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China Finance Online Company (NASDAQ:JRJC)

Q2 2009 Earnings Call

August 20, 2009 8:00 pm ET

Executives

Ally Zhang - IR

Zhiwei Zhao - CEO

Jeff Wang - CFO

Alex Xu - CSO

Analysts

Dick Wei - JPMorgan

Ping Luo - Global Hunter Securities

Jeff Osher - Harvest Capital

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the quarter two 2009 earning release conference call. (Operator Instructions). I must advise you that this conference is being recorded today, Friday, 21 of August 2009.

I would now like to hand the conference to your host today, Ms. Ally Zhang. Please go ahead Ally.

Ally Zhang

Welcome to China Finance Online Second Quarter 2009 Earnings Release Conference Call. Joining me today in the conference are our CEO, Mr. Zhiwei Zhao and our CFO, Mr. Jun Wang and our CSO, Alex Xu. After market close today, we issued a press release concerning the financial results for the second quarter 2009. The purpose of this conference is to provide detailed information regarding those financial results. Following our formal remarks, we’ll be happy to take any questions you might have.

Before we start, it’s my duty to remind you that during today’s conference call, we will make some forward-looking statements, including statements about the future developments, our market position, individual and institutional markets and our forward guidance.

These statements are made under the safe harbor provisions of the US Private Securities Litigation Reform Act of 1995. Statements that are not historic facts, including statements about our beliefs and expectations are forward-looking statements. These statements are based on our current plans, estimates, and projections, and therefore you should not place undue reliance on them.

Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statements. Potential risks and uncertainties include, but are not limited to the impact of the global economic crisis, fluctuations in quarterly operating results, our ability to successfully compete against new and existing competitors, changes in accounting policies, our ability to successfully acquire and integrate businesses, and the impact of our investment on our financial results.

Further information regarding this and other risks is included in China Finance Online’s annual report on Form 20-F for the year ended December 31, 2008 and other filings with the Securities and Exchange Commission.

China Finance Online does not undertake any obligation to update any forward-looking statements except as required under applicable law.

Now I will turn the call over to our CEO, Mr. Zhao.

Zhiwei Zhao

Hello everyone. Welcome to China Finance online 2009 second quarter earning release conference call.

Today's conference call will be conducted in the following segments. First, I’ll provide general overview of our second quarter operations, then our Chief Strategy Officer, Mr. Alex Xu will comment on some operations and strategy highlights in details. Next our Chief Financial Officer Mr. Jeff Wang will provide details of our financial performance. Lastly, we'll be able to answer any question you may have.

While the global financial crisis continue to impact major economy worldwide in Q2 2009, Chinese governments stimulus physical and economic policies started to show positive impact on domestic consumptions, economic growth and investors confidence. China appears on a gradual recovery track.

After reaching multi-year low in Q1, 2009, major US and European equity markets rebounded sharply in Q2 powered by expectations from a quick recovery. In China, the Asia market continues to enjoy a substantial rally driven by ample liquidity and favorable macro data. Chinese investors somewhat regained confidence during the quarter despite a tentative domestic and global recovery.

The company sees the market opportunity in Q2 2009, introduced a series of new products and focus on up-selling. Cash revenue for the quarter hit a record high of $21 million.

Meanwhile, we continue to focus our efforts on improving internal management, optimizing our resources and strengthening the company's capability to sustain long-term growth. We tried our best to control the elements that we can control in the current environment.

With the efforts of every employee at China Finance Online, we achieved attractive operating result in Q2 2009. Net revenue on the US GAAP was $12.28 million and adjusted net loss was $761,000.

While we clearly observed an uptick in market activities and in demand of our products, we believe Chinese economy is still in a slow rebound mode after bottoming from the crisis, and we could see lots of ups and downs on the way to full recovery. As such, we believe that choppy domestic equity market will continue to influence our operating results in coming quarters.

In this uncertain market environment, our management team is realistic and prudent in evaluating opportunities and the challenges we are facing over the next three to five years, particularly in 2009 where we’re continuing to seek an optimal balance between near-term results and long-term sustainable growth.

