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AsiaInfo Holdings, Inc. (NASDAQ:ASIA)

Q1 2006 Financial Results Earnings Conference Call

April 26th 2006, 8:00 PM

Executives

Eileen Chu - Investor Relations

Steve Zhang - President and Chief Executive Officer

Ying Han - Chief Financial Officer

Analysts

Chang Qiu - Forun Technology Research

Mark Hait - Hait Capital Management

Operator

Good day and welcome to today’s AsiaInfo Q1 2006 results announcement call. I am pleased to present Ms. Eileen Chu. Ms. Chu, please begin.

Eileen Chu

Hello everyone and welcome to AsiaInfo’s 2006 first quarter conference call. Today Steve Zhang, President and CEO of AsiaInfo will review some of AsiaInfo's business highlights for the most recent quarter; and Ying Han, AsiaInfo's Chief Financial Officer, will provide greater details on the financial results as well as guidance for the upcoming quarter. Mr. Zhang will then provide a few closing remarks and open the call to questions.

Before we continue, allow me to review our Safe Harbor statements. During this conference call, representatives of the Company may make forward-looking statements in an effort to assist you in understanding the Company and its results. Please refer to AsiaInfo’s reports filed with the SEC for discussions of important factors that could affect future results. Also, please take note that all figures mentioned during this conference call are in US dollars. I will now turn the call over to AsiaInfo’s President and CEO, Steve Zhang.

Steve Zhang

Hello, and thank you for joining us today. I am pleased to report today that AsiaInfo's net revenue and EPS exceeded our guidance for the quarter, as we continue to see strength in our core telecom businesses and saw better-than-expected performance in our security products and the services business.

I am encouraged by our financial results for the quarter, especially in the telecom business, which grew net revenues 11% year-over-year and 8% sequentially. We continue to see a growing proportion of telecom revenue come to us on a recurring basis, rather than as a result of a direct sales order, as carriers increasingly recognize the value provided by AsiaInfo's solutions.

During the quarter, as part of a pilot program to improve the data processing and analyzing capabilities of China Mobile's city-level branches, AsiaInfo constructed municipal level of our Data Mart applications of Jilin Mobile and Yunnan Mobile. We also successfully deployed meta data management platforms for China Mobile's provincial subsidiaries in Hebei and Jilin Mobile which greatly increased the quality of the carriers' data management.

These breakthrough projects are examples of how AsiaInfo is leveraging its experience and the competitive advantages to create a solution to help China's telecom carriers become more productive, more competitive and more profitable. We believe that the market for telecom software solutions will continue to grow, as more carriers look to projects such as this to create value.

In fact, according to MII statistics, total revenues for China's telecommunication industry in 2005 increased by 11.7% over 2004 to reach $71.9 billion. We will continue to grow our telecom business both by organically leveraging our technical expertise and unrivalled local market insight gained over the last 10 years. As well as through making selective acquisitions that can be easily integrated and allow us to expand our market share.

As I mentioned earlier, Lenovo-AsiaInfo security business performed better than expected during the quarter, posting a lower than anticipated operating loss. We are optimistic about the IP security market in China and are confident in Lenovo-AsiaInfo's management team, under the leadership of Bing Yu. Moreover, we believe that the worst is behind us as the material negative financial impact surrounding Lenovo-AsiaInfo has already been recorded in the fourth quarter of 2005.

We will continue to closely monitor the performance of our security business and keep you updated. As I mentioned previously, last quarter AsiaInfo initiated an inquiry into the issues surrounding their revenue shortfall in the Lenovo-AsiaInfo business unit during the fourth quarter of 2005. We are currently in the process of formulating claims to recover damages and we will provide more information as appropriate.

Let me now turn the call over to Ying Han who will review the quarter's financial highlights.

Ying Han

Thank you, Steve. This morning, early this evening we [inaudible - background noise] our press release, I will provide some additional information on key results for the quarter. I will also discuss guidance for the second quarter.

In the first quarter we exceeded our revenue guidance by more than $1 million and the EPS guidance by approximately $0.05. This reflects ongoing profitable growth in our core telecom business, and a significantly lower than expected operating loss in our security business.

While first quarter gross revenues in our telecom business were up, both year-over-year and sequentially, higher revenues from third party hardware pass-through resulted in lower gross margin during the period. This was largely due to two contracts signed in the fourth quarter of 2005 with hardware components from which revenue were realized upon delivery in the first quarter.

