KongZhong Corporation Q4 2009 Earnings Call Transcript

Mar.17.10 | About: KongZhong Corporation (KZ)

KongZhong Corporation (KONG) Q4 2009 Earnings Call Transcript March 16, 2010 8:30 PM ET

Executives

Wang Leilei – Chairman and CEO

Jay Chang – CFO

Analysts

Adam Krejcik – ROTH Capital Partners

Andrey Glukhov – Brean Murray

Alicia Yap – Citigroup

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2009 KongZhong Corp earnings conference call. My name is Tania, and I will be your event manager today. (Operator instructions) I would now like to hand the conference over to Jay Chang. Go ahead please.

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 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. On the call today, we have our Chairman and CEO, Mr. Wang Leilei; and myself, Jay Chang, the company’s CFO. I will go over our 4Q results before handing over the call to our CEO.

Total revenues for the fourth quarter of 2009 increased 28% year-over-year, but were down 2% quarter-over-quarter to $34.3 million, within our revised revenue guidance range of $34 million to $35 million due to the impact of the new mobile operator policies introduced in December 2009. As a function of the G+ mobile game billing platform, and underperformance in our online mobile game portfolio, sequential decline in mobile game revenues compared to total WVAS revenue.

Total gross profit was $15.7 million compared to $17.1 million in the third quarter, while gross margins were 46% overall compared to 49% in 3Q. However, please note that we have made some changes in how we present sales tax [ph] in the fourth quarter and going forward. Previously we had recorded sales tax in G&A expenses. But as of 4Q, we have changed this presentation could now disclose sales tax separately as reduction from revenue, as we believe that this change provides better comparability to our peers.

However, this change does not affect prior period results of operations, cash flow or financial position. When we effectively shift things [ph] sales tax from a G&A item to an above the line gross profit line item. Based on the new presentation, total operating expenses were $12 million in 4Q, roughly the same as 3Q, as we implemented strict cost controls on the back of newly introduced mobile operator policies.

Total operating profit in the fourth quarter was $3.6 compared to $5.3m in 3Q. While 4Q operating margins were 10.6% compared to 15.2% in the third quarter. In addition in the fourth quarter, we also bought the one-time investment impairment charge on our entire investment in Hui! Media, which was an investment the company made in January of 2008.

Including this charge fourth-quarter net profit was $2 million compared to $4.5 in the third quarter with 4Q net margins of 5.9% compared to 12.8% in the third quarter. While net profit per basic ADS was $0.06, and net profit per diluted ADS was $0.05.

Non-GAAP net profit in the fourth quarter was $5.4 million compared to $6.3 million in the third quarter, while non-GAAP net profit per diluted ADS was $0.13 based on 41.2 million ADS.

At the end of the fourth quarter, our cash and cash equivalents were $139 million or roughly $4 per basic ADS.

For the full year of 2009, total revenues were under $31.3 million, while total WVAS revenues were $98.2 million, total mobile game revenues were 27.3 million and total WVAS wireless Internet revenues were 5.76 million.

Net income for the full year of 2009 was $12.6 million, an increase compared to 2008 net loss of $20.66 million. While full year non-GAAP net income was $20.15 million, or 415% increase compared to 2008 non-GAAP net income of $2.91 million. In addition, during the first quarter we amended certain agreements with Dacheng, which had the effect of moving forward the consolidation days from roughly early February to January 14. As such, our 1Q guidance includes contributions from Dacheng as of January 14.

However, these amendments only affect the date of consolidations, and did not alter any of the commercial terms of our transactions.

Now I would like to turn to each business unit’s financial performance, namely mobile games, wireless Internet services and WVAS.

First turning to mobile games, total mobile game revenue in the fourth quarter was $7.35 million, a 172% increase from the same period last year, but the roughly 10% decrease from the third quarter. As mentioned previously, due to new Chinese mobile operator policies implemented in December 2009, billing was suspended for the G+ mobile game platform, negatively impacting both the company’s download of the mobile games revenues as well as online mobile games.

Mobile games gross profit for 4Q09 was $3.69 million compared to $4.67 million in the third quarter and $1.56 million in the same period last year or an increase of 137% compared to the same period last year, but a 21% decrease compared to 3Q. Mobile games gross margin was 50% compared to 57% in the third quarter and 58% in the fourth quarter of ’08. The sharper declines in mobile game gross margins compared to WVAS is due to our proactive shift to a new mobile game billing platform, namely China Mobile's monthly mobile game subscription package in order to offset the impact of the G+ mobile game platform being suspended in the beginning of December.

