Good day everyone. Welcome to the Xinyuan Real Estate Company Limited First Quarter 2011 Earnings Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the call over to IR Director, Helen Zhang for opening remarks and introductions. Please go ahead.
Helen Zhang – IR Director
Hello everyone and welcome to Xinyuan’s first quarter 2011 earnings conference call. The company’s first quarter earnings results were released earlier today and are available on a company’s IR website as well as on Newswire services.
Before we continue, please note that a discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the views expressed today.
Further information regarding this and other risks and uncertainties is included in our registration statement and our Form 20-F and other documents filed with the U.S. Securities and Exchange Commission. Xinyuan doesn’t assume any obligation to update any forward-looking statements, except as required under applicable law.
Today, you will hear from Mr. Yong Zhang, our Chairman and Chief Executive Officer, who will comment on current operations, and provide some perspectives on the market environment. He will be followed by Mr. Tom Gurnee, our Chief Financial Officer, who will provide some additional color on our performance, review the company’s financial results, and discuss our outlook for the reminder of 2011.
Following management prepared remarks we’ll open the call to questions. During the Q&A session, Mr. Zhang will speak in Mandarin, and I will translate his comments into English. Please note that unless otherwise stated, all figures mentioned during this conference call are in U.S. dollars.
I will now turn the call over to Xinyuan’s Chairman and CEO, Mr. Yong Zhang. Please go ahead, sir.
Yong Zhang – Chairman and Chief Executive Officer
Hello, everyone and thank you for attending us today. Our first quarter performance was below our expectations as sales were impacted by the new government measures to curb housing prices and speculation, which caused buyers to become more cautious. At the end of January, the government issued new restrictions, which do not allow local residents to have more than two houses or apartments and are even more strict for non-local residents.
While many of our apartment and home purchase (indiscernible) are first time buyers, the new regulation has resulted in purchasing delays by buyers hoping that the new restriction will cause prices to decline in the near future.
As we have seen with past regulation impacting home purchasing demand, we believe that the consumers will learn to cope with these policies. In fact, we have seen the trend improve in April. We cannot predict or control what the government will do, but we do believe our strategy and we’ll continue to focus on affordable developments in Tier II and III cities. Speculation has been lower in these cities and migrations to these cities continue to increase.
According to research of the Development Center of the State Council, the urbanization rate in China will grow at 0.9% annually during 2007 to 2020 and expected to reach 75% in 2017. We believe that urbanization and migration patterns will be the growth driver for the long-term development of the company. Overall, Xinyuan has strong financial position and ample cash presence, low debt ratio, and sizable land bank.
Our Shandong project will start pre-sales in the second quarter. As a result, we continue to be positive about our prospects for the future.
I will now turn the call over to Tom Gurnee, our Chief Financial Officer.
Tom Gurnee – Chief Financial Officer
Thank you. As noted by the Chairman, our sales results in the first quarter were less than expected due to the short-term effects of government policy pronouncements. But, as I will try to show you later in this call, margin and profit numbers were solid. After a drop in February, contract sales have sequentially increased in March and April and we look forward to a very strong May particularly with Jinan Splendid being launched this month. In short, our outlook for the year remains positive with sales and revenue guidance just slightly lower than our previous guidance, but with net income unchanged.
Let me talk about contract sales first. In the first quarter 2011, we recorded contract sales of 98 million which was 32% below the last year’s previous quarter, first quarter and 50% below last quarter and 15% below the company guidance provided last quarter. GFA sales comparisons are similar with virtually no price movement in the quarter. It should be noted again here that we have not lowered prices of any apartment category of any project. Anyway, it would be unfair to point the contract sales short fall versus guidance on Chinese New Year, although seasonality is definitely a key factor when comparing sequential quarters. In other words, we did factor Chinese New Year into our previous guidance. The primary reason we fell short of the first quarter contract sales expectations was the impact of additional mortgage and purchase restrictions imposed by central, regional and municipal governments.
On January 26, 2011, just before the Chinese New Year break, the Central Government issued additional restrictions and instructed regional, municipal governments to issue their own specific guidelines. Throughout the month of February and end of March, local governments one by one issued their guidelines while potential buyers waited. At first, they waited for guidelines to determine whether they could buy with reasonable mortgages, but later they just waited to see if prices would soften. Well, they haven’t. The net effect was evenly similar to the pattern noted after the April 2010 policy announcement. For example, last year in the first four months after the April policy announcement, contract sales dropped by 50% in the first month, a further 53% in the second month, followed by a 28% sequential increase in the third month and finally followed by a 252% increase in August 2010. By the fourth month of recovery, contract sales exceeded pre-policy announcement level by 6%.
