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Charm Communications, Inc. (NASDAQ:CHRM)

Q3 2012 Earnings Call

November 20, 2012 8:00 AM ET

Executives

Justin Raybeck – IR

He Dang – Chairman and CEO

Wei Zhou – CFO

Analysts

Dick Wei – JP Morgan

Operator

Hello. And thank you for standing by for Charm Communications 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 is being recorded. If you have any objections you may disconnect at this time.

I would now like to turn the call over to your host for today’s conference, Mr. Justin Raybeck from Ogilvy Financial.

Justin Raybeck

Hello, everyone. And welcome to Charm Communications earnings conference call for the third quarter ended September 30, 2012. The company’s earnings results were released yesterday and are available on the company’s IR website at ir.charmgroup.cn, as well as on newswire services.

Today, you will hear opening remarks from Charm’s Founder, Chairman and CEO, Mr. Dang, followed by the company’s Chief Financial Officer, Mr. Wei Zhou, who will provide a financial overview and guidance for the fourth quarter of 2012. After their prepared remarks, they will be available to answer your questions.

Before we continue, please note that the discussion today will contain certain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995.

These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Charm does not assume any obligation to update any forward-looking statements except as required under applicable law.

Also, please note that some of the information to be discussed includes non-GAAP financial measures as defined in Regulation G. The most directly comparable US GAAP financial measures and information reconciling these non-GAAP financial measures to Charm’s financial results prepared in accordance with US GAAP are included in Charm’s earnings release, which has been posted on the company’s IR website at ir.charmgroup.cn. Please note that this conference is being recorded. In addition, a webcast of this conference call will be available on Charm’s Investor Relations website.

I will now turn the call over to Charm Communications Founder, Chairman and CEO, Mr. Dang, for whom I will read a translation.

He Dang

(Interpreted). Hello, everyone. And welcome to our third quarter earnings conference call. We continued to see improvements in our business during the third quarter of 2012. Despite of persisting challenging market environment, our core advertising industry business outperformed the market once again in the third quarter both in terms of total spending and revenues.

And it’s on track to maintain its robust growth. This growth is attributable to our ability to provide integrated full service advertising solutions to our clients, with sports marketing and digital services making strong contributions. However, our principal media business continues to be affected by soft demand and regulatory changes although we are seeing improved margins from our newly acquired assets.

China’s macroeconomic slowdown has had a substantial impact on the advertising industry. As business activities remain sluggish, advertising demand across industries remain soft, making our operating environment difficult. We are seeing advertisers withholding their budgets coming into the fourth quarter and we believe they will carry them into next year before deploying them.

The CCTV Prime-time Auction, which serves as the key broader ad business and advertiser confidence to the upcoming year was held this past Sunday. Although the total value of auction pre-sold advertising resources or CCTV, a record high of RMB15.88 billion, the indicators for 2013 are relatively mixed. The growth rate of 11.39% compared to the previous year is the slowest we have seen in recent years. And we saw counter cyclical industries like Chinese Liquor dominating the auction, taking up 33% of the volume as compared to 27% last year. While industries like financials and telecoms and multinational companies decreased in commitments.

Charm Advertising secured the number one position in terms of successful bidding volume for the tenth consecutive year, underlining our leadership position and expertise with respect to CCTV.

Moving on now to our operating highlights for the third quarter.

Our advertising agency revenues grew a robust 47.3% year-over-year substantially outpacing the 13.6% billings growth as a result of our increased revenue extraction rate. In the third quarter, the revenue extraction rate was 7.5% compared to 5.8% in the third quarter of 2011. This slight improvement is mainly attributed to the cash won by our sports marketing team for Olympics related branding and placements as well as the diversification of ad spending beyond CCTV to internet and satellite platforms.

In the third quarter, Charm Advertising won the CCTV advertising business for COFCO Group, China’s largest food manufacturer and processor. In the satellite TV business Mengniu Dairy, further demonstrating our leadership position on both CCTV and satellite response.

Our sports marketing team ran successful campaigns for China Telecom and Chery Automobile during the Olympics this summer. We will continue to invest in this exciting area of our business and further develop our sports marketing team in the coming quarters. Our digital business continues to grow at a rapid pace in the third quarter with key wins from Charm Click and Charm Interactive.

