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AsiaInfo Holdings, Inc. (ASIA)

Q2 2007 Earnings Call

July 25, 2007 8:00 pm ET

Executives

Charles Zhang - Investor Relations

Steve Zhang - Chief Executive Officer, President, Director

Eileen Chu - Chief Financial Officer

Analysts

Brendan Barnicle - Pacific Crest Securities

Eric Kwan - BNP Paribas

Lun Lu - Morningstar

Presentation

Operator

Welcome to today’s AsiaInfo Q2 2007 results announcement event call. I am pleased to present Mr. Charles Zhang. For the first part of this call, all participants will be in listen-only mode and afterwards, there will be a question and answer session. Mr. Zhang, please begin.

Charles Zhang

Hello, everyone and welcome to AsiaInfo's second quarter 2007 conference call. Today, Steve Zhang, President and Chief Executive Officer of AsiaInfo, will review business highlights achieved during the second quarter and Eileen Chu, our Chief Financial Officer, will further discuss financial results and give third quarter guidance. Mr. Zhang will then provide a few closing remarks and open the call to questions.

Before we continue, please 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 that 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, and our other reports filed with the Securities and Exchange Commission.

Also please note that some of the information we will discuss includes non-GAAP financial measures. A reconciliation of the non-GAAP financial measures to the nearest GAAP financial measures can be found in our earning release, available on our website.

Finally, please take not that unless otherwise noted, all figures mentioned during the conference call are in U.S. dollars.

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

Steve Zhang

Hello and thank you for joining us today. I am pleased to report strong second quarter results, with net revenue growing 40% and net income growing over 85% year over year. This growth was driven by strong demand for high quality telecom software solutions and the continuous improvement in our IT security business.

Today I will take you through some of the significant telecom project wins of the quarter and talk briefly about market opportunities.

In the second quarter, we signed an agreement to upgrade China Unicom’s billing and CRM systems in Jiangsu province to help them support their new GPRS services.

In the fixed line market, we signed a contract with Zhejiang Netcom to expand their broadband billing system to better accommodate their growing subscriber base and increased demand for new services. Also in Zhejiang province, we signed a contract with China Telecom to deploy an integrated account inquiry system. This is the first time we have delivered this solution to a fixed line operator in China, although it is widely used by mobile operators. The account inquiry system is an important component of our core billing solution and this project is an excellent opportunity for us to demonstrate the value of our billing solutions for fixed line operators.

In addition to the increasing interest we are seeing for billing and CRM solutions, our business intelligence capability also continues to be well-received by the market. Telecom operators understand the value of data analysis and are increasingly using business intelligence software to devise marketing campaigns and differentiate service offerings.

In the second quarter, China Mobile’s Chongqing subsidiary signed a contract with us to expand their business intelligence system to better analyze market trends and user preferences.

Lastly, we recently signed another important contract with China Mobile to service the deployment of their next generation IP infrastructure. This project is an excellent opportunity to expand our relationship with China Mobile and develop a clearer understanding of their future service demands.

While our traditional products are seeing strong uptake, we are constantly working to anticipate customer needs and develop the next generation of tailor-made solutions. This includes our flagship BOSS 3.0, which is designed to provide a single customer interface and a number of custom-made solutions to meet the demands of 3G.

With a wide array of long-term market opportunities, we are focused on building for the future. Throughout the rest of 2007, we will continue to invest in R&D, sales and marketing and continue to look for small- to medium-sized acquisitions that complement our core competencies and help to build market share.

Turning to our security product and service business, we continue to deliver strong sales growth. With a highly qualified management team, growing sales and marketing personnel, and strong brand recognition, we are confident that this business will continue to expand in the second-half of 2007.

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

Eileen Chu

Thank you, Steve, and hello to everyone on the call. Second quarter telecom software products and solutions revenue rose 27% year over year and 8% sequentially, as we continued to see strong demand for AsiaInfo's telecom software solutions.

Our telecom service revenues increased 55% year over year and 14% sequentially. The increase in service revenues was in line with continuous growth in our telecommunications software business, which generates more need for services from our customers.

Total net revenue for the telecom business increased 30% year over year and 8% sequentially. Lenovo-AsiaInfo’s net revenue increased 158% year over year and 60% sequentially. The large year-over-year increase reflects continuous improvement of operation in this division and the sequential increase was primarily due to the seasonality in the first quarter of 2007.

Group gross margins of net revenue was 54% compared to 48% in the year-ago period and 55% in the previous quarter. The year-on-year increase was mainly due to improving operating results of our Lenovo-AsiaInfo division.

Total operating expenses were up 49% year over year and 10% sequentially. The increases were due to increased research and development, sales and marketing, and general and administrative expenses.

R&D expenses grew 19% year over year and 2% sequentially, reflecting our initiative to capitalize on growing opportunities in China’s telecom software market.

Sales and marketing expenses increased 61% year over year and 10% sequentially. The increases were primarily due to greater marketing assets to break into new customer accounts and prepare for growing market opportunities.

General and administrative expenses increased 94% year over year and 27% sequentially, primarily due to recovery of bad debt expenses in the year-ago period and the previous quarter.

During the quarter, our telecom business posted a contribution profit before corporate G&A expenses of $3.4 million, and our security products and services business posted a nominal loss.

Net income excluding share-based compensation expenses, amortization and impairment charges, and other operating income, a non-GAAP measure, was $3.9 million, or $0.09 per basic share.

Non-GAAP net income in the year-ago period was $1.7 million, or $0.04 per basic share, which included $0.2 million, or $0.01 per basic share, gain from discontinued components.

Non-GAAP net income in the previous quarter was $5.2 million, or $0.12 per basic share, which included $1.4 million, or $0.03 per basic share, gain from discontinued components.

