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Charm Communications Inc. (NASDAQ:CHRM)

Q2 2011 Earnings Call

July 28, 2011 8:00 am ET

Executives

Nicholas Manganaro – Ogilvy Financial

He Dang – Chairman and Chief Executive Officer

Wei Zhou – Chief Financial Officer

Analysts

James Marsh – Piper Jaffray

Nan Lee – SIG

Operator

Hello and thank you for standing by for the Charm Communications Earnings Conference Call. At this time, all participants are in listen-only mode. After management’s prepared remarks, there will be a question-and-answer session. Today’s conference is being recorded. If you have any objections you may disconnect at this time.

I would now like to turn the meeting over to your host for today’s conference, Mr. Nicholas Manganaro from Ogilvy Financial.

Nicholas Manganaro

Hello everyone and welcome to Charm Communications earnings conference call for the second fiscal quarter, which ended June 30, 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, Mr. Wei Zhou, who will provide a financial overview and guidance for the second quarter. After their prepared remarks, they will be available to answer your questions.

Before we continue, please note that the discussion today will contain certain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations.

Charm does not assume any obligation to update any forward-looking statements except is required under applicable law. Also, please note that some of the information to be discussed includes the 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 US 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’ll now turn the call over to Charm Communications Founder, Chairman and CEO, Mr. Dang.

He Dang

(Foreign Language)

Hello, and welcome to our second quarter 2011 earnings conference call.

(Foreign Language)

We continued to execute our company strategies and delivered solid growth in the second quarter of 2011 with impressive year-over-year increases across all of our business segments. We continued to gain market share during new client wins for both our traditional and non-traditional advertising businesses and solidified our market leadership position as a leading advertising agency in China.

Building on our core TV businesses, we also made significant inroads in our digital media business, where our internet agency business has more than doubled as a percentage of overall advertising agency revenues led by strong organic growth in our Charm Interactive business unit. All in all, we are pleased with our second quarter results in which we delivered excellent top and bottom line results.

(Foreign Language)

The macro environment remained strong in terms of demand from advertisers for the second quarter. And with rising media prices across the industry advertisers continue to move towards integrated media solutions with increased focus on targeting and effectiveness. We’ve been able to extend our integrated service capabilities by leveraging our core strength in television advertising, which still accounts for more than 60% of all advertising spending in China. Strategic acquisition of ClickPro, and our continued partnership with Aegis Media in forming a joint-digital trading platform we have strengthened our service offerings. Second half of the year we look to maintain our number one position with CCTV China’s largest television network and to grow our television related inventory at a healthy rates all of which will protect our core competitiveness.

(Foreign Language)

In terms of China’s overall advertising market Charm continue to capture a higher market share in the second quarter of 2011. Total customer advertising spending place through or with Charm increased 33.3% from $150.9 million in the second quarter of 2010 to $201.3 million in the second quarter of 2011 which is much higher than the 14% growth in the overall advertising market reported by CTR.

(Foreign Language)

Moving on to our operational highlights we continue to execute on our strategy in the second quarter winning new clients and expanding our business with existing clients.

(Foreign Language)

For Charm Advertising we witnessed robust billings growth of 27% in the second quarter, driven by strong demand for television advertising. On the strategic front we’re able to expand our industry coverage into the travel and tourism and internet sectors in particular on CCTV.

For travel and tourism we helped Shangxing Tourism Bureau and Hubei Tourism Bureau with our national branding campaigns. And for the internet industry we helped (inaudible) television campaigns. We continue to make investments and building out our media planning and buying platform for satellite and local television channels.

One key strategic initiatives in the second quarter was our VIP conferences in Beijing, Shanghai and Guangzhou where we had over 200 major clients along with the heads of advertising from CCTV and 14 other satellite channels and attendants. These conferences will set the tone for the second pitching season for Charm advertising.

(Foreign Language)

Our media investment business Shangxing Media again delivered stellar performance led by strong ratings for Tianjin satellite channels and Shanghai Dragon satellite channels as well as for CCTV programs Tianjin and Shanghai were consistently ranked the sixth and seventh most viewed satellite channels in China. With Shanghai featuring the most viewed show in China for the second quarter China has got talents.

We expect this momentum to carry in to the second half. We also made significant progress with Hubei Provincial Economic TV in the second quarter ramping up the sales operations there and moving forward – moving toward more normalized margins.

(Foreign Language)

With regard to Charm Interactive, we continue to expand our digital marketing capabilities and grow our client portfolio. Our Internet business is becoming a larger contributor to overall advertising revenues representing approximately 13% of total advertising revenues in the second quarter compared to 5% in full year 2010.

