20-F 1 c14487e20vf.htm FORM 20-F Form 20-F
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
(Mark One)
     
o   REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010.
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
OR
     
o   SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
Date of event requiring this shell company report                     
Commission file number: 001-33082
HOME INNS & HOTELS MANAGEMENT INC.
(Exact Name of Registrant as Specified in Its Charter)
N/A
(Translation of Registrant’s Name Into English)
Cayman Islands
(Jurisdiction of Incorporation or Organization)

No. 124 Caobao Road
Xuhui District
Shanghai 200235
People’s Republic of China
(Address of Principal Executive Offices)

David Jian Sun, Chief Executive Officer
No. 124 Caobao Road
Xuhui District
Shanghai 200235
People’s Republic of China
Phone: +86 21 3401 9898
Fax: +86 21 6483 5661
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act:
     
Title of Each Class   Name of Each Exchange On Which Registered
American Depositary Shares, each representing two ordinary
shares, par value $0.005 per share
  Nasdaq Global Market
Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
(Title of Class)
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report. 81,716,084 ordinary shares, par value US$0.005 per share, as of December 31, 2010.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes o No þ
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
         
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
U.S. GAAP þ

International Financial Reporting Standards as issued by the International Accounting Standards Board o
Other o
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. Item 17 o Item 18 o
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes o No o
 
 

 

 


 

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 Exhibit 2.2
 Exhibit 2.3
 Exhibit 2.4
 Exhibit 4.7
 Exhibit 4.10
 Exhibit 4.11
 Exhibit 4.12
 Exhibit 4.13
 Exhibit 8.1
 Exhibit 12.1
 Exhibit 12.2
 Exhibit 13.1
 Exhibit 13.2
 Exhibit 23.1
 Exhibit 23.2

 

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INTRODUCTION
Unless otherwise indicated and except where the context otherwise requires, references in this annual report on Form 20-F to:
    “we,” “us,” “our company,” “our” and “Home Inns” refer to Home Inns & Hotels Management Inc., a Cayman Islands company, and its predecessor entities and subsidiaries;
    “China” or “PRC” refers to the People’s Republic of China, excluding solely for the purpose of this report Taiwan, Hong Kong and Macau;
    “Top Star” refers, collectively, to Hong Kong Ai Home Hotel Investment Limited, Shanghai Chuwen Investment Holding Co., Ltd. and their subsidiaries, which we acquired in 2007;
    “our hotels” refers, collectively, to our leased-and-operated and franchised-and-managed hotels;
    “average daily rate” refers to total hotel room revenues divided by the total number of occupied rooms in a given period;
    “occupancy rate” refers to the total number of occupied rooms divided by the total number of available rooms in a given period;
    “outstanding ordinary shares” and “ordinary shares outstanding” refer to our outstanding ordinary shares, but excluding 3,917,922 ordinary shares that have been issued to The Bank of New York Mellon but are reserved in anticipation of the exercise of options and vesting of restricted shares under our Employee’s Stock Option Plan as well as the share incentive plan we adopted in 2006;
    “RevPAR” represents revenue per available room, which is calculated by dividing total hotel room revenues by the total number of available rooms in a given period, or by multiplying average daily rates and occupancy rates in a given period;
    “shares” or “ordinary shares” refers to our ordinary shares;
    “ADSs” refers to our American depositary shares, each of which represents two ordinary shares;
    “convertible bonds due 2012” refer to our US$ settled zero coupon convertible senior bonds due 2012 that were issued in December 2007;
    “convertible notes due 2015” refer to our US$184 million aggregate principal amount of 2.00% convertible senior notes due 2015 that were issued in December 2010; and
    “RMB” or “Renminbi” refers to the legal currency of China; “$,” “dollars,” “US$” or “U.S. dollars” refers to the legal currency of the United States; and “HK$” refers to the legal currency of Hong Kong.
This annual report on Form 20-F includes our audited consolidated financial statements for the years ended December 31, 2008, 2009 and 2010 and as of December 31, 2009 and 2010.
PART I.
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3. KEY INFORMATION
A. Selected Financial Data

 

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Our Selected Consolidated Financial Data
The following table presents our selected consolidated financial information. The selected consolidated statement of operations data for the years ended December 31, 2008, 2009 and 2010 and the consolidated balance sheet data as of December 31, 2009 and 2010 have been derived from our audited consolidated financial statements included elsewhere in this annual report. Our selected consolidated statement of operations data for the years ended December 31, 2006 and 2007 and our consolidated balance sheet data as of December 31, 2006, 2007 and 2008 have been derived from our audited consolidated financial statements not included in this annual report. Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP and reflect our current corporate structure as if it had been in existence throughout the relevant periods.
Our historical results do not necessarily indicate our results expected for any future periods. You should read the following information in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report.
                                                 
    For the Year Ended December 31,  
    2006     2007     2008     2009     2010  
    RMB     RMB     RMB     RMB     RMB     US$  
    (in thousands, except share, per share and per ADS data)  
Consolidated Statement of Operations Data
                                               
Revenues:
                                               
Leased-and-operated hotels
    567,895       963,050       1,771,762       2,453,105       2,910,458       440,978  
Franchised-and-managed hotels
    20,605       46,266       99,779       147,535       256,799       38,909  
 
                                   
Total revenues
    588,500       1,009,316       1,871,541       2,600,640       3,167,257       479,887  
Less: Business tax and related surcharges
    (33,977 )     (60,302 )     (111,870 )     (158,975 )     (191,232 )     (28,975 )
 
                                   
Net revenues
    554,523       949,014       1,759,671       2,441,665       2,976,025       450,912  
 
                                   
Operating costs and expenses(1):
                                               
Leased-and-operated hotel costs:
                                               
Rents and utilities
    (171,576 )     (299,792 )     (643,694 )     (797,944 )     (875,510 )     (132,653 )
Personnel costs
    (87,981 )     (155,611 )     (337,837 )     (461,949 )     (506,406 )     (76,728 )
Depreciation and amortization
    (44,619 )     (85,600 )     (190,698 )     (281,543 )     (308,888 )     (46,801 )
Consumables, food and beverage
    (43,482 )     (84,053 )     (143,555 )     (172,467 )     (173,256 )     (26,251 )
Others
    (56,019 )     (98,644 )     (182,284 )     (275,186 )     (310,705 )     (47,077 )
 
                                   
Total leased-and-operated hotel costs
    (403,677 )     (723,700 )     (1,498,068 )     (1,989,089 )     (2,174,765 )     (329,510 )
Sales and marketing expenses
    (11,488 )     (19,632 )     (27,161 )     (30,462 )     (33,257 )     (5,039 )
General and administrative expenses
    (64,793 )     (99,026 )     (152,648 )     (180,480 )     (237,610 )     (36,002 )
 
                                   
Total operating costs and expenses
    (479,958 )     (842,358 )     (1,677,877 )     (2,200,031 )     (2,445,632 )     (370,551 )
 
                                   
Income from operations
    74,566       106,656       81,794       241,634       530,393       80,361  
 
                                   
Interest income
    6,578       31,717       32,023       6,686       9,454       1,432  
Interest expense
    (6,143 )     (7,168 )     (28,136 )     (10,983 )     (2,024 )     (307 )
Issuance costs for convertible notes
                            (42,559 )     (6,448 )
Loss on change in fair value of convertible notes
                            (9,040 )     (1,370 )
Gain on buy-back of convertible bond
                103,291       69,327       2,480       376  
Other non-operating income
    5,309       8,434       10,971       16,248       22,223       3,367  
Foreign exchange loss, net
    (6,990 )     (53,221 )     (65,524 )     (286 )     (4,350 )     (659 )
 
                                   
Income before income tax expense and noncontrolling interests
    73,319       86,418       134,419       322,626       506,577       76,752  
Income tax expense
    (21,391 )     (45,035 )     (28,107 )     (62,166 )     (139,969 )     (21,207 )
Net Income(2)
    51,928       41,383       106,312       260,460       366,608       55,545  
 
                                   
Less: Net income attributable to noncontrolling interests
    (5,034 )     (5,627 )     (5,087 )     (4,457 )     (7,109 )     (1,077 )
 
                                   

 

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    For the Year Ended December 31,  
    2006     2007     2008     2009     2010  
    RMB     RMB     RMB     RMB     RMB     US$  
    (in thousands, except share, per share and per ADS data)  
Net income attributable to our shareholders
    46,894       35,756       101,225       256,003       359,499       54,468  
 
                                   
Amount allocated to participating preferred shareholders
    (16,174 )                              
 
                                   
Net income available to ordinary shareholders
    30,720       35,756       101,225       256,003       359,499       54,468  
 
                                   
 
Earning per share:
                                               
Basic
    0.86       0.52       1.43       3.37       4.45       0.67  
Diluted
    0.82       0.47       0.04       2.34       4.23       0.64  
Earnings per ADS(3):
                                               
Basic
    1.73       1.05       2.86       6.74       8.89       1.35  
Diluted
    1.64       0.93       0.09       4.69       8.45       1.28  
Weighted average ordinary shares outstanding:
                                               
Basic
    35,550,114       68,323,370       70,863,336       75,922,589       80,846,617       80,846,617  
Diluted
    37,530,332       76,883,995       78,037,433       80,895,112       84,747,102       84,747,102  
 
     
(1)   Share-based compensation expenses are included in the consolidated statement of operations data as follows:
                                                 
    For the Year Ended December 31,  
    2006     2007     2008     2009     2010  
    RMB     RMB     RMB     RMB     RMB     US$  
    (in thousands)  
Leased-and-operated hotel costs—personnel costs
    12       11       11                    
General and administrative expenses
    16,283       15,060       24,833       32,009       53,272       8,072  
     
(2)   Data from 2006 to 2008 were retrospectively adjusted to reflect the adoption of ASC 810.
 
(3)   Each ADS represents two ordinary shares.
The following table presents a summary of our consolidated balance sheet data as of December 31, 2006, 2007, 2008, 2009 and 2010:
                                                 
    As of December 31,  
    2006     2007     2008     2009     2010  
    RMB     RMB     RMB     RMB     RMB     US$  
    (in thousands)  
Consolidated Balance Sheet Data
                                               
Cash and cash equivalents
    758,004       1,562,600       608,445       829,592       2,382,643       361,007  
Total assets
    1,320,019       3,561,538       3,363,454       3,454,948       5,286,145       800,931  
Convertible bonds, current
                      363,506              
Current portion of long-term loan from a related party
    10,000                                
Total current liabilities
    323,229       804,922       639,518       925,630       838,576       127,056  
Deferred rental
    44,103       94,226       136,825       155,612       191,034       28,945  
Long-term loan from a related party
    50,000                                
Convertible bonds, non-current
          1,110,308       895,696             159,402       24,152  
Financial liability (convertible notes measured at fair value)
                            1,227,577       185,997  
Ordinary shares
    2,691       2,874       2,899       3,209       3,257       493  
Additional paid-in capital
    813,222       1,362,942       1,393,903       1,798,086       1,913,734       289,960  
Total our shareholders’ equity
    889,739       1,475,397       1,607,608       2,268,104       2,743,299       415,651  

 

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Exchange Rate Information
This annual report contains translations of RMB amounts into U.S. dollars at specific rates solely for the convenience of the reader. The conversion of RMB into U.S. dollars in this annual report is based on the certified exchange rate published by the Federal Reserve Board. Unless otherwise noted, all translations of financial data from RMB to U.S. dollars in this annual report were made at a rate of RMB 6.6000 to US$1.00, the certified exchange rate in effect as of December 30, 2010. We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, the rates stated below, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of RMB into foreign exchange and through restrictions on foreign trade. On April 22, 2011, the noon buying rate was RMB 6.5067 to US$1.00.
The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this annual report or will use in the preparation of our periodic reports or any other information to be provided to you. The source of these rates is the Federal Reserve Statistical Release.
                                 
    Noon Buying Rate  
    Period                    
Period   End     Average(1)     Low     High  
2006
    7.8041       7.9579       8.0702       7.8041  
2007
    7.2946       7.5806       7.8127       7.2946  
2008
    6.8225       6.9193       7.2946       6.7800  
2009
    6.8259       6.8295       6.8470       6.8176  
2010
                               
October
    6.6705       6.6675       6.6912       6.6397  
November
    6.6670       6.6538       6.6892       6.6330  
December
    6.6000       6.6497       6.6745       6.6000  
2011
                               
January
    6.6017       6.5964       6.6364       6.5809  
February
    6.5713       6.5761       6.5965       6.5520  
March
    6.5483       6.5645       6.5483       6.5743  
April (through April 22, 2011)
    6.5067       6.5315       6.4920       6.5477  
     
(1)   Annual averages are calculated from month-end rates. Monthly averages are calculated using the average of the daily rates during the relevant period.
B. Capitalization and Indebtedness
Not applicable.
C. Reasons for the Offer and Use of Proceeds
Not applicable.
D. Risk Factors

 

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Risks Related to Our Business
Our operating results are subject to conditions typically affecting the lodging industry.
Our operating results are subject to conditions typically affecting the lodging industry, including the following:
    changes in national, regional or local economic conditions;
    severe weather conditions, natural disasters or travelers’ fears of exposure to serious contagious diseases;
    competition from other hotels, the attractiveness of our hotels to customers, and our ability to maintain and increase sales to existing customers and attract new customers;
    local market conditions such as an oversupply of, or a reduction in demand for, hotel rooms;
    the quality and performance of managerial and other employees of our hotels;
    increases in operating costs and expenses due to inflation and other factors;
    the availability and cost of capital to allow us and our franchisees to fund construction and renovation of, and make other investments in, our hotels;
    seasonality of the lodging business; and
    the risk that leased properties may be subject to challenges as to their compliance with the relevant government regulations.
Changes in any of these conditions could adversely affect our occupancy rates, average daily rates and RevPAR or otherwise adversely affect our results of operations and financial condition.
We may not be able to manage our expected expansion, which could materially and adversely affect our operating results.
Since our inception, we have experienced substantial growth in our hotel network. We have increased the number of our hotels in operation in China from five in 2002 to 818 (with another 90 hotels contracted or under construction) as of December 31, 2010. We intend to continue to develop additional hotels in different geographic locations in China and increase our number of hotels in operation. In addition, in November 2010, we launched a new hotel brand for the midscale market, Yitel (or Heyi in Chinese), and announced plans to expand the Yitel brand with three or four hotels in 2011 and a target of 50 Yitel hotels within the next four to five years.
Our expansion has placed, and will continue to place, substantial demands on our managerial, operational, technological and other resources. Our planned expansion will also require us to maintain the consistency of each of our products and the quality of our services to ensure that our brands do not suffer as a result of any deviations, whether actual or perceived, in the consistency of each of our products and the quality of our services. In order to manage and support our growth, we must continue to improve our existing operational, administrative and technological systems and our financial and management controls, and recruit, train and retain qualified hotel management personnel as well as other administrative and sales and marketing personnel, particularly as we expand into new markets. We cannot assure you that we will be able to effectively and efficiently manage the growth of our operations, recruit and retain qualified personnel and integrate new hotels into our operations. Any failure to effectively and efficiently manage our expansion may materially and adversely affect our ability to capitalize on new business opportunities, which in turn may have a material adverse effect on our results of operation.
Expansion into new geographic markets and addition of new hotel products for which we have limited operating experience and brand recognition may present operating and marketing challenges that are different from those that we currently encounter in existing markets for our Home Inn hotels. In addition, our expansion within existing markets may adversely affect the financial performance of our existing hotels in those markets and, as a result, negatively affect our overall results of operations. Inability to anticipate the changing demands that expanding our operations will impose on our management and information and operational systems, or failure to quickly adapt our systems and procedures to the new markets, could result in revenue decline and increased expenses and otherwise harm our results of operations and financial condition.

 

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If the value of our brand or image diminishes, it could have a material and adverse effect on our business and results of operations.
Our “Home Inn” brand is associated with a leading economy hotel chain offering cleanliness, convenience and comfort with consistent, high-quality service among value-conscious individual business and leisure travelers in China. Our continued success in maintaining and enhancing our brand and image depends, to a large extent, on our ability to satisfy customer needs by further developing and maintaining our innovative and distinctive product and maintaining consistent quality of services across our hotel chain, as well as our ability to respond to competitive pressures. If we are unable to do so, our occupancy rates may decline, which could in turn adversely affect our results of operations. Our business may also be adversely affected if our public image or reputation were to be diminished by the operations of any of our hotels, whether due to unsatisfactory service, accidents or otherwise. Our brand is integral to our sales and marketing efforts. If the value of our brand or image is diminished or if our brand does not continue to be attractive to customers, our business and results of operations may be materially and adversely affected.
If we are not able to hire, train and retain qualified managerial and other employees for our hotel operations, our brand and our business may be materially and adversely affected.
Our managerial and other employees manage our hotels and interact with our customers on a daily basis. They are critical to maintaining the quality and consistency of our services as well as our established brand and reputation. It is important for us to attract qualified managerial and other employees who have experience in lodging or other consumer-service industries and are committed to our “customer-first” approach. There may be a limited supply of such qualified individuals in some of the cities in China where we have operations and other cities into which we intend to expand. In addition, criteria such as dedication are difficult to assess during the recruitment process. We must hire and train qualified managerial and other employees on a timely basis to keep pace with our growth while maintaining consistent quality of services across our hotels in various geographic locations. We must also provide continuous training to our managerial and other employees so that they are equipped with up-to-date knowledge of various aspects of our hotel operations and can meet our demand for high-quality services. If we fail to do so, the quality of our services may decrease in one or more of the markets where we operate, which in turn may have a material and adverse effect on our brand and our business.
We may not be able to successfully identify and secure additional hotel properties.
We plan to open more hotels in targeted markets to further grow our business. We may not be successful in identifying and leasing or franchising additional hotel properties at desirable locations and on commercially reasonable terms or at all. Some cities in China have undergone economic development and expansion for several decades while others are still at an early stage of development. In more developed cities, it may be difficult to increase the number of hotels because we or our competitors already have operations in such cities. In less developed cities, demand for our hotels may not increase as rapidly as we expect. Even if we are able to successfully identify and acquire new hotel properties via lease or franchise arrangements, new hotels may not generate the returns we expect. We also may incur costs in connection with evaluating hotel properties and negotiating with property owners, including ones that we are subsequently unable to lease or franchise. If we fail to successfully identify or compete for additional hotel properties, our ability to execute our growth strategy could be impaired and our business and prospects may be materially and adversely affected.

 

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We may not be able to develop hotel properties on a timely or cost-efficient basis, which may adversely affect our growth strategy and business.
We develop almost all of our leased-and-operated hotels directly. Our involvement in the development of properties presents a number of risks, including construction delays or cost overruns, which may result in increased project costs or forgone revenue. We may be unable to recover development costs we incur for projects that are not pursued to completion. Properties that we develop could become less attractive due to market saturation or oversupply, with the result that we may not be able to recover development costs at the expected rate, or at all. If we are unable to successfully manage our hotel development to minimize these risks, our growth strategy and business prospects may be adversely affected.
If we are unable to maintain our hotels’ good condition and attractive appearance, our hotel occupancy rates may decline.
In order to maintain our hotels’ good condition and attractive appearance, our hotels require ongoing renovations and other leasehold improvements, including periodic replacement of furniture, fixtures and equipment. If we and our franchisees do not make needed leasehold investments and improvements, we could lose our market share to our competitors and our hotel occupancy rates may decline.
Our costs and expenses may remain constant or increase even if our revenues decline.
A significant portion of our operating costs, including rent, is fixed. Accordingly, a decrease in our revenues could result in a disproportionately higher decrease in our earnings because our operating costs and expenses are unlikely to decrease proportionately. For example, the period during which China’s Spring Festival holiday occurs generally accounts for a lower portion of our annual revenues than other periods, but our expenses do not vary as significantly as changes in occupancy and revenues, since we need to continue to pay rent and salary, make regular repairs, maintenance and renovations and invest in other capital improvements throughout the year to maintain the attractiveness of our hotels. Our property development and renovation costs may increase as a result of increasing costs of materials. However, we have a limited ability to pass increased costs to customers through room rate increases. Therefore, our costs and expenses may remain constant or increase even if our revenues decline.
In addition, our leased-and-operated hotels typically incur significant pre-opening costs during the conversion stage, and may incur losses during the ramp-up stage. Should there be delays in conversion process or if the ramp-up is slower than expected, our financial performance can be materially and adversely impacted.
Our effort in developing our new hotel brand, Yitel (or Heyi in Chinese), may divert management attention and resources from our existing business, and if the new product is not well received by the market, we may not be able to generate sufficient revenue to offset the costs and expenses, and our overall financial performance and condition may be adversely affected.
In December 2008, we opened an experimental leased-and-operated hotel, the H Hotel, as part of our initiative to enter into the midscale hotel market, which targets individual business and leisure customers who have a higher travel budget than our core Home Inns customers, but a lower travel budget than the customers of high star-rated hotels. In 2010, we adopted a new brand name, Yitel (Heyi in Chinese), for our midscale hotel concept. We plan to convert the existing H Hotel into a Yitel brand hotel. We are in the process of fine-tuning product designs, features, and marketing plans for the Yitel brand. In November 2010, we announced plans to expand the Yitel brand with three or four hotels in 2011 and a target of 50 Yitel hotels within the next four to five years. If the new product is not well received by the market, we may not be able to generate sufficient revenue to offset the costs and expenses, and our overall financial performance and condition may be adversely affected.

 

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Our business is sensitive to global economic conditions. A severe or prolonged downturn in the global or Chinese economy could materially and adversely affect our business and our financial condition.
The global financial markets have experienced significant disruptions since 2008. While there has been improvement in some areas, it is still unclear whether the recovery is sustainable. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies adopted by the central banks and financial authorities of the world’s leading economies, including China’s. Continued concerns about the systemic impact of potential long-term and wide-spread recession, energy costs, geopolitical tensions, the availability and cost of credit, and the global housing and mortgage markets have contributed to increased market volatility and diminished expectations for economic growth around the world. There are still great uncertainties regarding the economic conditions and the demand for travel in China. Any slowdown in the Chinese economy would likely reduce the level of business and leisure travel, which would have a negative impact on our business, results of operations and financial condition, and continued turbulence in the international markets may adversely affect our ability to access the capital markets to meet liquidity needs.
Our financial and operating performance may be adversely affected by epidemics, severe weather conditions, natural disasters and other catastrophes.
Our financial and operating performance may be adversely affected by epidemics, severe weather conditions, natural disasters and other catastrophes, particularly in locations where we operate a large number of hotels. For example, the 2008 Sichuan earthquake had a negative impact on many businesses in the region, and reduced the operational performance of our hotels in the affected region due to reduced economic and travel activity there. Losses caused by epidemics, severe weather conditions, natural disasters and other catastrophes, including H1N1 flu, SARS, avian flu, earthquakes and typhoons, are either uninsurable or too expensive to justify insuring against in China. In the event an uninsured loss or a loss in excess of insured limits occurs, we could lose all or a portion of the capital we have invested in a hotel, as well as the anticipated future revenue from the hotel. In that event, we might nevertheless remain obligated for any financial obligations related to the hotel. Similarly, war (including the potential of war), terrorist activity (including threats of terrorist activity), social unrest and heightened travel security measures instituted in response and travel-related accidents, as well as geopolitical uncertainty and international conflict, will affect travel and may in turn have a material adverse effect on our business and results of operation. In addition, we may not be adequately prepared in contingency planning or recovery capability in relation to a major incident or crisis, and as a result our operational continuity may be adversely affected and our reputation may be harmed.
The lodging industry in China is highly competitive with relatively low barriers to entry, and if we are unable to compete successfully, our financial condition and results of operations may be harmed.
The lodging industry in China is highly competitive. Competition in the industry is primarily based on room rates, quality of accommodations, brand name recognition, convenience of location, geographic coverage, service quality, range of services, and guest amenities. We compete primarily with other economy hotel chains as well as various regional and local economy hotels. We also compete with two- and three-star hotels, as we offer rooms with standards comparable to many of those hotels while maintaining competitive pricing. In addition, we may also face competition from new entrants in the economy hotel segment in China. As compared to developing four- or five-star hotels, developing economy and midscale hotels does not require significant capital commitments or human resources. This relatively low barrier to entry potentially allows new competitors to enter our markets quickly to compete with our business. Furthermore, we compete with all other hotels for guests in each market in which we operate, as our typical business and leisure traveler customers may change their travel, spending and consumption patterns and choose to stay in hotels in different segments. New and existing competitors may offer competitive rates, greater convenience, services or amenities or superior facilities, which could attract customers away from our hotels, resulting in a decrease in occupancy and average daily rates for our hotels. Any of these factors may have an adverse effect on our competitive position, results of operations and financial condition.

 

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Failure to retain our senior management could harm our business.
We place substantial reliance on the lodging and other consumer-service industry experience and the institutional knowledge of members of our senior management team. Mr. David Jian Sun, our chief executive officer, Ms. Huiping Yan, our chief financial officer, Mr. Jason Zong, our chief operating officer, and Ms. May Wu, our chief strategy officer, are particularly important to our future success due to their substantial experience in the lodging and other consumer service industries. We do not carry key person insurance on any of our senior management team. The loss of the services of one or more of these members of our senior management team due to their departure or otherwise could hinder our ability to effectively manage our business and implement our growth strategies. Finding suitable replacements for Mr. Sun, Ms. Yan, Mr. Zong and Ms. Wu could be difficult, and competition for such personnel of similar experience is intense. If we lose the services of any of them, our business may be adversely affected.
Interruption or failure of our information and operational systems could impair our ability to effectively provide our services, which could damage our reputation.
Our ability to provide consistent and high-quality services throughout our hotel chain depends on the continued operation of our proprietary information and operational systems, including our property management, central reservation, customer relationship management and management reporting systems. Any damage to, or failure of, our systems could interrupt our service. Our systems are vulnerable to damage or interruption as a result of power loss, telecommunications failures, computer viruses, fires, floods, earthquakes, interruptions in access to our toll-free numbers, hacking or other attempts to harm our systems, and similar events. Our servers, which are maintained in Shanghai, may also be vulnerable to break-ins, sabotage and vandalism. Some of our systems are not fully redundant, and our disaster recovery planning does not account for all possible scenarios. In addition, our systems and technologies may become outdated and we may not be able to replace or introduce upgraded systems as quickly as our competitors or within budgeted costs for such upgrades. If we experience frequent or persistent system failures, our quality of services and our reputation could be harmed. The steps we need to take to increase the reliability and redundancy of our systems may be costly, which could reduce our operating margin, and there can be no assurance that whatever increased reliability may be achievable in practice would justify the costs incurred.
Failure to maintain the integrity of internal or customer data could result in harm to our reputation or subject us to costs, liabilities, fines or lawsuits.
Our business involves collecting and retaining large volumes of internal and customer data, including credit card numbers and other personal information as our various information technology systems enter, process, summarize and report such data. We also maintain information about various aspects of our business operations as well as our employees. The integrity and protection of our customer, employee and company data is critical to our business. Our customers and employees expect that we will adequately protect their personal information, and the regulations applicable to security and privacy are becoming increasingly important in China. A theft, loss, fraudulent or unlawful use of customer, employee or company data could harm our reputation or result in remedial and other costs including fines and litigation liabilities.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud.
We are subject to reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, adopted rules requiring every public company to include a management report on such company’s internal control over financial reporting in its annual report, which contains management’s assessment of the effectiveness of our internal control over financial reporting. Our management has concluded that our internal control over financial reporting was effective as of December 31, 2010. See “Item 15. Controls and Procedures.” Our independent registered public accounting firm has issued an attestation report as of December 31, 2010. See “Item 15. Controls and Procedures—Attestation Report of the Registered Public Accounting Firm.” However, if we fail to maintain effective internal control over financial reporting in the future, our management and our independent registered public accounting firm may not be able to conclude that we have effective internal control over financial reporting at a reasonable assurance level. This could in turn result in the loss of investor confidence in the reliability of our financial statements and negatively impact the trading price of our ADSs. Furthermore, we have incurred and anticipate that we will continue to incur considerable costs, management time and other resources in an effort to continue to comply with Section 404 and other requirements of the Sarbanes-Oxley Act.

 

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Any failure to protect our trademarks and other intellectual property rights could have a negative impact on our business.
We believe our brand, trade names, trademarks and other intellectual property are critical to our success. “Home Inn” is a highly recognized brand in the economy hotel segment of China’s lodging industry. The success of our business depends in part upon our continued ability to use our brand, trade names and trademarks to increase brand awareness and to further develop our brand. The unauthorized reproduction of our trademarks could diminish the value of our brand and its market acceptance, competitive advantages or goodwill. In addition, our proprietary information and operational systems, which have not been patented or otherwise registered as our property, are a key component of our competitive advantage and our growth strategy.
Monitoring and preventing the unauthorized use of our intellectual property is difficult. The measures we take to protect our brand, trade names, trademarks and other intellectual property rights may not be adequate to prevent their unauthorized use by third parties. Furthermore, the application of laws governing intellectual property rights in China and abroad is evolving, and could involve substantial uncertainties to us. If we are unable to adequately protect our brand, trade names, trademarks and other intellectual property rights, we may lose these rights and our business may suffer materially.
The growth of on-line and other hotel reservation intermediaries and travel consolidators may adversely affect our margins and profitability.
Some of our hotel rooms are booked through travel intermediaries and consolidators to whom we pay agency fees for such services. If these intermediaries and consolidators become the primary channel through which our customers make their bookings, they may be able to negotiate higher agency fee rates, reduced room rates, or other significant concessions from us. We believe that the aim of such intermediaries and consolidators is to have consumers develop loyalties to their reservation systems rather than to our brand. The operations of these travel intermediaries and consolidators may adversely affect our ability to control the supply and price of our room inventory, which would in turn adversely affect our margins and profitability.
Our expansion requires capital. If we fail to generate sufficient cash flow from operations and/or obtain outside financing when required, we may not be able to fund our planned expansion.
Each of our leased-and-operated hotels required a capital expenditure of approximately US$1 million to convert the leased property into one of our operational hotels. In addition, we typically incur substantial pre-opening expenses for leased-and-operated hotels during the conversion stage and incur losses during the initial ramp-up stage. In the past, we were able to fund such capital expenditures and pre-opening and other expenses from capital markets fund raising activities and cash flow generated internally from our operations. There is no assurance that we will continue to be able to access capital markets or generate sufficient cash flow internally to fund our planned expansion.

 

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Future acquisitions may have an adverse effect on our ability to manage our business.
If we are presented with appropriate opportunities, we may acquire businesses or assets that are complementary to our business. Future acquisitions, particularly actual or potential material acquisitions, would expose us to potential risks, including risks associated with unforeseen or hidden liabilities, the diversion of management attention and resources from our existing business and the inability to generate sufficient revenues to offset the costs and expenses of acquisitions. For example, we acquired Top Star in October of 2007, and added 25 hotels with approximately 4,000 rooms in 16 cities in China. Subsequently, we committed substantial management and financial resources on the integration and improvement of the Top Star hotels’ operations. Our operational and financial performance was negatively impacted by these acquired hotels during 2008. Any difficulties encountered in the acquisition and integration process may have an adverse effect on our ability to manage our business and near term profitability.
Our limited operating history makes it difficult to evaluate our future prospects and results of operations.
We believe that our future success depends on our ability to increase revenue and profitability from our operations. We have a limited operating history, having commenced operations in 2002. Accordingly, you should consider our future prospects in light of the risks and challenges encountered by a company with a limited operating history. These risks and challenges include those associated with our ability to:
    continue our growth while maintaining our profitability;
    maintain and enhance our competitive position in the economy hotel segment of the lodging industry in China;
    offer an innovative product to attract recurring and new customers;
    implement our strategy and modify it from time to time to respond effectively to competition and changes in customer preferences and needs;
    increase awareness of our “Home Inn” brand and continue to develop customer loyalty;
    attract, train, retain and motivate qualified personnel; and
    renew leases for our leased-and-operated hotels on commercially viable terms after the initial lease terms expire.
If we are unsuccessful in addressing any of these risks or challenges, our business may be materially and adversely affected.
Seasonality of our business may cause fluctuations in our revenues, cause our ADS price to decline, and adversely affect our profitability
The lodging industry is subject to fluctuations in revenues due to seasonality. The seasonality of our business may cause fluctuations in our quarterly operating results. Generally, the first quarter, in which both the New Year and Spring Festival holidays fall, accounts for a lower percentage of our annual revenues than other quarters of the year. Therefore, you should not rely on our operating results for prior quarters as an indication of our results in any future period. As our revenues may vary from quarter to quarter, our business is difficult to predict and our quarterly results could fall below investor expectations, which could cause our ADS price to decline. Furthermore, although it typically takes our new hotels three to six months to ramp up, the ramp-up process of some of our hotels can be delayed due to seasonality, which may negatively affect our revenues and profitability.

