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China GrenTech Corporation Limited (GRRF)
Q4 2006 Earnings Call
March 12, 2007 8:00 am ET
Executives
Jane Liu - Christensen
Yingjie Gao - Chairman of the Board, Chief Executive Officer
Rong Yu - Chief Financial Officer, Principal Accounting Officer, Director
Qingchang Liu - Vice President
Analysts
Mike Walkley - Piper Jaffray
Daniel Amir - W.R. Hambrecht+CO
Adele Mao - Susquehanna Financial Group
Li Tang - Pacific Crest Securities
Adam Clarke - Bear, Stearns & Co.
Presentation
Operator
Good morning, ladies and gentlemen. This is Nicole and I will be your operator for this conference call. I would like to welcome everyone to the China GrenTech fourth quarter and fiscal year 2006 earnings conference call. (Operator Instructions)
A broadcast replay of the call will be available for three months at the website of the company at www.grentech.com.cn. Telephone replay of the call will be available through 11:59 p.m. Tuesday, March 13, 2007, Eastern Standard Time. To access the replay, please call 1-888-286-8010, or 617-801-6888 if you are calling from outside the U.S. The access code will be 14718471.
The presentation slides for today’s conference call can be downloaded from the website of China GrenTech in the investors section, under Investor Events.
Now I would like to transfer the call to the moderator, Ms. Jane Liu of Christensen.
Jane Liu
Thank you, Operator. Good morning, ladies and gentlemen. Welcome to the fourth quarter fiscal year 2006 earnings conference call for China GrenTech. I am Jane Liu of Christensen. With me today are Mr. Yingjie Gao, Chairman and CEO; Ms. Rong Yu, CFO; and Mr. Qingchang Liu, Vice President.
For your reference, you can download the presentation materials from the company’s website. The address is www.grentech.com.cn.
Before we begin the call today, I would like to remind everyone of the company’s Safe Harbor policy regarding forward-looking comments. Such comments are based on current expectations of China GrenTech and therefore there can be no assurance that these expectations will prove to be correct. Because forward-looking statements involve risks and uncertainties, China GrenTech's actual results could differ materially from these statements.
Information for the fourth quarter of 2006 is also included with the company’s earnings press release that was made available this morning and in our 6-K that will be subsequently filed with the SEC.
Now, I would like to pass the call over to Gordon Gao of China GrenTech. Gordon, you may begin.
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Gordon Gao
Thank you, Jane, and welcome everyone to our call. The agenda for today’s conference is first we will start with a review of our results, then we will provide a broader overview of our business. Afterwards, we will move on to the guidance for quarter one 2007 and the full year. Finally, we will be happy to take your questions.
I will try to be somewhat brief about our comments on the financials. I hope most of you will have seen our results by now, so we will try to go through this and leave more time for Q&A. As you can see on this slide on page four, for the fourth quarter and fiscal year 2006, revenue for quarter four 2006 increased 19.1% year over year and a 16.3% increase for the full year.
Gross profit for quarter four 2006 increased 2.8% year over year and a 1.9% increase for the full year.
Net profit for quarter four decreased 26% year over year to RMB 114 million, and decreased 18% to RMB 148 million for the full year.
Diluted earnings per ADS for quarter four 2006 were RMB 4.58, or in U.S. dollars, $0.59, and diluted earnings per ADS for the fiscal year 2006 were RMB 6.25, or in U.S. dollars, $0.80.
We had a very good quarter from a top line perspective. However, decreased gross profits is an industry trend. We are no exception. However, a few factors drove down our results, including spending R&D for base station RF modules, internal control systems 404 compliance, and sales and marketing expenses.
Compared to the previous year, we witnessed a significant increase in both the quarterly and full-year revenues. This increase was mainly due to higher sales to Chinese operators, with the exception of China Unicom, while our overseas sales to other wireless coverage integrators and base station OEMs also demonstrated growth during this period. Revenues from China Unicom decreased by 7.5% for the fiscal year 2006 as China Unicom reduced its investments in CDMA.
In 2006, our revenues still derive mainly from domestic carriers. The revenues from China Unicom, China Mobile, China Telecom, China Netcom, overseas carriers, other integrators and OEMs were about 36%, 33%, 11%, 8%, 1%, 7%, and 4% respectively of the total turnover. The proportion from our largest customer, China Unicom, declined to 36% from 45% in 2005.
In terms of products, wireless coverage products and services and RF products accounted for about 96% and 4% respectively of the total revenue of 2006. This composition is similar to that of last year.
