GreenTree Hospitality Group Ltd (GHG) 2018 Q3 法說會逐字稿

Hello, ladies and gentlemen. Thank you for standing by for GreenTree's Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference call is being recorded.

I would now like to turn the meeting over to your host for today's call, Mr. Rene Vanguestaine of Christensen, the company's investor relations firm. Please proceed, Rene.

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

GreenTree's earnings release was distributed earlier today and is available on our IR website at ir. 998.com as well as on PR Newswire services. As a reminder, we also posted a PowerPoint presentation that accompanies our comments today to the same IR website.

On the call today from GreenTree are Mr. Alex Xu, Chairman and Chief Executive Officer; Ms. Selina Yang, VP of Operations; Ms. Jasmine Geffner, Chief Financial Officer; and Mr. Nicky Zheng, IR manager.

Mr. Xu will present the company's Q3 2018 performance overview, followed by Ms. Yang, who will discuss business operations and company highlights, and Ms. Geffner will then discuss financials and guidance. They will be available to answer your questions during the Q&A session that will follow.

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

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

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

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

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

I'm pleased to report our 2018 third quarter result. During this quarter, we remain committed to a steady and stable growth strategy as we explore the growing consumption trend in the second- and the third-tier cities and expand our geographical coverage across China. Now we're covering 278 cities at the end of September 2018. We now operate 2,558 hotels across 9 different brands from economy, mid-scale to mid-to-upscale limited services segment of the markets.

During the third quarter, we opened 146 new hotels and continued to grow our pipeline. We are on track to open more new hotels in the remaining part of the year. We also started to explore ways to grow our service apartment business recently. Finally, we continue to explore appropriate value-enhancing acquisition opportunities to help strengthen our hotel platform and increase long-term shareholder value.

In the third quarter of 2018, our total revenue grow 21.6% year-over-year to reach RMB 256.8 million. Gross profit increased 19.5% to RMB 180.7 million. Non-GAAP adjusted EBITDA rose 24.2% to RMB 156.5 million. Net income increased 36.3% to RMB 152.4 million, and the non-GAAP core net income rose 30.3% year-over-year to RMB 125.3 million, while gross margin trimmed slightly from 71.7% to 70.4%.

Adjusted EBITDA margin improved from 59.6% to 60.9%. Net margin improved from 52.9% to 53.3%, and the core net margin improved from 45.5% to 48.8% compared to a year ago. These results were driven by continued growth in our hotel network and improved operating performance at our existing hotels.

In the quarter, we opened 146 new hotels with half of these new open hotels in our mid-scale brand, around 35.6% in economy brands and around 14.4% in the mid-to-upscale brand. Our pipeline of new hotels increased from 306 at end of last year to 504 at September 30, 2018. Approximately 1/4 of our pipelines is in the mid- to upscale hotels, including Gme, Gya and VX, which we launched late last year. We opened 6 under the new 3 brands in the third quarter of 2018. We continue to spread our geographic footprint further across China. We now cover 278 cities, up from 263 cities at end of last year.

In terms of our operating performance, we saw steady progress across the board. Average daily room, or ADR, for the quarter increased by 4.4% year-over-year to RMB 167. Occupancy rate had a slight decrease of 0.2% to 87.2%, which was related to accelerating new hotel openings in the first 9 months of 2018 and the third quarter of 2018. And the revenues per available room increased 4.3% year-over-year to RMB 146.

One of the biggest driver of both our steady incremental improvements in operating performance and our high overall profitability is, again, our loyalty program. We now have 26 million individual loyal members and over 1.02 million corporate members. Out of the 26 million members, over 20 million of them have joined our premium paid membership program. Our strong brand and direct relationship with so many valued customers allowed us to continue to sell direct instead of relying on online travel agencies, which is more expensive to our hotels. In the most recent quarter, we sold approximately 94.9% of our room nights through our direct sales channel.

M&A is one of our key growth strategies in the near future. We are actively searching for appropriate M&A targets and are focused on brands and geographic areas that are complementary to our existing hotel portfolio. We believe the right acquisitions as well as smooth integration will help accelerate our planned long-term expansion.

