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Executives

Jay Kenneth Chang – Chief Financial Officer

Leilei Wang – Chairman and Chief Executive Officer

Analysts

Nick Ning – 86Research Ltd.

KongZhong Corporation (KONG) Q2 2013 Earnings Conference Call August 19, 2013 7:30 PM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Q2 2013 KongZhong Corp. Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. (Operator Instructions)

I must advise you this conference is being recorded today, August 20, 2013.

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

Jay Kenneth 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 discussion of risks and uncertainties relating to forward-looking statements and other factors, please see the documents we filed 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 continued interest in KongZhong. I’ll first review our 2Q results before handing over the call to our CEO, Mr. Wang Leilei. Total revenues for the second quarter of 2013 were US$43.6 million, compared to guidance of $43.5 million to $44.5 million, and representing a 13% decrease from the same period last year. Mobile games made up 9% of total revenues and Internet games contributed 54% of total revenues, with overall gaming revenues making up 62%.

Total gross profit was US$17.85 million in the second quarter, compared to our guidance range of $17 million to $18 million, representing an increase of 4% from the first quarter. Net income was US$6.5 million, compared to our guidance range of $5.5 million to $6.5 million, while basic net income per ADS was $0.16. Non-GAAP net income was US$7.82 million, above the guidance range of US$6.5 million to US$7.5 million, while non-GAAP diluted net income per ADS was $0.18.

As of June 30, 2013, the company had US$191.2 million in cash and cash equivalents, term deposits, held-to-maturity securities, and restricted cash or equivalent to $4.56 per ADS.

In Internet games, our revenues in the second quarter were US$23.62 million, a 3.3% increase from the same period last year, but a 16.8% decrease from the first quarter. Domestic Net – Internet game revenues were US$23.16 million, a 17% decrease from the first quarter, but a 10.7% increase from the same period last year. Domestic Net game revenues consisted primarily of revenues from World of Tanks. The normalization in 2Q Internet game revenues compared to 1Q was due to the commercial release of the Chinese tank series in the first quarter, which saw the frontloading of virtual items sales in the first quarter, compared to the second quarter.

Overseas Internet Game revenues were US$0.46 million, an 18% decrease from the first quarter. For the second quarter three-month period, mainland Chinese online game operations achieved average concurrent users or ACUs of 377,000, aggregated paying accounts of 838,000 with quarterly average ARPU of roughly RMB 172. ACUs in the second quarter were up 25% from the same period last year.

Internet game gross profit in the second quarter was US$11.16 million, an 8% decrease from the same period last year and a 15% decrease from the first quarter. 2Q Internet game gross margin was 47.3%, compared to 53% in the same period last year and 46% in the first quarter.

Now turning to mobile games, total mobile games revenues in the second quarter was US$3.74 million, a 40% decrease from the same period last year, but a slight 0.8% increase from first quarter. Feature phone mobile games revenues in the second quarter were US$2.85 million, compared to $2.37 million in the first quarter or a 20.5% quarter-over-quarter increase. Our mobile operator partners continued to implement strict operating policies and continued their de-emphasis of marketing feature phone mobile games. However, we saw a rebound in feature phone mobile game revenues as business volumes normalized from very low 1Q levels.

Smartphone mobile game revenues in the second quarter was US$0.89 million, a 34% decrease from 1Q. The decrease in smartphone mobile game revenues was due to a pause in new smartphone game launches in the second quarter, as we continued to transition a portion of our PC MMO game development team onto our internal smartphone game engine. We expect to launch a number of new smartphone games in 3Q and 4Q of this year.

Mobile game gross profit in the second quarter was US$1.51 million, an 18.9% decrease from the first quarter. WVAS revenues in the second quarter were US$16.23 million, a 22.5% decrease from the same period last year, but a 2.4% increase from 1Q. The WVAS operating environment stabilized compared to prior periods, but we continue to expect the WVAS operating environment to remain difficult for the remainder of 2013. WVAS gross profit in 2Q was US$5.2 million, a 43.2% increase from the first quarter. 2Q WVAS gross margin was 31.9% compared to 22.8% in the first quarter.