Our gross margin for quarter four 2006 was 46.5%, a decrease from 53.9% in the fourth quarter of last year. Our gross margin for fiscal 2006 was 47.5%, a decrease from 54.2% of last year. The decline was mainly due to pricing pressure of wireless coverage products.
Our operating margin for quarter four 2006 was 29.6%, which decreased from 41.9% in the fourth quarter of last year. Our full year operating margin was 21.5%, a decrease from 31.4% of last year.
The operating margin decrease is because in a strategic response, we expanded our marketing spending in an effort to aggressively strengthen our market share and we also increased our R&D spending for base station RF components and 3G-related products. Additionally, the 404 compliance required us to boost the spending on our internal control systems. These factors combined to drive our operating profit down. It also resulted in a decrease in net income. However, we believe those spendings will help prepared the company for expected growth in the 3G wireless coverage and base station RF markets in China.
Total cash increased from RMB 204.9 million as of December 31, 2005, to RMB 706 million as of December 31, 2006. Total cash includes cash and cash equivalents and pledged time deposits. This increase in cash was mainly attributable to the net proceeds from the IPO completed on March 30, 2006.
Total accounts receivable increased from RMB 999 million as of December 31, 2005 to RMB 1,016.1 million as of December 31, 2006. This increase was mainly attributable to the growth in revenues and a slower settlement from the major accounts receivables during the year, as well as the increase in long-term accounts receivables.
Inventory increased from RMB 370 million as of December 31, 2005 to RMB 434 million as of December 31, 2006. The increase was mainly due to an increase in finished goods inventories which are in the process of installation with customers.
Now I will turn to our business overview. Now this is on page nine; on the agenda, second, business overview.
While China Unicom decreased CDMA investment, the results being a slowdown in our network coverage business, all the other operators have been increasing their investment in network coverage. In order to fulfill their investment plans for the fiscal 2006, all the operators have accelerated their network coverage construction in quarter four, which contributed significantly to our growth in the quarter.
In addition, China GrenTech successfully won the bid from China Mobile centralized bidding for eight series of GSM wireless coverage products. The success of China GrenTech's in this process qualifies the company to supply coverage equipment to China Mobile for its GSM network, which will help increase the company’s market share from China Mobile.
Let’s turn to the next page, 11. Let us move on to the RF product sector. Currently, we have been qualified as the supplier for six major base station OEMs. In quarter four, a variety of company series products passed certification by Huawei and ZTE. The company won a bid for two major CDMA RF modules, taking 80% of the deal from Huawei and won a bid from Shanghai Bell Alcatel’s first tender for TD-SCMDA filters.
We are in volume supplies to three major base stations OEMs; ZTE’s, Siemens and Shanghai Bell Alcatel. The company became the primary supplier to ZTE for TD products and two key types of CDMA RF modules, and began the delivery of TD-SCMDA filters to the other two. We are also in the process of a trial supply to Huawei.
With GSM capacity expansion and the TD-SCDMA commercial trial network construction launching in China, as well as increasing demand for base stations from oversea markets, domestic and international base station OEMs are expanding the demand for base station RF modules. Management expects revenues from base station RF modules will have a big jump, growing 300% to 400% from 2006 to account for 10% to 15% of the total revenues in 2007.
Let’s turn to slide 12. However, we also faced the following challenges during quarter four: one, decline in ASP for 2G products -- this is an industry trend; second, China Unicom’s investments in CDMA has been slowing down; third, our production process for base station RF modules still has room for improvement.
In order to reduce the costs, China GrenTech made use of its proprietary technology and low-cost production patents to redesign various parts of the company’s trunk amplifiers and network coverage equipment. Such redesigns not only improved the product portfolio but also lowered product costs by reducing material use and simplifying the production lines. As a result, the company has minimized the impact on gross margins.
On the other hand, the company also changed its sales and marketing strategy to control the increase of sales costs, improving the sales cost utilization rate. The company is spending more resources in production lines and logistic platform to improve mass production processes.
Now let’s turn to the slide 13, the guidance for the first quarter and full year of 2007.
In the year 2007, the company will have four growth opportunities. First, the construction of the TD-SCDMA commercial trial network will start very soon. Secondly, the expansion of 2G network and demand for the Olympic stadiums 2G network coverage create the stable demand for 2G wireless coverage products. Third, revenue from overseas wireless coverage is expected to grow steadily. Fourth, growing demand for TD-SCDMA 2G expansion and demand for base station products from oversea markets continue to create significant need for RF products.
Slide 15. TD-SCDMA commercial trial networks construction will provide ample opportunities for both our wireless coverage business and base station RF module industry. GrenTech is well-prepared in the TD-SCDMA sector for future opportunities.
