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Charm Communications Inc. (NASDAQ:CHRM)

Q2 2010 Earnings Call

July 28, 2010 08:00 am ET

Executives

Henry Fraser - IR

He Dang - Chairman and CEO

Bao Li - CEO of Shangxing Media

Wei Zhou - CFO

Analysts

James Marsh - Piper Jaffray

Paul Keung - Oppenheimer

Operator

Hello and thank you for standing by for Charm Communications earnings conference call. At this time all participants are in 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 meeting over to your host for today’s conference, Henry Fraser from Brunswick Group.

Henry Fraser

Hello everyone and welcome to Charm Communications earnings conference call for the second fiscal quarter which ended June 30, 2010. 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 and Chairman Mr. Dang, followed by the company’s Chief Financial Officer Wei Zhou who will provide the financial overview and guidance for the second quarter. 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 laws. Also, please note that some of the information that we discuss include 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 shown as financial results prepared in accordance with US GAAP are included in Charm's earnings release which is being posted on the company’s IR website at ir.charmgroup.cn.

As a reminder, this conference is been recorded. In addition, a web cast of this conference call will be available on Charm's investor relation website. I will now turn the call over to Charm Communications' Founder, Chairman and CEO, Mr. Dang.

He Dang

[Foreign language]

Henry Fraser

Hello and welcome to our second quarter 2010 earnings conference call. Q2 still continues strong organic growth throughout our business as we consolidated our leading position in China’s fast growing advertising market with key hires.

He Dang

[Foreign language]

Henry Fraser

The total achievements in context, advertising in China continues to outperform as companies benefits from continued macro strength and raising Chinese domestic consumption. As you may know, according to recent CTR statistics, the advertising market in China grew at 22% during the first quarter of 2010 and we saw this momentum carrying into the second quarter.

He Dang

[Foreign language]

Henry Fraser

Charm occupies an enviable position in this exciting market. We have many of China’s top brands as loyal clients act as premium media resources and the team of industry veterans. The key to our future success is to continue to integrate these advantages and build out a platform that offers clients a seamless service. As before, we are seeing increasing demand for advertising positions which can be rolled out over a range of traditional and new media types. Clients are becoming increasingly aware that they need to be reaching out to customers in many different ways, and looking for an advertising partner which can effectively target different groups with the consistent message. I certainly believe that we are that partner.

He Dang

[Foreign Language]

Henry Fraser

I would like to take you through three core business segments and give some updates on our progress.

He Dang

[Foreign Language]

Henry Fraser

Charm Advertising’s agency business performed exceptionally year-on-year, driven by growth in a number of advertising trends and the average spending. In particular several of our key client wins for 2010, such as the Guangdong Development Bank and Harbin Pharmaceutical ramped up their spending in the second quarter. We made progress with the leading emerging brands, winning new clients but to outdoor gear manufacturer, more or like outdoor and business jet service provider, Capital Airlines.

We also received a larger than expected boost from clients advertising during World Cup matches, which contributed advertising turnover of nearly $18 million. Charm’s clients, including Snowbeer, (inaudible) and China Telecom accounted for 10.6% of the total World Cup in-match advertising clients on CCTV.

He Dang

[Foreign language]

Henry Fraser

We made several inputs in the wins in our creative services business over the quarter, what was notable among them was the Agriculture Bank of China, the first IPO national branding campaign. We won this plan the most creative project in the pitch with other global brands such as Ogilvy and Leo Burnett. Our pitch stood out because through our years of cooperation with the Agriculture Bank of China, we best understand its strategy envisioned in China’s domestic market.

Working with brands of this caliber testifies to our presence in the market, and also it demonstrates the strength of our integrated offering.

He Dang

[Foreign language]

Henry Fraser

I am also pleased to report that the billion joint venture with Aegis is making good progress. We recently pitched successfully for a full media account Toto, a Japanese company that produces bathroom fixtures. We also worked with (inaudible) a Chinese sports apparel manufacturer to design the successful interactive outdoor campaign during the World Cup. Both of the wins demonstrated the added value we can bring by working together with an international 4A company, and I look forward to bringing you more news in this front.

