Charm Communications' CEO Discusses Q1 2012 Results - Earnings Call Transcript

May.17.12 | About: Charm Communications (CHRM)

Charm Communications Inc. (NASDAQ:CHRM)

Q1 2012 Earnings Conference Call

May 17, 2012 8:00 AM ET

Executives

Nicholas Manganaro – Ogilvy Financial

Mr. He Dang – Chairman, Founder and CEO

Wei Zhou – Chief Financial Officer

Analysts

James Marsh – Piper Jaffray

Amanda Chin – Credit Suisse

Eddie Huang - AIF Capital

Operator

Hello and thank you for standing by for Charm Communication Earnings Conference call. At this time all participants are in a listen-only mode. After management’s prepared remarks there will be a question-and-answer session. Today’s conference is being recorded. If you have any objections you may disconnect at this time.

I would now like to turn the call over to your host for today’s conference, Mr. Nicholas Manganaro from Ogilvy Financial.

Nicholas Manganaro

Hello everyone and welcome to Charm Communications earnings conference call for the first quarter ended March 31, 2012. The company’s earnings results were released yesterday and are available on the company’s IR website at ir.charmgroup.cn as well as on newswire services.

Today, you will hear opening remarks from Charm’s Founder and Chairman, Mr. Dang, followed by the company’s Chief Financial Officer, Wei Zhou, who will provide a financial overview and guidance for the second quarter of 2012. After their prepared remarks, they will be available to answer your questions.

Before we begin, please note that the discussion today will contain certain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations.

Charm does not assume any obligation to update any forward-looking statements except as required under applicable law. Also, please note that some of the information to be discussed includes non-GAAP financial measures as defined in Regulation G. The most directly comparable U.S. GAAP financial measures and information reconciling these non-GAAP financial measures, the Charm’s financial results prepared in accordance with U.S. GAAP are included in Charm’s earnings release, which has been posted on the company’s IR website at ir.charmgroup.cn. Please note that this conference is being recorded. In addition, a webcast of this conference call will be available on Charm’s Investor Relations website.

I will now turn the call over to Charm Communications Founder, Chairman and CEO, Mr. Dang, for whom I will be the translation.

Mr. He Dang

(Foreign Language)

(Interpreted)

Hello everyone and welcome to our first quarter earnings conference call.

(Foreign Language)

(Interpreted)

In the first quarter of 2012, we continue to expand the scale of our overall business, with total advertising turnover or billings drawing 6% year-over-year. We achieved this against the backdrop of one of the weakest quarters for advertising growth in recent years. According to the CTR market research, the Chinese advertising market grew just 1.7% year-over-year in the first quarter of 2012.

(Foreign Language)

(Interpreted)

For our core advertising agency business, our gain in market share was much higher than in previous quarters, with year over year turnover growth of 31%. This growth speaks to the strategic investments we’ve been making to enhance our capabilities and client services. Another key driver of this robust growth is the increasing contribution from the digital space. Our advertising turnover was almost 4 times greater than in the first quarter of 2011.

(Foreign Language)

(Interpreted)

Given the current challenging macro environment, we firmly believe with an investment in talent and infrastructure within our core agency business will improve our competitive position in the market place, and allow us to capture significantly greater market share, especially as our competitors turn cautious with their investments. When the market rebounds and growth normalizes, we want to be able to provide our clients with an integrated full service television and internet advertising platform, capable of providing the best advertising solutions.

(Foreign Language)

(Interpreted)

The part of our business that has been most affected by the macro slowdown and regulatory changes is our satellite television media business. Foreseeing these challenges at the end of 2011, we reduced our exposure to China’s satellite channels. However, the combined attack was greater than anticipated and as a result first quarter’s sales came in below expectations. These challenges have continued in the second quarter, so we will continue to ramp up sales in order to minimize the short term media inventory risk. We do believe however, that these challenging conditions offer us a unique chance to opportunistically secure media deals with significant long term value, especially as media prices rationalize.