 

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We are subject to various franchise, hotel industry, construction, hygiene, health and safety, and environmental laws and regulations that may subject us to liability.
Our business is subject to various compliance and operational requirements under PRC laws. For example, we are required to obtain the approval from, and file initial and annual reports with, the PRC Ministry of Commerce to engage in the hotel franchising business. Each of our hotels is required to obtain a special industry license and a fire control approval issued by the local public security bureau, to have hotel operations included in the business scope of its business license, to obtain hygiene permits and environmental impact assessment approvals, and to comply with license requirements, rules, laws and regulations with respect to construction permit, zoning, fire prevention, public and food safety and environmental protection. See “Regulation — Regulations on Hotel Operation.”
If we fail to comply with any applicable construction, hygiene, health and safety, and environmental laws and regulations related to our business, we may be subject to potentially significant monetary damages and fines or the suspension of our operations or development activities. Furthermore, new regulations could also require us to retrofit or modify our hotels or incur other significant expenses. It is also possible that new zoning plans or regulations applicable to a specific location may cause us to relocate our hotel(s) in that location, or require additional approvals and licenses that may not be granted to us promptly or at all, which may adversely affect our operating results. Any failure by us to control the use of, or to adequately restrict the discharge of, hazardous substances in our development activities, or to otherwise operate in compliance with environmental laws could also subject us to potentially significant monetary damages and fines or the suspension of our hotel development activities or hotel operations, which could materially adversely affect our financial condition and results of operations.
Currently we have not obtained certain required approvals, licenses and permits in the PRC for our operations. Under applicable PRC law, the aforesaid noncompliance could result in administrative fines, suspension of operations or other penalties. We cannot assure you that we will not be subject to any challenges or other actions taken against us with respect such noncompliance.
Accidents or injuries in our hotels may adversely affect our reputation and subject us to liability.
There are inherent risks of accidents or injuries occurring in hotels or in connection with our hotel construction or operations. The occurrence of one or more such accidents or injuries could adversely affect our reputation for safety among customers and potential customers, harm our brand, result in liability, and increase our costs by requiring us to take additional measures to make our safety precautions even more visible and effective. Our current property and liability insurance policies may not provide adequate coverage and we may be unable to renew our insurance policies or obtain new insurance policies without increased premiums or decreased levels of coverage.
We have limited insurance coverage.
We carry property insurance that covers the assets that we own at our hotels, but not the buildings or any other assets owned by our lessors. Although we require our lessors to purchase customary insurance policies, we cannot guarantee that they will adhere to such requirements. If we were held liable for amounts and claims exceeding the limits of our insurance coverage or outside the scope of our insurance coverage, our business, results of operations and financial condition may be materially and adversely affected. In addition, we do not have any business disruption insurance coverage for our operations to cover losses that may be caused by severe weather conditions, natural disasters or catastrophic events, such as epidemics or earthquakes. Any business disruption or natural disaster may result in our incurring substantial costs and diversion of our resources.

 

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Our leases could be terminated early, we may not be able to renew our existing leases on commercially reasonable terms and our rents could increase substantially in the future, which could materially and adversely affect our business and results of operations.
Our lease agreements with third parties for our leased-and-operated hotels typically provide, among other things, that the lease agreements could be terminated under certain legal or factual circumstances. If our leases were terminated early, we may be entitled to liquidated damages and full or partial recovery of our investments in leasehold improvements, however, our operation of such properties may be interrupted or discontinued and we may incur costs in relocating our operations to other locations. Furthermore, we may have to pay losses and damages and incur other liabilities to our guests and other vendors due to breach or default of our contractual obligations for a particular property. As a result, our business and results of operations and financial condition may be adversely affected by early termination of our lease agreements.
We plan to renew our existing leases upon expiration. However, we may be unable to retain our leases on satisfactory terms, or at all. In particular, we may experience an increase in our rent payments and cost of revenues in connection with renegotiating our leases. If we fail to retain our leases or if a significant number of our existing leases are not renewed on satisfactory terms upon expiration, our costs may increase in the future. If we cannot pass the increased costs on to our guests through room rate increases, our operating margins and earnings could decrease and our results of operations could be materially and adversely affected.
Our legal right to lease certain properties could be challenged by property owners or other third parties, which could prevent us from continuing to operate the affected hotels or increase the costs associated with operating these hotels.
Except for one hotel property, we do not hold any land-use rights with respect to the land on which our hotels are located, nor do we own any of the hotel properties we operate. Instead, our business model relies on leases with third parties who either own the properties or lease the properties from the ultimate property owner. As of December 31, 2010, title certificates for 56 of the properties operated by us had not been obtained. We cannot assure you that title to properties we currently lease or franchise will not be challenged, and such challenges, if successful, could impair the development or operations of our hotels on such properties. In addition, we are subject to the risk of potential disputes with property owners. Such disputes, whether resolved in our favor or not, may divert management attention, harm our reputation or otherwise disrupt our business.
In several instances where our immediate lessors are not the ultimate owners of hotel properties, no consent was obtained from the owners to sublease the hotel properties to us. A lessor’s failure to duly obtain the title to the property or to receive any necessary approvals from the ultimate owner or the primary lease holder, as applicable, could potentially invalidate our lease or result in the renegotiation of such lease leading to less favorable terms. Moreover, we cannot assure you that the building ownership or leasehold in connection with our franchised-and-managed hotels will not be subject to similar third-party challenges. Some of the properties we or our franchisees lease from third parties were subject to mortgages at the time the leases were signed. In such circumstances and where consent to the lease was not obtained from the mortgage holder, the lease may not be binding on the transferee of the property if the mortgage holders foreclose on the mortgage and transfer the property, which could in turn materially and adversely affect our ability to operate the hotel facility.
Our lessors’ failure to comply with lease registration and other compliance requirements under PRC law may subject these lessors or us to fines or other penalties that may negatively affect our ability to operate our hotels.
As an operator and manager of hotel properties, we, our franchisees and those from whom we lease properties, are subject to a number of land- and property-related legal requirements. For instance, under PRC law, all lease agreements are required to be registered with the local housing bureau. Our standard lease agreement generally requires the lessor to make such registrations. However, as of December 31, 2010, most lessors of our leased-and-operated hotels had not obtained registrations of their leases from the relevant authorities as required. We continue to remind these lessors to obtain registrations under our lease agreements with them. In addition, based on the specific land use right certificates and property ownership certificates currently held by some of our lessors, certain hotel properties we lease are restricted to industrial and other uses, rather than for commercial service use. The failure of our lessors to register lease agreements as required by law or to ensure that the hotel properties are operated in compliance with their designated use may subject these lessors or us to fines or other penalties which may negatively affect our ability to operate the hotels covered under those leases.

 

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Risks Related to Doing Business in China
Changes in economic and political policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.
We conduct substantially all of our business operations in China. As the travel industry is highly sensitive to business and personal discretionary spending levels, it tends to decline during general economic downturns. Accordingly, our results of operations, financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. China’s economy differs from the economies of most developed countries in many respects, including with respect to the amount and degree of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While the PRC economy has experienced significant growth in the past 20 years, growth has been uneven across different regions and among various economic sectors of China. The PRC government has implemented various measures to encourage economic development and guide the allocation of resources. While some of these measures benefit the overall PRC economy, they may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. In addition, zoning requirements and other governmental mandates with respect to urban planning may change from time to time, and certain of our hotels may be demolished or relocated, for which we may not receive appropriate compensation.
As the PRC economy is increasingly intricately linked to the global economy, it is affected in various respects by downturns and recessions of major economies around the world, such as the recent global financial crisis. Stimulus measures designed to help China weather the recent global financial crisis may contribute to higher inflation, which could adversely affect our results of operations and financial condition. For example, certain operating costs and expenses, such as employee compensation and hotel operating expenses, may increase as a result of higher inflation. Measures to control the pace of economic growth may cause a decrease in the level of economic activity in China, which in turn could adversely affect our results of operations and financial condition. The PRC economy has been transitioning from a planned economy to a more market-oriented economy. Although the PRC government has implemented measures since the late 1970s emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of improved corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the PRC government. In addition, the PRC government continues to play a significant role in regulating industry development by imposing industrial policies. The PRC government also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. We cannot assure you that future actions and policies of the PRC government will not materially affect our liquidity and access to capital and our ability to operate our business.
Uncertainties with respect to the Chinese legal system could adversely affect us.
We conduct our business primarily through our subsidiaries in China. Our operations in China are governed by PRC laws and regulations. Our subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but do not have binding legal effect. Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published court decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

 

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Governmental control of currency conversion may affect the value of your investment.
The PRC government imposes controls on the convertibility of RMB into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our revenues in RMB. Under our current structure, our income will be primarily derived from dividend payments from our PRC subsidiaries. Shortages in the availability of foreign currency may restrict the ability of our PRC subsidiaries and our affiliated entities to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency-dominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. Our PRC subsidiaries may also retain foreign currency in their respective current account bank accounts for use in payment of international current account transactions. However, for most capital account items, approval from or registration with appropriate government authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies.
If we finance our PRC subsidiaries through additional capital contributions, the amount of these capital contributions must be approved by the Ministry of Commerce in China or its local counterpart. On August 29, 2008, SAFE promulgated Memorandum 142, a notice regulating the conversion by a foreign-invested company of foreign currency into Renminbi by restricting how the converted Renminbi may be used. The notice requires that Renminbi converted from the foreign currency-denominated capital of a foreign-invested company may only be used for purposes within the business scope approved by the applicable governmental authority and may not be used for equity investments within the PRC unless specifically provided for in its business scope. In addition, SAFE strengthened its oversight of the flow and use of Renminbi funds converted from the foreign currency denominated capital of a foreign-invested company. The use of such Renminbi may not be changed without approval from SAFE, and may not be used to repay Renminbi loans if the proceeds of such loans have not yet been used for purposes within the company’s approved business scope. Violations of Memorandum 142 may result in severe penalties, including substantial fines as set forth in the Foreign Exchange Administration Regulations. We cannot assure you that we will be able to complete the necessary government registrations or obtain the necessary government approvals on a timely basis, if at all, with respect to future loans by us to our PRC subsidiaries or with respect to future capital contributions by us to our PRC subsidiaries. If we fail to complete such registrations or obtain such approvals, our ability to contribute additional capitals to fund our PRC operations may be negatively affected, which could adversely and materially affect our liquidity and our ability to fund and expand our business.
Fluctuation in the value of the Renminbi may have a material adverse effect on your investment.
The conversion of Renminbi into foreign currencies, including U.S. dollars, is based on rates set by the People’s Bank of China. The PRC government allowed the Renminbi to appreciate by more than 20% against the U.S. dollar between July 2005 and July 2008. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the Renminbi and the U.S. dollar remained within a narrow band. Since June 2010, the PRC government has allowed the Renminbi to appreciate slowly against the U.S. dollar again. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the Renminbi and the U.S. dollar in the future.
As we rely entirely on dividends paid to us by our operating subsidiaries in China, any significant depreciation of the Renminbi against the U.S. dollar may have a material adverse effect on the value of, and any dividends payable on, our ADSs and common shares. If we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or for other business purposes, depreciation of the Renminbi against the U.S. dollar would reduce the U.S. dollar amount available to us. On the other hand, to the extent that we need to convert U.S. dollars into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. As of December 31, 2010, our U.S. dollar denominated financial assets consisted of a cash balance of approximately US$211.6 million. Fluctuation in the value of the Renminbi in either direction could have a material adverse effect on the value of our company and the value of your investment.

 

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PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders to personal liability and limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us, or otherwise adversely affect us.
SAFE issued a public notice in October 2005 along with related procedural guidance in January 2007 requiring PRC residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing with assets or equity of PRC companies, referred to in the notice as an “offshore special purpose company.” Under this public notice, PRC residents who are shareholders and/or beneficial owners of such offshore special purpose companies were required to register with the local SAFE branch before March 31, 2006. We have requested our shareholders and/or beneficial owners who are subject to the registration requirements under the SAFE notice to register with the local SAFE branch. Failure of these shareholders and/or beneficial owners to register with the local SAFE branch as required by the SAFE notice or failure of future shareholders of our company who are PRC residents to comply with the registration procedures set forth in the SAFE notice may subject such shareholders and/or beneficial owners to fines and other government actions and may also limit our ability to fund our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute dividends to our company or otherwise adversely affect our business.
We may be subject to fines and legal sanctions imposed by SAFE or other Chinese government authorities if we or our Chinese employees or directors fail to comply with PRC regulations relating to employee share options or shares granted by offshore special purpose companies or offshore listed companies to Chinese citizens.
Under applicable PRC regulations, all foreign exchange matters relating to employee stock holding plans, share option plans or similar plans with PRC citizens’ participation require approval from SAFE or its authorized local branch. In addition, Chinese citizens who are granted share options or shares by an offshore listed company are required, through a Chinese agent or Chinese subsidiary of the offshore listed company, to register with SAFE and complete certain other procedures. We are an offshore listed company and as a result we and our Chinese employees who have been granted share options or shares are subject to these regulations. We are in the process of filing with SAFE and undertaking certain other procedures according to these regulations. If we or our Chinese employees fail to comply with these regulations, we or our Chinese employees may be subject to fines or other legal sanctions imposed by SAFE or other Chinese government authorities.
We rely principally on dividends and other distributions on equity paid by our subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our subsidiaries entities to make payments to us could have a material adverse effect on our ability to conduct our business.
We are a holding company and we rely principally on dividends and other distributions from our subsidiaries in China for our cash requirements, including any debt we may incur. Current PRC regulations permit our subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, each of our subsidiaries in China is required to set aside at least 10% of its accumulated after-tax profits each year, if any, to fund certain statutory reserves until the aggregate amount of such statutory reserves reach 50% of its registered capital. These reserves are not distributable as cash dividends. As of December 31, 2010, aggregate net assets of RMB 1.90 billion (US$287.2 million) were not distributable in the form of dividends to us due to these PRC regulations. Furthermore, if our subsidiaries in China incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us. In addition, the PRC tax authorities may require us to adjust our taxable income under the contractual arrangements we currently have in place in a manner that would materially and adversely affect our subsidiaries’ ability to pay dividends and other distributions to us. Any limitation on the ability of our subsidiaries to distribute dividends or other payments to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends, or otherwise fund and conduct our business.

 

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The PRC tax treatment of our holding company structure under the Enterprise Income Tax Law is subject to uncertainties, and if such uncertainties are resolved unfavorably to us, we may incur higher taxes than we anticipate, and our net income and ability to pay dividends could be hampered.
We are a holding company incorporated in the Cayman Islands, which indirectly holds, through Home Inns Hong Kong and Hong Kong Ai Home Hotel Investment Limited, our subsidiaries in the PRC. We conduct substantially all of our business operations in China. The Enterprise Income Tax Law and its implementation rules provide that China-sourced income of foreign enterprises, such as dividends paid by a PRC subsidiary to its non-PRC resident overseas parent, will normally be subject to PRC withholding tax at a rate of 10%, unless there are applicable treaties that reduce such rate. Under a special arrangement between China and Hong Kong, dividends paid to enterprises incorporated in Hong Kong are subject to a preferential withholding tax rate of 5% provided that a Hong Kong resident enterprise owns over 25% of the PRC enterprise distributing the dividend and can be considered as a “beneficial owner” of the PRC enterprise. The State Administration for Taxation promulgated Notice Regarding Interpretation and Recognition of Beneficial Owners under Tax Treaties on October 27, 2009, which provides guidance on the determination of “beneficial owners”. If our Hong Kong subsidiaries are not considered to be the “beneficial owners” of our PRC subsidiaries under this notice, any dividends paid by our PRC subsidiaries to our Hong Kong subsidiaries would be subject to withholding tax at a rate of 10%.
Our foreign ADS or ordinary share holders may be subject to PRC withholding tax on the dividends payable by us and upon gains realized on their sales of our ADSs or ordinary shares if we are classified as a PRC “resident enterprise.”
Under the Enterprise Income Tax Law and its implementation rules, any gain realized by “non-resident enterprises” is subject to 10% withholding tax to the extent such gain is sourced within the PRC and (i) such “nonresident enterprise” has no establishment or premise in the PRC, or (ii) it has an establishment or premise in the PRC, but its income sourced within the PRC has no real connection with such establishment or premise, unless otherwise exempted or reduced by tax treaties. The Enterprise Income Tax Law and its implementation rules are relatively new and ambiguities exist with respect to the interpretation of the provisions relating to identification of PRC-sourced income. If we are recognized as a PRC resident enterprise under the Enterprise Income Tax Law by the PRC tax authorities, we may be required to withhold PRC income tax on capital gains realized from sales of our ADSs or ordinary shares by and dividends distributed to our foreign ADS or ordinary share holders that are “non-resident enterprises”, as such income may be regarded as income from “sources within the PRC”. In such case, our foreign ADS or ordinary share holders that are “non-resident enterprises” may become subject to a 10% withholding income tax under the Enterprise Income Law, unless any such foreign ADS or ordinary share holders is qualified for a preferential withholding rate or tax exemption under a tax treaty or tax law.
If the PRC tax authorities recognize us as a PRC resident enterprise under the Enterprise Income Tax Law, our ADS holders who are not PRC tax residents and seek to enjoy preferential tax rates under relevant tax treaties will need to apply to the PRC tax authorities for recognition of eligibility for such benefits in accordance with Memorandum 124, issued by the PRC State Administration of Taxation on August 24, 2009. It is likely that eligibility will be based on a substantive analysis of the ADS holders’ tax residency and economic substance. With respect to dividends, the “beneficial owner” tests will also apply. If determined to be ineligible for treaty benefits, such an ADS holder would become subject to higher PRC tax rates on capital gains realized from sales of our ADSs and on dividends on our ADSs.
In such circumstances, the value of such foreign ADS holders’ investment in our ADSs may be materially and adversely affected.

 

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The M&A rule sets forth complex procedures for acquisitions conducted by foreign investors which could make it more difficult to pursue growth through acquisitions.
On August 8, 2006, six PRC regulatory agencies including the PRC Ministry of Commerce and SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rule. The M&A Rule sets forth complex procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex, including requirements in some instances that the approvals from Ministry of Commerce be obtained. We may continue to expand our business in part by acquiring complementary businesses or assets in China. Complying with the requirements of the M&A Rule to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from the Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.
Risks Related to Our ADSs
The market price for our ADSs has been and may continue to be volatile.
The market price for our ADSs has been and may continue to be volatile and subject to wide fluctuations in response to factors including the following:
    revisions to our projected financial or operational performance by ourselves or by securities research analysts;
    actual or anticipated fluctuations in our quarterly operating results;
    conditions in the travel and lodging industries;
    changes in the performance or market valuations of other lodging companies;
    announcements by us or our competitors of new products, acquisitions, strategic partnerships, expansions or capital commitments;
    addition or departure of key personnel;
    fluctuations of exchange rates between the RMB and U.S. dollar or other foreign currencies;
    potential litigation or administrative investigations; and
    general economic or political conditions in China and elsewhere.
In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our ADSs.
We may need additional capital, and the sale of additional ADSs or other equity securities could result in additional dilution to our shareholders.
We believe that our current cash and cash equivalents, anticipated cash flow from operations and the proceeds from our past capital markets fundraising activities, and from undrawn bank credit facilities available to us will be sufficient to meet our anticipated cash needs for the foreseeable future. We may, however, require additional cash resources due to changed business conditions, strategic acquisitions or other future developments, including any re-financing needs or any investments or acquisitions we may decide to pursue. If these resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all, particularly in light of the current global economic crisis.

 

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Substantial future sales of our ADSs or ordinary shares in the public market, or the perception that these sales could occur, could cause the price of our ADSs to decline.
Additional sales of our ADSs or ordinary shares in the public market, or the perception that these sales could occur, could cause the market price of our ADSs to decline. In particular, certain holders of our ordinary shares and holders of our US$184 million aggregate principal amount of 2.00% convertible senior notes due 2015, which we refer to as our convertible notes due 2015, have the right to cause us to register the sale of a certain number of our shares under the Securities Act. Registration of these shares under the Securities Act would result in these shares becoming freely tradable without restriction under the Securities Act immediately upon the effectiveness of the registration. Sales of these registered shares in the public market could cause the price of our ADSs to decline.
Our corporate actions are substantially controlled by our officers, directors and principal shareholders.
As of December 31, 2010, our directors and officers beneficially owned a total of 5,440,911 of our ordinary shares. In addition, Beijing Tourism Group, or BTG, through its affiliate, owned 13,446,959 of our ordinary shares as of December 31, 2010, and has the right to appoint, and has appointed, two directors of our company. Furthermore, Ctrip.com International, Ltd., or Ctrip, reported that it and its subsidiaries had acquired ADSs on the open market and ordinary shares from us through a private placement representing an aggregate of 14,400,765 of our ordinary shares; two of Ctrip’s co-founders and directors are also our co-founders and directors. If our officers, directors and these two principal shareholders choose to act in concert, they would beneficially own 40.7% of our ordinary shares (calculated as of December 31, 2010) and could exert substantial influence over matters requiring approval by our shareholders, including electing directors and approving mergers or other business combination transactions. The concentration of our share ownership may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs or the value of our ordinary shares. These actions may be taken even if they are opposed by our other shareholders.
You may not have the same voting rights as the holders of our ordinary shares and may not receive voting materials in time to be able to exercise your right to vote.
Except as described in this annual report and in the deposit agreement, holders of our ADSs will not be able to exercise voting rights attaching to the shares represented by our ADSs directly. Holders of our ADSs may instruct the depositary or its nominee how to exercise the voting rights attaching to the shares represented by the ADSs. However, you may not receive voting materials in time to instruct the depositary to vote, and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote.
You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.
We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act or exempt from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of our ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.

 

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You may be subject to limitations on transfer of your ADSs.
Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.
You may face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited, because we are incorporated under Cayman Islands law, we conduct substantially all of our operations in China and the majority of our officers reside outside the United States.
We are incorporated in the Cayman Islands, and conduct substantially all of our operations in China through our wholly owned subsidiaries in China. Most of our directors and officers reside outside the United States and some or all of the assets of those persons are located outside of the United States. As a result, it may be difficult to effect service of process within the United States or elsewhere outside China upon our directors and officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws.
It may also be difficult or impossible for you to bring an action against us or against our directors and officers in the Cayman Islands or in China in the event that you believe that your rights have been infringed under the securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits. Moreover, our PRC counsel has advised us that the PRC does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts.
Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law (2010 Revision) and common law of the Cayman Islands. The rights of shareholders to take legal action against our directors and us, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws as compared to the United States, and provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.
As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.

 

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Our articles of association contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our ordinary shares and ADSs.
Our articles of association contain provisions limiting the ability of others to acquire control of our company or cause us to enter into change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. For example, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our ordinary shares, in the form of ADS or otherwise. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting and other rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.
Provisions of our convertible notes due 2015 could discourage an acquisition of us by a third party.
Certain provisions of our convertible notes due 2015 could make it more difficult or more expensive for a third party to acquire us. Upon the occurrence of a fundamental change, holders of our convertible notes due 2015 will have the right, at their option, to require us to repurchase all of their notes or any portion of the principal amount of such notes in integral multiples of US$1,000. In the event of a fundamental change, we may also be required to issue additional ADSs upon conversion of our convertible notes due 2015.
The depositary of our ADSs, except in limited circumstances, has granted to us a discretionary proxy to vote the ordinary shares underlying the ADSs if ADS holders do not vote at shareholders’ meetings, which could adversely affect ADS holders’ interests.
Under the deposit agreement for the ADSs, the depositary gave us a discretionary proxy to vote the ordinary shares underlying the ADSs at shareholders’ meetings if ADS holders do not vote, unless:
    we have failed to timely provide the depositary with our notice of meeting and related materials;
    we have instructed the depositary that we do not wish a discretionary proxy to be given;
    we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting;
    a matter to be voted on at the meeting would have a material adverse impact on shareholders; or
    voting at the meeting is made on a show of hands.
The effect of this discretionary proxy is that ADS holders cannot prevent ordinary shares underlying the ADSs from being voted, absent the situations described above. Holders of our ordinary shares are not subject to this discretionary proxy.
We may be classified as a passive foreign investment company, which could result in adverse United States federal income tax consequences for U.S. Holders.
Based on the price of our ADSs and ordinary shares and the composition of our income and assets, we believe that we were not a “passive foreign investment company,” or PFIC, for United States federal income tax purposes for our taxable year ending December 31, 2010. However, the application of the PFIC rules is subject to ambiguity in several aspects and, in addition, we must make a separate determination each year as to whether we are a PFIC (after the close of each taxable year). Accordingly, we cannot assure you that we will not be a PFIC for our current taxable year ending December 31, 2011 or any future taxable year. A non-U.S. corporation will be considered a PFIC for any taxable year if either (i) at least 75% of its gross income is passive income or (ii) at least 50% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income. The value of our assets generally will be determined by reference to the market price of our ADSs and ordinary shares, which may fluctuate considerably. In addition, the composition of our income and assets will be affected by how, and how quickly, we spend the cash we raise in any offering. In the event that we become classified as a PFIC, we do not intend to prepare or provide the information that would enable U.S. Holders to make an election to treat us as a qualified electing fund. Further, if we were treated as a PFIC for any taxable year during which a U.S. Holder held an ADS or an ordinary share, certain adverse United States federal income tax consequences could apply to the U.S. Holder. For the definition of “U.S. Holder” and a more detailed discussion of United States federal income tax consequences to U.S. Holders, see “ Item 10. Additional Information—E. Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.”

 

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ITEM 4. INFORMATION ON THE COMPANY
A. History and Development of the Company
Home Inns & Hotels Management (Hong Kong) Limited, or Home Inns Hong Kong, was incorporated in Hong Kong in May 2001 by its individual founders and Ctrip, a leading China-based travel consolidator. Through a series of transactions, Ctrip disposed of all of its ownership interest in Home Inns Hong Kong in August 2003 to focus on its core business of travel consolidation and to prepare for its initial public offering, which was completed in December 2003. However, after purchasing ADSs in a series of transactions on the open market in 2008 and 2009 and purchasing ordinary shares from us in a private placement in 2009, Ctrip now holds ADSs and ordinary shares through its subsidiaries representing 17.6% of our total outstanding ordinary shares according to its most recent filing with the SEC.
In April 2002, Home Inns Hong Kong and Beijing Capital Travel International Hotel Group Co., Ltd., or Beijing Capital Travel, entered into a joint venture agreement to form Home Inns & Hotels Management (Beijing) Limited, or Home Inns Beijing, to operate branded economy hotels in China. Beijing Capital Travel is a subsidiary of BTG. Home Inns Hong Kong and BTG owned 55% and 45%, respectively, of Home Inns Beijing when it commenced operations in July 2002. Subsequently, Home Inns Hong Kong gradually increased its ownership interest in Home Inns Beijing by contributing additional funds to the registered capital of Home Inns Beijing. Home Inns Hong Kong’s ownership interest in Home Inns Beijing was increased to 95.59% as of February 2005. In July 2007, we acquired the remaining 4.41% stake in Home Inns Beijing from BTG, making Home Inns Beijing our wholly-owned subsidiary.
In May 2006, we incorporated Home Inns & Hotels Management Inc. in the Cayman Islands in preparation for our initial public offering. In June 2006, all of the then-existing shareholders of Home Inns Hong Kong exchanged their respective shares of Home Inns Hong Kong for an equivalent number of shares of Home Inns & Hotels Management Inc. of equivalent classes. As a result, Home Inns Hong Kong became our wholly owned subsidiary in June 2006.
On October 31, 2006, we completed our initial public offering, in which we issued and sold 5,874,237 ADSs, representing 11,748,474 of our ordinary shares, and certain of our then shareholders sold 3,210,763 ADSs, representing 6,421,526 of our ordinary shares, in each case at a public offering price of US$13.80 per ADS. On May 4, 2007, we completed our second public offering, in which we issued and sold 1,478,155 ADSs, representing 2,956,310 of our ordinary shares, and certain of our shareholders sold 2,021,845 ADSs, representing 4,043,690 of our ordinary shares, in each case at a public offering price of US$34.27 per ADS.
In December 2007, we issued and sold RMB 1.11 billion aggregate principal amount of US$ settled zero coupon convertible senior bonds due 2012, which we refer to as our convertible bonds due 2012, to non-US investors under Regulation S of the Securities Act.
In October 2007, we acquired the Top Star hotel chain. The holdings we acquired from Top Star currently include 25 economy hotels with about 4,000 rooms located in 16 cities across China.
In December 2010, we issued and sold US$184 million aggregate principal amount of 2.00% convertible senior notes due 2015, or our convertible notes due 2015, to qualified institutional buyers under Section 144A of the Securities Act. The bonds had an initial conversion price of 20.2560 ADSs per US$1,000 principal amount of notes (equal to approximately US$49.37 per ADS). Our outstanding convertible notes due 2015 have an aggregate principal amount of US$184 million as of the date of this annual report.

 

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Our principal executive offices are located at No. 124 Caobao Road, Xuhui District, Shanghai 200235, People’s Republic of China. Our telephone number at this address is +86 21 3401 9898. Our agent for service of process in the U.S. is CT Corporation System, 111 Eighth Avenue, New York, New York 10011.
B. Business Overview
We are a leading economy hotel chain in China, based on the number of our hotels, the number of our hotel rooms, and the geographic coverage of our hotel chain. We develop and operate economy hotels across China under our award-winning “Home Inn” brand. Since we commenced operations in 2002, we have become one of the best-known economy hotel brands in China. We offer a consistent product and high-quality services to primarily serve the fast growing population of value-conscious individual business and leisure travelers who demand clean, comfortable and convenient lodging.
We have experienced substantial growth while maintaining profitability since 2003. Our Home Inns hotels in operation grew rapidly from 10 hotels in four cities as of the end of 2003 to 818 hotels in 146 cities as of the end of 2010. Our total revenues grew from RMB 1.01 billion in 2007 to RMB 3.17 billion (US$479.9 million) in 2010, at a compound annual growth rate, or CAGR, of 46.4%. Meanwhile, our net income attributable to shareholders grew from RMB 35.8 million in 2007 to RMB 359.5 million (US$54.5 million) in 2010, at a CAGR of 115.8%.
We have achieved our growth by utilizing two business models. We either lease real estate properties on which we develop and operate hotels, or we franchise our brand to hotel owners and manage these hotel properties. We refer to the former type of hotels as “leased-and-operated hotels” and to the latter type of hotels as “franchised-and-managed hotels.” As of December 31, 2010, our Home Inns hotel chain consisted of 454 leased-and-operated hotels in operation with an additional 21 leased-and-operated hotels contracted or under construction and 364 franchised-and-managed hotels in operation and an additional 69 franchised-and-managed hotels contracted or under construction. We purchase land-use rights to obtain strategically desirable sites in a limited number of occasions.
We have received many awards and accolades for our innovative, consistent and high-quality product and services across our hotel chain. We received the “Golden Pillow Award” for best brand in economy hotels in China in 2007, 2008, and 2009 from the 21st Century Business Herald, a nationwide economic journal in China. We have been recognized with inclusion in numerous top 10 lists, most notably Hotels China Magazine’s “Hotel Corporate Top 10” and “Budget Hotel Top 10” awards for 2008 and “Hotel Management Groups Top 10” award for 2009, the China Chain Store & Franchise Association’s “China Top 10 Hotel Brands” award for 2007, 2008 and 2010 and “China’s Top 100 Chain Enterprises” award for 2008. The Corporate Research Foundation named us as one of “China’s Top Employers” for 2007 and 2009. In 2010, we also won awards for “Excellent National Brand of China Hotel Industry” from the China Hotel Association, “International Franchisor of the Year” from the Singapore Franchising & Licensing Association and “China’s Most Popular Brand in Green Economy Hotels” from the Golden Pillow Award Committee.
Our Home Inns Hotel Chain
We are dedicated to providing a consistent and high-quality product to our customers, allowing them to enjoy the comforts of home while staying at any Home Inns hotel. Our Home Inns hotel chain is a leading economy hotel chain in China offering cleanliness, convenience, comfort and value to individual business and leisure travelers. In addition, in November 2010, we launched a new hotel brand targeting the midscale market, Yitel, or Heyi in Chinese, and target to have 50 Yitel hotels within the next four to five years.
As of December 31, 2010, our Home Inns hotel chain, including one H Hotel that that we plan to convert into a Yitel hotel, consisted of 818 hotels in operation and an additional 90 hotels contracted or under construction, covering 146 cities in China.

 

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Our Home Inns hotel chain currently covers most major metropolitan areas in China. We intend to further penetrate the existing cities and metropolitan areas where we have presence and also expand into additional cities in China with a population of over 800,000, annual GDP of over RMB 30 billion (US$4.5 billion), or both. We believe cities meeting these criteria generally have the potential for sustainable economic growth and increasing demand for hotel accommodation services.
A typical Home Inns hotel has 80 to 160 guest rooms. Each hotel has a standardized design, appearance, decor, color scheme, lighting scheme and set of guest amenities in each room, including a bedding package featuring mattresses meeting the standards of four-star hotels in China, free in-room broadband Internet access, a comfortable work space, air-conditioning and a supply of cold and hot drinking water. Home Inns hotels are strategically located to provide our guests with convenient access to major business districts, ground transportation hubs, major highways, shopping centers, industrial development zones, colleges and universities, and/or large residential neighborhoods.
The following table sets forth a complete listing of all of our hotels as of December 31, 2010.
                                 
