KongZhong Corporation Q4 2008 Earnings Call Transcript

KongZhong Corporation (KONG)

Q4 2008 Earnings Call Transcript

February 18, 2009 6:30 pm ET

Executives

Jay Chang – CFO

Leilei Wang – Chairman & CEO

Analysts

Ming Zhao – SIG

Jian Hou [ph]

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2008 KongZhong Corporation earnings conference call. My name is Jerry and I’ll be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Jay Chang, Chief Financial Officer for KongZhong. You may proceed, sir.

Jay Chang

Thank you, operator. This conference call may contain forward-looking statements although such statements are based on our own information and information from other sources we believe to be reliable. You should not place undue reliance on them. For additional discussions of risks and uncertainties relating to forward-looking statements and other factors, please see the documents we file from time to time with the Securities and Exchange Commission. We assume no obligation to update any forward-looking statements, which apply only as of the date of this conference call.

Hello and thank you for your interest in KongZhong. On the call today we have our Chairman and CEO, Mr. Wang Leilei; our Vice Chairman and Founder, Mr. Nick Yang; and myself, Jay Chang, the company’s CFO. I will briefly go over our 4Q results and discuss our recent announcement with Nokia Growth Partners before handing the call over to Mr. Wang Leilei.

Before discussing our fourth quarter performance, we are excited to announce that we have entered to a non-binding agreement to receive strategic expansion capital from Nokia Growth Partners. For those of you who are not familiar with Nokia Growth Partners, they are one of the world’s leading investors focused on growth stage companies in the mobile industry and its sole limited partner is Nokia.

Through this new relationship, we believe that KongZhong is now strategically aligned with the most powerful, non-operator distribution channel in the China market and a global leader in mobility. We estimate Nokia has roughly 40% market share of the overall mobile device market in China, and based at least on third-party industry study, roughly half or over half of all mobile game players in China use Nokia handsets.

As such, we believe that through this investment, we have to be able to develop an even closer business relationship with Nokia that would improve both our distribution profile and provide new avenues of growth for existing and new services. According to our agreement, Nokia Growth Partners will invest roughly $6.8 million into KONG in the form of five-year convertible senior notes, which will initially pay an interest of 8% subject to reduction of 6% based on the full year net profit performance of KONG. The conversion price will be set by the 75-day trailing trading average of our stock as of the date of this announcement. After three years, KONG will have the right, but also not – but not the obligation to prepay them [ph].

In addition, as part of this investment, Nokia Growth Partners will also receive 2 million ADS in warrants with the stock price of $5 per ADS, exercisable over the next five years. We believe this investment strategically aligns KONG’s interest with Nokia Growth Partners and Nokia China to sustainably build shareholder value over the long-term, especially as we continue to invest in our mobile game and KONG.net businesses in the coming 3G era.

Now turning over to our fourth quarter results. In the fourth quarter of 2008, we achieved total revenues of $26.7 million, exceeding our previous guidance range. Our mobile game business continued to perform well with revenues of $2.7 million in the fourth quarter, growing about 307% compared to the same period last year. Mobile game revenues now make up about 10% of our quarterly revenues compared to 3% last year.

Overall gross margins improved to 49% in the fourth quarter compared to 47% in the third quarter due to the increased contribution of our higher margin mobile game business and some of the efficiency initiatives we have implemented have begun to show some early gains in our WVAS business. Excluding the $21.6 million equivalent impairment charge we took in the third quarter of 2008, overall OpEx in the fourth quarter increased sequentially by only about 7% as we continue to invest in R&D and budget additional year-end KONG.net spending to market the new NBA season.

On a US GAAP basis, we saw a small operating loss. But excluding non-cash share-based compensation charges and amortization of intangibles, we returned our business to a small positive operating profit position in the fourth quarter. Accordingly, fourth quarter net profit was roughly $0.52 million while non-GAAP net profit was roughly $1.1 million. Based on our year-end fully diluted ADS outstanding of 35.93 million ADS, non-GAAP fully diluted net profit for ADS was about $0.03.

Lastly, at the end of 2008, we had roughly $136 million of cash and cash equivalents on our balance sheet. Finally, turning to our first quarter 2009 revenue guidance, based on information as of February 19 Beijing time, we expect total 1Q revenue to be in the range of $27.5 million to $28.5 million.

On that, now I would like to turn the call over to our CEO and Chairman, Mr. Wang Leilei, to further discuss fourth quarter business highlights and 2009 in going forward strategy. Leilei?

Leilei Wang

Thanks, Jay, and welcome onboard. In the fourth quarter, I was pleased with the performance of our team as we continued to execute our plan of 2008 and 2009 strategic plan. Compared to the previous quarter, our WVAS business maintained stable growth well over 4% improving our operational efficiency began to show some gains. For example, we accomplished a new business development team to work with local provincial based mobile operator to further develop our mobile music business and also the mobile game business and broaden our relationship with Nokia as part of their Nokia Content Discoverer handset for evolving services.