(Foreign Language)

(Interpreted)

Finally, I’d like to raise a key observation we’ve made in speaking to many of our advertisers across the market place. We believe these challenges are short term, as the advertisers have not reduced their annual advertising budgets like they did in 2009. Instead, they are simply holding on to their budgets and waiting for an appropriate time to spend, which we believe will be in the second half of the year, if there is (inaudible). Overall, we remain confident that China’s advertising market will be the long term beneficiary of the country’s growth and consumer spending. As long as we remain steadfast in executing our strategies, we will be well positioned to capture long term growth from this trend.

(Foreign Language)

(Interpreted)

Moving on to our operating highlights for the first quarter.

(Foreign Language)

(Interpreted)

Our advertising agency revenues grew a robust 45% year-over-year outpacing the aforementioned 31% in billings growth. This was due to an increased revenue extraction rate of 5.5% in the first quarter of 2012, compared to 4.9% in the first quarter of 2011, which reflects our ability to deliver integrated advertising solutions to our clients. We were particularly successful in selling digital solutions to our existing television clients.

(Foreign Language)

(Interpreted)

For Charm Advertising, we added two new prominent television media accounts, TCL one of the largest multinational consumer electronics companies based in Southern China and Baihe.com, a leading Chinese internet dating service provider. These client wins demonstrate the expansion of our geographic reach and industry coverage. We also made progress with our new sports modeling department, which established a three year sponsorship and promotional agreement with a number of China’s Winter Olympic Sports Associations, including China’s ice hockey, curling, short tracks speed skating, figure skating and freestyle skiing teams. The first client win for the sports marketing department was with one of our long term clients, China Citic Bank, which became the official sponsor of the Chinese national “Go” team as a way of marketing their new wealth management products.

(Foreign Language)

(Interpreted)

Our digital business experienced solid organic growth in the first quarter with successful wins for both Charm Click and Charm Interactive. Charm Interactive is now working with AAE travel, a joint venture between the worlds of leading online travel company Expedia and the award winning low cost airline AirAsia. Meanwhile, Charm Click went to search businesses for Tommy Hilfiger and MG Cosmetics. Also in the first quarter Charm Click received the 2012 Discovery award from Baidu, the leading Chinese language internet search provider, as well as the 2011 outstanding partner award from Taobao, China’s largest commerce market placed operator. The awards were based on the number of Charm Click clients, the volume of billings and the effectiveness of the SCM solutions delivered to both Baidu and Taobo in 2011. These awards speak to Charm Click’s leadership position with respect to two of the largest digital advertising eco systems in China. For Charm Interactive, we plan to invest further to enhance our online video services and capabilities.

(Foreign Language)

(Interpreted)

With servicing media as mentioned in the previous quarter, 2012 will be an especially challenging year. In the first quarter, the sales of our renewed media inventory were impacted by the macro slow down and regulatory changes. Although, sales of our new media inventory on CCTV and non-__1:04_____ satellite ramped up slower than anticipated. This led to lower and than expected sales for overall media business. Although, we still expect the overall business to ramp up through the course of the year and short term media inventory risk to lessen. The ramp up pace of our media business will be slower in the second quarter as advertisers remain cautious with their budget.

(Foreign Language)

(Interpreted)

With that being said, the current market offers us a tremendous opportunity to invest in media assets with long term value at reasonable prices. Just this month, we were able to secure an exclusive contract with Beijing Television for its sports channel BTV Sports, to the end of 2014. BTV Sports is a 24-hour sports channel broadcasting to greater Beijing with programming that include live and recorded popular athletic events, such as the English Premier League, UEFA Champions League, the Chinese Basketball Association and the NBA. We see tremendous growth potential in its assets of live sports broadcasting as a unique TV product that has not been affected by the digital revolution, and faces little in the way of regulatory hurdles. Although, the initial payments and ramp up period will impact our second quarter results, we believe this asset will integrate particularly well with our sports marketing solutions and generate healthy margins once ramped up.

