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Executives

Nick Beswick - Brunswick Group, IR

Donald Zhang - Co-Founder, Chairman and CEO

Harry Lu - Co-Founder, Vice Chairman and President

Kevin Wei - Chief Financial Officer

Analysts

Ella Ji - Oppenheimer

IFM Investments Limited (CTC) Q2 2013 Results Earnings Call August 15, 2013 8:00 AM ET

Operator

Good evening and thank you for standing by for Century 21 China Real Estate's 2013 Earnings Conference Call. At this time all participants are in a listen-only mode. After management's prepared remarks, there will be a question-and-answer session. Today's conference call is being recorded.

I will now turn the call over to your host for today, Nick Beswick.

Nick Beswick

Thank you, everyone, for joining us for Century 21 China Real Estate's second quarter 2013 earnings call. With us today are Donald Zhang, Co-Founder, Chairman and Chief Executive Officer; Harry Lu, Co-Founder, Vice Chairman and President; and Kevin Wei, the company's Chief Financial Officer.

Before we continue, please allow me to read you IFM Investment's Safe Harbor statement. Some of the statements during this conference call are forward-looking statements made under the Safe Harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended.

Forward-looking statements are 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.

IFM Investments Limited does not undertake any obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.

For those of you unable to listen to the entire call at this time, a recording will be available via webcast until August 22 on the company's corporate website at www.century21cn.com/english.

At this point, I would like to turn the call over to Mr. Donald Zhang.

Donald Zhang

Thank you, Nick. Hello everyone and thank you for joining us on today's call. The second quarter was a tough quarter as secondary transaction volumes declined significantly in anticipation of the implementation of new capital gains regulations in April.

As we mentioned in the last quarter, most of the demand that would normally have been realized in the second quarter was pulled forward into the first quarter, as buyers rushed to close deals before April. As it turned out, the effect was more dramatic than we anticipated, even though most cities ended up not implementing the tax. Volumes in major cities across China plummeted in April. And we only saw a gradual uptick in the market through the rest of the quarter. In Beijing, the only city where the tax was actually implemented, the impact was particularly strong with secondary transaction volumes dropping a full 70% from the previous quarter.

While this is not the first time there has been a short term spike in transaction volumes at a time of regulatory change, it was easily the biggest we have seen in our 13 years of operations in China. In terms of future policy changes, we don't anticipate anything that will have as dramatic an effect as the latest measure.

Regardless of this new tax, we are confident that the long-term outlook for China's secondary market remains strong and we should see a gradual return to normalized transaction volumes in the quarters ahead.

For the foreseeable future, we will stay focused on ensuring we have healthy, diversified revenue streams in place. In particular, the primary and the commercial sector continues to be a very encouraging area of growth for us. And in terms of our store network, we will maintain flexibility in order to benefit fully from upticks in market activity without exposing ourselves to unnecessary risk.

Finally, as you will have seen in our earnings release today, Kevin Wei has resigned as Century 21 China's CFO, effective within two months, but will be remaining on our board. Kevin has made a valuable contribution as our CFO over the past several years and we look forward to continuing to collaborate with him as a member of our Board.

Kevin will be replaced by Lulu Li, who will come in as acting CFO until we find a permanent replacement. Lulu has been with Century 21 China for a number of years and is a core member of our team. We look forward to working with her to manage the transition until the appointment of a permanent CFO. Thank you.

Harry Lu

Thank you, Donald, and welcome everyone to today's call. As Donald mentioned, the second quarter was tougher than we had expected. While revenue this quarter at RMB212 million was still 5% up on the same period last year, our fixed cost base was relatively high due to increased sales headcount and higher fixed salaries and benefit costs, following a strong end to the first quarter.

This led to a disappointing bottom-line performance, particularly considering the relatively solid results that we have produced over the last couple of quarters. Kevin will go into this more in a moment.

Now let's look at the performance of our various business segments. Our core company-owned brokerage segment had a difficult quarter, with revenue down 27% sequentially. This is to be expected considering the overall market environment and we were still encouraged by solid per-store efficiency.

Alongside our core sales brokerage business, rental services made a helpful contribution to revenue in this segment during Q2. In Beijing, where the market was particularly slow in the second quarter, rental revenues made up 26% of our total. This is a good example of the kind of revenue diversification that has allowed us to outperform through a very tough market in recent years.

Encouragingly our primary and commercial services segment posted another record quarter. Revenue from our Shanggu business unit increased a full 30% sequentially and 129% year-over-year. Primary is a big area in terms of its ability to insulate us from the kind of market fluctuations we saw from Q1 to Q2.

