The9 Limited (NCTY) Q4 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the The9 Limited 2H 2013 Financial Results Conference Call. My name is Annie [ph] and I'll be your coordinator for today. [Operator Instructions] As a reminder, the conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference. Please proceed, ma'am.

Thanks, operator. Hello everyone and thank you for joining us today for The9's second half 2013 financial results conference call. With me today are Mr. Jun Zhu, Chairman and Chief Executive Officer; Mr. George Lai, Chief Financial Officer. Mr. Jun will lead off by his prepared remarks and then George will have a detailed discussion of our financials. After that we will open the floor to take questions. Before we continue, as always, please allow me to review the Safe Harbor Statement in connection with today’s call. During the course of today’s call, certain projections or forward-looking statements may be made regarding The9's future financial performance or future events. We wish to caution you that such statements or predictions are based on our current information and expectations and actual results may differ materially from those projected in the forward-looking statements. We would also like to refer you to the documents that the company filed with the United States Securities and Exchange Commission. Those documents contain additional information concerning factors that could cause actual results to differ materially from those contained in the management’s projections or forward-looking statements. Now I would like to turn the call over to our Chairman and CEO, Mr. Jun.

[Interpreted] Good day, ladies and gentlemen. Thanks for participating in our discussion of The9's second half of the year 2013 results. Let’s discuss the latest projects of our company before covering the financials. Multi-screen era has begun in the recent two years, internet applications started to expand from PC to other platforms such as mobile and TV. In order to expand our user base with our years of effort in R&D, The9 has entered into the hardware area. On March 18 this year, ZTE9, the joint venture of The9 and ZTE, held a press conference for our Fun Box, the home entertainment set-top box. In early 2013, The9 and ZTE formed a joint venture ZTE9, which is engaged in home entertainment smart TV business. Based on our statistics and estimation, up to the end of 2013 ZTE9 has occupied over 90% of the China telecom IPTV market share. Our IPTV game platform and products has covered over 48 million users with over 20 million active users and more than 200 TV games. We plan to build up a platform within the next two years, which combines network, mobile and television. Our target is to capture 90% of the smart TV household users in China. Why do we cooperate with ZTE? The cooperation with ZTE fully leverage ZTE's powerful hardware R&D and manufacturing capability and experience. We can spend less time with hardware development and manufacturing so that we can catch up and surpass our industry peers. Why did ZTE9 accept Guangdong Guandeng's [ph] strategic investment? ZTE9 can leverage Guangdong Guandeng's [ph] strong distribution trend. In February this year, Guangdong Gong-tu Guandeng [ph] Investment Limited Company, a wholly-owned subsidiary of Guangdong Guandeng [ph], made a strategic investment in ZTE9. ZTE9 and Guangdong Guandeng [ph] intend to establish joint venture to provide games, read deals [ph], online reading, karaoke and other value-added services to 30 million television users in Guangdong. ZTE9 in that provides top-quality set-top box and value-added services to more users of Guangdong Guandeng [ph]. Why did The9 entered into this business one year ago? The9 has entered into the IPTV market for many years. We do not only provide games to the TV operators, China telecom IPTV and Guangdong Guandeng [ph] TV -- digital TV, but also operate the gaming platform of the TV operators. Through this cooperation, we want more users to enjoy the interactive smart TV, retain the users, and take a proactive role in other future business models in smart TV. In addition, the website [ph] R&D team invested by The9 is a very valuable team of MMORPG development. The valuable experience of game development can secure our future TV game content development. Why did ZTE9 chose NVIDIA chip? We want our Fun Box to operate traditional TV set-top boxes towards gaming platform. Inside a TV set-top box, the chip is the most important part. The hardware performance, future upgrade plans and timetable of the chip and also the timetable open to Android developers are very important to our Fun Box future, positioning and business model. If we do not have such support from NVIDIA chip, Fun Box will be difficult to compete with the future platform competitors including Xbox, Sony's PS4. We believe an open platform will win the battle against console closed platform. Unlike other set-top box in the market, the future of Fun Box will be [indiscernible] to TV games, including game content and control like game pads and no control [ph]. Of course we'll also take care of other consoles. The TV game market in China will have significant growth in the coming two years. It is expected that the smart TV [indiscernible] will reach 35 million [ph] in 2014. Based on The9's [indiscernible] resources especially being a well-known public company, The9 is actively exploring the opportunities to expand the Fun Box platform. We hope that through The9 as a public company in the U.S. capital market, we can have more U.S. and global investor and enjoy the future growth of the huge home entertainment market in China. To have better cost control for the development of our Fun Box gaming platform, we are considering different means to realize our investments soon in our game development, which got good market feedback. Recently we have signed a non-binding letter of intent with a company to dispose of two web games for consideration of RMB200 million. A press release will be issued in the event that parties entered into any definitive agreement with respect to the business disposal. Now let's discuss the progress of our new games. First of all is Firefall. Website [ph] closely monitors the community feedback of Firefall and continues to optimize the game platform, as well as to release upgrade patches that improve the core game play. Website [ph] keeps on these innovation features to Firefall, building rich content to the MMORPG and progressing to the success of game operation and commercialization. We have gone through different beta tests and the results have been very satisfactory. Firefall will be ready for commercialization in Europe and the U.S. very shortly. We are also preparing to launch the game in China and other parts of the world. QiJi Online [ph] is a web game developed based on the Flash 3D engine which The9 showcased in [indiscernible]. In the second half of 2013, the game went through internal closed beta tests and two commercial platform tests. We received very positive feedback which signals to have [ph] great market potential. In May this year we will release 2D series in different platforms and we will start the cross-platform development and cross-marketing. As of now we have completed cross-platform functions between PC and mobile. So we talked about our official licensed NBA Title. This NBA is a sports web game based on NBA content. With the official NBA license, we developed an open game play which maximize the NBA elements into the game and the players can experience the most brand-new NBA atmosphere. All [indiscernible] used in the game are real players' pictures and all [indiscernible] are in one-to-one installation [ph]. In addition, rich game content and powerful 3D engines will bring exceptional game experience to players. In February 2014, this NBA launched its user beta tests on the Tencent platform. Based on the test data, this NBA far exceeds the average rating of all web games in terms of new active users, retention rate and play ratio. Among these, retention rate, play time and play ratio all ranked the highest level on the Tencent platform. After optimization, we expect to launch this NBA in Q2, bringing extraordinary brand-new basketball web game experience to players. Among all the console platforms including Playstation, Xbox, NBA Title has been ranked very high for all different gaming platforms. So together with our [indiscernible] development, we already own lots of content including like NBA or large-scale MMO FPS [ph] game. So all this will be very [indiscernible] to our Fun Box gaming platform. This concludes our business highlights for the second half of 2013 and the outlook for the 2014. Now I'll hand over to our CFO to cover the financials.