(Foreign Language)

(Interpreted)

Looking ahead, we will continue to execute on our longer term strategy of providing a full service integrated advertizing platform with a particular focus on television and the internet, which we believe will best help the advertisers build their brands and reach China’s consumers. Key investments in talent and infrastructure will give us the foundation to support this strategy and achieve sustainable long term growth.

(Foreign Language)

(Interpreted)

I will now turn the call over to our CFO Wei Zhou who will discuss our financial results.

Wei Zhou

Thank you Chairman. Hello everyone on the call today. Before I go to the financials I would like to take you through our three core business segments to give you some updates on our progress. Please note that in the first section, I will be referencing some of our first quarter results using non-GAAP numbers in order to better convey our performance. We define non-GAAP turnover as a total customer advertise and spending placed through or with Charm in order to reflect the scale of our business.

In the past quarter we continue to outgrow the market from a billings perspective and gained additional market share. In the first quarter of 2012 turnover grew 6.1% year-over-year and declined 17.4% quarter-over-quarter to approximately $210 million. The year-over-year increase in turnover was mainly due to the increase in the number of advertising clients, and an increase in the spending from the existing clients. The quarter-over-quarter decline in turnover was largely attributed due to decline in the media and investment management business, as well as seasonal factors.

I will break them down by business. The non-GAAP turnover for the advertising agency business grew 30.5% year-over-year and decreased 0.5% quarter-over-quarter to $188 million in the first quarter of 2012. The year-over-year increase in the agency business turnover was mainly due to the increase in the number of new agency customers, and the increase in spending from existing clients. The quarter-to-quarter decrease in turnover was mainly attributed to slightly weaker demand in the first quarter due to seasonal factors.

In the first quarter of 2012, we provided advertising agency services to 160 advertising clients, most significant client wins in the first quarter were TCL and Baihe.com. The revenue extraction rate which is defined as revenue divided by turnover for the agency business was 5.5% compared to 4.9% in the first quarter of 2011 and 6.2% in the fourth quarter of 2011. The year-over-year increase in the revenue extraction rate was mainly due to increase in spending on non-CCTV media platforms, such as the satellite channels as well as internet, which -- both have higher extraction rates.

The quarter-over-quarter decrease in the revenue extraction rate was mainly due to strong seasonal related (inaudible) first quarter on CCTV, which generally has a lower extraction rate, compared to other media platforms. We expect the revenue extraction rate to increase as we expand our full service offerings across all media platforms under Charm, and ramp up digital media spending under Charm Interactive and Charm Click.

Our turnover for the media investment management business, principle media business, which operates under the Shangxing Media brand, declined 59% year-over-year and 56% quarter-over-quarter to $22 million. The decrease was mainly due to the dropping of several medial assets and transferring some of them to our principal business, such as Shanghai Dragon to our agency business in order to modify our inventory mix, and minimize the risk associated with the regulatory changes in the satellite market. For the first quarter of 2012, we had 150 advertisers for our principle media business compared to 225 advertisers from the first quarter of 2011. This is mainly due to the drop of Hubei satellite which had a larger number of small advertisers.

Now going back to the GAAP figures, total U.S. GAAP revenues was $33.5 million for the first quarter of 2012, a decrease of 46% compared to $56.3 million in the first quarter of 2011. A decrease of 58% compared to $80 million in the fourth quarter of 2011. Revenue for our agency business were $10.3 million for the first quarter of 2012, representing an increase of 44.6% compared to $7.1 million for first quarter 2011 and a decrease of 12.4% compared to $11.7 million for the fourth quarter 2011. The increase in agency revenue is consistent with the increase in turnover. Principle media business revenue was $22 million for the first quarter representing a 59% increase versus the first quarter of 2011, and a decrease of 66% compared to the fourth quarter 2011. The decrease in the revenue is consistent with the changes in turnover.

Branding and identity services revenues were $1.1 million for this first quarter of 2012 representing a decrease of 4.7% compared to $1.1 million in the first quarter of 2011, and a decrease of 64% compared to $3 million in the fourth quarter of 2011. The decrease in brand and identity services for quarter over quarter was mainly due to decrease in client demand for creative services in the firms.