For TD-SCDMA wireless coverage, we successfully developed TD-SCDMA trunk amplifiers, optical repeaters, and radio repeaters. Our TD-SCDMA repeaters and trunk amplifiers were awarded approval certificates by the government. The company is ideally poised for TD-SCDMA equipment production and technology training.
For base station RF components in TD-SCDMA, China GrenTech newly developed four types of TD filters, of which two are available to the market, and three types of TD-SCDMA amplifiers have yet to be introduced. We have started to supply in volume TD-SCDMA filters to Siemens and Shanghai Bell Alcatel.
Slide 16. We are confident about the growth prospects in 2007. As the RF module orders from base station OEM manufacturers increase rapidly, we estimate first quarter 2007 revenue will have a significant growth rate of 89% to 116%, and the revenue will be RMB 28 million to RMB 32 million, compared to RMB 14.8 million of last year.
Our full-year revenue growth from wireless coverage products is expected to be in the high-teens, while the revenue growth from the RF business to be approximately 300% to 400% in 2007, but our gross margin and operating margin will continue to decrease in 2007.
That takes us to the end of our presentation. We are now happy to answer your questions. Thank you.
Question-and-Answer Session
Operator
(Operator Instructions)
Your first question comes from the line of Mike Walkley from Piper Jaffray. Please proceed. Mr. Walkley, your line is open.
Mike Walkley - Piper Jaffray
Thank you very much. I was wondering if you could give us a little more guidance on your gross margin and operating margin targets for 2007 guidance.
Rong Yu (Translation)
To respond to your question, since it is mostly on the gross margin of those two products for the year 2007, while we believe that the 3G products will not necessarily be lower than 2G products, we expect that for the wireless coverage products, they will be roughly about 35% to 40%, and for the RF products, around 30%.
The proportion of RF products would increase slightly in the year 2007, about 10% to 15% in the total proportion of sales. So in sum, they will be roughly about 35% to 40% of the gross margin.
If I could just add one more impact; the impact on the gross margin also comes from the centralized bidding of China Mobile as well. Thank you.
Mike Walkley - Piper Jaffray
Thank you. And on your operating margin, with your continued investment in the RF component side, would you give us a range where you think your operating margins will be for 2007?
Rong Yu (Translation)
If we take the cost, for example, for the -- because we invest 65% of the total R&D investments are RF, so the cost for the RF would be about 6% to 6.5% and for the marketing it would be 13% to 14% for the development of our customers. For the general administration, it would be about 6% of the cost of the R&D. Thank you.
Operator
Your next question comes from the line of Daniel Amir with W.R. Hambrecht. Please proceed. Mr. Amir, your line is open.
Daniel Amir - W.R. Hambrecht+CO
Good morning. A couple of questions here; first of all, on the 3G side, can you expand a bit -- now that we seem to see that TD-SCDMA are the first licenses that are going to come out and then the others, it is a question whether they are going to come out in ’07 or not, what is in your guidance here for 2007? Can you expand a bit what portion of this and when do you expect this to start hitting your top line?
Gordon Gao
This is your first question, right? Would you like me to respond to the first question first?
Daniel Amir - W.R. Hambrecht+CO
Yes, related to 3G.
Qingchang Liu (Translation)
The first point Mr. Liu is trying to make is actually in our current portfolio, 30% of our wireless products comes from TD-SCDMA and 20% of the TD-SCDMA actually goes to the RF products, so in total roughly about 50% of the total revenue.
Daniel Amir - W.R. Hambrecht+CO
My question was more related to the fact that -- what is your exposure to 3G? Considering some of the 3G has been pushed out, how is that impacting your revenue growth rate here for 2007?
Qingchang Liu (Translation)
Actually, in China, when we talk about the 3G we talk about the TD-SCDMA. We are not really talking about the WCDMA and CD-2000.
To just elaborate on the TD-SCDMA scenario, as our reports mention, the Chinese Government has planned the trial in ten major cities of China. The licenses have not been issued yet but the rumors on the streets expose that the China Mobile is planning for the bidding for the TD-SCDMA for the trial networks, and actually for the total revenue investment involved doubled to 26.7 billion, among which 23.7 billion will go to equipment. So we perceive that such a market trend is inevitable. That is why we deal with 30% based on the current market perception.
Of course, if it does not happen, the 3G things, we also actually guide that we will maintain the low-teens, the two-digits development. Thank you.
Daniel Amir - W.R. Hambrecht+CO
My last question is; beyond 2007, what type of operating margins are you planning to run the company at? What is your long-term operating margin model?
