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Edited Transcript of HCITY*.MX earnings conference call or presentation 17-Oct-19 3:00pm GMT

Q3 2019 Hoteles City Express SAB de CV Earnings Call

CUAJIMALPA DE MOREL Oct 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Hoteles City Express SAB de CV earnings conference call or presentation Thursday, October 17, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Héctor Vázquez Montoya

Hoteles City Express, S.A.B. de C.V. - Deputy Director of IR

* Luis Eduardo Barrios Sánchez

Hoteles City Express, S.A.B. de C.V. - Chairman and CEO

* Paul Smith Márquez

Hoteles City Express, S.A.B. de C.V. - CFO

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Conference Call Participants

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* Andrea Lara Cid Antúnez

Signum Research - Junior Stock Market Analyst

* Daniel Rojas Vielman

HDI Capital, LLC - Investment Specialist

* Fernando Froylan Mendez Solther

JP Morgan Chase & Co, Research Division - Analyst

* Javier Gayol Zabalgoitia

GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst

* Ivan Peill

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Presentation

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Operator [1]

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Good morning, and welcome to the Hoteles City Express Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Ivan Peill of InspIR Group Investor Relations. Please go ahead.

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Ivan Peill, [2]

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Thank you, Jake, and good morning, everyone. Hoteles City Express third quarter 2019 results were released yesterday after the market close. The company's earnings release can be found on Hoteles City Express' website at www.cityexpress.com.

During this call, management's comments may include forward-looking statements, and we ask that you please refer to the legal disclaimer and the quarterly reports for guidance on this matter.

Joining us on today's call are Mr. Luis Barrios, Chief Executive Officer of Hoteles City Express; Mr. Paul Smith, Chief Financial Officer; and Mr. Héctor Vazquez, Investor Relations, Deputy Director.

Mr. Barrios will begin the call with some opening remarks followed by Mr. Smith, who will present the company's financial results. We'll then open the call for your questions.

Now it's my pleasure to turn the call over to Mr. Barrios.

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Luis Eduardo Barrios Sánchez, Hoteles City Express, S.A.B. de C.V. - Chairman and CEO [3]

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Good morning, everyone, and thank you for joining us to discuss Hoteles City Express third quarter results. Our results this quarter continue to reflect a defensive operation in a tough environment that leverages the competitive advantage derived from the geographic, industrial and market diversification that positions us as the leading chain in the limited service of Mexico.

Since our previous call, Mexico's economy unexpectedly slowed again and growth expectations have been revised downwards. The economy has been impacted by declining consumer and business confidence resulting from significant headline noise that has fueled uncertainty and market volatility. However, we are reasonably confident that the president's administration will return to be more pragmatic with its policy making, which would help rebuild confidence and stimulate growth in Mexico's private sector.

In our area of the economy, we have recently seen a more reasonable approach to construction in Mexico City, for example. However, we are still encountering license and permit delays in some locations, including Guadalajara where we have one hotel under construction and another one still in the permitting and licensing stages.

On a positive note, favorable growth trends continue in some of the markets where we operate, such as urban centers in the North of Mexico, where the export corridor remains strong. We have also witnessed sustainable growth in the Gulf and industrial corridor, where maquiladora and other manufacturing businesses are benefiting from increased foreign investment.

Additionally, due to ongoing trade tensions between the U.S. and China, some Asian companies are protecting themselves by establishing operations in Northern Mexico. And also economic activity in the Bajío region continues to be weak. We believe the conditions they are related to a cyclical effect, and we are also hopeful that safety issues in some of the regional cities will be resolved soon. In addition, our robust and efficient operating model has allowed us to continue capturing growth through our decentralized yield management system, which unlike the industry gives us significant commercial agility to react in a timely and efficient manner to adverse effects -- events.

Together, with our cultural transformation toward empowerment at the local level and gradual adoption of our inverted pyramid strategy, we have continued to leverage our proprietary innovative platforms based on the information and data we have at hand.

From a financial perspective, total revenues posted a high single-digit growth of 9.5% mainly driven by the positive momentum of our established portfolio, which continues to outperform the industry trends. However, adjusted EBITDA declined 6% on a comparable basis. The decrease was mainly attributed to continually rising energy costs, which have increased as much as 30% in a year-over-year basis and 70% since the beginning of 2018. In light of this, I'm pleased to report that our Clean Energy Supply and Acquisition Agreement became fully effective earlier this month. Our energy supply will cover 95% of the Hoteles City fully owned, co-owned and leased hotels and is expected to produce energy savings of more than 25% per year.

