Longtop Financial Technologies Limited F3Q10 (Qtr End 12/31/09) Earnings Call Transcript

| About: Longtop Financial (LFT)

Longtop Financial Technologies Limited (LFT)

F3Q10 (Qtr End 12/31/09) Earnings Call Transcript

February 10, 2010 7:30 pm ET

Executives

Charles Zhang – IR Director

Weizhou Lian – CEO

Derek Palaschuk – CFO

Analysts

Jon Maietta – Needham & Company

Tim Fox – Deutsche Bank

Joe Vafi – Jefferies & Company

Glenn Greene – Oppenheimer

Karl Keirstead – Kaufman Bros.

Joe Foresi – Janney Montgomery

Operator

Welcome to today's Longtop third quarter fiscal year 2010 results announcement. I am pleased to present Mr. Charles Zhang, IR Director. For the first part of this call, all participants will be in listen-only mode and afterwards, there will be a question-and-answer session.

Mr. Zhang, please begin.

Charles Zhang

Thanks, Erin. Thank you and welcome to our fiscal third quarter 2010 earnings conference call.

Joining me on the call today are Weizhou Lian, Chief Executive Officer; and Derek Palaschuk, Chief Financial Officer.

For today's agenda, management will discuss highlights of the quarter. This will be followed by a Q&A session. Before we continue, I refer you to our Safe Harbor statement in our earnings press release, which applies to this call as we will make forward-looking statements.

Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in U.S. dollars and are on non-GAAP basis.

I would now like to turn the call over to our CEO, Weizhou Lian, and I will translate Mr. Lian's comments.

Weizhou Lian

(Foreign Language)

Charles Zhang

Thank you for joining us for Longtop fiscal third quarter 2010 earnings conference call. Our strong performance evidenced by 58% software development revenue growth in the first nine months of fiscal 2010 underscores the strong demand for Longtop solutions and that we continue to strengthen our market leadership. We are again increasing our revenue and net income guidance on the back of the success and I am confident we can achieve our revised guidance for the full year 2010.

While we are in the preliminary stage of our 2011 fiscal year budgeting, I believe that 2011 first call consensus of $90 million for adjusted net income and $100 million to $160 million for revenue is definitely attainable. We expect average shares outstanding to be 59 million in fiscal 2011.

Weizhou Lian

(Foreign Language)

Charles Zhang

One of the key points I would like to leave with you today is that based on my more than 25 years experience in this industry, I firmly believe that strong banking than the insurance IT spending will continue over the next few years. In short, I never worry about demand. I always think about how Longtop can improve our product, solutions, and internal management to meet the increasing sophistication of our customers' requirements.

Weizhou Lian

(Foreign Language)

Charles Zhang

I have – always make it a habit to have regular contacts with our customers and especially so at this time of the year. My belief is that Chinese banks and the insurance companies are still in a relatively early stage in modernizing their IT infrastructure as they are experiencing significant growth, launching new products, facing more competition and increased regulatory requirements, which all require a stronger IT system. To that end, our customers continue to adopt new technologies to improve the performance and the competiveness of their IT systems.

We believe macro factors such as reserve ratio increases and the possibility that non-performing loans may increase won't have an active [ph] impact on our customers spending with us and on our sales cycle.

Weizhou Lian

(Foreign Language)

Charles Zhang

During the middle of the global financial crisis at this time last year, we indicated that there would be strong demand for Longtop solutions and in hindsight, we were correct. Part of the success [ph] of our business model, which supports our continued bullish view on IT spending can be attributed to firstly, our customer diversification strategy where our focus is the biggest customers. Starting from 2006, we successfully expanded into insurance and began to cover increasing numbers of large banks. Now, about 55% to 60% of our software revenue comes from non- Big Four Banks.

Secondly, our diversification is supported by a strong big four customer segments, which is the foundation of IT spending in the banking industry. We have been working with the Big Four Banks' customers hand in hand over the past 10 years and have built a stable long-term partnership with these customers.


Thirdly, our execution has been strong because of stable management. We are now supported by a senior management team of 22 people, which I believe is the best in the country. While we have a tremendous amount of improvement to make in our management and solutions, we have a solid foundation.