Rong Yu (Translation)
Actually, the operating margins, as I just mentioned, the R&D actually would decrease about 5% to 6% because we are involved more with the RF products. The same goes with marketing. Because of the change of the structure, we put more effort on RF product development, so the marketing costs will slow down. But for the moment, it will be roughly about the 13% to 14%. For the general administrations, it will go down but because the 404 compliance, that is why now it is slightly higher.
Operator
Your next question comes from the line of Adele Mao from Susquehanna. Please proceed.
Adele Mao - Susquehanna Financial Group
Thank you. You mentioned just now that China Mobile is expecting to spend RMB 23.7 billion in 3G equipment. That is equivalent to about $3 billion. I assume that is for the ten cities that will go on commercial trial, so those expenditures should be expended in 2007 and some part in 2008. Is that correct?
Qingchang Liu (Translation)
The expenditure I was just talking actually does not just come from China Mobile. It comes from China Telecom, China Netcom, the CapEx they expect to spend is actually, from our understanding, it is about the year 2007 only.
Also, just now we were talking about the RMB 23.7 billion and where they are going to spend, on what products. Especially I think what we are concerned on the wireless coverage products, which is our main market. According to the findings of the research institutions, about $100 million will be spent on our main market, i.e. the wireless coverage product. Thank you.
Adele Mao - Susquehanna Financial Group
What kind of market share -- out of this $100 million, what kind of market share are you looking to capture in 2007? Also, would you expect the mobile carriers expand their capital expenditure in the second phase of TD-SCDMA build-out in 2008? And what kind of market size of the expenditure would you expect for the industry overall?
Qingchang Liu (Translation)
To respond to your first question, in our guidance we did not really specify the specific numbers because actually we expect with our relationship with China Mobile in particularly involved with our RF business, we will get more market share in TD-SCDMA products.
On the wireless coverage product, essentially we have been growing in market share. In the year 2005, our market share was roughly about 10% to 15%, and in the year 2006, 16%. In 2007, we have every reason to expect more market share in this market segment.
Adele Mao - Susquehanna Financial Group
So this quarter versus last quarter’s earnings call, has the official delay really changed your expectation for 3G revenue ramp-up? You know, if the delay has negatively impacted your business pipeline for ’07? I assume not, right?
Qingchang Liu (Translation)
Actually, in fact when we talk about the 3G, we mainly talk about the delay of the issuing of license. In our real market expectations, it is more or less not really affecting us too much because we focus mostly on TD-SCDMA. Of course, without issuing the WCDMA and MT-2000, that would affect us, certain business, but not too much. In fact, if our market would be affected negatively, there would not be for the moment the WCDMA and MT-2000, but rather the TD-SCDMA.
But for us, from our market knowledge, the TD-SCDMA is inevitable that we are surely going to go to the market. That is why that supports our market share. Thank you.
Adele Mao - Susquehanna Financial Group
I just have a last question about your margin, just sort of a clarification from Ms. Yu’s earlier comments. She mentioned that wireless will be about 35% to 40%. I remember last quarter you guys were talking about 40% to 45%, and then RF close to 30%, while you talked about 30% to 40% before. Is this a lowered expectation from last quarter?
Rong Yu (Translation)
Actually, the reason we have mentioned in our report is it is on the centralized bidding by China Mobile, which had not been thoroughly calculated in our previous number or figure of 40% to 45%, so that leads to the slight decrease of that margin.
As to the decrease on the margins of RF products, it is based on our design of seizing more market share in 2007. That is why we lowered down our price a little bit, which effects the margin.
Operator
Your next question comes from the line of Li Tang from Pacific Crest Securities. Please proceed.
Li Tang - Pacific Crest Securities
Thank you. First question is when do you expect to start recognized revenue from TD-SCDMA wireless coverage products in 2007?
Qingchang Liu (Translation)
Quarter three.
Rong Yu (Translation)
Mostly focusing on the quarter four.
Li Tang - Pacific Crest Securities
Okay, great. The second question is on your RF component revenue guidance in 2007. That 300% or 400% is a very healthy growth. What gives you the confidence that your RF component revenue could ramp up in such a speed in 2007? Do you already have some order in hand, or do you have the pipeline that you can see that revenue to ramp up significantly in the second quarter or third quarter this year?
Qingchang Liu (Translation)
My first point to respond to your question is actually there are three factors. The first factor is coming from the OEM, the overseas, the base stations conduct a lot of procurements on the RF modules.
The second is coming from the TD network because there is a lot of procurement and there are a lot of orders increase, which gives us the confidence.
The third factor is coming from the GSM because of the overseas and domestic base stations have higher demand for RF modules.
Actually, for the TD-SCDMA, we have expectations of about RMB 5 billion.
