China Lodging Group Ltd (NASDAQ:HTHT) Q1 2018 Earnings Conference Call May 14, 2018 9:00 PM ET

Executives

Ida Yu – Senior Manager, IR

Min Zhang – CEO

Teo Nee Chuan – CFO

Analysts

Justin Kwok – Goldman Sachs Group

Tianxiao Hou – T.H. Capital

Billy Ng – Bank of America Merrill Lynch

Praveen Choudhary – Morgan Stanley

Tallan Zhou – Deutsche Bank

Juan Lin – 86Research Limited

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the China Lodging Group Q1 2018 Earnings Conference Call. [Operator Instructions]. Please be advised that today’s conference call is being recorded on please stay, the 15th of May, 2018. I would now like to hand the conference over to your speaker today, Ms. Ida Yu. Thank you. Please go ahead.

Ida Yu

Thank you Good morning, everyone. Thank you all for dialing in, and welcome to our First Quarter Earnings Conference Call. Joining us today is Mr. Ji Qi, our Founder and Executive Chairman; Ms. Jenny Zhang, our CEO; and Mr. Teo Nee Chuan, our CFO. Jenny and Teo will present the strategy review and Q1 results. Following their prepared remarks, management will be available to answer your questions.

Before we continue, please note that the discussion today will include forward-looking statements made under the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today.

A number of potential risks and uncertainties are outlined in our public filings with the SEC. China Lodging Group does not undertake any obligation to update any forward-looking statements, except as required under applicable law.

On the call today, we will also mention adjusted financial measures during the discussion of our performance. Reconciliations of those measures to comparable GAAP information can be found in the earnings release that was distributed earlier today.

As a reminder, this conference call is being recorded. The webcast of this conference call as well as supplementary slide presentation is available on the IR section of China Lodging Group’s website at ir.huazhu.com, H-U-A-Z-H-U dot com.

Now I would like to turn the call over to Jenny. Jenny, please?

Min Zhang

Good morning, everyone. I’m pleased to report a strong start to 2018. As shown on Page 2, in the first quarter, our RevPAR grew by 13.7%. Net revenues increased by 29.6%. Operating income margin was 14.7%, up from 10.7% a year ago. Adjusted EBITDA margin was 26.8%, up from 23.5% a year ago. Teo will provide more financial analysis later.

Before we moved to our strategic review, I’m also delighted to announce our strategic investment in AccorHotels in Q1. As you may recall, we formed a strategic alliance with AccorHotels in 2016. Upon the alliance, we have master franchisee rights for Mercure, ibis and ibis Styles, and co-development rights for Grand Mercure and Novotel as well as 28% stake in Accor Luxury and upscale hotel businesses in Pan-China region. Accor’s Chairman and CEO, Mr. Sebastien sits on our board. We now hold approximately 4.5% stake in AccorHotels through share repurchase from open market. We have engaged in discussions for a board representation in AccorHotels. We believe this will strengthen the partnership between the two groups and we expect to update you the progress in the next few quarters.

Let’s now move to the strategic review. Please allow me to remind you about Huazhu’s three strategic focuses this year on Page 4. First, we continue the fast expansion of midscale hotels. Specifically, we focus on continued growth in same hotel RevPAR through quality improvements. Second is innovation in upscale hotel segments. Page 5 shows that our fast expansion in mid-and upscale hotels is well on track. At the end of Q1 this year, our mid-and upscale rooms increased by 92% from a year ago, accounting for 32% in total room costs in operation right now. By looking at our pipeline, mid-and upscale rooms accounted for approximately 80%, up from 50% a year ago. This is a result from our continued efforts to enrich our brand portfolio and improve brand quality to satisfy customers and franchisees evolving needs.

Since we formed alliance with Accor in 2016, we launched new product design and increased those brand presence in China. This is part of our effort to expand our market share in midscale markets. Let’s take Mercure and ibis as an example, as shown on Page 6 and Page 7. At the end of Q1, it has 19 Mercure hotels in operation and 40 in pipeline. This is more than double the network we inherited from Accor two years ago.