Weizhou Lian

(Foreign Language)

Charles Zhang

Let me now give you an update of our quarterly progress as regards to customers, products, and acquisitions. Looking specifically at our customer segments, where the only change has been stronger growth than we anticipated.

Weizhou Lian

(Foreign Language)

Charles Zhang

For fiscal 2010, we now estimate Big Four Banks will grow by around 38% and be around 40% of our total software development revenue. You will recall our estimate in May 2009 was a year-on-year growth of 24% for our big four customers. We are continuing to strengthen both our sales and solution offering including consulting services. While we still expect to get our first contract from the Big Four Banks that is not our customer, the progress has been taking longer than we originally anticipated. So we may not have our first contract before March 31st, 2010.

Weizhou Lian

(Foreign Language)

Charles Zhang

When I look back over the past three years, I am really pleased how the Other Banks customer segment has grown. In our fiscal 2008, we had approximately $80 million in software revenue from Other Banks and this year, we will do well over $50 million. We expect other banks will grow by slightly over 55% for the full year as compared to early estimates of 30%.

Weizhou Lian

(Foreign Language)

Charles Zhang

The growth in our insurance segment clearly validates the rationale for our acquisition of Sysnet. While Sysnet brought us the two largest insurance companies in China, we will now also begin to target middle-size insurance companies with between RMB 2 billion and RMB 20 billion premium income. There is considerable demand for data integration and the business intelligence applications and the CRM solutions from these customers.

Weizhou Lian

(Foreign Language)

Charles Zhang

Before I talk about our products, I would like to assure our shareholders the pricing for our software development business is stable. As in previous years, I don't foresee any pricing pressure.

Weizhou Lian

(Foreign Language)

Charles Zhang

On the product side, the main development since our last earnings call has been the acquisition of the Giantstone. I am really excited about working with Mr. Cho Bong-Jin [ph], the Founder and CEO of Giantstone, to capture the opportunities in the core banking market. We will continue to expand and improve our product offering, which allows us improve market share and revenue for customers.

I am pleased that our standardized products have actually grown organically slightly faster than our customized products. I am also pleased in the fact that we have a strong growth in all of our four product segments.

Weizhou Lian

(Foreign Language)

Charles Zhang

Finally, let me now update you on our M&A activity. Given the strength of our balance sheet and opportunities in this industry, we hope to be even more active with acquisitions in the next 12 months. We are very aware about risks and difficulties of acquisitions in both directions; I personally spend a lot of time in this area. We try to mitigate the business indication risk by acquiring companies such as Giantstone, Sysnet, companies that we have known in the industry for a long time and the companies that are in fact much stronger than us in their respective area.

As a result of this strategy, their CEOs, all of whom are still working with us ending leading – end up with leading their own divisions at Longtop with a better platform for growth, supported by Longtop's brand name and broad customer base. To mitigate the back-office risk, we take over all of the back-office from – with our centralized back-office base in Xiamen. We strongly believe now is the time to take advantage of this opportunity.

Now, I like to turn the call over to Derek, our CFO.

Derek Palaschuk

Thank you, Lian Weizhou. Good day, everyone and thanks for joining our financial review. We are pleased to report a strong Q3 and once again increase our full year guidance. I will use most of my prepared remarks today to touch on areas that are not detailed in the earnings release.

Our software development business is performing well with year-on-year growth of 57.8% for the first nine months. We have guided for full year software development growth of 58.5%, indicating there was actually an acceleration of growth in our last quarter. Most of the growth has been organic and excluding Sysnet, which contributed $5.2 million of software development revenue in the first nine months, the organic growth is a healthy 50%.

With regard to order intake and backlog, excluding Sysnet, order intake was strong in Q3 with new software development contracts of $34 million compared to $20 million in the year-ago period, which is a 65% year-on-year increase.

At December 31st, 2009, we have a healthy software development backlog, excluding Sysnet, of $37 million compared to $46.5 million at September 30th and $26 million in the year-ago period. You should not be alarmed when you see the sequential drop in backlog at March 31st, 2010 as this is due to the seasonality of the contracting process where we signed the least amount of contracts in the calendar Q1.

