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China Finance Online Company (NASDAQ:JRJC)

Q3 2007 Earnings Call

November 20, 2007 8:00 pm ET

Executives

Alice Yung - Investor Relations

Zhiwei Zhao - Chief Executive Officer, Director

Jeff Wang - Chief Financial Officer

Analysts

Chris Fox - I.N. Fox Capital

Alex Xu - Brean Murray Carret & Co.

Anindya Chatterjee - Jefferies

Analyst for Dick Wei - J.P. Morgan

Operator

Thank you all for holding and welcome to the China FinanceOnline full year 2008 guidance and report third quarter 2007 un-auditedfinancial results conference call. (Operator Instructions) I would now like toturn the conference over to your host, Ms. Alice Yung. Go ahead please, Madam.

Alice Yung

Thank you, Operator. Hello, everyone. Welcome to ChinaFinance Online’s 2008 full year guidance raise and Q3 2007 earnings releaseconference call. Joining me today in the conference, our CEO, Mr. Zhiwei Zhao,and our CFO, Mr. Jun Wang. After market close today, we issued a press releasecontaining 2008 full year guidance raise and the financial results for thethird quarter 2007. The purpose of this conference is to provide detailedinformation regarding those financial results. Following our formal remarks, wewill be happy to take any questions you might have.

Before we start, it’s my duty to remind you that duringtoday’s conference call, we will make some forward-looking statements,including statements about our future development, our market position inindividual and institutional markets, and our third quarter revenue guidance --sorry, and our 2008 full year guidance.

The statements are made under the Safe Harbor provision ofthe U.S. Private Securities Litigation Reform Act of 1995. Statements that arenot historical facts, including statements about our beliefs and expectations,are forward-looking statements. These statements are based on current plans,estimates, and projections and therefore you should not place undue reliance onthem.

Forward-looking statements involve inherent risks anduncertainties. We caution you that a number of important factors could causeactual results to differ materially from those contained in any forward-lookingstatement. Potential risks and uncertainties include, but are not limited to,fluctuations in quarterly operating results, our ability to successfullycompete against new and existing competitors, changes in accounting policies,our ability to successfully acquire and integrate businesses, and the impact ofour investment on our financial results.

Further information regarding these and other risks isincluded in China Finance Online’s annual report on Form 20-F for the yearended December 31, 2006 and other filings with the Securities and ExchangeCommission.

China Finance Online does not undertake any obligation toupdate any forward-looking statements except as required under applicable law.

Now I will turn the call over to our CEO, Mr. Zhao.

Zhiwei Zhao (Translation)

Hello, everyone. Welcome to the conference call for ChinaFinance Online’s 2008 full year guidance raise and earnings release for Q32007. In the third quarter of 2007, China Finance Online has modified its corebusiness development plan and corporate development direction, [made itsrefocus] on the internal organic growth and external strategic acquisitions. Withthe [leading of such clear and] corporate strategic goals, we have obtainedgreat operating results in the third quarter.

In this quarter, our revenues continuously made a steady andrapid increase. Net revenue under U.S. GAAP reached $7.3 million, increased by78% quarter on quarter and 321% year over year. Meanwhile, cash in-flow hasindicated a strong increase, among which, cash for the subscription servicespaid by individual customers reach $11 million, setting a new record, whichmakes a solid foundation for the continuous development of the company.

From an operations perspective, once again we obtained greatresults in the third quarter. By the end of September 2007, registered user accountsof jrj.com and stockstar.com had reached 8.1 million, up by 0.8 million fromthe previous quarter and fee-based individual subscribers grew to 45,500, anincrease of 22% from the previous quarter.

Based on our leading role in the financial media market, inthe third quarter of 2007, we also actively searched for the possibletransformation of our business model, the extension of the value chain in thefinancial media market. As such, the driving power and energy of our companyhas become stronger and stronger. As a first step of the business modeltransformation, China Finance Online announced the acquisition of a Hong Kongbased securities brokerage firm, Daily Growth Investment Company Limited, inSeptember.

By acquiring Daily Growth Investment Company Limited, a HongKong based securities brokerage firm with a 35-year history, and integratingwith our existing resources, especially the vast user base of our website, wewill be able to provide our customers a diversified portfolio of brokerage and informationalservices in order to meet the very needs of our customers within the spectrumof future policy.

At present, this acquisition has been permitted by theSecurities and Futures Commission of Hong Kong and the transaction is expectedto be closed by the middle of December 2007. As an important milestone, thisacquisition marks a solid step towards the strategic transformation of ChinaFinance Online.