Total OpEx in the second quarter was US$13.3 million, compared to $13.13 in the first quarter, while product development expenses in the second quarter were US$6.46 million, compared to $6.14 million in the first quarter. The increase in product development expenses was due to additional resources and investments made towards our 2013 and 2014 game pipeline, including our Guild Wars 2 China team.

Sales and marketing expenses in the second quarter were $4.64 million, compared to $4.57 million in the first quarter, while G&A expenses in the second quarter were US$2.17 million. The company's total headcount increased slightly in the second quarter to 1,140 compared to 1,132 at the end of the first quarter.

Now turning to our third quarter 2013 guidance, the company expects total revenues for the third quarter of 2013 to be within the range of US$43 million to US$44 million, with business unit revenues at the midpoint expected to roughly consist of WVAS revenues of $16 million, mobile game revenues of $6 million, and Internet game revenues of US$21.5 million. We expect total gross profit to be within the range of US$19 million to US$20 million, total operating expenses to be US$19 million to US$20 million with net profit of $0.5 million to $1.5 million, and non-GAAP net profit to be expected to be within the range of US$1.5 million to US$2.5 million.

Two points in our guidance: first, increased level of operating expenses expected in the third quarter reflects an increase in sales and marketing activities for our company's smartphone Internet games. Secondly, our Internet game revenues, our guidance reflects a change from consumable items going to a concept at War Gaming termed as free to win, where we have credit users for previous purchases of consumable items, which is reflected in our 3Q guidance.

Now, I'd like to turn the call over to our CEO, Mr. Wang Leilei.

Leilei Wang

Thanks, Jay. Hi, good morning and good evening. I appreciate everyone’s continued interest in KongZhong. As Jay mentioned, our second quarter numbers are inline with expectation. Although cash revenue decline in the second quarter is seasonal, it is the normal pull back from our marketing cost steering from fourth quarter. If we look at the games, our breaking metric daily active user and the monthly active user driven significantly dropped. In fact, they maintained a small increase over the first quarter. The second half of September, World of Tanks we launched a new version with new contents incorporating new party game play systems, additional Chinese tanks and a new in-game consumptions items. We believe with large scale marketing efforts, World of Tanks, brand influence, user base and the revenue size, we will reach a new height.

For the third quarter will be an important quarter for KongZhong impair game business from Internet games to mobile games. We have completed development and the localization work for many game products. Following World of Tanks, three new games – the three new consoles: Guild Wars 2, World of Warplanes and our in-house self-developed game Master of the Meteor Blades will begin closed beta testing that will last two weeks or a month with nearly 10,000 of total user range. By testing the game’s core game play, users’ spending behavior and the retention rates, we can predict user base size and the expected revenue for each game, and make final decision on the timing of open beta period for each game.

Few more games named the Pocket Fort, and the High Load had already completed closed beta testing, formulae run through all these in July, the third quarter. So far the user retention rate and the paying rate and users’ ARPU are excellent and have met our expectations. They also aim to continuously improve the assurance for our new yielder’s guide, having new game play to enhance the in Icosystem. Pocket Fort 4 is the cartoon sale powered activated guidance, High Load is RPT real play type game with many Internet MultiVision features like card collecting and weapons in Tencent system.

In the third quarter, we will expect these games to the overseas market either operating by our sales, and are working with established game operator in these markets. The other two mobile games, Pocket Three Kingdoms, analyzing of the general, type already bound to the two more cost based testing states since early August this month. And we believe these two games will release for open beta in the fourth quarter this year. These two games both have highly innovative game play with Internet game quality MMORPG game progressive system and monetization systems.

In the future for every quarter, we will release one or two mobile games going to open beta and also one or two mobile games for closed beta testing for every quarter. As I said before, KongZhong has industry leading mobile game development, and the marketing capabilities. For instance, our game engines can support higher project graphics with medium phone memory usage. iOS and Android versions can be launched in the same time and also the new account to operate requires users to download entire [ATTL] games.

