Nine Energy Service, Inc. (NINE) Q4 2005 Earnings Call Transcript

Ladies and gentlemen thank you for standing by. Welcome to Fourth Quarter 2005 Ninetowns Digital World Trade Holdings Earnings Conference Call. My name is Liz and I will be your coordinator for today. At this time all participants are in listen only mode. We will however be facilitating a question and answer session towards the end of this conference. If at anytime during the call you require assistance please may key "*" followed by "0" and a coordinator will be happy to assist you. I would now to turn the call over to your host for today's presentation Ms. Lisa Zheng, please go ahead.

Thank you, operator. I would like to welcome everyone to Ninetowns' Fourth Quarter 2005 Results Conference Call. With me today are, Mr. Shuang Wang, Chief Executive Officer; Mr. Tommy Fork, Chief Financial Officer; and Mr. Eric Ho, Chief Strategy Officer. After our presentation, we will have time for any questions. Before we begin the formal remarks, participants are advised that this conference call will include statements about future events and expectations, which are forward-looking statements. All forward-looking statements involve risks and uncertainties and actual results may differ materially from those discussed in or implied by such forward-looking statements. These forward-looking statements speak only as of the date of this presentation and while we may update some statements from time-to-time, we assume no duty to update them to reflect new changing or unanticipated events or circumstances and you should not rely on such forward-looking statements. In particular, the Company expects to confirm risks such as (1) the entrance of additional competing software products into the Company’s marketplace; (2) the need for Company, to reevaluate the change its operating models; and (3) potential further encouragement by PRC Inspections Administration of the development of software products that may be competitively the Company’s existing software products All or any of which, may negatively and significantly affect the Company’s ability to generate total net revenue in the future. Before turning the call over to our chief strategy officer, I’d like you to know that the reference in this call to dollars refer to amounts in US dollars, and also to announce that Ninetowns plans to attend Deutsche Bank Access China Conference in Beijing on March 2nd. For a complete list of investor-related activities, please visit our English website at www.ninetowns.com/english. Also our English website you can access PowerPoint presentation in PDF format which we will refer to during the later part of our conf call today. I would now like to turn the call over to our Chief Strategy Officer, Eric. Please go ahead.

Thank you Lisa, thank you everyone for joining us today. The fourth quarter was another transition quarter for us. In mid February the PRC Inspection Administration formerly launched its software training program in 14 different regions including Shanxi, Guangdong and Zhejian among others. The actual software installation will likely to start in March and Ninetowns will be the exclusive vendor in helping these enterprises install the PRC Inspection Administrations software products. We are pleased that everything remains on track in terms of benchmarks and deliverables. We are also pleased, because we maintain our market leadership at close to 90% of the market share. We will also be able to maintain our sales momentum for our enterprise services, specialty sales service contract. Net income would have been higher as well but customer acquisition cost for the fourth quarter continues to remain at relatively high level because some potential enterprise points are waiting for the free software launch from the PRC Inspection Administration. Despite the transitions, sales of iDeclare continue to gain acceptance in a market place. We sold 2800 iDeclare packages, 12500 iDeclare maintenance contracts, 600 iProcess software packages in the fourth quarter. Some of our well know clients who purchased our iDeclare package service in the fourth quarter are Casio Electronics, Samsung, Motorola China Electronics, JiaoZuo WanFang Aluminum Industries, Hitachi machinery and Equipment, Beijing iTowNet cashmere products. Huya Group, Shan Dong Chenming Paper Group and CNOOC Petrochemical import and export company. At the end of fourth quarter, we estimate that the total number of companies making electronic import export filings with the PRC Inspections Administration was 136,000, of these approximately 123,000 are user of iDeclare, indicating that our market share among such e-filers was approximately 89.7%. In addition, in the fourth quarter, we signed a foreign currency monitoring systems contracts, amounting to US $140,000 with the State Administration of Foreign Exchange. Now, let me turn this call over to our Chief Financial Officer Tommy Fork for a brief review of key financial results. Tommy, please go ahead.

