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AsiaInfo Holdings, Inc. (ASIA)

Q4 2006 Earnings Call

January 24, 2007 7:00 pm ET

Executives

Rory Macpherson - Ogilvy Public Relations Worldwide

Steve Zhang - Chief Executive Officer, President, Director

Eileen Chu - Chief Financial Officer, Vice President

Analysts

Chang Qiu - Forun Technology Research

Ben Kedem - Kedem Capital Corporation

Lu Lun - Morningstar

Presentation

Operator

Welcome to the AsiaInfo fourth quarter and full-year 2006 results event call. I am pleased to present Mr. Rory Macpherson. For the first part of this call, all participants will be in listen-only mode. Afterwards, there will be a question-and-answer session. Mr. Macpherson, please begin.

Rory Macpherson

Hello everyone, and welcome to AsiaInfo’s fourth quarter and full-year 2006 conference call. Today, Steve Zhang, President and CEO of AsiaInfo, will review some of AsiaInfo’s business highlights for the most recent quarter, and Eileen Chu, AsiaInfo’s Chief Financial Officer, will provide greater detail on the financial results, as well as guidance for the upcoming quarter. Mr. Zhang will then provide a few closing remarks and open the call to questions.

Before we continue, allow me to read you AsiaInfo’s Safe Harbor statement.

During this conference call, representatives of the company may make forward-looking statements in an effort to assist you in understanding the company and its results. Please refer to AsiaInfo’s reports filed with the SEC for discussion of the important factors that could affect future results.

Also, please take note that all figures mentioned during this conference call are in U.S. dollars.

I will now turn the call over to AsiaInfo’s President and CEO, Steve Zhang.

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Steve Zhang

Hello and thank you for joining us. I am pleased to report that in the fourth quarter, we exceeded our net revenue guidance for the second quarter running and steady growth in our telecom business. Our security products and service business unit also performed well, with net revenue growing 28% over the previous quarter.

During the fourth quarter, we continued to focus on delivering telecom software solutions to China’s telecom carriers, making progress on a number of fronts.

The demand of AsiaInfo’s leading operational assistance and CRM solutions is continuing to rise, as carriers seek to differentiate their services, win customers and improve profitability in an increasingly competitive market.

For example, during the quarter we constructed new business support systems for Hubei and Shanxi Unicom. We also upgraded Beijing Mobile’s operational CRM -- customer relationship management system, to improve their sales and marketing processes.

We are also seeing exciting opportunities to develop billing systems that support new applications and the new business models.

With the expansion of China’s mobile user base and the advent of 3G, we expect operators to roll out new data service offerings in areas such as music download, entertainment, WAP, and the mobile media, and AsiaInfo is in a unique position to benefit from this strength. In fact, during the fourth quarter, we signed an agreement to build a content billing system at China Mobile’s headquarters that will provide higher flexibility in handling data on the value-added services.

In late 2006, we also formed an innovative revenue sharing agreement with China Unicom to launch a range of interactive voice response services. We believe that this has the potential to generate meaningful recurring revenue in the future and we will look to replicate this model with other telecom carriers going forward.

We also signed a new customer in the fourth quarter, signing a break-through contract with Shanxi Netcom to develop their business intelligence system, and we expanded business relations with two China Mobile subsidiaries, Vietnam Mobile and Tibet Mobile. We are now working with 27 of China Mobile’s 31 subsidiaries.

As I mentioned earlier, our security products on the services business continue to build on the growth that we have been seeing in recent quarters. The market for IT security remains a promising proposition for us, and we are confident that with our strong brand recognition and highly qualified management team, this business will continue to expand in the course of 2007.

Before I turn the call to Eileen, I would like to briefly talk about R&D. In China’s rapidly changing telecom environment, innovation is central to building the solutions that meet telecom operators’ needs. At AsiaInfo, we have consistently maintained a strong emphasis on R&D. Aside from developing upgrades to our flagship BOSS and the BI systems, we are also developing initiatives that help to drive revenue growth in the future, such as value-added services and the business management systems.

For example, recently we have been developing a new telecom solution called Business Application Management, or BAM. This system is designed to provide telecom operators with a real-time analysis of key business metrics across the network, including analysis of minutes of usage and revenue flow. We have had success trialing this innovative technology with China Mobile and are hoping to sign contracts in 2007.

