H World Group Limited (HTHT) Q4 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen thank you for standing by and welcome to Huazhu Group Limited Quarter Four 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions] And I must advise you that this conference is being recorded today, the 15th of March, 2019. I would now like to hand the conference over to your speaker today, Ida Yu. Thank you. Please go ahead.

Thank you, Richie. Good morning everyone. Thanks to all of you for dialing in and welcome to our fourth quarter and full year 2018 earnings conference call. Joining us today is Mr. Ji Qi, our Founder and Executive Chairman; Ms. Jenny Zhang, our CEO; and Mr. Teo Nee Chuan, our CFO. Jenny and Teo will present the strategy review and the Q4 and full year results. Following their prepared remarks, management will be available to answer your questions. Before we continue, please note that the discussion today will include forward-looking statements made under the Safe Harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. Huazhu Group does not undertake any obligation to update any forward-looking statements, except as required under applicable law. On the call today, we will also mention adjusted financial measures during the discussion of our performance. Reconciliations of those measures to comparable GAAP information can be found in the earnings release that was distributed earlier today. As a reminder, this conference call is being recorded. The webcast of this conference call as well as the supplementary slide presentation is available on the Investor Relations section of Huazhu Group's website at ir.huazhu.com. Now, I would like to turn the call over to Jenny. Jenny, please.