Cost of revenues for the first quarter of 2012 was $23.7 million, compared to $47.4 million and $51.8 million for the first quarter and fourth quarter of 2011 respectively. Remaining attributing to the year-over-year decrease in cost of revenue to the dropping of several media assets and our principal media business and we’re going to modify our inventory mix in the wake of regulatory changes in the satellite market.

Gross profit for the first quarter of 2012 was $9.8 million representing a decrease of 33.7% from $14.8 million for the first quarter of 2011, and a decrease of 65.5% from $28.5 million in the fourth quarter of 2011. Gross margin for the first quarter was 29.3% compared to 23.8% for the first quarter of 2011 and 35.5% for the fourth quarter of 2011. The year-over-year increase in gross margin is mainly due to the shifting of business from some of our principal media business to our agency business which had higher gross margin from an accounting perspective.

Selling and marketing expenses was $7.4 million for the first quarter of 2012 representing an increase of 48.2% from $5 million in the first quarter 2011 and a decrease of 23.1% from $9.6 million, in the fourth quarter of 2011. The year-over-year increase in selling and marketing expenses was primarily due to continued investment in company’s digital business including increased head count at Charm Interactive and Charm Click. Quarter-over-quarter decrease in our marketing expenses was primarily due to seasonal factors as fewer marketing events were held in the first quarter.

General and administrative expenses for the first quarter of 2012 grew 20% year-over-year and decreased 36.5% quarter-over-quarter to $2.1 million. The year-over-year increase is mainly attributed investments and infrastructure to support a long-term growth, such as investments in our office space and in IT systems.

Operating profit was $0.2 million or $200,000 for the first quarter of 2012, compared to $8.1 million for the first quarter of 2011 and $15.5 million for the fourth quarter of 2011. GAAP net income was $800,000 for the first quarter of 2012 representing a decrease of 90% from $8.2 million in the first quarter of 2011 and decrease of 94.8% from $15.7 million for the fourth quarter of 2011.

Fully diluted net income per ADS for the first quarter of 2012 was $0.1 compared to $0.19 and $0.36 for the first quarter of 2011 and fourth quarter of 2011 respectively. Each ADS represents two common shares. Our first quarter in non-GAAP net income, which excludes share based compensation expenses and impairments on investments was $1.9 million, a year-over-year decrease of 79% and the quarter-over-quarter decrease of 89%.

Net cash outflow from operation for the first quarter of 2012 was $4.7 million mainly due to a prepayment made for New Media Investments. As of March 31, 2012, net cash and cash equivalents of $132.5 million, compared to $139.4 million at the end of fourth quarter 2011. We also had 764 employees as of March 31, 2012 compared to 691 employees as of December 31, 2011.

And now turning to our business outlook, we estimate for our total revenues for the second quarter of 2012 will range from $36 million to $37.5 million. Second quarter 2012 non-GAAP net income, which excludes share based compensation expenses and impairments on investment is expected to be between $1.5 million to $2 million. We base these estimates on a foreign exchange rate of 6.3 RMB per U.S. dollar. This forecast reflects our current and preliminary view, which is subject to change.

Thank you for your attention. I’ll now hand the call over to operator who will open the lines for question. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) your first question comes from the line of James Marsh of Piper Jaffray.

James Marsh – Piper Jaffray

Thanks very much. You’ve mentioned in your prepared remarks the overall ad market have been a little bit softer in the first quarter. I was wondering if you could provide a little bit more color on which ad media seem to be doing well and which one is not so well, as well as which ad category seem to be holding up better than others, and then I have a second question. I guess it is somewhat related to the weaker ad market as well and I want to get a better sense on how you think your competitors are responding to the weaker ad market and to the changes in the regulatory rules, and it this helping you in the long term, or just trying to get a sense for how people’s behavior change in this market? Thanks.

