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FAB Universal Corp (NYSEMKT:FU)

Q4 2012 Earnings Conference Call

March 19, 2013 11:00 am ET

Executives

Chris Spencer - Chief Executive Officer

John Busshaus - Chief Financial Officer

Operator

Greetings, and welcome to the 2012 10-K Annual Report Shareholder Conference Call for FAB Universal. At this time, all participants are in a listen-only mode. (Operator Instructions) As a reminder, the conference is being recorded. It's now my pleasure to introduce your host, Chris Spencer. Thank you, Mr. Spencer, you may now begin.

Chris Spencer

Thank you. Thank you for joining us on the FAB Universal Corp 2012 year-end financial results earnings call. I'd like to turn over the call to John Busshaus, our CFO. John will read the required legal forward-looking statement disclaimer and then give a brief review of the financial statements. After that, I'll give you an overall business update and a peek at the future. John?

John Busshaus

Thanks, Chris. Legal notice regarding forward-looking statements. Forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, may be included in this teleconference. These statements relate to future events or our future financial performance. These statements are only predictions and may differ materially from actual future results or events. We disclaim any intention or obligation to revise any forward-looking statements, whether as a result of new information, future developments, or otherwise. There are important risk factors that could cause actual results to differ from those contained in forward-looking statements including, but not limited to, risks associated with the changes in general, economic, and business conditions, actions of our competitors, the extent to which we are able to develop new services and markets for our services, the time and expense involved in such development activities, the level of demand and market acceptance of our services, and changes in our business strategies.

Let's take a look at our financial statements. As we look at the balance sheet, our cash balance is $19.7 million. This is an increase of $5 million from the end of the third quarter. This increase was driven by a strong fourth quarter from our business operations. Other current assets, such as accounts receivable and inventory, increased significantly from 2011. These increases are due to the acquisition of Digital Entertainment International, which is what we refer to as FAB. Net property and equipment totaled $16.7 million, including our building with a value of $13.9 million.

The balance sheet also shows intangible assets, net of amortization, of $27.9 million and goodwill of approximately $60.6 million. Goodwill consists of $11.5 million for Libsyn and $49.1 million for FAB. Intangible assets consist of customer relations of $8.2 million, intellectual property of $3.9 million, trade names of $14 million, and non-compete of $1.6 million.

Our long-term deposits of $24.5 million includes anti-piracy sales guarantee deposits made to the product licensors, rent deposits made to landlords, and prepayments made for the opening of up to 10 new flagship retail stores in the future, something that Chris will discuss here shortly. During 2012, we spun off Future Healthcare of America on October 1 and all related assets and liabilities.

Looking at the liability side of our balance sheet, our accounts payable, short-term bank loans, taxes payable, and other payables and accrued expenses are a result of normal operating activities of our businesses. Deferred revenue, both short-term and long-term, are for payments made for the purchase of FAB membership cards and payments made by licensees to FAB for licensing what we call the 5C business model and FAB brand.

Licensees pay an upfront fee to license our 5C business for five years. As such, the revenue for these licenses is recognized over five years by the deferred revenue at December 31, 2012. With our acquisition of FAB and in accordance with GAAP, we recorded deferred revenue at its fair value as of the date of acquisition. Since that fair value was $9.2 million and the book amount was $29.8 million, it resulted in a reduction of deferred revenue as of the date of acquisition of $20.6 million from what FAB had recorded on their books. The deferred revenue treatment will have the effect of reducing reported revenue over the next five years by approximately $4 million to $5 million annually. The resulting reduction of revenue for the fourth quarter was $2.5 million. Please note that we already have the cash from this deferred revenue on hand as FAB membership cards, and licensing of 5C business requires upfront payment in full.

Moving on to our operating statement; revenue for the full year 2012 totaled $27.5 million. Revenue consists of $16.4 million from our wholesale distribution business with a gross profit of approximately 21%; $2 million in revenues came from our retail business with a gross profit of 28%; our 5C licensing and kiosk business delivered $7.8 million of revenue and gross profit of approximately 90%; and podcasting provided $3.8 million in revenue and gross profit of 57%. As a result, our overall gross profit was $11 million or 40%, and this number is after reducing total revenue by $2.5 million for the recording of deferred revenue mentioned before in accordance with GAAP process.

