SVN 7 Days Grp. Holdings Limited American Depositary Shares, Each Representing Three Ordinary Shares

Selected Consolidated Statement of Comprehensive Income: 

Selected Consolidated Balance Sheet Data:

Exchange Rate Information

Our business is conducted in China and substantially all of our net revenues are denominated in Renminbi. This annual report contains translations of Renminbi 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 noon buying rate in the City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. The exchange rate refers to the exchange rate as set forth in the H.10 statistical release of 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 RMB6.2301 to US$1.00, the noon buying rate in effect as of December 31, 2012. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, 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 Renminbi into foreign exchange and through restrictions on foreign trade. On April 5, 2013, the noon buying rate was RMB6.2005 to US$1.00.

The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollar for the periods indicated.

B. Capitalization and Indebtedness  

Not applicable.

C. Reasons for the Offer and Use of Proceeds

Not applicable.

D. Risk Factors

RISKS RELATING TO OUR BUSINESS AND INDUSTRY

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, among others:

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.

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 for customers primarily is based on hotel room rates, quality of accommodations, brand name recognition, convenience of location, geographic coverage, quality and range of services, and guest amenities. Our primary competitors are other economy hotel chains, as well as various regional and local economy hotels and local guest houses in each of the markets in which we operate. We also compete with one-, two- and three-star hotels, as we offer rooms with standards comparable to many of those hotels while maintaining competitive pricing. In the future, we may face increased competition from our existing competitors due to possible consolidations, new partnerships, arrangements or investments, such as the investment by Ctrip, the leading Chinese travel website, in two of our large competitors. We may also face competition from new players in the economy hotel segment in China since developing or converting an economy hotel requires a smaller commitment of capital and human resources and the PRC government may adopt measures designed to increase the number of economy and other hotels in China. This relatively low barrier to entry potentially allows new and existing competitors to enter or expand in our markets quickly and compete with our business. New and existing competitors may offer more competitive rates, greater convenience, superior services or amenities, or superior facilities, possibly attracting guests away from our hotels and resulting in lower occupancy and average daily rates for our hotels. Competitors may also outbid us in the selection of sites for new leased-and-operated hotel conversion, negotiate better management terms for potential managed hotels or offer better terms to our existing managed hotel owners, thereby slowing our anticipated pace of expansion. Furthermore, our typical guests may change their travel, spending and consumption patterns and choose to stay in other kinds of hotels, especially given the increase in our hotel room rates to keep pace with inflation. Any of these factors may have an adverse effect on our competitive position, results of operations and financial condition. Additionally, if we are unable to successfully execute our proposed strategy to enter into the high-end hotel market, we may be unable to generate revenues from such market in the amounts and by the times we anticipate, and our business, competitive position, financial condition and prospects may be adversely affected.

We may not be able to manage our expected growth, which could adversely affect our operating results.

We have experienced substantial growth since our inception. We have increased the number of hotels in our 7 Days chain in operation in China from five in 2005 to 1,345 as of December 31, 2012, and we intend to continue to convert, operate and manage additional hotels in markets where we have a presence and in additional cities in China. Our expansion has placed, and will continue to place, substantial demands on our managerial, financial, operational, information technology, or IT, and other resources. In order to manage and support our growth, we must continue to improve our existing managerial, operational and IT systems, and recruit, train and retain qualified hotel management and other personnel. Our planned expansion will also require us to maintain consistent and high-quality accommodations and services to ensure that our brand does not suffer as a result of any deviations, whether actual or perceived, in our quality standards. We cannot assure you that we will be able to effectively and efficiently manage the growth of our operations or maintain our quality standards. If we are unable to do so, our results of operations and financial condition may be materially and adversely affected.

In addition, our expansion within markets where we already have a presence may adversely affect the financial performance of our hotels in operation in those markets and, as a result, negatively affect our overall results of operations. Furthermore, expansion into new markets may present operating and marketing challenges that are different from those that we currently encounter in our existing markets. Expansion into new markets may also cause certain of our non-financial key performance indicators to decline, such as our average daily rate, average occupancy rate and RevPAR, as new markets may have lower average hotel room rates than markets in which we currently have a presence and our new hotels tend to have a lower occupancy rate than our more mature hotels. In particular, we have experienced a decrease in the average occupancy rate in recent three years, from 88.7% in 2010 to 84.6% in 2011, and to 81.3% in 2012. The decrease in 2012 is mainly due to our rapid addition of new hotels and the adverse impact of the macro economy situation in 2012. The significant number of hotels in the ramp-up stage have lower occupancy rate than mature hotels in existing markets, thereby affecting our overall financial and operational performance. Our inability to anticipate the changing demands that expanding operations will impose on our managerial, operational, IT, and other resources, or our failure to quickly adapt our systems and procedures to the demands of new markets, could result in lost revenues and increased expenses and otherwise harm our results of operations and financial condition.

For instance, we have initiated the process of developing a new hotel brand as part of our initiative to enter into the high-end hotel market, which targets individual business and leisure customers who have a higher travel budget than our core 7 Days customers. We are in the process of fine-tuning product designs, features, and marketing plans for the potential new hotel brand and have assigned a dedicated internal team to develop the brand concept and positioning. If the potential new hotel brand 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.

We had a history of losses in the years prior to 2010 and may not achieve sustained profitability.

Although we were profitable in 2010, 2011 and 2012, we had a history of net losses in the years prior to 2010. For the years ended December 31, 2008, and 2009, our net losses were RMB209.9 million, RMB102.2 million, respectively. As of December 31, 2012, we had an accumulated deficit of RMB62.3 million (US$10.0 million).  We may incur net losses again in our future periods as we expand our hotel chain and pursue our business strategy. In addition, because we recognize rent expense over the full lease term on a straight-line basis including any “free rent” lease period, we incur operating costs and expenses for hotels under conversion for which no revenues are being recognized during such period. Therefore, our income from operations will be adversely impacted during periods in which we continue to increase our number of leased-and-operated hotels, and this impact is likely to continue as we pursue our expansion strategy. Even though we were profitable in 2012, we may not be able to sustain or increase our profitability in the future.

We expect to need additional capital and we may not be able to obtain such capital in a timely manner or on acceptable terms, or at all.

We expect to need additional capital to implement our growth strategy, remain competitive or expand our hotel network. Our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties, including:

Our future capital needs and other business reasons could require us to sell additional equity or debt securities or obtain credit facilities. The sale of additional equity or equity-linked 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 and our ability to pay dividends to our shareholders. We may be unable to obtain additional capital in a timely manner or on acceptable terms, or at all, which could have a material adverse effect on our liquidity and financial condition and our ability to pursue our growth plans, particularly our ability to add more leased-and-operated hotels to our chain.

If we are not able to recruit, train and retain qualified managerial and other employees, our brand and our business may be materially and adversely affected.

Since 2009, we have been increasingly focused on expansion and growth through hotel management arrangements, in which we are responsible for managing these hotel, including decisions regarding hiring, appointing and training hotel managers and staff and managing sales, financial and operating performance. Our managerial and other employees operate our hotels and interact with our guests on a daily basis and are critical to maintaining our consistent and high-quality accommodations and services, as well as our established brand and reputation. We aim to recruit, train and retain entrepreneurial, motivated and positive customer service oriented managerial and other employees with backgrounds and experience in hotel, service and other industries. We must recruit and train qualified managerial and other employees on a timely basis to keep pace with our rapid growth. There may be a limited supply of such qualified individuals in some of the metropolitan markets where we have operations and other cities in China into which we intend to expand. In addition, criteria such as dedication to work and commitment to customer service are difficult to ascertain during the recruitment process. We also must provide continuous training to our managerial and other employees so that they can stay abreast of changes in our hotel operations and consumer preferences and demands, and meet and implement our quality standards. If we fail to recruit, train and retain qualified managerial and other employees, our quality standards may decrease in one or more of our hotels, which in turn may have a material and adverse effect on our brand, our business, and our financial condition and results of operations.

We may not be able to successfully and timely identify, secure or operate additional hotel properties.

We plan to open more hotels in markets where we have a presence and additional cities in China to further grow our business. In more developed cities, it may be difficult to increase the number of hotels because we or our competitors may already have operations in such cities, rental prices may increase, or our competitors may be able to gain leases of properties before we can do so. In some cases, our competitors may be willing to enter into less favorable lease or hotel management arrangements in order to prevent us from securing a particular property. On the other hand, in less developed cities, demand for our hotels may not increase as rapidly as we may expect. In addition, even if we are able to successfully identify and lease or manage new hotel properties, new hotels may not generate the returns we expect. Furthermore, we may incur costs in connection with evaluating properties and negotiating with property owners, lessors and managed hotel owners, including properties that we are subsequently unable to lease or manage. In some cases, negotiations with property owners may continue for an extended period, which may delay our anticipated conversion timeline. 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.

We may not be able to convert hotels on a timely or cost-efficient basis, which may adversely affect our growth strategy and business prospects.

We fund and oversee the conversion of our leased-and-operated hotels. Our involvement in the conversion of leased properties presents a number of risks, including conversion delays or cost overruns, which may result in increased project costs or lost revenues. We may be unable to recover conversion costs we incur for projects that are not pursued to completion. In addition, properties that we convert could become less attractive due to market saturation or oversupply, meaning we may be unable to recover conversion costs at the expected rate, or at all. Furthermore, we may not have available cash to complete projects that we have commenced, or we may be unable to obtain financing for conversion of future properties on favorable terms, if at all. If we are unable to successfully manage our hotel conversion activities to minimize these risks, our growth strategy and business prospects may be adversely affected.

Interruption or failure of our eCommerce platform or IT system could impair our ability to effectively provide accommodations and services, which could damage our reputation.