Within our Internet business, online video and search are our fastest growing segments representing approximately 30% and 15% of our total Internet agency revenues respectively.

Our clients are beginning to respond to our online video work with Youku and we will continue to strengthen this relationship as well as further develop our relationships with other key players in the online video space such as Sohu, (inaudible). Our search business also saw strong organic growth with 13 active clients compared to nine in the first quarter.

(Foreign Language)

We launched two key strategic digital initiatives in the second quarter. Our investments in ClickPro and our partnership with Aegis Media.

(Foreign Language)

With the acquisition of ClickPro, we plan to integrate a staff of 60 people with our existing search team and form Charm Click, which will specialize in performance marketing and focus on leading Internet platforms like Baidu, Taobao and Google. Charm Click will have the unique competitive advantage of being able to leverage Charm’s large client base and integrated advertising platform.

(Foreign Language)

Our joint-digital trading platform with Aegis Media formalizes our ongoing collaboration and provides additional synergies between our complementary businesses. These include increasing our efficiency in our digital marketing business, helping our clients achieve better pricing, and sharing research on digital media in order to enhance the overall quality of service to our clients all of which will strengthen our digital platform and further elevate our market position in the digital space.

(Foreign Language)

While more clients are exploring non-traditional forms of advertising, demand remains strong for our core CCTV business. We will continue to capitalize on this portion of our business to deliver a stable revenue growth, while at the same time expand our satellite TV and digital media offerings to grow our integrated media platform and meet our client needs for both offline and online advertising.

As we execute on these strategies, we are well positioned to capitalize on areas of growth within the advertising industry and establish Charm as the leading integrated advertising and media group in China.

(Foreign Language)

I will now hand the call over to Wei Zhou, our CFO to discuss our operational and financial progress.

Wei Zhou

Thank you, Chairman, Dang. Hello, everyone. Before I go to the financials I’d like to take you through our core three business segments and give you some updates on our progress. Please note that in the first section, I’ll be referencing some of our second quarter results using non-GAAP numbers in order to better convey our performance. We define non-GAAP turnover as total customer advertising spending placed through or with Charm to reflect the scale of our business.

In the past quarter, we continue to outgrow the market from a billings perspective and gained additional market share. In the second quarter of 2011, turnover grew 33% year-over-year and 1.5% quarter-over-quarter to approximately US$201 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. The quarter-to-quarter increase in turnover was mainly due to stronger demand from advertisers on media investment resources in the second quarter.

I’ll break them down by business. The non-GAAP turnover for the advertising agency business grew 26.5% year-over-year and decreased 1.7% quarter-over-quarter to US $141.7 million in the second quarter of 2011.

The year-over-year increase in the agency business turnover was mainly due to the increase in the number of new agency clients and the increase in the advertising spending from existing agency clients. The quarter-over-quarter decrease in turnover was mainly attributed to slight decrease in demand from clients in the second quarter, due to seasonal factors and was also partly attributed to suspension of advertising placements by a client from Vizeum in Japan after the earthquake there.

In the second quarter of 2011, we provided agency services to 141 of client accounts, three of which were acquired in second quarter. The most significant client wins in the second quarter included Lashou and Zhongpin as well as a number of clients for our search engine marketing business.

The revenue extraction rate, which is defined by revenue divided by turnover, was 4.4% for the agency business, compared to 4.8% in the second quarter of 2010, and 4.9% for the first quarter of 2011. The slight decrease was mainly due to our competitive pricing strategy when acquiring new clients and increasing market share.

Overall, we expect the revenue extraction rates to increase as the company expands its full service offerings across all media platforms under Charm Advertising and ramp up the digital media offerings on our Charm Interactive. I like also like to point out, the revenue extraction rate would have been 5.5% in the second quarter of 2011 as compared to 5.5% for the second quarter of 2010 and 6% for the first quarter of 2011, had the company included commission from Charm Advertising clients for advertising placements on Shangxing Media's resources.

Our turnover for the media investment management business or the principal media business, which operates under the Shangxing Media brand, grew 53% year-over-year and 10% quarter-over-quarter to $59.6 million. Compared with second quarter of 2010, the increase was mainly due to the addition of Hubei Provincial Economic TV. Compared with the first quarter of 2011, the 10% increase was primarily attributed to the ramp up of operations in Hubei as well as stronger demand for clients on Tianjin and Shanghai channels due to seasonal factors. For the second quarter of 2011, we had 290 advertisers for our principal media business compared to 264 advertisers for the second quarter of 2010.

