Hurray! Q3 2007 Earnings Call Transcript

Hurray! Holding Co., Ltd. (HRAY)

Q3 2007 Earnings Call

November 19, 2007 9:00 pm ET

Executives

QD Wang - Chairman and Chief Executive Officer

Sean Wang - President, Acting Chief Financial Officer, Chief Operating Officer

Analysts

Alicia Yapp - Citigroup

Analyst for C. Ming Zhao – SIG

Eddie Leung - Merrill Lynch

Helena Qiu - SBI E2-Capital

Presentation

Operator

Welcome to our third quarter 2007 earnings conference call. During this call, QD Wang, our Chairman and Chief Executive Officer; and Sean Wang, our President and Acting Chief Financial Officer, will discuss Hurray!’s financial results for the third quarter of 2007 and business operations. After their remarks, we will open the call for your questions.

Before we begin, I would like to remind you that during the course of this call we will be making forward-looking statements which are subject to risk and uncertainties. You can also identify forward-looking statements by terminology such as will, expects, anticipates, future, intends, plans, believes, estimates and similar statements. The accuracy of these statements may be impacted by a number of business risks and uncertainties that could cause our actual results to differ materially from those projected or anticipated.

Such risk and uncertainties include, but are not limited to, those outlined in our filings with the Securities and Exchange Commission, including our registration statement on Form F-1. We do not undertake any obligation to update these forward-looking statements except as required under applicable law.

Now I would like to invite QD Wang, our CEO, to address you. Please proceed, sir.

QD Wang

Good evening and good morning to those from Asia. Thank you for joining us on Hurray!’s third quarter 2007 earnings announcement. First of all, let’s start with the financial highlights. Our total revenues were $13.6 million, a decline of 6.5% quarter over quarter and 23.9% year over year, and below our previous guidance of $15.5 million to $16.5 million.

Wireless value-added service revenues was $11.4 million, a decline of 10.7% quarter over quarter and 30.6% year over year.

Recorded music revenues, which are from our record label business were $2.2 million, a growth of 22.8% quarter over quarter and 47.8% year over year.

Software and system integration service revenues was $4,000.

Net loss was $11.5 million. Net loss include a goodwill impairment charge of $9.6 million on our wireless business and a disposal gain of $0.03 million on selling of software and system integration services business.

Adjusted EBITDA was negative $11 million. Diluted loss per ADS was $0.53. Excluding the goodwill impairment charge and the disposal gain on the sale of the software and system integration business, non-GAAP fully diluted loss per ADS was$0.09.

Q3 was extremely challenging for us because the operating environment continued to deteriorate and we missed our revenue guidance. China Unicom's new revenue confirmation policy had a major impact on our business with them and the recent changes in policies by regulatory authorities and operators affecting particularly wireless applications for TV programs, as well as WAP portal services, have further limited our ability to generate profitable WVAS business.

In light of these recent changes, we took an impairment charge of $9.6 million in this quarter. However, our efforts in carrying out our content strategy made further progress as our music business produced growth of 22.8% quarter over quarter and 47.8% year over year, generating revenues of $2.2 million. We are confident about the prospect of transforming Hurray! into a leading entertainment production and distribution house in China.

Now I would like to turn it over to Sean for financial details and business highlights.

Sean Wang

Thank you, QD. I am going to give some detailed analysis on the business results.

Total revenues for the third quarter ended September 30, 2007 were $13.6 million, representing a 6.5% decrease from $14.6 million for the preceding quarter, and a 23.9% decrease from $17.9 million for the third quarter in 2006.

Total wireless value-added services revenues were $11.4 million for the third quarter of 2007, a decline of 10.7% as compared with $12.7 million in the previous quarter and decline of 30.6% as compared with $16.4 million in the third quarter of 2006.

Recorded music revenues -- which represent revenues of our controlled music companies Freeland Music, Huayi Brothers Music and Hurray! Secular Bird -- were $2.2 million, a growth of 22.8% as compared with $1.8 million in the previous quarter and growth of 47.8% as compared with $1.5 million in the third quarter of 2006.

Total gross margin was 23.5% for the third quarter of 2007 as compared with 32.9% for the previous quarter and 37.5% for the third quarter of 2006.