In conclusion, we are pleased with our performance so far this year. Although there's more hard work to be done in the coming years, we are confident in our business model, strategic positioning and the long-term growth strategies. And we'll continue to invest in our people, brand, system and technology in order to better serve our customers and franchisees and ensure the long-term healthy development of our hotel network.

Lastly, in the last quarter of 2018, we noticed there were some market headwind. We have already implemented franchisee support programs, including reduction of central reservation fees from RMB 10 to RMB 20 per reservations to approximately RMB 8 per room nights to ensure that every franchisee will continue to do well during the quarter and next year.

With that, I'll pass the call to Selina, who will discuss our business operations and the company's highlights.

Thank you, Alex. If you are following along our slides, I will skip the overview on Slide 5 and go straight to Slide 6.

Once again, the franchised-and-managed model remains our primary strategic focus. In fact, 98.8% of our hotels fall under this category. And as you can see on the chart on the right, F&M Hotels have been steadily increasing their contribution to our overall revenues. In the third quarter, the percentage reached almost 70%.

Let's turn to Slide 7. Another critical area of our business is our loyalty program. Our program differs considerably from most hotel businesses in the West. We have a paid program to which people sign up to enjoy a variety of premium perks and benefits. More importantly, we found that this program has allowed us to foster closer relationships with our guests. Members can book directly with us, which has helped us and our franchisees to reduce sales and the marketing fees and expenses, and our GreenTree members are very sticky customers.

Overall, we now have about 26 million members in our loyalty program along with 1,020,000 corporate members, up from approximately 24 million and 930,000 as of June 30, 2018, and approximately 21,820,000 as of December 31, 2017. Around 94.9% of room nights were sold through our own direct channels, which includes our individual loyal members and corporate members.

Moving on to Slide 8. You can see our RevPAR chart here. The third quarter is generally one of the high seasons during the year. In the 2 charts at the bottom of the page, you can see that, on a year-over-year basis, RevPAR for L&O increased by 4.8% to RMB 152, and RevPAR for F&M hotels increased by 4.3% to RMB 145 for the third quarter of 2018. Both segments showed healthy growth over the third quarter and first 9 months of last year mainly due to higher ADR.

On Slide 9, you can see that we worked very hard this past quarter to further boost our pipeline of new hotels. During the third quarter, our pipeline grew to 504, while we opened 146 hotels. In particular, we're trying to boost the growth and, at the same time, to diversify our portfolio by adding more hotels at the higher end and the economy segments of the market.

Currently, 82.8% of our hotels, really the core of our business, serves the middle end of the limited services market. This ratio continued to trend down this year from 86.6% at the end of 2017. In line with this strategy, during this quarter, we added 15 new GreenTree Eastern, 2 Gme, 1 Gya and 3 VX hotels, which primarily serves business and leisure travelers in the middle to upscale segment of the market. So the number of hotels in this segment increased to 3.2% of the total portfolio.

Meanwhile, the number of hotels in the economy segment grew to 14% with the addition of 52 economy hotels across our Vatica and Shell brands in the third quarter of 2018. We continue to roll out our 3 new brands at the middle to upscale end of the market as part of our strategy to strengthen our portfolio.

On Slide 10, you can see these brands, which we have named Gme, Gya and VX. They are costing around same price point for all 3 hotels, but the decor and positioning of each will be quite different as we cater to the taste of different segments of the market. Now we have 36 Gme, 21 Gya and 24 VX hotels in the pipeline as of September 30, 2018.

On Slide 11, we added 4 L&O hotels in this quarter, 2 under GreenTree Eastern brand, 1 under GreenTree Inn and 1 under a new brand in the middle-tier segment called Wumian. These hotels are in strategic location in Eastern and Southern China. We believe that we can further improve the performance of these hotels under our direct management.

With that, I will pass the call over to Jasmine, who will review our financials.

