E-House (China) Holdings Limited Q3 2008 Earnings Call Transcript

E-House (China) Holdings Limited (EJ)

Q3 2008 Earnings Call Transcript

November 20, 2008 8:00 am ET

Executives

Michelle Yuan – Manager, IR

Xin Zhou – Chairman and CEO

Li-Lan Cheng – CFO

Analysts

Colin Sebastian – Lazard Capital Markets

Echo He – Oppenheimer & Co.

Brandon Dobell – William Blair & Company

Hao Hong – Brean Murray, Carret & Co.

Robert Fong – Merrill Lynch

Michael Lin – Emerging Sovereign Group

Raymond Cheng – Credit Suisse

Presentation

Operator

Good evening and thank you for standing by for E-House’s third quarter 2008 earnings conference call. At this time all participants are in listen-only mode. After management’s prepared remarks, there will be a question-and-answer session. Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the meeting over to your host for today’s conference, Ms. Michelle Yuan, E-House's Investor Relations Manager. Please proceed.

Michelle Yuan

Hello everyone and welcome to E-House third quarter 2008 earnings conference call. Today we are going to give you an update on our financial results for the third quarter and first nine months of 2008. If you need a copy of the earnings press release or if you would like to sign up for our investor distribution list, please go to the IR section of our website at www.ehousechina.com.

Leading the call today is Mr. Xin Zhou, our Chairman and CEO, who will be giving a few business highlights for the third quarter 2008. Li-Lan Cheng, our CFO, will then discuss the financial results in more detail. We will then open the floor for Q&A.

Before we continue, please allow me to read you E-House's Safe Harbor statement. Some of the statements during this conference call are forward-looking in nature and subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to those outlined in our public filings with the SEC. You are encouraged to review the forward-looking statements section of our Annual Report on Form 20-F filed with the SEC for additional information concerning factors that could cause those differences.

Please take note that unless otherwise noted all figures mentioned during this conference call are in U.S. dollars. I will now turn the call over to E-House's Chairman and CEO, Mr. Xin Zhou. Mr. Zhou will be speaking in Mandarin and then I will translate his comments into English. Please go ahead, Mr. Zhou.

Xin Zhou

[interpreted] Thank you to everyone for joining us on the call today. I am pleased to report a good performance for E-House in the third quarter of 2008 despite the unfavorable market conditions. Our third quarter total revenue was $39 million, representing an increase of 28% year-over-year while our net income was $10.9 million, also increasing 28% over the same period of last year.

During the third quarter, China’s real estate industry experienced its most severe downturn in recent history. The continued deterioration in sentiment among potential real estate buyers, a slowdown in China's economy and the Beijing Olympic Games all contributed to the sharp decline in both primary and secondary real estate transaction volumes across most of the cities where we operate.

The total sales volume of properties sold by E-House also declined compared to the third quarter of 2007, when the market was at its peak. However, we were still able to achieve revenue and profit growth, largely due to our rapidly expanding consulting and information services business.

Looking ahead to the fourth quarter of 2008, we expect conditions within China's real estate sector to remain challenging. China's economic growth continues to show obvious signs of slowing down and consumer sentiment continues to deteriorate. Available data on real estate transactions in October continue to reveal a sharp decline in volume for most major cities compared to last year.

However, the Chinese government recently announced a series of measures aimed at stimulating economic growth and encouraging real estate purchases. These measures include lowering interest rates, reduction of taxes for certain types of real estate transactions, and favorable mortgage lending terms for certain types of real estate purchases. While the immediate impact of these measures may be limited, we believe that these measures will clearly help China's economy and the real estate sector over the long term.

I would also like to point out that since the October holiday period, many developers with projects in E- House's pipeline launched sales and carried out aggressive promotions in order to generate sales volume and cash flow. This has led to a substantial increase in sales volume for E-House compared to the third quarter. However, following the central bank's announcement in October of the new mortgage lending policy, most commercial banks have still not issued detailed rules to clarify whether and to what extent the favorable lending terms can be extended to a wider range of purchases than what the central bank has already specified.

This has caused a temporary halt in the signing of new mortgage loan agreements in many locations while consumers and bank branches wait for clear instructions. Since the definition of a successful sale in many of our agency contracts requires the signing of the mortgage loan agreement, the timing of our revenue recognition for many of our sales in the fourth quarter may be adversely affected. Our total revenues for the fourth quarter will be highly dependent on this factor.