    Hotels in Operation     Hotels Contracted(1)  
    Leased-and     Franchised-     Leased-and     Franchised-  
    Operated     and-Managed     Operated     and-Managed  
    Hotels     Hotels     Hotels     Hotels  
Beijing
    24       65       1 (2)     7  
Shanghai
    30 (3)     40              
Tianjin
    15       24       2       3  
Hangzhou
    4       26             2  
Xi’an
    18       12             2  
Shenyang
    13       11             3  
Nanjing
    12       9       1       1  
Suzhou
    7       13             1  
Shijiazhuang
    6       11             3  
Jinan
    11       7              
Xiamen
    2       13             2  
Guangzhou
    13       3             1  
Taiyuan
    5       6       2 (4)     4  
Wuhan
    14       1       1        
Qingdao
    7       5       2       2  
Wuxi
    4       10             1  
Dalian
    8       5             1  
Zhengzhou
    10       4              
Changzhou
    8       3             2  
Haerbin
    11       1             1  
Chengdu
    9       3              
Changchun
    9       3              
Ningbo
    4       6             1  
Lanzhou
    9       1             1  

 

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    Hotels in Operation     Hotels Contracted(1)  
    Leased-and     Franchised-     Leased-and     Franchised-  
    Operated     and-Managed     Operated     and-Managed  
    Hotels     Hotels     Hotels     Hotels  
Shenzhen
    9       1              
Fuzhou
    4       5              
Xuzhou
    7       1             1  
Wulumuqi
    7       1             1  
Kunming
    5       3             1  
Zibo
    6       1       1        
Yantai
    3       1       2       2  
Nanchang
    5       3              
Huhehaote
    6       1             1  
Changsha
    6       2              
Chongqing
    6       1              
Hefei
    4       1       1        
Weihai
    3       3              
Guiyang
    5             1        
Nantong
    3       1             1  
Nanning
    5                    
Yinchuan
    3                   2  
Tai’an
    3       1             1  
Shantou
    4       1              
Zhuhai
    4                    
Baoding
    2                   2  
Yangzhou
    2       2              
Baotou
    2       2              
Changshu
    1       3              
Dongguan
    4                    
Kunshan
          4              
Yancheng
    1       2             1  
Linyi
    1       2             1  
Jiangyin
    1       1             1  
Jilin
    3                    
Weifang
    2                   1  
Guilin
    2                   1  
Qiqihaer
    2       1              
Wuhu
    1       2              

 

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    Hotels in Operation     Hotels Contracted(1)  
    Leased-and     Franchised-     Leased-and     Franchised-  
    Operated     and-Managed     Operated     and-Managed  
    Hotels     Hotels     Hotels     Hotels  
Tangshan
    2                   1  
Shunde
    2                   1  
Langfang
    1       2              
Haikou
    2             1        
Xining
    1       2              
Lianyungang
    1       2              
Shaoxing
    2                    
Luoyang
    2                    
Bengbu
    2                    
Foshan
    2                    
Dezhou
    2                    
Heze
    1       1              
Dongying
    2                    
Rizhao
    2                    
Dandong
          2              
Liaocheng
    2                    
Binzhou
    2                    
Yichang
    2                    
Jinhua
    2                    
Zhangjiagang
    1       1              
Zaozhuang
    1             1        
Panjin
          2              
Huaian
          2              
Taizhou
          2              
Rongcheng
    1                   1  
Anshan
          1             1  
Jining
    2                    
Kaifeng
          1             1  
Xiangfan
    1             1        
Zhucheng
    1                   1  
Qinghuangdao
                      2  
Zhangjiajie
          1              
Zhongshan
    1                    
Yueyang
    1                    

 

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    Hotels in Operation     Hotels Contracted(1)  
    Leased-and     Franchised-     Leased-and     Franchised-  
    Operated     and-Managed     Operated     and-Managed  
    Hotels     Hotels     Hotels     Hotels  
Yixing
    1                    
Jiaxing
    1                    
Yanji
    1                    
Ma’anshan
    1                    
Yingkou
    1                    
Fushun
    1                    
Tonghua
    1                    
Zhenjiang
    1                    
Shishi
    1                    
Anqing
    1                    
Cangzhou
    1                    
Wuyishan
    1                    
Deyang
    1                    
Laiyang
    1                    
Jinzhou
    1                    
Quanzhou
    1                    
Puyang
          1              
Luohe
    1                    
Taicang
    1                    
Xinxiang
    1                    
Zhaoqing
    1                    
Huludao
    1                    
Wuwei
    1                    
Wuzhong
    1                    
Jingdezhen
          1              
Keshe
          1              
Zhongwei
                      1  
Qufu
    1                    
Datong
          1              
Huangshan
          1              
Handan
          1              
Suqian
          1              
Haimen
    1                    
chaozhou
    1                    

 

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    Hotels in Operation     Hotels Contracted(1)  
    Leased-and     Franchised-     Leased-and     Franchised-  
    Operated     and-Managed     Operated     and-Managed  
    Hotels     Hotels     Hotels     Hotels  
hegang
    1                    
Changzhi
          1              
Haining
          1              
Leshan
    1                    
Zunyi
          1              
Shiyan
                      1  
Jiujiang
          1              
Wendeng
          1              
Zhanjiang
          1              
Yizheng
    1                    
Yichun
    1                    
Yiyang
    1                    
Daqing
          1              
Jieyang
    1                    
Jiaonan
    1                    
Liaoyang
    1                    
Qidong
          1              
Liyang
          1              
Laiwu
          1              
Xingtai
    1                    
Huizhou
    1                    
Chaoyang
    1                    
AnYang
                      1  
Zhangjiakou
    1                    
Rushan
                      1  
Yulin
                1        
Fuxin
                      1  
Baishan
                      1  
Chifeng
                1        
Meizhou
                1        
Beihai
                1        
 
                       
TOTAL
    454       364       21       69  
 
                       
 
     
(1)   Contracted hotels include hotels which have not commenced operations but for which we have entered into binding leases or franchise agreements with the respective lessors or franchisees.
 
(2)   Including one Yitel hotel.
 
(3)   Including the only H Hotel, which we plan to convert into a Yitel hotel.
 
(4)   Including one Yitel hotel.

 

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Leased-and-operated Hotels. For our leased-and-operated hotels, we lease properties from real estate owners or lessors. We are responsible for hotel development and customization to conform to the standards of Home Inns, as well as repairs and maintenance and operating expenses of properties over the term of the lease. We are also responsible for all aspects of hotel operations and management, including hiring, training and supervising the managers and employees required to operate our hotels as well as purchasing supplies. We typically enjoy rental holidays of three to six months and pay fixed rent on a quarterly basis for the first three or five years of the lease term, after which we may be subject to a 3% to 5% increase every three to five years. We generally have a right of first refusal to extend the lease after the initial term expires. The annual rent for each of our leased-and-operated hotels ranges from RMB 0.5 million (US$0.08 million) to RMB 12.0 million (US$1.8 million), depending on the location, size and condition of each hotel property. The terms of our leases range from 5 to 21 years, most of which are 15 years. In general, upon expiration of these leases, we may dispose of the removable facilities, equipment and appliances installed by us while leasehold improvements and fixtures may be kept by the lessor on the premises.
In the case of early termination of a lease due to the lessor’s default, we are generally entitled to take all removable items installed by us and may also be compensated for the amount we spent in connection with the leasehold improvements. In the case of early termination of a lease due to our default, we are generally entitled to take all removable items installed by us and the lessor is entitled to the leasehold improvements which result from our investments.
Franchised-and-managed Hotels. For our franchised-and-managed hotels, we franchise our “Home Inn” brand to franchisees who are property owners, lessors or existing hotel operators, and we are generally responsible for managing these hotels, typically including the hiring and appointing of the general managers of these hotels. Under a typical franchise agreement between us and a franchisee, the franchisee is generally required to pay us an initial franchise fee of RMB 0.1 million (US$0.02 million) to RMB 0.4 million (US$0.06 million), a brand royalty fee of 3% of the revenues of the hotel, an annual management fee of 1.5% of the revenues of the hotel and an annual franchise fee of 1.5% of the revenues of the hotel. The franchisee is responsible for the costs of hotel development and customization to conform to the standards of Home Inns, as well as for repairs and maintenance and operating expenses of the hotel. In general, we enter into franchise arrangements in markets where we have established leased-and-operated hotels and are able to leverage our local knowledge and experience as well as marketing and administrative resources to better assist our franchised-and-managed hotels in these localities. The typical term for our franchise agreements is eight years.
The following table sets forth the number of our hotels in operation as of December 31, 2010.
                                         
                    Number of              
            Number of     Hotels Opened     Average        
            Hotels Opened     for No More     Number of     Typical  
    Total Number     for Over Six     Than Six     Rooms per     Lease/Franchise  
    of Hotels     Months     Months     Hotel     Term  
Leased-and-operated Hotels
    454       388       66       117     15 years
Franchised-and-managed Hotels
    364       282       82       112     8 years
We also operate seven leased-and-operated hotels through six joint ventures. Home Inns Hotel Management (Shanghai) Co., Ltd. owns 51% of three joint ventures, 65% of one joint venture, 70% of one joint venture and 75% of one other joint venture.

 

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We set the room rates of our hotels based on local market conditions with reference to room rates set by our competitors. As we primarily target individual business and leisure travelers, the month that includes Chinese New Year (which can fall in late January or early February) generally accounts for a lower portion of our annual revenues than other months. The following table presents certain selected operating data as of and for the dates and periods indicated. Our results of operations have been and will continue to be significantly affected by changes in these operating measures which are widely used in the hospitality industry.
                         
    As of and for the Year Ended  
    December 31,  
    2008     2009     2010  
Operating Data
                       
Total hotels in operation(1):
                       
Leased-and-operated hotels(2)
    326       390       454  
Franchised-and-managed hotels
    145       226       364  
Total rooms(1)
    55,631       71,671       93,898  
Number of cities(1):
    94       120       146  
Occupancy rate (as a percentage)
    85.0       91.5       93.5  
Average daily rate (in RMB)
    173       160       175  
RevPAR (in RMB)
    147       146       164  
 
     
(1)   As of the end of each period.
 
(2)   Includes seven hotels operated in 2008, 2009 and 2010 through joint ventures.
Hotel Development
We follow a structured and systematic development and construction process with respect to our development of new hotel properties. Our multi-step development process starts with planning and site identification. We have staff based in our head office in Shanghai focusing on identifying potential new markets and performing a comprehensive study of each new market by conducting site visits and gathering background information such as the regional economic conditions and availability of existing hotel accommodation services in the prospective new market. After the development team at our head office decides to pursue opportunities in a new market, we assign our regional development staff and the city general manager in each region to select ideal hotel locations in the chosen market. Once a site has been selected, we negotiate with the property owner while concurrently conducting due diligence investigations with respect to a number of major legal and regulatory aspects, including the owner’s land title and relevant zoning regulations. For our leased-and-operated hotels, we lease properties from real estate owners or lessors and we convert the properties into standardized Home Inns hotels. Our lease term negotiations are guided by a comprehensive set of criteria, including certain financial return requirements. All new hotel leases are subject to the final approval of four designated members of our investment committee, including our chief executive officer, David Jian Sun. As a leading branded economy hotel chain in China, we are generally able to establish credibility with property owners and secure desirable properties on reasonable terms. We commence constructing a standardized Home Inns hotel after definitive agreements with the owner have been executed. A majority of the construction materials and supplies for the new hotel are purchased through our centralized procurement system. For our franchised-and-managed hotels, we assist franchisees in refurbishing, renovating or constructing their properties after they join our branded hotel chain, and in meeting our brand specifications by providing technical expertise and cost-savings suggestions. Before completion of construction, we carry out a series of pre-opening activities, such as identifying and appointing the general manager and other members of the hotel management team, and hiring and training hotel staff in anticipation of the hotel opening. It typically takes four to six months from execution of a lease or franchise agreement to hotel opening.
We have incurred capital expenditures primarily in connection with leasehold improvements and investments in furniture, fixtures and equipment, technology and information and operational systems. Our capital expenditures totaled RMB 996.4 million, RMB 250.4 million and RMB 546.4 million (US$82.8 million) in 2008, 2009 and 2010 respectively. We will continue to make capital expenditures to meet the expected growth of our operations. We expect to meet our capital expenditure needs in the foreseeable future with cash generated from our operating activities and financing activities. We have not had any material divestiture during the past three years.

 

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We seek to lease or franchise properties that meet the following market- and hotel-specific criteria:
General Market Criteria
Economic Growth. We focus on cities and metropolitan areas that are approaching, or have already entered into, periods of significant economic growth. Such cities and metropolitan areas generally show growth in certain business activities as measured by employment opportunities, population growth rates, tourism and convention activities, air traffic volume, local commercial real estate occupancy, and retail sales volume. Markets that exhibit growth in these metrics typically have strong demand for hotel facilities and services. Provincial capitals also have strong demand for hotel facilities and services. We have identified over 220 such cities in China, including cities with a population of over 800,000 and annual GDP of over RMB 30 billion (US$4.5 billion). We intend to continue focusing on these cities and metropolitan areas going forward.
Geographic Diversification. We seek to maintain a geographically diverse portfolio of hotels to offset the effects of regional economic cycles. We will continue to expand into new urban business centers as opportunities arise that meet our investment criteria.
Favorable Development Environment. We seek lodging markets with favorable hotel development environment, including an absence of or minimal zoning constraints, an absence of lengthy local development approval and registration processes, as well as the availability of suitable sites and construction contractors.
Specific Hotel Criteria
Location and Market Appeal. We seek to invest in hotels situated near both business and leisure centers that tend to generate a broad base of demand for hotel accommodations and facilities. These demand drivers include transportation hubs, convention centers, business parks, shopping centers and other retail areas, major highways, tourist destinations, major universities and cultural and entertainment centers. The proximity of business and leisure centers will enable us to attract both weekday business travelers and weekend leisure guests.
Size and Facilities. We seek to develop and operate economy hotels with 80 to 160 guest rooms, which include amenities that are attractive to key demand segments such as individual business and leisure travelers. We believe operating economy hotels with 80 to 160 rooms allows us to best leverage our competitive strengths and maximize our profitability.
Financial Return Requirements. We require our development team, marketing team and city general managers to assess the potential financial return of every proposed new hotel. We will only develop hotels that exhibit a potential for meeting our internal financial return objectives both in the near term and over the term of the lease agreement.

 

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Hotel Management
We believe that skilled management is a critical element in maximizing revenues and profitability of our hotel operations. A majority of our senior hotel management team has extensive experience in the hospitality and other consumer-services industries. Personnel at our corporate office perform strategic planning, finance, project development, sales and marketing, training and other functions and guide, support and monitor our on-site hotel operations and executives. Each of our departments, including hotel operations, sales and marketing, human resources, training, information technology, development, legal, and accounting and finance, is staffed by an experienced team with significant expertise in their respective area. These departments support each hotel and its management in day-to-day activities by providing operating statistics, accounting and budgeting services, sales and revenue management, marketing and promotion support, cost controls, property management tools and other resources that we develop, maintain and deliver efficiently and effectively using our centralized corporate office resources. Key elements of our centralized hotel management programs include the following:
Budgeting and Monitoring. Our corporate office personnel work with the general manager of each hotel to set a detailed annual budget for revenues and cost categories of the hotel. The annual budget is based on historical operating performance of the hotel, planned targeted marketing, planned renovations, operational efficiencies and local market conditions. Through the use of our online property management and management reporting systems, we are able to track each hotel’s daily occupancy, average daily rates, RevPAR and other operating data. As a result, we can effectively and timely monitor the actual performance of each hotel and adjust sales efforts and other resources in time to take advantage of changes in the market and to maximize our profitability.
Quality Assurance and Training. We are dedicated to providing value and consistent quality standards to our customers. We have established quality standards for all aspects of our hotel operations that cover, among other areas, housekeeping, hotel maintenance and renovation, and service offering. To ensure compliance with our quality standards, we have developed a comprehensive set of procedural manuals relating to all aspects of our hotel operations to ensure that our employees follow the same standards. We have implemented comprehensive training programs to ensure the effectiveness and uniformity of our employee training through our centralized human resources department at our corporate office as well as through our dedicated training facility, Home Inns Academy.
The compliance of our hotels with quality standards is monitored through both scheduled and unannounced visits and reviews conducted periodically at each hotel. We require most of our employees to take periodic tests in order to monitor compliance with our quality standards. In addition, our practice of tracking customer comments through guest comment cards, and the direct solicitation of guest opinions regarding specific items, allows us to improve services and amenities at each hotel across our hotel chain.
Strategic Capital Improvements. To maintain our competitiveness and enhance our hotels’ appeal to targeted market segments, we require each of our hotels to allocate a fixed percentage of its revenue for periodic renovation and replacement of furnishings and equipment to maintain the quality and standards of our facilities. We base recommendations on capital spending decisions on customer feedback, strategic needs, and our targeted financial return on a given capital investment.
Centralized Procurement. We have implemented a centralized procurement system to allow us to obtain the best pricing available for the quality of goods sourced to our hotels in order to minimize the operating expenses of our hotels. As a leading branded economy hotel chain in China with nationwide scale, we are able to exert leverage over our suppliers of commodity goods and services.
Targeted Sales. We support each hotel’s local sales efforts with corporate office sales executives who develop and implement new marketing programs, and monitor and respond to specific market needs and preferences. We use a property management system to manage each property’s use of the various distribution channels in the lodging industry. Those channels include our central reservation system and toll-free numbers, third-party travel agents and other travel intermediaries, corporate travel offices and office managers. Based on market conditions, we adjust the number of rooms allocated to each of our sales channels on a daily basis in order to optimize our profitability.

 

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Hotel Information and Operational Systems
The principal objectives of our hotel operations are to generate higher RevPAR, control costs and increase the net operating income of our hotels, while providing our customers with high-quality services and value. Our integrated proprietary information and operational systems are designed to distinguish us in the marketplace, operate efficiently and cost-effectively and accommodate future growth. Our investment in our sophisticated system infrastructure has several key benefits: better customer service, simplification of the storage and processing of large amounts of data, facilitation of the large-scale operation and automation of the administration of our business and generating financial and operational information for each hotel to assist our corporate management in adjusting business strategies on a timely basis.
Our key hotel information and operational systems include the following:
Property Management System. Our proprietary property management system is designed to help our hotels maximize profitability and compete more effectively by managing their room inventory, rates and reservations. The property management system synchronizes each hotel’s room inventory with our reservation system, giving our reservation agents the capability to sell available rooms at our hotels. The property management system also includes a revenue management feature that calculates and suggests optimum rates based on each hotel’s past performance and projected occupancy. These tools enhance our ability to effectively manage our hotel operations and maximize RevPAR.
Central Reservation System. In 2010, approximately 15.2% of our total hotel room nights were booked through our proprietary central reservation system, which primarily consists of our toll-free telephone reservation system. As of December 31, 2010, we employed 150 reservation agents to serve customers who make hotel reservations by phone. Our trained reservation agents can match each caller with a Home Inns hotel that meets the caller’s needs. Our central reservation system provides a data link to all of our hotels so that confirmations are transmitted automatically to the hotel for which the reservations are made.
Customer Relationship Management System. Our proprietary customer relationship management system tracks the consumption patterns and accumulated and redeemed points of the active members of our Home Inns membership rewards program. This information enables us to analyze customer data on a company-wide basis as well as to develop a more specific and targeted marketing strategy.
Management Reporting System. We have designed a proprietary web-based management reporting system at each of our hotels and at our corporate office to monitor the daily financial and operating performance of each of our hotels. This system allows us to track each hotel’s daily occupancy, average daily rates, RevPAR and other operating and financial data. One of our ongoing primary objectives is to maintain reliable information, management and operational systems. We have implemented performance monitoring for all key systems to enable us to respond quickly to potential problems. Our computers and servers are hosted at a facility in Shanghai. This facility provides redundant utility systems, a backup electric generator and 24-hour server support. All servers have uninterrupted power supplies and redundant file systems to maximize system and data availability. We regularly back up our data to minimize the impact of data loss due to system failure.
Sales and Marketing
Our core targeted customers consist of value-oriented individual small-and-medium-enterprise business travelers and leisure travelers seeking comfortable and convenient lodging at an affordable price. We review our hotel pricing twice a year and typically adjust room rates annually based on the local market conditions of the city and the specific location of each hotel. Our head office team and our city and hotel managers jointly develop tailored marketing plans to drive sales for each hotel and in each city. We use management and operational systems to manage each hotel’s use of the various distribution channels in the lodging industry. Those channels include our centralized reservation system and toll-free numbers, third-party travel agents and other travel intermediaries and corporate travel offices. Our access to these channels allows us to further enhance occupancy rates of our hotels on a day-to-day basis.

 

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The following table presents the approximate percentage of room nights stayed in 2010 by customer channel:
         
    Approximate Percentage of  
    Total Room Nights Stayed  
Customer Channel   in 2010  
Central reservation system bookings by members of our Home Inns membership network
    11.9  
Central reservation system bookings by non-members of our Home Inns membership network
    4.3  
Reservations not booked through our central reservation system by members of our Home Inns membership network
    42.0  
Walk-ins
    10.0  
Corporate account
    14.1  
Travel agencies and consolidators
    4.2  
Others
    13.5  
 
     
Total
    100.0  
Our centralized reservation center is located in Shanghai, China and provides services 24 hours a day, seven days a week. Customers can call our nationwide toll free number to consult with our reservation agents, receive real-time hotel information and make hotel bookings. As of December 31, 2010, we employed 150 reservation agents, all of whom participated in a formal training program before commencing work. We believe we have sufficient capacity to meet the currently anticipated increases in call volume. Nevertheless, if we exceed this capacity, we believe we can add, within a reasonable time and at a reasonable cost, additional phone lines, computer systems and reservation agents to handle increasing call volumes without the need to undertake system redesign to our existing systems.
Our corporate marketing and advertising programs are designed to enhance consumer awareness and preference for the “Home Inn” brand as offering the greatest value, convenience and comfort in the economy hotel segment of the Chinese lodging industry, and to encourage customers’ use of our centralized reservation system. Marketing and advertising efforts include outdoor advertisements, distribution of flyers and other marketing materials on our hotel properties, television, internet and radio advertising, print advertising in consumer media and promotional events, special holiday promotions and joint promotional activities.
Since 2004, we have operated a Home Inns membership reward program to attract travelers by rewarding frequent stays with points towards free hotel stays, discounts on room rates, priority in hotel reservations and other rewards. As of December 31, 2010, our membership reward program had approximately 3,750,000 active members as compared to approximately 522,000, 1,283,000 and 2,617,000 active members as of December 31, 2007, 2008 and 2009 respectively. This program allows us to build customer loyalty as well as conduct lower cost, more targeted marketing campaigns.
Employees and Training
We believe that developing and maintaining a team of capable and motivated managerial and other employees are critical to our success. Because our managerial and other employees manage our hotels and interact with our customers on a daily basis, they are critical to maintaining the quality and consistency of our services as well as our brand and reputation. We seek to hire managerial employees with background and experience in hotel and other consumer services industries with a customer-first mentality. We aim to recruit, train and retain the best talent through a multi-step recruiting and training process while offering competitive performance-linked compensation packages and career advancement opportunities.

 

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We have implemented extensive training programs and periodic tests for managerial and other hotel-based staff primarily through our training facility, “Home Inns Academy.” New general managers of our hotels and executive assistants to general managers are required to undergo a two-month training period, during which they receive training in managing all core aspects of our hotel operations, as well as our company culture and philosophy. We also require our hotel general managers and city managers to participate in annual training programs so that they can stay abreast of changes in our hotel operations and consumer preferences and demands. In addition, all employees of a new hotel are required to undergo an approximately 25-day job training prior to commencing their duties. We also have trained on-site managers in many of our hotels to provide continuous training to our hotel staff. In addition to training, we have implemented periodic tests to assess the relevant knowledge and skills of our managerial and other employees.
To ensure that all of our hotels have the best possible performance, we have established an effective and clearly defined performance evaluation system based on a comprehensive set of key performance indicators that are aligned with a corresponding compensation structure. In addition, we provide capable and experienced hotel staff with opportunities to be promoted to management positions. We believe our performance-linked compensation structure, career-oriented training and career advancement opportunities are the key drivers that motivate our employees. As a result, we have experienced a very low attrition rate among our managerial staff since our inception. We were included in the Corporate Research Foundation’s list of “China’s Top Employers” for 2007 and 2009.
Excluding employees of our franchised-and-managed hotels, we had 12,686, 15,810 and 16,313 employees as of December 31, 2008, 2009 and 2010, respectively. As of December 31, 2010, our employees consisted of 14,662 hotel-based employees, 150 reservation agents at our centralized reservation center, and 1,501 corporate staff. Approximately 25.1% of our employees are associated with labor unions. We consider our relations with our employees to be good.
Competition
The lodging industry in China is highly fragmented and competitive, and we expect competition to persist and intensify. Hotels in China may but are not required to apply for star ratings as approved by tourism bureaus of local governments or the National Tourist Administration, or the NTA, based on the star rating regulations in China. This standard defines five distinct star ratings, i.e., one-star, two-star, three-star, four-star, and five-star, including platinum five-star. In order to obtain a particular star rating, a hotel must meet certain defined standards for the availability and quality of hotel facilities and public area, availability and quality of amenities in guest rooms, food and beverage facility, scope of guest services, and scope and quality of management infrastructure, etc. We have not applied for star ratings because we do not consider obtaining a star rating as necessary and our business has not been affected as we focus on meeting individual business and leisure travelers’ basic accommodation needs with affordable pricing, a comfortable lodging experience, high-quality services and standardized hotel rooms and amenities across our hotel chain.
We compete with other hotels for guests in each of the markets in which we operate. Competition in the industry is primarily based on room rates, quality of accommodations, brand name recognition, convenience of location, geographic coverage, service quality, range of services, and guest amenities. We compete primarily with other economy hotel chains, such as Jinjiang Star, Motel 168, 7 Days Inn, Han Ting, Green Tree Inn and Super 8, as well as various regional and local economy hotel chains. We also compete with two- and three-star hotels, as we offer rooms with standards comparable to many of those hotels and many of the amenities available at those hotels while maintaining competitive pricing and high-quality services tailored to individual business and leisure travelers. In addition, we may also face competition from new players in the economy hotel segment in China. As compared to four- or five-star hotels, developing an economy hotel requires a smaller commitment of capital and human resources. This relatively low barrier of entry permits new competitors to enter our markets quickly and compete with our business. Furthermore, we may face competition from all other hotels for guests in each of our markets, as our typical business and leisure traveler customers may change their travel and spending patterns and choose to stay in hotels in different segments.

 

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Intellectual Property
Our brand, trade names, trademarks, trade secrets and other intellectual property rights distinguish and protect our technology platforms, services and products from those of our competitors, and contribute to our competitive advantage in the economy hotel segment of the lodging industry in China. To protect our brand and other intellectual property, we rely on a combination of trademark, trade secret and copyright laws as well as imposing confidentiality obligations on our employees, contractors and others. We have a total of 70 registered trademarks in China, including ““, 9 trademarks which had been applied for by Top Star and 14 trademarks relating to our Yitel brand. We are applying for registration of 44 new trademarks in China. We have registered our domain name www.homeinns.com with the Internet Corporation for Assigned Names and Numbers.
We cannot assure you that our efforts to protect our intellectual property rights will be adequate or that third parties will not infringe or misappropriate these rights. If others are able to copy and use our proprietary information and operational system and other proprietary technology platform without spending time and resources to develop their own, we may not be able to maintain our competitive position. Furthermore, the application of laws governing intellectual property rights in China is uncertain and evolving and could involve substantial risks to us. If litigation is necessary to enforce our intellectual property rights or determine the scope of the proprietary rights of others, we may have to incur substantial costs or divert other resources, which could harm our business and prospects.
Insurance
We believe that our hotels are covered by property and liability insurance policies with coverage features and insured limits that we believe are customary for similar companies in China. We carry property insurance that covers the assets that we own at our hotels, but not the buildings or any other assets owned by our lessors. Although we require our lessors to purchase customary insurance policies, we cannot guarantee that they will adhere to such requirements. If we suffer losses or are held liable for amounts and claims exceeding the limits of our insurance coverage or outside the scope of our insurance coverage, our business, results of operations and financial condition may be materially and adversely affected.
Regulation
The hotel industry in China is subject to a number of laws and regulations, including laws and regulations relating specifically to hotel operation and management and commercial franchising, as well as those relating to environmental and consumer protection. The principal regulation governing foreign ownership of hotel businesses in the PRC is the Foreign Investment Industrial Guidance Catalogue, which was most recently updated on December 1, 2007. Under the regulation, the hotel industry belongs to the category of permitted foreign investment industry and there is no restriction on foreign investment in hotel businesses in China, other than regular business license and other permits that must be possessed by every lodging business in China. There are no regulatory ceilings on room rates in China. The market-based pricing is permissible for the hotel industry and room rates may be determined at the sole discretion of hotel management. Relative to other industries in China, regulation of the hotel industry in China is still developing and evolving. As a result, most legislative action has consisted of general measures such as industry standards, rules or circulars issued by different ministries rather than detailed legislation. Many of these standards, rules and circulars date from the late 1990’s, and it is expected that they may be amended, revised or expanded in the coming years as the hotel industry in China matures. This section summarizes the principal PRC regulations currently relevant to our business and operations.

 

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Regulations on Hotel Operation
Under applicable PRC regulations, anyone who applies to operate a hotel is subject to examination and approval by the local public security authority and must obtain a special industry license. Hotel operators have certain security control obligations as well. For example, the hotel must examine the identification card of any guest to whom accommodation is provided and make an accurate registration. The hotel must also report to the local public security authority if it discovers anyone violating the law, behaving suspiciously or an offender wanted by the public security authority.
A hotel must obtain a public area hygiene license and pass a fire prevention safety inspection by the local public security fire-fighting department before opening for business and must obtain a food hygiene license to serve food. Hotels that provide entertainment facilities, such as discos or ballrooms, are required to obtain a license for entertainment business operations. Hotels are also subject to regulations concerning other standards relating to the operation of public facilities. The relevant administrative authorities may impose penalties and even shut down hotels that violate the provisions.
All hotels that have been in operation for over one year are eligible to apply for a star rating assessment under the Regulations on the Assessment of the Star Rating of Tourist Hotels. There are five ratings from one star to five stars for tourist hotels, assessed based on the level of facilities, management standards and quality of service. A star rating, once granted, is valid for five years.
Regulations on Consumer Protection
Under the Law on the Protection of the Rights and Interests of Consumers, a business operator providing a commodity or service to a consumer is subject to a number of requirements, including the following:
(1) to ensure that commodities and services meet with certain safety requirements;
(2) to disclose serious defects of a commodity or a service and adopt preventive measures against damage occurrence;
(3) to provide consumers with true information and to refrain from conducting false advertising;
(4) not to set unreasonable or unfair terms for consumers or alleviate or release itself from civil liability for harming the legal rights and interests of consumers by means of standard contracts, circulars, announcements, shop notices or other means; and
(5) not to insult or slander consumers or to search the person of, or articles carried by, a consumer or to infringe upon the personal freedom of a consumer.
Business operators may be subject to civil liabilities for failing to fulfill the obligations discussed above. These liabilities include restoring the consumer’s reputation, eliminating the adverse effects suffered by the consumer, and offering an apology and compensation for any losses incurred. The following penalties may also be imposed upon business operators for the infraction of these obligations: issuance of a warning, confiscation of any illegal income, imposition of a fine, an order to cease business operation, revocation of its business license or imposition of criminal liabilities under circumstances that are specified in laws and statutory regulations.
The Interpretation of Some Issues concerning the Application of Law for the Trial of Cases on Compensation for Personal Injury enacted by the Supreme People’s Court further increases the liabilities of a business operator engaged in the operation of hotels, restaurants, or entertainment facilities and subjects such operators to compensatory liability for failing to fulfill their statutory obligation to a reasonable extent or to guarantee the personal safety of others.

 

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Regulations on Environmental Protection
The Law on Promoting Clean Production regulates service enterprises such as restaurants, entertainment establishments and hotels and requires them to use technologies and equipment that conserve energy and water and serve other environmental protection purposes, and to reduce or stop the use of consumer goods that waste resources or pollute the environment.
Regulations on Commercial Franchising
Franchise activities are subject to the supervision and administration of the Ministry of Commerce and its regional counterparts. Under applicable PRC regulations, franchisors must satisfy certain requirements including, among other things, having mature business models and the capacity to provide operation instruction, technical support and training to franchisees. Franchisors engaged in franchising activities without satisfying the above requirements may be subject to penalties such as the forfeit of illegal income and the imposition of monetary fines between RMB 100,000 and RMB 500,000 and may be bulletined by the Ministry of Commerce or its local counterparts. Franchise contracts shall include certain required provisions, such as terms, termination rights and payments.
Franchisors are generally required to file franchise contracts with the Ministry of Commerce or its local counterparts. Failure to report franchising activities may result in penalties such as fines up to RMB 100,000. Such noncompliance may also be bulletined. In the first quarter of every year, franchisors are required to report to Ministry of Commerce or its local counterparts any franchising contracts they executed, canceled, renewed or amended in the previous year.
The term of the franchising contracts shall be no less than three years unless franchisees otherwise agree. The franchisee is entitled to terminate the franchise contract at his sole discretion after a period of time.
Franchisors are also required to provide franchisees with basic information in writing and franchise contracts 30 days prior to the execution of such contracts. Failure to disclose or misrepresentation entitles the franchisee to terminate the franchise contact and may also result in fines for the franchisor of up to RMB 100,000. In addition, such noncompliance may be bulletined.
Regulations on Trademarks
PRC trademark law and regulations give protection to the holders of registered trademarks and trade names. The Trademark Office under the State Administration for Industry and Commerce handles trademark registrations and grants a term of ten years to registered trademarks. Trademark license agreement must be filed with the Trademark Office or its regional counterpart.
Regulations on Foreign Currency Exchange
Under various rules and regulations issued by SAFE and other relevant PRC government authorities, the Renminbi is convertible for current account items, such as trade related receipts and payments, interest and dividends. Capital account items, such as direct equity investments, loans and repatriation of investment, require the prior approval from SAFE or its local counterpart for conversion of Renminbi into a foreign currency, such as U.S. dollars, and remittance of the foreign currency outside the PRC.
Payments for transactions that take place within the PRC must be made in RMB. Unless otherwise approved, PRC companies must repatriate foreign currency payments received from abroad. Foreign-invested enterprises may retain foreign exchange in accounts with designated foreign exchange banks subject to a cap set by SAFE or its local counterpart. Unless otherwise approved, domestic enterprises must convert all of their foreign currency receipts into RMB.

 

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Regulations on Dividend Distribution
Under applicable PRC regulations, wholly foreign owned enterprises and Sino-foreign equity joint ventures in the PRC may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Additionally, these foreign-invested enterprises are required to set aside certain amounts of their accumulated profits each year, if any, to fund certain reserve funds. These reserves are not distributable as cash dividends except in the event of liquidation and cannot be used for working capital purposes. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—We rely principally on dividends and other distributions on equity paid by our subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our subsidiaries entities to make payments to us could have a material adverse effect on our ability to conduct our business.”
Regulations on Employee Stock Holding Plan or Stock Option Plan
Under applicable PRC regulations, all employee stock ownership plans, stock option plans and other similar plans with onshore individual participants and involving foreign exchange matters must be approved by SAFE or its authorized branch. Under the Application Procedure of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Company promulgated by SAFE in 2007, PRC citizens who are granted stock options or restricted share units or issued restricted shares by an overseas publicly listed company are required, through a PRC agent or PRC subsidiary of such overseas publicly listed company, to complete certain procedures and transactional foreign exchange matters upon the examination by, and approval of, SAFE. We and our PRC employees who have been granted stock options or restricted share units or issued restricted shares are subject to this rule.
Regulation on Mergers and Acquisitions
In 2006, six PRC regulatory agencies jointly adopted new regulations governing mergers and acquisitions, the M&A Rule, setting forth complex procedures and requirements, including requirements in some instances that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—The M&A rule sets forth complex procedures for acquisitions conducted by foreign investors which could make it more difficult to pursue growth through acquisitions.”