Third party hardware pass-through has been generally increasing in the past year as we focus on our high margin software business. However, from time to time we offer hardware for some projects in response to customer requests.

On a sequential basis, gross margin for the group increased from 23% to 36% as we saw better-than-expected performance in our Lenovo-AsiaInfo security business.

Total gross operating expenses for the quarter were up slightly year-over-year, and decreasing by 70% sequentially from the previous quarter, reflecting the large non-cash charge for impairment of goodwill and the acquired intangible assets due to the fourth quarter shuffle in revenue at Lenovo-AsiaInfo.

As Steve mentioned earlier, recurring revenues in our telecom business continue to increase, allowing us to reduce the lines on our direct salesforce. As a result, sales and marketing expenses decreased by 11% year-over-year and 25% sequentially.

General and administrative expenses increased 48% year-over-year, reflecting the legal fees relating to the Lenovo-AsiaInfo inquiry and the $800,000 provision for bad debt for the group. This is compared to a profit and a $400,000 write back in the provision for bad debt in the year ago period.

During the quarter, we posted an overall operating loss of $500,000 compared to an overall operating profit of $1.1 million in the year ago period. Our telecom business posted a contribution profit, before corporate G&A expenses, of $3.7 million; while Lenovo-AsiaInfo posted a contribution loss before corporate G&A expenses of $1.9 million.

Operating cash flow for the quarter was $7.2 million, up mainly as the result of enhanced collection efforts and the better use of financial instruments for vendor payments.

Moving into our balance sheet, our total cash and cash equivalents rose approximately $1 million to $93 million, reflecting the net operating cash flow of $7.2 million and the release of approximately $1 million of restricted cash, which was partially offset by share repurchase to the value of $7.4 million.

There was only a 2% decrease in notes receivable, since last quarter, reflecting enhanced collection efforts during the quarter. DSO decreased to 134 days compared to last quarter's 157 days. Payment rates were up 9% for the quarter, due to an increase in revenue for third party hardware pass-through. A large increase in notes payable and accounts payable for the quarter were in line with the increase in hardware inventory.

[Inaudible] stock increased from $4 million to $11 million as a result of a 90-day share repurchase program, which was originally announced in January of 2006. The board of directors has offered an extension to this share repurchase program for an additional 90 days from April 25th to July 24th; but make no change to the number of shares authorized to be repurchased under the plan.

Share purchase under the extended repurchase program will not begin until after the insider trading window closes on May 25th, 2006. As of April 11th, 2006 we have already repurchased 2.1 million common shares.

I will now read AsiaInfo's financial guidance for the second quarter of 2006. Please note that the following outlook statements are based on our current expectations. These statements are forward-looking, and actual results may differ materially.

Revenues net of hardware pass through in the second quarter are expected to be $18 million to $20 million and we expect second quarter earnings per basic share to be $0.01 to $0.02. We anticipate the Lenovo-AsiaInfo security products and services will post an operating loss of approximately $1 million in the second quarter, compared to the $1.9 million operating loss in the first quarter.

Now let me turn the call back to Steve for his closing remarks.

Steve Zhang

Thank you, Ying. The first quarter of 2006 was encouraging, as we focused on our core areas and made tangible progress in both telecom and the security businesses. In the telecom market, we leveraged our leading technology and local market insights to create innovative, value-added solutions for our customers. We have strong visibility for the telecom business for the rest of 2006, and we are confident that we will continue to dig deeper and uncover new areas where we can help our customers to increase competitiveness and generate value.

Also importantly during the first quarter we addressed our operational issues in our security products and services division, and saw better than expected results. We believe in this market and we were [inaudible] in key technology and brand recognition. We remain optimistic about this business.

Overall we are confident that our focused approach on core business will continue to put AsiaInfo firmly on a profitable growth track in 90 days; we have just begun and the real work lies ahead of us. Thank you for your continued support of AsiaInfo. I will now open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Chang Qiu, Forun Technology Research.

Chang Qiu, Forun Technology Research

Good morning, Steve and Ying. Congratulations on very good results.

Steve Zhang

Thank you.

Ying Han

Thank you, Chang.

