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IFM Investments Limited (Century 21 China Real Estate) (NYSE:CTC)

Q3 2011 Earnings Call

November 17, 2011, 8:00 a.m. ET

Executives

Donald Zhang - Co-founder, Chairman and Chief Executive Officer

Harry Lu - Co-founder, Vice Chairman and President

Kevin Wei - Chief Financial Officer

Josh Gartner – IR

Analysts

Liping Cai – William Blair

Ella Ji – Oppenheimer

Operator

Good evening and thank you for standing by for Century 21 China Real Estate's third quarter 2011 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 call is being recorded. I will now turn the call over to your host for today, Josh Gartner.

Josh Gartner

Thank you, everyone for joining us for Century 21 China Real Estate's third quarter 2011 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 Investments' 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 November 24 on our 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, Josh. Good day to everyone and thank you for joining us on this call.

China’s real estate market in the third quarter continued to be strongly affected by the stringent regulatory environment, and secondary market sales remained at depressed levels.

That said – we are beginning to see prices decline in some areas, a positive sign that the regulations are achieving their intended effect. This has been stronger in suburban areas, although we are also seeing limited price drops in city centers. Also, in some markets there have been changes in the loan approval process, which has resulted in first time homebuyers being able to secure loans somewhat more quickly.

As downward price pressure continues, many potential buyers appear to be waiting for prices to fall further. That said, we are hopeful that we have reached the bottom of the market in terms of secondary transaction volumes.

As you know, our strategy has been to diversify our revenue base in real estate services. And we’re making encouraging progress here. In particular, our primary business line, as well as primary sales through our retail store network saw strong growth in the third quarter.

We believe that primary sector sales [via exclusive contracts] are going to be a key growth area for Century 21 China. First – developers still have a lot of room to reduce prices, which we think will translate into higher primary volumes in the quarters ahead. Second – real estate developers are increasingly realizing the benefits of leveraging Century 21 China’s network of retail locations and established client base. This has been the case in the more sophisticated Shenzhen and Shanghai markets, and we’re just beginning to see traction in the Beijing market.

Let me now turn the call over to Harry, who will provide you with a further update on our business for the last quarter. Thank you.

Harry Lu

Thank you, Donald.

During the third quarter, we made clear progress in our strategy to reduce the impact of regulatory pressure in the secondary market on our overall business. In addition to diversifying our revenue base through the development of our primary and commercial business services that Donald mentioned, we have also taken significant steps to reduce our overall costs going forward.

I would like to update you on the progress that we have made in these two areas.

First, as Donald discussed earlier, our primary and commercial business service segment grew well in the third quarter, recording overall GFA of primary unit sales of approximately 95,000 square meters, up from approximately 37,000 in the previous quarter.

Our primary sales were particularly strong in Shanghai and Shenzhen, where developers have been more willing to reduce prices and to work with agencies like Century 21.

Notably – in Q3, our company owned brokerage units in Shanghai and Shenzhen contributed about 22% of overall company revenue through new home sales. This was up from 7.1% in Q2 2011. While our ability to sell primary units through our retail store network in Beijing has lagged behind Shanghai and Shenzhen, we have a strong pipeline and expect to see progress there as well.

This is a clear validation of our diversification strategy and demonstrates how our strong brand and established network enable us to adapt our business to market conditions.

Looking ahead, our primary and commercial business service pipeline remains strong, with a total GFA of 2.3 million square meters from 18 projects. We expect these to contribute significantly to revenue when they come online from the fourth quarter of 2011 through 2012.

The rental market has also been an important source of revenue for Century 21 China during the current downturn in the secondary sales market. Revenue from our rental business continued to be solid in the third quarter. We expect this line to remain a steady source of revenue beyond our traditional core business.

Our regional sub-franchise stores network is another piece of our diversification plan, and we are pleased that our acquisition earlier this year of 78 franchise stores in Chengdu has gone smoothly. We will continue to look for opportunities with high quality partners.

The second part of our strategy to deal with the current regulatory environment has been to reduce costs and streamline our operations.

Over the last two quarters, we have implemented a systematic strategy to maximize productivity across our store network. To do this we have used a combination of temporary store closings and permanently shutting underperforming locations.

By early-on recognizing the need to streamline, we have been able to reduce the number of stores in our network in a prudent and structured manner. This strategy has minimized the disruption to our overall sales network, enabling us to maintain staff morale and market share.

As of the second week of November, we had 446 stores in operation. Of those, 168 were in Beijing, 209 were in Shanghai, 63 were in Shenzhen, and six were in Chengdu. In addition, 13 stores were temporarily closed.

Toward the end of the third quarter we already began to see cost savings from the reduction of our underperforming stores, and we expect these cost savings to increase in the fourth quarter, and particularly into next year.

