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China TechFaith Wireless Comm. Tech. Ltd. (NASDAQ:CNTF)

Q3 2007 Earnings Call

November 13, 2007 7:00 pm ET

Executives

Joseph Bialta

Baozhuang Huo - Deputy Chief Executive Officer

Dr. Gilbert Lee - Director, President, Chief OperatingOfficer

Analysts

Adele Mao - Susquehanna

Brian White - Jefferies

Operator

Good day, ladies and gentlemen, and welcome to the ChinaTechFaith third quarter 2007 conference call. (Operator Instructions) Now, Iwould like to introduce Mr. Joseph [Bialta]. Please proceed.

Joseph Bialta

Thank you for joining China TechFaith's third quarter 2007earnings call. The company’s attorneys advise that this call will containforward-looking statements. These statements are made under the Safe Harborprovisions of the U.S. Private Securities Litigation Reform Act of 1995. Theseforward-looking statements can be identified by terminology such as will,expects, anticipates, future, intends, plans, believes, estimates, and similarstatements.

Among other things, the business outlook and quotations frommanagement and this announcement, as well as TechFaith's strategic andoperational plans contain forward-looking statements.

TechFaith may also make written or oral forward-lookingstatements in its periodic reports to the U.S. Securities and ExchangeCommission on Forms 20-F and 6-K, et cetera, in its annual report toshareholders, in press releases and other written material, and in other oralstatements made by its officers, directors, or employees to the third parties.

Statements that are not historical facts, includingstatements about TechFaith’s beliefs and expectations, are forward-lookingstatements. Forward-looking statements involve inherent risk and uncertainties.A number of important factors could cause actual results to differ materiallyfrom those contained in any forward-looking statement.

Potential risks and uncertainties include, but are notlimited 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 internationalcustomers, TechFaith's earnings or margin declines, failure of competing againstnew and existing competitors, and other risks outlined in TechFaith's filingswith the U.S. Securities and Exchange Commission, including its annual reporton Form 20-F.

TechFaith does not undertake any obligation to update anyforward-looking statement except as required under applicable law.

All information provided on today’s conference call is as oftoday’s date. China TechFaith does not undertake any obligation to update anyforward-looking statement except as required under applicable law.

With us today are Mr. Baozhuang Huo, the company’s DeputyCEO; and Dr. Gilbert Lee, President and COO. Mr. Dong, Chairman and CEO andChristopher Holbert, CFO, are also on today’s call and will be available forthe Q&A period.

Finally, if you have not received a copy of today’s resultscall, please call The Ruth Group at 646-536-7003, or you can get a copy of therelease off TechFaith's website.

I would now like to turn over the call to Mr. Baozhuang Huo.Please go ahead, sir.

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Baozhuang Huo

Thank you and welcome to our third quarter call. We areexcited and encouraged by the results in the third quarter. Revenue was up 20%over Q2 and up 122% over Q3 2006. We returned to profitability ahead ofschedule and are pleased with our momentum.

We continue to make significant progress in our business. Inthe past few quarters, we have quickly become one of the most successful newODMs in China, with 82.5% of total revenue coming from the ODM business.

The outlook of the fourth quarter of this year is alsopromising. We expect 10% to 14% revenue growth and to maintain sustainableprofit. We think the total revenue for 2007, more than 80% will be generatedfrom our ODM business. [inaudible] and royalty are expected to account for lessthan 20% of revenue, with smartphone up 20%, feature phone at 45%, wirelessmobile at 10% and others at 5%.

In the past 18 months, the industry in China has beenundergoing a lot of changes and challenges. Some of the independent designhouses became stagnant due to the weak [competitiveness] of their customers.Some did not make significant progress in development of 3G technology andexpansion into international markets, due to the lack of R&D capability andunderstanding of international markets. Some even went into bankruptcy due totheir failure to win enough contracts, even if they have outstanding[projects].

TechFaith not only survived; we have excelled. Oursuccessful expansion into international markets and the continued growth in thedomestic market enabled us to promote middle to high-end products, both homeand overseas. At the same time, products which have matured in internationalmarkets can be sold in the Chinese market at a reasonable margin.

Clearly we are different from most of the traditional ODMswhose competitiveness is hardware design and manufacturing efficiency. We arean ODM focusing on one-stop handset solution and we are fully aware thatwithout strong R&D capability and sustainable profitability, we will becomejust another ordinary ODM player.

In the past quarter, we were granted a new license agreementfrom QualComm and we are now able to develop, manufacture, and sell productscovering all 3G standards, including CDMA 2000, WCDMA UMTS, and TD-SCDMA.

We are also making major progress with new products. Wesuccessfully launched the world’s first WCDMA/GSM dual-mode, dual standby phoneand the world's first Windows-based GSM/CDMA dual mode dual standby pocket PCphone to respond to the demand of the global markets.