In addition to reinforcing our existing cost reduction program, this PPA is helping us advance our sustainability strategy. It will substantially reduce the greenhouse gases produced by our hotel operations. Annual reductions will be equivalent to taking approximately 4,200 cars off roads or planting 1.6 million trees.

Given the licensing and permitting delays that I touched upon earlier, we expect to open 10 more hotels this year and the beginning of 2020. As always, we will evaluate the investments opportunity with strict financial discipline without losing sight of our ROIC targets of 12% to 14%. However, we remain confident in our ability to effectively penetrate Mexico's primary markets, such as Mexico City, Monterey and Tijuana, where we see the greatest potential for the long-term growth, diversification and strong demand dynamics.

Finally, looking at the investment opportunity that City -- Hoteles City presents today, we believe that our company has significant potential for appreciation in value, given the scale and many milestones that we have delivered to the present market since our IPO. Over the last 5 years, Hoteles City Express has more than tripled its EBITDA figures becoming into the most profitable company in the Mexico's hotel sector.

Having said that, we will remain focused on continuing to offer our shareholders an attractive investment alternative and profitable growth and high potential for generating value in the medium and long term.

Now I would also like to hand the call to our CFO, Paul Smith, who will provide you with further details on our financial and operational performance.

Paul, would you, please?

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [4]

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Thank you, Luis. My remarks were based on Hoteles City Express' third quarter 2019 financial results which were prepared under IFRS.

During the third quarter, we did not add any hotel to our portfolio, which had 12 more properties than last year's comparable quarter. Of the 151 hotels in operation at the end of the quarter, 114 were established properties, 14 more than the third quarter of 2018. Our number of installed room nights during the quarter was 1.6 million, which represented a 9.7% increase compared to last year and partially accounted for the decline in a consolidated occupancy level.

As we mentioned in our previous reports, our ability to absorb new properties was impacted by adverse market conditions in both the first and third quarters. At the chain level, our ADR rose 6% to MXN 1,021, while RevPAR was 50 basis points below last year's quarter at MXN 596. Sales totaled MXN 811 million at the end of the quarter, a 9.5% increase, which was also due to a greater number of installed room nights.

In addition to our yield management system that we highlighted, we are still capturing more than 80% of reservations through our own reservation channels.

Revenues from hotel management decreased 10 -- 1% to MXN 44 million due to a smaller base of installed room nights in this category. The lower base in this segment was a result of our purchase of the City Express Chihuahua Hotel as well as sale of the City Express Junior Chihuahua Hotel, both previously operating under a pure franchise scheme.

Total cost rose 18.7% during the quarter, mainly due to increased installed room nights, higher energy cost and higher density per room -- occupied room night.

With regard to the increase in energy cost, as Luis noted, our purchase power agreement became fully effective earlier this month and is expected to reduce this cost for at least 25% annually. Again, annually, energy represents between 3.5% and 5% of sales hotel operation revenue at our established hotels.

Lastly, on cost, our sales and administration expenses rose 6.5% in the quarter. That brings us to a third quarter adjusted EBITDA which declined 6.2%, with the corresponding margin contracting 500 basis points.

Comprehensive financing costs increased 12.3% year-over-year to MXN 103.8 million due to disbursements from bank financing lines over the last 12 months for constructing new hotels and to higher interest rates on the funds we borrowed.

Our financial liability net of interest increased 21% during the last 9 months to MXN 5.2 billion. Cash and cash equivalents rose 4.5% to MXN 1.2 billion, bringing net debt to MXN 4.0 billion, up 26% during the period. That puts our net debt-to-EBITDA ratio at 4.1x. However, we expect this metric to decline as new hotels ramp up and because most of our funding needs up to 2020 have been met.

As a percentage of assets, our debt was 34% at the end of the period. Today, 70% of our debt is hedged at a 7.5% plus a spread of 1.2% on average. And we have the flexibility to adjust our hedges according to interest rate changes and at no additional cost. The combination of a 22% decline in operating income and increasing the third quarter financing cost led to 66% decrease in our net income, which totaled MXN 19.6 million. Also impacting our net income was a noncash net foreign exchange loss of MXN 4.8 million related to the valuation of equity interest in our subsidiaries in Chile and Colombia.