Good morning everyone. I'm pleased to report that Huazhu has delivered very strong results for 2018. To help our investors, as we hand the scale of our business in different off-lease and manachised models, we introduced a new metric called hotel turnover, which, for managed and franchised hotels, reflect the total revenue captured at hotel level instead of fees charged by Huazhu. As shown on page two, our hotel turnover increased by 23% to RMB29.7 billion in 2018. Our net revenues stood at RMB10 billion, a year-over-year increase of 22%, exceeding the high end of our guidance. Our adjusted EBITDA grew by 37% with a margin of 32.5%, up 3.6 percentage points from 28.9% last year. The adjusted net income increased by 36% with a margin of 17%, up 1.7 percentage points from 15.3% last year. Teo will provide [Technical Difficulty] later. Our robust topline growth is driven by both hotel network expansion and RevPAR growth, as illustrated on page three. In 2018, Huazhu's number of hotels in operation expanded by 13% net to 4,230 hotels. Our group blended RevPAR increased by 10% as the combined result of the RevPAR growth for mature hotels and the new hotel mix shift through midscale and upscale segments. Looking forward into 2019, we remain confident that our hotel expansion will accelerate on the backdrop of strong pipeline growth. On page four, our pipeline reached a new record of 1,105 hotels at the end of 2018. This represented 26% of hotels in operation at the end of 2018, significantly higher than 19% at the end of 2017 and 14% at the end of 2016. Approximately 80% of rooms in pipeline are under midscale and upscale brands. Our asset-light model of manachised and franchised has been our primary business model. Our powerful brand and the loyalty program continue to add value to our franchisees. We consistently grow our hotel portfolio with an increasing mix of manachised and franchised hotels. As shown on page five, at the end of 2018, our manachised and franchised hotel rooms accounted for 79% in total rooms in operation, further up by 1% from previous year. About 72% of these rooms are in Tier 1 and Tier 2 cities where we believe there are more sustainable demand for both business and leisure travel purpose and thus more resilient in performance. The asset-light model has also reduced our business volatility and helped Huazhu sail through changing economic environment. Page six illustrates the relationship between our same-hotel RevPAR growth and our financial performance. The top chart shows the same-hotel RevPAR growth from 2011 to 2018. The RevPAR growth fluctuates between the low of negative 3.6% to a high of 7.7% during this period. However, you may notice from the chart below that Huazhu continue to expand its EBITDA amount and largely, the margin percentage year-over-year during the same period despite the volatility of the RevPAR growth rate. Huazhu is able to continue to deliver solid financial performance on the various economic environment because we have been growing with an asset-light model, as explained earlier, with continuous focus on product innovation that meet the evolving needs of our customers and franchise owners. Before we get into more details of operations and the financials, I would like to take a few minutes to review how we have fulfilled our strategic focus in 2018. Page seven shows the summary of our strategic achievements this year. The first focus is the fast expansion for midscale hotels. For 2018, our mid and upscale hotel room count increased by 42%, which accounted for 38% of total rooms in operation at the end of 2018. In addition to 1,338 mid and upscale hotels in operation, we have 831 mid and upscale hotels in pipeline. The strong opening and pipeline growth consist of the contribution from mature brands like JI and Crystal Orange as well as our younger brands like Mercure and HanTing Premium. By leveraging Huazhu's centralized operational platform and over 100 million member loyalty program, these younger brands are poised to take off. Secondly, our focus on continuous growth in same-hotel RevPAR through quality improvements. In 2018, the same-hotel RevPAR increased by 5.5%, with a 5.6% growth in the economy segment and a 5.2% growth in mid and upscale segment. Our efforts to upgrade HanTing Hotel continued in 2018. As a result, the HanTing operated room ratio increased to 50% at the end of 2018, up from 38% in the prior year, and expects to exceed 6% by 2019. Thirdly, our focus on innovation in upscale hotel segment. The acquisition of Blossom Hill in late 2018 expanded Huazhu's footprint for leisure hospitality. We're also excited about three prime locations signed under Joya brand. I will elaborate the above points more in the following pages. Let's turn to page eight, on the first point, growth of midscale and upscale hotels. As you can see, our fast expansion in this segment is well on track. At the end of 2018, our mid and upscale hotel room inventory increased by 42% from a year ago. As shown on the right-hand side of the page, our pipeline for mid and upscale rooms accounted for approximately 80% of the total number of rooms in the pipeline, up from 77% a year