Our ability to provide consistent and high-quality accommodations and services across our hotel chain depends on the continued operation of our eCommerce platform and IT system. Any damage to, or failure of, our eCommerce platform or IT system could interrupt our service. Our eCommerce platform and IT system are vulnerable to damage or interruption as a result of power loss, telecommunications failures, computer viruses, hackers, fires, floods, earthquakes, interruptions in access to our toll-free numbers, or other attempts to harm our systems, and similar events. Our servers, which are maintained in Guangzhou, 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 eCommerce platform, IT system and related technologies may become outdated and we may not be able to replace or introduce upgrades as quickly as our competitors or within budgeted costs for such upgrades. If we experience frequent, prolonged or persistent eCommerce platform or IT system failures, the quality of our accommodations and services and our reputation could be harmed. The steps we need to take to increase the reliability and redundancy of our eCommerce platform and IT system may be costly, which could reduce our operating margin, and may not be successful in reducing the frequency or duration of any failures or service interruptions.

If the value of our brand diminishes, it could have a material adverse effect on our business and results of operations.

We believe our “7 Days Inn” brand is integral to our success, including the success of our sales and marketing efforts and our efforts to grow through hotel management arrangements. Our continued success in maintaining and enhancing our brand depends, to a large extent, on our ability to provide consistent and high-quality accommodations and services across our hotel chain, and design and introduce new accommodations and services to meet customer demands, as well as our ability to respond to competitive pressures. In addition, we and our managed hotel owners must maintain our hotels’ good condition and attractive appearance that requires ongoing renovations and other leasehold improvements, including periodic repair and replacement of furniture, fixtures and equipment. These ongoing renovations and other leasehold improvements require ongoing funding and, to the extent we or our managed hotel owners cannot fund these expenditures from existing cash or cash from operations, we or our managed hotel owners may need to borrow or raise capital through financing. We or our managed hotel owners may not be able to access capital on acceptable terms, or at all, and our managed hotel owners may be unwilling to spend capital when necessary, even if required by us. If we are unable to maintain and enhance our brand reputation, our occupancy and room rates may decline, which would adversely affect our business and results of operations.

Any failure to protect our trademarks and other intellectual property rights could have a negative impact on our business.

We believe our brand, trade name, trademarks and other intellectual property are critical to our success. “7 Days Inn” is a highly recognized brand in the economy hotel segment of China’s lodging industry and 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. We have applied for trademark registration for our “7 Days Inn” brand and logo in China, Hong Kong, Macao, the United States and Malaysia. Some of these applications have been rejected by the relevant authorities in China and Malaysia, and the remaining trademark registrations in China and elsewhere may not be granted. The unauthorized reproduction of our trademarks or the use of confusingly similar brands could diminish the value of our brand and its market acceptance, competitive advantages and goodwill. In addition, we consider our eCommerce platform and IT system to be key components of our competitive advantage and our growth strategy. We have obtained two utility model patents for our modular bathroom. We have received copyright registration certificates for 7 software programs developed by us. None of our other proprietary and operational systems have been patented or otherwise registered as our property. 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 be costly, involve substantial management time and resources to enforce and fail to prevent their unauthorized use by third parties. Furthermore, the application of laws governing intellectual property rights in China is uncertain and evolving, and could involve substantial risks 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.

We also may be subject to claims for infringement, invalidity, or indemnification relating to third parties’ intellectual property rights. Such claims may be time-consuming and costly to defend, divert management attention and resources, or require us to enter into licensing agreements, which may not be available on commercially reasonable terms, or at all.

Failure to retain our senior management team and other key employees could harm our business and operations.

Our future success significantly depends upon the continuing service of our senior management team and other key employees. If one or more members of our senior management team or other key employees are unable or unwilling to continue in their present position, we may not be able to replace them easily, or at all, and may incur additional expenses to recruit and retain qualified replacements. Furthermore, as we expect to continue to expand our operations and enter into the high-end hotel market, we will need to continue attracting and retaining experienced management, key service personnel and salespeople. We do not carry key person insurance on any of our senior management team.

Our costs and expenses may remain constant or increase even if our revenues decline.

A significant portion of our operating costs for a particular period, 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, during January and February, the months during which the Chinese New Year falls, our occupancy rates tend to decline and our revenues fall, but our expenses do not vary significantly since we continue to pay rent and salary, make regular repairs, conduct maintenance and renovations, and invest in other capital improvements on a continuous basis to maintain the attractiveness of our hotels. In addition, our conversion costs may increase as a result of increasing costs of materials and our labor costs may increase over time. However, we have a limited ability to pass increased costs on to guests through hotel room rate increases. Therefore, our costs and expenses may remain constant or increase even if our revenues decline, which would adversely affect our net margins and results of operations.

Our management agreements could be terminated early, we may not be able to renew our existing management agreements on commercially reasonable terms and the service fees we may collect could decrease substantially in the future, which could materially and adversely affect our operations.

Beginning in 2009, we gradually shifted our focus to hotel management arrangements. As of December 31, 2012, a total of 853 of our hotels are operated under hotel management arrangements and an additional 202 managed hotels are under conversion.  We rely heavily on management arrangements to continue our geographic expansion. Under our hotel management agreements, we license our brand to property owners, lessors or existing hotel operators. These agreements may be acquired, terminated, renegotiated or converted to franchise agreements in the ordinary course of our business. In addition, although our management agreements contain provisions limiting the ability of the property owners to terminate management agreements or to withhold consent to the renewal of such agreements, hotel property owners may still elect to breach such provisions and terminate their management agreements with us if, among other things, their properties are sold, if they default on indebtedness encumbering the property or upon a foreclosure of the property. There can be no assurance that we will be able to replace terminated management agreements, or that the terms of renegotiated contracts will be as favorable as the terms that existed before such renegotiations or conversion. As a result, our revenues derived from the service fees may decrease. In some circumstances, we may choose to terminate a management agreement upon a material breach of the property owner. Although we are entitled to damages under the management contract, there is no assurance that we can recover our losses.

We may not be able to successfully continue our managed hotel expansion.  

As of December 31, 2012, we had 853 managed hotels and we intend to pursue additional hotel management arrangements as part of our growth strategy. Such arrangements generally require us to license our brand to third parties and we are responsible for managing these hotels, including hiring and appointing hotel managers and staff. There can be no assurance that we will be able to identify and secure additional suitable hotel management arrangements or, if so, that we will be able to negotiate commercially reasonable terms. In addition, hotel management arrangements may limit our ability to maintain consistent and high-quality accommodations and services and may give rise to disputes with our managed hotel owners or dilute our brand, which could harm our business. Furthermore, if third parties use our brand in a harmful manner, our business and reputation may be adversely affected.

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 operations.

Our lease agreements with third parties for our leased-and-operated hotels typically provide, among other things, that the leases could be terminated under certain legal or factual circumstances. If our leases were terminated early, we may be entitled to amounts spent on leasehold improvements and liquidated damages but we would have to relocate our operations to other properties. We may not be able to generate revenues out of such leases and may incur additional costs in relocating such properties. We may incur significant legal fees and other costs in pursuing liquidated damages in the courts, and may not be able to obtain any damages at all. Furthermore, we may have to pay losses and damages and incur other liabilities to our guests and other vendors due to potential defaults under our contracts for a particular property. As a result, our business, results of operations and financial condition could be materially and adversely affected.

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.

We do not hold any land-use rights with respect to the land on which our leased-and-operated hotels are located nor do we own any of the hotel properties we operate. Instead, we primarily rely on leases with third parties who either own the properties or lease the properties from the ultimate property owner. As of December 31, 2012, 92 of our leased-and-operated hotels in operation were leased from lessors who were unable to provide us copies of title certificates for such properties. Title to these properties could be challenged and, if successful and if we are not adequately indemnified by the lessors for our related losses, these challenges could impair the conversion or operations of our hotels on such properties. In the event that we could no longer operate on such sites, the proportion of revenue from such hotels that we may lose may be higher than the proportion that such number of hotels represent of all of our hotels. As of December 31, 2012, 58 of our leased-and-operated hotels in operation were leased from lessors who are not the ultimate owners of such properties and no consent was obtained from the ultimate owners to sublease the hotel properties to us. These or future lessor’s failures 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 on less favorable terms. Moreover, building ownership or leaseholds in connection with our managed hotels could be subject to similar third-party challenges, possibly invalidating those leases or resulting in renegotiated leases and, in turn, possibly harming our managed hotel operations and brand. As of December 31, 2012, 32 of our leased-and-operated hotels in operation were subject to mortgages at the time the leases were signed where consent to the leases was not obtained from the respective mortgage holders. In such circumstances 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 holder forecloses on the mortgage and transfers the property, which could in turn materially and adversely affect our ability to operate the hotel facility or require us to renegotiate our lease on terms which could be substantially less favorable to us. Our managed hotel owners face similar risks. In addition to the above risks, we also face potential disputes with property owners. Such disputes, whether or not resolved in our favor, may divert management attention, involve significant cost, harm our reputation and otherwise disrupt our business.

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 of hotel properties, we, our managed hotel owners 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. For our leased-and-operated hotels, our standard lease agreement generally requires the lessor to make such registrations. However, as of December 31, 2012, 450 of the properties where we lease and operate our hotels were leased from lessors who had not obtained required registrations of their leases from the relevant authorities and we continue to remind these lessors to obtain registrations under our lease agreements with them. The failure to file these leases may result in fines or penalties on our lessors. 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 and we may commence hotel operations for hotels that have not yet received required commercial use zoning. The failure of our lessors 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 or the invalidity of our lease agreements, which may negatively affect our ability to operate the hotels covered under those leases. Our managed hotel owners face similar risks, which could subject them to fines and possible closure of the managed hotel and, in turn, could harm our managed hotel operations and brand. Since we commenced operations, we have been subject to fines for operating hotels which have not been zoned for commercial use. Although such fines have no material adverse effect on our business and operating results, there can be no assurance that we will not be subject to fines in the future or other penalties, including potentially being required to cease hotel operations at non-complying properties.

Our failure to comply with franchise regulations may result in penalties to us and could have a material adverse effect on our business.

In China, franchise activities are subject to the supervision and administration of the Ministry of Commerce and its local counterparts. Under the relevant regulations, franchisors are required to file their franchise contracts with the Ministry of Commerce or its local counterparts. Although we have filed our management agreements with the local counterpart of the Ministry of Commerce in Guangdong province, there is some uncertainty as to whether our management arrangements constitute franchising activities under these regulations. If relevant authorities determine that we have conducted but failed to properly report franchising activities in accordance with the regulations, we may not be able to continue to conduct our business using hotel management arrangements and our business would be adversely affected.