In Q1, Mercure’s same hotel RevPAR grew by 12.6% year-over-year. Ibis is also a new star in the entry-level midscale segment. At the end of Q1, we had 105 ibis hotels in operation and 62 in pipeline. Ibis achieved 14.5% year-over-year growth in same hotel RevPAR in Q1. During the past two years, great efforts have been made to introduce new designs to Chinese customers as well as increase hotel operational efficiency to enhance the profitability. The similar programs are also rolled out for Grand Mercure, Novotel and ibis Styles. We are confident that these changes will bear fruit in the coming quarters.

With the above concrete progress in midscale segments, our mid-and upscale hotels are increasing their contribution to our revenue. In Q1 2018, the revenue from mid-and upscale hotels increased by 87% to RMB 976 million, accounting for 47% of our total net revenues, up from 33% a year ago. Secondly, our focus on RevPAR growth. As shown on Page 9, we continue to achieve double-digit blended RevPAR growth in Q1, which is 13.7% increase year-over-year. A very strong growth in the relative low season. This is not only driven by the increase in ADR, but also more revenue contribution from mid-and upscale hotels. Page 10 provides a detailed view of the growth trends of our same hotel performance for hotels in operation for at least 18 months.

In Q1, our same hotel RevPAR increased by 6.5% with a 6.1% increase in same hotel ADR and 0.3 percentage points increase in occupancy. Breaking into months, the performance in large was very strong with 9.6% in same hotel RevPAR and the growth momentum continues into April as well. We expect the trend for ADR growth to continue, driven by Chinese consumers increasing spending on leisure. As shown on Page 11, the CAGR for disposable income per capita from 2013 to 2017 was 9.1% and a 10.3% for their spending on leisure contributes to a robust domestic travel market as shown on Page 12, domestic travel expenditures CAGR of 15% from 2013 to 2017. We remain confident for travel and emerging markets in the near term and long-term. Thirdly, our innovation in upscale as shown on Page 13, our Shanghai JoyaHotel had a soft opening this March. This is a flagship JoyaHotel hotel and we have a number of experiments in design and operation. Positioned as an upscale brand, Joya demonstrates oriental elegance. Partnering with Shang Xia, a famous luxury brand, Joya provides high-quality supplies and furnitures. The price range for Joya in Shanghai is between RMB 900 to RMB 1,200 per night.

With that, I will hand over the call to who will provide you a more detailed analysis of quarterly results. Teo, please?

Teo Nee Chuan

Thank you, Jenny. Good morning, everyone please turn to Page 15. At the end of Q1, 2018, we have 3,817 hotels in operation. We opened 127 hotels and closed 56 hotels, giving a net opening in this quarter of 71 hotels. We maintained our hotel opening guidance of 650 to 700 hotels for this year. Page 16 shows our hotel pipeline trend. Since Q1, 2016, we increased our hotel pipeline further in Q1 up to 744 at the end of Q1 2018, a 57% year-on-year increase from a year ago. Given such a robust hotel pipeline, we are confident in achieving our hotel opening target in 2018. Approximately 80% of the rooms in the pipeline are under mid-and upscale brands.

Turning to Page 17. Our group blended RevPAR grew by 13.7% in Q1. The growth in RevPAR was mainly driven by an increase in ADR of 13.9%, mainly due to the increasing mix of midscale and the upscale of economy hotels with a higher area as well as strong domestic travel demand that drives the same hotel RevPAR growth. As mentioned by Jenny earlier, our same hotel RevPAR growth was 6.5% in Q1 and, in particular, we recorded a high same hotel RevPAR growth of 9.6% in March 2018.

Before I go over the financial, I would like to take a short, while to explain the accounting rules changes that impact of our revenue recognition starting from January 1, 2018. As mentioned in our previous earnings call for Q4 2017, starting from January 12018, there are new accounting standards on revenue recognition affect our financial statements in two ways. Number one, the first recognition of the initial franchise fees. Previously our initial franchise fees was fully recorded as revenue upon hotel openings. Now this franchise fees has to be amortized over the remaining franchise period. Number 2, membership loyalty cost. Previously, the cost on membership loyalty are reflected in the hotel operations and selling expenses. Now the net charges are reflected in the net revenue line.

