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Executives

Jay Chang – CFO

Wang Lei Lei – CEO

Analysts

Unidentified Participants

KongZhong Corporation (KONG) Q4 2012 Earnings Call February 22, 2013 7:30 PM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Q4 2012 KongZhong Corporation Earnings Conference Call. [Operator Instructions].

I would now like to hand the conference over to your first speaker today, Mr. Jay Chang. Thank you. Please go ahead.

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 upon them. For additional discussion 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.

Thank you for your interest in KongZhong. I will first review our 4Q results before handing over the call to our CEO, Mr. Wang Leilei.

Total revenues for the fourth quarter 2012 was $42.63 million compared to the guidance range of $43 million to $44 million, and representing an 8% increase from the same period last year. As we continue to transition our business to become a cross-platform digital entertainment company, mobile game made up 10% of total revenues and internet games contributed 56% of total revenue, with overall gaming revenues making up 66% of total revenue.

Total gross profit was $18 million in the fourth quarter compared to guidance range of $17 million to $18 million, representing an 8% increase from the same period last year. The fourth quarter 2012 profit also included a $1.1 million non-cash amortization expense related to the warrants issued to Wargaming for World of Tanks.

Net income was $4.77 million compared to $6.22 million at 3Q and $5.67 million in the same period last year. Basic net income per ADS was $0.11. Non-GAAP net income was $7.74 million, above the guidance range of $6 million to $7 million, compared to $7.47 million in the same period last year. Non-GAAP diluted net income per ADS was $0.18. At the end of 2012, the company had $174 million in cash and cash equivalents, held to maturity securities and restricted cash or $4.18 per ADS in cash and cash equivalents.

For the full year 2012, total revenues were $186 million for the -- or 16.5% year-over-year increase, of which WVAS revenues were $77.8 million in 2012 compared to $80.3 million in 2011 or a 3% decrease year over year. Mobile game revenues were $21.2 million in 2012 compared to $40.85 million in 2011 or a 48% year-over-year decrease, and internet games were $87.42 million in 2012 compared to $38.9 million in 2011 or 125% year-over-year increase.

Net income in 2012 was $25.7 million compared to a net loss in 2011 of $7.65 million. However, this included a $20.26 million non-cash impairment loss of goodwill and intangible assets. If excluding this impairment loss, net income in 2011 would have been $12.6 million, implying 2012 net income increase of 104% from 2011. Non-GAAP net income was $35.9 million, a 42% increase compared to 2011 full-year non-GAAP net income of $25.2 million. For the full year of 2012, the company achieved historic highs in net income and non-GAAP net income since the company went public in 2004.

Now, turning to our business units' performance. Internet games revenues were $23.8 million in fourth quarter, an 80% increase from the same period last year. Revenues from World of Tanks continued to grow in the fourth quarter, while revenues in self-developed games and overseas game revenues declined as the company has refocused our efforts on domestic game development towards more differentiated internet game genres and smartphone games.

Domestic net game revenues were $22.85 million, an 86% increase from the same period last year. Overseas net game revenues were $1 million or a 20% decrease from 3Q. Total overseas revenues as a percentage of total net game revenues in the fourth quarter were 4% compared to 5.7% in the third quarter.

For the fourth quarter three-month period, Mainland China online game operations achieved average concurrent users of 300,000, aggregated paying accounts of 832,000, with a quarterly average revenue per user of RMB173. ACUs in 4Q were up 55% from the same period last year.

Internet game gross profit in the fourth quarter was $11.4 million, a 57% increase from the same period last year. Fourth quarter 2012 internet game gross margin was 48%.

Total mobile game revenues in the fourth quarter were $4.17 million, a 21% decrease in the third quarter and a 45% decrease from the same period last year.

Feature phone mobile game revenues in the fourth quarter were $2.13 million compared to $3.48 million at 3Q or a 39% quarter-over-quarter decrease. Our mobile operator partners continue to implement strict operating policies and continue to de-emphasize the marketing of feature phone mobile games. We continue to see difficulties in 2013 for our legacy feature phone mobile game business.

Smartphone mobile games in the fourth quarter were $2.04 million, a 14.9% increase from 3Q, representing 49% of total mobile game revenues. Up to the end of 4Q of 2012, our smartphone mobile games have been downloaded over 30 million times cumulatively, and during the fourth quarter period we averaged over $1.3 million monthly active users to our smartphone games.

Mobile game gross profit in the fourth quarter was $2.4 million, a 5% decrease from 3Q, as the policies from mobile operator partners in our mobile game monthly subscription business continue to [reap a higher churn], offset by sequential growth in gross profits for the smartphone games. Fourth quarter mobile game gross margin improved overall to 57.6% from 48% in the third quarter. The improvement in mobile game gross margins is due to the increasing mix of smartphone mobile game revenues which have a higher gross margin compared to feature phone mobile games.