Shanggu has really benefitted from its integration into the Century 21 China network as well as our brand and it’s now posted a succession of record quarters. This quarter, were it not for a number of a project delays, Shanggu's performance would have been even stronger.

We are confident that Shanggu will remain a solid contributor to our primary and commercial services segment. Elsewhere, our mortgage management services segment continues to perform well. Revenue in this segment increased 9% sequentially and by over 40% year-on-year. We expect a solid performance here through the rest of the year.

In terms of our store network, the average number of stores in operation in Q2 was roughly flat from Q1. Last time out, we talked about a bottom-up growth model – meaning we prefer to add headcount to our strongest sales teams first before we think about adding new stores.

As we explained, the idea here is to make sure new sales staff can make a contribution as quickly as possible. And it also limits risk in a dynamic market. In Q2, for example, while there was a sizeable increase in headcount, the impact on costs was limited by the fact that the new staff for the most part joined existing teams rather than new stores.

Going forward, we plan to trim our network slightly to adjust for current market conditions, primarily through headcount reductions. We are constantly assessing the performance of our individual stores and we'll look for opportunities to reduce our cost base in places where we haven't been performing as well as we would like.

Overall, we are confident going into the second half of 2013. As the market gradually picks up, we expect improved performance in our company-owned brokerage segment, complemented by the diverse revenue streams we’ve built up in recent quarters. Our Shanggu primary business and our mortgage management segment have been particularly consistent performers in recent quarters, and we expect them to remain solid going forward.

Our priority is still maintaining the diversity and flexibility that the current market environment demands. With the biggest shock to the market hopefully behind us, we are hopeful we have a period of a steady top- and bottom-line growth ahead of us.

With that, I would like to turn the call over to Kevin for a more detailed look at our financial performance in the second quarter. Kevin?

Kevin Wei

Great. Thanks Harry. Now, I'd like to share with you some detailed breakdown of our second quarter of 2013 unaudited financial results. Please note that all points stated in monetary amounts are in RMB unless otherwise noted.

Revenue from company-owned brokerage services was approximately RMB156 million in the second quarter of 2013, representing a 27.3% sequential decrease and a 10% year-over-year decrease, contributing close to 74% of total net revenue.

The sequential decrease was mainly due to lower sales and purchase transaction volumes completed in Q2 2013 and the year-over-year decrease primarily resulted from the decreased new home sales volumes. Specifically, we completed about 3,700 sales and purchase transactions during the second quarter versus about 5,810 transactions in Q1, 2013 and about 4,840 transactions in Q2 2012.

Among the sales and purchase transactions in Q2, 2013, new home sales transactions accounted for 14% compared to 11% in Q1, 2013 and 30% during the same period of 2012. The average number of sales offices in operation changed slightly to 322 in Q2 2013 from 316 in Q1 2013, and 327 in Q2 2012.

Our average monthly net revenues per operating sales office decreased to about RMB161,000 in Q2 2013, representing a 29.1% decrease from about RMB227,000 in Q1, 2013 and a 9% decrease from RMB177,000 in Q2 of last year.

Revenue from our primary and commercial business segment in Q2 2013 reached another record high of RMB43.8 million net revenue, contributing about 21% of the total net revenue, representing a 29.6% sequential increase and a 129.3% year-over-year increase.

The sequential increase was mainly due to the fact that more new commercial properties with higher weighted ASP per square meter in Q2 2013 were sold, which accounted for 68% of total primary revenue. We sold approximately 43,300 square meters GFA of commercial properties in Q2 2013 versus 29,000 square meters in the previous quarter.

Our primary and commercial services segment achieved 21.1% net income margin before allocation of any headquarters expenses in Q2 2013. Weighted ASP for the quarter was 15,800 per square meter with a weighted average commission rate from developers at around 2.06%.

The year-over-year increase was mainly a result of more new properties sold. We sold approximately 169,920 square meters GFA of new properties compared to 79,660 square meters GFA in the same period of 2012. Specifically, our ShangGu business unit sold approximately 142,731 square meters GFA, or 84% of our total primary GFA sold in Q2 2013.

Revenue from mortgage management services in Q2 2013 was RMB9.3 million, representing a 16.3% sequential increase and a 50% year-over-year increase, and 4% of total net revenue. The sequential increase was mainly due to higher revenues from home equity loans we brokered.

The year-over-year increase resulted from an increase in revenues from both traditional home mortgage loans and a home equity loans. We referred RMB768 million in traditional home mortgage loans and RMB243 million in home equity loans to banks in Q2 2013.

