Here’s the entire text of the prepared remarks from China Techfaith Wireless’ (ticker: CNTF) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.
David Pasquale, U.S. IR/Media Contact
Eva Hon, Chief Financial Officer
Bob Huo, President
Brian White, L.P., Analyst
Marian Dolan, Moon Capital, Analyst
Tienyu Sieh, Merrill Lynch, Analyst
Leticia Yu, Analyst
Chang Tiu, Foreign Technology Research, Journalist
Good evening, ladies and gentlemen. Thank you for standing by. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session.
I would now like to turn the conference over to David Pasquale. Please go ahead, sir.
David Pasquale, U.S. IR/Media Contact
Thank you, Operator. And thank you, everyone, for attending China TechFaith's third quarter 2005 earnings call. With us today are the Company's Chief Executive Officer, Mr. Defu Dong, President Bob Huo, and Chief Financial Officer Eva Hon.
The format of the call will be Eva Hon reviewing the financial highlights, and then Bob providing an update on the Company's strategy. We will then have time for any questions. The three Company executives will be available for all of your questions at that time.
Please also know, however, that there's a PowerPoint presentation that has been loaded onto the Company's investor relations website, and can be downloaded to accompany the prepared comments and for the Q&A. The link is under the Q3 Webcast link.
Before we begin the formal call, the Company's attorneys advise that this call will contain forward-looking statements. These statements are made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminology such as "will", "expects", "anticipates", "future", "intends", "plans", "believes", "estimates", and similar statements.
Among other things, the business outlook and quotations from management in this call, as well as TechFaith's strategic and operational plans contain forward-looking statements. TechFaith may also make written, oral, or forward-looking statements in its periodic reports to the U.S. Securities and Exchange Commission on Forms 20-F and 6-K, etc., in its annual reports to shareholders, in press releases and other written materials, and in oral statements made by its officers, directors, or employees or third parties.
Statements that are not assertible facts, including statements about TechFaith's beliefs and expectations are forward-looking statements. Forward-looking statements involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those contained in any forward-looking statements.
Potential risks and uncertainties include, but are not limited to TechFaith's limited operating history; mobile handset brand owners' discontinuation or reduction of the use of independent design houses; TechFaith's ability to retain existing or attract additional international customers; TechFaith's earnings or margin declines; failure of competing against new and existing competitors; and other risks outlined in TechFaith's filing with the U.S. Securities and Exchange Commission, including its registration statement on Form F-1 as amended. TechFaith does not undertake any obligation to update any forward-looking statements except as required under applicable law.
I would now like to turn the call over to Ms. Eva Hon. Please go ahead.
Eva Hon, Chief Financial Officer
Thank you, David. And welcome, everyone, to our third quarter call. As was in our earnings release, it was an impressive quarter for us from an operations standpoint. We continue to leverage our relative low operating costs, while supporting a higher revenue base.
Highlights from the third quarter include net revenue increased to $23.3 million, representing 94% year-over-year growth.
Income from operations increased to $10.5 million, representing 158% year-over-year growth.
Net income increased to $11.4 million, for a 208% year-over-year growth.
Diluted earnings per ADS for the quarter was $0.26.
On page five, results compare on a nine month basis. One point to note is while turnover increased an impressive 107% over the same period 1 year ago.
Gross profit increased 130%.
Operating profit increased 170%.
And net income increased 166%.
This trend shows we have been capable to try and increase revenue over a stable cost basis.
Turn to page six. You will see we have some analysis on design fee and royalty income combined. This is a more effort reflection of total compensation we’ve received from our customers for a design project.
Third quarter's design fee plus royalty income was $20.7 million compared to $19.5 million in the second quarter of '05. An increase of 106% from $10 million in the same quarter of '04.
Design fees for the third quarter of '05 was 16.8%, an 82% increase as compared to $9.1 million for the same period in '04. And $15 million in the second quarter of '05. The increase on a year-over-year basis was due to an increase in the number of revenue cost-building models across the life cycle revenue margin.
Royalty income in the third quarter of '05 was $4.1 million, which increased 383% in the same quarter in '04, and decreased 9.1% on the second quarter of '05. This increase was due to our customers' shipments of more royalty-contributing handsets.
Looking at the composition of design fees and royalty fees, one point to note is that 11% of the revenue from UMTS in the prior quarters was from our first 3G UMTS phone to be launched in Europe. Because we were in progress to achieve the next revenue margin for the 3G project in the third quarter, thus we recognized no revenue. We expect revenue from UMTS in non-China markets to resume in the fourth quarter this year.
In addition, we have also generated steadily increased revenue from CDMA 1X from first quarter to third quarter this year.
Overall, gross margin was 61.1% for the third quarter of '05, compared to 55% in the same quarter in '04.
Design fee plus royalty margin remained stable at approximately 66% in the third quarter.