Before entering into franchise agreements, the franchisor is required to disclose and provide specified written information to the franchisee regarding the franchise business, which includes certain proprietary information. If our management agreements are determined to be franchise agreements by relevant authorities and we have failed to disclose the required information correctly, accurately and fully, our managed hotel owners would have the right to terminate the management agreements, which could result in a material adverse effect on our business. Furthermore, franchise agreements are required to include certain provisions, such as termination rights and payment obligations. If our management agreements are determined to be franchise agreements by relevant authorities and the terms of our agreements are deemed to violate such requirement, such terms may be treated as invalid and unenforceable by our managed hotel owners and we may be required to terminate or revise our agreements on terms more favorable to our managed hotel owners, which could materially diminish the economic value of our agreements.

We may be liable for improper use or appropriation of personal information provided by members of our 7 Days Club.

We require our 7 Days Club members to provide certain personal information to us when they register their membership and as part of our 7 Days Club, retain and analyze such information in order to enhance our services to our customers. In doing so, we attempt to comply in all respects with applicable laws, including PRC laws, relating to the collection and storage of such personal information. In addition, we have taken commercially reasonable measures to keep such personal information safe and have implemented a privacy policy regarding the use of such information. However, we cannot assure you that individuals with access to personal information will abide by our privacy policy or that the personal information will not be appropriated by third parties, such as hackers, which may result in the inappropriate use or release of such information and could lead to potential lawsuits from members of our 7 Days Club and liability to us for not protecting their personal information. 

The implementation of our offshore holding company structure related to the equity interests in Guangzhou 7 Days Hotel Management Co., Ltd. and Guangzhou 7 Days Inn Co., Ltd. may be challenged by PRC regulatory agencies to have violated a PRC regulation and, if challenged, we may be required to divest these equity interests and may be subject to administrative fines and other penalties.

Prior to November 2005, all of the outstanding equity interests of Guangzhou 7 Days Hotel Management Co., Ltd., a PRC limited liability company, or 7 Days Guangzhou, were held in trust for our company by Mr. Nanyan Zheng, our former chief executive officer and co-chairman of the board of directors, and Mr. Linde Huang, who was an employee of a company affiliated with Mr. Boquan He, one of our founders and our co-chairman. The equity interests in 7 Days Guangzhou held in trust for our company by Mr. Huang were previously held in trust for our company by Mr. Guangji Chen until Mr. Chen left our company. Our investment in 7 Days Guangzhou through this trust arrangement was not approved by the Bureau of Foreign Trade and Economic Cooperation of Guangzhou, which is required under PRC laws. In November 2005, our beneficial ownership in the equity interests in 7 Days Guangzhou were transferred to 7 Days Inn (Shenzhen) Co., Ltd., or 7 Days Shenzhen, pursuant to a trust agreement entered into among Messrs. Zheng and Huang and 7 Days Shenzhen, and the prior trust arrangement with our company was terminated. In addition, prior to October 2005, all of the outstanding equity interests in Guangzhou 7 Days Inn Co., Ltd., a PRC limited liability company, or 7 Days Inn Guangzhou, were held in trust for 7 Days Shenzhen by Messrs. Zheng and Huang. In October and November 2006, we completed the restructuring related to 7 Days Guangzhou and 7 Days Inn Guangzhou, as a result of which 7 Days Shenzhen now holds all of the outstanding equity interests of 7 Days Guangzhou and 7 Days Inn Guangzhou directly instead of through these trust arrangements. The completion of these formalities was registered with local government authorities in Guangzhou and our PRC counsel, Commerce & Finance Law Offices, has advised us that the completion of such formalities does not render the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors that became effective on September 8, 2006, or the New M&A Rule, applicable. Under the New M&A Rule, acquisitions by an offshore special purpose vehicle, or SPV, of domestic equity interests related to it are subject to the approval of the Ministry of Commerce. We cannot guarantee you, however, that relevant PRC government authorities will not determine that approval of the Ministry of Commerce was required. If relevant PRC government authorities deem our transactions with 7 Days Guangzhou and 7 Days Inn Guangzhou to be an “acquisition” subject to the New M&A Rule, we may have violated the New M&A Rule and could be subject to administrative fines and other penalties from relevant PRC authorities, may be required to obtain approval for such transactions from the Ministry of Commerce and could be required to divest 7 Days Guangzhou and 7 Days Inn Guangzhou, in which case we would lose the benefit of the revenues from hotels operated by such entities, which is substantial. There are no specific declarations of fines or penalties for such violations under current PRC laws and regulations and so the penalties we may suffer are uncertain. As of December 31, 2012, 7 Days Guangzhou and 7 Days Inn Guangzhou operated a total of 33 hotels, which accounted for 4.7% of our total revenues in 2012. Any of these events could have a material adverse effect on our business, operating results, and reputation and the trading price of our ADSs.

We have not obtained approvals from the local counterparts of the Ministry of Commerce and the National Development and Reform Commission in connection with our ownership of 7 Days Inn (HK) Investment Co., Limited, and if our ownership is challenged we may be subject to administrative fines and other penalties.

When we established 7 Days Inn (HK) Investment Co., Limited, we were required to obtain approvals from the respective local counterparts of the Ministry of Commerce and the National Development and Reform Commission under relevant PRC laws and regulations. We have obtained the approval from the local counterpart of the Ministry of Commerce but our application with the local counterpart of the National Development and Reform Commission was turned down because the relevant officials of the local National Development and Reform Commission were of the view that its approval was not required. Nevertheless, if, in the future, the local National Development and Reform Commission adopts a different interpretation, our failure to obtain its approval in connection with our equity interest in 7 Days Inn (HK) Investment Co., Limited may be challenged and we may be subject to administrative fines and other penalties.

We are subject to various hotel industry, health and safety, and environmental laws and regulations that may subject us to liability.

Our PRC counsel, Commerce & Finance Law Offices, has advised us that each hotel in our chain must hold a basic business license and a special industry license issued by the local public security bureau and must have hotel operation included in the business scope of their respective business license. Our business is also subject to various health and safety and environmental laws and regulations that affect our operations and conversion activities in the jurisdictions in which we operate, including building, zoning, fire prevention, public safety, health and sanitary requirements. Of our leased-and-operated hotels in operation as of the date of this annual report, 38 are in the process of obtaining a basic business license, 47 are in the process of obtaining their organization code certificates, 48 are in the process of obtaining their special industry licenses, 49 are in the process of obtaining their public health permits, 14 are in the process of obtaining their tax or land registration certificates, 18 are in the process of obtaining approvals from local fire prevention authorities and 120 of our hotels serving breakfast are in the process of obtaining the relevant approvals from local health administrations for such activities. As a result of these compliance failures, we have been and may be subject to monetary damages, the imposition of fines against us, or the suspension or disruption of our operations or conversion activities, which could materially adversely affect our financial condition and results of operations. Furthermore, a majority of our leased-and-operated hotels in operation as of December 31, 2012 have not obtained environmental approvals from local environmental protection agencies. While we are trying to obtain the required approvals in due course, this noncompliance could result in administrative fines, suspension of hotel operations or other penalties under applicable PRC law.  From the time that we commenced operations through December 31, 2012, we were subject to fines of approximately US$51,000 due to non-compliance with applicable health and environmental regulations. Although several hotels were required to temporarily cease operation due to non-compliance with applicable health and safety regulations, this has not resulted in material adverse impact on our business and operational performance. We cannot guarantee that we will not be subject to any challenges or other actions with respect to such noncompliance.

If we fail to comply with any future material environmental, health and safety laws and regulations related to our business, we may be subject to additional monetary damages, the imposition of fines against us, or the suspension of our operations or conversion activities. Furthermore, new regulations could also require us to retrofit or modify our hotels or incur other significant expenses. Any failure by us to control the use of, or to adequately restrict the discharge of, hazardous substances in our conversion activities, or otherwise operate in compliance with environmental laws, could subject us to potentially significant monetary damages and fines or suspension of our business operations, which could materially adversely affect our financial condition and results of operations.

Owners of our managed hotels are subject to these same permit and safety requirements. Although our managed hotel arrangements require the hotel owners to obtain and maintain all required permits or licenses, we have limited control over the managed hotel owners. Any failure to obtain and maintain the required permits or licenses by owners of the managed hotels may require us to delay opening of a managed hotel or to forgo or terminate our managed hotel arrangement, which could harm our brand, result in lost management revenues and subject us to potential indirect liability.

Accidents, injuries or prohibited activities in our hotels may adversely affect our reputation and subject us to liability.

There are inherent risks of accidents, injuries or prohibited activities (such as illegal drug use, gambling, violence or prostitution by guests) taking place in hotels. The occurrence of one or more accidents, injuries or prohibited activities at any of our hotels could adversely affect our safety reputation among guests, harm our brand, decrease our overall occupancy rates, and increase our costs by requiring us to implement additional safety measures. In addition, if accidents, injuries or prohibited activities occur at any of our hotels, we may be held liable for costs or damages and fines. Our current property and liability insurance policies may not provide adequate or any coverage for such losses, and we may be unable to renew our insurance policies or obtain new insurance policies without increases in premiums and deductibles or decreases in coverage levels, or at all.

Our financial and operating performance may be adversely affected by epidemics, adverse weather conditions, natural disasters and other catastrophes.