While we have closed our less competitive store locations, we have also reduced our headcount, primarily through attrition. During Q3, the weighted average of our company-owned store sales force, excluding the primary agency business, was about 19% leaner than it was during Q2 2011. We will continue to focus our resources on the best performing store locations and most capable staff.

Overall, the Chinese real estate market continues to present serious challenges. However, we believe our systematic approach of diversifying our business lines and proactively reducing costs positions us very competitively.

With that, I will now turn over to Kevin Wei, our CFO, for a detailed discussion of our second quarter financial performance.

Kevin Wei?

Kevin Wei

Thank you Harry. Now I would like to share with you our third quarter 2011 unaudited financial results.

The Company’s total consolidated net revenue in the third quarter of 2011 was 156.5 million RMB, representing a 7.1% sequential decrease from 168.5 million RMB, and a year-over-year increase of 13.2% from 138.3 million RMB.

Revenue from company-owned brokerage services was approximately 135.7 million RMB, representing a 3.6% sequential decrease, and a 5.2% year over year increase. The sequential decrease was mainly due to lower sales and purchase transaction volumes completed in Q3 of 2011. Specifically, we completed 3,386 sales & purchase transactions during Q3 versus 3,763 transactions in Q2 of 2011, a 10% decrease. Among the 3,386 sales and purchase transactions, new homes sales transactions accounted for 30% during Q3 of 2011, a significant increase from 12.5% during Q2 of 2011. This increase is due to stronger sales alliance programs with developers by our Shanghai and Shenzhen company-owned sales networks as Harry mentioned earlier. For Q3, total rental commission accounted for 21% of company-owned brokerage services revenue, through approximately 8,563 rental transaction completed in Q3. Although the rental transaction volume declined 13.8% sequentially, rental commission revenue only declined 3% due to increased rental prices in Beijing and Shanghai.

The average number of operating sales offices decreased to 479 in Q3 from 582 in Q2 of 2011, as a result of our permanent and temporary store closings. During Q3, we also had an average number of 34 stores that were temporarily closed. As of the second week of November, we have 446 company owned stores in operations and 13 temporarily-closed stores. Our average monthly net revenues per operating sales office increased to 94,400 RMB for Q3 from 80,500 RMB in Q2 of 2011.

Revenue from the primary and commercial business segment in Q3 of 2011 was approximately 13 million RMB, or 8.3% of total net revenue. This 31.3% sequential increase was mainly due to the sales of approximately 95,000 square meters GFA of new homes and consulting fees earned on advising developers on some new commercial real estate projects. The newly acquired Beijing ShangGu business unit brought in 7.5 million RMB net revenue during the third quarter of 2011 through selling close to 82,000 square meters GFA. For Q3 of 2011, the weighted average ASP was 5,761 RMB per square meter, with weighted average commission rate at around 2.04% from the developers.

Although we have experienced some delays in some of these primary agency projects during Q3, we have been continuing to build up our pipeline of primary residential and commercial projects. And we remain hopeful to generate more significant commission revenue from primary and commercial business segment going into 2012.

Revenue from mortgage management services in Q3 of 2011 was approximately 4.7 million RMB, or 3% of total net revenue, representing a 20.3% sequential decrease and a 6% year-over-year decrease. These decreases were mainly due to the decrease in the total home equity loans we advised our customers to 105 million RMB in Q3 of 2011, as compared with 170 million RMB for Q2 of 2011, and 220 million RMB for Q3 of 2010. Our mortgage management services segment achieved a slight profit in Q3 2011.

Revenue from franchise services in the third quarter of 2011 was approximately 3.1 million RMB, which accounts for 2% of total net revenue, representing a 74.2% sequential decrease, and a 20.5% year-over-year decrease. The sequential decrease was primarily due to the fact that in Q2 of 2011, the company entering into sub-franchise agreements with two new regional sub-franchisors, while we did not grant any new regional sub franchisors in Q3 of 2011.

On the cost side, our commission and other agent-related costs in Q3 of 2011 were 109.4 million RMB, representing a 8.7 % sequential decrease and a 32.8% year-over-year increase. The sequential decrease was primarily due to approximately 8.9 million RMB cost reductions in sales staff base salary and benefit expenses in Q3 from Q2 of 2011. This reduction is a direct result of having an average sales staff number of 7,800 in company-owned brokerage segment in Q3, as compared to 9,700 in Q2 of 2011 along with the reduction of our sales offices in company-owned brokerage unit mentioned previously. The year over year increase was mainly due to increases in base salaries and benefit costs in the company-owned brokerage segment as a result of an increase in headcount for sales staff. As to the variable costs, our commission expenses as a percentage of total consolidated revenue for Q3 of 2011 was 28.2%, compared with 27.1% for Q2 of 2011, and 27.5% Q3 of last year.

