Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

AsiaInfo-Linkage, Inc. (NASDAQ:ASIA)

Q3 2010 Earnings Call Transcript

November 2, 2010 8:00 pm ET

Executives

Jane Wang – IR

Libin Sun – Executive Co-Chairman

James Ding – Chairman

Steve Zhang – President and CEO

Michael Wu – CFO

Analysts

Meghna Ladha – Susquehanna

Karl Keirstead – BMO Capital Markets

Kun Tao – Roth Capital Partners

James Friedman – Susquehanna

Brendan Barnicle – Pacific Crest Securities

Scott Sutherland – Wedbush Securities

Donald Lu – Goldman Sachs

Casey Nelson – Alistair Capital Management

Iris Zhang – RBS

Mars Cao – UBS

Leping Huang – Nomura International

Eva Leung – Deutsche Bank

Melvin Yang – Morgan Stanley

Operator

Good morning and thank you for standing by for AsiaInfo-Linkage third quarter 2010 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 call over to your host for today’s conference, Jane Wang, AsiaInfo-Linkage’s Investor Relations Director.

Jane Wang

Hello, everyone, and welcome to AsiaInfo-Linkage third quarter 2010 earnings conference call. Joining us today on the call are our Co-Chairman, Libin Sun; Co-Chairman, James Ding; and Director, Edward Tian. Our Co-Chairman will begin by speaking briefly on the integration progress of the company.

Then, Steve Zhang, AsiaInfo-Linkage’s President and CEO, will review business highlights from the quarter and discuss strategies. And our new Chief Financial Officer, Michael Wu, will discuss financial results of the third quarter 2010 and give guidance for the next quarter of 2010.

Before we continue, please allow me to review AsiaInfo-Linkage’s Safe Harbor statement. Information discussed during this conference call might be forward-looking in nature and is subject to the risks and uncertainties that may cause actual results to differ materially from our current expectations.

To understand the factors that could cause results to materially differ from those in the forward-looking statements, please refer to our Annual Report on Form 10-K for the fiscal year ended December the 31, 2009 and reports subsequently as filed with the Securities and Exchange Commission.

Also, please note that some of the information to be discussed includes non-GAAP financial measures as defined in Regulation G. The most directly comparable GAAP financial measures and information reconciling those non-GAAP financial measures to AsiaInfo-Linkage’s financial results prepared in accordance with GAAP are included in AsiaInfo-Linkage’s earnings release, which has been posted on the Investor Relations section of AsiaInfo-Linkage’s website, www.asiainfolinkage.com.

Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in U.S. dollars.

I will now turn the call over to AsiaInfo-Linkage’s Co-Chairman, Libin Sun. Our Senior IR Manager, Jimmy Xia, will translate for him.

Libin Sun

[Foreign Language] Thank you, Jane. Hello and thank you for joining the call today.

[Foreign Language] I am delighted to speak briefly on the progress of the company’s integration. As Co-Chairman of the Board, I am honored today that the Board is confident and optimistic of the future strategy and development of the company.

[Foreign language] We are very pleased with the integration process so far and the smooth transition led by Steve and the rest of the senior management team. The merger effectively doubled our market share and created a preeminent player in the communication software solutions and IT services industry.

[Foreign language] As we look forward to the future, the Board will continue to support management as they move to capitalize under opportunities to grow the business.

I now would like to turn the call over to my counterpart, Co-Chairman, James Ding.

James Ding

Thank you, Libin. Good morning, everyone. Just to give you some additional color on the integration progress, under the leadership of the CEO, Steve Zhang and strong full support from Co-Chairman, Sun Libin and his team the Company are nearly finished with our front and backend integration.

Our HR, finance and email system are already fully integrated and we expect to completely finish the front and backend integration by the end of the first quarter of next year.

In the third quarter, we conducted a sales training and our catalogue of 80 AsiaInfo-Linkage solutions that we had identified earlier this year. During the training we asked our sales team to choose the top three solutions from customer perspective to determine whether to up sell and the cross-sell opportunities lie.

I am very pleased at this front with our progress and look forward to additional traction in the upcoming quarters.

Before turning the call over to Steve, I just want to -- our shareholders – I want our shareholders to know that our focus is on providing long-term shareholder value. And we’re very grateful for your support as we move forward into the new era.

At this point, I’ll hand the call over to Steve. Steve?

Steve Zhang

Thanks, James and Libin. Hello everyone and good morning. And thank you for joining the call today. This quarter marks a significant milestone for our company as it is the first time AsiaInfo-Linkage report earnings that consolidated Linkage’s operating results and the financial position.

In the third quarter, we met guidance recording non-GAAP net revenue of $130 million, an increase of 85% year-over-year and a non-GAAP net income attributable to AsiaInfo-Linkage per basic share of $0.40.

Please note that, assuming that the merger of Linkage occurred on January 1, 2009. On this pro forma basis, net revenue for the third quarter of 2010 would have increased 7% year-over-year. This highlights that we are still on track to meet our goal of 15 to 20% year-over-year net revenue growth on the pro forma basis for the full year.

Moving on to our three main customer accounts. Demand continues to be healthy in our China Mobile account and that we don’t foresee any dips in IT spending from the carrier. We are ramping up our NG-BOSS 2.0 rollout and anticipate the final three to four business intelligence 2.0 contract to be completed in the fourth quarter of this year.

Additionally, the design specs for NG-BOSS 3.0 have been completed and will be rolled out at the end of this year and the first half 2011. With our substantial headquarter mandated upgrades to existing business operation support systems that will drive and we will drive meaningful revenues in 2011.