Our financial and operating performance may be adversely affected by epidemics, adverse weather conditions, natural disasters and other catastrophes, particularly in locations where we have a concentration of hotels. For example, in early 2003, several economies in Asia, including China, were affected by the outbreak of severe acute respiratory syndrome, or SARS. During May and June of 2003, many businesses in China were closed by the PRC government to prevent transmission of SARS. In addition, in 2008 and 2009, some Asian countries, including China, encountered incidents of the H5N1 strain of bird flu, or avian flu. Avian flu, which originally spread through poultry, is capable in some circumstances of being transmitted to humans and is often fatal. In 2009, there was a global outbreak of the H1N1 virus, or swine flu, which affected many regional economies in China. The swine flu outbreak had a negative impact on many businesses in Shenzhen, including our business, due to reduced business travel between Hong Kong and Shenzhen. Furthermore, the 2008 Sichuan earthquake also had a negative impact on many businesses in the region, including our business, due to reduced economic and travel activity in the affected region. Losses caused by epidemics, adverse weather conditions, natural disasters and other catastrophes, including SARS, avian flu, swine flu, earthquakes or 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 for war), terrorist activities (including threats of terrorist activities) and travel-related accidents, as well as geopolitical uncertainty and international conflict, may affect travel and may in turn have a material adverse effect on our business and results of operations. 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.

We have limited insurance coverage.

Our property insurance covers the assets that we own at our hotels and the buildings in which our leased-and-operated hotels and managed hotels operate. We also require our lessors and managed hotel owners to purchase customary insurance policies but they may fail to satisfy these requirements. If we 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. In addition, we do not have any business disruption insurance coverage for our operations to cover losses possibly caused by adverse weather conditions, natural disasters or catastrophic events, such as SARS, avian flu, swine flu, earthquakes or typhoons. Any business disruptions or natural disasters may result in our incurring substantial costs and diversion of our resources. Furthermore, we do not carry key person insurance on any of our senior management team.

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 report from management on its internal control over financial reporting in its annual report containing management’s assessment of the effectiveness of the company’s internal control over financial reporting. In addition, an independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. While our management concluded that our internal control over financial reporting was effective as of December 31, 2012, our management may later conclude that our internal control is not effective. Moreover, even if our management concludes in the future that our internal control is effective, our independent registered public accounting firm may disagree. If our independent registered public accounting firm is not satisfied with our internal control over financial reporting or the level at which our internal control over financial reporting is designed, documented, operated or reviewed, or if the independent registered public accounting firm interprets the requirements, rules or regulations differently from the way we do, then they may issue an adverse or qualified opinion.

Any of these outcomes could result in a loss of investor confidence in the reliability of our audited consolidated financial statements, which could materially and adversely affect the trading price of our ADSs. Our reporting obligations as a public company will continue to place a significant strain on our managerial, operational and financial resources and systems for the foreseeable future.

If we grant employee share options and other share-based compensation in the future, our net profit could be adversely affected.

We believe our share incentive plan and other similar types of incentive plans are important to attract and retain key personnel. We have granted share options in the past and expect to do so in the future. As a result of the grant of share options, we incurred share-based compensation expenses of RMB15.5 million in 2010 and modified the exercise price of certain options granted to our employees during 2010 and 2011. Our share-based compensation expense amounted to RMB43.5 million for the year ended December 31, 2011.  As a result of grant of share options in 2012, we incurred share-based compensation expenses of RMB27.1 million (US$4.4 million) in 2012. We may continue to incur share-based compensation expenses in the future. We have adopted FASB ASC Topic 718, Compensation-Stock Compensation, or ASC Topic 718, in accounting for our share-based compensation. We account for compensation expenses for all share options, including share options granted to our directors and employees, using a fair-value based method and recognize the expense in our consolidated statement of operations in accordance with U.S. GAAP, which may have a material adverse effect on our net profit.

Our PRC subsidiaries have advanced funds among each other, which practice may have violated PRC regulations on inter-company lending and we may be subject to administrative fines and other penalties as a result of such violation.

As of December 31, 2012, 7 Days Shenzhen had advanced an aggregate amount of approximately RMB222.3 million (US$35.7 million) to our various PRC subsidiaries in which we own at least a majority interest. Our PRC counsel, Commerce & Finance Law Offices, has advised us that these inter-company loans may have violated certain PRC laws and regulations regarding commercial loans. As a result, we may be required to unwind these transactions and may be subject to administrative fines, which could have a material adverse effect on our business, operating results, reputation and trading price of our ADSs.

The use of variable interest entities (“VIEs”) in establishing hotels to be acquired and then operated by us may expose us to greater than expected financial losses and may prevent us from realizing all the expected economic rewards from the VIEs.  

Pursuant to U.S. GAAP guidance ASC 810-10 “Consolidation of Variable Interest Entities,” certain of our entities are considered VIEs because the total equity investment at risk (paid-in capital of RMB1.0 million) of each of these entities was not sufficient to finance its intended activities without additional subordinated financial support. These VIEs were established to open hotels to be operated as hotels to be acquired and then operated by us, and we and certain individuals hold equity interests of 51% and 49%, respectively, in each of these VIEs. In addition, we have provided subordinated debt to the VIEs to support construction and on-going operation of the VIEs. The amounts due to us by the VIEs as of December 31, 2011 and 2012 were RMB114.0 million and RMB173.2 million (US$27.8 million), respectively. If the hotels established via the VIEs perform poorly financially, the VIEs may be unable to repay the amounts due to us and therefore, negatively affect our overall results of operations.

We may pursue selective acquisitions to complement our organic growth which may not be successful.

We may pursue selective acquisitions to complement our organic growth. If we decide to pursue selective acquisitions, we may not be successful in identifying suitable acquisition opportunities or completing such transactions, and our competitors may be more effective in executing and closing acquisitions in competitive bid situations than us. Our ability to enter into and complete acquisitions may be restricted by, or subject to, various approvals under PRC law or may not otherwise be possible, may result in a possible dilutive issuance of our securities, or may require us to seek additional financing. We also may experience difficulties integrating acquired operations, services, corporate cultures and personnel into our existing business and operations. Completed acquisitions may also expose us to potential risks, including risks associated with unforeseen or hidden liabilities, the diversion of resources from our existing business, and the potential loss of, or harm to, relationships with our employees or guests, as a result of our integration of new businesses. In addition, following completion of an acquisition, our management and resources may be diverted from their core business activities due to the integration process, which diversion may harm the effective management of our business. Furthermore, it may not be possible to achieve the expected level of any synergy benefits on integration and/or the actual cost of delivering such benefits may exceed the anticipated cost. Any of these factors may have an adverse effect on our competitive position, results of operations and financial condition.

The growth of third-party websites and other hotel reservation intermediaries and travel consolidators may adversely affect our margins and profitability.

Some of our hotel rooms are reserved through third-party websites and other hotel reservation intermediaries and travel consolidators to whom we pay commissions for such services. We believe that the aim of such intermediaries and consolidators is to have consumers develop loyalties to their reservation systems rather than to hotel brands such as ours. If these intermediaries and consolidators become a significant channel through which our guests make reservations, they may be able to negotiate higher commissions, reduced room rates, or other significant concessions from us, which could adversely affect our margins and profitability.

Certain of our non-financial key performance indicators may not be directly comparable to those of our competitors.

We may calculate certain of our non-financial key performance indicators, such as average occupancy rate and average daily rate, in a manner different than our competitors. As a result, certain of our non-financial key performance indicators may not be directly comparable to those of our competitors.

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 significantly increase revenue and maintain profitability from our operations. We have a limited operating history since we formed our company in 2004. Our limited operating history and significant growth make it difficult to evaluate our historical performance or prospects. In addition, fluctuations in results could make period-to-period comparisons difficult. 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, among others:

If we are unsuccessful in addressing any of these risks or challenges, our business may be materially and adversely affected.

RISKS RELATED TO THE REGULATION OF OUR BUSINESS

We are subject to governmental regulations affecting the lodging industry and the costs of complying with governmental regulations, or our failure to comply with such regulations, could harm our financial condition and results of operations.

We are subject to numerous national and local government regulations affecting the lodging industry, including building, zoning, fire prevention, public safety, health and sanitary requirements. Increased government regulation could require us to make unplanned expenditures, which could result in higher operating costs. Any failure to comply with these requirements or other governmental regulations could result in government fines or other penalties, which may negatively affect our ability to operate hotels covered by these requirements and adversely affect our reputation, financial condition and results of operations.

Our failure to obtain the prior approval of the China Securities Regulatory Commission, or CSRC, for our IPO and the listing and trading of our ADSs on the NYSE could have a material adverse effect on our business, operating results, reputation and trading price of our ADSs; a recent regulation also establishes more complex procedures for acquisitions conducted by foreign investors which could make it more difficult to pursue growth through acquisitions.

Six PRC regulatory agencies, including the CSRC, promulgated a regulation effective on September 8, 2006 that purports to require that an offshore SPV formed for listing purposes and controlled directly or indirectly by PRC companies or individuals shall obtain the approval of the CSRC prior to the listing and trading of such SPV’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published on its official website procedures specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings. However, the application of this PRC regulation remains unclear, with no consensus currently existing among the leading PRC law firms regarding the scope and applicability of the CSRC approval requirement.

Our PRC counsel, Commerce & Finance Law Offices, has advised us that, based on their understanding of the current PRC laws, regulations and rules and the procedures announced on September 21, 2006:

The regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of our foreign currency in our offshore bank accounts into the PRC, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our ADSs.

In addition, if the CSRC later requires that we obtain its approval, we may be unable to obtain a waiver of the CSRC approval requirements, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding these CSRC approval requirements could have a material adverse effect on the trading price of our ADSs.

The regulation also established additional 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 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. In the future, we may grow our business in part by acquiring complementary businesses. Complying with the requirements of these additional procedures and requirements 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.

Regulations relating to offshore investment activities by PRC residents may increase our administrative burden and create regulatory uncertainties that could restrict our overseas and cross-border investment activities, and failure by our shareholders who are PRC residents to make any required applications and filings pursuant to such regulations may prevent us from being able to distribute profits and could expose us and our PRC resident shareholders to liability under PRC law.

