Executives:
Yunfan Zhou - Chairman & Chief Executive Officer
Nick Yang - President
Sam Sun - Chief Financial Officer
Analysts:
Michael Olson – Piper Jaffray
James Lee – WR Hambrecht
Jonathan Glow – Lehman Bros.
Ming Zhao - Susquehanna International
TRANSCRIPT SPONSOR |
KongZhong Corporation (KONG) Q1 2007 Earnings Call May 21, 2007 8:30 PM ET
Operator
Good day ladies and gentlemen, and welcome to the first quarter 2007 KongZhong Corporation earnings conference call. My name is Melanie and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference.
If you require operator assistance at any time, please press Star Zero, and a coordinator will assist you. As a reminder this call is being recorded for replay purposes.
I will now like to turn the call over to Mr. Sam Sun, the Chief Financial Officer. Please proceed sir.
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| China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy. To sponsor a Seeking Alpha transcript click here. |
Sam Sun
Thank you. Hello everyone, welcome to KongZhong Corporation's first quarter 2007 earnings conference call. You can find our Q1 2007 earnings press release at our website ir.kongzhong.com. This is Sam Sun, Chief Financial Officer of the company. We also have Yunfan Zhou, our Chairman and CEO, and Nick Yang, our President, on the line.
I will first go through our financial highlights. After my discussion, I will turn it over to Yunfan. He will review our operations and talk about our business outlook.
Overall, our Q1 financial results are in line with what we expected in March. Our Q1 total revenues were $20.13 million, in line with our guidance of $20-21 million. In Q1, while the whole advertising market is typically at its seasonal low point, our mobile advertising revenues generated from our wireless Internet portal, Kong.net, reached $116,000, a 12% increase from Q4 2006.
Our gross margin in Q1 was 53%, about 2 percentage points higher than the previous quarter. The higher growth margin is primarily due to a lower percentage of revenues derived from China Unicom, China Telecom and the China Netcom, which generally charge a higher revenue sharing fee.
Total operating expenses in Q1 2007 were $9.83 million. We continue our efforts in wireless internet business. In Q1 we spent $2.63 million related to our wireless internet sites. We expect to spend more in Q2.
Our US GAAP net income was $1.56 million in Q1. Diluted US GAAP earnings per ADS were $0.04 in Q1.
Operating margin was 5% and net margin was 8%. First quarter non-GAAP income was $2.13 million, which excluded share-based compensation costs of $569,000 and amortization of intangibles of $206,000. Diluted non-GAAP income per ADS was $0.06.
With that, I will now turn it over to Yunfan for his remarks.
Yunfan Zhou
Thank you Sam. The first quarter was a challenging quarter for us, given the tough WVAS operating environment, while revenues met our guidance. As we have announced, there are some recent actions from China Mobile on the WVAS business. These changes will probably have a significant adverse impact on our WVAS revenue in the future. So based on the information available by now, and after any significant changes in policy and regulations of telecom operators at MII, we expect our Q2 revenues to be between $16 million and $18 million.
In addition to the wireless WVAS business, we are pleased about the good progress in the wireless Internet business. We announced earlier that we plan to increase our mobile advertising sales efforts in 2007. We target to increase our mobile advertising revenues five times, from about $200,000 in 2006 to about $1 million in 2007.
Our mobile advertising revenue increased 12% sequentially to $116,000 in Q1, based on a current growth trend in Q2. I believe we are now on-track to achieve our annual advertising target.
On March 16, 2007, we launched our new wireless internet community site Ko.cn. Users can register at Ko.cn to get their own virtual space. The features include a personalized domain name, friend system, chat room, photo album, blog, and more.
We subsequently started to more marketing campaigns to promote the community site, namely “Guangdong University Supergirl” contest, and the cell-phone photography contest. We expect a synergy between our wireless internet portal, Kong.net, and the community site, Ko.cn, will increase the stickiness of the sites and drive traffic.