We are also witnessing demand at a provincial level for projects with local specific requirements at each province that we currently support. Finally, we are also seeing opportunities in our China Mobile account in the area of – in the areas of business operation consulting.

Moving to China Unicom, we are also busy with headquarter mandated requirements for incremental upgrades for all Unicom provinces and they’re similar to China Mobile. We are working on provincial level specific requirements for new functionality and are providing upgrade services to the existing – the assets in several provinces.

This includes upgrade to Unicom’s internal projects or internet portals that allow their retailers to conduct marketing and sales functions and allow consumer to look up billing information, product subscriptions and to conduct other queries. We also see opportunities going into the next year from Unicom’s broadband access network upgrades and the broadband billing upgrades.

Regarding the BSS systems delays in the six Northern provinces, we are anticipating the RP process to restart this quarter.

For China Telecom this year there was no headquarter mandated upgrade that we saw for the other two carriers. So, our China Telecom has been more challenging this quarter. Most of the projects we have undertaken for Telecom have been provisional level specific requirements, and upgrades to existing billing systems.

China Telecom’s billings 3.0 and the CRM 2.0 projects have been delayed to next year, although we are conducting test and the soft trials for the carrier in November with contracts anticipated in the first half of 2011. While challenging I would like note that this project delays are already being considered in our full-year revenue expectations of 15 to 20% year-over-year growth on a pro forma basis.

I would like to highlight that our revenue mix have evolved to become more diversified and less concentrated and dependent on one carrier as we increase the number of Unicom and Telecom contracts from Linkage.

Our China Telecom account comprises approximately 50% of our total net revenue, compared to approximately 67% last quarter. China Unicom and China Telecom make up 23% and 17% respectively.

On the international front, this quarter we announced that we entered into an agreement with Mfone a leading provider of fixed and mobile telecommunication services in Cambodia to develop a Business Intelligence system for the operator. Although the sales cycles are long, we’ll continue to make steady stride forward in our long-term international expansion effort.

And then briefly commenting our Hangzhou Zhongbo business. Our objective in the cable market at this time is to expand more market share. In the third quarter we have won two new clients, (inaudible) providing billing and the CRM services to this two cable operators. As I have noted in the past, the government has set a goal of consolidating this highly fragmented industry and I am confident that will play a leading role.

Before I turn the call over to our CFO, Michael Wu, I would like to briefly introduce him as some of you may not have had the opportunity to meet him yet, Michael brings a wealth of IT and telecom experience to our management team. Most recently he served as the Chief Financial Officer of iSoftStone and the Group Finance Vice President of Huawei. I am confident that he will help us to continue enhancing our financial controls and build closer relationships within the financial community.

Now I would like to turn the call over to Michael.

Michael Wu

Thank you, Steve. And hello to everyone on the call. Please note that all numbers I will discuss today are U.S. dollar unless otherwise noted. Also, unless noted, the number I will discuss today include Linkage consolidated financial results. Third quarter non-GAAP net revenue for the telecom solution business was 104 million, an increase of 1 to 2% year-over-year and 7 to 8% sequentially. The substantial year-over-year and sequential increases were due to the combination of revenue from Linkage after the merger and the change in revenue mix.

On a pro forma basis, our telecom solution business would have increased 10% year-over-year. Gross margin as a percentage of net revenue for the telecom business was 46% in the third quarter compared to 55% in the year ago quarter and the 59% in the previous quarter. Third quarter, net revenue for the Security business division decreased 8% year-over-year, and increased 16% sequentially to 9 million in the third quarter.

Gross margin as a percentage of net revenue for our Security business was 71% in the third quarter unchanged from the previous quarter. Non-GAAP gross margin excluding amortization of intangible assets related to the Linkage merger as a percentage of net revenue for the company was 52% in the third quarter compared to 57% in the year ago period and the 61% in the previous quarter.

The year-over-year and the sequential decreases in gross margin were primarily due to the company deploying more of its R&D employees into client service teams after the Linkage merger which resulted in higher cost of revenue but lower R&D expenses.

Sales and marketing expenses increased 74% year-over-year and 81% sequentially in the third quarter. The year-over-year and sequential increases were mainly due to the merger of AsiaInfo-Linkage.

Our G&A expenses increased 6% year-over-year and decreased 13% sequentially in this quarter. The sequential decrease in G&A expenses was mainly the result of 1.6 million credit of the provision of allowance for doubtful accounts resulting from the successfully collection of a previous software trade receivable in third quarter.

R&D expenses were nearly unchanged from a year-ago period and increased 11% sequentially in the third quarter, which mainly reflect our effort to develop best-in-class products, solutions and offerings to meet demand of customers.

As we have noted, R&D expenses as a percentage of revenue came down due to more R&D employees being deployed into client service team after the Linkage merger, which resulted in higher cost of revenue but lower R&D expenses.

Total operating expenses increased 40% year-over-year and 37% sequentially during this quarter. Income from operations in the third quarter increased 87% year-over-year and 31% sequentially. We are encouraged by our improving operating efficiency, as we recorded an operating margin of net revenue excluding amortization of intangibles related to the Linkage merger of 26% due to economics of scale. Long-term our goal is to achieve an operating margin of net revenue which excludes amortization of intangible assets of approximately 22% to 24%.

Other income for the third quarter was approximately 0.5 million, nearly unchanged from the last year and a decrease from approximately 1.5 million in the previous quarter.

Net income excluding share based compensation expenses, amortization of acquired intangible assets and the after-tax dividend income or non-GAAP net income was 30 million in the third quarter of 2010 or $0.40 per basic share versus 13 million or $0.29 per basic share in the year ago quarter and 17 million or $0.35 per basic share in the previous quarter.