(inaudible) I would like to say that in this challenging environment, E-House's position remains highly unique and favorable. As developers struggle to generate sales volume and streamline their management and cost structure, we thereby continue to gain market share by signing more projects while building an unprecedented project pipeline. Our consulting business also benefits from developers' increased need for better information and market intelligence. Once the industry starts to recover, we will be well positioned to resume robust growth.

I will now turn the call over to Mr. Li-Lan Cheng, our CFO, who will review the quarter’s financial highlights.

Li-Lan Cheng

Thank you, Mr. Zhou, and greeting to everyone on the call. Now I will walk you through our third quarter results in more detail. Total revenues were $39.3 million for the third quarter of 2008, an increase of 28% from $30.6 million for the same quarter in 2007.

For the first nine months of 2008 total revenues were $115.5 million, an increase of 63% from $70.7 million for the same period in 2007.

Revenues from primary real estate agency services were $20.1 million for the third quarter of 2008, a decrease of 22% from $25.7 million for the same period in 2007. This decrease was mainly due to reduced overall real estate transaction volume in most of the cities where the Company operates as a result of slower growth in China’s economy and further deterioration of the demand for real estate purchases. These factors contributed to decreases in both GFA and total transaction value of new properties sold by the Company. In the third quarter we sold one million square meters of new properties compared to 1.4 million square meters in the same period of 2007.

For the first nine months of 2008, revenues from primary real estate agency services were $70.3 million, an increase of 19% from $59 million for the same period in 2007. The average commission rate was 2.4% in the first nine months of 2008 compared to 2.3% in the same period of 2007.

Revenues from secondary real estate brokerage services were $1.8 million for the third quarter of 2008, a decrease of 47% from $3.3 million for the same period in 2007. This decrease was due to factors similar to those that caused a decrease in our revenues from primary real estate agency services.

For the first nine months of 2008, revenues from secondary real estate brokerage services were $7.8 million, an increase of 7% from $7.4 million for the same period in 2007. As of September 30th, 2008, E-House had a total of 136 secondary real estate brokerage stores in five cities in China, compared to 161 stores as of June 30, 2008. This is a result of the Company's decision to selectively close those stores whose leases expired and whose operating performance had been poor.

Revenues from real estate consulting and information services were $17.2 million for the third quarter of 2008, a substantial increase from $1.7 million for the same quarter in 2007. The increase was primarily due to substantial consulting revenues derived from strategic arrangements the Company entered into with major developers covering multiple cities and projects and an increase in the number and size of consulting projects completed for other developers. The increase also resulted from the completion of a consulting project associated with land transfer for a client.

For the first nine months of 2008, revenues from real estate consulting and information services were $36.6 million, a substantial increase from $4.3 million for the same period in 2007.

Cost of Revenues, which is project related cost associated with our primary real estate agency services, was $8.1 million for the third quarter of 2008, a decrease of 4% from $8.4 million for the same quarter in 2007. This decrease was primarily due to lower commissions paid to the Company's sales staff as a result of lower transaction values for new properties sold and lower project- related advertising and promotion expenses that the Company was contractually obligated to pay for several primary real estate projects.

This was partially offset by increases in base salaries and benefits paid to the Company's sales staff, higher operating costs incurred at sales offices, and higher cost associated with developing, maintaining, and updating the CRIC database system as a result of the expansion of the Company's real estate consulting and information services.

For the first nine months of 2008, cost of revenues was $21.4 million, an increase of 40% from $15.3 million for the same period in 2007.

Selling, General, and Administrative Expenses were $21.4 million for the third quarter of 2008, an increase of 83% from $11.7 million for the same quarter in 2007. This was primarily due to an increase in staff salaries, bonuses, consulting expenses, rental and travel expenses as a result of hiring additional managerial employees and the expansion of consulting and information services. The increase was also due to higher share-based compensation expenses as a result of share options granted in 2007 and 2008.

For the first nine months of 2008, selling, general, and administrative expenses were $55 million, an increase of 88% from $29.2 million for the same period in 2007.

Income from operations was $9.9 million for the third quarter of 2008, a decrease of 7% from $10.5 million for the same quarter in 2007.

Income from operations and operating margin for the third quarter of 2008 both declined as compared to the same period in 2007 as our cost base increased more than our revenues.

For the first nine months of 2008, income from operations was $39.1 million, an increase of 49% from $26.2 million for the same period in 2007.

Net income was $10.9 million for the third quarter of 2008, an increase of 28% from $8.5 million for the same quarter in 2007.

