Welcome to your Third Quarter 2005, Ninetowns Digital World Trade Holdings Conference Call. My name is Liz and I’ll be your coordinator for today. At this time operations are in a listen-only mode. We will have a review facilitating a question and answer session towards the end of this conference. As at any time during the call you require assistance please key, “*”, followed by “0”. And our coordinator will be happy to assist you. I would now like to turn the conference over to your host for today’s presentation Ms. Lisa Zheng, please go ahead.
Lisa Zheng, Investor Relations
Thank you operator and I’d like to welcome everyone to Ninetowns Third Quarter 2005 Results Conference Call. With me today are Mr. Shuang Wang, Chief Executive Officer; Mr. Tommy Fork, Chief Financial Officer; and Mr. Eric Ho, Chief Strategy Officer. After our presentation ,we will have time for any questions.
Before we begin the formal remarks, participants are advised that this conference call will include statements about future events and expectations, which are forward-looking statements. All forward-looking statements involve risks and uncertainties and actual results may differ materially from those discussed or implied by such forward-looking statements. These forward-looking statements speak only as of the date of this presentation and while we may update some statements from time-to-time, we have no duty to update that to reflect new changing or unanticipated events or circumstances and you should not rely on such forward-looking statements.
In particular, the company expects to confirm risks such as (1) the entrance of additional competing software products into the company’s marketplace; (2) the need for company , to reevaluate the change into operating models; and (3) potential further encouragement by PRC inspections administration of the development of software products that may be competitively the company’s existing software products All or any of which, may negatively and significantly affect the company’s ability to generate total net revenue in the future.
Before turning the call over to our chief strategy officer, I’d like you to know that the reference in this call to dollars refer to amounts in US dollars, and also to announce that Ninetowns plans to attend the JP Morgan China Conference in Beijing on November 16. For a complete list of investor-related activities, please visit our English website at www.ninetowns.com/english. I would now like to turn the call over to our CSO, Eric. Please go ahead.
Eric Ho, Chief Strategy Officer
Thank you Lisa, and thank you everyone for joining us today. The third quarter was another solid quarter for Ninetowns. This was a transition quarter for us and we expect the transition to at least continue into the second quarter of 2006.
We are pleased because we maintained our market leadership at close to 90% of the market share and we were able to maintain our sales momentum for our enterprise software services, especially the sale of maintenance contracts which drove third quarter revenue to the high end of prior guidance. Net income, would have been higher. However, customer acquisition costs for the third quarter increased because some potential enterprise clients are waiting for the free software launch from the PRC Inspections Administration.
Despite the transition, sales of iDeclare continue to gain acceptance in the marketplace. We sold 5,000 iDeclare packages; 13,600 iDeclare maintenance contracts and 900 iProcess software packages in the third quarter.
Some of the well known clients who purchased our iDeclare software in the third quarters are Dupont China Holding, Pfizer Pharmaceuticals Valent, MetroGene Cash and Carry (ph); Kimberly-Clark Personal Hygienic Products (Nanjing), Shanghai Whitecat Shareholding Company, Guangdong Midea Refrigeration Equipment, Massen Group (ph), and the Ching Instruments and the major liability companies.
At the end of the third quarter, we estimate that total number of companies making electronic import- export filings with the PRC Inspection Administrations was 134,000. Of these, approximately 119,000 are users of iDeclare indicating that our market share among such e-filers was approximately 88.8%.
In addition, in the third quarter we were selected as the winner of $400,000 development contract for the PRC Inspection Administration software products. That has certain basic functionalities similar to those of our existing software products iDeclare and iProcess.
Currently under the supervision of the PRC Inspection Administration, there are close to 100 users beta testing these tailored software products. And we estimate that by mid-December over 400 beta tests will likely be completed in selected regions of Guangdong and Ningbo (ph). If these beta tests prove to be successful, then we estimate that the PRC Inspections Administration will officially launch these software products.
Our headcount at the end of the third quarter 2005 was approximately 760 employees, of which approximately 300 are in R&D. Approximately 400 are in Sales and Marketing.
Now let me turn the call over to our chief financial officer Tommy Fork for a brief review of key financial results. Tommy, please go ahead.
Tommy Fork, Chief Financial Officer
Thank you, Eric. We generated total revenue of $7.3 million for the third quarter of 2005 representing a 12.4% increase compared to $6.3 million for the third quarter of 2004. As expected, this represented a slight decrease of 6.3% compared to second quarter of 2005. Net revenue from enterprise software for the third quarter of 2005 was $6.4 million representing 67.8% of our total revenue as compared to 96.4% and 60.5% for the third quarter of 2004 and the second quarter of 2005 respectively.
Net revenue from software development service for the third quarter of 2005 was $0.8 million representing 11.5% of total revenue as compared to 3.6% and 19.5% for the third quarter of 2004, and the second quarter of 2005 respectively.
