F-1/A 1 df1a.htm AMENDMENT NO. 1 TO FORM F-1 AMENDMENT NO. 1 TO FORM F-1
Table of Contents

As filed with the Securities and Exchange Commission on April 19, 2007

Registration No. 333-142190

 


SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


Amendment No. 1

to

FORM F-1

REGISTRATION STATEMENT

UNDER THE SECURITIES ACT OF 1933

 


HOME INNS & HOTELS MANAGEMENT INC.

(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)

No. 400 Tian Yao Qiao Road

Shanghai 200030, People’s Republic of China

+(8621) 6486-1818

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 


CT Corporation System

111 Eighth Avenue

New York, New York 10011

(212) 664-1666

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 


Copies to:

 

David T. Zhang, Esq.

Z. Julie Gao, Esq.

Latham & Watkins LLP

41st Floor, One Exchange Square

8 Connaught Place, Central

Hong Kong

+(852) 2522-7886

 

Leiming Chen, Esq.

Simpson Thacher & Bartlett LLP

35th Floor, 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. ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨                     

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. ¨                     

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. ¨                     

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. ¨

 


CALCULATION OF REGISTRATION FEE

 

 

Title of each class of

securities to be registered

  Amount to be
registered
  Proposed maximum
offering price per
ordinary share
   

Proposed maximum
aggregate offering

price

  Amount of
registration fee

Ordinary shares, par value US$0.005 per share (1)

  8,050,000(2)   US$ 17.64 (2)   US$ 142,002,000(2)(3)   US$ 4,360

(1) American depositary shares issuable upon deposit of the ordinary shares registered hereby have been registered under a separate registration statement on Form F-6 (Registration No. 333-137983). Each American depositary share represents two ordinary shares.
(2) Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(c) under the Securities Act of 1933, as amended, based on the average of the high and low trading prices on April 18, 2007 of the Registrant’s American depositary shares listed on the Nasdaq Global Market and representing the Registrant’s ordinary shares.
(3) Includes ordinary 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 also includes ordinary shares that may be purchased by the underwriters pursuant to an over-allotment option. These ordinary shares are not being registered for the purpose of sales outside the United States.

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 Commission, acting pursuant to such Section 8(a), may determine.

 



Table of Contents

The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion. Dated             , 2007.

3,500,000 American Depositary Shares

LOGO

Home Inns & Hotels Management Inc.

Representing 7,000,000 Ordinary Shares

 


This is a public offering of American depositary shares, or ADSs, of Home Inns & Hotels Management Inc., or Home Inns. Home Inns is offering 1,478,155 ADSs, and the selling shareholders disclosed in this prospectus is offering an additional 2,021,845 ADSs. Each ADS represents two ordinary shares. The ADSs are evidenced by American depositary receipts, or ADRs. Home Inns will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

The public offering price of the ADSs is US$             per ADS. Our ADSs are listed on the Nasdaq Global Market under the symbol “HMIN.” On April 18, 2007, the last trading price for our ADSs as reported on the Nasdaq Global Market was US$35.46 per ADS. There is currently no public market for our ordinary shares.

The underwriters have an option to purchase up to an additional 221,724 ADSs from Home Inns and an additional 303,276 ADSs from the selling shareholders at the public offering price, less underwriting discounts and commissions, within 30 days from the date of this prospectus.

See “ Risk Factors” beginning on page 13 to read about risks you should consider before buying the ADSs.

 

    

Public offering
price

   Underwriting
discounts and
commissions
   Proceeds,
before expenses, to
Home Inns
   Proceeds, before
expenses, to
the selling
shareholders

Per ADS

  

US$

   US$    US$    US$

Total

  

US$

   US$    US$    US$

The underwriters expect to deliver the ADSs evidenced by the ADRs against payment in U.S. dollars in New York, New York on             , 2007.

Neither the United States Securities and Exchange Commission nor any state securities commission or other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

Credit Suisse   Merrill Lynch & Co.

CIBC World Markets

The date of this prospectus is             , 2007


Table of Contents

TABLE OF CONTENTS

 

     Page

PROSPECTUS SUMMARY

   1

RISK FACTORS

   13

FORWARD-LOOKING STATEMENTS

   28

USE OF PROCEEDS

   29

DIVIDEND POLICY

   30

CAPITALIZATION

   31

DILUTION

   32

MARKET PRICE INFORMATION FOR OUR ADSS

   33

EXCHANGE RATE INFORMATION

   34

ENFORCEABILITY OF CIVIL LIABILITIES

   35

SELECTED CONSOLIDATED FINANCIAL DATA

   36

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   41

INDUSTRY BACKGROUND

   64

BUSINESS

   68

REGULATION

   82

MANAGEMENT

   86

PRINCIPAL AND SELLING SHAREHOLDERS

   93

RELATED PARTY TRANSACTIONS

   95

DESCRIPTION OF SHARE CAPITAL

   98

DESCRIPTION OF AMERICAN DEPOSITARY SHARES

   102

SHARES ELIGIBLE FOR FUTURE SALE

   109

TAXATION

   111

UNDERWRITING

   116

EXPENSES RELATING TO THIS OFFERING

   122

LEGAL MATTERS

   123

EXPERTS

   123

WHERE YOU CAN FIND ADDITIONAL INFORMATION

   123

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

   F-1

 


No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell only the ADSs offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information in this prospectus is current only as of the date of this prospectus.

 

i


Table of Contents

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements appearing elsewhere in this prospectus. In addition to this summary, we urge you to read the entire prospectus carefully, especially the risks of investing in our ADSs discussed under “Risk Factors,” before deciding whether to buy our ADSs.

Home Inns & Hotels Management Inc.

Our Company

We are a leading economy hotel chain in China, based on the number of our hotels and the number of our hotel rooms, as well as the geographic coverage of our hotel chain. We develop and operate economy hotels across China under our award-winning “Home Inn” brand. Since we commenced operations in 2002, we have become one of the best-known economy hotel brands in China. We offer a consistent product and high-quality services to primarily serve the fast growing population of value-conscious individual business and leisure travelers who demand clean, comfortable and convenient lodging.

We have achieved our growth by utilizing two business models. We either lease real estate properties on which we develop and operate hotels, or we franchise our brand to hotel owners and manage these hotel properties. We refer to the former type of hotels as “leased-and-operated hotels” and to the latter type of hotels as “franchised-and-managed hotels.” As of March 31, 2007, our Home Inns hotel chain consisted of 97 leased-and-operated hotels in operation with an additional 36 leased-and-operated hotels under development and 48 franchised-and-managed hotels in operation and an additional 12 franchised-and-managed hotels under development, covering 53 cities in China. We have received many awards and accolades for our innovative, consistent and high-quality product and services across our hotel chain, including the “2006 Leading Brand in Economy Hotels in China” from the China Hotel Association, the “Golden Pillow Award” for best brand in economy hotels in China in 2006 from the 21st Century Business Herald, a nationwide economic journal in China, and being named one of the “2006 Top 10 Leading Consumers Brands” by the China Enterprise Culture Improvement Association.

We have experienced substantial growth while maintaining profitability since 2003. Our Home Inns hotels in operation grew rapidly from 10 hotels in four cities as of the end of 2003 to 134 hotels in 39 cities as of the end of 2006, and our net income grew from RMB 1.5 million in 2003 to RMB 46.9 million (US$6.0 million) in 2006, representing a compound annual growth rate, or CAGR, of 215%.

Industry Background

China’s lodging industry has expanded rapidly as a result of the substantial growth of the Chinese economy over the past several years. According to Euromonitor International, or Euromonitor, total sales in China’s lodging industry grew from RMB 190 billion in 1999 to RMB 264 billion in 2004.

While China’s lodging industry continues to grow, it remains highly fragmented. According to Euromonitor, hotels accounted for only approximately 5% of total lodging outlets in China in 2004, with the remainder being guesthouses and other privately owned lodging outlets. Within the hotel sector of the lodging industry, the top ten brands accounted for an approximate 6% market share in 2004 in terms of sales.

Economy hotel chains have emerged and expanded in China in recent years to primarily target value-conscious individual business and leisure travelers. The growth in demand for economy hotel chains in China is being driven by both general factors, including the growth of the Chinese economy and the growth of China’s travel and lodging industry, as well as more specific factors, such as a rapid increase in the number of small- to medium-sized enterprises, or SMEs, the growth of domestic tourism, the expansion of urban business centers and the fragmentation of the lodging industry.

 

1


Table of Contents

We believe the economy hotel market in China is still at an early stage of development. There are significant growth opportunities for economy hotel operators to develop new properties and convert existing lodging facilities. The ability of an economy hotel chain to compete in the current market is determined by the hotel chain’s ability to provide a consistent product, high-quality services, an efficient reservation system and effective sales channels, as well as its brand-name recognition and geographic coverage. We believe economy hotel chains that have established a reputable brand and a nationwide network, such as our Home Inns hotel chain, are well-positioned to capture the opportunities presented by the continuing growth of the economy hotel market in China.

Our Strengths, Strategies and Challenges

We believe that the following competitive strengths contribute to our success and differentiate us from our competitors:

 

   

scale and leadership in the economy hotel market in China, as measured by the number of our hotels and hotel rooms, as well as the geographic coverage of our hotel chain;

 

   

innovative, distinctive and consistent product;

 

   

outstanding track record, as evidenced by our ability to rapidly expand our hotel chain from ten hotels operating in four cities as of the end of 2003 to 134 hotels operating in 39 cities as of December 31, 2006, while having maintained profitability since 2003;

 

   

efficient and integrated operational infrastructure and information systems; and

 

   

experienced management team and motivated staff.

Our goal is to become the leading economy hotel chain in China. We intend to achieve our goal by pursuing the following growth strategies:

 

   

expand geographical coverage to capitalize on our early-mover advantage;

 

   

increase penetration in existing markets;

 

   

continue to build brand awareness and customer loyalty;

 

   

increase our revenue per available room, or RevPAR, by optimizing customer channel mix and maximizing room rate growth; and

 

   

further enhance our information and operational systems and human resources management.

The successful execution of our strategies is subject to certain risks and uncertainties, including:

 

   

risks associated with our limited operating history;

 

   

uncertainties associated with our ability to continue our growth while maintaining our profitability;

 

   

uncertainties in our ability to expand our operations while maintaining the consistent quality of our product and enhancing profitability;

 

   

uncertainties in our ability to respond to competitive pressures; and

 

   

uncertainties associated with factors typically affecting the lodging industry, including changes in economic conditions, natural disasters or outbreaks of serious contagious diseases in markets where we have a presence.

Please see “Risk Factors” and other information included in this prospectus for a detailed discussion of these risks and uncertainties.

 

2


Table of Contents

Corporate Information

We incorporated Home Inns & Hotels Management (Hong Kong) Limited, or Home Inns Hong Kong, in May 2001 and commenced operations in July 2002 through Home Inns & Hotels Management (Beijing) Co, Ltd., or Home Inns Beijing, a company established in China, and its subsidiaries and affiliates. In May 2006, we established a holding company, Home Inns & Hotels Management Inc., under the laws of the Cayman Islands in preparation for our initial public offering, which was completed in October 2006.

Our principal executive offices are located at No. 400 Tian Yao Qiao Road, Shanghai 200030, People’s Republic of China. Our telephone number at this address is +(8621) 6486-1818. Our registered office in the Cayman Islands is located at the offices of M&C Corporate Services Limited, P.O Box 309GT, Ugland House, South Church Street, George Town, Grand Cayman, Cayman Islands, British West Indies. In addition, we have two branch offices in China. Our agent for service of process in the United States is CT Corporation System, located at 111 Eighth Avenue, 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://english.homeinns.com. The information contained on our website is not a part of this prospectus.

 

3


Table of Contents

Corporate Structure and History

The following diagram illustrates our corporate structure as of March 31, 2007.

LOGO

 


* Home Inns Shanghai owns 75% of one joint venture and 51% of each of the other three joint ventures.

Home Inns Hong Kong was incorporated in Hong Kong in May 2001 by its individual founders and Ctrip.com International, Ltd., or Ctrip, a leading China-based travel consolidator. Through a series of transactions, Ctrip disposed of all of its ownership interest in Home Inns Hong Kong in August 2003 to focus on its core business of travel consolidation and to prepare for its initial public offering, which was completed in December 2003.

In April 2002, Home Inns Hong Kong and Beijing Capital Travel International Hotel Group Co., Ltd., or Beijing Capital Travel, entered into a joint venture agreement to form Home Inns Beijing to operate branded economy hotels in China. Beijing Capital Travel is a subsidiary of Beijing Tourism Group, or BTG. Home Inns Hong Kong and BTG owned 55% and 45%, respectively, of Home Inns Beijing when it commenced operations in July 2002. Subsequently, Home Inns Hong Kong gradually increased its ownership interest in Home Inns Beijing by contributing additional funds to the registered capital of Home Inns Beijing. Home Inns Hong Kong’s ownership interest in Home Inns Beijing was increased to 95.59% as of February 2005.

We have been actively managing Home Inns Beijing since its inception. Home Inns Hong Kong’s ownership in Home Inns Beijing was accounted for under the equity method since Home Inns Beijing’s inception until April 2004 because, during this period of time, BTG had substantive participation rights that enabled it to

 

4


Table of Contents

veto significant decisions made by Home Inns Hong Kong. In April 2004, Home Inns Hong Kong and Beijing Capital Travel entered into a revised joint venture agreement, under which Home Inns Hong Kong obtained control of Home Inns Beijing. As a result, Home Inns Beijing has been our consolidated subsidiary since then.

In May 2006, we incorporated Home Inns & Hotels Management Inc. in the Cayman Islands in preparation for our initial public offering. In June 2006, all of the then-existing shareholders of Home Inns Hong Kong exchanged their respective shares of Home Inns Hong Kong for an equivalent number of shares of Home Inns & Hotels Management Inc. of equivalent classes. As a result, Home Inns Hong Kong became our wholly owned subsidiary in June 2006. Our consolidated financial statements reflect the share exchange in June 2006 and have been prepared as if our current corporate structure had been in existence throughout the relevant periods. On October 31, 2006, we completed our initial public offering, in which we issued and sold 5,874,237 ADSs, representing 11,748,474 of our ordinary shares, and certain of our then shareholders sold 3,210,763 ADSs, representing 6,421,526 of our ordinary shares, in each case at a public offering price of US$13.80 per ADS.

 

5


Table of Contents

Conventions Which Apply to this Prospectus

Unless we indicate otherwise, all information in this prospectus reflects no exercise by the underwriters of their option to purchase up to 221,724 additional ADSs representing 443,448 ordinary shares from us and up to 303,276 additional ADSs representing 606,552 ordinary shares from the selling shareholders.

Except where the context otherwise requires and for purposes of this prospectus only:

 

   

“we,” “us,” “our company,” “our” and “Home Inns” refer to Home Inns & Hotels Management Inc., a Cayman Islands company, and its predecessor entities and subsidiaries, except in the context of discussing our consolidated financial data for the periods prior to April 2004, where the reference excludes Home Inns Beijing and its subsidiaries;

 

   

“BTG” refers to Beijing Tourism Group, a state-owned enterprise established in the PRC, and its predecessors and subsidiaries, including Beijing Capital Travel International Hotel Group Co., Ltd.;

 

   

“China” or “PRC” refers to the People’s Republic of China, excluding Taiwan, Hong Kong and Macau;

 

   

“Home Inns Beijing” refers to Home Inns & Hotels Management (Beijing) Co., Ltd., and its subsidiaries, which have been our consolidated subsidiaries since April 2004;

 

   

“Home Inns Hong Kong” refers to Home Inns & Hotels Management (Hong Kong) Limited;

 

   

“Home Inns Shanghai” refers to Home Inns & Hotels Management (Shanghai) Co., Ltd.;

 

   

“our hotels” refers, collectively, to our leased-and-operated and franchised-and-managed hotels;

 

   

“average daily rate” refers to total hotel room revenues divided by the total number of occupied rooms in a given period;

 

   

“occupancy rate” refers to the total number of occupied rooms divided by the total number of available rooms in a given period;

 

   

“RevPAR” represents revenue per available room, which is calculated by dividing total hotel room revenues by the total number of available rooms in a given period, or by multiplying average daily rates and occupancy rates in a given period;

 

   

“shares” or “ordinary shares” refers to our ordinary shares; “preferred shares” refers to our Series A convertible preferred shares, Series B convertible preferred shares and Series C convertible preferred shares, collectively, all of which were converted into an equal number of ordinary shares on October 31, 2006 upon the completion of our initial public offering;

 

   

“ADSs” refers to our American depositary shares, each of which represents two ordinary shares, and “ADRs” refers to the American depositary receipts that evidence our ADSs; and

 

   

“RMB” or “Renminbi” refers to the legal currency of China; “$,” “dollars,” “US$” or “U.S. dollars” refers to the legal currency of the United States; and “HK$” refers to the legal currency of Hong Kong.

 

6


Table of Contents

THE OFFERING

The following information assumes that the underwriters will not exercise their option to purchase additional ADSs in the offering, unless otherwise indicated.

 

Offering price

US$             per ADS.

 

ADSs offered by us

1,478,155 ADSs.

 

ADSs offered by the selling shareholders

2,021,845 ADSs.

 

Total ADSs offered in this offering

3,500,000 ADSs.

 

ADSs outstanding immediately after this offering

12,585,000 ADSs.

 

Ordinary shares outstanding immediately after this offering

69,403,259 ordinary shares.

 

ADS to ordinary share ratio

One ADS represents two ordinary shares.

 

The ADSs

The ADSs will be evidenced by ADRs.

 

   

The depositary will hold the ordinary shares underlying your ADSs. You will have rights as provided in the deposit agreement.

 

   

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.

 

   

You may turn in your ADSs to the depositary in exchange for ordinary shares. The depositary will charge you fees for any exchange.

 

   

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.

 

Over-allotment option

We and the selling shareholders have granted to the underwriters an option, which is exercisable within 30 days from the date of this prospectus, to purchase up to an aggregate of 525,000 additional ADSs.

 

Use of proceeds

We estimate that our net proceeds from this offering will be approximately US$             million, based on the last trading price of our ADSs on             , 2007 of US$             per ADS. We plan to use the net proceeds we receive from this offering to fund capital expenditures, improve our financial strength and flexibility, fund potential strategic acquisitions and for general corporate purposes. See “Use of Proceeds” for additional information.

 

7


Table of Contents
 

We will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

 

Lock-up

We and the selling shareholders have agreed with the underwriters to a lock-up of shares for a period of 90 days after the date of this prospectus. In addition, our directors and officers have also agreed with the underwriters to a lock-up of shares for a period of 60 days after the date of this prospectus. Poly Victory Investments Limited, one of our principal shareholders, remains subject to a three-year lock-up period which commenced on October 25, 2006. See “Underwriting.”

 

Listing

Our ADSs are listed on the Nasdaq Global Market under the symbol “HMIN.” Our ordinary shares are not listed on any exchange or traded on any automated quotation system.

 

Risk factors

See “Risk Factors” and other information included in this prospectus for a discussion of risks you should carefully consider before investing in our ADSs.

 

Depositary

The Bank of New York.

The number of ordinary shares that will be outstanding immediately after this offering:

 

   

excludes 3,198,886 ordinary shares issuable upon the exercise of options outstanding as of the date of this prospectus, at a weighted average exercise price of US$3.11 per share; and

 

   

excludes ordinary shares reserved for future issuances under our share incentive plans.

 

8


Table of Contents

Our Summary Consolidated Financial and Operating Data

You should read the following information in conjunction with our and Home Inns Beijing’s consolidated financial statements and related notes, “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

The following summary consolidated financial information has been derived from our consolidated financial statements included elsewhere in this prospectus. Our summary consolidated statement of operations data for the years ended December 31, 2004, 2005 and 2006, and our consolidated balance sheet data as of December 31, 2006, have been derived from our consolidated financial statements for the relevant periods which have been audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, an independent registered public accounting firm, and are prepared and presented in accordance with generally accepted accounting principles in the United States, or U.S. GAAP, and reflect our current corporate structure as if it had been in existence throughout the relevant periods.

 

     For the Year Ended December 31,  
     2004     2005     2006  
     RMB     RMB     RMB     US$  
     (in thousands, except share, per share and per ADS
data)
 

Consolidated Statement of Operations Data:

        

Total Revenues

   96,000     285,861     588,500     75,409  

Less: Business tax and related surcharges

   (5,101 )   (16,830 )   (33,977 )   (4,354 )
                        

Net revenues

   90,899     269,031     554,523     71,055  

Operating costs and expenses(1)

   (82,176 )   (238,689 )   (479,957 )   (61,500 )
                        

Income from operations

   8,723     30,342     74,566     9,555  

Income before income tax expense, minority interests and share of income of affiliated companies

   9,183     32,255     73,319     9,395  

Minority interests

   552     (4,797 )   (5,034 )   (645 )

Share of income of affiliated companies

   1,972     —       —       —    

Net income

   5,969     20,933     46,894     6,009  

Amount allocated to participating preferred shareholders

   (2,960 )   (9,487 )   (16,174 )   (2,073 )
                        

Net income available to ordinary shareholders

   3,009     11,446     30,720     3,936  

Earnings per share

        

Basic

   0.15     0.42     0.86     0.11  

Diluted

   0.15     0.40     0.82     0.10  

Earnings per ADS(2)

        

Basic

   0.30     0.84     1.73     0.22  

Diluted

   0.30     0.80     1.64     0.21  

Weighted average ordinary shares outstanding:

        

Basic

   19,981,424     27,399,140     35,550,114     35,550,114  

Diluted

   20,315,681     28,713,188     37,530,332     37,530,332  

(1)    Include share-based compensation expenses as follows:

      

     
     For the Year Ended December 31,  
     2004     2005     2006  
     RMB     RMB     RMB     US$  
     (in thousands)  

Share-based compensation expenses

   149     960     16,295     2,088  

 

(2) Each ADS represents two ordinary shares.

 

9


Table of Contents
     As of December 31, 2006
     Actual    As adjusted (1)(2)
     RMB    US$    RMB    US$
     (in thousands)

Consolidated Balance Sheet Data:

           

Cash and cash equivalents

   758,004    97,129      

Total assets

   1,320,019    169,144      

Total current liabilities

   323,229    41,418      

Total shareholders’ equity

   889,739    114,009      

(1) Our consolidated balance sheet data as of December 31, 2006 are adjusted to give effect to the issuance and sale of              ADSs by us in this offering, based on the assumed public offering price of US$             per ADS, after deducting estimated underwriting discounts, commissions and estimated offering expenses payable by us and assuming no exercise of the underwriters’ over-allotment option.
(2) A US$1.00 increase (decrease) in the assumed public offering price of US$         per ADS would increase (decrease) the amounts representing cash and cash equivalents, total assets and total shareholders’ equity by US$        .

The following table presents certain unaudited financial data and selected operating data as of and for the dates and years indicated. We present operating data for 2004 as if we had consolidated Home Inns Beijing throughout the relevant period.

 

     As of and for the Year Ended
December 31,
     2004    2005    2006

Non-GAAP Financial Data:

        

EBITDA(1) (in thousands of RMB)

   17,684    51,790    114,452

Operating Data:

        

Total hotels in operation:

        

Leased-and-operated hotels(2)

   18    54    94

Franchised-and-managed hotels

   8    14    40

Total rooms

   2,991    8,197    16,162

Geographic coverage:

        

Number of cities

   8    22    39

Occupancy rate (as a percentage)

   86.8    89.8    92.8

Average daily rate (in RMB)

   191    182    182

RevPAR (in RMB)

   166    163    169

(1) We believe that earnings before interest, income tax expense, depreciation and amortization, or EBITDA, is a useful financial metric by which to assess our operating and financial performance before the impact of investing and financing transactions and income taxes. 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. Given the significant investments that we have made in the past in property, plant and equipment, depreciation and amortization expenses comprise a significant portion of our cost structure. We believe that EBITDA will provide investors with a useful tool for comparability between periods because it eliminates depreciation and amortization expenses attributable to capital expenditures. The presentation of EBITDA 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 has certain limitations. Depreciation and amortization expenses for various long-term assets, income tax expense, interest expense and interest income have been and will be incurred and are not reflected in the presentation of EBITDA. Each of these items should also be considered in the overall evaluation of our results. Additionally, EBITDA 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 and interest income, income tax expense, 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 term EBITDA is not defined under U.S. GAAP, and EBITDA is not 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 may not be comparable to EBITDA or similarly titled measures utilized by other companies since such other companies may not calculate EBITDA in the same manner as we do.