Total operating expense for the third quarter of '05 was $3.7 million compared to $2.8 million in the year-ago period. And $3.6 million in the second quarter of '05. The increase is primarily due to growth in the Company's business, and higher general and administrative expenses associated with being a public Company, following the Company’s made '05 IPO.
Operating margin was $45.1 million in the third quarter of '05, in line with our second quarter's level. This was compared to $33.8 million in the year-ago period.
Net margins reached 48.8%, compared to 53.2% in the second quarter of '02 --'05. However, compared to normalized net margin of 46.5% in second quarter by excluding written back of interest expenses. Net margin in third quarter continued to improve over previous quarters.
In terms of our outlook, based on the assumption of our continued success in the international market, and stabilization of overall domestic markets, we are reiterating our full year '05 outlook for revenue to be approximately $90 million, with earnings per ADS at $0.93. Based on 43.8 million total outstanding ADS at September 30, 2005.
Let me now turn over the call to Bob Huo, for a review of our strategy.
Bob Huo, President
Thank you, Eva. TechFaith continues to expand business worldwide by supporting customers through a bold platform. We are positioned for growth, as operators require more high levels and service and advanced communication technology. We are excited because the faster new technology are adopted by the market, there will be more demand in TechFaith's specialized service from brand owner and operators.
We see the handset market is shifting for an open market on 2G and 2.5G GSM products to our operator-tailored markets, or CDMA1X, WCDMA, EVDO and HSDPA. We are 2.5G GSM giants, and in CDMA1X technologies, in a 3G solution on WCDMA/UMTS.
We are also developing CDMA 2000 EVDO, TD-SCDMA, and HSDPA, for PDA/Smart Phone technology. We are able to provide a solution based on Linux and WindowsCE operating systems.
Page 10. A key requirement of design MMI and UI, essentially is a middle area so far on dual interface. Operators increasingly require customization in the features in the look and the feel. For example, the SimPhone marketed by CMHK and the Vodafone have different customization features in the look and the feel.
The handset market is moving from the traditional one handset with one MMI/UI for different operators to an operator-tailored environment. Operators require different MMI/UI software as OEM cannot use this. Resulting in the OEM’s higher, and a higher development cost.
Page 11. Our core competency in developing reusable software and the module remain the same. However, new requirements in MMI and UI customizations for the operator, for an owner on developing cost. We can provide a similar MMI/UI for different brand owners for the same operators. And thus shortening development time and reduced costs.
Page 12. I can update you on how we see our business geographically. We split our market into three segments. The first column China, India, South America, and other Asian Markets. Secondly, Japan. And third is Europe and America.
With regard to our domestic Asia market, we remain with our position to serve this market. We have extensive experience in this market. We have a strong churn record for both domestic and international customers. Handset technology certification is relatively low. We are optimizing on also low cost model targeted for emerging markets such as South America and India.
We are positioned to serve the Japan market. We also have a strong track record in working with Japanese brand owners with the main share of the market. This is a more sophisticated market from a technology standpoint. We have to leverage our strong software expertise. We intend to focus on relations for the operator and the brand owner.
Finally, we are very active now in Europe and America. We announced our intention to further establish our presence in this imposing market. Europe in particular has relatively high technology sophistication. Operator in both marketing and acquisition, we are uniquely positioned as we successfully launch our first 3G UMTS phone in Europe.
Page 13. In summary, the following is all our business.
For 2.5G GSM handset design business, we estimate contributions for China and other Asian markets to remain stable. We are targeting the Europe and the American markets.
Revenue from 2.5G CDMA1X technology contribution in '05, and it had clear growth opportunity in '06 for China and other emerging markets, India and South America. We believe our CDMA1X products will be launched in Japan, Europe, and the American markets in second half of '06.
Page 14. About 3G UMTS technology, our first product was launched in October of this year in Europe. We understand our 3G UMTS will be launched in Japan in first half '06.
We are expecting that EVDO products will be launched in Q4 next year in America.
For UMTS and EVDO in the China market, it's subject to the license timetable.
We are currently actively developing 3.5G HSDPA technologies.
Page 15. We started to provide a turnkey solution to chipset provider. Turnkey solution has a following to value added economize development value chain. And a short time to market, low R&D investment and provide enough flexibility for customers.
Page 16. Let me first touch on wireless module. This has been a business focused on some of smaller design house and competitors. These products are based on RF and the base band technology used in handset design. And thus, we have significant cost advantage. We have launched the GSM/GPRS, CDMA1X modules, and expect to launch 3G UMTS modules, and are developing EVDO, HSDPA modules, for settlements of entry barrier for whole design industry.
For Smartphone products, we are setting up Company in Shenzhen to provide global service. The business is expected to provide a design solution and provide a one-stop service.
Lastly, on application software. This business is under development. We expect revenue contribution in second half of '06. We expect to utilize TechFaith's partners in distribution channel, current customer, and chipset providers to grow the business. Products include WAP, JAVA, MMS, DRM, multimedia software, and so on.
Okay. Operator, we are now ready for any questions.
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