While this new mobile game platform is expected to be a more stable source of reoccurring revenue in the short term, it relies more on our mobile operator partner’s resources, and includes an additional operator distribution channel fee. However, as the current mobile service policy environment stabilizes, we expect to be able to leverage more of our own distribution resources in the future, bypassing these additional fees. As such we are working with China Mobile’s (inaudible) mobile gaming platform such that by the end of 2Q we should resume a more normalized revenue share ratio for mobile game business. However, in the interim, we would expect gross margins for our mobile game business to decline to roughly the 40% level in 1Q and stabilize in the 50% to 55% level over the medium term.

Revenues from downloadable mobile games were $6.52 million representing a 218% increase from the same period last year, but a decrease of roughly 8% from 3Q. Revenues from downloadable games made up roughly 89% of total mobile game revenues compared to 86% in the third quarter, as downloadable mobile games were less impacted compared to online mobile gaming revenues.

Revenues from online mobile games were $0.83 million, an increase of 27% from the same period last year, but a decrease of 26% from 3Q. In addition to the factors cited, just cited, the poor performance of Feng Shen, our newer online mobile game, has not compensated for the gradual decline in revenues for Tian Jie our older online mobile game.

Depending on market conditions, the company intends to refresh our online mobile game content portfolio in 2010 by launching new online mobile game titles this year while seeking to improve the performance of our existing online mobile games.

Revenues from Tian Jie accounted for roughly 89% of total online mobile game revenues while revenues from Feng Shen accounted for the remaining 11%, compared to 3% in the third quarter.

Wireless Internet service revenues were $1.72 million in the fourth quarter, representing an increase of 117% from the same period last year and increase of 14% from 3Q. In 4Q, 40% of WIS revenues, or Wireless Internet services, were from wireless advertising with the remaining 60% of revenues were from premium services on the Kong.net mobile Internet site and revenues coming from our newly acquired Internet literature site, Zhulang.com.

Turning to WVAS, WVAS revenues in the fourth quarter increased 9% from 4Q to $25.27 million, and were only down slightly compared to the third quarter. Revenues from 2.5G services accounted for approximately 19% of total WVAS revenues compared to 20% in 3Q, while revenues from 2G services represented the remaining 81%. The small decrease in WVAS revenues in 4Q compared to 3Q was primarily due to new Chinese mobile operator policies implemented in December 2009.

Now turning to our 1Q guidance, we expect total revenues to be roughly $37.5 million with WVAS at $24 million, mobile games as $8.5 million, Wireless Internet services at $1 million and our newly formed Internet online game business unit, which resulted from our acquisition of Dacheng Networks with $4.0 million in revenues.

For Dacheng, however, our revenue guidance only includes results as of January 14. However, for the full quarter operating metrics and our online gaming business unit, we would expect roughly total aggregate paying accounts to be in the range of 180,000 an average concurrent users or ACUs in the roughly 80,000 range.

For WVS, we provided our updated guidance in the first quarter at the end of January of $19 million to $20 million. The performance in January and February exceeded our expectations, but March’s performance had slightly underperformed our expectations as we implemented a number of new policies including new SMS code management system and handset embedding new policies.

As a result, we do expect future post 1Q WVAS operating periods to still be in the roughly $20 million a quarter range. The 1Q margins, overall we expect gross profit to be 43% to 44%, operating profit margins to be roughly 4.5% to 4.8% and net profit margins to also be roughly 4.5% to 4.8%. Once again this gross margin range reflects our updated presentation of sales tax as previously discussed.

We expect non-GAAP net profit margin to be 12% to 12.5%, which reflects the additional software and other amortizations related to the acquisition of Dacheng. Finally, as we diversify our business away from the WVAS business, based on the just discussed guidance, we would expect roughly one third of total revenues to come from mobile and online gaming, while roughly 40% of total gross profit to come from mobile and online gaming.

Now I would like to turn the call over to our CEO, Mr. Wang Leilei to discuss our fourth quarter business highlights and recent business developments.