He Dang

[Foreign language]

Henry Fraser

As part of our strategy to stay close to our clients, in the second quarter we opened an agency service center in Chengdu, which is the capital city of Sichuan province in southwest China. This will help grow our presence in the region and provide underground service for our key client accounts. We know have offices in Guangzhou, Tianjin, Shanghai and Chengdu.

He Dang

[Foreign language]

Henry Fraser

Moving on to Shangxing Media.

He Dang

[Foreign Language]

Henry Fraser

Q2 saw a growth of nearly 120% year-on-year, quite an achievement by any standards. This was mainly due to a ramp-up in CCTV sales over the quarter, and increased demand for advertising on the two satellite channels in our portfolio.

He Dang

[Foreign Language]

Henry Fraser

As many of you know, Shangxing Media is our principal media business, which invests in premium advertising resources. Currently our portfolio includes four CCTV programs and two satellite TV channels, Shanghai Dragon TV and Tianjin Satellite TV. Using these resources, we are able to create customized commercials and branded content for use on targeted channels and programs. Advertisers benefit from access to specific market demographics, and differentiated ad campaigns. And the media owners benefit from maximizing commercial value from their channels.

He Dang

[Foreign Language]

Henry Fraser

We also kicked up several unique branded content campaigns plans on our satellite channels. For example people in the hair care groups, Sleek brands, a leading domestic hair and body care program became the program sponsor of Shanghai Dragon TV, a new reality dating show, one in a hundred and second, a leading domestic female shoe brand showcased its new summer lines on a weekly entertainment show on the same channel.

He Dang

[Foreign language]

Henry Fraser

We would like to highlight, in the second quarter Shangxing satellite channel's ratings continue to improve and it was ranked 6th among all satellite channels according to CSM Media Research. This is a significant improvement from being ranked 12th in 2009 and 8th in the first quarter of 2010 and demonstrate the effectiveness of our media consultancy services which we have used to help Shangxing Satellite TV improve its channel positioning and programming.

He Dang

[Foreign language]

Henry Fraser

By consistently delivering values to both advertisers and media owners, we are building a sustainable business platform in Shangxing Media. Going forward, we will continue to make investments to grow our portfolios of premium advertising resources.

He Dang

[Foreign language]

Henry Fraser

With that in mind, we are delighted to welcome Bao Li to be recently appointed CEO of Shangxing Media. He most recently served as the Vice Director of Advertising at Anhui Television Network and the head of Anhui Online TV, responsible for all of the network's advertising sales, program promotions and event marketing. With Li's extensive experience, working with National Advertisers and knowledge of television media helped to elevate Anhui TV to one of China's leading provincial television networks. With experience of developing media resources to ensure a win-win for our clients and media owners, especially in branded content and soft advertising will help the long-term expansion of Shangxing Media.

Bao Li

[Foreign Language]

Henry Fraser

Bao Li is one of the key hires we have made in recent months to enhance our team, which is one of the strategic objectives of our recent IPO. He joins other industry veterans to bring best-in-class service to our clients.

Bao Li

[Foreign Language]

Henry Fraser

Moving now to Charm Interactive, our new digital media.

Bao Li

[Foreign Language]

Henry Fraser

As I mentioned earlier, clients are increasingly moving towards integrated multimedia advertising strategies, and Charm Interactive is crucial in meeting this demand. Through this business we can offer effective online marketing strategies to complement additional TV advertising, providing a one-stop shop for our clients. We have grown going from the business from nine professionals in Q1 to 31 today, and already we are seeing successes in this segment.

In just two months, we have effectively built a media platform for Charm Interactive with increment from preferred buying rates with China’s top footholds and vertical space, including all of the top 7 online video (inaudible). This demonstrates the strength of Charm’s brand and our power of buying in the China’s domestic market.

Bao Li

[Foreign Language]

Henry Fraser

The talk of our new media advertising strategy, we just announced our collaboration with D.A.Consortium, one of the top 3 digital advertising agencies in Japan. On the returns of the agreement, Charm Interactive and D.A.Consortium will support one another in their respective markets, as well as collaborating over the development of technology platforms. Additionally, Charm will be responsible for all of D.A.Consortiums digital media buying in China.