Total consolidated operating costs for the third quarter of 2011 were 81.2 million RMB, representing a 4.8% sequential increase, and a 46.6% year-over-year increase. During the third quarter this year, we have incurred approximately 15.4 million RMB write-off charges in store closing related costs such as unamortized leasehold improvement and forfeited rental deposits. Without considering such store closure-related costs, total operating costs reduced by approximately 5.7 million RMB in Q3 from Q2 2011, mainly due to the savings in store rental and other store related expenses along with our sequential store reductions. For the similar reason, the year-over-year increase was mainly due to approximately 15.4 million RMB write-off charges, as well as rental and other store related costs increases, and around 4.5 million RMB additional operating costs for the primary and commercial business segment. Total depreciation and amortization expenses for Q3 of 2011 were 9.3 million RMB.

Our total SGA expenses in the third quarter of 2011 were 57.5 million RMB, representing a 10.6% sequential increase, and a 20.0% year over year increase. These increases were largely due to an increase in non-sales staff hires, as well as fluctuations in marketing expenses, professional fees and general corporate expenses.

Net loss attributable to IFM Investments Limited in Q3 of 2011 was 91.7 million RMB, compared to a net loss of 80.4 million RMB in Q2 of 2011 and 47.4 million RMB in Q3 of 2010. Excluding share based compensation expenses, Non-GAAP net loss attributable to IFM Investments Limited for Q3 of 2011 was 91.0 million RMB, compared to a non-GAAP net loss of 80.1 million RMB in Q2 of 2011 and 44.6 million RMB in Q3 of last year.

On the balance sheet items, we had 296.2 million RMB in cash and time deposits as of September 30, 2011, as compared to 423.3 million RMB as of June 30, 2011. Including 50.1 million RMB of short-term loans receivables outstanding as of September 30, 2011, we would have 346.3 million RMB or 54.3 million USD equivalents in cash and cash equivalents and time deposits. During Q3 2011, our cash used in operating activities was approximately 76.6 million RMB, and cash used in major investing activities include a 25 million RMB first installment of acquisition payment for ShangGu, 8.2 million RMB in capital expenditures, and 18 million RMB in providing short-term loans with property collateral.

Our net accounts receivable balance as of September 30, 2011 was 72.4 million RMB, increased from 60.4 million RMB as of June 30, 2011. This increase is mainly due to more primary sales, which have a longer receivable cycle from the developers. Our average AR turnover day is approximately 39 days for the third quarter of 2011.

Finally, regarding guidance for the fourth quarter of 2011.

Based on the current market conditions that we detailed earlier, we are estimating our total net revenue for the fourth quarter of 2011 will be in the range of 140 million to 155 million RMB. This forecast reflects our current and preliminary view, which is subject to change.

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

Question-and-Answer Session

Operator

The question-and-answer session of this conference will now begin. Your first question comes from the line of Ms. Liping Cai from William Blair. Please ask your question.

Liping Cai – William Blair

Hi, good evening. My first question is regarding your stall closure plan. Do you plan to close additional stores for the rest of this year or next year? And what are the closing related costs that you have budgeted in for the fourth quarter?

Kevin Wei

We will continue to evaluate the, you know, the necessity to further shift down our some of our non-profitable stores in the Beijing, Shanghai, Shenzhen. And you know, we closed at, you know, a little bit over 100 in the third quarter, we have incurred about RMB15 million internal store closure cost. In the fourth quarter, you know, we do not have any specific guidance in terms of the store closure really in costs, but that gives you kind of a guideline in terms of we probably incurred 150,000 per store that we closed in terms of one-off charges.

But we did say, you know, disclose that we have 446 stores now in operation with 13 in temporary closure mode. And by the end of this year, you know, we could trend down a little bit further from the 446 level, but not probably in the greater peak level as such as the third quarter.

Liping Cai – William Blair

And then, given the current market situation, for each store you are having some, getting some revenues from primary transactions and also revenues from rental. I wonder, what is the breakeven level, for each store currently, if it’s still the 150,000 per month that we used to estimate on?

Kevin Wei

Yeah, I think the breakeven still remains fairly consistent for our company owned project business whether it would generate revenue from, you know, is this secondary home sales or new home sales or rental revenues. And RMB150,000 to RMB155,000 per month are still the breakeven point.

Having said that –

Liping Cai – William Blair

Yes, go ahead.

Kevin Wei

Sorry, having said that I mean, honestly we have reduced quite a number of stores throughout the last two quarters. And obviously, we’re managing our so called, you know, the SG&A cost for those respective company owned store, cities as well. Theoretically if we don’t reduce enough of that back-office cost that, the breakeven cost could go slightly higher as well. But you know, our goal is to continue to maintain that level of breakeven point.