ago. Our diversified mid and upscale hotel brand portfolio, with profitable hotel operating models, continue to attract potential franchisees into Huazhu's hotel network. On page nine, to help our investors to better understand our midscale brands at their respective development stage, we categorized these brands according to their scale and the city coverage. In the very left column in Stage I, debut; we have Mercure, HanTing Premium, Manxin, and Novotel. Each has fewer than 100 hotels in operation, and it covers fewer than 50 cities, but moving rightwards with strong pipeline. These relatively younger brands offer very unique value proposition to our guests and franchisees. Stage II; grow, within 100 to 500 hotels and covering 50 to 100 cities. Those brands categorized in the grow stage include Starway, Crystal Orange and Orange Select, ibis and ibis Styles combined. They're becoming our new growth [Technical Difficulty]. The Stage III, flourish, represents hotel comps of plus 500 to 2,000 and a city coverage of 100 to 400. Thanks to great guest experience and a profitable operating model, JI Hotel had 553 hotels in operation at the end of 2018 and 282 in pipeline. The strong growth momentum of JI will continue in 2019. We're optimistic about the industry prospect and the confidence in our quality brand to outperform competition. In the long run, we anticipate that we will have multiple midscale brands to reach or exceed 2,000 hotels. It is defined as Stage IV, establish, in our life cycle analysis. In addition, a few of our midscale brands will grow to over 500 hotels. I would like to visualize the growth for two brands in the next two pages to help you get a flavor. First of all, JI brand. By the end of 2018, JI Hotel covered 132 cities with more than 500 hotels. In 2018, JI brand registered a 5% same-hotel RevPAR growth, a very strong momentum. Given JI brand's characteristic design and a superior profitability, we believe that JI brand will continue to accelerate growth in years to come. The next milestone will be to hit 1,000 hotels, and that's expected to be achieved in 2020. The second example is Mercure. At the end of 2018, we had 39 Mercure hotels in operation and 69 in pipeline. In 2018, the same-hotel RevPAR for Mercure brand grew by 9.6%. In addition to a remarkable RevPAR performance, this brand has been fully integrated into Huazhu operating platform, which allow us to run with project efficiency standard and leverage Huazhu's loyalty program. For example, the staff-to-room ratio is currently at 0.2, represents a 40% saving in headcount and the personnel cost compared to its original model with the staff-to-room ratio of 0.35. We expect Mercure brand to hit its 100-hotel milestone next year. As mentioned in the last two pages, we have a good progress in the midscale segment. As a result, the revenue contribution from our mid and upscale hotels has continued to increase. As shown on page 12, in 2018, the revenue from mid and upscale hotels increased by 52% and account for 50% of total net revenues. Turning to page 13, our Q4 same-hotel RevPAR stood at 3.9%, resulting in a 5.5% growth for the full year. After six quarters of phenomenal same-hotel RevPAR growth since Q1 2017, partly due to low comparable base, the third and fourth quarter of 2018 reported same-hotel RevPAR growth of 4.2% and 3.9%, which we believe is healthy and also, it represents a more sustainable level of growth. The same-hotel RevPAR growth was mainly driven by ADR growth as we continue to attract customers who are looking for product innovation to satisfy their needs. On page 14, similar to what we shared with you on previous calls, our hotel occupancy remains at a high level of 87% for mature hotels and 90% for the full year, outperforming the China industry average by 20 percentage points relatively consistently. For the first two months in 2019, we continue to see a positive trend of same-hotel RevPAR growth. Finally, please turn to page 15; I'm pleased with our footprint into upscale resort brand by acquiring Blossom Hill in late 2018. Positioned as an upscale lifestyle and resort brand, most of Blossom Hill's hotels are located in typical scenic spots. In 2019, we are going to showcase its new urban hotel at downtown landmark in Shanghai. We also decided to convert VUE Hotel in Beijing Hou Hai, center of the city, into a Blossom Hill Hotel. This includes a conversion from VUE Hotel that will be done near term. This hotel with 80 guestrooms is housed in a cozy historical building, featuring a café, a splendid Spanish restaurant and a bar overseeing Hou Hai. Last, but not the least, heading into 2019, we will continue to focus on a few strategic aspects as shown on page 16. First, we will continue the fast expansion of our hotel network. Secondly, we will focus on the innovative application of technologies to improve guest experience and operational efficiency. Third, we will make steady progress in upscale hotel segment. We expect to bring you more exciting news in the next earnings call. With that, I will hand over the call to Teo, who will provide you a more detailed analysis on operational and financial results. Teo, please.