Bao Li

[Foreign Language]

Henry Fraser

Over the last few years, Charm has seen incredible growth and I am conscious that as we develop it, it is important to maintain effective management structure to reinforce our core value and ensure that we work together as one. This is why during the second of 2010 we formed the Service Solution Committee, a management group of key executives from different areas of the company. We work together to make sure we maintain consistent high standards of service across our different businesses.

The committee also provides a forum for free flow of ideas between key operational staff, which generates innovative solutions and enhances are integrated advertising platform.

Bao Li

[Foreign Language]

Henry Fraser

I would also like to thank Lee Li for his exceptional service as CEO of Charm Advertising. He resigned at the end of June to be close with his family in Shanghai. He had a successful career as CEO of ZenithOptimedia in China and came after retirement to join Charm in 2008. He had experience in managing 4A advertising agencies in China and establishing professional training structures that was extremely valuable to Charm in the last two years.

It leaves us with a solid experience management team. We continue our expansion and to build on our strong client portfolio. I have resumed the CEO of Charm Adverting and will be supported by our Service Solution Committee.

Bao Li

[Foreign Language]

Henry Fraser

In addition, our Board Director, Patrick Stahle, the former CEO of Aegis Media Asia Pacific and current Chairman of Aegis Media's Global Solutions Group has agreed to come to Charm on a regular basis to provide advice and training, to help develop and maintain industry best practice at Charm Advertising.

Bao Li

[Foreign Language]

Henry Fraser

This is a very pleasing and formative time for Charm. China’s advertising market is growing strongly, and Charm is a leading industry player, putting us in a position to gain market share. We are integrating our three core business segments to bring comprehensive advertising solutions to our blue chip clients and we are recruiting top industry talent to further enhance our management team. I look forward to bringing you more updates as we work towards our goal of being China’s first world leading advertising and media group.

Bao Li

[Foreign Language]

Henry Fraser

I will now hand you over to Wei Zhou, our CFO to discuss the details of our operational program.

Wei Zhou

Thank you (inaudible) and hello everyone on the call. Please note that for the first section I’ll be referencing some of our second quarter results using non-GAAP numbers in order to better convey our performance.

We define our non-GAAP turnover, which is the first line, as our total customer advertising spend increased with or through Charm. Quarterly turnover best reflects the scale of our business. In the second quarter of 2010, total turnover grew 96.5% year-over-year and 6.5% quarter-over-quarter so approximately $159 million. The increase in turnover was mainly due to the increase in number of advertising clients and increase in advertising spending from the existing client as well as increased revenue from advertising around the World Cup and the Shanghai Expo.

Breaking down by business, turnover in our advertising agency business which is the total customer spending placed to Charm, grew 89.9% year-over-year and 5.8% quarter-over-quarter in the second quarter to $112 million. The increase in our agency business turnover was mainly due to the increase in the number of new agency clients and increasing in advertising spending from existing agency clients. We also benefited from the World Cup which added $17.8 million to agency turnover.

In the second quarter of 2010, we provided advertising agency services to a total of 101 accounts, 11 of which were bought in the second quarter. Extraction rate for agency business which is defined as revenue divided by turnover was 4.8% compared to 5.4% and 5.0% for the second quarter of '09 and first quarter of '10 respectively. The lower revenue extraction rate was primarily due to the fact that we are yet to receive the media rebate related to world cup advertising spending as the exact amount has yet to be announced by CCTV. Once announced, this revenue will be booked accordingly.

When excluding the world cup advertising spending, the revenue extraction rate for the agency business for the quarter will be 5.3%. Overall, we expect the revenue extraction rate to increase as we expand our full service offerings across all the platforms under term advertising and as you ramp up digital media offering under Charm Interactive. Turnover to our media investment management for principal media business, Shangxing Media which is equivalent to US GAAP revenue grew at 118.2% year-over-year and 8.9% quarter-over-quarter to $39 million compared to which second quarter of 2009, the increase was primarily due to the increase in satellite TV revenues as a result of price increases and the addition of four new CCTV programs which we began operating during the first quarter of 2010. Compared to the first quarter of 2010, the increase was mainly due to the seasonal effect of satellite TV and ramp up of CCTV sales.

