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AsiaInfo Holdings, Inc. (ASIA)

Q1 2007 Earnings Call

April 25, 2007 8:00 pm ET

Executives

Charles Zhang - Investor Relations

Steve Zhang - Chief Executive Officer, President, Director

Eileen Chu - Chief Financial Officer, Vice President

Analysts

Eric Kasper - ThinkEquity

Chang Qiu - Sensor Capital

Li Tang - Pacific Crest Securities

Presentation

Operator

Welcome to today’s AsiaInfo Q1 2007 results announcement event call. I am pleased to present Mr. Charles Zhang. (Operator Instructions) Mr. Zhang, please begin.

Charles Zhang

Hello, everyone, and welcome to AsiaInfo's first quarter 2007 conference call. Today, Steve Zhang, President and CEO of AsiaInfo, will review some of our 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: some information we will discuss during this conference call is forward-looking in nature and subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. To understand factors that could cause results to materially differ from those in the forward-looking statements, please refer to our annual report on Form 10-K for the fiscal year ended December 31, 2006, as filed with the Securities and Exchange Commission.

Also, please take note that unless otherwise noted, 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. Steve.

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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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Steve Zhang

Hello and thank you for joining us today. I am happy to report that AsiaInfo’s net revenue for the first quarter grew by 25% year over year and we exceeded our EPS guidance for the quarter.

We were encouraged by continued growth in our telecom software solutions business, as net revenues from this division grew by 90% year over year. Also, our security products in the service business delivered healthy results within our expectations.

Before I go through some of the highlights from the quarter, I would like to note that the first quarter is generally the slowest of the year for many Chinese companies due to the long break for the Chinese New Year. This is the case for both our telecom and IT security business.

In the first quarter, we experienced healthy demand for our market-leading BOSS and BI assistance and signed contracts to enhance business intelligence systems for nine China Mobile subsidiaries, and we committed to upgrading China Mobile’s BOSS system in four provinces.

We also grew our market share in the telecom software space, with new contracts to develop business intelligence systems for Yunnan Mobile and Tibet Mobile. With these two additions, our leadership in the China Mobile market has extended to 15 provinces and to the company’s headquarters.

Today, AsiaInfo's business intelligence systems supports more than 150 million users and over 500 terabytes of data and are 50% of China’s total business intelligence market.

With high product stickiness in our telecom software solutions, our leading market position gives us a strong platform to deliver regular system upgrades and to provide complementary telecom solutions.

Beyond our core telecom solutions, we also won new contracts during the quarter for our new telecom software solution. First, we partnered with China Unicom to create a CDMA push mail platform that will allow users to synchronize e-mail accounts and send and receive e-mails on the go.

Second, we recently won a contract to develop China’s first mobile device management platform for China Mobile. This pioneering system, which enhances end-user experience by allowing automatic software updates, will trial in China Mobile’s headquarters before being expanded to other China Mobile subsidiaries. We see promising market potential for this new solution.

Third, we also recently won our first 3G BOSS bid to be an exclusive provider for China Mobile’s entire extended TD-SCDMA provincial trials, covering four provinces and the three municipalities. We believe this deal lays down a solid foundation for future growth momentum in China’s telecom software market.

While these recent wins collectively demonstrate industry confidence in AsiaInfo's ability to deliver quality innovative solutions, we remain focused on our future growth. To this end during the quarter, we added around 40 people to our R&D and software service team. We also achieved level 5 CMMI certification, which certifies the maturity and the quality of our software development processes.

As I mentioned earlier, there is a strong seasonality impact in the IT security business in the first quarter. Despite this, we saw excellent growth here on a year-over-year basis. In 2007, we remain focused on execution and staying ahead of the market by introducing new products and product upgrades. We believe there is a good opportunity to grow this business through the rest of 2007.

I will now turn the call over it Eileen Chu, our Chief Financial Officer, who will review the quarter’s financial highlights.

Eileen Chu

Thank you, Steve, and greetings to everyone on the call. First quarter telecom software products and solutions revenue rose 21% year over year and decreased 3% sequentially, as we continued to see strong demand for AsiaInfo's BOSS and BI solutions.

Our telecom service revenue increased 15% year over year and 3% sequentially. Total net revenue for the telecom software solution business increased 19% year over year and decreased 2% sequentially. As Steve mentioned, the sequential decrease was primarily due to the seasonality impact in the first quarter of 2007.

Lenovo-AsiaInfo’s net revenue increased 144% year over year and decreased 40% sequentially. The large year-over-year increase indicated the healthy recovery of the business. The sequential decrease reflected the normal seasonal impact of the Chinese New Year holiday.

Gross margin for Lenovo-AsiaInfo increased from 52% in the fourth quarter of 2006 to 61% in the first quarter, primarily due to continued improvements in return rates. This led to gross margin improvement for the entire company of 7% year over year and 1% sequentially.

