Charm Communications Inc.
Q1 2011 Earnings Call
April 28, 2011 8:00 AM ET
Nicholas Manganaro – Ogilvy Financial
He Dang – Chairman and CEO
Wei Zhou – CFO
James Marsh – Piper Jaffray
Nan Lee – SIG
Hello and thank you for standing by for Charm Communications Earnings Conference Call. At this time all participants are in a 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, Mr. Nicholas Manganaro from Ogilvy Financial.
Hello everyone and welcome to Charm Communications earnings conference call for the first fiscal quarter which ended March 31, 2011. 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 a financial overview and guidance for the first 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 law. 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 US GAAP financial measures and information reconciling these non-GAAP financial measures, the Charm’s financial results prepared in accordance with U.S. GAAP are included in Charm’s earnings release, which has been posted on the company’s IR website at ir.charmgroup.cn.
As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on Charm’s Investor Relations website.
I will now turn the call over to Charm Communications Founder, Chairman and CEO, Mr. Dang.
Hello, and welcome to our first quarter 2011 earnings conference call. We’re pleased to announce that we had a good start to 2011. We delivered solid growth in the first quarter of the year in both our top and bottom line guidance. Against the positive macro industry backdrop and strong demand for integrated advertising services, we continued to build scale this quarter, further expanding our market share and solidifying our position as a leading advertising agency in China. We also made good headwind in our digital media business, Charm Interactive, as we ramped up our service capability and added a number of high profile clients.
In the first quarter, we once again saw a positive growth trends in the advertising market and continued to see strong spending by clients across media platforms. While traditional forms of media such as television still enjoy market dominance for advertisers, new media, particularly the internet are commanding more and more advertising dollars. In line with this industry trends, we’ve strategically positioned ourselves to continue to enhance our traditional advertising businesses as well as increasingly build out our new media platform. All-in-all, we expect a robust advertising market for 2011 with total advertising spending in China to increase 15% this year, driven by China’s continuous rapid economic development, the formation of mega cities and the increase in overall consumption and large metro policies as well as in second and third tier city.
In addition, in March of this year, we were once again awarded the title of CCTV’s top advertising agency for 2010, based on the total amount of advertising spending placed on behalf of clients on CCTV which is China’s biggest television network. This leadership position is important and it gives us a strategic advantage to enlarge national brand. And those brands with aspirations are becoming national brands. What I’m more pleased with is that we have been able to leverage this leadership position and our strong Blue Chip Client base to transform Charm into an integrated agency with a diversified media platform with only 37% of total revenues in the first quarter are attributed to CCTV related media. We are keen to further strengthen our integrated media offerings through deepening cooperation with our strategic partner, Aegis Media and with continued investments in our staff and infrastructure.
In terms of China’s advertising market, Charm continued to capture higher market share in the first quarter of 2011 by outgrowing the market as measured by gross billings. Our total customer advertising spending placed through or with Charm increased 40% year-over-year to $198 million in the first quarter of 2011. As such, we’re satisfied with the progress we’ve made across our business.
Moving on to highlights of our operations, we continued to execute on our strategy in the first quarter, winning new clients and expanding our business with existing clients.
For Charm advertising we saw robust billings growth of 34% in our agency business, driven by strong demand for television advertising. This translated into increased spending by existing customers as well as the addition of a number of new major clients including Baidu, Huayi Brothers, Yunnan Baiyao (ph) Pharmaceutical. Altogether, in another way seasonally weak first quarter, we added five new advertising client accounts, which significantly enhanced our market position and brand value.
One area I would particularly like to highlight is the significant progress we have made in the non-CCTV television media planning and buying platform. We have Baidu to broadcast its Chinese New Year Greetings simultaneously on 14 provisional satellite and local terrestrial channels during the Chinese holiday season in January and February.