On May 15, 2007, China Internet Network Information Center released its first-ever China WAP report. Our wireless Internet portal, Kong.net, is ranked as one of the top 10 most-frequently-visited WAP sites. CNNIC didn't release specific ranking positions.
The China WAP report states that as of March 31, 2007, China's active WAP user population reached 39 million, and the number of independent WAP domain names reached 65,000. Given the fact that there are over 480 million cell-phone users, and over 140 million internet users in China, the current 39 million WAP users base has a very big growth potential in the next few years. That's why we are very confident about the future of the wireless internet business. We'll continue to make our best efforts to increase our brand awareness, traffic, and mobile advertising revenue.
To summarize, although we are facing a difficult time in the WVAS business, KongZhong's management firmly believes that a continuous investment in our wireless internet business is the right strategy for us to achieve our vision, which is to build Kong.net to be the largest wireless Internet portal in China. Thank you.
Sam Sun
Operator, open the lines for questions and answers please.
Question-and-Answer Session
Operator
Ladies and gentlemen, if you would like to ask a question, please press Star One. If your question has been answered, or you'd like to withdraw your question, you may press Star Two. Please press Star One to begin, and stand by for our first question.
And our first question comes from the line of Michael Olson with Piper Jaffray. Go ahead.
Michael Olson – Piper Jaffray
Hi, thank you very much. It sounds like China Mobile has its own WVAS product on certain handsets only. And I'm just wondering, what stops them from getting on all China Mobile handsets, and do you expect that this will become a larger issue for your China Mobile revenue going forward?
Sam Sun
Well, they've only started the effort to market their own products since early May. So right now, it's still too early for us to really have a good feeling about what the magnitude of the impact of China Mobile selling their own WVAS product. So I guess it will take us a while, maybe one to two months, to have a better feeling about that impact.
As to what else China Mobile can do to market and sell their own WVAS product, at present we don't know.
Michael Olson – Piper Jaffray
OK, and do you expect China Unicom's margin will increase to 30% when you renew your contract with them in June?
Sam Sun
For China Unicom, yes, we are going to renew the contract with them in June. As to the revenue share and percentage, we still haven't heard anything concrete from China Unicom.
Michael Olson – Piper Jaffray
OK, do you think it will change at all, or do you expect it to stay unchanged?
Sam Sun
We really don't know.
Michael Olson – Piper Jaffray
OK, understood. And will all of the WVAS providers be renegotiating their contracts in June with China Unicom, as well?
Sam Sun
All WVAS providers will renew their contract in June of 2007, (inaudible) contract.
Michael Olson – Piper Jaffray
OK. You talked about $15 million on Kong.net in '07. Do you still expect to spend $15 million on Kong.net?
Yunfan Zhou
Yes, I think right now we still plan to spend roughly around that number.
Michael Olson – Piper Jaffray
OK. And one last one, what do you expect income taxes will look like for the next few quarters?
Sam Sun
Well, we don't give annual guidance. Right now, what we can say is that in Q2, the revenue according to our estimate will be $16-18 million. And going forward, it's difficult to tell because, first, it still takes time for us to have a good feeling about China Mobile's action.
Michael Olson – Piper Jaffray
OK, thank you very much.
Operator
Our next question comes from the line of James Lee with WR Hambrecht. Go ahead.
James Lee – WR Hambrecht
Thanks for taking my call. First question regarding your cash flow statement acquisition of subsidiaries for $17 million. Can you guys just elaborate what that is? I think the acquisition may just be last payment and also there was a head count deduction during the quarter. Can you guys clarify as to what that head count reduction related to and lastly maybe Sam can talk about the guidance a little bit since we are ready in late May. Can you talk about the run rate, this sort of compares to the run rate of business in April and May versus what we experienced in 1Q and how you do you expect that trend to look like going to June thanks.
Sam Sun
Yeah, James that first question. That $17 million payment, yes you are right that’s the last payment to the shareholders of Sharp Edge and that’s the earn-out payment, the final payment.