Thank you, Selina. We delivered another solid quarter of operating and financial results.

Moving on to Slide 13. We now have a total of 2,558 hotels with 209,463 rooms. On a year-over-year basis, we increased our hotel numbers by 20.7%. During the quarter, we opened 146 new hotels. By comparison, we opened 109 hotels in Q3 2017 and 425 for the full year 2017. So as you can see, we substantially accelerated our hotel openings in Q3 2018 in the first 9 months of 2018. Of the 146 hotels opened in Q3, 73 were in the mid-scale segment, 21 in the business to mid-to-upscale segment and 52 in the economy segment. Of this, we opened 10 hotels in Tier 1 cities, 28 in Tier 2 cities and the remaining 108 in smaller cities in China.

During the quarter, we only closed 22 hotels. So net-net, we added 124 hotels to our portfolio. We closed 5 hotels due to their noncompliance with our brand and operating standards and closed 2 hotels due to hotel upgrade. We also closed 15 hotels due to property-related issues, including rezoning, returning of government-owned properties, and expiry of leases and so on.

On Slide 14, you can see some of our key operating metrics. During the quarter, we continued to see improvements in our operating performance across the board. The key numbers to look at here are the orange bars representing the performance of our F&M hotels. These hotels make up the biggest part of our business. The performance of our L&O hotels skewed a bit higher because we added 4 L&O hotels, renovated 6 L&O hotels this quarter and converted 1 L&O to F&M hotel after the second quarter of 2017.

In terms of our F&M Hotels, our ADR improved by 4.4% to RMB 166 in the third quarter of this year. RevPAR increased by 4.3% to RMB 145, while the occupancy rate for our F&M hotels had a slight decrease of 0.2% to 87.5%, which was due to the acceleration of new-hotel openings in the quarter.

On Slide 15, you can see that total revenues grew 21.6% year-over-year to reach RMB 256.8 million in the third quarter of 2018. The year-over-year increase was primarily attributable to 4 factors: First, the increase of 123 F&M hotels in our network; second, the addition of 4 L&O hotels in this quarter; third, improved RevPAR for both F&M and L&O hotels; and fourth, growth in our loyal membership. This was partially offset by the renovation of 6 L&O hotels in the third quarter of 2018 and the conversion of 1 L&O to F&M hotel after the second quarter of 2017.

Total revenue from F&M hotels for the third quarter rose 20.3% to RMB 179.7 million. Meanwhile, revenue from L&O hotels rose 19.7% to RMB 57.4 million. During the first 9 months of 2018, total revenues rose by 21.7% to RMB 695.1 million. Total revenues for F&M hotels for the first 9 months of 2018 were RMB 489.1 million, up by 23.5% year-over-year. Total revenues from L&O hotels in the same period were RMB 151.3 million, increased by 10.6% year-over-year.

Moving over to the expense side of the P&L, please look at the 3 graphs on the right-hand side of Slide 16. High -- Hotel operating costs for the third quarter of 2018 were RMB 76.1 million. The year-over-year increase of 27.2% was mainly attributable to 3 factors: First, the increased number of general managers in our hotel network; second, other costs associated with the expansion of F&M hotels; third, higher operating costs for the 4 newly added L&O hotels.

Selling and marketing expenses for the third quarter of 2018 were RMB 11.3 million. The year-over-year increase of 10.1% in the third quarter of 2018 was mainly attributable to model room construction, exhibition and other advertising and promotion expenses related to our 3 new mid-to-upscale brands, increased personnel, compensation and other costs, i.e., travel expenses of business development personnel as a result of the increased opening of hotels.

General and administrative expenses for the third quarter of 2018 were RMB 24.2 million. The year-over-year increase of 13.6% in the third quarter of 2018 was primarily attributable to increased share-based compensation expenses.

Overall, total operating cost and expenses grew 22% year-over-year to RMB 111.7 million. It grew 18.2% year-over-year to RMB 311.1 million in the first 9 months of 2018.

