NQ Mobile's (NQ) CEO Zemin Xu on Q3 2016 Results - Earnings Call Transcript

| About: NQ Mobile (NQ)

NQ Mobile Inc. (NYSE:NQ)

Q3 2016 Earnings Conference Call

November 30, 2016 07:30 PM ET

Executives

Dahlia Wei - Director of IR

Matt Mathison - VP Capital Markets

Justin Chen - President

Zemin Xu - CEO

Roland Wu - CFO

Analysts

Jun Zhang - Rosenblatt Securities

Operator

Ladies and gentlemen, thank you for standing by and welcome to the NQ Mobile’s Third Quarter 2016 Results 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 that this conference is being recorded today Thursday, 1st of December 2016.

I would now like to hand the conference over to your first speaker, Ms. Dahlia Wei, Director of Investor Relations of NQ Mobile. Thank you. Please go ahead.

Dahlia Wei

Good evening and good morning in Asia. We welcome you to NQ Mobile conference call to discuss the financial results for the third quarter of 2016. On this call tonight is our Chairman, Dr. Vincent Shi; our CEO, Mr. Zemin Xu; our President, Mr. Justin Chen; our CFO, Mr. Roland Wu; and our Vice President of Capital Markets, Mr. Matt Mathison. We thank you for joining us. Before we begin, here is our Safe Harbor disclaimer. Please note that the discussion today will contain certain forward-looking statements made under the Safe Harbor provision of the U.S. Private Securities Litigation Reform Act of 1995.

These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. NQ Mobile does not assume any obligation to update any forward-looking statements except as required under applicable law. Also, please note that some of the information to be discussed includes non-GAAP financial measures as defined in Regulation G. The most direct comparable U.S. GAAP financial measures and the information reconciling those non-GAAP financial measures to NQ Mobile’s financial results prepared in accordance with U.S. GAAP are included in our earnings release posted earlier today.

Finally, as a reminder, this conference call is being recorded. We are also offering investors a webcast of today’s conference call, which can be found on the Investor Relations section, follow our IR website, at ir.nq.com. I will now turn the call over to Matt.

Matt Mathison

Thanks, Dahlia. We thank you all for joining us today. Today’s call is going to go as follows. Justin is going to provide you with an update on our FL Mobile divestment; our Chief Executive Officer, Mr. Zemin Xu is going to make some remarks. I will then walk us through and provide us an update on our businesses and operating trends; and our CFO, Mr. Wu, will then review the financials and outlook. We will then open the call up for Q&A. Justin, go ahead.

Justin Chen

Thanks, Matt. And thank you everyone for joining us today. I want to provide you with a summary of where we stand with our FL Mobile Divestment in light of the several developments and announcement made over the past month.

As announced at the beginning of November, the company and all parties involved terminated the Shenzhen Prince transaction due to regulatory uncertainty and changing capital market situation in China. Following this termination, there were two other changes that we announced about a week ago. As previously disclosed, both the agreement with Dr. Shi on his 22% purchase and the agreement with the Xinjiang Yinghe the affiliate of the management of FL Mobile on their 12% purchase had the option to request the reversal of this transaction under certain conditions, including not obtaining the necessary governmental approvals to close FL Mobile Divestment.

Accordingly and after the termination of the agreement with the Shenzhen Prince the company agreed to reverse the transaction with the Xinjiang Yinghe completely and take back the 12% equity interest in FL Mobile. And also partially reverse the transaction with Dr. Shi and take back 5.66% of the 22 total equity interest in FL Mobile from him.

Following these update and changes, let me clearly detail the current status of the FL Mobile divestment. The company had sold 16.34% equity interest in FL Mobile to Dr. Shi for a total consideration of RMB653.6 million, which is proportionately adjusted total of the initial 22% stake for RMB880 million. The company has received 50% of this consideration, for a total of RMB326.8 million, with the remaining 50% due to us at the closing of the FL Mobile Divestment.

Since the company already had received RMB440 million, which represented 50% of the initial RMB880 million total for 22%, the company will return to Dr. Shi RMB113.2 million to proportionately adjust the correct amount. Both the company and Dr. Shi have the right to request to reverse this transaction if certain closing conditions are not met. The company had sold 13.13% equity interest in FL Mobile to Jinxin Hengrui's for a total consideration of RMB656.5 million; the company has received RMB525.5 million.

The company had sold 3.53% equity interest in FL Mobile to Jinxin Haoyue for a total consideration of RMB176.5 million, the company has received RMB105.9 million. The company had sold 3% equity interest in FL Mobile to Jinxin Huatong for a total consideration of RMB115 million, the company has received RMB90 million. And finally, the company has sold 1% equity interest in FL Mobile to Tibet Zhuohua for a total consideration of RMB50 million, the company has received RMB30 million.