Gross margin for wireless value-added services was 19.6% for the third quarter of 2007, as compared with 30.1% in Q2 2007 and 36.9% for Q3 2006. Recorded music gross margin was 43.1% for the third quarter of 2007 as compared to 51.7% in Q2 and 45.1% for the third quarter of 2006.

Total gross profit was $3.2 million for the third quarter of 2007, representing a decline of 33.1% as compared with $4.8 million for the previous quarter and a decline of 52.5% as compared with $6.7 million for the third quarter of 2006.

Total operating expenses were $15.3 million for the third quarter of 2007, representing growth of 225.4% as compared to $4.7 million for the previous quarter and growth of 179.5% as compared to $5.5 million for the third quarter of 2006. Total operating expenses included $9.6 million in goodwill impairment charge for our wireless business.

Interest income for the third quarter of 2007 was $0.6 million, the same as the previous quarter. Income tax benefit was $0.1 million in the third quarter 2007, compared to income tax expense of $0.2 million in the third quarter of 2006, and $0.04 million in the previous quarter.

Net loss was $11.5 million for the third quarter of 2007. Net margin was a negative 84.7% for the third quarter of 2007 as compared to the previous quarter’s positive margins of 1.3% and 9.0% for the third quarter of 2006.

Adjusted loss before interest, tax, depreciation, amortization and stock- based compensation --adjusted EBITDA -- was $11.0 million for the quarter. Reconciliations of net loss under U.S. GAAP and adjusted EBITDA are included at the end of this release.

Fully diluted loss per ADS was $0.53 based on a weighted average of 21.8 million diluted ADS for the third quarter of 2007. This figure compares to earnings per ADS of $0.01 based on a weighted average of 21.8 million diluted ADS for the previous quarter and earnings per ADS of $0.07 based on a weighted average of 21.7 million diluted ADS for the third quarter of 2006.

Excluding the goodwill impairment charge and the disposal gain on the sale of the software and system integration business, non-GAAP fully diluted loss per ADS was $0.09 based on a weighted average of 21.8 million diluted ADS for the third quarter of 2007.

As of September 30, 2007, the company had outstanding 21.7 million basic ADS and 21.8 million fully diluted ADS, excluding share options granted above the average market value of Hurray! stock for the quarter, as their effect would have been anti-dilutive.

As of September 30, 2007, the company had $64.8 million in cash and cash equivalents.

Now I am going to talk about business highlights.

The business highlights for this quarter in particular, we have some gains in the music business. Hurray! released a series of new songs including two albums and two singles and launched successful marketing programs to promote the new releases simultaneously over Internet and wireless platforms.

"I Will Repay Love With Anything" ("Wo Yong Suo You Bao Da Ai"), was awarded Best Film Song at the Hong Kong Golden Bauhinia.

Hurray! artists including Jane Zhang, Huizhen Li, Yu Quan, Wenjie Shang, Zheng Huang, and others were invited to the One-Year Countdown Celebration for Beijing Olympics, a very important event in China. The event was held separately in Beijing and Macao.

In addition, Huayi Brothers Music popular artist, Jane Zhang, was appointed Ambassador of UNICEF in September, after her concert was successfully held in Beijing on July 28.

New Run Entertainment had significant progress in the company's TV programs. Entertainment programs including "Angel Superstar" ("Tian Shi Ming Xing Hui"), "Entertainment Super Soldier" ("Zong Yi Qi Bing") and TV Series "When Snow Falls in Love with Plum Blossom" ("Dang Xue Hua Ai Shang Mei Hua") are among the most successful and highly rated TV programs of the company.

Hurray! signed up a number of new artists, including: Boran Jing, the champion in "Go, Good Boy! 2007" and the "Most Popular Star on the Internet” by Huayi Brothers Music; Xinbo Fu by Huayi Brothers Music; and Jing Hu and Ke Zhao by Hurray! Freeland.

Hurray! launched 14 new titles on China Mobile's game portal, including "Loafter Swordsman2", "Space Fortress", and "Country Heroes".

The business outlook. For the fourth quarter 2007, Hurray! expects its total consolidated revenues to be between $13 million and $14 million, reflecting the continued impact of tightened enforcement of policy and regulation changes previously announced by the Ministry of Information Industry (MII) and mobile operators.