In the third quarter, Charm Click won exclusive agency business for five years European business, highlighting our leadership position in the SCM sector, and marketing Charm Clicks array in the markets outside of China. At the same time, Charm Click continued to win search accounts for both new and existing clients, including Bosideng, Michelin, Guangdong Development Bank. At the end of the third quarter, Charm Click served 61 clients including 10 clients from Europe, a number we expect to grow.

Our Taobao applications, Taokuaiche and Taokuaici, which help Taobao merchants manage their search advertising are also are showing robust growth. We will continue to invest in their development as relative technology behind our SCM services to provide our clients with effective SCM solutions.

During the quarter, Cathy Chen with the Charm Interactive team in Shanghai to win the digital marketing business for CAMPA, a China based over the counter pharmaceutical company. The campaign which is expected to start next year includes both social media and video and marks Cathy’s first major win since joining us in August. The win offers a good example of how our investments particularly in key hires are delivering business results. We will continue to foster our digital business and build innovative digital platforms that are capable of integrating with traditional advertising and media planning.

As noted throughout the year, 2012 has been a challenging period for Shangxing Media. The weak macro conditions and top-side ITV regulations has made a difficult operating environment. Although revenues and margins are down from historic levels, we did see revenue pick up in the third quarter, and we expect this trend to continue throughout the rest of the year.

Although the market is difficult for the media business, we see this time as a good opportunity to pick up new assets, with media prices as low as they are, we will continue to seek attractive media deals that offer significant long-term value and fit within our strategy for developing a more sustainable media business model.

In summary, the scale of our business has not changed and we remain in a healthy market position relative to our peers. Our core agency business is strong with significant digital contributions which we expect to increase as we invest in its staff and infrastructure. We’re also confident, we have the right strategies in place to allow our media business to withstand short-term challenges and sustain long-term growth.

While we expect relatively weak advertising conditions to continue through the rest of this year, we are confident in our ability to deliver improved, innovative and integrated advertising solutions to our customers as our business progresses.

I will now turn the call over to our CFO, Wei Zhou who will discuss our financial results.

Wei Zhou

Thank you Chairman Dang and hello everyone on the call today. Before I go through the financials, I would like to take you through our three core business segments to give you some updates on our progress to date.

Please note that in the first section I’ll be referencing some of our third quarter results using non-GAAP numbers in order to better convey our performance. We define non-GAAP turnover as a total customer advertising spending placed through which Charm in order reflect the scale of our business.

In the third quarter of 2012, turnover declined 1.7% year-on-year and increased 10.8% quarter-over-quarter to approximately $216.5 million. The year-over-year decrease in turnover was mainly due to the decrease in the media investment business, which was the result of the company’s operating media assets at the beginning of 2012 to modify – to reduce risk and ways of regulatory changes at cyber market.

The 10.8% quarter-over-quarter increase was – internal growth was largely due to seasonal factors. I will breakdown our business. The non-GAAP turnover for the Advertising Agency business grew 13.6% year-over-year and increased 6.8% quarter-over-quarter to $125 million in the third quarter of 2012.

The year-over-year increase in the Agency business turnover was mainly due to the increase in the number of new agency clients and the increase in spending from existing clients. The 6.8% quarter-over-quarter increase was mainly attributed to seasonal factors.

In the third quarter of 2012, we provided Advertising Agency services to 157 advertising client accounts, two of which were acquired in the third quarter of 2012. the most significant client was in the third quarter (inaudible), Michelin, Guangdong Bank and Bosideng are some of the accounts for our digital business and some of them are for our comprehensive advertising business.

The revenue extraction rate, which is defined as revenue divided by turnover for the Agency business was 7.5%, compared to 5.8% in the third quarter of 2011 and 5.7% in the second quarter of 2012.

The increase in the revenue extraction rate was mainly due to related branding placements, which had relatively higher revenue extraction rates and also partly due to increased advertising spending on non CCTV media platforms, including the internet and satellite channels, both of which have higher extraction rates for CCTV.

We expect that the revenue extraction rate to increase as we expand our full service offerings across all media platforms under Charm Advertising and ramp up digital media offerings under Charm Interactive and Charm Click.

Turnover for our Principal Media business, which operates under the Shangxing Media brand, declined 42.8% year-over-year and increased 39.2% quarter-over-quarter to $34.1 million.