Thank you, Eric. For the fourth quarter of 2005, we generated total net revenue of $6.5 million, representing a decrease of 15.8% compared to $7.5 million for the fourth quarter of 2004. As expected this represents a decrease of 11.0% compared to the third quarter of 2005. Net revenue from enterprise software for the fourth quarter of 2005 was $8.5 (phonetic) million, representing 88.4% of the total net revenue as compared to 87.0% and 87.8% for the fourth quarter of 2004, and fourth quarter of 2005 respectively. Net revenue from software development services for the fourth quarter of 2005 was $0.7 million, representing 11.1% of total net revenue. As compared to 12.9% and 11.5% for the fourth quarter of 2004, and fourth quarter of 2005 respectively. For the full year 2005, we generated total net revenues of $29.7 million, representing a 19% increase over the year 2004. Enterprise software net revenue was 84.7% of total revenue as compared to 93.6% for the full year 2004. Software development services revenue represented 15.0% as compared to 6.3% for the full year 2004. Our gross profit was $6.0 million for the fourth quarter of 2005, $77.3 million (phonetic) for the full year 2005. We achieved gross profit margin of 92.1% and 92.0% for the fourth quarter. This compares to a 96.2% for the fourth quarter of '04 and 97.8% for the full year 2004. Gross margin fro the fourth quarter of 2005 was 93.0%. As usual for the full year 2005, we have registered high gross profit margin of over 95% for our enterprise service business. However the growth profit margins for our software development services for the full year 2005 was approximately 50%. This was mainly due to the completion of several system integration contracts with some local PRC Inspection Administration services which have relatively in low gross margin due to their higher software component. Capital expenses for the fourth quarter of 2005, were $1.0 million, representing a decrease 96.2% over the fourth quarter of 2004. Capital expenses for the full year 2005 were $3.2 million representing an increase of 61% over the full year of 2004. Because of the transition, software and service sales are becoming very difficult resulting a much higher growth and the emphasis on cost. General and Administrative expenses for the fourth quarter of 2005 were $1.7 million, representing an increase of 7.6% over the fourth quarter of 2004. General and Administrative expenses for the full year of 2005 were $6.0 million, representing an increase of 36.0% over the full year 2004. The increase was primarily due to increased professional service cost after revaluation. To extend our product line, we continue to emphasize research and development, resulting in $545,000 for the fourth quarter of 2005, and $1.4 million for the full year 2005. This compares to $1,92,000 in Q4 of 2004 and $482,000 for the full year 2004. Total operating expenses for fourth quarter of 2005 were $3.4 million, representing an increase of 47.2% from the further quarter of 2004 and an increase of 6.4% for the fourth quarter of 2005. Total operating expenses for the full year 2005, were $10.7 million, representing an increase of 50.8% from the full year 2004. As a result our operating income of fourth quarter of 2005 was $2.6 billion representing a 49.2% decrease compared to the $5.0 million for the fourth quarter of 2004. Operating income for the full year 2005 was $15.6 million, representing an 3.9% decrease compared to $16.9 million for the full year of 2004. Operating margin for the fourth quarter and the full year of 2005 were 41% and 55.9% respectively. This compares to operating margins of 66.5% and 69.3% for the fourth quarter of 2004 and full year of 2005 respectively. Net income for the fourth quarter of 2005 were $3.4 million, or $0.09 per share on a diluted basis, representing a 36.5% decrease compared to net income of $5.2 million for the fourth quarter of 2004. Net income for the full year 2005 was $18.8 million or $0.052 per share on a diluted basis representing an 13.2% increase compared to a net income of $16.2 million for the full year 2004. The diluted ADS per share accounts for 4% of 2005 and for the full year of 2005 was $35.6 million and $35.8 million respectively. We believe the end of fourth quarter of 2005 in a very strong financial position with our cash and bank balances including short term investment of $116.3 million, $1.7 million in cash operations in the fourth quarter. Finally, in accordance with our revenue recognition policy in which our enterprise software sales and the related maintenance contract sales are recognized over a 12 month period. Our short-term unearned revenue balance of the fourth quarter '05 was $8.4 million, this compares to the $10.6 million at the end of the third quarter of '05. We expect to recognize this unearned revenue balance of $8.4 million as revenue in the next 12 months. Let me now turn the call back to our chief executive officer.