Operating cash flow for the second quarter was a net outflow of $8.4 million, primarily due to bonus payments for 2006, which were made during the second quarter.

Moving to our balance sheet, our total cash provision, including cash and cash equivalents, restricted cash, and short-term investments, was $164.5 million, compared to $166.3 million at the end of the first quarter 2007.

DSO for the quarter was 116 days versus last quarter’s 117 days.

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

Net revenue for the third quarter of 2007 is expected to be $27 million to $29 million, representing 15% to 23% year over year growth, and we expect third quarter earnings per basic share from continuing operations to be $0.07 to $0.08, representing 40% to 50% year-over-year growth. This is compared to earnings per basic share from continuing operations of $0.05 in the third quarter of 2006.

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

Steve Zhang

Thank you, Eileen, and thank you all 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 Brendan Barnicle at Pacific Crest Securities. Please go ahead, Brendan.

Brendan Barnicle - Pacific Crest Securities

Thank you. I was interested in operating margins and when we might begin to see a little more improvement there. I understand you are doing a lot of investment right now but when might we start to see some improvement on that side?

Steve Zhang

We do see our operating margins didn’t grow much in the second quarter because we are investing some of the marketing and sales efforts to break into new accounts. We expect operating margin to improve in the fourth quarter this year.

Brendan Barnicle - Pacific Crest Securities

And what do you have as a target operating margin, sort of the near-term?

Steve Zhang

Our targeted operating margin is 8% to 10%.

Brendan Barnicle - Pacific Crest Securities

Okay, and then if you go into the third quarter, do you typically see any seasonality?

Steve Zhang

Pardon?

Brendan Barnicle - Pacific Crest Securities

Just into the third quarter, do you typically see any seasonality?

Steve Zhang

No, actually our seasonality normally is the first quarter is a slow quarter for both our telecom business and security business. The fourth quarter tends to be the strongest.

Brendan Barnicle - Pacific Crest Securities

Excellent. All right, thank you very much.

Operator

Our next question is from Eric Kwan at BNP Paribas. Please go ahead.

Eric Kwan - BNP Paribas

I just have two questions. First of all, great quarter. My question is you seem to be having a lot of volatility in the third-party hardware, especially this quarter. You are declining from $7 million to about $3 million. Just going forward, what is your view on the third-party hardware? Is this going mostly one-off?

I also notice that AsiaInfo, the Lenovo business, there is a huge increase in third-party hardware. Just give us some color on how we would model this hardware going forward.

Steve Zhang

Actually, internally we don’t have a management target for the hardware. We always focus on net revenue, which is the total contract minus the third-party hardware. That is why you see the hardware pass-through tends to fluctuate a little bit. It depends on what kind of contracts we get but we always focus our management effort in making sure that we deliver the net revenue targets.

Eric Kwan - BNP Paribas

I see. So we should really view this as a total package, your service to the telco operators. Is that what you are targeting?

Steve Zhang

No, we are always trying to focus our operation focus on our own software and services. We don’t put much focus on the third-party software. We only provide the third-party hardware if the margin, it makes sense to us.

Eric Kwan - BNP Paribas

All right. I have another question and I’ll get back to the queue. I notice there is improvement in the Lenovo AsiaInfo business. Do you expect it to break even by next quarter or what is the timeline you have committed before?

Steve Zhang

Our expectation is to break even in the third quarter.

Eric Kwan - BNP Paribas

In the third quarter, okay. Thanks.

Operator

There are currently no questions in queue. (Operator Instructions) Our next question is from Lun Lu from Morningstar. Please go ahead, Lun.

Lun Lu - Morningstar

Good morning, Steve and Eileen. Thanks for taking my questions. I have three questions. Could you please provide the latest update for the business from China Mobile, China Unicom, and China Telecom and China Netcom respectively? I mean the total percentage of each of them.

Steve Zhang

During the third quarter -- in the second quarter for telecom business, China Mobile is about 61% of our net revenue.

Lun Lu - Morningstar

61?

Steve Zhang

61. China Netcom is about 8%, China Telecom is about 5%, China Unicom is about 10%, and other --

Lun Lu - Morningstar

Thank you.

Operator

There are currently no more questions in queue. (Operator Instructions) Our next question is from Eric Kwan from BNP Paribas. Please go ahead.

Eric Kwan - BNP Paribas

Just adding a question, you mentioned -- I noticed that you have some increase in terms of sales and marketing expense, both on an absolute term and a percentage term. Could you just elaborate a bit more on what kind of initiatives you are taking and how will they benefit the future earnings growth? Thanks.

Steve Zhang

We are making some of the marketing efforts to break into some new accounts. For example, we are working with both [inaudible] and operators to participate in their 3G related billing or billing testing efforts.

We also have some international travels related to getting the new accounts in the second quarter. Hopefully we’ll see some results in the second-half of this year.

Eric Kwan - BNP Paribas

Thanks. Great quarter.

Operator

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

Lun Lu - Morningstar

I still have my two questions. The second one is what is the total amount of the TD trial contracts year-to-date, and what percentage will be recognized in Q3?

Another question is could you break down the third quarter revenue guidance?

Eileen Chu

Sorry, what is your last question again?

Lun Lu - Morningstar

The last question is could you break down the Q3 revenue guidance.

Eileen Chu

By segment? Actually, we don’t give out guidance by segment, so I’m sorry. We only give out guidance on a group numbers.

Lun Lu - Morningstar

Okay, and what about the total amount of the TD trial contracts?

Eileen Chu

Actually, normally it is our policy not to disclose contract amounts but actually, because the contract was signed this quarter, so you can expect that a major percentage of the contract revenue will be recognized in the coming two quarters.

Lun Lu - Morningstar

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 Charles. Thank you. Bye-bye.

Operator

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

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