Slide 17 shows that, during the third quarter of 2018, gross margin decreased slightly by 1.3% to 70.4%, while we were able to improve adjusted EBITDA margin by 1.3% to 60.9%, net margin by 6.4% to 59.3% and core net profit margin by 3.3% to 48.8%. Overall, gross profit grew 19.5% year-over-year to RMB 180.7 million.

Adjusted EBITDA increased 24.2% year-over-year to RMB 156.5 million. Net income increased 36.3% to RMB 152.4 million. And finally, core net income increased 30.3% to RMB 125.3 million. Basic and diluted earnings per ADS improved by 23% to RMB 1.50, equivalent to USD 0.22, while basic and diluted core net income per ADS improved by 17.1% to RMB 1.23 in the third quarter of 2018.

On Slide 18, we show consistent growth and healthy margins during the first 9 months of 2018 as well.

Moving on to Slide 19. Our IPO has bolstered our balance sheet further, which was already strong given our ability to consistently generate strong cash flow from operations. During the third quarter of 2018, operating cash inflow was RMB 202.9 million. Cash and cash equivalents balance increased to almost RMB 2 billion. This provides us with more resources to consider and evaluate additional capital investment and potential acquisitions.

Lastly, in terms of guidance, we reaffirm a 20% to 25% year-over-year growth in total revenues for the full year 2018.

This concludes our prepared remarks. Operator, we're now ready to begin the Q&A session. Thank you.

(Operator Instructions) The first question today comes from Justin Kwok with Goldman Sachs.

Perhaps, I have 2 questions, one on the franchisee support program and the other one on the service apartment, more on the strategic side. Now the first one, I hear Alex mentioning that they've initiated the franchisee support program in the quarter, which will lower the membership transfer fee or the booking fee for the franchisees. I just want to get a sense on the backdrop on those. Is it more related to competition? Or is it more related to some of the franchisees expressing their concerns on the operating environment? What other measures are there in the support program? And would you be able to give some color or quantify a bit on the impact to your revenue or to your profit on that side? That's the first question. The second question would be on the service apartment. I read in your press release that you're also exploring the service apartment segment. Can I check what exactly is this? What are your plans and whether you can give some color on the progress on that?

Okay, Justin, this is Alex. And thank you so much for the 2 important questions. With regard to the franchisee support program, we -- the company always initiates those program proactively. We rarely wait for the franchisee to ask for help because, by then, we think it's too late. We think that we have heard some concerns over the uncertainty of the economy for the fourth quarter and for next year due to this bit of slowdown -- a little bit of slowdown in China economy and also the trade conflict. So we just sensed some franchisee may be worried about their continued profitability. We want to make sure even with the current environment, our franchisee can continue to generate the same amount or even higher profitability for the individual hotels. So as a result, we developed this incentive program. We think that we -- this incentive program coupled with the increase in membership drive will improve and at least help our franchisees during the fourth quarter, next quarter and the next year as well. We have not, in our network, experienced any major or noticeable slowdowns in the consumer demand. However, by reading industry report, we noticed there as you saw some long-distance traveler, such as leisure and business travelers may -- there may be a reduction of that, and there may be a reduction of the higher-end travels. But our strategy has always been focusing on there in providing, delivering the core -- hardcore demand for our everyday business and travelers and that the value priced hotel chain is especially important for them during any kind of economic change time for the small- to medium-sized business travelers. So that's our -- the reason for GreenTree to initiate the support programs. We actually, during the last downturn -- or during some downturn in certain geographic areas, the economic changes, we always have the franchisee support program. For instance, we may reduce some of the fees for the franchisee and usage fees from 5% maybe we gave before in 2009, 2008 financial crisis or during certain small regional economic change time will provide the support. So on balance, we don't think there will be a major impact on the company for the earnings because we always think that with healthy franchisees we can support their profitabilities, again, they will support our growth of the hotel network. So that's the franchisee -- so that's the franchisee support program. So we may implement further franchisee support program depend on how the economy -- yes, part of the travel market goes. So with regard to the service apartment, as you -- sorry about that. Many people do not know that GreenTree started GreenTree apartment almost 10 years ago, during the 2007/2008. We are kind of experiencing the business model for running a service apartment. However -- and we did not find a viable business model to grow that service apartment business primarily because the rental fees -- the rental market -- the price for rentals are not very high at the time. But 10 years later, right now, we see the rental market has a stronger demand, and we think that it's time for us to revisit the GreenTree apartment -- service apartment for a little bit shorter and mid-term stay. So we think that, in the future, will complement our business, but our focus is still going to be our hotel business. We just started this department with a small scale and to just pick up where we left 10 years ago. As you know that last 10 years, the service apartment has gone through a lot of changes, and many, many people tried different kind of business model, but most of them, we have observed, are not very successful, but we think that there is a way and that there may be some ways we can make it work better just like a hotel member. Justin, I hope I answered your questions?