As for our organic growth, we employed effective measures toattract, retain, identify [inaudible] and up-sell to [target] customers, asmore consistent with our business model and the development directions, andfocused on three key areas of product development, website platforms, and salesforce. We have obtained significant improvements in the following aspects.

First of all, from the perspective of product development,we reinforced the building of a financial database at Genius. In this quarter,China Finance Online formed a strategic alliance with the China Center forFinancial Research at Tsinghua University. Tsinghua University will provide uswith exclusive technical advice and support. [Until now, the counterparts] haveconducted a series of practical strategic cooperation in the programs ofbuilding a financial database and trained personnel exchange, which contributesa lot in the reinforcement of our competitive advantage and market [power].

Meanwhile, we have never stopped our progress in productdevelopment. With the rapid development of China’s stock market and [fundmarkets], the investors are in urgent need of the fund information serviceswhich is more professional, timely, and comprehensive. We developed a series of[inaudible] oriented new products on [fund] software. The launching of thiskind of new product will contribute in gaining a solid foundation of thisfurther capability of the company.

Secondly, in the perspective of consolidating the advantageof our website as a platform, one of our two websites, jrj.com, launched twointeractive communities, istock and ifund. Also, stockstar.com launched anotherinteractive community named stock bar. All of these Internet products were wellreceived by users of our website and will play a very active role in attractingand retaining customers.

In addition, both jrj.com and stockstar.com launched a HongKong channel, which will provide comprehensive information on Hong Kong stocksand give guidance on investments. It will make a solid foundation for ourfuture securities brokerage business and the integration of informationservices and brokerage services.

Meanwhile, 2007 China open market investment competitionamong individual investors was [concluded] after six months of intensecompetition through the cooperation of our two leading financial websites,jrj.com and stockstar.com, and the securities channel of Chinese CentralTelevision, the largest and the most influential TV station in China, China’s[inaudible], one of the leading financial [inaudible] in China, and HaitongSecurities, one of the top brokerage firms in China.

This competition has greatly reinforced the brand effect ofjrj.com and stockstar.com within the spectrum of individual and institutionalinvestors. 2008 China open market investment competition among individualinvestors will be launched in January 2008.

Thirdly, in the perspective of the sales force expansion, weare in the process of setting up new call centers to hire 500 additionaltelemarketers by the middle of 2008, to further enhance and expand our salesnetwork and sales capabilities.

Backed by our strong operating results in Q3 and ourcontinuously improving execution capabilities, the management team has no doubtthat we are able to lead the company to the new level in 2008. Therefore, weraise the 2008 full year guidance of net revenue and the adjusted earnings.Exclusive of potential acquisitions, we expect 2008 full year net revenue to bewithin the range of $50 million to $60 million, and 2008 full year adjustedearnings exclusive of the effects of potential acquisitions, are expected to bewithin the range of $22 million to $28 million.

We will never stop our progress in innovation and[application]. We will [seek] for organic growth as well as the [inaudible]integration of the external resources while enhancing scalability of productdevelopment, website construction, and telemarketing capabilities andtherefore, with a cultivating and reinforcing focus on the operating differentiationof China Finance Online, we will create greater value for our shareholders.

Finally, I would like to take this opportunity to express mygreat appreciation to our investors, research analysts, and all other partners.We look forward to your continued support.

Now, I would like to turn the call over to our CFO, Jeff, togive more details on the financial part. Thank you.

Jeff Wang

Thank you. Hello, everyone. Welcome to our third quarter2007 earnings conference call. Driven by strong cash revenues from individualsubscription business in four consecutive quarters since Q4 2006, net revenuesin Q3 2007 were reported at a record high level of $7.3 million, in line withour previously released guidance of $7.1 million to $7.5 million, and up 321%year over year and 28% quarter over quarter.

Operating cash in-flows during the third quarter of 2007 was$14.53 million, among which cash in-flow from subscription services provided toindividual customers, our core business, set another record of $11.06 million,up 35% compared to $8.19 million in the past quarter.

Net operating cash flows for the third quarter of 2007 were$6.33 million, compared to $6.42 million in the past quarter.

Subscription services provided to individual customers, ourcore business, represents approximately 84% of net revenues in Q3 of 2007compared to 81% in Q2 2007. Net revenues from this service line totaled $6.16million for this quarter, an increase of 413% from $1.2 million in the thirdquarter of 2006 and an increase of 32% from $4.66 million in the previousquarter.

Deferred revenue at the end of this quarter was recorded$18.84 million compared to $14.38 million from the previous quarter.