We continue to fine tune our business plan and laying foundations for future growth. Our top priority in 2009 is to upgrade talent pool, enrich financial database, strengthen product development, optimize customer management, integrate technology platform and lift execution capability. Our record breaking cash revenue in Q2 ’09 indicated that our enhanced infrastructure is capable to support a much larger business scale.

We will continue to leverage our complementary resources through strategic partnerships. We also believe we should be able to consolidate valuable assets at reasonable prices to further extend our product services offerings along with value chain. These steps should put us in a better competitive position in the long run.

Our management team believes the above-mentioned improvement and upgrade should put a solid foundation for China Finance Online to sustain healthy long-term growth. Of course, we acknowledge our certainty in current environment and will be extremely prudent in managing our balance sheet while deploying necessary resources in core areas.

Based on our current view of macro trend in China, we reiterate our goal to achieve free cash flow positive in 2009 on a full year basis excluding potential M&A activities.

China Finance Online's management team and employees will proactively respond to the challenging macro environment in China and globally. With our responsibility to our shareholders in mind, we intend to work even harder to achieve a proper future.

Finally I would like to take this opportunity to express my great appreciation to our investors, analysts and all other partners. We look forward to your continuous support.

Now, I'd like to turn the call over to Alex Xu, our CSO to provide some details in operations and strategy highlights.

Alex Xu

Thank you, good morning and good evening everyone. Welcome to our Earnings Call. Well we start to see some tentative sign of economic recovery in China and globally as Mr. Zhao mentioned. The pass to a full recovery appears choppy. The volatility in equity market continued to weigh on our daily operations during the quarter, as Chinese investors reacted to the change of marketing environment in a more swift pattern than before.

As domestic Asia market produced a sharp rebound in the second quarter 2009, we saw increased activity from some of our customers. With full awareness that such market performance may not be sustainable, we adjusted our sales strategy to capitalize on this window of opportunity. Most of our sales team focused their effort on up-selling high-end products and services to existing customers, as opposed to expand our user base with low-end products.

This was a trade-off we made strategically in the quarter. We will probably continue to make such adjustments based on market conditions at time being, in an effort to seek an optimal balance between near-term results and long-term growth.

With the successful execution of the strategy, cash revenue in the second quarter 2009 hit a record high of $21 million, compared to $5.6 million in prior quarter. Net revenue from our core individual software business remained stable quarter-over-quarter at about $10.7 million. As market mood improved, registered users to our two websites grow at a relatively faster pace of 670,000 to reach 12.4 million in total. Paid subscribers to our service grew modestly to 110,000 roughly from 107,000 a quarter ago.

We continue to improve our product portfolio to proactively address the ever changing market environment. At the beginning of the year, we launched a new technology platform for next-generation products. The platform should enable us to introduce flexible modular products, faster and more cost-efficient. Some of our newly launched products already benefit from this platform.

For 2Q '09, the contributing percentage from our three main categories of individual software products changed meaningfully with a shift toward high-end fundamental analysis packages. This is a result of our targeted selling strategy and overall favorable market environment.

We expect to see some changes in the next quarter or two, as we update our product portfolio and market condition varies. Since the beginning of 2008, we start to offer products on shorter contract term to meet diverse customer demand.

In the second quarter 2009, the mix of subscription contract terms, again moved toward mid-to-long end of our offering spectrum. ARPU was relatively flat quarter-over-quarter. Please note that historically, our ARPU calculation is based on GAAP revenue as opposed to cash revenue.

During the quarter, our sales and marketing team continued to do an outstanding job on the volatile market. We maintained our telemarketing headcount in 2Q '09 at around 800, and we will continue to evaluate overall headcount at the company, based on market conditions as we move through 2009.

With regard to our Hong Kong based Daily Growth brokerage operations, as we mentioned in the previous communications, we gradually ramped up activities and made progress one step at a time. At the end of 2Q ’09, daily Growth had approximately 1,330 customers accounts.

Our strategic alliance with China Telecom continued to move forward in 2Q ’09, and we continue to make progresses in multiple fronts, including broadband, wireline, and wireless. We continued to implement the details of the partnership on the province by province basis, and have so far covered over 10 provinces.