The effective tax rate for the third quarter of 2010 was approximately 16.4%, which increased slightly from the previous quarter as a result of more stringent enforcement of the R&D super deduction by tax bureau. We would like to note that we are pending approval of key software enterprise tax benefit which will lower our tax rate to 10%.

DSOs in the third quarter of 2010 was 134 days versus 117 days in the previous quarter. We witnessed a slowdown in cash collection due to the renaming of legal entity that leads the approval process of the combined company by the clients. Moreover as a combined company Unicom and Telecom are partners from Linkage which traditionally have longer DSOs. Given these impacts DSO fluctuated during the year and our priority is to continue to carefully manage and improve our DSO. Operating cash flow for the quarter was a net outflow of approximately 1.6 million.

Inactive operating cash flow was primarily the result of renaming of the legal entity, lengthy approval process from the clients and the longer DSO due to the Linkage merger.

And moving to our balance sheet as of September 30, 2010, our cash and cash equivalent and restricted cash totaled 192 million, and we have the short-term investments totaling 42 million.

And for our fourth quarter 2010 guidance, we expect net revenue for AsiaInfo-Linkage, to be in the range of 119 million to 123 million, and we expect fourth quarter 2010 net income attributable to AsiaInfo-Linkage Inc. per basic share non-GAAP to be in the range of $0.40 to $0.43.

And for the full year, we maintain a net revenue to growth of 15% to 20% on a pro forma basis and we are raising our guidance net income attributable per basic share on a non-GAAP basis to be ranging of 1.49 to 1.52.

Now, let me turn the call back to Steve for his closing remarks.

Steve Zhang

Thank you, Michael. To end our prepared statement, I just want to reiterate a few things. First we have reached a significant milestone in our integration process and this quarter marks the first quarter we have included Linkage’s consolidated financial results.

Second, there are house of demands for our IT software and solutions from all three carriers and we are seeing promising signs with the delayed projects as we expect Unicom’s six Northern province to restart RP – to restart the RFP process in the fourth quarter and we are conducting software trials and testing for telecoms dealing and the CRM solutions with contracts expected in the first half of 2011.

And lastly, integration is progressing smoothly and excluding the amortization of the intangibles related to the Linkage merger our gross margin is healthy and the operating efficiency is steadily improving.

Thank you for your continuous support of AsiaInfo-Linkage. And I will now open the call to questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Meghna Ladha with Susquehanna. Please proceed.

Meghna Ladha – Susquehanna

Hi. Thanks for taking my question. My first question was, Steve, can you remind us again what is the gross margin from new projects versus old recurring projects? And my second question is that you’re expanding into international market. Do the international projects have similar margin characteristic as the domestic business?

Steve Zhang

We generally don’t disclose the margins for new contracts versus existing upgrade contracts. But normally, the contracts from our existing customer base tends to be higher than the new customers. What’s your second question?

Meghna Ladha – Susquehanna

So you’re expanding into international. So do the international project carry -- have similar margin characteristic as the domestic business?

Steve Zhang

Well, so far, we’ve only signed one contract, which carries very good margin. But I don’t think, at this point, we can draw any conclusion from that one single contract.

Meghna Ladha – Susquehanna

Okay. And the one last was, you indicated that Linkage has longer DSO. Tell us what the DSO was this quarter and compare it to last quarter. Thank you.

Steve Zhang

Could you repeat your question? The line wasn’t quite clear.

Meghna Ladha – Susquehanna

Sure. Yeah. So you indicated that Linkage has longer DSOs. So did you give a number because I’m not sure if I heard it, but what was the DSO this quarter and can you compare it to last quarter? Thank you.

Steve Zhang

The DSO for this quarter, I think, as mentioned by Michael, was 135 days?

Michael Wu

134 days.

Steve Zhang

134 days versus the DSO for AsiaInfo standalone in the previous quarter was 117 days.

Meghna Ladha – Susquehanna

Thank you.

Steve Zhang

Thank you.

Operator

Our next question comes from the line of Karl Keirstead from BMO Capital Markets. Please proceed.

Karl Keirstead – BMO Capital Markets

Yeah, hi, thank you. If you look at your fourth quarter revenue guidance, it implies a pro forma growth rate of about 9%. My guess is that, as investors try to think about 2011 they might take that 9% assume it’s a reasonable growth rate for next year. And then on top of that add on an estimate of the deferred revenues from the Telecom and Unicom contract delays. Steve, is that an appropriate way to go about it. Or are there other things that we need to keep in mind as we model 2011 growth?

Steve Zhang

Hey, Karl, I think at this time we don’t want to comment 2011 revenue growth guidance, as we are still in the fourth quarter, we are still in the process of doing our next year’s budget. However, given that as I mentioned in my conference call, we are seeing a lot of demand from our China Mobile account NG-BOSS 3.0. And for China Unicom account as we mentioned we expect Northern six province to restart RFP process in the fourth quarter. And adding some other international opportunities as well as cable market opportunities. We continue to believe that we’ll experience very decent growth next year. But we are not going to give any specific ranges at this point.

Karl Keirstead – BMO Capital Markets

Okay. And then may be as a second question. Steve, it looked like your operating margins came above at least my estimates and I think estimates of many and I am wondering what were the primary drivers. Did you in fact realize more cost synergies from the Linkage acquisition than you were anticipating?