 

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Regulation of Loans between a Foreign Company and its Chinese Subsidiary
A loan denominated in foreign currency made by foreign investors as shareholders in a foreign-invested enterprise is considered to be foreign debt in China and is subject to several Chinese laws and regulations. Under these rules and regulations, a shareholder loan in the form of foreign debt made to a Chinese entity does not require the prior approval of SAFE. However, such foreign debt must be registered with and recorded by SAFE or its local branch in accordance with relevant PRC laws and regulations. Each of our PRC subsidiaries can legally borrow foreign currency denominated loans up to its borrowing limit, which is defined as the difference between the amount of its “total investment” and “registered capital” as approved by the Ministry of Commerce or its local counterparts. Interest payments, if any, on the loans are subject to a 10% withholding tax unless any such foreign shareholder’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement. If the amount of foreign currency denominated loan of any of our PRC subsidiaries exceeds its borrowing limit, we are required to apply to the relevant Chinese authorities to increase the total investment amount and registered capital to allow the excess foreign debt to be registered with SAFE.
Tax
See “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Taxation.”

 

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C. Organizational Structure
The following diagram illustrates our company’s organizational structure, and the place of formation, ownership interest and affiliation of each of our subsidiaries.
(FLOW CHART)
     
*   Home Inns Hotel Management (Shanghai) Co., Ltd. owns 51% of three joint ventures, 65% of one joint venture, 70% of one joint venture and 75% of one other joint venture.

 

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D. Property, Plant and Equipment
Our headquarters are located in Shanghai, China, where we lease approximately 3,123 square meters of office space. As of December 31, 2010, we leased 454 out of our 818 hotel facilities with an aggregate size of 204,000 square meters. For detailed information about the locations of our hotels, see “Item 4. Information On the Company—B. Business Overview—Our Home Inns Hotel Chain.”
ITEM 4A. UNRESOLVED STAFF COMMENTS
None.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report on Form 20-F. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Item 3. Key Information—D. Risk Factors” or in other parts of this annual report on Form 20-F.
A. Operating Results
Key Performance Indicators
We utilize a set of non-financial and financial key performance indicators which our senior management reviews frequently. The review of these indicators facilitates timely evaluation of the performance of our business and effective communication of results and key decisions, allowing us to react promptly to changing customer demands and market conditions.
Our non-financial key performance indicators consist of the increase in the total number of hotels and hotel rooms in our Home Inns hotel chain as well as the RevPAR achieved by our hotels. The increase in the number of hotels in our hotel chain is largely affected by the demand for our hotels in various cities and our ability to successfully identify and secure new properties and develop new hotels at desirable locations. RevPAR is a commonly used operating measure in the hospitality industry and is defined as the product of average occupancy rates and average daily rates achieved. Occupancy rates of our hotels mainly depend on the locations of our hotels, the effectiveness of our sales and brand promotion efforts, our ability to maintain the consistency and quality of our facilities and service, the performance of managerial and other employees of our hotels, as well as our ability to respond to competitive pressure. We set room rates of our hotels primarily based on the location of a hotel and room rates charged by our competitors within the same locality. Changes in RevPAR primarily due to changes in average occupancy rates achieved have different implications on our total revenues and profitability than changes in RevPAR primarily due to changes in average daily rates achieved. For example, increases in occupancy at our hotels would generally lead to increases in room revenues as well as additional incremental costs, such as housekeeping services, utilities and room amenity costs. However, RevPAR increases due to higher room rates generally would not result in these additional room-related costs. As a result, RevPAR increases due to higher room rates would have a greater positive effect on our profitability.
Our financial key performance indicators consist of our revenue and cost structure, which are discussed in greater details in the following paragraphs. In addition, we use EBITDA, a non-GAAP financial measure, as a key financial performance indicator to assess our operating results before the impact of interest, income taxes, depreciation and amortization. Given the significant investments that we have made in leasehold improvements, depreciation and amortization expense comprises a significant portion of our cost structure. We believe that EBITDA is widely used by other companies in the lodging industry and may be used by investors as a measure of our financial performance.

 

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Revenues. In 2010, we generated total revenues of RMB 3.17 billion (US$479.9 million). Our revenues are significantly affected by the following operating measures, which are widely used in the hospitality industry and appear throughout this annual report:
    the total number of hotels in our hotel chain;
    the total number of hotel rooms in our hotel chain;
    occupancy rates achieved by our hotels;
    average daily rates achieved by our hotels; and
    the RevPAR achieved by our hotels, which represents the product of average daily rates and occupancy rates.
Our future revenue growth will depend significantly upon our ability to expand our hotel chain into new markets in China and maintain and further increase occupancy rates, average daily rates and RevPAR at existing hotels. As of December 31, 2010, we had entered into binding contracts with lessors of 21 properties for our leased-and-operated hotels which are currently under development. We expect to incur an additional RMB 167.3 million (US$25.3 million) in capital expenditures in connection with the completion of the leasehold improvements of these hotels. We intend to fund this planned expansion with our operating cash flow, existing cash balance and bank credit facilities.
The following table sets forth the revenues generated by our leased and-operated hotels and franchised-and-managed hotels, both in absolute amount and as a percentage of total revenues for the periods indicated.
                                                         
    For the Year Ended December 31,  
    2008     2009     2010  
    RMB     %     RMB     %     RMB     US$     %  
    (in thousands, except share, per share and per ADS data)  
Consolidated Statement of Operations Data
                                                       
Revenues:
                                                       
Leased-and-operated hotels
    1,771,762       94.7       2,453,105       94.3       2,910,458       440,978       91.9  
Franchised-and-managed hotels
    99,779       5.3       147,535       5.7       256,799       38,909       8.1  
 
                                         
Total revenues
    1,871,541       100.0       2,600,640       100.0       3,167,257       479,887       100.0  
Less: Business tax and related surcharges
    (111,870 )     (6.0 )     (158,975 )     (6.1 )     (191,232 )     (28,975 )     (6.0 )
 
                                         
Net revenues
    1,759,671       94.0       2,441,665       93.9       2,976,025       450,912       94.0  
Leased-and-operated Hotels. In 2010, we generated revenues of RMB 2.9 billion (US$441.0 million) from our leased-and-operated hotels, which accounted for 91.9% of our total revenues for the year. We expect that revenues from our leased-and-operated hotels will continue to constitute a substantial majority of our total revenues in the foreseeable future.
For our leased-and-operated hotels, we lease properties from real estate owners or lessors and we are responsible for hotel development and customization to conform them to the standards of Home Inns, as well as for repairs and maintenance and operating costs and expenses of properties over the term of the lease. We are also responsible for all aspects of hotel operations and management, including hiring, training and supervising the managers and employees required to operate our hotels and purchasing supplies. We typically pay fixed rent on a quarterly basis for the first three or five years of the lease term, after which we are generally subject to a 3% to 5% increase every three to five years.

 

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Revenues from our leased-and-operated hotels primarily consist of revenues from sales of room stays and, to a much lesser extent, revenues from sales of food and beverage at our hotels and other services. We recognize revenues from sales of room stays, food and beverage when our services are rendered.
Franchised-and-managed Hotels. In 2010, we generated revenues of RMB 256.8 million (US$38.9 million) from our franchised-and-managed hotels, which accounted for 8.1% of our total revenues for the year. We expect that revenues from our franchised-and-managed hotels will increase in the foreseeable future as we add more franchised-and-managed hotels in our hotel chain.
For our franchised-and-managed hotels, we franchise our “Home Inn” brand to franchisees who are property owners, lessors or existing hotel operators, and we are generally responsible for managing these hotels. Under a typical franchise agreement between us and a franchisee, the franchisee is generally required to pay us an initial franchise fee of RMB 3,000 per room, a brand royalty fee of 3% of the revenues of the hotel, and an annual franchise fee of 1.5% of the revenues of the hotel. The franchisee is responsible for the costs of hotel development and customization to conform to the standards of Home Inns, as well as for repairs and maintenance and operating expenses of the hotel. We assist the franchisee in property design, construction, systems installation, and hotel personnel recruiting and training before the franchised-and-managed hotel commences operations. We allow our franchisees to utilize our integrated hotel information and operational systems, such as central reservation system, and charge them an annual or variable fee for such use.
We recognize the initial franchise fee as revenue when the franchised-and-managed hotel opens for business, the fee becomes non-refundable, and we have fulfilled all our commitments and obligations. We recognize ongoing franchise and management fees as revenues when the franchised-and-managed hotel recognizes revenues from which we derive the fees. We recognize fees received from franchisees for system usage, maintenance and support as revenues when our services are rendered.
Operating Costs and Expenses. Our operating costs and expenses consist of costs for our leased-and-operated hotels, sales and marketing expenses, general and administrative expenses and other operating expenses. The following table sets forth the components of our operating costs and expenses, both in absolute amount and as a percentage of total revenues for the periods indicated.
                                                         
    For the Year Ended December 31,  
    2008     2009     2010  
    RMB     %     RMB     %     RMB     US$     %  
    (in thousands except percentages)  
Total revenues
    1,871,541       100.0       2,600,640       100.0       3,167,257       479,887       100.0  
Less: Business tax and related surcharges
    (111,870 )     (6.0 )     (158,975 )     (6.1 )     (191,232 )     (28,975 )     (6.0 )
 
                                         
Net revenues
    1,759,671       94.0       2,441,665       93.9       2,976,025       450,912       94.0  
 
                                         
Operating costs and expenses:
                                                       
Leased-and-operated hotel costs:
                                                       
Rents and utilities
    (643,694 )     (34.4 )     (797,944 )     (30.7 )     (875,510 )     (132,653 )     (27.6 )
Personnel costs
    (337,837 )     (18.1 )     (461,949 )     (17.8 )     (506,406 )     (76,728 )     (16.0 )
Depreciation and amortization
    (190,698 )     (10.2 )     (281,543 )     (10.8 )     (308,888 )     (46,801 )     (9.8 )
Consumables, food and beverage
    (143,555 )     (7.7 )     (172,467 )     (6.6 )     (173,256 )     (26,251 )     (5.5 )
Others
    (182,284 )     (9.7 )     (275,186 )     (10.6 )     (310,705 )     (47,077 )     (9.8 )
 
                                         
Total leased-and-operated hotel costs
    (1,498,068 )     (80.0 )     (1,989,089 )     (76.5 )     (2,174,765 )     (329,510 )     (68.7 )
Sales and marketing expenses
    (27,161 )     (1.5 )     (30,462 )     (1.2 )     (33,257 )     (5,039 )     (1.0 )
General and administrative expenses
    (152,648 )     (8.2 )     (180,480 )     (6.9 )     (237,610 )     (36,002 )     (7.5 )
 
                                         
Total operating costs and expenses
    (1,677,877 )     (89.7 )     (2,200,031 )     (84.6 )     (2,445,632 )     (370,551 )     (77.2 )
 
                                         

 

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Leased-and-operated Hotel Costs. Our leased-and-operated hotel costs consist of costs and expenses directly attributable to our operation of leased-and-operated hotels, primarily including rental payments and utility costs for hotel properties, compensation and benefits for our hotel-based employees, costs of hotel room consumable products, depreciation and amortization of leasehold improvements, and agency fees to travel intermediaries and consolidators. We anticipate that our leased-and-operated hotel costs will increase as we continue to open new leased-and-operated hotels and hire additional hotel-based employees.
Sales and Marketing Expenses. Our sales and marketing expenses primarily consist of advertising expenses, production costs of marketing materials, expenses associated with our membership reward program, and compensation and benefits for our sales and marketing personnel, including personnel at our centralized reservation center. We expect that our sales and marketing expenses will increase as we further expand into new geographic locations and promote our brand.
General and Administrative Expenses. Our general and administrative expenses primarily consist of compensation and benefits for our corporate office employees and other employees who are not sales and marketing or hotel-based employees, costs of third-party professional services, and rental payments relating to office and administrative functions. We expect that our general and administrative expenses will increase in the near term as we hire additional personnel and incur additional costs in connection with the expansion of our business.
Our leased-and-operated hotel costs and general and administrative expenses include share-based compensation expenses. The following table sets forth the allocation of our share-based compensation expenses both in absolute amount and as a percentage of total share-based compensation expenses, among the cost and expense items set forth below. Share-based compensation expenses are allocated among these items based on the nature of the work our employees were assigned to perform.
                                                         
    For the Year Ended December 31,  
    2008     2009     2010  
    RMB     %     RMB     %     RMB     US$     %  
    (in thousands except percentages)  
Leased-and-operated hotel costs—personnel costs
    11       0.0                                
General and administrative expenses
    24,833       100.0       32,009       100.0       53,272       8,072       100.0  
 
                                         
Total share-based compensation expenses
    24,844       100.0       32,009       100.0       53,272       8,072       100.0  
Taxation
We are incorporated in the Cayman Islands. Under Cayman Islands law, we are not subject to income or capital gains tax. In addition, dividend payments are not subject to withholding tax in the Cayman Islands.
Home Inns Hong Kong was subject to a profit tax at the rate of 17.5% on assessable profit determined under relevant Hong Kong tax regulations. To date, Home Inns Hong Kong has not been required to pay profit tax as it has had no assessable profit.
Our subsidiaries and affiliated entities in China are subject to a business tax at a rate of approximately 6% on revenues generated from providing services and related surcharges by various local tax authorities. In addition, our subsidiaries and affiliated entities in China are generally subject to the standard enterprise income tax at a rate of 25%. However, some of our subsidiaries are subject to lower enterprise income tax rates due to the preferential tax treatments granted by the local tax authorities. For example, our wholly owned subsidiary, Hemei Hotel Management Company, enjoyed a 20% enterprise income tax rate during 2009 due to its place of incorporation and operation in the Pudong New District of Shanghai. It is now subject to a tax rate of 22% in 2010, and its tax rate is expected to increase to 24% and then 25% in 2011 and 2012, respectively.

 

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Enterprises that had been granted preferential tax treatment by the relevant tax authorities before January 1, 2008, the effective date of the new law, have their tax rate gradually raised to 25% over a five-year period. Enterprises that were entitled to exemptions or reductions from the standard income tax rate for a fixed term may continue to enjoy such treatment until the fixed term expires.
The Enterprise Income Tax Law also provides that enterprises established outside of China whose “de facto management bodies” are located in China are considered “resident enterprises” and will generally be subject to the uniform 25% enterprise income tax rate on their global income.
Under the Enterprise Income Tax Law and its implementation regulations, a 10% PRC income tax is applicable to dividends payable to investors that are “non-resident enterprises,” i.e., enterprises that do not have an establishment or place of business in the PRC, to the extent such dividends have their sources within the PRC. Such dividends are also subject to the 10% tax even if the recipient has an establishment or place of business in the PRC if the relevant income is not effectively connected with the establishment or place of business. Undistributed earnings generated prior to January 1, 2008 are exempt from the 10% PRC income tax. We are a holding company incorporated in the Cayman Islands, which indirectly holds, through Home Inns Hong Kong, Hong Kong Ai Home Hotel Investment Limited and Yitel Hotel Management (Hong Kong) Limited, our equity interests in our PRC subsidiaries. Our business operations are principally conducted through PRC subsidiaries. Thus, dividends for earnings accumulated beginning on January 1, 2008 payable to us by our subsidiaries in China, will be subject to the 10% income tax if we are considered as “non-resident enterprises” under the Enterprise Income Tax Law.
Under a special arrangement between China and Hong Kong, dividends from our PRC subsidiaries paid to us through our Hong Kong subsidiary, which would otherwise be subject to a 10% withholding tax, may be subject to a 5% preferential withholding tax if our Hong Kong subsidiary can be considered as a “beneficial owner” of our PRC subsidiaries and is otherwise entitled to the benefits under the special arrangement. The State Administration for Taxation promulgated Notice Regarding Interpretation and Recognition of Beneficial Owners under Tax Treaties on October 27, 2009, which provides guidance on the determination of “beneficial owners”. If our Hong Kong subsidiaries are not considered to be the “beneficial owners” of our PRC subsidiaries under this notice, any dividends paid by our PRC subsidiaries to our Hong Kong subsidiaries would be subject to withholding tax at a rate of 10%. Moreover, under the Enterprise Income Tax Law, foreign ADS holders may be subject to a 10% withholding tax upon dividends payable by us and gains realized on the sale or other disposition of ADSs or ordinary shares, if such income is sourced from within the PRC.
Critical Accounting Policies
We prepare financial statements in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect the reported amounts of our assets and liabilities and the disclosure of our contingent assets and liabilities at the end of each fiscal period and the reported amounts of revenues and expenses during each fiscal period. We continually evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and assumptions that we believe to be reasonable, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.
The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing our financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

 

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Basis of Consolidation
Our consolidated financial statements included elsewhere in this annual report include the financial statements of Home Inns & Hotels Management Inc., its subsidiaries and variable interest entities, or VIEs. All significant transactions and balances among Home Inns & Hotels Management Inc., its subsidiaries and certain VIEs have been eliminated upon consolidation.
In accounting for VIEs and their consolidation, prior to January 1, 2010, we followed U.S. GAAP guidance called “U.S. FIN 46(R): Consolidation of Variable Interest Entities”, under which certain entities were considered VIEs because the equity at risk for the entities was not sufficient to finance their intended activities without additional financial support. We were considered the primary beneficiary of these entities because we absorbed a majority of the entities’ expected losses and received a majority of the entities’ expected residual returns. Accordingly, the financial statements of the following VIEs had been consolidated into the Company’s financial statements since their respective date of establishment/acquisition:
         
Name of VIE   Our ownership interest  
Home Inns & Hotels Management (Xiamen) Co., Ltd.
    51 %
Home Inns & Hotels Management (Fuzhou) Co., Ltd.
    51 %
Home Inns & Hotels Management (Caoxi) Co., Ltd.
    51 %
Home Inns & Hotels Management (Caobao) Co., Ltd.
    75 %
Home Inns & Hotels Management (Dongguan) Co., Ltd.
    65 %
Home Inns & Hotels Kuaijie (Fuzhou) Co., Ltd.
    70 %
As of January 1, 2010, we adopted further guidance issued in June 2009, which modified the method for determining whether entities are VIEs as well as the methods permitted for determining the primary beneficiary of VIEs. This guidance also requires ongoing reassessments of whether a company is the primary beneficiary of VIEs and enhanced disclosures related to a company’s involvement with VIEs.
In accordance with the new guidance, we are deemed to have a controlling financial interest and are the primary beneficiary of the same VIEs, as we have both the power to direct the activities of the VIEs that most significantly impact the VIEs’ economic performance and an obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIEs. As a result, we continue to consolidate the same VIEs that were consolidated prior to January 1, 2010 and adoption of the new guidance did not have any impact on our consolidated financial statements.
Goodwill
Goodwill represents the excess of the cost of an acquired entity over the appropriate share of the fair value of the identifiable assets, including separately identifiable intangible assets, and liabilities acquired. Goodwill is allocated to respective reporting units. U.S. GAAP requires that a two-step impairment test be performed annually or whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The first step of the test for impairment compares the book value of our reporting unit under which goodwill is recorded to its estimated fair value. The second step of the goodwill impairment test, which is only required when the net book value of the reporting unit exceeds the fair value, measures impairment as the difference between the implied fair value of goodwill and its book value. Goodwill is not amortized. No impairment was recognized for the years ended December 31, 2008, 2009 and 2010. As of December 31, 2010, all goodwill is allocated to the hotel operations reporting unit. We use estimates and judgments in these impairment tests, and if different estimates or judgments had been utilized, the timing or the amount of the impairment charges could have been different.

 

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Impairment of Long-lived Assets and Definite-lived Intangible Assets
We review long-lived assets and definite-lived intangible assets for impairment whenever events or changes in circumstances indicate that carrying amount of an asset may not be recoverable. We assess the recoverability of the long-lived assets and definite-lived intangible assets (other than goodwill) by comparing the carrying amount to the estimated future undiscounted cash flow associated with the related assets. If the estimated future undiscounted cash flows are less than the carrying value, an indication of impairment is present and we recognize a loss for the difference between fair value, using the expected discounted cash flows, and the carrying value of the assets. We use estimates and judgments in these impairment tests, and if different estimates or judgments had been utilized, the timing or the amount of the impairment charges could be different. The impairment recognized for the years ended December 31, 2008, 2009 and 2010 was nil, RMB 5.5 million and nil, respectively.
Accruals for Customer Reward Program
We invite our customers to participate in a customer reward program. Prior to November 14, 2004, membership was free of charge. We commenced charging a one-time membership fee after that date for new members. Members enjoy discounts on room rates, priority in hotel reservation, and accumulate membership points for their paid stays, which can be redeemed for membership upgrades, room night awards and other gifts. The estimated incremental costs to provide membership upgrades, room night awards and other gifts are accrued and recorded as a provision for customer reward program as members accumulate points and recognized as sales and marketing expense in the accompanying statement of operations. As members redeem awards or their entitlements expire, the provision is reduced correspondingly. As of December 31, 2008, 2009 and 2010, we made provisions of RMB 8.6 million, RMB 13.3 million and RMB 17.4 million (US$2.6 million), respectively, based on the estimated liabilities under the customer reward program.
Revenue Recognition
Revenue from leased-and-operated hotels represents primarily room rentals and food and beverage sales from the leased-and-operated hotels. We recognize such revenues when goods are delivered and services are provided.
Revenues from franchised-and-managed hotels are derived from franchise agreements where the franchisees are required to pay (i) an initial one-time franchise fee and (ii) on-going management and service fees based on a percentage of revenue, which historically have approximated 5% to 6% of the room revenues of the franchised hotels. The one-time franchise fee is recognized when the franchised hotel opens for business, the fee becomes non-refundable, and we have fulfilled all of our commitments and obligations, including having provided the assistance to the franchisees in property design, leasehold improvement construction project management, systems installation, personnel recruiting and training. On-going management and service fees are recognized when the underlying service revenue is recognized by the franchisees’ operations. Other revenues generated from franchise agreements include system maintenance and support fee and central reservation system usage fee, which are recognized when services are provided.
Revenues from the one-time membership fees generated from our customer reward program are recognized over the estimated average customer relationship period or deferred and recognized once the probability that the member will demand further service becomes remote. Since 2006, we have been analyzing the historic usage pattern of membership cards and noted that membership cards with no activity for more than a year are most likely to expire in the future. Therefore, we recognize revenue from one-time membership fees when membership cards expire or membership records show no activity for a year, and the membership fees for remaining valid cards are recorded as deferred revenue. For the years ended December 31, 2008, 2009 and 2010, we recognized revenue of RMB 11.0 million, RMB 14.4 million and RMB 33.8 million (US$5.1 million) from one-time membership fees, respectively.

 

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We will continue to monitor membership activity patterns. We expect to recognize one-time membership fees over the length of the average life of memberships once we have obtained sufficient historical data to estimate such length.
Share-based Compensation
We adopted accounting rule ASC 718 Effective January 1, 2006. Under the fair value recognition provisions of ASC 178, we applied the prospective transition method and measured share-based compensation at fair value on the awards’ grant date based on the estimated number of awards that are expected to vest. Under the prospective transition method, we continued to account for non-vested awards outstanding under the old method. Only awards granted (or modified, repurchased, or cancelled) after the adoption of ASC 718 were accounted for under the provisions of ASC 718.
In conjunction with the adoption of ASC 718, we are required to estimate forfeitures at the time of grant and revise in subsequent periods if actual forfeitures differ from those estimates. Compensation expense is recognized on a straight-line basis over the requisite service period of the award based on the fair value of the award on grant date. The requisite service period is the vesting period, which is generally four years.
We have granted options to our directors, officers and other employees under our option plans. Determination of the amount of share-based compensation expense to be recognized requires significant judgment, including, most importantly, the estimated fair value of our ordinary shares underlying the options as of each date of grant. Before we were listed on the Nasdaq Global Market in October 2006, we engaged an independent appraiser to assist in the determination of the fair value of our ordinary shares underlying options for most of our option grants. Since our ADSs were listed on the Nasdaq Global Market in October 2006, we have determined the estimated fair value of our ordinary shares underlying the options based on the closing trading price of our ADSs as of the option grant date.
The determination of the fair value of stock options on the date of grant using an option-pricing model is affected by assumptions regarding a number of complex and subjective variables, including our expected stock price volatility over the vesting period, risk-free interest rate, expected dividend yield, and actual and projected employee stock option exercise behaviors. Furthermore, we are required to estimate forfeitures for options granted or modified after January 1, 2006 at the time of grant and recognize stock-based compensation expense only for those awards that are expected to vest. If actual forfeitures differ from those estimates, we may need to revise those estimates used in subsequent periods.
Share-based compensation expense recognized for the years ended December 31, 2008, 2009 and 2010 amounted to RMB 24.8 million, RMB 32.0 million and RMB 53.3 million (US$8.1 million), respectively.
Taxation
Income tax expenses are recorded using the liability method. Deferred tax assets or liabilities are recognized for the estimated future tax effects attributable to temporary differences and tax loss carry forwards. Deferred tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in statements of operations in the period that includes the enactment date.
Our effective tax rate was 28% in 2010 compared with 19% in 2009. The increase in our effective tax rate was mainly due to a decrease in convertible bond buyback gains (which are not subject to income taxes) in 2010 as well as the issuance costs, fair value loss and interest expenses related to our convertible notes due 2015 (none of which are deductible for income tax purposes).
A valuation allowance is recorded to reduce the amount of deferred tax assets if it is considered more likely than not that such assets will not be realized. In doing so, management must make judgments and estimates as to whether we have future taxable income available to utilize the deferred tax assets. As of December 31, 2009 and 2010, we had deferred tax assets of RMB 148.5 million and RMB 141.5 million (US$21.4 million), respectively, and a valuation allowance of RMB 39.7 million and RMB 28.3 million (US$4.3 million), respectively.

 

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Selected Operating Data
The following table presents certain selected operating data of our company as of and for the dates and periods indicated. Our revenues have been and will continue to be significantly affected by these operating measures which are widely used in the hospitality industry.
                         
    As of and for the Year Ended  
    December 31,  
    2008     2009     2010  
 
                       
Operating Data
                       
Total hotels in operation(1):
                       
Leased-and-operated hotels(2)
    326       390       454  
Franchised-and-managed hotels
    145       226       364  
Total rooms(1)
    55,631       71,671       93,898  
Number of cities(1):
    94       120       146  
Occupancy rate (as a percentage)
    85.0       91.5       93.5  
Average daily rate (in RMB)
    173       160       175  
RevPAR (in RMB)
    147       146       164  
     
(1)   As of the end of each period.
 
(2)   Includes seven hotels operated through separate joint ventures with third parties. Home Inns Hotel Management (Shanghai) Co., Ltd. owns 51% of three joint ventures, 65% of one joint venture, 70% of one joint venture and 75% of one other joint venture.
Results of Operations
The following table sets forth a summary of our consolidated results of operations, both in absolute amount and as a percentage of total revenues for the periods indicated. This information should be read together with our consolidated financial statements and related notes included at the end of this annual report. Our limited operating history makes it difficult to predict future operating results. We believe that the period-to-period comparison of operating results should not be relied upon as being indicative of future performance.
                                                         
    For the Year Ended December 31,  
    2008     2009     2010  
    RMB     %     RMB     %     RMB     US$     %  
    (in thousands except percentages)  
Consolidated Statement of Operations Data
                                                       
Revenues:
                                                       
Leased-and-operated hotels
    1,771,762       94.7       2,453,105       94.3       2,910,458       440,978       91.9  
Franchised-and-managed hotels
    99,779       5.3       147,535       5.7       256,799       38,909       8.1  
 
                                         
Total revenues
    1,871,541       100.0       2,600,640       100.0       3,167,257       479,887       100.0  
Less: Business tax and related surcharges
    (111,870 )     (6.0 )     (158,975 )     (6.1 )     (191,232 )     (28,975 )     (6.0 )
 
                                         
Net revenues
    1,759,671       94.0       2,441,665       93.9       2,976,025       450,912       94.0  
 
                                         
Operating costs and expenses:
                                                       
Leased-and-operated hotel costs:
                                                       
Rents and utilities
    (643,694 )     (34.4 )     (797,944 )     (30.7 )     (875,510 )     (132,653 )     (27.6 )
Personnel costs
    (337,837 )     (18.1 )     (461,949 )     (17.8 )     (506,406 )     (76,728 )     (16.0 )
Depreciation and amortization
    (190,698 )     (10.2 )     (281,543 )     (10.8 )     (308,888 )     (46,801 )     (9.8 )

 

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    For the Year Ended December 31,  
    2008     2009     2010  
    RMB     %     RMB     %     RMB     US$     %  
    (in thousands except percentages)  
Consumables, food and beverage
    (143,555 )     (7.7 )     (172,467 )     (6.6 )     (173,256 )     (26,251 )     (5.5 )
Others
    (182,284 )     (9.7 )     (275,186 )     (10.6 )     (310,705 )     (47,077 )     (9.8 )
 
                                         
Total leased-and-operated hotel costs
    (1,498,068 )     (80.0 )     (1,989,089 )     (76.5 )     (2,174,765 )     (329,510 )     (68.7 )
Sales and marketing expenses
    (27,161 )     (1.5 )     (30,462 )     (1.2 )     (33,257 )     (5,039 )     (1.0 )
General and administrative expenses
    (152,648 )     (8.2 )     (180,480 )     (6.9 )     (237,610 )     (36,002 )     (7.5 )
 
                                         
Total operating costs and expenses
    (1,677,877 )     (89.7 )     (2,200,031 )     (84.6 )     (2,445,632 )     (370,551 )     (77.2 )
 
                                         
Income from operations
    81,794       4.4       241,634       9.3       530,393       80,361       16.7  
 
                                         
Interest income, net
    3,887       0.2       (4,297 )     (0.2 )     7,430       1,126       0.2  
Issuance costs for convertible notes
                            (42,559 )     (6,448 )     (1.34 )
Loss on change in fair value of convertible notes
                            (9,040 )     (1,370 )     (0.3 )
Gain on buy-back of convertible bond
    103,291       5.5       69,327       2.7       2,480       376       0.1  
Other non-operating income
    10,971       0.6       16,248       0.6       22,223       3,367       0.7  
Foreign exchange loss, net
    (65,524 )     (3.5 )     (286 )     0.0       (4,350 )     (659 )     (0.1 )
Income tax expense
    (28,107 )     (1.5 )     (62,166 )     (2.4 )     (139,969 )     (21,207 )     (4.4 )
Net Income
    106,312       6       260,460       10       366,608       55,545       11.6  
 
                                         
Noncontrolling interests
    (5,087 )     (0.3 )     (4,457 )     (0.2 )     (7,109 )     (1,077 )     (0.2 )
 
                                         
Net income attributable to shareholders
    101,225       5.4       256,003       9.8       359,499       54,468       11.4  
 
                                         
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Revenues. Our total revenues increased by 21.8% from RMB 2.60 billion in 2009 to RMB 3.17 billion (US$479.9 million) in 2010.
    Leased-and-operated Hotels. Revenues from our leased-and-operated hotels increased by 18.6% from RMB 2.45 billion in 2009 to RMB 2.91 billion (US$441.0 million ) in 2010. This increase was primarily due to an increase in the number of leased-and-operated hotels in operation from 390 hotels with 46,496 rooms as of December 31, 2009 to 454 hotels with 53,067 rooms as of December 31, 2010, as well as an increase in our average daily rate and occupancy rate.
    Franchised-and-managed Hotels. Revenues from our franchised-and-managed hotels increased by 74.1% from RMB 147.5 million in 2009 to RMB 256.8 million (US$38.9 million) in 2010. This growth was primarily due to an increase in the number of franchised-and-managed hotels in operation from 226 hotels with 25,175 rooms as of December 31, 2009 to 364 hotels with 40,831 rooms as of December 31, 2010, as well as increased management service fees due to an increase in the average daily rate and occupancy rate of our franchised-and-managed hotels.
Operating Costs and Expenses. Our total operating costs and expenses increased by 11.2% from RMB 2.20 billion in 2009 to 2.45 billion (US$370.6 million) in 2010. This increase resulted from increases in all of our operating cost and expense line items as we substantially expanded our operations in 2010.
    Leased-and-operated Hotel Costs. Our leased-and-operated hotel costs increased from RMB 1.99 billion in 2009 to RMB 2.17 billion (US$329.5 million) in 2010. This increase was primarily driven by the increased number of leased-and-operated hotels in operation from 390 hotels with 46,496 rooms as of December 31, 2009 to 454 hotels with 53,067 rooms as of December 31, 2010.