Mobile game business grew 14% quarter-on-quarter and over 300% year-on-year. As with all of more discussion channels, including seeing strong growth on Nokia channels and we continue to expand our library of downloadable games, in line with the operators’ choices for this year. Both downloadable games and mobile MMO were drivers in the fourth quarter. And while we expect the downloadable games to be a more significant contributor to our game business in this year, we are also actively planning to launch our next major mobile MMORPG game sometime in the second quarter of this year called Tian Jie Online. Tian Jie Online is a major upgrade from highly rated current mobile MMO game Tian Jie in terms of both product development, quality and user experience.

Turning to KONG.net, KONG.net experienced 30% quarter-on-quarter traffic growth in overall web traffic in the fourth quarter or more than doubling from the same period last year. Driven by the popularity of KONG.net as a recognized mobile entertainment site in China, key channels for KONG.net include NBA channel, the mobile in the world [ph] and mobile games. We plan to continuously invest in KONG.net as we believe long-term there are significant synergies in the KONG.net platform across our mobile game and WVAS business, and vice versa, but are doing so in a manner, in a cost efficient manner gives overall market condition.

Looking forward to 2009, we see our core strategy is focused on three key areas. Number one, seek to consolidate market share in the WVAS industry, well managing our return on investment in new and existing channels to create a stable but feasible flow of cash flow for our higher growth business. Number two, our key growth driver for 2009, we plan to increase our mobile game business contribution to 25% of overall revenues and even higher contribution to gross profit. To achieve this target, we are thinking to develop broader set of distribution channels for our game library supported by our new partnership [ph] with Nokia and more importantly, continue to increase the site and improve quality of our in-house game development capabilities.

Number three, continue to grow the size and thickness of KONG.net community by increasing investment in the product development capabilities of the KONG.net team that have observed some interesting success stories in the Japanese mobile social network market, which we believe can be tailored to the China market and have begun to implement some platform changes to KONG.net. (inaudible) expect earning material contributions to our revenues in the near-term. Our near-term target is for the traffic and user thickness, user acquisition. Finally, we believe 2009 is a good year for KongZhong and we are very happy to work closely with Nokia China.

Operator, I’d like to open the call to questions now. Thank you.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Ming Zhao with SIG. You may proceed.

Ming Zhao – SIG

Thank you for taking my question. Good morning, Leilei and Jay. I have two questions. First question, regarding the investment from Nokia, when I look at your cash balance, you have $136 million cash on the book, which means you don’t necessarily need the cash and the interest rate is not low. So, on the operational level, what kind of cooperation you will have with Nokia in exchange for this investment?

Jay Chang

So in terms of the instrument itself, actually if you look at the current convertible market, at least in Asia content, we’ve done some comparables, and actually we believe that the terms actually relatively attractive given the current market conditions, which to some extent I think some people would say maybe actually – even the market may even be closed. But at the end of the day, we weren’t looking to really raise capital. As you mentioned, we have plenty of cap reserves in our balance sheet and we are in a very stable capital position now. We really look to build partnerships with some of the leading players in the China market, and we believe Nokia – and Nokia Growth Partners represents that. (inaudible) actually in our game business, in our SE [ph] business, we are actually already generating a significant – a reasonably significant portion of our revenues from Nokia today. But given our continued conversations with them over the past few months, we feel like it is a lot more potential to work closely as well as even expand our distribution for both the traditional SE business as well as our game business in the future and more importantly hopefully KONG.net in the future as well.

Leilei Wang

As we mentioned, the total handsets sold in 2008 is about 40% market share, handsets sold coming from Nokia. And most of the mobile game players – and it seems over 50% coming from the Nokia handsets. So it’s very important distribution channel for our mobile game business in the future. And also we were working closely with Nokia China to operate – cooperation with Nokia.com, Nokia (inaudible) and the Nokia downloadable platform portals. This is more helpful for us to increase our revenues from the mobile game and other social business.

Jay Chang

I’d like to add one thing. We were quite focused steadier of other markets around the world. We’ve seen very large success stories and success by means of [ph] profitability of mobile Internet companies. And in markets like Korea and Japan, you tend to need to partner with a favorable large partner to have any degree of great success. And we feel that Nokia represents one of those partners that we can work with. That all said, we still place a great amount of importance on our operator relationship going forward as well.

Ming Zhao – SIG

Okay, that’s good. And my second question is, Leilei, if I’ve listened correctly – hear correctly on your strategy, it seems like you will develop mobile gaming as a key strategy this year and KONG.net may be the second. But KONG.net is hard to monetize. So should we be looking at a year that most of your growth is from the mobile gaming? And if possible, can we understand when on the operating profit level the company can become profitable?