Steve Zhang

I think we achieved certain amount of energy this quarter, but as I mentioned very earlier on when we first announced this deal, this deal wasn’t about cost synergy. We were trying to seek more revenue synergy. I think the reason for this quarter, quarter three is just that, we have been -- given that it’s the first quarter for our financial reporting being put together, and we did a good job in controlling cost, but also, I think we also achieved, for the new projects we are achieving some economy scale that given that we only need to give out one version of the product going forward.

Karl Keirstead – BMO Capital Markets

Okay. Thank you.

Operator

Our next question comes from the line of Kun Tao with Roth Capital Partners. Please proceed.

Kun Tao – Roth Capital Partners

Thank you for taking my questions. Steve, the first question is regarding your operating expenses, if you look at the line item G&A, you add back 1.6 million of the bad debt recovery it is still lot lower than your previous numbers plus Linkage, because Linkage reported about 2 million a quarter. So, which is significantly lower than previous number plus Linkage, it also apply to R&D, the R&D Linkage, if you used your previous number plus Linkage it should be a lot higher than what you reported this quarter. Do you have information on this, or what we can project going forward?

Steve Zhang

I think on the G&A, I don’t know whether you are comparing the G&A with sequential previous quarter. In the previous quarter, we were including some of the merger-related expense. That’s why even you add back the 1.6 million bad debt recovery in the third quarter, the G&A was still lower than the previous two quarters on average because the previous two quarters include MA-related expense in the G&A.

Kun Tao – Roth Capital Partners

Yeah, I think the G&A – which in the first Q, which was higher 8.7, but looking back to average of 4.6, roughly 4 plus the proxy of Linkage G&A cost was about 4 million too. So G&A if you add one-to-one it should be around 7 to 8 million versus what reported, 5.6, is there any synergy cost saving or what we should look at going forward?

Steve Zhang

I think going forward probably it will be in the range of 5 to 7 million. I mean, Michael do you want to comment on that?

Michael Wu

Right. Going forward, I think G&A range for the combined company is in the mid range 5% to 7% of the revenue.

Kun Tao – Roth Capital Partners

5% to 7%? Is that right, Michael?

Michael Wu

Correct.

Steve Zhang

Kun, I don’t know you’re taking the original Linkage’s G&A number from Linkage’s public F1 filing?

Kun Tao – Roth Capital Partners

Yeah. The proxy that was released. I did not...

Steve Zhang

Our accounting people just told me that original Linkage they include their whole company’s sales bonus in the G&A expense. So when we are doing this quarter’s financial reporting consolidation we’ve put the sales bonus into the sales expense instead of putting the sales bonus accrual in the G&A expense.

Kun Tao – Roth Capital Partners

Okay. All right. That’s very helpful. Another question regarding your gross margin, so you had about 5.4 million which is affecting your cost of goods sold from the station of acquisitions, so going forward should we add those 5.4 million the same amount in each quarter going forward or --?

Michael Wu

Kun, there is a in total a 200 so roughly 230 million intangible assets related to the Linkage merger and that intangible assets will be amortized over the years from the shortest of 5 years as the backlog and longer 19 years as the trademark. So in this year and next year the number should be right 10 million, 10.4 million, roughly 50% up to the cost of revenue and the rest down to expenses in this year and next year and over the year the amortization of the intangible assets will be lower than the early years.

Kun Tao – Roth Capital Partners

Okay. So excluding this amortization your gross margin is around 51.8% which is lot lower than AsiaInfo alone is it purely due to the Linkage or on China Unicom and China Telecom margins or are there any other reasons -- what can we expect going forward?

Michael Wu

The lower gross margin of the company compared with the AsiaInfo Linkage standalone gross margin is primarily due to the Linkage traditionally booked some of the R&D expenses into the cost of revenue.

Steve Zhang

Kun, I want to comment on your remark that the lower gross margin is not due to more Unicom and Telecom businesses just the way how the – how in the financial accounting the product environment seems traditionally in the Linkage side is booked as cost of revenue.

Kun Tao – Roth Capital Partners

Okay. So...

Steve Zhang

Kun, I think going forward we will probably -- since I don’t want at this point to split the technical team, so going forward we will continue to -- on the Linkage side to group the technical delivery team and development team together.

Kun Tao – Roth Capital Partners

Okay, all right. Thank you so much.

Steve Zhang

Thanks.

Operator

Our next question comes from the line of James Friedman with Susquehanna. Please proceed.

James Friedman – Susquehanna

Hi, Steve, hi Michael.

Steve Zhang

Hi, Jimmy.

Michael Wu

Hi.

James Friedman – Susquehanna

I wanted to ask about your assumptions for the Q4 guidance, do you see the revenue guidance as a base case or in the instance that you were to see a budget flush, could there be potentially upside to the revenue that you have guided for?

Steve Zhang

Well, I won’t comment whether the base case or does any positive surprises if they is a budget flush. Even if there is a budget flush I think it will impact our sales order probably less on the revenue side, because the sales order will go into our backlog for next year’s revenue pool because if there is a budget flush they come in at a very end of the quarter and it will be -- no, we probably don’t have enough time to put the project together to deliver the revenues.

James Friedman – Susquehanna

I also wanted to ask if you would Steve, if you could repeat your comments about the customer contributions from Mobile, Telecom and Unicom pro forma for the acquisition that would be helpful?

Steve Zhang

We have the number for the third quarter that just passed. In terms of the revenue contribution for the third quarter as I mentioned, China Mobile is 50%, Unicom is 23% and China Telecom is 17% and the rest is contributed by our link -- security plus cable plus international roughly 11%.

James Friedman – Susquehanna

Last question, you – Michael you had stated the cash balance of the company I think 292, does that now include the cash payment that was made to Linkage?