The number I have just gone through explained the way we look at turnover, revenue extraction rate in our businesses and include non-GAAP measures. In terms of GAAP figures the results are as follows. Total US GAAP revenue for the quarter was $45.3 million representing an increase of 107.4% compared to $21.8 million for the second quarter of 2009 at an increase of 7.9% compared to $42 million for the first quarter of 2010.

Revenues from our advertising agency business was $5.4 million for the second quarter of 2010 representing an increase of 70.7% compared to $3.2 million in the second quarter of 2009 and an increase of 1.6% compared to the $5.3 million in the first quarter of 2010. The increase in agency rev business revenue is consistent with the increase in turnover.

The principal media business revenues were $39 million for the second quarter of 2010 representing an increase of 118.2% compared to the $17.9 million for the second quarter of 2009 at an increase of 8.9% compared to $35.8 million in the first quarter of 2010. The second quarter of 2010 we had 264 advertisers for the principal media business compared with a 161 advertisers in the second quarter of 2009.

Brand and identity services revenue were $0.9 million in the second quarter of 2010 representing increase of 13.8% compared to $0.8 in second quarter of 2009 and remains stable as compared to $0.9 million for the first quarter of 2010.

Cost of revenue for the second quarter of 2010 was $30.1 million compared to $14.9 million and $29.5 million for the second quarter of ‘09 and first quarter of 2010 respectively. We attribute the increase compared with the second quarter of ’09, mainly to the addition of four new CCTV programs, which we began operating in 2010. And an increase in higher satellite TV media costs. Compared with the first quarter of 2010, the increase is mainly due to business costs as a result of higher revenue.

Gross profit at the second quarter of 2010 was $15.2 million, representing an increase of 119.7% from $6.9 million in the second quarter of 2009, and an increase of 22.1% from $12.4 million in the first quarter of 2010.

Selling and marketing expenses were $4.8 million for the second quarter of 2010, representing an increase of 82.7% and $2.6 million for the second quarter of 2009, an increase of 13.6% from $4.2 million for the first quarter of 2010. We attribute the increase the selling and marketing expenses, with increase in headcount to build up our internet agency business, Charm Interactive, and also to investments in human capital to ramp up the Vizeum joint venture with Aegis Media.

Selling and marketing expenses represented 10.6% of our total revenues for the second quarter of 2010, compared to 12% for the second quarter of ‘09 and 10.1% for first quarter of 2010. We attributed a decrease in selling and marketing as a percentage of total revenue compared to the second quarter 2009, primarily to increase efficiencies of scale.

G&A expenses were $1.6 million for the second quarter of 2010, compared to $0.9 million for the second quarter of ‘09 and $1 million for the first quarter for 2010. We attribute the increase in G&A expenses compared to first quarter of 2010, primarily to higher share-based compensation charges related to IPO options and investment in management of finance personnel at the Vizeum joint venture in the second quarter of 2010.

As a result of the foregoing, operating profit was $8.8 million for the second quarter of 2010, which represented a significant increase from the $3.4 million for the second quarter of ‘09 and an increase from $7.2 million for the first quarter of 2010.

For the second quarter of 2010, the Company had tax expenses of $400,000.

Net income was $8.4 million for the second quarter of 2010, representing an increase of a 148.1% from $3.4 million for the second quarter of 2009, an increase of 22.7% from $6.8 million for the first quarter of 2010. Forward diluted net income for ADS for the second quarter of 2010 was $0.22 compared to $0.02 and $0.18 for the second quarter of 09 and first quarter of ‘10 respectively.

Each ADS represents two common shares, the company’s second quarter and non-GAAP net income which excludes share based compensation was $9.1 million, compared to $3.9 million for the second quarter of ‘09 and $7.4 million the first quarter of ‘10.