You will recall we started our current fiscal year with backlog at March 31st, 2009 of $19 million, which is only about 14% of our total estimated 2010 software revenue excluding Sysnet of $135 million. Just as a reminder, our backlog figure only includes amounts where we have executed contracts and does not include any pipeline business.


We have always said investors should not expect our operating margins to go up, but they will gradually trend downward as we expand our business and continue to acquire companies. Our adjusted operating income margin for this year will end up somewhere around 47%, which is equal to the guidance we gave in May 2009 and down from 49% in the previous year.

You should also keep in mind our May 2009 guidance for fiscal 2010 was for $67 million in adjusted operating income and we are now guiding for $77.5 million. Our focus is on expanding market share and delivering healthy year-on-year operating income growth as opposed to setting minimum margin standards.

With respect to the differences between U.S. GAAP and our adjusted results, the major item is share-based compensation, which is currently on a run rate of about $10 million per year excluding any new grants. We expect our share-based compensation, excluding compensation charges resulting from our founder distributing his shares to employees and ex-employees, will continue to increase as a percentage of revenue.

Also related to share-based compensation is that one of our founders has informed us that in either Q4 2010 or Q1 2011, he will be gifting approximately 3 million shares with an approximate value of $100 million based on the current stock price to a number of employees and ex-employees who helped him build the company. Even though the gift is not made by Longtop, it is U.S. GAAP requirement that when a shareholder makes such a contribution, the company has to report it as an expense, which would be $100 million.

I would like to emphasize that this is a non-cash event that has no impact on the number of shares outstanding, the net assets, or adjusted net income of Longtop. You may recall we took a $24.8 million charge for share-based compensation in the quarter ended December 31st, 2007 for a similar event. The 3 million shares will not create an overhang in the market as we understand the founder will require the shares to be sold over a multi-year period.

I would now like to address our operating cash flow and accounts receivable. You will recall we started off the year slowly in terms of cash flow from operations and we committed the back half of the year would be better, which is what has happened. Operating cash flow for the nine months ended December was $50.1 million, an increase of 46.8% year-on-year.

Let me finish my prepared remarks with comments on our accounts receivable in order to explain the bump in our accounts receivable of $31.2 million from $56.4 million at September 30th to $87.6 million at the end of December. There are three components to our accounts receivable balance. Firstly, system integration receivables where we record the gross receivable in accounts receivable and we report revenue on a net basis. Secondly, what we term unbilled receivables where revenue has been recognized, but the customer has not been billed. Thirdly, accounts receivable we have actually invoiced the customer.

With respect to the $31.2 million increase from September 30th, this can be very easily explained. $11 million of the increase is due to us having $18 million in system integration receivables at December 31st compared to $7 million at September 30th. The increase is from Sysnet system integration business, where in Q3 they had contracts with their largest insurance customer, which contributed to the higher other services revenue this quarter. We expect these larger system integration receivables to be settled in fiscal Q1 or Q2 2011.

The remaining increase corresponds to the $18 million increase in deferred revenue from $19 million at September 30th to $37 million at December 31st. Most of the increase in deferred revenue arose in December because a lot of invoices were issued ahead of revenue recognition as our customers tried to use their budgets before their own December year-end.

This December invoicing created an increase in both accounts receivable and deferred revenue. If you look at the corresponding period a year ago, at December 31st, 2008, we only had $16 million in deferred revenue. So again, this is an example of the strong demand that we see in the market.


That concludes my prepared remarks. And operator, if you would please open the line for questions?

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is Jon Maietta from Needham & Company. Please begin.

Jon Maietta – Needham & Company

Hi, thanks very much. The first question I had, Derek, with regard to the Q4 guidance that excludes Giantstone, how should we think about Giantstone in general terms? Is that kind of a $1 million revenue business per month, was it fairly one year over the course of the calendar year?

Derek Palaschuk

Yes, Jon. We closed Giantstone just a couple of weeks ago and the integration is going very well and we are really excited about the opportunity. So what we've set for full year – next year, we would Giantstone to have a revenue that’s somewhere $15 million and adjusted net income of $3.75 million. We don't know what's actually going to happen this quarter because we are just in the process now of taking over their accounting system. But I think what you will see next year is that kind of similar to Sysnet, the revenue recognition in the front half of the year will be less than the back half of the year.