Gross profit for the third quarter of 2005 was $6.8 million or 93.0% of our total revenue. representing an increase of 6.6% compared to $6.2 million or 96.1%, of total net revenue for the third quarter of 2004. Gross profit for second quarter of 2005 was $7.0 million or 19.5% of total revenue. As usual, we have relatively high gross profit margin of over 95% for our enterprise software business. However, the gross profit margin for our software development services in the third quarter was approximately 50%. This mainly is due to the completion of several small system integration contracts with some local PRC Inspections Administration offices which had relatively low profit margins due to the higher hardware components.
Selling expenses for the third quarter of 2005 were $1.0 million compared to $454,000 in Q3 2004 and $636,000 in Q2 2005. Because of the transition. Software and services sales are becoming relatively typical. We’re serving in higher overall customer administration costs.
General and administrative expenses for third quarter of 2005 were $1.9 million compared to 1.1 million in Q3 2004 and $1.4 million in Q2 2005. The increase from Q2 was primarily due to increase of professional service costs. At the same time we continue to maintain our efforts in the research and development resulting in 266,000 for the third quarter of 2005 compared to 236,000 in Q3 2004 and 267,000 in Q2 2005.
Total operating expenses for the third quarter of 2005 were 3.2 million representing an increase of 69.5% from the third quarter of 2004 and increase of 23.2% from the second quarter of 2005.
Operating income for the third quarter of 2005 was $3.6 million representing a 21.5% decrease compared to $4.5 million for third quarter of 2004. Operating income for the second quarter of 2005 was $4.7 million. The main reasons for the decline in operating income are because of the increasing services and G&A expenses.
Operating margin for the third quarter of 2005 was 50.0%. This compares to operating margins of 71.7% and 60.6% for the third quarter of 2004 and second quarter of 2005 respectively.
Net income for the third quarter of 2005 decreased to $4.1 million representing a 5.9% decrease compared to net income of $4.3 million for the first quarter of 2004. Net income for the second quarter of 2005 was $5.1 million. Diluted earnings per ADS or shares for the third quarter of 2005 were $0.11. This compares to the diluted earning per ADS or share of $0.15 or $0.14 for the third quarter of 2004 and second quarter of 2005 respectively. We believe we’ll end the third quarter of 2005 in a really strong financial position with a debt-free balance sheet and with a cash and short term investment balance of $112.5 million.
We generated also $1.5 million in cash from operations in the first quarter. Finally, in accordance with our revenue reconciliation policies, we reached our enterprise software sales and maintenance contract sales are recognized over a 12-month period. Our earnings that is filed at the end of the third quarter of 2005 was $10.6 million, this compares to $11.6 million at end of the second quarter of 2005. We expect to recognize this at the end of the new balance of $10.6 million as revenue in the next 12 months. I will now turn the call back to our Chief Strategy Officer, Eric. Please go ahead Eric.
Eric Ho, Chief Strategy Officer
Thank you, Tommy. In summary, as we mentioned in our last conference call with investors since the emergence of the free software, we have adjusted our business model in order to better compete in the marketplace. After the PRC Inspection Administration starts providing the free software, we expect to continue to divide our revenue stream from two components.
The critical difference between our prior operations is that we expect the government’s initiative to help accelerate the number of companies adopting e-filings. The benefits are compelling versus traditional paper filing and we continue to expect e-filing to become the de facto standard. The PRC official’s endorsement is expected to go a long way toward giving the market confidence in e-filings and the need to convert.
As we move forward, we expect the first component of our revenue to be from the sale of our upgraded services from the free software of both iDeclare and iProcess. For iDeclare instead of charging a one-time license fee of $550, we expect to charge a one-time initialization fee of $550 for upgrading to our premium services and features compared to the free software along with an annual maintenance fee of $180 from the second year onwards.
Also, in certain regions of China, we expect continue to charge users for each iDeclare application filing. The application is expected to cost approximately $2.50 per transition. For iProcess we plan to launch a standard package with a one-time initialization fee in the range of $400 to $600 for upgrading to our premium services and features from the free software along with an annual maintenance fee in the range of $200 to $400 from the second year onwards. As a result, we expect our enterprise software model to evolve into a subscription-based model for our software services.
The second component of our revenue will still be divided from our software development services.
In terms of guidance for the fourth quarter of 2005, we expect revenues to be in the range of 6.4 million to 7.2 million. With net income in the range $2 million to $2.9 million or diluted EPS of $0.05 to $0.08. For the full year we are reiterating our prior guidance.
We continue to expect the total revenue to be in the range of $26.5 million to $30.5 million; operating margin to be in the range of 53% to 58%; and diluted earnings per share or EPS to be in the range of $0.44 to $0.50. This is based on the fully diluted share count of 36 million shares or ADS. Operator that conclude our prepared comments, we will be happy to take any questions now.
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