Xinyuan Real Estate Co., Ltd.
Q3 2010 Earnings Call Transcript

Published: 10 Nov 2010

[Operator:]

Good day, everyone. Welcome to the Xinyuan Real Estate Company Limited third quarter 2010 earnings conference call. Today's conference is being recorded. At this time, I would now like to turn the conference over to Ms. Helen Zhang for opening remarks and introductions. Please go ahead ma'am.

[Helen Zhang:]

Hello everyone. And welcome to Xinyuan's third quarter 2010 earnings conference call. The company's third quarter earnings results were released earlier today and are available on the company's IR website as well as on Newswire services. Before we continue, please note that the 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 these and other risks and uncertainties is included in our registration statement and our Form 20-F and other documents filed with the US Securities and Exchange Commission. Xinyuan does not 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 our 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 remainder of the year 2010. Following management's 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:]

Hello. [inaudible] Helen and thank you for joining us today. We were pleased with our third quarter performance, which improved compared to the second quarter and was [above the high end of our] schedule. Revenues, contracted sales, GFA sales, and the gross margin are increased compared to the second quarter. [inaudible] GFA sales at three of our major active projects in Suzhao, Chengdu, and Zhengzhou are improved compared to the second quarter. Xuzhou Colorful Garden also began adding to our GFA sales on schedule in August. Our revenues increased sequentially. We kept a tight focus on our costs. Our expenses were down as a percent of revenue compared to the second quarter and the prior year, boosting our profitability. In September, the government issued a new circular on housing policy to [prevent high ASP growth and to decrease speculation]. The government is [inaudible] down payment and suspending mortgage lending for first time buyers and non-local lenders. The new circular will increase some uncertainty in our outlook. We believe we have a good position for future development with [inaudible] three of our major projects, namely Chengdu Splendid II, Zhengzhou Modern City, and Zhengzhou Colorful Garden, which began pre-sales in the past two quarters, make [inaudible] the contribution for our sales in the fourth quarter. In the first quarter next year we will have [inaudible] to our active projects and our [land] bank is fully funded. This gives us a path for further growth into next year, with our focus on affordable development in Q2 and three cities. We are excited about our future growth opportunities. I will now turn the call over to Tom Gurnee, our chief financial officer.

[Tom Gurnee:]