Michael Wu

We already placed the cash considerations with Linkage in the third quarter. So that cash balance at end of third quarter is net cash balance after the payments to Linkage.

Steve Zhang

I think its 234 instead of 292 as you mentioned. Jimmy, where did you get that 292 number?

James Friedman – Susquehanna

I apologize maybe I misheard it but 234 is the correct.

Steve Zhang

That’s the (inaudible) up-front investment.

James Friedman – Susquehanna

Okay. Thank you.

Steve Zhang

Thank you.

Operator

Our next question comes from the line of Brendan Barnicle with Pacific Crest Securities. Please proceed.

Brendan Barnicle – Pacific Crest Securities

Thanks so much, guys. I wanted to follow back up on that question about the amortization of intangibles. So Mike, you were saying it would be a 10.4 million benefit to the quarter, when we -- when we add it back for non-GAAP purposes and should we be using, is that a safe assumption to use for every quarter next year or will it start to decline some point next year?

Steve Zhang

Sorry. Can you ask the question again closer to the speaker?

Brendan Barnicle – Pacific Crest Securities

Sure. So the amortization of intangibles, you said that will be a benefit in the fourth quarter of about 10.4 million that’s what you will be adding back to the non-GAAP numbers. Now would we stay at that level of 10.4 million per quarter, all through 2011?

Michael Wu

That will be the roughly right assumption when you put model in 2011 based on the amortization schedule.

Brendan Barnicle – Pacific Crest Securities

And so it would be 10.4 million per quarter?

Michael Wu

Correct

Brendan Barnicle – Pacific Crest Securities

Okay. Steve, I think in your prepared comments, you mentioned that the pro forma organic growth for the company was 7%, did I have that right?

Steve Zhang

7% for the third quarter.

Brendan Barnicle – Pacific Crest Securities

Okay. And on the last call you had highlighted some of the issues that China Mobile and China Unicom, you sound more confident about China Unicom now. What has changed in terms of your visibility around those two accounts?

Steve Zhang

I think we remained the same as on China Mobile compared with our July conference call. And we continue to see they are progressing as with their original plan. I think on the Unicom side, we are seeing the delayed contracts, they are restarting from the effort to try to restart RFP process in the fourth quarter this year. Hopefully you will move ahead given that there are only two months left in this calendar year.

Brendan Barnicle – Pacific Crest Securities

When will you know for sure, if that is going to proceed and what the timing on this might be?

Steve Zhang

Well, I think, at this point those are all very sensitive information so I think it should happen in the fourth quarter but I cannot really comment on the exact timing.

Brendan Barnicle – Pacific Crest Securities

All right. Thank you. That does it for me.

Steve Zhang

Okay. Thank you, Brandon.

Operator

Our next question comes from the line of Scott Sutherland with Wedbush Securities. Please proceed.

Scott Sutherland – Wedbush Securities

Thank you. Hi, Steve, and welcome, Michael.

Michael Wu

Hey, Scott. Thank you.

Scott Sutherland – Wedbush Securities

Most of my questions have been answered. Maybe, talk a little bit about your gross margin. You’ve talked about a R&D shift, and you’ve obviously seen the shift towards the software part of the business model. Do you think those margins could stay in the high 40s permanently or is there any shifts going in that direction still?

Michael Wu

I think this is just the first quarter. We are consolidating the Linkage financial results. I think in the third quarter our gross margin of net revenue excluding the amortization with Linkage merger stands at 52%. I think, probably, going forward, we will see the margin somewhere around the 50s – from 50 to 55.

Scott Sutherland – Wedbush Securities

Okay. And the software piece of that was 46.5% in the business model. Is it going to stay down there? I know it dropped from 61%. You indicated you shifted some of the employees into the client services space. Is that a permanent move?

Michael Wu

I think we are adding more people in the client service team – that’s right – as we are seeking more of those onsite services projects.

Scott Sutherland – Wedbush Securities

When you guys pursue the cable market, are you making an investment and would you consider that market a loss leader right now or is it profitable already?

Steve Zhang

It’s about breakeven at this point. It’s still very small only less than 2 million revenue contribution last quarter. I think at this point our focus is for this business to expand their market share because we think it is still in their very early stages of the cable market consolidation and grabbing more market shares at this point will yield future results for us.

Scott Sutherland – Wedbush Securities

Okay. Lastly what’s the tax rate in your guidance for Q4 and what’s the timeline to get a preferred software vendor status to for the 10% rate?

Steve Zhang

Well, prepared applications for the approval from the tax bureau and we expect we can get the approval from tax in the first quarter of next year.

Scott Sutherland – Wedbush Securities

Okay, great, thank you.

Operator

Our next question comes from the line of Donald Lu with Goldman Sachs. Please proceed.

Donald Lu – Goldman Sachs

Hi, Steve. Good morning.

Steve Zhang

Hi, Donald.

Donald Lu – Goldman Sachs

Yeah, my first question is on the growth outlook maybe for next year. I know it’s too early to give a guidance, but just from your conversation with customers, would you see that they’re spending and also AsiaInfo will continue to grow revenue next year like the same pace as this year or is that going to change?

Steve Zhang

I think, as I mentioned in my answer to Karl’s question, at this point, we are not giving a specific range for next year’s growth rate. But we see there are still a lot of the growth drivers for us. One, there is still – carriers are still experiencing a very healthy mobile number subscriber growth and the competition among the carriers are getting more intense and they are seeking more sophisticated IT system to help them to run their customer service better to differentiate the customer experience.