In summary, as Luis emphasized, we will remain disciplined with our key investments and continue to maintain strict criteria for every project we undertake. Achieving an attractive spread between our cost of capital and investment returns continue to be our focus. If necessary, we'll adjust our portfolio pipeline in favor of cash generation.

Thank you for your attention. Operator, please begin the Q&A portion of our call.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Javier Gayol with GBM.

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Javier Gayol Zabalgoitia, GBM Grupo Bursátil Mexicano, S.A. de C.V. Casa de Bolsa, Research Division - Research Analyst [2]

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I was just wondering -- and we saw a decrease in occupancies, and we understand this to be somewhat of an industry matter, but we wanted to see how are you guys looking at it and what sort of metrics could we compare the performance of your portfolio with the industry? And what has this performance been historically? So just to get a better sense of how are you guys doing against the industry? And if this is something more of a macro thing that's going on around the business or is it -- could be located into some corridor specifically? Or if you could just give us a little bit more color on that.

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Héctor Vázquez Montoya, Hoteles City Express, S.A.B. de C.V. - Deputy Director of IR [3]

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Hello, Javier, this is Hector Vazquez. That's a really good question though. First of all, and as Luis just emphasized, we have a decentralized yield management system which unlike to the industry give us a significant commercial agility to react in a timely and efficient manner.

Additionally, we operate with the lowest ratio of employees per available room, which help us to maximize our operating margins. Also, it is worth mentioning that we have a vertical -- that we have a vertical integrated model that allows to have a lower cost per key, which is around 25% less of that of the industry. As a result of these, we could manage to have a lower ADR when compared to the industry without compromising our operating figures, which is something that you have seen during the year. I don't know Paul, if you want to comment.

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [4]

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Just to complement on the industry view, I think it was a soft quarter for the industry, only one of our public competitors have published their information for September and for the third quarter, but we believe that this is going to be symptomatic for the industry. We're very happy also with the performance of our established portfolio, which we believe is more comparable to that of the industry. And even though we're expecting that the industry will probably post a negative RevPAR, just remember that our established portfolio did manage to grow RevPAR up to 200 basis points for the quarter.

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Operator [5]

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The next question comes from Froylan Mendez with JPMorgan.

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Fernando Froylan Mendez Solther, JP Morgan Chase & Co, Research Division - Analyst [6]

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This is Froylan from JPMorgan. So can you help us with more granularity on the margin contraction during the quarter? How much came from energy? How much from new hotels? And how much from lower margins in the management business? That's my first question.

The second one. Could you provide us a little bit more on your growth plans, if you're going to focus more a little bit on retaining cash? And how does this new outlook might impact your plans for increasing the franchise or the managed portion of your portfolio?

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [7]

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Thank you very much for your questions, Froylan. So on the first one, I'd assume that if -- so the biggest impact, as Luis mentioned, was basically on the hotel expenses. I would basically explain this that about half of the increase in the base expense came from the opening of new properties. As you know, those properties haven't fully matured. And as a result of that, we don't have necessarily the ADR or occupancy levels that I said to fully absorb those expenses. So about half of the increment came from that. And then if you split the other half in 2, basically, the 2 halves come from: one, higher energy costs, that's the main impact and, as Luis also mentioned, this will be fully eliminated starting on the fourth quarter of this year. And the second portion of that is basically higher density per room. One of the things that we have -- what we note there is softness in the demand is when we see the higher number of guests per room in the reservations. So -- that basically accounts for the explanation.

On your second question, basically, the biggest impact to our pipeline this year has been licensing. We have 4 projects that were supposed to be fully licensed by the beginning of the year, and we're finally getting through the new administration in Guadalajara, but that delay has basically gone up and that makes -- it's not going to be feasible anymore to open them this year. That's the biggest impact we're seeing. And we have focused a little bit more on the co-investments and also on the franchise. We have a work in process for -- right now for 9 hotels next year. You will see that those -- we don't expect any delays into those, and then we're also expecting another 4 to 5 starts from here to the first quarter and basically that's going to end up the year for next year to about 10 to 14 properties on the pipeline.

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Fernando Froylan Mendez Solther, JP Morgan Chase & Co, Research Division - Analyst [8]

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Okay. And was there no impact from the lower margins in the management business during the quarter? And can you explain a little bit how should we think about in long term for margins in these business units?