Thank you. Let me start this call by taking our listeners back to this time in last quarter, when we were doing our conference call. At that time, the government had introduced new real estate mortgage policies on April 17. Banks, and particularly in Kunshan and Shanghai, virtually stopped making mortgages for a few months as they pondered how to implement the new policy. After an abrupt drop in sales in late April, we did begin to see some life in July sales figures. Some buyers, at least, were coping with the new rules and buying some apartments, albeit at much lower volumes than before the policy announcement. In this uncertain environment, we were about to introduce one new project, Xuzhou Colorful Garden, in Jiangsu Province, and we were about to receive crucial new sales permits for our Zhengzhou Modern City project, which had sold so well in May and April despite the new policies. By the time of last quarter's earnings, we were still trying to determine the impact going forward of the new policy on Xinyuan sales rates and buyer mortgage availability. So in this uncertain environment, we provided the third quarter guidance quite cautiously. Since then, the government has weighed in with more policy pronouncements. On September 29 a new mortgage policy was issued, raising minimum down payments from 20% to 30% for first apartment buyers and prohibiting mortgages for third-time apartment buyers or non-residents. And earlier this month the government announced an interest rate hike of 25 basis points and further rate hikes are expected. In this environment, we were quite pleased with our sales results versus what we had expected at this time last quarter. GFA, or gross floor area, sales totaled over 137,000 square meters, fully 51,000 square meters above Q2, and 57,000 square meters above my guidance. The main drivers of the gains were our newer projects. Xuzhou Colorful Garden launched in August 2010 and sold over 24,000 square meters in the third quarter. Zhengzhou Modern City, launched in May of 2010 and selling 22,000 square meters in the second quarter, rose sharply to 58,000 square meters in the third quarter on receipt of new sales permits. The Modern City project has proven to be a very popular project with apartment buyers. Chengdu Splendid II successfully launched in April, then dropping precipitously with the issuance of the April 17 policy, sold nearly 16,000 square meters as buyers ultimately coped with the new policies. Chengdu continues strong as we speak, with over 22,000 square meters sold in the month of October alone. Meanwhile, our larger active projects, Suzhou International City Garden and Kunshan International City Garden, recovered from zero apartment sales in May and June. Suzhou had its best quarter of 2010, at 9,900 square meters, while Kunshan averaged 30 apartment sales per month in the third quarter and achieved 53 apartment sales just in the month of October. In short, buyers are learning to cope with the new policies. Meanwhile, pricing is holding up nicely. The company's composite average selling price did decrease in the quarter from RMB7,683 per square meter to RMB7,480 per square meter, but this was entirely due to mix, as contract sales of higher-priced projects, namely Suzhou International City Garden and Kunshan, grew modestly while the sales of the more moderately priced projects, like Modern City, Chengdu, and Xuzhou, grew sharply. Even within a project, mix can be a factor, and this is evidenced by Chengdu Splendid I, where the remaining inventory is largely lower-priced commercially zoned 40-year land use rights apartments, versus the higher-priced residentially zoned 70-year land use rights apartments that predominated in earlier periods. Since the April 17, 2010 policy announcement, the company has not lowered prices on any of its apartments of any type, in any of its projects. In fact, although prices have been virtually flat since the April 17 announcement, prices for apartments in projects operating a year ago are up more than 50% year-on-year. So with GFA up, and ASPs firm, of course our contract sales numbers for Q3 were well ahead of guidance. Contract sales totaled $151 million, versus $97 million recorded in the second quarter, and versus previous guidance of just $80 million to $85 million. Let's turn to the financial statements and address third quarter revenue. For the quarter ended September 30, 2010, the company's total revenue, using the percentage of completion method, was $107.6 million, compared to $94.5 million for the quarter ended June 30 and $128 million in the quarter ended September 30. Our guidance had been $95 million to $100 million. Included in the $107.6 million is the net effect of a $15.9 million contract sales reversal recorded for our Kunshan project, which I can describe below as follows. As of September 30, 2010, there were sales contracts for 294 apartments outstanding for more than 90 days from contract signature date, without mortgage proceeds having being received by the company. The sales value of all these contracts was RMB245 million, or $36 million, and the deposits received against all those contracts totaled RMB60 million, or $8.8 million. As we all know by now, the government policy of April 17 affected Kunshan more than any other Xinyuan project, as our mortgage lending partners in Kunshan and Shanghai suspended all mortgage lending of any type while they awaited instructions from their respective headquarters in Beijing or elsewhere. Our buyer profile up to now has been a mirror image