The comparative on 2017 numbers starting from Q1, 2018, have been adjusted to reflect the changes in accounting treatment. With that, let’s move on to the financial results on Page 18. Our net revenue grew by 29.6% year-over-year in Q1 or 30.3% under the previous accounting standards, exceeding the high and of our guidance for Q1.

Breaking down the revenue growth in Q1, net revenue from our leased and operating or operative hotels improved by 28% year-over-year and net revenue from our manachised and franchised hotels were up 34% year-over-year. The increase in net revenue was mainly contributed by consolidation of Crystal Orange, contribution from the same hotel RevPAR growth and new hotel openings. In Q1, 2018, revenue from and franchised hotels accounted for 24.22%, up from 23.5% a year ago.

As demonstrated on Page 19, our Q1 operating profit grew by 76.8% and the operating margin expanded by 4 percentage points year-over-year to 14.7%. The improved operating margin was mainly contributed by improved operating efficiencies from and partially offset by preopening expenses. Our hotel operating costs and other operating costs as a percentage of net revenue increased by 2.3 percentage points year-over-year due to improved blended RevPAR and better efficiencies from scale. The preopening expenses as a percentage of net revenue increased by 2.1 percentage point due to higher number of leased mid-and upscale hotels under construction compared to Q1 2017.

We have 37 hotels under construction in Q1 compared to 15 in 2017. The SG&A expenses and other operating income as a percentage of net revenue decreased by 3.8 percentage points year-over-year, mainly due to the one-off transaction costs related to Crystal Orange acquisitions totaling CNY46 million in 2017 and better operating efficiencies from

Turning to Page 20. The strong RevPAR growth and better operating efficiency trends and profitability growth. In Q1 2018, our adjusted EBITDA increased by 47% year-over-year to CNY560 million, while our adjusted EBITDA margin expanded by 3.3 percentage points from 23.5% to 26.8%. Our adjusted net income increased by 68% year-over-year to CNY282 million, while the adjusted net income margin expanded by 3.1 percentage point from 10.4% to 13.5%.

The non-GAAP adjustment mentioned on this page included the unrealized loss from the fair value changes of equity investments totaling CNY136.7 million in share-based compensation expense. The non-GAAP adjustment on unrealized loss from the fair value changes of equity securities totaling CNY136.7 million for the first quarter, mainly represent the unrealized loss from our investment in equity securities such as AccorHotels and [indiscernible].

According to the new U.S. GAAP effective from January 1, 2018, we are required to reflect the unrealized loss or gain from changes related to this equity except those which we accounted for as equally matters investment in the net income. The unrealized loss from this equity and securities in the first quarter for 2018 was due to the lower share price at the end of first quarter 2018 compared to the those at the end of the fourth quarter of 2017. This accounting treatment will have a significant impact on our GAAP net income going forward. For example, the closing price of AccorHotels was €46.45 on May 11, 2018. Therefore, the unrealized gain on this Accor investment alone in the second quarter up to May 11, 2018, would have been approximately CNY260 million.

Moving on to the cash flow status on Page 21. In Q1 2018, our net cash from operations reached CNY420 million, while the CapEx for maintenance and new developments totaled CNY367 million. As a result, the free cash flow in Q1 was CNY53 million. In Q1, we down our loan facilities, including the syndication loans and share-based financing, totaling CNY3.67 billion to the — sorry, totaling CNY3.67 million and invested approximately 3.67, sorry, and invested CNY3.65 billion for our investment activities, which mainly comprises for the purchase of Accor hotel stocks.

At the end of Q1, we had cash and cash equivalents and restricted cash of approximately CNY4 billion. Finally, our guidance on Page 22. Thanks to the better-than-expected RevPAR outlook, we revised upwards our full year revenue growth estimate from previously 16% to 19% to 18% to 22%. For the second quarter of 2018, we expect the net revenue to grow 24% to 26% year-over-year.

With that, let’s open the floor for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from the line of Justin Kwok from Goldman Sachs.

Justin Kwok

Perhaps I’ll have two questions. One on Accor and the other one on RevPAR. On the strategic investment in Accor, I want to get a sense on to things. One, are happy with the current 4.5% stake? What’s the goal for the ownership vessel or the size of investments going forward? And the other thing that, as you already mentioned that you started the alliance with this company since 2016, with this crossownership in mind, what extra or what else are you expect to achieve in the coming few years on this investment? That’s the first question.

