CNTF

China TechFaith Wireless Communication Technology Limited (CNTF)

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TRANSCRIPT SPONSOR

China TechFaith Wireless Comm. Tech. Ltd. (CNTF)

Q3 2007 Earnings Call

November 13, 2007 7:00 pm ET

Executives

Joseph Bialta

Baozhuang Huo - Deputy Chief Executive Officer

Dr. Gilbert Lee - Director, President, Chief Operating Officer

Analysts

Adele Mao - Susquehanna

Brian White - Jefferies

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the China TechFaith third quarter 2007 conference call. (Operator Instructions) Now, I would like to introduce Mr. Joseph [Bialta]. Please proceed.

Joseph Bialta

Thank you for joining China TechFaith's third quarter 2007 earnings call. The company’s attorneys advise that this call will contain forward-looking statements. These statements are made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminology such as will, expects, anticipates, future, intends, plans, believes, estimates, and similar statements.

Among other things, the business outlook and quotations from management and this announcement, as well as TechFaith's strategic and operational plans contain forward-looking statements.

TechFaith may also make written or oral forward-looking statements in its periodic reports to the U.S. Securities and Exchange Commission on Forms 20-F and 6-K, et cetera, in its annual report to shareholders, in press releases and other written material, and in other oral statements made by its officers, directors, or employees to the third parties.

Statements that are not historical facts, including statements about TechFaith’s beliefs and expectations, are forward-looking statements. Forward-looking statements involve inherent risk and uncertainties. A number of important factors could cause actual results to differ materially from those contained in any forward-looking statement.

Potential risks and uncertainties include, but are not limited to, TechFaith's limited operating history, mobile handset brand owners' discontinuation or reduction of the use of independent design houses, TechFaith's ability to retain existing or attract additional international customers, TechFaith's earnings or margin declines, failure of competing against new and existing competitors, and other risks outlined in TechFaith's filings with the U.S. Securities and Exchange Commission, including its annual report on Form 20-F.

TechFaith does not undertake any obligation to update any forward-looking statement except as required under applicable law.

All information provided on today’s conference call is as of today’s date. China TechFaith does not undertake any obligation to update any forward-looking statement except as required under applicable law.

With us today are Mr. Baozhuang Huo, the company’s Deputy CEO; and Dr. Gilbert Lee, President and COO. Mr. Dong, Chairman and CEO and Christopher Holbert, CFO, are also on today’s call and will be available for the Q&A period.

Finally, if you have not received a copy of today’s results call, please call The Ruth Group at 646-536-7003, or you can get a copy of the release off TechFaith's website.

I would now like to turn over the call to Mr. Baozhuang Huo. Please go ahead, sir.

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Baozhuang Huo

Thank you and welcome to our third quarter call. We are excited and encouraged by the results in the third quarter. Revenue was up 20% over Q2 and up 122% over Q3 2006. We returned to profitability ahead of schedule and are pleased with our momentum.

We continue to make significant progress in our business. In the past few quarters, we have quickly become one of the most successful new ODMs in China, with 82.5% of total revenue coming from the ODM business.

The outlook of the fourth quarter of this year is also promising. We expect 10% to 14% revenue growth and to maintain sustainable profit. We think the total revenue for 2007, more than 80% will be generated from our ODM business. [inaudible] and royalty are expected to account for less than 20% of revenue, with smartphone up 20%, feature phone at 45%, wireless mobile at 10% and others at 5%.

In the past 18 months, the industry in China has been undergoing a lot of changes and challenges. Some of the independent design houses became stagnant due to the weak [competitiveness] of their customers. Some did not make significant progress in development of 3G technology and expansion into international markets, due to the lack of R&D capability and understanding of international markets. Some even went into bankruptcy due to their failure to win enough contracts, even if they have outstanding [projects].

TechFaith not only survived; we have excelled. Our successful expansion into international markets and the continued growth in the domestic market enabled us to promote middle to high-end products, both home and overseas. At the same time, products which have matured in international markets can be sold in the Chinese market at a reasonable margin.

Clearly we are different from most of the traditional ODMs whose competitiveness is hardware design and manufacturing efficiency. We are an ODM focusing on one-stop handset solution and we are fully aware that without strong R&D capability and sustainable profitability, we will become just another ordinary ODM player.

In the past quarter, we were granted a new license agreement from QualComm and we are now able to develop, manufacture, and sell products covering all 3G standards, including CDMA 2000, WCDMA UMTS, and TD-SCDMA.

We are also making major progress with new products. We successfully launched the world’s first WCDMA/GSM dual-mode, dual standby phone and the world's first Windows-based GSM/CDMA dual mode dual standby pocket PC phone to respond to the demand of the global markets.

