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Edited Transcript of GHG.N earnings conference call or presentation 20-Nov-19 1:00pm GMT

Q3 2019 GreenTree Hospitality Group Ltd Earnings Call

Nov 29, 2019 (Thomson StreetEvents) -- Edited Transcript of GreenTree Hospitality Group Ltd earnings conference call or presentation Wednesday, November 20, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alex S. Xu

GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO

* Qing Huang

GreenTree Hospitality Group Ltd. - Director of IT Department

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Conference Call Participants

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* Colin Yao

Goldman Sachs Group Inc., Research Division - Research Analyst

* Hay Ling Ng

BofA Merrill Lynch, Research Division - Research Analyst

* Jisheng Liu

CLSA Limited, Research Division - Research Analyst

* Ken Chong

Jefferies LLC, Research Division - Equity Associate

* Nate Deng

China Renaissance Securities (US) Inc., Research Division - Research Analyst

* Rene Vanguestaine

Christensen & Associates - Chairman & CEO

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Presentation

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Operator [1]

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Hello, and welcome to GreenTree Hospitality Group Ltd.'s Third Quarter 2019 Financial Results Release Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Rene Vanguestaine. Please go ahead.

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Rene Vanguestaine, Christensen & Associates - Chairman & CEO [2]

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Thank you, Andrew. Hello, everyone, and thank you for joining us today.

GreenTree's earnings release is still being processed and will be available on our IR website at ir. 998.com soon as well as on PR Newswire services. We have posted a PowerPoint presentation on that same website that accompanies our comments today and that you can use to follow the call.

On the call today from GreenTree are Mr. Alex Xu, Chairman and Chief Executive Officer; Ms. Megan Huang, Director of IT Department; and Mr. Nicky Zheng, IR Manager. Please note that Ms. Selina Yang, Chief Financial Officer, is currently on maternity leave.

Mr. Xu will present the company's third quarter 2019 performance overview, business operations and company highlights, and Ms. Huang, on behalf of Ms. Yang, will then discuss financials and guidance. They will be available to answer your questions during the Q&A session that follows.

Before we begin, I'd like to remind you that this conference call contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminology such as may, will, expects, anticipates, aims, future, intends, plans, believes, estimates, continue, target, is or are likely to, going forward, confident, outlook and similar statements. Any statements that are not historical facts, including statements about the company and its industry, are forward-looking statements.

Such statements are based upon management's current expectations and current market and operating conditions and relate to events that involve known and unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond the company's control, which may cause the company's actual results, performance or achievements to differ materially from those in the forward-looking statements. You should not place undue reliance on these forward-looking statements.

Further information regarding these and other risks, uncertainties or factors is included in the company's filing with the U.S. Securities and Exchange Commission. All information provided, including the forward-looking statements made during this conference call, are current as of today's date. The company does not undertake any obligation to update any forward-looking statement as a result of new information, future events or otherwise, except as required under applicable law.

It is now my pleasure to introduce our Chairman and Chief Executive Officer, Mr. Alex Xu. Mr. Xu, please go ahead.

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [3]

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Thank you, Rene, and thanks, everyone, for joining our earnings call today.

As already mentioned, Ms. Selina Yang, Chief Financial Officer, is currently on maternity leave. So you can see on Slide 3, we now have a new member in our management family. And her name is Iris and who will say hello to everyone and apologize for causing some delay to you this time.

Now please turn to Slide -- Page #6. I'm pleased to report our 2019 third quarter results, our seventh consecutive quarter of solid operating and financial performance. We grew our geographic coverage to 309 cities across China by the end of September, up from 278 cities by the end of September of 2018, an 11.2% year-over-year growth. We now have 3,102 hotels in operation, a 21.3% year-over-year increase across 12 brands in the economy, mid-scale, mid-to-upscale and luxury brands.

Total revenue grew 20.1% year-over-year to RMB 292.1 million. Gross profit increased 21.4% to RMB 204.9 million. Non-GAAP adjusted EBITDA rose 11.6% to RMB 177.1 million. And the core net income per ADS, that's basic and diluted non-GAAP, improved by 16.5% to RMB 1.3, which is equivalent to USD 0.18.