We all know that among the six major players, ZTE, Huawei, Siemens, Alcatel, actually we have already started the order process. We have so far about RMB 25 million in orders. There are also orders from the GSM, the TD for the main products. Also, we have some small orders from Huawei, which is going to be very big very soon, and we also have the orders from Siemens and Alcatel for the TD filters.
Yingjie Gao (Translation)
I am Yingjie Gao, the Chairman of GrenTech. I would like to add one point on our RF products. Actually, RF products is our core distinction, the core competence of our company which distinguishes our company from other competitors.
Actually, RF products is our major strategy for our sustainable development and growth. We could see that from the year 2006, we invested more RF R&D. In fact, our R&D staff on RF exceeds the number of R&D staff on wireless coverage.
The RF base products actually have maintained the strong momentum for growth for the coming few years. Actually, the regulatory framework also provides an optimal environment for such development. For example, the Ministry of Information Industry has given the five-year plan, among which the base chips and also our RF products are the major targets for the planned development.
Operator
Your next question comes from the line of Adam Clark from Bear Stearns. Please proceed.
Adam Clarke - Bear, Stearns & Co.
Congratulations on the quarter. I was just wondering if you could give anymore detail in terms of the visibility on the TD-SCDMA indoor coverage. I know you said that you would be booking revenue potentially in Q3 or Q4, but do you know when you would expect to be submitting bids for those projects? Is that anything in the near-term? Thanks.
Qingchang Liu (Translation)
Thank you for your questions on the visibility of the development of TD. Actually, China Mobile is still in the preparations for bidding and has not started bidding yet. That is why we cannot give you exactly the detailed visibility. But according to the roadmap of TD development, by the end of May, the equipment bidding will be completed. By the end of October, the network will be completed in construction. So that is why we expect that the quarter three, we start building all that equipment. On quarter four, we are going to see some revenues from this market share. Thank you.
Operator
(Operator Instructions)
Your next question is a follow-up question from the line of Mike Walkley from Piper Jaffray. Please proceed.
Mike Walkley - Piper Jaffray
Thank you. I just wanted to follow-up on your RF business. Could you give us some more details? I thought I heard you say you had an 80% share of something for Huawei. Can you give us a little color on your Huawei business and when that starts to ramp in terms of revenue?
Qingchang Liu (Translation)
If I could introduce the scenario of Huawei, just to clarify first about that 80%. The 80% is actually coming from the CDMA bidding of Huawei, one of the modules. Actually, we are already the qualified supplier for Huawei, in comparison of the audits or certification of Huawei, and we have already started small quantity supply. Actually, we are going to provide more in quantity very soon. That is why there is the close relationship with Huawei and our strong confidence in the market. Thank you.
Mike Walkley - Piper Jaffray
Thanks, and then on your RF coverage business -- would you expect that business to be up sequentially in terms of Q1, above Q4 levels?
Qingchang Liu (Translation)
We could predict the RF products in the whole year from quarter one to quarter four, we already know that so now we have RMB 25 million in orders in RF, mostly from ZTE, Huawei and Siemens and Alcatel. So the whole year we will proceed in quite a steady growth on that, and of course the orders are mostly coming from ZTE and Huawei. Thank you.
Mike Walkley - Piper Jaffray
One last question for me; for 2007, what tax rate are you assuming? Just the tax rate for 2007.
Qingchang Liu (Translation)
2007, we are facing two opportunities. First is coming from RF, and we expect there will be a higher gross on that market. Secondly coming from the TD network wireless coverage, because there is more demand on that. We also think that there is still market existing on 2G. Of course, there is also the oversea market, the OEM procurement. That is why we, based on all this information and opportunities, we predict a revenue growth of 13%. Of course, there are other factors, as Ms. Yu just mentioned -- the decrease of ASPs, which affects our gross and net margins, but we firmly believe that we are still here in the industry and one of the top players in revenue generation. Thank you.
Operator
There are no further questions at this time. I would now like to turn the call back over to Ms. Jane Liu.
Jane Liu
Thank you, Operator. A link to the replay of this call will be available for three months at www.grentech.com.cn in the investors section under Investor Events. A dial-in version of the replay can be heard at 888-286-8010 if you are in the U.S., or at 1-617-801-6888 for international calls. The dial-in replay will be available until 11:59 p.m. Tuesday, March 13, 2007 Eastern Time. The access code will be 14718471.
If you have additional questions, please feel free to contact Mr. Qingchang Liu of GrenTech at 867-558-350-1796, or e-mail liuqingchang@powercn.com. Thank you again and have a nice day.
Operator
Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.
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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. To sponsor a Seeking Alpha transcript click here. |
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