We helped China pose life insurance to complement its national brand campaign on CCTV with four regional campaigns on Sitiawan, Tainjin, Xian Xi and Shangxi satellite channels. We have (inaudible) pharmaceutical to penetrate the North Eastern China region with the targeted regional campaign on satellite and local terrestrial in all three provinces in North Eastern China.
We’ve made great strides in our digital media agency business, Charm Interactive, expanding our digital marketing capabilities and growing our client portfolio. We recently had a significant win for Charm Interactive, where we were awarded the digital marketing business for 2011 for high sense group, a multibillion dollar leading home appliance, telecommunications, and IT manufacturer in China.
We are also particularly focused on expanding our digital marketing capabilities especially with the development of the online video segment as we are seeing an influx of advertisers coming on to the internet through this medium. We have established a close working relationship with Youku and we feel well positioned to leverage our leadership position in television advertising in our large Blue Chip client base to capture the growth in this new segment. Another key area where we have made progress has been our search business, where we helped nine brands with their search campaign on Baidu and Google, including the travel website tunio.com, Weston Derry (ph) and online payment agent China PNR.
Our joint venture with Aegis Media, building in China also had a significant win with the Orion food account, which is the popular snack food manufacturer.
Shangxing media also delivered solid performance this quarter led by strong ratings by Tainjin and Shanghai Dragon satellite channels, which ranked 6th and 7th respectively in terms of rating ranking for all satellite channels.
For new media resources, we continued to be in a ramp up base with Hubei Provincial Economic TV, expanding our sales operations and building up the local sales team. We’re making good progress on this front and expect results from Hubei to improve throughout the course of the year and for margins to normalize. We also received a very positive response for the new Beijing Gehua Digital Cable TV advertising platform from our advertisers. But, the sales are already making a positive contribution to our bottom line.
One key focus for Shangxing Media has been helping advertising to take advantage of the branded content and soft advertising opportunities available on our channels. And we ran five such brand TV programs sponsorships in the first quarter. One major campaign is Wahaha sponsorship of a Happy Family Show on Tainjin satellite channel. Another major campaign is BBK sponsorship of the popular job interview show, It Has Be You, also in Tainjin. We’re seeing stronger demands from advertisers for these types of brand sponsorship opportunities and we’ll make it a strategic focus under Shangxing Media to work with both the TV networks and the advertisers to expand our capability in this area.
Looking into the rest of 2011, we expect the overall advertising market will remain robust as domestic consumption especially from second and third tier cities continues to grow. However, we are seeing rising media prices across the industry, which is making advertisers more cautious with their spending. We see this as a positive trend for Charm as company is seeking more accurately targeted advertisements with greater return, more and more advertisers will be turning to professional and integrated agencies like Charm for advice.
Finally, while our more traditional agency business will continue to provide us with stable revenue growth, we look forward to increasingly diversify out of our CCTV business and into satellite and local television, search online video and display advertising. This will allow us to agenda a higher level of customer stickiness as we continue to grow with our clients, offering them an increasingly integrated and comprehensive service platform that ultimately capitalizes on new pockets of growth, while helping us to expand our market share to become a leading integrated advertising and media group in China.
I will now hand the call over to Wei Zhou, our CFO to discuss our operational and financial progress.
Thank you, Chairman Dang. Hello, everyone. Before I go to the financials I’d like to take you through our three core business segments to give you some updates on our progress. Please note that in this section, I’ll be referencing some of our first quarter results using non-GAAP numbers in order to better convey our performance. We define non-GAAP turnover as the total customer advertising spending placed through or with Charm to reflect the scale of our business.
In this past quarter, we continued to outgrow the market from a total billing, that’s better by total billings and gain additional market share. In the first quarter of 2011, turnover grew 40% year-over-year to approximately $198 million. The year-over-year increase in turnover was mainly due to the increase in the number of advertising clients and the increase in advertising spending from existing clients.