In summary, the company had sold 37% equity interest in FL Mobile for a total consideration of RMB1.687 billion and retains 63% currently. The company had so far received RMB1.078 billion of the proceeds to-date. This is the most up-to-date information. The company is moving ahead and focused on reaching a conclusive decision regarding the divestment. We look forward to providing you with this information shortly and are working to reach a conclusion as soon as possible.

Now let me turn the call over to our CEO, Mr. Xu.

Zemin Xu

Thank you, Justin. Hello everyone and thank you for joining us. I am very pleased as the continued solid performance in our business during the third quarter. Well the FL Mobile Divestment remains our major focus. We have continued to go through about our day-to-day work. We look forward to finishing 2016 on a strong note and that we’ll continue to share our progress with you. Thank you.

Matt Mathison

Thanks Zemin, and thank you Justin for that clear summary of the entire FL Mobile Divestment given many recent updates. It is taking much longer than anyone could have anticipated and we have actually executed and delivered on a significant portion of the divestment so far and received a significant amount of cash considerations so far. Having said that, I'm a big believer that things happen for a reason. And while the uncertainty in the regulatory environment and the changing capitals and market dynamics in China certainly created lengthy delays and ultimately led to the change we continue to move forward.

In fact, one of the outcomes of this entire process is that it has been very visible by more and more investors. We set out to unlock the value of the FL Mobile business for our shareholders and we continue to be on that path. To monetize these businesses and then to in turn use that significant cash to enhance shareholder value through buybacks and to be in a stronger financial position to invest in the future. This is what we intended on doing and this is what we continue to do. As Justin just mentioned, we are working to move as quickly and swiftly as we can to reach a conclusion on the FL Mobile Divestment and we hope to be able to share this with you soon. Now stay tuned.

Over the past year, we have also executed on many of our other business objectives. We reached the new record level within our Mobile Value Added Services or MVAS segment in the third quarter. And we saw a strong year-over-year growth again led by a solid FL Mobile performance and a record performance by Showself.

Let me provide you with a more detailed discussion about our FL Mobile businesses. I would characterize the performance of our gaming business in the third quarter as solid. Many of our legacy titles continue to contribute in a stable manner. While our newly launched games performed in line with our expectations. In addition, we highlighted the successful launch of the Legend of Three Kingdoms during our second quarter conference call. That game launched right at the end of the second quarter. This game performs well in the third quarter and we expect it to continue in the fourth quarter.

In addition, after FL Mobile consolidated the Hetu subsidiary, the overseas business continues to perform solidly and the geographic expansion is additive to the overall business performance. Finally we continue to see a strong pipeline of games going forward.

As for the advertising segment, the third quarter was in line with our expectations. This quarter saw a continuation of the solid trends from last quarter, which included an expansion of our ad network business in overseas channels, the solid performance of our recently consolidated Launcher subsidiary and the improvement of the monetization of some of our other applications with third party app referrals.

Let me now provide you with the more detailed discussion about our Showself businesses. The Live Mobile social video market in China is still a hot market and we are performing well in this market. In fact, we have well exceeded our expectations for the run rate of this year already in the third quarter. We mentioned last quarter that we had launched several new applications within this segment including Lehai and Haixiu. Both of those new applications are performing well and we do continue to look at ways to expand user penetration, activity and interest. Revenues from this segment represented over 172% year-over-year growth and more than half of the MVAS segment.

Monthly active users was 8.4 million, representing over 71% year-over-year growth. As we mentioned last quarter as we add new platforms and technology, it is important to note that we continually shift our marketing focus and new user acquisition priorities. We're continuing to focus on not only generating new users, but also growing the engagement of our paying users and ARPU, which we are so far pleased with. This is a competitive space and we are focused on ensuring that we focus on growth, but we remain disciplined about the cost of that growth. We are certainly ahead of our own expectations so far this year and look forward to a strong finish in the fourth quarter.

Let me now elaborate and discuss our Showself Desktop and Showself Lock Screen businesses. As a reminder, this is our collective group of applications that are personalized, interactive and programmable mobile desktop applications including dynamic wallpapers and lock screens. The traffic from this set of applications was impacted during the third quarter, which was the primary reason for the overall MAU decline for the overall company. The overall MAU decline for the group was primarily the result of a decline in vLife users. There is no material financial impact from this MAU decline, as the reduction came primarily from our vLife user base and does not impact the overall revenues much from a percentage wise basis.

