Shanda Games' CEO Discusses Q2 2013 Results - Earnings Call Transcript

Aug.29.13 | About: Shanda Games (GAME)

Shanda Games Ltd (NASDAQ:GAME)

Q2 2013 Earnings Conference Call

August 28, 2013 9:00 p.m. ET

Executives

Ellen Chiu – IR Director

Xiangdong Zhang – CEO

Richard Wei – CFO

Analysts

Timothy Chan – Morgan Stanley

George Meng – Macquarie

Wendy Huang – Standard Chartered

Mark Marostica – Piper Jaffray

Thomas Chong – BOCI

Andy Yeung – Oppenheimer

Operator

Welcome to Shanda Games Limited's Second Quarter 2013 Financial Results Conference Call.

The conference call will be recorded and available for replay in its entirety. A copy of Shanda Games 2013 second quarter results announcement can be found and downloaded from its Investor Relations website, ir.shandagames.com.

(Operator Instructions). I would now like to turn the call over to Ellen Chiu, Shanda Games Investor Relations Director. Please proceed, ma'am.

Ellen Chiu

Thank you. Good morning and good evening everyone. On behalf of Shanda Games, I would like to welcome everyone to our 2013 second quarter financial results conference call. With me today are Mr. Xiangdong Zhang, our CEO, and Mr. Richard Wei, our CFO.

Before we begin, I would also like to remind you that management comments during the call will include forward-looking statements that are based on our current expectations and are intended to qualify for the Safe Harbor from liability for such statements established in the US Private Securities Litigation Reform Act of 1995.

All statements other than statements of historical fact during the conference call are forward-looking statements which are subject to significant risks and uncertainties. Actual results may differ materially from those contained in the forward-looking statements. So please to take a minute to read the Safe Harbor statement in Shanda Games' second quarter results 2013 earnings release.

In addition, please note, for discussion purposes, all numbers were translated into US dollars based on the exchange rate of RMB6.1787 per US dollar.

Now I would like to turn the call over to our CEO, Mr. Xiangdong Zhang.

Xiangdong Zhang

Thank you, Ellen, and thank you for joining us today. As I mentioned on our last earnings call, we had a solid start to the year, particularly in our mobile games segment, an area that has become one of our main strategy focuses. With the acquisition of the operating and distribution platform, sdo.com, our mobile strategy has become more focused. As we start to integrate and mobilize this platform, we expect to create synergies and facilitate the launch and operating of future mobile games by leveraging this platform.

Early last month we successfully launched Million Arthur in China where it immediately became the second top-grossing app across all categories on Apple's App Store in China on its first day. Through an extensive marketing effort and the strengthening of our platform, we are able to directly reach out to our target audience. We will continue to add new content to prolong the game's lifecycle by leveraging our expertise in MMO games.

In addition to China, we are now looking for opportunities to bring to new markets such as Singapore and Malaysia. The game contributed 9% of total revenue during the second quarter, which does not include revenue contribution from China. We hope to continue to build upon the success of Million Arthur with 36 new mobile games in the pipeline, including the mobile version of Dragon Nest, Guardian Cross and Hell Lord.

Last week we announced the launch of mobile platform G-Home. We believe G-Home represents an important milestone in our mobile game development as we work to convert our substantial MMO user base to mobile user base.

G-Home is a consolidated mobile platform that encompasses various functions including unique password, unique virtual currency, custom service, G-Q social community, and G-Games. Through G-Home, we believe we can efficiently reach out to new and current users as we create a sticky mobile community around them, positioning itself as a flagship games center.

G-Home will vertically integrate higher-end users, high-quality content and a premier service. We plan to publish all in the top 1% of mobile games selected from the market. With G-Home, users will no longer face the dilemma of choosing one game out of millions and will be able to easily locate games that appeal to them through the various functions the platform offers.

In addition, the user base and the publish and distribution functions the platform as well aid our game portfolio in reaching a high hit ratio without the additional promotional cost. (inaudible) reach of audience, G-Home also plans to collaborate with third-party platforms and markets through revenue-sharing arrangements or to allow users to access G-Home directly on third-party platforms.

It is true that mobile games tend to have shorter lifecycles than traditional MMO games. But they are also less culture-oriented and can cater to a large audience that often can span across multi markets. Therefore, a fully comprehensive mobile platform plays a much bigger role than any individual title in successfully launched mobile games.