Jon Maietta – Needham & Company

Okay. And then what remains in terms of the integration from both a people standpoint, as well as process? You just mentioned you are taking over the back-end accounting system for example.

Derek Palaschuk

Yes, maybe we'll just translate that for Lian Weizhou.

Jon Maietta – Needham & Company

Sure.

Weizhou Lian

(Foreign Language)

Derek Palaschuk

So Jon, the – overall, the integration is going very smooth. We've already started the back-office integration in Xiamen and that includes the contract management, business management, HR management, recruiting, compensation and benefits, accounting and legal and we expect to have that – the back-office done actually before Chinese New Year.

On the business side is – (inaudible) has a very good – or Giantstone has a very good management team, they are very mature. So the business integration is actually quite clear and really quite simple for us. We want them to continue to run their existing business because we don't have this solution capability. We also have the same customer. So from the customer side, there is definitely no integration risk because we also do a lot of work with the customer.

So on the business side, the objective is to use our brand and our sales platform to help Giantstone basically push the SAP banking system to other larger joint-stock banks in China, and then secondly is to sell their own proprietary core banking solution to the smaller banks.

Jon Maietta – Needham & Company

Okay. And then my final question was with regard to the short-term borrowings in the balance sheet of approximately $27 million. Was that related to Giantstone as well?

Derek Palaschuk

That's a good question, Jon. To – what that was related to is that when we did our follow-on, it was all in U.S. dollars and our objective is to convert that into renminbi as quick as possible. Number one is renminbi appreciating; number two, the interest rates are much higher; and the number three reason we did this to finance our acquisitions in China. So the quickest way for us to do that was actually take out loan. So we are using these loans on a very short-term basis and once the amounts are transferred from overseas into China, these loans will be repaid, so within four months – so definitely before the end of June, these loans will all come off our balance sheet.

Jon Maietta – Needham & Company

Okay. Thank you very much.

Derek Palaschuk

Thank you.

Operator

The next question is Tim Fox from Deutsche Bank. Please begin.

Tim Fox – Deutsche Bank

Hi, thanks. Good morning. Congratulations on the execution. My first question for Lian Weizhou was around Giantstone and particularly focused on the smaller banking customer. I think you made it pretty clear that the demand environment for the large and super-regional banks remains very strong. But as far as taking the core system into the small banks, are there any risks given what we are seeing around tightening regulatory changes that that may not actually accelerate in calendar '10?

Derek Palaschuk

Okay. Let me just translate that from him.

Weizhou Lian

(Foreign Language)

Derek Palaschuk

Okay. Tim, so basically, we are – this solution is aimed at very small banks and the actual – total package maybe be a few million renminbi. So for that reason, he doesn't think that the banks cutting back their spending is going to have a big impact because it's not a big investment for a small bank.


And then in terms of how the solution is structured, it was for very small banks, it's immature, and it's a packet solution. And what that allows us to do is basically to be implemented in these very small banks on a very cost-effective way. It doesn't take a lot of implementation. So example, it might – it can be done in 10 months – actually 10 man months of implementation. So we don't really see that as being an issue.

And then right now, Tim, in the $15 million in revenue that we gave next year for Giantstone, there really isn’t much in there for the smaller banking solutions. That's more of a – maybe a two year out where it will start picking up.

Tim Fox – Deutsche Bank

Okay. So that's predominantly the mentioned [ph] bank and the SAP implementation there on that side?

Derek Palaschuk

Correct.

Tim Fox – Deutsche Bank

My other question, I guess, given what one of your public peers has gone through recently in their December quarter, I think many investors are sitting back, probably scratching their heads and saying, how is it that Longtop can beat and raise again. Maybe you can just help us think through what exactly your competitive positioning is relative to that company and at this point, do you think budgets are fairly well set for calendar '10?

Derek Palaschuk

Tim, we'll just translate that for Lian Weizhou.

Weizhou Lian

(Foreign Language)

Derek Palaschuk

So Tim, let me translate your question about the – basically the status of the 2010 budgeting. So because of the financial crisis last year, the budgeting was somewhat basically pushed out and delayed, but what Lian Weizhou is seeing now is that basically the budgeting cycle is back to normal and the way that would work is in – the fourth calendar quarter, the banks start their budgets and then by Chinese New Year, which is just around the corner, they will basically fix their budgets.