Jay Chang

You mean –

Leilei Wang

Maybe we just revised some strategy on the development strategy of our KONG.net. Before we joined the KongZhong, KONG.net is operated as a media – mobile media portal. And revenue model is really on the mobile ad services. We just – we have a new trend in 2008 (inaudible) KONG.net is not only a content channel for KONG.net portal, we just mix with the community-based features. And we believe in the future, after two or three years, KONG.net will have a socially recognized community-based portal. And although we have waited in Japan to have further communication with many of the successful mobile Internet social network companies, they are going well and they have T2T model. That means the traffic to transaction consumer base. And they sell the virtual goods on their communities and they just rely on the charter [ph] ball game business, many of the flash games. Maybe in China the mobile community has more synergy with our mobile games. So we believe KONG.net in the future is our very important sales channel for our WVAS business and mobile game business. And for 2009 we believe this is more cost efficient than 2008 because the community-based services is more efficient than content-based services. We don’t need to pay much more money to aggregate the content from traditional content providers, and we don’t need to pay much more marketing fees for the branding [ph] and wiring for the media portals and user acquisitions, and user experience is more higher and high quality users than the content-based users.

Ming Zhao – SIG

Okay. And Jay, actually my other question was – I know you don’t guide on the EPS line or the operating profit line. Does management have a timetable for reaching profitability on the operating line?

Jay Chang

I guess that would be guidance in itself. But what I can say is in terms of spending on KONG.net, it would be definitely reduced from past periods. We hope on an annual basis the burn there is between $5 million and $10 million. And we hope to keep it towards the low end if possible on an annual basis.

Ming Zhao – SIG

Okay. Okay, that’s good. That was very helpful. Thank you, guys.

Jay Chang

Yes, thank you.

Operator

(Operator instructions) And you do have a question from the line of Jian Hou [ph]. You may proceed.

Jian Hou

Hi, Jay and Leilei, long time no see.

Leilei Wang

Hi.

Jay Chang

Hi, Jian, how are you doing?

Jian Hou

I just have a – it seems I haven’t really covered (inaudible) for a while. And there is one question, I think it’s regarding the industry, and recently after (inaudible) I guess and there was a sort of a crackdown on WAP downloads and in terms of content – what kind of content can be downloaded, or what content you can’t. So there was some kind of a content cleaning. So I just wonder if that is some kind of a negative factor for wireless business in general.

Leilei Wang

In China, always the contents (inaudible). And especially for some seasonal – Chinese New Year and some big meetings happen, we believe we have more focus on the payment related content, which is less leverage in impact, especially for the focus on the mobile game business. And it seems to us the revelation impact is not a hazard for this year. And the content strategy from the government regulation except for the news and some agreed [ph] contents, we believe we have no impact for some content revelation impact.

Jian Hou

And also in the past I believe in mobile game revenue-wise is really associated with what kind of bandwidth and China Mobile to give – if China Mobile gives a better (inaudible) bandwidth and mobile game revenue can increase a lot. So do you think that you guys are still under the constraints of China Mobile?

Leilei Wang

Yes, exactly right. The China Mobile in 2009, they will have a heavy reduction about the accessory fees. They have a big discount to acquire more mobile Internet users and a lot more people to use mobile Internet services. I think it’s big – from the Q4 numbers for our website traffic is about 30% growth. And also some of our achievement shows one more – mobile Internet people lag to see more times on handsets to play mobile games and to use a lot of community features.

Jay Chang

Let me just add on to that to give you a specific example of China Mobile has done. I mean, obviously they have – overall they have reduced tariffs as of January 1, 2009 by about two-thirds or about 66%. But in terms of the kind of the monthly fees, previously if you paid 5 renminbi a month, you got about 10 megs of data. Now you still pay 5 renminbi, but now you get 30 megs of data. So that actually is very positive I think for mobile game and obviously mobile Internet going forward. And I think that’s a direct response to obviously the restructuring in the telecom industry and the issuance of 3G licenses. So we are monitoring situation and we are managing our business appropriately given kind of the current environment. But I think some structural issues that we had in the past are turning into our favor although we still have to execute.

Jian Hou

And (inaudible) see China do some investigation about mobile game, and I believe there was a new business model, which just matches some of our T1 Online game, which really got away from China Mobile network, whatsoever, is not on a download base, but much more on the item – pay per item base. So are you considering to adopt this model?

Jay Chang

Yes. Actually – we actually already are the number one mobile MMO developer and operator in China although it’s very relatively small scale. Users download a client, a Java client generally, and they can enter the same kind of virtual world although it’s slimmed [ph] down and fit it for the mobile environment where they can play for free. And if they would like to purchase additional items, then they may say that way usually through the operator billing system. So the operator actually is still involved in the whole ecosystem. That said, people when they play for free, they start to pay GPRS tariff general. But that business for us now is roughly about $650,000, $670,000 in the fourth quarter. So it’s still relatively small. But we’re launching our new game in the second quarter, which has a lot more features, a lot more attractive. It came to kind of two years of experience we have from operating the number one MMO game in China. And we are very hopeful that it can contribute more to our overall business, but it’s something that once we launch it we can provide additional feedback to you.

Jian Hou

That’s great. And that’s about all my questions. Thank you.

Jay Chang

Okay, thank you. And good to hear from you again.

Operator

And there are no additional questions at this time.

Jay Chang

Okay. I’d like to thank everybody for listening and taking interest in KongZhong and our fourth quarter results, as well as the announcement related to the investment, the non-binding agreement we signed with Nokia Growth Partners. And I look forward to speaking to you all in the coming weeks, months, and years ahead. So thank you very much.

Operator

Thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect. Good day.

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