 

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    Sales and Marketing Expenses. Our sales and marketing expenses for 2010 were RMB 33.3 million (US$5.0 million), representing 1.1% of total revenue, compared with RMB 30.5 million or 1.2% of total revenue in 2009. The decrease as a percentage of revenue in 2010 was a result of our larger revenue base.
    General and Administrative Expenses. Our general and administrative expenses increased by 31.7% from RMB 180.5 million in 2009 to RMB 237.6 million (US$36.0 million) in 2010. General and administrative expenses, excluding share-based compensation (non-GAAP) and reimbursable personnel costs for franchised-and-managed hotels, were RMB 138.9 million (US$21.0 million) or 4.8% of total revenues, compared with 4.9% in 2009. The decrease in this ratio represented greater efficiency as a result of increased economies of scale and improved productivity.
Income from Operations. Our income from operations increased by 119.5% from RMB 241.6 million in 2009 to RMB 530.4 million (US$80.4 million) in 2010. The increase in our income from operations in 2010 was mainly attributable to the increase in our number of hotels in operation and total rooms, the increase in our average daily rate and occupancy rate, and lower operating costs and expenses as a percentage of our total revenues due to greater economies of scale.
Interest Income (Expense), Net. Our net interest income increased substantially from negative RMB 4.3 million in 2009 to RMB 7.4 million (US$1.1 million) in 2010, primarily because of an increase in interest income from larger amounts of cash and cash equivalents and a decrease in interest expense for the convertible bonds due 2012, offset in part by the accrual of interest beginning on December 21, 2010 on our newly issued convertible notes due 2015.
Issuance Cost for Convertible Notes. Our issuance cost for convertible notes increased from nil in 2009 to RMB 42.6 million (US$6.4 million) in 2010 because we issued our convertible notes due 2015.
Loss on Change in Fair Value of Convertible Notes. Our loss on change in fair value of convertible notes increased from nil in 2009 to RMB 9.0 million (US$1.4 million) in 2010 primarily due to fluctuation in the fair value of our convertible notes due 2015, which we issued in December 2010.
Gain on Buy-back of Convertible Bond. Our gain on buy-back of convertible bonds decreased from RMB 69.3 million in 2009 to RMB 2.5 million (US$0.4 million) in 2010 primarily because the amount of our aggregate repurchases of convertible bonds decreased from RMB 462.0 million in 2009 to RMB 202.7 million (US$30.7 million) in 2010, and the market value of our convertible bonds due 2012 continued to recover in 2010.
Foreign Exchange Loss, Net. Our net foreign exchange loss increased from RMB 0.3 million in 2009 to RMB 4.4 million (US$0.7 million) in 2010, primarily because of depreciation of the U.S. dollar against the Renminbi and larger U.S. dollar cash balances during the course of 2010.
Income Tax Expense. Our income tax expense increased by 125.2% from RMB 62.2 million in 2009 to RMB 140.0 million (US$21.2 million) in 2010, primarily because of higher current income tax expense due to improved operating results in 2010.
Net Income. We had net income of RMB 366.6 million (US$55.5 million) in 2010, an increase of 40.8% from net income of RMB 260.5 million in 2009, primarily due to the improved operating results in 2010, offset in part by the decrease of gain on buy-back of convertible bonds due 2012 and issuance costs of our convertible notes due 2015.
Noncontrolling Interests. Noncontrolling interests represent our joint venture partners’ share of the net income of the seven leased-and-operated hotels owned by the joint ventures in 2009 and 2010. Noncontrolling interests amounted to RMB 7.1 million (US$1.1 million) in 2010 compared to RMB 4.5 million in 2009.

 

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Net Income Attributable to Shareholders. As a result of the foregoing, we had net income attributable to shareholders of RMB 359.5 million (US$54.5 million) in 2010, an increase of 40.4% from net income of RMB 256.0 million in 2009.
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Revenues. Our total revenues increased by 39.0% from RMB 1.87 billion in 2008 to RMB 2.60 billion in 2009.
    Leased-and-operated Hotels. Revenues from our leased-and-operated hotels increased by 38.5% from RMB 1.77 billion in 2008 to RMB 2.45 billion in 2009. This increase was primarily due to an increase in the number of leased-and-operated hotels in operation from 326 hotels with 39,188 rooms as of December 31, 2008 to 390 hotels with 46,496 rooms as of December 31, 2009.
    Franchised-and-managed Hotels. Revenues from our franchised-and-managed hotels increased by 47.9% from RMB 99.8 million in 2008 to RMB 147.5 million in 2009. This growth was primarily due to an increase in the number of franchised-and-managed hotels in operation from 145 hotels with 16,443 rooms as of December 31, 2008 to 226 hotels with 25,175 rooms as of December 31, 2009.
Operating Costs and Expenses. Our total operating costs and expenses increased by 31.0% from RMB 1.68 billion in 2008 to 2.20 billion in 2009. This increase resulted from increases in all of our cost and expense line items as we substantially expanded our operations in 2009.
    Leased-and-operated Hotel Costs. Our leased-and-operated hotel costs increased from RMB 1.50 billion in 2008 to RMB 1.99 billion in 2009. This increase was primarily driven by the increased number of leased-and-operated hotels in operation from 326 hotels with 39,188 rooms as of December 31, 2008 to 390 hotels with 46,496 rooms as of December 31, 2009. It was offset by a decrease in pre-opening costs incurred for leased-and-operated hotels under conversion because the number of net new leased-and-operated hotel opened was down from 130 in 2008 to 64 in 2009, and fewer hotels were under conversion during 2009 compared with 2008.
    Sales and Marketing Expenses. Our sales and marketing expenses for 2009 were RMB 30.5 million, representing 1.2% of total revenue, compared with RMB 27.2 million or 1.5% of total revenue in 2008. The decrease as a percentage of revenue in 2009 was a result of our conservative marketing plan based on the economic outlook and fewer new hotel openings, and is also a result of a larger revenue base.
    General and Administrative Expenses. Our general and administrative expenses increased by 18.2% from RMB 152.6 million in 2008 to RMB 180.5 million in 2009. General and administrative expenses excluding share-based compensation (non-GAAP) were RMB 148.5 million or 5.7% of total revenues, compared with 6.8% in 2008. The improvement in the ratio of general and administrative expenses to total revenues reflects the positive operational leverage achieved during the year. In addition, reduced new hotel development activities in most part of 2009 led to a lower level of related expenses.
Income from Operations. Our income from operations increased by 195.4% from RMB 81.8 million in 2008 to RMB 241.6 million in 2009 as a cumulative result of the above factors. Our income from operations in 2009 was positively impacted by the lower pre-opening expenses for hotels under conversion as a result of a moderate expansion, higher occupancy rate which had a positive impact as majority of our hotel level costs are fixed, higher franchise revenue, which has no direct costs, and better ratios for sales and marketing expenses and general and administrative expenses.
Interest Income (Expense), Net. Our net interest income decreased substantially from RMB 3.9 million in 2008 to a negative RMB 4.3 million, primarily because cash was invested in new hotel development and used for convertible bond repurchases as well as general corporate purposes throughout the year, offset in part by reduced interest expense as a result of our buy-back of convertible bonds.
Gain on Buy-back of Convertible Bond. Our gain on buy-back of convertible bond decreased from RMB 103.3 million in 2008 to RMB 69.3 million in 2009 primarily because the market value of our convertible bonds has recovered significantly in 2009. The decrease in gain on buy-back of convertible bond was offset in part by the larger principal amount of bonds that we bought back in 2009.

 

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Foreign Exchange Loss, Net. Our net foreign exchange loss decreased from RMB 65.5 million in 2008 to RMB 0.3 million in 2009, primarily because there was no substantial change in the exchange rate between the U.S. dollar and the RMB during the course of 2009.
Income Tax Expense. Our income tax expense increased by 121.2% from RMB 28.1 million in 2008 to RMB 62.2 million in 2009, primarily because we recorded significantly less deferred income tax benefit in 2009, and to a lesser extent, higher current income tax expense due to improved operating results.
Net Income. We had net income of RMB 260.5 million in 2009, an increase of 145.0% from net income of RMB 106.3 million in 2008, primarily due to the improved operating results in 2009 and, to a lesser extent, due to a gain on buy-back of convertible bonds.
Noncontrolling Interests. Noncontrolling interests represent our joint venture partners’ share of the net income of the seven leased-and-operated hotels owned by the joint ventures in 2008 and 2009. Noncontrolling interests amounted to RMB 4.5 million in 2009 compared to RMB 5.1 million in 2008.
Net Income Attributable to Shareholders. As a result of the foregoing, we had net income attributable to shareholders of RMB 256.0 million in 2009, an increase of 152.9% from net income of RMB 101.2 million in 2008.
B. Liquidity and Capital Resources
Our principal sources of liquidity have been cash generated from operating activities, our sale of ordinary shares through private placements, borrowings from third-party lenders as well as the proceeds we received from our public offerings of ordinary shares and our offerings of convertible bonds and notes. Our cash and cash equivalents consist of cash on hand and liquid investments which are unrestricted as to withdrawal or use, and which have original maturities of three months or less that are placed with banks and other financial institutions. Our financing activities consist of issuance and sale of our shares and convertible bonds and notes to investors and related parties, borrowings from third-party lenders and our public offerings of our shares. As of the date of this annual report, we had convertible bonds with an outstanding principal amount of RMB 157.0 million (US$23.8 million), convertible notes with an outstanding principal amount of US$184.0 million, and the remaining funds available under our credit facilities in the aggregate amounted to approximately RMB 800.0 million (US$121.2 million). As of December 31, 2010, we had entered into binding contracts with lessors of 21 properties for our leased-and-operated hotels under development. We expect to incur an additional RMB 167.3 million (US$25.3 million) in capital expenditures in connection with the completion of the leasehold improvements of these hotels. We intend to fund this planned expansion with our operating cash flow, our existing cash balance and bank credit facilities.
We have been able to meet our working capital needs, and we believe that we will be able to meet our working capital needs in the foreseeable future, with our operating cash flow, existing cash balance and bank credit facilities.
The following table sets forth a summary of our cash flows for the periods indicated:
                                 
    For the Year Ended December 31,  
    2008     2009     2010  
    RMB     RMB     RMB     US$  
    (in thousands except percentages)  
Net cash provided by operating activities
    356,886       648,663       878,694       133,136  
Net cash used in investing activities
    (964,315 )     (323,501 )     (355,962 )     (53,933 )
Net cash (used)/provided by financing activities
    (281,202 )     (103,729 )     1,040,250       157,614  
Effect of foreign exchange rate changes on cash and cash equivalents
    (65,524 )     (286 )     (11,195 )     (1,697 )
Net (decrease)/increase in cash and cash equivalents
    (954,155 )     221,147       1,553,051       235,311  
Cash and cash equivalents at beginning of period
    1,562,600       608,445       829,592       125,696  
Cash and cash equivalents at end of the period
    608,445       829,592       2,382,643       361,007  

 

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Operating Activities
Net cash provided by operating activities amounted to RMB 878.7 million (US$133.1 million) in 2010, as compared to net income of RMB 366.6 million. The principal working capital items accounting for the difference between our net cash provided by operating activities and net income were an increase in salaries and welfare payable of RMB 38.2 million (US$5.8 million) mainly as a result of higher year-end bonuses payable to employees due to our improved annual performance, an increase in deferred rental of RMB 35.4 million (US$5.4 million) as a result of an increase in the number of our contracted and newly opened leased-and-operated hotels, and an increase in deferred revenue (current and non-current) of RMB 27.7 million (US$4.2 million) mainly as a result of increases in initial franchise fees received and cash received from sale of membership programs. The other principal non-cash items accounting for the difference between our net cash provided by operating activities and net income were depreciation and amortization of RMB 320.0 million (US$48.5 million) primarily relating to our leased-and-operated hotels, share-based compensation of RMB 53.3 million (US$8.1 million) primarily relating to share options we granted in years prior to 2010, and issuance costs for convertible notes of RMB 42.6 million (US$6.4 million) relating to our issuance of convertible notes in December 2010.
Net cash provided by operating activities amounted to RMB 648.7 million in 2009, as compared to net income of RMB 256.0 million. Our gain on repurchase of our convertible bonds amounted to RMB 69.3 million. Our deferred revenues (current and non-current) increased by RMB 41.7 million mainly as a result of increase in initial franchise fees received and cash received from sale of membership programs. Our salaries and welfare payables increased by RMB 34.0 million, which was in line with the increase of our personnel costs. Our other payables and accruals increased by RMB 39.8 million. The principal non-cash items accounting for such difference were (1) RMB 286.6 million in depreciation and amortization, an increase of 46% from RMB 200 million in 2008 mainly due to the substantial increase of the number of our leased-and-operated hotels in operation, and (2) RMB 32.0 million on share-based compensation.
Net cash provided by operating activities increased from RMB 214.6 million in 2007 to RMB 356.9 million in 2008. The increase resulted from our expanded operations from 266 hotels in operation with 32,726 hotel rooms as of December 31, 2007 to 471 hotels in operation with 55,631 hotel rooms as of December 31, 2008.
Investing Activities
Our cash used in investing activities is primarily related to our leasehold improvements and purchase of equipment and fixtures used in leased-and-operated hotels.
Net cash used in investing activities in 2010 amounted to RMB 356.0 million (US$53.9 million), primarily due to our leasehold improvements and purchase of equipment and fixtures used in leased-and-operated hotels.
Net cash used in investing activities increased from RMB 323.5 million in 2009 to RMB 356.0 million (US$53.9 million) in 2010, primarily because we collected cash from a short-term investment of RMB 102 million in 2009, and nil in 2010. This was offset in part by a decrease in cash payments for capital expenditures from RMB 426.6 million in 2009 to RMB 373.5 million (US$56.6 million) in 2010.

 

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Net cash used in investing activities decreased from RMB 964.3 million in 2008 to RMB 323.5 million in 2009, primarily because we used considerably less cash as capital expenditures to open new hotels, and to a lesser extent, used less cash to acquire subsidiaries.
Financing Activities
Our financing activities consist of issuance and sale of our shares and convertible bonds and notes to investors and related parties, borrowings from third-party lenders and our public offerings of our shares. We expect these facilities to be renewable under similar terms and conditions upon expiration if we are not in default under the existing terms.
Net cash provided by financing activities in 2010 amounted to RMB 1.04 billion (US$157.6 million), primarily from the proceeds from our issuance of convertible notes due 2015. Net cash used in financing activities in 2009 amounted to RMB 103.7 million and was primarily attributable to the repurchase of part of our outstanding convertible bonds, offset in part by the proceeds from our additional private placement of ordinary shares. Net cash used in financing activities in 2008 amounted to RMB 281.2 million and was primarily attributable to the repurchasing of part of our outstanding convertible bonds and the repayment of our bank debt.
Capital Expenditures
Our capital expenditures were incurred primarily in connection with leasehold improvements, investments in furniture, fixtures and equipment and technology, information and operational software. Our capital expenditures totaled RMB 996.4 million, RMB 250.4 million and RMB 546.4 million (US$82.8 million) in 2008, 2009 and 2010, respectively. We will continue to make capital expenditures to meet the expected growth of our operations and expect cash generated from our operating activities and financing activities will meet our capital expenditure needs in the foreseeable future.
C. Research and Development, Patents and Licenses, Etc.
Intellectual Property
Our brand, trade names, trademarks, trade secrets and other intellectual property rights distinguish and protect our technology platforms, services and products from those of our competitors, and contribute to our competitive advantage in the economy hotel segment of the lodging industry in China. To protect our brand and other intellectual property, we rely on a combination of trademark, trade secret and copyright laws as well as imposing confidentiality obligations on our employees, contractors and others. We have a total of 70 registered trademarks in China, including “(CHINESE CHARACTER)” nine trademarks which had been applied for by Top Star and 14 trademarks relating to our Yitel brand. We have registered our domain name www.homeinns.com with the Internet Corporation for Assigned Names and Numbers.
We cannot assure you that our efforts to protect our intellectual property rights will be adequate or that third parties will not infringe or misappropriate these rights. If others are able to copy and use our proprietary information and operational system and other proprietary information and operational system and other proprietary technology platform without spending time and resources to develop their own, we may not be able to maintain our competitive position. Furthermore, the application of laws governing intellectual property rights in China is uncertain and evolving and could involve substantial risks to us. If litigation is necessary to enforce our intellectual property rights or determine the scope of the proprietary rights of others, we may have to incur substantial costs or divert other resources, which could harm our business and prospects.

 

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D. Trend Information
Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events since January 1, 2010 that are reasonably likely to have a material adverse effect on our net revenues, income, profitability, liquidity or capital resources, or that caused the disclosed financial information to be not necessarily indicative of future operating results or financial conditions.
E. Off-balance Sheet Arrangements
Other than operating lease obligations set forth in the table below in “Item 5. Operating and Financial Review and Prospects—F. Tabular Disclosure of Contractual Obligations,” we have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
F. Tabular Disclosure of Contractual Obligations
The following table sets forth our contractual obligations as of December 31, 2010:
                                         
    Payment Due by Period  
            Less than                     More than  
    Total     1 year     1-3 years     3-5 years     5 years  
    (in RMB millions)  
Convertible bonds and notes
    1,509       25       208       1,276        
Operating lease obligations
    8,444       720       1,514       1,523       4,687  
Purchase obligations
    167       167                    
 
                             
Total
    10,120       912       1,722       2,799       4,687  
Our convertible bonds due 2012 will mature in December 2012, unless previously converted into our ordinary shares at a conversion price of US$26.545 (equal to US$53.09 per ADS), based on a fixed exchange rate of RMB 7.4 to US$1.00. According to the terms of our convertible bonds, the number of ordinary shares to be issued on conversion is fixed. A holder will receive 509.079 ordinary shares per RMB 100,000 principal amount of bonds upon conversion, subject only to contingent adjustment for dilutive events or change of control.
Our convertible notes due 2015 will mature in December 2015, unless earlier repurchased or converted.
Our operating lease obligations relate to our obligations under lease agreements with lessors of our leased-and-operated hotels. Our purchase obligations primarily consisted of our contractual commitments relating to leasehold improvements and installation of equipment for our leased-and-operated hotels.
G. Safe Harbor
This annual report on Form 20-F contains forward-looking statements that relate to future events, including our future operating results and conditions, our prospects and our future financial performance and condition, all of which are largely based on our current expectations and projections. The forward-looking statements are contained principally in the sections entitled “Item 3. Key Information—D. Risk Factors,” “Item 4. Information on the Company” and “Item 5. Operating and Financial Review and Prospects.” These statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements by terminology such as “may,” “will,” “expect,” “anticipate,” “future,” “intend,” “plan,” “believe,” “estimate,” “is/are likely to” or other and similar expressions. Forward-looking statements involve inherent risks and uncertainties.

 

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We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include:
    our anticipated growth strategies;
    our future business development, results of operations and financial condition;
    expected changes in our revenues and certain cost or expense items;
    our ability to attract customers and leverage our brand;
    trends and competition in the lodging industry; and
    our ability to develop new hotels at desirable locations in a timely and cost-effective manner.
You should read thoroughly this annual report and the documents that we refer to in this annual report with the understanding that our actual future results may be materially different from and worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements. Other sections of this annual report include additional factors which could adversely impact our business and financial performance. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. You should not rely upon forward-looking statements as predictions of future events. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. Directors and Senior Management
The following table sets forth information regarding our executive officers and directors as of December 31, 2010.
             
Name   Age   Position/Title
Yunxin Mei
    62     Co-Chairman of the Board of Directors
Neil Nanpeng Shen
    43     Co-Founder, Co-Chairman of the Board of Directors
David Jian Sun
    46     Chief Executive Officer, Director
May Wu
    43     Chief Strategy Officer
Huiping Yan
    44     Chief Financial Officer
Jason Zong
    46     Chief Operating Officer
Min Bao
    51     Independent Director
James Jianzhang Liang
    41     Co-Founder, Independent Director
Kenneth Gaw
    40     Independent Director
Terry Yongmin Hu
    41     Independent Director
Arthur M. Wang
    50     Independent Director
Yunxin Mei has served as our director since May 2004. Since 2000, Mr. Mei has been the vice chairman and president of BTG responsible for the overall operations and management as well as executing BTG’s mid- and long-term development plans. He also serves on the boards of Home Inns Hong Kong, Home Inns Beijing and Beijing Tourism Group (HK) Holdings Company Ltd. as well as on the boards of several other companies, including Poly Victory Investments Limited, Viobright International Investments Ltd. and Profit Act Investment Ltd., all of which are holding companies investing in the hotel business in China.

 

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Neil Nanpeng Shen is one of the co-founders of our company and has been our company’s director since our inception and our independent director since 2007. Mr. Shen is the founding managing partner of Sequoia Capital China and has been with Sequoia Capital China since its inception in October 2005. Mr. Shen co-founded Ctrip, a NASDAQ listed company that is the largest travel consolidator in China. Currently, Mr. Shen is a director of Ctrip, a director of E-House (China) Holdings Limited, the leading real estate service provider in China listed on the NYSE, a director of China Real Estate Information Corporation, a leading provider of real estate information, consulting and online services in China listed on NASDAQ, a director of American Dairy, Inc., an infant milk company listed on the NYSE, a director of Peak Sport Products Co., a sportswear company listed on the Hong Kong Stock Exchange, a director of China Nuokang Bio-Pharmaceutical Inc., a biopharmaceutical company listed on NASDAQ, the chairman of Mecox Lane Limited, an operator of online platform for apparel and accessories listed on NASDAQ, a director of Le Gaga Holdings Limited, a greenhouse vegetable producer listed on NASDAQ, and a director of Qihoo 360 Technology Co. Ltd., an internet company listed on NYSE. Mr. Shen is also an independent director and a member of the nominating committee of Focus Media Holding Limited, an out-of-home media and advertising network company listed on NASDAQ, and serves on the boards of a number of private companies based in China. He served as Ctrip’s chief financial officer from 2000 to October 2005 and as president from August 2003 to October 2005. Prior to founding Ctrip, Mr. Shen worked for more than eight years in the investment banking industry in New York and Hong Kong. Mr. Shen received a bachelor’s degree from Shanghai Jiao Tong University in China and a master’s degree from the School of Management at Yale University.
David Jian Sun has served as our director and chief executive officer since December 2004. Mr. Sun has over ten years of consumer industry experience. From 2003 to December 2004, Mr. Sun served as a vice president of operations for B&Q (China) Ltd., a subsidiary of Kingfisher plc, the third largest home improvement retail group in the world, overseeing the operation of 15 B&Q superstores in China. From 2000 to 2003, Mr. Sun served as a vice president of marketing for B&Q (China) Ltd., leading B&Q’s market positioning and branding efforts in China. Mr. Sun holds a bachelor’s degree from Shanghai Medical University in China.
May Wu has served as our chief strategy officer since April 2010. From July 2006 to April 2010, she served as our chief financial officer. In November 2010, she was appointed as the chief executive officer of our Yitel brand to lead its development and expansion. She served as our senior vice president of finance from March 2006 to June 2006. Prior to joining Home Inns, Ms. Wu was a first vice president at Schroder Investment Management North America Inc. from January 2005 to March 2006, and a vice president from January 2003 to December 2004. She was responsible for investment research and management for various funds, specializing in consumer and services sectors. From 1998 to 2002, Ms. Wu was an equity research analyst at J.P. Morgan Asset Management where she also served as a vice president from 2000 to 2002. She has served as an independent director and chairwoman of the audit committee of E-House (China) Holdings Limited, a leading real estate service company based in China and listed on the New York Stock Exchange, since August 2008. Ms. Wu holds a bachelor’s degree from Fudan University in China, a master’s degree from Brooklyn College at the City University of New York and an MBA degree from the J.L. Kellogg Graduate School of Management at Northwestern University.
Huiping Yan has served as our chief financial officer since April 2010. She was our senior vice president of finance and strategy from July 2009 to April 2010. Prior to joining Home Inns, Ms. Yan spent 11 years at General Electric Company (GE) in both the United States and Asia, serving in a number of key roles in corporate financial management including tax controller of GE Energy, chief financial officer and a director of GE Hydro Equipment Asia, Ltd., headquarter chief financial officer and financial planning and analysis manager of GE Energy Inspection and Repair Services, lead finance program manager of mergers, acquisitions & integrations of GE Energy Infrastructure. Ms. Yan worked at Deloitte & Touche (US) from 1992 to 1998 and advanced to the position of tax manager of international services prior to joining GE. Ms. Yan studied at Shanghai International Studies University and holds a bachelor’s degree in business administration with an accounting major from Hawaii Pacific University. Ms. Yan graduated from the GE experienced finance leadership program and is a US certified public accountant.
Jason Zong has served as our chief operating officer since January 2008. He served as our senior vice president of operations from October 2006 to December 2007. Mr. Zong has more than 10 years of consumer industry experience. From December 2004 to October 2006, Mr. Zong served as vice president of operations and east region general manager of China for B&Q (China) Ltd., a subsidiary of Kingfisher plc, the third largest home improvement retail group in the world. From June 2001 to December 2004, Mr. Zong served as vice president of operations for Lotus Supermarket Chain Store Co., Ltd. Mr. Zong holds a bachelor’s degree from Fudan University.

 

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Min Bao has served as our director since March 2006. Mr. Bao has served as the vice president of BTG since July 2008. From February 2007 to July 2008, he was the assistant general manager of BTG. From February 2006 to February 2007, Mr. Bao was the general manager of BTG-International Hotel Group Co., Ltd. From June 2002 to February 2006, he was the general manager of Beijing Chang Fu Gong Center Co., Ltd., a holding company that owns a hotel and residential and commercial properties. Prior to that, he served as the general manager of Novotel Xin Qiao Beijing Hotel. Mr. Bao currently serves on the boards of Home Inns Beijing and Home Inns Hong Kong as well as the boards of several companies, including Poly Victory Investments Limited., BTG-International Hotel Group Co., Ltd. and Henan Xing Ya Jian Guo Hotel, all of which are China-based hotel companies.
James Jianzhang Liang is one of the co-founders of our company. He has served as our director since our inception. Mr. Liang co-founded Ctrip and has been a director of Ctrip since its inception and the chairman of its board of directors since August 2003. Mr. Liang also served as Ctrip’s chief executive officer from 2000 to January 2006. Prior to founding Ctrip, Mr. Liang held a number of technical and managerial positions with Oracle Corporation from 1991 to 1999 in the United States and China, including the head of the ERP consulting division of Oracle China from 1997 to 1999. Mr. Liang received his master’s and bachelor’s degrees from Georgia Institute of Technology. He also attended an undergraduate program at Fudan University in China.
Kenneth Gaw has served as our independent director since October 2006. Since 1999, Mr. Gaw has been a managing director of Pioneer Global Group Limited, a company listed on the Hong Kong Stock Exchange that primarily focuses on real estate and hotel investments in Hong Kong, Macau, China and South East Asia. Mr. Gaw is also a co-founder of Gaw Capital Partners, a private equity fund focusing on a real estate investment and management. Mr. Gaw currently serves on the boards of several companies, including Gaw Capital Partners, Hong Kong Thailand Business Council, a non-profit organization, and Dusit Thani Public Company Limited, a company that owns and operates hotels in Thailand. Mr. Gaw received a bachelor’s degree in applied mathematics and economics from Brown University in the United States.
Terry Yongmin Hu has served as our independent director since October 2006. Mr. Hu is a partner at FountainVest Partners (Asia) Limited, a China-focused private equity firm, and currently serves on the boards of Central China Real Estate Company Limited, an investment company focusing on property development, property leasing and construction, and L.K. Technology Holdings Limited, a manufacturer and designer of machinery, both of which are listed on the Hong Kong Stock Exchange. From May 2005 to October 2007, Mr. Hu served as a managing director of Temasek Holdings (HK) Limited, an investment company that focuses on private equity investments in China. Prior to joining Temasek Holdings in May 2005, Mr. Hu was a director at Credit Suisse (HK) Limited where he was responsible for its technology, media and telecommunications investment banking efforts in China. Before joining Credit Suisse in August 2004, Mr. Hu worked for a number of years at Bear Stearns Asia Limited where he last served as a vice president of investment banking and the chief representative of its Shanghai office. Mr. Hu received a bachelor’s degree in English language and literature from Fudan University in China.
Arthur M. Wang has served as our independent director and member of the audit committee of the board of directors since September 2009. Mr. Wang is the chief executive officer and a director of Gigamedia Limited (NASDAQ: GIGM). He is also a member of the board of Linmark Group, a Hong Kong Stock Exchange listed global sourcing firm, where he serves as chair of the compensation committee. Previously, Mr. Wang was a managing partner of 698 Capital Limited, an Asian investment firm, as well as an executive director of KGI Asia Limited (“KGI”). At KGI, Mr. Wang served as head of corporate finance. He has also served as an investment advisor and board member of UFJ Asia Finance Technology Fund of the UFJ Group (formerly the Sanwa Bank Group of Japan), and as a board member and director of Softbank Investment International (Strategic) Limited, the Hong Kong Stock Exchange listed arm of Softbank Corporation. Mr. Wang received his Bachelor of Arts degree from the University of California, Los Angeles and his juris doctorate degree from Yale Law School. He previously practiced corporate and securities law in the New York and Hong Kong offices of Skadden, Arps, Slate, Meagher & Flom LLP.

 

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Employment Agreements
We have entered into an employment agreement with each of our senior executive officers. We may terminate a senior executive officer’s employment for cause, at any time, without notice or remuneration, for certain acts of the officer, including, but not limited to, a conviction or plea of guilty to a felony, willful misconduct to our detriment or a failure to perform agreed duties. A senior executive officer may terminate his or her employment at any time without penalty if there is a material reduction in his or her authority, duties and responsibilities or if there is a material breach by us, provided that we are allowed to correct or cure within 30 days upon receipt of his or her written notice of intent to terminate on such basis. Furthermore, either we or an executive officer may terminate employment at any time without cause upon advance written notice to the other party. Each senior executive officer is entitled to certain benefits upon termination, including a severance pay equal to three months’ salary, if he or she resigns for certain specified good reasons or if we terminate his or her employment due to his or her incapacitation. We will indemnify an executive officer for his losses based on or related to his or her acts and decisions made in the course of his or her performance of duties within the scope of his or her employment.
Each senior executive officer has agreed to hold in strict confidence any trade secrets or technical secrets of our company. Each officer also agrees to comply with all material applicable laws and regulations related to his or her responsibilities at our company as well as all material written corporate and business policies and procedures of our company.
B. Compensation of Directors and Executive Officers
For the fiscal year ended December 31, 2010, we paid an aggregate of approximately RMB 7.0 million (US$1.1 million) in cash to our senior executive officers, and we did not pay any cash compensation to our non-executive directors.
Share Incentives
2003 Plan. In 2003, we adopted our Employee’s Stock Option Plan, or the 2003 Plan, to attract and retain the best available personnel, provide additional incentives to employees, directors and consultants, and promote the success of our business. Our board of directors authorized the issuance of up to 4,784,226 ordinary shares upon exercise of awards granted under our 2003 Plan. We no longer grant options or other awards under the 2003 Plan as we now grant options and other awards under our 2006 Share Incentive Plan, or the 2006 Plan.
Plan Administration. Our board of directors, or a committee designated by our board or directors, administers the 2003 Plan. The committee or the full board of directors, as appropriate, determines the provisions and terms and conditions of each option grant.
Stock Option and Stock Purchase Right Agreements. Options and stock purchase rights granted under our 2003 Plan are evidenced by a stock option agreement or a stock purchase right agreement, as applicable, that sets forth the terms, conditions and limitations for each grant. In addition, the stock option agreement and the stock purchase right agreement also provide that securities granted are subject to a 180-day lock-up period following the effective date of a registration statement filed by us under the Security Act, if so requested by us or any representative of the underwriters in connection with any registration of the offering of any of our securities.

 

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Eligibility. Employees, directors and consultants of our company or any of our related entities, which include our subsidiaries or any entities in which we hold a substantial ownership interest, are eligible for awards under the 2003 Plan.
Acceleration of Options upon Corporate Transactions. The outstanding options will terminate and accelerate upon occurrence of a change-of-control corporate transaction where the successor entity does not assume our outstanding options under the 2003 Plan. In such event, each outstanding option will become fully vested and immediately exercisable, and the transfer restrictions on the awards will be released and the repurchase or forfeiture rights will terminate immediately before the date of the change-of-control transaction provided that the grantee’s continuous service with us shall not be terminated before that date.
Term of the Options. The term of each option grant are stated in the applicable stock option agreement, provided that the term may not exceed 10 years from the date of the grant.
Vesting Schedule. In general, the plan administrator determines, or the stock option agreement specifies, the vesting schedule.
Transfer Restrictions. Options to purchase our ordinary shares may not be transferred in any manner by the optionee other than by will or the laws of succession and may be exercised during the lifetime of the optionee only by the optionee.
Termination of the 2003 Plan. Unless terminated earlier, the 2003 Plan will terminate automatically in 2013. Our board of directors has the authority to amend or terminate the 2003 Plan subject to shareholder approval to the extent necessary to comply with applicable law. However, no such action may (i) impair the rights of any optionee unless agreed by the optionee and the 2003 Plan administrator or (ii) affect the 2003 Plan administrator’s ability to exercise the powers granted to it under our 2003 Plan.
2006 Plan. In 2006, our board of directors and shareholders approved a new share incentive plan, the 2006 Plan. As of December 31, 2010, 9,633,500 shares were permitted to be issued upon exercise of awards granted under our 2006 Plan.
Types of Awards. The types of awards we may grant under our 2006 Plan include the following:
    options to purchase our ordinary shares;
    restricted shares, which may be subject to forfeiture, representing non-transferable ordinary shares;
    restricted share units, which may be subject to forfeiture, representing the right to receive our ordinary shares at a specified date in the future;
    share appreciation rights, which provide for payment to the grantee based upon increases in the price of our ordinary shares over a set base price; and
    dividend equivalent rights, which represent the value of the dividends per share that we pay.
Awards may be designated in the form of ADSs instead of ordinary shares. If we designate an award in the form of ADSs, the number of shares issuable under the 2006 Plan will be adjusted to reflect a ratio of one ADS to two ordinary shares.
Eligibility. We may grant awards to employees, directors and consultants of our company or any of our related entities, which include our subsidiaries or any entities in which we hold a substantial ownership interest. However, we may grant options that are intended to qualify as incentive stock options, or ISOs, only to our employees and employees of our majority-owned subsidiaries.