The PRC State Administration of Foreign Exchange, or the SAFE, has promulgated Circular No. 75 issued in October 2005, and its implementation rules issued in May 2007 and later amended in May 2011, requiring registration with the local SAFE in connection with direct or indirect offshore investment by PRC residents. The regulation applies to our shareholders who are PRC residents and also applies to our offshore acquisitions. Under the SAFE regulations, any PRC resident who makes, or has previously made, direct or indirect investments in an offshore company is required to register such investments with a local branch of the SAFE. In addition, any PRC resident who is a direct or indirect shareholder of an offshore company is required to file or update the registration with a local branch of the SAFE with respect to that offshore company and any material capital variation relating to its round-trip investment, such as an increase or decrease in its share capital, transfer or swap of its shares, merger, division, long-term equity or debt investment and creation of any security interest. If a PRC shareholder with a direct or indirect stake in an offshore parent company fails to make the required SAFE registration, the PRC subsidiaries of such offshore parent company may be prohibited from making distributions of profit to the offshore parent and from paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the PRC subsidiaries. Further, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for violation of the relevant rules relating to transfers of foreign exchange.

As a result of uncertainty regarding the SAFE regulations, it remains unclear how such regulations, and any future legislation concerning offshore or cross-border transactions, will be interpreted, amended or implemented by the relevant government authorities. We cannot assure you that all of our shareholders who are PRC residents will comply with our request to make or obtain any applicable registrations or approvals required by the regulation or other related legislation. The failure or inability of our PRC resident shareholders to receive any required approvals or make any required registrations may subject us to fines and legal sanctions, restrict our overseas or cross-border investment activities, limit our PRC subsidiary’s ability to make distributions or pay dividends or affect our ownership structure, as a result of which our acquisition strategy and business operations and our ability to distribute profits to you could be materially and adversely affected.

Our current employment practices may be restricted under the labor contract law of the PRC and our labor costs may increase as a result.

China‘s labor contract law imposes requirements concerning, among others, the types of contracts to be executed between an employer and its employees and establishes time limits for probationary periods and for how long an employee can be placed in a fixed-term employment contract. Due to the limited period of effectiveness of the new labor contract law and the lack of clarity with respect to its implementation and potential penalties and fines, it is uncertain how it will impact our current employment policies and practices. We cannot assure you that our employment policies and practices do not, or will not, violate the new labor contract law and that we will not be subject to related penalties, fines or legal fees. For example, to eliminate the need for local human resource managers for each of our hotels, we have outsourced the human resources administration with respect to our employees below the level of assistant hotel manager to three specialized independent human resources companies, which are responsible for managing, among others, payrolls, social insurance contributions and local residency permits of covered employees. On December 28, 2012, the Labor Contract Law was further revised by the Standing Committee of the National People's Congress, the revised part will become effective after July 1, 2013, according to which only those meeting certain requirements and obtained the required license from the labor administrative department may carry out the labor outsourcing business. The dispatched laborer shall receive the same pay as others doing the same work. We may not be able to continue this practice under the new labor contract law, which would increase our human resources administration expenses. Furthermore, even if we are allowed to continue this practice, we may be held jointly liable under the new labor contract law for any damages to such employees caused by these human resources companies including lost wages , if these human resources companies did not pay such employees their wages. If we are subject to large penalties or fees related to the new labor contract law, our business, financial condition and results of operations may be materially and adversely affected.

Our corporate structure may limit our ability to receive dividends from, and transfer funds to, our PRC subsidiary, which could restrict our ability to act in response to changing market conditions.

We are a Cayman Islands holding company and substantially all of our operations are conducted through our wholly-owned PRC subsidiary, 7 Days Shenzhen. We rely on dividends and other distributions from 7 Days Shenzhen to provide us with our cash flow and allow us to pay dividends on the shares underlying our ADSs and meet our other obligations. Current regulations in China permit our PRC subsidiary to pay dividends to us only out of its accumulated distributable profits, if any, determined in accordance with their articles of association and PRC accounting standards and regulations. The ability of 7 Days Shenzhen to make dividends and other payments to us may be restricted by factors that include changes in applicable foreign exchange and other laws and regulations. In particular, under PRC law, our subsidiary may only pay dividends after 10% of its after-tax profits have been set aside as reserve funds, unless such reserves have reached at least 50% of its registered capital. Such cash reserve may not be distributed as cash dividends. 7 Days Shenzhen is also required to allocate a portion of its after-tax profits, as determined by its board of directors, to its staff welfare and bonus funds, which may not be distributed to it shareholders. In addition, if our operating subsidiary incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments to us. Moreover, the profit available for distribution from our operating subsidiary is determined in accordance with generally accepted accounting principles in China. This calculation may differ from that performed in accordance with U.S. GAAP. As a result, we may not have sufficient distributions from our PRC subsidiary to enable necessary profit distributions to us or any distributions to our shareholders in the future, the calculation of which would be based upon our financial statements prepared under PRC GAAP. Distributions by our PRC subsidiary to us other than as dividends may be subject to governmental approval and taxation. Any transfer of funds from our company to our PRC subsidiary, either as a shareholder loan or as an increase in registered capital, is subject to registration or approval of Chinese government authorities, including the relevant administration of foreign exchange and/or the relevant examining and approval authority. These limitations on the free flow of funds between us and our PRC subsidiary could restrict our ability to act in response to changing market conditions.

Discontinuation of the preferential tax treatment currently available to us could result in a decrease of our net income and materially and adversely affect our financial condition and results of operations.

Our PRC subsidiaries are subject to enterprise income tax in China. Prior to December 31, 2007, the enterprise income tax rate for all of our PRC subsidiaries, except for 7 Days Shenzhen’s branches located in Shenzhen, was 33%, the statutory rate under the then-effective PRC enterprise income tax law and regulations, while 7 Days Shenzhen’s branches located in Shenzhen enjoyed a reduced 15% rate as a foreign-invested enterprise located in the Shenzhen Special Economic Zone. In addition, in March 2006, as a foreign-invested enterprise located in the Shenzhen Special Economic Zone that is engaged in a service business and meeting certain other criteria, 7 Days Shenzhen was granted a one-year exemption to be followed by a two-year 50% reduction of enterprise income tax, starting from 2007 when our taxable profits more than offset our accumulated tax losses brought forward. As a result, 7 Days Shenzhen was exempted from paying enterprise income tax for taxable year 2007.

China passed the new Enterprise Income Tax Law or the New EIT Law effective on January 1, 2008. The New EIT Law significantly curtails tax incentives granted to foreign-invested enterprises under its predecessor. However, the New EIT Law also (i) reduces the statutory rate of enterprise income tax from 33% to 25%, (ii) permits companies to continue to enjoy their existing tax incentives, adjusted by certain transitional phase-out rules, and (iii) introduces new tax incentives, subject to various qualification criteria. Pursuant to the phase-out rules, 7 Days Shenzhen’s branches located in Shenzhen were subject to a gradual increase in rates over the five-year transition period, from 9% in 2008 to 10% in 2009, 22% in 2010, 24% in 2011 and the new statutory enterprise income tax rate of 25% from 2012 onwards. 7 Days Shenzhen’s branches located in cities other than Shenzhen were subject to a tax rate of 12.5% in 2008 and 2009 under the phase-out rules, and the new statutory enterprise income tax rate of 25% from 2010 onwards. In addition, Guangzhou Seven Software Development Co., Ltd., or Guangzhou Seven, another PRC subsidiary of us, is entitled to a two-year tax exemption followed by a three-year 50% tax reduction starting from its first profit-making year on the basis of its status as a software development company.  Guangzhou Seven commenced its tax holiday in 2010 and thus is exempt from enterprise income tax in 2010 and 2011, and is subject to income taxes at a rate of 12.5% from 2012 to 2014 and at a rate of 25% from 2015 onwards.

The discontinuation of the preferential tax treatments currently available to Guangzhou Seven will cause our effective tax rate to increase, which could have a material adverse effect on our results of operations. We expect that our current effective tax rate will increase in the future.

Under China’s New EIT Law, we may be classified as a “resident enterprise” of China, which could result in unfavorable tax consequences to us and our non-PRC shareholders.

Under China’s New EIT Law that became effective on January 1, 2008, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise” and is generally subject to the uniform 25% enterprise income tax rate on its worldwide income. On December 6, 2007, the State Council adopted the Regulation on the Implementation of PRC Enterprise Income Tax Law, effective as of January 1, 2008, which defines the “de facto management body” as an establishment that has substantial management and control over the business, personnel, accounts and properties of an enterprise. In addition, a tax circular issued by the State Administration of Taxation (the “SAT”) on April 22, 2009, or Circular 82, regarding the standards used to classify certain Chinese-controlled enterprises established outside of China as “resident enterprises” clarified that dividends and other income paid by such “resident enterprises” will be considered to be PRC source income, subject to PRC withholding tax currently at a rate of 10%, when paid to non-PRC enterprise shareholders. This recent circular also subjects such “resident enterprises” to various reporting requirements with the PRC tax authorities. In addition, Circular 82 details that certain Chinese-controlled enterprises will be classified as “resident enterprises” if the following are located or resident in China: senior management personnel and departments that are responsible for daily production, operation and management; financial and personnel decision making bodies; key properties, accounting books, company seal, and minutes of board meetings and shareholders’ meetings; and half or more of the senior management or directors having voting rights. On July 27, 2011, the SAT issued Administrative Measures of Enterprise Income Tax of Chinese-controlled Offshore Incorporated Resident Enterprises (Trial), or Bulletin 45, which became effective on September 1, 2011, to provide further guidance on the implementation of Circular 82. Bulletin 45 clarifies certain issues related to determining PRC resident enterprise status, post-determination administration and which competent tax authorities are responsible for determining offshore incorporated PRC resident enterprise status. Bulletin 45 specifies that when provided with a copy of a Chinese tax resident determination certificate issued by the competent tax authorities from an offshore incorporated PRC resident enterprise, the payer should not withhold 10% income tax when paying Chinese-sourced dividends, interest and royalties to the offshore incorporated PRC resident enterprise.