WVAS revenues in the fourth quarter were $14.62 million, a 37% decrease from 3Q and a 21% decrease from the same period last year. As per prior period WVAS revenue guidance, the WVAS operating and policy environment deteriorated in 4Q compared to 3Q, and we expect these difficulties to continue in 2013. WVAS gross profit in the fourth quarter was $4.2 million, a 40.5% decrease from 3Q. 4Q WVAS gross margin was 28.4% compared to 30.2% in the third quarter.

Total OpEx in the fourth quarter was $14.43 million compared to $13.33 million at 3Q. Product development expenses in the fourth quarter were $5.3 million compared to $4.55 in the third quarter. And the increase in product development expenses was due to additional resources and investments made towards our 2013 game pipeline, including our Guild Wars 2 China team.

Sales and marketing expenses in the fourth quarter were $5.93 million compared to $5.8 million in the third quarter, while G&A expenses in the fourth quarter were $3.18 million compared to $2.87 million in 3Q. The company's total headcount increased by the end of the year 1,100 staff compared to 1,035 staff at the end of 3Q. The increase in headcount is associated with our recruitment of new staff for our 2013 game pipeline.

Operating income in the fourth quarter was $3.7 million compared to $5.85 million operating income in 3Q and $4.7 million operating income in the same period last year. Operating margins in the fourth quarter were 8.7% compared to 11.7% in 3Q.

Now, turning to our 1Q 2013 guidance. We expect total revenues for the first quarter of 2013 to be within the range of $45 million to $46 million, with business unit revenues at the midpoint expected to roughly consist of $15.5 million for WVAS, $4 million for mobile game revenues, and $26 million for internet game revenues. We expect total gross profit to be within the range of $17 million to $18 million, total operating profit and net profit to be within the range of $3 million to $4 million, and we expect non-GAAP net profit to be between $5.5 million and $6.5 million. Within internet games, we expect to see continued sequential growth from World of Tanks, offset by further weakness in our domestic and overseas revenues from self-developed games. And lastly, our slightly lower 1Q non-GAAP net profit guidance compared to the 4Q guidance reflect continued investment in staff and resources for our new internet and smartphone game pipeline.

Now I'd like to turn the call over to our CEO,

Wang Lei Lei

Thanks, Jay. Good morning and good evening. Thank you for your continued interest for the KongZhong Corporation.

Firstly, I will introduce some highlights for KongZhong 2012 operation summary. For 2012, we achieved year to year strong growth, over [400%] growth for net earnings to [$25 million] and included non-GAAP growth over 40% growth. This is due to KongZhong's diversified strategy to continue to engage and invest in gaming business.

For internet gaming business of KongZhong, we achieved over 100% growth for our World of Tanks in terms of operating profit. And we continue to build a long-term strategic partnership with our most important overseas production partner Wargaming, and we have license of their portfolio products in China. And despite that, we continue to sign the contract with some overseas famous producers, like we have a partnership with [Houghton], [Mac] warrior-type game, partnership with some very famous shooter game in US market to license their product for Chinese market.

And also we revised our in-house developing gaming strategy from MMORPG type games to Chinese martial arts [useful] type game. We can see all this game with licensees from overseas. And also in-house development was a big differentiator compared with traditional MMORPG game in the market. These products all contain rich, [useful] features and content. And also it's very important products we licensed from the US producers called Guild Wars 2. Now we have over eight games pipeline to support KongZhong's next two or three years' strategy.

For mobile game business, we [suffered] a transition period for 2012. We see the market changed a lot from feature phones to smartphones, and also from the carriers [guarded] market towards open market. We do a lot of restructuring work during the 2012 to adapt the changing market. This includes the [inaudible] acquisition to build up smartphone, developing engine platform across iOS and Android. And also we transferred many of our existing developing teams, including internet gaming team, Java gaming team, to smartphone gaming development team. Now we build up 12 smartphone gaming studios in the company, we believe in the coming quarter, I believe the four new smartphone games will be introduced to the market.

For 2013, we believe it's very exciting and a competitive year for KongZhong. We will see stable growth for our internet gaming business in terms of solid growth for World of Tanks and also we have I believe the four new products will be ready for launch in China market. We focus on role-playing and the Guild Wars. These are very two important games for KongZhong. We believe KongZhong will be [bridging] to the first-tier player in China market, gaming market in 2013 if we have very successful launch for the two more new games in the market.

And also we talked about smartphone business for 2013 for KongZhong smartphone business, and we believe, for the leverage of our experience from internet gaming developing and also we have very high technology platform, gaming engine, and we will just launch I believe the 10 new [hard-core] smartphone products across iOS and Android platform, and we will be a first tier of smartphone gaming developer, operator in China market in terms of revenues.

For WVAS, we will continue to optimize cost structure to maintain the cash cow position for the WVAS business to support KongZhong's new business, include smartphone gaming business and the internet gaming business.

