Nine Energy Service, Inc. (NINE) Q1 2006 Earnings Call Transcript

Good day ladies and gentlemen, and welcome to the Ninetowns Digital World Trade Holdings 2006 Q1 earnings conference call. My name is Letitia and I will be your coordinator for today. Operator instructions. I would now like to turn the presentation over to Lisa Zheng, Assistant Vice President, Investor Relations. Please proceed, ma’am.

Thank you, operator. I would like to welcome everyone to Ninetowns Q1 2006 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 re-evaluate and change its operating model. 3). Potential further encouragement by the PRC Inspections Administration of the development of software products that may be competitive with 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 would like to note that references in this call to dollars refer to amounts in U.S. dollars. I would now like to turn the call over to our CSO. Eric, please go ahead.

Thank you, Lisa. Thank you for joining us today. Q1 was another transition quarter for Ninetowns as well as a seasonally slow quarter due to the Chinese New Year holiday. As of early May, the PRC Inspections Administration is still conducting software training in the 14 regions, of which about 5,000 enterprises have completed training and installation. Of these 5,000 enterprises, about 2,500 have already commenced their peak volume using the free software. Despite the transition, sales of iDeclare continued to gain acceptance in the marketplace, although at a slower pace. We sold 1,500 iDeclare packages and 6,800 iDeclare maintenance renewal contracts in Q1. We were pleased to be able to maintain our sales momentum for our enterprises services, especially the sales of service contracts. Some of our well-known clients who purchased our iDeclare packages in Q1 are COFCO Grain & Oil Import & Export Company, Hangzhou Refinery China Petrochemical Company, Yuchai Machinery Company, Sino Tran Guangdong Company, Budweiser Wuhan International Brewing Company, (AS Tien Zhing Pottery Company?), (ECTO, Zha Mien?) Company, (Lao Te China Foods Company?). At the end of Q1, we estimated that the total number of companies making electronic import-export filings with the PRC Inspections Administration were 139,000. Of these, approximately 124,000 are users of our iDeclare software, indicating that Ninetowns market share among such e-filers was approximately 89%. Our headcount at end of Q1 2006 was about 900 employees, of which approximately 325 are in R&D and approximately 454 are in sales and marketing. Now, let me turn the call over to our Chief Financial Officer, Tommy Fork, for a brief review of the key financial results. Tommy, please go ahead.

Thank you, Eric. During Q1, we generated total revenue of $6.1 million, representing a 23.9% decrease compared to $7.7 million for the Q1 2005. As expected, this represents a slight decrease of 7.1% compared to Q4 2005. Net revenue from enterprise software for Q1 was $5.0 million, representing 82% of total revenue, as compared to 83.1% and 88.4% for first and fourth quarters of 2005 respectively. Net revenue from software development services for the Q1 was $1.1 million, representing 17.4% of total net revenue, as compared to 16.9% and 11.1% for the first and fourth quarters of 2005 respectively. Gross profit for Q1 was $5.8 million, or 94.6% of total net revenue, representing a decrease of 22.2% compared to $7.2 million, or 92.6% of the total net revenue for the Q1 2005. Gross profit Q4 2005 was $6.0 million, or 92.1% of net revenue. As usual, we have a relatively high portion of the market of over 95% for our enterprise software business. The gross profit margins for our software development services in Q1 were 17.5%. Selling expenses for Q1 were $851,000, compared to $440,000 in Q1 2005 and $1.1 million in Q4 2005. General and administrative expenses for Q1 were $1.9 million, compared to $592,000 in Q1 2005 and $1.7 million in Q4 2005. At the same time, we continued to maintain our efforts in the research and development opportunities, resulting in $183,000 for Q1 compared to $300,000 in Q1 2005 and $545,000 in Q4 2005. Total operating expenses for Q1 were $3.3 million, representing an increase of 86.4% over (Q1 2005?) and an increase of 1.3% on Q4 2005. Operating income for Q1 was $2.4 million, representing a 57.0% decrease compared to $5.4 million for the Q1 2005. Operating income for Q4 2005 was $2.6 million. Operating margin for the Q1 was 39.6%, this compares to operating margins of 70.1% and 40.1% for the first and the fourth quarters of 2005 respectively. Net income for Q1 was $2.9 million, representing a 53.1% decrease compared to net income of $5.9 million for the Q1 2005. Net income for Q4 2005 was $3.4 million. Diluted earnings per ADS / share for the Q1 was $0.08, this compares to the diluted earnings per ADS / share of $0.16 and $0.09 for the first and fourth quarters of 2005 respectively. As expected, Q1 2006 was a transitional quarter for us, however despite the transition and slow seasonality, we were still able to achieve profitability in Q1 2006. We continue to end Q1 2006 in a very strong financial position. We’ve a healthy balance sheet and we have cash and short-term reserves(?) of $116.8 million. 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 at the end of Q1 was $5.7 million. This compares to $8.4 million at the end of Q4 2005. The reduction in sales and unearned revenue was due to both the decreasing sales and slow seasonality. We expect to recognize this unearned revenue balance of $5.7 million as revenue in the next 12 months. Finally, for Q1 2006, we generated $1.4 million in cash from operations. Operator, that is the end of our prepared comments. We would now be happy to take any questions.

Thank you. Operator instructions. And your first question comes from the line of Dick Wang of JP Morgan. Please proceed. Dick Wang(?), JP Morgan: Hi, good morning. Hi Shuang, Tommy and Eric.

Hi, good morning, Dick. Dick Wang(?), JP Morgan: I will start off with a first question. You mentioned a dash for the free software that is about 2,500 users using the software already. I wondered how many of those users have begun paying for the upgrade services? Or buying the upgrade pack, should I say.