Yes.

The next question comes from Billy Ng with Bank of America Merrill Lynch.

I also have 2 questions. And one is to follow up on Justin questions regarding the franchisee support program. I think, since Alex, you mentioned that we have done that before in the last few cycles, so like -- can you describe, like, how easy to roll back, right, when things are improving again? Whether some of those measures can be rolled back and especially the case how easy was that? And also, I know you mentioned a little bit of like it's not going to impact the profitability or the financial that much from our perspective. So roughly speaking, less the -- if -- without those programs for those target franchisees, let's say, if we are getting 4%, 5% of the top line, and with those program, how much can that be -- can we still get the similar kind of the revenue or it will be slightly lower? And that's question number one. And then question number two is, in terms of, I know this is still a bit early, but in terms of next years, the number of target opening, roughly speaking, because we saw your competitors, some of them have increased their pipeline and most likely will have more openings than this year's, but some competitors probably are already seeing peak of the openings in this year's and will have smaller number of opening next years. What do you think in our case and GreenTree's, do you feel that we can open more hotels than this year's or more likely will become a little bit more conservative given the macro uncertainty?

Thanks, Billy. Again, because this is related to our strategy and operation, I'll pick up the first questions even though I think Selina and Jasmine are well aware of what we are doing. The first regarding the incentive program whether once we implemented and whether it's difficult to roll back or not. I'd say, we have experience for that -- when the market improves, we can easily roll it back because, according to the contract, we have a specific term governing those kind of policies in terms of reservation program and reservation fees. And so by the contract, by the spirit of cooperation, we never really experienced any challenge of rolling those programs back. And we -- our franchisee are very thankful and appreciative to have a partner like GreenTree in the past. And our heart and our support always goes with them. And so, however, GreenTree is also the first mover -- I believe we are the first to reduce a lot of reservation fees from CNY 20 to CNY 10 preliminary already, primarily because 10 years ago, our support franchisees of those reservations are coming from telephone -- live telephone operators. With the newer technology, we also are improved the system support, automation and some simple AI and our reservation in terms of central support, the cost have gradually decreased. So with our reduction of the fees to franchisee saves our cost. So initially, we always designed that that's not a additional income because we generate the income from 4.5% to 6% royalty fees. We think we should -- the other support really should be a cost at most pass-through. So the reservation fee is really additional fees from the franchisee, and we incur additional cost. So we have to continue to innovate to deploy the AI to improve our technology platform to reduce our central and corporate offices expense in that end, so the net result is not going to be having any major, major impact to the company's bottom line. And so that's the franchisee support program. In terms of the second year -- next year's target opening, Billy, as we discussed with our analyst and our investors in the past, we have -- always have a 3-year strategic plan. And we don't -- we do not accelerate when the market is really hot, and we do not decelerate when market is cooling down. In the last 2 years, when the market is really hot, we actually are really reserved in terms of advising our franchisee not to bid up the rent and the lease expenses and be careful and -- but during the market correction, our program will be very effective to help our franchisee in terms of selecting the right site, selecting the right property, right lease expenses. So our plan is 1,800 hotels for the next 3 years. So the next year, we'll continue to be around 600, if not more. And we believe we should be very comfortable to achieve that target. At the beginning of the year, we have 306 in the pipeline. Now we have almost 200 more or 504 in the pipeline. I think we'll continue to build the pipeline, not really sure. The next 3 years we can easily achieve the target. So that's regarding our next year plan, Billy.