On the growth side, we are excited that we have won thefirst contract from a customer that is not in the traditionaltelecommunications sector. We are working on [demands] in the broader,non-telecommunications market such as commercial and [inaudible] industry.

We have diversified our customer base by successfullypenetrating the China market and the overseas market, including Asia, Europe,and Russia, and we made inroads in North America, Middle East, and LatinAmerica in this quarter.

With that as a background, let me turn the call over to ourPresident and COO, Dr. Lee.

Dr. Gilbert Lee

Thank you. In the following session, I will cover coreoperational highlights and financial highlights related to the third quarter.

The first one is our feature phones enjoyed a healthygrowth. Feature phone revenue in Q3 was $18.15 million, which was 243%sequential growth over the second quarter. In Q3, feature phone shipment wasaround 191,000 units, with ASP around $95. In Q4, shipments are expected to bearound 220,000 units, with ASP around $123.

Our feature phone customers are mainly in emerging marketssuch as Southeast Asia and Eastern Europe. At present, feature phones aremainly 2.5G or GSM CDMA dual mode, dual standby phones. We will launch more 3Gphones in Q4 this year. We expect high sequential growth for feature phones inthe coming quarters.

In terms of the models, we will launch 12 new models in thesecond half of this year. There are five models of GSMX phones, five models ofWCDMA, which is a 3G phone, and two CDMA1X phones.

Okay, this is the first highlight I want to address. Nowlet’s turn to the second highlight. The sales of smartphones will continue togrow in the coming quarters. Smartphone revenue was $8.7 million in the thirdquarter, which is 32% sequential growth over the second quarter.

Total smartphone shipments in Q3 was around 47,000 units.Shipment expectation in Q4 is about 60,000 units, with ASP of $200.

In the second half of 2007, we will launch seven new models.They are two CDMA1X phones and two models of GSMX with GPS phones, one [HSDPA]phones, which is a 3.5G, and one model with a GSM CDMA dual mode and one modelis GSM dual SIM phone, and last one is a GSMX slim music phone.

Okay, now let me address the third highlight which isrelated to our data card and wireless module business.

Revenue in Q3 was lower than our expectation. This is mainlybecause shipments of and orders from a domestic customer for [inaudible] brandgot delayed, due to the change of schedule at the customer side.

We launched four 2.75Gs, which was a GSMX model and 1 3Gmodel in Q3. Due to strong orders in the pipeline, we expect the revenue in Q4will resume to the normal level.

Now, the number four highlight and it is the last highlightfor operation issues, is we remain positive on the development in TD-SCDMA. Wehave already signed four TD-SCDMA contracts. We expect to sign another one witha domestic customer in this quarter. TD-SCDMA projects will start generatingrevenue in Q4. We will server our TD-SCDMA customers either in the form of adesign plus royalty or in ODM model.

Now, turning to two items related to our finance issues. Ijust want to add some explanation to our earlier release. Number one, bad debtprovision was $199,000, inventory provision was $1.3 million. Inventoryprovision method is subject to the lower between costs and market value.

The second finance highlight is reduction of R&D in thequarter is mainly related to engineers’ salary and benefits. Duringrestructuring in Q2, all platforms were closed. Supporting staff for the oldplatform were downsized. Our R&D team is now focusing on 3G, 3.5Gtechnology and our ODM business. This change resulted in the reduction ofR&D expenses in Q3.

We have around 1,300 employees at present. Ninety-percentare engineers. We will maintain this staff level through this year.

Looking into next year, we are targeting continual revenuegrowth and profitability. We will maintain tight cost control and focus ongaining momentum in our business.

Operator, that concludes our formal comments. We are nowready to take any questions.

Question-and-AnswerSession

Operator

(Operator Instructions) Your first question comes from theline of Adele Mao with Susquehanna International. Please proceed.

Adele Mao -Susquehanna

I have several questions. Seeing your revenue mix changingsignificantly from second quarter to more feature phones in the third quarter,could you talk about your expectation for revenue mix going forward? How shouldwe think about growth into 2008 indifferent areas of your business?

Dr. Gilbert Lee

Okay. As I stated, in Q4 we will continue to see the stronggrowth in this area. In last quarter, in Q4 we expect to ship 220,000 units.

Over the year, feature phone business will take about 30% --will take about 45% of our business and I think next year, both smartphone andfeature phones will dominate our business and what Bob just mentioned, in thelong run we expect the phone business, the ODM business, including smartphoneand feature phone, and data card will [be more] than 80% of our long-termrevenue stream.

Adele Mao -Susquehanna

Okay. Looking at your gross margin for the quarter, itstayed sort of flat from last quarter but your revenue mix is very different.Could you just discuss margin trends in the key business areas and howsustainable they are in -- I guess the most important ones are smartphones andfeature phone?