This year, after the January policy announcement, contract sales dropped by 53% in February, followed by increases of 16% and 42% in March and April respectively, with May expected to record a further 126% increase with the launch of Jinan Splendid. By the fourth month of recovery, we expect contract sales to exceed preannouncement levels by 76%. In short, buyer reactions to the latest policies appear similar but milder than the reaction after the April 2010 policy announcements. But obviously this will need to be confirmed. And our outlook does not contemplate further policy pronouncements beyond today’s.
While continuing on contract sales, a brief comment on the Kunshan project. In the first quarter 2011, the company recorded contract sales for Kunshan International City Garden of US$6.8 million at a quite high ASP per square meter of RMB11,336, that’s US$1722. If we eliminate the impact of commercial space sold as part of that, the residential ASP was RMB9529 per square meter or US$1455 or slightly higher than the previous quarter. All 41 contracts recorded in the first quarter of 2011 are clearly executable under prevailing government policies as of today, May 12, 2011. Zhengzhou Modern City and Xuzhou projects continued to be the major sales drivers for the company.
And finally, we are pleased to note that Yipinxiangshan II was launched at the very end of March. This project was the centerpiece of our JV partner buyout in November 2010. While it had very minimal impact on the first quarter contribute significantly from the second quarter onwards.
Now, let’s turn to the financial statements and address first quarter revenue. For the quarter ended March 31, 2011, the company’s total revenue using the percentage of completion method was $91.8 million compared to $137 million for the quarter ended December 31, 2010. Our guidance had been $120 million. Two factors drove the 23% shortfall guidance. First was the shortfall in contract sales that I described previously. The second factor was the lower percentage of completion on active projects than expected. This made up over half of the reported revenue shortfall to guidance.
Let me try to explain. Under the percentage of completion method, cumulative revenues calculated by multiplying cumulative contract sales times the percent of cumulative actual cost incurred versus the total estimated project cost. Thus lower actual cost incurred on a project will lead to a lower reported revenue figure even if the total estimated project cost is unchanged, since actual cost incurred is accrued based on the progress of individual subcontractors on their individual contracts.
Slower than expected progress by subcontractors will reduce the project percent complete which in turn will reduce reported revenue for a given period. This is exactly what happened to Xinyuan in the first quarter. In general, subcontractors have made less progress on their contracts than we had estimated. And here I need to partially invoke the Chinese New Year Defense as it is difficult to estimate subcontractor progress when their workforce is off for weeks and many migrant workers simply do not return to the job.
Additional factors in the shortfall were some permitting issues on some projects and a couple of contractor disputes, but nothing out of the ordinary. In short, we projected spending on large projects to expand from Q4, 2010 into 2011 and in fact it contracted in the quarter. I should note, however, that no material changes were made to projected completion dates or to total project cost estimates. This is important. The impact of under-spending this quarter was on the timing of revenue recognition not on the expected total revenue to be recognized per project.
Now, let me comment on gross margin. Gross margin totaled 27.3% of revenue in Q1, 2011 down a little bit from last quarter and there is good reason for that. Through March 31, 2011, we have amortized in the first quarter $4.2 million of the total $10.2 million purchase price adjustment related to the acquisition of Jiantou Xinyuan made in November 2010. The purchase price adjustment was based on an independent appraisal of our Yipinxiangshan I and II projects. It was allocated between the two projects and is being amortized over the remaining contract sales of each project. You can expect Q2, this next quarter’s amortization of the remaining $6 million adjustment to approximately $1.2 million in Q2. And that will be followed by about $800,000 per quarter through the end of this year and with the remainder amortized in 2012.
Also impacting margin was the quarterly review of total project cost and sales estimates for certain projects resulting in a $3.4 million cumulative gross profit being recognized in the first quarter under the percentage of completion method. The first quarter impact was primarily driven by one project, Yipinxiangshan I, a project acquired with the Jiantou Xinyuan acquisition in November 2010. This project that is 97% sold and 97% complete recorded higher than expected ASPs in the fourth quarter of 2010.