On the growth side, we are excited that we have won the first contract from a customer that is not in the traditional telecommunications sector. We are working on [demands] in the broader, non-telecommunications market such as commercial and [inaudible] industry.

We have diversified our customer base by successfully penetrating the China market and the overseas market, including Asia, Europe, and Russia, and we made inroads in North America, Middle East, and Latin America in this quarter.

With that as a background, let me turn the call over to our President and COO, Dr. Lee.

Dr. Gilbert Lee

Thank you. In the following session, I will cover core operational highlights and financial highlights related to the third quarter.

The first one is our feature phones enjoyed a healthy growth. Feature phone revenue in Q3 was $18.15 million, which was 243% sequential growth over the second quarter. In Q3, feature phone shipment was around 191,000 units, with ASP around $95. In Q4, shipments are expected to be around 220,000 units, with ASP around $123.

Our feature phone customers are mainly in emerging markets such as Southeast Asia and Eastern Europe. At present, feature phones are mainly 2.5G or GSM CDMA dual mode, dual standby phones. We will launch more 3G phones in Q4 this year. We expect high sequential growth for feature phones in the coming quarters.

In terms of the models, we will launch 12 new models in the second half of this year. There are five models of GSMX phones, five models of WCDMA, which is a 3G phone, and two CDMA1X phones.

Okay, this is the first highlight I want to address. Now let’s turn to the second highlight. The sales of smartphones will continue to grow in the coming quarters. Smartphone revenue was $8.7 million in the third quarter, which is 32% sequential growth over the second quarter.

Total smartphone shipments in Q3 was around 47,000 units. Shipment expectation in Q4 is about 60,000 units, with ASP of $200.

In the second half of 2007, we will launch seven new models. They are two CDMA1X phones and two models of GSMX with GPS phones, one [HSDPA] phones, which is a 3.5G, and one model with a GSM CDMA dual mode and one model is GSM dual SIM phone, and last one is a GSMX slim music phone.

Okay, now let me address the third highlight which is related to our data card and wireless module business.

Revenue in Q3 was lower than our expectation. This is mainly because shipments of and orders from a domestic customer for [inaudible] brand got delayed, due to the change of schedule at the customer side.

We launched four 2.75Gs, which was a GSMX model and 1 3G model in Q3. Due to strong orders in the pipeline, we expect the revenue in Q4 will resume to the normal level.

Now, the number four highlight and it is the last highlight for operation issues, is we remain positive on the development in TD-SCDMA. We have already signed four TD-SCDMA contracts. We expect to sign another one with a domestic customer in this quarter. TD-SCDMA projects will start generating revenue in Q4. We will server our TD-SCDMA customers either in the form of a design plus royalty or in ODM model.

Now, turning to two items related to our finance issues. I just want to add some explanation to our earlier release. Number one, bad debt provision was $199,000, inventory provision was $1.3 million. Inventory provision method is subject to the lower between costs and market value.

The second finance highlight is reduction of R&D in the quarter is mainly related to engineers’ salary and benefits. During restructuring in Q2, all platforms were closed. Supporting staff for the old platform were downsized. Our R&D team is now focusing on 3G, 3.5G technology and our ODM business. This change resulted in the reduction of R&D expenses in Q3.

We have around 1,300 employees at present. Ninety-percent are engineers. We will maintain this staff level through this year.

Looking into next year, we are targeting continual revenue growth and profitability. We will maintain tight cost control and focus on gaining momentum in our business.

Operator, that concludes our formal comments. We are now ready to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Adele Mao with Susquehanna International. Please proceed.

Adele Mao - Susquehanna

I have several questions. Seeing your revenue mix changing significantly from second quarter to more feature phones in the third quarter, could you talk about your expectation for revenue mix going forward? How should we think about growth into 2008 in different areas of your business?

Dr. Gilbert Lee

Okay. As I stated, in Q4 we will continue to see the strong growth in this area. In last quarter, in Q4 we expect to ship 220,000 units.

Over the year, feature phone business will take about 30% -- will take about 45% of our business and I think next year, both smartphone and feature phones will dominate our business and what Bob just mentioned, in the long run we expect the phone business, the ODM business, including smartphone and feature phone, and data card will [be more] than 80% of our long-term revenue stream.

Adele Mao - Susquehanna

Okay. Looking at your gross margin for the quarter, it stayed sort of flat from last quarter but your revenue mix is very different. Could you just discuss margin trends in the key business areas and how sustainable they are in -- I guess the most important ones are smartphones and feature phone?

Dr. Gilbert Lee

More and more, we will concentrate on mid and high tier. We are not competing at the low tier volume phone. In this area, our demand is so strong so I think the margin will not erode, and either will maintain stable in this level and even is a chance we get higher margin in next year.