Currently, there are no detailed rules or precedents governing the procedures and specific criteria for determining de facto management bodies, which are applicable to our company or our overseas subsidiary. Although the determining criteria set forth in Circular 82 and Bulletin 45 may reflect the SAT’s general position on how the “de facto management body” test should be applied in determining the tax resident status of offshore enterprises, Circular 82 and Bulletin only apply to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those controlled by individuals or foreign enterprises like us. Therefore, we do not currently consider our Company or any of our overseas subsidiaries to be a PRC resident enterprise. However, if the PRC tax authorities take the view that the determining criteria set forth in Circular 82 and Bulletin 45 reflects a general position on how the “de facto management body” test should be applied in determining the tax resident status of all offshore enterprises and determine that our Cayman Islands holding company is a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on proceeds from our IPO and other non-China source income would be subject to PRC enterprise income tax at a rate of 25%, in comparison to no taxation in the Cayman Islands. Second, although under the enterprise income tax law and its implementing rules and Bulletin 45, dividends paid by a PRC tax resident enterprise to an offshore incorporated PRC tax resident enterprise controlled by a PRC enterprise or enterprise group would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax because the PRC foreign exchange control authorities, which enforce the withholding tax, or the PRC tax authorities have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes but not controlled by PRC enterprise or enterprise group like us. Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a withholding tax of 10% for our non-PRC enterprise shareholders or a potential withholding tax of 20% for non-PRC individual shareholders is imposed on dividends we pay to them and with respect to gains derived by our non-PRC shareholders from transferring our shares or ADSs. In addition to the uncertainty in how the new “resident enterprise” classification could apply, it is also possible that the rules may change in the future, possibly with retroactive effect.  We are actively monitoring the “resident enterprise” classification rules and are evaluating appropriate organization changes to avoid this treatment, to the extent possible.

The New EIT Law will affect tax exemptions on dividends to be paid by our PRC subsidiary to us through our Hong Kong subsidiary and we may not able to obtain certain treaty benefits under the relevant tax treaty.

We are a holding company incorporated under the laws of the Cayman Islands.  We conduct substantially all of our business through our PRC subsidiaries and we derive all of our income from it.  Prior to January 1, 2008, dividends derived by foreign enterprises from business operations in China were not subject to the PRC enterprise income tax.  However, such tax exemption ceased after January 1, 2008 with the effectiveness of the New EIT Law and a withholding tax rate of 10% will apply on such dividends, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for a preferential withholding arrangement. Pursuant to the Notice of the State Administration of Taxation on Negotiated Reduction of Dividends and Interest Rates, or Notice 112, which was issued on January 29, 2008, the Arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion, or the Double Taxation Arrangement (Hong Kong), which became effective on December 8, 2006, such withholding tax rate may be lowered to 5% if the PRC enterprise is at least 25% held by a Hong Kong enterprise. In October 2009, the SAT issued the Circular on How to Interpret and Recognize the “Beneficial Owner” in Tax Treaties, or Circular 601. In June 2012, the State Administration of Taxation further promulgated the Notice on How to Determine the Beneficial Owners in Tax Agreement, or Circular 30. According to Circular 601 and Circular 30, non-resident enterprises that cannot provide valid supporting documents as “beneficial owners” may not be approved to enjoy tax treaty benefits, and “beneficial owners” refers to individuals, enterprises or other organizations, which are normally engaged in substantive operations. These rules also set forth certain adverse factors on the recognition of a “beneficial owner.” Specifically, they expressly exclude a “conduit company,” or any company established for the purposes of avoiding or reducing tax obligations or transferring or accumulating profits and not engaged in actual operations such as manufacturing, sales or management, from being a “beneficial owner.” On June 29, 2012, the SAT further issued the Announcement of the SAT regarding Recognition of “Beneficial Owner” under Tax Treaties, or Announcement 30, which provides that a comprehensive analysis should be made when determining the beneficial owner status based on various factors that supported by various types of documents including the articles of association, financial statements, records of cash movements, board meeting minutes, board resolutions, staffing and materials, relevant expenditures, functions and risk assumption as well as relevant contracts and other information. As a result, dividends from our PRC subsidiaries paid to us through our 7 Days Inn Group (HK) Limited may be subject to a reduced withholding tax at a rate of 5% if our 7 Days Inn Group (HK) Limited is determined to be a Hong Kong tax resident and is considered to be a “beneficial owner” that is generally engaged in substantial business activities and entitled to treaty benefits under the Double Taxation Arrangement (Hong Kong). Otherwise, we may not be able to enjoy the preferential withholding tax rate of 5% under the tax treaty and therefore be subject to withholding tax at a rate of 10% with respect to dividends to be paid by our PRC subsidiaries to us through our 7 Days Inn Group (HK) Limited.

We may be subject to fines and legal sanctions imposed by the SAFE or other Chinese government authorities if we or our Chinese employees or directors fail to comply with recent Chinese regulations relating to employee share options or shares granted by offshore special purpose companies or offshore listed companies to Chinese citizens.

On December 25, 2006, the People’s Bank of China, or the PBOC, issued the Administration Measures on Individual Foreign Exchange Control, and the corresponding Implementation Rules were issued by the SAFE on January 5, 2007. Both of these regulations became effective on February 1, 2007. According to these regulations, all foreign exchange matters relating to employee stock holding plans, share option plans or similar plans with PRC citizens’ participation require approval from the SAFE or its authorized branch. On February 25, 2012, the SAFE issued the Notice of Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas-Listed Company, or the Stock Incentive Rule. Under the Stock Incentive Rule, Chinese citizens who are granted stock incentives, including but not limited to 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 the SAFE and complete certain other procedures. We are an offshore listed company and as a result we and our Chinese employees or directors who have been granted stock incentives are subject to the Stock Incentive Rule. We are in the process of filing with the SAFE and undertaking certain other procedures according to the Stock Incentive Rule. If we or our Chinese employees or directors fail to comply with these regulations, we or our Chinese employees or directors may be subject to fines or other legal sanctions imposed by the SAFE or other Chinese government authorities.

RISKS RELATED TO DOING BUSINESS IN CHINA

Our business, financial condition and results of operations may be adversely affected by the downturn in the global or Chinese economy and adverse changes in economic and political policies of the PRC government. In addition, we may be adversely affected by the possible “hard landing” of China’s economy in the future.

The global financial markets have experienced significant disruptions since 2008, the economic effects of which have persisted through 2011. China’s economy has also faced challenges. To the extent that there have been improvements in some areas, it is uncertain whether such recovery is sustainable, in particular under current European economic and sovereign debt crisis. Because all of our business operations are conducted in China, our business and prospects may be materially and adversely affected by any deterioration in China’s macroeconomic environment. 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 developments in China.

The PRC government 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. Between late 2003 and mid-2008, the PRC government implemented a number of measures from time to time, such as increasing the PBOC’s statutory deposit reserve ratio and imposing commercial bank lending guidelines, that had the effect of slowing the growth of credit, in attempts to slow the growth of the Chinese economy. In response to the recent global and Chinese economic downturn, the PRC government has promulgated several measures aimed at expanding credit and stimulating economic growth. It is unclear whether PRC economic policies will be effective in stimulating growth, and the PRC government may not be effective in creating stable economic growth in the future or have a positive effect on us. For example, our results of operations and financial condition may be adversely affected by government control over capital investments or changes in environmental, health, labor or tax regulations that are applicable to us.

There is a possibility that China’s economic growth rate may materially decline in the near future, which may have adverse effects on our financial condition and results of operations. Risk of a material slowdown in China’s economic growth rate is based on several current or emerging factors including: (i) overinvestment by the government and businesses and excessive credit offered by banks; (ii) a rudimentary monetary policy; (iii) excessive privileges to state-owned enterprises at the expense of private enterprises; (iv) the dwindling supply of surplus labor; (v) a decrease in exports due to weaker demand overseas; and (vi) failure to boost domestic consumption . Although we are uncertain about the extent to which the recent global financial and economic crisis and potential rapid slowdown of China’s economic growth may impact our business in the short term and long term, there is a risk that our business, results of operations and prospects would be materially and adversely affected by any ongoing global economic downturn or slowdown of China’s growth rate.

Rapid urbanization and changes in zoning and urban planning in China may cause the real property in which we operate our hotels to be demolished, removed or otherwise affected.

China is undergoing a rapid urbanization process, and zoning requirements and other governmental mandates with respect to urban planning of a particular area may change from time to time. When there is a change in zoning requirements or other governmental mandates with respect to the areas where our hotels are located, the affected real property in which we operate our hotels may need to be demolished or removed. As a result, we may have to relocate our hotels to other locations. To date, we have only experienced one instance of demolition and relocation in Wuhan, but may experience more in the future. Any such demolition and relocation could cause us to lose primary locations for our hotels and we may not be able to achieve comparable operating results following any relocation. While we may be reimbursed for such demolition and relocation, the reimbursement, as determined by the relevant government authorities, may fail to sufficiently cover our direct and indirect losses. Accordingly, our business, results of operations and financial condition could be adversely affected.

Uncertainties with respect to the Chinese legal system could adversely affect us.

The PRC legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. The overall effect of legislation over the past three decades has significantly enhanced the protections afforded to various forms of foreign investment in China. Our PRC subsidiary, 7 Days Shenzhen, is a foreign-invested enterprise incorporated in China. It is subject to laws and regulations applicable to foreign investment in China in general and laws and regulations applicable to foreign-invested enterprises in particular. However, these laws, regulations and legal requirements change frequently, and their interpretation and enforcement involve uncertainties. For example, we may have to resort to administrative and court proceedings to enforce the legal protection that we enjoy either by law or contract. However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy than in more developed legal systems. In addition, such uncertainties, including the inability to enforce our contracts, could materially and adversely affect our business and operations. Furthermore, the PRC legal system is based in part on government policies and internal rules (some of which are not published in a timely manner or at all) that may have retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. Furthermore, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries. Accordingly, we cannot predict the effect of future developments in the PRC legal system, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, or the preemption of local regulations by national laws. These uncertainties could limit the legal protections available to us and our foreign investors, including you.

Governmental control of currency conversion may limit our ability to use our revenues effectively and the ability of our PRC subsidiaries to obtain financing.