Total operating expenses for the quarter were up 17% year over year and down 1% sequentially. The year-over-year increase in operating expenses was primarily due to higher non-cash expenses recognized in the first quarter of 2007, including share-based compensation expenses and amortization of intangible assets relating to two acquisitions completed in late 2006.

R&D expenses grew 28% year over year and 10% sequentially, reflecting our initiative to capitalize on growing opportunities in China’s telecom software market.

Sales and marketing expenses increased 54% year over year and decreased 6% sequentially. The year-over-year increase was mainly due to greater headcount and higher sales commission, which grew in line with the increase in sales orders in the first quarter of 2007.

General and administrative expenses decreased 38% year over year and 3% sequentially, primarily due to the recovery of certain bad debt.

During the quarter, our telecom business posted a contribution profit before corporate G&A expenses of $3.5 million. In the first quarter, Lenovo-AsiaInfo recorded other operating income of $2.7 million. This income related to a settlement agreement that AsiaInfo entered into with Lenovo Group Limited to resolve certain matters arising out of the acquisition agreement dated July 27, 2004, and an escrow agreement dated October 19, 2004 between the company and Lenovo. For further information, please refer to the company's current report on Form 8-K dated January 30, 2007.

As a result, Lenovo-AsiaInfo posted a contribution profit before corporate G&A expenses of $2 million. Excluding this other operating income, Lenovo-AsiaInfo would have posted a contribution loss of approximately $0.8 million.

In the first quarter of 2007, we also closed a transaction to sell our financial services IT solutions business. As a result, AsiaInfo recorded a gain from the sale of discontinued operations of $1.4 million in the first quarter.

Net income excluding share-based compensation expense, amortization and impairment charges, and other operating income, which is a non-GAAP measure, was $5.2 million in the first quarter of 2007, or $0.12 per basic share. Non-GAAP net income in the year-ago period was $0.6 million or $0.01 per basic share. Non-GAAP net income in the previous quarter was $3.1 million or $0.07 per basic share.

Operating cash flow in the first quarter of 2007 was a net outflow of approximately $3 million, primarily due to strong cash collection in the previous quarter.

Moving to our balance sheet, our total cash and cash equivalent plus short-term investment increased sequentially by approximately $2.8 million to $153.2 million during the quarter, primarily reflecting a higher return on certain short-term investments.

Accounts receivable rose to $42.4 million from $35.2 million at the end of the fourth quarter of 2006, reflecting the strong collection efforts in the previous quarters.

DSO for the quarter was 117 days versus last quarter’s 120 days.

I will now read you AsiaInfo's financial guidance for the second 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.

Revenues net of hardware in the second quarter of 2007 is expected to be $25 million to $27 million, reflecting 26% to 36% year-over-year growth.

We expect second quarter earnings per basic share from continuing operations to be $0.06 to $0.07. This is compared to earnings per basic share from continuing operations of $0.03 in the second quarter of 2006.

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

Steve Zhang

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

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question is from Eric [Kasper] at ThinkEquity. Please go ahead.

Eric Kasper - ThinkEquity

Thank you very much. I wonder if you could tell us what your expectations are for the BOSS with the 3G TD-SCDMA network. As it rolls past a trial into a full-scale launch, do you expect them to introduce second and potentially third sources there? Or do you think for a little while they might see fit to have just one source if you do an outstanding job of supporting them here?

Steve Zhang

You are referring to our providing the bidding on the CRM to the TD-SCDMA trial, right? Right now, we are the only provider in the provincial trials. Of course, it is our intention that we do a very good delivery job and hopefully when China Mobile wants to push for a full-scale deployment, we will have a very competitive advantage in winning the entire contract.

Eric Kasper - ThinkEquity

So you think you could -- it’s possible at least that they will go with a single source for the whole network once they get into full deployment?

Steve Zhang

Well, that is the direction we are working on.

Eric Kasper - ThinkEquity

Great. Good luck. I wonder if you could also answer a question about the mobile device management product. I am not familiar with exactly what functionality you have built into that, but that would be interesting. And then, if you could describe whether you think that would be [of interest] to obviously the other main potential customer also?

Steve Zhang

Yes, and this is a very interesting and exciting solution for us. Device management, the main purpose is to support China Mobile’s initiative for their own handset introduction in the future.

As you know, the handset is becoming more and more sophisticated and all the smartphones plus China Mobile’s own branded handset, they want to have over-the-air support and upgrade capability. So we are building this device management platform for China Mobile to enable them to do the handset upgrade, handset parameters gathering and all over the air. This will enhance their support but they also want to be able to identify what kind of terminals, what kind of handset the regular consumer is using, and based on the handset parameters, they can push tailored data applications on to the handset.