Thank you, Jenny. Good morning everyone. Please turn to page 18. We are thrilled to report that we continued with our fast expansion growth path in 2018. We opened two hotels every day, with a total of 723 new openings in 2018. At the end of 2018, total number of hotels in operation has reached 4,230. We have achieved total gross openings of 723 hotels or net of 484 hotels in 2018. The net opening of 484 hotels represent 13% growth in hotel count. As Jenny mentioned earlier, we are confident to further accelerate our hotel expansion in 2019, given our increasing pipeline. Turning to page 19, in Q4, our group blended RevPAR grew by 8.1%. This is mainly driven by an increase of ADR of 9.2% year-over-year. The increase in our blended RevPAR was driven by 6.3% year-over-year increase in mature hotel RevPAR and the increasing mix of mid and upscale and upgraded hotels. For the full year of 2018, our group blended hotel RevPAR increased by 10%. The ADR increased by 11.2%, and the increase was partially offset by a one percentage point decrease in occupancy. You may notice that the absolute level of our occupancy was very high at 87%. This 87% occupancy takes into account all of our 4,200 hotels in total, with 723 new hotels opened in 2018. A significant number of these newly opened hotels are recently completed and are still at the ramp-up stage with a lower ramped occupancy. Moving on to financial results on page 20, our net revenues grew by 20.6% in Q4 and 22.3% for the full year of 2018, exceeding the high end of our previous guidance. Breaking down the revenue growth in 2018, the net revenues from our leased and operated hotels improved by 18% and net revenue from our manachised and franchised hotels was up 37% year-over-year. In 2018, the net revenue contributed by our asset-light manachised business model accounted for 25.1% in total revenue, up 2.6 percentage points from 22.5% in 2017. We expect that contribution from the franchise business will continue to increase going forward. As demonstrated on page 21, when referring to the box on the bottom-left corner, the hotel operating cost and other operating cost as a percentage of the net revenue decreased by 4.7 percentage points year-over-year. This is mainly due to our improved blended RevPAR -- sorry, better operating efficiencies from scale. In 2017, we booked impairment loss of RMB169 million in hotel operating cost and RMB35 million in 2018. Excluding the impact of these impairment loss in 2017 and 2018, the hotel operating cost and other operating cost as a percentage of net revenue would have been reduced by three percentage points. The preopening expenses as percentage of net revenue was 2.5%, the same as last year. The SG&A expenses and other operating income as a percentage of net revenue decreased by 1.3 percentage points year-over-year. In 2018, there are certain one-time deals recorded in other office income such as compensation received, and we also have losses related to the termination of leased hotels totaling RMB130 million. And in 2017, such one-off amount was approximately RMB30 million. Our full year operating margin expanded by six percentage points year-over-year to then 23.3%, driven mainly by better operating leverage and improved RevPAR as well as hotel expansion and certain one-off gains mentioned above. Excluding the above-mentioned one-off gains in both 2017 and 2018, the operating margin would have been improved by 3.3 percentage points in 2018. Turning to page 22, in 2018, we recorded strong growth in our core earnings, driven by both strong RevPAR growth and a better operating leverage. The non-GAAP adjusted mentioned on this page included unrealized loss from fair value changes of equity securities relating to our investments, such as Accor shares and [Indiscernible], totaling RMB914 million, as well as share-based compensation of RMB83 million in 2018. Excluding these non-GAAP adjustments, in 2018, our adjusted EBITDA increased by 37% to RMB3.3 billion, while our EBITDA margin expanded from 28.9% to 32.5%. The adjusted net income increased 36% year-over-year to RMB1.7 billion, while the adjusted net income margin have expanded from 15.3% to 17%. Moving on to the cash flow statement on page 23, for 2018, we generated RMB3 billion of net cash from operations. After the capital expenditure on maintenance and new developments totaling approximately RMB1.2 billion, the free cash flow generated in 2018 totaled RMB1.6 billion. In 2018, we draw down -- we drew down our U.S. dollar syndication loans bank treaty and also raised the margin financing, totaling 4.3 billion, to finance the purchase of Accor shares. We invested approximately RMB5.15 billion in total for the Accor shares for the acquisition of Blossom Hill and some small investments in hotel-related funds. At the end of 2018, we had cash and cash equivalents of RMB4.9 billion. Turning to page 24, in 2018, we declared a cash dividend of $100 million, equivalent to $0.34 per share. This dividend is more than double than the 2017 dividend. Thanks to the tax planning arrangement, we were able to reduce the withholding tax on dividends we [Indiscernible] from China from 10% to 5%. Therefore, we were able to double the dividend payment while maintaining the withholding tax amount paid to the tax authorities. We expect to maintain the current level of dividends going forward. Turning to page 25, we will implement a new lease standard, ASC 842, starting from January 1st, 2019. This will affect our lease, which are on a fixed payment basis with a term greater than 12 months. We estimate that the adoption of this standard will result in the recognition of right of use asset and lease liabilities of approximately $2 billion to $2.2 billion respectively as of January 1st, 2019. In the absence of any impairment, there will be no major change of any brand recognized in the income statement. However, given the maturity is higher like our used assets on our balance sheet, any lease impairments, if any, may be higher, which will negatively impact operating profit in the year of impairment. Please note that the current year results will not be restated with the impact of this accounting change and, therefore, comparative periods remain as reported historically. Upon adoption of this accounting -- of this standard, we do not expect to have any change in our cash flow statements. Finally, our guidance on page 26, in 2019, we plan to accelerate our gross opening to 800 to 900 hotels, 75% of which are midscale and upscale hotels. For the revenue guidance, we expect to achieve a net revenue growth rate of 13% to 15% in Q1 2019. For the full year, in 2019, we expect a net revenue growth of 15% to 17%. With that, let's open the call for questions.