We were also able to enjoy certain economies in lowering our completed projected cost estimates for that project. Just as a benchmark in the previous quarter, the change in estimates impact was much higher. As a whole, we can expect Xinyuan margins to edge up to the high 20s, low 30s of the remainder of the year.
Let me move on to selling, general, and administrative expenses. They totaled $7.4 million in the first quarter of 2011 down from $9.1 million in the fourth quarter of 2010. As a percent of revenue, SG&A did edge up from 6.7% to 8.0%. Expenses followed along established pattern, where selling expenses largely variable and SG&A expenses largely fixed, look for expenses to fall as a percent of revenue over the remainder of the year as revenue increases.
Income tax, nothing noteworthy there, they held steady at 36.4% of pre-tax income. Net income for the first quarter of 2011 was $11.6 million. This compares to $21.6 million in the fourth quarter of 2010 and was $1.4 million below the company’s first quarter net income guidance of $13 million. Net income as a percent of revenue reached 12.7% versus guidance of 10.8%.
We are pleased to report the excellent net margin results despite lower reported revenue. Diluted net earnings per share for the first quarter of 2011 were $0.08 equivalent to $0.16 per ADS and that compares to $0.14 equivalent to $0.28 per ADS in the fourth quarter of 2010.
I’ll comment briefly on the balance sheet. Our balance sheet gets stronger. As of March 31, 2011, the company reported cash and cash equivalents of $349 million compared to $296 million at the end of December 2010. Total debt did increase from $296 million at the end of December 2010 to $322 million at the end of March.
But by the end of the first quarter 2011, total cash exceeded total debt. This is somewhat of a milestone for Xinyuan. Real estate property under development fell from $711 million in December to $669 million at the end of March 2011. This reflected the project under-spending discussed above and had a positive impact on cash flow. Cash flow from operations totaled $35 million pretty solid although it was down from $67 million last quarter, but quite healthy given normal historical seasonal patterns with Chinese New Year.
So, let me briefly share with you our outlook for the second quarter of 2011. Contract sales are expected to reach $155 million to $160 million in the second quarter, up a minimum of 55% from the first quarter of 2011. Revenue under the percentage of completion method is projected at US$140 million to $150 million and net income should top $20 million.
Significant events contemplated in the quarter include Jinan Splendid launching in May 2011 and Zhengzhou Century Park East A is on track to launch in late June although this particular outlook contemplates a mid Q3 impact. I should also note the full impact at Yipinxiangshan II will be felt this quarter.
For the total year 2011 outlook, contract sales are expected to range between $650 million and $675 million slightly below previous guidance of $710 million. Revenue for the year should reach $625 million to $650 million, previous guidance was (indiscernible).
In both the second quarter and the full year guidance, I have taken the liberty of including some buffer to potential under-spending risk that is the effects I discussed earlier about spending less than expected on projects having the impact on revenue.
Now, net income in the full year is unchanged from the previous guidance at $75 million. Margins continue improve. Expenses are under control. We are very comfortable that we are going to produce very nice net income this year.
Significant events for the year beyond what I’ve already described, we do expect Zhengzhou Century Park East B to be introduced in the third quarter and Zhengzhou Royal Palace in the third quarter. We also expect to begin attendance at land auctions. We are doing lots of preparation for that now and we are exploring alternative land acquisition techniques.
Before I signoff, I should make a note about share valuation. Investors comment frequently and they are concerned about our languishing share price of just $2.25 when last traded yesterday. This represents a 2011 PE of about 2 with the discount to book at 67% and rising. We have been urged by many investors to consider making a dividend or a stock buyback, particularly given our ever stronger cash position.
The Chairman and I have discussed this diligently over the last few months and we appreciate the wisdom of those urging action. So far withholding us back are these concerns. First, before making capital commitments, we want to confirm or believe that buyers will reach (indiscernible) in the rational manner. Are the gains we’ve seen over the past two months sustainable? Will the Jinan Splendid launch meet expectations? These are uncertainties that we want some visibility on.
Second, we want to preserve our ability to participate in attractive land auctions. Land prices are unstable. Many believe there will be very good apartments available in the second half of this year. Given our long-term growth strategy, we want to be able to act quickly when opportunities come clear. We are actively assessing land auctions when premiums are lowering. We would like to see more than just a few available projects.