Thank you Tommy, I would turn your attention to the PowerPoint file we have prepared and you can access from our investor website. First, I think I will skip the first two pages, and because that is routine and however, I do want to mention that safe harbor statement that was put on the front of this presentations. Let me summarize here some of the key metrics for our fiscal Q4, 2005 operations. I will go through any detail here, you can read through this at your convenience, I only want to point out that the sale of our iDeclare packages, are under some pressure. Given a new free software initiative by PRC Inspections Administration, however, we believe that by leveraging the potential penetration of the free software, we are likely to obtain more opportunities to sell our premium services and increase our revenue in the future. Next I am going to point out some differences between the free software and the Ninetowns pay versions. As shown here our iDeclare, in terms of comparing based on two key metrics. Which are the functionalities and services, you can see the free software in terms of functionality, there is no automatic regulation updates versus that of premium service that NINE (phonetic) can provide, we have automotive regulation updates. And also through our pay version, we will be able to provide and inspection free estimates. Also the prices of those and risks assessments, whereas the free software did not have. For the services the free software ofcourse did not contain any services support, but we do have a 24/7 service support with Ninetown premium services. And for iProcess on the next page, using the same comparison metrics, the free software for iProcess again there is no automatic regulation updates. For Ninetown's premium services we do have the automated regulation updates. For iProcess, for the Ninetown premium services, we provide as we call Expert System, which would automatically provide real-time benchmark and performance monitoring report and optimizations for the user. Whereas the free software for iProcess does not have this function. As for the service, again Ninetown premium services we provide 24/7 service support where as the free software does not have that. Now I want illustrate first based on the revenues, our business are based on our pricing structure which is shown here, for enterprise services, we will charge a one time upgrade of $550 for iDeclare, similar initiation fee between $400 and $600 for iProcess. From second year onwards we also charge annual fee of about $180 for iDeclare, $200 to $400 for iProcess. We still have a portion of iDeclare customers being charged by each application volume at about $2.50 per transaction. The development services is a contract based transaction. We will continue to be priced on the time and material basis, or fix fee basis. Now finally, I want to emphasize that our long term goal is to be a one stop international trade service provider. In making the entire import/export process more efficient and effective for enterprises. Here we want to reexamine the chart that we mentioned before. We recently reexamined this chart that the international trade value change and decided to focus our business into four areas as shown here. Number one, Trade opportunities refers providing B2B service for our clients, Number two, Logistics Services, Number three, turn services return services, refers to our current declaration business under PRC Instruction Administration as well as potential declaration related business under PRC customs. And finally number four is what we call dead open services which include Forex, Tax Refund or International Trade Transactions. Operator that concludes our prepared comments. We would now be happy to take any questions.

Operator Instructions And your first questions comes from the line of Joseph Vafi of Jeffries & Company.

Hi. everyone and good morning.

Hi. Good afternoon Jo.

I was wondering if you could talk a little bit about, in your prepared remarks you talked about going into some new area tier (phonetic). Are there companies available for acquisitions that in your industry that you think that fit a profile that could be attractive and that could potentially get you back on growth path, this year.

Thank you Jo. As you know that the M&A activity has been in the routine operation business for us, and also we will use that as the growth platform as well. For the new business that we mentioned on our last slide, yes, some of the areas we do see some companies around and represent good values, it will be our target companies however, we want to point now, when we make the acquisitions, we do have several criteria's. First it is has to be a very synergetic, meaning that it provides lot of synergy to our core business. And secondly I think which is very important that we will look for, or we will prefer the company, who have the quickest earnings for us, if not immediately, it has to be within a year. Third, we are looking for strong management team, and superior technology and good product base. So those are the elements that we are looking for, yes, we do some companies in those areas, which would help us, to accomplish the robust future goals.

Okay. And maybe one follow up, in your press release you didn't really, there was real formal guidance in terms of numbers, I know that it is transition year, can you tell us what was the thought process, was there about not providing guidance in terms of numbers for calendar '06. Thank you.

Yes. In our guidance, in our news announcements, we do not provide guidance at this time, I think it is very simple to say that because, for fiscal 2006, although that we are very confident on our future, and long term goal. But we are going to have new business initiatives, and new business models, so all of those things to represent many variables, and we also find that the visibility is quite low. So at this point, we will not provide forward future guidance, at this point.