Min Zhang

Investment in Accor, currently holds approximately 4.5% stake and we don’t have any plan to increase the stake in the near term. And in terms of what other further value will bring to each other, we believe by a partnership, we can bring each other an additional value. For part two, we are going to have a deeper collaboration with Accor in the China market. There are a few initiatives we are under discussion. And we also feel Accor’s global experience will also help us when we go overseas. And from exercise, our deep knowledge in multi-problem as well as in technology could be beneficial to Accor’s business. So we see a lot of potential areas to collaborate further in future business.

Justin Kwok

Perhaps I’ll just switch to the RevPAR question then. Since you mentioned that on March you’ve already seen 9.6% in same hotel RevPAR growth, could you mind to share a little bit on what you’re seeing into April and May? And with the upward revision on your full year revenue guidance, what’s the same hotel RevPAR that you guys are modeling into the full year? I remember back in March, the guidance is around 3% to 5%. So what’s the target for the year now?

Teo Nee Chuan

Okay. This is Teo. Okay, coming to the first question is on the — in March, the same hotel RevPAR growth was approximately 9.6%. In April, we see that same hotel RevPAR growth are according approximately the same rate as March. And we expect that this trend may actually continue for a short while, but going forward, we will still need to be cautious to see that any changes on this trend. But so far, the trend has been really positive. The second thing is that we are revising upwards our total revenue and guidance. It is mainly because that we see that the trend during the first quarter as well as what we see up to like April is that what we have already original expected for guidance in March. So we estimate that the same hotel guidance — the same hotel RevPAR to be in the mid-single digit kind of range.

Justin Kwok

Okay. Could I follow up with one more question?

Teo Nee Chuan

Sure.

Justin Kwok

It’s actually on the closing. So I know that in presentation also purchase guidance that you are looking at closing roughly 200 stores for 2018. Can I the rational behind closing these number of stores this year? What’s the broad reason? Is it franchise issue? And in 2019 and forward, would this number continue to be this quantum?

Teo Nee Chuan

Okay. We closed approximately 56 hotels in Q1 and we expect to close approximately 200. We maintain to be at this level. And then, going forward, in Q1 2019, I’ll say that approximately 50% of the closure was mainly due to the issues, for example, the expiry of the leases and then some et cetera. So we expect that the trend maintain the closure rate of approximately 200 hotels going forward as well.

Operator

Your next question comes from the line of Tian Hou from T.H. Capital.

Tianxiao Hou

Crystal Orange you acquired a year ago. So now you are entering into the anniversary. So I wonder what’s the ADR and the occupancy trend for this Crystal Orange hotel in the current quarter, in Q1 as well as in Q2, what’s the impact of that? Or in other words, the average Crystal Orange, the ADR and occupancy relative to the group, where they stay and where they’re going? That’s the question.

Teo Nee Chuan

Okay. Thank you. What you Crystal Orange, we see that the — the RevPAR, sorry, the ADR for the Crystal Orange was actually higher than it’s actually higher other midscale hotels. The ADR is pretty maintained. However, we do see that the occupancy has improved a little bit since we took over because the has been able to channel our members into the occupancies. So we see that there is still a lot more work to do because while we are helping them improve their RevPAR through better occupancy, we also see the opportunities for us to help them to rationalize the cost so that we can squeeze more profit up from their operations. The work has not completed and it is still ongoing. In fact, in 2017, we have completed the consolidated of the back-end office. In 2018, we continue on to streamline and to increase the efficiency from the operational perspective.

Tianxiao Hou

That’s very helpful. I want to follow up with another question regarding the revenue consolidation. So currently, leased and operated hotels was about 75% of total revenue and the trend is declining. So I wonder what’s the trend going forward? Should we expect the franchised hotel or managed-care total contribute more to the total revenue?

Teo Nee Chuan

Thank you. For leased and operated hotels, we have a much smaller number of leased and operated hotels. Having said that, leased and operated hotels are contributed 100% of revenue RevPAR growth, as far as the revenue. However, for the managed-care hotels, we are growing a significant more numbers in terms of hotels and however, we only get approximately 10% share of the revenue from managed hotels. So this mix, although it shows that the trending, the trend of the revenue growth is that we will see continually increase in terms of the growth rate for the managed hotels will be higher compared to the lease and operated hotels due to the same reason. Having said that, we expect by going through the asset-light model, we would capitalized on the economies of scale and improve our operating profit margins.