The next question comes from Praveen Choudhary with Morgan Stanley.

I have 2 questions. The first question is related to your cash flow statement. I see you have given loan to franchisees in this quarter, around $35 million. But then you have given loan to third parties. Would you explain what that is, that $156 million? And including that loan to franchisees around $200 million, is that also to support your franchisee at this time when they're struggling? The related question is, this time around, your growth rate as well as your peer's growth rate is 20% to 30%, and yet, it seems like you're worried about down cycle and you're helping your franchisees. What other indications are you seeing based on your conversations with the franchisee that is making you either nervous or you're taking a proactive measure?

Okay. Thanks, Praveen. And I appreciate for your continued support as always. Regarding detailed breakdown, I'll have Jasmine or Selina to answer there. But I'll give you overall picture of that. The support to our franchisees are coming from those franchisees. Typically in the past, they may have a easier time, let's say, to borrow in the marketplace from the various financing programs, including from the banks. In the last year, I think, that the PIP, so-called finance market and also the bank financing are tighter than before to some of our franchisees, so the result that we see some quite good opportunities, we do not want to discourage our franchisees not to do it. So we roll out those franchisees that we're providing the loans to them to help them to speed up. But those loans are typically provided for those outstanding franchisees. They already have successful hotels in operation. They have proven they have the experience, ability to run a big hotel. So we provide those kind of loans to them. So the second, with rolling out those -- the supporting program is, the market that sometimes is not the -- the actual numbers matter, it's the rumors and they sometimes hit the news that make people -- some have concerns and cautious. And so that -- we want -- during this time, we want to encourage our franchisees to do more in marketing and sales, and so -- and as a result, we also want to show our company will also participate in that to help them to work together. And so we -- now where we even during 2009/2010, we really did not experience a slowdown in terms of correction for use in RevPAR in our hotel network, if I recall. So -- and that's the [spirit] we are working under, okay. And that -- we are -- I think, our franchisee are in the best position because the products and the price of our hotel products are really meeting the demand for the small- to medium-sized business travelers, okay. So for detailed number breakdown, I'll leave that to Jasmine.

Praveen, this is Jasmine. Now regarding the loan to third parties, they're mostly to third parties that are related to our hotel business. For example, we make short-term loans to a company that's an operator of 168.com, which is our online e-commerce platform serving our members and hotel guests. Basically, our members can -- and hotel guests can use the points they accrue by staying at hotels to exchange for products on this online platform, so we give them short-term loans to support their working capital needs. We do charge market interest rate of 4% to 6% on an arm's length basis.

Are they are expected to pay back?

They're expected to pay back before year-end.

The next question comes from Ingrid Zhang, UBS.

My question would be, could you please provide a bit color on the 2019 outlook, especially on the RevPAR trend because there are rising market concerns about economy uncertainty, and some investors we talk to are really expecting RevPAR growth to decelerate to below 1%. Would you give us a bit more color on this? How do you expect the hotel industry RevPAR trend to be in next year and maybe owned [GHT] specific as well?

Okay. Even though my CFO told me we don't gave out the RevPAR guidance in the past, but I still think that this is a valid question, and we really appreciate you asking. We -- our hotel was priced at a -- always reasonably. So we don't accelerate the pricing -- increase the price very rapidly, sharply during good time. We don't decrease those during bad time very much either. So I think -- we think in the long run, by same segment, the hotel pricing should more be in line with the CPI, and by the way, if we improved the product's quality, it may increase a little bit higher, so like 3% to 5%. So we don't expect that there'll be -- at least at this moment, we don't expect really a decline or sharp deviance from that number. So if the market really changes, maybe we should see a slight reduction, but we do not feel that we will be that much negatively impacted. So I wish I would also have a fully proven vision to tell for next year, but that's what we are budgeting or planning along with the CPI.