This compares with RMB856 million in traditional home mortgage loans and RMB164 million in home equity loans in Q1 2013 and RMB466 million in traditional home mortgage loans and RMB115 million in home equity loans in Q2 of last year.

Revenue from advising consumers on home equity loans plus service fees and interest earned from consumer credit loans accounted for 62.8% of our total mortgage service segment revenue in the second quarter of 2013. For the second quarter of 2013, our mortgage management services segment continued to be profitable before allocation of any headquarters expenses.

Revenue from franchise services in the second quarter of 2013 was approximately RMB2.8 million representing a 12% sequential increase, an 86.7% year-over-year increase and 1% of total net revenue.

The sequential and year-over-year increases were mainly due to more initial fees received from the sale of franchise rights in Beijing. At the end of the second quarter, we had 30 individual franchise offices in Beijing city, up from 22 offices at the end of Q1, 2013.

On the cost side, our commission and other agent-related costs in the second quarter of 2013 were RMB142.9 million, representing an 8.2% sequential decrease and a 23.9% year-over-year increase and equivalent to 67.4% of total net revenue in the quarter.

The sequential decrease was primarily due to a decrease in commission expenses as a result of lower revenues from company-owned brokerage services. Specifically, commission costs decreased by RMB22.1 million from Q1 2013, as a direct result of lower revenue generated from our company-owned brokerage services segment. The year-over-year increase was attributable to an increase of RMB12.5 million in Shanggu's commission expenses as it contributed more revenue in the second quarter of 2013.

In addition, there was an overall increase of RMB15.8 million in fixed r and benefit costs from Q2 2012 due to an increase in both the number of sales professionals and the average salary level. We employed an average of 6,550 sales staff in our company-owned brokerage segment in Q2 2013, as compared to 5,760 in Q1 2013 and 5,140 in Q2 2012.

Our total commission expenses as a percentage of total consolidated revenue for Q2 2013 was 35.9%, compared with 37.9% and 32.1% for Q1 2013 and Q2 2012 respectively. Total consolidated operating costs for the second quarter of 2013 were RMB47.5 million, representing a 12% sequential increase, and a 15.9% year-over-year increase.

Excluding expenses related to sales office closures, total operating costs increased by RMB5.5 million sequentially and RMB7.1 million year-over-year. The sequential and year-over-year increases were mainly due to increases in rental costs resulting from the higher average rental rate in our company-owned brokerage network and third-party commission costs incurred in our primary and commercial services segment.

Total depreciation and amortization expenses for Q2 2013 were RMB5.7 million. Our total SG&A expenses in the second quarter of 2013 were RMB53.9 million representing a 0.2% sequential decrease and a 25.6% year-over-year increase. The year-over-year increase was primarily due to an increase in marketing expenses and payroll expenses for non-sales staff. Our marketing expenses increased by 5.6 million year over year. The payroll-non-sales increased by 2.4 million year over year as a result of increased headcount.

A goodwill impairment of RMB20.4 million was incurred in the second quarter of 2013. This was due to a shortfall in the results of operations of our Shanggu business unit, as compared to those previously estimated during acquisition.

However, we booked a net change in fair value with the amount of RMB22 million as the contingent consideration payable related to the Shanggu acquisition decreased from million to RMB12 million as of period end Q2.

Net loss attributable to IFM Investments Limited in Q2 2013 was RMB33 million compared to net income attributable to IFM Investments Limited of RMB5.4 million in Q1 2013 and net income attributable to IFM Investments Limited of 0.8 million in Q2 2012.

On the balance sheet, we had RMB169.3 million in cash as of June 30, 2013. If we would include RMB27 million of net short-term loan receivables balance outstanding as of June 30, 2013, we would have RMB196.3 million or $32 million equivalent in cash and cash equivalents, a decrease of 13.8% from March 31, 2013.

Our net accounts receivable balance as of June 30, 2013 was RMB208.9 million, a decrease from RMB215.1 million as of March 31, 2013. Our average AR turnover day was approximately 92 days for the second quarter of 2013.

Now for our guidance for the third quarter…

Based on the current market conditions that we detailed earlier, we're estimating our total net revenue for the third quarter of 2013 will be in the range of RMB220 million to RMB230 million. This forecast reflects our current and preliminary view, which is subject to change.

And lastly, as you may have already read in today's release, after serving Century 21 China Real Estate for more than five and half years as CFO, I'll be leaving the company to pursue all our current interest. I appreciate the experience to having work here with the management team, with our board members, as well as shareholders and investors. And I wish Century 21 China Real Estate will continue to grow in the future.