Thank you.

Your next question comes from Andy Nahas from Prospect Funds.

Thank you. Yes. I was wondering how the Marketing spend might have to go up, to advertise your services to, the value added software services to all the new potential customers out there or is the government going to aggressively market for you?

Yes. I think for the iProcess software, it is actually the governments, free software will be launched first, as we mentioned, we already started the process, we will cooperate or collaborate with the government initiative, and as we mentioned that we have a training program, already started out in 14 regions in China and this will ofcourse will incur on marketing spending, on our front. So I guess the question is with that particularly increase our marketing spending, but I think at this juncture, it is, the program is just started and rolling out, so we do not have a very good visibility in terms of the spending levels or the, for the marketing activities, for that particular new business, so I don't if this answer your question.

Yeah. Yes, it sounds like, this, you won't be able to just rely on the government to get the word out, it sounds like you are going to have to take some of that initiative yourself. I believe.

I think we are in collaboration with the government to do so, and I think the governments marketing method, is that for every different offices, the government will have a list of enterprises who have been using electronic filing system. So the government officers, they will send out mails in writing or make a call to those enterprises who are qualified for this software and tell them the benefits of this new software, so definitely the government will participate and right now we will help them to fulfill the government's free software initiative.

Okay. Thank you.

Your next question comes from David Riedel of Riedel Research.

Good morning gentlemen.

Good morning.

Congratulations on a strong quarter. I wanted to ask about two things that you mentioned, you mentioned your exclusive status, as a exclusive vendor, is that for the installations that are ongoing in these 14 locations.

Correct.

Do you have an estimate of how many installations you will doing in the coming months, or quarter? Or perhaps how many people you are expecting to go through the training programs?

Although that, we are very confident on the future growth and we think that the government is strong behind this project, it is still, it is very stage, for this free software to roll out, now the visibility is low, so really don't have any guidance to provide to you in terms of numbers being trained or the future software being sold for this kind of numbers moving forward.

Okay. Fine. One last question, if I could please. You mentioned, something at the end of your comments about currency contracts that you guided to at the end of the quarter. Could you talk about those a little bit?

Yes. That is what we call software development services. Which is system integration type of work as I mentioned is pretty much case by case project and it is fixed fee or kind of material based project. We provide those kind of services, to very selective government agencies who has had the business with our software, you know, so that is very selective projects. And that specific project is for them to monitor their currency inflow and outflow, process. So that is system installation related project or so called Foreign Administration Office in mainland China.

Very good. Thank you.

Your next question comes from Chang Qiu of Forun Technology Inc.

Right. Good morning. Now, Eric and Tommy on, given what you have said visibility is now, may be unless asked, you know, you already know, for example, how much transaction based business you did with the Dongguan area in Q4 and how you expect that as changing in '06.

As I mentioned in our prepared comments, transaction based business will remain as it is right now, moving forward we do believe that transaction based business will still remain, so the customers are there, those customers are used to, use transaction based method to file their applications. So I think the business will be here and this transaction based business will not disappear in 3006, although that 2006 represent a year that we are going to roll out many different services. But the transaction based business will remain in the GuangDong area.

But Tommy, what is the revenue amount in Q4 in that area?

In Q4, (indiscernible) US dollar

I am sorry?

$1 million.

Okay. Also, how many maintenance contracts you have signed up during Q4?

The maintenance contracts for Q4'05 is 12,500. In year 2005 as a whole, the whole year is 39,700.

Okay, on the spending part, you further mentioned, the marketing part you probably needed to help the government to roll this free software out, but on R&D, on the product development side the lots of spending therefore we should expect.

Well, with count to, yes, as you know that there are so many process are going on, the unit initiatives are rolling out, really we are here to do business long term so, we will believe that, we require necessary and diverse full of talents not only in R&D and also in marketing to help us to grow our business in the longer term. We do expect that, with that mind set we will be very prudent to manage our business as we have been in the past so, I think R&D is on the directional side, we think that the total spending of R&D expenses if you compare with '05, in '06 will be increasing and we will increase that the budget but as mentioned I because there are so many variables and visibility is very low so, we don’t have any specific projection for you to provide at this moment for the guidance.