For our subscription business, individual customers paytheir entire subscription fee up front in cash for services to be received overa specified period of time, typically 12 months. Under U.S. GAAP, such cashsubscription fees are recognized as net revenues ratably over the serviceperiod and the prepaid service fees made by customers for subscription servicesthat haven’t been rendered at the end of a reporting period are recorded asdeferred revenue on the balance sheet.

The significant increase in deferred revenue for the thirdquarter is due to a strong increase in prepaid subscription fees which will berecognized as revenues under U.S. GAAP in the next several quarters.

Gross margin was 84% in the third quarter compared to 82%and 81% for the same period in 2006 and the second quarter of 2007respectively.

Please note that the cost of revenues for the third quarterof 2007 included website maintenance and development expenses of $634,000.Website maintenance and development expenses include bandwidth costs, personnelrelated expenses, server depreciation expenses, and content expenses for ourjrj.com and stockstar.com websites.

Since advertising related services, which represent 7% ofour net revenue in the third quarter of 2007, are no longer a sizable businessof our company and websites of jrj.com and stockstar.com are both used as aplatform to attract and retain potential users of our subscription services,website maintenance and development expenses do not have direct relationshipwith net revenues recognized in the third quarter of 2007.

Excluding website maintenance and development expenses of $634,000,the gross margin for the third quarter of 2007 would have been 92%.

In order to help investors to better understand ourbusiness, we provide more non-GAAP financial measures in the [inaudible], whichexcludes share-based awards granted to employees. We believe that bothmanagement and investors benefit from referring to these non-GAAP financialmeasures in assessing our performance and when planning a forecast in futureperiods.

Non-GAAP operating expenses totaled $3.59 million, up 20%compared to $3 million from the previous quarter. The quarter-over-quarterincrease is primarily due to the increased compensation expenses for the salesteam as a result of the increased headcount and improved performance.

Due to our intensified efforts in product development, thenon-GAAP product development expenses for this quarter totaled $575,000, up 38%quarter over quarter. In this quarter, non-GAAP operating profit was $2.52million, an increase of 364% from $543,000 in the third quarter of 2006 and anincrease of 53% from $1.65 million in the previous quarter.

Non-GAAP operating margin in the third quarter was 34.5%,compared to 31.4% in the same period last year and 28.9% in the previousquarter. We also reported $2.98 million non-GAAP net revenues for this quarter,increased by 249% from $853,000 from the third quarter of 2006 and 38% from$2.16 million in the previous quarter.

Non-GAAP net income margin for the third quarter 2007 is41%, compared to 49% in the same quarter last year and 38% in the secondquarter of 2007. Adjusted EBITDA was $2.78 million in the third quarter of2007, compared to $608,000 in the third quarter of 2006 and $1.87 million inthe previous quarter, up 357% year over year and 49% quarter over quarter.

Our cash and cash equivalents were $64.08 million at the endof this quarter, an increase of $7.93 million, up from $56.15 million by theend of June 2007. Our cash balance as of Q3 2007 includes cash denominated inRMB, the local currency in China, equivalent to $52.39 million.

Regarding our outlook for Q4 2007 and beyond, we currentlyexpect to generate net revenues in an amount ranging from $8.2 million to $9million for the fourth quarter 2007, representing a 225% to 257% increase fromthe corresponding period in 2006.

We will provide our guidance on Q4 2007 adjusted earningsnon-GAAP, defined as net income excluding share-based compensation expenses, inJanuary 2008.

Backed by record deferred revenue and also operating cashin-flows, a strong product pipeline, steadily increasing registered user baseand continuous enhancement in telemarketing capabilities, we now raise ourprojected net revenues for ‘08 to a range from $50 million to $60 million,compared to the previous guidance of $45 million to $51 million, and we alsoraise our projected adjusted earnings for ‘08 from the previous guidance of $19million to $23 million to the range of $22 million to $28 million, or $1 to$1.27 per fully diluted ADS based on an estimated 22 million total ADSoutstanding.

Based on our guidance, we expect our non-GAAP net incomemargin to continue to improve up to 47%, at the high end of our 2008 guidance,compared to 41% in the third quarter of 2007.

In addition to growing the registered user base of ourwebsites and rolling out more products, we are in the process of setting up newcall centers to hire 500 additional telemarketers by the middle of 2008 tofurther expand our telemarketing team from 260 telemarketers as of September30, 2007, to 760 telemarketers.

Telemarketing plays an instrumental role in the conversionfrom free registered users of our website to fee-based subscribers, and webelieve that all else equal, the increase in the number of telemarketers willhelp grow our top line and bottom line as well.

