KongZhong Corporation CEO Discusses Q1 2011 Results - Earnings Call Transcript

| About: KongZhong Corporation (KZ)
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KongZhong Corporation (KONG) Q1 2011 Earnings Call May 25, 2011 9:30 PM ET


Jay Chang – CFO

Wang Leilei – CEO


Adam Krejcik – ROTH Capital Partners LLC


Good day, ladies and gentlemen, and welcome to the Q1 2011 KongZhong Corp earnings conference call. My name is Walter, and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Jay Chang, Chief Financial Officer; and Wang Lei, Chief Executive Officer.

Jay Chang

Thank you, operator. This conference call may contain forward-looking statements. Although such statements are based on our own information and information from other sources we believe to be reliable, you should not place undue reliance on them. For additional discussions 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 continued interest in KongZhong. I’ll first go over our 1Q results, before handing over the call to our CEO, Mr. Wang Leilei.

Total revenues for the first quarter of 2011 were $40.1 million, an 11% sequential increase, but a 1% decrease from the same period last year.

As we continue to transition our business to become a cross-platform digital entertainment company, mobile games made up 31% of total revenues, Internet games contributed 16% and combined, mobile and Internet games made up nearly half of 1Q total revenues.

Total gross profit was $16.5 million, compared to $16 million in 4Q, while gross margins declined to 41% compared to 44% in 4Q. Total operating expenses, we have $11.4 million, a decrease from $19.8 million in 4Q and $14 million in 1Q of 2010.

Net loss in 1Q was $0.46 million; however, this included a charge related to a change in the fair value of the Dacheng contingent consideration of roughly $3.7 million. Excluding this, net income in 1Q was $3.2 million, a 3% increase compared to $3.17 million in 1Q of the same period last year.

Basic net loss per ADS was $0.01 based on 37.6 million ADS. Non-GAAP net income was $6.9 million, in line with the company’s guidance range of $6 million to $7 million, while non-GAAP diluted net income per ADS was $0.17.

As of 1Q, the company had $118.3 million cash and cash equivalents or $3.1 per basic ADS in cash and cash equivalents. This included a $9.3 million payment for the early extinguishment of convertible note issued to – a partial extinguishment of the convertible note issued to Nokia Growth Partners, a $14.6 million payment for the cash portion related to the final payment for Dacheng and a $21.2 million investment in RENMINIBI denominated short-term loan to a third party. It’s including the value of this RENMINIBI third-party loan which was made totally for the purpose of treasury management.

Total cash and third-party loans amounted to $140 million exiting the first quarter of 2011.

Now, I would like turn to each business unit’s financial performance in the mobile games, Internet games, and WVAS. Total mobile game revenues in 1Q were $12.3 million, a 29% increase from the same period last year but a 4% decrease from 4Q.

Revenues from downloadable mobile games were $11.69, representing a 31% increase from the same period last year, but a decrease of 5% from 4Q.

In 1Q, revenues from monthly mobile game subscriptions in partnership with China Mobile

were stable compared to 4Q, but one-time download revenues were negatively impacted by changes in China Mobile's marketing policies of mobile games on the Monternet portal.

In 1Q, average monthly mobile game subscribers were maintained at roughly 2 million per month. In 1Q, mobile games underperformed our expectations as China Mobile continued to adjust their mobile game marketing strategies and we see these difficulties continuing into 2Q. However, the company continues to invest in the development of mobile games, including iPhone and the Android platform and expect to accelerate our development of these platforms in the coming quarters as the market develops.

Revenues from online mobile games were $0.6 million, 11% increase from the same period last year and a 30% increase from 4Q. Online mobile games benefited sequentially due to seasonal promotions of our online mobile games.

Turning to Internet Games, Internet Games revenues were $6.5 million in 1Q, a 10% increase from 4Q and a 53.3% increase compared to 1Q 2010. Net Game revenues outperformed our expectations due to the strong initial performance of WoT or World of Tanks, which was launched commercially on March 15th.

Domestic Internet game revenues were $5 million, a 38% increase from 4Q and a 27% increase from 1Q due to the successful commercial launch of WoT.