Finally, I am pleased to welcome Eileen Chu, our new Chief Financial Officer, who will review the quarter’s financial highlights.

Eileen Chu

Thank you, Steve. Good morning. Rather than repeating all of the numbers in our press release, I will provide some additional information on key reserves for the quarter. I will also discuss guidance for the first quarter.

Fourth quarter telecom software products and solution revenues rose 41% year over year and 9% sequentially, as telecom operators invested in BOSS and BI system upgrades to increase their competitiveness.

Our telecom service revenues decreased 13% sequentially, primarily due to a large contract with China Unicom that was recognized in the third quarter of 2006.

Total net revenue for the telecom business increased 32% year over year and 5% sequentially.

Lenovo-AsiaInfo’s net revenues increased 876% year over year and 28% sequentially. The year-over-year increase was primarily due to significantly lower-than-expected shipment volume for the business unit in the year-ago period. The sequential increase reflected strong sales efforts during the quarter.

Gross margin for Lenovo-AsiaInfo also increased from 45% in the third quarter to 52% in the fourth quarter, as revenue growth outpaced the growth in costs. Gross margins for the group decreased 1% sequentially, primarily due to greater third-party hardware [passed through] in the fourth quarter.

Total group operating expenses for the quarter were down 64% year over year, but rose 11% sequentially. As we noted in the release, the year-over-year decrease was primarily due to $21.2 million non-cash charge for impairment of good will and acquired intangible assets related to the Lenovo-AsiaInfo business unit in the year-ago period.

Sales and marketing expenses increased 22% year over year and 16% sequentially. The sequential increase was in line with the increased sales and marketing activities during the fourth quarter of 2006.

Group G&A expenses increased 31% sequentially, primarily due to changes in the provision for [inaudible].

Group R&D expenses were marginally lower both year over year and sequentially.

During the quarter, our telecom business posted a contribution profit before corporate G&A expenses of $3.5 million. Lenovo-AsiaInfo posted a contribution loss before corporate G&A expenses of $0.1 million.

As you have seen in the press release, we will be providing non-GAAP figures going forward to help investors compare reporting periods on an apples-to-apples basis. Non-GAAP net income and EPS measures exclude certain non-cash expenses, including share-based compensation expenses, amortization expenses of acquired intangible assets, and impairment of good will and acquired intangible assets.

You can find a reconciliation table and a more detailed discussion of non-GAAP measures in our press release.

Non-GAAP net income was $3.1 million in the fourth quarter of 2006, or $0.07 per basic share. Non-GAAP net loss in the year-ago period was $18.3 million, or $0.40 per basic share. Non-GAAP net income in the previous quarter was $2.7 million, or $0.06 per basic share.

Operating cash flow for the quarter was $27.6 million, reflecting strong year-end collection efforts.

Moving to our balance sheet, our total cash and cash equivalents plus short-term investments increased sequentially about $30.9 million to $150.5 million, reflecting the large positive cash flow during the quarter.

Both notes receivable and accounts receivable decreased sequentially due to the enhanced collection efforts. DSO for the quarter was 120 days versus last quarter’s 147 days.

Looking at the fiscal year 2006, net revenue was $86.7 million, a 16% increase year over year, mainly reflecting the continued growth in the telecom business and improvement in the Lenovo-AsiaInfo business. Lenovo-AsiaInfo contributed 10% to total net revenue during the year.

Full-year 2006 revenue from telecom software products and solutions grew by 32% compared to 2005, leading to an 18% increase in telecom net revenue for the year.

Gross revenue for the full year 2006 increased by 21% compared to 2005, mainly due to increases in telecom software products and solution revenues and third-party hardware revenues.

2006 full-year gross margin was comparable to 2005.

Operating income for 2006 was $1.9 million compared to an operating loss of $27.1 million in 2005. The operating loss in 2005 was again primarily due to the large non-cash impairment charge incurred in the fourth quarter of 2005 relating to the Lenovo-AsiaInfo business unit during the same period.

Net income for 2006 was $5.8 million, or $0.13 per basic share. Non-GAAP net income was $8.1 million for the full year 2006, or $0.19 per basic share. Non-GAAP net loss in 2005 was $14.4 million, or $0.32 per basic share.

