KongZhong Corporation's CEO Discusses Q3 2013 Results - Earnings Call Transcript

| About: KongZhong Corporation (KZ)

Kong Zhong Corporation (KONG) Q3 2013 Earnings Conference Call November 20, 2013 7:30 PM ET

Executives

Jay Kenneth Chang – Chief Financial Officer

Leilei Wang – Chairman and Chief Executive Officer

Analysts

Nick Ning – 86Research Ltd.

[Vivian Mau] – [Woodberry Management]

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2013 KongZhong Corp. Earnings Conference Call.

(Operator Instructions). I must advise you that this conference is being recorded today, Thursday, the 21st of November, 2013.

I would now like to hand the conference over to your host, Mr. Jay Chang, Chief Financial Officer. Thank you. Please go ahead.

Jay Kenneth 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.

I will first review our 3Q results before handing over the call to our CEO, Mr. Wang Leilei.

Total revenues for the third quarter were $44.08 million compared to the guidance range of $43 million to $44 million, and representing a 1.2% increase from the second quarter. As we continue to transition our business to become a cross-platform digital entertainment company, mobile games made up 10.7% of total revenues and internet games contributed 48.5% of total revenues, with overall game revenues making up 59.1%. Total gross profit was $19.1 million in the third quarter compared to our guidance range of $19 million to $20 million, representing a 7% increase from the second quarter.

Net loss in the third quarter was $2.68 million, which included a $1.56 million impairment loss on our tangible assets and a $2 million impairment loss on long-term investments. Excluding these impairment losses, net income in the third quarter was $0.88 million, in line with our guidance range of $0.5 million to $1.5 million. Basic net loss per ADS was $0.06.

Non-GAAP net income was $1.5 million, in line with our guidance range of $1.5 million to $2.5 million. Non-GAAP diluted net income per ADS was $0.03. At the end of the third quarter, the company had $205 million in cash and cash equivalents, term deposits, held to maturity securities and restricted cash, or roughly $4.71 per ADS -- per ADS.

Turning to our business units, internet games. Internet game revenues in the third quarter were $21.37 million, slightly increased from the same period last year and a decrease of 9.5% from the second quarter. Domestic net game revenues were $20.78 million, a 10.3% decrease in the second quarter, but a 2.2% increase from the same period last year. Domestic net game revenues is primarily revenues from World of Tanks. Domestic net game revenue declined sequentially due to seasonal factors and a pause in major content updates which are not expected until the fourth quarter.

Overseas net game revenues were $0.59 million, a 27.6% increase from the second quarter but a 52% decrease from the same period last year. For the third quarter three-month period, Mainland Chinese online game operations achieved average concurrent users of 399,000, aggregated paying accounts of 763,000, with a quarterly average revenue per user or ARPU of RMB168.

Internet gross profit in the third quarter was $10.33 million, an 8% increase from the same period of last year but a 7.5% decrease from 2Q. 3Q internet game gross margins were 48.3% compared to 44.4% in the same period last year and 47.3% in the second quarter.

Turning to mobile games, mobile game revenues in the third quarter were $4.7 million, a 10.6% decrease from the same period of last year but a 25.8% increase from the second quarter. Feature phone mobile games in the third quarter were $3.21 million compared to $2.85 million in the second quarter or 12.7% quarter-over-quarter increase. However, our mobile operator partners continue to implement strict operating policies and continue to de-emphasize the marketing of feature phone mobile games.

Smartphone mobile games in the third quarter were $1.49 million, a 68% increase from 2Q and now represent 31.8% of total mobile game revenues. We expect to launch a number of new smartphone games in the fourth quarter period and first quarter period next year. For the third quarter three-month period, smartphone game operation achieved average monthly active users of 1.03 million users, aggregated paying accounts of 46,000, with a quarterly average revenue per user of RMB198. We also achieved 1.2 million new registered users in September for our smartphone game business as the bulk of our 3Q marketing expenses for smartphone game users were mainly towards the end of the third quarter.

Mobile game gross profit in the third quarter was $2.3 million, a 53% increase from 2Q. 3Q, and as well as mobile game gross margin, were 49.1% in the third quarter compared to 48% in the same period last year and 40.4% in 2Q.

Now turning to WVAS. WVAS in the third quarter was $18.01 million, a 22% decrease from the same period last year but an 11% increase from 2Q. The WVAS operating environment stabilized compared to prior periods, but we continue to expect WVAS operating environment to remain difficult for the remainder of 2013. WVAS gross profit was $6.46 million, a 24.8% increase from 2Q, while gross margins were 35.9% compared to 31.9% in the second quarter.

Total operating expenses in the third quarter were $19.96 million compared to $13.27 million in the second quarter. Product development expenses were $6.99 million compared to $6.46 million in the second quarter. The increase in product development expenses was due to additional resources and investments made towards our 2014 game pipeline including Guild Wars 2 China.