 

10


Table of Contents
     A reconciliation of EBITDA to net income, which is the most directly comparable U.S. GAAP measure, is provided below:

 

     For the Year Ended December 31,  
     2004      2005      2006  
     RMB      RMB      RMB      US$  
     (in thousands)  

Net income

   5,969      20,933      46,894      6,009  

Interest income

   (88 )    (223 )    (6,578 )    (843 )

Interest expense

   98      709      6,143      787  

Income tax expense

   5,738      6,526      21,390      2,741  

Depreciation and amortization

   5,967      23,845      46,603      5,972  
                           

EBITDA

   17,684      51,790      114,452      14,666  
                           

 

(2) Includes four hotels operated through separate joint ventures with third parties. We own 75% of one joint venture and 51% of each of the other three joint ventures.

 

11


Table of Contents

Home Inns Beijing’s Summary Consolidated Financial Data

You should read the following information in conjunction with Home Inns Beijing’s consolidated financial statements and related notes, “Home Inns Beijing’s Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

The following summary consolidated financial information has been derived from Home Inns Beijing’s consolidated financial statements included elsewhere in this prospectus. Home Inns Beijing’s consolidated statement of operations data for the year ended December 31, 2004 has been derived from its consolidated financial statements which has been audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, an independent registered public accounting firm, and is prepared and presented in accordance with U.S. GAAP.

In April 2002, Home Inns Hong Kong and BTG entered into a joint venture agreement to form Home Inns Beijing to operate branded economy hotels in China. Home Inns Hong Kong and BTG owned 55% and 45%, respectively, of Home Inns Beijing when it commenced operations in July 2002. Subsequently, Home Inns Hong Kong gradually increased its ownership interest in Home Inns Beijing by contributing additional funds to the registered capital of Home Inns Beijing. Home Inns Hong Kong’s ownership interest in Home Inns Beijing was increased to 95.59% as of February 2005.

We have been actively managing Home Inns Beijing since its inception. Home Inns Hong Kong’s ownership in Home Inns Beijing was initially accounted for under the equity method since Home Inns Beijing’s inception until April 2004 because, during this period of time, BTG had substantive participation rights that enabled it to veto significant decisions made by Home Inns Hong Kong. In April 2004, Home Inns Hong Kong and Beijing Capital Travel entered into a revised joint venture agreement, under which Home Inns Hong Kong obtained effective control of Home Inns Beijing. As a result, Home Inns Beijing has been accounted for as our consolidated subsidiary since then.

 

     For the Year
Ended
December 31,
2004
 

Revenues

   115,278  

Less: Business tax and related surcharges

   (6,150 )

Net revenues

   109,128  

Operating costs and expenses

   (96,139 )

Income from operations

   12,989  

Net income

   7,735  

 

12


Table of Contents

RISK FACTORS

You should consider carefully all of the information in this prospectus, including the risks and uncertainties described below, before making an investment in our ADSs. Any of the following risks could have a material adverse effect on our business, financial condition and results of operations. In any such case, the market price of our ADSs could decline, and you may lose all or part of your investment.

Risks Related to Our Business

Our operating results are subject to conditions typically affecting the lodging industry.

Our operating results are subject to conditions typically affecting the lodging industry, including the following:

 

   

changes in the national, regional or local economic conditions;

 

   

natural disasters or travelers’ fears of exposure to serious contagious diseases;

 

   

the attractiveness of our hotels to customers and competition from other hotels;

 

   

local market conditions such as an oversupply of, or a reduction in demand for, hotel rooms;

 

   

the performance of managerial and other employees of our hotels; and

 

   

increases in operating costs and expenses due to inflation and other factors.

Changes in any of these conditions could adversely affect our occupancy rates, average daily rates and RevPAR or otherwise adversely affect our results of operations and financial condition.

We may not be able to manage our expected growth, which could adversely affect our operating results.

Since our inception, we have experienced substantial growth. We have increased the number of our hotels in operation in China from five in 2002 to 134 as of December 31, 2006, 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 product and the quality of our services to ensure that our brand does not suffer as a result of any deviations, whether actual or perceived, in the consistency of our product and the quality of our services. 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 operation.

Expansion into new markets may present operating and marketing challenges that are different from those that we currently encounter in our existing markets. In addition, our expansion within existing markets may adversely affect the financial performance of our existing hotels in those markets and, as a result, negatively affect our overall results of operations. Our inability to anticipate the changing demands that 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 lost revenue and increased expenses, and otherwise harm our results of operations and financial condition.

 

13


Table of Contents

If the value of our brand or image diminishes, it could have a material and adverse effect on our business and results of operations.

Our “Home Inn” brand is associated with a leading economy hotel chain offering cleanness, convenience and comfort with consistent, high-quality service among value-conscious individual business and leisure travelers in China. 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 product 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. Our brand is integral to our sales and marketing efforts. If the value of our brand or image is diminished or if our brand does not continue to be attractive to customers, our business and results of operations may be materially and adversely affected.

If we are not able to hire, train and retain qualified managerial and other employees, our brand and 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 brand and reputation. It is important for us to attract qualified managerial and other employees who have experience in lodging or other consumer-service industries and are committed to our “customer-first” approach. There may be 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, criteria such as dedication are difficult to ascertain during the recruitment process. We must 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 are equipped with 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 in one or more of the markets where we operate, which in turn may have a material and adverse effect on our brand and our business.

We may not be able to successfully identify or secure additional hotel properties.

We plan to open more hotels in targeted markets to further grow our business. We may not be successful in identifying and leasing or franchising additional hotel properties at desirable locations and on commercially reasonable terms or at all. Some cities in China have undergone economic development and expansion for several decades while others are still at an early stage of development. In more developed cities, it may be difficult to increase the number of hotels because we or our competitors already have operations in such cities. In less developed cities, demand for our hotels may not increase as rapidly as we expect. Even if we are able to successfully identify and acquire new hotel properties via lease or franchise arrangements, new hotels may not generate the returns we expect. We also may incur costs in connection with evaluating hotel properties and negotiating with property owners, including ones that we are subsequently unable to lease or franchise. If we fail to successfully identify or compete for additional hotel properties, our ability to execute our growth strategy could be impaired and our business and prospects may be materially and adversely affected.

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. In early 2003, several economies in Asia, including China, were affected by the outbreak of severe acute respiratory syndrome, or SARS. During May and June of 2003, many businesses in China were closed by the PRC government to prevent

 

14


Table of Contents

transmission of SARS. Our business and results of operations were materially and adversely affected by the outbreak of SARS. In addition, some Asian countries, including China, have recently encountered incidents of the H5N1 strain of bird flu, or avian flu. This disease, which originally spread through poultry populations, is capable in some circumstances of being transmitted to humans and is often fatal. Losses caused by epidemics, natural disasters and other catastrophes, including SARS, avian flu, 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 could lose all or a portion of the capital we have invested in a hotel, as well as the anticipated future revenue from the hotel. In that event, we might nevertheless remain obligated for any financial obligations related to the hotel. Similarly, war (including the potential for war) and terrorist activity (including threats of terrorist activity), 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 operation. 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 affected and our reputation may be harmed.

Our legal right to lease certain properties could be challenged by property owners or other third parties, which could prevent us from continuing to operate the affected hotels or increase the costs associated with operating these hotels.

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, our business model relies on leases with third parties who either own the properties or lease the properties from the ultimate property owner. As of December 31, 2006, title certificates for six of the properties operated by us had not been obtained. We cannot assure you that title to properties we currently lease or franchise will not be challenged. There may be challenges to the title of the properties which, if successful, could impair the development or operations of our hotels on such properties. In addition, we are subject to the risk of potential disputes with property owners. Such disputes, whether resolved in our favor or not, may divert management attention, harm our reputation or otherwise disrupt our business.

Where our immediate lessors are not the ultimate owners of hotel properties, in several instances no consent was obtained from the owners to sublease the hotel properties to us. A lessor’s failure to duly obtain the title to the property or to receive any necessary approvals from the ultimate owner or the primary lease holder, as applicable, could potentially invalidate our lease or result in the renegotiation of such lease leading to less favorable terms. Moreover, we cannot assure you that the building ownership or leasehold in connection with our franchised-and-managed hotels will not be subject to similar third-party challenges. Some of the properties we or our franchisees lease from third parties were subject to mortgages at the time the leases were signed. In such circumstances and where consent to the lease was not obtained from the mortgage holder, the lease may not be binding on the transferee of the property if the mortgage holders foreclose on the mortgage and transfer the property, which could in turn materially and adversely affect our ability to operate the hotel facility.

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. Competition in the industry is primarily based on room rates, quality of accommodations, brand name recognition, convenience of location, geographic coverage, service quality, range of services, and guest amenities. We compete primarily with other economy hotel chains as well as various regional and local economy hotels. We also compete with two- and three-star hotels, as we offer rooms with standards comparable to many of those hotels while maintaining competitive pricing. In addition, we may also face competition from new entrants in the economy hotel segment in China. As compared to developing four- or five-star hotels, developing economy hotels does not require significant capital commitments or human resources. This relatively low barrier to entry potentially allows new competitors to enter our markets quickly to compete with our business. Furthermore, we compete with all other hotels for guests in each market in which we operate, as our typical business and leisure traveler customers may change their travel, spending and consumption patterns and choose to stay in hotels in different segments. New and existing competitors may offer

 

15


Table of Contents

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 limited operating history makes it difficult to evaluate our future prospects and results of operations.

We believe that our future success depends on our ability to significantly increase revenue and profitability from our operations. We have a limited operating history, having only commenced operations in 2002. 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 maintaining our profitability;

 

   

preserving our competitive position in the economy hotel segment of the lodging industry in China;

 

   

offering an innovative product 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 “Home Inn” brand 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.

Failure to retain our senior management could harm our business.

We place substantial reliance on the lodging and other consumer-service industry experience and the institutional knowledge of members of our senior management team. Mr. David Jian Sun, our chief executive officer, Ms. May Wu, our chief financial officer, and Ms. Rixin Liang, our chief operating officer, are particularly important to our future success due to their substantial experience in the lodging and other consumer-service industries. We do not carry key person insurance on any of our senior management team. The loss of the services of one or more of these members of our senior management team due to their departure or otherwise could hinder our ability to effectively manage our business and implement our growth strategies. Finding suitable replacements for Mr. Sun, Ms. Wu and Ms. Liang could be difficult, and competition for such personnel of similar experience is intense. If we lose the services of any of them, our business may be adversely affected.

Interruption or failure of our information and operational systems could impair our ability to effectively provide our services, which could damage our reputation.

Our ability to provide consistent and high-quality services throughout our hotel chain depends on the continued operation of our proprietary information and operational systems, including our property management, central reservation, customer relationship management and management reporting systems. Any damage to, or failure of, our systems could interrupt our service. Our systems are vulnerable to damage or interruption as a result of power loss, telecommunications failures, computer viruses, fires, floods, earthquakes, interruptions in access to our toll-free numbers, hacking or other attempts to harm our systems, and similar events. Our servers, which are maintained in Shanghai, may also be vulnerable to break-ins, sabotage and vandalism. Some of our systems are not fully redundant, and our disaster recovery planning does not account for all possible scenarios. In addition, our systems and technologies may 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 frequent or persistent system failures, our quality of services and our reputation could be harmed. The steps we need to take to increase the reliability and redundancy of our systems may be costly, which could reduce our operating margin, and may not be successful in reducing the frequency or duration of system failures and service interruptions.

 

16


Table of Contents

Any failure to protect our trademarks and other intellectual property rights could have a negative impact on our business.

We believe our brand, trade name, trademarks and other intellectual property are critical to our success. “Home Inn” is a highly recognized brand in the economy hotel segment of China’s lodging industry. The success of our business depends in part upon our continued ability to use our brand, trade names and trademarks to increase brand awareness and to further develop our brand. 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 or otherwise registered as our property, are a key component of our competitive advantage and our growth strategy.

Monitoring and preventing the unauthorized use of our intellectual property is difficult. The measures we take to protect our brand, 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 uncertain and evolving, and could involve substantial risks to us. If we are unable to adequately protect our brand, trade names, trademarks and other intellectual property rights, we may lose these rights and our business may suffer materially.

Accidents or injuries in our hotels may adversely affect our reputation and subject us to liability.

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. If accidents or injuries occur at any of our hotels, we may be held liable for costs related to the injuries. Our current property and liability insurance policies may not provide adequate coverage and 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 not be able to develop hotel properties on a timely or cost-efficient basis, which may adversely affect our growth strategy and business.

We develop all of our leased-and-operated hotels directly. Our involvement in the development of properties presents a number of risks, including construction delays or cost overruns, which may result in increased project costs or forgone revenue. We may be unable to recover development costs we incur for projects that are not pursued to completion. Properties that we develop could become less attractive due to market saturation or oversupply, with the result that we may not be able to recover development costs at the expected rate, or at all. In addition, we may not have available cash to complete projects that have commenced, or we may be unable to obtain financings for development of future properties on favorable terms, if at all. If we are unable to successfully manage our hotel development to minimize these risks, our growth strategy and business prospects may be adversely affected.

Our costs and expenses may remain constant or increase even if our revenues decline.

A significant portion of our operating costs, including rent, is fixed. Accordingly, a decrease in our 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 period during which China’s Spring Festival holiday falls generally accounts for a lower portion of our annual revenues than the other periods, but our expenses do not vary as significantly as changes in occupancy and revenues, since 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. Our property development and renovation costs may increase as a result of increasing costs of materials. However, we have a 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.

 

17


Table of Contents

Our lessors’ failure to comply with lease registration and other compliance requirements under PRC law may subject these lessors or us to fines or other penalties that may negatively affect our ability to operate our hotels.

As an operator and manager of hotel properties, we, our franchisees and those from whom we lease properties, are subject to a number of land- and property-related legal requirements. For instance, under PRC law, all lease agreements are required to be registered with the local housing bureau. Our standard lease agreement generally requires the lessor to make such registrations. However, as of December 31, 2006, lessors of 47 hotels we lease and operate had not obtained registrations of their leases from the relevant authorities as required. We continue to remind these lessors to obtain registrations under our lease agreements with them. In addition, based on the specific land use right certificates and property ownership certificates currently held by some of our lessors, certain hotel properties we lease are restricted to industrial and other uses, rather than for commercial service use. The failure of our lessors to register lease agreements as required by law or to ensure that the hotel properties are operated in compliance with their designated use may subject these lessors or us to fines or other penalties which may negatively affect our ability to operate the hotels covered under those leases.

We have limited insurance coverage.

We carry property insurance that covers the assets that we own at our hotels, but not the buildings or any other assets owned by our lessors. Although we require our lessors to purchase customary insurance policies, we cannot guarantee that they will adhere to such requirements. If we were held liable for amounts and claims exceeding the limits of our insurance coverage or outside the scope of our insurance coverage, our business, results of operations and financial condition may be materially and adversely affected. In addition, we do not have any business disruption insurance coverage for our operations to cover losses that may be caused by natural disasters or catastrophic events, such as SARS or avian flu. Any business disruption or natural disaster may result in our incurring substantial costs and diversion of our resources.

If we are unable to maintain our hotels’ good condition and attractive appearance, our hotel occupancy rates may decline.

In order to maintain our hotels’ good condition and attractive appearance, our hotels require ongoing renovations and other leasehold improvements, including periodic replacement of furniture, fixtures and equipment. If we and our franchisees do not make needed leasehold investments and improvements, we could lose our market share to our competitors and our hotel occupancy rates may decline.

The growth of on-line and other hotel reservation intermediaries and travel consolidators may adversely affect our margins and profitability.

Some of our hotel rooms are booked through travel intermediaries and consolidators to whom we pay commissions for such services. If these intermediaries and consolidators become the primary channel through which our customers make their bookings, they may be able to negotiate higher commissions, reduced room rates, or other significant concessions from us. We believe that the aim of such intermediaries and consolidators is to have consumers develop loyalties to their reservation systems rather than to our brand. The operations 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.

If we fail to maintain an effective system of internal controls over financial reporting, we may not be able to accurately report our financial results or prevent fraud.

We are subject to reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, adopted rules requiring every public company to include a management report on such company’s internal

 

18


Table of Contents

controls over financial reporting in its annual report, which contains management’s assessment of the effectiveness of our internal controls over financial reporting. In addition, an independent registered public accounting firm must attest to and report on management’s assessment of the effectiveness of the company’s internal controls over financial reporting. These requirements will first apply to our annual report on Form 20-F for the fiscal year ending on December 31, 2007. Our management may conclude that our internal controls over our financial reporting are not effective. Moreover, even if our management concludes that our internal controls over financial reporting is effective, our independent registered public accounting firm may still decline to attest to our management’s assessment or 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. 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 our initial public offering in October 2006, we were a young, private company with limited accounting and other resources with which to adequately address our internal controls and procedures. When our independent registered public accounting firm audited our consolidated financial statements for the three years ended December 31, 2005, they identified certain control deficiencies, including two material weaknesses in our internal control over financial reporting, as defined in Audit Standard No. 2 of the Public Company Accounting Standards Board. Specifically, the two material weaknesses identified by our independent registered public accounting firm consisted of (i) our lack of adequate review and monitoring over financial reporting and disclosure process, as well as our lack of sufficient control over the financial closing and reporting procedures; and (ii) the lack of sufficient U.S. GAAP knowledge of our accounting staff. We have taken measures to remediate these material weaknesses and other control deficiencies, including implementing additional control procedures, reinforcing the existing controls and recruiting additional finance and accounting personnel. As a result, when our independent registered public accounting firm audited our consolidated financial statements for the year ended December 31, 2006, they noted that most of the factors causing the above two material weaknesses had been remediated or improved. We plan to remediate our material weaknesses and other control deficiencies in time to meet the deadline for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act. If, however, we fail to timely achieve and maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal controls over financial reporting. Our failure to achieve and maintain effective internal controls over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our ADSs. Furthermore, we anticipate that we will incur considerable costs and devote significant management time and efforts and other resources to comply with Section 404 of the Sarbanes-Oxley Act.

We incur increased costs as a result of being a public company.

As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company prior to our initial public offering in October 2006. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the SEC and Nasdaq, 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. In addition, we incur ongoning additional costs associated with our public company reporting requirements. 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.

The new M&A rule sets forth complex procedures for acquisitions conducted by foreign investors which could make it more difficult to pursue growth through acquisitions.

On August 8, 2006, six PRC regulatory agencies, namely, the PRC Ministry of Commerce, the State Assets Supervision and Administration Commission, or SASAC, the State Administration for Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission, or the CSRC, and the PRC State Administration of Foreign Exchange, or SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rule, which became effective on

 

19


Table of Contents

September 8, 2006. The New M&A Rule sets forth complex procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex, including requirements in some instances that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. We may grow our business in part by acquiring complementary businesses or assets in China. 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 Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

If the relevant PRC authorities take the position that this offering is subject to their approval because a shareholder of ours is controlled by a state-owned entity, we may be subject to administrative sanctions or penalties.

A notice issued by the State Council of China in June 1997, or the State Council notice, required certain PRC companies to receive approval from relevant PRC authorities prior to transferring assets out of China for purposes of effecting a public offering and listing. Specifically, the State Council notice provides that, if a non-public offshore company with “PRC funds,” or a PRC funded company, plans to issue and list shares outside the PRC, approval from the relevant government authorities at the provincial level or higher or the approval of the CSRC may be required. The ultimate owner of Poly Victory, one of our shareholders, is BTG, a PRC state-owned enterprise. Although Poly Victory currently holds 20.1% of our outstanding voting securities, it does not control or have significant influence on us as we have a controlling group that in the aggregate owns 26.7% of our outstanding voting securities. This group consists of seven individuals who are unrelated to Poly Victory or BTG and who have entered into an acting-in-concert agreement. Under the terms of the State Council notice, it is not clear whether Poly Victory’s investment in our company would cause us to be treated as a PRC funded company for purposes of the notice. Our PRC counsel, Commerce & Finance Law Offices, has advised us that the State Council notice does not apply to Poly Victory in the context of this offering because Poly Victory has no control over us, and no application for approval from any PRC government authority in connection with this offering has been made. However, if any relevant government authority subsequently determines that the State Council notice applies to this offering, we may be subject to administrative sanctions or penalties.

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 travel 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 20 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. Since late 2003, the PRC

 

20


Table of Contents

government implemented a number of measures, such as increasing the People’s Bank of China’s statutory deposit reserve ratio and imposing commercial bank lending guidelines that had the effect of restricting 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 adversely affect us.

We conduct our business primarily through our subsidiaries in China. Our operations in China are governed by PRC laws and regulations. Our subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently-enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published court decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

Governmental control of currency conversion may 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. We receive substantially all of our revenues in RMB. Under our current structure, our income will be primarily derived from dividend payments from our PRC subsidiaries. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiaries and our affiliated entity to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency dominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from SAFE, by complying with certain procedural requirements. However, 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.

Fluctuation in the value of the RMB may have a material adverse effect on your investment.

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within a managed band based on market supply and demand and by reference to a basket of certain foreign currencies. This change in policy has resulted in an approximately 6.1% appreciation of the RMB against the U.S. dollar between July 21, 2005 and December 31, 2006. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which may result in a further and more significant appreciation of the RMB against the U.S. dollar. Our revenues and costs are mostly denominated in the RMB, and a significant portion of our financial assets are also denominated in the RMB. We rely entirely on dividends paid to us by our subsidiaries in China. Any significant revaluation of the RMB may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our ADSs in U.S. dollars. For example, an appreciation of the RMB against the U.S. dollar would make any new RMB-denominated investments or expenditures more costly to us, to the extent that we need to convert

 

21


Table of Contents

U.S. dollars into the RMB for such purposes. An appreciation of the RMB against the U.S. dollar would also result in foreign currency translation losses for financial reporting purposes when we translate our U.S. dollar denominated financial assets into the RMB, as the RMB is our reporting currency. As of December 31, 2006, our U.S. dollar denominated financial assets consisted solely of a cash balance of approximately US$82.5 million. We expect to have additional U.S. dollar denominated assets from the net proceeds we will receive from this offering pending our application of such proceeds to the uses described in “Use of Proceeds.”

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.

SAFE issued a public notice in October 2005 requiring PRC residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing with assets or equity of PRC companies, referred to in the notice as an “offshore special purpose company.” Under this public notice, PRC residents who are shareholders and/or beneficial owners of such offshore special purpose companies were required to register with the local SAFE branch before March 31, 2006. We have requested our shareholders and/or beneficial owners who are subject to the registration requirements under the SAFE notice to register with the local SAFE branch. Failure of these shareholders and/or beneficial owners to register with the local SAFE branch as required by the SAFE notice or failure of future shareholders of our company who are PRC residents to comply with the registration procedures set forth in the SAFE notice may subject such shareholders and/or beneficial owners to fines and other government actions and may also limit our ability to fund our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute dividends to our company or otherwise adversely affect our business.

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 entities 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 Chinese 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, 2006, aggregate net assets of RMB 154.6 million (US$19.8 million) were 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. In addition, the PRC tax authorities may require us to adjust our taxable income under the contractual arrangements we currently have in place in a manner that would materially and adversely affect our subsidiaries’ ability to pay dividends and other distributions to us. Any limitation on the ability 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 we will receive from this offering to make loans or additional capital contributions to our PRC operating subsidiaries.

In utilizing the proceeds we will receive from 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 must be registered with the SAFE.

 

22


Table of Contents

We may also decide to finance our subsidiaries by means of capital contributions. These capital contributions must be approved by the PRC Ministry of Commerce or its local counterpart. 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 we will receive from 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.

We have benefited from certain financial subsidies and preferential tax treatments in China. Reduction or elimination of these subsidies or preferential tax treatments may have an adverse effect on our results of operations.