Operating performance also remained solid, especially compared to the overall performance of the Chinese hospitality sector, according to STR report. Our blended average daily room rate increased by 4.2% year-over-year to RMB 174. Occupancy rate had a slight 1.3% decrease to 85.9%, primarily due to 250 in existing hotels in renovation, the accelerated new hotel openings in the quarter as well as a lower occupancy rate in our luxury segment. However, revenue per available room increased 2.7% year-over-year to RMB 149.

Moving to Slide #7. At the end of the quarter, we operated 3,102 hotels, 21.3% higher than a year ago. 30 of these hotels were leased and operated or L&O hotels, and 3,072 franchised and managed or F&M hotels. While the mid-scale segment remains the core of our business with more than 73.8% of our hotels, we're diversifying our portfolio by adding hotels in both the higher end and the economy segment of the market. The number of hotels in the luxury segment and mid-to-upscale segment increased to 6.2% of the total portfolio, and the economy segment grew to 20%.

Turning to Slide #8. We opened 181 hotels compared to 146 in third quarter of 2018. That's a 24% increase. Three of those new openings were in the luxury segment, 20 were in the mid-to-upscale segment, 92 were in the mid-scale segment and 66 were in the economy segment. Sixteen of the newly opened hotels were in Tier 1 cities, 32 in Tier 2 cities and the remaining 127 in select Tier 3 cities and other cities in China.

Meanwhile, we closed 34 hotels, 15 due to brand upgrade and 13 due to noncompliance with our company's brand and operating standards, the remaining 6 due to property-related issues. So net-net, we added 147 hotels to our portfolio. We are proud that we actually only closed 19 hotels in this quarter because almost all franchisees have been benefited from our operation and support.

Turning to Slide #9. Our pipeline of new hotels also increased from 596 on June 30 to 652 on September 30. Around 26.8% of these hotels are in the mid-to-upscale and the luxury segment, 39.6% are in mid-scale and around 33.6% in the economy sector.

Slide #10 summarizes some of our key operating metrics. We continue to see improved operating performance across the board. The key numbers to look at here are the purple bars representing the performance of our F&M hotels. Our F&M hotel ADR improved 4.2% to RMB 173. RevPAR increased 2.6% to RMB 149, while the occupancy rate decreased from 87.5% to 86.1%. The performance of our L&O hotel was steady with ADR up 6.8% to RMB 224 as certain L&O hotels come back online after the completion of the renovations.

Slide 11 shows our RevPAR trend. We delivered a 7.5% year-over-year increase in RevPAR for our L&O hotel to RMB 164, while RevPAR for our F&M hotel increased by 2.6% to RMB 149.

Let's turn to Slide 12. Another critical area of our business is our loyalty program. Ours is a paid program in which members enjoy a variety of premium perks and benefits, especially after the company integrated the membership program with several partners, including Da Niang Dumplings, Gourmet Noodle House, Yibon Hotel Group and so on. This enables members to use membership points and benefits interchangeably. Our loyalty program helped us foster closer relationships with our guests who can book with us directly, therefore, reducing sales and marketing fees and expenses. Overall, we now have about 39 million individual members and 1.45 million corporate members, up from approximately 36 million and 1.38 million as of June 30, and our members are very loyal customers. During the quarter, around 93.1% of all room nights were sold directly, primarily to our individual and corporate members.

Now let me talk about a few recent developments that you can find on Slide #13. We added 23 mid-to-upscale and luxury hotels, including Argyle, GreenTree Eastern, Gem, Gya, VX and Ausotel hotels. At the end of this quarter, we had 21 Argyle, 22 Gem, 18 Gya and 19 VX hotels in the pipeline as we continue our accelerating expansion into the mid-to-upscale and the luxury segment.

In conclusion, we are very proud of our company's strong performance, in particular, the meaningful increase in sales and the strong guest preference delivered by our diversified brand portfolio, especially in light of the shifting Chinese economy. We remain confident in our business model, strategic positioning and the long-term growth strategy. We will continue to invest in our people, brand, system and technology in order to better serve our guests and franchisees and they ensure the healthy development of our company for the long run.

With that, I will pass the call over to our Director of IT, Megan Huang, who will summarize our financial performance for the quarter 3.