Now I am going to talk about, in particular, the sale of software and system integration business. On October 8, 2007, the company announced the signing of definitive agreements to sell its software and system integration business unit, Hurray! Times Communication for $4.8 million in cash to one of its primary institutional shareholders, Taiwan Mobile Holding Co., a wholly-owned subsidiary of Taiwan Mobile which is a leading telecom service provider in Taiwan.

The total consideration is subject to adjustments based on the financial performance of Hurray! Times' business in certain periods following the closing of the acquisition. The transaction is expected to close before March 31, 2008, subject to required China regulatory approvals and other customary closing conditions.

In Q3 we took a goodwill impairment charge of 9.6. Now I am going to say the reasons for this impairment charge. In may, 2007, China Mobile began the operational practice of displaying a service fee reminder to WAP service users when they request the download of a WAP page onto their mobile handsets and seeking their confirmation before processing the download request. In addition, China Mobile started to place links to only its own WVAS offerings on the embedded menus of mobile handsets with customized software for China Mobile users.

In the past, such embedded menus on handsets featured links to all popular products on China Mobile's networks, including the products of the group. The company believes the above changes by China Mobile could have an adverse impact on the company's WVAS business, in particular WAP business.

As of September 2007, the market capitalization of the company was lower than net book value and an impairment indicator was shown. In view of the potential adverse impact of the above change and other changes mentioned earlier and the uncertainties in future operating environment, the Company tested the carrying value of goodwill for impairment as at September 30, 2007 and recorded an impairment charge of $9.6 million for the three months ended September 30, 2007 relating to the goodwill of the company's wireless value-added service business.

The valuation was arrived at after using a combination of a market value approach and an income approach. Any continued adverse changes in mobile operators' policies or in the competitive environment could lead to additional impairment charges and the company is continually monitoring such changes to assess their impact.

Now, I turn this over to QD.

QD Wang

That’s all of our earnings announcement presentation. Now we would like to open for questions.

Question-and-Answer Session

Operator

Your first question comes from Alicia Yapp - Citigroup.

Alicia Yapp - Citigroup

Yes, good morning. I have two questions. First of all, can you please update us on the overall regulatory environment? Specifically, will Q4 continue to be impacted by the change of the China Unicom policy? Can you help us understand the seriousness of the impact on your business as well as your peers?

Sean Wang

The regulatory environment as we see it continues to be quite tight, and the change in China Unicom’s revenue confirmation policy had a very significant impact on our business. For Q3, because of the change in this policy and compared to the quarter before, no such change. As a result, our revenue from China Unicom decreased by $1.3 million, so that’s a huge hit on us just because of the change in policy. We expect this new policy will be staying even until Q4, and we’re not so sure about next year. But for Q4, this new policy will still be there.

QD Wang

We do believe actually, this policy will have the same impact to our peers in this market. Looking forward, Q4 like Sean say, the business will be impacted for such a policy. Looking forward starting from next year, we expect the WVAS environment will improve gradually quarter after quarter, and service providers working some front to grow their revenue gradually starting from next year.

Alicia Yapp - Citigroup

Can you just give us your Q4 guidance, it already included the impact from China Unicom?

Sean Wang

Right, and Q4 guidance we already factored in the impact from this change in China Unicom’s revenue confirmation policy.

Alicia Yapp - Citigroup

My second question is regarding your announcement on the merger. Could you tell us the trailing revenue run rate for Enlight Media and what expectations should we expect for 2007 and 2008? Thank you.

QD Wang

Actually we are working on their numbers in ‘07 with Deloitte as the auditing company right now. Also we are on working on the guidance for ‘08 and we probably will have the auditors and more updated numbers available but we don’t think we can talk specific numbers on this phone call.

Alicia Yapp - Citigroup

What about the historical trailing revenue run rate?

Sean Wang

Enlight has been a very profitable company and they of course, they had their share of ups and downs but the company has been profitable for the past four or five years. Especially the company was doing extremely well in 2003, 2004 and also recently they have been doing quite well. I think based on their past track record and their performance, we feel very comfortable working with this company.

As QD mentioned, right now Deloitte is auditing their ‘07 financials and also because we’ve signed the definitive agreement and the two companies are in the closing process, we are going to be working on our 2008 financials and I think once the closing is done we are going to tell the market what we expect for this combined company.

