )
Selling and marketing expenses
    (6,360 )     (8,772 )     (10,287 )     (15,391 )     (8,847 )     (16,305 )     (18,546 )     (14,120 )
General and administrative expenses
    (19,151 )     (19,216 )     (22,277 )     (21,021 )     (19,814 )     (14,225 )     (21,724 )     (27,902 )
Pre-operating expenses
    (37,952 )     (25,412 )     (30,219 )     (14,479 )     (14,963 )     (7,718 )     (7,518 )     (7,622 )
Total operating costs and expenses
    (180,735 )     (195,866 )     (250,226 )     (291,074 )     (285,274 )     (277,338 )     (304,056 )     (317,108 )
Income (loss) from operations
    (59,630 )     (24,234 )     (36,045 )     (33,743 )     (31,738 )     37,958       37,053       33,142  
Interest income
    215       959       1,687       925       271       206       630       763  
Interest expenses
                      (1,249 )     (1,338 )     (2,422 )     (2,493 )     (2,534 )
Foreign exchange gain (loss)
    (1,557 )     (1,533 )     (10,879 )     85       (3 )     8       12       (77 )
Change in fair value of warrants
    4,016       4,520                                      
Income (loss) before income taxes
    (56,956 )     (20,288 )     (45,237 )     (33,982 )     (32,808 )     35,750       35,202       31,294  
Tax expense (benefit)
    (8,544 )     (3,043 )     (6,786 )     (5,507 )     (5,577 )     6,078       9,112       8,377  
Net income (loss)
    (48,412 )     (17,245 )     (38,451 )     (28,475 )     (27,231 )     29,672       26,090       22,917  
Less: net income (loss) attributable to noncontrolling interest
    (265 )     (1,467 )     (655 )     (1,192 )     (276 )     (1,725 )     (3,826 )     (3,076 )
Net income (loss) attributable to China Lodging Group, Limited
    (48,677 )     (18,712 )     (39,106 )     (29,667 )     (27,507 )     27,947       22,264       19,841  


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Note: (1)  Includes share-based compensation expenses as follows:
 
                                                                 
    For the Three Months Ended  
    March 31,
    June 30,
    September 31,
    December 31,
    March 31,
    June 30,
    September 31,
    December 31,
 
    2008     2008     2008     2008     2009     2009     2009     2009  
    (in RMB thousands)  
 
Share-based compensation expenses
    1,173       1,273       1,185       1,184       1,251       1,264       2,158       3,282  
 
The following table presents certain selected operating data of our company as of and for the eight quarters in the period ended December 31, 2009.
 
                                                                 
    As of and for the Three Months Ended
    March 31,
  June 30,
  September 30,
  December 31,
  March 31,
  June 30,
  September 30,
  December 31,
    2008   2008   2008   2008   2009   2009   2009   2009
 
Operating Data:
                                                               
Total hotels in operation
    86       102       145       167       181       200       216       236  
Leased-and-operated hotels
    81       96       127       145       151       160       166       173  
Franchised-and-managed hotels
    5       6       18       22       30       40       50       63  
Total hotel rooms in operation
    10,562       12,863       18,076       21,033       22,744       24,707       26,475       28,360  
Leased-and-operated hotels
    9,993       12,224       16,123       18,414       19,223       20,235       20,906       21,658  
Franchised-and-managed hotels
    569       639       1,953       2,619       3,521       4,472       5,569       6,702  
Number of cities
    27       29       35       35       36       38       38       39  
Occupancy rate (as a percentage)
                                                               
Leased-and-operated hotels
    84       91       87       90       86       96       98       96  
Franchised-and-managed hotels
    78       83       61       78       80       91       95       91  
Total hotels in operation
    84       90       85       89       85       96       98       95  
Average daily room rate (in RMB)
                                                               
Leased-and-operated hotels
    176       181       180       177       169       175       175       178  
Franchised-and-managed hotels
    183       179       184       177       170       173       171       173  
Total hotels in operation
    176       181       180       177       169       174       174       177  
RevPAR (in RMB)
                                                               
Leased-and-operated hotels
    148       164       157       159       145       168       172       171  
Franchised-and-managed hotels
    143       149       113       138       136       157       163       158  
Total hotels in operation
    148       163       153       157       144       167       171       168  
 
Our Liquidity and Capital Resources
 
Our principal sources of liquidity have been our sale of preferred shares, ordinary shares and convertible notes through private placements and borrowings from PRC commercial banks and cash generated from operating activities. Our cash and cash equivalents consist of cash on hand and liquid investments which have maturities of three months or less when acquired and are unrestricted as to withdrawal or use. As of December 31, 2009, we had entered into binding contracts with lessors of 21 properties for our leased-and-operated hotels under development. As of December 31, 2009, we expected to incur approximately RMB247.7 million of capital expenditures in connection with certain recently completed leasehold improvements and to fund the leasehold improvements of these 21 leased-and-operated hotels. We intend to fund this planned expansion with our operating cash flow and our cash balance.
 
Our working capital as of December 31, 2009 was RMB51.1 million. We have been able to meet our working capital needs, and we believe that we will be able to meet our working capital needs in the foreseeable future with our operating cash flow and existing cash balance.


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The following table sets forth a summary of our cash flows for the periods indicated:
 
                                 
    Year Ended December 31,  
    2007     2008     2009