Tianxiao Hou

Okay. So I have a last question. So asset light management — asset-light sale in the hotel management. So I wonder what’s our kind of management system or the cloud type of management system have you guys putting in place managing not to make the high-end also mid-end or low end as well as your operated hotels and the franchised hotel it seems like a quite a complex task. So just wonder what’s behind those lights assets sales and to give you such kind of efficiency?

Teo Nee Chuan

We managed the leased and operated hotels and manachised hotels in the same manner. The only difference in that for the leased and operated hotels, the entire account is by China Lodging, while under the manachised total, only the hotel managers are employed by China Lodging. So in the way that these hotels either the leased and operated hotels as well as the manachised hotels, they are supported by regional and centralized group which will be able to capitalize this on the economies of scale appear. So for example, regional managers they can support say 20 to 25 hotels each. So by adding on leased and operated hotels or managed hotels, the on the regional managers is the same. But having said that, by not having to invest in the capital expenditures for the manachised hotels as well as payroll of the hotel staff, China Lodging are able to capitalize on China Lodging operating platform and information technology to help the manachised hotels to achieve the similar efficiencies as our leased and operated hotels.

Operator

Your next question comes from the line of Billy Ng from Merrill Lynch.

Billy Ng

The first question, I just try to get a very quick sense of what’s happening in Q2 so far. From what we hear from the industry, RevPAR has been very strong in April, but if you can provide any color on April and May, that would be appreciated.

Teo Nee Chuan

From our numbers, we see that the RevPAR in April is approximately similar to those in March. So it is very strong. It is very strong.

Billy Ng

Okay. And then, a question on tax in particular, for this quarter, we see the tax rate actually is quite low, if we back out the unrealized loss. So the effective tax rate is about only 15%. So why the tax rate has been much lower, I think not just in this quarter, but also starting from fourth quarter 2017 as well. And also, that kind of tax rate, will then be sustainable for the rest of the year?

Teo Nee Chuan

Okay. What you mentioned. Our effective tax rate right now is 25.6%. Having said that, you are rightly. You pointed out that unrealized losses, if you take it out, the effective tax rate would be lower. The main reason is the change in the way we treated some of the capital expenses. Previously, while auction expenses on tax has been reflected in the below the line, which we call it the OTA, but currently, that reduction has been reflected in our tax line both in the income statements. So we expect that the trend will continue.

Billy Ng

Okay. And just one last thing, very quickly. What that share margin financing facility mean? Like is that related to the Accor investment? And what is the cost?

Teo Nee Chuan

Right. I’ll give you a little backdrop. We purchased — we purchased the Accor hotel shares using margin financing, whereby, we pledged the shares purchased for the financing. The facilities that we used is approximately USD 290 million or €260 million at the back of the value of approximately €590 million. So the LTV for the financing is approximately 40% and the interest rate, interest on the margin financing is approximately 1.7%. So the reason why it fluctuates in this manner is because taking into account of the routine dividend payable by Accor at the dividend yield of 2.6%. If you take out the reporting tax, then that will be more than covered the interest expense that you need to pay on the margin financing. In fact the amount that you need to pay for the margin financing. Now just to give you an example, is that we recently received the dividend approximately €9 million, that will more than cover our interest expense and higher margin financing.

Billy Ng

Sorry. Can I ask you again, the 1.7% based on LIBOR or based on something? I understand.

Teo Nee Chuan

It is the LIBOR. LIBOR in Europe is currently . So 1.7%.

Billy Ng

Okay. May I ask one last thing. I know someone asked that already regarding the Accor investments. Since we don’t have any plans to increase the stake right now, but what will be the exit strategy? Let’s say, one potential, of course, to lead to more collaboration that on the other hand, let’s say, it seems like you more like a financial investment right now? Do you have kind of like a target or if the share rise more than 20%, 30% or how should we think about this?