Overseas Internet game revenues were $1.52 million, a 34% decrease from 4Q, but a

384% increase from 1Q10. Total overseas revenues as a percentage of total Net game revenues in 1Q were 23% compared to 39% in 4Q.

For the 1Q, domestic mainland Chinese online game operations achieved average concurrent users or ACUs, 145,000 compared to 81,000 in 4Q and aggregate paying accounts of 218,000 with quarterly ARPU of RENMINIBI 150,000 compared to 120,000 APAs in 4Q with ARPU of 200. WoT operational metrics for ACUs and APAs were only recorded from March 2011.

However, please note 1Q ACUs are not a full three-month average, as WoT was only launched in March. If using a full-three month average for WoT which would have assumed 0 ACUs in January and February, then first quarter ACUs would have been roughly flat compared to the 4Q levels.

Now turning to WVAS, WVAS revenues in the first quarter of 2011 were $20.4 million, a 23% increase from 4Q, but a 21% decrease from the same period last year. WVAS revenues rebounded from depressed 4Q levels due to a more stabilized WVAS operating environment and growth in our mobile literature business. In 1Q, 2G revenues represented 79% of total WVAS revenues, while 2.5G services made up 21%.

Turning to operating expenses, operating expenses in 1Q were $11.4 million, a decrease from $19.8 million in 4Q and $14 million in 1Q.

Product development expenses in the first quarter were $3.61 million compared to $4.77 million in 4Q or a 24% decrease. Product development headcount remained roughly the same in 1Q with the decrease in expenses mainly related to a decrease in intangibles associated with our acquisition of Dacheng after the 2010 year-end final consideration payment adjustments were made based on Dacheng's actual full-year performance and future expected performance.

Sales and marketing expenses in 1Q were $4.83 million compared to $4.13 million in 4Q and

$4.41 million in the same period last year. The increase in sales and marketing was driven by activities related to the commercial launch of WoT and we expect to continue to make continued marketing investments in WoT and our other new games in the coming quarters.

G&A in 1Q was $2.94 million compared to $2.13 million in 4Q and $2.8 million in the same period last year. We would expect G&A to be maintained at roughly first quarter – 1Q levels in the coming period.

Operating profit for the first quarter was $5.16 million with operating margins of 12.9% compared to operating loss $3.80 million in 4Q and operating profit of $3.7 million in the first quarter of 2010. The company's total headcount remained stable at 1,037 people compared to 1,050 people at the end of 4Q.

Now turning to our revised and total consideration and final payment for Dacheng, on March 23rd 2011, the company finalized our acquisition of Dacheng when the US GAAP audited 2010 full year net profit of $8.03 million was confirmed. Based on this net profit figure, the final consideration was determined to consist of $14.6 million in cash and $25.6 million in ordinary shares of the company.

Based on the terms of our agreement, we issued roughly 3.1 million ADS, however, due to the differences of the May 23rd price and the calculated price of the number of shares issued, there was a small charge related to the change in contingent consideration recorded in our 1Q P&L.

Turning our early extinguishment of the convertibles notes to Nokia, on February 25th, the company prepaid roughly 70% of the aggregate principal payment of the five-year convertible senior notes for $9.31 million in cash, plus any accrued but unpaid interest. The prepaid portion of the notes had rights to be converted into 1.33 million ADS equivalent to roughly a 3.5% of the company's total outstanding shares as of the end of 2010.

As a result, we recorded a $1.6 million non-cash charge to our 1Q earnings as a result of the premium paid to the underlying conversion price of the convertible notes.

And lastly, turning to our 2Q 2011 guidance, we expects total revenues for the second quarter of 2011 to be within the range of $41.5 million to $42.5 million, with business unit revenues at the mid-point expected to roughly consist of WVAS revenues of $20 million, mobile game revenues of $12 million and Internet Game revenues of $10 million.

We expect total gross profit to be within the range of $16 million to $17 million, total operating profit to be $4 million to $5 million, net profit to be $4 million to $5 million, and we expect non-GAAP net profit to be between $6 million to $7 million. Now, I would like to turn the call over to our CEO, Mr. Wang Leilei, to discuss our first quarter business highlights and recent business developments.

