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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

Presentation

Operator

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

Alice Yung

Thank you, Operator. Hello, everyone. Welcome to China Finance Online’s 2008 full year guidance raise and Q3 2007 earnings release conference 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 release containing 2008 full year guidance raise and the financial results for the third quarter 2007. The purpose of this conference is to provide detailed information regarding those financial results. Following our formal remarks, we will be happy to take any questions you might have.

Before we start, it’s my duty to remind you that during today’s conference call, we will make some forward-looking statements, including statements about our future development, our market position in individual 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 of the U.S. Private Securities Litigation Reform Act of 1995. Statements that are not 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 on them.

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

Further information regarding these and other risks is included in China Finance Online’s annual report on Form 20-F for the year ended December 31, 2006 and other filings with the Securities and Exchange Commission.

China Finance Online does not undertake any obligation to update 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 China Finance Online’s 2008 full year guidance raise and earnings release for Q3 2007. In the third quarter of 2007, China Finance Online has modified its core business development plan and corporate development direction, [made its refocus] on the internal organic growth and external strategic acquisitions. With the [leading of such clear and] corporate strategic goals, we have obtained great operating results in the third quarter.

In this quarter, our revenues continuously made a steady and rapid increase. Net revenue under U.S. GAAP reached $7.3 million, increased by 78% quarter on quarter and 321% year over year. Meanwhile, cash in-flow has indicated a strong increase, among which, cash for the subscription services paid by individual customers reach $11 million, setting a new record, which makes a solid foundation for the continuous development of the company.

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

Based on our leading role in the financial media market, in the third quarter of 2007, we also actively searched for the possible transformation of our business model, the extension of the value chain in the financial media market. As such, the driving power and energy of our company has become stronger and stronger. As a first step of the business model transformation, China Finance Online announced the acquisition of a Hong Kong based securities brokerage firm, Daily Growth Investment Company Limited, in September.

By acquiring Daily Growth Investment Company Limited, a Hong Kong based securities brokerage firm with a 35-year history, and integrating with our existing resources, especially the vast user base of our website, we will be able to provide our customers a diversified portfolio of brokerage and informational services in order to meet the very needs of our customers within the spectrum of future policy.

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

As for our organic growth, we employed effective measures to attract, retain, identify [inaudible] and up-sell to [target] customers, as more consistent with our business model and the development directions, and focused on three key areas of product development, website platforms, and sales force. 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 for Financial Research at Tsinghua University. Tsinghua University will provide us with exclusive technical advice and support. [Until now, the counterparts] have conducted a series of practical strategic cooperation in the programs of building a financial database and trained personnel exchange, which contributes a lot in the reinforcement of our competitive advantage and market [power].

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

Secondly, in the perspective of consolidating the advantage of our website as a platform, one of our two websites, jrj.com, launched two interactive communities, istock and ifund. Also, stockstar.com launched another interactive community named stock bar. All of these Internet products were well received by users of our website and will play a very active role in attracting and retaining customers.

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

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

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

Thirdly, in the perspective of the sales force expansion, we are in the process of setting up new call centers to hire 500 additional telemarketers by the middle of 2008, to further enhance and expand our sales network and sales capabilities.

Backed by our strong operating results in Q3 and our continuously improving execution capabilities, the management team has no doubt that we are able to lead the company to the new level in 2008. Therefore, we raise the 2008 full year guidance of net revenue and the adjusted earnings. Exclusive of potential acquisitions, we expect 2008 full year net revenue to be within the range of $50 million to $60 million, and 2008 full year adjusted earnings exclusive of the effects of potential acquisitions, are expected to be within 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 product development, website construction, and telemarketing capabilities and therefore, with a cultivating and reinforcing focus on the operating differentiation of China Finance Online, we will create greater value for our shareholders.

Finally, I would like to take this opportunity to express my great 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, to give more details on the financial part. Thank you.

Jeff Wang

Thank you. Hello, everyone. Welcome to our third quarter 2007 earnings conference call. Driven by strong cash revenues from individual subscription business in four consecutive quarters since Q4 2006, net revenues in Q3 2007 were reported at a record high level of $7.3 million, in line with our 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 to individual 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, our core business, represents approximately 84% of net revenues in Q3 of 2007 compared to 81% in Q2 2007. Net revenues from this service line totaled $6.16 million for this quarter, an increase of 413% from $1.2 million in the third quarter of 2006 and an increase of 32% from $4.66 million in the previous quarter.

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 pay their entire subscription fee up front in cash for services to be received over a specified period of time, typically 12 months. Under U.S. GAAP, such cash subscription fees are recognized as net revenues ratably over the service period and the prepaid service fees made by customers for subscription services that haven’t been rendered at the end of a reporting period are recorded as deferred revenue on the balance sheet.

The significant increase in deferred revenue for the third quarter is due to a strong increase in prepaid subscription fees which will be recognized 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 2007 respectively.

Please note that the cost of revenues for the third quarter of 2007 included website maintenance and development expenses of $634,000. Website maintenance and development expenses include bandwidth costs, personnel related expenses, server depreciation expenses, and content expenses for our jrj.com and stockstar.com websites.

Since advertising related services, which represent 7% of our net revenue in the third quarter of 2007, are no longer a sizable business of our company and websites of jrj.com and stockstar.com are both used as a platform to attract and retain potential users of our subscription services, website maintenance and development expenses do not have direct relationship with 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 our business, we provide more non-GAAP financial measures in the [inaudible], which excludes share-based awards granted to employees. We believe that both management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning a forecast in future periods.