Now that's all for the highlights of 2012 and further looking for 2013. Now I'd like to open the questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions].

The first question comes from [Lei Wethe]. Please ask your question.

Unidentified Participant

Good morning. Can you just elaborate on the operating conditions in the value-added services, what are the -- the issue with the carriers, and how much further decline should we expect off of the current run rate?

Wang Lei Lei

I think it's very seasonal decline in the fourth quarter always happen for the WVAS because carrier was strengthen the regulation rules in fourth quarter to [anti] user complaints, and we believe the WVAS business is slightly decline compared with 2012 in terms of revenue, but still it's a cash cow for the whole KongZhong's business.

Hello?

Unidentified Participant

Yeah. Okay. Thank you.

Operator

Thank you. [Operator Instructions].

Your next question comes from [Lin Gao]. Please ask your question.

Unidentified Participant

Yes, hi. So I want to know your performance for the beta test for the Dragon's Inn. I know that you started the beta test for Dragon's Inn in Q4 of 2012. So that's my first question.

Wang Lei Lei

Hi, the Dragon's Inn in Q4 is internal testing and sooner or later we will have open market testing in the middle of March and maybe in Q1's result we will give you some good explanation about testing performance for Dragon's Inn. We will launch the Dragon's Inn officially in the market in -- maybe in the first month of second quarter this year.

Unidentified Participant

Okay, thank you. So, basically I noticed that previously you're very optimistic about Kung Fu Hero, but the result is not so good. And then you have a pipeline of many exciting games, I think mostly in the second half of 2013. We know that if they're successful, obviously they'll be very good for the company. However, I want to know what is it in your mind that, you know, if there were any risks for those games, that what are the point that you think we should be very careful about your new pipeline in the second half of 2013.

Wang Lei Lei

Okay. I think for Kung Fu Hero, it's not very successful as we expected. We believe the whole market suffered the same situation, the traditional MMO games not very popular in the market in China. And as I mentioned, we'll focus more differentiated game types, even licensee from overseas or even in-house development games. Now our development team just focus on develop Chinese martial arts [useful] type game.

And you mentioned about the risk of the company. We believe as other companies, you know, it's a one-game [risk] sometimes means, you know, we have very successful one game of World of Tanks and, you know, we want to build up another large -- large-scale profitable gain, and we want to select it from our strong pipeline. As I mentioned, for this year we are at least four games in the open market testing step and in the government approval processing now, but for this year we will select two of the four games to launch in the market. Maybe it includes the Guild Wars 2, very successful game in the Europe/US market, and also another game we can select from World of Tanks.

This is our strategy. We want to build up another large-scale profitable game to -- against the one-game risk in the market for KongZhong internet gaming business.

Unidentified Participant

So my last question is, I'm right about the timing, right? That most of the games will be launched in the second half of this year, right?

Jay Chang

Yes.

Unidentified Participant

Okay. Thank you.

Jay Chang

Okay.

Operator

Thank you. Your next question comes from [Lo Rosa]. Please ask your question.

Unidentified Participant

Yes, thanks. Can you elaborate how much more profitable is the content that you develop in-house as compared with licensed content?

Jay Chang

In terms of our historic results or our future-looking kind of results?

Unidentified Participant

Well, how much is the gross margin, 100% as opposed to 50%, how should we think about it?

Jay Chang

Well, if you're self-developed, then there's no revenue share, and then your gross margin is significantly higher. But as you can see, World of Tanks is our primary game now. We built our internet game business around that. And that is about a 50% gross margin business.

In the future, as we launch more licensed games, that gross margin structure will be similar. We are developing, as our CEO mentioned, a martial arts mobile game, which is self-developed and wouldn't have that revenue share. But that game right now is slated to come out -- to start testing probably in the second half of 2013. In terms of commercial launch, that's, you know, based on the testing data.

Unidentified Participant

Okay. Second question is, priorities for your cash and including, are you spending meaningful time with acquisitions or are you making kind of proactive uses for cash, or how should we think about that?

Jay Chang

Well, two things. One is we have made significant investments in our cash, both on acquisitions. We acquired a smartphone gaming company. We have made significant commitments of our balance sheet to games like Guild Wars 2 to, if we execute properly, we believe that will have the potential to elevate up to tier 1 status in the China game market as a publisher. And we are doing share buybacks. We have released some information in terms of up to our 4Q results, you know, an active share buyback plan which we initiated in November 2012, which is -- continue to be ongoing. So we actually are, you know, quite active in leveraging and using our cash balance for shareholder value.

Unidentified Participant

Thank you, Jay.

Operator

Thank you. If there are no further questions at this time, I'd now like to hand the conference back to our presenters. Please continue.

Jay Chang

Thank you very much for your continued interest in KongZhong, and we look forward to hearing and meeting again with you on the upcoming months and quarters. Thank you very much.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may now disconnect.

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