Various local tax authorities in China have provided financial subsidies in the form of certain tax refunds to us. However, these tax authorities may reduce or eliminate any or all of these financial subsidies at any time in the future. There is no assurance that we will continue to receive any financial subsidies in the form of tax refunds or otherwise as the grant of such subsidies is within the discretion of relevant local government authorities. In addition, some of our subsidiaries are subject to lower enterprise income tax rates or tax exemptions due to the preferential tax treatments granted by the local tax authorities. For example, our wholly owned subsidiary, Hemei Hotel Management Company, enjoys a 15% enterprise income tax rate due to its place of incorporation and operation in the Pudong New District of Shanghai. If such preferential tax treatments granted by local tax authorities are deemed to be in violation of national laws and regulations or are abolished or altered, our subsidiaries will be subject to the standard enterprise income tax rate, which currently is 33%. Under current PRC regulations, if it is determined that a taxpayer has underpaid tax due to prior advice from relevant tax authorities, the taxpayer may still be required to pay the full amount of unpaid tax within three years after such determination but the taxpayer will not be subject to any penalty or late payment fee. On March 16, 2007, the National People’s Congress, the Chinese legislature, passed a new tax law, which will take effect on January 1, 2008. The new law applies a uniform 25% enterprise income tax rate to both foreign-invested enterprises and domestic enterprises. There will be a transition period for enterprises, whether foreign-invested or domestic, which currently receive preferential tax treatments granted by relevant tax authorities. Enterprises that are subject to an enterprise income tax rate lower than 25% may continue to enjoy the lower rate and gradually transfer to the new tax rate within five years after the effective date of the new law. Enterprises that are currently entitled to exemptions or reductions from the standard income tax rate for a fixed term may continue to enjoy such treatment until the fixed term expires. Preferential tax treatments will continue to be granted to industries and projects that are strongly supported and encouraged by the state, and enterprises otherwise classified as “new and high technology enterprises strongly supported by the state” will be entitled to a 15% enterprise income tax rate. However, the new tax law does not define this term. The new tax law also provides that enterprises established outside of China whose “de facto management bodies” are located in China are considered “resident enterprises” and will generally be subject to the uniform 25% enterprise income tax rate on their global income. The new tax law does not define the term “de facto management bodies.” Reduction or elimination of the financial subsidies or preferential tax treatments we currently enjoy or imposition of additional taxes on us or our subsidiaries in China may have a material adverse effect on our results of operations.

Risks Related to Our ADSs and This Offering

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:

 

   

revisions to our projected financial or operations targets;

 

   

actual or anticipated fluctuations in our quarterly operating results;

 

   

changes in projections or estimates relating to our financial or operational performance by securities research analysts;

 

23


Table of Contents
   

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.

You will experience immediate dilution in the net tangible book value of ADSs purchased.

When you purchase ADSs in the offering at the public offering price of US$             per ADS you will incur immediate dilution of US$             per ADS. See “Dilution.” In addition, you may experience further dilution to the extent that additional ordinary shares are issued upon exercise of outstanding options and options we may grant from time to time.

We may need additional capital, and the sale of additional ADSs or other equity securities could result in additional dilution to our shareholders.

We believe that our current cash and cash equivalents, anticipated cash flow from operations and the proceeds from our initial public offering in October 2006 and 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 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.

Substantial future sales of our ADSs in the public market, or the perception that these sales could occur, could cause the price of our ADSs to decline.

Additional sales of our ordinary shares in the public market after this offering, or the perception that these sales could occur, could cause the market price of our ADSs to decline. Upon completion of this offering, we will have 69,403,259 ordinary shares outstanding. All shares sold in this offering will be freely transferable without restriction or additional registration under the Securities Act of 1933, as amended, or the Securities Act. The remaining ordinary shares outstanding after this offering will be available for sale, upon the expiration of the applicable lock-up period, subject to volume and other restrictions as applicable under Rule 144 under the Securities Act. Any or all of these shares may be released prior to expiration of the lock-up period at the discretion of the lead underwriters for this offering. To the extent shares are released before the expiration of the relevant lock-up period and these shares are sold into the market, the market price of our ADSs could decline. See “Shares Eligible for Future Sale.”

 

24


Table of Contents

In addition, certain holders of our ordinary shares have the right to cause us to register the sale of a certain number of our shares under the Securities Act. 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.

Our corporate actions are substantially controlled by our officers, directors and principal shareholders.

Seven individual shareholders of our company, namely, Neil Nanpeng Shen, Qi Ji, Chung Lau, Min Fan, Rixin Liang, David Jian Sun and May Wu, have entered into an acting-in-concert agreement, under which they have agreed to act together on all matters requiring shareholder approval and to appoint one representative to vote on behalf of all of them at our shareholder meetings until July 2007. These seven shareholders, who hold a total of 17,769,037 ordinary shares, or 25.6% of our outstanding voting securities immediately after the closing of this offering, could exert substantial influence over matters requiring approval by our shareholders, including electing directors and approving mergers or other business combination transactions. In addition, BTG, through its affiliate, Poly Victory, will own 19.3% of our outstanding voting securities immediately after the closing of this offering and has the right to appoint, and has appointed, two directors of our company. The concentration of our share ownership may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company 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.

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 have appointed 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 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 represented by the ADRs 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.

 

25


Table of Contents

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, the laws of the Cayman Islands and of China may render you unable 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. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law (2004 Revision) and 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 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 articles of association 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 an opportunity 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. 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 ADS 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 fall and the voting and other rights of the holders of our common shares and ADSs may be materially and adversely affected.

 

26


Table of Contents

Our management will have considerable discretion as to the use of our net proceeds from this offering.

We have not allocated the majority of our net proceeds of this offering to any particular purpose. Rather, 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 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.

We may be classified as a passive foreign investment company, which could result in adverse United States federal income tax consequences for U.S. Holders.

Based on the expected price of our ADSs and ordinary shares following this offering, and the composition of our income and assets, we do not expect to be considered a “passive foreign investment company,” or PFIC, for United States federal income tax purposes for our current taxable year ending December 31, 2007, and we expect to operate in such a manner so as not to become a PFIC in the future. However, we must make a separate determination each year as to whether we are a PFIC (after the close of each taxable year). Accordingly, we cannot assure you that we will not be a PFIC for our current taxable year ending December 31, 2007 or any future taxable year. A non-U.S. corporation will be considered a PFIC for any taxable year if either (i) at least 75% of its gross income is passive income or (ii) at least 50% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income. The value of our assets generally will be determined by reference to the market price of our ADSs and ordinary shares, which may fluctuate considerably. In addition, the composition of our income and assets will be affected by how, and how quickly, we spend the cash we raise in any offering. If we were treated as a PFIC for any taxable year during which a U.S. Holder held an ADS or an ordinary share, certain adverse United States federal income tax consequences could apply to the U.S. Holder. For the definition of “U.S. Holder” and a more detailed discussion of United States federal income tax consequencies to U.S. Holders, see “Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.”

 

27


Table of Contents

FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve risks and uncertainties. All statements other than statements of historical facts are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

You can identify these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “likely to” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include:

 

   

our anticipated growth strategies;

 

   

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;

 

   

trends and competition in the lodging industry; and

 

   

our ability to develop new hotels at desirable locations in a timely and cost-effective manner.

You should read thoroughly this prospectus and the documents that we refer to in this prospectus with the understanding that our actual future results may be materially different from and worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements. Other sections of this prospectus include additional factors which could adversely impact our business and financial performance. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

28


Table of Contents

USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately US$             million based on the last trading price of our ADSs on             , 2007 of US$             per ADS, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us. We will not receive any of the proceeds from the sale of ADSs by the selling shareholders.

The primary purposes of this offering are to raise capital to fund working capital, improve our financial strength and flexibility, fund potential strategic acquisitions and for other general corporate purposes.

In utilizing the proceeds we will receive from this offering, as an offshore holding company we are permitted, under PRC regulations, to provide funding to our PRC subsidiaries only through loans or capital contributions. Subject to satisfaction of applicable government registrations and approval requirements, we may extend inter-company loans or make additional capital contributions to our PRC subsidiaries to fund their capital expenditures or working capital. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all. See “Risk Factors—Risks Related to Doing Business in China—PRC regulation of loans and direct investment by offshore holding companies to PRC entities may delay or prevent us from using the proceeds we will receive from this offering to make loans or additional capital contributions to our PRC operating subsidiaries.”

The foregoing represents our current intentions to use and allocate the net proceeds we will receive from this offering based upon our present plans and business conditions. Our management, however, will have significant flexibility and discretion to apply the net proceeds of this offering. If an unforeseen event occurs or business conditions change, we may use the proceeds we will receive from this offering differently than as described in this prospectus.

Pending use of the net proceeds we will receive from this offering, we intend to hold our net proceeds in demand deposits.

 

29


Table of Contents

DIVIDEND POLICY

We have no present plan to declare and pay any dividends on our shares or ADSs in the near future. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

We are a holding company incorporated in the Cayman Islands. We rely on dividends from our subsidiaries in China. 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 is required to set aside a certain amount of its accumulated after-tax profits each year, if any, to fund certain statutory reserves. These reserves may not be distributed as cash dividends. Further, if our subsidiaries in China incur debt on their own behalf, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us.

Our board of directors has complete discretion as to whether to distribute dividends, subject to the approval of our shareholders. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant. If we pay any dividends, we will pay our ADS holders 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.

 

30


Table of Contents

CAPITALIZATION

The following table sets forth our capitalization as of December 31, 2006:

 

   

on an actual basis;

 

   

on an as adjusted basis to reflect the issuance and sale of 2,956,310 ordinary shares in the form of ADSs by us in this offering at the assumed public offering price of US$             per share, based on the last trading price of our ADSs on             , 2007 as adjusted to reflect the ratio of one ADS to two ordinary shares, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

You should read this table together with our consolidated financial statements and 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, 2006  
     Actual    As adjusted(1)  
     RMB    US$    RMB    US$  
     (in thousands)  

Loans

   184,000    23,577      

Shareholders’ equity:

           

Ordinary shares, US$0.005 par value, 200,000,000 shares authorized, 65,712,839 shares issued and outstanding on an actual basis,              shares issued and outstanding as adjusted

   2,691    345      

Additional paid-in capital

   813,222    104,204      

Statutory reserve

   23,415    3,000      

Retained earnings

   50,411    6,460      

Total shareholders’ equity

   889,739    114,009      
                     

Total capitalization

   1,073,739    137,586      
                     

 

(1) A US$1.00 increase (decrease) in the assumed public offering price of US$         per ADS would increase (decrease) the amounts representing total shareholders’ equity and total capitalization by US$        .

 

31


Table of Contents

DILUTION

Our net tangible book value as of December 31, 2006 was approximately US$1.65 per share, and US$3.29 per ADS. Net tangible book value per share represents the amount of total tangible assets, minus the amount of total liabilities, divided by the total number of ordinary shares outstanding. Dilution is determined by subtracting net tangible book value per ordinary share from the assumed public offering price per ordinary share.

Without taking into account any other changes in such net tangible book value after December 31, 2006, other than to give effect to our sale of 1,478,155 ADSs in this offering, at the assumed public offering price of US$             per ADS based on the last trading price of our ADSs on             , 2007 of US$             per ADS, after deducting underwriting discounts and commission and the estimated offering expenses payable by us, and after deduction of underwriting discounts and commissions and estimated offering expenses, our pro forma net tangible book value at December 31, 2006 would have been US$             per outstanding ordinary share, including ordinary shares underlying our outstanding ADSs, or US$             per ADS. This represents an immediate increase in net tangible book value of US$             per ordinary share, or US$             per ADS, to existing shareholders and an immediate dilution in net tangible book value of US$             per ordinary share, or US$             per ADS, to purchasers of ADSs in this offering.

The following table illustrates the dilution on a per ordinary share basis based on the assumed public offering price of US$             per ordinary share and assuming all ADSs are exchanged for ordinary shares:

 

Assumed public offering price per ordinary share

   US$             

Net tangible book value per ordinary share

   US$             
      

Amount of dilution in net tangible book value per ordinary share to new investors in the offering

   US$             
      

Amount of dilution in net tangible book value per ADS to new investors in the offering

   US$             
      

A US$1.00 increase (decrease) in the assumed public offering price of US$             per ADS would increase (decrease) our pro forma net tangible book value after giving effect to the offering by US$            , the pro forma net tangible book value per ordinary share and per ADS after giving effect to this offering by US$             per ordinary share and US$             per ADS and the dilution in pro forma net tangible book value per ordinary share and per ADS to new investors in this offering by US$             per ordinary share and US$             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 underwriting discounts and commissions and other offering expenses.

The following table summarizes, on a pro forma basis as of December 31, 2006, the differences between the shareholders as of December 31, 2006 and the new investors with respect to the number of ordinary shares purchased from us, the total consideration paid and the average price per ordinary share paid at the assumed public offering price of US$             per ADS before deducting estimated underwriting discounts and commissions and estimated offering expenses. The pro forma information discussed above is illustrative only.

 

     Ordinary Shares
Purchased
    Total Consideration     Average Price
Per Ordinary
Share
   Average Price
Per ADS
     Number    Percent     Amount    Percent           

Existing shareholders

           %   US$                      %   US$                 US$             

New investors

           %           %     
                             

Total

           %   US$                      %     
                             

The discussion and tables above also assume no exercise of any outstanding stock options. As of the date of this prospectus, there are 3,198,886 ordinary shares issuable upon exercise of outstanding stock options at a weighted average exercise price of US$3.11 per share, and there are 200,927 ordinary shares plus 6% of our total outstanding shares from time to time (excluding shares issuable upon exercise of options or otherwise pursuant to any of our share incentive plans) available for future issuance upon the exercise of future grants under our share incentive plans. To the extent that any of these options are exercised, there will be further dilution to new investors.

 

32


Table of Contents

MARKET PRICE INFORMATION FOR OUR ADSs

Our ADSs, each representing two of our ordinary shares, have been listed on the Nasdaq Global Market since October 26, 2006. Our ADSs trade under the symbol “HMIN.” For the period from October 26, 2006 to April 18, 2007 the trading price of our ADSs on the Nasdaq Global Market has ranged from US$21.50 to US$49.50 per ADS. The following table provides the high and low trading prices for our ADSs on the Nasdaq Global Market for each of the months since our initial public offering.

 

     Trading Price
     High    Low
     US$    US$

Monthly Highs and Lows

     

2006 (from October 26)

     

October (from October 26)

   26.77    21.50

November

   34.80    23.65

December

   39.02    30.11

2007

     

January

   47.49    36.05

February

   49.50    39.20

March

   40.79    33.74

April (through April 18)

   37.39    34.77

 

33


Table of Contents

EXCHANGE RATE INFORMATION

Our business is conducted in China and substantially all of our revenues are denominated in RMB. However, periodic reports made to shareholders will be expressed in U.S. dollars using the then current exchange rates. This prospectus contains translations of RMB amounts into U.S. dollars at specific rates solely for the convenience of the reader. The conversion of RMB into U.S. dollars in this prospectus is based on the noon buying rate in The City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations of financial data from RMB to U.S. dollars in this prospectus were made at a rate of RMB 7.8041 to US$1.00, the noon buying rate in effect as of December 31, 2006. 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, the rates stated below, 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 April 18, 2007, the noon buying rate was RMB 7.7208 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. The source of these rates is the Federal Reserve Bank of New York.

 

      Noon Buying Rate

Period

   Period
End
   Average (1)    Low    High
     (RMB Per US$1.00)

2002

   8.2800    8.2770    8.2800    8.2669

2003

   8.2767    8.2772    8.2800    8.2765

2004

   8.2765    8.2768    8.2774    8.2764

2005

   8.0702    8.1940    8.2765    8.0702

2006

   7.8041    7.9723    8.0702    7.8041

October

   7.8785    7.9018    7.9168    7.8728

November

   7.8340    7.8622    7.8750    7.8303

December

   7.8041    7.8219    7.8350    7.8041

2007

           

January

   7.7714    7.7876    7.8127    7.7705

February

   7.7410    7.7502    7.7632    7.7410

March

   7.7232    7.7369    7.7454    7.7232

April (through April 18)

   7.7208    7.7274    7.7345    7.7208

(1) Annual averages are calculated from month-end rates. Monthly averages are calculated using the average of the daily rates during the relevant period.

 

34


Table of Contents

ENFORCEABILITY OF CIVIL LIABILITIES

We were incorporated in the Cayman Islands in order to enjoy the following benefits:

 

   

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.

However, certain disadvantages accompany incorporation in the Cayman Islands. These disadvantages include:

 

   

the Cayman Islands has a less developed body of securities laws as compared to the United States and these securities laws provide significantly less protection to investors; and

 

   

Cayman Islands companies may not have standing to sue before the federal courts of the United States.

Our constituent 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.

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, 111 Eighth Avenue, New York, New York 10011, as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.

Maples and Calder, our counsel as to Cayman Islands law, and Commerce & Finance Law Offices, our counsel as to PRC law, have advised us, respectively, 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.

Maples and Calder has further 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.

Commerce & Finance Law Offices has further advised us that the recognition and enforcement of foreign judgments are provided for under PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions.

 

35


Table of Contents

SELECTED CONSOLIDATED FINANCIAL DATA

Our Selected Consolidated Financial Data

You should read the following information in conjunction with our and Home Inns Beijing’s consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

The following table presents our selected consolidated financial information. The selected consolidated statement of operations data for the years ended December 31, 2004, 2005 and 2006 and the selected consolidated balance sheet data as of December 31, 2005 and 2006 have been derived from our consolidated financial statements included elsewhere in this prospectus. Our consolidated statement of operations data for the years ended December 31, 2003, 2004, 2005 and 2006 and our consolidated balance sheet data as of December 31, 2004, 2005 and 2006 have been derived from our consolidated financial statements for the relevant periods which have been audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, an independent registered public accounting firm, and are prepared and presented in accordance with U.S. GAAP, and reflect our current corporate structure as if it had been in existence throughout the relevant periods. Our selected consolidated statement of operations data for the year ended December 31, 2002 and our consolidated balance sheet data as of December 31, 2002 and 2003 have been derived from our unaudited consolidated financial statements which are not included in this prospectus. We have prepared the unaudited consolidated financial information on the same basis as our audited consolidated financial statements. The unaudited consolidated financial information includes all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Our historical results do not necessarily indicate results expected for any future periods.

We have been actively managing Home Inns Beijing since its inception. Home Inns Hong Kong’s ownership in Home Inns Beijing was accounted for under the equity method since Home Inns Beijing’s inception until April 2004, because during this period of time, BTG had substantive participation rights that enabled it to veto significant decisions made by Home Inns Hong Kong. In April 2004, Home Inns Hong Kong and Beijing Capital Travel, a subsidiary of BTG, entered into a revised joint venture agreement, under which Home Inns Hong Kong obtained control of Home Inns Beijing. As a result, Home Inns Beijing has been our consolidated subsidiary since then.

 

     For the Year Ended December 31,  
     2002    2003    2004     2005     2006  
     RMB    RMB    RMB     RMB     RMB     US$  
     (in thousands, except share, per share and per ADS data)  

Consolidated Statement of Operations Data

              

Revenues:

              

Leased-and-operated hotels

   —      —      93,687     279,948     567,895     72,769  

Franchised-and-managed hotels

   —      —      2,313     5,913     20,605     2,640  
                                  

Total revenues

   —      —      96,000     285,861     588,500     75,409  
                                  

Less: Business tax and related surcharges

   —      —      (5,101 )   (16,830 )   (33,977 )   (4,354 )
                                  

Net revenues

   —      —      90,899     269,031     554,523     71,055  
                                  

 

36


Table of Contents
     For the Year Ended December 31,  
     2002     2003     2004     2005     2006  
     RMB     RMB     RMB     RMB     RMB     US$  
     (in thousands, except share, per share and per ADS data)  

Consolidated Statement of Operations Data (continued)

            

Operating costs and expenses(1):

            

Leased-and-operated hotel costs:

            

Rents and utilities

   —       —       (30,703 )   (94,784 )   (171,576 )   (21,985 )

Personnel costs

   —       —       (12,949 )   (41,225 )   (87,980 )   (11,274 )

Depreciation and amortization

   —       —       (5,681 )   (23,335 )   (44,620 )   (5,717 )

Consumables, food and beverage

   —       —       (6,441 )   (20,765 )   (43,482 )   (5,572 )

Others

   —       —       (8,162 )   (26,100 )   (56,019 )   (7,178 )
                                    

Total leased-and-operated hotel costs

   —       —       (63,936 )   (206,209 )   (403,677 )   (51,726 )
                                    

Sales and marketing expenses

   —       —       (2,113 )   (7,691 )   (11,488 )   (1,472 )

General and administrative expenses

   (40 )   (365 )   (16,127 )   (24,789 )   (64,792 )   (8,302 )
                                    

Total operating costs and expenses

   (40 )   (365 )   (82,176 )   (238,689 )   (479,957 )   (61,500 )
                                    

Income (loss) from operations

   (40 )   (365 )   8,723     30,342     74,566     9,555  
                                    

Interest income

   2     1     89     222     6,578     843  

Interest expense

   —       —       (98 )   (709 )   (6,143 )   (787 )

Other non-operating income

   —       —       325     2,146     5,308     680  

Foreign exchange gain (loss), net

       144     254     (6,990 )   (896 )
                                    

Income (loss) before income tax expense, minority interests and share of income of affiliated companies

   (38 )   (364 )   9,183     32,255     73,319     9,395  
                                    

Income tax expense

   —       —       (5,738 )   (6,525 )   (21,391 )   (2,741 )

Minority interests

   —       —       552     (4,797 )   (5,034 )   (645 )

Share of income (loss) of affiliated companies

   (535 )   1,878     1,972     —       —       —    
                                    

Net income (loss)

   (573 )   1,514     5,969     20,933     46,894     6,009  
                                    

Amount allocated to participating preferred shareholders

   —       (868 )   (2,960 )   (9,487 )   (16,174 )   (2,073 )
                                    

Net income (loss) available to ordinary shareholders

   (573 )   646     3,009     11,446     30,720     3,936  
                                    

Earnings (loss) per share:

            

Basic

   (0.05 )   0.06     0.15     0.42     0.86     0.11  

Diluted

   (0.05 )   0.06     0.15     0.40     0.82     0.10  

Earnings (loss) per ADS(2):

            

Basic

   (0.10 )   0.12     0.30     0.84     1.73     0.22  

Diluted

   (0.10 )   0.12     0.30     0.80     1.64     0.21  

Weighted average ordinary shares outstanding:

            

Basic

   11,000,000     11,000,000     19,981,424     27,399,140     35,550,114     35,550,114  

Diluted

   11,000,000     11,000,000     20,315,681     28,713,188     37,530,332     37,530,332  

(1) Share-based compensation expenses are included in the consolidated statement of operations data as follows:

 

     For the Year Ended December 31,
     2002    2003    2004    2005    2006
     RMB    RMB    RMB    RMB    RMB    US$
     (in thousands)

Leased-and-operated hotel costs—personnel costs

   —      —      8    8    12    2

General and administrative expenses

   —      —      141    952    16,283    2,086

 

(2) Each ADS represents two ordinary shares.

 

37


Table of Contents

The following table presents a summary of our consolidated balance sheet data as of December 31, 2002, 2003, 2004, 2005 and 2006:

 

     As of December 31,
     2002    2003    2004    2005    2006
     RMB    RMB    RMB    RMB    RMB    US$
     (in thousands)

Consolidated Balance Sheet Data:

                 

Cash and cash equivalents

   1,797    11,342    26,292    37,727    758,004    97,129

Total assets

   6,983    47,466    174,304    375,002    1,320,019    169,144

Current portion of long-term loan from a related party

   —      —      —      —      10,000    1,281

Total current liabilities

   2,054    2,193    39,768    119,187    323,229    41,418

Deferred rental

   —      —      11,890    26,534    44,103    5,651

Long-term loan from a related party

   —      —      —      40,000    50,000    6,407

Convertible preferred shares

   —      813    813    949    —      —  

Ordinary shares

   455    455    1,134    1,134    2,691    345

Additional paid-in capital

   5,046    43,062    110,687    152,878    813,222    104,204

Total shareholders’ equity

   4,929    45,273    116,861    179,083    889,739    114,009

 

38


Table of Contents

Home Inns Beijing’s Selected Consolidated Financial Data

You should read the following information in conjunction with Home Inns Beijing’s consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

The following selected consolidated financial information has been derived from Home Inns Beijing’s consolidated financial statements included elsewhere in this prospectus. Home Inns Beijing’s consolidated statement of operations data and consolidated balance sheet data for the year ended December 31, 2004 and as of December 31, 2004 have been derived from its consolidated financial statements for the relevant periods which have been audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, an independent registered public accounting firm, and are prepared and presented in accordance with U.S. GAAP.

We have been actively managing Home Inns Beijing since its inception. Home Inns Hong Kong’s ownership in Home Inns Beijing was accounted for under the equity method since Home Inns Beijing’s inception until April 2004, because during this period of time, BTG had substantive participation rights that enabled it to veto significant decisions made by Home Inns Hong Kong. In April 2004, Home Inns Hong Kong and Beijing Capital Travel, a subsidiary of BTG, entered into a revised joint venture agreement, under which Home Inns Hong Kong obtained control of Home Inns Beijing. As a result, Home Inns Beijing has been our consolidated subsidiary since then.