Our valued added service unit worked closely with their counterparties at China Telecom. We believe this strategic alliance is important to our long-term growth over the course of the next few years. With the experience gaining from this partnership, we are also seeking other business opportunities with other carriers in China.

As we discussed in the previous calls, while we continue to pursue consistent execution in our operating targets in 2009, we will selectively allocate significant time and resources to further strengthen our competitive advantage in some key areas of our corporation, such as data, products, and technologies through internal improvement and external collaboration.

Above all, we believe the overall quality of our teams is a key to our long-term success. Our talent upgrading program is well under way to systematically attract high quality individuals to replace under performers. At the same time, we also constantly review our operations to remove waste and inefficiency.

With the effort we put in thus far, we believe our current infrastructure is capable of sustaining a much larger business scale. We remain confident that we should be able to achieve free cash flow positive in 2009 on the full year basis, excluding potential M&A activities.

With that, I conclude my prepared remarks and would like to turn the call over to Jeff Wang, our CFO. He will go over financial details with you.

Jeff Wang

Thank you, Alex. Hello, everyone. Welcome to our second quarter 2009 earnings conference call. In the second quarter of 2009, net revenues reached $12.28 million, compared to $14.68 million for the same period in 2008, and $11.76 million for the first quarter of 2009, down 16% year-over-year and up 4% quarter-over-quarter.

Subscription services provided to individual customers represent 88% of net revenues in Q2 2009, down from 91% from the previous quarter. Net revenues from this service line totaled $10.71 million in the Q2 '09.

In the second quarter, advertising-related revenues were $774,000, representing 6% of net revenues for the quarter.

Revenues from mobile value added services were $271,000 in the second quarter of 2009, representing 2% of net revenues for the quarter.

Revenues from subscription service fees paid by institutional customers were $279,000 in the second quarter of 2009, representing 2% of net revenues for the quarter.

Revenues from securities brokerage businesses provided by Daily Growth were $206,000 in the second quarter of '09, representing 2% of net revenues for the quarter.

Other revenues were $41,000, representing less than 1% of net revenues for the quarter. Deferred revenue at end of Q2 2009, reached the company's record high of $41.79 million, with current deferred revenue of $28.27 million and non-current deferred revenue of $13.52 million.

Gross margin was 83% in the second quarter of '09, compared to 86% in the same period last year and 87% in the first quarter of 2009.

Operating expenses, excluding stock-based compensation, were 98%, compared to 48% for the second quarter of 2008 and a 74% for the first quarter of 2009. General and administrative expenses, excluding stock-based compensation for the second quarter, was 20% of net revenues, compared to 15% for the second quarter of '08 and 19% for the first quarter of 2009.

Sales and marketing expenses excluding share-based compensation for the second quarter were 53% of net revenues, an increase from 24% for the same quarter of 2008 and 39% for the first quarter of 2009.

Product development expenses excluding share-based compensation for the second quarter were 25% of net revenues, increased from 5% for the same period last year and 16% for the first quarter of 2009.

In the second quarter of 2009, loss from operations was $3.22 million, compared to income from operations of $3.58 million for the same quarter of 2008, and the loss of $207,000 for the first quarter of 2009.

Excluding the share-based compensation, loss from operation in this quarter would have been $1.59 million, compared to $5.54 million for the same quarter of 2008, and $1.54 million for the first quarter of 2009.

Net loss for the second quarter was $2.4 million. Excluding share-based compensation, non-GAAP net loss for this quarter would have been $761,000, compared to net income of $6.53 million in Q2 2008, and $1.62 million in Q1 2009.

Non-GAAP net income margin for the second quarter of 2009 was negative 6%, compared to non-GAAP net income margin of 54% for the same period of 2008, and 14% for the first quarter of 2009.

Our cash and cash equivalents were $100.63 million at end of the second quarter of 2009. Cash inflow from subscription services provided to individual customers was $21.03 million, up from $16.72 million for the second quarter of 2008 and $5.6 million for the previous quarter.

Regarding our outlook for Q3 2009 and beyond, we currently expect to generate net revenues in a range between $12 million and $13 million for the third quarter of 2009. With the unpredictable market conditions, we assume a choppy business environment in the coming quarter. Given the uncertainty ahead, we continue to suggest the investment communities to take a conservative view in their forecast for our performance in the following quarters. We’re now ready to take any questions you may have. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). We have the first question from Dick Wei from JPMorgan. Please ask your question.