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [9]

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So I -- during the call, I mentioned the consolidated numbers so that you could see the net effect of basically the 2 hotels in Chihuahua. For the other portion, if you're looking at the non-IFRS data, the main impact is basically the delay in the start of those 4 projects. So what you're not seeing is our devco internally charging our opco. Those fees for the development of those 4 hotels that were basically delayed. In that sense, there is no impact to the margins on the management company.

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Operator [10]

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(Operator Instructions) The next question comes from Andrea Lara with Signum Research.

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Andrea Lara Cid Antúnez, Signum Research - Junior Stock Market Analyst [11]

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I just have 2 questions. With all these economic and political uncertainty, where do you think your company will go in the next few years?

And the second is, could you give us more information about the FSTAY Portfolio progress, and if you're planning to make any changes on the portfolio?

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [12]

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Andrea, this is Paul Smith. Thank you very much for your 2 questions. Let me address the first one and then I'll go to the second one. So one very important thing to consider, Andrea, is that we're basically located in the most attractive economic corridors of the country. That basically correlates you to an export industry. We see that export industry being very strong. So I'm not going to talk about the headline noise, I'm going to talk about more the structural strictness of this country. Given where the conflict between the U.S. and China is in commercial terms, there is -- our view is that the U.S. definitely needs Mexico if it wants to remain competitive in its own manufacturing. And the only way you can basically substitute China right now is also if you increase activity in Mexico. So we see that as a core strength of the country. Bear in mind that we're also seeing a lot of activity actually of Asian companies coming into the border towns basically installing fixed capacity in those towns and basically trying to bypass those royalties by also leveraging on the -- on Mexican label, which, as you know, is basically less expensive than that of China. So -- and then on the -- I would say on the headline side of things, what we're basically seeing is also a little bit more a return to pragmatism by the current administration. I believe that the current administration is quite concerned without having economic growth. I believe that they also fully understand that they have caused most of the...

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Operator [13]

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(technical difficulty) Pardon me, it looks like we have lost the connection to the speakers, ladies and gentlemen, and please stand by while we connect.

Pardon me, ladies and gentlemen, sorry, for the interruption. We are waiting for the speakers to get back in, and it looks like they have just connected back into the call.

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [14]

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My apologies, Andrea. I was cut off. So on that second part of the first question, what I was alluding to is the pragmatism that we have started to see flowing back into the administration decisions. We're looking very positively at the, I believe, it's 120 new projects that are going to be co-investment with the private sector in Mexico, and we're also looking with a very positive view that the team make efforts that we have been placing with the U.S. administration will also come to a fruition of this agreement. This pragmatism, we believe, is rooted in the fact that we believe that the new administration recognizes that without economic growth, there is a risk that it may lose Congress in the 2021 election. So with those 2 aspects in mind, what I would say is that the outlook for the country is actually very positive in our view.

For the second part of your question. So if you look at the report, you will see that the FSTAY Portfolio as reported on our IFRS numbers is actually behaving much better than its comparable Fibra market comparables. And you will see also that it's yielding significantly better margins as well as most of its competitors. What we're basically doing is adding -- so we haven't done this formally, but probably by the fourth quarter or at the end of the year, we'll do an update on the vehicles where we can add more properties, and then we can also showcase the actual new size of that portfolio. We have continued stabilizing our hotels and we have continued to add properties to this portfolio. If you look at our corporate presentation for the third quarter, you will see that we have about 72 new properties there and that the size of the vehicle is now about MXN 9 billion. We have more properties joining in at the 31st of December of this year. So at the end of the fourth quarter, we will publish an update on that. I hope that answers your 2 questions.

And I'm sorry, one last key thing. So we continued to speak to investors about the potential launch of the vehicle and basically stressing out that this vehicle is very -- it's strategic for the company. What we believe is that, now that we have entered into an easing cycle by the Mexican Central Bank, the expectation is that the lowering of the interest rates in the Mexican system and in particular with the M10 bond being below in the near future of 600 basis points, there will be also an opportunity to reprice this vehicle into the equity market.