Operator, we are ready to take any questions from investors.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] There are currently no questions at this time. I would now like to hand the conference back to today's presenters. Please continue.

Operator, we have been noted that some of the analysts actually pressed, but maybe the system is not working. Can you check?

Yes. All right. So, the first question is from the line of Justin Kwok. Your line is now open.

Hi, thanks for taking my question. Perhaps, I'll share then two questions, one on the growth guidance and the other one on margins. So, I think you have very good finish on 2018, and now your full year guidance is 15% to 17% of the net revenue growth. Can I check what kind of RevPAR function you are baking into this set of forecasts? And on the other hand, have you been baking in the forecast for the development or the grooming up of the soft brand, which you have probably announced back in the December Huazhu Conference in a way, so whether the soft brands will start to kick in any meaningful or small impact in 2019. The second question on margins is that now in 2018, you got faster RevPAR growth and also some lower base effect on the G&A because of these long-term share-based compensation booking. Into 2019, would there be any guidance on the margin outlook moving forward? Thank you.

Hi Justin, this is Teo. Regarding the growth assumptions, right now, we built in approximately 3% growth in the same-hotel RevPAR, and we have not built in the revenue from our soft brand yet. The main reason is because we are still in the incubating stage and we have to see how big can we grow this business. On the second question, on the margin, we expect that the hotel business will continue to generate a certain amount of margin expansion. However, as mentioned in the last quarter call, as well as we will actually continue to invest the margin expansion and to build some of the new business as well as the software -- as well as the soft brand. In addition, we will also -- as mentioned by Jenny earlier, we will put in some money, we'll also invest in some of the experimentations on the upscale brand, so that may ease the way of some of our margin expansions.

All right. Any color on the progress of the soft brand as a follow-up? Thanks.

Yes. We have deployed constantly through the development team to accelerate the growth of our soft brands. Most of our brands are existing brands that are already in the market for a few years, such as Starway, Elan, and Hi Inn. We are also going to launch a new brand called Madison in the next couple of weeks, which is going to accelerate our growth in the upscale segment. In general speaking, we are happy with the launch of the expansion acceleration program. Yet, because we are still in the early stage, we don't want to provide unreliable prediction about how much revenue they are going to generate within this year. We will keep you guys updated in our next earnings call.

Thank you.

Thank you. The next question we have is from the line of Praveen Choudhary. Your line is now open.

Thank you. Thanks for taking my call. Hi Jenny, hi Mr. Teo. A very quick question from me. You mentioned about the full year guidance of 15% to 17% revenue growth, it's baking around 3% like-for-like RevPAR growth. Considering Q1 revenue growth is smaller, 13% to 15%, is that because your RevPAR assumption for Q1 is much less, as in 1% to 2%? Or is it just a function of less number of new openings?

Okay. The reason why we think that the -- we built in the 13% to 15% is because that there was -- number one is that last year, due to the timing of the Chinese New Year, is that there is actually a high base in Q1 last year. In addition to that is that we -- from the trend that we see right now, we see that the traffic has been picking up after the Chinese New Year, so we would like to -- we think that the momentum would bring in higher revenue both in the coming quarters. Plus, as you may already know, is that Q1 is the most volatile piece because the trends have been low. It's lower in an entire year, so we would like to build in this assumption so that we'll see how it goes in the next couple of quarters.

Okay. Got it. Thank you. Can I also ask that in Q1 of 1019, Crystal Orange will be part of like-for-like RevPAR? And the second related question is when you give us like-for-like RevPAR for full year 3%, what could be the total RevPAR growth? Example, in Q4, you had RevPAR increase of 8.1% versus the same store sales of 3.9%, so there's a gap because of the mix improvement, right? Just trying to understand your revenue guidance on the full year number for the total RevPAR not just like-for-like in your assumption.

The blended RevPAR is usually like 3% -- around 3% to 4% increase higher than the same-hotel RevPAR growth. As you rightly mentioned, this is mainly due to mix change.

And Q1, would you be putting like-for-like -- is Crystal Orange inside like-for-like?

Yes, we will include the Crystal Orange hotel in the like-for-like in Q1.

Okay, great. Maybe one last question for me, if I can. This whole RevPAR improvement is because of the mix. Market wants to -- investors want to understand how long this mix improvement can last. I mean, clearly, your pipeline is very much skewed towards midscale. Can you talk about this supply-demand scenario in midscale and if the economy slowdown that we saw in fourth quarter and up to Chinese New Year impacts your midscale supply demand occupancy or any such thing? Thank you.