Min Zhang

We consider the investment into Accor as a strategic investment. At the same time, we enjoy the benefits of group liquidity on the stock. Currently, we don’t have a price target to exit. We expect our previous linkage, the partnership of the two parties. And given Accor has completed the project and also, recently positive, Accor will continue to perform better and we have an expectation of a stock price increase in the future.

Operator

Your next question comes from the line of Praveen Choudhary from Morgan Stanley.

Praveen Choudhary

I have two questions. The first one is related to midscale segment in which we are making inroads. I just wanted to understand if Jenny, can you explain the current supply-demand situation? And the devil’s advocate will say that there might be too much concentration, too many other competitors are focused on the same space. How do you see that supply-demand situation? And also, and demand is much more understandable. I think supply is what I want to understand your thoughts. And also, while your ADRs are moving very fast, are you getting closer to full scale hotels and in China, that number is not very high. So how much more can you go? That’s the first question.

Min Zhang

Okay. Very good questions. Our midscale market would continue to see the demand growing very fast. As we have shown some of the macro numbers, the demand, the travel spending in China last year has increased by 17% and we continue to see that strong demand coming in due to the China’s economy as well as the general check of consumption upgrades. And the bases supply of midscale hotels in China is actually very small. So despite there are meaningful increasing supply in the past few months and as well as in the coming years, we think it will still be required plenty of opportunities for the midscale brand. And actually, given the huge base of the travel spending, this consumption upgrades will actually be a very huge incremental demand for midscale hotels. It won’t be easy for all the hotel leaders to catch up in that end. So I don’t think — see any risk of oversupply in the foreseeable future for midscale hotels.

And on ADR, if you look at the upscale and luxury hotels in China, there is a very strong recovery in their rates. Actually, the increase in the past year in their ADR is phenomenal. I think the statistics is above 10% increase. So I think, the increase in upscale and luxury will also open up more space for our midscale and upper midscale hotels in their pricing. So we expect — if you look at the confidence indexes of the high-end hotels and hotel years, it is coming to a record high based on some industry research. If you compare hotel price in China versus some of the more developed economy, in general Chinese hotels are still very cheap, no matter you are looking at economy, midscale, upscale or luxury. We believe with the consumers more spending on traveling, the ADR of the whole industry are going to improve gradually.

Praveen Choudhary

My second question is related to your pipeline. You have 744 hotels in the pipeline in fourth quarter ’16, you had only 442. Do you think that your current guidance for the net openings of 450 to 500 is too conservative considering your pipeline has gone up substantially over the last one year?

Teo Nee Chuan

Right. We would like to maintain the hotel openings of 650 to 700, given that we appreciate that the pipeline has increased, but having said that, we would see we will look at the numbers in Q2 to see how it will develop because always revise upward and revise downward. So we will keep it at that and see how it goes in Q2.

Min Zhang

I would say that there is a change that we might see the guidance, but we also see the regulatory control across China, especially the main cities are very packed right now. The way I have seen our franchisees hotel growing some of owned leased hotels, their opening schedule is delayed by some of those regulatory changes. That’s something we will always need to be cautious about.

Praveen Choudhary

Got it. May be a last question for me, if I may. Can you update us in terms of your thought around acquisitions? You have done some really good acquisitions historically, including Crystal Orange, but your cash pile has depleted. Again, you are gearing level is very good, but how should we think about any future acquisitions, whether in China or overseas?

Min Zhang

We surely see acquisitions as a supplementary tool to our organic growth to expand our network and our business base. As we stated earlier, we are very disciplined and selective in our acquisitions. We look strategic validation and our capability of integration. So we have been continuously exploring different opportunities, whether we don’t have any closed to yet.

Operator

[Operator Instructions]. Your next question comes from the line of Tallan Zhou from Deutsche Bank.

Tallan Zhou

I have three questions. First one, because last quarter, we had I think CNY4.5 million transaction, sorry, CNY45 million transaction fee for Crystal Orange. So am I correct in expecting accelerating adjusted EBIDTAR for net profit in the second quarter because we don’t have that in the second quarter? That’s my first question.

Teo Nee Chuan

Sorry. The CNY46 million acquisition cost was related to 2017.

Tallan Zhou

So second quarter 2018 we see an accelerating EBITDAR growth.