Net income increased and net margin was stable for the third quarter of 2008 compared to the same period in 2007 due to a downward adjustment of our effective tax rate following the government's confirmation of the 18% applicable tax rate for our primary agency business in Shanghai, as opposed to the 25% tax rate applicable for most other businesses and in other cities in China.

For the first nine months of 2008, net income was $31.3 million, an increase of 62% from $19.3 million for the same period in 2007.

Now, moving to the balance sheet and cash flow, as of September 30th, 2008, we had a cash balance of $173.1 million. Net cash outflow from operating activities was $43.3 million in the third quarter of 2008. The cash outflow from operating activities was primarily due to an increase in customer deposits by approximately $26.2 million and an increase in accounts receivables by approximately $25.4 million, partially offset by our net income of $10.9 million.

I will now read E-House financial guidance for the fourth quarter of 2008. We estimate that our revenues for the fourth quarter of 2008 will be in the range of $36 million to $40 million, representing a decrease of 29% to 21% over the same quarter in 2007.

For the full year 2008, we estimate that our revenues will be in the range of $152 million to $156 million, representing an increase of 25% to 29% over 2007. This updated annual revenue guidance reflects our expectations that challenging market conditions will persist through the remainder of 2008 due to highly volatile financial and credit markets, the effect of decreased consumer spending within the real estate industry over the near term, and uncertainty relating to the timing of our revenue recognition in the fourth quarter.

In addition to the uncertainty with our revenues for the fourth quarter as Mr. Zhou stated, we expect our fourth quarter operating and net margins to be lower than the same period in 2007. This is because our fourth quarter revenue is unlikely to increase proportionally as much as our cost base has compared to the same period in 2007, when we recorded very strong revenue growth. In addition, we also had a much lower effective tax rate in the fourth quarter of 2007 than what we expect to receive this year.

That concludes my part of the presentation and now we’ll open the floor for question and answers.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Colin Sebastian from Lazard Capital Markets. Please proceed.

Colin Sebastian – Lazard Capital Markets

Good evening and thanks for taking my questions. First of all, I was hoping you can provide a little more context on the Q4 guidance. If I do the math – if I am doing the math correctly, it looks like you are assuming roughly a 50% decline in primary agency services over last year and that’s holding the consulting and secondary segments flat sequentially from Q3. So does – first of all, does that sound about right?

Li-Lan Cheng

That’s about right, yes.

Colin Sebastian – Lazard Capital Markets

Okay. And you are assuming –

Li-Lan Cheng

It’s all driven by – it’s all driven by the amount of GFA for which we can recognize revenue.

Colin Sebastian – Lazard Capital Markets

Okay. And you are assuming obviously that the recent freezing up of the market based on the lack of clarity on mortgages will continue through the end of the year?

Li-Lan Cheng

No, we are not assuming it will continue through the end of the year, but in the most – I guess the – in the most pessimistic scenario, if we don’t see a pick up in the speed or pace at which we can recognize – so that’s what we are saying. I guess I will say the low end of our range roughly correspond to that kind of scenario which means that so far the pace at which we – the mortgage agreements have been signed, it gets maintained for the second half of this quarter without major pickup.

Colin Sebastian – Lazard Capital Markets

Okay. And could you talk a little more specifically about the pipeline, which I understand is still very strong but perhaps either in terms of the quantity of the projects that you have in the pipeline or perhaps how quickly your partners will be able to ramp development once the market does start.

Xin Zhou

[interpreted] Yes. The – roughly speaking, the total amount of GFA that we have signed if you add all of the GFA’s that either are included in all of our contracts over the next roughly five years, that number exceeds 50 million square meters. And it’s between 50 million square meters and 60 million square meters. The amount – of this amount, the number of GFA that developers plan to sell for 2009 is somewhere between 20 million square meters and 25 million square meters. Now, it will depend on how much of that can be absorbed by the market. Will obviously depend on the – how well the market recovers, but I think – it’s fairly safe to say the amount that we expect to sell for next year will be greater than what we consult for this year.

Colin Sebastian – Lazard Capital Markets

Okay, thanks. And then last question, can you talk a little bit about the customer deposits from the quarter? Were those related to a specific partner and do you expect these deposits to be a normal course of the business going forward in this type of amount?

Li-Lan Cheng

No, the deposit we have outstanding is now – increase or you are probably focusing on the increase in the deposit. That did not come from any one developer. It comes from a number of developers with whom we entered into the agency agreements. And we expect that number to fall by the end of the year as we expect some amounts to be paid back.

Colin Sebastian – Lazard Capital Markets

Okay. Thank you very much.

Li-Lan Cheng

Thank you.