I’ll break down by business. The non-GAAP turnover for the advertising agency business grew (Audio Gap) decrease 5% quarter-over-quarter a 144 million. The year-over-year increase in advertising agency business or agency business was mainly due to the increase in number of new agency clients and the increase in advertising spending from existing agency clients. The quarter-over-quarter decrease in turnover was mainly due to reduced placement demands from clients as a result of seasonality in first quarter.
In the first quarter of 2011, we provided advertising agency services to a 140 advertising client accounts, five of which were acquired in the first quarter of 2011. The most significant client win that Mr. Dang mentioned in the first quarter were Baidu, Huayi Brothers and High Sense (ph).
The revenue extraction rate which is defined as revenue divided by turnover for the agency business was 4.9% in the first quarter. Although, we expect revenue extraction rate to increase as company expands its full offerings across media platforms under Charm advertising and ramp up our digital media offering under Charm Interactive, one potential change affecting the overall industry is that CCTV lowered its commission structure in the past quarter reducing to rebate structure to agencies. We do not feel that this change in the commission structure would have a substantial impact on our agency business. But, we do anticipate that our marginal affect or agency revenue. Anticipating this possibility and in line with our long term strategy, we’ve already begun to diversify our agency business away from CCTV into satellite, regional television, online videos, search display advertising on the internet. And we’ll continue to do so throughout the course of the year and going forward.
The turnover for our media investment management business or principal media business which operates under the Shangxing media brand grew 51% year-over-year and 15.3% quarter-over-quarter to $54 million. Compared with our first quarter of 2010, the increase was mainly due to the increase in satellite TV revenue as well as the addition of Hubei Provincial Economic TV. Compared with the fourth quarter of 2010, the increase was mainly due to the addition of Hubei Provincial Economic TV. The first quarter of 2011, we added, we had 325 advertisers for our principal media business, compared with 206 advertisers for the first quarter of 2010.
Now going back to the GAAP figures, our U.S. GAAP revenue was $62.3 million for the first quarter of 2011 representing an increase of 48.4% compared to $42 million in the first quarter of 2010 and an increase of 9.8% compared to $56.7 million in the fourth quarter of 2010.
Revenue for our advertising agency business was $7.1 million for the first quarter of 2011, representing an increase of 34.1% compared to $5.3 million in the first quarter of 2010 and a decrease of 8% compared to $7.8 million in the fourth quarter of 2010. Principal media revenue was $54 million in the first quarter of 2011, representing an increase of 51% compared to $35.8 million for the first quarter 2010. And an increase of 15.3% compared to $46.9 million for the fourth quarter of 2010.
The year-over-year increase in both the agency and the principal media business revenues are consistent with the increase in turnover, while the quarter-over-quarter decrease in agency business was largely due to stronger demand from clients in the fourth quarter due to seasonal factors.
Brand and identity service revenues were $1.1 million for the first quarter of 2011, representing an increase of 27.7 % compared to $900,000 in the first quarter of 2010 and a decrease of 46.6% compared to $2.1 million in the fourth quarter of 2010. The decrease in brand and identity services revenues were mainly, compared with the fourth quarter of 2010 were mainly due to less client demands for creative services in the first quarter.
Cost of revenues for the first quarter of 2011 was $47.4 million compared to $29.5 million in the first quarter 2010 and $34.6 million in the fourth quarter of 2010 respectively. We mainly attribute to the increase in the cost of revenues to the addition of Hubei Provincial Economic TV and an increase in media cost for the renewed resources.
Gross profit for the first quarter of 2011 was $14.8 million, representing an increase of 19.3% from $12.4 million in the first quarter of 2010 and a decrease of 32.9% from $22.1 million for the fourth quarter of 2010. Gross margins for the first quarter of 2011 were 23.8% compared to 29.7% in the first quarter of 2010 and 39% for the fourth quarter of 2010. The sequential decrease in gross profit and gross margin are mainly due to the – the sequential decrease in gross margin was mainly due to the addition of Hubei Economic TV which commenced operation in 2011 and still is in its ramp up phase. Nonetheless, the margin compression is within our expectation and we expect margins to normalize through the course of the year. Furthermore, if we exclude Hubei Provincial Economic TV from the principal media business, the gross would have been 32.5% for the first quarter 2011.