We believe our mobile games revenue will grow steadily with the launch of numerous titles on G-Home in China, South Korea, Taiwan and Singapore going forward.

On the back of Million Arthur's launch in China, we expect our mobile games revenue to grow approximately 50% Q-to-Q in the third quarter and account over 10% of total revenue. Moreover, we will leverage our G-Home mobile platform to accumulate users and make it into a cross-promotion platform.

The cross-platform promotional events will be held as we facilitate (inaudible) the service for MMO games through a unique password. We believe that G-Home will aid us in broadening our MMO user base and growing revenue as we remove the barriers between our MMO and mobile users. We aim to attract 50% of our MMO users to G-Home by the end of this year.

As for our MMO segment, we continue to revitalize our existing games and also have plans to launch new games. Mir II and Woool remain stable as we prepare to launch expansion packs later this summer. We also launched an expansion pack for Dragon Nest last month, in which we raised the level cap from 60 to 70. AION 4.0 version aided the game's growth substantially in the second quarter, and we aim to further support the game by new content from the launch of 4.3 version this month.

Meanwhile, Final Fantasy XIV is progressing well, as we [approve paying] for different stage of beta testing in the server in the first quarter. In addition to China, we have also successfully launched Hades Realm II in Korea and Japan in the second quarter. We are excited to launch Dungeon Striker in Japan in the fourth quarter and in China sometime next year. With the support of new games in the pipeline, we expect to keep our gamers engaged.

In summary, we are excited about opportunities that lies ahead. From early days of PC gaming in China through to the mobile revolution that we currently experience, we have always driving to believe the innovation and great game play that our user demanded. Over the past 12 years we have accumulated a community of users which is our most valuable internet user based in -- which is the most valuable internet user base in the industry.

Through the G-Home platform, we will continuously introduce these users the best quality content and offer them our industry-leading platform service. I'm confident in our ability to capitalize on the positive long-term fundamentals of online gaming industry. I look forward to building the new foundations that will aid us in improving our financial and operating performance over the long term.

With that, I would like to conclude my remarks and turn the call to Richard.

Richard Wei

Thank you. As always, our full earnings release with financial statement is available on our website, as well as most major financial portals. I will now briefly review the highlights of our second quarter 2013 results and provide an outlook for the third quarter 2013. We will take questions afterwards.

Let me start with our second quarter results. In line with our previous quarter's guidance, our second quarter net revenues were RMB1.09 billion, equivalent to $176 million, flat quarter over quarter and a decrease of 4% year over year. Net revenues generated from MMO games increased 0.5% quarter over quarter and declined 11% year over year to RMB982 million, equivalent to $159 million in the second quarter of this year.

During the second quarter, the company continued to introduce a number of free functions and game plays as a way to enhance user engagement and increase user stickiness. As a result, average monthly active users or MAU for MMO games increased 1.5% quarter over quarter to 18.9 million.

Average monthly paying users or MPU for MMO games decreased 5.2% quarter over quarter to 3.2 million as some low-paying accounts became free accounts in certain games. ARPU increased 4.7% quarter over quarter to RMB98.

Net revenues generated from mobile games were RMB102 million, equivalent to $17 million in the second quarter, a decrease of 4.4% from last quarter and compared with nil in the same period last year. The quarter-over-quarter decrease was primarily due to the decline in revenue from Million Arthur in Korea as users spent less on in-game purchases and virtual items. This was partially offset by the first full quarter of revenue contribution from Million Arthur in Taiwan following its launch in March of this year.

Average daily active users or DAU for mobile games were approximately 400,000 in the second quarter of this year compared with 302,000 in the prior quarter. The sequential increase was primarily due to the launch of Million Arthur in Taiwan in March of this year. Average revenue per DAU or ARDAU for mobile games decreased 28.6% quarter over quarter to RMB2.8. The quarter-over-quarter decrease in ARDAU for mobile games was mainly due to, one, the decline in ARDAU of Million Arthur in Korea as users consumed fewer in-game items, and to a lower ARDAU level for Million Arthur in Taiwan and Korea as users in Taiwan generally spend less in the game than users in Korea.

Other revenues were RMB1.8 million, equivalent to $0.2 million in the second quarter of this year, up 5.9% quarter over quarter and down 93.4% year over year. The year-over-year decrease in other revenues was primarily due to a decrease in advertising revenues in China during the second quarter of this year. Excuse me.