Cash flow from operations for the second quarter of 2010 was positive. As of June 30th, 2010, we are cash and cash equivalent of a $121 million. As of June 30th, 2010, we also had 401 employees, compared to 347 employees as of March 31st, 2010.

And now our business outlook. The company estimate that total revenue for the third quarter of 2010 will range from 49 to $50.5 million, of which the revenues from our agency business, which also includes brand and identity services revenue are expected to between $6.5 million and $7.0 million, and revenues from our principle media business are expected to between $42.5 million and $33.5 million.

Third quarter 2010 non-GAAP net income, which excludes the share base compensation expenses, is expected to be between $11 million and $11.5 million. We believe that total revenue for full year 2010 will range from $189 million to $192 million. Non-GAAP net income for full year 2010 which excludes share-based compensation expenses is expected to be between $39 million and $41 million. We base these estimates on a foreign exchange rate of RMB 6.7815 to US $1. This forecast reflects our current and preliminary view which is subject to change.

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

Question-and-Answer Session

Operator

We will now take your questions. (Operator Instructions) And the first question will come from the line of James Marsh, Piper Jaffray

James Marsh - Piper Jaffray

Can you talk a little about pricing trends in general, and if you break up the difference between your ad pricing and the additional volume consumer new contracts? I’m just trying to get a view for the underlined ad pricing trends.

Wei Zhou

In terms of overall prices, I think from a year-to-year basis for our CCTV business, I think the increase was a little bit less than around 20% in terms of price increase. And then that for the satellite business, especially on the principal side, I think the increase was slightly higher in the mid 20s range.

James Marsh - Piper Jaffray

And then I just had one follow-up question, Wei, you mentioned some of the seasonality between CCTV and satellite, and I was just wondering do they have different seasonality patterns at all or are they pretty much the same? Should we model any specific seasonality differences between the CCTV agency business and the satellite media investment management business?

Wei Zhou

Yes, for the agency business, I’ll break it down between agency and principal. For the agency business I think where we basically have around 80% of our turnover for the agency coming from CCTV. The seasonality of that is that, it’s particularly strong in the first and fourth quarter, with our second and third quarter being slightly weaker.

And going to the principal media assignments in some of the satellite business, it’s sort of the seasonality historically has been stronger during the course of the year, with fourth quarter being the strongest. But I think this year we’re seeing something that’s a little bit different compared to last year, because of the special events that have occurred in the first half of the year, especially with Shanghai Expo starting in May, and as well as the World Cup kicking off last month.

So we sort of saw a shift in some of the advertiser spending from later when the second half of the year, actually bumped up into the first half of the year. The overall seasonality in fact this year is probably less though as compared to 2009.

James Marsh - Piper Jaffray

And would you think that that’s just a timing issue where they had a budget and they’re going to spend a little bit more a bit earlier in the year because of these one time events, or these incremental ad dollars that are added to the market?

Wei Zhou

I think from what we’re seeing from our client, I think it’s more in terms of allocation of ad dollars to an earlier event.

Operator

And the next question will come from the line of Paul Keung, Oppenheimer.

Paul Keung - Oppenheimer

So, another one on the third quarter. I was just curious and as opposed to year end, I was curious where you are and what the process relates to negotiating some of the satellites, the new and existing satellite contracts for next year and then one follow-up question?

Wei Zhou

Yeah I will turn that over to He Dang.

He Dang

[Foreign Language]

Wei Zhou

Typically negotiation with satellite channels start in the third quarter with negotiations starting in the third quarter and we will hopefully wrap up the negotiation at the start of the fourth quarter and then sort of assign before the end of the year. And we have the same plan for after this year.

Paul Keung - Oppenheimer

Okay. I understand. Actually on that note, CCTVs I think the auctions in November occurs again like any sort of communication as you approach that time in terms of way you think pricing will be assured and see if you could…

He Dang

[Foreign Language]

Wei Zhou

In terms of for 2011, I think as usual, CCTV's auction would take place in November and then from looking at it now, our Charm has already started our preparation process for this auction and we actually do not expect any sort of anything different from sort of our historical experience. So we expect to have a successful auction process this year as well for China.

Operator

(Operator Instructions). The next question will come from the line of (inaudible).