I think the third one is the new technology, the 3G, that new broadband network are creating a lot of extra services, which will require more IT systems to support. Like the one I mentioned in my last conference call is wireless LAN integration, full integration into the carrier 3G network. This has produced a lot of demand for us to provide authentication authorization for the wireless LAN service.

Going forward, the carriers are looking to integrate all those systems together to provide a customer various moves experience. So I think all those are the business drivers for carriers to continue to invest in the IT sector.

Donald Lu – Goldman Sachs

Yeah, just specifically on the last opportunity you commented on the wireless LAN, is there any – can you give us a little bit quantitative indication of that opportunity, is that going to be like 1 million for province if you do the full upgrade for seamless conversion authentification for let’s say China Mobile?

Steve Zhang

I think – let’s put this way, Donald, I think this year we expand our wireless LAN authentication software into like roughly 15 China Mobile provinces and the probably 15 China Unicom provinces and this is only the first phase.

And going forward, I think the customers are trying to find what’s the best way to fully integrate the wireless LAN related authentication software with the traditional wireless billing, so that they can offer their customers a stimulus and a smooth user experience. And I cannot comment on the size of per province, but those are additional IT requirements popping up during the quick growth of data traffic on their network.

Donald Lu – Goldman Sachs

Sure. Great. And on the cost side, is there any target in terms of the total headcounts for next year and also how should we model the operating margin for next year?

Steve Zhang

Donald, I think at this point as we mentioned, we are still in the early stage of doing next year’s budget. So I cannot give you next year’s headcount. I don’t know the target, but for the fourth quarter, this quarter, we are still trying to add close to 500 people.

Donald Lu – Goldman Sachs

So you’ve got 500 people, okay. And this – those people are mostly in the service side, you mentioned…?

Steve Zhang

Our both product development team as well as service team.

Donald Lu – Goldman Sachs

Okay. Great. And my last question is on your recent win at China Mobile and the also congratulations on that. That’s probably – it’s the most important economy in China – I mean China Mobile Beijing win. Can you give us some detail about your status at China Mobile Beijing; are you now the only dealing suppliers there?

Steve Zhang

Okay. Thanks, Donald, for bringing this issue up. And in Beijing Mobile, we recently announced the contract. We have been chosen by Beijing Mobile to be their convergent billing supplier.

As most of you know that traditionally, Beijing Mobile has been using Amdocs for their billing – as their billing provider. And but Beijing Mobile made a decision last year to migrate part of their prepaid business to our billing platform and the billing platform we put into production last year performed very well. So this year, we were dealing by Beijing Mobile to be the only billing provider going forward.

Now, right now, we are in the process of migrating their users from the traditional billing platform to our new convergent billing platform.

Donald Lu – Goldman Sachs

Right. Thank you, Steve.

Steve Zhang

Thank you, Donald.

Operator

Our next question comes from the line of Carol Wang with Morgan Stanley. Please proceed. Ms. Wang, your line is open. You may proceed with your question.

Steve Zhang

Hey, Carol.

Operator

Our next question comes from the line of Iris Zhang with RBS. Please proceed. Iris Zhang, your line is open.

Steve Zhang

Seems to be some issue with numbers calling in from Hong Kong.

Operator

Our next question comes from the line of Casey Nelson. Please proceed.

Casey Nelson – Alistair Capital Management

Yes. Can you hear me?

Steve Zhang

Yes. Hello, I can’t hear you.

Casey Nelson – Alistair Capital Management

I can, okay. Sorry about that. Our first question was unbilled receivables, do you have that number available?

Michael Wu

Our total accounts receivable at this point at the end of Q3 was 237.7 million.

Casey Nelson – Alistair Capital Management

And how many of them were unbilled receivables?

Michael Wu

50% to 55% were unbilled receivables.

Casey Nelson – Alistair Capital Management

Okay. And deferred revenues were about flat sequentially, which I guess was a little surprising given the acquisition of Linkage, can you speak to that a little bit, please?

Michael Wu

Oh, sure. Deferred revenue, we’ve always had the seasonal impact on deferred revenue quarter-over-quarter. So the quarterly flat to Asian is still there and separately will also experience some of the project delay from China Unicom and China Telecom as Steve mentioned earlier. And we have already reflected that delay of the revenue in the guidance adjustment. So the delay of the project what an revenue adjustment knows will cause decrease obviously for revenue in this quarter.

Casey Nelson – Alistair Capital Management

Okay. I guess, I don’t really understand the seasonal aspect, because it looks like deferred revenue has historically increased from Q2 to Q3 in the last few years?

Steve Zhang

Actually, the sales tends to be – helps volatility. Traditionally, our largest quarter is always the quarter four given that the carriers need to spend their budget. And this year our sales cycle tends to be longer in Q3, because of the company’s renaming and that makes our contract approval – sales contract approval thought process tends to be longer, because we renamed the company. And in carriers, internal IT system, they need to add another round of approval process. That’s also a cause why our cash collection comes in slower than original expectation.

Michael Wu

In terms of seasonality, if you look at historical numbers of the deferred revenue back to the past 10 quarters, you may noted – note, the lower deferred revenue always appeared in the two quarters in the middle year either Q2 or Q3 and say last year and the year ago including the 2008 year – 2008, the Q4 deferred revenue number is much higher than the middle of the quarter Q3 or Q2. So that’s the reason to mention seasonality is still there.

Casey Nelson – Alistair Capital Management

So we should look for a lot more of deferred revenue in the next quarter?

Michael Wu

We expect the new order will be increased. The revenue increased in the fourth quarter.