Substantially all of our net revenues are currently generated in Renminbi. Any future restrictions on currency exchanges may limit our ability to use net revenues generated in Renminbi to make dividends or other payments in U.S. dollars or fund possible business activities outside China. Although the PRC government introduced regulations in 1996 to allow greater convertibility of Renminbi for current account transactions, significant restrictions still remain, including primarily the restriction that enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents. In addition, remittance of foreign currencies abroad and conversion of Renminbi for capital account items, including direct investment and loans, is subject to government approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. On November 19, 2012, SAFE promulgated the Notice on Further Improve and Adjust the Direct Investment Foreign Exchange Administration Policies, or Circular 59, according to which, certain administrative approval procedures were simplified, or abolished to approve the direct investment foreign exchange administration. For example, foreign invested enterprises, like our PRC subsidiaries, may increase its registered capital by using its legal earnings including capital reserves, surplus reserves or accumulated profits or re-invest them without obtaining prior foreign exchange approvals from SAFE. However, we cannot assure you the Chinese regulatory authorities will continue to lose threstrictions on foreign exchange administration or will not impose more stringent restrictions on the convertibility of Renminbi, especially with respect to foreign exchange transactions. 

If we finance our PRC subsidiaries through additional capital contributions, the amount of these capital contributions must be approved by the Ministry of Commerce or its local counterpart. On August 29, 2008, the SAFE promulgated Circular 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 otherwise in its business scope. SAFE further promulgated the Circular on Further Clarification and Regulation of the Issues Concerning the Administration of Certain Capital Account Foreign Exchange Businesses, or Circular 45, on November 16, 2011, which expressly prohibits foreign-invested enterprises from using the registered capital settled in Renminbi converted from foreign currencies to grant loans through entrustment arrangements with a bank, repay inter-company loans or repay bank loans that have been transferred to a third party. In addition, the 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 the 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 Circular 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 repatriate our foreign currency in our offshore bank accounts into the PRC and to capitalize or otherwise 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.

Fluctuations in the value of the Renminbi may have a material adverse effect on your investment.

The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among others, changes in political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi was permitted to fluctuate within a managed band based on market supply and demand and by reference to a basket of certain foreign currencies. Following the removal of the U.S. dollar peg, the RMB appreciated more than 32.8% against the U.S. dollar between July 21, 2005 and December 31, 2012. However, the PBOC regularly intervenes in the foreign exchange market to achieve policy goals. There remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the RMB against the U.S. dollar.  More recently, the PRC government has indicated a willingness to allow the RMB to appreciate against the U.S. dollar. It is difficult to predict how long the current situation may last and when and how RMB exchange rates may change going forward.

Substantially all of our revenues and costs are denominated in the Renminbi, and a significant portion of our financial assets are also denominated in the Renminbi. We rely entirely on dividends paid to us by our subsidiaries in China. Any significant fluctuation in the Renminbi exchange rate may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our ADSs in U.S. dollars. For example, an appreciation of the Renminbi against the U.S. dollar would make any new Renminbi-denominated investments or expenditures more costly to us, to the extent that we need to convert U.S. dollars into the Renminbi for such purposes. An appreciation of the Renminbi against the U.S. dollar would also result in foreign currency translation losses for financial reporting purposes when we translate our U.S. dollar-denominated financial assets into the Renminbi, as the Renminbi is our reporting currency. Furthermore, a depreciation of the Renminbi against the U.S. dollar would decrease the value of our Renminbi-denominated profits in U.S. dollar terms and increase the value of any U.S. dollar-denominated debt on our balance sheet. As of December 31, 2012, our U.S. dollar-denominated financial assets consisted of bank deposits amounting to US$10.7 million.

You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on U.S. or other foreign laws against us, our management or the experts named in this annual report.

We conduct substantially all of our operations in China and substantially all of our assets are located in China. In addition, most of our directors and all of our executive officers reside within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon most of our directors and senior executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. It would also be difficult for investors to bring an original lawsuit against us or our directors or executive officers before a Chinese court based on U.S. federal securities laws or otherwise. Moreover, our PRC legal counsel, Commercial & Finance Law Offices, has advised us that the PRC does not have treaties with the United States, as well as many other countries providing for the reciprocal recognition and enforcement of judgments of courts. As such, recognition and enforcement in China of judgments against us, our directors, executive officers or others obtained from a court in any of those jurisdictions may be difficult or impossible to enforce.

RISKS RELATED TO OUR ORDINARY SHARES AND ADSs

There can be no assurance that the agreement and plan of merger entered into with various parties on February 28, 2013 and the going private transaction contemplated thereby will be approved by our shareholders or successfully consummated. Potential uncertainty involving the going private transaction may adversely affect our business and the market price of our ADSs.

On September 26, 2012, our board of directors received a proposal letter from certain of our existing shareholders, including Mr. Boquan He, Mr. Nanyan Zheng, the co-founders and co-chairmen of the board, and their respective affiliates, and joint sponsors including the Carlyle Group and Sequoia Capital China and their respective affiliates, to acquire all of our ordinary shares not currently owned by them in a going private transaction for US$4.2333 per share and US$12.70 per ADS, as the case may be, in cash, subject to certain conditions. Following receipt of the proposal, our board of directors formed a special committee of independent directors to consider the proposal as well as any alternative proposals. On February 28, 2013, we entered into a definitive agreement and plan of merger (“Merger Agreement”) with various parties pursuant to which Keystone Lodging Company Limited (“Parent”) will acquire our company for US$4.60 per share and US$13.80 per ADS, as the case may be, through the merger of its wholly owned acquisition subsidiary, Keystone Lodging Acquisition Limited, with and into our company, with our company continuing as the surviving corporation and a wholly owned subsidiary of Parent (the “Merger”). The per ADS merger consideration to be paid in the Merger represents a 30.6% premium over the closing price of US$10.57 per ADS as quoted by the NYSE on September 25, 2012, the last trading day prior to our announcement on September 26, 2012 that we had received a going private proposal.

The Merger is subject to customary closing conditions as well as the approval by an affirmative vote of holders of the Company’s ordinary shares representing at least two-thirds of the ordinary shares present and voting in person or by proxy as a single class at an extraordinary general meeting of our shareholders which will be convened to consider the approval of the Merger Agreement and the Merger. Mr. Boquan He and Mr. Nanyan Zheng, along with their affiliates, together with the other rollover shareholders, have agreed with Parent pursuant to a support agreement to vote their ordinary shares in favor of the proposal to approve and authorize the Merger Agreement and the Merger. However, there can be no assurance that the Merger will be approved by sufficient affirmative vote or consummated.

The Merger, whether or not consummated, presents a risk of diverting management focus, employee attention and resources from other strategic opportunities and from operational matters. In addition, we are subject to various restrictions under the Merger Agreement on the conduct of our business prior to the completion of the Merger, which may delay or prevent us from undertaking business opportunities that may arise pending completion of the Merger.

On March 29, 2013, we filed a going private transaction statement on Schedule 13E-3 which attaches as an exhibit a preliminary proxy statement that, subject to completion, will be used in connection with the extraordinary general meeting of our shareholders. Please refer to the preliminary proxy statement for more information about the Merger including the effects of the Merger on our company and the effects on our company if the Merger is not completed.

Future sales, or perceived sales, of ADSs or ordinary shares by existing shareholders could cause the price of our ADSs to decline.

Sales of our ordinary shares in the public market, or the perception that these sales could occur, could cause the market price of our ADSs to decline. As of December 31, 2011 and 2012, we had 149,931,935 and 146,950,151 ordinary shares outstanding. All shares sold in our IPO are freely transferable without restriction or additional registration under the U.S. Securities Act of 1933, as amended, or the Securities Act. The remaining ordinary shares outstanding are available for sale, subject to volume and other restrictions, as applicable, under Rule 144 under the Securities Act or under contractual arrangements. To the extent that such shares are sold into the market, the market price of our ADSs could decline.

In addition, certain holders of our ordinary shares will have the right to cause us to register the sale of their shares under the Securities Act upon the occurrence of certain circumstances. 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 statement relating to such shares. Resales of these registered shares in the public market, or the perception that such resales could occur, could cause the price of our ADSs to decline.

Our corporate actions are substantially controlled by our officers, directors and principal shareholders.

As of March 31, 2013, our executive officers, directors and principal shareholders beneficially own approximately 58.3% of our outstanding shares. These shareholders, acting individually or as a group, could exert control over and substantially influence matters such as electing directors and approving mergers or other business combination transactions. This concentration of ownership and voting power may also 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 that might reduce the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders, including those who own our ADSs.

On September 26, 2012, our board of directors received a proposal letter from affiliates of Mr. Boquan He and Mr. Nanyan Zheng, the co-chairmen of the board, and certain sponsors to acquire all of our outstanding ordinary shares in a going private transaction. On February 28, 2013, we entered into the Merger Agreement with Parent and certain other parties in connection with the Merger. See “Risk Factors—Risks Related to Our Ordinary Shares and ADSs—There can be no assurance that the agreement and plan of merger entered into with various parties on February 28, 2013 and the going private transaction contemplated thereby will be approved by our shareholders or successfully consummated. Potential uncertainty involving the going private transaction may adversely affect our business and the market price of our ADSs.” The co-chairmen’s ownership in our company and their agreement with Parent to vote in favor of the proposal to approve and authorize the Merger may effectively prevent a competing bid for our company, which may be against your best interests.  

We may be classified as a passive foreign investment company, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs or ordinary shares.

Depending upon the value of our ordinary shares and ADSs and the nature and composition of our assets and income over time, we could be classified as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes. We will be classified as a PFIC in any taxable year if either (a) the average quarterly value of our gross assets that produce passive income or are held for the production of passive income is at least 50% of the average quarterly value of our total gross assets or (b) 75% or more of our gross income for the taxable year is passive income. According to these technical rules, we would likely become a PFIC for a given taxable year if our market capitalization were to decrease significantly while we hold substantial cash and cash equivalents in that year.