For example, our cash in-flows from subscription servicesprovided to retail customers grew steadily from $7.2 million in Q1 2007 to $11million in Q3 2007, up 54%. During this period, the number of telemarketersincreased from 110 to 260, up 136%. Because it takes time to recruit and traintelemarketers to get them up to speed, it is reasonable to expect that with a growthrate of cash revenues led behind the growth rate of telemarketers.

Telemarketers are primarily compensated through commissionswith low fixed salary. At their full capacity, new call centers with 500telemarketers will add fixed operating expenses, including salaries, benefits,depreciation and office rental expenses, of approximately $2 million per year.

Our guidance on 2008 financial performance has alreadyreflected the expenses of the new call centers.

We believe that our plan to triple the size of ourtelemarketing team from 260 as of Q3 2007 to 760 by the middle of 2008 willcontribute significantly to our projected financial performance in 2008.

We are now ready to take any questions you may have.

Question-and-AnswerSession

Operator

(Operator Instructions) The first question is coming fromChris Fox from [I.N. Fox Capital]. Go ahead, please.

Chris Fox - I.N. FoxCapital

Hello and thank you for taking my questions. What I waswondering about is on a longer term basis, what is the plan for China Financein light of the likelihood of further development in Internet companies such asBaidu, potentially offering the services you charge for for free.

In the United States, subscription services are limited.Companies like thestreet.com don’t have great revenues and profits and it seemsto be because brokerage firms offer these services for free and so do companieslike Yahoo! and Google. So in the context of the Chinese market, I would becurious how you plan to address that.

Jeff Wang

Thank you, Chris. Actually, I will answer your questionfirst and our CEO may add some other points.

Basically, the information we offer on our website is free.Our website is similar, offers free content similar to Yahoo.com or Baidu.com,or similar to thestreet.com. But our subscription based services, our premierservice that we have premier content and most of these subscription servicesare not Internet based. They are downloadable software installed on computersand some of the low ticket products are installed on cell phones.

To support these subscription services, we acquired --actually, our in-house proprietary database provider Genius last year and as weannounced earlier this quarter, Genius also -- we also struck a strategicalliance with Tsinghua University, one of the top universities in China, toco-develop, to improve the quality of our data and also our content.

This can well-serve the growth of our business in thefuture.

Chris Fox - I.N. FoxCapital

Thank you.

Operator

(Operator Instructions) The next question is coming fromAlex Xu from Brean Murray. Go ahead, please.

Alex Xu - BreanMurray Carret & Co.

Thank you. I have a quick question; I joined the call alittle bit late so I don’t know whether you already mentioned this or not --can you comment a little bit regarding the overall macro environment in China,particularly the Chinese stock market and the Hong Kong stock market, for thatmatter, how that impacts or not impacts your business and what’s your outlook-- for example, what’s your guidance for 2008 factor into what kind of a macroenvironment in your guidance, basically? Can you comment a little bit on that?Thanks.

Jeff Wang

Sure. Talking about the macro environment on our business, Ithink people actually are more interested in, for example, the stock market inChina and also the U.S. market overall and whether this will have a negativeimpact on our business.

To be honest, the stock market does have an impact on ourbusiness but actually, something different in China, because China is anemerging market, even though the Chinese stock market has been declining overthe past quarter, over the past month I think about 15%, but from the U.S.perspective, it’s probably -- [they trigger] a thought of whether the Chinesestock market has become a [bear] market. But because the Chinese market isactually an emerging market, the volatility in China can happen significantlyin a particular quarter or month and will actually start to improvesignificantly in the following period.

For example, in the middle of this year, around May 30th,the Chinese stock index also fell actually over 10% within a week and then themarket bounced back in the month afterwards.

To summarize this point, we don’t believe the Chinese marketis entering any concerns about a bear market or not. We are actually -- themarket really is dependent on the growth of the Chinese economy and there isconsensus that the Chinese economy will grow steadily over the coming years.

In addition to the external factors, we also focus on thegrowth of our internal factors, primarily growing the registered user base ofour websites, what stands to be another growth period in the third quarter of2007. And we also -- that depends on how we roll out more product, and as wedid this quarter, we just announced that we’ll roll out Fund Guru, which is amutual fund individual tools, target over 10 million mutual fund investors inChina.

Also, we will hire over about 500 telemarketers startingfrom now until the middle of 2008. We believe that the increase oftelemarketers have actually a clear correlation with the growth in our top lineand also bottom line.

So supported by the internal factors that we can control,that’s growing the registered user base, rolling out more product, and actuallyadding more telemarketers to more efficiently convert free users to fee-basedusers and also to up-sell to low-end fee-based users, to lead to high-endfee-based customers.