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Qing Huang, GreenTree Hospitality Group Ltd. - Director of IT Department [4]

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Thank you, Alex.

Let me refer you to Slide 15, where you can see that our combined total revenues grew 20.1% year-over-year to RMB 292.1 million, primarily due to 3 factors: the opening of 180 F&M hotels and 1 L&O hotel, improved RevPAR both in F&M and L&O hotels and growth in our loyalty membership program. Growth was partially offset by the renovation of 6 L&O hotels during the quarter.

Total revenue from F&M hotels rose 19.2% to RMB 219.6 million, while total revenue from L&O hotels rose 22.9% to RMB 72.6 million. On the same slide, during the first 9 months of 2019, total revenues rose by 20.6% to RMB 802.4 million. Total revenues from F&M hotels were RMB 617.5 million, up by 21.2% year-over-year. And total revenues from L&O hotels were RMB 184.9 million, up by 18.5% year-over-year.

Moving to Slide 16, the cost and expense side of the P&L. Hotel operating costs were RMB 87.3 million, up 17.1% year-over-year, which is mainly attributable to costs associated with the expansion of our F&M hotels, including staff costs, consumables, higher depreciation and amortization, higher onetime renovation costs related to the renovation of 6 L&O hotels and 250 F&M hotels as well as the operating costs of Argyle. These were partly offset by the closure of 1 L&O hotel. For the first 9 months of this year, hotel operating costs were RMB 246.2 million, up 21.6%.

Selling and marketing expenses were RMB 20.8 million, up 71.3% year-over-year, mainly attributable to the incentive bonus to hotel staff and operations team, the operation of the newly added hotel brands such as increased advertising and promotion expenses to improve our brand recognition and increased personnel compensation and other costs. Selling and marketing expenses for the first 9 months of 2019 were RMB 61.8 million, up 84.4% year-over-year.

General and administrative expenses were RMB 39.9 million, up 64.6% year-over-year, mainly because of increased IT research and development costs, headquarter staff costs, legal, DD, M&A and other consulting fee, increase of share-based payment as well as the G&A expense of Argyle. General and administrative expenses for the first 9 months were RMB 105.4 million, up 51% year-over-year. Overall, combined total operating cost and expenses grew 33.4% year-over-year to RMB 148 million.

On Slide 17, you can see that gross profit grew 21.4% year-over-year to RMB 204.9 million. Gross margin increased to 70.1%. Adjusted EBITDA increased 11.6% year-over-year to RMB 177.1 million. And adjusted EBITDA margins decreased by 4.6% to 60.6%.

Moving on to Slide 18. In this quarter, net income decreased 28.4% to RMB 102.2 million and the net margin was 35%. The decrease was primarily due to market fluctuation in our investment portfolio and the increase in total operating costs and expenses. Core net income increased 16.5% to RMB 134.8 million and core net margin decreased by 1.4% to 46.2%.

Let's look at Slide 19. Net income per ADS, basic and diluted, decreased by 28.4% to RMB 1.01, equal to USD 0.14, while core net income per ADS, basic and diluted non-GAAP, improved by 15.9% to RMB 1.32, equal to USD 0.18. In the first 9 months of this year, net income per ADS, basic and diluted, improved by 9.9% to RMB 3.6, equal to USD 0.50, while core net income per ADS, basic and diluted non-GAAP, increased by 12.7% to RMB 3.46, equal to USD 0.48.

Moving on to Slide 20. During the first 9 months of 2019, our operating net cash inflow was RMB 395.5 million. As of September 30, we had cash and cash equivalents of almost RMB 2.1 billion. This provides us with ample resources as we continue to evaluate additional potential investments and acquisitions. And we do not anticipate the need to raise additional capital at this stage.

Lastly, in terms of guidance, we expect total revenue for the full year 2019 to grow 20% to 25% from 2018. The change was due to delayed consolidation of Urban and the speed up of our renovation program.

This concludes our prepared remarks. Operator, we are now ready to begin the Q&A session. Thanks.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And the first question comes from Ken Chong of Jefferies.