Wang Leilei

Thanks, Jay and hello, everyone. Against a stabilized WVAS environment, the KongZhong continued to generate stable non-GAAP net profit while building up future growth opportunities in our Internet gaming and the mobile gaming business.

In WVAS, while the operating environment remains difficult, we were able to show some improvement from fourth quarter gross profit levels – of these levels may be challenging,

KongZhong will strive to maintain fourth quarter gross profit levels in the coming quarters.

As we said before, KongZhong positioned WVAS business, it’s cash cow business [ph] developing mobile gaming and the Internet gaming business is very glad to see from last quarter, mobile gaming, plus Internet gaming gross profit have already exceeded WVAS business and also, we will continue to invest more on WVAS R&D for new 3G platform cloud applications.

In mobile games, we underperformed our expectations as China Mobile continued to adjust their

mobile gaming marketing strategies and we see this difficulties continue into the second quarter, however, we continue to the invest in the development of mobile games, including the iPhone and Android platform, we think is more efficient to programming our midware to convert or transfer our – most of our Java-based game to iPhone and Android-based game contents and accelerate our development of these platforms in the coming quarters as the market develops.

Now, almost all of our WVAS and mobile gaming revenue came in from 2G and 2.5G users. I believe, mobile market in China is in the transition period that from 2G to 2.5G to 3G. And also, we believe in the – well, two years, KongZhong’s wireless related revenue, for the most part, will come from the 3G users, and also, we do believe the 3G killer apps [ph] mobile gaming and the mobile reading business in the future.

KongZhong’s Internet gaming business has started – also, turning to the Internet games, KongZhong’s Internet gaming business has started from 2010 through (inaudible) focus on self-developing and operating three dimension gaming products.

On the other hand, we build up open platform to have more corporations with overseas game developer and producer to operate their game in Mainland China. We believe this strong complementary and a very good to our self-developing operations gaming business, because our developing team can get many service during the corporation and the communication with overseas partners and producers. And also, this overseas licensed game products can enrich our gaming portfolio.

On March 15th, we successfully launched World of Tanks, WoT, to the market and based on the first few months of operation, continue to believe that WoT has potential to one of the top team-based shooting game in the Mainland China. Our strategy for developing the World of Tanks has been to gradually developing our core and the loyal community for WoT in China similar to the development of the Russian market. And over the course of the next few quarters, due to the larger base of WoT players through all our promotions with Internet parties [ph] and online competition.

In terms of our game pipeline, the development of our self-developed 3D MMORPGs, Kung Fu Hero and Emofaze 3, the second in the EMFZ series, continue on track with third quarter 2011 open beta targeted for Kung Fu Hero and a late 2011 or early 2012 open beta target for EMFZ3.

To further diversify our online game portfolio, we recently announced our partnership with Gamepot of Japan to exclusively operate one of the most popular online first person shooting game in Japan, Paperman in China. Lastly, I like to address the various reports in the media regarding my personal situation. As you know, China is a country with its own laws and practices and as Chinese citizen my must stick to, adhere to those laws and practices. As a result,

As result, I’m unable to discuss any of the maters being speculated in the media at the present time.

I hope you can understand and respect the local laws and the practices in this matter; however, what I believe is more important that I have maintained and continue to execute my role as Chairman of the Board and the CEO of the KongZhong and continue to do so. Myself and my team continue to execute our strategy to become (inaudible) the company and believe our first quarter results and the second quarter guidance continue to show progress towards that. And I look forward to your questions regarding KongZhong and our future business developments.

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

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Adam Krejcik, ROTH Capital Partners. Please proceed.

Adam Krejcik – ROTH Capital Partners LLC

Yeah, hi, good morning everyone. Thanks for taking my call. Just kind of following up on this last comments Leilei, I understand the sensitive nature but any indication you can give us when you might be able to comment on this matter? Is there any type of timetable or time horizon? Obviously, it’s one of the major concerns in the market right now.

Jay Chang

I think – Adam, I think we’ve addressed that issue and that’s all we could say at this time of the current situation, so.

Adam Krejcik – ROTH Capital Partners LLC

Okay. I guess going into financials then, can you just first elaborate the loans of the third party? Can you discuss what are the terms there and just a little more detail on who that was for and what’s it related to?