The second question, the headcount reduction, well it’s a normal staff turnover. Its only because we experienced a staff turnover probably a little bit higher than Europe because normally we did annual performance evaluation around Chinese new year time so after that probably more people decide to leave because of the annual performance appraisal so that’s not any major type of reduction program.
About your third question, the revenue performance. If we look at our revenue performance month over month, we can see that the later impact coming in from early May since China Mobile started their actions. Right now the major impact as we discussed in our press release in our website, the web revenue. Our estimate was that web revenue for the Q2 compared to Q1 can decrease about 50-60% compared to Q1. That’s the major hit to our revenue.
James Lee – WR Hambrecht
OK, if I may have a follow up question here Sam.
Do you expect any other segment of your revenue to recover being Q2. Obviously SMS was down pretty big in 1Q, that’s mostly due to regulatory business within your operation. Do you expect some recovery heading into the second quarter?
Sam Sun
Well most of the revenue lines will remain flat due to comparative Q1. For revenue there could be some growth since we already did better in Q1 revenue compared to Q4 last year and Q2 there could be some further growth, Q2 compared to Q1.
As to MMS, we also expect another 30-40% decrease for MMS revenue.
James Lee – WR Hambrecht
And what is that may I ask?
Sam Sun
Well the major reason is that around the end of march, China Mobile upgraded their MMS system and fortunately after this upgrading with the system laws, a lot of the information of our subscription users, so we expect that we need to redeem those users maybe not on a consistent business but maybe on download business so if (inaudible) will get back those users. So expect that Q2 will have a decrease of MM of 30-40% as compared to Q1.
James Lee – WR Hambrecht
OK. My last question, I know you answered a lot of questions, I really appreciate it. Regarding the handset lines, can you talk about how big of a scale that is, give us a sense how many handset manufacturers they are working with right now, how much overlap do they have with your business so we can get a sense of where they are right now in terms of deploying the handset agreement.
Sam Sun
China Mobile never published such information. China Mobile started to have particular alliances with handset selectors and handset manufacturers about 2-3 years ago. So, for us the impact right now, our evaluation of the impact is altogether 50-60% of web revenue decrease. But as to the exact number, I guess it still takes a while for us to have a good feeling about the impact.
James Lee – WR Hambrecht
OK, thank you so much, I will get back in the queue.
Sam Sun
Thank you.
Operator
Our next question comes from the line of Jonathan Glow with Lehman Bros. Go ahead.
Jonathan Glow – Lehman Bros.
Thanks you very much for taking my question. Actually some of the questions have already been addressed, I would just like to ask a general question overall. So under the current environment, what kind of sales stretch are you going to adopt to grow your sales, is it very product closed or are you going to focus very much on your mobile advertisement?
Yunfan Zhou
I think for the couple as I said, the recent actions from China Mobile actually will probably see a part of (inaudible) revenue very much in 2Q and probably in the next few quarters. Right now we believe that for other business lines, there are still certain risks if China Mobile or the other operators change their policy and regulations. What we can do is focus the new product development, be focused on the new message, promoting our products and we tried to recover some loss due to the policy changes.
For mobile advertisements, it still takes some time for it to reach a very big scale. We expect that this year’s revenue could be reaching $1 million. In comparison to our quarterly WVAS revenue, it is still kind of more. So I believe that for the second half of the year for 2Q and second half of the year, we will still try to minimize our loss of revenue from WVAS to try to grow our mobile advertising revenue. So hopefully, the mobile advertising revenue will pick up in the next month to two years time to offset some of the loss in WVAS.
Jonathan Glow – Lehman Bros.
OK, thanks.
Zunfan Zhou
OK, thank you.
Operator
As a reminder ladies and gentlemen, if you would like to ask a question, please press Star One on your touchtone phone.
And our next question comes from the line of James Lee with WR Hambrecht. Go ahead.
