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Executives

Sam Sun - Chief Financial Officer

Yunfan Zhou - Chairman of the Board, Chief Executive Officer

Nick Yang - President, Chief Technology Officer, Director

Analysts

Andy Patel - Visions Investments

C. Ming Zhao - Susquehanna Financial Group

Michael Olson - Piper Jaffray

Sam Lee - Primarius Capital

Stanley Wong - Mobile Wireless

KongZhong Corporation (KONG) Q4 2007 Earnings Call March 4, 2008 7:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2007 KongZhong Corp. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Sam Sun, Chief Financial Officer. Please proceed, sir.

Sam Sun

Thank you. Hello, everyone. Welcome to KongZhong Corporation’s fourth quarter 2007 earnings conference call. You can find our Q4 2007 earnings release at our website, ir.kongzhong.com. This is Sam Sun, Chief Financial Officer for the company, with 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, who will review our operations and talk about our business outlook.

Overall, our Q4 financial results are better than what we expected in November 2007. Our Q4 total revenues were $19.81 million, exceeding our guidance of $18.5 million to $19.5 million. Our WVAS revenues increased in the areas of WAP, SMS, IVR, and CRBT. Our WVAS gross margin in Q4 was 48%, about four percentage points lower than the previous quarter. This is primarily due to the higher percentage of IVR revenues which generally were derived at a higher cost compared to other revenues.

In Q1 2008, we will focus more on revenue growth in WAP, SMS, and MMS, as such revenues in general enjoy higher margins.

Total WVAS operating expenses in Q4 2007 were $6.76 million, slightly higher than Q3.

In Q4, our mobile advertising revenues continued its growth trend and reached $298,000, a 12% increase from Q3. We continue our efforts in wireless Internet business. In Q4, we spent $3.22 million related with our wireless Internet sites, 24% higher than Q3, as we spent more marketing and advertising efforts on our NBA official websites. For the whole year 2007, we spent $10.64 million relating to our wireless Internet sites. We plan to spend about $10 million to $15 million in 2008.

Our U.S. GAAP net income was $687,000 in Q4. Diluted U.S. GAAP earnings per ADS were $0.02 in Q4. For 2007, our U.S. GAAP net income was $2.83 million and diluted earnings per ADS were $0.08.

Fourth quarter non-GAAP income was $1.57 million, which excluded share-based compensation costs of $672,000 and amortization of intangibles of $215,000. Diluted non-GAAP income per ADS was $0.04. For the whole year 2007, non-GAAP income was $6.01 million and diluted non-GAAP income per ADS was $0.17.

With that, I will now turn it over to Yunfan for his remarks.

Yunfan Zhou

Thank you, Sam. First of all, we are happy that we have regained the growth momentum in the WVAS business in Q4 2007. Our total revenues in Q4 increased 16% sequentially to $19.81 million, exceeding our guidance of between $18.5 million and $19.5 million. Our total revenues in 2007 was $74.02 million, about a 31% decrease from the 2006 level. Over 98% of the total revenues came from the WVAS business in Q4 and in the whole year 2007. Looking forward, although we face many continuous challenges in the WVAS business, we expect to have a better WVAS business in 2008.

There are a lot of rumors talking about the reform in the Chinese telecommunication industry nowadays. However, there is nothing confirmed or announced yet. We are paying close attention to this. Based on the information available by today, we expect our Q1 revenues to be between $20 million and $21 million.

In addition to the stabilized WVAS business, we are also pleased about the good progress in the wireless Internet business. Our mobile advertising revenues increased 12% sequentially to $298,000. Total mobile advertising revenues in 2007 were $903,000, a 328% increase from the 2006 level.

In Q4, we began the full operation of the official Chinese NBA mobile website, which then became the major driver to increase our traffic and user base and our mobile advertising revenues.