Selling and marketing expenses were $5 million for the first quarter of 2011, representing an increase of 18.8% from $4.2 million in the first quarter of 2010 and a decrease of 8.7% from the $5.5 million in the fourth quarter of 2010. The increase in selling and marketing expenses compared with the first quarter 2010 was primarily due to increase in headcount at Charm Interactive. Selling and marketing expenses represented 8% of the company’s total revenues for the first quarter of 2011 compared to 10.1% for the first quarter of 2010, and 9.7% for the fourth quarter of 2010.
General and administrative expenses were $1.8 million for the first quarter of 2011 compared to $1 million for the first quarter of 2010 and $2.5 million for the fourth quarter of 2010. The 73% year-over-year increase in general and administrative expenses was mainly due to greater professional expenses which we incurred by the Company after the company became publicly listed. The 28.7% sequential decrease was primarily due to higher professional expenses incurred in the fourth quarter of 2010.
As a result of the above operating profit was $8.1 million for the first quarter of 2011 compared to $7.2 million for the first quarter 2010 and $14.1 million for fourth quarter of 2010. We have solid growth in net income exceeding guidance of – we have solid in our non-GAAP net income exceeding guidance of $8.25 to $8.75 million. Our first quarter non-GAAP net income which includes share-based compensation expenses and impairments on investments was $8.9 million compared to $7.4 million in the first quarter of 2010 and $14.5 million in the fourth quarter of 2010. GAAP net income was $8.2 million for the first quarter of 2011 representing an increase of 20% from $6.8 million in the first quarter of 2010 and a decrease of 33% from $12.2 million for the fourth quarter of 2010.
Fully diluted net income for EPS for the first quarter 2011 was $0.19 compared to $0.18 and $0.29 for the first quarter of 2010 and fourth quarter of 2010 respectively.
Cash flow from operations for the first quarter of 2011 was positive. And as of March 31, 2011 we had cash and cash equivalents of $130.5 million compared to $123.3 million at the end of the fourth quarter of 2010. Also as of March 31, 2011, we have 560 employees, compared to 525 employees as of December 31, 2010.
And now, we turn to our business outlook. We estimate our total revenues for the second quarter of 2011 will range from $66 million to $67.5 million. Second quarter 2011 non-GAAP net income which excludes share-based compensation expenses and impairment on investments is expected to be between $11.25 million to $11.75 million. We base these estimates on a foreign exchange rate of 6.58 RNB per US$1. This forecast reflects our current and preliminary view which is subject to change. Thank you for attention. I will now hand the call over to operator.
Thank you for your attention, I will now hand the call over to Nick from Ogilvy.
Thank you, for your attention. We’ll now hand the call over to the operator who will open the line for questions.
(Operator Instructions) And your first question comes from the line of James Marsh with Piper Jaffray. Please proceed.
James Marsh – Piper Jaffray
Yes, thank you. During Jim and Dang’s prepared remarks you discussed building up a new media platform. And obviously, that’s a big opportunity for the company. But, what I was really interested in how you plan to get there? Is this something that you think you can due to organic growth alone or do you really need to do acquisitions here? And if you’re going to do acquisitions, should we expect those to be relatively small or would you consider something more material? Just related to that, I’m assuming that you would do some acquisitions, help me understand what the key characteristics that you guys would be looking for to find deals that make sense for you?
James, thank you very much for the question. Let me translate that from Mr. Dang, and then he and I will specifically go over the questions together.