Our game design and operations teams have stunning reputations in the industry, because we have accumulated valuable excellence from both our multimedia games, media player games and Outland single-player games. You probably are quite concerned about our third quarter guidance. We decided to reporting almost all of our operating profit to market of our games in the third quarter.

We believe the quality of our game will determine the user acquisition cost and the efficiency of the market higher costs. As a result, we are highly confident about the quality of both of our license fees and all of the games from international games to mobile games, including their traffic policies, core game play and the monetization structures. The third quarter, will be an important quarter for KongZhong, as our marketing activities will expand across multiple media platforms dramatically increased over brand recognition and user acquisition. We believe we will be able to reach a new height in terms of our game user space and also we’re looking forward for the good results for our fourth quarter revenue. We will give detailed analysis of the results of our marketing spending in the third quarter’s conference call.

Operator, I like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Nick Ning from 86Research. Please ask your question.

Nick Ning – 86Research Ltd.

Hi, Leilei and Jay. Thanks for taking my questions. So my first question is about your company revenue was higher than we expected and your guidance also assume to be stable in third quarter. So what is the challenge in this business? How should we look at this going forward, and what is the growth driver for WVAS and feature phone mobile games revenue in the second quarter?

Leilei Wang

As we mentioned always the WVAS revenue is cash cost for KongZhong’s all business and you can see that it always have the seasonal revenue growth from Q2 to Q3 and also have the seasonal revenue decline for Q4 part of the revelation from the carrier and also where we can see some slightly redundant for our feature phone business will be needed for the long-term for the looking, our major mobile revenue coming from the smartphone growth.

Nick Ning – 86Research Ltd.

Okay. Thank you, and also your guidance for this $2 million sequential decline for Internet games, despite our last sales promotion third quarter, is that mainly due to log of that return in the third quarter, is this mostly from this decline or is up or what is the meaning for that. I mean, what is the seasonality for this game?

Jay Kenneth Chang

I’ll highlight a few things. One is the big promotion that we’re spending is primarily for the back-end of 3Q, but we want to see results from World of Tanks and some of our smartphone into the fourth quarter. The second thing is the guidance that we mentioned and what I mentioned on the prepared remarks is as War Gaming as we took away the ability to get Golden Bullet in the game.

In China, there was a significant amount of users who we had to credit, previous purchase of the Golden Bullet and in the third quarter, they actually are spending credit versus historically, they may have charge for that, and that resulted more than 10% of total revenues, and if you look at our guidance with that revenues could have been more likely flat. But the third thing is, the patches, the content updates from our first quarter, the Chinese tank series now, until I guess at the end of September, have not really had any real additional new consumption area for Chinese users.

So, although DAUs, and MAUs and PCUs have remained stable or even slightly increased, the consumption areas for Chinese users has stabilized. After as Leilei mentioned, when we report our 3Q results, we’ll report the effectiveness and results of our big marketing spend coming up for World of Tanks towards the end of September.

Nick Ning – 86Research Ltd.

Okay thanks. And also about this commercial launch of Guild Wars 2, World of Warplanes and Master of the Meteor Blades? Any color on the commercial launch schedule for this week? Have you (inaudible)?

Jay Kenneth Chang

Not currently, all three games were actively and focused on making sure that closed beta tests go very well and smoothly, based on the results of the beta test we’re working very close with all our partners and obviously, our internal games Master of the Meteor Blades to ensure that we get the games right. and then based on that we’ll decide jointly with some of the partners of the commercial launch date.

Nick Ning – 86Research Ltd.

And then what is the revenue model for the Global Wall Street that’s already still being decided?

Jay Kenneth Chang

We haven’t put this – discuss -- talk about that publicly yet. We’re working closely with our [Internet] to find a business model which should fit the China market. beyond that, I’m not going to say anything more.

Nick Ning – 86Research Ltd.

Okay. so you also mentioned that with our eight new mobile games in our pipeline for second half, what kind of games are they, does that also include the (inaudible) games we have already seen in August. Is it mostly towards the highly (inaudible) model or it is more diversifying?