During the second quarter, games with revenue contribution of over 10% included Mir II, Woool and Dragon Nest, which accounted for approximately 31%, 12% and 11% of total revenues, respectively.

Gross profit during the quarter increased 0.5% quarter over quarter and decreased 0.6% year over year to RMB701 million, equivalent to $113 million. Gross margin was 64.6%, up from 64.3% in the first quarter of this year and 62.4% in the second quarter of last year.

Operating income decreased 1.8% quarter over quarter and 17.6% year over year to RMB292 million, equivalent to $47 million. Operating margin was 26.9% in the second quarter compared with 27.4% in the preceding quarter and 31.4% in the same period last year. In line with our earlier guidance, non-GAAP operating margin was 30.1% in the second quarter of this year compared with 31% in the preceding quarter and 34.6% in the same period last year.

Income tax benefit was RMB26 million, equivalent to $4.2 million during the second quarter of this year, compared with income tax expenses of RMB80 million in the preceding quarter and RMB99 million in the same period last year. The quarter-over-quarter and year-over-year changes were primarily due to one of our subsidiaries receiving a pool for preferred tax rates for the years 2011 and 2012 as a key national software enterprise during the second quarter of this year. Therefore, the company reversed RMB97 million, equivalent to $16 million in income tax expenses during the quarter, for the excess tax charge in 2011 and 2012. We've set our effective tax rate in Q3 this year to be similar to that in Q1 this year which was 23.4%.

Income attributed to ordinary shareholders was RMB374 million, equivalent to $61 million, an increase of 52.9% quarter over quarter and an increase of 21.4% year over year. Earnings per diluted ADS were RMB1.4, equivalent to $0.22, an increase of 55.6% from RMB0.9 in the first quarter and an increase of 27.3% from RMB1.1 in the second quarter of last year.

Non-GAAP net income attributed to ordinary shareholders totaled RMB401 million, equivalent to $65 million, an increase of 45.5% quarter over quarter and an increase of 18.9% year over year. Non-GAAP earnings per diluted ADS were RMB1.50, equivalent to $0.24, an increase of 47.1%, from RMB1.02 in the first quarter and an increase of 25% from RMB1.20 in the same period last year. Excuse me.

Turning to the balance sheet, the company's cash and cash equivalents, short-term investments and restricted cash, net of loans and dividends payable, increased from RMB3.49 billion as of March 31 this year to RMB3.95 billion, equivalent to $640 million, as of June 30th this year.

Now turning to guidance for the third quarter of this year, we expect our revenues in Q3 to increase 3% to 4% quarter over quarter, driven primarily by the successful launch of our mobile game Million Arthur in China.

Mobile game revenues in the third quarter this year is projected to grow approximately 50% quarter over quarter and account for over 10% of total net revenues. With the acquisition of two affiliates providing user and payment platform services from a parent company, we estimate our gross margin and non-GAAP profit margin in third quarter of this year to be approximately 71% to 72% and 42% and 43%, respectively.

Excluding the impact of this acquisition, Shanda Games gross margin the third quarter of this year is projected to be between 63% to 64% compared with 64.6% in the second quarter, mainly due to a shift in revenue mix as revenue from licensed games is expected to become a larger portion of total revenue.

Excluding the impact of this acquisition, non-GAAP operating margin in the third quarter of this year is projected to decline modestly from its second quarter non-GAAP operating margin of 30.1% as a result of the small decline in gross margin in third quarter.

Share-based compensation expenses in Q3 is projected to be approximately RMB13 million. We also expect to book approximately RMB20 million in government subsidies in Q3.

That concludes my discussion. I'll now turn the call back to Ellen.

Ellen Chiu

Thank you, Richard. We'll now take your questions. Operator, please go ahead.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions).

Your first question from the line comes from Timothy Chan from Morgan Stanley. Please ask your question.

Timothy Chan – Morgan Stanley

Hi, good morning. Thank you very much for taking my question. My question is actually related to mobile games. Can you maybe talk more about how you would attract 50% of your MMO gamers to your mobile game platform by the end of this year? That is question number one.

And number two, I also want to ask about the advantage, as far as the disadvantage of not using the transitional mobile game distribution channels in China. Thank you.