Casey Nelson – Alistair Capital Management

Okay. Right. And then I know you seldom see that cash collection cycle, but this is the second quarter in a row it’s negative operating cash flow if I’m remembering right and I just wanted to understand if this was going to continue, if this is a new level of DSOs or if we’re going to revert back and get back down to historical levels, so if this is new higher DSO level that we’re going to – that we’ll persist?

Steve Zhang

I think in the going forward in the quarter four, we definitely are pushing more aggressively in our cash collection to reduce our DSO level. And I think going forward; definitely lowering the DSO including cash flow is a very high priority for our management team. And however I think that DSO will be higher compared with the traditional AsiaInfo standalone given that our – we’re seeing more revenue mix from Unicom and Telecom. These 2 accounts tend to have longer DSOs.

Casey Nelson – Alistair Capital Management

Okay. And then last question, if I could, I didn’t quite understand why we couldn’t separate out the historical portion that attributes to AsiaInfo and compare that to AsiaInfo historically, given that contracts were signed presumably before the Linkage deal – all the revenue being recognized is presumably associated with contracts signed before the Linkage deal was done?

Steve Zhang

Your questions were why don’t we have two separate management reporting for – in the quarters three for AsiaInfo and the Linkage?

Casey Nelson – Alistair Capital Management

I was just looking for the peer AsiaInfo historical before the Linkage merger, because we now have a pro forma, but I was looking for AsiaInfo separated out. You mentioned it in your press release.

Steve Zhang

I mean, in Q3, we are already doing the full integration. We are also merging our regional service teams. So going forward, it’s becoming difficult for us to separate AsiaInfo on the Linkage from the organization structure.

Casey Nelson – Alistair Capital Management

Okay. All right. Thank you.

Steve Zhang

Thank you.

Operator

Our next question comes from the line of Iris Zhang with RBS Capital Markets. Please proceed.

Iris Zhang – RBS

Okay. Steve and Michael, congratulations on very good quarter. I’m curious about our integration process. Could you give us some color on the current status as well as our goal in the next few months? Thank you.

Steve Zhang

I think a quarter has passed and it’s the official merger. And in the third quarter, we completed the integration for our sales team and we completed the integration on the financial reporting systems. We completed the integration for our internal HR system. We also have one single unified contract approval process.

I think, going forward, as we as far as the budgeting cycle for next year, we’ll leverage a bit budgeting cycle to do more even more index integration of the traditional AsiaInfo-Linkage will completely move into a fully merged organization structure and we will continue to put all the employees expense reporting system into one single system and to support our cross-selling activities. I think, hopefully, we’ll get all the integration issues behind us by the first half of next year.

Iris Zhang – RBS

Great. And also for the incentive plan, targeting both Linkage and AsiaInfo employees, do we still expect it to be launched by the end of this year?

Steve Zhang

The short-term inventive plan, the bonus plan for this year has been fully integrated into one single sales plan. And that has been announced internally for all of our employees in August. The long-term incentive plan we are still working with our board to get it approved. And hopefully, we can get it down by the end of this quarter.

Iris Zhang – RBS

Thank you.

Steve Zhang

Thank you.

Operator

Our next question comes from the line Mars Cao with UBS. Please proceed.

Mars Cao – UBS

Good morning, Steve, good morning, Michael. I have 2 questions. The first is, nullifying your proxy of Linkage Q4 a strong season for Linkage. So, buy this token, can I assume that the Q4 will be also a strong season going forward? And then the second question is that, you said that you said that you had collectively a weak season Q4 for the security business sector. So what are you outlooks for first – for going forward?

And then the third question is that will you provide a pro forma financials for Linkage and AsiaInfo for the full-year 2009 by this year end? Thank you for taking my questions.

Steve Zhang

Well, what’s your third question? I generally remember all the questions. The other question is whether we’ll provide the pro forma for AsiaInfo-Linkage for 2010 by the end of this year?

Mars Cao – UBS

Yeah, ‘10 to ‘09?

Steve Zhang

‘09, I think, already Linkage as a standalone entity, AsiaInfo as a standalone entity has already been filed with SEC.

Mars Cao – UBS

I just find that the – is that the first three quarters of Linkage standalone?

Steve Zhang

For 2009?

Mars Cao – UBS

Yes.

Steve Zhang

You can talk to our IR people to get the...

Mars Cao – UBS

Okay, okay. Thank you.

Steve Zhang

If you look at the file, the 8-K [ph] reported, we filed on September. It depends; you will find the quarterly potential numbers of AsiaInfo – of Linkage.

Mars Cao – UBS

Okay, okay.

Steve Zhang

Regarding your second question, the security business, yes, the security business in the third quarter has a year-over-year decline. And in the fourth quarter this year, we see – we do see them have sequential quarter-over-quarter growth, but compared with the quarter four 2009, I think the security business is still struggling a little bit, because we don’t have many large government contractors yet.

Mars Cao – UBS

And so what’s your balance for ’11 [ph], the year-over-year growth?

Steve Zhang

We don’t provide the separate revenue growth guidance for different business alliance.

Mars Cao – UBS

Okay. Okay. Thank you. So how about the first question, what’s the outlook for the Q4? Your Q4 seems high, seasonal high in the history, especially for Linkage. So I assume it will be also high season going forward?

Steve Zhang

We already provided the Q4 guidance.

Mars Cao – UBS

Okay.

Steve Zhang

Q4 revenue is $119 million to $123 million.

Mars Cao – UBS

Okay. Thank you.

Operator

Our next question comes from the line of Leping Huang. Please proceed.