James, I think for this, in terms of our looking at our long term plans for digital business, I think what we hope to achieve is that we currently have already build up a very strong team at Charm Interactive. And what their focus is, is basically on a providing a fully integrated digital campaign. And then what we hope to achieve at Charm Interactive is actually having them to basically prepare, have the capability to provide, or we call it integrated digital campaign, especially aimed at our Charm client which are currently fits in Charm advertising. But within sort of digital advertising network, we’re seeing is that there are three areas of particular faster growth. First is online video, second is search, and third is our social network marketing. With respect to video, we hope to grow that business organically by leveraging our expertise within television in particular with a lot of the traditional television advertisers. In that, we have already started working with all of the top sort of meeting online videos sites in China, and that includes Youko, Tudou, (Sohu) as well as our TV. I think within here, what we hope to do is actually build this business organically again leveraging on our existing client base. So some of the other areas, where we probably consider either through partnerships or joint-venture or in search certain situations working with our strategic investor Aegis Media.
And then, in terms of the characteristics of what you are talking about the terms of, what we are looking forward in doing these deals, I think we have to value sort of what we deal as well as what sort of the capability especially in terms of technology that we need and in particular I think should add that’s extremely interesting for us is actually in search. What we found sort of, in the first quarter as Mr. Dang mentioned on the call, we have around 9 brands that we helped with the search marketing through Baidu and Google here. And so here I think what we are looking to do is actually enhance our own sort of technical expertise. And that could be potentially through, as I mentioned partnerships or acquisition. I think long term wise, I think we are very keen on growing this business but I think a lot of skills that we do not had internally we hope to build that externally.
James Marsh – Piper Jaffray
Okay. It’s extremely helpful. Thank you very much.
And your next question comes from the line of (Nan Lee) with SIG. Please proceed.
Nan Lee – SIG
Good evening everyone. Thank you for taking my question. I have a question about the, well I heard there is a regulation number 67 that has reduced to add inventories on TV station. So, I’m just wondering if that’s going to impact the TV and budget from your customers.
Thank you Nan. I think on that, I think it’s article 67 or 61 that came out, I think at the beginning of 2010. And that basically said that on from a television advertising perspective, it can take no more than 20% per hour can be used for advertising and then that number reduced to 15% during primetime. And it also sort of changed the classification of television infomercials from TV programming to count as advertising. And I think that impact us flow through television, already in 2010 where we see a reduction in terms of inventory. In terms of how that has impacted our business, I think that sort of the channel that was running a lot of the sort of against that regulation initially are sort of the lot in the lower linked channels. So, in terms of our business having really reduced sort of the inventory for the assets that we currently manage or Shanghai Tainjin who does lot of CCTV, but what it has had an impact on is the overall television pricing environment. In that, it actually has helped to increase prices for television advertising. I think as a result of that what we are seeing right now is that some of the advertisers within certain industries are being priced out of television, but if not, they’re not really reducing their TV budget but what they’re looking for is actually more targeted on advertising on specific TV channels. And what we are trying to capitalize here is basically the availability or the popularity of the online video which has sometime similar targeted effects as a lot of sort of the regional on television channels.
Nan Lee – SIG
Thank you. That’s very helpful. And also you mentioned about just a follow up question on the price increase. I think you mentioned in the preparation remarks, you see the TV average increased that might impact the customers’ budget. I’m just wondering, how much do you see the TV budget, sorry, the TV had been increased?
I think in terms of pricing trend within a television, I think it kind we’re kind of very committed there on from CCTV to sort of that satellite for the commercials. I think the CCTV, what we saw as a result of the November auction last year it was around anywhere averaged about 10% to 15% increase. And then that increase is little bit higher for a lot of prime satellite channels, we’re sort of the leading channels who have been able to raise the prices, anywhere between 15% to 20% in some situation they really sort after resources on the satellite channels got up over 25%. But I think all-in-all, we probably see around 15% increase on average for television advertising.
Nan Lee – SIG
(Operator Instructions). And at this time, there are no further questions in queue. And now I would like to turn the call back over Mr. Nicholas Manganaro for closing remark.
Thank you for joining the call. This concludes our earnings conference. Thank you.
Thank you for joining today’s conference. This concludes the presentation. You may now disconnect. Good day.