 

     For the Year Ended December 31,  
     2004  
    

RMB

(in thousands)

 

Consolidated Statement of Operations Data:

  

Revenues:

  

Leased-and-operated hotels

   112,914  

Franchised-and-managed hotels

   2,364  
      

Total revenues

   115,278  
      

Less: Business tax and related surcharges

   (6,150 )
      

Net revenues

   109,128  
      

Operating costs and expenses(1):

  

Leased-and-operated hotel costs:

  

Rents and utilities

   (36,463 )

Personnel costs

   (15,653 )

Consumables, food and beverage

   (8,149 )

Depreciation and amortization

   (6,685 )

Others

   (10,019 )
      

Total leased-and-operated hotel costs

   (76,969 )
      

Sales and marketing expenses

   (2,563 )

General and administrative expenses

   (16,607 )
      

Total operating costs and expenses

   (96,139 )
      

Income from operations

   12,989  
      

Interest income

   110  

Interest expense

   (125 )

Other non-operating income

   328  
      

Income before income tax expense and minority interests

   13,302  
      

Income tax expense

   (6,861 )

Minority interests

   1,294  

Share of income of affiliated companies

   —    
      

Net income

   7,735  
      

 

39


Table of Contents

(1) Includes share-based compensation expenses are included in the statement of operations data as follows:

 

     For the Year Ended December 31,
     2004
     RMB
     (in thousands)

Leased-and-operated hotel costs—personnel costs

   8

General and administrative expenses

   141

The following table presents a summary of Home Inns Beijing’s consolidated balance sheet data as of December 31, 2004:

 

     As of December 31,
     2004
     RMB
     (in thousands)

Consolidated Balance Sheet Data:

  

Cash and cash equivalents

   16,710

Total assets

   130,562

Total current liabilities

   39,900

Deferred rental

   11,890

Paid-in capital

   68,945

Additional paid-in capital

   150

Total shareholders’ equity

   78,346

 

40


Table of Contents

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 are a leading economy hotel chain in China, based on the number of our hotels and the number of our hotel rooms, as well as the geographic coverage of our hotel chain. We develop and operate economy hotels across China under our award-winning Home Inn brand. We have experienced substantial growth while maintaining profitability since 2003. Our Home Inns hotels in operation grew rapidly from 10 hotels in four cities at the end of 2003 to 134 hotels in 39 cities as of the end of 2006, and our net income grew from RMB 1.5 million in 2003 to RMB 46.9 million (US$6.0 million) in 2006, representing a CAGR of 215%. As of March 31, 2007, our Home Inns hotel chain consisted of 97 leased-and-operated hotels in operation with an additional 36 leased-and-operated hotels under development and 48 franchised-and-managed hotels in operation and an additional 12 franchised-and-managed hotels under development, covering 53 cities in China.

We have achieved our growth by utilizing two business models. We either lease properties on which we develop and operate hotels, or we franchise our brand to hotel owners and manage these hotels. We refer to the former type of hotels as “leased-and-operated hotels” and to the latter type of hotels as “franchised-and-managed hotels.” Our recent growth has been primarily organic, through developing and operating additional hotels in existing markets and expanding the geographic reach of our hotel chain. We intend to develop and operate additional hotels under both business models to maintain or achieve a dominant position in every market covered by our Home Inns hotel chain.

Our operating results are subject to conditions typically affecting the lodging industry, including changes in the national, regional or local economic conditions in China; natural disasters or travelers’ fears of exposure to serious contagious diseases; the attractiveness of our hotels to customers and competition from other hotels; local market conditions, such as an oversupply of, or a reduction in demand for, hotel rooms; and increases in operating costs and expenses due to inflation and other factors. Unfavorable changes in any of these conditions could negatively impact our occupancy rates, average daily rates and, as a result, RevPAR or otherwise adversely affect our results of operations. While our operating results are influenced by conditions typically affecting the lodging industry and also by conditions in each of the geographic markets we operate, they are more directly affected by company-specific key performance indicators as discussed below.

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 us 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 Home Inns hotel chain as well as the RevPAR achieved by our hotels. The increase in the number of hotels in our hotel chain is largely affected by the demand for our hotels in various cities and our ability to successfully identify and secure new properties and develop new hotels at desirable locations. RevPAR is a commonly used operating measure in the hospitality industry and is defined as the product of average occupancy

 

41


Table of Contents

rates and average daily rates achieved. Occupancy rates of our hotels mainly depend on the locations of our hotels, the effectiveness of our sales and brand promotion efforts, our ability to maintain the consistency and quality of our facilities and service, the performance of managerial and other employees of our hotels, as well as our ability to respond to competitive pressure. We set room rates of our hotels primarily based on the location of a hotel and room rates charged by our competitors within the same locality. Changes in RevPAR primarily due to changes in average occupancy rates achieved have different implications on our total revenues and profitability than changes in RevPAR primarily due to changes in average daily rates achieved. For example, increases in occupancy at our hotels would generally lead to increases in room revenues as well as additional incremental costs, such as housekeeping services, utilities and room amenity costs. However, RevPAR increases due to higher room rates generally would not result in these additional room-related costs. As a result, RevPAR increases due to higher room rates would have a greater positive effect on our profitability.

Our financial key performance indicators consist of our revenue and cost structure, which are discussed in greater details in the following paragraphs. In addition, we use EBITDA, a non-GAAP financial measure, as a key financial performance indicator to assess our operating results before the impact of interest, income taxes, depreciation and amortization. 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.

Revenues. In 2006, we generated total revenues of RMB 588.5 million (US$75.4 million). Our revenues are significantly affected by the following operating measures, which are widely used in the hospitality industry and appear throughout this prospectus:

 

   

the total number of hotels in our hotel chain;

 

   

the total number of hotel rooms in our hotel chain;

 

   

occupancy rates achieved by our hotels;

 

   

average daily rates achieved by our hotels; and

 

   

the RevPAR achieved by our hotels, which represents the product of average daily rates and occupancy rates.

Our future revenue growth will depend significantly upon our ability to expand our hotel chain into new markets in China and maintain and further increase occupancy rates, average daily rates and RevPAR at existing hotels. As of December 31, 2006, we had entered into binding contracts with lessors of 28 properties for our leased-and-operated hotels which are currently under development. We expect to incur an additional RMB 167 million (US$21.4 million) in capital expenditures in connection with the completion of the leasehold improvements of these hotels. We intend to fund this planned expansion with our operating cash flow and existing cash balance.

 

42


Table of Contents

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.

 

     For the Year Ended December 31,  
     2004     2005     2006  
     RMB     %     RMB     %     RMB     US$     %  
     (in thousands except percentages)  

Revenues:

              

Leased-and-operated hotels

   93,687     97.6     279,948     97.9     567,895     72,769     96.5  

Franchised-and-managed hotels

   2,313     2.4     5,913     2.1     20,605     2,640     3.5  
                                          

Total revenues

   96,000     100.0     285,861     100.0     588,500     75,409     100.0  
                                          

Less: Business tax and related surcharges

   (5,101 )   (5.3 )   (16,830 )   (5.9 )   (33,977 )   (4,354 )   (5.8 )
                                          

Net revenues

   90,899     94.7     269,031     94.1     554,523     71,055     94.2  
                                          

Leased-and-operated Hotels. In 2006, we generated revenues of RMB 567.9 million (US$72.8 million) from our leased-and-operated hotels, which accounted for 96.5% 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.

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 the standards of Home Inns, 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 managers and employees required to operate our hotels and purchasing supplies. We typically pay fixed rent on a 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.

Revenues from our leased-and-operated hotels primarily consist of revenues from sales of room stays and, to a much lesser extent, revenues from sales of food and beverage at our hotels and other services. We recognize revenues from sales of room stays, food and beverage when our services are rendered.

Franchised-and-managed Hotels. In 2006, we generated revenues of RMB 20.6 million (US$2.6 million) from our franchised-and-managed hotels, which accounted for 3.5% 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.

For our franchised-and-managed hotels, we franchise our “Home Inn” brand to franchisees who are property owners, lessors or existing hotel operators, and we are generally responsible for managing these hotels. Under a typical franchise agreement between us and a franchisee, the franchisee is generally required to pay us an initial franchise fee of RMB 200,000 to RMB 300,000, annual franchise fees of 3% of the revenues of the hotel, as well as an annual management fee of 3% of the revenues of the hotel. The franchisee is responsible for the costs of hotel development and customization to conform to the standards of Home Inns, as well as for repairs and maintenance and operating expenses of the hotel. We assist the franchisee in property design, construction, systems installation, and hotel personnel recruiting and training before the franchised-and-managed hotel commences operations. We allow our franchisees to utilize our integrated hotel information and operational systems, such as central reservation system, and charge them an annual or variable fee for such use.

We recognize the initial franchise fee as revenue when the franchised-and-managed hotel opens for business, the fee becomes non-refundable, and we have fulfilled all our commitments and obligations. We

 

43


Table of Contents

recognize ongoing franchise and management fees as revenues when the franchised-and-managed hotel recognizes revenues from which we derive the fees. We recognize fees received from franchisees for system usage, maintenance and support as revenues when our services are rendered.

Operating Costs and Expenses. Our operating costs and expenses consist of costs for our leased-and-operated hotels, sales and marketing expenses, general and administrative expenses and other operating 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.

 

     For the Year Ended December 31,  
     2004     2005     2006  
     RMB     %     RMB     %     RMB     US$     %  
     (in thousands except percentages)  

Total revenues

   96,000     100.0     285,861     100.0     588,500     75,409     100.0  

Less: Business tax and related surcharges

   (5,101 )   (5.3 )   (16,830 )   (5.9 )   (33,977 )   (4,354 )   (5.8 )
                                          

Net revenues

   90,899     94.7     269,031     94.1     554,523     71,055     94.2  
                                          

Leased-and-operated hotel costs:

              

Rents and utilities

   (30,703 )   (32.0 )   (94,784 )   (33.1 )   (171,576 )   (21,985 )   (29.2 )

Personnel costs

   (12,949 )   (13.5 )   (41,225 )   (14.4 )   (87,980 )   (11,274 )   (14.9 )

Depreciation and amortization

   (5,681 )   (5.9 )   (23,335 )   (8.2 )   (44,620 )   (5,717 )   (7.6 )

Consumables, food and beverage

   (6,441 )   (6.7 )   (20,765 )   (7.3 )   (43,482 )   (5,572 )   (7.4 )

Others

   (8,162 )   (8.5 )   (26,100 )   (9.1 )   (56,019 )   (7,178 )   (9.5 )
                                          

Total leased-and-operated hotel costs

   (63,936 )   (66.6 )   (206,209 )   (72.1 )   (403,677 )   (51,726 )   (68.6 )
                                          

Sales and marketing expenses

   (2,113 )   (2.2 )   (7,691 )   (2.7 )   (11,488 )   (1,472 )   (2.0 )

General and administrative expenses

   (16,127 )   (16.8 )   (24,789 )   (8.7 )   (64,792 )   (8,302 )   (11.0 )
                                          

Total operating costs and expenses

   (82,176 )   (85.6 )   (238,689 )   (83.5 )   (479,957 )   (61,500 )   (81.6 )
                                          

Leased-and-operated Hotel Costs. Our leased-and-operated hotel costs consist of costs and expenses directly attributable to our operation of leased-and-operated hotels, primarily including rental payments and utility costs for hotel properties, compensation and benefits for our hotel-based employees, costs of hotel room consumable products, depreciation and amortization of leasehold improvements, and commissions to travel intermediaries and consolidators. We anticipate that our leased-and-operated hotel costs will increase as we continue to open new leased-and-operated hotels and hire additional hotel-based employees.

Sales and Marketing Expenses. Our sales and marketing expenses primarily consist of advertising expenses, production costs of marketing materials, expenses associated with our membership reward program, and compensation and benefits for our sales and marketing personnel, including personnel at our centralized reservation center. We expect that our sales and marketing expenses will increase as we further expand into new geographic locations and promote our brand.

General and Administrative Expenses. Our general and administrative expenses primarily consist of compensation and benefits for our corporate office employees and other employees who are not sales and marketing or hotel-based employees, costs of third-party professional services, and rental payments relating to office and administrative functions. 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 publicly traded company, including costs of enhancing our internal control.

Our leased-and-operated hotel costs and general and administrative expenses include share-based compensation expenses. The following table sets forth the allocation of our share-based compensation expenses

 

44


Table of Contents

both in absolute amount and as a percentage of total share-based compensation expenses, among the cost and expense items set forth below. Share-based compensation expenses are allocated among these items based on the nature of the work our employees were assigned to perform.

 

     For the Year Ended December 31,
     2004    2005    2006
     RMB    %    RMB    %    RMB    US$    %
     (in thousands except percentages)

Leased-and-operated hotel costs—personnel costs

   8    5.4    8    0.8    12    2    0.1

General and administrative expenses

   141    94.6    952    99.2    16,283    2,086    99.9
                                  

Total share-based compensation expenses

   149    100.0    960    100.0    16,295    2,088    100.0
                                  

We adopted an Employee’s Stock Option Plan, or the Option Plan, in 2003 and have granted options and stock purchase rights under the Option Plan since 2003. Prior to December 31, 2005, we accounted for share-based compensation arrangements in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” or APB No. 25, and complied with the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” or SFAS No. 123. Under APB No. 25, compensation cost is recognized based on the difference, if any, between the estimated fair value of our ordinary shares and the amount an employee is required to pay to acquire the ordinary shares, as determined on the date the option is granted. Total compensation cost is recorded in shareholders’ equity as additional paid-in capital and deferred share-based compensation. Deferred share-based compensation is amortized on a straight-line basis and charged to expense over the vesting period of the underlying options.

We adopted a 2006 Share Incentive Plan, or the 2006 Plan, in 2006 and have granted options under the 2006 Plan. Beginning on January 1, 2006, we adopted SFAS No. 123 (revised 2004), “Share-Based Payment,” or SFAS No. 123 (R), under which share-based compensation expenses have been recognized generally over the vesting period of the award based on the fair value of the award on the grant date. The adoption of SFAS No. 123(R) in 2006 resulted in the recognition of incremental share-based compensation costs in 2006 of RMB 684,295 (US$87,684) and a reduction in net income of RMB 684,295 (US$87,684).

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.

Home Inns Hong Kong is subject to a profit tax at the rate of 17.5% on assessable profit determined under relevant Hong Kong tax regulations. To date, Home Inns Hong Kong has not been required to pay profit tax as it had no assessable profit.

Our subsidiaries and affiliated entities in China are subject to a business tax at a rate of approximately 5.5% on revenues generated from providing services and related surcharges by various local tax authorities. In addition, our subsidiaries and affiliated entities in China are generally subject to the standard enterprise income tax rate, which currently is 33%. However, some of our subsidiaries are subject to lower enterprise income tax rates due to the preferential tax treatments granted by the local tax authorities. For example, our wholly owned subsidiary, Hemei Hotel Management Company, enjoys a reduced 15% enterprise income tax rate due to its place of incorporation and operation in the Pudong New District of Shanghai.

Various local tax authorities in China have provided financial subsidies in the form of certain tax refunds to us. However, these tax authorities could reduce or eliminate any or all of these financial subsidies at any time in the future. Reduction or elimination of the financial subsidies we currently enjoy may have an adverse effect on our results of operations.

 

45


Table of Contents

Critical Accounting Policies

We prepare financial statements in accordance with 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 continually 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.

Basis of Consolidation

Our consolidated financial statements included elsewhere in this prospectus include the financial statements of Home Inns & Hotels Management Inc., its subsidiaries and variable interest entity, or VIE, subsidiaries.

We applied the provisions of Financial Accounting Standards Board, or FASB, Interpretation No. 46 (Revised 2003), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” or FIN46(R), to account for certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support.

Under FIN46(R), a company is required to consolidate a VIE if that company has a variable interest that will absorb a majority of the expected losses, receives a majority of the entity’s expected residual returns, or both. The company that absorbs a majority of the VIE’s expected losses and receives a majority of the VIE’s expected residual returns is a primary beneficiary.

We are the primary beneficiary of four variable interest entities, Home Inns & Hotels Management (Xiamen) Co., Ltd, or Home Inns Xiamen, Home Inns & Hotels Management (Fuzhou) Co., Ltd, or Home Inns Fuzhou, Home Inns & Hotels Management (Caoxi) Co., Ltd, or Home Inns Caoxi, and Home Inns & Hotels Management (Caobao) Co., Ltd, or Home Inns Caobao, of which the principal activity generally relates to hotel management. The total registered capital of the four VIEs was RMB 4.0 million (US$0.5 million) as of December 31, 2006. The entities were considered variable interest entities because the equity at risk of each entity was not sufficient to finance its intended activities without additional financial support. We have a 51% ownership interest in Home Inns Xiamen, Home Inns Fuzhou and Home Inns Caoxi and 75% ownership interest in Home Inns Caobao, and we are considered the primary beneficiary of these entities because we absorb a majority of the entities’ expected losses and receive a majority of the entities’ expected residual returns. As a result, the operations of the VIEs are included in our consolidated financial statements since their incorporation in 2004.

The entities that operate the franchised-and-managed hotels are considered variable interest entities as the franchisees do not have the ability to make decisions that have a significant impact on the success of the franchise arrangement. However, as the franchisees provide all necessary capital to finance the operation of the franchised properties and absorb a majority of the expected losses, we are not considered the primary beneficiary of those entities.

 

46


Table of Contents

Property and Equipment

We state property and equipment at cost less accumulated depreciation and accumulated impairment losses, if any. We depreciate property and equipment to write off their cost less expected residual value, on a straight line basis over their expected useful lives.

At each balance sheet date, we consider both internal and external sources of information to assess whether there is any indication that assets included in property and equipment are impaired. If any such indication exists, we estimate the recoverable amount of assets and, if less than carrying value, an impairment loss is recognized to reduce the carrying value of the assets to their recoverable amount. We recognize such impairment losses in the consolidated profit and loss account. The gain or loss on disposal of property and equipment is the difference between the net sales proceeds and the carrying amount of the underlying asset, and is recognized in the consolidated profit and loss account.

Goodwill

Goodwill represents the excess of the cost of an acquired entity over the appropriate share of the fair value of the identifiable assets, including separately identifiable intangible assets, and liabilities acquired. The provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” or SFAS 142, require that a two-step impairment test be performed annually or whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The first step of the test for impairment compares the book value of our reporting unit under which goodwill is recorded to its estimated fair value. The second step of the goodwill impairment test, which is only required when the net book value of the reporting unit exceeds the fair value, measures impairment as the difference between the implied fair value of goodwill and its book value. Goodwill is not amortized. We recognized no impairment for the periods presented in this prospectus.

Intangible Assets

Intangible assets consist primarily of intangible assets acquired in business combinations. We apply the criteria specified in SFAS No. 141 “Business Combinations,” or SFAS 141, to determine whether an intangible asset should be recognized separately from goodwill. We recognize intangible assets acquired through business acquisitions as assets separate from goodwill if they satisfy either the “contractual-legal” or “separability” criterion. We recognize and measure intangible assets, including favorable lease agreements and certain franchise agreements existing as of the date of acquisition, at fair value upon acquisition. Intangible assets from such business combination transactions are amortized over the remaining operating lease term or the franchise agreement term, as appropriate. We state purchased software at cost, which comprises purchase price less accumulated amortization and impairment, if any.

Impairment of Long-lived Assets and Definite-lived Intangible Assets

We review long-lived assets and definite-lived intangible assets for impairment whenever events or changes in circumstances indicate that carrying amount of an asset may not be recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” or SFAS 144. We assess the recoverability of the long-lived assets and definite-lived intangible assets (other than goodwill) by comparing the carrying amount to the estimated future undiscounted cash flow associated with the related assets. If the estimated future undiscounted cash flows are less than the carrying value, an indication of impairment is present and we recognize a loss for the difference between fair value, using the expected discounted cash flows, and the carrying value of the assets. We use estimates and judgments in these impairment tests, and if different estimates or judgments had been utilized, the timing or the amount of the impairment charges could be different. We recognised no impairment for the periods presented.

 

47


Table of Contents

Accruals for Customer Reward Program

We invite our customers to participate in a customer reward program. Prior to November 14, 2004, membership was free of charge. We commenced charging a one-time membership fee after that date for new members. Members enjoy discounts on room rates, priority in hotel reservation, and accumulate membership points for their paid stays, which can be redeemed for membership upgrades, room night awards and other gifts. The estimated incremental costs to provide membership upgrades, room night awards and other gifts are accrued and recorded as a provision for customer reward program as members accumulate points and recognized as sales and marketing expense in the accompanying statement of operations. As members redeem awards or their entitlements expire, the provision is reduced correspondingly. As of December 31, 2005 and 2006, we made provisions of RMB 776,645 and RMB 2,743,366 (US$351,529), respectively, based on the estimated liabilities under the customer reward program.

Revenue Recognition

Revenue from leased-and-operated hotels represents primarily room rentals and food and beverage sales from the leased-and-operated hotels. We recognize such revenues when goods and services are delivered.

Revenues from franchised-and-managed hotels are derived from franchise agreements where the franchisees are required to pay (i) an initial one-time franchise fee and (ii) on-going management and service fees based on a percentage of revenue, which approximate 5% to 6% of the room revenues of the franchised hotels. The one-time franchise fee is recognized when the franchised hotel opens for business, the fee becomes non-refundable, and we have fulfilled all of our commitments and obligations, including having provided the assistance to the franchisees in property design, leasehold improvement construction project management, systems installation, personnel recruiting and training. On-going management and service fees are recognized when the underlying service revenue is recognized by the franchisees’ operations. Other revenues generated from franchise agreements include system maintenance and support fee and central reservation system usage fee, which are recognized when services are provided.

Revenues from the one-time membership fees are recognized over the estimated average customer relationship period. Prior to 2006, given the limited history in operating our customer reward program, all one-time membership fees were recognized as deferred revenue when received. In 2006, our management made an analysis on the historic pattern of the activities of membership cards and noted that membership cards with no activities for more than one year are most likely to expire in the future and therefore we recognized revenue from one-time membership fees when membership records show lack of usage activity for a year. For the year ended December 31, 2006, we recognized revenues of RMB 1,802,462 (US$230,963) from one-time membership fees.

Share-based Compensation

Prior to December 31, 2005, we accounted for share-based compensation arrangements in accordance with APB No. 25, and complied with the disclosure provisions of SFAS No. 123. Under APB No. 25, compensation cost is recognized based on the difference, if any, between the estimated fair value of our ordinary shares and the amount an employee is required to pay to acquire the ordinary shares, as determined on the date the option is granted. Total compensation cost is recorded in shareholders’ equity as additional paid-in capital and deferred share-based compensation. Deferred share-based compensation is amortized on a straight-line basis and charged to expense over the vesting period of the underlying options.

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R), which revises SFAS No. 123, and supersedes APB No. 25. Under the fair value recognition provisions of SFAS No. 123(R), we applied the prospective transition method and measured share-based compensation at fair value on the awards’ grant date based on the estimated number of awards that are expected to vest. Under the prospective transition method, we continued to account for non-vested awards outstanding under the provisions

 

48


Table of Contents

of APB No. 25. Only awards granted (or modified, repurchased, or cancelled) after the adoption of SFAS No. 123(R) were accounted for under the provisions of SFAS No. 123(R). The “deferred share-based compensation” line on our consolidated balance sheet, a contra-equity line representing the amount of unrecognized share-based compensation costs, was eliminated as of January 1, 2006.

We have granted options to our directors, officers and other employees under our option plans. The following table sets forth a summary of our option grants since the beginning of 2004.

 

Date of Grant

   Number of Ordinary
Shares Underlying
Options Granted
   Option Exercise
Price (in US$)
  

Fair Value of
Ordinary Shares

(in US$)

   Type of
Valuation
 

03/01/2004

   604,182    0.3309    0.1239    (1 )

09/01/2004

   542,428    0.3309    0.7589    (1 )

01/01/2005

   461,589    0.3309    0.9324    (1 )

07/01/2005

   180,000    1.5310    1.3327    (1 )

12/01/2005

   586,483    2.2500    1.9730    (1 )

03/01/2006

   300,000    1.5310    2.7170    (2 )

03/17/2006

   510,000    2.7170    2.7170    (2 )

07/04/2006

   302,000    3.2020    3.2020    (2 )

10/02/2006

   659,000    5.5000    5.5000    (3 )

12/26/2006

   156,000    16.6400    16.6400    (4 )

(1) Retrospective valuation by the independent appraiser.
(2) Contemporaneous valuation by the independent appraiser.
(3) Good faith determination by our board of directors based on the midpoint of the then-estimated price range for our initial public offering.
(4) Closing price on the Nasdaq Global Market on the grant date.