QD Wang

Also right after this earning announcement, Sean, our CFO, will conduct road shows to talk with major investors as to what is going on here. One thing I would like to emphasize here is based on their solid track record in the past three to five years, they were a profitable business. Also based on our estimation for 2008, a very promising year, the out years and the future three to five years, the entertainment content production and media industry will enjoy double-digit average growth.

We feel very confident and we believe the combination of the two companies will bring both Hurray! and Enlight to the next layer to enjoy medium and long-term sustainable growth. But for its fiscal number we will actually talk with all of the major investors and our research analysis firms later on.

Operator

Your next question comes from Analyst for C. Ming Zhao - SIG.

Analyst for C. Ming Zhao - SIG

Good morning, QD and Sean. Congratulations on your merger with Enlight Media. I also have a follow-up question about Enlight Media. Would you please give us more color on Enlight Media’s business model? For example, how does it share the revenue with TV stations?

QD Wang

Basically we would like to describe Enlight Media as the largest private TV program, TV drama and outdoor largest events and activities of writers, producers, publishers, advisors in the China market. Actually in summary, Enlight is the largest private entertainment content producer in the China market we ever met. Also, they have a cross-traditional media platform and they actually have a close relationship and alliance with around 600 national, provincial and local TV channels and local radio channels, outdoor and [pay-per-meters] network in China. So we’d like to say they have the largest and fullest coverage traditional cross-platform media in China.

The combination of the two companies makes us feel very, very excited about our future and we would like to summarize in three major points for this combination.

First, this combination helps Hurray! to a great extent to transform Hurray! from the [inaudible] business into the entertainment content production and cross-platform media companies.

Second, the two companies actually have very much a complementary business. Hurray! Has the largest music and wireless games content. Enlight has the largest TV program, TV drama, film, and largest outdoor events.

In terms of the platform, Hurray! is pretty good at the wireless Internet offline digital channel building. Enlight, like I mentioned before, has the largest traditional media coverage including a few hundred TV channels, radios and outdoor [pay-per-meters]. So put two companies together and we definitely will form the market leadership in terms of the entertainment content production and media company.

Looking forward, the media and entertainment industry and market will enjoy pretty good medium and long-growth gross especially with the Olympic year coming. We do believe the combined company is well-positioned to fully take the opportunity to grow and also can have with that, the opportunity to enjoy long-term sustainable growth as the entertainment and media industry grows in China.

Analyst for C. Ming Zhao - SIG

Do you know how many TV products Enlight Media has in total? How many products are still performing? What’s the average life cycle of Enlight’s Media TV products?

QD Wang

Actually, so far Enlight has six pretty good TV programs broadcasting through the BTV, the Beijing TV stations, through the CETV, the China Education TV satellite channels, as well as a few other provincial satellite TV channels. Simultaneously, they are working on the two to three new TV programs and we’ll actually have the broadcasting through the other provincial satellite TV channels.

These six to eight TV programs also will go through, like we mentioned before, a few hundred locals; we means provincial and municipal TV channels to cover the whole of China. They also actually produced 200 hours of TV drama this year, and next year they actually plan to produce more TV dramas, 250 hours or even 300 hours of TV dramas, and broadcasting through a few hundred TV channels.

This year, they also distributed wide picture movies. Next year they target to produce six to eight picture movies. That’s pretty much about the TV programs, TV drama and film. Simultaneously, they organized five more events: the award ceremonies that covers music, modeling, fashions, TV drama and film in China.

Sean Wang

Enlight has some of the top-rated TV programs, such as The Music Chart program sponsored by Mengniu, the top consumer brand in China, and also a top-rated entertainment and news program, Big Star and of course they also have highly rated programs like Fashion Chart and TV Drama Chart. So those are really very popular programs here in China and also the top ad dollar earners for Enlight.

Analyst for C. Ming Zhao - SIG

What are the top five TV station time is for Enlight Media? You just mentioned Beijing TV and who else?

QD Wang

Beijing TV and the China Education TV channel. They also have cooperation with Anhui TV and some other provincials, and they do work with a lot of local television stations. Of course, the national channel, they also work with [inaudible] Satellite TV channel and [inaudible] Satellite TV channel.

Operator

Your next question comes from Eddie Leung - Merrill Lynch.