 

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Plan Administration. The compensation committee of our board of directors, or a committee designated by the compensation committee, will administer the 2006 Plan. However, with respect to awards made to our independent directors and executive officers, the entire board of directors will administer the 2006 Plan. The compensation committee or the full board of directors, as appropriate, will determine the individuals who will receive grants, the types of awards to be granted and terms and conditions of each award grant, including any vesting or forfeiture restrictions.
Award Agreement. Awards granted under our 2006 Plan will be evidenced by an award agreement that will set forth the terms, conditions and limitations for each award. In addition, in the case of options, the award agreement will also specify whether the option constitutes an ISO or a non-qualifying stock option.
Acceleration of Awards upon Corporate Transactions. The outstanding awards will accelerate upon occurrence of a change-of-control corporate transaction where the successor entity does not assume our outstanding awards under the 2006 Plan. In such event, each outstanding award will become fully vested and immediately exercisable, and the transfer restrictions on the awards will be released and any forfeiture provisions will terminate immediately before the date of the change-of-control transaction. If the successor entity assumes our outstanding awards and later terminates the grantee’s service without cause within 12 months of the change-of-control transaction, the outstanding awards will automatically become fully vested and exercisable.
Exercise Price and Term of Awards. In general, the plan administrator determines the exercise price of an award and sets forth the price in the award agreement. The exercise price may be fixed or variable price related to the fair market value of our ordinary shares. However, ISOs may not be granted to any individual if the fair market value of the shares underlying such ISOs that are exercisable in any calendar year exceeds US$100,000 or other limitations imposed by law. Also, if we grant an ISO to an employee, who, at the time of that grant, owns shares representing more than 10% of the voting power of all classes of our share capital, the exercise price cannot be less than 110% of the fair market value of our ordinary shares on the date of that grant.
The term of each award will be stated in the award agreement. The term of an award shall not exceed 10 years from the date of the grant, except that five years is maximum term of an ISO granted to an employee who holds more than 10% of the voting power of our share capital.
Amendment and Termination. Our board of directors may at any time amend, suspend or terminate the 2006 Plan. Amendments to the 2006 Plan are subject to shareholder approval to the extent required by law, or stock exchange rules or regulations. Additionally, shareholder approval will be specifically required to increase the number of shares available for issuance under the 2006 Plan or to extend the term of an option beyond ten years. Unless terminated earlier, the 2006 Plan will expire and no further awards may be granted after the tenth anniversary of the shareholder approval of the 2006 Plan.
Amendment to the 2006 Plan. In 2009, our board of directors and shareholders approved an amendment to our 2006 Plan to increase the award pool under the 2006 Plan by that number of shares equal to 6% of our total outstanding shares as of November 3, 2009.

 

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The following table summarizes the options granted to our directors and executive officers and other individuals as a group as of December 31, 2010, without giving effect to options that were exercised or terminated.
                                 
    Options     Exercise Price             Date of  
Name   Awarded     (US$/Share)     Date of Grant     Expiration  
Yunxin Mei
    150,000       2.72       3/17/2006       3/16/2011  
 
    50,000       5.5       10/2/2006       10/1/2011  
 
    7,500       17.395       4/20/2007       4/19/2012  
 
    46,500       3.63 *     10/27/2008       10/26/2013  
 
    20,000       7.33       7/14/2009       7/13/2014  
 
    24,000       16.165       3/19/2010       3/18/2015  
Neil Nanpeng Shen
    100,000       0.3309       1/1/2005       12/31/2009  
 
    150,000       2.72       3/17/2006       3/16/2011  
 
    50,000       5.5       10/2/2006       10/1/2011  
 
    7,500       17.395       4/20/2007       4/19/2012  
 
    46,500       3.63 *     10/27/2008       10/26/2013  
 
    20,000       7.33       7/14/2009       7/13/2014  
 
    24,000       16.165       3/19/2010       3/18/2015  
David Jian Sun
    271,000       0.3309       1/1/2005       12/31/2009  
 
    109,000       2.25       12/1/2005       11/30/2010  
 
    70,000       2.72       3/17/2006       3/16/2011  
 
    142,500       5.5       10/2/2006       10/1/2011  
 
    30,000       17.395       4/20/2007       4/19/2012  
 
    170,000       3.63 *     10/27/2008       10/26/2013  
 
    100,000       7.33       7/14/2009       7/13/2014  
 
    96,000       16.165       3/19/2010       3/18/2015  
May Wu
    300,000       1.53       3/1/2006       2/28/2011  
 
    142,500       5.5       10/2/2006       10/1/2011  
 
    26,000       17.395       4/20/2007       4/19/2012  
 
    150,000       3.63 *     10/27/2008       10/26/2013  
 
    60,000       7.33       7/14/2009       7/13/2014  
 
    48,000       16.165       3/19/2010       3/18/2015  
Huiping Yan
    150,000       7.33       7/14/2009       7/13/2014  
 
    98,000       16.165       3/19/2010       3/18/2015  
Jason Zong
    200,000       5.5       10/2/2006       10/1/2011  
 
    12,500       17.395       4/20/2007       4/19/2012  
 
    101,500       3.63 *     10/27/2008       10/26/2013  
 
    60,000       7.33       7/14/2009       7/13/2014  
 
    72,000       16.165       3/19/2010       3/18/2015  
Min Bao
    70,000       2.72       3/17/2006       3/16/2011  
 
    4,000       17.395       4/20/2007       4/19/2012  
 
    24,000       3.63 *     10/27/2008       10/26/2013  
 
    10,000       7.33       7/14/2009       7/13/2014  
 
    12,000       16.165       3/19/2010       3/18/2015  
James Jianzhang Liang
    70,000       2.72       3/17/2006       3/16/2011  
 
    4,000       17.395       4/20/2007       4/19/2012  
 
    24,000       3.63 *     10/27/2008       10/26/2013  
 
    10,000       7.33       7/14/2009       7/13/2014  
 
    12,000       16.165       3/19/2010       3/18/2015  
Kenneth Gaw
    70,000       3.202       7/4/2006       7/3/2011  
 
    4,000       17.395       4/20/2007       4/19/2012  
 
    24,000       3.63 *     10/27/2008       10/26/2013  
 
    10,000       7.33       7/14/2009       7/13/2014  
 
    12,000       16.165       3/19/2010       3/18/2015  
Terry Yongmin Hu
    70,000       3.202       7/4/2006       7/3/2011  
 
    4,000       17.395       4/20/2007       4/19/2012  
 
    24,000       3.63 *     10/27/2008       10/26/2013  
 
    10,000       7.33       7/14/2009       7/13/2014  
 
    15,000       16.165       3/19/2010       3/18/2015  
Arthur Wang
    60,000       13.29       10/30/2009       10/29/2014  
 
    12,000       16.165       3/19/2010       3/18/2015  
Other individuals as a group
    7,984,162       *                  
 
     
*   On October 27, 2008, we cancelled the unvested portion of the options held by each of our option grantees and granted them new options that would entitle each of them to acquire the same number of our ordinary shares underlying the cancelled options at a new strike price, with a new vesting schedule beginning from October 27, 2008. The information in the above table gives effect to the cancellation of the unvested portion of the old options and grant of the new options to each of the directors and officers named in the table.

 

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C. Board Practices
Our board of directors currently has eight members. A director is not required to hold any shares in the company by way of qualification. A director may vote with respect to any contract, proposed contract or arrangement in which he is materially interested. A director may exercise all the powers of the company to borrow money, mortgage its undertaking, property and uncalled capital, and issue debentures or other securities whenever money is borrowed or as security for any obligation of the company or of any third party.
In 2010, our board held meetings or passed resolutions by unanimous written consent 12 times.
Committees of the Board of Directors
We have established two committees under the board of directors: the audit committee and the compensation committee. We currently do not plan to establish a nominating committee. The independent directors of our company will select and recommend to the board for nomination by the board such candidates as the directors, in the exercise of their judgment, have found to be well qualified and willing and available to serve as our directors prior to each annual meeting of our shareholders at which meeting directors are to be elected or re-elected. In addition, our board of directors has resolved that director nomination be approved by a majority of the board as well as a majority of the independent directors of the board. In compliance with Rule 5605(b)(1) of the Nasdaq Marketplace Rules, all members of each of our board committees will be independent directors. We have adopted a charter for each of the board committees. Each committee’s members and functions are described below.
Audit Committee. Our audit committee consists of Messrs. Arthur M. Wang, Kenneth Gaw and Terry Yongmin Hu. We have determined that all the members of our audit committee satisfy the “independence” requirements of Rule 10A-3 under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and Nasdaq Marketplace Rule 5605(c)(2)(A) and all the members of our audit committee are audit committee financial experts as defined in the instructions to Item 16A of the Form 20-F. The audit committee will oversee our accounting and financial reporting processes and the audits of the financial statements of our company. The audit committee will be responsible for, among other things:
    selecting the independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by the independent auditors;
    reviewing with the independent auditors any audit problems or difficulties and management’s response;
    reviewing and approving all proposed related party transactions, as defined in Item 404 of Regulation S-K under the Securities Act;
    discussing the annual audited financial statements with management and the independent auditors;
    reviewing major issues as to the adequacy of our internal control; and
    meeting separately and periodically with management and the independent auditors.

 

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In 2010, our audit committee held meetings or passed resolutions by unanimous written consent six times.
Compensation Committee. Our compensation committee consists of Messrs. Neil Nanpeng Shen, Kenneth Gaw and Terry Yongmin Hu. We have determined that all the members of our compensation committee satisfy the “independence” requirements of Rule 5605(d) of Nasdaq Stock Market Marketplace Rules. The compensation committee assists the board in reviewing and approving the compensation structure, including all forms of compensation, relating to our directors and executive officers. Our chief executive officer may not be present at any committee meeting during which his compensation is deliberated. The compensation committee will be responsible for, among other things:
    reviewing and approving the total compensation package for our three most senior executives;
    reviewing and recommending to the board with respect to the compensation of our directors; and
    reviewing periodically and approving any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.
In 2010, our compensation committee held meetings or passed resolutions by unanimous written consent two times.
Duties of Directors
Under Cayman Islands law, our directors have a duty of loyalty to act honestly in good faith with a view to our best interests. Our directors also have a duty to exercise the skill they actually possess and such care and diligence that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association.
Terms of Directors and Officers
Our officers are elected by and serve at the discretion of our shareholders and board of directors in accordance with our articles of association. Our directors are not subject to a term of office and hold office until such time as they are removed from office by special resolution or the unanimous written resolution of all shareholders. A director will be removed from office automatically if, among other things, the director (i) becomes bankrupt or makes any arrangement or composition with his creditors; or (ii) dies or is found by our company to be or becomes of unsound mind.
D. Employees
Excluding employees of our franchised-and-managed hotels, we had 13,131, 15,810 and 16,313 employees as of December 31, 2008, 2009 and 2010, respectively. As of December 31, 2010, our employees consisted of 14,662 hotel-based employees, 150 reservation agents at our centralized reservation center, and 1,501 corporate staff. Approximately 25.1% of our employees are associated with labor unions. We consider our relations with our employees to be good.

 

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E. Share Ownership
The following table sets forth information with respect to the beneficial ownership of our ordinary shares as of March 31, 2011 by:
    each of our directors and executive officers; and
    each person known to us to own beneficially more than 5% of our ordinary shares.
                 
    Shares Beneficially Owned  
    Number(1)     %(2)  
Directors and Executive Officers:
               
Neil Nanpeng Shen(3)
    18,904,266       23.02 %
James Jianzhang Liang(4)
    15,207,159       18.53 %
Yunxin Mei(5)
    13,481,009       16.42 %
Min Bao(6)
    13,461,459       16.41 %
David Jian Sun(7)
    324,132       *  
May Wu(8)
    200,127       *  
Jason Zong(9)
    164,250       *  
Kenneth Gaw(10)
    86,959       *  
Huiping Yan(11)
    30,350       *  
Arthur Wang(12)
    18,000       *  
Terry Yongmin Hu(13)
    9,750       *  
All Directors and Executive Officers as a Group(14)
    34,039,737       41.20 %
Principal Shareholders:
               
Ctrip.com International, Ltd.(15)
    14,400,765       17.55 %
Poly Victory Investments Limited(16)
    13,446,959       16.39 %
Maverick Capital, Ltd.(17)
    5,886,692       7.17 %
FMR LLC (18)
    4,715,920       5.75 %
 
     
*   Less than 1%.
 
(1)   Beneficial ownership is determined in accordance with the rules of the SEC and includes voting or investment owner with respect to the securities.
 
(2)   For each person and group included in this table, percentage ownership is calculated by dividing the number of shares beneficially owned by such person or group by the sum of (i) 82,046,440, which was the number of ordinary shares outstanding as of March 31, 2011, and (ii) the number of ordinary shares underlying share options held by such person or group that are exercisable within 60 days after March 31, 2011.
 
(3)   Includes (i) 250,000 ordinary shares held by Mr. Shen; (ii) 3,955,389 ordinary shares held by Smart Master International Limited (“Smart Master”), a British Virgin Islands company solely owned and controlled by Mr. Shen; (iii) 206,362 ordinary shares represented by ADS held by Smart Master; (iv) 91,750 ordinary shares issuable upon exercise of options held by Mr. Shen that are exercisable within 60 days after March 31, 2011 and (v) 7,514,503 ordinary shares and 3,443,131 ADSs representing 6,886,262 ordinary shares held by subsidiaries of Ctrip, of which Mr. Shen is a co-founder and a director. The business address of Mr. Shen is Suite 2215, Two Pacific Place, 88 Queensway, Hong Kong.
 
(4)   Includes (i) 784,894 ordinary shares represented by ADS held by Ms. Lau, Mr. Liang’s wife; (ii) 21,500 ordinary shares issuable upon exercise of options held by Mr. Liang that that are exercisable within 60 days after March 31, 2011 and (iii) 7,514,503 ordinary shares and 3,443,131 ADSs representing 6,886,262 ordinary shares held by subsidiaries of Ctrip, of which Mr. Liang is chairman, a co-founder and a director. Mr. Liang disclaims the beneficial ownership of all the shares held by his wife. The business address of Mr. Liang is Ctrip.com International, Ltd., 99 Fu Quan Road, Shanghai 200335, People’s Republic of China.
 
(5)   Includes (i) 34,050 ordinary shares issuable upon exercise of options held by Mr. Mei that are exercisable within 60 days after March 31, 2011 and (ii) 13,446,959 ordinary shares held by Poly Victory Investments Limited, of which Mr. Mei is a director. Mr. Mei is also the vice chairman and president of BTG, the parent company of Poly Victory Investments Limited. The business address of Mr. Mei is No.10 Yabao Road, Chaoyang District, Beijing 100020, People’s Republic of China.

 

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(6)   Includes (i) 5,500 ordinary shares represented by ADS and 9,000 ordinary shares issuable upon exercise of options held by Mr. Bao that are exercisable within 60 days after March 31, 2011 and (ii) 13,446,959 ordinary shares held by Poly Victory Investments Limited, of which Mr. Bao is a director. Mr. Bao is also serves on the board of BTG, the parent company of Poly Victory Investments Limited. The business address of Mr. Bao is No.10 Yabao Road, Chaoyang District, Beijing 100020, People’s Republic of China.
 
(7)   Includes (i) 188,806 ordinary shares held by Peace Unity Investments Limited, a company solely owned and controlled by Mr. Sun, (ii) 40,000 ordinary shares held by Mr. Sun’s daughters; (iii) 95,326 ordinary shares issuable upon exercise of options held by Mr. Sun that are exercisable within 60 days after March 31, 2011. The business address of Mr. Sun is No. 124, Caobao Road, Xuhui District, Shanghai 200235, People’s Republic of China.
 
(8)   Includes 100,001 ordinary shares held by Ms. Wu and 100,126 ordinary shares issuable upon exercise of options held by Ms. Wu that are exercisable within 60 days after March 31, 2011. The business address of Ms. Wu is No. 124, Caobao Road, Xuhui District, Shanghai 200235, People’s Republic of China.
 
(9)   Includes 14,000 ordinary shares represented by ADS and 150,250 ordinary shares issuable upon exercise of options held by Mr. Zong that are exercisable within 60 days after March 31, 2010. The business address of Mr. Zong is No. 124, Caobao Road, Xuhui District, Shanghai 200235, People’s Republic of China.
 
(10)   Includes (i) 32,800 ordinary shares represented by ADS held by Mr. Gaw; (ii) 32,659 ordinary shares held by Top Elite Company Limited, a company solely owned and controlled by Mr. Gaw, and (iii) 21,500 ordinary shares issuable upon exercise of options held by Mr. Gaw that are exercisable within 60 days after March 31, 2011. The business address of Mr. Gaw is 22nd Floor, 1 Lyndhurst Tower, No. 1 Lyndhurst Terrace, Central, Hong Kong.
 
(11)   These 30,350 ordinary shares are issuable upon exercise of options held by Ms. Yan that are exercisable within 60 days after March 31, 2011. The business address of Ms. Yan is No. 124, Caobao Road, Xuhui District, Shanghai 200235, People’s Republic of China.
 
(12)   These 18,000 ordinary shares are issuable upon exercise of options held by Mr. Wang that are exercisable within 60 days after March 31, 2011. The business address of Mr. Wang is the Centrium, 22/F, 60 Wyndham Street, Central, Hong Kong.
 
(13)   These 9,750 ordinary shares are issuable upon exercise of options held by Mr. Hu that are exercisable within 60 days after March 31, 2011. The business address of Mr. Hu is Suite 906 ICBC Tower, 3 Garden Road, Central, Hong Kong.
 
(14)   Includes 33,458,135 ordinary shares, and 581,602 ordinary shares issuable upon exercise of options that are exercisable within 60 days after March 31, 2011.
 
(15)   Based on the Schedule 13D/A filed with the SEC on May 21, 2009. The ordinary shares consist of 7,514,503 ordinary shares through private placement and 3,443,131 ADSs representing 6,886,262 ordinary shares purchased by Ctrip and its wholly-owned subsidiaries.
 
(16)   Poly Victory Investments Limited, a company incorporated in the British Virgin Islands, is beneficially owned by Beijing Tourism Group, which is a state-owned enterprise in China. The registered office of Poly Victory Investment Limited is Palm Grove House, P.O. Box 432, Road Town, Tortola, British Virgin Islands.
 
(17)   Based on the Schedule 13G filed with the SEC on February 14, 2011. The principal business office of Maverick Capital, Ltd. is 300 Crescent Court, 18th Floor, Dallas, Texas 75201. Maverick Capital, Ltd., an investment adviser registered under Section 203 of the Investment Advisers Act of 1940, is the beneficial owner of 5,886,692 ordinary shares represented by ADS as a result of the investment discretion it exercises over its clients’ accounts.
 
(18)   Based on the Schedule 13G filed with the SEC on March 10, 2011. FMR LLC’s principal business office is 82 Devonshire Street, Boston, Massachusetts 02109. Fidelity Management & Research Company, 82 Devonshire Street, Boston, Massachusetts 02109, a wholly-owned subsidiary of FMR LLC and an investment adviser registered under Section 203 of the Investment Advisers Act of 1940, is the beneficial owner of 4,715,920 ordinary shares represented by ADS as a result of acting as investment adviser to various investment companies registered under Section 8 of the Investment Company Act of 1940.

 

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None of our existing shareholders have different voting rights from other shareholders. We are not aware of any arrangement that may, at a subsequent date, result in a change of control of our company.
As of March 31, 2011, we had 82,046,440 ordinary shares issued and outstanding. To our knowledge, we had only one record shareholder in the United States, The Bank of New York Mellon, which is the depositary of our ADS program and held approximately 68.77% of our total outstanding ordinary shares. The number of beneficial owners of our ADSs in the United States is likely to be much larger than the number of record holders of our ordinary shares in the United States.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. Major Shareholders
Please refer to “Item 6. Directors, Senior Management and Employees—E. Share Ownership.”
B. Related Party Transactions
Shareholders’ Agreement
In connection with our reorganization in June 2006, we and our then existing shareholders entered into a shareholders agreement, which incorporates the principal terms of the previous shareholders agreements between Home Inns Hong Kong and our shareholders. Under this agreement, these shareholders are entitled to certain registration rights, including demand registration and Form F-3 or Form S-3 registration.
Transaction with Jian Guo Inns
Jian Guo Inns Beijing Ltd., or Jian Guo Inns, is a subsidiary of BTG, which is the parent company of Poly Victory Investments Limited, one of our principal shareholders. Jian Guo Inns was the lessor of four leased-and-operated Home Inns hotels in 2003. Since 2004, Jian Guo Inns has been the lessor of three leased-and-operated Home Inns hotels. In 2008, 2009 and 2010, we paid RMB 2.8 million, RMB 2.8 million and RMB 2.8 million (US$0.4 million), respectively, to Jian Guo Inns as rental payments.
Transactions with Ctrip
Two of Ctrip’s directors, Neil Nanpeng Shen and James Jianzhang Liang, are also our directors. In addition, one of Ctrip’s directors, Qi Ji, was our director and chief executive officer from 2002 to January 2005, and another of Ctrip’s directors, Suyang Zhang, was our director from 2001 to 2006. Some of our customers book our hotel rooms through Ctrip and we pay agency fees to Ctrip for such bookings. The amounts paid to Ctrip as agency fees in 2008, 2009, 2010 and thus far in 2011 were RMB 14.8 million, RMB 20.9 million, RMB 18.2 million and RMB 3.7 million (US$0.6  million), respectively.
In May 2009, we sold Ctrip 7,514,503 ordinary shares through a private placement for US$50 million in cash. The purchase price per ordinary share was set at US$6.6538, calculated as the average of the closing prices for our ADSs on Nasdaq for each trading day within the 30 calendar days preceding the date of the definitive purchase agreement. As Ctrip and its wholly owned subsidiary had previously purchased 3,443,131 of our ADSs on the open market representing 6,886,262 ordinary shares, this transaction increased Ctrip’s ownership in us to 14,400,765 ordinary shares, representing 18.25% of our ordinary shares outstanding upon the completion of the private placement.
See “Item 10. Additional Information—C. Material contracts” for a description of the registration rights agreement we have entered into with Ctrip.

 

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Employment Agreements
See “Item 6. Directors, Senior Management and Employees—A. Directors and Senior Management—Employment Agreements” for a description of the employment agreements we have entered into with our senior executive officers.
Share Incentives
See “Item 6. Directors, Senior Management and Employees—B. Compensation of Directors and Executive Officers—Share Incentives” for a description of share options we have granted to our directors, officers and other individuals as a group.
C. Interests of Experts and Counsel
Not applicable.
ITEM 8. FINANCIAL INFORMATION
A. Consolidated Statements and Other Financial Information
We have appended consolidated financial statements filed as part of this annual report.
Legal and Administrative Proceedings
We are subject to legal proceedings, investigations and claims incidental to the conduct of our business from time to time. We are not currently a party to, nor are we aware of, any legal proceeding, investigation or claim which, in the opinion of our management, is likely to have a material adverse effect on our business, financial condition or results of operations.
Dividend Policy
We have no present plan to declare and pay any dividends on our shares or ADSs in the near future. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.
We are a holding company incorporated in the Cayman Islands. We rely on dividends from our subsidiaries in China. Current PRC regulations permit our subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, each of our subsidiaries in China is required to set aside a certain amount of its accumulated after-tax profits each year, if any, to fund certain statutory reserves. These reserves may not be distributed as cash dividends. Further, if our subsidiaries in China incur debt on their own behalf, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us.
Our board of directors has complete discretion as to whether to distribute dividends, subject to the approval of our shareholders. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant. If we pay any dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder.

 

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B. Significant Changes
Except as disclosed elsewhere in this annual report, we have not experienced any significant changes since the date of our audited consolidated financial statements included in this annual report.
ITEM 9. THE OFFER AND LISTING
A. Offering and Listing Details
Market Price Information for our American Depositary Shares
Our ADSs, each representing two of our ordinary shares, have been listed on the Nasdaq Global Market since October 26, 2006. Our ADSs trade under the symbol “HMIN.”
The following table provides the high and low closing prices for our ADSs on the Nasdaq Global Market for each period indicated.
                 
    Trading Price  
    High     Low  
    US$     US$  
Annual Highs and Lows
               
2006 (from October 26, 2006)
    39.02       21.50  
2007
    50.08       24.00  
2008
    36.00       7.00  
2009
    37.93       7.63  
2010
    53.66       27.89  
 
               
Quarterly Highs and Lows
               
First Quarter 2009
    10.28       7.63  
Second Quarter 2009
    18.34       9.75  
Third Quarter 2009
    30.75       13.22  
Fourth Quarter 2009
    37.93       25.51  
First Quarter 2010
    40.06       27.89  
Second Quarter 2010
    41.75       30.79  
Third Quarter 2010
    50.79       37.30  
Fourth Quarter 2010
    53.66       39.67  
First Quarter 2011
    40.83       32.55  
 
               
Monthly Highs and Lows
               
2010
               
October
    53.66       48.60  
November
    51.60       44.82  
December
    47.29       39.67  
2011
               
January
    40.25       33.73  
February
    34.96       32.55  
March
    40.83       34.00  
April (through April 25, 2011)
    44.48       41.41  

 

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B. Plan of Distribution
Not applicable.
C. Markets
Our ADSs, each representing two of our ordinary shares, have been listed on the Nasdaq Global Market since October 26, 2006 under the symbol “HMIN.”
D. Selling Shareholders
Not applicable.
E. Dilution
Not applicable.
F. Expenses of the Issue
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A. Share Capital
Not applicable.
B. Memorandum and Articles of Association
The following are summaries of material provisions of our amended and restated memorandum and articles of association, as well as the Companies Law (2010 Revision) insofar as they relate to the material terms of our ordinary shares.
Registered Office and Objects
Our registered office is at the offices of Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman KY1-1104, Cayman Islands. The objects for which our company is established are unrestricted and we have full power and authority to carry out any object not prohibited by the Companies Law (2010 Revision) or as the same may be revised from time to time, or any other law of the Cayman Islands.
Board of Directors
See “Item 6.C. Board Practices — Board of Directors.”

 

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Ordinary Shares
General. All of our outstanding ordinary shares are fully paid and non-assessable. Certificates representing the ordinary shares are issued in registered form. Our shareholders who are non-residents of the Cayman Islands may freely hold and vote their shares.
Dividends. The holders of our ordinary shares are entitled to such dividends as may be declared by our board of directors subject to the Companies Law.
Voting Rights. Each ordinary share is entitled to one vote on all matters upon which the ordinary shares are entitled to vote. Voting at any shareholders’ meeting is by show of hands unless a poll is demanded. A poll may be demanded by one or more shareholders present in person or by proxy entitled to vote and who together held not less than 10% of the paid up voting share capital of our company.
A quorum required for a meeting of shareholders consists of shareholders present in person or by proxy or, if a corporation or other non-natural person, by its duly authorized representative, holding not less than one-third of our voting share capital. Shareholders’ meetings may be held annually and may be convened by our board of directors on its own initiative or upon a request to the directors by shareholders holding in aggregate at least one-third of our voting share capital. Advance notice of at least 14 days is required for the convening of our annual general meeting and other shareholders’ meetings.
An ordinary resolution to be passed by the shareholders requires the affirmative vote of a simple majority of the votes attaching to the ordinary shares cast in a general meeting, while a special resolution requires the affirmative vote of no less than two-thirds of the votes attaching to the ordinary shares cast in a general meeting. A special resolution is required for important matters such as a change of name. Holders of the ordinary shares may effect certain changes by ordinary resolution, including alter the amount of our authorized share capital, consolidate and divide all or any of our share capital into shares of larger amount than our existing share capital, and cancel any shares.
Transfer of Shares. Subject to the restrictions of our memorandum and articles of association, as applicable, any of our shareholders may transfer all or any of his or her ordinary shares by an instrument of transfer in the usual or common form or any other form approved by our board.
Liquidation. On a return of capital on winding up or otherwise (other than on conversion, redemption or purchase of shares), assets available for distribution among the holders of ordinary shares shall be distributed among the holders of the ordinary shares on a pro rata basis. If our assets available for distribution are insufficient to repay all of the paid-up capital, the assets will be distributed so that the losses are borne by our shareholders proportionately.
Calls on Shares and Forfeiture of Shares. Our board of directors may from time to time make calls upon shareholders for any amounts unpaid on their shares in a notice served to such shareholders at least 14 days prior to the specified time and place of payment. The shares that have been called upon and remain unpaid on the specified time are subject to forfeiture.
Redemption of Shares. Subject to the provisions of the Companies Law, we may issue shares on terms that are subject to redemption, at our option or at the option of the holders, on such terms and in such manner as may be determined by special resolution.
Variations of Rights of Shares. All or any of the special rights attached to any class of shares may, subject to the provisions of the Companies Law, be varied either with the written consent of the holders of a majority of the issued shares of that class or with the sanction of a resolution passed by at least a majority of the holders of the shares of the class present in person or by proxy at a separate general meeting of the holders of the shares of that class.

 

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Inspection of Books and Records. Holders of our ordinary shares will have no general right under Cayman Islands law to inspect or obtain copies of our list of shareholders or our corporate records. However, we will provide our shareholders with annual audited financial statements.
C. Material Contracts
We have not entered into any material contracts other than in the ordinary course of business and other than those described in “Item 4. Information on the Company”, in this “Item 10.C. Material Contracts” or elsewhere in this annual report on Form 20-F.
Registration Rights of Ctrip
Set forth below is a description of the registration rights we granted to Ctrip in May 2009:
Demand Registration Rights. At any time, holders of at least 25% of the ordinary shares held by Ctrip and its transferees and assignees have the right to demand that we file a registration statement covering the offer and sale of their securities. We are obligated under the registration rights agreement to use our best efforts to register our ordinary shares for resale if Ctrip or its transferees and assignees make such a request. We are not obligated to affect such demand registrations on more than three occasions. If the holders of shares initiating a demand intend to distribute their shares by mean of an underwriting, the underwriters will have the right to limit the number of shares having registration rights to be included in the registration statement. We have the ability to defer the filing of a registration statement for up to 90 days if we furnish to the demanding holder or holders a certificate signed by one of our directors stating that in the good faith judgment of the board of directors, filing of a registration statement will be detrimental to us and our shareholders, but we cannot exercise the deferral right more than once in any 12-month period.
Piggyback Registration Rights. If we propose to file a registration statement with respect to a public offering of our securities for our own account or for the account of any person that is not Ctrip or its transferees and assignees, we must offer Ctrip and its transferees and assignees the opportunity to include their securities in the registration statement. If the registration statement is for an underwritten offering and the underwriters determine that marketing factors require a limitation on the number of shares to be underwritten, the number of shares included in the offering and the underwriting will be allocated first to the Company, second to Ctrip and its transferees and assignees, and third to other holders.
Form F-3 Registration Rights. When we are eligible for use of Form F-3, holders of at least 25% of the ordinary shares held by Ctrip or its transferees and assignees have the right to request that we file a registration statement under Form F-3. Such requests for registrations are not counted as demand registrations. We have the ability to defer the filing of such a registration statement for up to 90 days if we furnish to the requesting holder or holders a certificate signed by one of our directors stating that in the good faith judgment of the board of directors, filing of a registration statement will be detrimental to us and our shareholders, but we cannot exercise the deferral right more than once in any 12-month period.
Expenses of Registration. We will pay all expenses, other than underwriting discounts and commissions, relating to any demand, piggyback or F-3 registration.

 

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Registration Rights Relating to Convertible Notes due 2015
In connection with the issuance of our convertible notes due 2015 in December 2010, we agreed to file by July 19, 2011, at our expense, an effective shelf registration statement for re-sales by holders of our convertible notes due 2015 and any securities into which such notes are converted, and we agreed to file certain supplements and amendments to the shelf registration statement upon requests from such holders.
D. Exchange Controls
See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulations on Foreign Currency Exchange.”
E. Taxation
The following summary of the material Cayman Islands, Hong Kong, People’s Republic of China and United States federal income tax consequences of an investment in our ADSs or ordinary shares is based upon laws and relevant interpretations thereof in effect as of the date of this annual report, all of which are subject to change. This summary does not deal with all possible tax consequences relating to an investment in our ADSs or ordinary shares, such as the tax consequences under state, local and other tax laws.
Cayman Islands Taxation
The Cayman Islands does not impose any withholding taxes on dividends paid to shareholders by a Cayman Islands corporation, nor does the Cayman Islands impose any other taxes on shareholders of a Cayman Islands corporation who are not themselves residents of the Cayman Islands. The Cayman Islands is not a party to any tax treaties that are applicable to any payments made to or by our company.
People’s Republic of China Taxation
Under the Enterprise Income Tax Law, enterprises established outside of China but whose “de facto management body” is located in China are considered “resident enterprises” for PRC tax purposes. Under the applicable implementation regulations, “de facto management body” is defined as the organizational body that effectively exercises overall management and control over production and business operations, personnel, finance and accounting, and properties of the enterprise. Substantially all of our management is currently based in China, and may remain in China in the future. If we are treated as a “resident enterprise” for PRC tax purposes, foreign holders of our ADSs or ordinary shares may be subject to a 10% PRC withholding tax upon dividends payable by us and on gains realized on their sales or other dispositions of our ADSs or ordinary shares. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—Our foreign ADS holders may be subject to PRC withholding tax on the dividends payable by us and upon gains realized on their sales of our ADSs if we are classified as a PRC ‘resident enterprise.’”
United States Federal Income Taxation
The following discussion describes the material U.S. federal income tax consequences to U.S. Holders (defined below) under present law of an investment in the ADSs or ordinary shares. This summary applies only to investors that hold the ADSs or ordinary shares as capital assets and that have the U.S. dollar as their functional currency. This discussion is based on the tax laws of the United States as in effect on the date of this annual report and on U.S. Treasury regulations in effect or, in some cases, proposed, as of the date of this annual report, as well as judicial and administrative interpretations thereof available on or before such date. All of the foregoing authorities are subject to change, which change could apply retroactively and could affect the tax consequences described below.

