Brendan Barnicle (Pacific Crest Securities): As we look through last year, you had margins improve throughout the year, as well as EPS. Would you expect that same trajectory where we see continued improvement quarter to quarter?
Steve Zhang: The operating margin improvement has been a focus and will continue to be a focus for us. Our long-term operating margin as a part of net revenue is 12% to 15% for the longer term. That’s the company average in this business segment.
Donald Lu (Goldman Sachs): On your Q1 guidance, how much is from the telecom business revenue? What’s the trend for telecom and the Lenovo business?
Steve Zhang: Probably 90% is telecom and even less than 10% for IT security business. Typically in quarter one our security business has a strong seasonality. It tends to have a very slow quarter one and a very strong quarter four.
Donald Lu (Goldman Sachs): The deferred revenue was about $29 million at the end of Q4 and your Q1 guidance is only $29 million to $31 million. What is the nature of your backlog at this point?
Steve Zhang: For our backlog, it takes three quarters to realize them into revenue and we normally don’t disclose our backlog numbers because the fluctuation on the quarters. For the deferred revenue, it also tends to fluctuate. It depends on when we sign the contract, when we got the prepayment on those contracts. But it’s a good indication also of our sales effort.
Donald Lu (Goldman Sachs): What is the outlook for other income for 2008? You have a very good result for investment income in 2007, but apparently the China stock market has been a little bit challenging these days. What should we model?
Eileen Chu: We have been doing well in the investment area. While that is not our focus, this year our investment is about $9 million. Going forward, it might not be as good as that. In 2006, our return from our investment is about more or less around $4 million, because I can’t really give you a prediction on one particular number, especially on investments. But you can use that as a reference or a ballpark number.
Donald Lu (Goldman Sachs): China is going through a pretty hefty inflation right now. Can you talk about labor costs?
Eileen Chu: Our salaries are very competitive compared to other high tech companies in China and on top of salaries, we believe that other employee benefits are also very important in order to retain our employees. We have carried out a lot of corporate culture promotions in our companies to promote that too.
Donald Lu (Goldman Sachs): How should we model the average cost per employee? Should we just say there is a 10% increase every year?
Eileen Chu: I wouldn’t say our salary costs will increase 10% per year. Our salary increment is about 5% to 7%, which is more or less around the industry norm. But if you look at our revenue and costs, our revenue growth is faster than our cost growth. It is reflected in our gross margin. If you look at our gross margin for the last few quarters or even back in 2006, it has more or less run in the range of 54% to 56%.
Howard Wong: You have added a lot of expense in SG&A and R&D in order to prepare for the future new products that will be required by your customers and also to increase the number of customers. But now that that infrastructure is built, the growth in SG&A in absolute terms will be limited going ahead in 2008, 2009. Is that true? What limits do you think one can expect in absolute terms?
Steve Zhang: We expect the growth rate for our R&D expense definitely will be lower than our revenue growth in future and right now we don’t give out the numbers for our 2008, how do we break down our R&D expense growth. But we definitely expect our R&D investment we made over the last two years will enable us not only to have the new solution, new product but since we already made the investment, the R&D growth rate definitely will be lower than our revenue growth rate.
Howard Wong: The SG&A in 4Q is 10% higher than in 3Q. Is that seasonality or is there any particular reason?
Steve Zhang: There is a seasonality for our business, especially the seasonality is very evident in our IT security business. The higher SG&A expense for Q4, one is we accrue more sales commission when our sales teams sign more contracts. Also, for Q3, SG&A was lowered by our special government tax refund compared with Q3, the Q4 number is much higher. There were two reasons. One, we do accrue more sales costs because of the strong sales contract turnover in Q4. The Q3 number was lowered by a special tax refund.
Howard Wong: In absolute terms, do you think it will be below 10%?
Steve Zhang: It would probably be between 10% and 20% still, because we think China is still a fast-growing market. We don’t want to under-invest in our R&D efforts.
Howard Wong: Can you give an idea of what percentage of the SG&A would be variable and what component would be fixed? For the fixed component, what growth can we expect?
Steve Zhang: For our SG&A, and our G&A excluding the sales is roughly $8 million to $9 million a year, and that’s the fixed part. The rest of them are the variable components. I would also expect our sales component to grow between 10% and 20%. We expect our G&A to remain constant.
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