Wang Leilei

Thanks, Jay. Good morning everyone. I'm pleased to report that KongZhong continue to generate the positive cash flows, although we have under our new realm of government (inaudible) policies being implemented by mobile operators. However what was more important was through our acquisition of Dacheng Networks we have begun to diversify our business across mobile and PC-based Internet gaming platforms, and I do believe we have the potential to be one of the leading players in the China market.

Now I would like to first discuss our mobile business before discussing our plans for KongZhong’s PC-based online gaming business. First, we expect the policy environment to remain stable, allowing for all our WVAS business to stabilize in the short-term, and over the mid-term, have the potential to gradually gain some of the previous levels of cash flow we generated at (inaudible). This would come from reduction in the number of service providers in the market, and the mobile operators working more closely with a few trusted players like KongZhong.

Second, for our mobile games business, in the first quarter we expected a rebound in total revenues fourth quarter as we build out the number of monthly subscribers on China Mobile’s mobile game monthly subscription package platform. Currently, we are one of the leading partners with China Mobile with over 1 million users subscribing to our (inaudible) per month mobile gaming packages. As mentioned in our earnings release because of current restrictions on promoting mobile services, (inaudible) this has improved an additional distribution fee.

As the policy environment stabilizes, we are already working with China Mobile’s mobile game center in Shandong [ph] Province to use our own distribution resulted so that we can bypass some of these additional fees and improve our gross margins for our mobile game business. We expect to do some time towards the end of the second quarter.

For KONG.net, we continued to see strong growth in users and traffic as KONG.net will be one of the few healthy (inaudible) mobile Internet sites focused on mobile entertainment services, especially for Ko.cn, our mobile gaming community and the cn, the leading mobile in the (inaudible) in China.

Going into first quarter, Ko.cn and .cn made up roughly two-thirds of total traffic on (inaudible) and each grew roughly 40% quarter-on-quarter in fourth quarter from third quarter.

Now turning to our online gaming business, Loong, [ph] 3D MMORPG title self-developed game was launched at the end of 2009, and has become one of the top domestically developed three-dimension online games for the Mainland China market with fixed concurrent user is 150,000 and average concurrent user is about 80,000.

Although the Chinese New Year period is generally a seasonally slow period for online games, Loong has performed in line with our expectations, the same as the wins we announced of our acquisition of Dacheng in December 2009. Looking forward, we expect to launch a new extension pack for Loong at the end of April and through distribution partners in Hong Kong and Taiwan, and overseas market like Malaysia towards the end of first quarter.

More importantly, our strategy for developing KongZhong’s online gaming business this year is based on three key areas, high-quality three dimension MMORPG first based on Dacheng’s proven 3-D game engine, we plan to continue to press on developing high-quality 3-D MMORPGs for both the China and domestic market and the International market.

We believe we have competitive advantage in the three-dimensional online gaming market in China based on the success of our Loong to date. Second, with a portfolio. With our online game development team of over 300 staff, we plan to build out a more diversified portfolio of online games, as we recognize the risk of operating one game as we are currently doing.

So in addition to the expansion pack for Loong towards the end of April, we plan to launch another three dimension MMORPG (inaudible) online, sometime towards the end of the second quarter of this year, and other 3-D MMORPG games for (inaudible) sometime in the third quarter for this year.

(inaudible) is based on one of the (inaudible). Based on the performance of this three self developed game titles, we’ll also then plan to launch Kung Fu 2 in the early 2011 with the potential for at least another two MMORPGs to be in the later stage of development by the end of 2010.

The third important area has been our distribution channel for our online games, as we enhance our plan of having a more diversified portfolio of high quality 3-D MMORPG, I expect our team to be more aggressive in building of our own offline distribution channels, which is currently limited to mainly online media of advertising.

I continue to be optimistic about KongZhong’s ability to transition through this period as a more diversified, more product driven and more profitable company.

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

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Adam Krejcik with ROTH Capital Partners. Please proceed with your question.

Adam Krejcik – ROTH Capital Partners

Yes, hi. Thanks for taking my questions. Two questions, the first, any kind of update you can provide on when some of these restrictions that the mobile operators have implemented might get lifted? For example, the WAP billing, and then I have some follow up questions regarding your Online Game business.

Jay Chang

For the WAP billing area, we have heard that there is potential they may open up the WAP billing platform sometime in the May time frame, i.e, the second quarter, but it would be not like the same kind of operating guidelines or qualities they had in the past. So it will be a little more stricter type of operating guidelines. We're not exactly sure what those are specifically, what they would be yet.