I guess this is more on this way compared to your Q4 your increase in budget or you will remain about the product?

You mean in Q1 of this year or 2006 as a whole?

Yeah.

Chang, i am sorry I don’t have this number for the time being because, there is still, there is a 1 month away from the quarter end, we do not have any specific detail number to provide in terms of a this quarter's forecast and those specific numbers in R&D or marketing expenses.

Okay, alright thank you

Sure.

Operator Instructions Your next question comes from the line of Chris Thurman from Morgan Stanley.

Hello, how are you doing?

Hi, doing fine thank you Chris.

My question has to do with the roll out of free software and I was wondering if you could let us know who you anticipate to use free software, do you actually see corporation, with consumer, or is this more a single person who runs no business using the free software?

Well, definitely this software is what we called for the enterprises, specifically the software is designed for the company who are in the business of import and export business, they do you have requirement for them to report their applications to the government so, I think this software is designed for the enterprises.

So, do you anticipate that corporations will actually use the free software, they will pay you premium software?

Yes, long term it is our hope that they will upgrade from the free software to the premium services that will provide as I mentioned in the slide on the presentation and we do provide a lot more functions and which are very valuable to those enterprises, so we do expect that the free software user will convert to our premium services as we provide in the future may be later part this year.

Okay and do you have any estimates on how many users you think are going for jump on board because of free software?

Well at this moment it is too early for us to tell how many users will jump on Board, but I do want to clarify some based on information if I would, we have close to 1,20,000 customer base so far and this actually has taken us about five years to build. So we do believe that for the initial stage those existing customers will be our target customers moving forward. So those customers, who had been using our iDeclare products and they do have the computer and they already enjoy the benefit of the iDeclare, with the rolling out of iProcess, the combination of those two software will really help them to shorten the clearance time greatly as we mentioned before that currently majority of the time being spent on the iProcess side. So with this in mind, we do believe that a big chunk of those customers will migrate to this high iProcess software in future.

And my last question is you talked previously about the acquisitions I was wondering if you could provide a time line when would ideally you will be willing to acquire a company, is it in 2006 or should we anticipate past 2006?

Well as I mentioned before that M&A has been loosing operation for us although that we haven't done any deals yet, but that doesn't mean that we haven't reviewed the deal, infact we are quite busy over the last year or two, we have been looking for suitable companies to acquire. I heard someone mentioned that we are glad, we are pleased with what we have not done as not with, what we have done. So we are not in a very hasty mode to acquire anything but when the opportunity presents itself, we will definitely make the move. So I think for NINE 2006, because of there is new product line, new initiatives coming out, I think we will present a case when it becomes available to the market we would tell the market what we are going to do.

Thank you.

Thank you.

Operator instructions And you have a follow up from Andy Nahas of Prospect Funds.

Thank you. If the existing customers are some of your best prospects for the paid service, first of all do you think they might migrate right away to the new paid service rather than trying the free software for while and also I was wondering how much it the new paid service will cost, compared to may be what they were paying before?

Andy, yes thank you for the questions. I think even for the existing users of iDeclare we do expect that they would use their free software first, as a client wrote out, in 14 regions and acceptance has been extremely well and I think almost 100% of those users they are willing to participate, adopt this free software offered by the government. We do expect that in the later part of this year they will convert their free software to our premium services. But it is as I had mentioned it is too early because the variables are so many and the visibility is very low so we do not have a compare number or detail number to provide to you how many of those customers will adopt a new paid services. As to the pricing scheme is something that we are in consideration as well, so I think when the product rolled out we would definitely provide that to the market as well.

Okay thank you very much.

You have no further questions at this.

Thank you, now I would like to turn the call to our Chief Executive Officer Mr. Shuang Wang. Shuang please.

Thank you, operator. Thank you for participating on today's call. I just want to assure that we are working hard to meet the challenge during the transition period. Please feel free to call our investor relations agencies, in New York or you can contact us directly. Thanks again.

Thank you. Operator, this concludes our presentation today, thank you.

Ladies and Gentlemen this concludes conference call for today, we thank you for your participation you may now disconnect and have a good day.