Dick Wei - JPMorgan

Hi, morning and congrats on the good quarter and thanks for taking my questions. My first question is that obviously this quarter you guys have a very strong cash flow at $27 million. So in the medium term or more in the near term, anything the company can do to improve it's renewal rate, or how the company position itself to kind of prevent the potentially slowdown in the Asia market. Thanks.

Alex Xu

Thanks, Dick. This is Alex. Yeah, what we’re trying to do as always in terms to improve the renewal rate and to basically return our customer is mainly from the product offering perspective, as I mentioned in the prepared remarks that we launched a new technology platform early this year, and so far in the second quarter we already see some results in terms of product based on that platform with more functions and more stable, and that’s one way to kind of retain our customers, at the same time we will continue to adding modules on that platform or we sort of a repackaging modules on our platform to produce different type of products or different function of the products that attract new customers to our surveys.

At the same time, obviously the overall market environment definitely has some influence to our business as we mentioned in the prepared remarks that part is sort of beyond our control, but we can do is to adjust our selling strategy according to the market environment. As we did in the second quarter, in a relatively I'd say positive environment, we will probably on the one hand try to maximize the per user contribution and at the same time maintain the user base.

In a relatively soft market environment, we will introduce or marketing more, sort of a low-end products to attract small fee based users and that actually prepared us to offsetting the future. So that's the overall strategy we’re taking to attract new users at the same time to retain existing customers.

Dick Wei - JPMorgan

For the second quarter can you talk a bit about in terms of cash revenue perspective, what are product ticked up?

Alex Xu

You mean which products are selling best?

Dick Wei - JPMorgan

Right, yes. From the new sign up?

Alex Xu

As I mentioned in my remarks the fundamental analysis product this quarter is the big seller, in part because of our strategy as you know the fundamental products is at the high-end of our product offering, and this quarter we decide to focus more effort to sell that package.

So the contribution from that package, these fundamental products is much higher than in the normal quarter per say and relatively speaking the very low end technical analysis products is at a very small percentage of a contribution to the quarter. So, I don't have to exactly say the per products kind of breakdown, but just in general in category wise, fundamental analysis is a majority of the sales cash revenue for the quarter.

Dick Wei - JPMorgan

Then just a couple of smaller questions. Just wonder where does the tax benefits come from, and then also the customer advance of $2.5 million, just trying to understand that.

Alex Xu

Jeff do you want to take.

Jeff Wang

Well, about the tax benefit, it’s a regular item that we generate from the tax holiday we enjoy from a different actually operating vehicles located in different cities especially in Beijing. And about the customer advance, I believe that is related to our brokerage business, that is what I belief.

Dick Wei - JPMorgan

Yes. So, the $2.5 million is mainly from, probably not related to individual subscription.

Jeff Wang

Well, there shouldn’t be region to actually you know individual subscriptions, but the advance from a customers paid by individual customers are actually reported as deferred revenues, if they are not recorded already actually service already provided. So basically that's why you see deferred revenues increased substantially, given the increased cash revenues from our individual customers from our subscription business.

Dick Wei - JPMorgan

Just on the tax front, what is kind of the tax rate guidance going like next one or two years?

Jeff Wang

Well, it's still reasonable to assume actually tax rate to be below 10% on overall basis.

Operator

The next question comes from Ping Luo from Global Hunter Securities. Please ask your question.

Ping Luo - Global Hunter Securities

My first question is regarding cash revenue. You have $21 million cash revenue in the quarter, much higher than last quarter and the same quarter last year. Of course, we know that this Chinese stock market has been performing extremely strong in the second quarter. As that stock market rally slowdown or that we actually see 15%, 20% correction in the last two weeks, do we see this cash revenue also slow down in the following quarters?

Alex Xu

This is Ally. As I mentioned, when I answered Dick's question, we certainly see some influence on the overall market environment to our operations, which we can do is to try to mitigate that impact by introducing the right products at the right time to the right customer and so far, because last quarter, the second quarter as you said the Chinese market is a very robust market and the global market as well and we had the record-setting quarter. We do not expect kind of a record-setting quarter in the following quarters, every quarter.