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Luis Eduardo Barrios Sánchez, Hoteles City Express, S.A.B. de C.V. - Chairman and CEO [15]

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This is Luis Barrios. Just to follow on, on that. I would tell you that we have been in close contact with the authorities -- on the Secretary of Tourism. And I can tell you is I have the chance to be this -- the keynote speaker in the last Acapulco Tourism meeting, which is called the Tianguis. And that is the most important fair in the country when it comes to tourism because we address to all the foreign suppliers and distributors of Mexican tourism products. And in that speech, I asked the President if they could help us with 2 things: one was support in advertising and promotional budgets; and the second one was to level off the core -- the playground when it came to competing with electronic or digital platforms.

And in the end, everybody thought that they were too -- I was too naïve in asking such questions directly to the -- request to the President. And in the end, what I can tell you is that as of now, we have gotten 1 of the 2. And 1 of the 2 is that they are through the Secretary of Hacienda, they have issued an opinion about the treatment of the taxes that all those platforms have to pay in Mexico. So that is the first step towards leveling off the playground. That tells you a little bit of the pragmatism that the country or the President is providing in certain responses. Even though they are slow, but at least there is an answer and that is already being implemented and that's a request and there are some facts that the government has -- or steps that the government has taken on it.

In terms of the distribution of the advertising and promotional -- promotion, if they have started to understand how this industry works and we have been able to get closer to the Ministry of Tourism and now we will be working on a monthly basis in order to draw an agenda. So these are signs as well as, for instance, the immediate approval of the CFE contemplate -- I mean the distribution of gas that was somehow stalled and was going to be expropriated. There were noises about being expropriated. In the end, the contracts were signed and now we're up and running with those hedge investments.

So I think the government is moving along towards certain -- getting much more knowledge about the country and the industries are and at the same time, even though they're slow, but they are providing us with answers and some messages that give us a certain light as to the uncertainty of the investment. I would say that if this private sector begins to fell some certainty level and rates, that Paul was mentioning, are coming down, I think that those 2 would be 2 very good catalyzers of what the investment -- how the investment's going to start flowing and moving along and reaching previous years' level. So in essence, what I'm trying to say, I think we're -- the industry, in general, is going towards small slump because the economy is stalling or beginning to stall. However, the new government has begun to show some light in -- at the end of the tunnel.

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Operator [16]

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(Operator Instructions) The next question comes from Daniel Rojas with HDI Capital.

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Daniel Rojas Vielman, HDI Capital, LLC - Investment Specialist [17]

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My question is regarding El Bajío. Could you give us more color on the situation there? How has they developed? Now that we're in October, has it become better? Do you think it will improve going into the end of the year? Anything you can add, I would be thankful.

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Paul Smith Márquez, Hoteles City Express, S.A.B. de C.V. - CFO [18]

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Sure. So basically -- and this is Paul Smith. Thank you for your question. So basically what happened is that we had a change in government, so both Governor and the municipal authorities in Guadalajara are brand-new. We're brand-new by December of last year. At the beginning, we just couldn't get through. So very similar to what happened in Mexico City, basically the window for receipt of licensing was basically closed and if it was not closed, the response times were not there. So we started looking for contacts with the Tourism Ministry of the state and also of the city to try to get them to accelerate or basically to recognize that we wanted to do the investment.

Bear in mind that we have currently one hotel in the process and that was fully licensed, but we were also getting concerned that, as you know, once you finalize the construction, you need an operating permit as well. So basically, there was no response through the first quarter or the second quarter. We managed to get some traction with the Governor's office and with the state's investment office. Basically, those contacts started to lead us to the new -- there were a lot of changes also in terms of personnel.

And now, finally, what's happening is that now that we have finally a contact there to present the numbers, they basically need help in determining what to review, what are the papers, why do you require X and Y documents and so on and so forth. So we're in basically that process right now. We have received good feedback in 2 of the projects. The economic side of the project doesn't make sense, which basically leads us to believe that they're taking a parametric information as opposed to specific information of the project. We're currently working with them to adjust those. And hopefully, sometime in the fourth quarter, we will begin groundworks in those properties. I hope that clears the question, Daniel.

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Operator [19]

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This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Barrios for any closing remarks.

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Luis Eduardo Barrios Sánchez, Hoteles City Express, S.A.B. de C.V. - Chairman and CEO [20]

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This concludes -- sorry. Thank you, again, for joining us on today's earnings call. As you know, all the information concerning our third quarter results has been posted to our website and our financial and investor relations team are available to answer any additional questions that you might have. We wish you a good day.

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Operator [21]

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