Teo Nee Chuan

In Q2 is that we may not have a margin growth as much because we don’t have the benefit of higher of low comp in 2017, correct?

Tallan Zhou

Yes.

Teo Nee Chuan

Okay. I would say that when we determine the overall margin growth, as mentioned to you, our overall in 2018, we expect a marginal of say, 1.5% to 2% margin expansion. We expect that from the entire operations, from the economy of scale from due to the increasing scales. Having said that, the growth in EBITDA margin may not be as high, as you rightly pointed out. But having said that, we do see that the RevPAR in Q2 compared to the Q1 will help to improve the margin going forward, because Q1 is actually one of the lowest — is our lowest season in the entire year.

Tallan Zhou

Okay. Got you. Second question is, do you help us to break down the 29.5% revenue growth. Like, I just want to know how much growth is contributed by Crystal Orange because last quarter, we didn’t have that.

Teo Nee Chuan

Okay. The revenue growth of 29.5%, of which approximately 18% is coming from the Crystal Orange consolidation and the remaining approximately like 11.6% was from our

Tallan Zhou

Okay. Last question. You mentioned accounting change on preopening. Now we need to sort of — we can just recognize it one time, right. So if everything remained pretty much the same as last quarter, how much of our EBITDA or operating profit would have been higher?

Teo Nee Chuan

Let me correct you. The accounting changes is not on the preopening, the accounting changes is on the revenue recognition on the initial fee, our franchise fee that we receive.

Min Zhang

That’s right.

Teo Nee Chuan

As well as the royalty membership fees. So I would say that the impact is not significant.

Operator

[Operator Instructions]. Your next question comes from the line of Juan Lin from 86Research.

Juan Lin

My first question is on the upscale hotels. Could you please elaborate a bit more on your experiment, the progress of your experiment in upscale segment innovation and outlook of operating number of rooms RevPAR, ADR and occupancy rate with upscale segment. Second question is regarding the cost. In fourth quarter, as a percentage of lease and operating revenue seems to have increased on a year-over-year basis. Could you please elaborate the reason behind it? And whether lease and operating revenue related to the will continue trending up on a year-over-year basis going forward?

Min Zhang

We believe upscale market is getting more and more to us. One is the RevPAR growth in upscale, the recovery is quite significant. And secondly, I think we are finally a management company, the upscale and the luxury hotels provide a much bigger revue base for a fee generation. And from their customer life cycle perspective, we also want to be able to offer a reach widespread, full range kind of products to our customers so we can meet their needs in different location and different stage of their life. So given that entry into the upscale market is a strategically important for us. For now, we are still at the early stage. We are exploring the possibility of enhancing the Joya product. As you can see from the new Joya in Shanghai, we want to position that as a very elegantly designed upscale brand. We are also working on our brands like Novotel and Grand Mercure. We have launched a new Mercure, a new Novotel just a couple of months ago, also in Shanghai, which is also very attractive location as well as a product design. We expect to open a new Grand Mercure in the central location of which is also important Tier 1 cities. So we are going to test with those properties and to gain a more experience in this domain. And once we achieve success in those initial flagships, indeed, we believe we are going to expand much quicker in this area.

Teo Nee Chuan

Okay. Adjusting your second question on increased cost, you are rightly pointed out that there is some escalation on cost. The reason behind that is because they make some adjustments on the revised outlook, the unit payment for our cleaning ladies. The reason why we do that is we think that by increasing, by giving them a better pay for the better quality of the work that they perform will provide a clean product that our customer will demand. So in that way, we hope that the increasing will help us to attract more customers, which will improve our RevPAR further. So we expect that the percentage of the payroll, the percentage of net revenue will maintain at the Q1 level going forward. And of course, having said that, we hope that our staff will earn more money because it will perform better with a better profitability on each hotels.

Operator

There are no further questions at this time. I would now like to hand the conference back to today’s presenters. Please continue.

Ida Yu

Thank you, everyone. And this concludes today’s call. We look to update you in the next earnings call in August. Thank you. Bye, bye.

Min Zhang

Bye, bye.

Operator

Thank you. Ladies and gentlemen, that this concludes our conference for today. Thank you for participating. You may all disconnect.

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