We have recently signed a strategic alliance agreement with Focus Wireless Media Technology Company Limited, or Focus Wireless, a subsidiary of Focus Media, to jointly expand our mobile advertising business and leveraging on the strong advertising sales force on Focus Wireless and KongZhong's reputable wireless Internet portal, kong.net. We expect the strategic alliance to help generate a significant portion of our mobile advertising revenues over the next two years.

Looking forward, our target for the mobile advertising revenues in 2008 is between $2 million to $3 million. We are confident about the future of our wireless Internet business, with our partnerships with NBA, MSN, Opera, Focus Wireless, et cetera. We are making our best efforts to increase our brand awareness, traffic, and mobile advertising revenue.

To summarize, although we are facing continuous challenges in WVAS, KongZhong's management believes that we will have a better WVAS business in 2008. Our investment in the 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, we will open the line for questions and answers, please.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line Andy Patel with Visions Investments.

Andy Patel - Visions Investments

My question is the revenue that is generated from the wireless was about $230,000 while you have spent almost like $3 million in advertising. How do you justify this?

Sam Sun

Hello, Operator?

Operator

Hello, sir? Can you hear me?

Andy Patel - Visions Investments

Yes, I just asked a question. My question is on the wireless, you spent $3 million with a revenue of $250,000, with a net loss of almost $2.8 million. How do you justify this? Hello?

Sam Sun

Hello, Operator?

Operator

Sir, can you hear me?

Andy Patel - Visions Investments

Yeah, I just --

Sam Sun

Yeah, I can hear you. Please open the line for Q&A, please.

Operator

Sir, you already have a question being asked.

Sam Sun

I haven’t heard anything.

Operator

Andy, please re-ask your question.

Andy Patel - Visions Investments

Okay, my question is for the wireless side, you have spent almost $3 million with a net revenue of $280,000, with a net loss of almost $2.7 million. How do you justify that?

Sam Sun

Well, we believe the wireless Internet strategy is the right strategy for KongZhong to achieve long-term future growth. That’s the strategy KongZhong has taken, so in Q4, since we officially started the NBA wireless -- the official NBA wireless website, so we spent more marketing and advertising efforts on that. That’s the reason the Q4 spending on the wireless Internet business is higher than Q3 and previous quarters.

And actually, in the beginning of 2007, we already planned to spend $10 million to $15 million in 2007, a similar level as we plan today for 2008. So for the whole year 2007, we spent $10.64 million relating to our wireless Internet site, which is consistent with what we planned at the beginning of 2007.

Nick Yang

This is Nick. I am the President of the company. There is a little more I want to add. If you look at the Internet portal today, the PC Internet portal today, whether it’s Yahoo! or whether it’s Sina or Sohu in China, they have lost more 50 or in some cases more than $100 million in net loss before they turn profit. And right now, if you look at their profit number of Yahoo!, of course, it’s huge off the advertising business on the PC Internet. And if you look at Sina’s financial numbers, they are making millions and tens of millions of dollars off of the PC Internet advertising business.

So in the media business model, you have to invest before you turn profit and once you do, you have the momentum to continually gain profit from this business. So right now, we are in the investment stage.

Operator

Your next question comes from the line of Ming Zhao with SIG. Please proceed.

C. Ming Zhao - Susquehanna Financial Group

Good morning, guys. A question on the cooperation with Focus Media; can you give us some details on how are you going to work with them and for the economics between you and Focus Media for providing wireless advertising?

Sam Sun

Good evening. About the cooperation with Focus Wireless, it’s -- I think they principally -- Focus Wireless has a very strong sales force and we already have a pretty strong reputable wireless Internet set, Kong.net, so both parties are going to put the strongest resources we have together in order to boost the wireless Internet and mobile advertising business.

The cooperation is at this stage is a two-year cooperation and we believe from now on about at least 30% to 40% of our mobile advertising revenue will come from the cooperation with Focus Wireless.

C. Ming Zhao - Susquehanna Financial Group

Okay, so is this like they are providing some advertising technologies and then providing some of the WAP-based advertising, and then you are going to -- [inaudible] based on [inaudible] to you guys?