On April 10, 2007, our board of directors approved the grant of options to our employees to purchase shares totaling approximately 2% of our current total outstanding shares in 2007, or approximately 1.3 million shares. Names of grantees, option exercise price and other material terms will be finalized by us and approved by our compensation committee.

Determination of the amount of share-based compensation expense to be recognized requires significant judgment, including, most importantly, the estimated fair value of our ordinary shares underlying the options as of each date of grant. We engaged an independent appraiser to assist in the determination of the fair value of our ordinary shares underlying options as of each date of grant since January 1, 2004. Determining the fair value of ordinary shares requires making complex and subjective judgments regarding projected financial and operating results, our unique business risks, the liquidity of our shares and our operating history and prospects at the time of grant.

In assessing the fair value of our ordinary shares, our independent appraiser considered the following principal factors:

 

   

the nature of our company since our inception;

 

   

the global economic outlook in general and the specific economic and competitive elements affecting our business and market;

 

   

the nature and prospects of the lodging industry in China;

 

   

the market-derived investment returns of entities engaged in the hotel operation business;

 

   

the growth of our operations; and

 

   

our business risks.

 

49


Table of Contents

Our independent appriaiser believes the income approach, also known as the discounted cash flow, or DCF, approach, to be most relevant and reliable only if it is a contemporaneous valuation in which the key assumptions exist at the valuation date and are not biased by hindsight. As we were a young, start-up company prior to 2006 and did not prepare cash flow projections during the period, our independent appraiser adopted the market approach to determine the fair values of our ordinary shares as of various dates in 2004 and 2005. Under this approach, financial ratios and market price data of comparable companies are analyzed. Ten comparable companies were selected primarily based on the nature of the business, the geographical location and the consideration of other market participants. The ten companies selected are primarily engaged in the hotel operation business. Our independent appraiser determined market multiples of the comparable companies based on the latest available financial information. The market multiples were then adjusted to take into account our growth and business risk. The market multiples so derived were applied to our performance indicators and discounted to reflect the lack of liquidity.

Our independent appraiser used a combination of the income approach and the market approach to assess the fair value of our ordinary shares in 2006. The income approach involves applying appropriate discount rates to estimated cash flows that are based on earnings forecasts. The major assumptions used in deriving the fair values are consistent with our business plan, including:

 

   

opening schedule of new hotels;

 

   

average occupancy rate;

 

   

average daily room rate; and

 

   

operating margins.

Other major assumptions used by our independent appraiser in calculating the fair values of our ordinary share in 2006 include the following:

 

   

Weight of DCF and market multiples: The independent appraiser assigned 60% weight to the DCF approach and 40% weight to the market multiples approach because we had achieved better visibility of future earnings at the time, which made the DCF approach more meaningful.

 

   

Weighted average costs of capital, or WACC: WACC of between 15% and 16.5% were used. This was the combined result of the changes in risk-free rate, industry average beta, and the decrease in our company-specific risk as we continued to grow and meet important milestones.

 

   

Capital market valuation multiples: The independent appraiser obtained and assessed updated capital market valuation data of ten comparable companies.

 

   

Lack of marketability discount, or LOMD: The independent appraiser quantified the LOMD by the Black-Scholes option-pricing model. This method treats the right to sell our ordinary shares freely before a liquidity event as a put option. The farther the valuation date is from a liquidation event, the higher the option value and thus the higher the implied LOMD. The LOMD was determined to be 6.9%.

The above assumptions used by our independent appraiser in deriving the fair values were consistent with our business plan and major milestones achieved by us. Our independent appraiser also used other general assumptions, including the following:

 

   

no material changes in the existing political, legal, fiscal and economic conditions and travel industry in China;

 

   

no major changes in tax law in China or the tax rates applicable to our subsidiaries and consolidated affiliated entities in China;

 

   

exchange rates between the Renminbi and U.S. dollars will not differ materially from current rates;

 

   

our future growth will not be constrained by the lack of funding;

 

50


Table of Contents
   

our ability to retain competent management and key personnel to support our ongoing operations; and

 

   

industry trends and market conditions for hotel and related industries will not deviate significantly from economic forecasts.

These assumptions are inherently uncertain. The increase in the fair value of our ordinary shares from January 2004 to July 2006 was primarily attributable to the growth of our revenues and net income as well as the number of hotels in operation as indicated in the table below. In addition, the rapid and substantial expansion of Home Inns hotels during the period has proved the viability of our business strategy and execution capability and enhanced our credibility, as demonstrated by our successful financings through issuance of preferred shares to unrelated third-party investors and obtaining credit facilities from commercial banks.

 

As of and for the Quarter Ended

   Revenues
(in RMB thousands)
  

Net Income

(in RMB thousands)

   No. of Hotels
in Operation
  

Other Major Milestones

03/31/2004

   —      1,922    14   

06/30/2004

   25,580    1,648    17    Obtaining control of Home Inns Beijing

09/30/2004

   32,769    1,864    24   

12/31/2004

   37,651    534    26   

03/31/2005

   45,275    3,126    36    Obtaining RMB40 million financing through issuance of Series C preferred shares to unrelated third-party investors

06/30/2005

   64,131    5,179    44    Obtaining financing from BTG in the form of an RMB80 million credit facility provided by a commercial bank entrusted by BTG

09/30/2005

   77,733    5,199    54   

12/31/2005

   98,722    7,431    68    Obtaining RMB20 million unsecured loans from a commercial bank in China

03/31/2006

   110,672    7,885    75   

06/30/2006

   138,387    19,364    82    Obtaining RMB46 million unsecured loans from a commercial bank in China

Share-based compensation expense recognized for the years ended December 31, 2004, 2005 and 2006 amounted to RMB 149,705, RMB 959,826 and RMB 16,295,324 (US$2,088,046), respectively.

Taxation

Income tax expenses are recorded using the liability method. Deferred tax assets or liabilities are recognized for the estimated future tax effects attributable to temporary differences and tax loss carryforwards. Deferred tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in statements of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the amount of deferred tax assets if it is considered more likely than not that such assets will not be realized. In doing so, management must make judgments and estimates as to whether we have future taxable income available to utilize the deferred tax assets. As of December 31, 2005 and 2006, we had deferred tax assets of RMB 15,295,113 and RMB 32,091,738 (US$4,112,164), respectively. No valuation allowance was made against the deferred tax assets as of December 31, 2005 and 2006.

 

51


Table of Contents

Selected Operating Data

The following table presents certain selected operating data of our company as of and for the dates and periods indicated. We present operating data for 2004 to include those of Home Inns Beijing since Home Inns Beijing was managed by us throughout 2004. Our revenues have been and will continue to be significantly affected by these operating measures which are widely used in the hospitality industry.

 

     As of and for the Year
Ended December 31,
     2004    2005    2006

Operating Data:

        

Total hotels in operation:

        

Leased-and-operated hotels(1)

   18    54    94

Franchised-and-managed hotels

   8    14    40

Total rooms

   2,991    8,197    16,162

Geographic coverage:

        

Number of cities

   8    22    39

Occupancy rate (as a percentage)

   86.8    89.8    92.8

Average daily rate (in RMB)

   191    182    182

RevPAR (in RMB)

   166    163    169

(1) Includes four hotels operated through separate joint ventures with third parties. We own 75% of one joint venture and 51% of each of the other three joint ventures.

Results of Operations

In April 2002, we and BTG formed Home Inns Beijing to operate economy hotels in China. We and BTG owned 55% and 45%, respectively, of Home Inns Beijing upon its formation. We have been actively managing Home Inns Beijing since it commenced operations in 2002. Subsequently, Home Inns Hong Kong gradually increased its ownership interest in Home Inns Beijing by contributing additional funds to the registered capital of Home Inns Beijing. Home Inns Hong Kong increased its ownership interest in Home Inns Beijing to 95.59% as of February 2005. In April 2004, we and Beijing Capital Travel, a subsidiary of BTG, entered into a revised joint venture agreement under which we gained control of Home Inns Beijing, which has been our consolidated subsidiary since then. For periods prior to April 2004, we accounted for our interest in Home Inns Beijing using the equity method as BTG had the participation rights in certain decisions in the ordinary course of business of Home Inns Beijing.

The following table sets forth certain unaudited financial data relating to our consolidated results of operations in 2004 assuming we had held a 93.47% interest in Home Inns Beijing and consolidated Home Inns Beijing throughout 2003 and 2004. This information has been derived from Note 7 to our consolidated financial statements included elsewhere in this prospectus and is presented below for you to have a better understanding of the financial results of the Home Inns hotel chain in this period.

 

     For the Year Ended December 31,
     2004
     RMB
     (in thousands)

Net revenues

   109,128

Income from operations

   12,989

Net income

   7,735

 

52


Table of Contents

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, 2006. This information should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. Our business has grown rapidly and substantially since we commenced operations in July 2002. 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 results for any future quarters or for a full year.

 

    For the Three Months Ended  
    March 31,
2005
    June 30,
2005
    September 30,
2005
    December 31,
2005
    March 31,
2006
    June 30,
2006
    September 30,
2006
    December 31,
2006
 
    (in RMB thousands)  

Consolidated Statement of Operations Data:

               

Revenues:

               

Leased-and-operated hotels

  44,203     62,775     75,939     97,031     108,681     134,811     152,956     171,447  

Franchised-and-Managed hotels

  1,072     1,356     1,794     1,691     1,991     3,576     7,396     7,642  
                                               

Total revenues

  45,275     64,131     77,733     98,722     110,672     138,387     160,352     179,089  
                                               

Less: Business tax and related surcharges

  (2,848 )   (3,821 )   (4,370 )   (5,792 )   (5,908 )   (7,436 )   (9,087 )   (11,546 )
                                               

Net revenues

  42,427     60,310     73,363     92,930     104,764     130,951     151,265     167,543  
                                               

Operating costs and expenses(1):

               

Leased-and-operated hotel costs:

               

Rents and utilities

  (15,797 )   (20,904 )   (26,825 )   (31,257 )   (36,512 )   (37,464 )   (45,253 )   (52,347 )

Personnel costs

  (6,435 )   (9,347 )   (10,542 )   (14,901 )   (17,711 )   (18,791 )   (23,409 )   (28,070 )

Consumables, food and beverage

  (2,857 )   (4,752 )   (5,839 )   (7,317 )   (8,166 )   (9,645 )   (11,078 )   (14,593 )

Depreciation and amortization

  (3,843 )   (4,985 )   (5,903 )   (8,603 )   (9,078 )   (10,652 )   (11,320 )   (13,570 )

Others

  (3,913 )   (5,870 )   (7,713 )   (8,603 )   (11,642 )   (11,380 )   (14,348 )   (18,650 )
                                               

Total leased-and-operated hotel costs

  (32,845 )   (45,858 )   (56,822 )   (70,681 )   (83,109 )   (87,932 )   (105,408 )   (127,230 )
                                               

Sales and marketing expenses

  (971 )   (1,783 )   (2,046 )   (2,891 )   (1,683 )   (2,215 )   (3,260 )   (4,329 )

General and administrative expenses

  (5,985 )   (4,565 )   (6,261 )   (7,979 )   (7,223 )   (13,645 )   (28,079 )   (15,843 )
                                               

Total operating costs and expenses

  (39,801 )   (52,206 )   (65,129 )   (81,551 )   (92,015 )   (103,792 )   (136,747 )   (147,402 )
                                               

Income from operations

  2,626     8,104     8,234     11,379     12,749     27,159     14,518     20,141  
                                               

Interest income

  28     68     47     80     68     223     255     6,031  

Interest expense

  —       —       (215 )   (494 )   (1,149 )   (1,570 )   (1,645 )   (1,779 )

Other non-operating income

  1,813     62     117     154     50     1,650     3,265     343  

Foreign exchange gain (loss), net

  210     2     77     (35 )   (48 )   18     (897 )   (6,063 )
                                               

Income before income tax expense, minority interests and share of income (loss) of affiliated companies

  4,677     8,236     8,260     11,084     11,670     27,480     15,496     18,673  
                                               

Income tax expense

  (935 )   (1,657 )   (1,661 )   (2,272 )   (2,739 )   (6,465 )   (6,534 )   (5,653 )

Minority interests

  (616 )   (1,400 )   (1,400 )   (1,381 )   (1,046 )   (1,651 )   (1,060 )   (1,277 )
                                               

Net Income

  3,126     5,179     5,199     7,431     7,885     19,364     7,902     11,743  
                                               

(1) Share-based compensation expenses are included in our operating costs and expenses as follows:

 

 

Leased-and-operated hotel cost - personnel costs

  2     2     2     2     3     3     3     3  

General and administrative expenses

  233     249     230     240     344     685     13,693     1,561  

 

53


Table of Contents

Excluding the share-base compensation expenses, our quarterly revenues, operating income and net income have experienced continued growth for the eight quarters in the period ended December 31, 2006, except that we experienced a decrease in our operating income and net income in the quarter ended December 31, 2006. This decrease was primarily due to an increase in pre-operating expenses of the hotels under development, as well as an increase in the number of leased-and-operated hotels opened for operation during the quarter.

The following table presents certain selected operating data of our company as of and for the eight quarters in the period ended December 31, 2006.

 

    For the Three Months Ended
    March 31,
2005
  June 30,
2005
  September 30,
2005
  December 31,
2005
  March 31,
2006
  June 30,
2006
  September 30,
2006
  December 31,
2006

Operating Data:

               

Total hotels in operation:

               

Leased-and-operated hotels

  26   34   41   54   60   63   78   94

Franchised-and-managed hotels

  10   10   13   14   15   19   29   40

Total rooms

  4,269   5,372   6,512   8,197   8,972   9,707   12,729   16,162

Geographic coverage:

               

Number of cities

  10   11   13   22   23   26   32   39

Occupancy rate (as a percentage)

  81.6   90.4   93.1   90.9   89.5   97.7   94.0   90.4

Average daily rate (in RMB)

  183   184   181   181   175   186   183   182

RevPAR (in RMB)

  149   166   169   165   157   182   172   165

 

54


Table of Contents

Our 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. Our business has grown rapidly and substantially since we commenced operations in July 2002. Our limited operating history makes it difficult to predict future operating results. We believe that the period-to-period comparison of operating results should not be relied upon as being indicative of future performance.

 

     For the Year Ended December 31,  
     2004     2005     2006  
     RMB     %     RMB     %     RMB     US$     %  
     (in thousands except percentages)  

Consolidated Statement of Operations Data:

              

Revenues:

              

Leased-and-operated hotels

   93,687     97.6     279,948     97.9     567,895     72,769     96.5  

Franchised-and-managed hotels

   2,313     2.4     5,913     2.1     20,605     2,640     3.5  
                                          

Total revenues

   96,000     100.0     285,861     100.0     588,500     75,409     100.0  
                                          

Less: Business tax and related surcharges

   (5,101 )   (5.3 )   (16,830 )   (5.9 )   (33,977 )   (4,354 )   (5.8 )
                                          

Net revenues

   90,899     94.7     269,031     94.1     554,523     71,055     94.2  
                                          

Operating costs and expenses:

              

Leased-and-operated hotel costs:

              

Rents and utilities

   (30,703 )   (32.0 )   (94,784 )   (33.1 )   (171,576 )   (21,985 )   (29.2 )

Personnel costs

   (12,949 )   (13.5 )   (41,225 )   (14.4 )   (87,980 )   (11,274 )   (14.9 )

Depreciation and amortization

   (5,681 )   (5.9 )   (23,335 )   (8.2 )   (44,620 )   (5,717 )   (7.6 )

Consumables, food and beverage

   (6,441 )   (6.7 )   (20,765 )   (7.3 )   (43,482 )   (5,572 )   (7.4 )

Others

   (8,162 )   (8.5 )   (26,100 )   (9.1 )   (56,019 )   (7,178 )   (9.5 )
                                          

Total leased-and-operated hotel costs

   (63,936 )   (66.6 )   (206,209 )   (72.1 )   (403,677 )   (51,726 )   (68.6 )

Sales and marketing expenses

   (2,113 )   (2.2 )   (7,691 )   (2.7 )   (11,488 )   (1,472 )   (2.0 )

General and administrative expenses

   (16,127 )   (16.8 )   (24,789 )   (8.7 )   (64,792 )   (8,302 )   (11.0 )
                                          

Total operating costs and expenses

   (82,176 )   (85.6 )   (238,689 )   (83.5 )   (479,957 )   (61,500 )   (81.6 )
                                          

Income from operations

   8,723     9.1     30,342     10.6     74,566     9,555     12.6  
                                          

Interest income (expense), net

   (9 )   —       (486 )   (0.2 )   435     56     0.1  

Other non-operating income

   325     0.3     2,146     0.8     5,308     680     0.9  

Foreign exchange gain (loss), net

   144     0.2     254     0.1     (6,990 )   (896 )   (1.2 )

Income tax expense

   (5,738 )   (6.0 )   (6,526 )   (2.3 )   (21,391 )   (2,741 )   (3.6 )

Minority interests

   552     0.6     (4,797 )   (1.7 )   (5,034 )   (645 )   (0.9 )

Share of income of affiliated companies

   1,972     2.1     —       —       —       —       —    
                                          

Net income

   5,969     6.3     20,933     7.3     46,894     6,009     7.9  
                                          

 

55


Table of Contents

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

Revenues. Our total revenues increased by 105.9% from RMB 285.9 million in 2005 to RMB 588.5 million (US$75.4 million) in 2006.

 

   

Leased-and-operated Hotels. Revenues from our leased-and-operated hotels increased by 102.9% from RMB 279.9 million in 2005 to RMB 567.9 million (US$72.8 million) in 2006. This increase was primarily due to our substantial expansion of leased-and-operated hotels from 54 hotels and 6,555 rooms as of December 31, 2005 to 94 hotels and 11,395 rooms as of December 31, 2006.

 

   

Franchised-and-managed Hotels. Revenues from our franchised-and-managed hotels increased substantially by 248.5% from RMB 5.9 million in 2005 to RMB 20.6 million (US$2.6 million) in 2006. This growth was primarily due to an increase in the number of franchised-and-managed hotels from 14 hotels with 1,642 rooms as of December 31, 2005 to 40 hotels with 4,767 rooms as of December 31, 2006.

Operating Costs and Expenses. Our total operating costs and expenses increased substantially from RMB 238.7 million in 2005 to RMB 480.0 million (US$61.5 million) in 2006. This increase resulted from increases in all of our cost and expense line items as we substantially expanded our operations in 2006.

 

   

Leased-and-operated Hotel Costs. Our leased-and-operated hotel costs increased substantially from RMB 206.2 million in 2005 to RMB 403.7 million (US$51.7 million) in 2006. This increase was primarily because all items comprising our leased-and-operated hotel costs increased substantially as we expanded our leased-and-operated hotels from 54 hotels and 6,555 rooms as of December 31, 2005 to 94 hotels and 11,395 rooms as of December 31, 2006.

 

   

Sales and Marketing Expenses. Our sales and marketing expenses increased substantially from RMB 7.7 million in 2005 to RMB 11.5 million (US$1.5 million) in 2006. This increase was primarily due to increased marketing and promotional expenses in connection with 66 new hotels that opened in 2006.

 

   

General and Administrative Expenses. Our general and administrative expenses increased by 161.4% from RMB 24.8 million in 2005 to RMB 64.8 million (US$8.3 million) in 2006, primarily due to an increase in the total compensation and benefits for our administrative staff as a result of our hiring of over 80 new employees in the areas of finance and accounting, human resources and general administration to support our expanded operations in 2006.

Income from Operations. Our income from operations increased by 145.8% from RMB 30.3 million in 2005 to RMB 74.6 million (US$9.6 million) in 2006 as a cumulative result of the above factors.

Interest Income (Expense), Net. We incurred net interest expense of RMB 0.5 million in 2005 due to our then outstanding loans. We recorded net interest income of RMB 0.4 million (US$55,800) in 2006, primarily due to interest income from proceeds of our initial public offering.

Foreign Exchange Gain (Loss), Net. We incurred a net foreign exchange loss of RMB 7.0 million (US$0.9 million) in 2006, as compared to a net foreign exchange gain of RMB 0.3 million, primarily due to the U.S. dollar net proceeds we received from our initial public offering in October 2006 and the RMB appreciation since then until the end of 2006.

Income Tax Expenses. Our income tax expenses increased by 227.8% from RMB 6.5 million in 2005 to RMB 21.4 million (US$2.7 million) in 2006, primarily because of the increased income of our operating subsidiaries in China.

Minority Interest. Minority interest represents BTG’s share of our net income based on its equity interest in Home Inns Beijing and our joint venture partners’ share of the net income of the four leased-and-operated hotels owned by the joint ventures. Minority interest increased substantially to RMB 5.0 million (US$0.6 million) in 2006, due to our increased net income in 2006.

Net Income. As a result of the foregoing, we had net income of RMB 46.9 million (US$6.0 million) in 2006, an increase of 124.0% from net income of RMB 20.9 million in 2005.

 

56


Table of Contents

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

Revenues. Our total revenues increased by 197.8% from RMB 96.0 million in 2004 to RMB 285.9 million in 2005. In addition to the reasons discussed below, the revenue increase was also due to the effect of our consolidation of Home Inns Beijing since April 2004.

 

   

Leased-and-operated Hotels. Revenues from our leased-and-operated hotels increased by 198.7% from RMB 93.7 million in 2004 to RMB 279.9 million in 2005. This increase was primarily due to our substantial expansion of leased-and-operated hotels from 18 hotels and 2,060 rooms as of December 31, 2004 to 54 hotels and 6,555 rooms as of December 31, 2005.

 

   

Franchised-and-managed Hotels. Revenues from our franchised-and-managed hotels increased substantially from RMB 2.3 million in 2004 to RMB 5.9 million in 2005. This growth was primarily due to an increase in the number of franchised-and-managed hotels from eight hotels with 931 rooms as of December 31, 2004 to 14 hotels with 1,642 rooms as of December 31, 2005.

Operating Costs and Expenses. Our total operating costs and expenses increased substantially from RMB 82.2 million in 2004 to RMB 238.7 million in 2005. This increase resulted from increases in all of our cost and expense line items as we substantially expanded our operations in 2005 and consolidated Home Inns Beijing in April 2004.

 

   

Leased-and-operated Hotel Costs. Our leased-and-operated hotel costs increased substantially from RMB 63.9 million in 2004 to RMB 206.2 million in 2005. This increase was primarily because all items comprising our leased-and-operated hotel costs increased substantially as we expanded our leased-and-operated hotels from 18 hotels and 2,060 rooms as of December 31, 2004 to 54 hotels and 6,555 rooms as of December 31, 2005.

 

   

Sales and Marketing Expenses. Our sales and marketing expenses increased substantially from RMB 2.1 million in 2004 to RMB 7.7 million in 2005. This increase was primarily due to increased marketing and promotional expenses in connection with 42 new hotels that opened in 2005.

 

   

General and Administrative Expenses. Our general and administrative expenses increased by 53.7% from RMB 16.1 million in 2004 to RMB 24.8 million in 2005, primarily due to an increase in the total compensation and benefits for our administrative staff as a result of our hiring of over 60 new employees in the areas of finance and accounting, technology infrastructure, human resources and general administration to support our expanded operations in 2005.

Income from Operations. Our income from operations increased by 247.8% from RMB 8.7 million in 2004 to RMB 30.3 million in 2005 as a cumulative result of the above factors.

Interest Income (Expense), Net. Our net interest expense increased substantially from RMB 9.3 thousand in 2004 to RMB 0.5 million in 2005, primarily due to the interest accrued on our loans from BTG in 2005.

Share of Income of Affiliated Companies. Our share of income of affiliated companies decreased from RMB 2.0 million in 2004 to nil in 2005 because we consolidated Home Inns Beijing in April 2004.

Income Tax Expenses. Our income tax expenses increased by 14.0% from RMB 5.7 million in 2004 to RMB 6.5 million in 2005, primarily because of the increased income of our operating subsidiaries in China.

Minority Interest. Minority interest represents BTG’s share of our net income based on its equity interest in Home Inns Beijing and our joint venture partners’ share of the net income of the four leased-and-operated hotels owned by the joint ventures. Minority interest increased substantially to RMB 4.8 million in 2005, due to our consolidation of Home Inns Beijing since April 2004 as well as our increased net income in 2005.

Net Income. As a result of the foregoing, we had net income of RMB20.9 million in 2005, an increase of 250.7% from net income of RMB6.0 million in 2004.