So thank you, Mr. Zhu, and hi everyone. I will now take you through an overview of our third and fourth quarter of 2013 financial results. Our net revenues in the third quarter of 2013 amounted to $5.6 million, representing a 29.5% increase from $4.3 million in the second quarter of 2013 and a 4.5% increase from $5.4 million in the third quarter of 2012. The increase from the previous quarter was primarily due to an increase in net revenues from Planetside 2 and Firefall. Our net revenues in the fourth quarter of 2013 amounted to $4.1 million, representing a 26.8% decrease from $5.6 million in the third quarter of 2013 and a 33.5% increase from $3.1 million in the fourth quarter of 2012. The decrease from the previous quarter was primarily due to a decrease in net revenues from several web games. The increase from the fourth quarter of 2012 was primarily due to an increase in net revenues from Planetside 2 and Firefall. Our gross loss in the third quarter of 2013 amounted to $1.4 million, compared with a $0.5 million gross profit in the second quarter of 2013 and a gross profit of $2.4 million in the third quarter of 2012. The gross loss in the third quarter of 2013 was primarily due to the impairment of prepaid royalties and deferred cost of Planetside 2 as lower-than-expected revenues were generated. Our gross profit in the fourth quarter of 2013 amounted to $0.5 million, compared to gross loss of $1.4 million in the third quarter of 2013 and a gross loss of $0.2 million in the fourth quarter of 2012. The gross profit in the fourth quarter of 2013 was primarily due to an increase in net revenues from Planetside 2 and Firefall. In the third quarter of 2013, our operating expenses were $20.8 million, representing a 15.6% decrease from $24.7 million in the second quarter of 2013 and a 38.5% decrease from $33.9 million in the third quarter of 2012. The decrease from the second quarter of 2013 was primarily due to a decrease in general and administrative expense as a result of the decrease in share-based compensation. The decrease from the third quarter of 2012 was primarily due to a decrease in product development expenses as a result of our restructuring of investments in and termination of certain contractual arrangements with certain game development variable interest entities in the third quarter of 2012, a decrease in marketing expenses related to Firefall, as well as a decrease in general and administrative expense as a result of our cost cutting efforts. In the fourth quarter of 2013, our operating expenses were $20.9 million, representing a 0.3% increase from $20.8 million in the third quarter of 2013 and a 15.0% decrease from $24.6 million in the fourth quarter of 2012. The increase from the third quarter of 2013 was primarily due to the increase in impairment loss on certain equipment, intangible assets and other long-lived assets, offset by the decrease in marketing expense and product development expense. The decrease from the fourth quarter of 2012 was primarily due to decrease in marketing expenses, product development expenses and general and administrative expenses, offset by the increase in impairment loss of certain equipment, intangible assets and other long-lived assets. In the third quarter of 2013, our net loss attributable to the holders of ordinary shares was $20.1 million, representing a 27.6% decrease from $27.7 million in the second quarter of 2013 and a 28% decrease from $27.9 million in the third quarter of 2012. Our fully diluted loss per share and per ADS in the third quarter of 2013 was $0.88, compared to $1.21 in the second quarter of 2013 and $1.14 in the third quarter of 2012. In the fourth quarter of 2013, our net loss attributable to holders of ordinary shares was $20.3 million, representing a 1.1% increase from $20.1 million in the third quarter of 2013 and a 6% increase from $19.1 million in the fourth quarter of 2012. Our fully diluted loss per share and per ADS in the fourth quarter of 2013 was $0.88, compared to $0.88 in the third quarter of 2013 and $0.78 in the fourth quarter of 2012. So, thank you for listening to our presentation today. At this point we'll take questions. Thanks, operator.