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Ken Chong, Jefferies LLC, Research Division - Equity Associate [2]

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Congratulations on the results. And I just want to ask about the RevPAR outlook towards the fourth quarter. It's good to see that in the third quarter we still delivered positive blended RevPAR growth. I'm just wondering for the fourth quarter now we're already in late November, do you have any color on the RevPAR trend? And how is it like when we have a breakdown by room rate and occupancy? And the second question is more from the threat from industry peers like OYO. When they expand so many economy hotels under their soft brands, do we see the need to open more in our side as well to sustain our market share?

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [3]

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Thanks, Ken. Great questions. Let's talk about the fourth quarter first. At this moment because we discussed before, we have value price business model. And we try to work really hard to focus on the direct sales. We have a loyal customer base as a result. And we see our RevPAR will be continuously stable or will be improved slightly for the fourth quarter this year. And that, however, we will speed up the renovations because after renovations, we clearly see the major improvement after the CapEx and after the slight upgrade in certain hotels. So during the renovation period we may see some negative impact towards the occupancy and ADR. And so excluding the impact of that, we should be able to see some gradual and a small, slight increase of the performance over the same quarter last year. So far, we have not been negatively impacted by some of the concern from our customers.

And on the second question, regarding the soft brand, the entry of that, we did see there's a lot of changes in that area. However, our belief is still the brand should have a certain value that is standardized or quality services, both to your guests and to your franchisees, and so that both of them have to be really happy. And so we will maintain that high quality in that end in order to make sure we have a sustainable growth. And we certainly do not want to have an up and down for our future growth so we have been really careful in terms of monitoring that progress.

The market of China, the hospitality is huge. So I think that there is ample opportunities. And whoever can do the job consistently and continue the same high quality, I think, eventually, will succeed. So that's why, Ken, we have continued to maintain our standard in our development. We have not added a lot of non-soft brand products. But as I said, that we're monitoring that, we'll evaluate that, and we also added some development personnel as well as the operation personnel. We were training them to see whether we needed to add more just in case we need to add more soft brand if there's a need from our existing franchisees for the next year.

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Operator [4]

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(Operator Instructions) The next question comes from Nate Deng of China Renaissance.

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Nate Deng, China Renaissance Securities (US) Inc., Research Division - Research Analyst [5]

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Congratulations to the great results and congratulations to Selina and Iris. I have 3 questions, if I may. The first one is about the operating metrics. Can you maybe give us a little bit color on the same hotel RevPAR growth in this quarter and what it's like by different tier of cities? Maybe the first one comes first.

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [6]

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So the same hotel, when you take a look at the numbers because -- so the same hotels, I believe we have a RevPAR. The mid-scale is up 2.3%, economy up to 3.6%, and the mid-to-upscale to luxury was down 3.7%. So that's basically the RevPAR like-for-like growth. And that's our organic. But our consolidated is broken down by the following: for luxury, we are seeing flat; mid-to-upscale, 0.2% decrease; mid-scale is 2.3% increase and economy is a 3.6% increase. That's on RevPAR.

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Nate Deng, China Renaissance Securities (US) Inc., Research Division - Research Analyst [7]

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Okay. And the other question is about the operating expense hike because we have seen a significant increase in SG&A cost. So maybe can you give us a little bit more color on the breakdown of, say, IT development cost, headquarter staff cost, sales and marketing for new brands, how much is it? And going forward, what is the kind of normalized EBITDA margin that we expect?

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [8]

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Okay. So thanks, Nate, for those 2 questions. So the selling and marketing expenses, we have basically 3 components there. One component is the Argyle consolidation. And that has contributed to about 21% of the increase. And we think that factor will be gone by the next year. And then the following 50% roughly, we had onetime selling expenses because we have this 15-year anniversary. We have done some promotions. And that's roughly close to CNY 6 million in that expenses. And then I think that's up 47%. Excluding those 2 major items, and then there are miscellaneous activities, our core sales and marketing, regular sales and marketing expenses only increased 2.9%.

And so regarding to the G&A, again, that's about 3 areas. One is Argyle consolidation which contributed to about 7.1% increase out of that total number. And then the R&D, this quarter we spend CNY 5.7 million. And so we amortize that. But even with that, we have an increase of CNY 4 million in that R&D. So that's like 16.7%, about 17%.