Sales and marketing expenses in the third quarter were $10.94 million compared to $4.64 million in the second quarter. The sharp increase in sales and marketing expense was primarily in three main areas: user acquisition for our new smartphone games; secondly, new user acquisition and increased branding for World of Tanks; and thirdly, raising the overall branding of KongZhong as a leading game publisher in China.

G&A expenses in the third quarter were $2 million compared to $2.17 million in the second quarter, while our total headcount increased in the third quarter to 1,166 staff compared to 1,140 staff at the end of 2Q.

Now turning to our fourth quarter guidance. For the period ending December 31st, 2013, we expect total revenue in the fourth quarter to be within the range of $41 million to $42 million, with business unit revenue at the midpoint to consist roughly of WVAS revenues of $13 million, feature phone mobile game revenue of $2 million, smartphone game revenues of $3.5 million, and internet game revenues of $23 million.

Our 4Q WVAS guidance reflects the typical seasonal low at the end of each year as operator policies are more tightly implemented. However, we do expect 2014 WVAS revenues to be relatively stable compared to 2013.

In addition, the company expects total gross profit to be within the range of $20 million to $21 million, net profit to be $8 million to $9 million, and non-GAAP net profit is expected to be $9 million to $10 million.

Now I'd like to turn the call over to our CEO, Mr. Wang Leilei.

Leilei Wang

Thanks, Jay. Good morning and good evening everyone. First of all, thank you for everyone's continued support and care for KongZhong Corporation.

The third quarter is a very important one for KongZhong. Just like what Jay had said, we have greatly increased human [bandwidth] for MMO internet games and smartphone games, especially strengthening smartphone game products, company brand and World of Tank sales and marketing for new player, user acquisition, so that these new players can provide the company continued strong cash flow for the next few quarters.

Let's talk about internet games. Just like the third quarter of last year, due to seasonal factors like school exams and holidays, in addition to lacking major content updates, World of Tanks revenue has decreased slightly compared to the last quarter. But it's still higher the same period year over year.

In the fourth quarter we have three important content updates, including new German and Soviet series tanks, new seven versus seven team mode, and a brand-new series of Japanese tanks. We believe this will not only provide users substantial new content and improve [indiscernible] but also strong push for revenue and popularity. As the company's major project Guild Wars 2 have finished its second closed beta test and has been approved by the General Administration of Press and Publications audit, according to the test feedback, KongZhong continues to improve Chinese new user experience on the localized Chinese content. We believe we will find an opportunity to launch open beta sometime in first half of 2014.

Similarly, World of Warplanes is undergoing tests and localization work. And very soon it will also receive GAPP approval and eventually launch open beta in the first half of next year. Moreover, in the third quarter we have licensed two new foreign games, Blitzkrieg 3 and Auto Club Revolution.

Blitzkrieg 3 is a core product of Nival, a well-established Russian game producer and publisher. It is a World War II background real-time strategy activity game. Its predecessor single-player games have huge user base around the world and in China. Our goal is to push Blitzkrieg 3 towards the market in the second half of 2014. We believe using KongZhong's large user base of [military tanks] and Blitzkrieg, innovative core game play, it will surely be very successful in China.

Auto Club Revolution was developed by Eutech, a studio with over 25 years of [raising] game experience and realistic racing simulation game. It has partnered with over 50 car manufacturers and 100% [indiscernible] each vehicle's external appearance on the features. Facing China's huge user base of internet gamers and car fans, we believe it will achieve success in China. We expect to launch Auto Club Revolution open beta in the second half of 2014.

Okay, let's go to the smartphone business. Smartphone game division is an important division for KongZhong, with focus on sales development and sales and marketing. In the third quarter we have heavily marketed Pocket Fort and High Load and conducted tests with [indicated] users for the Legend of Three Kingdom Heroes [indiscernible] Three Kingdoms. We can say these four mobile MMO games have all -- have good new user acquisition ability, user retention, payer penetration and ARPU.

Also in the third quarter we have licensed KuiBa, an award-winning and very popular Chinese animated feature film from the famous Vassoon Animation Studios. We plan to develop mobile MMO games, internet games using the KuiBa IP. And also the content we will continue to license overseas and domestic IP for game development. Moreover, we saw smartphone game revenue has increased over 60% in the third quarter compared with Q2. And also we believe it will again increase over 60% in the fourth quarter compared to the third quarter as well.

In addition, we continue to expand overseas markets and cooperate with domestic and foreign mobile platforms. Also we are strengthening our capability to localize our games for foreign markets, including supporting some community features like Facebook, Twitter and YouTube social network, and adopting foreign content. Within the fourth quarter we will start introducing our [situation] of overseas markets and domestic platform cooperation to everyone.