Ellen Chiu

(Chinese language spoken)

Xiangdong Zhang

(Interpreted). Tim, to your first question, that's why we're introducing the G-Home platform. And G-Home is not just an app store. It's more like a flashy app store. And on the platform, we offer a unique passport, unique virtual currency, customer service and the G-Q social community, and also the G-Games. And through those services, we expect to provide a consolidated service to our users, and therefore can combine the PC users to the G-Home platform. That's how we expect to convert our PC users to the mobile users.

To your second question, we don't cooperate with the traditional app store or distribution channels for now, but we aim to leverage our G-Home platform to introduce those high-quality G-Games which only account for 1% of the game pool.

And we also expect to leverage fully of our resources to operate mobile phones as we do in our games. And for our G-Home platform, we also target to cooperate with other third party platforms or markets to better reach out to our users. So that is how we expect to promote our mobile games with cooperating traditionally.

Timothy Chan – Morgan Stanley

Thank you.

Operator

Thank you. Your next question comes from George Meng from Macquarie. Please ask the question.

George Meng – Macquarie

Hi, good morning. Thank you very much for taking my question. I have two questions. Number one is relating to your mobile strategy, G-Home. So I just want to learn like the split that you are going to give to third-party developers if, you know, you are going to put back these elite games from third party developers on your platform.

So what is going to be -- because I read from the media coverage, it says up to 90%, but I just wanted to get a sense what is the average that you are going to share to the third-party developers.

And also, you mentioned that for now, you won’t cooperate for your own games, or license games, to cooperate with traditional app stores. But I remember you said previously that you are open to maybe do that in the future, meaning sharing revenue with like the app stores like G-Home or 91. So do you have any change in mind now and do you think -- are you worried about the loss of potential users if you exclude those channels?

And this is my first question, I have a follow up. Thanks very much.

Xiangdong Zhang

(Interpreted). So for our revenue sharing, there are actually two portions of the sharing. One is to share with the developers and the second portion is to share with the platforms that we cooperate. And although the revenue sharing was the platform, plus the developer may account for as much as 90%, but that is going to account for the minority in terms of the total -- in terms of the ttoal revenue sharing pool.

And also, we do not -- so, we do not look forward to cooperating with third party platform by each individual title, that we look forward to building G-Home to a flashy game app store where there are multiple [unique] games on the platform. Then we will introduce the platform to other third-party platforms and that's how we -- that's why we are looking forward to expanding the G-Home app store right now.

And we also have other -- the plans to cooperate with third parties and we will announce when we come close.

George Meng – Macquarie

Okay, got it. Thanks. And my second question is related to your third quarter guidance, and this year your guidance implies that your mobile revenue will be up about like RMB50 million in the third quarter. But because the Million Arthur is launched in mid-July, and I read from the media coverage saying that during the first two weeks the revenue or the gross billing already reached like RMB30 million, and for iOS, I guess, you guys, you know, get a 70% and for Android, then you got close to 100%. So I just wonder, you know, are you being quite conservative on the guidance or you know, do you think that the RMB30 million reported by the media is not the true figure. Thanks a lot.

Xiangdong Zhang

(Interpreted). George, I think, you know, your extrapolation is a good one for the China market but the total mobile game revenue base comes from Korea and Taiwan as well. And we are expecting some decline in the other two markets.

So on a combine basis, I think that the 50% increase is reasonable.

George Meng – Macquarie

Okay, got it. That is very helpful. Thanks a lot.

Operator

Thank you, your next question comes from Wendy Huang from Standard Chartered. Please ask the question.

Wendy Huang – Standard Chartered

Thank you. Your provided some helpful data points regarding the mobile game in your press release. I just wondered if you can give more color on the DAU of Million Arthur in China and also the ARPU level that you are seeing in the China market.

And also, just a follow up on the previous question about the next quarter's mobile game growth. So since the Taiwan market was launched after Korean market so I guess eh decline you mentioned earlier was mainly pointing to Korea market. Then when do you actually expect this game to maybe start decline in the Taiwan market, so that we can get some flavor about the life span and when it should peak out for a typical big mobile game. Thank you.

Hello?

Ellen Chiu

Yes, Wendy. Hold on a sec.

Wendy Huang – Standard Chartered

Okay.

Xiangdong Zhang

(Interpreted). Wendy, for your first question, the DAU and the ARDAU in China -- sorry, the DAU in China, we prefer not to disclose. But the ARDAU based on the DAU number, it is very similar to the second quarter's number.