Dr. Gilbert Lee

More and more, we will concentrate on mid and high tier. Weare not competing at the low tier volume phone. In this area, our demand is sostrong so I think the margin will not erode, and either will maintain stable inthis level and even is a chance we get higher margin in next year.

Adele Mao -Susquehanna

Okay, great. My last question is related to your comment onthe operator brand got delayed at customer side. How much of the revenueactually was pushed out to the fourth quarter?

Dr. Gilbert Lee

It is about $2 million.

Adele Mao -Susquehanna

Great. That’s all I have. Thank you.

Operator

Your next question comes from the line of Brian White withJefferies. Please proceed.

Brian White -Jefferies

Yes, Gilbert, I’m wondering if you could talk a little bitabout the inventories. We saw a 75% sequential up-tick in inventories. What canyou attribute that to?

Dr. Gilbert Lee

Remember in last year, the ODM business was a small portionof our total revenue. In Q3, ODM accounted for 83% of our total revenue, so asthe ODM business is increasing sharply in this year, we need to procure aminimum volume of components and material to enjoy a bigger discount. We alsoneed some low lead times components, so we can get a shorter turnaround timefor the delivery.

In the short-run, inventory increase will be parallel to therevenue increase. However, the management team, Bob and Chris, they are workingon a new project and are going to an innovative way. We will make the inventorycome down a little bit or at least stay at the same level in the long runcompared with our revenue growth.

Brian White -Jefferies

Gilbert, will inventory decline sequentially in the Decemberquarter? Or it is going to just rise with sales?

Dr. Gilbert Lee

I will say maintain -- it will increase a little bit but itis not significant in Q4.

Brian White -Jefferies

And what is the inventory? Are these raw components or is itactually a finished product?

Dr. Gilbert Lee

Currently, all raw material. We don’t have any finishedproduct. Once there is a finished product, we will ship right away. We arecustom-made. We are not cookie makers.

Brian White -Jefferies

Okay, and Gilbert, can you talk a little bit about what youare seeing in the component market in terms of tightness? I mean, there’s beena lot of talk about certain components in handsets being tight, so you areholding on to these inventories, maybe lead times are long -- just talk aboutwhat you are seeing out there, what’s tight and what’s not.

Baozhuang Huo

Actually, the components, the kinds of the mobile phones,the whole market, the shipment is very big so a lot of the components, the leadtime is very long, some even longer than three months, even four months. So weshould prepare some key components to make sure our delivery lead time is in areasonable range.

Actually in Q1, Q2, we just get orders and the money fromcustomers, everything from customers and then we prepare the material. So wefind that [inaudible] a lot of, the shipment delay issue. As you know, for onephone, there are a lot of components inside. So for reduced the shipment leadtime and make sure our order can be on time delivery, so we prepare somematerial. But we are control this inventory in the [inaudible].

Brian White -Jefferies

Okay, is there anything you can point to, like a poweramplifier or memory or any type of particular component?

Baozhuang Huo

Actually, for those kinds of components, it’s [inaudible]shortage in the [inaudible] market, but for those components, we use -- wetypically, we are [inaudible] very big [forecast] actually. That’s the best[inaudible], so this way we can make sure our delivery.

Brian White -Jefferies

Okay, and just finally, if we look at the feature phone andthe smartphone market, it seems this year, smartphones have been disappointingand feature phones have been better than expected. Could you just, from a bigpicture point of view, talk about what’s happening there? Why is the smartphonenot gaining as much traction as the feature phone?

Baozhuang Huo

Don’t forget, the worldwide market, the ratio betweenfeature phone to the smartphone is four to one, so when we launch our high tierphones with rich features, the customer is just so easily attracted by ourfeature phone and they switch from smartphone to feature phone.

Brian White -Jefferies

Okay, and Gilbert, where are these being sold into thefeature phone, in terms of distribution service provider, OEM -- how does thatlook on a percentage basis?

Dr. Gilbert Lee

We stock three categories -- number one is localdistributor, local channels. Number two is local OEM, local branding. Andnumber three is telephone operators. These are the three categories of ourcustomer base.

Brian White -Jefferies

Thank you.

Operator

(Operator Instructions) At this time, there are no morequestions in queue. I would like to turn the presentation over to managementfor any closing remarks.

Dr. Gilbert Lee

I will represent our management team and say thank you toall the investors. It’s been a tough year for the last four quarters. We reallystruggled but everybody is on Mr. Dong's strategy. We focused on the strategy,we said what we wanted to do and we did what we wanted to do. And this is aturning quarter; finally we are returned to profitability and the wholemanagement team has a very high confidence this is not a one quarter onlyevent. You will see the strong growth, both on the top line and the bottomline. We will maintain a healthy strong growth quarter by quarter.

I hope we will constantly deliver the good results to eachof you. Again, thank you, everybody.

Operator

Thank you for your participation in this conference. This concludesthe presentation and you may now disconnect. Good day.

TRANSCRIPT SPONSOR



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