Operator

Your next question comes from the line of Echo He from Oppenheimer. Please proceed.

Echo He – Oppenheimer & Co.

Hi. The first question is when you set a delay of regional bank implementation (inaudible) and it affected your sales, does this also affect the sales you made on October first week?

Li-Lan Cheng

To some extent, yes, because normally from the time – normally from the time a customer walks in to a showroom, decide on a unit, and sign something as a letter of intent, and then come back sign a formal agreement and then prepare all the supporting materials to the bank, and the bank goes through a credit review, and then finally they sign the loan agreement. It takes typically a month or two for that to – for that process to happen. So, the sales we generated during the early October holiday period, a big part of that was also hit by this halt in the loan application because the banks will tell the customers there may be new more better policy, better terms coming out in the next couple of weeks, let’s just wait until we figure out what we can do and whether – if you want particular type of purchase will qualify for this more favorable terms. So, yes, part of that was also expected.

Echo He – Oppenheimer & Co.

Okay. So approximately what kind of percentage of the sales would be affected or was affected?

Li-Lan Cheng

I am sorry, what kind of –?

Echo He – Oppenheimer & Co.

What’s the percentage of the October first week sales?

Li-Lan Cheng

Right now we have close to a million square meters of sales that’s in that status.

Echo He – Oppenheimer & Co.

Okay. You mean all together, right?

Li-Lan Cheng

Yes, and that’s a very – that’s at that normally high level (inaudible) the highest level we’ve ever seen. Normally, we have only a fraction of that outstanding as kind of a – in a transition from – intent from early – from signing agreements to signing mortgage loan agreements. This is thus far a too high a number.

Echo He – Oppenheimer & Co.

Okay. This second question is for the consulting service, how many are from – on just the income, how much is from the – your subscribers, how is from the big projects?

Xin Zhou

[interpreted] Roughly one-third of the consulting and information revenue comes from subscription based service. Another third comes from our regular market reports – market updates that people – that developers get. And another roughly one-third comes from project-related consulting services.

And an increasing number of developers come to appreciate the value – the amount of information in out database and also they – so they – they are actually buying and subscribing more of our analytical reports based on that database. So this will provide a strong driver for the – for future growth in this area.

Echo He – Oppenheimer & Co.

Okay. Thank you so much, and that was very helpful. (inaudible)

Li-Lan Cheng

Thank you.

Operator

Your next question comes from the line of Brandon Dobell from William Blair. Please proceed.

Brandon Dobell – William Blair & Company

Hi, thanks. First a small question, about how large was the project, the consulting project for the land transfer for a client in the quarter?

Li-Lan Cheng

Yes, that one project earned us revenue of roughly $5 million.

Brandon Dobell – William Blair & Company

I see.

Li-Lan Cheng

So, if you take that out our – the rest of it was about $12 million.

Brandon Dobell – William Blair & Company

Got it, okay. And more broadly, in the consulting business, how sustainable is this pace of revenue, this level of revenue? Do you think – that your – that the demand for consulting services changes if the market gets better, let’s say, in the first part of 2009, or is this just a – is this a – the right run rate for the business, just given how many developers you are working with on how many different projects.

Xin Zhou

[interpreted] Yes, we view our revenues from consulting services this year as the beginning of a long term sustainable growth and development in this area. We began to promote our database in September of last year. And more and more people have come to realize the value in that database. But so far revenues derived directly from the database is still quite small. But on the other hand, we are seeing the strongest growth potential in what we call information based services, not – maybe not just purely subscribing to the database but analytical reports, other value-added services based on the database. And we believe that once we go through this volatile cycle, more and more developers will realize when they develop their next projects they will realize that they need better information, they need better intelligence. So we have every confidence that what we achieved this year in this area it will be sustained.

Brandon Dobell – William Blair & Company

Okay. Turning back to the primary business, two quick questions, one, in the quarter or probably more importantly in the one million GFA that’s kind of in limbo or on hold right now, is there any significant customer concentration? You know does one developer account for an overly large percentage of that amount? And I guess the same kind of question for the consulting business, as you look out the fourth quarter going into 2009, is the consulting business reliant upon a particular developer for the majority of the revenue right now?

Li-Lan Cheng

No, the answer to both questions is no. The customer mix for the roughly one million square meters of the sales in limbo is no – it’s not any different from our customer mix for the sales that have been recorded and revenue for which – for which revenue was recognized. And also for our consulting business, this year – next year we are not reliant – relying on any one particular customer. I mean obviously we will always try to sign up big customers because they can buy our services for multiple cities for multiple projects, but we are not relying on any one of them.