In conclusion, we expect smartphone game markets will have substantial growth in the next three to five years, even overtaking internet game market. Through our strong product R&D and marketing and globalization abilities, we can expand our market in China, Southeast Asia, North America and Europe and contribute as much revenue and net income as KongZhong's internet game business.

For WVAS business, due to the decline of feature phone users and impact of changing mobile carrier regulations, its revenue continues to slightly -- decrease slightly. Just what we have promised before, we will focus revenue from game business and decrease relying on revenue share from mobile carriers in China. At the same time, we use our good partnership with existing content manufacturers and channels and mobile carriers game platform [indiscernible] to support and develop smartphone game business with a focus especially on China's low-cost handset manufacturers and the tier 2 and 3 cities consumers. We believe these users and handset manufacturers will become smartphone essential channels.

Operator, now I'd like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions).

You have your first question from the line of Nick Ning from 86Research. Please go ahead.

Nick Ning – 86Research Ltd.

Hi. Thanks for taking my questions. So my first question is on your third quarter mobile game revenue, it seems a little bit softer than your original expectations. So could you give us some color on that and are we satisfied with the performance of our smartphone games so far? Thank you.

Jay Kenneth Chang

Nick, your voice was muddled. I don’t know, if you could repeat the question please.

Nick Ning – 86Research Ltd.

Sorry. My first question is that your mobile game revenue is softer than your original expectation. So could you give us some color on that? And are we satisfied with the performance of our smartphone games so far? Thank you.

Jay Kenneth Chang

We're actually very satisfied with the performance so far. As you know, in game development, we want to make sure we get the game right versus maybe relative to one or two months difference kind of to market. As we talked about in previous conference calls, you know, we a year ago made a decision to really beef up and spend more time on developing higher quality, differentiated hard-core mobile MMO games. And now the year of development of that strategy is now starting to come to market. And as Leilei mentioned on his remarks, we do expect significant growth in the fourth quarter of this period which end -- as well as next year as we start deploying the four games we talked about on the call as well as additional games in our roadmap. So we're very excited about the potential for our smartphone games.

Nick Ning – 86Research Ltd.

Okay, thank you. And second question is about your WVAS revenue. This business line has been growing for the third consecutive quarter since fourth quarter last year. So -- and this quarter -- fourth -- third quarter is stronger than KongZhong had expected. So where does this upside came from?

Jay Kenneth Chang

The key thing for WVAS is really not look so much at the top line, you look at the gross profit line. And that's been more relatively stable compared to the I think higher volatility on the top line just given the different revenue shares for different channels for all the different operator partnerships we have.

I think the key thing to note is there is a pretty substantial decline in the fourth quarter we're expecting for WVAS, but the decline in the gross profit is not as sharp. And more importantly, the visibility we see today is WVAS next year should be relatively stable compared to 2013. And the fourth quarter reflects a similar kind of seasonal low in the fourth quarter of 2012.

Nick Ning – 86Research Ltd.

Okay, that's very helpful. And for your first quarter, internet gaming revenue, we expect it to grow a little bit. So what's the driver for your first quarter internet gaming revenue then? Is this more from your new games or it is mostly driven by World of Tanks?

Jay Kenneth Chang

If you're talking about our fourth quarter guidance, we haven't provided first quarter 2014 guidance yet, but for our fourth quarter 2013 guidance, yes, the increase is from World of Tanks. As we discussed, we spent quite a significant amount of marketing resources in the third quarter to market, in addition to smartphone games, World of Tanks. And with the new seven versus seven team mode and additional new tank content, we currently see an increased demand and usage and even DAUs, MAUs in World of Tanks compared to the third quarter which as we mentioned before we believe is always a seasonal low.

Nick Ning – 86Research Ltd.

Okay. That's very helpful. Then also, can we also take a look at our World of Tanks trend in the longer time span, say, is it too aggressive for us to assume that in 2014 and 2015 this game can still grow by double digit on a year-over-year basis? Thank you.

Jay Kenneth Chang

We believe that there's still definitely potential for World of Tanks to grow over the next two to three years. There's a number of important things we're doing to solidify the mid-core of the game, including reintroducing Clan Wars to help better [midterm] retention in the game as well as the new seven versus seven mode which I believe was only released on November 5th in China, has a better attach point to internet [indiscernible] users which we think we can have room to improve.

In addition to that, we're working -- continue to be working very closely with Wargaming to deliver more localized content for the China market. And we are still working very closely and hard to eventually launch World of Warplanes and eventually World of Warships. And we think that those three games combined with Clan Wars has a lot of differentiation in the marketplace. So we're still very positive on the outlook for all of the Wargaming games in addition to World of Tanks.

Nick Ning – 86Research Ltd.