Certainly, we have the cash available to make a meaningful dividend payment or to execute stock buyback when we have the visibility we are looking for. We will act, as always, in the shareholders’ best long-term interest.
This concludes our prepared remarks for today’s call and operator we are now ready to take some questions.
Thank you, sir. (Operator Instructions)
We’ll take our first from Kun Tao at Roth Capital Partners.
Kun Tao – Roth Capital Partners
Hey, thanks for taking my questions. First question is, Tom, I understand the gross margin was helped a little by the project revised, cost revised and also impacted by some of your acquisitions. So, what is your net-net gross margin?
Well, we had the 4.2 million amortization. That obviously hurt to the tune of about 5%. We expect our net-net to be somewhere in the 30% range. The increase in estimates of 3.4 million is well below what we did in the previous quarter and we expect – this is a little bit lower, we’re little bit more, we are very conservative on our projections for these. And we do expect that favorable adjustment for change in estimates to continue throughout the year. So, you are asking me what is basically normalized gross profit. It has moved up during this year and all the new projects are at approximately 30% plus, well, very high 20s to mid 40s margin. So, we expect margin, certainly in the high 20s to low 30s.
Kun Tao – Roth Capital Partners
Okay, okay. For the construction schedule, you mentioned in Q1 actually slowed down a little bit. What certification in the remaining of 2011? Are you going to continue to slow down the construction schedule or?
We didn’t really slow down. This is, that’s really funny. Let me describe how we do the cost estimate. We look at each subcontract within a project and each one is evaluated for what percent complete that project that subcontract is. In fact this is the basis for payment of the contract. So, contract-by-contract we list the percent complete and it turns out that the movement in that percent complete was not as high as we expected for the first quarter. There was no slowdown per se, but there was less, should we say, less progress by our subcontractors than we expected.
Now, this could be made up very quickly in the next quarter. It wasn’t a conscious decision to slow down construction. It’s just we made the percent completed at the end of the quarter was lower than we expected. We believe this will work out over the remainder of the year, but I have learned a lesson here in my mathematics, I’m taking a bit of a cushion between my expected percent complete and what I’m going to use to calculate revenue to tell you.
Kun Tao – Roth Capital Partners
Okay, okay. And also regarding your contract sales, it seems like Xuzhou and also Kunshan continue to be impacted significantly, also Chengdu I noted this quarter was also impacted a lot. So, what’s your strategy under the current industry (indiscernible)? Do you expect to maybe lower price, may also stimulate purchasing or what’s your strategy going forward?
Kun, if you don’t mind, I’d like to have this translated for the Chairman and answer that.
Our Xuzhou and Kunshan projects are heavily impacted by the restriction policy. However, as we are seeing that in April and May, the contractors are less fluctuated.
We expect the contractors from both Xuzhou and Kunshan for this year will grow slightly this year and have significant portion of their overall performance.
Both of these Xuzhou and Kunshan projects will be completed by the end of this year in the area surrounding Shanghai and even included Shanghai, we are very unique product.
We believe that under these restricted policies and also restricted mortgage policy, they complete a project in Shanghai or in the regions surrounding Shanghai will have a nice performance this year.
Our contract sales for Chengdu in April has achieved more than 100% of our sales target and I believe that the sales of Chengdu project will be fully finished by around this year.
Kun Tao – Roth Capital Partners
Excuse me, Kun I think you asked about price too. Can you comment on price for Xuzhou and Kunshan?
We believe that price for our Kunshan project compared to the surrounding project is comparatively low than we think in about.
For Xuzhou project, we think the current price is reasonable and we don’t increase the price.
Well, the Chengdu project and we believe that there is still room for the spending price increase because by the end of the quarter the project will be completed.
And Kun, I’ll just note that in our projection – in my projections for guidance, I have softer prices, of course, than our marketing guys sitting across the table here and our Chairman.
Kun Tao – Roth Capital Partners
Sorry. That’s all for my questions. Thank you very much.
(Operator Instructions) And there are no questions at this time.
Tom Gurnee – Chief Financial Officer
From our Xinyuan staff, we want to thank everybody very much for participating in this call. And if there are any questions after this that come to mind after the session, please feel free to e-mail us at Xinyuan.
And that does conclude today’s conference. We thank you all for the participation.
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