Wei Zhou

Hi James. I’ll take the first question. In terms of ad from the media perspective I think if you look at the number that we got from CTR which runs sort of the overall market research, we saw around 1.7% increase in the ad market. And if you look at within that ad market I think the numbers we saw for television was around 1.4% which is consistent with the overall market; however, if you look at print media for example newspaper, there is a sharp decline of little bit under 10% quarter by year-over-year. For the digital media, the overall internet media, internet advertizing that increased, we just saw an increase of around 25 to 26% in the data from CTR. And within sort of internet definitely search and video has been faster growers, both achieving over 50% growth, with sort of display lagging significantly.

From sort of for the second question, I have to answer your second question in terms the competitive dynamic in the market. I think is a combination of players in this market. First of all, if you look at the satellite channels themselves, I think from their perspective I think we saw probably revenues compared to last year. If you look at some of the leading satellite channels in China, which look (inaudible) I think all of them saw a decline in the ratings as well as revenue compared to last year. So, I think from our perspective looking at back at what we did at sort of end of last year. We minimized our exposure to that space. I think was the right decision and if you turn it over to sort of the competing agencies that we compete with, including the international agencies I think we definitely seeing decline in spending at some of the major accounts, in the data that we saw. For example in the FMCG category, especially I think for the spending on television, some of the major brands and some of the major spenders, from them top two or three spenders, we are looking at around 5 to 10% decline in terms of where they are spending that money. So, I think it is definitely a challenging environment, but as Mr. Dang said I think, we are not seeing advertisers sort of cutting back on their spending as we have saw near the end of 2008 and 2009. It is just that a lot of the advertisers are sitting on that budget and then waiting for that, and we believe that money—that budget will still get released into the market later in the year.

James Marsh – Piper Jaffray

Okay, that is extremely helpful thank you. And then just one quick followup related to your sports channel investment. You said that because it hits into the second quarter, could you give us a kind of rough amount of money that you are making to get the rights sets of sports management business and is that recurring or it is just a one-time pay.

Wei Zhou

Yeah. We signed a sort of the contract—sort of similar, sort of how we signed these assets is that we will pay them 2 to 3 months about a quarter of deposit first and then typically we will pay about 1 to 2 months of media cost as well. So, in terms of a cash commitment it is only about 3 to 4 months upfront. From an accounting perspective, it is booked on a sort of monthly basis. So, in terms of our working capital commitment is only around say 4 months total upfront, but that being said the contract starts June 1. So – and then what we need to do in the meantime is basically develop the sales activities over the next quarter or two. So, mainly we expect that cost to ease into the second quarter for about a month for us, but going forward where we see a lot of value is that we are able to lock this channel up, until the end of 2014. So, from a return perspective we expect this channel to generate the 25 to 30% return, the cash are returned on a sort of the long term basis over that period. But because this is a, what we believe this is a very key prime asset, especially with the Olympics taking off in July, the ramp up time maybe faster than sort of some of the other assets, that we have operated previously like the Hubei last year and then also (inaudible) satellite, which we took up first quarter of this year.

James Marsh – Piper Jaffray

Okay, thanks very much.

Operator

(Operator Instructions) Your next question comes from Amanda Chin of Credit Suisse.

Amanda Chin – Credit Suisse

Hello, hi, thank you. This is Amanda Chin from Credit Suisse asking question on behalf of Wallace Cheung. I have two questions here first it seems that the advertising market is (inaudible) so, can we know are there any special reasons behind this or do you think the risk will carry through the rest of the year?

Wei Zhou

Thank you Amanda. I’ll translate the question for Mr. Dang and I’ll have him sort of to go over that.

He Dang

(Foreign Language)

(Interpreted)

I’ll translate the answer for Mr. Dang. The advertising market I think currently reflects the macro economic environment. Of course from speaking to a lot of our clients, there is an issue of business confidence, but that being said we still believe that for a lot other clients that we’ve spoken to, they still – their business is actually still operating okay and they are waiting for some more clarity within the macro environment before they release their budget. Of course, we will carefully monitor the economic environment and we act appropriately if the condition changes.