This concludes our prepared remarks. Operator, now, we are ready for questions. Please begin with the first question.

Question and Answer session

Operator

Thank you. We will now begin the question-and-answer session. And our first question comes from the line of Ella Ji of Oppenheimer. Please go ahead.

Ella Ji – Oppenheimer

Good evening, Donald, Harry and Kevin. Thank you for taking my questions. First one is with regards to the market sentiment on China real estate market. So it has been a while since our new five measures and policies -- and it seems that the -- you have also said that there's no future policy, a significant change of policy expected at this moment.

So could you comment on what are you seeing on the market, what sort of customers are now coming to your stores and they're intuitive in buying a house. Are they mostly ordinary people or are you seeing investors there?

Harry Lu

Okay. This is Harry. Thank you, Ella, for the question. I think currently what we seeing in the market actually after the imposes so called capital gains tax, we see really a boom or jump on transaction volumes on the month of March but right after that you can see the big drop in the City of Beijing and Shanghai, especially in City of Beijing. It dropped to around seven thousand following that law.

But right after that even to make this situation worse, Beijing Municipal Government kind of impose a new so-called appraisal valuation system which caused the transaction cost increased a little bit further more. They basically kind of increased the valuation twice for a changing hand in the City of Beijing. And that's a valid reason, kind of, a further slowdown the market recovery.

But even with that, we did see from month to month starting from the month of April, the transaction volumes deal now is picking up because there is no strong demand from the end-user.

To answer your latest question, I think the most of our customers we see come to our store obviously is end-user or so-called upgrader. People want to upgrade their home to a little bit larger space. Lot of big amount of people is actually first-time home buyer in cities of Beijing.

The rest of the country, because it didn't really impose the so-called capital gain tax, just a sentimental change by -- instead of the new policy -- remember in the month of March, people are expecting those municipal government come up to impose these capital gains tax, but actually it turned out didn't happen and they didn't really impose that.

So most of the people already purchased homes in the month of March and then you see the market actually is slowing down in the following months. But even with that we did see the market kind of coming back recovery because more people are kind of expect to see a more stable real estate market especially in terms of a real estate price. So customers' confidence on price is still there.

So that's the reason, why we see a property, we already see that the big change on transaction volume and that's what we have see here in the market. Ella, does that answer your question?

Ella Ji – Oppenheimer

Yes. That's very helpful. And then my second question is with regards to your network expansion plan. We saw a small pick-up in number of stores in 2Q. Could you elaborate on your full-year network expansion trend for the remainder of the year? Thanks.

Harry Lu

We are not expecting a big increase on store numbers, but we do see as what we said on a script that to reduce the numbers who is underperforming and then at the same time, obviously, going to add some store in some best performance areas. So I'm not expecting a big change on the store number here looking at the current market situation at this moment.

Ella Ji – Oppenheimer

Okay. And then with regards to your Shanggu business. I think you mentioned that there were some projects they’re being delayed in the prepared remarks. So could you also give us a little bit more details there? That's my third question.

Harry Lu

Yes. We do have some projects that has been delayed and I know even some revenue cannot be recognized at this moment because basically we want to -- the local bank actually require that the building being finished so that they can grant their mortgages, you know I mean, our internal policy where we're going to wait until the bank can issue these mortgages so that we can recognize revenue as a part of a revenue delayed recognition.

And on the other hand, they do have some project being delayed but still it is a good pipeline there. We are expecting to realize that revenue in the rest of the year, this year.

Kevin Wei

Just to add, the total pipeline as of now for prime rate service segment is about 1.5 million square meters GFA.

Ella Ji – Oppenheimer

And does that include the project that's being delayed?

Kevin Wei

No. I mean, for certain parts of the project have been delayed, we did not include in this pipeline calculation. There is a certain project that will obviously base on discussions with developer that we expect to be signed in the past quarter for example and it did not get signed. And so these are probably the delays that we're referring to.

Ella Ji – Oppenheimer

Okay. And then moving on to expenses. So I think you also mentioned that there's an increase in your rental costs. So how big is that increase average and how much should we see with regards to the impact on the margins going forward?

Kevin Wei

Right now, this is because some of our lease sales offices, 322 on average for the Q2 have been up for renewal, so at a three-year renewal point that sometime we have to pay as incremental increases. So on average year-over-year this past quarter our average rental cost for sales office per month increased from RMB22,000 per month to like RMB26,000 per month, so it just give you a benchmark.