Brandon Dobell – William Blair & Company

Okay. And then final question for you. The commission rates in the quarter held up pretty well. How should we think about the level of the commission rates that you are getting these days? Given the lower volumes are the developers giving you bigger incentives even at lower volume rates and as volume increases should we see an increase in commission rates or will it remain roughly in this kind of 2.5% level?

Li-Lan Cheng

Yes, we see our commission rate pretty much maintained at the current level still. And we always said between 2% and 2.5%. If any one quarter goes to sub 2.7%-2.8% I always say you still expect our annual average to be around between 2% and 2.5%.

Brandon Dobell – William Blair & Company

Okay, great, thanks a lot.

Operator

(Operator instructions) The next question comes from the line of Hao Hong from Brean Murray. Please proceed.

Hao Hong – Brean Murray, Carret & Co.

Thank you. Hi Li-Lan, Xin Zhou.

Li-Lan Cheng

Hi.

Hao Hong – Brean Murray, Carret & Co.

Yes. I want to ask a question on commission rate. Just now you disclosed that for the first nine months your commission rate is 2.4%. But for the first quarter your commission rate was 2.8% according to my calculation and second quarter is about 2.6%. So that is implying that your commission rates in the third quarter is actually coming down rather substantially. I am not sure whether my understanding is correct.

Li-Lan Cheng

Yes, your calculation of the number is a number that is correct, but I have always said that – the commission rate for each – for every single quarter tends to fluctuate quite a bit depending on what particular projects, where revenue gets recognized. Our average commission rate is always an average of many different rates across different projects, obviously. So when we had 2.8% for the first quarter, we cautioned that for the full year I still expect somewhere between 2% and 2.5%.

Hao Hong – Brean Murray, Carret & Co.

Okay. And second question, I want to ask a further question on the fourth quarter guidance. You gave $36 million to $40 million for the fourth quarter. I remember a few weeks ago you announced that during the Golden week you sold 800,000 square meters at the value of $5.5 billion and if I use the commission rate of 2.2% and also assuming that even though some revenue cannot be recognized that’s done in the first week of October. And just now you mentioned that normally you take one to two months for a customer to – from signing out the contract to getting a loan, and then you can recognize revenues. So I assume that most of that revenue could be recognized by the end of the fourth quarter. So that should give you about $17 million. And then during the Q&A session you also mentioned that you expect consulting revenue continue to go up or at least at the same level sequentially in the fourth quarter this year. So that will give you another $17 million and then let’s assume some revenue from the secondary transaction. So that should easily get you to $36 million, the low end of your guidance even if you don’t do much now. I am just wondering whether you are being conservative for your fourth quarter.

Li-Lan Cheng

Well, the main reason we are giving this range is the uncertainty about – the first part of your assumption, namely how much of the sales we generated including the sales we generated during the October period can be recognized as our revenue the main problem is that the normal pace of taking one to two months for the whole sales product to complete and for us to recognize revenue no longer holds as we have observed in the last few weeks. So that’s the main concern here.

Hao Hong – Brean Murray, Carret & Co.

Okay. And also wanted to ask about the Evergrande deposit. Any progress in collecting those deposits back because Evergrande seems to be very aggressive in the Nanjing – in the City of Nanjing and they claim that they sold many square meters in that city. And I remember according to your original contract once the project starts not only you can recover the deposit, I am just wondering whether you could give us an update on that?

Li-Lan Cheng

Yes, Evergrande deposit has been repaid exactly on schedule. They repaid some in the first quarter, they repaid in the second quarter, and they repaid a portion in the third quarter. Everything was exactly on schedule. And we expect more repayment in the fourth quarter as well.

Hao Hong – Brean Murray, Carret & Co.

Right. And so how – so how much have they – is it possible to disclose how much have they repaid you guys so far?

Li-Lan Cheng

50% of the total.

Hao Hong – Brean Murray, Carret & Co.

Okay. One last question on – so – okay, and one last question on the consulting. It’s going very fast but also I noticed that your unbilled receivable on your balance sheet and also your receivable balance is going up. So I am wondering whether it is because the cash cycle for this business is longer, even longer than your primary and secondary cash cycles. So as a result, the cash conversion from the growth in this business is slower than usual.

Li-Lan Cheng

No, that’s actually not true. First of all, the increase in accounts receivable in the third quarter was quite normal. For the lat two years, our total receivable level was maintained at about seven to eight months on an annual basis about seven to eight months of our total sales. So quarter when we report it, $39 million close to $40 million of total revenue, it was actually normal for the receivable to increase by slightly over $20 million. So there is – first of all, that increase is nothing to be alarmed about. And I am pretty confident by the end of the year our total receivable situation will still be stable.