 

57


Table of Contents

Home Inns Beijing’s Results of Operations in 2004

The following table sets forth a summary of Home Inns Beijing’s 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 Home Inns Beijing’s consolidated financial statements and related notes included elsewhere in this prospectus.

 

     For the Year Ended December 31,  
     2004     %  
     (in RMB thousands except percentages)  

Consolidated Statement of Operations Data:

    

Revenues:

    

Leased-and-operated hotels

   112,914     97.9  

Franchised-and-managed hotels

   2,364     2.1  
            

Total revenues

   115,278     100.0  
            

Less: Business tax and related surcharges

   (6,150 )   (5.3 )
            

Net revenues

   109,128     94.7  
            

Operating costs and expenses:

    

Leased-and-operated hotel costs:

    

Rents and utilities

   (36,462 )   (31.6 )

Personnel costs

   (15,653 )   (13.6 )

Consumables, food and beverage

   (8,149 )   (7.1 )

Depreciation and amortization

   (6,685 )   (5.8 )

Others

   (10,019 )   (8.7 )
            

Total leased-and-operated hotel costs

   (76,968 )   (66.8 )
            

Sales and marketing expenses

   (2,564 )   (2.2 )

General and administrative expenses

   (16,607 )   (14.4 )
            

Total operating costs and expenses

   (96,139 )   (83.4 )
            

Income from operations

   12,989     11.3  
            

Interest income (expense), net

   (15 )   0.0  
            

Other non-operating income

   328     0.3  

Income tax expense

   (6,861 )   (6.0 )

Minority interests

   1,294     1.1  
            

Net income

   7,735     6.7  
            

Our Liquidity and Capital Resources

Our principal sources of liquidity have been cash generated from operating activities, our sale of ordinary shares and preferred shares through private placements, borrowings from BTG and third-party lenders as well as the proceeds we received from our initial public offering. Our cash and cash equivalents consist of cash on hand and liquid investments which are unrestricted as to withdrawal or use, and which have maturities of three months or less that are placed with banks and other financial institutions. As of December 31, 2006, we had entered into binding contracts with lessors of 28 properties for our leased-and-operated hotels under development. We expect to incur an additional RMB 167 million (US$21.4 million) in capital expenditures in connection with the completion of the leasehold improvements of these hotels. We intend to fund this planned expansion with our operating cash flow and existing cash balance.

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.

 

58


Table of Contents

The following table sets forth a summary of our cash flows for the periods indicated:

 

     For the Year Ended December 31,  
     2004     2005     2006  
     RMB     RMB     RMB     US$  
     (in thousands)  

Net cash provided by operating activities

   28,664     70,604     161,973     20,755  

Net cash used in investing activities

   (42,319 )   (159,339 )   (213,795 )   (27,395 )

Net cash provided by financing activities

   28,605     100,170     779,089     99,831  

Effect of foreign exchange rate changes on cash and cash equivalents

   —       —       (6,990 )   (896 )
                        

Net increase in cash and cash equivalents

   14,950     11,435     720,277     92,295  

Cash and cash equivalents at beginning of period

   11,342     26,292     37,727     4,834  
                        

Cash and cash equivalents at end of the period

   26,292     37,727     758,004     97,129  
                        

Operating Activities

We have financed our operating activities primarily through cash generated from operations. We currently anticipate that we will be able to meet our needs to fund operations beyond the next twelve months with operating cash flow and existing cash balances.

Net cash provided by operating activities increased substantially to RMB 162.0 million (US$20.8 million) in 2006. The increase resulted from our expanded operations in 2006 and was mainly attributable to several factors, including (i) our net income of RMB 46.9 million (US$6.0 million) in 2006, (ii) an add-back of non-cash depreciation and amortization expenses of RMB 46.6 million (US$6.0 million), (iii) an increase in deferred revenues of RMB 12.2 million (US$1.6 million), (iv) an increase in deferred rental of RMB 17.6 million (US$2.3 million), (v) an increase in salary and welfare payable of RMB 14.2 million (US$1.8 million), and (vi) an increase in other payables and accruals of RMB 13.2 million (US$1.7 million), offset in part by the increases in prepayments and other current assets. These changes were primarily attributable to the expansion of the Home Inns hotel chain from 68 hotels with 8,197 hotel rooms as of December 31, 2005 to 134 hotels with 16,162 hotel rooms as of December 31, 2006. Net cash provided by operating activities amounted to RMB 70.6 million in 2005. The increase was mainly attributable to several factors, including (i) our net income of RMB 20.9 million, (ii) an add-back of non-cash depreciation and amortization expenses of RMB 23.8 million, (iii) a substantial increase in deferred rental of RMB 14.6 million, (iv) an increase in income tax payable of RMB 7.6 million, and (v) an increase in deferred revenues of RMB 5.9 million. These changes were primarily attributable to the expansion of the Home Inns hotel chain from 26 hotels with 2,991 hotel rooms as of December 31, 2004 to 68 hotels with 8,197 hotel rooms as of December 31, 2005.

Investing Activities

Our cash used in investing activities is primarily related to our leasehold improvements and purchase of equipment and fixtures used in leased-and-operated hotels. Net cash used in investing activities increased from RMB 159.3 million in 2005 to RMB 213.8 million (US$27.4 million) in 2006, primarily due to an increase in our leasehold improvements and purchase of furniture, fixture and equipment used in an increased number of leased-and-operated hotels in 2006. Net cash used in investing activities increased from RMB 42.3 million in 2004 to RMB 159.3 million in 2005, primarily due to a substantial increase in our leasehold improvements and purchase of equipment and fixtures used in an increased number of leased-and-operated hotels in 2005.

 

59


Table of Contents

Financing Activities

Our financing activities consist of issuance and sale of our shares to investors and related parties and borrowings from third-party lenders and our initial public offering. The following table sets forth a summary of our outstanding indebtedness as of March 31, 2007:

 

Lender

   Date of
Loan
Initiation
   Due Date   

Principal

(in RMB)

  

Principal

(in US$)

   Interest
Rate
 

China Merchants Bank

   10/12/2006    04/11/2007    20,000,000    2,562,755    5.022 %

China Merchants Bank

   10/16/2006    04/15/2007    20,000,000    2,562,755    5.022 %

China Merchants Bank

   11/29/2006    05/28/2007    4,000,000    512,551    5.022 %

China Merchants Bank

   12/22/2006    04/21/2007    40,000,000    5,125,511    5.022 %

China Merchants Bank

   01/29/2007    05/28/2007    40,000,000    5,125,511    5.022 %

China Merchants Bank

   02/15/2007    08/14/2007    16,000,000    2,050,204    5.022 %

China Merchants Bank

   03/22/2007    09/21/2007    20,000,000    2,562,755    5.103 %

China Merchants Bank (1)

   03/21/2007    09/20/2007    54,310,000    6,959,162    5.103 %

(1) This loan was pledged by bank deposits of US$7,800,000.

We are required under each loan or financing transaction agreement to notify the lender in advance before we enter into a material merger and acquisition, spin-off, corporate reorganization, new joint venture or sale of material assets transaction. None of our lenders have the right to prevent us from entering into any of these transactions. As of March 31, 2007, the remaining funds available under our credit facilities in the aggregate amounted to approximately RMB 40.0 million (US$3.8 million). Our loans from China Merchants Bank were drawn under a revolving credit facility which allows us to renew each loan for additional six-month terms at the same interest rate upon expiration of the initial term.

Net cash provided by financing activities in 2006 amounted to RMB 779.1 million (US$99.8 million) and was primarily attributable to the net proceeds from our initial public offering, offset in part by the amount of debt we repaid during the period. Net cash provided by financing activities increased substantially from RMB 28.6 million in 2004 to RMB 100.2 million in 2005. Cash provided by financing activities in 2005 consisted of a total of RMB 60.0 million borrowings from a related party and third-party lenders and the RMB 40.3 million proceeds from our issuance and sale of preferred shares in the year. Net cash provided by financing activities in 2004 consisted of the RMB 30.4 million proceeds from our issuance and sale of our ordinary shares, partially offset by the repayment of our RMB 3.0 million short-term borrowings in the year.

Home Inns Beijing’s Liquidity and Capital Resources

Home Inns Beijing’s principal sources of liquidity have been cash generated from operating activities and capital contributions from its shareholders. Home Inns Beijing’s cash and cash equivalents consist of cash on hand and liquid investments which are unrestricted as to withdrawal or use, and which have maturities of three months or less that are placed with banks and other financial institutions.

The following table sets forth a summary of Home Inns Beijing’s cash flows for the period indicated:

 

     For the Year Ended December 31,  
     2004  
     (in RMB thousands)  

Net cash provided by operating activities

   36,330  

Net cash used in investing activities

   (67,623 )

Net cash provided by financing activities

   31,720  
      

Net increase in cash and cash equivalents

   427  

Cash and cash equivalents at beginning of period

   16,283  
      

Cash and cash equivalents at end of the period

   16,710  
      

 

60


Table of Contents

Operating Activities

Home Inns Beijing has financed its operating activities primarily through cash generated from operations. Net cash provided by operating activities amounted to RMB 36.3 million in 2004.

Investing Activities

Home Inns Beijing’s cash used in investing activities was primarily related to leasehold improvements and purchase of furniture, fixture and equipment used in leased-and-operated hotels. Net cash used in investing activities amounted to RMB 67.6 million in 2004.

Financing Activities

Home Inns Beijing’s cash provided by financing activities was related to capital contributions from its shareholders. Net cash provided by financing activities amounted to RMB 31.7 million in 2004.

Capital Expenditures

Our and Home Inn Beijing’s capital expenditures were incurred primarily in connection with leasehold improvements, investments in furniture, fixtures and equipment and technology, information and operational software. Our capital expenditures totaled RMB 61.7 million, RMB 193.2 million and RMB 237.9 million (US$30.5 million) in 2004, 2005 and 2006, respectively. Home Inns Beijing’s capital expenditures totaled RMB 70.5 million in 2004. We will continue to make capital expenditures to meet the expected growth of our operations and expect cash generated from our operating activities and financing activities will meet our capital expenditure needs in the foreseeable future.

Contractual Obligations

The following table sets forth our contractual obligations as of December 31, 2006:

 

     Payment Due by Period
     Total    Less than
1 year
   1-3
years
   3-5
years
   More than
5 years
     (in RMB millions)

Long-term debt obligations, including interest payables

   54    3    51    —      —  

Operating lease obligations

   2,354    169    359    367    1,459

Purchase obligations

   136    136    —      —      —  
                        

Total

   2,544    308    410    367    1,459
                        

Our operating lease obligations related to our obligations under lease agreements with lessors of our leased-and-operated hotels. Our purchase obligations primarily consisted of our contractual commitments relating to leasehold improvements and installation of equipment for our leased-and-operated hotels.

Off-Balance Sheet Commitments and Arrangements

Other than operating lease obligations set forth in the table above, we have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

 

61


Table of Contents

Inflation

Inflation in China has not materially impacted our results of operations in recent years. According to the National Bureau of Statistics of China, the change of consumer price index in China was 3.9%, 1.8% and 1.5% in 2004, 2005 and 2006, respectively.

Holding Company Structure

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 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. Under PRC law, each of Home Inns Beijing, a Sino-foreign enterprise, and Hemei, a wholly foreign owned enterprise, is required to set aside a portion of its after-tax profits each year to fund a statutory reserve and to further set aside a portion of its after-tax profits to fund the employee welfare fund at the discretion of the board or the enterprise itself. Although the statutory reserves can be used, among other ways, to increase the registered capital and eliminate future losses in excess of retained earnings of the respective companies, the reserve funds are not distributable as cash dividends except in the event of liquidation of these subsidiaries.

Quantitative and Qualitative Disclosure about Market Risk

Interest Rate Risk

Our exposure to interest rate risk primarily relates to the interest rates for our outstanding debt and the interest income generated by excess cash invested in liquid investments with original maturities of three months or less. As of March 31, 2007, our total outstanding loans amounted to RMB 214.3 million (US$27.5 million) with interest rates varying from 5.022% to 5.103%. We have not used any derivative financial instruments to manage our interest risk exposure. Interest-earning instruments carry a degree of interest rate risk. We have not been exposed to material risks due to changes in interest rates. However, our future interest income may be lower than expected due to changes in market interest rates.

Foreign Exchange Risk

Substantially all of our revenues and most of our expenses are denominated in RMB. Our exposure to foreign exchange risk primarily relates to cash and cash equivalent denominated in U.S. dollars as a result of our past issuances of preferred shares through a private placement and proceeds from this offering. We do not believe that we currently have any significant direct foreign exchange risk and have not hedged exposures denominated in foreign currencies or any other derivative financial instruments. Although in general, our exposure to foreign exchange risks should be limited, the value of your investment in our ADSs will be affected by the foreign exchange rate between U.S. dollars and RMB because the value of our business is effectively denominated in RMB, while the ADSs will be traded in U.S. dollars.

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions. The conversion of RMB into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bank of China. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 6.1% appreciation of the RMB against the U.S. dollar by December 31, 2006. There remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the RMB against the U.S. dollar. To the extent that we need to convert U.S. dollars we receive from this

 

62


Table of Contents

offering into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we receive from the conversion. Conversely, if we decide to convert our RMB denominated cash amounts into U.S. dollars amounts for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us. We have not used any forward contracts or currency borrowings to hedge our exposure to foreign currency exchange risk.

Recent Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109,” or FIN 48. This interpretation, among other things, creates a two-step approach for evaluating uncertain tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more likely than not to be sustained upon examination. Measurement (step two) determines the amount of benefit that more-likely-than-not will be realized upon settlement. Derecognition of a tax position that was previously recognized would occur when a company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. FIN 48 specifically prohibits the use of a valuation allowance as a substitute for derecognition of tax positions, and it has expanded disclosure requirements. The provisions of FIN 48 is effective on January 1, 2007, with the cumulative effect of the change in accounting principle, if any, recorded as an adjustment to opening retained earnings. We are still in the process of assessment of the relevant impact from the adoption of FIN 48.

In September 2006, the SEC released Staff Accounting Bulletin No.108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” or SAB No. 108. SAB No. 108 provides interpretive guidance on the SEC’s views on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The provision of SAB No. 108 is effective for the year ended December 31, 2006. Our management does not believe the adoption of SAB No. 108 had a significant impact on the consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” or SFAS No. 157, which clarifies the definition of fair value, establishes guidelines for measuring fair value, and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements and eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS No. 157 will be effective for the Company on January 1, 2008. Our management does not believe the adoption of SFAS No. 157 will have a material effect on the consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R),” or SFAS No. 158, which requires plan sponsors of defined benefit pension and other postretirement benefit plans to recognize the funded status of such benefit plans in the consolidated balance sheet, measure the fair value of plan assets and benefit obligations as of the date of the fiscal year-end statement of financial position, and provide additional disclosures. Our management does not believe the adoption of SFAS No. 158 will have a material effect on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” or SFAS No. 159, which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 will be effective for the Company on January 1, 2008. Our management does not believe the adoption of SFAS No. 159 will have a material impact on its consolidated financial statements.

 

63


Table of Contents

INDUSTRY BACKGROUND

Emergence and Expansion of Economy Hotel Chains in China

China’s lodging industry has expanded rapidly as a result of the substantial growth of the Chinese economy and travel industry over the past several years. According to Euromonitor, the total number of room-nights in China grew from 811 million in 1999 to 1.2 billion in 2004 and total sales grew from RMB 190 billion in 1999 to RMB 264 billion in 2004.

The lodging industry in China consists of hotels as well as other forms of accommodation such as guesthouses and privately-owned lodging outlets. Although hotels accounted for only approximately 2.5% and 5.0% of total lodging outlets in China in 1999 and 2004, respectively, the hotel sector represents an increasingly significant portion of the lodging market, accounting for approximately 44.5% and 60.2% of total sales in the lodging market in 1999 and 2004, respectively, according to Euromonitor.

Historically, hotel development projects in China generally focused on star-rated hotels that were primarily targeted at international tourists and corporate travelers. In recent years, economy hotel chains have emerged and expanded in China, gaining a growing customer base consisting primarily of individual domestic business and leisure travelers. According to the 2006 China Economy Hotel Survey published by China’s Ministry of Commerce and the China Hotel Association, or the 2006 Economy Hotel Report, since the concept of a branded economy hotel chain was first introduced in China in 1997, several branded economy hotel chains, including Jinjiang Star, Home Inns and Motel 168, have emerged primarily in China’s economically prosperous eastern coastal region. Since 2004, the growth of branded economy hotel chains in China has accelerated, as evidenced by the existing chains’ rapid expansion into new urban business centers in other regions of China.

Economy hotel chains in China mainly target value-conscious domestic business and leisure travelers who demand convenient lodging, a consistent product and high-quality services. According to the 2006 Economy Hotel Report, in 2005, 37% of economy hotel guests were individual business travelers, 23% were contract corporate customers and 20% were individual leisure travelers. Economy hotel chains aim to satisfy customers’ basic accommodation needs with affordable pricing, a comfortable lodging experience and a standardized product.

The following table sets forth a summary of certain data concerning economy hotel chains in China.

 

     Total Number
of Hotels(2)
   Total Number
of Rooms(2)
   Number of Rooms
Per Hotel(2)
   Average Daily Rate
(in RMB) (3)
   Average Occupancy
Rate (%)(2)(3)

2004(1)

   173    21,716    —      —      —  

2005(1)

   273    36,144    58 to 244    134 to 202    85 to 96

(1) Source: 2006 Economy Hotel Report.
(2) Calculated based only on the data of selected economy hotel chains in China as of the end of each year.
(3) The range represents differences across regional market, including the northern, eastern, southeastern, central, southwestern, northwestern, southern, Beijing and Shanghai markets.

According to the 2006 Economy Hotel Report, the top three economy hotel chains in China, namely, Jinjiang Star, Home Inns and Motel 168, had market shares of 20%, 18% and 10%, respectively, of the Chinese economy hotel market in 2005. Competition among economy hotel chains in China is primarily based on a hotel chain’s ability to provide a consistent product, high-quality services, an efficient reservation system and effective sales channels, as well as specific product features including the design, decoration and guest amenities of the hotels within the chain.

The economy hotel chain segment of China’s lodging industry is still at an early stage of development. However, it is expanding rapidly as a result of a number of factors. There are general factors such as the growth

 

64


Table of Contents

of the Chinese economy and the growth of the travel and lodging industries in China. In addition, there are more specific factors driving the growth of economy hotel chains in China, such as fast-growing small- to medium-sized enterprises, or SMEs, the growth of domestic tourism, the expansion of urban business centers and the fragmentation of the hotel industry.

General Factors Driving the Growth of Economy Hotel Chains in China

Growth of the Economy in China. China’s economy has grown and is expected to continue to grow rapidly. According to the Economist Intelligence Unit, the gross domestic product in real terms, or real GDP, of China grew from RMB 5.4 trillion (US$677.9 billion) in 2001 to RMB 7.9 trillion (US$984.3 billion) in 2005, representing a compound annual growth rate, or CAGR, of 9.8%, and is expected to reach RMB 11.6 trillion (US$1.4 trillion) in 2010, representing a CAGR of 7.6% from 2006 to 2010.

The following table sets forth a summary of certain data regarding China’s economic growth for the years from 2001 to 2005.

 

     2001    2002    2003    2004    2005    CAGR (2001-2005)  

Real GDP (in billions of RMB)(1)

   5,419    5,911    6,504    7,160    7,869    9.8 %

Real GDP per capita (in RMB)(1) 

   4,246    4,602    5,033    5,508    6,018    9.1 %

Disposable income per capita (in US$)(1)

   490    546    603    682    759    11.5 %

(1) Source: Economist Intelligence Unit.

The following table sets forth a summary of certain projections regarding China’s economic growth for the periods from 2006 to 2010.

 

     2006    2007    2008    2009    2010    CAGR (2006-2010)  

Real GDP (in billions of RMB)(1)

   8,619    9,306    10,034    10,787    11,570    7.6 %

Real GDP per capita (in RMB)(1) 

   6,554    7,034    7,538    8,070    8,618    7.1 %

Disposable income per capita (in US$)(1)

   854    964    1,050    1,130    1,220    9.3 %

(1) Source: Economist Intelligence Unit.

Growth of the Travel Industry in China. Rapid economic growth in China has led to a significant increase in domestic travel activities. Domestic travel volume increased by 75% from approximately 629 million trips in 1995 to approximately 1.1 billion trips in 2004, according to Yearbook of China Tourism Statistics (2005). The substantial increase in domestic travel activities has in turn resulted in significant growth in spending on domestic travel from RMB 352.2 billion (US$44.1 billion) in 2001 to RMB 528.6 billion (US$66.1 billion) in 2005, representing a CAGR of 10.7%, according to Yearbook of China Tourism Statistics (2005).

The following table sets forth a summary of certain data regarding the growth of the travel industry in China for the years from 2001 to 2004.

 

     2001    2002    2003(3)    2004    CAGR (2001-2004)  

Total spending on domestic travel (in billions of RMB)(1)

   352.2    387.8    344.2    471.1    10.2 %

Number of domestic trips (in millions)(1)

   784    878    870    1,102    12.0 %

Number of travelers (overnight visitors) (in millions)(2)

   33.2    36.8    33.0    41.8    8.0 %

Number of domestic air passengers (in millions)(1)

   68.3    77.6    80.8    110.5    17.4 %

(1) Source: China Statistics Yearbook (2005).
(2) Source: Yearbook of China Tourism Statistics (2005).
(3) In 2003, the travel industry in China was negatively affected by the SARS outbreak beginning in March of that year.

 

65


Table of Contents

Growth of the Lodging Industry in China. The substantial growth of the Chinese economy and travel industry has led to a rapid expansion of the lodging industry in China. According to Yearbook of China Tourism Statistics (2005), the number of star-rated hotels, as rated by China National Tourism Bureau, grew from 1,913 in 1995 to 10,888 in 2004, with the number of hotel rooms growing from 486,114 in 1995 to 1,237,851 in 2004.

The following table sets forth a summary of certain data concerning the lodging industry in China as of the dates indicated.

 

     As of December 31,  
     2001    2002    2003    2004    CAGR (2001-2004)  

Number of one- to three-star hotels(1)

   6,788    8,070    8,826    9,675    12.5 %

Number of four- to five-star hotels(1)

   570    810    925    1,213    28.6 %

Number of hotel rooms of star-rated hotels(1)

   816,260    897,206    992,804    1,237,851    14.9 %

Number of occupied hotel room-nights (in millions)(2)

   174    197    203    275    16.4 %

(1) Source: Yearbook of China Tourism Statistics (2005).
(2) Calculated by multiplying number of hotel rooms by average occupancy rate and 365 days, except for 2004, a leap year, in which there were 366 days.

While the supply of hotel rooms has continued to grow, China’s hotels sector has demonstrated its ability to absorb the increase in room supply due to the strong demand for hotel rooms and the overall economic growth, as evidenced by an increase of 22.5% in RevPAR from 2001 to 2004 and a 51.6% increase in the supply of rooms over the same period.

The following table sets forth a summary of certain operating data of star-rated hotels for the years from 2001 to 2004.

 

     2001    2002    2003    2004

Average occupancy rate (in percentage)(1)(2)

   58.5    60.2    56.1    60.6

Average daily rate (in RMB)(1)

   198.1    210.5    218.0    234.0

RevPAR (in RMB)(1)(2)

   115.8    126.6    122.4    141.8

(1) Source: Yearbook of China Tourism Statistics (2005).
(2) Average occupancy rate and RevPAR in 2003 were negatively affected by the SARS outbreak beginning in March of that year.

Specific Factors Driving the Growth of Economy Hotel Chains in China

Fast Growing SMEs. As a result of PRC economy’s transition from a planned economy to a more market-oriented economy, the number of SMEs in China increased from 21.2 million in 2001 to 23.5 million in 2005, and is expected to reach 30.4 million by the end of 2010, according to iResearch. This growth has led to SMEs’ significant contribution to China’s GDP, which was estimated to be 60% of China’s GDP in 2003 according to the United Nations Conference on Trade and Development (Improving the Competitiveness of SMEs Through Enhancing Productive Capacity, UNCTAD/ITE/TEB/2005/1), as well as a substantial increase in business travel by employees of SMEs according to the 2006 Economy Hotel Report. Given their relatively modest budgets, SMEs are generally more value-oriented. As a result, SMEs’ travel policies are more likely to require their employees to stay in economy hotels that provide services tailored to their needs. According to the 2006 Economy Hotel Report, in 2005, 37% of economy hotel guests were individual business travelers, of whom we believe a substantial majority were SME travelers. We believe SME travelers will continue to comprise a substantial and growing portion of the customer base for economy hotels in China.