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

Due to our intensified efforts in product development, the non-GAAP product development expenses for this quarter totaled $575,000, up 38% quarter over quarter. In this quarter, non-GAAP operating profit was $2.52 million, an increase of 364% from $543,000 in the third quarter of 2006 and an increase 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 previous quarter. 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 is 41%, compared to 49% in the same quarter last year and 38% in the second quarter of 2007. Adjusted EBITDA was $2.78 million in the third quarter of 2007, compared to $608,000 in the third quarter of 2006 and $1.87 million in the previous quarter, up 357% year over year and 49% quarter over quarter.

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

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

We will provide our guidance on Q4 2007 adjusted earnings non-GAAP, defined as net income excluding share-based compensation expenses, in January 2008.

Backed by record deferred revenue and also operating cash in-flows, a strong product pipeline, steadily increasing registered user base and continuous enhancement in telemarketing capabilities, we now raise our projected 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 also raise our projected adjusted earnings for ‘08 from the previous guidance of $19 million 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 ADS outstanding.

Based on our guidance, we expect our non-GAAP net income margin 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 our websites and rolling out more products, we are in the process of setting up new call centers to hire 500 additional telemarketers by the middle of 2008 to further expand our telemarketing team from 260 telemarketers as of September 30, 2007, to 760 telemarketers.

Telemarketing plays an instrumental role in the conversion from free registered users of our website to fee-based subscribers, and we believe that all else equal, the increase in the number of telemarketers will help grow our top line and bottom line as well.

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

Telemarketers are primarily compensated through commissions with low fixed salary. At their full capacity, new call centers with 500 telemarketers 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 already reflected the expenses of the new call centers.

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

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

Question-and-Answer Session

Operator

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

Chris Fox - I.N. Fox Capital

Hello and thank you for taking my questions. What I was wondering about is on a longer term basis, what is the plan for China Finance in light of the likelihood of further development in Internet companies such as Baidu, 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 seems to be because brokerage firms offer these services for free and so do companies like Yahoo! and Google. So in the context of the Chinese market, I would be curious how you plan to address that.

Jeff Wang

Thank you, Chris. Actually, I will answer your question first 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 premier service that we have premier content and most of these subscription services are not Internet based. They are downloadable software installed on computers and 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 we announced earlier this quarter, Genius also -- we also struck a strategic alliance with Tsinghua University, one of the top universities in China, to co-develop, to improve the quality of our data and also our content.

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

Chris Fox - I.N. Fox Capital

Thank you.

Operator

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

Alex Xu - Brean Murray Carret & Co.

Thank you. I have a quick question; I joined the call a little 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 that matter, 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 macro environment in your guidance, basically? Can you comment a little bit on that? Thanks.

Jeff Wang

Sure. Talking about the macro environment on our business, I think people actually are more interested in, for example, the stock market in China and also the U.S. market overall and whether this will have a negative impact on our business.

To be honest, the stock market does have an impact on our business but actually, something different in China, because China is an emerging market, even though the Chinese stock market has been declining over the 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 Chinese stock market has become a [bear] market. But because the Chinese market is actually an emerging market, the volatility in China can happen significantly in a particular quarter or month and will actually start to improve significantly 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 the market bounced back in the month afterwards.

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

In addition to the external factors, we also focus on the growth of our internal factors, primarily growing the registered user base of our websites, what stands to be another growth period in the third quarter of 2007. And we also -- that depends on how we roll out more product, and as we did this quarter, we just announced that we’ll roll out Fund Guru, which is a mutual fund individual tools, target over 10 million mutual fund investors in China.

Also, we will hire over about 500 telemarketers starting from now until the middle of 2008. We believe that the increase of telemarketers have actually a clear correlation with the growth in our top line and 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 actually adding more telemarketers to more efficiently convert free users to fee-based users and also to up-sell to low-end fee-based users, to lead to high-end fee-based customers.

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

Alex Xu - Brean Murray Carret & Co.

Thank you.

Operator

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

Anindya Chatterjee - Jefferies

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

And question number two is, despite the debate that can continue 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 you are needed to cut your costs, whether it comes through marketing, sales, or your technology costs? How do you think you can [fuel down] in case there is a slowdown on the revenue front?

Jeff Wang

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

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

And our website maintenance expense, for this quarter from example, it’s only $0.6 million, less than 10% of our total revenue. So in this sense, our business has a very good operating leverage to benefit from the growth in our business. And although we don’t see any actual foreseeable downturn in our business, but if there is a dramatic decline in the market, we are 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 about acquisitions and how we are going to spend our cash, if any, for the acquisition strategy.

Zhiwei Zhao (Translation)

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

We have been searching and communicating with the qualified targets. 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 from Dick 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, just on the 2008 guidance, can management comment a little bit about what are the assumptions for the different revenue segments, to help us understand the kind of revenue mix slightly? And I have a second question later.

Jeff Wang

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

Analyst for Dick Wei - J.P. Morgan

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

Jeff Wang

The average subscription fee for this quarter is about $620 per year. That’s the average subscription fee. And the total subscribers for this quarter is about 16,000 subscribers, new subscribers, actual fee-based subscribers 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 from existing customers and also we have actually new subscribers. Because we have very aggressive growth goals, including our target for 2008, our focus really is down to grow, to attract more subscribers. Without new subscribers, we cannot 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 further questions at this time.

Alice Yung

Okay. All right. That’s all for today’s conference. If you still 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 for joining us today. Thank you.

Operator

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

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