So now, our senior sales people and Lian Weizhou are meeting a lot of customers and we've been working with them to understand their budget and they are in the process of basically being locked down now and what he is seeing is really no different from what he's been saying in the past is that these banks have long-term investment plans, they have – facing competitive pressures, so that in both banking and insurance he is optimistic on their budgets for 2010. And then he will talk – answer your second question.

Weizhou Lian

(Foreign Language)

Charles Zhang

And in terms of our competitive position and what makes us different from our competitors, number one, we believe we have in-depth understanding of the market and the industry. At the beginning of the year, we expect the market will – the demand for our solution will continue to be very strong and we focus on the biggest customers.

Number two is because of our business model and customer strategy, we have a well diversified customer base where our focus is the biggest customers. Number three, we have a very comprehensive solution line and also, we have very strong financial support to make acquisitions to continue to consolidate the market, also because of our very strong internal execution.

Weizhou Lian

(Foreign Language)

Charles Zhang

And he also wants to emphasize that we have the best management team in this industry and a very strong back-office system in terms of our IT process, policies and product management process.

Derek Palaschuk

And Tim, I'll just add to that is you remember we were having this conversation last year at this time when basically the world was falling apart and we went – and Lian Weizhou had met all our customers – actually he went back and met them again because he didn’t think anyone was going to believe him when he said that they wouldn't cut their spending in the last calendar year.

So he's basically been through the same process and actually he came in – we are in Shanghai today and he met with one of the biggest – a very large insurance company and he came in that's doing same thing, they are going to increase their spending next year, there is no question. So Lian Weizhou doesn't see any issues with demand.

Tim Fox – Deutsche Bank

Great. Thanks, I'll pass it along. Xiexie, Weizhou.

Weizhou Lian

Xiexie.

Operator

The next question is Joe Vafi from Jefferies & Company.

Weizhou Lian

Ninhao.

Joe Vafi – Jefferies & Company

Hello, good morning and ninhao to everyone.

Derek Palaschuk

Ninhao.

Joe Vafi – Jefferies & Company

Good results. A few questions. Number one, I know that Lian Weizhou, you mentioned a little bit more about you building out your management team. Obviously, the company is growing a lot and you've done some acquisitions. So it might be interesting and helpful for people to have a little more color on how the management team is being organized, is it by customers, is it by vertical market, by type of solution just to give us an idea of how the management structure can be in place to ensure growth in the future.

Derek Palaschuk

Okay, Joe. Let me just translate that.

Weizhou Lian

(Foreign Language)

Derek Palaschuk

So the way that we are organized, firstly on the technology side, we have the technology team divided into delivery, what we call solution center, and as well as research and we have strong teams and VPs leading all of these different areas. On the sales side is – our sales people are divided into both industry and product. On the industry side, banking, insurance, enterprise customers. And then on the product, it's divided by our product lines. So example, core banking, BI, including data integration, testing, CRM, world trade finance, risk management, insurance.

And then the – when we acquire companies, this is really – a lot of times they are much stronger than us on the product side. So they get basically integrated into the product side. And then in terms of our back-office, we've already talked about – based in Xiamen and a centralized back-office.

Joe Vafi – Jefferies & Company

Okay, that’s helpful. And then secondly, I think I heard correctly that you threw out some preliminary guidance for next year. Any kind of more color there relative to the outlook for the Big Four versus Other Banks and other – your other buckets of revenue at this point and how are you kind of looking at that outlook for the next year?

Derek Palaschuk

Okay, Joe. Maybe I'll take that one. So what we've done is we are in the – we are in the early – the reason we changed our year-end to March 31st is basically we could get the customers' budget stats and then we prepare our annual budget. So right now, we are (inaudible) very comfortable with $260 million in revenue and $90 million in adjusted net income.

In terms of how that's going to break out by customer is we prefer that you would actually wait until our next conference call and we'll be able to give you more color on that because now we are actually just going through and – he is setting the quarters for the different sales people. But one thing is clear is that demand will be strong basically across all four of our customer areas.