But I want to provide you with some additional color as to what happened. During the third quarter there were some regulatory related changes that several large handset makers enacted. These changes required an over the year upgrade that impacted our user counts as the vLife screens and desktops were not included in this OTA push. This impact may gradually recover in the fourth quarter and we do not see any material impact to our overall financial performance as a result of this. At the end of the third quarter of 2016 we had more than 65 million MAUs and 40 million DAUs. We have not included the Launcher MAUs into these figures, but I will start providing you with the separate figures now.

At the end of the third quarter of 2016 Launcher had 8 million MAUs, which is up from 6.7 million last quarter. There is no comparable year-over-year figure until we get to the first quarter of 2017. As a reminder Launcher is doing well with its monetization. We'll continue to work on finding ways to monetize the Showself Desktop and Lock Screen traffic, but for now Launcher will contribute more of this segment’s revenues.

Our Showself Music Radar business does continue to grow its traffic as well. At the end of the third quarter, our Music Radar application or Doreso applications have more than 19 million MAUs and we did see bump in our unique daily search queries to 18 million now from 14.9 million a year ago.

Now lastly, before I turn the call over to our CFO, I wish to mention our Linkmotion business. We invested in Link Motion in the middle of 2015 last year and begin consolidating the business at that time. We have been a mobile focused company from the very inception. In the previous decade plus, the technology innovation and advancement within the mobile landscape has been centered on the smartphone. We believe that the automotive and smartcar markets will play a more and more important role in the mobile innovation and mobile advancement in the future decades.

We are positioning ourselves for this and we believe we have the technology and innovation that will enable us to hopefully capture some of this very large trend. We will share with you some exciting developments from our Linkmotion business in the coming several quarters as they materialize.

With that, I wish to turn the call over to our CFO Mr. Wu who will walk you through our financial performance.

Roland Wu

Thank you, Matt. Now, let us turn our attention to the financials. I wish to work through some of the highlights and provide you with additional details behind the results. It’s important to mention that I will be using figures excluding the NationSky business for all the numbers in the comparable period in order to better compare the nature of the business as we have previously done. I also wish to highlight representation of the RMB the majority of our business is in China and denominating in RMB. However we report in US dollars given the significant depreciation in the RMB, our reported figures translated into US dollar is under representing the underlying performance, especially in our top-line figures.

For example, the foreign exchange rate used to translate our financials in the year ago period was 6.26 and in the previous quarter was 6.53. The foreign exchange rate use to translate our financial in this quarter is 6.66 or equivalent of a 6.4% translation impact from the year-ago period and 2% impact from last quarter obviously the RMB was depreciated even further up to now. I mentioned this just as a half reference point for you to consider the underlying financial performance relative to the reported figures in U.S. dollars.

Now let us start with a discussion of our revenues in the third quarter of 2016. We generated $91.1 million in net revenues for the third quarter of 2016, which was an increase of 8.8% [ph] compared with last quarter. Revenues from revenues from our MVAS segment reached a record level in the third quarter and increased 13% Q-o-Q. This was due to the strong performance of the FL Mobile and Showself business. FL Mobile’s domestic business remains healthy and their international business is being supported by Hetu subsidiary. The Showself business perform great and reached a record level and constitute more than half of our total MVAS segment in the third quarter.

Our advertising revenues increased 4.2% Q-o-Q still in line with our expectations there following a strong second quarter. Revenues derived from our enterprise mobility business increased 37% when compared with last quarter, mainly because the second half of the year is always a seasonal stronger period for this business. As a result, we also purchased additional hardware inventory in preparation for the stronger order at the end of the year timeframe, which was the main reason for the higher prepaid [ph] line items on our balance sheet.

Next, let’s spend a few minutes discussing our gross margin and walk you through some of the key elements within our cost of sales. Our gross margin in this quarter was 22.9% compared to 33.8% last quarter also our gross profit decreased 26.3% Q-o-Q, the decrease in gross margin was mostly from two factors; first, a much higher percentage of our mobile gaming business in this quarter was booked on a gross basis, because of the mix of exclusive titles versus net basis last quarter. Second, there was higher performance of our enterprise hardware business compared to last quarter.

Let me now walk you through our operating expenses. In the third quarter, total operating expenses was $24.2 million and increased 13.7% from last quarter. This increase was mainly due to higher general and administrative expenses, which came from higher compensation costs and the provision for doubtful accounts. As a percentage of revenues our operating cost was normal and only slightly increased to 26.5% of revenues from 25.4% compared with last quarter. Total share based compensation expenses was $3.4 million in the third quarter. The increase was mainly due to restricted shares to management of a subsidiary.