Thank you. And then on your Guild Wars 2, your partner NCsoft on their earnings call, that game might be delayed a little bit. And he said they will start the launch of testing in the first half next year if I hear him right. So just wonder what caused the delay and is there any update on Guild Wars 2's commercial launch schedule? Thank you.

Jay Kenneth Chang

Yes. So we mentioned that we hope there's a chance to open beta in the first half of next year. But I think that the core strategy that we're taking with ArenaNet and NCsoft is to really evaluate the next closed beta test and see how that performed, before we decide an official commercial launch date.

We just did perform the closed beta two test which -- and the retention and the user feedback was very, very positive. But we, because we built this game as very special and very unique in the China market, we wanted -- we're working very closely with ArenaNet to localize it properly, including some of the new user tutorial to make sure that we do this game properly for the China market.

Nick Ning – 86Research Ltd.

Okay. My last question is on your expenses for next year. So with several interesting titles including this Guild Wars 2 to be -- to start launch of testing next year, should we expect an increase in sales and marketing for 2014, especially in the first half?

Jay Kenneth Chang

As I mentioned, for any launch of the game, we're going to base it on, you know, the most recent closed beta test, to understand the business model, the retention rate, the ARPU, the paying user ratio, so on and so forth. So any spend that we do will be based on some of those operating metrics which we'll have in hand.

As we haven't released or talked about any of our first half or second half specific commercialization dates, I can't give you any specifics on specific -- in terms of marketing. However, in the third quarter, what we wanted to show is that we're willing to spend our marketing for good games in the marketplace. And we believe World of Warplanes, Guild Wars 2, Blitzkrieg 3, ACR are good games, [Hokken], are good games that we believe we would spend significantly in the marketplace, but only after we have good current data from any closed beta test.

Nick Ning – 86Research Ltd.

Okay. That's all my questions. Thank you, Jay and Leilei.

Jay Kenneth Chang

Thank you.

Operator

Your next question comes from the line of [Vivian Mau] from [Woodberry Management]. Please go ahead and ask your questions.

[Vivian Mau] – [Woodberry Management]

Hi. Thanks for taking my questions. I have three questions here. Number one is that you mentioned that there was a pause in game content update in the third quarter. So wonder whether this problem had been fully solved. So that's the first question.

Jay Kenneth Chang

Yes. As we mentioned, in the fourth quarter there's a number of new and exciting content update to World of Tanks, including the seven versus seven mode, as well as other, I think the German tank three, and eventually the, hopefully towards the end of this year or early next year, the Japanese tank three. So yes, there's definitely a huge amount of content coming in the fourth quarter period, but they were not released in the third quarter.

[Vivian Mau] – [Woodberry Management]

Okay, thanks. And the second question is regarding the second closed beta test of Guild Wars 2. Could management share any number with us, like for example how many servers were used during the second half?

Jay Kenneth Chang

So the second test was a very, very small-scale test, much less than 10,000 total accounts. So I think any numbers that we share are not really going to be representative of the future potential of the game as it addresses hopefully more mass market users. So anything I give you right now, I don't think it's that representative.

But one thing I would tell you though, based on the users that did come to the game, A, we do feel that there are probably more hard-core fans of Guild Wars 2. The retention rate were higher than I think most games that have gone through beta test in the past three years though. So that probably is as much as I can [probably say] right now.

[Vivian Mau] – [Woodberry Management]

Okay. So, and then shall we expect like much larger scale when you launch the open beta test next year?

Jay Kenneth Chang

I think as I mentioned, you know, we do plan to do hopefully at least one more post beta test with Guild Wars 2. Based on the results of that, then we'll decide any commercialization or open beta dates and testing scale.

[Vivian Mau] – [Woodberry Management]

Okay. Thanks. And my last question is a follow-up to the expense guidance. So given that the sales and marketing expense surged in the third quarter, I understand that's for branding efforts. So just want get a rough guidance on what should we expect for the fourth quarter and next year, in particular how much would you like to spend for the marketing of Guild Wars 2 and for the marketing of smartphone games.

Jay Kenneth Chang

So for the fourth quarter we expect sales and marketing and overall to go back similar to 1Q, 2Q 2013 level. I think that if you work back the numbers, that's implied in our non-GAAP or GAAP net profit guidance.

For 2014 we do have a lot of new and exciting PC games which we do want to launch to the market aggressively based on closed beta test feedback. And we would expect to spend a significant amount on a game like Guild Wars 2 based on the closed beta test feedback.

[Vivian Mau] – [Woodberry Management]

Okay, that's helpful. Thank you.

Jay Kenneth Chang

Okay. Thank you.

Operator

(Operator Instructions).

There are no further questions from the phone lines at this time. I'll now hand back over to your host today. Please continue.

Jay Kenneth Chang

Thank you for your continued interest in KongZhong and we look forward to hearing from you and meeting you in the future. Thank you very much.

Operator

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

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