And also the consulting business, if anything, had a shorter receivable cycle than our primary agency business. Of the – of our three main business lines, the secondary brokerage service had the shortest receivables cycle because individual buyers and sellers have to pay us commission before we close the deal for them. so there – for that business there is also almost no receivable, no (inaudible) in the receivables.

And then the second (inaudible) is probably consulting. Most of the length in the receivables comes from primary business and that’s just, as we explained in the past, that’s just the nature of this business in China. Everyone who is engaged in primary agency business faces that issue. But there is nothing unusual that happened during the third quarter here.

Hao Hong – Brean Murray, Carret & Co.

Okay. Thank you. Thank you, Li-Lan.

Li-Lan Cheng

Thank you.

Operator

Your next question comes from the line of Robert Fong from Merrill Lynch. Please proceed.

Robert Fong – Merrill Lynch

Hi, good evening, gentlemen. I just wanted to touch on the customer deposits. Now, you’ve mentioned that there has been repayment by Evergrande as scheduled, so their net balance, if it’s more than 50%, should be down to about US$50 million. So that means about $70 million of the $120 million sitting on your balance sheet as of the end of the third quarter. Is – from every one else, and that is still a rather sizable number. I am just wondering is the cost of getting new business going to get that much more difficult or that much higher going forward. That’s a first part of the question. And secondly, as the environment deteriorates, obviously the risk – the business risk, financial risks are also going to increase and even though you haven’t had any problems in the past with material bad debts, what measures are you taking now to reduce the likelihood of bad debt chares going forward? I mean would you be willing to turn down business if the condition of the developer is a bit too shaky? Thank you.

Xin Zhou

[interpreted] Yes. First of all the percentage of all our projects that involves customer deposits is still a small percentage and it mainly involves projects that are either highly sought after, highly competitive or (inaudible) projects that we will be willing to offer or agree to a deposit.

And for every case that involves a deposit, we go through various rigorous analysis to assess the potential risk. And also in the process of sales, we employ a very tight control of the process. This – by the time we are involved with the developer in the sales process, that’s when the developer starts to reap the benefit of the development and start to see cash flow come in. And whenever we are in – we have deposit involved, we try to keep a very tight control process to ensure repayment of our deposit.

Robert Fong – Merrill Lynch

Okay. And just want to follow up on the tax rate. Now, in the – in your announcement it mentions that the 18% applicable corporate tax rate for your primary agency business in Shanghai, does that mean only commissions sourced in Shanghai get the favorable tax rate of 18%? Or is that 18% for all your primary commission across the country? And what was the basis for getting this favorable preferential tax rate? I thought the whole purpose of tax reform was to have a unified and simplified rate. Thank you.

Li-Lan Cheng

The 18% is a legacy of the past tax regime when tax rates were different. Prior to the beginning of this year, China had a 33% corporate tax rate for most of China, but then in several places in China there was – they were designated either a special economic zone or received some kind of treatment where they had lower rate. Pudong district in Shanghai is such a place where it enjoyed a 15% tax rate before. And our subsidiary, one of E-House's subsidiary that’s – that covers our primary business in Shanghai is registered in the Pudong district. So prior to ’08 our business, our primary in Shanghai, namely our commission income in Shanghai was entitled to 15% whereas the rest of the – our revenue from the rest of the country had a 33%. Now this year, they – under the new tax law all of China is about to be subjected to 25% tax rate, but the government allowed for a five-year transition for those places that had a 15% rate to gradually move up to 25%. And this year would be 18%; next year will be 20% and 22%, 24%, and so on. But whether Pudong district in Shanghai qualify for this transition, the government never made it clear, never explicitly said we could. So for the first two quarters we were on the assumption that it would not qualify. So we were applying 25% rate to all of our business, all of our revenue. And the sometimes during the third quarter, finally the government tax bureau told everyone that indeed for the whole year we could record our profits according to the 18% rate. So that’s when we made the adjustment to our effective tax rate.

Operator

Your next question comes from the line of Michael Lin from ESG. Please proceed.

Michael Lin – Emerging Sovereign Group

Hi, Li-Lan, just a follow-up on Robert’s last question. Regarding bad debt, can you talk about your policies for reserving for bad debt and how your allowance for doubtful accounts has changed over time? And then the second question is on you margins. In the third quarter it looks like your EBIT margin has fallen from the historic 40% to around 25%, and you mentioned for your guidance that margins in the fourth quarter will also be down. Can you give us a sense for what your cost base – your SG&A expense line look like next quarter?