of our projects in other geographies. About 20% of our Kunshan buyers are Shanghai residents who are prospective owner-occupiers, and 80% are investors from [inaudible] province, maybe Shanghai and other provinces. Only occasionally do we encounter a Kunshan resident buyer. Perhaps one or two apartments per month are sold to Kunshan residents. For reference, our other projects in China average greater than 90% owner-occupiers, and there are just one or two apartments contracted throughout China that have not secured mortgages 90 days after contract signature. In short, this was a localized Kunshan project problem. We have kept in close contact with our contracted buyers in Kunshan, and both parties have generally agreed to await clarification of policy before taking any contract enforcement action. As of September 30, 2010, just six apartment buyers had requested deposit refunds. Meanwhile, after the April 17 announcement, we amended our standard sales contracts to require a 30% down payment versus 20% previously, and a second 20% installment due in June 2011 for second and third buyers. Buyers would then secure a mortgage or pay for the apartment in full after June 2011. Severe financial penalties apply for non-compliance. Now, all apartment sales since April 17 utilize this revised standard contract. Now that the government has issued a second policy statement on September 29, it's becoming clear that investor buyers are unlikely to be able to secure mortgages in the near future. The company believes that a number of buyers who signed contracts prior to April 17 will request to cancel their contracts and seek a refund of their deposits. Although management believes the company is not legally obligated to do so, it expects that it will honor certain requests on a case by case basis. The company is studying various scenarios for dealing with the 294 apartment buyers who are delinquent in obtaining mortgages. We expect to approach buyers on a case by case basis to propose customized replacement contracts. In cases where we cannot reach agreement, we will terminate contracts and refund deposits, some without financial penalties and some with financial penalties, depending on the nature of the delinquency. It should be noted that the average price of the 294 apartments is RMB8,035 per square meter, while for those with deposits below 30% the ASP is about RMB7,950 per square meter. Meanwhile, the ASP for Kunshan in October 2010 was RMB9,338 per square meter. In short, these 294 buyers enjoy a discount of approximately 15% from prevailing prices in our Kunshan project. So Xinyuan feels it's prudent to recognize the estimated impact of these potential contract cancellations in these third quarter results. We estimated that approximately 43% of the 294 sales contracts 90 days or more old without a mortgage will ultimately cancel their contracts with or without the agreement of Xinyuan. We have therefore recognized a contract sales reversal of $15.9 million in the third quarter, which in turn has reduced revenue, recognized under the percentage of completion method, by $10.8 million. Gross profit was correspondingly reduced by about $2.5 million. Now I'll move on to gross margins. Gross margin reached $29.3 million in the quarter. It's up from $20.2 million last quarter. As mentioned earlier, this quarter was negatively impacted by $2.5 million due to the Kunshan sales reversal. As a percent of revenue, we saw a fairly sharp increase, from 21.2% in the second quarter of 2010 to 27.2% this quarter. The primary driver of the improved margins was the sharp growth and thus higher mix of our newer, higher margin projects, namely Zhengzhou Modern City and Xuzhou Colorful Garden. A lesser factor was a revision of the total project costs and sales estimates for certain projects, resulting in a $2.9 million of cumulative gross profit being recognized in the third quarter under the percentage of completion method. The third quarter benefit of this revision of estimates was primarily driven by two mature projects, and on Colorful Garden and Chengdu Splendid I, which recorded higher than projected sustained ASPs in the third quarter. Moving on, selling, general, and administrative expenses dropped to $900,000 sequentially, from $8.4 million in Q2, to $7.5 million in the third quarter. As a percent of revenue, SG&A fell from 8.9% to 6.9%. The quarter to quarter reduction was expected, as heavy Q2 legal fees were not repeated. This was partially offset by agent sales commissions going higher than expected on higher contract sales. Meanwhile, headcount as of September 30 has been reduced to 380 people from 427 in June 2010. Income tax expenses in the third quarter totaled $15 million, or 65.2% of income before taxes, compared to $3.6, or 27% in the 2010 second quarter. Obviously this cries out for an explanation. The increase was due to the recording in the third quarter of 2010 of $6.4 million of additional income tax liabilities due to the land value added tax in Jiangsu Province, where the Suzhou, Kunsan, and Xuzhou projects are currently operating. In the third quarter, the tax authorities of Jiangsu Province issued their interpretation of the definition of "a standard ordinary apartment." For the purposes of land value added tax, that had a major impact on Xinyuan's LVAT liability for past and present projects in the province. First, some background on LVAT. There are basically three classes of space for the purposes of calculating LVAT set forth in the State Administration of Taxation circular