OK. I think the question is for the iProcess which we have been installing in 14 regions, now there are about 2,500 using this. For the time being, those packages are free of charge at this moment. We have (inaudible) collecting money from those users at this moment. Dick Wang(?), JP Morgan: OK. When do you think they will convert using the upgrade service? Or the upgrade pack?

I think the plan is that because this is such a new software, the iProcess, our plan is that at least in the marketplace, the user needs to have some time to get used to it and learn how to use it. We don’t think we would start collecting money from a user until the next couple of months. So it’s going to be another two or three months, maybe into the second half of this year. Dick Wang(?), JP Morgan: All right. Great. Can you also tell us about your international operation on new initiatives?

International expansion in the shipping area? Is that your question, sorry, Dick? Dick Wang(?), JP Morgan: What I mean is the new business lines.

You mean the service provider. We want to become a one-stop international trade service provider, is that the plan you were talking about? Dick Wang(?), JP Morgan: Right.

Yes. I think since many months ago, we have told the market that we believe there is a business opportunity in China that we want to position ourselves to become a one-stop international trade service provider. I think the project has started and we have been working on it. We believe some time in this year, we are going to launch this kind of service gradually, maybe toward the second half of this year. Dick Wang(?), JP Morgan: OK. Last question, in terms of the interest income, it seems to be down a bit while your cash balance is about the same. I just wondered what’s the reason for that.

You mean the interest income? Dick Wang(?), JP Morgan: Correct.

OK. I will revert the question to Tommy Fork, our Chief Financial Officer.

Sorry, can you repeat the question? Dick Wang(?), JP Morgan: Sure. I just wondered, the interest income came down from about RMD6.3 million to about RMD4.4 million for the quarter. I guess your cash balance was the same. I just wondered if anything has changed to cause this decline (or to support quarter income?), (inaudible).

No. Actually in the income, (the interest there is?) the same, a similar level as last (inaudible) (change my theory?), but it may be due to, in this quarter, we have some (interest in a lot of pools?). Dick Wang(?), JP Morgan: OK. Great. Thanks a lot.

Your next question comes from the line of Chang Qiu of Forun Technology Inc. Please proceed. Chang Qiu, Forun Technology: Good morning, Eric, Tommy and Shuang. Maybe one question for you guys, when iProcess is for free, why are there customers out there paying for iDeclare? Can you help us understand this?

Yes. Qiu I thank you for the question. I think currently in the marketplace, the iProcess free package is out there. The purpose for iProcess is for these particular functions. However, in that package, it includes the basic functionality of iDeclare which is free of charge. However, for some of the customers, they already know iDeclare, and iDeclare is a premium product in the marketplace for many years. They don’t want to wait for the free version of iDeclare or they don’t think the basic functionality of iDeclare within this iProcess package is sufficient enough, so they still are willing to pay for the iDeclare, the Ninetowns(?) version, and purchase iDelcare in Q1. I think that is the market situation at this moment. Maybe Mr. Wang would like to add more comments on it.

(Speaks in Chinese.)

Previously, when we sold our software, we packaged software and services in one package with our software. But for the time being, because of the policy changes, the software becomes free. However the service that we provide is not free and will come with a charge. The evidence has shown that in Q1 this year, we will still be able to sell about 6,800 maintenance contracts, and that we believe is evidence that the customers are still using the services that are provided by Ninetowns. Chang Qiu, Forun Technology: OK. For the next few quarters, do you expect the order array for iDeclare will be as at this level, or do you anticipate a decline or otherwise?

Chang Qiu, I think we already stated that in the last conference call. Because right now the visibility is quite low for us, frankly because iProcess is still rolling out and it’s free of charge so a lot of our customers are in a wait and see attitude, so it would be very difficult for us to make a forecast or predict what is going to happen in the second or third quarter moving forward. I think at this moment we won’t be able to answer specifically what kind of forecast or estimate that we will make in quarters to come. Chang Qiu, Forun Technology: One thing for sure is that your customers are, even for those who ordered iDeclare, or people who are waiting – do you see a lot of potential customers who are waiting? They just cannot make their decision?

You mean a lot of customers are waiting for iDeclare? Or waiting for iProcess? Chang Qiu, Forun Technology: It is more I think the iDeclare order range, it’s more like a surprise year so I’m trying to understand, you know, how that part of the business will go in the case of a free iProcess.

I think the business of iDeclare, the charge version, definitely will be affected by the movement of free iProcess. I think that the number has shown that in the last quarter and the previous two quarters, compared with the whole year of last year. The customers actually are taking a ‘wait and see’ attitude. They will see if they can get a free version. However, some of the customers, if they are in need of iDeclare services, they will actually pay for it. We also proved that in Q1 as well. I think overall the business of iDeclare will be affected a little bit, but as to a specific number or the forecast, we really cannot predict at this moment, because the visibility is not very high. Chang Qiu, Forun Technology: All right. Thank you.

As a reminder, ladies and gentlemen, to ask a question, please press *1 on your touch-tone telephone. Please stand by for your next question. At this time there are no more questions. I will now turn this call over (inaudible) for closing remarks.

Thank you, operator, and thanks again to everyone on this call. In summary, I want to emphasize that in addition to executing our core business of iDeclare and iProcess (in comparative stories?) (inaudible) quarters, in 2006 we’ll be expanding our product breadth. This is a substantial opportunity to launch new models and to leverage the power of our established customer base to extend our scope(?) in the (national trade and vital chain?). (Please contact us if you have any questions.?)

Thanks for your participation in today’ conference, this concludes the presentation. You may all disconnect, and have a good day.