Li-Lan Cheng

Yes, on your first question, our policy of – for bad debt reserve is that we analyze each account, each customer, each accounts receivable on an individual basis. We evaluate whether there is any risk for non-payment for that account. The nature of our business is at least for your primary agency business is such that in every given year we have relatively small number of contracts – for 2007, it was about 100, and for 2008, it’s about 200. So we have a relatively low number of contracts. But each contract amount is – on average fairly substantial. So our policy is to evaluate each and single one of them to see if there is a problem rather than applying a percentage of the entire accounts receivable and make a provision as some companies do. So that’s our policy. And historically, our bad debt reserve for each year, or each quarter has been very small. We would have maybe one or two isolated cases every year or two where we would run into a potential problem and whenever we thought that was the case, we would make the appropriate reserve. And that situation has not changed for the last three or four years.

And on your second question, on margins, overall, our cost base, in terms of our headcount and the just regular SG&A overall this year will be 70% to 75% higher than 2007. That’s the rough figure. And so if our total revenue doesn’t grow by that much our margin tends to decline because within a year, within six to nine months most of our cost and expenses are fixed except for the portion that represents the commission we pay to our sales people. So that’s our cost base.

From the third to the fourth quarter, if you just look at sequentially, I don’t expect that overall SG&A level to go up by a big amount. It’s going to be fairly stable.

Michael Lin – Emerging Sovereign Group

Okay, great. Thanks.

Operator

Your next question is a follow-up from the line of Hao Hong from Brean Murray. Please proceed.

Hao Hong – Brean Murray, Carret & Co.

Thank you. Hi, Li-Lan, I just want to ask one more question on tax rate. I am not sure whether you’ve answered it previously. I notice that in this quarter your tax rate is substantially lower than your (inaudible) quarter and also lower than the same period last year. I am just wondering whether this low tax rate is sustainable going forward and what tax rate should we be using for 2009.

Li-Lan Cheng

No, I answered part of that to earlier – to Robert’s question. The reason the quarter rate was low was that we finally got confirmation from the Shanghai government that the Shanghai Pudong tax rate for this year, for the whole year will be 18%. Until we officially receive that word we had to assume it would be 25% as the rest of the country. So if you look at our first two quarters, the effective tax rate we were using was about 25%. Now that we learn that it will be 18%, we reflected the cumulative change of that tax rate all in the third quarter. So that’s why in this one quarter you have a very low rate because that reflects the overall cumulative rate. For the full year, our overall effective tax rate, I expect that to be between 21% and 22%.

Hao Hong – Brean Murray, Carret & Co.

Okay, thank you. And also I notice that you disclosed in this quarter the operating cash flow is rather negative and I remember in the first two quarters you actually had good positive cash flow. Assuming going to the fourth quarter your primary business is more or less slowing down but you are getting good revenue from consulting business and your SG&A, your cover expense same – more or less the same on a quarter-on-quarter basis, then should we be expecting a similar level of cash burn in the fourth quarter or do you expect some improvement?

Li-Lan Cheng

No, for the full year I fully expect our operating cash flow to be positive. In fact it should, if anything, it should be greater than our operating profit. The negative cash flow from operating activities for the third quarter was almost entirely due to an increase in customer deposits. But we expect a substantial amount of that to be paid back during the fourth quarter. So, just wait till the end of the year and then we’ll come back and see what the full year looks like. I think the full year operating cash flow should be positive.

Hao Hong – Brean Murray, Carret & Co.

Okay. Thank you.

Operator

Your next question comes from the line of Mr. Robert Fong. Please proceed.

Robert Fong – Merrill Lynch

Hi, Li-Lan, just wanted to see if you guys can provide some additional color on just the state of the different markets overall. You mentioned some issues with regard to some sales being held in a stasis while clarification comes or it doesn’t come from banks as to how they apply the policies. But just what are you seeing overall in terms of market? Which cities are basically a bit more resilient than others? Have the outskirts really been hurt compared to city centers? What kind of pricing trends are there? Can you maybe shed a bit of color on that since you guys do have projects in a – cut across a broad geography in China? Thank you.

Xin Zhou

[interpreted] The overall sentiment, the overall conditions of the real estate market is sill very – we think it’s still very pessimistic and volatile. The government issued some polices in recent weeks aimed at stimulating the industry. We think that those policies will show their effects but it will take some time. Typically it takes longer for the real estate market to respond to government policies. It takes longer than for instance the stock market. So we think over the next three to six months we may see the industry, the market stabilizing and may start to improve.