So deleted all of that, I think then we also have prepared, as I mentioned to you, the cost of adding the development and the operation in preparation for the next year and a higher speed of growth. But we think that's a regular expense and that the speed of increase will be slowed down. So excluding those, it's going to be less than 47%. Then we also have the continuous evaluation, like consulting fees, DD and various advisory cost that's a little higher because we're evaluating systematically some opportunities. And that is a 10% increase. So deleting all of that, so the net core G&A is about 30% increase. So Nate, that's our breakdown.

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Operator [9]

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The next question comes from Colin Yao of Goldman Sachs.

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Colin Yao, Goldman Sachs Group Inc., Research Division - Research Analyst [10]

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Congratulations on the strong results. I basically have 2 questions. The first one will be regarding on the same hotel RevPAR. So comparatively speaking since GreenTree has been delivering very resilient performance in terms of same hotel RevPAR, I would like to know comparing to your peers why GreenTree overperformed comparatively speaking? And also my second question will be on further expansion in the mid-scale and upscale segment. Since you are still sitting on ample cash resources, would you be considering opening up more leased and owned hotels or seeking some mid to high end hotel investment opportunities, both domestically and globally? Yes. So here are my 2 questions.

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [11]

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Okay. So the first question regarding our performance comparing with our peers. We really have not compared to our peers that closely because we think that we use a business model that value pricing, I think, is our key and to pay attention to the need of our loyalty members, our corporate memberships, what their need. So we do not, for instance, adjust our price constantly. And we have basically a value pricing model. And because of the economy, the shifting, the change, because of the change of the shifting of the economy, I think that both corporate travelers as well as individual travelers are in conflict with the travel budget. So we have always believed in the end value-priced products and services will be in great demand.

And secondly, that we have, as we have said to you before, and we developed and strengthened our membership development programs. We strengthened our marketing programs. We targeted our membership sales and marketing. We also have one of a kind because our parent company has a restaurant chain which we have more than close to 100 million and 100 million visitors per year, where we can use the point of contact to market our brand. And so a combination of all of that made the sales and marketing programs more effective. I think that it also stabilized in the more volatile market our ADR, occupancy and therefore, the RevPAR. So I think those are the key factors.

And with regard to the second question, we are evaluating opportunities and trying to deploy our cash responsibly to further grow our China market. So we are monitoring that. And we think there will be a great opportunity ahead. And so that if we have strategically located properties and also well priced, we will do selectively our own leased-and-operated hotels or owned hotels.

Globally, we believe our strength, management strength and the core competencies are based in China. So unless those opportunities are coming to us from our franchisees or from our customers, we will not divert our focus to elsewhere. And I think the opportunity is here in China and also the sphere of influence such as nearby China. So our focus of growth for the next few years are continuing to be focused in domestically. We think the market will be really, really good. And there will be ample opportunities.

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Operator [12]

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The next question comes from Jisheng Liu of CLSA.

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Jisheng Liu, CLSA Limited, Research Division - Research Analyst [13]

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I have a couple of questions. Maybe 2 quick ones first. First one was on the guidance for 2019. I noticed that you have put a new revenue guidance of 20% to 25% year-on-year growth in 2019 versus 2018. I was just wondering if this is only on organic basis.

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [14]

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Primarily. That include a number of months of the consolidation of Argyle. But I think that will be very much delayed, the Urban consolidation. That's probably less than 1 month or less. So primarily, you can see it primarily from organic growth.

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Jisheng Liu, CLSA Limited, Research Division - Research Analyst [15]

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Yes. At the end of second quarter '19, you actually said the revenue of 2019 was expected to grow by 23%, 28% from 2018. So by the time, actually, Urban was already -- sorry, Argyle was already consolidated. So I was just wondering, so if that guidance was actually -- so 20% to 25% of revenue growth for this quarter, which was announced for 2019 target. So that would be rather considered as a top line growth guide down in that sense. So if that were true, it means that our fourth quarter implied revenue growth will be much slower. So why was that actually?