Sam Sun

Could you repeat that? I don’t think we heard the question. Sorry, could you repeat that? The static on the line is just --

C. Ming Zhao - Susquehanna Financial Group

Sure. The question is in terms of the partnership with Focus Media, do they provide the [inaudible] and other technologies for you guys, and then provide the sales people to sell your inventory, and then you guys share revenue together?

Sam Sun

Actually, the cooperation is a distribution partnership, meaning that Focus Media, Focus wireless, in this case, recognizes the value of the KongZhong Kong.net assets, so they believe that they can form a very good sales force for KongZhong. So we want to work together in the future, sales [alliances] together, so they will sell our advertising inventory, our WAP advertising inventory for us and we’ll get revenue sharing from that.

In that case, it’s not a relationship which they take all of the revenue, sales revenue from the Kong.net business. It’s that we still have our own sales force, which I have in the company. So we are going to work together selling the KongZhong inventory.

And I think in the next two years, the KongZhong sales team will learn a lot from the Focus Media sales team because, of course, they have a very good, very strong sales team. And we believe that we can have significant improvements in the advertising business based on this cooperation. I think it’s going to be win-win for everybody.

C. Ming Zhao - Susquehanna Financial Group

Okay, great. Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Michael Olson with Piper Jaffray. Please proceed.

Michael Olson - Piper Jaffray

Good morning, everybody. I just have one quick question, most of my other questions have been answered, but when you look at the gross margins for this quarter, it looks like it was around 48% for the December quarter and just looking into ’08, is there any guidance you can give us as far as what the gross margin should look like in ’08? If not an exact number, kind of what the trend should be? Thank you very much.

Sam Sun

Well, in terms of the gross margin, we think looking into Q1 of ’08, the gross margin should be similar or slightly increased compared to Q4 2007. The main reason is, as I already mentioned, that in Q407 our IVR revenue increased a lot but generally speaking, IVR revenue has a lower margin compared to other types of revenues. So in Q1 2008, we already shifted our focus from increasing IVR revenue to increasing high margin revenue, such as WAP revenue, SMS revenue, and MMS revenue. So we don’t expect for Q1 2008, although we guided a higher revenue compared to Q4 2008, compared to Q4 2007, we actually don’t expect any revenue growth in the IVR revenue side. We actually expect revenue growth from the other revenue line, so that our gross margin can stabilize or even improve in Q1 2008.

Michael Olson - Piper Jaffray

Okay, that’s really helpful. So do you think that that ability will continue in the gross margin throughout the remainder of the year? Do you think there is a chance that the gross margin for the full year could be potentially in the -- above 50%, or is that too aggressive?

Sam Sun

Well, we hope we can maintain this business model throughout the whole year 2008, because this model is a healthy business model.

Michael Olson - Piper Jaffray

Okay. Thanks very much.

Operator

(Operator Instructions) We have a question from the line of Sam Lee with [Primarius] Capital. Please proceed.

Sam Lee - Primarius Capital

Good evening, good morning. I have a couple of questions. Can you describe, as much as you can, you mentioned that the -- it’s a continuing challenging environment for the WVAS environment. Can you talk about that a little more? Has that -- say in the last couple of years, has it been better or just different, given the environmental and regulatory environment, where they have cleaned up a lot of the bad business practices and a lot of the smaller players have left the market, leaving some of the survivors like yourself? Can you describe what that environment has been like? Has it been better or has it been worse and what kinds of challenges are you seeing?

Yunfan Zhou

I think first of all, I think the challenging environment basically comes from the following sides; first of all, it is regulatory policies, because there have been new regulatory policies introduced by China Mobile and other operators from time to time. In last Q4, it has been pretty smooth in the regulatory environment. We didn’t have any big hits of revenue from any business line in the last Q4.

However, what I mean by challenging in the future is that it is pretty hard to predict what the operators, what new policies they will launch in the future, so that is one thing. And this has been quite the case for the past two or three years -- the regulatory environment is basically made by the operators and we don’t have much influence on that. And also the Ministry of Information Industry.