Chang Qiu, Forun Technology Research

Steve, one question for you first. With four of the major operators in China announced an increased spending budget for 2006, I would like to see your view on the telecom software business. Previously you were growing 10-11% year-over-year. What is your new projection?

Steve Zhang

You are saying that telecom operators have increased their investment budget for this year?

Chang Qiu, Forun Technology Research

Right.

Steve Zhang

We see that for China Mobile. That has been increased by about 11%. So China Unicom, because China Unicom was going through some senior management changes, I think it has an impact for our China Unicom business, in the second half of this year. We expect to see more than 10% organic growth in the full year 2006 for our telecom business.

Chang Qiu, Forun Technology Research

Ying, for your guidance, or maybe even for your Q1 results, do you have any stock-based compensation expense?

Ying Han

For Q1, I don't think we have. Let me check, good question. We have, as we announced previously, we have all the stock options vested in 2005. So we do have the amortization for newly issued restricted stock, but the amount is not very material.

Chang Qiu, Forun Technology Research

This was incorporated in your Q2 guidance?

Ying Han

Yes, you are right. Q1 we have about $136,000.

Chang Qiu, Forun Technology Research

$136,000. And how much is in Q2?

Ying Han

It is roughly the same, because all of our stock options were vested already in the year of 2005.

Chang Qiu, Forun Technology Research

Okay. Back to your guidance, it looks like you have a vast improvement in the securities business, but on the [OFM], how you are guiding the total revenue between $18 million and $20 million, which means are you seeing the telecom software business down due to sequential reasons? Or due to just because you tried to be conservative?

Ying Han

I think the telecom business sequentially will be flat in Q2 because we had obviously a little bit lower performance in Q1 because of the holidays. But we do expect these to continue to grow sequentially.

Chang Qiu, Forun Technology Research

Okay, thanks. I will let other people ask their questions and I may come back later.

Ying Han

Thank you, Chang.

Operator

(Operator Instructions) We again have Chang Qiu with Forun Technology Research. Please go ahead., Mr. Qiu.

Chang Qiu, Forun Technology Research

Yes, Steve maybe you can give some color regarding your service revenue? We see some decrease there. I just wonder what is the situation?

Steve Zhang

I think the service revenue drop was caused by several reasons. One is in our last year's quarter one, we do have our discontinued ERP implementation service unit and since we no longer have that business, part of the reason is due to that fall.

Ying Han

This is Ying. For the service revenue, actually it includes all of the non-software related services there, that revenue actually we have decreased for some period already, because we focused on our software products and solutions related to service revenues.

Chang Qiu, Forun Technology Research

And for the bad debt provision, do you see that in the coming quarter or in the coming quarters? Or is that just a one-time provision?

Ying Han

For the bad debt provision, by our track record you can see, sometimes we have bad debt provisions and sometimes we have write backs. I remind you, we make provisions according to the Company policies, but actually we have not much real bad debt, because it just takes time to collect the accounts. We make 100% provisions for all of the accounts over one year, but later we collect it. That is why you often see the numbers up and down, just because of that reason.

Chang Qiu, Forun Technology Research

Okay, And for the income tax, I thought you had quite some operating loss carried forward. How should we understand the effective tax here?

Ying Han

Our effective tax rate this quarter and the previous year are about 15% because we do have the telecom business which is very profitable; we have Lenovo-AsiaInfo, non-telecom business, losing money there. So it is a combination that we still have some of the income tax payable there.

Chang Qiu, Forun Technology Research

Your profit/loss at Lenovo offset the income?

Ying Han

We do have some tax payable in there, but given the loss -- it is big in Lenovo-AsiaInfo, and the profit is also very big for the telecom business and they are two separate, legal entities. After our tax planning and transfer pricing, we still have some tax payables there.

Chang Qiu, Forun Technology Research

Okay, thank you. Thanks a lot for this very good quarter and I hope you keep doing the good work.

Eileen Chu

Thank you, Chang.

Steve Zhang

Again, thank you for joining us today. If you have any further questions, please do not hesitate to contact myself, Ying or any of our investor relations representatives.

Operator

We have another question on the line. Are you happy to take more questions?

Steve Zhang

Yes, yes.

Operator

Okay, our next question is from Mark Hait from Hait Capital Management. Go ahead, Mr. Hait.