Joe Vafi – Jefferies & Company

Okay. That's great. Thanks a lot. Thanks, Derek. Xiexie. Thank you.

Derek Palaschuk

Xiexie. Thank you, Joe.

Operator

The next question is Glenn Greene from Oppenheimer. Please begin.

Glenn Greene – Oppenheimer

Thank you and good morning.

Derek Palaschuk

Good morning.

Glenn Greene – Oppenheimer

I guess the first question is just the strength within Other Banks. If you could talk a little bit about that, I mean, it looks like it was up over 60% and I think you talked about 50% growth for the year, seems like you are getting a lot of traction there. Maybe a little bit of color on what sort of products are resonating and what's really driving it and maybe a little deeper dive on what sort of – what portion of the Other Banks, was it joint-stock banks – just a little bit more color on the strength there?

Derek Palaschuk

Okay. We'll just translate that, Glenn. One second.

Weizhou Lian

(Foreign Language)

Derek Palaschuk

So right now, we are – Glenn, we are targeting basically the joint-stock banks in China, as well as the largest city banks. And the reason that we've experienced such strong growth and he thinks the growth is going to continue is that we have a very strong competitive advantage.

That competitive advantage comes from, first of all – is we cover a lot of the joint-stock companies and the joint-stock banks and the larger city banks and what that allows us to do is basically leverage on the experience of working with the different banks. They also are in different phases of their development, different stages of their investments, so basically gives us a very – almost like a recurring revenue stream, what we do with one bank, we can reuse in another bank. Also, on the product side is that we have the most comprehensive product offering and again, that comes from having to work with a number of different banks and again, they are in different phases of investment.

And then what's really helped us with and why we are able to so successfully enter the Other Bank segment is because our customer base started with the Big Four Banks and they are the leaders in terms of technology setting trends, IT development, and the fact that we are able to build solutions for them and then basically, leverage and sell simplified versions of that has been a very – made the sales cycle and the product development very effective.

Glenn Greene – Oppenheimer

Okay. And then just the – just – it sounds like the progress landing that contract getting over the goal line with the last of the Big Four Banks has been delayed, I guess, a little bit or just has been a little bit of challenge to get that finished. Could you just sort of tell us what's sort of been happening there and why you are struggling to sort of just land that contract and get into that big bank?

Derek Palaschuk

Okay, Glenn. Let me just translate that.

Weizhou Lian

(Foreign Language)

Charles Zhang

And thanks, Glenn. Actually, we still see very big opportunities at ICBC, but the problem is that their process – internal process for a new vendor, and that's Longtop, is pretty long, although we still definitely hope to get our first contract from ICBC even though it will happen later than what we have anticipated.

Generally, their data (inaudible) is to use very big global consulting companies to do the (inaudible) and to their – to the delivery of your own because we have the biggest development center in China. So they seldom give the delivery work – implementation work to big vendors like Longtop. As a result, our focus is to – on the consulting side, we definitely hope to get the consulting contract, but the process is complicated.

Derek Palaschuk

So Glenn, we think we'll actually get there with the consulting contract. And again, we've always said this is not going to be material to our guidance. There is nothing included in our guidance for this, but it would be an important milestone for the company.

Glenn Greene – Oppenheimer

Okay. And then just quickly, Derek, the tax rate to assume for '11?

Derek Palaschuk

So the tax rate for 2011, you can assume 11% to 12%. We did record in this past quarter a $4 million tax benefit, which takes our tax down to around 7% to 8% this year. But that won't be our – that's not a recurring tax adjustment. So it will basically go back to around 12% or 13%.

Glenn Greene – Oppenheimer

Okay, great. Thank you.

Weizhou Lian

Thank you.

Operator

(Operator Instructions). The next question is Karl Keirstead from Kaufman Bros. Please begin.

Karl Keirstead – Kaufman Bros.

Hi, good morning. Derek, I've got a question about Sysnet. It looks like Sysnet outperformed and contributed meaningfully to the revenue upside in the December quarter and had a trickle down into operating margins and receivables. Could you just outline what happened with that asset in the December quarter and maybe you could refresh what your guidance is for Sysnet for the full year fiscal '10 so that we can strip it out and check the organic growth? Thanks.