And secondly, there are a lot of rumors about the possible reform and reorganization of the Chinese telecom operators and even the Ministry of Information Industry. Right now, we don’t have any confirmed news. However, this may impact our business. We believe there could be a positive side from this reform of the Chinese telecom operators to our revenues. However, it is kind of too early to say that.

Based on the operational side, I think we have been pretty smooth internally. We are making a lot of efforts to promote our services for all the different four operators and we have seen a pretty good growth of our IVR business in Q4 and we do expect to have growth for other business lines in Q1 as well.

So I think basically we are making our best efforts and the challenging side basically comes from the outside factors.

Sam Lee - Primarius Capital

Okay, very good. I’ve got one other follow-up, kind of a -- just administrative; any update on investor meetings going forward, as far as anything you are going to do in China or in the U.S. in the next quarter? Are you presenting at any conferences or coming to the U.S. to do any road shows?

Yunfan Zhou

Actually, I am going to attend two investor conferences next week. One in Shanghai, organized by Piper Jaffray; the other one in Beijing by Goldman Sachs.

Sam Lee - Primarius Capital

Okay, and how about in the U.S.? Anything in the U.S.?

Yunfan Zhou

No specific plans at this stage.

Sam Lee - Primarius Capital

Okay, very good. Thanks a lot.

Operator

Your next question comes from the line of Stanley Wong with [Mobile Wireless]. Please proceed.

Stanley Wong - Mobile Wireless

Good morning and congratulations on the earnings. My question is first quickly, very specific about the mobile games. So what do you guys see the trend in the mobile games in China and what is your revenue projection for this year or next quarter from the mobile games?

Nick Yang

I think mobile games is -- as we have seen before in the past few years has been mostly casual games and mostly single download games. And right now, we are seeing the trend that the online games, especially in the online MMORPGs or the online casual games start to take growth in this area. This is what I believe will happen. It will be the major trend of the mobile game business in China, is that the trend will be from single download games it will migrate toward the network games. As the network gets faster, as the network rates get cheaper, and as more and more operators get into the mobile operation business, I think mobile games will take a very significant growth in the future. That’s my belief what the trend will be.

And we have seen very good progress of our mobile games. We have a mobile game called -- in Chinese the name is called Tian Jie. I don’t know if we have an official English -- Reincarnation is the English name for this game.

It is taking a very sticky user base because [inaudible] is a player in our mobile game and we have seen a very strong traction of our mobile game, because it is a major MMORPG work.

So I think in the future that as this experience of operating mobile online games, I think it will be a very strong advantage for KongZhong in the future in the mobile game business.

Stanley Wong - Mobile Wireless

So did you see any increase from the last year, the players -- basically what kind of data do you have from the mobile game player increase, or what is the rate you see?

Nick Yang

What I see is the trend is for users who migrate from a single download games to the mobile online games. I definitely see this transition. Secondly is that the increases in the mobile handset capabilities has been a very good plus for this industry, is that because the memory gets cheaper, the CPUs get cheaper, so you can have faster phones and bigger memories for cheaper prices, so a lot of the players can afford these phones with the capabilities to play.

Right now, currently we have over 500,000 registered users for Tian Jie, the Reincarnation. And as we can see from our traffic numbers, is that these users are very, very sticky. They are more -- I believe they are a lot stickier than our portal site, and I think in the future that this will be a -- I think it will be a major part of our revenue and profit for our company, mobile online games. So that’s what --

Stanley Wong - Mobile Wireless

Okay, thank you. How do you monetize the mobile, the online mobile games?

Nick Yang

Right now, what we have is that playing the mobile online game is free, so you can play it for free, just like [Jun Tu] or many other online games in China. First of all, you play, you can play for free but you buy the swords, the weapons, the armors, the medicines. There’s lots of ways you can charge the users to play better, so you separate the people who want to play for free and the people who are willing to pay a lot of money to get a much better user experience.