Operating expenses for 2012 were $13.8 million versus $11 million in 2011. This increase is due to acquisition related costs and the recording of non-cash expense totaling approximately $5.1 million for the issuance of stock to consultants, employees and then directors. Of these expenses, FAB incurred $2.9 million of operating expenses since the acquisition date. For 2011, the operating expense was driven by $7 million of non-cash goodwill impairment expense that we recognized and a slight increase in research and development costs.

As a result, the fourth quarter of 2012 delivered our first quarter of net income at $2.3 million or $0.11 per share and comprehensive income of $3.3 million or $0.16 per share. For the year, net loss was $4 million or $0.36 per share, a decrease from our third quarter net loss of $5.9 million.

As I stated on the third quarter call, I'm very excited about the future of our Company with the acquisition and the cash that this business is generating for our shareholders. As mentioned previously, we are able to generate net income of $2.3 million and increase our cash balance by $5 million in the fourth quarter. I think we should see similar results during most of 2013.

Chris, back to you.

Chris Spencer

Thanks, John. As you know, we closed the acquisition of Digital Entertainment International, a Hong Kong company known as FAB, on September 26, just four days before the end of the third quarter. I can tell you now that it has gone a lot smoother than John or I had previously anticipated. The integration teams did their jobs extremely well with one common goal in mind, and not only did we have a stellar quarter in terms of business operations, but we had a very timely and efficient end of the year audit and annual report process.

So, a quick look back at the financials that John just went over. I'd like to highlight a few points, then explain a few others. Please excuse any duplicate information from what John just said. I also tend to round down a little bit, so the numbers are just a tad off or different. But anyway, we had overall revenues of just over $27 million in all of 2012, a little over $24 million up from the full year revenues of $3.1 million in 2011. The overall increase of revenues for 2012 is clearly due to the acquisition of Digital Entertainment International, or FAB. However, I'd like to point out that we successfully grew overall revenues in each of the four quarters in 2012, even prior to the closing of the acquisition, which is a major milestone for our Company here.

For the full year of 2012, FAB posted a net loss of just over $4 million or $0.34 per share, that's before the currency adjustments, versus a net loss of almost $10 million or $1.31 per share in 2011. This loss for 2012 was due in large part to the acquisition related stock issuances and expenses that John mentioned. For the full year of 2012, we had non-cash expenses of just over $7 million. So what I wanted to point out here was, we lost $4 million and $7 million of that was non-cash related.

For the fourth quarter 2012, we recorded revenues of $23.9 million, up from revenues of $880,000 in the fourth quarter of 2011, again in large part due to the FAB acquisition. And then finally here, for the fourth quarter 2012, we posted net income of $2.2 million, $2.3 million, or $0.11 per share, versus a net loss of $7.8 million or $1.03 per share in the fourth quarter of 2011. This number includes the fact that we had a substantial amount of deferred revenue and non-cash expenses in the fourth quarter. While our GAAP reported net income was only $2.2 million, due to this deferred revenue and non-cash expenses, we increased our cash on hand by $5 million in the fourth quarter, as John mentioned, which for our business here is just phenomenal, adding $5 million in cash in the quarter. Business was very good. We report over $19 million cash on hand as of December 31 and we expect that to continue to grow going forward.

It's management's opinion that our fourth quarter financial performance was strong, with all of our business divisions exceeding our expectations. We had a record profit for the fourth quarter and we expect to see strong growth throughout 2013. We look forward to generating about $100 million in business in 2013 and we plan to continue to aggressively look for substantial cash generating digital media acquisitions, both in the U.S. and abroad.

In regards to additional acquisition, we believe FAB is producing enough cash flow right now to support substantial acquisition, and the prices we're seeing are attractive. We are looking for something that has strong cash flow and can be a real value-add for our 8,000 location network in Asia.

So now, a little guidance for you. FAB Universal Corp expects to generate between $23.1 million and $23.8 million in revenue in the first quarter of 2013 and between $98.9 million and $102.6 million for the full-year 2013. The Company expects after-tax net income between $4.1 million and $4.4 million for the first quarter of 2013 and between $19.3 million and $20.1 million for the full year of 2013.

So to conclude this financial section here, as of December 31, we had just under 21 million shares outstanding. We are projecting net income for 2013 of about $20 million and we reported just over $19 million cash in the bank as of the end of December. As I said, business is good and we believe it will continue to grow and produce significant cash throughout the year.