Derek Palaschuk

No problem, Karl. And if – once you get a chance to go through the script and the earnings, we've laid out the details, Sysnet contribution on the revenue side. So we started the year saying that Sysnet would do $9 million in revenue and that they would do – basically, they contribute $1 million of adjusted operating income. So we are basically at $10 million in revenue for the – basically for the first nine months of our fiscal year. We think Sysnet will do around $2 million in the next quarter.

And then in terms of their operating income, you'll recall that actually the first quarter they gave us a loss. If you remember, in our first quarter, we had over $500,000 loss from Sysnet. And then last quarter was basically breakeven. So now they are basically at their $1 million – a little bit over their $1 million target. So they will end up giving us about $1.5 million this year.

And the reason that business is – was more seasonal is because their customers are the largest insurance companies in China and they are more back-end loaded than the banks. And also, Sysnet had some very large system integration contracts, which were executed in Q3. But we are very happy with the Sysnet's integration and their business performance.

Karl Keirstead – Kaufman Bros.

Okay, great. And then for the March quarter, looks like you are raising your revenue guidance by a couple of million, but you are reaffirming the non-GAAP margin guidance of $16 million. So it looks like your margin, as a percentage of revs, is going to come down a little bit. Is – maybe you could add a little color as to what the offsets are there.

Derek Palaschuk

Well, we – when we look at our margin structure, we always look at it from a full year, we don't look at quarters. So the most important thing for us is that in May of last year, we said our operating margins would be 47% and we are saying that they are going to get there for the full year.

And the fact – so the fact that Q4, the operating margins are going to – will be somewhere around 40% is exactly what we would have expected because the revenue base is lower, but we are basically carrying the same amount of fixed costs. So the 40% operating margin for Q4 is exactly what we expected at the beginning of the year and it shouldn’t – it doesn’t indicate that our – we are having a serious margin erosion.

Karl Keirstead – Kaufman Bros.

Okay, great. And then maybe lastly, just because China Construction Bank is your largest single client and the largest client for the other publicly traded bank software firm, could you add a little color on how CCB tracked in the quarter and what you would expect for the March quarter?

Derek Palaschuk

So CCB was basically right on budget. We didn’t see – CCB continues to be our biggest customer. It was right on budget, there was absolutely no cutbacks in contracts, no projects cancelled, and in terms of Q4, the – basically, we already have all of the CCB revenue in backlog. So we don't see any risk of CCB cutting back its spending with us.

Karl Keirstead – Kaufman Bros.

Okay, great. Thanks and congrats.

Derek Palaschuk

Thank you, Karl.

Weizhou Lian

Thank you.

Operator

The next question is Joe Foresi from Janney Montgomery.

Joe Foresi – Janney Montgomery

Hi, guys. Good morning.

Derek Palaschuk

Good morning.

Weizhou Lian

Good morning.

Joe Foresi – Janney Montgomery

I wonder if you could just maybe define – I know you talked about it briefly, but maybe the budget process as it takes place over there. It sounds like you are going through discussions now and then the budgets are set by – before the New Year. Are those budgets typically closed, have they ever been opened in the past, and maybe any color on any level of discretionary spending that's – that maybe you feel is a part of that budget?

Charles Zhang

Okay, we'll just translate that. So one second please.

Weizhou Lian

(Foreign Language)

Charles Zhang

Hi, Joe. In terms of the transparent IT spending yearly, they have – first of all, they are highly defined and the yearly have long-term IT development clients four, five or seven years. We call it IT blueprint and that represents a big direction for next couple of years. And in terms of their annual budget planning, there are a couple of components. Number one is their infrastructure spending, that's basically the hardware spending. Number two is the long-term projects where we find a lot of recurring revenue opportunities, that's for long projects.

And then they have some new projects depending on the business departments' requirements and regulatory for these requirements. Over the past 10 years, we never see the – there is a big cut in their budget when they execute on their budget, but sometimes they do either (inaudible) projects to meet more urgent business requirements or regulatory requirements. So the cancellation or – cancellation of projects never happened to us.