 

66


Table of Contents

Growth of Domestic Tourism. In conjunction with growing disposable income per capita in China, the central government and various levels of local governments in China have actively promoted the development of the leisure travel market. According to Euromonitor, domestic tourist expenditure increased by approximately 40% from RMB 394 billion in 1999 to RMB 551 billion in 2004 while tourism spending on accommodation increased by 39% from RMB 190 billion in 1999 to RMB 264 billion in 2004. As China’s economy and disposable income per capita continue to grow, leisure travel activities in China are expected to continue to increase, especially in conjunction with the 2008 Summer Olympics in Beijing and the 2010 World Expo in Shanghai.

Expansion of Urban Business Centers. Substantial economic growth in China during the past decades has resulted in the rapid expansion of urban business centers across China, each with a population of over four million people, GDP of over RMB 80 billion (US$10.0 billion) or both. According to China City Statistics Yearbook (2005), China had over 100 cities each with a population of over four million and over 50 cities each with annual GDP of over RMB 80 billion (US$10.0 billion) as of the end of 2004. We believe the expansion of urban business centers has fostered and will continue to support increasing business travel among different business centers across China, resulting in growing demand for economy hotel chains that have broad geographic coverage and strong brand recognition in China.

Fragmentation of the Hotel Industry. The hotel industry is still highly fragmented in China compared to other markets despite an increase of supply in recent years. As of 2004, the top ten hotel brands in China had an approximately 6% share of the Chinese hotel market in terms of sales while the top ten hotel brands in the United States had a 60% share of the U.S. hotel market according to Euromonitor. Most international hotel brands that have a presence in China focus primarily on the upscale segment while many one- to three-star hotels and unrated lodging outlets generally lag in utilizing professional management to deliver quality services. We believe such fragmentation has created opportunities for leading economy hotel chains to further grow and gain market share by focusing on domestic value-conscious customers who demand convenient lodging as well as a consistent product and high-quality services.

 

67


Table of Contents

BUSINESS

Overview

We are a leading economy hotel chain in China, based on the number of our hotels, the number of our hotel rooms, as well as the geographic coverage of our hotel chain. We develop and operate economy hotels across China under our award-winning “Home Inn” brand. Since we commenced operations in 2002, we have become one of the best-known economy hotel brands in China. We offer a consistent product and high-quality services to primarily serve the fast growing population of value-conscious individual business and leisure travelers who demand clean, comfortable and convenient lodging.

We have achieved our growth by utilizing two business models. We either lease real estate properties on which we develop and operate hotels, or we franchise our brand to hotel owners and manage these hotel properties. We refer to the former type of hotels as “leased-and-operated hotels” and to the latter type of hotels as “franchised-and-managed hotels.” As of March 31, 2007, our Home Inns hotel chain consisted of 97 leased-and-operated hotels in operation with an additional 36 leased-and-operated hotels under development and 48 franchised-and-managed hotels in operation and an additional 12 franchised-and-managed hotels under development, covering 53 cities in China. We have received many awards and accolades for our innovative, consistent and high-quality product and services across our hotel chain, including the “2006 Leading Brand in Economy Hotels in China” from the Chinese Hotel Industry Association, the “Golden Pillow Award” for best brand in economy hotels in China in 2006 from the 21st Century Business Herald, a nationwide economic journal in China, and being named one of the “2006 Top 10 Leading Consumer Brands” by the China Enterprise Culture Improvement Association.

We have experienced substantial growth while maintaining profitability since 2003. Our Home Inns hotels in operation grew rapidly from 10 hotels in four cities as of the end of 2003 to 134 hotels in 39 cities as of the end of 2006, and our net income grew from RMB 1.5 million in 2003 to RMB 46.9 million (US$6.0 million) in 2006, representing a CAGR of 215%.

Our Strengths

We believe that the following competitive strengths contribute to our success and differentiate us from our competitors:

Scale and Leadership in the Economy Hotel Market in China. Home Inns is a leading economy hotel chain in China, with a nationwide network of 145 hotels in operation and an additional 48 hotels under development covering 53 cities as of March 31, 2007. We believe our broad hotel network, strong brand recognition and reputation have allowed us to attract customers and establish our leading market position. We have a loyal customer base, as evidenced by the extensive Home Inns membership network consisting of approximately 200,000 active members as of December 31, 2006. Members of our Home Inns membership network contributed approximately 44% of our total room-nights sold in 2006. We believe we are usually our customers’ first choice when they travel to different cities due to our extensive geographic coverage and consistent product and high-quality service.

Our early-mover status in many of our markets and established regional operational synergy have enabled us to develop and operate hotels efficiently and successfully in our targeted markets. As a leading national branded economy hotel chain in China, we have been able to establish credibility with property owners and secure desirable properties on favorable lease terms. In addition, our scale allows us to achieve efficiency in many aspects of our operations, including property development and design, purchasing, systems development and implementation, recruiting and training.

Innovative, Distinctive and Consistent Product. We constantly evaluate the needs and preferences of our targeted customers and our cost structure in an effort to provide a product that caters to our customers’ needs and

 

68


Table of Contents

preferences while maintaining our profitability. While we offer a standardized product in all of our hotels to maintain the uniformity of our hotel chain, we have developed innovative and unique product features, consisting of the design, appearance, color scheme, decoration, lighting and amenities of Home Inns hotels. We believe this makes our hotels attractive to customers and differentiates us from our competitors. One of the most important goals of our operations is to provide consistent, high-quality service to customers across our hotel chain to enable them to enjoy the comforts of home while staying at different Home Inns hotels. To achieve this goal, we have created a comprehensive set of procedural manuals relating to all aspects of our hotel operations to guide our employees to follow the same standards, thereby ensuring the same high quality of services across our Home Inns chain. Our focus in these areas since our inception has allowed us to establish and maintain our Home Inns hotel chain as a leading economy hotel chain in China offering competitive pricing and consistent cleanness, convenience, comfort to value-conscious individual business and leisure travelers. As a result, our hotels consistently enjoy high occupancy rates, which were 86.8%, 89.8% and 92.8% in 2004, 2005 and 2006, respectively.

Outstanding Track Record. Since we commenced operations in 2002, we have developed a track record of expanding our business operations primarily through organic growth while maintaining a consistent and high-quality product and achieving strong financial performance. Our Home Inns hotels in operation grew rapidly from five hotels as of the end of 2002 to 134 hotels as of December 31, 2006, and the geographic coverage of our Home Inns hotels in operation increased from two cities as of the end of 2002 to 39 cities as of December 31, 2006. We have achieved and maintained profitability since 2003, even as we rapidly expanded our business operations and continued to upgrade our product. In addition, we have successfully maintained and enhanced our brand and image, as evidenced by numerous recognitions and awards received by us, including the “2006 Leading Brand in Economy Hotels in China” from the China Hotel Association and the “Golden Pillow Award” for best brand in economy hotels in China in 2006 from the 21st Century Business Herald, a nationwide economic journal in China.

Efficient and Integrated Operational Infrastructure and Information Systems. To ensure that all of our hotels perform optimally, we have established an effective performance evaluation system based on a comprehensive set of clearly defined key performance indicators that are aligned with a corresponding compensation structure. In addition, we have adopted a company-wide best-practice proprietary information system developed in-house by our seasoned information technology team which has extensive operating knowledge of the hotel industry and is closely integrated with our business operations. Our management reporting system allows us to monitor each hotel’s performance and other aspects of our operations on a timely basis. By having current information readily available, we are able to better refine our resource allocation, respond to changes in each geographic market, adjust operational details, and set budgetary targets. Our centralized reservation system allows customers to book hotel rooms utilizing toll-free phone access to our centralized reservation center or through the Internet at any time. Our customer relationship management system tracks the consumption patterns and accumulated and redeemed points of members of our Home Inns membership reward program, allowing us to analyze customer data on a timely and company-wide basis and further improve our customer service accordingly. Our property management system synchronizes each hotel’s room inventory with our reservation system, giving our reservation agents the capability to sell last rooms at every hotel.

Experienced Management Team and Motivated Staff. Our management team has extensive experience in the hospitality and other consumer product and service industries and a proven track record of identifying, developing, operating and managing hotel properties successfully. In addition, we have successfully recruited, trained and retained a team of skilled, committed and motivated managerial and other employees at each of our hotels. We believe our performance-linked compensation structure, career-oriented training and career advancement opportunities are the key drivers that motivate our employees. We provide capable and experienced employees with opportunities to be promoted to management positions. As a result, many of our hotels are managed by qualified employees who have achieved their current positions through internal promotion. Through our training facility, Home Inns Academy, we have implemented extensive training programs and conducted

 

69


Table of Contents

periodic tests to ensure our employees are equipped with up-to-date knowledge of various aspects of our hotel operations and our demand for high-quality services. We have experienced a low attrition rate among our managerial staff since our inception. We believe our employees are motivated and well-trained to deliver high-quality services to our customers. This has significantly contributed to our successful track record and loyal customer base.

Our Strategy

Our goal is to become the leading economy hotel chain in China. We intend to leverage our competitive strengths to replicate our business model consistently in both existing and new markets in China. We also intend to sustain our growth by developing additional Home Inns hotels under both the leased-and-operated and the franchised-and-managed business models to maintain or achieve a dominant position in markets that we decide to enter or expand. Our primary growth strategies include:

Expand Geographical Coverage to Capitalize on Early-Mover Advantage. Home Inns currently has one of the broadest geographical coverage in China among major domestic and international hotel chains, with 145 hotels in operation and an additional 48 hotels under development covering 53 cities as of March 31, 2007. We believe by capitalizing on our early-mover advantage when entering and developing a given geographical market, we can capture a significant market share ahead of our competitors. Our target markets include major metropolitan areas, regional centers demonstrating strong economic growth, and select resort/tourism destinations. We have based and intend to continue to base our expansion program to enter into new markets, focusing on provincial capitals and cities that have strong GDP growth, a high population concentration or both. We have identified over 100 such cities that we intend to focus more on going forward. We intend to continue broadening our geographical coverage and to be a leading player in these markets.

Increase Penetration in Existing Markets. We intend to continue growing organically and increase our penetration in the existing cities in which we operate by selectively establishing more Home Inns hotels, focusing on locating our hotels near ground transportation hubs, business centers, shopping centers, industrial development zones, colleges and universities, and large residential neighborhoods. We believe many of our existing markets are still under-served by hotels catering to individual business and leisure travelers who demand value as well as consistent high-quality service. Given the extensive awareness of, and loyalty to, our Home Inn brand, our growing Home Inns membership network, and our strong local market experience and expertise, we believe that we are well positioned to capture a larger market share in our existing markets.

Continue to Build Brand Awareness and Customer Loyalty. As a leader in the emerging economy hotel chain sector, Home Inns has already achieved significant brand recognition among our existing and target customers. Since word-of-mouth referrals have been, and will continue to be, a key factor in building awareness of our brand, we intend to continue enhancing the Home Inn brand by maintaining the consistency of the high quality products and services that we provide. We continually seek innovative ideas to achieve the best home-away-from-home experience for our customers. We have engaged outside design firms to review our current product and identify potential improvements. In order to continue improving the quality of our services and to meet our customers’ changing demands, we intend to proactively seek customer feedback through a variety of methods, including frequent interactions between our hotel managers and our customers. We also intend to continue improving our Home Inns membership reward program to attract and retain repeat customers and expand our membership network. In addition, we intend to leverage the experience of our dedicated marketing team to further enhance our brand through a variety of initiatives, including increased advertising and launching chain-wide and regional promotional programs and events.

Increase RevPAR by Optimizing Customer Channel Mix and Maximizing Room Rate Growth. We believe our leadership allows us to benefit from industry-wide growth. We intend to further increase RevPAR by optimizing customer channel mix. We receive room reservations from our customers through multiple channels,

 

70


Table of Contents

including our central reservation system, or CRS, our Home Inns membership network, walk-ins, corporate accounts, and travel agencies and consolidators.

Different customer channels require different pricing strategies. Our proprietary information systems track information regarding the customer channel mix at the hotel- and company-level, thereby providing our hotel managers the information necessary to analyze and optimize the mixture of customer channels and pricing strategies through various sales and marketing programs to maximize our hotels’ occupancy and RevPAR. We intend to continue to improve and leverage our information and operational systems to increase RevPAR.

In addition, in markets where demand for hotel rooms exceeds supply, we intend to incrementally increase room rates as we believe any such room rate increases will have a minimal effect on our occupancy rates due to our superior products and services, customer loyalty and brand recognition. We expect room rate increases to result in increased RevPAR and enhanced profitability.

Further Enhance Our Information and Operational Systems and Human Resources Management. We believe our proprietary information and operational systems have given us a significant competitive advantage, and we intend to continue to upgrade our technology and systems and develop new, innovative features and applications to support our anticipated growth and further enhance the management and operational efficiency of our hotels. We also believe the ability to train and retain our employees is important to our growth strategy. We intend to further leverage Home Inns Academy to facilitate the sharing of best practices and to develop a management talent pool with sufficient capacity to meet the demands presented by our rapid growth. In addition, we will continue to refine our performance evaluation system, compensation schemes and career development initiatives for our employees. By closely and systematically monitoring our employees’ performance and aligning their interests with those of management and our shareholders, we believe that we can continue to attract, train and retain qualified managerial and other employees to maintain our consistent high-quality services across our hotel chain.

Pursue Strategic Acquisitions. We intend to pursue strategic acquisitions to obtain properties, assets and businesses that own properties and assets that we believe are complementary to our business and growth strategies. We may also acquire properties and assets from our existing franchisees, thereby converting existing franchised-and-managed hotels into leased-and-operated hotels. When evaluating a potential acquisition, we will consider the attractiveness of the property’s location within the existing cities in which we operate or in the new geographic markets where we intend to expand. We will also consider the acquisition’s potential for meeting our internal financial return objectives over the long term. We believe that such strategic acquisitions may provide an effective means to expand our geographical coverage, increase our penetration in existing markets, increase our revenue and further enhance our leadership position as well as our ability to provide an attractive return on investment for our investors.

 

71


Table of Contents

Our Home Inns Hotel Chain

We are dedicated to providing a consistent and high-quality product to our customers, allowing them to enjoy the comforts of home while staying at any Home Inns hotel. Our Home Inns hotel chain is a leading economy hotel chain in China offering cleanness, convenience, comfort and value to individual business and leisure travelers.

As of March 31, 2007, our Home Inns hotel chain consisted of 145 hotels in operation and an additional 48 hotels under development, covering 53 cities in China. The following map sets forth the geographic coverage of our hotel chain as of March 31, 2007.

LOGO

Our Home Inns hotel chain covers most major metropolitan areas in China. We intend to further penetrate the existing metropolitan markets where we have a presence and also expand into additional cities in China with a population of over four million, annual GDP of over RMB 80 billion (US$10.0 billion), or both. We believe cities meeting these criteria generally have the potential for sustainable economic growth and increasing demand for hotel accommodation services.

A typical Home Inns hotel has 80 to 150 guest rooms. Each hotel has a standardized design, appearance, decor, color scheme, lighting scheme and set of guest amenities in each room, including a bedding package featuring mattresses meeting the standards of four-star hotels in China, free in-room broadband Internet access, a comfortable work space, air-conditioning and a supply of cold and hot drinking water. Home Inns hotels are strategically located to provide our guests with convenient access to major business districts, ground transportation hubs, major highways, shopping centers, industrial development zones, colleges and universities, and/or large residential neighborhoods.

 

72


Table of Contents

The following table sets forth a complete listing of all of our hotels as of March 31, 2007.

 

     Hotels in Operation    Hotels Contracted

City

   Leased-and
Operated Hotels
   Franchised-
and-
Managed Hotels
   Leased-and
Operated Hotels
   Franchised-
and-
Managed Hotels

Beijing

   11    17    1    5

Shanghai

   15    8       1

Suzhou

   4    4    1    1

Hangzhou

   2    5      

Fuzhou

   2       1   

Wuxi

   3         

Tianjin

   7    5    2    2

Xiamen

   1       1    1

Ningbo

   1    1      

Shenzhen

   3         

Guangzhou

   3    1      

Wuhan

   3       2   

Chongqing

   1         

Chengdu

   3         

Shenyang

   2    1    2   

Dalian

   2         

Nanjing

   5    2    1   

Hefei

   1       1   

Zhengzhou

   2    1    2   

Qingdao

   4       1   

Xi'an

   1       2    1

Harbin

   1         

Shijiazhuang

   2    1    1   

Changchun

      1    2   

Nanning

         2   

Nanchang

         1   

Huhehaote

         1   

Jinan

   1       2   

Taiyuan

         1   

Changzhou

   3         

Nantong

   1         

Shaoxing

   1         

Jiangyin

   1         

Zhuhai

   1         

Yangzhou

   1         

Zhongshan

   1         

Zibo

   1       1   

Luoyang

   1         

Foshan

         1   

Yantai

   1         

Weifang

   1       1   

Weihai

   1         

Baoding

         1   

Jilin

   1         

Baotou

   1         

Bengbu

   1         

Zhangjiajie

      1      

Dezhou

         1   

Changshu

            1

Xuzhou

         1   

Guiyang

         1   

Changsha

         1   

Guilin

         1   
                   

Total

   97    48    36    12
                   

(1) Contracted hotels include hotels which have not commenced operations but for which we have entered into binding leases or franchise agreements with the respective lessors or franchisees.

 

73


Table of Contents

Leased-and-operated Hotels. 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 the standards of Home Inns, as well as repairs and maintenance and operating 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 managers and employees required to operate our hotels and purchasing supplies. We typically pay fixed rent on a quarterly basis for the first three or five years of the lease term, after which we may be subject to a 3% to 5% increase every three to five years. We generally have a right of first refusal to extend the lease after the initial term expires. The annual rent for each of our leased-and-operated hotels ranges from RMB 0.6 million (US$0.08 million) to RMB 5.2 million (US$0.7 million), depending on the location, size and condition of each hotel property. The terms of our leases range from eight to 20 years, most of which are 15 years. In general, upon expiration of these leases, we may dispose of the removable facilities, equipment and appliances installed by us while leasehold improvements and fixtures may be kept by the lessor on the premises. In the case of early termination of a lease due to the lessor’s default, we are generally entitled to take all removable items installed by us and may also be compensated for the amount we spent in connection with the leasehold improvements. In the case of early termination of a lease due to our default, we are generally entitled to take all removable items installed by us and the lessor is entitled to the leasehold improvements which result from our investments.

Franchised-and-managed Hotels. For our franchised-and-managed hotels, we franchise our Home Inn brand to franchisees who are property owners, lessors or existing hotel operators, and we are generally responsible for managing these hotels, typically including the hiring and appointing of the general managers of these hotels. Under a typical franchise agreement between us and a franchisee, the franchisee is generally required to pay us an initial franchise fee of RMB 0.2 million (US$0.03 million) to RMB 0.3 million (US$0.04 million), annual franchise fees of 3% of the revenues of the hotel, as well as an annual management fee of 3% of the revenues of the hotel. The franchisee is responsible for the costs of hotel development and customization to conform to the standards of Home Inns, as well as for repairs and maintenance and operating expenses of the hotel. In general, we enter into franchise arrangements in markets where we have established leased-and-operated hotels and are able to leverage our local knowledge and experience as well as marketing and administrative resources to better assist our franchised-and-managed hotels in these localities. The typical term for our franchise agreements is five years.

The following table sets forth the number of our hotels in operation as of March 31, 2007.

 

     Total
Number
of Hotels
   Number of
Hotels Opened
for Over Six
Months
   Number of
Hotels Opened
for No More
Than Six Months
   Average
Number of
Rooms per Hotel
   Typical
Lease/Franchise
Term

Leased-and-operated Hotels

   97    78    19    121    15 years

Franchised-and-managed Hotels

   48    29    19    118    5 years

We also operate four leased-and-operated hotels through separate joint ventures with third parties. Home Inns Shanghai owns 75% of one joint venture and 51% of each of the other three joint ventures.

 

74


Table of Contents

We set the room rates of our hotels based on local market conditions with reference to room rates set by our competitors. As we primarily target individual business and leisure travelers, January or February, the month during which the Chinese New Year falls, generally accounts for a lower portion of our annual revenues than other months. The following table presents certain selected operating data as of and for the dates and periods indicated. We present operating data for 2004 as if we had consolidated Home Inns Beijing throughout the year. Our results of operations have been and will continue to be significantly affected by changes in these operating measures which are widely used in the hospitality industry.

 

     As of and for the Year
Ended December 31,
     2004    2005    2006

Operating Data:

        

Total hotels in operation(1):

        

Leased-and-operated hotels(2)

   18    54    94

Franchised-and-managed hotels

   8    14    40

Total rooms(1)

   2,991    8,197    16,162

Geographic coverage(1):

        

Number of cities

   8    22    39

Occupancy rate (as a percentage)

   86.8    89.8    92.8

Average daily rate (in RMB)

   191    182    182

RevPAR (in RMB)

   166    163    169

(1) As of the end of each period.
(2) Includes four hotels operated through separate joint ventures with third parties.

Hotel Development

We follow a structured and systematic development and construction process with respect to new hotel properties. Our multi-step development process starts with planning and site identification. We have staff based in our head office in Shanghai focusing on identifying potential new markets and performing a comprehensive study of each new market by conducting site visits and gathering background information such as the regional economic conditions and availability of existing hotel accommodation services in the prospective new market. After the development team at our head office decides to pursue opportunities in a new market, we assign our regional development staff and the city general manager in each region to select ideal hotel locations in the chosen market. Once a site has been selected, we negotiate with the property owner while concurrently conducting due diligence investigations with respect to a number of major legal and regulatory aspects, including the owner’s land title and relevant zoning regulations. For our leased-and-operated hotels, we lease properties from real estate owners or lessors and we convert the properties into standardized Home Inns hotels. Our lease term negotiations are guided by a comprehensive set of criteria, including certain financial return requirements. All new hotel leases are subject to the final approval of four designated directors of Home Inns Beijing, including our chief executive officer, David Jian Sun. As a leading branded economy hotel chain in China, we are generally able to establish credibility with property owners and secure desirable properties on reasonable terms. We commence constructing a standardized Home Inns hotel after definitive agreements with the owner have been executed. A majority of the construction materials and supplies for the new hotel are purchased through our centralized procurement system. For our franchised-and-managed hotels, we assist franchisees in refurbishing, renovating or constructing their properties after they join our branded hotel chain, and in meeting our brand specifications by providing technical expertise and cost-savings suggestions. Before completion of construction, we carry out a series of pre-opening activities, such as identifying and appointing the general manager and other members of the hotel management team, and hiring and training hotel staff in anticipation of the hotel opening. It typically takes four to six months from execution of a lease or franchise agreement to hotel opening.

We have incurred capital expenditures primarily in connection with leasehold improvements and investments in furniture, fixtures and equipment, technology and information and operational systems. Our

 

75


Table of Contents

capital expenditures totaled RMB 61.7 million, RMB 193.2 million and RMB 237.9 million (US$30.5 million) in 2004, 2005 and 2006, respectively. We will continue to make capital expenditures to meet the expected growth of our operations. We expect to meet our capital expenditure needs in the foreseeable future with cash generated from our operating activities and financing activities. We have not had any material divestiture during the past three years.

We seek to lease or franchise properties that meet the following market- and hotel-specific criteria:

General Market Criteria

Economic Growth. We focus on cities that are approaching, or have already entered into, periods of significant economic growth. Such cities generally show growth in certain business activities as measured by employment opportunities, population growth rates, tourism and convention activities, air traffic volume, local commercial real estate occupancy, and retail sales volume. Markets that exhibit growth in these metrics typically have strong demand for hotel facilities and services. We have identified over 100 such cities in China, including cities each with a population of over four million, annual GDP of over RMB 80 billion (US$10.0 billion) or both, and provincial capitals. We intend to focus more on these cities going forward.

Geographic Diversification. We seek to maintain a geographically diverse portfolio of hotels to offset the effects of regional economic cycles. We will continue to expand into new urban business centers as opportunities arise that meet our investment criteria.

Favorable Development Environment. We seek lodging markets with favorable hotel development environment, including an absence of or minimal zoning constraints, an absence of lengthy local development approval and registration processes, as well as the availability of suitable sites and construction contractors.

Specific Hotel Criteria

Location and Market Appeal. We seek to invest in hotels situated near both business and leisure centers that tend to generate a broad base of demand for hotel accommodations and facilities. These demand drivers include transportation hubs, convention centers, business parks, shopping centers and other retail areas, major highways, tourist destinations, major universities and cultural and entertainment centers. The confluence of nearby business and leisure centers will enable us to attract both weekday business travelers and weekend leisure guests.