 

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The following discussion does not deal with the tax consequences to any particular investor or to persons in special tax situations such as:
    banks;
    certain financial institutions;
    regulated investment companies;
    real estate investment trusts;
    insurance companies;
    broker dealers;
    U.S. expatriates;
    traders that elect to mark to market;
    tax-exempt entities;
    persons liable for alternative minimum tax;
    persons holding an ADS or ordinary share as part of a straddle, hedging, constructive sale, conversion or integrated transaction;
    persons that actually or constructively own 10.0% or more of our voting stock;
    persons who acquired ADSs or ordinary shares pursuant to the exercise of any employee share option or otherwise as compensation; or
    persons holding ADSs or ordinary shares through partnerships or other pass-through entities for U.S. federal income tax purposes.
U.S. HOLDERS ARE URGED TO CONSULT THEIR TAX ADVISORS ABOUT THE APPLICATION OF THE U.S. FEDERAL TAX RULES TO THEIR PARTICULAR CIRCUMSTANCES AS WELL AS THE STATE AND LOCAL AND FOREIGN TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF ADSs OR ORDINARY SHARES.
The discussion below of the U.S. federal income tax consequences to “U.S. Holders” will apply if you are a beneficial owner of ADSs or ordinary shares and you are, for U.S. federal income tax purposes,
    an individual who is a citizen or resident of the United States;
    a corporation (or other entity taxable as a corporation) organized under the laws of the United States, any State or the District of Columbia;
    an estate whose income is subject to U.S. federal income taxation regardless of its source; or
    a trust that (1) is subject to the supervision of a court within the United States and the control of one or more U.S. persons or (2) has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person.
If you are a partner in partnership or other entity taxable as a partnership that holds ADSs or ordinary shares, your tax treatment generally will depend on your status and the activities of the partnership.
The discussion below assumes that the representations contained in the deposit agreement are true and that the obligations in the deposit agreement and any related agreement will be complied with in accordance with their terms. If you hold ADSs, you should be treated as the holder of the underlying ordinary shares represented by those ADSs for U.S. federal income tax purposes. Accordingly, deposits or withdrawals of ordinary shares for ADSs will not be subject to U.S. federal income tax.
The U.S. Treasury has expressed concerns that parties to whom ADSs are pre-released, or intermediaries in the chain of ownership between holders of ADSs and the issuer of the security underlying the ADSs, may be taking actions that are inconsistent with the claiming, by U.S. Holders of ADSs, of foreign tax credits for U.S. federal income tax purposes. Such actions would also be inconsistent with the claiming of the reduced rate of tax applicable to dividends received by certain non-corporate U.S. Holders, as described below. Accordingly, the availability of the reduced tax rate for dividends received by certain non-corporate U.S. Holders could be affected by future actions that may be taken by the U.S. Treasury, intermediaries in the chain of ownership between us and holders of the ADSs, or parties to whom ADSs are pre-released.

 

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Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares
Subject to the passive foreign investment company rules discussed below, the gross amount of all our distributions to you with respect to the ADSs or ordinary shares generally will be included in your gross income as ordinary dividend income on the date of actual or constructive receipt by the depositary, in the case of ADSs, or by you, in the case of ordinary shares, but only to the extent that the distribution is paid out of our current or accumulated earnings and profits (as determined under U.S. federal income tax principles). To the extent that the amount of the distribution exceeds our current and accumulated earnings and profits, it will be treated first as a tax-free return of your tax basis in your ADSs or ordinary shares, and to the extent the amount of the distribution exceeds your tax basis, the excess will be taxed as capital gain. As we do not maintain records of earnings and profits in accordance with U.S. Federal income tax principles, U.S. Holders should expect that the full amount of any distribution will be reported as dividend. The dividends will not be eligible for the dividends-received deduction allowed to corporations in respect of dividends received from other U.S. corporations.
With respect to non-corporate U.S. Holders including individual U.S. Holders, for taxable years beginning before January 1, 2013, dividends may constitute “qualified dividend income” that is taxed at the lower applicable capital gains rate provided that (1) the ADSs or ordinary shares, as applicable, are readily tradable on an established securities market in the United States or we are eligible for the benefit of the income tax treaty between the United States and the PRC, (2) we are not a passive foreign investment company (as discussed below) for either our taxable year in which the dividend was paid or the preceding taxable year, and (3) certain holding period requirements are met. Under Internal Revenue Service authority, ordinary shares, or ADSs representing such shares, are considered for the purpose of clause (1) above to be readily tradable on an established securities market in the United States if they are listed on the Nasdaq Global Market, as our ADSs are (but not our ordinary shares). Thus, we do not believe that dividends that we pay on our ordinary shares that are not backed by ADSs currently meet the conditions required for these reduced tax rates. There can be no assurance that our ADSs will be considered readily tradable on an established securities market in later years. You should consult your tax advisors regarding the availability of the lower rate for dividends paid with respect to our ADSs or ordinary shares.
Dividends will constitute foreign source income for foreign tax credit limitation purposes. If the dividends are qualified dividend income (as discussed above), the amount of the dividend taken into account for purposes of calculating the foreign tax credit limitation generally will be limited to the gross amount of the dividend, multiplied by the reduced rate divided by the highest rate of tax normally applicable to dividends. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose, dividends distributed by us with respect to the ADSs or ordinary shares generally will constitute “passive category income” or, in the case of certain U.S. Holders, constitute “general category income.” Subject to certain conditions and limitations, any PRC withholding taxes on dividends may be treated as foreign taxes eligible for credit against your U.S. federal income tax liability. U.S. Holders should consult their tax advisors regarding the creditability of any PRC tax.
Taxation of Disposition of ADSs or Ordinary Shares
Subject to the passive foreign investment company rules discussed below, you will recognize taxable gain or loss on any sale, exchange or other taxable disposition of an ADS or ordinary share equal to the difference between the amount realized for the ADS or ordinary share and your tax basis in the ADS or ordinary share. The gain or loss generally will be capital gain or loss. If you are a non-corporate U.S. Holder, including an individual U.S. Holder, who has held the ADS or ordinary share for more than one year, you will be eligible for reduced tax rates. The deductibility of capital losses is subject to limitations. Any such gain or loss that you recognize generally will be treated as U.S. source income or loss for foreign tax credit limitation purposes. However, in the event we are deemed to be a Chinese resident enterprise under PRC tax law, we may be eligible for the benefits of the income tax treaty between the United States and the PRC. In such event, if PRC tax were to be imposed on any gain from the disposition of the ADSs or ordinary shares, a U.S. Holder that is eligible for the benefits of the income tax treaty between the United States and the PRC may elect to treat such gain as PRC source income. U.S. Holders should consult their tax advisors regarding the creditability of any PRC tax.

 

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Passive Foreign Investment Company
Based on the price of our ADSs and ordinary shares and the composition of our income and assets, we believe that we were not a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for our taxable year that ended December 31, 2010. However, the application of the PFIC rules is subject to ambiguity in several aspects and, in addition, we must make a separate determination each year as to whether we are a PFIC (after the close of each taxable year). Accordingly, we cannot assure you that we will not be a PFIC for our current taxable year ending December 31, 2011 or any future taxable year. A non-U.S. corporation is considered to be a PFIC for any taxable year if either:
    at least 75% of its gross income is passive income (the “income test”), or
    at least 50% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income (the “asset test”).
We will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any other corporation in which we own, directly or indirectly, 25% or more (by value) of the stock.
We must make a separate determination each year as to whether we are a PFIC. As a result, our PFIC status may change. In particular, because the total value of our assets for purposes of the asset test generally will be calculated using the market price of our ADSs and ordinary shares, our PFIC status will depend in large part on the market price of our ADSs and ordinary shares, which may fluctuate considerably. Accordingly, fluctuations in the market price of the ADSs and ordinary shares may result in our being a PFIC for any year. In addition, the composition of our income and assets will be affected by how, and how quickly, we spend the cash we raise in any offering. If we are a PFIC for any year during which you hold ADSs or ordinary shares, we generally will continue to be treated as a PFIC for all succeeding years during which you hold ADSs or ordinary shares. However, if we cease to be a PFIC, you may avoid some of the adverse effects of the PFIC regime by making a deemed sale election with respect to the ADSs or ordinary shares, as applicable. If we are a PFIC for any taxable year and any of our foreign subsidiaries is also a PFIC, a U.S. Holder would be treated as owning a proportionate amount (by value) of the shares of the lower-tier PFIC for purposes of the application of these rules. You are urged to consult your tax advisors about the application of the PFIC rules to any of our subsidiaries.
If we are a PFIC for any taxable year during which you hold ADSs or ordinary shares, you will be subject to special tax rules with respect to any “excess distribution” that you receive and any gain you realize from a sale or other disposition (including a pledge) of the ADSs or ordinary shares, unless you make a “mark-to-market” election as discussed below. Distributions you receive in a taxable year that are greater than 125% of the average annual distributions you received during the shorter of the three preceding taxable years or your holding period for the ADSs or ordinary shares will be treated as an excess distribution. Under these special tax rules:
    the excess distribution or gain will be allocated ratably over your holding period for the ADSs or ordinary shares,
    the amount allocated to the current taxable year, and any taxable year prior to the first taxable year in which we became a PFIC, will be treated as ordinary income, and
    the amount allocated to each other year will be subject to the highest tax rate in effect for that year and the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each such year.

 

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The tax liability for amounts allocated to years prior to the year of disposition or “excess distribution” cannot be offset by any net operating losses for such years, and gains (but not losses) realized on the sale of the ADSs or ordinary shares cannot be treated as capital, even if you hold the ADSs or ordinary shares as capital assets.
If a company that is a PFIC provides certain information to U.S. Holders, a U.S. Holder can then avoid certain adverse tax consequences described above by making a “qualified electing fund” election to be taxed currently on its proportionate share of the PFIC’s ordinary income and net capital gains. However, we do not intend to prepare or provide the information that would enable you to make a qualified electing fund election.
Alternatively, a U.S. Holder of “marketable stock” (as defined below) in a PFIC may make a mark-to-market election with respect to such stock to elect out of the tax treatment discussed above. If you make a valid mark-to-market election for the ADSs or ordinary shares, you will include in income each year an amount equal to the excess, if any, of the fair market value of the ADSs or ordinary shares as of the close of your taxable year over your adjusted basis in such ADSs or ordinary shares. You are allowed a deduction for the excess, if any, of the adjusted basis of the ADSs or ordinary shares over their fair market value as of the close of the taxable year. However, deductions are allowable only to the extent of any net mark-to-market gains on the ADSs or ordinary shares included in your income for prior taxable years. Amounts included in your income under a mark-to-market election, as well as gain on the actual sale or other disposition of the ADSs or ordinary shares, are treated as ordinary income. Ordinary loss treatment also applies to the deductible portion of any mark-to-market loss on the ADSs or ordinary shares, as well as to any loss realized on the actual sale or disposition of the ADSs or ordinary shares, to the extent that the amount of such loss does not exceed the net mark-to-market gains previously included for such ADSs or ordinary shares. Your basis in the ADSs or ordinary shares will be adjusted to reflect any such income or loss amounts. If you make such an election, the tax rules that apply to distributions by corporations that are not PFICs will apply to distributions by us, except that the lower applicable capital gains rate discussed above under “—Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares” will not apply.
The mark-to-market election is available only for “marketable stock,” which is stock that is traded in other than de minimis quantities on at least 15 days during each calendar quarter (“regularly traded”) on a qualified exchange or other market, as defined in applicable U.S. Treasury regulations. The Nasdaq Global Market is a qualified exchange and, consequently, provided that the ADSs continue to be listed on the Nasdaq Global Market and are regularly traded, if you are a holder of ADSs, the mark-to-market election would be available to you were we to be a PFIC.
If you hold ADSs or ordinary shares in any year in which we are a PFIC, you will be required to file Internal Revenue Service Form 8621 regarding distributions received on the ADSs or ordinary shares and any gain realized on the disposition of the ADSs or ordinary shares.
You are urged to consult your tax advisor regarding the application of the PFIC rules to your investment in ADSs or ordinary shares.
Information Reporting and Backup Withholding
Pursuant to the Hiring Incentives to Restore Employment Act enacted on March 18, 2010, you may be required to submit to the Internal Revenue Service certain information reporting with respect to your ADSs or ordinary shares, including, the name and address of the issuer, such information as is necessary to identify the class or issue of which such ADSs or ordinary shares is a part, and the maximum value of the asset during the taxable year. Penalties are imposed if you are required to submit such information to the Internal Revenue Service and fail to do so. In addition, dividend payments with respect to ADSs or ordinary shares and proceeds from the sale, exchange or redemption of ADSs or ordinary shares may be subject to information reporting to the Internal Revenue Service and possible U.S. backup withholding at a current rate of 28%. Backup withholding will not apply, however, to a U.S. Holder who furnishes a correct taxpayer identification number and makes any other required certification or who is otherwise exempt from backup withholding. U.S. Holders who are required to establish their exempt status generally must provide such certification on Internal Revenue Service Form W-9. U.S. Holders should consult their tax advisors regarding the application of the U.S. information reporting and backup withholding rules.

 

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Backup withholding is not an additional tax. Amounts withheld as backup withholding may be credited against your U.S. federal income tax liability, and you may obtain a refund of any excess amounts withheld under the backup withholding rules by timely filing the appropriate claim for refund with the Internal Revenue Service and furnishing any required information.
F. Dividends and Paying Agents
Not applicable.
G. Statement by Experts
Not applicable.
H. Documents on Display
We are subject to the periodic reporting and other informational requirements of the Exchange Act. Under the Exchange Act, we are required to file reports and other information with the SEC. Specifically, we are required to file annually a Form 20-F no later than six months after the close of each fiscal year, which is December 31. For the fiscal year ending December 31, 2011 and thereafter, that deadline will be reduced to no later than four months after the close of each fiscal year. Copies of reports and other information, when so filed, may be inspected without charge and may be obtained at prescribed rates at the public reference facilities maintained by the SEC at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtain information regarding the Washington, D.C. Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a web site at www.sec.gov that contains reports, proxy and information statements, and other information regarding registrants that make electronic filings with the SEC using its EDGAR system. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act.
We will furnish The Bank of New York, the depositary of our ADSs, with our annual reports, which will include a review of operations and annual audited consolidated financial statements prepared in conformity with U.S. GAAP, and all notices of shareholders’ meetings and other reports and communications that are made generally available to our shareholders. The depositary will make such notices, reports and communications available to holders of ADSs and, upon our request, will mail to all record holders of ADSs the information contained in any notice of a shareholders’ meeting received by the depositary from us.
I. Subsidiary Information
For a listing of our subsidiaries, see “Item 4. Information on the Company—C. Organizational Structure.”

 

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ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Our exposure to interest rate risk typically relates to any interest rates for our outstanding debt and the interest income generated by excess cash invested in liquid investments with original maturities of three months or less. Other than our convertible bonds and notes, both of which have fixed interests rates, we did not have any outstanding loans as of December 31, 2010. We have not used any derivative financial instruments to manage our interest risk exposure. Interest-earning instruments carry a degree of interest rate risk. We have not been exposed to material risks due to changes in interest rates. Our future interest income may increase or decrease due to changes in market interest rates.
Foreign Exchange Risk
Substantially all of our revenues and most of our expenses are denominated in RMB. Our exposure to foreign exchange risk primarily relates to cash and cash equivalent denominated in U.S. dollars as a result of our proceeds from our public offerings and our convertible bond and note offerings. For every 1% that the U.S. dollar appreciates or depreciates against the RMB, the value of our U.S. dollar-denominated cash and cash equivalents in RMB terms would rise or fall in value by RMB 14.2 million. We have not hedged exposures denominated in foreign currencies or any other derivative financial instruments. Although in general, our exposure to foreign exchange risks should be limited, the value of your investment in our ADSs will be affected by the foreign exchange rate between U.S. dollars and RMB because the value of our business is effectively denominated in RMB, while the ADSs will be traded in U.S. dollars.
The conversion of Renminbi into foreign currencies, including U.S. dollars, is based on rates set by the People’s Bank of China. The PRC government allowed the Renminbi to appreciate by more than 20% against the U.S. dollar between July 2005 and July 2008. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the Renminbi and the U.S. dollar remained within a narrow band. Since June 2010, the PRC government has allowed the Renminbi to appreciate slowly against the U.S. dollar again. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the Renminbi and the U.S. dollar in the future.
We have not used any forward contracts or currency borrowings to hedge our exposure to foreign currency exchange risk.
Inflation
Since our inception, inflation in China has not materially impacted our results of operations. According to the National Bureau of Statistics of China, the annual average percent changes in the consumer price index in China for 2008, 2009 and 2010 were an increase of 5.9%, a decrease of 0.7% and an increase of 3.3%, respectively. The year-over-year percent changes in the consumer price index for February 2009, 2010 and 2011 were a decrease of 1.6%, an increase of 2.7% and an increase of 4.9%, respectively. Although we have not been materially affected by inflation in the past, we may be affected if China experiences higher rates of inflation in the future.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
A. Debt Securities
Not applicable.

 

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B. Warrants and Rights
Not applicable.
C. Other Securities
Not applicable.
D. American Depositary Shares
Fees and Charges Our ADS holders May Have to Pay
The Bank of New York Mellon, the depositary of our ADS program, collects its fees for issuance and cancellation of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary also collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may collect its annual fee for depositary services by deduction from cash distributions or by directly billing investors or by charging the book-entry system accounts of participants acting for them. The depositary may generally refuse to provide fee-attracting services until its fees for those services are paid.
     
Persons depositing or withdrawing shares must pay:   For:
 
US$5.00 (or less) per 100 ADSs (or portion of 100 ADSs)
 
    Issuance of ADSs, including issuances resulting from a distribution of shares or rights or other property
 
   
 
 
    Cancellation of ADSs for the purpose of withdrawal, including if the deposit agreement terminates
 
   
US$0.02 (or less) per ADS
 
    Any cash distribution to registered ADS holders
 
   
A fee equivalent to the fee that would be payable if securities distributed had been shares and the shares had been deposited for issuance of ADSs
 
    Distribution of securities distributed to holders of deposited securities which are distributed by the depositary to registered ADS holders
 
   
US$0.02 (or less) per ADS per calendar year
 
    Depositary services
 
   
Registration or transfer fees
 
    Transfer and registration of shares on our share register to or from the name of the depositary or its agent when you deposit or withdraw shares
 
   
Expenses of the depositary
 
    Cable, telex and facsimile transmissions (when expressly provided in the deposit agreement)
 
   
 
 
    Converting foreign currency to U.S. dollars
 
   
Taxes and other governmental charges the depositary or the custodian have to pay on any ADS or share underlying an ADS, for example, stock transfer taxes, stamp duty or withholding taxes
 
    As necessary
 
   
Any charges incurred by the depositary or
its agents for servicing the deposited
securities
 
    As necessary

 

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Fees and Other Payments Made by the Depositary to Us
The depositary has agreed to reimburse us for expenses we incur that are related to the establishment and maintenance of the ADR program, including investor relations expenses. There are limits on the amount of expenses for which the depositary will reimburse us, but the amount of reimbursement available to us is not linked to the amounts of fees the depositary collects from investors. We were entitled to receive US$218,356.34 (after withholding tax) for the period between January 1, 2010 and October 31, 2010 from the depositary as reimbursement for our expenses incurred in connection with investor relationship programs related to the ADS facility. In addition, we are entitled to receive US$368,000 (including withholding tax) for the period between November 2010 and October 2011 from the depositary as the reimbursement for the same purpose. For the year ended December 31, 2010, a total of US$252,744.54 (after withholding tax) has been paid to us.
PART II.
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
Not applicable.
ITEM 15. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, has performed an evaluation of the effectiveness of our disclosure controls and procedures within the meaning of Rules 13a-15(e) and 15d-15(e) of the Exchange Act as of the end of the period covered by this report. Based on such evaluation, our management has concluded that, as of the end of the period covered by this annual report, our disclosure controls and procedures were effective.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) under the Exchange Act. Our management evaluated the effectiveness of our internal control over financial reporting based on criteria established in the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2010.

 

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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness of our internal control over financial reporting to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
Our independent registered public accounting firm, PricewaterhouseCoopers Zhong Tian CPAs Limited Company, has audited the effectiveness of our internal control over financial reporting as of December 31, 2010, as stated in its report, which appears on page F-2 of this annual report on Form 20-F.
Attestation Report of the Registered Public Accounting Firm
See the consolidated financial statements of Home Inns & Hotels Management Inc., which are included at the end of this annual report.
Changes in Internal Control
There were no significant changes in internal control for the year ended December 31, 2010.
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
Our board of directors has determined that Terry Yongmin Hu, Kenneth Gaw and Arthur M. Wang, all of whom are members of our audit committee and independent directors (under the standards set forth in Nasdaq Marketplace Rule 5605(c)(2) and Rule 10A-3 under the Exchange Act), are audit committee financial experts.
ITEM 16B. CODE OF ETHICS
Our board of directors adopted a code of business conduct and ethics on October 2, 2006 that applies to our directors, officers, employees and agents, including certain provisions that specifically apply to our executive officers and any other persons who perform similar functions for us. We have filed our code of business conduct and ethics as an exhibit to our registration statement on Form F-1 (No. 333-137800). On March 3, 2010, our board of directors amended the code of business conduct and ethics adopted in 2006 and appointed Tanya Xiaoxian Tang, who was the head of our internal audit department, as our chief compliance officer. Tanya Xiaoxian Tang resigned from our company in July 2010, and our board of directors has not appointed her replacement. We intend to hire a new head of our internal audit department, and appoint such person as our chief compliance officer. Until such person is hired, Mr. Jianfeng Geng, an employee in our internal audit department, is acting as a chief compliance officer for the purposes of our code of business conduct and ethics. The amended code of business conduct and ethics is filed as an exhibit to this annual report.

 

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ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the aggregate fees by categories specified below in connection with certain professional services rendered by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, our principal external auditors, for the periods indicated. We did not pay any other fees to our auditors during the periods indicated below.
                 
    For the Year Ended December 31,  
    2009     2010  
    (in thousands of RMB)  
Audit fees(1)
    7,150       7,865  
Audit-related fees
          1,338  
Tax fees
           
All other fees
           
 
     
(1)   “Audit fees” means the aggregate fees billed for professional services rendered by our principal auditors for the audit of our annual financial statements and the review of our comparative interim financial statements.
 
(2)   “Audit-related fees” means the aggregate fees billed for professional services rendered by our principal auditors in connection with the offering in 2010 of our convertible notes due 2015.
The policy of our audit committee is to pre-approve all audit and non-audit services provided by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, including audit services, audit-related services, tax services and other services as described above, other than those for de minimis services which are approved by the Audit Committee prior to the completion of the audit.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
None.
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT
Not applicable.
ITEM 16G. CORPORATE GOVERNANCE
Nasdaq Marketplace Rule 5250(d)(1) requires each issuer to distribute to shareholders copies of an annual report containing audited financial statements of the company and its subsidiaries. It further requires that the report be distributed to shareholders a reasonable period of time prior to the company’s annual meeting of shareholders and that it be filed with Nasdaq at the time it is distributed to shareholders. Nasdaq Marketplace Rule 5620(a) requires each issuer to hold an annual meeting of shareholders no later than one year after the end of the issuer’s fiscal year-end. Nasdaq Marketplace Rule 5635(c) and IM-5635-1 require each issuer to seek shareholder approval for any material amendments to the issuer’s equity compensation plans or other equity compensation arrangements, including a repricing of outstanding options. However, Nasdaq Marketplace Rule 5615(a)(3) permits foreign private issuers like us to follow “home country practice” in certain corporate governance matters.
Maples and Calder, our Cayman Islands counsel, has provided a letter to the Nasdaq Stock Market certifying that under Cayman Islands law, we are not required to hold annual shareholder meetings. We followed home country practice with respect to annual meetings and did not hold an annual shareholder meeting in 2010. We may hold annual shareholder meetings in the future if there are issues that require shareholder approval.

 

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Maples and Calder has also provided a letter to the Nasdaq Stock Market certifying that under Cayman Islands law, we are not required to seek shareholder approval for amendments to our existing equity incentive plans or arrangements. We followed home country practice with respect to certain equity incentive arrangements with our option grantees. In October 2008, we cancelled the unvested portion of the options of each of our option grantees and issued them new options for the same number of underlying ordinary shares, with new vesting schedules and a reduced strike price.
Nasdaq Marketplace Rule 5605(c)(2)(A) requires an audit committee to have a minimum of three members. Pursuant to Nasdaq Marketplace Rule 5615(a)(3), we followed home country practice with respect to the audit committee composition requirement. Maples and Calder has provided a letter to the Nasdaq Stock Market certifying that both the Cayman Islands laws and our articles of association permit us to have only two members serving on the audit committee. During the period from May 21, 2009 to September 22, 2009, our audit committee consisted of only two members. Since September 23, 2009, our audit committee has had three members.
Other than the above, we have followed and intend to continue to follow the applicable corporate governance standards under Nasdaq Marketplace Rules.
In accordance with Nasdaq Marketplace Rule 5250(d)(1), we will post this annual report on Form 20-F on our company website english.homeinns.com. In addition, we will provide hard copies of our annual report free of charge to shareholders and ADS holders upon request.
PART III.
ITEM 17. FINANCIAL STATEMENTS
We have elected to provide financial statements pursuant to Item 18.
ITEM 18. FINANCIAL STATEMENTS
The consolidated financial statements of Home Inns & Hotels Management Inc. are included at the end of this annual report.
ITEM 19. EXHIBITS
         
Exhibit    
Number   Description of Document
       
 
  1.1    
Amended and Restated Memorandum and Articles of Association of the Registrant, effective November 3, 2009 (incorporated by reference to Exhibit 99.3 of Form 6-K (File No. 001-33082) filed with the SEC on November 4, 2009)
       
 
  2.1    
Indenture, dated December 10, 2007, constituting RMB 1,110,000,000 USD Settled Zero Coupon Convertible Senior Bonds due December 10, 2012 (incorporated by reference to Exhibit 2.1 of our annual report on Form 20-F (File No. 001-33082) filed with the SEC on April 18, 2008)
       
 
  2.2 *  
Indenture, dated December 21, 2010, constituting US$184,000,000 2.00% Convertible Senior Notes due December 15, 2015

 

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Exhibit    
Number   Description of Document
       
 
  2.3 *  
Amendment Agreement regarding indenture, dated April 26, 2011, between the Registrant and The Bank of New York Mellon, as trustee
       
 
  2.4 *  
Registration Rights Agreement among the Registrant, Credit Suisse Securities (USA) LLC and J.P. Morgan Securities Ltd., dated December 21, 2010
       
 
  4.1    
Employment Agreement between the Registrant and Jason Zong, dated January 1, 2007 (incorporated by reference to Exhibit 4.1 of our annual report on Form 20-F (File No. 001-33082) filed with the SEC on April 18, 2008)
       
 
  4.2    
Agreement for the Sale and Purchase of Hong Kong Ai Home Hotel Investment Limited dated October 21, 2007 (incorporated by reference to Exhibit 4.2 of our annual report on Form 20-F (File No. 001-33082) filed with the SEC on April 18, 2008)
       
 
  4.3    
English translation of Agreement for the Sale and Purchase of Shanghai Chuwen Holding Investment Ltd. dated October 21, 2007 (incorporated by reference to Exhibit 4.3 of our annual report on Form 20-F (File No. 001-33082) filed with the SEC on April 18, 2008)
       
 
  4.4    
Purchase Agreement by and between the Registrant and Ctrip.com International, Ltd. dated as of May 7, 2009 (incorporated by reference to Exhibit 4.4 of our annual report on Form 20-F (File No. 001-33082) filed with the SEC on April 21, 2010)
       
 
  4.5    
Registration Rights Agreement by and among the Registrant and Ctrip.com International, Ltd. as of May 7, 2009 (incorporated by reference to Exhibit 4.5 of our annual report on Form 20-F (File No. 001-33082) filed with the SEC on April 21, 2010)
       
 
  4.6    
Amended and Restated 2006 Share Incentive Plan, effective November 3, 2009 (incorporated by reference to Exhibit 99.2 of Form 6-K (File No. 001-33082) filed with the SEC on November 4, 2009)
       
 
  4.7 *  
Purchase Agreement for convertible notes due 2015 among the Registrant, Credit Suisse Securities (USA) LLC and J.P. Morgan Securities Ltd., dated December 14, 2010
       
 
  4.8    
Employment Agreement between the Registrant and David Jian Sun, dated January 1, 2007 (incorporated by reference to Exhibit 10.3 of our F-1 registration statement (File No. 333-142190), as amended, initially filed with the SEC on April 18, 2007)
       
 
  4.9    
Employment Agreement between the Registrant and May Wu, dated January 1, 2007 (incorporated by reference to Exhibit 10.5 of our F-1 registration statement (File No. 333-142190), as amended, initially filed with the SEC on April 18, 2007)
       
 
  4.10 *  
Employment Agreement between the Registrant and Huiping Yan, dated July 13, 2009
       
 
  4.11 *  
Amendment to Employment Agreement between the Registrant and Jason Zong, effective January 1, 2008
       
 
  4.12 *  
Amendment to Employment Agreement between the Registrant and May Wu, effective April 22, 2010
       
 
  4.13 *  
Amendment to Employment Agreement between the Registrant and Huiping Yan, effective April 22, 2010
       
 
  8.1 *  
Subsidiaries of the Registrant
       
 
  9.1    
Shareholders agreement, dated June 29, 2006 (incorporated by reference to Exhibit 4.8 from our F-1 registration statement (File No. 333-142190), as amended, initially filed with the SEC on April 18, 2007)
       
 
  11.1    
Code of Business Conduct and Ethics of the Registrant, as amended on March 3, 2010 (incorporated by reference to Exhibit 11.1 of our annual report on Form 20-F (File No. 001-33082) filed with the SEC on April 21, 2010).
       
 
  12.1 *  
CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  12.2 *  
CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  13.1 *  
CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
  13.2 *  
CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
  23.1 *  
Consent of Maples and Calder
 
  23.2 *  
Consent of PricewaterhouseCoopers Zhong Tian CPAs Limited Company
 
     
*   Filed with this Annual Report on Form 20-F.

 

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SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
         
  HOME INNS & HOTELS MANAGEMENT INC.
 
 
  By:   /s/ David Jian Sun  
    Name:   David Jian Sun   
    Title:   Director and Chief Executive Officer   
Date: April 27, 2011

 

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HOME INNS & HOTELS MANAGEMENT INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 


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(PRICEWATERHOUSECOOPERS LOGO)
     
 
  (CHINESE CHARACTER)
 
  11th Floor
 
  PricewaterhouseCoopers Center
 
  2 Corporate Avenue
 
  202 Hu Bin Road
 
  Shanghai 200021
 
  People’s Republic of China
 
  Telephone +86 (21) 2323 8888
 
  Facsimile +86 (21) 2323 8800
 
  www.pwccn.com
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Home Inns & Hotels Management Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of Home Inns & Hotels Management Inc. (the “Company”) and its subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, appearing in Item 15 of this Form 20-F. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers Zhong Tian CPAs Limited Company
PricewaterhouseCoopers Zhong Tian CPAs Limited Company
 
Shanghai, the People’s Republic of China
 
April 27, 2011

 

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HOME INNS & HOTELS MANAGEMENT INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2008, 2009 AND 2010
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
                                     
    Note   2008     2009     2010     2010  
                                US$ thousands  
                                (Note 2(d))  
Revenues:
                                   
Leased-and-operated hotels
        1,771,762       2,453,105       2,910,458       440,978  
Franchised-and-managed hotels
        99,779       147,535       256,799       38,909  
 
                           
Total revenues
        1,871,541       2,600,640       3,167,257       479,887  
Less: Business tax and related surcharges
        (111,870 )     (158,975 )     (191,232 )     (28,975 )
Net revenues
        1,759,671       2,441,665       2,976,025       450,912  
Operating costs and expenses:
                                   
Leased-and-operated hotel costs —
                                   
Rents and utilities
        (643,694 )     (797,944 )     (875,510 )     (132,653 )
Personnel costs
        (337,837 )     (461,949 )     (506,406 )     (76,728 )
Depreciation and amortization
        (190,698 )     (281,543 )     (308,888 )     (46,801 )
Consumables, food and beverage
        (143,555 )     (172,467 )     (173,256 )     (26,251 )
Others
        (182,284 )     (275,186 )     (310,705 )     (47,077 )
 
                           
Total leased-and-operated hotel costs
        (1,498,068 )     (1,989,089 )     (2,174,765 )     (329,510 )
Sales and marketing expenses
  2(w)     (27,161 )     (30,462 )     (33,257 )     (5,039 )
General and administrative expenses
        (152,648 )     (180,480 )     (237,610 )     (36,002 )
 
                           
Total operating costs and expenses
        (1,677,877 )     (2,200,031 )     (2,445,632 )     (370,551 )
 
                           
Income from operations
        81,794       241,634       530,393       80,361  
 
                           
Interest income
        32,023       6,686       9,454       1,432  
Interest expense
        (28,136 )     (10,983 )     (2,024 )     (307 )
Issuance costs for convertible notes
  10                 (42,559 )     (6,448 )
Loss on change in fair value of convertible notes
  10                 (9,040 )     (1,370 )
Gain on buy-back of convertible bonds
  9     103,291       69,327       2,480       376  
Other non-operating income
  2(ac)     10,971       16,248       22,223       3,367  
Foreign exchange loss, net
  2(c)     (65,524 )     (286 )     (4,350 )     (659 )
 
                           
Income before income tax expense and noncontrolling interests
        134,419       322,626       506,577       76,752  
Income tax expenses
  4     (28,107 )     (62,166 )     (139,969 )     (21,207 )
 
                           
Net income
        106,312       260,460       366,608       55,545  
 
                                   
Less: Net income attributable to noncontrolling interests
        (5,087 )     (4,457 )     (7,109 )     (1,077 )
 
                           
Net income attributable to Home Inns’ shareholders
        101,225       256,003       359,499       54,468  
 
                           
 
                                   
Earnings per share
  13                                
— Basic
        1.43       3.37       4.45       0.67  
 
                           
— Diluted
        0.04       2.34       4.23       0.64  
 
                           
Weighted average ordinary shares outstanding
                                   
— Basic
        70,863,336       75,922,589       80,846,617       80,846,617  
 
                           
— Diluted
        78,037,433       80,895,112       84,747,102       84,747,102  
 
                           
Share-based compensation expense was included in the statement of operations as follows:
                                   
Leased-and-operated hotel costs — Personnel costs
        11                    
General and administrative expenses
        24,833       32,009       53,272       8,072  
The accompanying notes are an integral part of these consolidated financial statements.