We believe we were not a PFIC for U.S. federal income tax purposes for our taxable year ended December 31, 2012, and do not expect to be a PFIC for any taxable year in the foreseeable future. However, the application of the PFIC rules is subject to ambiguity in several respects, and, in addition, PFIC status is tested each taxable year and will depend on the composition of our assets and income and the value of our assets (including, among others, goodwill and equity investments in less than 25% owned entities) from time to time. Because we currently hold, and expect to continue to hold, a substantial amount of cash and other passive assets and, because the value of our assets is likely to be determined in large part by reference to the market prices of our ADSs and ordinary shares, which are likely to fluctuate, there can no assurance that we will not be classified as a PFIC for 2013 or for any taxable year. If we are treated as a PFIC for any taxable year during which a U.S. investor held our ADSs or ordinary shares, certain adverse U.S. federal income tax consequences would apply to the U.S. investor. For more information on the U.S. tax consequences to you that would result from our classification as a PFIC, see Item 10.E, “Taxation—Passive Foreign Investment Company.”

ADS holders may lose some or all of the value of a distribution by the depositary if the depositary cannot convert Renminbi into U.S. dollars on a reasonable basis at the time of such distribution for regulatory or other reasons.

The depositary of our ADSs has agreed to pay to ADS holders the cash dividends or other distributions it or the custodian receives on ordinary shares or other deposited securities after deducting its fees and expenses. ADS holders will receive these distributions in proportion to the number of ordinary shares that such holder’s ADSs represent.

The depositary will convert any cash dividend or other cash distribution we pay on the ordinary shares into U.S. dollars, if it can do so on a practicable basis and can transfer the U.S. dollars to the United States. If that is not possible or if any approval from any government is needed and cannot be obtained, the depositary is allowed to distribute Renminbi only to those ADS holders to whom it is possible to do so. It will hold Renminbi that it cannot convert for the account of the ADS holders who have not been paid. However, it will not invest Renminbi and it will not be liable for interest. In addition, if the exchange rates fluctuate during a time when the depositary cannot convert Renminbi at the time of such distribution for regulatory or other reasons, the ADS holders who have not been paid may lose some or all of the value of the distribution.

The sale, deposit, cancellation and transfer of the ADSs issued after an exercise of rights may be restricted under applicable U.S. securities laws.

If we offer holders of our ordinary shares any rights to subscribe for additional shares or any other rights, the depositary may make these rights available to ADS holders if it is lawful and reasonably practicable to do so. However, the depositary may allow rights that are not distributed or sold to lapse. In that case, ADS holders will receive no value for them. In addition, U.S. securities laws may restrict the sale, deposit, cancellation and transfer of the ADSs issued after the exercise of rights. Under the deposit agreement, the depositary will not distribute rights to ADS holders unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the Securities Act with respect to ADS holders, or are registered under the provisions of the Securities Act. We can give no assurance that we can establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, ADS holders may be unable to participate in our rights offerings and may experience additional dilution of their holdings as a result.

The trading prices of our ADSs are volatile, which could result in substantial losses to investors.

The trading prices for our ADSs are volatile and could fluctuate widely in response to factors beyond our control. In particular, the performance and fluctuation of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States may affect the volatility in the price of and trading volumes for our ADSs. A number of PRC companies have listed their securities on U.S. stock markets and many of these companies have experienced significant volatility, including significant price declines in connection with their initial public offerings. The trading performances of these PRC companies’ securities at the time of or after their offerings may affect overall investor sentiment towards PRC companies listed in the United States and, consequently, may impact the trading performance of our ADSs. These broad market and industry factors may significantly affect the market price and volatility of our ADSs, regardless of our actual operating performance.

In addition to market and industry factors, the price and trading volume of our ADSs may be highly volatile for specific business reasons. Factors such as variations in our financial results, announcements of new business initiatives by us or by our competitors, recruitment or departure of key personnel, changes in the estimates of our financial results by financial analysts or others, or changes in the recommendations of any securities analysts electing to follow our securities or the securities of our competitors could cause the market price for our ADSs to change substantially. Any of these factors may result in large and sudden changes in the trading volume and price of our ADSs.

Our amended and restated memorandum and 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 amended and restated memorandum and 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 ADSs 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 decline and the voting and other rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.

Our independent registered public accounting firm’s audit documentation related to their audit report included in this annual report may be located in the Peoples’ Republic of China. The Public Company Accounting Oversight Board currently cannot inspect audit documentation located in China and, as such, you may be deprived of the benefits of such inspection.

Our independent registered public accounting firm that issues the audit report included in our annual reports filed with the U.S. Securities and Exchange Commission, as auditors of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board (United States) (“the “PCAOB”), is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the applicable laws of the United States and professional standards.  Our operations are principally conducted in the Peoples’ Republic of China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities. Accordingly, any audit documentation located in China related to our independent registered public accounting firm’s report included in our filings with the U.S. Securities and Exchange Commission is not currently inspected by the PCAOB.

Inspections conducted by the PCAOB outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality.  This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating audit documentation located in China and its related quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections. 

The inability of the PCAOB to conduct inspections in China makes it more difficult to evaluate the effectiveness of our independent registered public accounting firm’s audit procedures or quality control procedures as compared to audits outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

Recently, the SEC commenced administrative proceedings under Rule 102(e) of its Rules of Practice and also under the Sarbanes-Oxley Act of 2002 against the Chinese affiliates of the “big four” accounting firms, including our auditors, and also against BDO China Dahua. The Rule 102(e) proceedings initiated by the SEC relate to these firms’ failure to produce documents, including audit workpapers, to the request of the SEC pursuant to Section 106 of the Sarbanes-Oxley Act of 2002, as the auditors located in the PRC are not in a position lawfully to produce documents directly to the SEC because of restrictions under PRC law and specific directives issued by the China Securities Regulatory Commission. As the administrative proceedings are ongoing, it is difficult to determine their outcome or the impact thereof on us. We are not involved in these proceedings and are not subject to any SEC investigations. Nor are the issues raised by these proceedings specific to our auditors. However, if the administrative judge were to find in favor of the SEC under the proceeding and depending upon the remedies sought by the SEC, these audit firms could be barred from practicing before the SEC and hence unable to continue to be the auditors for China-based companies like ourselves. As a result, we may not be able to meeting the ongoing reporting requirements under the U.S. Securities Exchange Act of 1934, as amended, which may ultimately result in our deregistration from the SEC and delisting from the NYSE. Moreover, any negative news about the proceedings against these audit firms may erode investor confidence in China-based, United States listed companies and the market price of our ADSs may be adversely affected.

We are a Cayman Islands company and, because judicial precedent regarding the rights of shareholders is more limited under Cayman Islands law than that under U.S. law, our shareholders may have less protection for their shareholder rights than they would under U.S. law.

Our corporate affairs are governed by our amended and restated memorandum and articles of association, the Cayman Islands Companies Law (2012 Revision), as amended, and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, 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 precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States. In addition, some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands. Furthermore, shareholders of Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.

Our shareholders will have limited ability to bring an action against us or against our directors and officers, or to enforce a judgment against us or them, because we are incorporated in the Cayman Islands, because we conduct a majority of our operations in China, and because the majority of our directors and 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. All of our 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 or impossible for our shareholders to bring an original action against us or against these individuals in the Cayman Islands or in China in the event that our shareholders believe that their rights have been infringed under the U.S. federal securities laws or otherwise. Even if our shareholders are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render our shareholders 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. For more information regarding the relevant laws of the Cayman Islands, see Item 3.D, “Key Information—Risk Factors—Risks Related to Our Ordinary Shares and ADSs—We are a Cayman Islands company and, because judicial precedent regarding the rights of shareholders is more limited under Cayman Islands law than under U.S. law, our shareholders may have less protection for their shareholder rights than they would under U.S. law.”

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests with respect to actions taken by management, members of the board or directors, or controlling shareholders than they would as public shareholders of a U.S. corporation. 

The voting rights of ADS holders are limited in several significant ways by the terms of the deposit agreement.

Holders of our ADSs may only exercise their voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Upon receipt of voting instructions from a holder of ADSs in the manner set forth in the deposit agreement, the depositary will endeavor to vote the underlying ordinary shares in accordance with these instructions. Under our amended and restated memorandum and articles of association and Cayman Islands law, the minimum notice period required for convening a general meeting is 21 days. When a general meeting is convened, ADS holders may not receive sufficient notice of a shareholders’ meeting to permit them to withdraw their ordinary shares to allow them to cast their vote with respect to any specific matter at the meeting. In addition, the depositary and its agents may not be able to send voting instructions to ADS holders or carry out ADS holders’ voting instructions in a timely manner. We will make all reasonable efforts to cause the depositary to extend voting rights to ADS holders in a timely manner, but we cannot assure ADS holders that they will receive the voting materials in time to ensure that they can instruct the depositary to vote their shares. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast, or for the effect of any such vote. As a result, ADS holders may not be able to exercise their right to vote and they may lack recourse if their ordinary shares are not voted as requested.

The depositary of our ADSs, except in limited circumstances, 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 and the ability of our shareholders as a group to influence the management of our company.

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:

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, and it may be more difficult for shareholders to influence the management of our company. Holders of our ordinary shares are not subject to this discretionary proxy.

ADS holders may not receive distributions on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to ADS holders.

The depositary of our ADSs has agreed to pay ADS holders the cash dividends or other distributions it or the custodian for our ADSs receives on our ordinary shares or other deposited securities after deducting its fees and expenses. ADS holders will receive these distributions in proportion to the number of our ordinary shares their ADSs represent. However, the depositary is not responsible if it is unlawful or impractical to make a distribution available to any ADS holders. For example, it could be unlawful to make a distribution to ADS holders if it consists of securities that require registration under the Securities Act but that are not properly registered or distributed pursuant to an applicable exemption from registration. The depositary is not responsible for making a distribution available to any ADS holders if any government approval or registration is required for such distribution. We have no obligation to take any other action to permit the distribution of our ADSs, ordinary shares, rights or anything else to ADS holders. This means that ADS holders may not receive the distributions we make on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to ADS holders. These restrictions may have a material and adverse effect on the value of the ADSs.

ADS holders may be subject to limitations on transfer of the ADSs.

The ADSs, which may be represented by ADRs, 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. The depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary thinks it is necessary or advisable to do so in connection with the performance of its duty under the deposit agreement, including due to any requirement of law or of any government or governmental body, or under any provision of the deposit agreement.