In this quarter, net loss was $2.8 million compared with the net loss of $2.4 million a year ago and net income $5.3 million just last quarter. The difference between net income, net income of attributable to NQ was affected by the treatment of the portion of FL Mobile that was transferred pursuant to the related share purchase agreements as non-controlling interest in this quarter. GAAP net loss attributable to NQ Mobile was $9 million in this quarter or $0.09 performance ADS with a $6.2 million impact from the NCI line item I just mentioned.

Finally, let me conclude my review of the financial performance for the third quarter of 2016 by highlighting of few other things. First, our balance sheet, we end this quarter with $330.3 million of cash and cash equivalents, term deposits and restricted cash. Net cash used in operation for this quarter was $11.3 million, which was primarily the result of two factors. The timing of our receivables, which increased at the end of the quarter and was up at the end of the quarter and increase in various tax paid.

Total cash used in investment outside of the proceeds from FL Mobile Divestment was $11.3 million including the final payment to Xinjiang and additional payment to Launcher and a new investee relate to our broadcast video business.

And finally to our guidance and outlook, inline of the mainly to of the currency depreciation and the subsequent headwind in our translated results that RMB foreign currency translation rates impact our forecast made at the beginning of the year, we would not inspect the variance in our full year net revenue performance to be outside of the percentage of the ongoing currency depreciation changes. Thank you.

Matt Mathison

Thanks, Roland. This concludes our prepaid remarks for the presentation. Operator, will you please open up the lines for our Q&A.

Question-and-Answer Session

Operator

Sure. [Operator Instructions] Our first question today comes from the line of Jun Zhang from Rosenblatt Securities. Jun, please go ahead.

Jun Zhang

Good morning, thanks for taking my question. I have a couple of questions, so first one could you talk a little bit about the RMD depreciation impact on the revenue? And what’s your expectation going forward because it seems that RMD is going to continue depreciate in the next -- over the next couple of quarters. So, what’s the -- what’s your take away that how is that going to affect revenue growth for the next couple of quarters? Thanks.

Matt Mathison

Jun, thanks for the question. Again as Roland just kind of went over, remember the vast majority of our financials are generated in RMD, and so it really doesn't impact the actual numbers. However we do report our numbers in dollar terms. And so the rate by which we translate those RMB financials obviously is impacted as the depreciation has obviously materialized over the course of this year dramatically. And I think most people expect that to continue.

Up to this point we have not reported the precise constant currency impact as of yet, but I do think it's worth mentioning. And as Roland just said, again if you look at our financial guidance and you look at the RMB rate that was used at the beginning of the year to put that guidance forward, you're seeing 7%, 8% maybe even 9% difference in depreciation in the currency rate that will be used at the end of this year, which is significant. But as Roland just said any variance to our full year reported US dollar term revenues will not be greater than that -- will not be greater that variance. So I think a good number that you could use is maybe 4% or 5%.

So this is mostly a top-line impact just on the reported basis. But it's just something to be helpful of and we’re obviously mindful of that we wanted to address it on the call today. You still there Jun?

Jun Zhang

Yes, I'm here, thanks. So my second question is that could you give us more color on the gross margin and operating margin from the Q3. It seems that it's coming down sequentially from Q2. Is there any change in the Q3 that affect the both margins?

Matt Mathison

Yes this is a great question. And I think it’s an important one to address. There is really two primary factors and one of them is the largest factors to the gross margin performance in the third quarter. In our FL Mobile business, remember we book revenues on a gross basis if the gaming title is an exclusive title to FL Mobile. So what that means is we book revenues gross and then as a cost of sale have to back out the portion that's due to the app store and the portion that's due to the game developer. It's a non-exclusive title, those revenues for non-exclusive titles are booked net of the game developer portion.

And so the fluctuation in the gross margin was largely tied to the performance of our exclusive titles. In fact, in the third quarter almost 90% of our total gaming revenues came from exclusive titles not quite but almost 90%. To give you some sort of comparison that figure was closer to 60% in the second quarter. So that impact alone drove the gross margin performance of the FL Mobile business down. And again, we’ve talked about this revenue mix fluctuation in the past. The gaming revenues or the gaming gross margin business fluctuates because of that accounting treatment from the 30s to the mid-50s. In Q2 it was in the 50s, in Q3 it was in the low 30s that was really the bulk of the reason why gross margins declined and why the cost of sales obviously went up.