James Lee - WR Hambrecht
I’m sorry, it’s me again. A quick question regarding competition from other free websites out there that may offer very similar products and services versus yours, are you still making that into your guidance…number one have you seen competition from them? The free product bringing some potential free games substituting your products you are currently charging from the mobile (inaudible) first. If the answer is yes, are you taking that into consideration as you start looking ahead in terms of guidance in 2Q and activities going into 3Q? Thanks.
Sam Sun
I think that the major reason that we got our revenue down in 2Q is due to the actions from China Mobile. We have been facing this competition from other free websites for pretty long time. Many of the free websites may offer a similar service as you have just described but we haven’t seen that as a big threat to our WVAS revenues. We really impact the revenues what the actions taken by China Mobile. I think most of the explanations for that is a lot of it now is actually from different channels. China Mobile is based on their embedded menus in the cell phones. And for our free website, they promote their product through different ways. So actually, it probably didn't impact the WIS business that much.
James Lee - WR Hambrecht
OK, great, thank you.
Operator
Our next question comes from the line of Ming Zhao with Susquehanna International. Go ahead.
Ming Zhao - Susquehanna International
Hi, good morning. Actually, this is Hya for Ming Zhao. We have two questions. The first question is also about your guidance however it's more from a positive point of view. So, in your second quarter guidance we saw a $3 million drop in the top line. In (inaudible), China Mobile started to remind users of GPIS fee on May 17. So this $3 million decline looks like only representing the half-quarter net impact from this new policy. As such, do you expect to see another $3 million drop further in Q3 sequentially?
Sam Sun
OK, first, there are two reasons contributing to the decrease of our Q2 revenue guidance. One is the impact of the fee reminder. Another reason is that China Mobile started to promote their own WVAS product instead of all the products of various (inaudible). So, just for the fee reminder itself, it can only explain the total $3-4 million revenue decrease. So it's two reasons.
And also, officially China Mobile started the reminder on May 17, but province by province, many of them started, for example, May 9, 10, 11...they already started this. And also, for China Mobile promoting their own WIS product, they started also in early May, like May 8-9. So this $3-4 million revenue decrease is almost about two months effective for Q2.
You are right that in Q3, the impact will be the whole three months. So it's possible that the Q3 revenue will be further decreased compared to Q2. But right now it's still too early for us to say whether Q2 revenue will be down or up. Because, first, it still takes us time to evaluate the impact of China Mobile actions. Second, we may also expect some revenue increase in other revenue lines.
Ming Zhao - Susquehanna International
Yes, thank you. OK, so for the second portion, as for your margin, except for the gross margin, other margins will also decline. So could you please give us some color what margins will be in the second quarter? Do you expect to see it further down?
Sam Sun
Our gross margin for WVAS in Q1 was 53%. Excluding the spending on wireless internet sites, our operating margin for WVAS was actually around 15-20%, which is pretty stable over the quarter. So, our feeling was that for Q2, excluding the spending on wireless internet sites, the operating margin for WVAS will still be in the range of 15-20%. So it's really how much we spend on the wireless internet site. And we explained that we are going to spend more than Q1 on wireless internet sites.
Ming Zhao - Susquehanna International
OK, thank you.
Operator
Again, ladies and gentlemen, if you would like to ask a question, please press Star One on your touch-tone phone.
Ladies and gentlemen, I'm not showing any further questions at this time. I would like to turn the call back over to the management for any closing remarks. Please proceed.
Sam Sun
Yeah, thanks everyone for dialing in. Q1 is a tough quarter, and we believe Q2 will be a tough quarter too. And we look forward to talking to you again next quarter on our Q2 revenue conference call. Thank you.
Operator
Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the presentation. You may now disconnect your lines. Have a good evening.
| TRANSCRIPT SPONSOR
China Direct (ticker: CHND.OB) is a diversified management and consulting company. Our mission is to create a platform to empower medium sized Chinese entities to effectively compete in the global economy. As your direct link to China, our organization serves as a vehicle to allow investors to participate directly in the rapid growth of the Chinese economy. To sponsor a Seeking Alpha transcript click here. |
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