Next question comes from Juan Lin with 86Research.

So I have 2 questions. My first question is on business expansion. You have been accelerating new hotel openings, especially in the mid-upscale hotel category. Oh, you also provided the pipeline for the upscale hotels. I wonder if you could break down your economy and the mid-scale hotel? And then also, in terms of Tier 1, Tier 2 cities versus Tier 3 cities, what is your future hotel opening plan in terms of geographic distributions of what the different tiers of cities? Also, you mentioned that you are actually looking for M&A target. I wonder if the M&A target is mainly to facilitate upward expansion or geographic expansion? Second question is on operating efficiency. If I exclude the revenue mix factor, I still see a pretty good improvement in operating efficiency. I wonder in addition to RevPAR improvement, what are the approaches or factors that have been driving the operating efficiency improvement?

Okay. All right. In terms of breakdown of the numbers, I'll leave that for Selina or Jasmine in terms of the economy hotel's pipeline. I think there's numbers over there. First-tier, second-tier, third-tier cities, I think our focus is going to be on the organic growth. So wherever there are good opportunities, we will go there. But in the last quarter, I believe, the second-, third-tier cities were more. But detailed numbers, I will leave that to Selina. But in terms of the margin, in the past, we have always tried to adopt the technology in helping our people to do a better job. So last time, I think, we discussed there are still a slight -- there will still be a slight improvement with the margin in our business. We think we have not reached to the optimum yet. The company has been also working really hard on the technology platform. I think that's the driver for our continued productivity increase. And the second is our effective joint marketing program and also our membership -- loyal membership program that's really standing out. Our membership program, I think, differs from a lot of others, and you don't see our -- it's going to take a large amount of members, but our members, I believe, really quality paid memberships, they help a great deal. And so those factors are contributing to the improved profit margin. In terms of the M&A, we are looking for both, and both brand -- complementary brand operator and also geographic area complementary operator. And so we think, with the current market condition, there will be even, I think -- valuation opportunities in that area will be more than in the hot market. So we're working really hard, and we think that -- but we -- even though we have urgency, we know that to grow, but we also want to be disciplined. We're making sure we find the right match with the right team, right philosophy and reasonable price with the right growth plan. So we are applying very disciplined criteria for selecting our partner, the future acquisition partners. And so the numbers, I'm leaving to Jasmine and Selina.

Okay. Of our pipeline of new hotels, we see that about 1/4 of our pipeline -- pipeline of our hotels is in the business to mid-to-upscale hotels, and about 23% are our economy hotels, including our Vatica and the Shell, these 2 brands.

So the balance, I think the business to (inaudible), so 23%, right, is in the budget category Vatica and Shell.

Yes, exactly.

The next question comes from Jisheng Liu with CLSA.

If I may, I have 3 questions. So number one on the F&M hotel openings. So I see in the press release that you have put a temporary waiver on the Shell hotel during the third quarter of '18. So I'm just wondering what's the reason behind that because, as Alex mentioned, you've put some support to your hotel franchisees, but I will pretty much understand temporary waiver for the initial franchise fee of Shell hotel has pushed towards more accelerating hotel openings. So I'm just wondering if you have continues plan in the future to put that kind of waiver, or if you would even more expand to other hotels, such as Vatica? So that's my first question. The second one is on the L&O hotels. So during third quarter, I've seen that you have got 1 opening of L&O and 3 conversions from F&M. So just wondering what's the rationale behind that, and what's your plan going into 2019? Number three is on, I guess, you guys have also heard about a scandal last week across all hotel industry in China where the cleaning staff are not doing their job very properly. So just wondering if you guys foresee any regulatory issues going into the industry, and if you are going to input even more internal control procedures?