The year-over-year increase was mainly due to the slowdown in a broader economic market and the dropping of several medial assets at the beginning of 2012. The quarter-over-quarter increase is turnover in the Principal Media business stand mainly from our exclusive Agency Agreement with Beijing Television’s sports channel, and BTV-Sports, which we found in June 2012 at large from our seasonal factors.

In the third quarter of 2012, we had 231 advertisers for our Principal Media business, compared to 303 advertisers in the third quarter of 2011 and 207 advertisers in the second quarter of 2012.

Now going back to the GAAP figures, total US GAAP revenues was $48.8 million in the third quarter of 2012, exceeding our guidance and representing a 30.5% increase, compared to $70.2 million in the third quarter of 2011 and an increase of 35.7%, compared to $36 million in the second quarter of 2012.

Revenues for our Advertising Agency business were $13.6 million in the third quarter of 2012, an increase of 47.3%, compared to $9.3 million in the third quarter of 2011, and an increase of 39.3%, compared to $9.8 million in the second quarter of 2012. The change in the Agency revenues, are consistent with the changes in turnover and extraction rate.

Principal Media business revenues were $34.1 million in the third quarter of 2012, a decrease of 42.8%, compared to $59.6 million in the third quarter of 2011, and an increase of 39.2%, compared to $24.5 million in the second quarter of 2012. The changes in the principal media business revenues are consistent with the change in turnovers.

Branding and Identity Services revenues were $1.1 million in the third quarter of 2012, a decrease of 17.9%, compared to $1.4 million in the third quarter of 2011, and a decrease 34.2% compared to $1.7 million in the second quarter of 2012. Decrease in branding advertising services were primarily due to decreased client demand for creative services in the third quarter of 2012.

Cost of revenues for the third quarter of 2012 was $34.5 million, a decrease of 27.7% compared to $47.7 million in the third quarter of 2011 and an increase of 38.7%, compared to $24.9 million in the second quarter of 2012.

We mainly attribute the year-over-year decrease, the dropping of media assets. Cost of revenues for the Media Investment Management business increased quarter-over-quarter, mainly as a result of the addition of the new media asset BTV-Sports in June 2012.

Gross profit in the third quarter of 2012 was $14.4 million, a decrease of 36.2% from $22.5 million in the third quarter of 2011, and an increase of 29.2% from $11.1 million in the second quarter of 2012.

Gross margins in the third quarter of 2012 were 29.4%, compared to 32.1% in the third quarter of 2011 and 30.9% in the second quarter of 2012. The year-over-year gross profit decrease was mainly due to lower contribution from the principal media business. The quarter-over-quarter increase in gross profit is mainly due to a ramp-up in the new media assets NB-media, our new principal media business.

Selling and marketing expenses were $9.4 million in the third quarter of 2012, an increase of 46.6% from $6.7 million in the third quarter of 2011 and an increase of 19% from $7.9 million in the second quarter of 2012. The year-over-year, quarter-over-quarter increase is primarily due to increased headcount, including executive hires.

Selling and marketing expenses represented 19.3% of our total revenues in the third quarter of 2012, compared to 9.5% in the third quarter of 2011 and 21.9% in the second quarter of 2012.

The year-over-year increase in selling and marketing expenses as a percentage of total revenues was mainly due to the shift of business from our Principal Media business to our Agency business, which tends to have higher selling and marketing expenses as a percentage of revenue.

General and administrative expenses in the third quarter of 2012 grew 106.2% year-over-year and increased 91% quarter-over-quarter to $5.4 million. The year-over-year and quarter-over-quarter increase were mainly attributable for the bad debt provision of $2.8 million in the third quarter of 2012. On this result of our subscriber, more cautious risk model with regards to our outstanding inventory in a relatively weak advertising environment.

Operating loss was negative $200,000 in the third quarter of 2012, compared to an operating profit of $13.2 million in the third quarter of 2011 and an operating profit of $200,000 in the second quarter of 2012.

Our GAAP net income was $100,000 for the third quarter of 2012, representing a decrease of 99.3% from $13.2 million in the third quarter of 2011 and a decrease of 89% from $800,000 in the second quarter of 2012.

Fully diluted net loss per ADS in the third quarter of 2012 was $0.01, compared to fully diluted net income per ADS of $0.31 in the third quarter of 2011 and fully diluted net income per ADS of $0.01 in the second quarter of 2012, each ADS represents two common shares.