Jay Kenneth Chang

They’re very diversified, the eight number includes Pocket Fort and [High Load], as well as the other two games as Leilei mentioned that are coming in the fourth quarter, there are four other games that are in development, which more likely by 2014, our launches. They range from real-time strategy, asynchronous PvP to Internet RPG, the car collecting games to potentially Diablo 3 type action-RPG games as well as even traditional (inaudible)/Internet MMORPG type games. But our goal is to really focus on the high-end of the market where we have very large teams, pretty significant R&D investment as well as taking a lot of the things we learned from the PC market onto the smartphone.

Leilei Wang

Although, it’s our first the Pocket Fort for iOS 4 for English version and also learned first Pocket Fort for Android version in the 2008 market.

Nick Ning – 86Research Ltd.

Okay, that’s very helpful. I mean, so do we also license and published other developer’s games and if so you are basically a big part of our mobile game business?

Jay Kenneth Chang

For smartphone games, our primary focus is to self-develop and self-publish for content, which has a global market, we will evaluate game by game, whether we want to partner with an established overseas player or kind of self-publish on our own in the overseas market.

Nick Ning – 86Research Ltd.

Just talk to a little concern that for our mobile games was nothing about mobile games, but we booked revenue on a net basis range. We put platform fees plus 30% revenue share to Apple in [Cortland] or where do we put it?

Jay Kenneth Chang

Correct in net basis.

Nick Ning – 86Research Ltd.

And so how will you look at our mobile game gross margin going forward? what is the biggest component there and what will be the biggest variable expense going forward?

Jay Kenneth Chang

There are a number of variables, but in our 3Q guidance, the increase is both smartphone games, as well as feature phone games. We actually are still normalizing from the 1Q level so the guidance; we’re assuming feature phone games also increase sequentially in the third quarter, as well as smartphone games. However, as smartphones games continue to grow, which we expect much operating the feature phone games, we would expect the gross margins to increase to much higher levels from our 2Q by gross margin levels on mobile games, as the gross margins on smartphone games are much higher than the feature phone games.

Nick Ning – 86Research Ltd.

Well, thanks. What is our view on the impact of (inaudible) game platform maybe, on the overall China mobile game market, this (inaudible) other players and they currently make games for -- platform as well?

Jay Kenneth Chang

I didn’t understand the question. Could you repeat it, please?

Nick Ning – 86Research Ltd.

I mean, what is our view on this impact from (inaudible) new platform, since we’ve seen any platform maybe, on the China’s overall mobile game market, what is the impact on this and these vision game platforms grew out other small players with growth potentials on the KongZhong net games for the vision platform?

Leilei Wang

Yes. I think for Tencent, reaching platforms game is all Halo games and KongZhong’s mobile gaming developing strategy of the focused (inaudible) games, RPG type forward defense, PVP type online games. So we believe that’s a different game type and for some reasons, for Tencent’s reaching platform is easier to promote (inaudible) game. But for KongZhong and others this game produces, we focused our (inaudible) games for mobile area and we believe the content under the core game play setting of the business. So we mentioned, we will publish or do marketing -- operate the game all ourselves for the market from the Mainland China to overseas market.

Jay Kenneth Chang

Hello?

Nick Ning – 86Research Ltd.

Okay. Thanks a lot for that. And then, what is the --and sequential increasing our intangible asset in this quarter, is that also due to Global Wall Street?

Jay Kenneth Chang

No, that’s due to other license agreements for new game, which we have not disclosed yet, the names of those partners.

Nick Ning – 86Research Ltd.

Okay. Okay that’s all my questions. Thanks a lot.

Jay Kenneth Chang

Thank you.

Leilei Wang

Thank you.

Operator

(Operator Instructions) There are no further questions at this time. Please continue.

Jay Kenneth Chang

Thank you, operator, and thank you all for your interest in KongZhong and we look forward to speaking to you in the following weeks and next few quarters. Thank you very much.

Operator

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

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