I think the mix shift will continue. Number one, we are still growing our midscale business very fast. Secondly, even within midscale, we are accelerating growth at the upper midscale part of the business. Thirdly, we are also putting more effort into the growth of our upscale business. So, all those factors are going to continue, and we expect a long runway for our blended RevPAR growth to continue.

Very helpful Jenny and again thank you and congratulations for a great set of results.

Thank you.

Thank you. Your next question we have is from the line of Mr. Alan [Indiscernible]. Your line is now open sir.

Yes, hi thank you. Thank you management for the call. Can I ask you a follow-up on the first quarter announcement, what have you seen for January, February RevPAR growth, actually, for like-for-like and blended RevPAR? And can I also -- understand that you have mentioned in that you had -- you will see -- still some margin leverage for the hotel business, but put more investment to software and new brand? And would that be -- would that mean that the blend, the margin -- blended margin for this year will not expand as much as last year? Or you'll -- actually, you will invest all the margin expansion for a -- doing investment there. Thank you.

Hi Alan, let me answer the first question first. In the January and February is that we are still growing on a same-hotel RevPAR growth basis, we are still in a positive territory, in the low digits. But on the following question, can you repeat that, perhaps one question at a time?

Yes. So, the margin -- you mentioned there will be some margin expansion still for the hotel business and you have put more investment into new brands and top brand segment. And as a result will we still see margin expansion overall for the company or are we going to see flat margin more likely for FY 2019?

Okay. On this question, is that we expect the margin expansion to continue, and then we will spend money in investing in not only the soft brand but also in some the new business as well as the upscale hotels. We have -- we expect that the impact of that is still very uncertain because we're still at very early stage on exactly how much money we would need to spend on this investment. So, we will be able to see the growth even in the coming quarters.

Sure. Thank you. And then I have a follow-up question on the new hotel openings. Given the macro economy is weaker and then would that impact your hotel opening -- especially, the franchisee within the soft-opened new hotels?

So far, the signing and opening are well on track. And when we look at our business by segment, we see the majority of our business, especially economy hotels and our core and midscale brands, actually performed quite strongly in today's economic environment. So, we don't expect the signing and opening of new hotels will experience any major slowdown.

Okay. Thank you.

Thank you. The next question we have is from the line of Mr. Billy Ng from Bank of America. Your line is now open sir.

Hi, good morning and congratulations on a very strong set of results. I have two questions. One is can you give us a little bit more color, because when we look at the STR data, January was kind of weak, probably because of the timing of Chinese New Year. But can you provide a little bit more color what happened after Chinese New Year's? And what kind of same-store RevPAR we have seen largely pertain in the last few weeks? And my second question is just can you provide any color or outlook of the M&A market right now? Like in 2019, we looked at -- some of the public equities multiple has compressed, will that become a bit easier? Or it's still quite challenging to find new opportunities within China at this point?

This is Jenny. On the question about the recent performance trend, we have seen January and February combined will continue to see positive growth of this new hotel RevPAR, which we believe, in today's economic environment, this is a positive indicator. We will discuss the performance in more detail when it comes to our quarterly end disclosure. And on acquisition, as you have seen, we have been an active but cautious acquirer of various brands to reach our strategic goal of creating a strong and a full range brand portfolio. So, we will continue actively looking into various opportunities but take a very rational perspective in doing those deals.

All right. Thank you.

Thank you. The next question we have is from the line of Mr. Dylan Chu from CLSA. Your line is now open.

Thanks management for the presentation and congratulations on the good results, good guidance. I've got a couple of questions I'll ask one by one. Firstly, just in terms of manachised and franchised effective take rate, thanks for sort of discussing the turnover metric. If my calculations are right, it seems like 4Q 2018 effective take rate on manachised and franchised operations increased both sequentially and on a year-over-year basis. Could you please share some color just in terms of the drivers? Should we consider this sort of seasonal or actually sustainable? And any sort of guidance on sort of take rate going forward into this year would be very helpful.

Yes. The take rate -- the effective take rate from the manachised and franchised business had actually gone up, they ticked up a little bit. This is -- what you observed is correct. This is actually mainly driven by the increasing contributions from the -- our centralized reservation systems, it means that the customer that we push through to our franchisee. So, because we charge a percentage based on the traffic that we charge to the franchisee, so the increasing traffic to the franchisees are from our centralized reservation systems where it contributed positively to our take rate. And we -- it is also our continuous effort to increase the percentage of room nights that is contributed by our -- from a directional channel. So, we hope that this trend will continue, and then we will continue to have a higher take rate going forward.