AsiaInfo’s full year net operating cash flow was $35.8 million, driven by strong year-end collection efforts.

I will now read you AsiaInfo’s financial guidance for the first quarter 2007. Please note that the following outlook statements are based on our current expectations. These statements are forward-looking and actual results may differ materially.

Revenue net of hardware [passed through] in the first quarter of 2007 are expected to be $23 million to $24 million, representing 22% to 28% year-over-year growth.

We expect first quarter earnings per basic share from continuing operations to be $0.03 to $0.04. This is compared to earnings per basic share of $0.01 in the first quarter of 2006.

We anticipate that the Lenovo-AsiaInfo business unit will make a loss of $0.6 million to $0.8 million lost in the first quarter due to seasonality in the business relating to the long Chinese New Year holiday.

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

Steve Zhang

Thank you, Eileen. The fourth quarter of 2006 gave good indications of the direction of telecom spending in the coming quarters. We are seeing a trend towards increasing budgets for traditional operation systems, expansions and enhancements, as well as for innovative billing, CRM, and we have solutions to meet the changing nature of telecom. With our expertise and the focus of our core business line, we are confident that we are well-positioned to benefit from this change.

Thank you for your continued support of AsiaInfo. I will now open the call to questions.

Question-and-Answer Session

Operator

(Operator)

Our first question is from Chang Qiu of Forun Technology Research. Please go ahead.

Chang Qiu - Forun Technology Research

Good morning, Steve and Eileen. Steve, it looks like you had a good recovery in the Lenovo-AsiaInfo business. As you mentioned, there is some seasonality in the first quarter. Going forward, can you give us some idea when you will achieve break-even for that business?

Steve Zhang

We expect to achieve operational results break-even in quarter two or quarter three of this year. We are striving to get to the break-even point in the second quarter.

Chang Qiu - Forun Technology Research

I see. Okay, and also, you mentioned you have business with 27 of the provincial China Mobile subsidiaries out of 31. For that 27, you have all BOSS or BI? Could you maybe breakdown how many of those you have BOSS business, how many you have CRM or BI business?

Steve Zhang

We have about nine-and-a-half provinces we are providing BOSS and the billings. We have 15 provinces where we are providing the BI solution. There is some overlap for this nine and 15, but we also provide other solutions to other provincial subsidiaries, like our Short Messaging Gateway, or BOSS network management systems.

Chang Qiu - Forun Technology Research

Do you expect any -- for example, for the BOSS system, do you expect any adoption by other provincial carriers here?

Steve Zhang

We are working on that. In the year 2006, we increased our market share for our business intelligence, BI, solutions. We increased the market share by two provincial subsidiaries, and we will work very hard to see whether we can grow our BOSS solutions in 2007.

Chang Qiu - Forun Technology Research

You also mentioned that your real-time, the new software, the real-time monitoring for the operation metrics. You mentioned you may win some newer contracts in ’07. Is that basically with China Mobile or also with the other telecom carriers here?

Steve Zhang

Because China Mobile’s IT support systems build-up is well ahead of other operators, and so this new advanced, real-time analysis system, we’ve seen that we most likely will see the first deployment in China Mobile. The deployment at the other operators won’t happen until maybe 2008.

Chang Qiu - Forun Technology Research

I see. So for this new tool, what’s the timing for China Mobile implementation? What is your guess of the size of the implementation?

Steve Zhang

I cannot really give you a very precise timing for the deployment. I think most likely quarter three of 2007, because right now we are doing the trials in the headquarters and they are going to have their planning meeting session in March. So if we are lucky, we hopefully sign the contract in the second quarter and start deployment in the third quarter.

Chang Qiu - Forun Technology Research

All right.

Steve Zhang

It takes some time for them to approve the solution and make sure all the provincial subsidiaries are starting to plan for this.

Chang Qiu - Forun Technology Research

Okay. Thank you.

Operator

Our next question is from Ben Kedem from Kedem Capital Corporation. Please go ahead.

Ben Kedem - Kedem Capital Corporation

During the quarter, you announced many contracts with all the major Chinese telecom companies. Can you tell us when these contracts are going to make meaningful contributions to your numbers?