In terms of SMS and handset embedding, I think you know, some of the policies that they started to implement, which we’re seeing some impact in the March period will continue for quite some time as those are I think are more of a long-term type of trend. However, I think that on the flip side of that we are seeing a lot of less or I guess less regulated smaller type of fees [ph] probably over the next couple of quarters having less and less an opportunity, even work with China Mobile under that new policy regime. So we think over the medium term there is actually a lot more potential for us to gain a lot of market share in this marketplace, but obviously in the interim period there is a transitional phase that we need to go through.

Adam Krejcik – ROTH Capital Partners

Okay, great. And then on Loong for the game, could you talk about –- I got the user metrics, but just how those are trending as of late? Are you seeing PC users exceeding 150,000? And on the same token, do you expect, even though it is early, that you can kind of continue to grow revenues for that game on a sequential basis here?

Jay Chang

So, the PCU number is actually more towards the launch period. I think, right now, currently the ACU figure is actually relatively stable. In the current month, I was not getting too much operation detail. You know, we actually haven't done a lot of marketing. We’re saving it up for the new expansion pack we plan at the end of April. So you know, based on a lot of the updated content of additional features in the game, including (inaudible) fighting system that were introduced again in April. We are fairly reasonably confident that we can see additional growth from the current level we see today.

But I think in the second quarter another aspect of our ability to grow the online gaming business is going to be also related to the oversee [ph] of our international markets. So as I mentioned in the prepared remarks, we are launching towards the end of March in Hong Kong and Taiwan. We've already launched in Malaysia and over the course of the second quarter we are preparing for other overseas markets as well.

Adam Krejcik – ROTH Capital Partners

Okay and one final one if I can. Did I hear it right that you're going to launch two additional MMORPGs this year?

Jay Chang

That's correct. One, sorry…

Adam Krejcik – ROTH Capital Partners

So that – from when you originally acquired Dacheng, I think you provided some preliminary revenue guidance for the full year 2010. Does that change your assumptions now for the full year in terms of what Dacheng can contribute?

Jay Chang

Oh, I think at the current moment we are going to stick to kind of the expectations we put out in the December 15th presentation related to the acquisition of Dacheng. We always said at that time that we felt that there was room for them to exceed those and depending on performance growth and even potentially to exceed those significantly, but at the current moment you know, Loong is performing in line with our expectations, and we hope the new expansion pack can reintroduce addition growth into the base content and the base game player base that we have today, and then as we launch these other games over the course of the second quarter or third quarter depending on how they go as you know, you know, the online gaming business, there are risks when you launch new games. But we are fairly confident that the quality of the games that we have is actually reasonable that we’ll see additional ability to aggregate more users and build out a more diverse portfolio of 3-D MMO.

Adam Krejcik – ROTH Capital Partners

Very helpful. I appreciate it. Thanks.

Jay Chang

Thank you.

Operator

Are we ready for our next question?

Jay Chang

Yes.

Operator

Our next question comes from the line of Andrey Glukhov with Brean Murray. Please proceed with your question.

Andrey Glukhov – Brean Murray

Yes, thanks for taking the question. First, if I may follow up on the regulatory landscape, since we just went through the Consumer Day. I think the CCTV had some language against some of the SDs that had – to the prime message delivery software preinstalled on some of the cell phones. Just to be clear, do you guys have any exposure to some of the practices that they discussed in the expo?

Jay Chang

At the moment, we don't see or we have any significant exposure to that. I think a lot of that, the practices that were exposed or discussed on the CCTV programming relates mainly to very small kind of MTK handset providers in southern China. Based on kind of our fourth-quarter revenue kind of figure and kind of preliminary 1Q, we have exposure to southern China roughly 15% to 20% of WBS revenues.

So we don't feel actually a significant exposure. On top of that we were not part of that and the practices that we have with our handset vendors are here to the new kind of menu driven handset embedding practices and new SMS code management system that China Mobile has implemented, and we provided update at the end of January on that. So, you know, we think after Consumer Day, things should be fairly stable I think going forward. Obviously, I think they are still going through a transition period, but I think the key word is I think much more stability after Monday.

Andrey Glukhov – Brean Murray

And you know, in light of the fact that the ultimate outcome here is going to be sort of concentration of the trust of the speed with which the telcos would be working, are you guys going to explore? Are you thinking about exploring any fire sale opportunities, particularly in maybe the intranet and the gaming space?