Thank you. That's very helpful. Secondly, just in terms of historical cost, last quarter's cost. Hotel operating expenses were actually very strong outcome overall. Could you just please just give us a little bit more color in terms of driver of that very strong cost control? And, specifically, why other hotel operating expenses actually declined around about RMB200 million last year to RMB150 million despite quite strong revenue outcome? Just any color in terms of cost would be very helpful.

Okay. The hotel operating cost as a percentage of revenue has declined, as I mentioned earlier. The main reason -- there are two main reasons behind that. Number one is that we actually run a better operating leverage without increasing number of scale as well as the increasing contribution from manachised and franchised business is number one. And number two, I mentioned early in my presentation is that in 2017, there is actually impairment loss of RMB169 million that was recorded in hotel within cost other. Whereas in this year, in 2018, the impairment loss recorded in this new line is only RMB35 million. So, there is actually a drop of around RMB130 million due to that. So, the lower operating cost as a percent of revenue, it was helped by the reduction in the impairment loss recorded.

Great. Thanks. Just a question at the fleet. Just in terms of openings, quite strong guidance. Just related to this, could you please share an update in terms of CapEx and dividends for 2019, please?

Okay. Our capital expenditure, we expect to increase our capital expenditure to, I would say, coming to around RMB1.9 billion to RMB2 billion in 2019. The main reason is because, number one, is that our new hotel capital expenditure is expected to be approximately RMB1.2 billion. And then there's -- our maintenance and upgrades will be approximately RMB400 million, and we will spend -- we actually have a budget to spend approximately RMB200 million as part of the payment for our headquarters' construction cost.

Thanks. Just last question, just sort of operationally. Our -- your hotel pipeline has reached a historical high as well. Just sort of what sort of the capacity utilization rate of our sort of development team? Let's say, by end of this year, the pipeline were to increase towards maybe 1,300 or 1,500, will we need to increase headcount or sort of our current capability is already enough?

Okay. No, I suppose you said -- you may see that the result of a higher pipeline this year, actually our investment in some of the development team, that started off last year. In Q2, there was a question of why there's an increase in the G&A expenses, and this is the result of which. So, in fact, this is known. So, what we have been seeing is that the productivity from our development team has not been fully released yet, so there may be some benefits in terms of like increasing [Indiscernible] from our existing team. However, if it goes beyond this stage, then we may need to increase the -- our development teams further.

Yes. Yes, understand. I guess, my question would be just given our investment last year around second quarter, so do you still have enough capacity?

I'm sorry. Can you repeat the question?

So, yes, I think I've got to your question -- I've got your answer. So, that's all from my side. Thanks very much.

Thank you.

Thank you. We have the next question from the line of Aras Poon from Citigroup. You may now ask your question.

Good morning management. This is Aras from Citi. So, thanks for taking my question. First, can you give us a little bit more colors in terms of the operating trends that you see in Tier 1 and 2 cities and also the lower tier cities? I mean you have the very strong portfolios in Tier 1 and Tier 2 cities, but given the company's continued expansion, you had increased your hotel counts, should we expect you to gradually have more exposure in the lower tier? So, we'd like to get a sense of how do you see the growth opportunity there and how do you see the trends there. When you say 3% like-for-like RevPAR growth that you are looking for, do you see a huge difference between the higher tier cities and the lower tier cities? Thank you.

We actually see growth opportunities across all tiers of cities from Tier 1 to Tier 3. So, we are actually going to deploy our development team to capture the full range of the opportunities. Currently, we don't have a deep penetration into the Tier 3 cities yet. But we see a few of our mature brands such as HanTing, JI Hotel plus a few others actually have demonstrated strong business case in Tier 3 cities, which give us the confidence to accelerate growth in those margins. And in terms of the upscale hotels, we also feel there are demands across all tiers.

Do you see the RevPAR trends very different in the higher-tier cities and the lower-tier cities?