Okay. Thank you for the 3 great questions. First of all, in terms of the Shell hotels, we did have a waiver or delayed payment of the initial application fees. I think those are conditional, and we have rolled out a program because the market there, there are new players -- a lot of new players coming to, they said, different area off a different program, and we want to give our franchisees a sense of comfort and confidence that, in the future, once the performance above the market and above and beyond what they have been operating, then those fees will be paid to us. And because our people really worked very hard to help our franchisees in beginning for the selection during business -- doing the business analysis and the various other design and improvement of -- so we incur work like -- were really different than most other probably LatAm if they stick with budget or budget segment. We do want to provide a comprehensive 360-degree support to our franchisees. So our cost structure is there. So we will collect, I think -- we're confident we'll collect them. And so in the future, depending on the market, we'll want to continue to give our franchisees confidence that we can deliver a better performance. I think that the program will show that. So we enjoy also very, very big support from them. I have personally talked to a few of our franchisees in that categories, and I'm more than pleased with the performance. Secondly, with the 3 L&O hotel conversions, those conversions, we have a few criteria. First of all, the hotel will be located -- is located in a strategic location and, for instance, that the hotels are converted and located in 2 of the Fortune 500 companies abroad close to the headquarters. And our franchisees wants to have the proceeds to do -- some of them wants to do more hotels, and some of them that really want us to acquire and really the rest with them. So those the -- mainly the cases where we think, strategically speaking, and we'll have a longer-term lease in a strategic location. And for those, also, very -- going to be our model hotels for new mid- to upscale business -- new mid- to upscale brand. And so that's our rationale for picking up the hotels. So we're not picking up hotels just because it has a very -- excellent financial performance or returns. So the third regarding the scandal, we're not surprised by that because we know the management of our room service is very tough -- it's a tough job. We understand also that, because the team -- the people from different hotels coming today to going to work, and so there is inconsistent behavior and that we have thousands and thousands of our people, and we purely just sometimes cannot guarantee an individual -- everybody will work, perform the best. As a result, we think the training and management system -- a supervisory supporting role or supporting system is very, very important. And we implemented an ethical working standard. So our ethics code is printed in every single workroom, and in the storage room, in housekeeping, maintenance room. So we have those ethical code to discourage those kind of behavior. So we think it is up to each individual operator to do their own management, to do a good job in that end. So we're also trying to find the right technology. In the past, we explored, for instance, police types of video camera, and there were variable products. And so I think that it is really a combination of your constant education, training, supervision and support, and with the right system, I think we can do a better job. And so that we are -- it's kind of sad to see what's happening along into other 5-star industry side, and hopefully, we all can do a better job. In terms of regulation, we don't -- at least we think the government are very smart. They can recognize the kind of problem, and we just cannot probably rule out in every single one of so-called bad behavior in workplace. And so we hope there'll be some smart policy, but every policy coming up, I think the government will be sensible, and I think they will be sensitive to the industry's condition and need. We don't think there will be a really a new regulations that will be negatively impacting the industry. I think to the contrary, we think that it will help the industry's continued healthy growth.

(Operator Instructions) The next question...

By the way, I'm not reading those from prepared scripts. Anticipate this is conversation. So my English still needs to be improved, so if you see a bad programmer, don't transcribe the way it is and correct it for me.

The next question comes from [Bruce Mei] with UBS.

Actually, Selina has already answered one of my questions. And could you please provide any guidance on your closures in 2019? And I want to also doublecheck that, Alex, before you mentioned that, in 2019, you will open around 600 hotels, right. That's right?

That's right. Yes. Next 3 years, we're opening 1,800 for 3 years. So you do the math, but we do a 3-year plan, and so we think that averaging 600 per year.

Okay. And could you, please...

That's opening. On the closure, we have estimated 4% in the past, right around 4%. And we think that next year will not be sharply deviated from that. We still intend the lowest closure rate in the industry due to the profitability of our individual hotel owners. But sometimes, they can drag in further new problem -- creating new problem because when our franchisees are profitable, and they -- sometimes some of them are having less incentive to upgrade. And so we have to work really hard. So this year, we'll roll out the incentive program for those upgrades. But the closure right around 4% plus or minus (inaudible).

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

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

Thank you.

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