Our third quarter non-GAAP net income, which excludes share-based compensation expenses, amortization of intangible assets was $800,000, a decrease of 94.2%, compared to $14.2 million in the third quarter of 2011 and a decrease of 46.6%, compared to $1.5 million in the second quarter of 2012.

Net cash flow from operations in the third quarter was negative $4.8 million, mainly due to cash outflow for the newly acquired BTV Sports still on its ramp-up phase. As of September 30, 2012, we had cash and cash equivalents of $117.9 million, compared to $124.3 million at the end of the second quarter of 2012. We had 842 employees as of September 30, 2012, compared to 809 employees as of June 30, 2012.

And now turning to our business outlook, we estimate our total revenues for the fourth quarter of 2012 will range from $47 million to $49.5 million. Fourth quarter 2012 non-GAAP net loss, which excludes share-based compensation expenses and amortization of intangible assets, is expected to be between $2.5 million to $2 million. We base these estimates on a foreign exchange rate of RMB6.3 per $1. This forecast reflects our current and preliminary view, which is subject to change.

Thank you for your attention. And I will now hand the call over to operator, who will open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Dick Wei from JP Morgan. Please go ahead.

Dick Wei – JP Morgan

Hi, thank you for taking my questions. I just want to see any recruits for the satellite TV for next year from the CCTV Auction? That would be my first question. Thank you.

Wei Zhou

Hi Dick, thank you for your question. I think in relations to the CCTV Auction, I think we saw 11.39% of strengthens in terms of the total committed spending compared to last year. As you’ll remember the increase last year was around 12.5% and the increase percentage years before that was around the 15% mark. So, sort of overlapped by year, this is the smallest amount of increase on a year-on-year perspective.

If you look at the overall advertising industry, the macroeconomic slowdown has definitely impacted business here, which in turn has impacted advertising industry. We’re actually seeing advertisers withholding or spending and cutting their budget, throughout the course of this year. And we believe that we can actually carry that low budget next year before at this point in addition ad dollars.

I think if we’re speaking about CCTV versus sort of other media, especially sort of comparable satellite channels, what we’re seeing is that, advertisers are focused on two things. First, obviously warned they’re becoming more focused on the effectiveness of advertising such that they are actually focusing more on promotional campaigns as well as sort of sales related campaigns and ad relative expense.

And second of all, they’re actually focusing more presently on our influential media, and that could be some of the hit shows or hit – our shows are drawn better on satellite channels and also on sort of the key ad-slots for CCTV. So, if you look at the CCTV Auction, some of the asset price has increased two or three counts in for the last year, with asset prices remain relatively flat. So that is directly related to a perceived influential level in terms of some of the media assets.

Dick Wei – JP Morgan

Great. And my final follow-up on the advertising rate for this year, any thoughts about relative growth for ad-rate for next year, that the satellite TV works as online media with the surge quarter display advertising, if any info that would be helpful? Thank you.

Wei Zhou

Yeah, in terms of the rate increases, typically advertisers will take a look at historical rate is that, on course the CCTV Auction, many of the other media platforms will take reference in terms of the year-on-year increase from CCTV and then adjust the rate curve accordingly.

And I think we’ll probably see the same thing this year but when you look at some of the key assets for CCTV as I mentioned before, we’re actually seeing relatively flat beyond their prices. So, I think the media inflation pressure which we’ve seen over the last few years will actually be less this year. So, I think across other media if you take CCTV as a signal, we’re not going to see that much media inflation or price inflation, best price inflation like for other media as well.

I think, and that being said, if your media is perceived as a sort of influential media or if you can continue to build on the performance, I think then those media itself will have some kind of pricing power. For example, what we’re seeing is that the number one TV show in China last year was, The Voice of China, which to me is the lead sponsorship for that show, actually increased around two to three times during the auction for our Charm satellite channel. And the same is true for say from the specials ads with CCTV.

Dick Wei – JP Morgan

Okay, great. Thank you very much.

Operator

(Operator Instructions). Thank you. We are now approaching the end of the conference call. I will now turn the call over to Chief Financial Officer, Mr. Wei Zhou for his closing remarks.

Wei Zhou

Thank you for joining us today. If you have any questions, please feel free to contact us in the future.

Operator

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

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