Ella Ji – Oppenheimer

RMB22,000 to RMB23,000?

Kevin Wei

Yes, RMB26,000.

Ella Ji – Oppenheimer

Okay. RMB26,000, okay.

Kevin Wei

Yes.

Ella Ji – Oppenheimer

That's the average rental cost per month.

Kevin Wei

Yes.

Ella Ji – Oppenheimer

Okay. Got it.

Kevin Wei

And also, bear in mind as a little more detail for the accounting wise, we need to do straight line so some of these new lease agreement we signed that we have escalating every year increases, so we had a straight line all the three-year rental cost starting from the first year.

Ella Ji – Oppenheimer

Okay. So that means going forward…

Kevin Wei

That contributed increases like RMB26,000 versus about a year ago.

Ella Ji – Oppenheimer

Okay. But going forward, let's say, for the second half of the year and also into 2014, should we continue to see this increase in average rental costs?

Kevin Wei

Well, it's not going be always a linear line like that. As I mentioned, normally we sign, we'll just sign another three years. So it would just be a portion of the 322 stores that will get a renew when the lease term get due. But in general, I think overall rental trend is an uptick going forward, but it does not necessarily always means at this rate.

Ella Ji – Oppenheimer

Okay. Got it. So talking about margins on general basis, going forward comparing to 2Q, should we continue to see cost and expenses as a percentage of revenue trending up or do you think you are able to maintain at this level?

Kevin Wei

Let me explain a little bit before -- this quarter the cost gone up mainly in the sales staff salary, base salary cost as we increased on an average about like over 750 agents or sales staff quarter over quarter and that China has been -- although that's an average number, but the trend has been declining from April to June and even to July, actually, we're gradually reducing the headcount of the sales team.

Just bear in mind that the buildup of the sales people's headcount is really in response to a big run-up in the month of March as we mentioned earlier. So even though it's a fixed expense, I mean, that is driven on the headcount, so that's the variable part. So we're really going to manage that closely based on what we need to have, as Harry mentioned, some of the trim of the poor performance sales officers in a lot of way they will terminate that we will trim the poor performance sales staff as well.

But in terms of the cost per sales agent, let say, per sales team member has not gone up this quarter, mostly just the headcount. The rental office we just mentioned already and the other part is just purely the commission and a commission, obviously, are driven by the sales revenue level in this quarter. Those commission expenses are actually lower compared to the first quarter because of the March volume.

I guess on the overall company level, the reason that we had a loss, I mean, the point is that because our company-owned brokerage services revenue was just in the lower at RMB156 million compared to the Q1. And even though we gave at RMB220 million to RMB230 million revenue guidance, which is just similar to the overall guidance, should be breakdown of this RMB220 million have more of the revenue come from the company-owned brokerage sales offices, we would have hoped the margin situation would improve.

Ella Ji – Oppenheimer

Okay. That's very helpful. Thank you, Kevin.

Kevin Wei

You're welcome.

Ella Ji – Oppenheimer

So, and then I want to ask you about -- currently on the market we are seeing some companies providing e-commerce services for a brokerage, sector brokerage firms and agents. So could you comment the trend that you're seeing, I know you have your own company proprietary website? So how much sales is now coming from -- sales lease is now coming from the Internet? And could you also talk about the customer acquisition costs for this new sales channel? Is it more efficient for you than the traditional sales office?

Harry Lu

Yes. Ella, basically, from our figure around 50% of our business lease is generated from Internet at this moment and from all of these, 15% in the lead actually generated by our own advertised website. That's basically what we have here right now.

And return on our investment on Internet is always been pretty good. Meaning to acquisition cost for client actually is relatively much lower than the traditional costs by owning our office or something like that. Obviously, to have an office is still very important. We believe the office presentation and the web presentation is a tool both very important factor that attracts customer to our store.

And when customer see you have a store here and then when they check on the Internet they see you're advertised there or leasing there, obviously, is more helpful for them to gain this like confidence to working into your office. But obviously it's become very important channel for us to obtain a customer here.

Ella Ji

Okay. Thank you. Thank you, Harry, and thank you, everyone. That's all my questions.

Donald Zhang

Thank you.

Kevin Wei

Thanks.

Operator

Thank you. We are now approaching the end of the conference call. I will now turn the call over to the CFO of Century 21 China Real Estate, Mr. Kevin Wei, for his closing remarks.

Kevin Wei

Well, thank you everyone for joining us for today's call. Looking forward to speaking with everyone again in the next quarter. Thank you.

Harry Lu

Thank you.

Operator

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

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