 

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HOME INNS & HOTELS MANAGEMENT INC.
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2009 AND 2010
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
                             
    Note   2009     2010     2010  
                        US$ thousands  
                        (Note 2(d))  
ASSETS
                           
Current assets:
                           
Cash and cash equivalents
  2(e)     829,592       2,382,643       361,007  
Restricted cash
  2(f)           21,552       3,265  
Accounts receivable
  2(h)     32,069       43,274       6,557  
Receivables from related parties
  14     3,136       5,659       857  
Consumables
        15,319       25,459       3,857  
Prepayments and other current assets
  3, 2(h)     53,054       77,886       11,801  
Deferred tax assets, current
  4     38,918       42,613       6,457  
 
                     
Total current assets
        972,088       2,599,086       393,801  
 
                     
Property and equipment, net
  5     1,905,307       2,104,393       318,847  
Goodwill
  6     390,882       390,882       59,225  
Intangible assets, net
  7     43,184       42,393       6,423  
Other assets
        33,861       50,473       7,647  
Deferred tax assets, non-current
  4     109,626       98,918       14,988  
 
                     
Total assets
        3,454,948       5,286,145       800,931  
 
                     
LIABILITIES
                           
Current liabilities:
                           
Accounts payable
        21,654       45,742       6,931  
Payables to related parties
  14     3,815       4,182       634  
Convertible bonds, current
  9     363,506              
Salaries and welfare payable
        103,667       141,839       21,491  
Income tax payable
        61,764       42,397       6,424  
Other taxes payable
        15,361       15,308       2,319  
Deferred revenues
        57,232       73,150       11,083  
Accruals for customer reward program
  2(r)     13,331       17,406       2,637  
Other unpaid and accruals
  8     67,502       79,434       12,034  
Other payables
  8     217,798       419,118       63,503  
 
                     
Total current liabilities
        925,630       838,576       127,056  
 
                     
The accompanying notes are an integral part of these consolidated financial statements.

 

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HOME INNS & HOTELS MANAGEMENT INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
AS OF DECEMBER 31, 2009 AND 2010
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
                             
    Note   2009     2010     2010  
                        US$ thousands  
                        (Note 2(d))  
Deferred rental
        155,612       191,034       28,945  
Deferred revenues, non-current
        45,240       56,996       8,636  
Deposits
        20,735       33,454       5,069  
Unfavorable lease liability
  7     14,585       13,211       2,002  
Convertible bonds, non-current
  9           159,402       24,152  
Financial liability (Convertible notes measured at fair value)
  10           1,227,577       185,997  
Deferred tax liability, non-current
  4     11,577       11,552       1,750  
 
                     
Total liabilities
        1,173,379       2,531,802       383,607  
 
                     
 
                           
Commitments and contingencies
  15                        
 
                           
Shareholders’ equity
                           
Ordinary shares (US$ 0.005 par value; 200,000,000 shares authorized, 80,303,510 and 81,716,084 shares issued and outstanding as of December 31, 2009 and 2010, respectively)
  11     3,209       3,257       493  
Additional paid-in capital
        1,798,086       1,913,734       289,960  
Statutory reserves
  2(ad)     67,591       94,114       14,260  
Retained earnings
        399,218       732,194       110,938  
 
                     
Total Home Inns shareholders’ equity
        2,268,104       2,743,299       415,651  
 
                     
 
                           
Noncontrolling interests
        13,465       11,044       1,673  
 
                     
Total shareholders’ equity
        2,281,569       2,754,343       417,324  
 
                     
 
                           
Total liabilities and shareholders’ equity
        3,454,948       5,286,145       800,931  
 
                     
The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

HOME INNS & HOTELS MANAGEMENT INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2008, 2009 AND 2010
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
                                                         
                    Additional                             Total  
    Ordinary shares     paid-in     Statutory     Retained     Noncontrolling     shareholders’  
    Shares     Amount     Capital     reserves     earnings     interests     equity  
 
                                                       
Balance as of January 1, 2008
    70,487,385       2,874       1,362,942       41,333       68,248       11,087       1,486,484  
 
                                         
Exercise of stock purchase right (Note 12)
    215,286       8       1,982                         1,990  
Exercise of stock option (Note 12)
    510,124       17       4,135                         4,152  
Recognition of share-based compensation costs
                24,844                         24,844  
Dividends distributed to noncontrolling interests
                                  (2,850 )     (2,850 )
Net income
                            101,225       5,087       106,312  
Appropriations to statutory reserves
                      8,661       (8,661 )            
Acquisition of a subsidiary
                                  5,400       5,400  
Establishment of a variable interest entity
                                  349       349  
 
                                         
 
                                                       
Balance as of December 31, 2008
    71,212,795       2,899       1,393,903       49,994       160,812       19,073       1,626,681  
 
                                         
Issuance of ordinary shares to Ctrip.com International, Ltd. (Note 11)
    7,514,503       256       340,822                         341,078  
Exercise of stock purchase right (Note 12)
    188,824       6       1,642                         1,648  
Exercise of stock option (Note 12)
    1,387,388       48       29,710                         29,758  
Recognition of share-base compensation costs
                32,009                         32,009  
Dividends distributed to noncontrolling interests
                                  (5,889 )     (5,889 )
Net income
                            256,003       4,457       260,460  
Appropriations to statutory reserves
                      17,597       (17,597 )            
Acquisition of noncontrolling interest of a subsidiary
                                  (4,176 )     (4,176 )
 
                                         
 
                                                       
Balance as of December 31, 2009
    80,303,510       3,209       1,798,086       67,591       399,218       13,465       2,281,569  
 
                                         
The accompanying notes are an integral part of these consolidated financial statements

 

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Table of Contents

HOME INNS & HOTELS MANAGEMENT INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2008, 2009 AND 2010
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
                                                         
                    Additional                             Total  
    Ordinary shares     paid-in     Statutory     Retained     Noncontrolling     shareholders’  
    Shares     Amount     Capital     reserves     earnings     interests     equity  
 
                                                       
Balance as of December 31, 2009
    80,303,510       3,209       1,798,086       67,591       399,218       13,465       2,281,569  
 
                                         
Exercise of stock purchase right (Note 12)
    75,000       3       781                         784  
Exercise of stock option (Note 12)
    1,337,574       45       61,595                         61,640  
Recognition of share-based compensation costs
                53,272                         53,272  
Dividends distributed to noncontrolling interests
                                  (9,530 )     (9,530 )
Net income
                            359,499       7,109       366,608  
Appropriations to statutory reserves
                      26,523       (26,523 )            
 
                                         
 
                                                       
Balance as of December 31, 2010
    81,716,084       3,257       1,913,734       94,114       732,194       11,044       2,754,343  
 
                                         
 
                                                       
Balance as of December 31, 2010 US$ thousands (Note 2(d))
    81,716,084       493       289,960       14,260       110,938       1,673       417,324  
 
                                         
The accompanying notes are an integral part of these consolidated financial statements

 

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HOME INNS & HOTELS MANAGEMENT INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2008, 2009 AND 2010
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
                                 
    2008     2009     2010     2010  
                            US$ thousands  
                            (Note 2(d))  
Cash flows from operating activities:
                               
Net income
    106,312       260,460       366,608       55,545  
Adjustments to reconcile net income to net cash provided by operating activities:
                               
Share-based compensation
    24,844       32,009       53,272       8,072  
Depreciation and amortization
    199,989       286,574       319,988       48,483  
Foreign exchange loss, net
    65,524       286       4,350       659  
Loss/(gain) from disposal of property and equipment
    2,315       (2,946 )     (6,165 )     (934 )
Impairment loss of property and equipment
          5,477              
Gain on buy-back of convertible bonds
    (103,290 )     (69,327 )     (2,480 )     (376 )
Issuance costs for convertible notes
                42,559       6,448  
Loss on change in fair value of convertible notes
                9,040       1,370  
Deferred income tax
    (55,572 )     (29,843 )     6,789       1,029  
Change in assets and liabilities, net of effects of acquisitions:
                               
Increase in accounts receivable
    (6,163 )     (8,935 )     (11,205 )     (1,698 )
Increase in receivables from related parties
    (245 )     (3,136 )     (2,523 )     (382 )
(Increase)/decrease in consumables
    (7,391 )     11,566       (10,140 )     (1,536 )
Decrease/(increase) in prepayments and other current assets
    1,116       8,497       (25,674 )     (3,890 )
Decrease/(increase) in other assets
    19,017       (684 )     (8,813 )     (1,335 )
Increase/(decrease) in accounts payable
    7,260       (1,043 )     24,088       3,650  
Increase/(decrease) in payables to related parties
    17       (1,206 )     1,150       174  
Increase in salaries and welfare payable
    21,236       33,994       38,172       5,784  
Increase/(decrease) in income tax payable
    9,375       9,306       (19,367 )     (2,934 )
Increase/(decrease) in other taxes payable
    3,718       2,643       (53 )     (8 )
Increase in accruals for customer reward program
    3,148       4,744       4,075       617  
(Decrease)/increase in other payables and accruals
    (18,993 )     39,764       19,409       2,941  
Increase in deferred revenues, current and non-current
    22,941       41,693       27,674       4,193  
Increase in deferred rental
    42,599       18,787       35,422       5,367  
Increase in deposits
    13,741       6,994       12,719       1,927  
Increase in interest accruals for convertible bonds
    5,388       2,989       1,063       161  
 
                       
Net cash provided by operating activities
    356,886       648,663       879,958       133,327  
 
                       
The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

HOME INNS & HOTELS MANAGEMENT INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2007, 2008 AND 2009
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
                                 
    2008     2009     2010     2010  
                            US$ thousands  
                            (Note 2(d))  
Cash flows from investing activities:
                               
Proceeds from sale of property and equipment
    1,657       15,171       21,708       3,289  
Purchase of property and equipment
    (828,484 )     (426,591 )     (373,531 )     (56,595 )
Purchase of intangible assets
    (3,905 )     (4,322 )     (3,539 )     (536 )
Cash (paid) and collected for short term investment
    (100,000 )     102,206              
Net cash used for the acquisition of subsidiaries
    (33,583 )     (9,965 )     (600 )     (91 )
 
                       
Net cash used in investing activities
    (964,315 )     (323,501 )     (355,962 )     (53,933 )
 
                       
Cash flows from financing activities:
                            0  
Net proceeds from issuance of ordinary shares
          341,078              
Proceeds from share option exercise
    4,872       26,975       63,644       9,643  
Net proceeds from issuance of convertible notes
                1,188,823       180,125  
Buy-back of convertible bonds
    (113,370 )     (462,029 )     (202,687 )     (30,710 )
Payment for bond offering related transaction costs
    (4,885 )                  
Repayment of acquired subsidiaries’ debts to former shareholders
    (52,467 )     (5,481 )            
Restricted cash collected for short-term borrowings
    173,849                    
Proceeds from short-term borrowings
    340,000       10,000       24,900       3,773  
Repayment of short-term borrowings
    (609,000 )     (10,000 )     (24,900 )     (3,773 )
Repayment of long-term loan
    (18,036 )                  
Dividend paid by variable interest entities to noncontrolling interests shareholders
    (3,515 )     (4,272 )     (9,530 )     (1,444 )
Other financing activities
    1,350                      
 
                       
Net cash (used)/provided by financing activities
    (281,202 )     (103,729 )     1,040,250       157,614  
 
                       
 
                               
Effect of foreign exchange rate changes on cash and cash equivalents
    (65,524 )     (286 )     (11,195 )     (1,697 )
 
                               
Net (decrease)/increase in cash and cash equivalents
    (954,155 )     221,147       1,553,051       235,311  
Cash and cash equivalents, beginning of year
    1,562,600       608,445       829,592       125,696  
 
                       
Cash and cash equivalents, end of year
    608,445       829,592       2,382,643       361,007  
 
                       
 
                               
Supplemental disclosure of cash flow information
                               
Cash paid during the year for income taxes
    (73,897 )     (82,703 )     (152,547 )     (23,113 )
Cash paid during the year for interest
    (7,733 )     (43 )     (211 )     (32 )
 
                               
Supplemental schedule of non-cash activities:
                               
Accruals related to the construction costs of property and equipment
    163,967             169,196       25,636  
Accruals related to the issuance costs for convertible notes
                5,998       909  
Restricted cash related to the exercise of the employee stock option
                21,552       3,265  
The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

HOME INNS & HOTELS MANAGEMENT INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
1. ORGANIZATION AND NATURE OF OPERATIONS
The accompanying consolidated financial statements include the financial statements of Home Inns & Hotels Management Inc. (“the Company”), its subsidiaries, and variable interest entities (“VIEs”) for which the Company is the primary beneficiary (“VIE subsidiary”). The Company and its consolidated subsidiaries and VIE subsidiaries are collectively referred to as the “Group”.
The Company was established in Cayman Islands on May 30, 2006. In June 2006, all the then existing shareholders of Home Inns & Hotels Management (Hong Kong) Limited (“Home Inns HK”), the Company’s predecessor, exchanged their respective shares in Home Inns HK for an equivalent number of shares in the Company. As a result, Home Inns HK became a wholly-owned subsidiary of the Company. Home Inns HK did not have any operations until April 2002 when Home Inns & Hotels Management (Beijing) Co., Ltd. (“Home Inns Beijing”), a hotel operation and management company, was established as a joint venture of Home Inns HK and Beijing Capital Travel International Hotel Group Co., Ltd. (“Beijing Capital Travel”), a subsidiary of Beijing Tourism Group (“BTG”). At inception, Home Inns HK and BTG, through Beijing Capital Travel, owned 55% and 45% interest in Home Inns Beijing, respectively. Through a series of financing activities and acquisitions, Home Inns Beijing has become a wholly-owned subsidiary in July 2007.
In October 2006, the Company completed an initial public offering of American Depositary Shares (“ADSs”). ADSs of the Company are traded from October 26, 2006 on Nasdaq Global Market under the symbol “HMIN” in the United States.
The principal activities of the Group are to develop, lease, operate, franchise, and manage economy hotels under the Home Inn brand in the People’s Republic of China (“PRC”). The Group either leases real estate properties on which it develops and operates hotels or franchises the Home Inn brand to hotel owners and manages these hotels. The former type of hotels is referred to as “leased-and-operated hotels” and the latter type of hotels as “franchised-and-managed hotels.”
Leased-and-operated hotels
The Group leases hotel properties from property owners and develops these hotels directly, by hiring, training and supervising the managers and employees to operate the hotels. The Group is responsible for hotel development and customization to conform to the standards of Home Inns, as well as repairs and maintenance, operating expenses and management of properties over the term of the lease. Under the lease arrangements, the Group typically enjoys rental holiday of three to six months and pays fixed rent on a quarterly basis for the first three or five years of the lease term, after which the rental payments may be subject to an increase every three to five years.
Franchised-and-managed hotels
The Group enters into certain franchise arrangements with hotel owners for which the Group is responsible for managing the hotels, including hiring and appointment of the general manager of each franchised-and-managed hotel. Under a typical franchise agreement, the franchisee is required to pay an initial franchise fee and ongoing management service fees equal to a certain percentage of the revenues of the hotel. The franchisee is responsible for the costs of hotel development and customization and the costs of its operations. The term of the franchise agreement is typically 5 years or 8 years and is renewable only upon mutual agreement between the Group and the franchisee.

 

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Table of Contents

HOME INNS & HOTELS MANAGEMENT INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
2. PRINCIPAL ACCOUNTING POLICIES
The principal accounting policies adopted in the preparation of these consolidated financial statements are set out below:
a. Basis of presentation and use of estimates
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”).
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ materially from those estimates.
b. Basis of consolidation and accounting for investments
The consolidated financial statements include the financial statements of the Company, its subsidiaries and VIEs. All significant transactions and balances between the Company, its subsidiaries and certain VIEs have been eliminated upon consolidation.
A subsidiary is an entity in which the Company, directly or indirectly, controls more than one half of the voting power; has the power to appoint or remove the majority of the members of the board of directors; to cast a majority of votes at the meeting of the board of directors or to govern the financial and operating policies of the investee under a statute or agreement among the shareholders or equity holders.
Prior to January 1, 2010, the Company follows FIN 46(R): Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, in accounting for variable interest entities and the consolidation. Certain entities were considered variable interest entities because the equity at risk of each entity was not sufficient to finance its intended activities without additional financial support. The Company was considered the primary beneficiary of these entities because it absorbs a majority of the entities’ expected losses and receives a majority of the entities’ expected residual returns. Accordingly, the financial statements of the following VIEs are consolidated into the Company’s financial statements since their respective date of establishment/acquisition:
         
Name of VIE   The Company’s ownership interest  
 
       
Home Inns & Hotels Management (Xiamen) Co., Ltd. (“Home Inns Xiamen”)
    51 %
Home Inns & Hotels Management (Fuzhou) Co., Ltd. (“Home Inns Fuzhou”)
    51 %
Home Inns & Hotels Management (Caoxi) Co., Ltd. (“Home Inns Caoxi”)
    51 %
Home Inns & Hotels Management (Caobao) Co., Ltd. (“Home Inns Caobao”)
    75 %
Home Inns & Hotels Management (Dongguan) Co., Ltd. (“Home Inns Dongguan”)
    65 %
Home Inns & Hotels Kuaijie (Fuzhou) Co., Ltd. (“Home Inns Fuzhou Kuaijie”)
    70 %
In June 2009, the FASB issued FAS 167: Amendments to FASB Interpretation No. 46(R), codified primarily in the Consolidation Topic of the FASB ASC 810. This guidance modifies the method for determining whether an entity is a variable interest entity as well as the methods permitted for determining the primary beneficiary of a variable interest entity. In addition, this guidance requires ongoing reassessments of whether a company is the primary beneficiary of a variable interest entity and enhanced disclosures related to a company’s involvement with a variable interest entity. The Company adopted this guidance as of January 1, 2010.
In accordance with the new guidance, the Company is deemed to have a controlling financial interest and is the primary beneficiary of these VIEs as it has both the power to direct the activities of the VIEs that most significantly impact the VIEs’ economic performance and an obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. As a result, the Company continues to consolidate the same VIEs that were consolidated prior to January 1, 2010 and the adoption of FAS 167 effective as of January 1, 2010 did not have impact on the Company’s consolidated financial statements.

 

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HOME INNS & HOTELS MANAGEMENT INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
The total registered capital of the six VIEs was RMB 6,010 as of December 31, 2009 and December 31, 2010. The total net assets of the six VIEs were RMB 31,333 and RMB 26,262 as of December 31, 2009 and December 31, 2010, respectively. The total net income of the six VIE was RMB 12,268, RMB 11,436 and RMB 16,257 in the year ended December 31, 2008, 2009, and 2010, respectively. Management monitors the regulatory risk associated with these contractual arrangements. There are no consolidated VIE assets that are collateral for the VIE obligations and which can only be used to settle the VIE’s obligations. Creditors of the VIE have no recourse to the general credit of Home Inns & Hotels Management (Shanghai) Co., Ltd., which is the primary beneficiary of the VIEs.
The Company evaluates its business relationships such as those with franchisees to identify potential variable interest entities. Generally, these businesses qualify for a scope exception under the consolidation guidance. The Company has concluded that consolidation of any such entities is not appropriate for the periods presented under both FIN 46(R) and FAS 167.
c. Foreign currencies
The Group’s functional currency and reporting currency is Renminbi (“RMB”). Transactions denominated in currencies other than RMB are translated into RMB at the exchange rates quoted by the People’s Bank of China (the “PBOC”) prevailing at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies are translated into RMB using the applicable exchange rates quoted by the PBOC at the balance sheet dates. All such exchange gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations.
The RMB is not a freely convertible currency. The PRC State Administration for Foreign Exchange, under the authority of the People’s Bank of China, controls the conversion of RMB into foreign currencies. The value of the RMB is subject to changes in central government policies and to international economic and political developments affecting supply and demand in the China foreign exchange trading system market.
d. Convenience translation
Translations of balances in the statements of operations, balance sheet and statement of cash flows from RMB into United States dollars (“US$”) as of and for the year ended December 31, 2010 are solely for the convenience of the reader and were calculated at the rate of US$ 1.00 = RMB 6.6000, on December 31, 2010, representing the certificated exchange rate published by the Federal Reserve Board. No representation is intended to imply that the RMB amounts could have been, or could be, converted, realized or settled into US$ at that rate on December 31, 2010, or at any other rate.
e. Cash and cash equivalents
Cash and cash equivalents comprise cash on hand and liquid investment which are unrestricted as to withdrawal or use, and which have original maturities of three months or less that are placed with banks or other financial institutions. Cash and cash equivalents balance as of December 31, 2009 included US$ 23,313 thousand and HK$ 0.4 thousand. Cash and cash equivalents balance as of December 31, 2010 included US$ 211,592 thousand and HK $0.1 thousand.
f. Restricted cash
Restricted cash represents cash proceeds from the exercise of share options by the Company’s employees which are yet to be transmitted to them.
g. Short-term investment
Short-term marketable securities are measured at fair value. In 2009, the Group fully redeemed its short-term investment of RMB 100 million which represented cash invested in close-end fund with original maturities greater than three months. There was no short-term investment balance as at December 31, 2009 and 2010.
h. Allowance for doubtful accounts
Provision is made against receivables to the extent collection is considered to be doubtful. Accounts receivable and other receivables in the balance sheet are stated net of such provision, if any. As of December 31, 2009 and 2010, the Group has not recorded any allowance for doubtful accounts.

 

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HOME INNS & HOTELS MANAGEMENT INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
i. Consumables
The Group purchases consumables for the operation of leased-and-operated hotels. Consumables include fabrics, such as towels and beddings, which need to be renewed periodically. Consumables are amortized over their useful lives, generally one year or less, from the time they are put into use and are stated at purchase price less accumulated amortization.
j. Property and equipment, net
Property and equipment are stated at cost less accumulated depreciation and amortization and impairment losses, if any. The cost of property and equipment comprises its purchase price and any directly attributable costs, including interest cost during the period the asset is brought to its working condition and location for its intended use.
Depreciation and amortization of property and equipment is provided using the straight line method over their expected useful lives. The expected useful lives are as follows:
     
Buildings
  40 years
Leasehold improvements
  Over the shorter of the economic useful life or the lease period
Machinery and equipment
  5 to 10 years
Furniture, fixtures and office equipment
  3 to 5 years
Construction in progress represents leasehold improvements under construction or installation and is stated at cost. Cost comprises original cost of property and equipment, installation, construction and other direct costs. Construction in progress is transferred to property and equipment and depreciation commences when the asset is ready for its intended use.
Expenditures for repairs and maintenance are expensed as incurred. Gain or loss on disposal of property and equipment, if any, is recognized in the statements of operations as the difference between the net sales proceeds and the carrying amount of the underlying asset.
k. Fair value measurement
The Company adopted Accounting Standard Codification (“ASC”) 820 “Fair value measurements and disclosures” on January 1, 2008. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The guidance outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. Under GAAP, certain assets and liabilities must be measured at fair value, and the guidance details the disclosures that are required for items measured at fair value.
The Company measures the fair value of financial assets and liabilities using inputs from the following three levels of the fair value hierarchy. The three levels are as follows:
Level 1 inputs are unadjusted quoted prices in active markets for identical assets that the management has the ability to access at the measurement date.
Level 2 inputs include quoted prices for similar assets in active markets, quoted prices for identical or similar assets in markets that are nor active, inputs other than quoted prices that are observable for the asset (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
Level 3 includes unobservable inputs that reflect the management’s assumptions about the assumptions that market participants would use in pricing the asset. The management develops these inputs based on the best information available, including the own data.

 

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HOME INNS & HOTELS MANAGEMENT INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
l. Fair value of financial instruments
Financial instruments of the Group primarily comprise of cash and cash equivalents, restricted cash, short-term investments, receivables, payables, accruals, convertible bonds and financial liability. In accordance with ASC 820, fair value of cash and cash equivalents, restricted cash, receivables, payables, and accruals is measured using Level 1 inputs and their carrying values approximated their estimated fair values due to the short-term nature of these financial instruments. Fair value of convertible bonds is measured using Level 1 input, which is based on quotes obtained from over-the-counter trading activities (refer to Note 9). Fair value of financial liability is measured using Level 3 inputs, which is measured using binomial model. The estimated fair value of financial liability amounted to approximately RMB 1,227,577 (US$ 185,997) as of December 31, 2010 (refer to Note 10).
The Company determines the fair value of the financial liabilities associated with the issuances of convertible notes in 2010 using the binomial model, one of the option pricing methods. The valuation involves complex and subjective judgment and the Company’s best estimates of the probability of occurrence of future events, such as fundamental changes, on the valuation date. Under the binomial valuation model, the Company uses a weighted risk-free and risky interest rate (the combination of the risk free rate plus the credit spread for the underlying notes) weighted by the probability of conversion as internally solved out by binomial model in discounting its cash flows. The main inputs to this model include the underlying share price, the expected share volatility, the expected dividend yield, the risk free and risky interest rate etc.
m. Business combinations and non controlling interests
U.S. GAAP requires that business combinations be accounted for under the purchase method. From January 1, 2009, the group adopted ASC805 (formerly referred to as SFAS No. 141 (revised 2007), “Business combinations”). Following this adoption, the cost of an acquisition is measured as the aggregate of the fair values at the date of exchange of the assets given, liabilities incurred, and equity instruments issued. The costs directly attributable to the acquisition are expensed as incurred. Identifiable assets, liabilities and contingent liabilities acquired or assumed are measured separately at their fair value as of the acquisition date, irrespective of the extent of any non controlling interests. The excess of the (i) the total of cost of acquisition, fair value of the non controlling interests and acquisition date fair value of any previously held equity interest in the acquiree over (ii) the fair value of the identifiable net assets of the acquiree is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in the income statement.
The determination and allocation of fair values to the identifiable assets acquired and liabilities assumed is based on various assumptions and valuation methodologies requiring considerable management judgment, the most significant variables in these valuations are discount rates, terminal values, the number of years on which to base the cash flow projections, as will as the assumptions and estimates used to determine the cash inflows and outflows. Management determines discount rates to be used based on the risk inherent in the related activity’s current business model and industry comparisons. Terminal values are based on the expected life of products and forecasted life cycle and forecasted cash flows over that period. Although we believe that the assumptions applied in the determination are reasonable based on information available at the date of acquisition, actual results may differ from the forecasted amounts and the difference could be material.
n. Goodwill
Goodwill represents the excess of the cost of an acquired entity over the appropriate share of the fair value of the identifiable assets and liabilities acquired including separately identifiable intangible assets and are allocated to respective reporting units. US GAAP requires that a two-step impairment test be performed annually or whenever events or changes in circumstances indicate that the carrying value of the goodwill may not be recoverable. The first step of the test for impairment compares the book value of the Group’s reporting unit under which goodwill is recorded to its estimated fair value. The second step of the goodwill impairment test, which is only required when the net book value of the reporting unit exceeds the fair value, measures the impairment as the difference between the implied fair value of goodwill and its book value. Goodwill is not amortized. No impairment was recognized for the years ended December 31, 2008, 2009 and 2010. At December 31, 2010, all of the Company’s goodwill was allocated to the hotel operations reporting unit.

 

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HOME INNS & HOTELS MANAGEMENT INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
o. Intangible assets, net
Intangible assets consist primarily of intangible assets acquired in business combinations. Intangible assets acquired through business combinations are recognized as assets separate from goodwill if they satisfy either the “contractual-legal” or “separability” criterion. Intangible assets, including favorable lease agreements and certain franchise agreements existing as of the date of acquisition, are recognized and measured at fair value upon acquisition. Intangible assets from such business combination transactions are amortized over the remaining operating lease term or the franchise agreement term, as appropriate. Unfavorable lease agreements acquired through business combinations is recognized as a liability.
Purchased software is stated at cost less accumulated amortization and impairment, if any.
p. Impairment of long-lived assets and definite-lived intangible assets
Long-lived assets and definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that carrying amount of an asset may not be recoverable. If the total of the expected future undiscounted cash flows is less than the carrying value, an indication of impairment is present and a loss is recognized in the statements of operations for the difference between the fair value, using the expected future discounted cash flows, and the carrying value of the assets. The impairment loss recognized for the year ended December 31, 2008, 2009 and 2010 was nil, RMB 5,477 and nil, respectively.
q. Employee benefits
The employees of the Company’s PRC subsidiaries and VIE subsidiaries are entitled to staff welfare benefits including medical care, housing fund, unemployment insurance and pension benefits. These entities are required to accrue for these benefits based on certain percentages of the employees’ salaries, subject to certain ceilings, in accordance with the relevant PRC regulations and make contributions to the government-sponsored plans out of the amounts accrued. Employee benefits expense was RMB 77,916, RMB 90,525 and RMB 103,292 for the years ended December 31, 2008, 2009 and 2010, respectively. Amounts accrued and included in salaries and welfare payable and other unpaid and accruals in the balance sheets were RMB 3,414 and RMB 3,796 for the years ended December 31, 2009 and 2010, respectively.
r. Accruals for customer reward program
The Group invites its customers to participate in a customer reward program. Prior to November 14, 2004, membership was free of charge. A one-time membership fee was charged after that date for new members. Members enjoy discounts on room rates, priority in hotel reservation, and accumulate membership points for their paid stays, which can be redeemed for membership upgrades, room night awards and other gifts. The estimated incremental costs to provide membership upgrades, room night awards and other gifts are accrued and recorded as accruals for customer reward program as members accumulate points and recognized as sales and marketing expenses in the statements of operations. As members redeem awards or their entitlements expire, the provision is reduced correspondingly. As of December 31, 2009 and 2010, the accruals for customer reward program amounted to RMB 13,331 and RMB 17,406, respectively, based on the estimated liabilities under the customer reward program.
s. Deferred Revenue
Deferred revenue generally consists of advances received from customers for room stays, initial franchise fees received prior to the Group fulfilling its commitments to the franchisee, and cash received from sale of membership programs. Non-current portion of deferred revenue represents cash received from sales of membership program, which is recognized after one year from the balance sheet date.

 

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HOME INNS & HOTELS MANAGEMENT INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
t. Revenue recognition
Revenues from leased-and-operated hotels represent primarily room rentals and food and beverage sales from the leased-and-operated hotels. Such revenues are recognized when goods are delivered and services are provided.
Revenues from franchised-and-managed hotels are derived from franchise agreements where the franchisees are required to pay (i) an initial one-time franchise fee and (ii) on-going management and service fees based on a percentage of revenue, which approximates 5% to 6% of the room revenues of the franchised hotels. The one-time franchise fee is recognized when the franchised hotel opens for business, the fee becomes non-refundable, and the Group has fulfilled all its commitments and obligations, including the assistance to the franchisees in property design, leasehold improvement construction project management, systems installation, personnel recruiting and training. On-going management and service fees are recognized when the underlying service revenue is recognized by the franchisees’ operations. Other revenues generated from franchise agreements include system maintenance and support fee and central reservation system (“CRS”) usage fee, which are recognized when services are provided.
Prior to 2006, given the limited history in operating the Group’s customer reward program (Note 2(r)), all one-time membership fees were recognized as deferred revenue when received. In 2006, management made an analysis of the historic activity pattern of membership cards and noted that membership cards with no activity for more than a year are most likely to expire in the future. Therefore, the Group recognizes revenue from one-time membership fees when membership records show no activity after a year. For the years ended December 31, 2008, 2009 and 2010, the Company recognized revenue of RMB 10,958, RMB 14,434 and RMB 33,846 from one-time membership fees, respectively.
The Group will continue to monitor membership activity patterns and will utilize such information to estimate the average life of members. When the Company has sufficient historical experience, the Company expects it will recognize one-time membership fees over the average life of members.
u. Business tax and related surcharge
The Group is subject to business tax and related surcharges on the services provided in the PRC. Such tax is levied based on turnover at an applicable rate of 5.5% and is recorded as a reduction of revenues.
v. Leased-and-operated hotel costs
Leased-and-operated hotel costs include all direct costs incurred in the operation of the leased-and-operated hotels and consist primarily of property rentals and related expenses, utility costs, personnel compensation, amortization of guest room consumables, amortization of leasehold improvements, depreciation of equipment, amortization of consumables costs, food and beverage.
w. Sales and marketing expenses
Sales and marketing expenses consist primarily of advertising related expenses, expenses associated with the Company’s membership reward program, payroll and related compensation for the Group’s sales and marketing personnel and entertainment expenses relating to marketing activities. Advertising related expenses, including promotion expenses and production costs of marketing materials, are charged to the statements of operations as incurred and amounted to RMB 11,972, RMB 12,614 and RMB 11,361 for the years ended December 31, 2008, 2009 and 2010, respectively.
x. Share-based compensation
The Group accounts for share-based compensation arrangements with employees in accordance with ASC 718 “Compensation — Stock Compensation”. It requires the Group to measure at the grant date the fair value of the stock-based award and recognize compensation expense, net of estimated forfeitures, on a straight-line basis, over the requisite service period. The Company uses the Black-Scholes option pricing model to determine the fair value of stock options. The requisite service period is the vesting period, which is generally 4 years. Forfeitures are estimated at the time of grant and revise in subsequent periods if actual forfeitures differ from those estimates.

 

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HOME INNS & HOTELS MANAGEMENT INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Amounts expressed in RMB in thousands, except share and per share data and where otherwise stated)
y. Operating leases
Leases where substantially all the risks and rewards of ownership of assets remain with the lessor are accounted for as operating leases. Payments made under operating leases net of any incentives received from the lessor are charged to the consolidated statements of operations on a straight-line basis over the terms of the underlying lease.
z. Borrowing costs
Interest cost incurred on funds used to construct leasehold improvements during the active construction period is capitalized. For the years ended December 31, 2008, 2009 and 2010, total interest capitalized was RMB 1,127, nil and nil, respectively.
aa. Pre-operating expenditure
Pre-operating expenditure represents start-up costs, other than amounts capitalized as leasehold improvements, for leased-and-operated hotels are charged to the consolidated statements of operations in the period in which it is incurred.
ab. Taxation
The provision for income taxes is based on the income and expense amounts recorded in our consolidated statements of operations. Income tax expenses are recorded using the