So, in some way, there will be fluctuations in cash revenue over the next few quarters, but that’s in part because the market environment changed, and also what we can do is again to improve our product offering and to make our sales strategy works better and to conquer any market change. So, basically, we will see fluctuation, but I don’t think we would see continuous record-breaking going forward.

Ping Luo - Global Hunter Securities

In terms of the Q3 guidance, you gave a very modest guidance of 12 to 13, meaning basically almost flat from the second quarter. So even with a very strong cash revenue in the second quarter, we are still guiding a previous last third quarter. So, basically, that I guess has to do with the way you recognize your cash revenue over time. Can you explain a little more on that?

Alex Xu

Yes. As you mentioned, our business model or our revenue model is as such that we’re collecting cash upfront and amortize over the next, in the normally four quarters. So the cash revenue in the second quarter, even though it set a record, but the real contribution to the second quarter GAAP revenue from this part of account revenue is very limited basically.

You can almost assume like a one troughs kind of a contribution, but the vast majority of the GAAP revenue in the second quarter was determined by the previous three to fourth quarter's cash revenue. As you know, the first quarter, we had very low cash revenue at $5.6 million that certainly had a big impact through the second quarter GAAP revenue.

So you’re right, and because of the way we recognize revenue, you won’t see the immediate kind of a showing in the GAAP number, even if our cash number becomes stronger in one particular quarter.

Ping Luo - Global Hunter Securities

In terms of this $21 million cash revenue, can you give kind of a rough breakdown like, what percentage is for short-term contract at least three months or six months and what percentage of the revenue coming from sales of longer-term contract one year or over?

Alex Xu

I would say the overall contract terms on average is moving towards the mid- to-high end of the spectrum as I mentioned in the prepared remarks. There is not much change at the lower end, say below six months kind of a distribution, but in the distributions above six months, we see that beyond one year contribution to the tax revenue increased to, let say, last quarter was about some 25 percentage and this quarter was close to 40%, and last quarter at the same time, the six months to one year contract down from 60% to about 45%. So basically, that's the move from six to one year, to beyond one year about 15% move.

Ping Luo - Global Hunter Securities

This 40% is beyond one year is including one-year contract or is like more than one year contract?

Alex Xu

It's more than one-year contract. It can be one year three months, one year six months or two years, whatever the combination you might have.

Ping Luo - Global Hunter Securities

Your growth margin was 83% this quarter compared to about 56, 86 last quarter and 87 in the Q2 last year. Can you explain why the growth margin was down and how you see that gross margin going forward?

Alex Xu

The main cost for the gross margin decline was related to actually the one sentence we mentioned in the press release that is, we paid a performance based bonus in second quarter, because we have a record second quarter. And as you know, our website maintenance cost goes to the cost of goods sold, and within that website maintenance cost there is a basically headcount cost for those who maintain the website and design the contents. So that part goes with the bonus pay, the basically the manpower cost within the cost of good sold increased a little bit. That's the main cost for the gross margin coming done from 86 or 87 to83%.

As we mentioned I believe in the previously calls that a normalized per say a gross margin, we look at it, it should be in the low to mid 80 percentage points going forward.

Ping Luo - Global Hunter Securities

80% to 85% you're saying?

Alex Xu

Right.

Ping Luo - Global Hunter Securities

I understand in terms of operating expenses, this quarter your sales and marketing expense is much higher in the first quarter is because of the sales commission paid, but also in the product development is also basically $3 million this quarter versus $1.9 million last quarter is also a pretty big increase. So is that also kind of bonus paid to the product development people or what kind of level we are also looking going forward?

Alex Xu

You are probably right, because the R&D team, obviously is a pretty big chunk of our headcount and the second quarter they also received the performance-based bonus.

At the same time, as we mentioned in many, many times that R&D or product development is one area that we want to invest in this particular year, so we are definitely upgrading the headcount, the quality of the headcount within the R&D team associated with that the cost for those headcount increased from previous quarter, so that's the two main reasons that drive the R&D cost higher.