[Helen Zhang:]

And that's the conclusion of management's prepared remarks, and now we'll welcome your questions.

[Operator:]

[Operator Instructions.] We'll go first to Kun Tao with Roth Capital Partners.

[Kun Tao:]

First one, Tom, on your sales reversal, I'm assuming everything that you already projected would not get mortgaged or reversed for Q3. Is that correct?

[Tom Gurnee:]

I'm not sure what you meant by that, but I did not have any further reversals. What I have booked is an estimate of where our total reversals will be in the future.

[Kun Tao:]

So how has the policy changed, or what is the policy right now, that will affect your Suzhou sales - your Kunshan sales. Is that true - only local residents can buy in Suzhou and Shanghai, otherwise no one can get a mortgage for foreign buyers?

[Tom Gurnee:]

Let's be careful here. Suzhou is not affected. People can buy, they just can't get mortgages. So for example, investors from [Zhanjiang] Province, they make up a large part of the backlog there. They cannot get mortgages, period. When they signed up, they were regularly getting mortgages - 80% mortgages with 20% down payments and attractive mortgages. Now they're not getting mortgages.

[Kun Tao:]

So how would this possibly affect your sales going forward do you think?

[Tom Gurnee:]

Well, we're already feeling it since April 17. That's what I said in my remarks. We sold 53-54 apartments in October. We're selling 30-50 this - we're nowhere near where we were before, but it's solid. And ironically, Kun, if people do return these apartments our estimates for the total project profitability will probably go up because the ASPs for those apartments are much lower than prevailing ASPs.

[Kun Tao:]

That's helpful. I couldn't hear clearly. You say your tax rate is 36.9%?

[Tom Gurnee:]

36.0%. It went from 34.2% to 36%.

[Kun Tao:]

That's the blended overall tax rate going forward?

[Tom Gurnee:]

Yes.

[Kun Tao:]

In terms of your future projects, you mentioned you have five projects under planning that will be on pre-sale in Q1 of next year. What's the construction stage for those five projects right now?

[Yong Zhang:]

[Translated] All the five new projects, construction has been commenced, and as we said the first pre-sales will start in Q1 next year.

[Kun Tao:]

So when do you expect revenue could be recognized from those five projects?

[Tom Gurnee:]

As soon as we start pre-sale. The percent complete will be maybe 40% because we'll have the land and a little bit of spending, so the percentage complete will be about 40%, so if we book a dollar of contract sales we'll record $0.40 of revenue.

[Kun Tao:]

And looking at your projects under planning, they're mostly in Zhengzhou and one in Jinan, [Tier II cities]. Do you have any plans of going beyond those cities in the future?

[Tom Gurnee:]

Yes, and on that plan we have slides. That's all we have. No, but we have included [Tianjin, Wu shi, Xian] on these lists. But these auctions come infrequently and we do not have a full list of the auctions in those towns. So yes, we have plans to expand, but I can't tell you exactly which cities. Rest assured, it's a Tier II city and we will take advantage of auctions where they take place. The last one we did so with the new geography was Xuzhou and that worked out beautifully because the execution on that project was excellent, with the new management team.

[Kun Tao:]

So you expect auction on the land or you purchase additional land in 2011?

[Tom Gurnee:]

Yes, definitely. I'm pushing for 2010, but more than likely Q1 in 2011, yes.

[Kun Tao:]

Last question, maybe for Mr. Zhang, on overall buying sentiment or overall the real estate industry given the fact that the September policy comes out and it seems like government wants to put additional pressure in controlling of all the real estate markets in China. So what he feels on the overall industry and how would that impact Xinyuan's sales in 2011.

[Yong Zhang:]

[Translated] After the new policies at the end of September, we don't think that it will give any material impact. For example, our original sales target for October was RMB500 million and actually we're realizing more than RMB400 million. And for the cities that we have presence in and current projects, the number of visitors is still solid.

[Tom Gurnee:]

I think the net impact of the September 29 change was simply people realized it wasn’t going away. I don't think there was any incremental impact. It just that people realized there's no loosening of that policy coming soon.

[Operator:]

[Operator Instructions.] And at this time it does appear that we have no further questions. I'll turn the conference back to our speakers for any additional or closing remarks.

[Tom Gurnee:]

We just want to thank you very much for listening in. We assume the lack of questions was due to the clarity of our presentation. Thank you very much and we look forward to having a great quarter in the fourth quarter and reporting stellar results to you in about three months. Thank you. Copyright policy