For the lifecycle of the game, in Taiwan the Million Arthur is still growing quite steadily in Taiwan so we also expect the game to grow healthily in China.

Wendy Huang – Standard Chartered

Okay. And so I have a broader question about the mobile game market and Shanda's position, so where do you see the overall Chinese mobile game market revenue to grow in 2013 and 2014?

I think there has been a quite big diversions in terms of different market forecasts for the Chinese mobile game market. So if you can share some insights from your end, that would be helpful. And also, where do you see Shanda Games' revenue share to grow in this particular market in the near to medium term. Thank you.

Xiangdong Zhang

(Interpreted). So the more -- we expect the mobile game industry to be over RMB8 billion market size this year. And next year we also expect to see a very high growth which will continue the strength of this year.

As for our mobile game revenue, we expect to continue to launch high-quality mobile games and which will [advance] our mobile game revenue if you account for 50% of our total revenue in the next three to five years.

Wendy Huang – Standard Chartered

Thank you.

Operator

Thank you. Your next question comes from Mark Marostica from Piper Jaffray. Please ask a question.

Mark Marostica – Piper Jaffray

Yes. I have two questions. First is with regards to Million Arthur. Could you give us a sense of how the game's daily active users have been trending over the last three to four weeks, have they been accelerating, decelerating, stable, with respect to China? And then I have a second question.

Xiangdong Zhang

(Interpreted). Our DAU continue to grow in the past couple of weeks and we also have a new version in September which will continue to add the momentum of the DAU growth.

Mark Marostica – Piper Jaffray Okay, thank you for the color. And one follow up, you talked about 36 pipeline games for mobile, can you give us some color as to the timing of the launch of those games, how many expect to launch in Q3 and Q4, and also, any particular games that we should be watchful that you have high hopes for? Thank you.

Xiangdong Zhang

(Interpreted). we are going to launch five to six mobile games in Korea and Taiwan respectively and in China, we are also going to launch three to four mobile games before the year end.

For the highlight for that, there is Hell Lord, which is inhouse developed by Actoz and there is also the mobile version of Dragon Nest. And also, Guardian Cross by Square Enix. Those three are those that we think are with high potentials.

Mark Marostica – Piper Jaffray

Thank you.

Operator

Thank you. Your next question comes from Thomas Chong from BOCI. Please ask the question.

Thomas Chong – BOCI

Hi, good morning. I have two questions. The first question is for your third quarter guidance, if I deduct the mobile games revenue, it seems that MMO revenue in the quarter is experiencing a slight decline given you guys will launch a lump of expansion packs for your key titles, I just wondered what is the reason for the relatively soft quarter.

And my second question is regarding the mobile games. Do you think the top five mobile games in your 36 games in your pipeline with contribute 50% of your mobile games revenue in the future? Thanks.

Xiangdong Zhang

(Interpreted). So for our Q3 guidance, MMO revenue is slightly declined to flattish and the main reason is because AION will decline in the third quarter because we launched 4.0 versions which is a major expansion pack in Q2 and [in fact has waned] in the third quarter. So that is the main reason for this -- for the slight decline of the MMO segment.

And for your second question, we -- as we just mentioned, mobile game will account for over 10% of our total revenue.

Thomas Chong – BOCI

Thanks.

Operator

Thank you. We are now taking the final question. Your last question comes from Andy Yeung from Oppenheimer. Please go ahead.

Andy Yeung – Oppenheimer

Hi, good morning. Thank you for taking my questions. My first question actually is also about G-Home so when we you know, look at the game platform, mobile game platform there, one is that you know, is it already for domestic China only?

And second is you know, when you look at you know, publishing the top 1% games, how do you select, you know, the top 1% game. And how do you differentiate yourself, you know, how do you get those games and how do you differentiate yourself from the app store or the game applications?

Xiangdong Zhang

(Interpreted). We also will look forward Lenovo launch G-Home in markets outside of China and as for how we select the 1% game in the market, we -- indeed we have a couple of sources, and we also have accumulated a certain experience by operating in the past couple of years, and we have internal sender in terms of how to select the best quality games.

And aside from that, we believe that G-Home's platform will also enhance the quality and the playing experience of the mobile games we selected and that is also what we have been looking for.

Andy Yeung – Oppenheimer

Okay, thank you.

Ellen Chiu

Thanks. Thank you again for joining us today and if you have any further questions, please feel free to contact us.

Have a nice day.

Operator

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

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