Steve Zhang

I think they will start making contributions in the year 2007. Normally when we sign the contracts, it takes us nine months to deliver the full contract.

Ben Kedem - Kedem Capital Corporation

I see. So it will take approximately nine months until we will see contributions?

Steve Zhang

No, it will take us nine months to deliver 90% of the contract. Basically, over the nine months, here we base it on our revenue recognition policy. We will recognize part of the contract as revenue. Normally when we sign the contracts, it takes nine months for us to get the customer to sign the preliminary acceptance test, pass the preliminary acceptance test. That’s the milestone when we need to recognize about 90% of the contract value.

Ben Kedem - Kedem Capital Corporation

I see, but the contribution should start almost right away when you announce the contract?

Steve Zhang

No, when we start delivering. For example, we may need to install our software, and also when we have a project team that starts working on those projects, we’ll recognize the revenue based on a policy that is in line with project progress.

Ben Kedem - Kedem Capital Corporation

I see. So it’s a build-up situation.

Steve Zhang

Yes.

Eileen Chu

Basically, we’re using a contract accounting method to recognize our revenue.

Ben Kedem - Kedem Capital Corporation

I couldn’t hear you. Could you repeat it, please?

Eileen Chu

Basically, we are using a contract accounting method to recognize our revenue.

Ben Kedem - Kedem Capital Corporation

I see. Now, another question, do you work only with Chinese telecom companies, or do you also work with international telecom companies?

Steve Zhang

At this stage, we are working only with Chinese telecom operators.

Ben Kedem - Kedem Capital Corporation

I see. Is there a reason for that?

Steve Zhang

Well, I think one of the reasons is that the domestic market is growing very rapidly. We right now do not have enough resources to go overseas. Also, I think the international expansion needs a lot of resources and we are still evaluating that approach.

Ben Kedem - Kedem Capital Corporation

One of the other things that I would like, are you listed in China or not?

Steve Zhang

Pardon? I didn’t hear your question.

Ben Kedem - Kedem Capital Corporation

The question is, is your stock also listed on any of the Chinese stock exchanges, or is it only on the NASDAQ?

Steve Zhang

Only on the NASDAQ.

Ben Kedem - Kedem Capital Corporation

Okay. Thank you very much.

Operator

Our next question is from Lu Lun at Morningstar. Please go ahead.

Lu Lun - Morningstar

Good morning, Steve and Eileen. Congratulations on your strong performance in 2006. My first question is, could you update any market share for these four telecom carriers, sort of updates on the numbers?

Steve Zhang

Do you mean our market share?

Lu Lun - Morningstar

Yes.

Steve Zhang

We increased our market share in China Mobile by two provincial subsidiaries for our BI solutions in 2006. Now we are serving 15 subsidiaries of China Mobile to deploy our business intelligence solutions. For our billing and the BOSS solution, we have about nine-and-a-half provinces. We also have eight provinces where we deliver call center solutions.

For China Netcom in 2006, we also increased our market share for our business intelligence solutions. We got a new contract last quarter to support Shanxi Netcom.

For China Unicom, I think we’ll see some good growth going into 2007. We secured a contract to provide [Tianjin] Unicom the [RP] access solutions.

In China Telecom, which is our smallest unit, in 2006 we also made a breakthrough. We got into the [Tianjin] telecom to provide a key component to their BSS solutions. We also got onto the shortlist in China Telecom headquarter to provide their future 3G billing system. We didn’t announce that yet because it is not a contract. It’s only -- five vendors are chosen to be on their provider shortlist.

Lu Lun - Morningstar

All right, so China Mobile is still the largest customer of your company?

Steve Zhang

Yes, that’s correct.

Lu Lun - Morningstar

Do you have the breakdown for the revenue for these four companies? How much of the revenue is generated from China Mobile and the other three telecom companies?

Eileen Chu

Actually, we don’t provide the numbers at this stage. We will have more detailed percentage breakdowns in our annual report.

Lu Lun - Morningstar

All right. When can we expect the annual report will be available?

Eileen Chu

That will be before March 15th.

Lu Lun - Morningstar

Okay. Thank you. My second question, who are the main competitors in China, from both domestic and international firms?