Unidentified Analyst

Just on your senior hires, I mean you talked a lot about the senior hires that you made recently. Are there any particular segments of your business where you think these hires will have a particular impact? For example, gaining more international clients and so on.

Wei Zhou

Let me translate that real quick. [Foreign Language]

He Dang

[Foreign Language]

Wei Zhou

In terms of where we stood on sort of the position that we have in terms of bringing new people in is one of the strategy we had derived yearly. This is consistently our submission clients, and be a pioneer in the market, especially as more of our domestic customers have integrated solution, as well as multimedia on advertising need. I think [predominantly] that most of these forward hires that we have is over many years of experience in advertising industry, and have either worked with or knows Charm on a professional level before we make a hire. One notable hire we had is May Zhang who will be VP of Integrated Communications. She has over 10 years of experience at Ogilvy, and then although she has only been on board for less than a month, we’ve already made progress on the front that you mentioned, which is our international customers, especially with her ability to integrate creative services with the overall communication strategy that we provide.

Unidentified Analyst

And then just a quick follow-up question. On your comment about the momentum of the advertising market in China, dissimilar to the first quarter where it was 22%. Do you think these sorts of year-on-year growth rates can be sustained to the second half of the year?

He Dang

[Foreign language]

Wei Zhou

The overall market remains robust the first half. When you make a sort of half to half comparison to say first half of this year compared to the last where there is a very sharp seasonality effect because of financial crisis, so that this year, as I mentioned, spending will be more normalized, it will be less seasonality, especially the special events in the most of the first half. But I think overall, on the growth trend, we don’t see any change in overall growth trend.

Operator

And the next question will come from the line (inaudible) from FIG.

Unidentified Analyst

I doubt if someone has already asked this question, I apologize then. Well, in the press release is that strong growth in Q2 is also part of the Q2 the Shanghai Expo and World Cup. I‘m just wondering if you can comment on that, do you think that was the one-time event or in terms of top line, what should we expect for the remainder of the year? Thank you.

Wei Zhou

I think I answered that initially when James asked it. I think overall in terms of overall ad sense for the full year, we do not expect any changes from our exciting customers. I think what the impact of the Shanghai Expo and World Cup have on our business is that in term of the allocation of the ad sense from the customers, and that’s typically were you have very strong third quarter and fourth quarter then they allocated some of that budget to sort of specifically to these two specific events in the second quarter. But in terms of overall for the full year ad spend, we don’t see changes.

Unidentified Analyst

I also have one follow-up question. Can you comment on the new agreement with Digital Advertising Consortium, what are financial impacts do you think in the reminder of the year or next year? Thank you.

Wei Zhou

D.A.C. is actually, they are founded in 1996, as sort of the top advertising agency, traditional agencies which can. And for them, they are basically, they have been in the China, I think a couple of years ago, and then they took many of their Japanese customers with them. But I think what this speaks to is sort of the strength of the Charm Interactive business. I think for us, although we have only formed the Charm Interactive business for about just a quarter, we've been able to, because of Charm's brand and our buying power in the market, we've actually been able to negotiate very good buying rates with many of the traditional portals, as well as verticals and online video slice.

So, I think with these prices, I think we became a very natural corporation for D.A.C.’s footstep. They actually are going to do all of their buying in China for their customers through Charm. On top of that, I think we also worked with them in terms of, if any Chinese customers have advertising needs in Japan or any of their other customers have needs in China, I think we'll have also a further corporation on that. I think for this year, what this does is that it sorts of funds up our expectations for Charm Interactive.

I think we expect around RMB100 million of our turnover from Charm Interactive this year and we expect this cooperation the D.A.C. will help to sort of firm up that budget. Thank you.

Operator

And there are no more questions at this time. I'd like to turn the call back to Henry Fraser for closing remarks.

Henry Fraser

Again, thank you for joining us today. If you have got any further questions, please do not hesitate to contact our investor relations team by sending an e-mail to charm@brunswickgroup.com.

Operator

Ladies and this concludes today's presentation. Thank you for your participation. You may now disconnect and have a great day.

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