Eric Kasper - ThinkEquity

Excellent. I wonder if there might also be play there either within the current product or within a future iteration of the product that would somehow serve the security interests of a user or the service provider. Specifically, I’m of the belief that security gets to be more important as we go forward here, as I think we have seen certainly over the last five years. I wonder if maybe there is a play there for you also.

Steve Zhang

Eric, I think you are right. We just signed the first phase of the contract. Right now, we are in the delivery process of the first phase of the contract. We already have a team working with our clients, working on the specifications for the second phase rollout. I think security will be -- it may not be in the second phase but it definitely will be in a future phase of the rollout.

Eric Kasper - ThinkEquity

Excellent. I guess that is probably enough. I will get back in queue.

Operator

Our next question is from Chang Qiu from Sensor Capital. Please go ahead.

Chang Qiu - Sensor Capital

Good morning. Your Q2 guidance is quite strong. Can you elaborate some more, maybe in terms of both sides of your business, the tech side and the telecom side?

Steve Zhang

For our second quarter guidance, I think our telecom business will continue to grow year over year, and our security business should be very close to break-even in the second quarter.

Chang Qiu - Sensor Capital

On the expense side in Q2 relative to Q1, can you give us some color there, what we should expect?

Steve Zhang

On the expense side?

Chang Qiu - Sensor Capital

Right.

Eileen Chu

Actually, we are not expecting any major one-off expenses in Q2. As explained earlier, Q1 we had some one-off other operating income but we don’t foresee this kind of income or expenses in our Q2 results.

Chang Qiu - Sensor Capital

Okay. All right, thank you.

Operator

Our next question is from Li Tang at Pacific Crest Securities. Please go ahead.

Li Tang - Pacific Crest Securities

Thank you. Steve, what is your estimate of the market size of China’s telecom enterprise software market in Q107 and what is the year-over-year growth rate?

Steve Zhang

You mean the entire --

Li Tang - Pacific Crest Securities

Market.

Steve Zhang

The entire market? We believe the entire telecom BSS market size is roughly probably, for the entire year, roughly $400 million.

Li Tang - Pacific Crest Securities

What do you see as the growth rate for the market in 2007?

Steve Zhang

There is a lot of uncertainty still related to the 3G license issue and if this uncertainty is resolved, we believe the market should grow 15% to 20%.

Li Tang - Pacific Crest Securities

Great, and the second question is actually back on the handset device management, how do you charge China Mobile on that? Is that a one-time R&D effort, or do you actually charge them per handset received?

Steve Zhang

It is not a per handset received charge model. It is based on time and material. But we -- this kind of project is similar to our existing billing in the [TRM] project, and in the future there will be a maintenance revenue, there will be upgrade revenue.

Li Tang - Pacific Crest Securities

For this phase of the development, does that cover certain provinces?

Steve Zhang

It is only in the headquarters. It is a headquarter-centralized trial system. If it goes very well, it will be rolled out to the provinces. Because as you know in China, China Mobile has a huge subscription number and one centralized system will not be able to scale to support 350 million subscribers.

In our current design, we designed two levels. Our current design for China Mobile is going to be two levels; the centralized level and the provincial level. In the first phase, we are helping them to build and trial the headquarter system.

Li Tang - Pacific Crest Securities

Okay, so is it fair to assume that could turn into a major contribution to your revenue in the future? It seems to me that is a new area and China Mobile has quite a bit of handsets, so through China Mobile may be one-third of China’s total handset demand. I am just trying to measure how big this opportunity could be.

Steve Zhang

If this system gets rolled out across the provincial subsidiaries, it will be a major market opportunity for us. We also have high expectations for this new solution.

Li Tang - Pacific Crest Securities

Okay, great. One last question is on the push e-mail with China Unicom; do you expect China Mobile will launch a similar product and you will be helping them to do that?

Steve Zhang

China Mobile is already working with RIM, Research in Motion, in delivering the BlackBerry service in China, so we are not involved in providing BlackBerry type of push e-mail services with China Mobile.

Li Tang - Pacific Crest Securities

We heard that China Mobile may have a lower cost version of the e-mail program. Is that something you --

Steve Zhang

We are involved in providing the e-mail platform to China Mobile but it is not in the enterprise push mail market. In China Mobile, they have two brands for their mail services. One is for targeting enterprise power customers for the push mail. Even for push mail they have the high-end version, which is the BlackBerry, and the low-end version, which is provided by another company. But we are providing the e-mail target in the non-push mail market.

Li Tang - Pacific Crest Securities

Got it. Thank you.

Operator

There are currently no questions in queue. (Operator Instructions) As there are no further questions, we will now begin closing comments. Please go ahead, Mr. Zhang.

Steve Zhang

Again, 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.

TRANSCRIPT SPONSOR

China Direct Logo

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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