We are confident that actually we can grow our businessregardless of the market fluctuation in China, although definitely in theshort-term the market fluctuation may have some negative impact on ourbusiness.

Alex Xu - BreanMurray Carret & Co.

Thank you.

Operator

(Operator Instructions) The next question is coming from AnindyaChatterjee from Jefferies. Go ahead, please.

Anindya Chatterjee -Jefferies

Thanks for taking my call. Two separate questions; one, youhave a lot of cash in hand right now, the $64 million plus that you have. Howdo you plan to ideally spend that going forward? Are you looking atacquisitions? If so, in which segments are you planning to buy -- anotherbrokerage outfit or is it another research outfit? What’s the plan there?

And question number two is, despite the debate that cancontinue forever, as to if there is a slowdown in the Chinese stock market,whether that will impact your business or not, how well-prepared are you if youare needed to cut your costs, whether it comes through marketing, sales, oryour technology costs? How do you think you can [fuel down] in case there is aslowdown on the revenue front?

Jeff Wang

I’ll answer your second question and then I will turn thefirst question over to my CEO, regarding the acquisition strategy.

Regarding how we are prepared to reacting to a down marketin terms of actually being, how to reduce our costs, most of the operationcosts of our business are variable costs. For example, our -- it is only aboutapproximately $2 million of our operating expenses, non-GAAP operating expensesare fixed costs. Our sales and marketing expenses, over half of the sale andmarketing expenses actually are commission, bonus paid to the telemarketingteam, telemarketers and also their management supporting team. If there is norevenue, there is going to be no commission or bonus paid to the telemarketingteam.

And our website maintenance expense, for this quarter fromexample, it’s only $0.6 million, less than 10% of our total revenue. So in thissense, our business has a very good operating leverage to benefit from thegrowth in our business. And although we don’t see any actual foreseeabledownturn in our business, but if there is a dramatic decline in the market, weare not -- we won’t hit hard because we don’t have a high fixed cost structure.

So now our CEO, Mr. Zhao, will answer your question aboutacquisitions and how we are going to spend our cash, if any, for theacquisition strategy.

Zhiwei Zhao (Translation)

We have been accelerating the [content] development for internalorganic growth and external acquisitions. Acquisition is one of our importanttools to create great value for our shareholders. Any complementary resourcesand capabilities will be considered as an acquisition target.

We have been searching and communicating with the qualifiedtargets. We will be doing that in the long term. Thank you.

Anindya Chatterjee -Jefferies

Thank you very much.

Operator

(Operator Instructions) The next question is coming fromDick Wei from J.P. Morgan. Go ahead, please.

Analyst for Dick Wei- J.P. Morgan

This is [inaudible] calling in for Dick Wei. Firstly,congratulations on the good quarter. I have a couple of questions. First, juston the 2008 guidance, can management comment a little bit about what are theassumptions for the different revenue segments, to help us understand the kindof revenue mix slightly? And I have a second question later.

Jeff Wang

Our projected revenues for 2008 is primarily generated fromthe subscription services provided to our retail customers, our current corebusiness. We do not expect significant growth from our service lines, nor havewe [structured into] any growth from the potential acquisitions, including thepending acquisition of Daily Growth, which is expected to be closed by themiddle of December.

Analyst for Dick Wei- J.P. Morgan

Thank you. And my second question actually is on the cashin-flows from individual subscribers. Can you please provide a breakdown interms of the average subscription fee and the number of subscribers?

Jeff Wang

The average subscription fee for this quarter is about $620per year. That’s the average subscription fee. And the total subscribers forthis quarter is about 16,000 subscribers, new subscribers, actual fee-basedsubscribers in this quarter.

Analyst for Dick Wei- J.P. Morgan

Right, and these are still mostly from new subscribers,right, not the repeat subscribers?

Jeff Wang

Well, they are about -- I think about 20% comes fromexisting customers and also we have actually new subscribers. Because we havevery aggressive growth goals, including our target for 2008, our focus reallyis down to grow, to attract more subscribers. Without new subscribers, wecannot fuel the growth of our 2007/2008 targets.

Analyst for Dick Wei- J.P. Morgan

Great. Okay. Thank you.

Operator

(Operator Instructions) Thank you. We have no furtherquestions at this time.

Alice Yung

Okay. All right. That’s all for today’s conference. If youstill have any further questions, please call our IR group at 8610-5832-5288,and our e-mail address is ir@jrj.com. Ladies and gentlemen, thank you again forjoining us today. Thank you.

Operator

Thank you for your participation in today’s conference. Thisconcludes the meeting. You may now disconnect your lines.

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