Jay Chang

We were always open to different value accretive kind of acquisitions. I think the thing that is being impacted the most though in this current environment are kind of the bread-and-butter SP [ph], which is something that we want to diversify away from and move more towards the mobile gaming, product development mobile gaming as well as online game business. So we are open to all those, but I think in terms of having fire sale opportunities, you know, those are the businesses that we are not so much interested in because those are things we are trying to move away from.

Andrey Glukhov – Brean Murray

Okay. And then lastly, in terms of the licensing of Loong to Hong Kong and Taiwan, how are you guys going to recognize the licensing revenue? Do you recognize the bulk upfront upon commercialization, or do you spread it over the life of that contract?

Jay Chang

Spread it over the life of the contract, roughly two to three years.

Andrey Glukhov – Brean Murray

All right, okay. Thanks.

Jay Chang

Okay, thank you.

Operator

(Operator instructions).

Jay Chang

Okay, if there are no further questions, then we thank everybody for their time and interest in KongZhong. We look forward to speaking to you over the next few months and quarters.

Operator

Sorry for interruption Mr. Chang. We just got a question in the queue.

Jay Chang

Okay. Please.

Operator

All right. We have a question from the line of Alicia Yap with Citigroup. Please proceed with your question.

Alicia Yap – Citigroup

Hi, yes I just have one quick question on the Mobile Games. Would you attribute the underperformance of the Mobile MMO more related to the games specific issues, or is it more related to the impact from the mobile payment platform?

Jay Chang

It's more related to the game specific issues. Yes, some function with design more as a PC-based online game, and that turned out to be a lot more complex for kind of the current mobile online game user. So that game I think was designed very well. It's just didn't really suit the market, little bit complex for the mobile phone and that's why we haven't seen its performance well as we had expected. Obviously, there are some limitations in the marketplace with G+ platform going down. So far I think we would prefer to focus on things and so [ph] and we felt that we can improve upon the game and those are things we're trying to fix for the remainder of 2010.

Alicia Yap – Citigroup

I see. To follow up on the Mobile Games business, since because I didn't – one of the bigger trend this year is towards the mobile games is the social games. What are your expectations on the overall mobile games industry going forward and then how are you going to participate more on that?

Jay Chang

I think the social games on the mobile phone in China is still very, very early just because to get a large-scale number of users, you need to go through WAP platform, which actually have a lot of limitations on user interface, ease of use, and so forth. In addition, the WAP billing platform is shut down now as well. So monetization actually is relatively difficult. In markets around the world whether it's PC-based, you know, on Facebook, MySpace or in Japan with (inaudible) they actually leveraged flash light [ph] technologies to make the games more social, more interactive.

In China, there is no support for flash light. So I think we're still very, very early days with social games, obviously on the mobile side in China, and as a result of that, you know, our focus over the next I think two or three years at least for now is still going to be on the downloadable games like Java games as well as mobile MMOs. That said, the traffic and user stickiness we are seeing with Ko.cn, which does have some WAP based social games is actually doing much better than our expectations, but of a relatively low base, and as we mentioned in our 1Q guidance, it does have some monetization issues in the near term, but I think over the long term, we're still committed to developing Ko.cn as one of the leading mobile game community for the phone in China, but it will take a longer time to develop into a more mature kind of scalable business.

Alicia Yap – Citigroup

I see and then just lastly on your Loong. Since that you say it's performing in line with expectations, but then do you think which games – and because obviously given the increased competition in the industry, do you have confidence with your April expansion pack that it can lead to more higher ACU and PCU, or is it more just for increasing the ARPU for the revenue?

Jay Chang

Our expectation is that the new content introduced in the game should make the game more attractive, and reduce the churn rate in the game versus trying to over monetize. Obviously that's not something we want to manage this game for relatively long period of time as we continue to build up a more diversified portfolio, but you know, at the end of the day, I think we’ll have to see how it performs (inaudible) April and into May.

Alicia Yap – Citigroup

Okay. Thank you so much.

Jay Chang

Thank you.

Operator

And so, we have no additional questions at this time.

Jay Chang

Okay, then we can conclude that call and once again I thank everybody for their interest in KongZhong, and look forward to speaking to you in the near future. Thank you.

Operator

Thank you for attending today's conference. This concludes the presentation. You may now disconnect and have a great day.

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