Now, going back to the GAAP figures, the U.S. GAAP revenue was $67.3 million for the second quarter of 2011, which was in line with the upper range of – which is in the upper range of our guidance. It represents a 48.5% increase compared to $45.3 million in the second quarter of 2010 and an increase of 8% as compared to the first quarter of 2011.

Revenues from our advertising agency business were $6.2 million for the second quarter of 2011, representing a 14.4% increase compared to the second quarter of 2010 and a 13.3% increase compared to the first quarter of 2011. Principal media business revenues were $59.6 million in the second quarter of 2011, representing a 52.9% increase versus the first quarter of 2010 and an increase of 10% compared to the first quarter of 2011.

The increase and decrease in the agency and principal media business revenues are all consistent with the changes in turnover. Brand and identity services revenues were $1.6 million for the second quarter of 2011, representing an increase of 64.6% compared to $0.9 million in the second quarter 2010, and an increase of 39% compared to the $1.1 million in the first quarter of 2011. The increase in the brand and identity services were mainly due to strong client demand for creative services in the second quarter of 2011.

Cost of revenues for the second quarter of 2011 was $48.7 million compared to $30 million in the second quarter of 2010 and $47 million for the first quarter of 2011. We mainly attribute to the increase in cost of revenues to the addition of Hubei Provincial Economic TV and the increase in TV media cost for the two satellite channels and four CCTV programs.

Gross profit in second quarter 2011 was $18.6 million representing an increase of 22.3% from $15.2 million in second quarter 2010 and an increase of 25.2% from $14.8 million for the first quarter of 2011. Gross margin for the second quarter of 2011 was 27.6% compared to 33.5% in the second quarter of 2010 and 23.8% in the first quarter of 2011.

The year-over-year gross margin decrease was mainly due to the addition of Beijing Gehua Cable TV Network and Hubei Provincial Economic TV which commenced operation in 2011 and still is in its ramp up phase. Selling and marketing expenses were $5.8 million in the second quarter of 2011, representing an increase of 20% from $4.8 million in the second quarter of 2010 and an increase of 15.4% from $5 million in the first quarter of 2011.

The increase in selling and marketing expenses compared with the second quarter of 2010 was primarily due to increased headcount at Charm Interactive. Selling and marketing expenses represented 8.6% of our total revenues for the second quarter of 2011 compared to 10.6% for the second quarter of 2010 and 8% for the first quarter of 2011.

G&A expenses in the second quarter of 2011 grew 23.1% year-over-year and 10.9% quarter-over-quarter to $2 million. The growth is in line with expansion of the scale of the business.

As a result of the above, operating profit was $10.9 million in the second quarter of 2011 compared to $8.8 million in the second quarter of 2010 and $8.1 million in the first quarter of 2011, representing a 24% year-over-year growth and 35% sequentially growth respectively. For the second quarter of 2011, we have tax expenses of US$557,000. GAAP net income was $11 million for the second quarter of 2011 representing an increase of 30.5% from $8.4 million in the second quarter 2010 and an increase of 33.9% from $8.2 million in the first quarter of 2011.

Fully diluted net income per ADS for the second quarter was $0.26 compared to $0.22 and $0.19 for the second quarter of 2010 and first quarter of 2011 respectively. Each ADS represents two common shares. We delivered solid non-GAAP net income growth coming in at the high-end of our guidance. Our second quarter non-GAAP net income, which excludes share-based compensation and impairment on investments was $11.7 million compared to $9.1 million for the second quarter of 2010 and $8.9 million for the first quarter of 2011.

Cash flow from operations for the second quarter of 2011 was positive. And as of June 30, 2011, we had cash and cash equivalents of $132.4 million compared to $130.5 million at the end of the first quarter of 2011. Also as of June 30, 2011, we have 580 employees, compared to 530 employees as of March 31, 2010.

And now, we turn to our business outlook. We estimate our total revenues for the third quarter of 2011 will range from $69 million to $70.5 million. Third quarter 2011 non-GAAP net income which excludes share-based compensation expenses and impairment on investments is expected to be between $13.75 million to $14.25 million. We base these estimates on a foreign exchange rate of 6.5 RMB per US$1. This forecast reflects our current and preliminary view which is subject to change.

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

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of James Marsh from Piper Jaffray. Please proceed.

James Marsh – Piper Jaffray

Thank you for taking my question. It seems like you’re making some pretty substantial headway on the internet advertising side and I was just hoping you could discuss where you think long-term internet advertising margins could go and which parts of that internet business potentially the most margin upside? Thank you.