And in terms of the differences among different markets, still the worst hit market, the market that’s showing the deepest slump is still the Pearl River Harbor Guangdong and Shandong area and to a less extent Beijing, Tianjin, and Shanghai also showed a sharp deterioration during the third quarter. If there are cities that did relatively well, it’s those cities that in the energy or natural resources concentrated place, for instance Tiecheng [ph] did relatively well during this period.

Now in terms of a potential recovery, we continue to believe that Shanghai and Beijing will probably recover sooner and to a greater extent than the Pearl River Harbor. And in each of these major cities we continue to believe that the central locations, the key locations will do better than the suburbs.

Robert Fong – Merrill Lynch

Any color on the willingness or ability of developers to cut prices further and are – at some point price cuts don’t work anymore, so what’s a general attitude and outlook for pricing in the fourth quarter and also going into 2009?

Xin Zhou

[interpreted] Well, wait and see the need for – the needs for many developers to raise – to push sales and raise the rates (inaudible) is urgent. And also other developers we talked to, there are certainly lack of willingness to lower prices. They all recognize the need to do that. And in terms of – also in terms of profit margin, as long as they didn’t obtain land at the peak of the price cycle in 2007, there is still room to lower prices and so generate profit. The single most important factor that holds them back from lowering prices more is the potential for the earlier buyers of their same products to get very angry to cause trouble. So that’s the biggest concern for many of these developers. Otherwise, there is no – they are perfectly willing to lower prices more.

Operator

Your next question comes from the line of Ronnie Jones [ph] from Credit Suisse. Please proceed.

Raymond Cheng – Credit Suisse

This is Raymond Cheng. Actually, I just want to ask, you know that given that you said there will be a lot of purchases the developer, right. So what do you expect the net change from those customer deposits and what is your expectation on the cash level by the end of this year? That is my first question. And second question is, is it 21% to 22% effective rate is also applied in 2009? That is the second question. And third question is that I find that your number of secondary shops has dropped to 136 from 2Q 161. Do you expect to further cut the number of job in secondary staff in – by the end of this year or maybe in the 2009?

Li-Lan Cheng

Well, your first question, we do expect that a substantial amount of our deposits will be paid back during the fourth quarter. So, I don’t want to give out a number for our year-end and for our year-end cash balance because a lot of that depends on the actual sales performance, our revenue. But you certainly should see a much higher cash balance by the end of the year and a reduced amount of deposits outstanding. Now, on the second question, the – next year, barring any other changes, our effective tax rate should be slightly higher because next year Shanghai will be subject to 20% while the rest of the country will still be 25%. So the average will gradually creep up.

Raymond Cheng – Credit Suisse

Okay.

Li-Lan Cheng

Yes, on you last question –

Xin Zhou

[interpreted] Yes, overall our approach to our secondary broker stores is maintain stability. We don’t have massive number of closing planned. See the stores we closed basically we are talking about eight or nine stores per city, for each of our three major cities, mainly involve those stores, like is said earlier, whose leases expired and we – whose operating performance was not good. So going forward, our overall policy for the store (inaudible) will still be stable.

Raymond Cheng – Credit Suisse

Okay. Just a follow-up, for the customer deposit, assuming you didn’t enter any new contract with those developer, so you need not pay deposit for them. So what is your current plans I mean how much can CapEx?

Li-Lan Cheng

Sorry, I don’t think I understand your question.

Raymond Cheng – Credit Suisse

That is assuming you didn’t enter any new contract with those developers, I mean you need not pay the deposit for them right? So under your current schedule, how much can you get there from – for example right, Evergrande or some other developer?

Li-Lan Cheng

Well, if we had not entered into any new contract then our deposit outstanding would have been obviously lower than at the end of the second quarter because we did get deposit back from some developers including—

Raymond Cheng – Credit Suisse

Yes, so estimate how much?

Li-Lan Cheng

Estimate how much?

Raymond Cheng – Credit Suisse

Yes, that means how much can you get back on that?

Li-Lan Cheng

Well, at least $20 million left.

Operator

We are now approaching the end of the conference call. I will now turn the call over to E-House's Investor Relations Manager, Ms. Michelle Yuan for closing remarks.

Michelle Yuan

Once again, I would like to thank all of you for joining us on today's call. If you have any follow-up questions, please don't hesitate to contact us. Thank you.

Xin Zhou

Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation, you may now disconnect. Good day.

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