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [16]

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Initially, we anticipated that we will have a consolidation of Urban for the entire fourth quarter, but that will be delayed for 2 months or so, which will have a negative impact on the revenue growth for the M&A. And secondly is that we, as I mentioned to you, that we speeded up. We feel that during the transition period we speed up the existing hotel renovation is very important. So we have a renovation program, aggressive program that's being implemented. And so we will have a higher number of hotels being renovated. So we do not necessarily want to force the closure of our hotels and we want to give and incentivize our franchisees to renovate during this period of time. So due to these 2 factors and that the reduction of the growth, the revenue from consolidation from the M&A and also the speed of this renovation, and we will see that the guidance will drop 3%.

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Jisheng Liu, CLSA Limited, Research Division - Research Analyst [17]

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Got it. That's very clear. Second one was, because you just mentioned you have been adding development personnel. So may I know how many personnel in development did you actually have by the end of, let's say, June 2019? And how many do we have like just now? And how many do we plan to add in future actually? Any color would be helpful.

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [18]

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Sorry, based on my memory, I think that in this quarter, in the third quarter, we added about -- because we're screening those. We come and our development personnel come in for 3 months, for 6 months. There's a trial period because not everyone can be made into a full-time after the training can be a full-time BD person. So I think the last quarter, we have hired close to 45 personnel. And at the end of the third quarter, we also have screened out quite a bit. So at the end of the third quarter, I think we have about 200, plus or minus, BD personnel. It is the training and also that then it is the screening process that cost a great deal. So that's the number. And overall this quarter, we plan to add another 40. So by the year-end, we think we should have 240 to 250. That's our plan.

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Jisheng Liu, CLSA Limited, Research Division - Research Analyst [19]

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Great. And the third question, I actually noticed some of your brands, actually 2, may have been going through a rebranding exercise. So Argyle actually in the presentation of last quarter, the name was Argyle only. And this quarter, it has become Argyle Grand Hotel. And for Gme Hotel, last quarter, it was Gme Hotel, this quarter it was renamed to Gem Hotel. So if my understanding was right, you are actually doing some rebranding exercise on there. So may we get a sense what's the rationale behind that? Because if there's no real economic impact, I think franchisees may get pretty confused because previously, they have one brand and now the brand has actually changed a little bit. So what's the rationale behind it if any color could be shared on this?

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [20]

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That's a great question. No. There's no change of the brand in any of those logos, Chinese. I think that the Argyle will always have the Argyle and then they have a brand. They have a lot of other things that are then depending on the property type. So that I think we just use the representative, one of the most representative of the hotel brand there.

In terms of our Gem, gemei jiudian, that is Gemei Hotel. That's how we spell. And we said G-E-M-E-I then people will delete a couple of them on the English side and Gme and Gem. And I think our guests like the Gem, the Gem that spells correctly that are in English that the customers and the investors. So that's on the English side, we just slightly modify in terms of our brand. But there's no brand changes to our customers in China so apologize for the confusion.

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Jisheng Liu, CLSA Limited, Research Division - Research Analyst [21]

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Maybe just a little, the last little element to check with you. Actually, last year during fourth quarter, you actually paid out a dividend. So should we expect that dividend during the next quarter? And if there is, what amount should we expect for next quarter?

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [22]

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We have announced a plan for a dividend policy. We would, I think, stick to that for the time being, unless announced otherwise.

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Operator [23]

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(Operator Instructions) I see we have a follow-up from Nate Deng of China Renaissance.

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Nate Deng, China Renaissance Securities (US) Inc., Research Division - Research Analyst [24]

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Alex, maybe one follow-up question about our strategy because I think previously someone asking about the OYO soft brand impact. And we are also seeing major China hotel groups saying they're going to penetrate into lower-tier cities. So my question is, how are we conducting this increasing competition in the lower-tier city, which is our target market? And are we expecting some kind of increased competition and maybe price war, something like that to happen? And should we expect the cost of developing new hotels to increase in the future? And how are we going to cope with it?