Adele Mao - Susquehanna

Okay, great. My last question is related to your comment on the operator brand got delayed at customer side. How much of the revenue actually was pushed out to the fourth quarter?

Dr. Gilbert Lee

It is about $2 million.

Adele Mao - Susquehanna

Great. That’s all I have. Thank you.

Operator

Your next question comes from the line of Brian White with Jefferies. Please proceed.

Brian White - Jefferies

Yes, Gilbert, I’m wondering if you could talk a little bit about the inventories. We saw a 75% sequential up-tick in inventories. What can you attribute that to?

Dr. Gilbert Lee

Remember in last year, the ODM business was a small portion of our total revenue. In Q3, ODM accounted for 83% of our total revenue, so as the ODM business is increasing sharply in this year, we need to procure a minimum volume of components and material to enjoy a bigger discount. We also need some low lead times components, so we can get a shorter turnaround time for the delivery.

In the short-run, inventory increase will be parallel to the revenue increase. However, the management team, Bob and Chris, they are working on a new project and are going to an innovative way. We will make the inventory come down a little bit or at least stay at the same level in the long run compared with our revenue growth.

Brian White - Jefferies

Gilbert, will inventory decline sequentially in the December quarter? Or it is going to just rise with sales?

Dr. Gilbert Lee

I will say maintain -- it will increase a little bit but it is not significant in Q4.

Brian White - Jefferies

And what is the inventory? Are these raw components or is it actually a finished product?

Dr. Gilbert Lee

Currently, all raw material. We don’t have any finished product. Once there is a finished product, we will ship right away. We are custom-made. We are not cookie makers.

Brian White - Jefferies

Okay, and Gilbert, can you talk a little bit about what you are seeing in the component market in terms of tightness? I mean, there’s been a lot of talk about certain components in handsets being tight, so you are holding on to these inventories, maybe lead times are long -- just talk about what you are seeing out there, what’s tight and what’s not.

Baozhuang Huo

Actually, the components, the kinds of the mobile phones, the whole market, the shipment is very big so a lot of the components, the lead time is very long, some even longer than three months, even four months. So we should prepare some key components to make sure our delivery lead time is in a reasonable range.

Actually in Q1, Q2, we just get orders and the money from customers, everything from customers and then we prepare the material. So we find that [inaudible] a lot of, the shipment delay issue. As you know, for one phone, there are a lot of components inside. So for reduced the shipment lead time and make sure our order can be on time delivery, so we prepare some material. But we are control this inventory in the [inaudible].

Brian White - Jefferies

Okay, is there anything you can point to, like a power amplifier or memory or any type of particular component?

Baozhuang Huo

Actually, for those kinds of components, it’s [inaudible] shortage in the [inaudible] market, but for those components, we use -- we typically, we are [inaudible] very big [forecast] actually. That’s the best [inaudible], so this way we can make sure our delivery.

Brian White - Jefferies

Okay, and just finally, if we look at the feature phone and the smartphone market, it seems this year, smartphones have been disappointing and feature phones have been better than expected. Could you just, from a big picture point of view, talk about what’s happening there? Why is the smartphone not gaining as much traction as the feature phone?

Baozhuang Huo

Don’t forget, the worldwide market, the ratio between feature phone to the smartphone is four to one, so when we launch our high tier phones with rich features, the customer is just so easily attracted by our feature phone and they switch from smartphone to feature phone.

Brian White - Jefferies

Okay, and Gilbert, where are these being sold into the feature phone, in terms of distribution service provider, OEM -- how does that look on a percentage basis?

Dr. Gilbert Lee

We stock three categories -- number one is local distributor, local channels. Number two is local OEM, local branding. And number three is telephone operators. These are the three categories of our customer base.

Brian White - Jefferies

Thank you.

Operator

(Operator Instructions) At this time, there are no more questions in queue. I would like to turn the presentation over to management for any closing remarks.

Dr. Gilbert Lee

I will represent our management team and say thank you to all the investors. It’s been a tough year for the last four quarters. We really struggled but everybody is on Mr. Dong's strategy. We focused on the strategy, we said what we wanted to do and we did what we wanted to do. And this is a turning quarter; finally we are returned to profitability and the whole management team has a very high confidence this is not a one quarter only event. You will see the strong growth, both on the top line and the bottom line. We will maintain a healthy strong growth quarter by quarter.

I hope we will constantly deliver the good results to each of you. Again, thank you, everybody.

Operator

Thank you for your participation in this conference. This concludes the presentation and you may now disconnect. Good day.

TRANSCRIPT SPONSOR



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