Liping Cai – William Blair

Okay. And then, it looks like, I mean, you are shifting a little bit away from secondary transactions, you have almost quite a high percentage of revenues coming from primary and rental. But do you expect this trend to continue, meaning secondary might not be your core business one day?

Harry Lu

Okay, this is Harry. I think probably the reason you see this changed that the cost in some cities especially in cities like Shanghai you do see that the development actually lower their price faster than secondary home owner. And that’s the reason why you kind of shift to capture this opportunity by you know, encouraging our sales agent in retail store to, you know, work more on the new project.

So, this really depends on what kind of the shift that between the new homes sales and secondary home of the price shift in those areas, but are expand in next one quarter or two at least, this shift will be continue to see kind of, you know, to work on the primary project in (inaudible) folks on the secondary markets, especially for those retail stores.

Liping Cai – William Blair

Okay, all right. And then, last question is regarding your – I guess adding new franchisees. Your regional franchisor you didn’t add any this quarter. And I’m sure the market demand probably is not very high at given the current situation. But do you expect to expand into additional cities?

Donald Zhang

Yes, we’ll continue to look for, you know, different working partners at new cities or the cities still available for us to grant our license. And it’s a much more selective process for us. And of course the market condition is, also is a factor in terms of being successful grant of the new region. But we’ve been doing this for the last 11 years and we will continue to look for the right partners for those respective regions in the cities.

Liping Cai – William Blair

Okay, all right. Thank you very much.

Donald Zhang

Thank you Liping.

Operator

(Operator Instructions). Your next question comes from the line of Ella Ji from Oppenheimer. Please ask the question.

Ella Ji – Oppenheimer

Hi, good evening. Firstly, I think you mentioned that you’re hopeful that the market for a secondary broker would have a reach to bottom by the end of this year. Could you elaborate a little bit on that? Is, there any signs on the market that you are seeing that is give you some hope?

Donald Zhang

Actually no. What we see, we’re actually, we are operating in three major cities, which is, Beijing, Shanghai and Shenzhen. For last month we did see that the transaction volume was as low as like 2,800 units changing hand in the city of Shenzhen. And this is a very, very transaction volume and then also, the same thing happened in Beijing. And one thing we observe now is we do see the relative price drop pretty quick right now in those major cities, not only on the suburban area but we already started to see price drop went down in center of city.

So, that’s there is a good sign when we see that the price can reach a certain level let’s say 20% to 25% drop from the euro level. So probably you can see some more above than 100 come back to the market. And also because we look at the next quarter, the Chinese New Year is kind of early. So, probably I think we’re going to see some similarity factor as well. So, we kind of like expect right now the transaction volume already in such a very low level, so that’s the reason why plan and probably we’re going to see it’s already at bottom of the transaction volume, I’m not talking about price, but we’re talking about volume.

Ella Ji – Oppenheimer

Got it. Thanks, that’s helpful. And then, could you also talk about your plan in terms of number of sales force you have. Do you also plan to continue to trim down on the sales team?

Donald Zhang

So, I think the main focus is that to trend on the underperforming offices, but at the same time we wanted to keep low every office you have in the reasonable number of agents so that they can you know, work in that office. We think, you know, we don’t have enough people or good agents that obviously the action process trends down more instead of trying to cutting agents. Because nowadays given the nature of our business the turnover rates are pretty high. Basically, you know, you can just reduce the number of agents by stop hiring instead of trying to cutting off agents.

Ella Ji – Oppenheimer

Okay, got it. And then, we see a nice cost – sequential cost decline in commissions and in operating costs. But SG&A is plus quarter-over-quarter. So, what’s your expectation for that going forward? Should we expect it to come down as well?

Kevin Wei

Well, our SG&A expenses only varied around during the second quarter of this year versus the third quarter. Like I mentioned earlier it’s basically sometimes it’s a mix of fluctuation of different line items, for example the marketing expenses and professional fees and etcetera. So, but in general, you know, the absolute dollar amount, RMB amount is not that huge even with that fluctuation. I think every quarter we incur just about similar amount. So, going forward unless we have some, you know, major event or that require some significant G&A spending, we would expect to be a similar range of that in the last three quarters.

Ella Ji – Oppenheimer

Okay. And lastly, it’s about your cash management. Given that you are occurring negative operating cash flows through this year. I’m wondering if you have any plan of probably, raise some cash either of your debt or equity offerings?

Kevin Wei

Currently we don’t have any specific comments about finance at this point.

Ella Ji – Oppenheimer

Okay, thanks.

Kevin Wei

Great. Thank you, Ella.

Operator

(Operator Instructions). We are now approaching the end of 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 our earnings call today. We’re looking forward to speaking with everyone again soon. And thank you and have a good day.

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