Eddie Leung - Merrill Lynch

Very interesting merger. Two questions regarding the merger. I heard that for some of the content producers in China, one of the problems that they face is basically the distribution channels are the TV stations. Can you talk a little bit about if you see any synergies of Beijing’s Hurray! and Enlight on that regard, and whether you think Hurray! will help and might see some of the distribution problems that they may face?

On the integration plans regarding the two companies, have you guys figured out how you will structure the future company, presuming the merger goes through?

QD Wang

Actually the first question is very, very important for the content company actually how to find the right distribution channels and how to negotiation with the distribution channels for the business part. Put two companies together, and we actually form the largest entertainment content company in China. We have the largest, probably, of TV programs, TV drama, plus the largest music content, as well as the wireless game content.

Once you actually have more market share and become the largest and enjoys more popular entertainment content you will actually gain your ground to negotiation with traditional media or actually the digital channels.

For example and if you are the #1 TV program you have a much higher quality TV program as well as high quality, very popular music content, plus games. Here we put them altogether with traditional TV channels, for example BTV, the Beijing TV stations. Our programs are much greater and have a more famous singer and stars and we have a more attractive game and so will make our programs more attractive. Like Shanghai TV, like a Guangdong TV are more interested such kind of things, such kind of stars. So this is good for us to negotiate and bargaining with our traditional TV channels.

Simultaneously, once you have TV content, you have video content, you have a field content plus our music things and game things, it’s also gaining Hurray! some good ground to negotiations with a wireless carrier like China Mobile, China Unicom where it’s a large entertainment content provider in China now and we have the most popular not only music but also video, with Europe promoting 3D Olympic applications in China Mobile and China Unicom.

Also we’re working on more ground and have more opportunity to list our service to get more promotion results from China Mobile, China Unicom to put through our services.

So the combination actually will benefit all our TV content and music and wireless content and will put through our service ,through both traditional TV stations and radio stations as real as wireless and Internet channels.

Sean Wang

Some people have suspected Hurray! was going to get out of high speed business; that’s not true. The combination with Enlight will really help Hurray! to double that business and we intend to be in this business, and we intend to grow this business, especially in the combined company with the content support and also other channels to promote our WVAS business. The way I see it, our WVAS business will benefit and will have some great growth again. We’re not going to get out of the ISP business; we’re going to continue that. We see that in a combined company, our business will benefit.

To your second question, talking about a merger of these two companies. We are going to work on this right away. Yesterday we signed the agreement, and today we have started already trying to combine these two companies to get ready and apply for the necessary approvals with the authorities. We target, as we mentioned, in the first quarter of next year to close the deal. So far, we feel pretty good about the targeted closing time.

Operator

Your next question comes from Helena Qiu - SBI E2-Capital .

Helena Qiu - SBI E2-Capital

I want to know if you have some leeway with Beijing TV? I heard about some more restrictions about interactive programs. Have you seen anything about this, and how are you going to start to see your JV with Beijing TV make a contribution to the company?

QD Wang

Actually there is a new policy coming out and perhaps, I will sum it up the for the TV shows, especially for the wireless interactive, or interactive TV shows, like the [inaudible]. We are currently evaluating the impact for our geo-based business, and we evaluate this geo-based business with the BTV right now. We probably will re-plan how we are going to continue this geo-based business and how we’re going to generate revenue under the new policy and a new environment. We would like to share with you when we have the new evaluations and the new proposals and the new plans about this JV.

Helena Qiu - SBI E2-Capital

So now it’s impossible for you to launch the interactive TV programs, right?

QD Wang

It’s only actually for the TV show programs like American Idol, this type of TV program. For the generic type of TV program, you can still build in some wireless interactive things.

Operator

At this time we have no further questions in queue. I would now like to turn the call back over to Mr. QD Wang for closing remarks. Please proceed.

QD Wang

Thank you for joining Hurray!’s Q3 2007 earning announcement. We are very excited about the merger with Enlight and we do believe this merger actually will bring the synergies of the two companies, and looking forward we’re excited about the Olympic Games year. We believe the combined new company will enjoy vast and significant growth next year, and also in the medium and long term, sustainable growth.

We really like to share with all of the investors and research analysts from time to time about what’s going on about Hurray! and also the combined new companies. Thank you.

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