Actually, it's not -- it's a little bit difficult to categorize by tier because China's economy has been growing evenly from region to region. For example, in Tier 1 cities, Beijing, in the recent couple of years, has been continuously very strong. But Shanghai may experience a little bit more fluctuation depending on how the exhibition activities are going on from year-to-year. So, it's a little bit difficult to just generalize by tier of cities. It's more relevant to think about them in region-by-region or city-by-city.

Okay, that's very helpful. Thank you.

Thank you. And we have the next question from the line of Lina Yan from HSBC. You may now ask your question.

Hi management, thank you very much for taking my question. My first question is regarding your pipeline. You have reached a peak pipeline in 2018. And the question is do you think this pipeline will continue to grow? Maybe you can give us some color from a top-down point of view. For example, like for the growing market, midscale and upscale, how do you think the market can grow into? Like in terms of the total number of midscale and upscale hotels, what's your market share in this market segment? And for the more mature economic like limited service hotel segments, what do you think the market share consolidation opportunity will help you grow your pipeline in the future? And also, like related to the discussion on city tier like exposure, if you talk about the potential growth in pipeline, what kind of opportunity do you see in Tier 3 cities? And do you still have expansion opportunities in the big four cities? That's my first question.

We have seen -- we have actually conducted a survey recently to understand what kind of market share we are having in China. And according to gross market value, we are only somewhere between 3% to 4% of the total China hotel market. If you look into -- so number one, we feel we have a lot of room for market share gain in China. And secondly, if you break down into the city-by-city data, you will see the consolidated level of cities vary but are generally low. You can see for Tier 3 cities, most of the cities' consolidation level is less than 10%. And the Tier 1 cities are also only between 10% to 25%. So, this kind of consolidation level also represents opportunities across the different tiers of cities. So, with that, we believe with our increased efforts and the investments into development teams, we will continue to see our pipeline and opening to grow in the coming few years.

Okay, that's very helpful. But just a follow-up for midscale and upscale, like in three years' time, do you think -- what's the market capacity for that, like the total number of midscale and upscale limited service hotels?

As you can see in our pipeline, we are going to open a significant number of midscale and upscale hotels each year. This year, I believe for midscale and upscale alone, we are going to open more than 700 of those.

Okay. Thank you very much. I also have a second question. Like upgrade is also a very important driver for your overall portfolio. Can you give us guidance on the progress of upgrade? And what kind of like upgrade are we expecting this year?

As you have seen, we have increased the rental leases or new product ratio for HanTing to 50% by the end of last year. And we expect to grow it further into 60% by the end of this year. This trend will continue into the next few years.

Okay. Thank you. But like for this upgrade, will we see a structural change? Like is it upgrade to HanTing 3.0? Or even to like a higher, like a midscale, like a kind of upgrade? Is there like further shift in this upgrade?

Most of the HanTing will be upgraded into HanTing new version or HanTing Premium within the same brand portfolio. A small percentage of the upgrades, we'll change HanTing into JI Hotel.

Okay. Thank you. And I have like a -- last question is on the pipeline. Can you give us more -- like details on the gross opening? What's the breakdown between own and leased and franchised and managed? And for closure, what is the breakdown between these two business models? Thank you.

Sorry, can you repeat the questions?

So, for 2019 gross opening guidance and closure guidance, what is the breakdown by business models, owned and leased and franchised and managed? Or like what's the gross opening for owned and leased and closure for owned and leased?

Okay. Our gross opening, we expect to be 800 to 900 hotels, of which approximately like 40 to 50 will be leased and operated. Whereas for closures, we plan to close approximately in the range of around 200, maybe in the range of maybe 20 to 25 or 20 to 30 will be leased and operated.

Okay. Thank you. And would it be possible for you to share with us what is the same-store RevPAR growth in December last year? And that's my last question. Thank you very much.

I'm sorry, because the same-hotel RevPAR -- there is the same-hotel RevPAR growth in the 6-K.

Okay. Thank you.

Thank you. I would now like to hand the conference back to today's presenters. Please continue.

Thank you. Thank you, everyone, for taking time today, and we look forward to talking to you in the next earnings call. Bye, bye.

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