So right now, this type of game operation I believe is the mainstream way to operate games in China. And what we have seen is that on the mobile phones, right now if you play our game, Reincarnation, there’s many ways you can pay us. You can pay us via SMS, you can pay us via payment cards. Right now we have worked with many payment companies. You can pay us even with China Mobile’s prepaid cards. There’s many ways you can pay us. There’s just -- if you go on any shop in China to buy these game cards, you can pay us.

So the payment is not a problem. And also, playing games doesn’t cost a lot in terms of traffic because the amount of bytes you send across the network is very small. The game is -- so you have downloaded a [big game client] into your phone but when you play, you don’t transmit a lot of data.

The rough analysis I have for playing the game Reincarnation is that for every hour of play, you only transmit 500K, 500 kilobytes of data for an hour. So even with any plan, a user pays roughly only RMB20 a month in terms of traffic charges by China Mobile and you can play Tian Jie, you can play Reincarnation for free, only pay RMB20 for the traffic charges. So it’s not -- it’s really not -- it’s really economical for players to play. It’s not a big charge for them.

Stanley Wong - Mobile Wireless

Okay, so do you have any game publishers already you guys basically work with or do you guys develop all the online games by yourself?

Nick Yang

We develop them in-house. The company we have acquired a few years ago, Tianjin Mammoth, is we believe is the very, very top mobile game developer in China. If you talk around the industry, you know that Mammoth is a pretty strong team and very strong brand in mobile games. So our strategy is to develop our own major online games in-house. And also, we want to have the operational experience in-house as well, because we believe this experience in developing any operations of the major mobile online games will be an advantage for us in the future when this market takes off, so we are not reliant on outside companies, either [for technology or operations].

Stanley Wong - Mobile Wireless

Okay. Thank you.

Operator

Your next question comes as a follow-up from the line of Andy Patel with Visions Investments. Please proceed.

Andy Patel - Visions Investments

My next -- I wanted to get a guidance from you on more on where the company is heading. For the last four quarters compared to four quarters prior to that, your revenue has gone down. You are spending a lot of money on advertising and the gaming industry, you are not making money on. I mean, how do you see this company growing with this type of set-up in the next few years?

Sam Sun

If you compare our Q4 2007 revenue with that of Q4 2006, it’s decreasing but the major reason is that, as we discussed in previous quarters, we experienced the regulatory changes since the second half of 2006 and then in Q2 2007, so we were absorbing all the adverse effects of the regulatory changes quarter over quarter and we hit the bottom in Q2 or Q3 of 2007. Now Q4, we have seen a pretty healthy growth from Q3.

So this is the history and the picture of KongZhong's business. And right now, KongZhong has a couple of business lines. One of them is the WVAS business, which KongZhong started the WVAS operations as early as 2002, and it is still the major business of what KongZhong is doing today.

And so the WVAS business, as I mentioned, we hit the bottom and then we have seen a healthy growth in Q4 2007 and we expect a better WVAS business in 2008. And KongZhong is also investing into the wireless Internet business since 2006, and KongZhong believes this is the right strategy and continues such investment in 2007, and will continue this kind of investment in 2008. And we already said we spent over $10 million in 2007 and we plan to spend another $10 million to $15 million in 2008, because we believe this wireless Internet business can contribute KongZhong the future growth.

In addition to the WVAS business and wireless Internet business, KongZhong also has a sizable team to design and operate the mobile online games. We believe in this field, KongZhong is already a leading company in China in terms of the mobile online games development and mobile online games operation.

And we think our patient has been paid back since the mobile online games has some sign of taking off this year, but of course we are still conservative in this and we think the mobile online game business looks good but in 2008, it may be a little early to expect really a sizable return from mobile online games, but surely it should increase pretty fast.

Andy Patel - Visions Investments

Okay, thank you.

Operator

There are no further questions at this time.

Sam Sun

Operator, any other questions?

Operator

No, sir, there are no further questions at this time.

Sam Sun

All right. Well, thanks to everyone for calling in and we look forward to talking to you again next quarter. Thanks.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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