Steve Zhang

The major competitors that we see are still the local companies, like Linkage and Digital China. We see very rare local players.

Lu Lun - Morningstar

Okay, I’ll pass this question then. The third question is as a service provider, do you see any contracts related to the 3G project?

Steve Zhang

I did not hear your question. Could you repeat it?

Lu Lun - Morningstar

As a service providers, do you see any service related to the coming 3G project?

Steve Zhang

Actually, we made a news release in November or December. We signed a large contract with China Mobile to provide their comp and billing system.

Lu Lun - Morningstar

Okay, so now you do see that 3G is going on in China, right?

Steve Zhang

Yes, I think even though basically everybody knows, even though the 3G license is an issue, and China Mobile, China Telecom, they are going ahead to build a trial system.

Lu Lun - Morningstar

Do you have any idea or color of how big it will be for year 2007? I mean for the service section.

Steve Zhang

You mean how big the telecom carriers will spend on 3G?

Lu Lun - Morningstar

Yes.

Steve Zhang

Well, we hear a lot of numbers, but those numbers, we don’t know whether it has any -- I think most likely, it’s going to be about $1 million for China Mobile.

Lu Lun - Morningstar

Do you have any other numbers for the other three?

Steve Zhang

No, the other three, I mean, officially they don’t have 3G licenses.

Lu Lun - Morningstar

Yes, okay. All right, my last question is, do you see the increase in cap-ex in the following years accompanying the increased sales at AsiaInfo? The cap-ex, capital expenditures?

Steve Zhang

Do you mean our cap-ex or telecom’s cap-ex?

Lu Lun - Morningstar

No, your company’s cap-ex.

Steve Zhang

We don’t see any major cap-ex going forward.

Lu Lun - Morningstar

Okay, I remember it’s about 1.22, mainly for 2005. Do you have the number for 2006?

Eileen Chu

Do you mean on the -- as a fixed asset?

Lu Lun - Morningstar

No, I mean your cap-ex number in 2006.

Eileen Chu

Actually, it’s not very -- I think it’s about $1 million, most likely lower than $1 million.

Lu Lun - Morningstar

Do you think this number will continue to stay at this level going forward?

Eileen Chu

It should be approximately the same.

Lu Lun - Morningstar

Okay. Thank you. That’s all of my questions. Thank you again.

Operator

Our next question is from Chang Qiu from Forun Technology Research. Please go ahead.

Chang Qiu - Forun Technology Research

Good morning again. Steve, could you give us some clarification regarding your revenue sharing deal with China Unicom? Do you maybe also see any of that kind of a deal with other operators?

Steve Zhang

First of all, we signed this agreement with China Unicom last August. Basically, China Unicom is building a platform to support their wireless base of value-added services. We provided the software, basic software and services to them and we will collect a percentage of the value-added services generated by this platform.

Chang Qiu - Forun Technology Research

That’s all over China Unicom’s network, or just some provincial networks?

Steve Zhang

It’s for all China Unicom.

Chang Qiu - Forun Technology Research

I see. Do you see any other telecom operators will may be also using this model?

Steve Zhang

I think China Mobile already has their own platform. Starting from this year, we’ll work to see whether we can break into China Netcom and China Telecom. I mean, this is a model where we think is very promising in the future, because the revenue nature is recurring. Also, it’s growing very nicely month over month.

Chang Qiu - Forun Technology Research

So far in ’06, do you have any revenue from this revenue sharing deal?

Steve Zhang

Yes, in 2006, I think we recognized about RMB 3 million, if I remember correctly.

Chang Qiu - Forun Technology Research

Eileen, one question for you. What is the cash flow from operations for ’06?

Eileen Chu

For 2006 for the year? For the whole year?

Chang Qiu - Forun Technology Research

Right.

Eileen Chu

Operating cash flow is $35.8 million for the whole year.

Chang Qiu - Forun Technology Research

Okay. Thank you.

Operator

(Operator Instructions)

As there are no further questions, we will now begin closing comments. Please go ahead, Mr. Macpherson.

Steve Zhang

Thank you for joining us today. If you have any further questions, please do not hesitate to contact myself, Eileen, or any of our investor relations representatives. Bye-bye.

Operator

This concludes our conference call. Thank you all for attending.

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China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy.

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