Wei Zhou

Thanks, James. I think overall for the internet business, we expect extraction rate to come in at least in the 10% range. I think in the long-term, we expect it to be in between around 10% to 12%. Currently in terms of the different media that we’re advertising on the internet, which consists of display advertising, online video as well as search engine marketing, I think currently online video offers the most attractive extraction rate.

James Marsh – Piper Jaffray

Okay. Thanks very much.

Operator

(Operator Instructions) Your next question comes from the line of Matthew Dodds from (inaudible). Please proceed.

Unidentified Analyst

Hi, good results. Just a couple of things I wanted to ask, one was about cash, the sort of the cash position expanded in the quarter, but perhaps not by quite as much as I might have expected, given the prosperity of the quarter and I just want to know what else is going on there in terms of usage of cash in the second quarter. And the other part of the question was, just a little bit of a color on your third quarter, so the projections, which obviously is quite significantly stronger earnings in the third quarter, which I think might partly be seasonal and presumably it’s also partly Hubei TV ramping up sort of comparable prosperity. But so I just want a bit of color on that? Thanks.

Wei Zhou

Thanks, Matthew. For the cash use in terms of the quarter, there was a sort of payment to the dividend payable to the largest shareholder that we paid out of around $5 million. And then, in terms of the – so we have basically the operating cash flow for the quarter was much bigger than the change in the sort of the overall cash position.

In terms of the sort of guidance for the third quarter I think, especially I think one of the things is seasonal factors. I think, especially for the media and investment management business as you’ve seen sort of our historical trend it does improve throughout the course of the year with fourth quarter being the strongest. And adding to that, I think we definitely expect the sales operation at Hubei to incrementally improve throughout the course of the year.

Operator

(Operator Instructions) Your next question comes from the line of Nan Lee from SIG. Please proceed.

Nan Lee – SIG

Good evening, everyone. Thank you for taking my question. First to congratulate on strong quarter I’m just wondering if you can comment on China advertising sector in the second half of 2011, just wondering if you do see strong demand from you customers? You know, there are some discussions on China macroeconomic slow down, I’m just wondering if you have in these trends. Thank you.

Wei Zhou

Sure. Thanks, Nan. In terms of overall, I think to comment you on the first half; I think we saw continued demand for advertising in the first half. In the second quarter according to the data from CTR, the overall advertising market grew down at 14% pace. And I think one of the contributing factors to that strong growth has basically been that domestic consumption here remains strong and then that trend we expect to continue into the second half. So we will remain positive about the second half of the year.

I think however, with increasing inflationary pressures in the macro economy and as well as the tightening I think there will be challenge in the second half in particular with specific industries such as our real estate and auto, but I think for Charm we’re confident in our ability to expand our integrated media offerings while also building up on our strength in traditional television such that we can continue to solidify our position within this environment.

Operator

(Operator Instructions) Your next question comes from the line of (inaudible) Please proceed.

Unidentified Analyst

Hi. I kind of just echo what everyone else has said the results look to be very strong. Having gone through your statement and also listening to what you’re saying earlier on, I would like to just focus a little bit on the revenue extraction rate where you actually highlighted that has decline a little bit to 4.4% from 4.8% a year ago. In your announcement you talk about the fact that you actually were quite competitive in your pricing in order to win business, and I am wondering where that is likely to have ongoing margin impact whether it was very specific to a couple of pieces of big business that you felt was worth cutting prices to win?

Wei Zhou

Thanks, [Philip]. I think part of that is attributable to basically our expansion into the non-CCTV television business. In terms of expanding our market share in that, so it’s that, we have to be a little bit more competitive in terms of wining the new businesses there. I think additionally, I think one of the comment that we made in the call is that the current calculation of the extraction rate, we don’t take into account of the commission the internal bookings that we make in terms of placements for on to Shanghai and Tainjin and sort of the CCTV principal media resources by Charm advertising clients.

I think if we take into that effect sort of we then the sort of the extraction rate would have been around 5.5% in the second quarter in 2011, and that same number sort of second quarter 2010. So I think that reflects the sort of you know the overall healthiness of the business hasn’t really changed sort of you know on a year-to-year basis.

I think, in the long run, we expect that as digital spending within Charm increases as large sort of you know the satellite businesses sort of normalize the non-CCTV television business normalizes into the second half and into next year, we expect in a longer-term in expanding extraction rate.

Unidentified Analyst

Thank you very much.

Operator

(Operator Instructions) There are no other questions in queue at this time.

Nicholas Manganaro

There are no additional questions, we will ramp up. Thank you again for joining us today. This concludes Charm’s earnings call.

Operator

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

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