Mark Hait - Hait Capital Management

I have a series of questions about first, Lenovo. Then I want to talk to you about your buyback. I am a little confused on what really happened with Lenovo. After you bought it, a bunch of the people that sold the Company to you, they left and then now are they competing against you? What is going on there?

Steve Zhang

During the fourth quarter we started an inquiry into the issues that caused the revenue shortfall. We are currently in the process of formulating claims to recover damages. While several former Lenovo-AsiaInfo employees have established a company, we do not believe that to be a competitive threat. Lenovo-AsiaInfo's business is under new management. We are cautiously optimistic about the future.

Mark Hait - Hait Capital Management

Okay. Did they take a lot of your clients away?

Steve Zhang

They took some of the security clients away, yes.

Ying Han

But most of them are staying with AsiaInfo.

Mark Hait - Hait Capital Management

Okay, that's good. How many salespeople did they take?

Steve Zhang

They took about 30 salespeople away.

Mark Hait - Hait Capital Management

That sounds like a lot.

Steve Zhang

Right.

Mark Hait - Hait Capital Management

How many have you replaced?

Steve Zhang

Well, we have replaced them all in the first quarter. Because the sales model for our security business is mostly through channels, so we did a lot of work to stabilize our channel business.

Mark Hait - Hait Capital Management

Okay. Were these people under non-compete clauses with the sale of the business to you?

Steve Zhang

Well, we are still investigating into that issue.

Mark Hait - Hait Capital Management

So they sold the Company, when? In the middle of 2005?

Steve Zhang

I didn't get your question.

Mark Hait - Hait Capital Management

When did you buy that company?

Steve Zhang

We bought the Company in October, 2004. The transaction was closed in October 2004.

Mark Hait - Hait Capital Management

And then they left at the end of 2005?

Steve Zhang

Right.

Mark Hait - Hait Capital Management

All right. And what has been your revenue shortfall? What is the amount of money, on an annualized basis?

Ying Han

Excuse me?

Steve Zhang

The revenue for our security business before they left is about $3 million a quarter.

Mark Hait - Hait Capital Management

And how much is it running at now?

Steve Zhang

Right now, for our first quarter the revenue is about $1 million.

Mark Hait - Hait Capital Management

Do you think you are going to make that back up to the $3 million, or how long is that going to take?

Steve Zhang

Well we expect to go back to the $3 million level in the second half of this year.

Mark Hait - Hait Capital Management

Okay. Now, you have a lot of cash on your balance sheet, cash and securities, and I noticed you started a buyback program. You did about half of the shares that you'd promised you were going to buy in 90 days. I noticed that they are still in treasury and that you had indicated that you weren't going to retire them. So my first question is, are you really going to buy 4 million shares and then not retire them and give them to employees and things like that? That's almost 9% of the Company.

Ying Han

For the treasury stock, actually we did two stock repurchase programs already. The first one we did was last year, we bought the stock for the purpose of the acquisition of Lenovo-AsiaInfo. Because we have a lot of cash on hand, that is why we just buy back the shares and then reissue it for the acquisition purposes if there are any there. That is the first repurchase.

Now we continue to repurchase --

Mark Hait - Hait Capital Management

Hold it, hold it. If you have a lot of cash, why do you need to issue shares to make an acquisition?

Ying Han

Because when we do an acquisition, most of the time the sellers want AsiaInfo shares instead of cash. Then we have a lot of cash. So what we did is that we used the cash to buy back shares, and then issue the shares to the seller.

Mark Hait - Hait Capital Management

Well wouldn't it be better for shareholders to just give them part of the cash, rather than buying back the shares and not retiring them? It would be better for shareholders if you just paid cash.

Now the other question I have, you have so much cash, what is the possibility of returning some of that cash to the shareholders, since you are not really using it?

Ying Han

No plan for that yet. We still plan to use up cash to grow the business in a very good potential market there.

Mark Hait - Hait Capital Management

Okay. Well that's just an idea for you to consider. It might help your stock price, and then you could issue more shares in your acquisitions.

Ying Han

Sure. Thank you.

Mark Hait - Hait Capital Management

Thank you.

Operator

(Operator Instructions) There are currently no more questions. We will move to closing comments. Ms. Chu, please go ahead.

Eileen Chu

Thank you for joining us today. If you have any further questions, you can contact our IR representative anytime. Thanks again.

Operator

This concludes today's conference call. Thank you all for attending.

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