In terms of going forward, I guess, we will continue to improve the R&D team, but I think this quarter, the second quarter there is a sort of a one-time effect, which is the bonus payment, so it won't happen every quarter. So in the coming quarters even if we continue to improve the quality of the R&D team, I would say the overall R&D cost, probably we will maintain at the relatively stable level.

Ping Luo - Global Hunter Securities

Roughly the third quarter, we’re having two months into the quarter. Can you tell us a little bit about the business activity and sales, how does it compare to the second quarter? We are seeing continued increasing in activity, or we’re seeing some slowdown? I don’t know whether you can comment on that.

Alex Xu

I just have to refer back to the earlier question you asked. Basically, we definitely see the marketing influence on our operations during the third quarter, and we will counter that with our, whether it’s sales strategy or product offerings. You know, we do not expect in the following quarters, every quarter will be record-breaking, but it will be fluctuating over the next few quarters.

Operator

Thank you. The next question comes from Jeff Osher from Harvest Capital. Please ask your question.

Jeff Osher - Harvest Capital

Yeah, hi guys, a couple of questions. First, congratulations. It sounds like some of the past callers may be confusing GAAP accounting with cash flow accounting, but along those lines, I want to make sure. Your commissions, they’re paid on a cash basis, so you recognize most if not all of the cost upfront, even though you differ effectively three quarters assuming the revenue gets booked on the first day, and if it’s later, subsequent amortized revenue for the quarter, you only recognize a fragment of that contractual revenue, the rest gets deferred whereas your cost get recognized upfront. Is that correct?

Alex Xu

Jeff, this is Alex. Thanks for your question.

Jeff Osher - Harvest Capital

Hi, Alex.

Alex Xu

That’s basically the facts, and that’s one reason why you see even though this quarter we have a record-setting cash revenue and our GAAP revenue relatively flattish, but the earnings coming down significant because we pay cash commissions upfront to all the software sales. So in any given quarter if you see a sudden increase on cash revenue, you can almost expect a decrease on the earnings side because of this, the way we recognize revenue and the way we paid commissions.

Jeff Osher - Harvest Capital

I guess when we just look at your normalized free cash flow even for the CapEx, you had a monster free cash flow quarter. As far as the conversion ratio, part of the opportunity, I think most of your investors and analysts look at is the fact you had such a large registered user base and such a large addressable market and it sounds like you targeted existing selling. Did you still view your conversion ration, which right now is under 1%, as significant source of opportunity for the company going forward?

Alex Xu

Absolutely, and, as I said, this strategic change during the quarter was really driven by the fact that market was so strong in the second quarter and we don’t want sort of a miss this opportunity and that’s why we change in our strategy a little bit to focus on existing customers.

Over the long run, let's say in a normal course of the business, we will continue to focus our efforts, mainly at least on affecting new customers and to improve that conversion rate, that below 1% rate obviously is very low and we see great opportunities in that area. Obviously, we need to introduce more or better products to increase our conversion rate. This particular quarter is just a, if you may and call it abnormal in the way that we set a strategy in that way.

Jeff Osher - Harvest Capital

Last question, about half of your market cap is in cash and you continue to throw off a lot of cash flow. If you look out at the M&A front and you and Jeff made several references and you also made references to it in your press release, the potential for M&A without discussing specific targets. Are you seeing opportunities to either increase the product offering or continue to expand the addressable market for the company?

Alex Xu

I mean on M&A front, I think I mentioned in the previous calls that, based on current market condition, based on our internal estimate or evaluation, we believe most of the going forward M&A activities probably will on a incremental base in terms of a scale and in terms of opportunity.

In other words, we will use the M&A opportunity to enhance our product offering to basically plug the holes in our operations or in area that we are weak or we are less competitive to make our business overall become stronger and more comprehensive and the large-sized acquisitions at least so far is probably not our priority at this point.

Operator

(Operator Instructions). There are no further questions from the telephone participants, sir.

Ally Zhang

Okay, all right. That’s all for today's conference. If you still have any further questions, please call our IR group at 8610-5832-5288 and our e-mail address is ir@jrj.com. Ladies and gentlemen, thank you again for joining us today. Thank you.

Operator

Thank you. That does conclude our conference for today. Thank you for your participating. You may all now disconnect.

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