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [25]

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Thanks, Nate. That's a great question. We clearly see there are more opportunities in the third tier and the fourth tier cities in China. And the first tier and second tier, the brand penetration rates are much higher. So going to the third, fourth, fifth tier and the demand for the management resource is much higher. I think that there is a price war right now in terms of the initial brand application fees, the initial fees. A lot of people will give you a large discount. And there is a competition on that end. We are clearly also seeing that impact. So we have adjusted our fees to position ourselves to compete effectively. But so far, I think that because of our past performance and because franchisee, the hotel owner can see our sustained profitability and performance, so we have the development, 50%, as we said, more than 50% is driven by our existing franchisees on the new openings and the referrals. So we're pretty confident that number will continue and will potentially next year further increase.

And we have a trend in the past consistently, our operating managers to be sent to the third, fourth tier cities. We have the largest, I think, number of area managers in the company. And so we think we are uniquely positioned to do a better job in the third, fourth and fifth tier cities because, as we said, the revenue, the ADR, and that there is a ceiling in that end. And so the operating efficiency and the systems and the support, the logistics are crucial to make the hotel operation profitable and sustainable. So in that end, we believe we're uniquely positioned and qualified. So we're not really concerned a lot more competition, in the past 10 years, we do see -- past 15 years, some brands come and go. And it is the solid operator who will continue to deliver the performance to the franchisee who will be the one to stay.

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Operator [26]

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(Operator Instructions) The next question comes from Billy Ng of Bank of America.

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Hay Ling Ng, BofA Merrill Lynch, Research Division - Research Analyst [27]

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Alex, just have a follow-up on that question. Would you mind to tell us what do you think about the current environment? Like you do mention the competition become a little bit more intense. But of course, we do believe GreenTree is very well positioned on that. But in terms of like profitability of the franchisees, how do you see your own franchisees' profitability compared to a year ago? And also maybe in terms of overall industry, how profitable or not profitable at this stage? And as a result, in 2020, whether you think there will be bigger opportunities for you guys to help those unprofitable operators out there to join the franchise or in general, it will be a very tough environment for everyone? So like the incentive to open new hotels are low. What stage are we in at this point?

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Alex S. Xu, GreenTree Hospitality Group Ltd. - Founder, Chairman & CEO [28]

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Okay. So Billy, thank you so much for the questions. For our franchisees, our profitability has been very stable. Because in order to operate a profitable hotel, it goes through a lot of preparation in terms of design and construction cost, preopening cost, the operating cost, the sales and marketing cost and also the ability to have direct sales forces in addition to work with so many online players there. So it is a comprehensive sales and marketing and management skill set the team has to have to deliver a return to our franchisees. So for our existing hotels with no need for renovations, our profitability stays the same. And our original plan, the investment return period of 3 to 3.5 years. And I think we are still in that range for many hotels.

We have hotels in older hotels that need to be renovated and that they will be more impacted by a newly opened hotel nearby so they have a reduced performance. And their return period, in other words, their profitability get reduced, but most of them already the capital paid back years ago. So they are in a better position to reinvest some of the dollars to renovate and instead their profitability will come back. Because what we designed in terms of the hotel products and pricing really meet the core demand for the everyday leisure and business travelers, so that is about 108, according to China's hotel statistics. The average hotel stay is about $177. So we really want to target the mid-market and to address the great demand. So the majority of our franchisees' profitability remain the same. And that's why I think they are really pleased about the upcoming opportunities and that they are developing more hotels. And so we anticipate next year, we should have the same or higher speed of growth. And we have gone through that in 2009, 2010, and I think our growth really have not been impacted that much.

And in terms of going in the future about economy conditions, we think that because there is a pressure in terms of the debt services for many small- and medium-sized corporation and even for some, we've seen some household debt level increase that may put a damp in terms of household expenditures or small business travel budget. But I believe the core demand are still there. So as long as we don't deviate, overspend in terms of design and construction and to price our hotel above four or five-stars RevPAR, I think the sector will be very healthy and at least at the sector we stay. And comparing with a lot of different sectors, I believe the hospitality sector is really a sunrise industry and we're really blessed to be in that play.

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Operator [29]

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(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to Megan Huang for any closing remarks.

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Qing Huang, GreenTree Hospitality Group Ltd. - Director of IT Department [30]

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Thank you, operator. In closing, on behalf of the entire GreenTree management team, we thank you for your interest and participation in today's call. If you require any further information or have any interest in visiting us in China, please do not hesitate to contact us. This concludes the call.

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Operator [31]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.