Size and Facilities. We seek to develop and operate economy hotels with 80 to 150 guest rooms, which include amenities that are attractive to key demand segments such as individual business and leisure travelers. We believe operating economy hotels with 80 to 150 rooms allows us to best leverage our competitive strengths and maximize our profitability.

Financial Return Requirements. We require our development team, marketing team and city general managers to assess the potential financial return of every proposed new hotel. We will only develop hotels that exhibit a potential for meeting our internal financial return objectives both in the near term and over the term of the lease agreement.

Hotel Management

We believe that skilled management is a critical element in maximizing revenues and profitability of our hotel operations. A majority of our senior hotel management team has extensive experience in the hospitality and other consumer-services industries. Personnel at our corporate office perform strategic planning, finance, project development, sales and marketing, training and other functions and guide, support and monitor our on-site hotel operations and executives. Each of our departments, including hotel operations, sales and marketing, human resources, training, information technology, development, legal, and accounting and finance, is staffed by an

 

76


Table of Contents

experienced team with significant expertise in their respective area. These departments support each hotel and its management in day-to-day activities by providing operating statistics, accounting and budgeting services, sales and revenue management, marketing and promotion support, cost controls, property management tools and other resources that we develop, maintain and deliver efficiently and effectively using our centralized corporate office resources. Key elements of our centralized hotel management programs include the following:

Budgeting and Monitoring. Our corporate office personnel work with the general manager of each hotel to set a detailed annual budget for revenues and cost categories of the hotel. The annual budget is based on historical operating performance of the hotel, planned targeted marketing, planned renovations, operational efficiencies and local market conditions. Through the use of our online property management and management reporting systems, we are able to track each hotel’s daily occupancy, average daily rates, RevPAR and other operating data. As a result, we can effectively and timely monitor the actual performance of each hotel. By having current hotel operating information available on a timely basis, we can adjust sales efforts and other resources in time to take advantage of changes in the market and to maximize our profitability.

Quality Assurance and Training. We are dedicated to providing value and consistent quality standards to our customers. We have established quality standards for all aspects of our hotel operations that cover, among other areas, housekeeping, hotel maintenance and renovation, and service offering. To ensure compliance with our quality standards, we have developed a comprehensive set of procedural manuals relating to all aspects of our hotel operations to ensure that our employees follow the same standards. We have implemented comprehensive training programs to ensure the effectiveness and uniformity of our employee training through our centralized human resources department at our corporate office as well as through our dedicated training facility, Home Inns Academy.

The compliance of our hotels with quality standards is monitored through both scheduled and unannounced visits and reviews conducted periodically at each hotel. We require most of our employees to take periodic tests in order to monitor compliance with our quality standards. In addition, our practice of tracking customer comments through guest comment cards, and the direct solicitation of guest opinions regarding specific items, allows us to improve services and amenities at each hotel across our hotel chain.

Strategic Capital Improvements. To maintain our competitiveness and enhance our hotels’ appeal to targeted market segments, we require each of our hotels to allocate a fixed percentage of its revenue for periodic renovation and replacement of furnishings and equipment to maintain the quality and standards of our facilities. We base recommendations on capital spending decisions on customer feedback, strategic needs, and our targeted financial return on a given capital investment.

Centralized Procurement. We have implemented a centralized procurement system to allow us to obtain the best pricing available for the quality of goods sourced to our hotels in order to minimize the operating expenses of our hotels. As a leading branded economy hotel chain in China with nationwide scale, we are able to exert leverage over our suppliers of commodity goods and services.

Targeted Sales. We support each hotel’s local sales efforts with corporate office sales executives who develop and implement new marketing programs, and monitor and respond to specific market needs and preferences. We use a property management system, or PMS, to manage each property’s use of the various distribution channels in the lodging industry. Those channels include our central reservation system and toll-free numbers, third-party travel agents and other travel intermediaries, corporate travel offices and office managers. Based on market conditions, we adjust the number of rooms allocated to each of our sales channels on a daily basis in order to optimize our profitability.

 

77


Table of Contents

Hotel Information and Operational Systems

The principal objectives of our hotel operations are to generate higher RevPAR, control costs and increase the net operating income of our hotels, while providing our customers with high-quality services and value. Our integrated proprietary information and operational systems are designed to distinguish us in the marketplace, operate efficiently and cost-effectively and accommodate future growth. Our investment in our sophisticated system infrastructure has several key benefits: better customer service, simplification of the storage and processing of large amounts of data, facilitation of the large-scale operation and automation of the administration of our business and generating financial and operational information for each hotel to assist our corporate management in adjusting business strategies on a timely basis.

Our key hotel information and operational systems include the following:

Property Management System (PMS). Our proprietary PMS system is designed to help our hotels maximize profitability and compete more effectively by managing their room inventory, rates and reservations. The PMS system synchronizes each hotel’s room inventory with our reservation system, giving our reservation agents the capability to sell last rooms at our hotels. The PMS system also includes a revenue management feature that calculates and suggests optimum rates based on each hotel’s past performance and projected occupancy. These tools enhance our ability to effectively manage our hotel operations and maximize RevPAR.

Central Reservation System (CRS). Approximately 17% of our total hotel room nights are booked through our proprietary CRS system, which primarily consists of our toll-free telephone reservation system. As of December 31, 2006, we employed 37 reservation agents to serve customers who make hotel reservations by phone. Our trained reservation agents can match each caller with a Home Inns hotel that meets the caller’s needs. Our CRS provides a data link to all of our hotels so that confirmations are transmitted automatically to the hotel for which the reservations are made.

Customer Relationship Management System (CRM). Our proprietary CRM system tracks the consumption patterns and accumulated and redeemed points of the active members of our Home Inns membership rewards program. This information enables us to analyze customer data on a company-wide basis as well as to develop a more specific and targeted marketing strategy.

Management Reporting System. We have designed a proprietary web-based management reporting system at each of our hotels and at our corporate office to monitor the daily financial and operating performance of each of our hotels. This system allows us to track each hotel’s daily occupancy, average daily rates, RevPAR and other operating and financial data.

One of our ongoing primary objectives is to maintain reliable information, management and operational systems. We have implemented performance monitoring for all key systems to enable us to respond quickly to potential problems. Our computers and servers are hosted at a facility in Shanghai. This facility provides redundant utility systems, a backup electric generator and 24-hour server support. All servers have uninterrupted power supplies and redundant file systems to maximize system and data availability. We regularly back up our data to minimize the impact of data loss due to system failure.

Sales and Marketing

Our core targeted customers consist of value-oriented individual SME business travelers and leisure travelers seeking comfortable and convenient lodging at an affordable price. We review our hotel pricing twice a year and typically adjust room rates annually based on the local market conditions of the city and the specific location of each hotel. Our head office team and our city and hotel managers jointly develop tailored marketing plans to drive sales for each hotel and in each city. We use management and operational systems to manage each hotel’s use of the various distribution channels in the lodging industry. Those channels include our centralized

 

78


Table of Contents

reservation system and toll-free numbers, third-party travel agents and other travel intermediaries and corporate travel offices. Our access to these channels allows us to further enhance occupancy rates of our hotels on a day-to-day basis.

The following table presents the percentage of room nights stayed in 2006 by customer channel:

 

Customer Channel

   Percentage of Total
Room Nights Stayed in 2006

CRS bookings by members of our Home Inns membership network

   14.9

CRS bookings by non-members of our Home Inns membership network

   2.3

Reservations not booked through CRS by members of our Home Inns membership network

   28.7

Walk-ins

   18.3

Corporate accounts

   16.2

Travel agencies and consolidators

   8.2

Others

   11.4
    

Total

   100.0

Our centralized reservation center is located in Shanghai, China and is operated daily from 9:00 A.M. to 9:30 P.M., seven days a week. Customers can call our nationwide toll free number to consult with our reservation agents, receive real-time hotel information and make hotel bookings. As of December 31, 2006, we employed 37 reservation agents, all of whom participated in a formal training program before commencing work. We believe we have sufficient capacity to meet the currently anticipated increases in call volume. Nevertheless, if we exceed this capacity, we believe we can add, within a reasonable time and at a reasonable cost, additional phone lines, computer systems and reservation agents to handle increasing call volumes without the need to undertake system redesign to our existing systems.

Our corporate marketing and advertising programs are designed to enhance consumer awareness and preference for the Home Inn brand as offering the greatest value, convenience and comfort in the economy hotel segment of the Chinese lodging industry, and to encourage customers’ use of our centralized reservation system. Marketing and advertising efforts include outdoor advertisements, distribution of flyers and other marketing materials on our hotel properties, television, internet and radio advertising, print advertising in consumer media and promotional events, special holiday promotions and joint promotional activities.

Since 2004, we have operated a Home Inns membership reward program to attract travelers by rewarding frequent stays with points towards free hotel stays, discounts on room rates, priority in hotel reservations and other rewards. As of December 31, 2006, our membership reward program had approximately 200,000 active members as compared to approximately 58,000, 105,000 and 130,000 active members as of June 30, 2005, December 31, 2005 and June 30, 2006, respectively. This program allows us to build customer loyalty as well as conduct lower cost, more targeted marketing campaigns.

Employees and Training

We believe that developing and maintaining a team of capable and motivated managerial and other employees are critical to our success. Because 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 brand and reputation. We seek to hire managerial employees with background and experience in hotel and other consumer services industries with a customer-first mentality. We aim to recruit, train and retain the best talent through a multi-step recruiting and training process while offering competitive performance-linked compensation packages and career advancement opportunities.

 

79


Table of Contents

We have implemented extensive training programs and periodic tests for managerial and other hotel-based staff primarily through our training facility, “Home Inns Academy.” New general managers of our hotels and executive assistants to general managers are required to undergo a two-month training period, during which they receive training in managing all core aspects of our hotel operations, as well as our company culture and philosophy. We also require our hotel general managers and city managers to participate in annual training programs so that they can stay abreast of changes in our hotel operations and consumer preferences and demands. In addition, all employees of a new hotel are required to undergo an approximately 25-day job training prior to commencing their duties. We also have trained on-site managers in many of our hotels to provide continuous training to our hotel staff. In addition to training, we have implemented periodic tests to assess the relevant knowledge and skills of our managerial and other employees.

To ensure that all of our hotels have optimal and satisfactory performance, we have established an effective and clearly-defined performance evaluation system based on a comprehensive set of key performance indicators that are aligned with a corresponding compensation structure. In addition, we provide capable and experienced hotel staff with opportunities to be promoted to management positions. We believe our performance-linked compensation structure, career-oriented training and career advancement opportunities are the key drivers that motivate our employees. As a result, we have experienced a very low attrition rate among our managerial staff since our inception. We were included in the Corporate Research Foundation’s list of “2007 China Top Employers.”

We had 1,183, 2,792 and 6,291 employees as of December 31, 2004, 2005 and 2006, respectively. As of December 31, 2006, our employees consisted of 5,898 hotel-based employees (including 1,698 employees at our franchised hotels), 37 reservation agents at our centralized reservation center, and 356 corporate staff. None of our employees is represented by a labor union. We consider our relations with our employees to be good.

Competition

The lodging industry in China is highly fragmented and competitive, and we expect competition to persist and intensify. Hotels in China are not required to, but may, apply for star ratings as approved by tourism bureaus of local governments or the National Tourist Administration based on the star rating regulations in China. This standard defines five distinct star ratings, i.e., 1-Star, 2-Star, 3-Star, 4-Star and 5-Star, including Platinum 5-star. In order to obtain a particular star rating, a hotel must meet certain defined standards for the availability and quality of hotel facilities and public area, availability and quality of amenities in guest rooms, food and beverage facility, scope of guest services, and scope and quality of management infrastructure, etc. We have not applied for star ratings because we do not consider obtaining a star rating as necessary and our business has not been affected as we focus on meeting individual business and leisure travelers’ basic accommodation needs with affordable pricing, a comfortable lodging experience, high-quality services and standardized hotel rooms and amenities across our hotel chain.

We compete with other hotels for guests in each of the markets in which we operate. Competition in the industry is primarily based on room rates, quality of accommodations, brand name recognition, convenience of location, geographic coverage, service quality, range of services, and guest amenities. We compete primarily with other economy hotel chains, such as Jinjiang Star, Motel 168, Super 8 and Ibis, as well as various regional and local economy hotel chains. We also compete with two- and three-star hotels, as we offer rooms with standards comparable to many of those hotels and many of the amenities available at those hotels while maintaining competitive pricing and high-quality services tailored to individual business and leisure travelers. In addition, we may also face competition from new players in the economy hotel segment in China. As compared to four- or five-star hotels, developing an economy hotel requires a smaller commitment of capital and human resources. This relatively lower barrier of entry permits new competitors to enter our markets quickly and compete with our business. Furthermore, we may face competition from all other hotels for guests in each of our markets, as our typical business and leisure traveler customers may change their travel and spending patterns and choose to stay in hotels in different segments.

 

80


Table of Contents

Intellectual Property

Our brand, trade names, trademarks, trade secrets and other intellectual property rights distinguish and protect our technology platforms, services and products from those of our competitors, and contribute to our competitive advantage in the economy hotel segment of the lodging industry in China. To protect our brand and other intellectual property, we rely on a combination of trademark, trade secret and copyright laws as well as imposing confidentiality obligations on our employees, contractors and others. We have a total of ten registered trademarks in China, including “ LOGO”, and are applying for registration of eight new trademarks in China. We have registered our domain name www.homeinns.com with the Internet Corporation for Assigned Names and Numbers.

We cannot assure you that our efforts to protect our intellectual property rights will be adequate or that third parties will not infringe or misappropriate these rights. If others are able to copy and use our proprietary information and operational system and other proprietary technology platform without spending time and resources to develop their own, we may not be able to maintain our competitive position. Furthermore, the application of laws governing intellectual property rights in China is uncertain and evolving and could involve substantial risks to us. If litigation is necessary to enforce our intellectual property rights or determine the scope of the proprietary rights of others, we may have to incur substantial costs or divert other resources, which could harm our business and prospects.

Insurance

We believe that our hotels are covered by adequate property and liability insurance policies with coverage features and insured limits that we believe are customary for similar companies in China. We carry property insurance that covers the assets that we own at our hotels, but not the buildings or any other assets owned by our lessors. Although we require our lessors to purchase customary insurance policies, we cannot guarantee that they will adhere to such requirements. If we were held liable for amounts and claims exceeding the limits of our insurance coverage or outside the scope of our insurance coverage, our business, results of operations and financial condition may be materially and adversely affected.

Facilities

Our headquarters are located in Shanghai, China, where we lease approximately 700 square meters of office space. As of December 31, 2006, we leased 94 out of our 134 hotel facilities with an aggregate size of 597,994 square meters. For detailed information about the locations of our hotels, see “—Our Home Inns Hotel Chain.”

Legal Proceedings

We are subject to legal proceedings, investigations and claims incidental to the conduct of our business from time to time. We are not currently a party to, nor are we aware of, any legal proceeding, investigation or claim which, in the opinion of our management, is likely to have a material adverse effect on our business, financial condition or results of operations.

 

81


Table of Contents

REGULATION

The hotel industry in China is subject to a number of laws and regulations, including laws and regulations relating specifically to hotel operation and management and commercial franchising, as well as those relating to environmental and consumer protection. The principal regulation governing foreign ownership of hotel businesses in the PRC is the Foreign Investment Industrial Guidance Catalogue, which became effective as of January 1, 2005. Under the regulation, the hotel industry belongs to the category of permitted foreign investment industry and there is no restriction on foreign investment in hotel businesses in China, other than regular business license and other permits that must be possessed by every lodging business in China. There are no regulatory ceilings on room rates in China. The market-based pricing is permissible for the hotel industry and room rates may be determined at the sole discretion of hotel management. Relative to other industries in China, regulation of the hotel industry in China is still developing and evolving. As a result, most legislative action has consisted of general measures such as industry standards, rules or circulars issued by different ministries rather than detailed legislation. Many of these standards, rules and circulars date from the late 1990’s, and it is expected that they may be amended, revised or expanded in the coming years as the hotel industry in China matures. This section summarizes the principal PRC regulations currently relevant to our business and operations.

Regulations on Hotel Operation

In November 1987, the Ministry of Public Security issued the Measures for the Control of Security in the Hotel Industry, and in June 2004, the State Council promulgated Decision of the State Council on Establishing Administrative License for the Administrative Examination and Approval Items Really Necessary To Be Retained. Under these two regulations, anyone who applies to operate a hotel is subject to examination and approval by the local public security authority and must obtain a Special Industry License. The Measures for the Control of Security in the Hotel Industry impose certain security control obligations on the operators. For example, the hotel must examine the identification card of any guest to whom accommodation is provided and make an accurate registration. The hotel must also report to the local public security authority if it discovers anyone violating the law, behaving suspiciously or an offender wanted by the public security authority.

In April 1987, the State Council promulgated the Public Area Hygiene Administration Regulations, according to which, a hotel must obtain a public area hygiene license before opening for business. In October 1995, the Standing Committee of the National People’s Congress, or the SCNPC, enacted the PRC Law on Food Hygiene, according to which any hotel that provides food must obtain a food hygiene license. In April 1998, SCNPC enacted the Fire Prevention Law. The Fire Prevention Law requires that public gathering places such as hotels pass a fire prevention safety inspection by the local public security fire-fighting department prior to opening for business. In January 2006, the State Council promulgated the Regulations for Administration of Entertainment Places, In March 2006, the Ministry of Culture issued the Circular on Carrying out the Regulations for Administration of Entertainment Places, under these regulations, hotels that provide entertainment facilities, such as discos or ballrooms, are required to obtain a license for entertainment business operations. The above regulations also set forth obligations concerning public security, hygiene, fire prevention, and other standards relating to the operation of public facilities. The relevant administrative authorities may impose penalties and even shut down hotels that violate the provisions.

In 2003, the National Tourist Administration, or the NTA, promulgated the Regulations on the Assessment of the Star Rating 0f Tourist Hotels, or the Star Rating Regulations. Under the Star Rating Regulations, all hotels with operations of over one year are eligible to apply for a star rating assessment. There are five ratings from one star to five stars for tourist hotels, assessed based on the level of facilities, management standards and quality of service. A star rating, once granted, is valid for five years.

 

82


Table of Contents

Regulations on Consumer Protection

In October 1993, the SCNPC promulgated the Law on the Protection of the Rights and Interests of Consumers, or the Consumer Protection Law. Under the Consumer Protection Law, a business operator providing a commodity or service to a consumer is subject to a number of requirements, including the following:

 

  (1) to ensure that commodities and services meet with certain safety requirements;

 

  (2) to disclose serious defects of a commodity or a service and adopt preventive measures against damage occurrence;

 

  (3) to provide consumers with true information and to refrain from conducting false advertising;

 

  (4) not to set unreasonable or unfair terms for consumers or alleviate or release itself from civil liability for harming the legal rights and interests of consumers by means of standard contracts, circulars, announcements, shop notices or other means; and

 

  (5) not to insult or slander consumers or to search the person of, or articles carried by, a consumer or to infringe upon the personal freedom of a consumer.

Business operators may be subject to civil liabilities for failing to fulfill the obligations discussed above. These liabilities include restoring the consumer’s reputation, eliminating the adverse effects suffered by the consumer, and offering an apology and compensation for any losses incurred. The following penalties may also be imposed upon business operators for the infraction of these obligations: issuance of a warning, confiscation of any illegal income, imposition of a fine, an order to cease business operation, revocation of its business license or imposition of criminal liabilities under circumstances that are specified in laws and statutory regulations.

In December 2003, the Supreme People’s Court enacted the Interpretation of Some Issues concerning the Application of Law for the Trial of Cases on Compensation for Personal Injury, which further increases the liabilities of a business operator engaged in the operation of hotels, restaurants, or entertainment facilities and subjects such operators to compensatory liability for failing to fulfill their statutory obligation to a reasonable extent or to guarantee the personal safety of others.

Regulations on Environmental Protection

In June 2002, the SCNPC issued the Law on Promoting Clean Production which regulates service enterprises such as restaurants, entertainment establishments and hotels and requires them to use technologies and equipment that conserve energy and water, serve other environmental protection purposes, and reduce or stop the use of consumer goods that waste resources or pollute the environment.

Regulations on Commercial Franchising

Franchise operations are subject to the supervision and administration of the Ministry of Commerce, or the MOC, and its regional counterparts. The MOC promulgated the Administrative Measures on Commercial Franchise Operations or Commercial Franchise Measures on December 30, 2004.

Under the Commercial Franchise Measures, a franchiser must satisfy certain requirements including having: sufficient business resources such as relevant trademarks, trade names and business models which it has been duly authorized to use; the capability to provide long-term business guidance and training services to franchisees; and ownership of at least two self-operated shops that have been in operation for at least one year within China and which were set up by itself or its subsidiaries or holding company. In January of each year, franchisers are required to file franchise contracts executed the previous year with the local commerce administrative authorities with jurisdiction over the franchiser’s locale and the franchisee’s locale.

The franchiser is also required to provide the franchisee with true and accurate basic information relating to the franchise 20 days prior to the execution of a franchise agreement, including:

 

  (1) the name, domiciles, registered capital, scope of business and term of franchise of the franchiser, basic information relating to financial statements audited by an accounting firm and tax payments;

 

83


Table of Contents
  (2) the number, location, business status and investment budget for all franchise outlets of the franchisee, and the ratio of terminated franchisees to the total number of franchisees;

 

  (3) information on the registration and license of trademarks and details of trade name, business model and other business resources, and details of any lawsuits relating to the trademarks or trade names;

 

  (4) the type, amount and method of payment of franchise fees and the method of refund of deposit;

 

  (5) information on any lawsuit in which the franchiser has been involved in the previous five years;

 

  (6) goods or services that the franchiser can provide to the franchisee and any conditions or restrictions on their provision;

 

  (7) a certification of its ability to provide training and guidance and specific details on training or guidance to be provided;

 

  (8) basic information regarding the legal representative and other primary responsible persons, and whether they have any criminal record and whether they are personally liable for the bankruptcy of any enterprise; and

 

  (9) other information and materials required to be disclosed by a franchiser upon the request of the franchisee.

Failure to disclose information in accordance with the provisions may result in the imposition of fines on the franchiser or the revocation of its business license. In addition, where a franchisee suffers any economic loss due to the provision of incomplete or false information by the franchiser, the franchiser shall be liable for compensatory damages.

The Commercial Franchising Measures also contain special provisions regarding franchising undertaken by foreign invested enterprises, or FIEs. Under the Commercial Franchising Measures, if an existing FIE wishes to operate a franchise in China it must apply to its original examination and approval authority to expand its business scope to include “engaging in commercial activities by way of franchise.” In addition, franchise contracts executed in the previous year are required to be filed with its original examination and approval authority and the commerce administrative authorities at the place where the franchisee is located.

Regulations on Trademarks

Both the PRC Trademark Law, adopted in 1982 and revised in 2001, and the Implementation Regulation of the PRC Trademark Law adopted by State Council in 2002, give protection to the holders of registered trademarks and trade names. The Trademark Office under the State Administration for Industry and Commerce handles trademark registrations and grants a term of ten years to registered trademarks. Trademark license agreement must be filed with the Trademark Office or its regional counterpart.

Regulations on Foreign Currency Exchange

Under the Foreign Currency Administration Rules promulgated in 1996 and revised in 1997 and various regulations issued by State Administration of Foreign Exchange, or SAFE, and other relevant PRC government authorities, the Renminbi is convertible for current account items, such as trade related receipts and payments, interest and dividend. Capital account items, such as direct equity investments, loans and repatriation of investment, require the prior approval from SAFE or its local counterpart for conversion of Renminbi into a foreign currency, such as U.S. dollars, and remittance of the foreign currency outside the PRC.

Payments for transactions that take place within the PRC must be made in RMB. Unless otherwise approved, PRC companies must repatriate foreign currency payments received from abroad. Foreign-invested enterprises may retain foreign exchange in accounts with designated foreign exchange banks subject to a cap set by SAFE or its local counterpart. Unless otherwise approved, domestic enterprises must convert all of their foreign currency receipts into RMB.

 

84


Table of Contents

Regulations on Dividend Distribution

The principal regulations governing dividend distributions by wholly foreign owned enterprises and Sino-foreign equity joint ventures include:

 

   

the Wholly Foreign Owned Enterprise Law (1986), as amended;

 

   

the Wholly Foreign Owned Enterprise Law Implementing Rules (1990), as amended;

 

   

the Sino-foreign Equity Joint Venture Enterprise Law (1979), as amended; and