Amanda Chin – Credit Suisse

Thank you, and my second question is also about the sports. Can you explain why you signed BTV sports (inaudible)?

Wei Zhou

Yeah, I think it’s related to sort of what we’ve talked about in the call. I think when we looked at the market sort of near to end of last year we saw there as a disconnect between the expectation from the media owners and also the pricing expectation from the clients. I think from a TV owner’s perspective, I think especially for lot of the satellite channels, they’ve had 4 or 5 straight successful years. And they basically were able to improve their ratings, and increase their prices. But what we saw was that because of this regulatory impact, we felt that some of the asking prices for media especially for the principle business was not sustainable into the year. And then that has happened essentially and is still happening right now. So, but what’s interesting is that so some of the agencies that basically you know, bought some of these inventory, have basically dropped out from the market place. And as these, agencies drop out from the market place, these channels still need to look for partners that can support them in terms of their sales and marketing activities. So that being said, we felt that the negotiating leverage now returns to agencies that have both sales and marketing capabilities to support these satellite channels and have the capital to sort of to buy out some of these media assets. We felt for sports its actually a very unique asset and its very neutral from a regulatory perspective and also because of live broadcast of sporting events, basketball, football, even the Olympics, the live broadcast is not affected by digital. So you’re not going to see sort of audience leaving from this type of television product, as you have been seeing from say television drama or even shows by online video per se. So, we felt that this is a safe asset to invest in and also its at a reasonable price and we felt that like we should be able to generate healthy margins on this asset, you know over the next two and half years.

Amanda Chin – Credit Suisse

Thank you, it was helpful.

Operator

(Operator Instructions) The next question comes from the line of Eddie Huang of AIF Capital.

Eddie Huang - AIF Capital

(inaudible) could you give us some more color about how you use different channels (inaudible?

Wei Zhou

I’m sorry, Eddie, basically I couldn’t hear your question and felt sort of Guangdong, can you…

Eddie Huang - AIF Capital

Can you give us some more color about how Guangdong has been doing over the past quarter and how that’s going to pan out slipping into the second quarter versus your original (inaudible)?

Wei Zhou

Yeah. For the new assets that we added for the year, its basically a few programs on CCTV 8 and CCTV 10, as well as Guangdong based National Satellite Channel, which is Cantonese channel based broadcasted within Guangdong Province. I think for these assets, I think what we’re seeing is that, the ramp up has been slower vis-a-vis our expectation. I think the impact of that as we talked about on the call, we have to do a combination I think, mainly more due to sort of the macro environment, especially I think as impacted by sort of the Chinese New Year seasonality, as well as sort of our ability to build up the selling and marketing staff within that region. I think our expectation for that channel is still for it to turn to be gross profit positive for the full year. It’s just that the speed ramp up is slower than our expectation.

Eddie Huang - AIF Capital

I understand, thank you. And in light of the guidance that the executives have given for the second quarter was it between a million and a half or two million, for non-GAAP net income. What are your views on the expense side of (inaudible) are you expecting to again keep ramping that up, or is there some measures to pin that back a little bit as you see that the top line is summing up?

Wei Zhou

I think, as Mr. Dang mentioned, we’re carefully monitoring the economic environment, as well as our focus in terms of our strategy in terms of building up, especially our agency business. I think we have to separate the two businesses that we operate, on the agency side we actually delivered a very strong results, 45% year-over-year increase from a revenue perspective because of the ramping up in terms of digital spending, I think for that side of operation, I think we will continue to ramp up the investments, especially in terms of talent on the digital side as well as infrastructure and investments in IT. I think for the media side of the business, I think as I said before, we believe that second half of the year we should be able to see things normalizing, but from an investment perspective, as we talked about a couple of months ago is that bulk of that investments will come through in the second half of the year. So, I think we still have some decision power in terms of whether to ramp up or maintain.

Eddie Huang - AIF Capital

Thank you Wei.

Nicholas Manganaro

Thank you for your participation, this concludes the company’s earnings call. Good day.

Operator

Thank you for participating in today's conference, you many now disconnect.

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