Derek Palaschuk

So I think the answer to your question is actually the discretionary spending is normally adding to the budget. So what happens is basically they have a list of projects, a long-term plan and because of business and other requirements – product requirements, they end up actually normally adding to their budget. So Lian Weizhou hasn't seen them on the IT services and software side. That's where we are – that's obviously where we are focusing. We haven't seen them fix a budget and then two, three months later open up their budget and then cut the budget.

Joe Foresi – Janney Montgomery

So just to be clear – I know you guys talked about fiscal 2011. When you go out and you look at what potential revenues look like for next year and you discuss that with us, you are including just what's been allocated from a fixed perspective or does that include some guesstimate or estimate of what the potential discretionary spending above the fixed estimate would be?

Derek Palaschuk

So we are in the process now of really doing budgets by customers. But traditionally what's happened in the past is we have – we are doing phase two, phase three of projects that we started in the past. So we know that those projects are going to come in, as well as our sales people are constantly working with the banks in their offices, regular communication – Lian Weizhou is in regular communication with them. So we also have a very detailed front-log and that’s why – and then when we look at the overall growth rate, if you basically look organic, street has it at around a 23% organic growth rate.

So we know that we are very – that's why we say we are very comfortable with that growth rate based on the pipeline we have now and the history we have with our customers. And then when we do our own internal budgets and Lian Weizhou basically fix the quarter with the sales people, on our next call we will give detailed guidance by customer segment.

Joe Foresi – Janney Montgomery

Okay. And then just may be another question here. Going into a year typically, how much – it seems like you have very good visibility on the quarter, but maybe just on a percentage basis, given the discussion we've talked about fixed-price projects, what – what could you – is there a way to peg maybe what's your visibility is on an annual number?

Derek Palaschuk

Yes, our business is a little bit unusual because our backlog number is very small because our contracts – the projects are quite – some of the – the projects are actually quite big, but with our customers as they split the big projects into multiple contracts and in our backlog, we only report what's contracted. And if you look at the end of March 2009, we had $19 million in backlog and if we would have said we are going to do a $135 million in organic revenue from our software business, you would have said "you guys are crazy," and that's what people used to say in the past.

And so our visibility comes from having a very, very detailed pipeline of what projects, the banks we've already bid – we have to bid on a lot of our projects. So we have a very detailed pipeline, the banks have also told us which projects we are going to do. So we can also prepare our resources. So that's basically – so the support behind our – and then you saw we have – we have $37 million in deferred revenue. So basically that's the details behind our – basically a bottoms-up approach to how we build our budget.

Joe Foresi – Janney Montgomery

And then one last one. I know you talked about margins and you've been very upfront about margins coming down going forward. Maybe you could just give us some thoughts on maybe the magnitude that maybe they would be coming down and what you are seeing as sort of pressures on the margin front going forward?

Derek Palaschuk

Sure. And in terms of how much we see them coming down, what we've – we've always said they are not going to crash, but if you look this year from 2009 fiscal to fiscal 2010, the operating margin dropped around 2%. And then you would also – acquired Sysnet, which had operating margins a little bit over 10%. So it's just going to be a gradual margin decline and then what's driving that margin decline, it's really – it’s mainly on the gross margin side.

And we are trying to grow our business as quickly as we can, expand into more verticals, into more product lines, new customers, and we are willing to invest in order to do that. We are also having to improve our consulting capabilities, and those people don't – we don't end up with 70% plus gross margins on those people.

Also, we have a lot more people in Beijing now than we did previously. The costs of operating in Beijing are also higher. So it's just a function of those different areas, but there is absolutely no pricing pressure from our customers. So that's definitely not an issue for us.

Joe Foresi – Janney Montgomery

Great. Thank you, very helpful. Thank you.

Operator

Thank you. We will now begin closing comments. Please go ahead, Mr. Zhang.

Charles Zhang

Thank you, everyone for joining us. If you have any questions, please feel free to contact us. Thank you.

Weizhou Lian

Thank you. Xiexie.

Derek Palaschuk

Thank you.

Operator

Ladies and gentlemen, please note that a digital recording for the conference will be available for replay after this conference – this call completing for 30 days. To access the recording, please dial Arkadin Global Conference on Hong Kong IDD plus 852-3005-2020 or the toll free numbers, and key in the conference reference 136397 hash sign when your call is connected. This concludes our conference call. Thank you all for attending. Good-bye.

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