Leping Huang – Nomura International

Hello, can you hear me?

Steve Zhang

Yeah, particularly be louder.

Leping Huang – Nomura International

Okay. Hello, can you hear me?

Steve Zhang

Yes.

Leping Huang – Nomura International

Yeah. Thank you to take question. So my question is about this – we congratulate you get this new contract from this Beijing Mobile. But do you see any change of the landscape basically in this set of compatible software market in China? It’s very specified general question, because we see as a (inaudible) we see this company’s service revenues they grow quite high in this quarter. Of course cannot compare directly with the software business, but do you see a competition in this telecom IT software business are changing after the merge with Linkage or do you see more easier for you to get contract nowadays? This is first question.

The second question, can you give me more – give us more color for the next year, what will be the operators’ focus area in your view to this telecom market software spending? Yeah.

Steve Zhang

To answer you first question on in terms of competitive landscape, we didn’t see much change in the third quarter on the competitive landscape. We are still mostly competing against mostly domestic competitors like Huawei, ZTE, as well as Digital China for our telecom software solutions. And I didn’t quite hear your second question.

Leping Huang – Nomura International

The second question is that for the – if we look next year, so what we can – are there any low fee operators, are there any difference of the operators focus area in this IT spending or other words, what is the difference if you look the growth of these 3 operators IT spending?

Steve Zhang

I think all the operators definitely are looking to have more analogical applications to help them to run their marketing fields campaigns more effective. And I think they are also looking for IT systems to support them to run their broadband network more efficiently.

Leping Huang – Nomura International

We know that you don’t like to give guidance for next year about your company, but do you have a rough idea about what would be the industrial growth, I mean, for next year, for the telecom and IT software in China?

Steve Zhang

I don’t think the budget – the carrier has made next year’s budget yet.

Leping Huang – Nomura International

Yeah, okay.

Steve Zhang

Thank you.

Operator

Our next question comes from the line of Eva Leung. Please proceed.

Eva Leung – Deutsche Bank

Hello?

Steve Zhang

Hello. Hi, Eva.

Eva Leung – Deutsche Bank

Hi, Michael. Hi, Steve.

Michael Wu

Hi.

Eva Leung – Deutsche Bank

First question, on the amortization of intangible assets, for your third quarter you have a 10.9 million, what is the breakdown between cost and marketing and sales marketing?

Michael Wu

Again as mentioned, the total amortization of intangible assets related to the Linkage acquired is US$227 million and that include backlog, the core technologies, customer relations trademark, IT R&D. Majority of the total intangible assets coming from the customer relationship was 140 million and trademark 28 million and the existing technologies 37 million. Backlog and (inaudible) take the rest. And that total 227 million will be amortized to over 19 years. A number in the first and second year will be the highest and then slowdown over the next 19 years.

Eva Leung – Deutsche Bank

Okay. So you don’t really give us specific number for between the cost and the marketing?

Steve Zhang

Sorry – can you repeat the question again?

Eva Leung – Deutsche Bank

I just want to get a general or the exact percent of the amortization that goes into third quarter, just in third quarter for cost and marketing?

Steve Zhang

I think roughly half of the – went into cost, half of that amortization went into sales and marketing for third quarter.

Eva Leung – Deutsche Bank

Okay. All right. (inaudible) of the third party hardware, is that going to be in the same trend going forward or it increased quite a bit from second quarter?

Steve Zhang

They increased compared with the second quarter or…?

Eva Leung – Deutsche Bank

The second quarter, I mean should we be expecting a third party hardware to be about the same amount going forward?

Steve Zhang

I don’t want people to focus on the third party hardware amount, because it’s not a management’s focus. We run our business very focused mostly on net revenue and the third party hardware tends to fluctuate. So it will go up and down on a quarterly basis, but it shouldn’t have major impact on our net revenue, we would like all the (inaudible) on the net revenue.

Eva Leung – Deutsche Bank

Okay. Thanks

Steve Zhang

Thank you.

Operator

Our next question comes from the line of Melvin Yang [ph] with Morgan Stanley. Pleas proceed.

Melvin Yang – Morgan Stanley

Hello.

Steve Zhang

Hey, Melvin.

Melvin Yang – Morgan Stanley

Hi. My first question is about project with Unicom and Telecom. Regarding the project in Unicom, if there is a kick off seen in fourth quarter this year, when will we see the revenues in our comps payment?

Steve Zhang

It will be next year.

Melvin Yang – Morgan Stanley

Next year may be first half?

Steve Zhang

It will depend, probably, yes.

Melvin Yang – Morgan Stanley

And how about China Telecom project, (inaudible) 2011 when will be there revenue (inaudible)?

Michael Wu

It will be gradually coming in, because we tend to sign those contracts on a provincial by – province by province basis, so if we – for some of the province, we would sign the contract in the first quarter (inaudible) revenue contribution in the first half, but for some other provinces, we get contract signed in the second half, the revenue for those province will come in the second half.

Melvin Yang – Morgan Stanley

So, how about the delay around this timing of (inaudible) revenue?

Steve Zhang

From the contract signing until we realize the 90% of the revenue, it roughly takes 9 months for us to deliver the revenue to deliver the project.

Melvin Yang – Morgan Stanley

Thank you.

Steve Zhang

Thank you.

Operator

At this time, I would now like to turn the call back over to Mrs. Jane Wang for closing remarks.

Jane Wang

Thank you everyone. If you have any further questions, please contact us. Thank you.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: AsiaInfo-Linkage CEO Discusses Q3 2010 Results - Earnings Call Transcript
This Transcript
All Transcripts