Jay Chang

It’s the one year short-term security instrument defined under US capital loan to a third party. It’s really to start doing treasury management as you know in China is still closed economy. Most of our capital cash is in Renminbi, but we are seeking to take a portion of assets to seek us slightly higher yield. The instrument is roughly only one year instrument related and it’s about say 6% coupon instrument.

Adam Krejcik – ROTH Capital Partners LLC

Sorry, 6% you said?

Jay Chang


Adam Krejcik – ROTH Capital Partners LLC

Okay. Got that. And then the gross margins for your Internet online game business Q1 was I think 60%, what – your guidance for Q2, does that assume a similar type of gross margin or should we expect any major fluctuations one way or the other?

Jay Chang

No, you should expect that to go even slightly lower just because in 2Q the majority of the growth we’re seeing is from World of Tanks. But, World of Tanks is a third party and we have a revenue share with that third-party developer. And – but I think that the key thing is them to focus on the operating margin given that we don’t have any product development costs on that. In addition to that, you can expect our sales and marketing to be roughly in line with kind of the 1Q levels at least I think in the second quarter based on our guidance if you look at the operating profit guidance that we’re able to grow World of Tanks but without having to spend significant amounts below gross profit or in our sales and marketing line. So, I think for us, we’re looking at this business from a operating, profit line basis. In future quarters, as we launch Kung Fu Heros and Emofaze 3, we would expect that margin to potentially improve significantly depending on the performance games, given we don’t have revenue share. Those are self developed, but those costs are obviously in the product development side.

Wang Leilei

I would like to add to Jay. We hope our – the very important self developed game Kung Fu Heros will launch in Q3 and I think the margin rate will go back. Thanks.

Adam Krejcik – ROTH Capital Partners LLC

Okay. And then for the Internet online game revenue in Q2 guided for roughly at $10 million, just wondering can you give us a sense how of that should be from overseas?

Jay Chang

Overseas would be just over $1 million [ph] roughly.

Adam Krejcik – ROTH Capital Partners LLC

Okay. And then for mobile games slow down here and you’re seeing that trend continue in Q2. Any expectations for that queue to grow again in the second half of the year or is that fairly limited visibility?

Jay Chang

There’s definitely potential for the rest of the year. I think what just described happening is during the first quarter China Mobile faster than we expected, adjusted their marketing strategy for its Monternet, which their WAP portal for mobile games and they basically discontinued a lot of the previous a la carte mobile download type business and shuck it into the mobile subscription business, so ourselves another partner. But more importantly, the mobile game center in Jiangsu province has now actually put all the authority of mobile game promotions to each of the provinces and that transition is happening right now, which is why you’re seeing slow down in the first half of 2011. After that transition happens, we expect there is potential for it and the second half show continued growth. But we’re working with all the provinces, which takes a lot of time, lot of man effort and logistics for us to work with them. In terms of China Mobile game centers, they’re on target, they’re still expecting kind of more than 30, 40% year-over-year growth from 2010. But that’s going to be – a lot will be based on the execution and coordination by ourselves and mobile game center in all the different provinces separately something that our team is working on right now.

Wang Leilei

And also one I want to add to Jay that from the analyses from our backend mobile gaming data and the user behavior, we see more and more users like to pay subscription fees to use all the mobile gaming service. This number is growing fast and that means more and more people like to pay subscription fee to enjoy our the games. Hello?

Adam Krejcik – ROTH Capital Partners LLC

Okay. Have you broken out what the split is between the revenues from subscription versus downloads? I apologize if I missed that.

Jay Chang

If everything is going to – go ahead.

Wang Leilei

I think it’s about –now it’s about 6 to 8% of our total mobile gaming revenue coming from the subscription based revenue and other from transaction base.

Adam Krejcik – ROTH Capital Partners LLC

Got it.

Wang Leilei


Adam Krejcik – ROTH Capital Partners LLC

Yeah. Thank you.

Wang Leilei

Thank you.


(Operator instructions)

Jay Chang

Thank you, operator. If there’s no further questions, then we thank everybody for their continued interest in KongZhong and hopefully we’ll be able to visit Beijing, we can meet you and I look forward to your continued interest and follow up questions over the course of next few weeks and months. So, thank you very much.

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