The second reason had a smaller impact but had to do with the enterprise business. Obviously we had a slightly stronger and higher percentage of our overall business coming from the enterprise side. Just keep I mind while we're not focused on hardware sales and the trust that business generally. The second half of the year is always a seasonally stronger period for that enterprise business. And so as that business preformed a little bit better in Q3 that also had an impact on gross margins.

Jun Zhang

Okay thanks. And also about DSO seems to be increasing little bit. Is that due to the enterprise business or is that due to other business growth?

Matt Mathison

Well, actually DSOs didn't really go up that much overall for the Group. If you're talking about the accounts receivable figure, which went up by a little more than RMB20 million, that came from the two fastest growing business units, Showself and FL Mobile. Again timing of receivables at the end of the quarter and things like that. So that was the impact there.

Jun Zhang

Okay. And also coming back to the FL Mobile Divestment, so what the -- I know you're probably not been able to disclose lot of information, but could you talk little bit about what’s the directional for FL Mobile as the management -- does management team still stick with the setting FL Mobile to the other parties, or what’s kind of the directional change is going to be for FL Mobile?

Matt Mathison

Sure, let me just reiterate what Justin said. We are obviously still going down the path to divest the entire FL Mobile business that hasn’t changed and just to reiterate what we said, we obviously can’t provide too much specifics, while we’re in the middle of that, but we continue to work on divesting the business and we’re working as hard as we can to reach a conclusion as soon as possible.

Jun Zhang

Thanks. And also I think when you announced the Zhongzhi investment in the convertible bonds, a lot of the question that are why you need the Zhongzhi Investment? And also what’s the purpose of the Zhongzhi investment seems that is kind of the Chinese based funds that investing in the U.S listed company for the -- through their convertible bonds. Could you give us more color on the Zhongzhi Investment and what’s the background and logic of that investment? Thanks.

Matt Mathison

Let me just say this, we’re very excited about having them as a partner, we view the investment as truly a great and important institutional sponsorship for us, obviously there were benefits in terms of getting that investment in US dollars and clearing up the old CB things like that. But we view this as a great new partnership and a new institutional sponsor. As you know, we invited the Chairwoman to the Board. She now is a Board member. And so we view this really much more than just as an investment, this is a new partnership.

Jun Zhang

Okay, thanks. And my last question -- Yes go ahead.

Matt Mathison

Go ahead with your last question.

Jun Zhang

Yes sure. So my last question is the cash and buyback, so by the end of the Q3 what’s the cash include, what’s part of the cash that you include, is that already include the Zhongzhi investments and what’s the cash outflow coming from? And also what’s the -- when the window opens for the corporate buyback? Thanks.

Matt Mathison

So your questions about cash, the new investment closed in the fourth quarter, so that was not included in the balance sheet statements that were reported for Q3, none of that was. That will show up in our Q4 results. In terms of the cash outflows, if you’re talking about the cash flow from operations, is that what you are referring to?

Jun Zhang

Yes, that’s correct.

Matt Mathison

Sure, so the $11.3 million again more than $11.3 million came from the change in receivables, which was obviously offset some by the change in payables. But both of those things together accounted for the difference in our cash flow from operations. Without the timing of those receivable changes, cash flow from operations would have been positive.

And again the other part of that also had to do with the taxable accounts across the balance sheet, which had a negative impact to cash flow from operations of a few million dollars as well. So change in receivables and the taxable accounts more than accounted for that $11.3 million in cash outflow from operations. The last question, can you remind me what’s the last part was?

Jun Zhang

Yes buyback window and the commitment on the buyback.

Matt Mathison

So again, let me just reiterate what I said in the prepared remarks on the buyback commitment, remember as a company we set out on the path to divest FL Mobile to raise the cash and then to use the cash for two reasons buyback was one of them. We remained committed to that. As we have said for quite some time now, we are not going to announce a buyback authorization until there is an opportunity to actually execute it and I am not going to get into the practice of discussing specifically when that is or when the window might open. But suffice to say as we continue to move forward to reaching a conclusion on the FL Mobile Divestment, you’ll just have to stay tuned.

Jun Zhang

Okay, thanks. That’s all my questions. Thanks a lot.

Operator

[Operator Instructions]

Matt Mathison

Operator is there any more questions.

Operator

No, that concludes today’s question-and-answer session now. I’ll now like to hand the conference back to Mr. Mathison for closing remarks.

Matt Mathison

Great, thank you all for joining us, we look forward to sharing updates with you in the future. Have a great day.

Operator

Ladies and gentlemen, that concludes our conference for today. We thank you all of your participation. You may now disconnect.

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