Okay, now, a brief business update for you here. As we've disclosed previously, FAB has four business divisions, all related to media and entertainment distribution. The first one I want to talk about to you is podcasting. Our podcasting business continues to grow at a steady, albeit modest, pace. In 2012, algorithmic adjusted download requests topped 1.6 billion. This new milestone equates to nearly 5 million audience requests for podcast shows each and every day, representing 1.7 million hours of daily content distributed to 240 countries around the world. Unique monthly audience members continue to grow to over 25 million individuals at the beginning of 2013, marking another milestone achievement. Our podcast network is expected to reach over 60 million unique individuals for all of 2013 and provide approximately $1 million in free cash flow. That's a new milestone for us here, now that the podcasting business is starting to produce cash flow for us here.

Number two, the retail. FAB first started out about 16 years ago as a retail store selling CDs. Today, we have two superstores, each over 20,000 square feet, which are in high-traffic shopping mall. In addition to selling DVDs and CDs and other forms of digital entertainment, these stores are used to build the FAB brand. The way we do this is by having star signings where you can meet and greet your favorite movie star or rock star or pop star. These events attract upwards of 10,000 people and are held approximately once per week. The FAB store in Beijing is the place to launch a new album or movie. The subsequent pictures, newspaper articles, and videos are used throughout the FAB licensee network that gives the FAB brand stature and credibility, and it really seems to be working, and you can gauge this by the number of brand licenses and kiosks we are selling each quarter.

Everyone knows FAB is the place to buy high quality media. In 2013, we plan to open two new superstores and plan to open many express style stores through previously announced partnerships with a major cinema chain and a chain of supermarkets. So these are smaller, kind of more compact, mini-stores inside other businesses, specifically this cinema chain and the chain of supermarkets that are very prominent, they are mainly located in the Beijing and they are expanding outwards right now, and we're very excited about those. We think there's a very captured market for our products there.

Alright, number three, wholesale. As FAB began growing as a retailer years ago, at times having many small retail stores in several cities, we always seem to have a hard time getting quality non-pirated movies and music albums to sell. So as a result, FAB created its own wholesale distribution division. This division supplies CDs, DVDs, and other forms of entertainment content to over 80 customers in Asia. FAB delivers products through a fleet of trucks and ships products through express mail, producing approximately half of the free cash flow for FAB.

And then finally here, FAB brand licensing and kiosk. What is the FAB brand license? A FAB brand licensee can have a small FAB branded retail store selling CDs and DVDs and other similar products along with an ATM style FAB Intelligent Media Kiosk, or a FAB brand licensee can have no physical store and just kiosk. Some licensees have just the kiosk and put them in high-traffic areas and create a kiosk route for themselves, if you will, and some licensees have small FAB branded media stores in retail areas and have one or more kiosks in their store.

When you think of a FAB kiosk, think of a stand-alone ATM machine that you would see at your local restaurant. These Intelligent Media Kiosks are very elegant and very sophisticated. They are simple to use and allow consumers to purchase copyright-protected music, video games, ringtones, digital books, and movies, directly to their cell phones, memory drives or other mobile storage devices. The kiosks have TV type screens in them and run paid advertisements and FAB also sells membership cards for the heavy users. We currently have about 3,000 paid memberships. When you put this model together, the best way we can describe it, as we have in the past, is iTunes meets Redbox meets Netflix.

Currently, FAB Universal has over 8,400 licensees with 12,000 kiosks in over 40 cities throughout China. That number is way up from where we were before when we first started announcing the number of licensees and the number of kiosks about a year ago when we were just getting going with FAB and starting on the due diligence process. This is a strong franchise style network and it continues to grow rapidly, enjoying approximately 80% gross margins in the fourth quarter. As John just reported, it was actually closer to 90%, I was smoothing it a little bit for some going forward.

Now, as for the future of the brand license and kiosk business, the plan is simple, rapid expansion. Right now, we're in 40 cities. There's over 160 cities in China with a population of 1 million people or more. Of the 1.3 billion people in China, half are now living in urban areas. With the cash flow that this business segment generates, we can fund rapid expansion internally. This is the future of the FAB business model and this is where we see the most potential growth going forward, and with 90% margins last quarter, we're obviously very excited about this business. We're looking right now to grow the content that is included in the kiosk. As I mentioned before, we're looking with the supermarket and the cinema chains to grow the FAB licensees or the small express type stores. We really feel that things are firing on all cylinders over there and it's moving forward very aggressively and with great margins.

So, that is for today. We had an outstanding quarter generating $5 million in cash and we expect to have a strong 2013. Business is good. Thank you very much for being a part of this call and it's a really exciting time for FAB Universal. We look forward to speaking with you again in May. Thank you.

Question-and-Answer Session

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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