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question today comes from the line of Thomas Chong of Bank of China. Please ask your question. Thomas Chong – BOCI: Hi, good morning. Thanks for taking my questions. I have two questions. My first question is regarding the set-top box market in China. I just want to get a sense of how much market share do you think the set-top box can capture the online gaming sector in the next few years? And how much market share do you think Fun Box can capture? I have a second question. Thanks.

[Chinese language spoken] So, so far we do not have an exact estimation on the market share after the launch of our Fun Box, but our Fun Box is very different from all the other Fun Box -- all the other set-top box in the market, because our hardware of our Fun Box is much better than the other set-top box. But the other set-top box users can use to do the read deal [ph] or music. But for our Fun Box, on top of that, we can also have lots of game plays.

[Interpreted] So to follow to your question and explain more about our Fun Box plan, so what's special about our Fun Box is we are using NVIDIA chip, the hardcore development of Fun Box. So to answer more about the NVIDIA chip used by our Fun Box, now currently we are using a chip called Chip 4 [ph]. And in July and August time we will upgrade our Fun Box NVIDIA chip to Tei 1 [ph]. So Tei 1 [ph] you can -- you mention is function is more close to the Xbox 360 and PlayStation 3. And then in next year NVIDIA will introduce a new chip, it's called Tei 2 [ph]. And the Tei 2 [ph] functionality is similar to Xbox 1 and also similar to PlayStation 4. So our Fun Box is running under the Android system, so we can use an analog just like what happened in the past when Apple first started their iOS system, it is more like a closed system, so which is similar to the PlayStation and Xbox platform. So since we are using the Android system, we expect Android will, on the TV platform, also go through the open platform strategy. So we believe that going forward, under the open platform strategy, our competitor will be Xbox and also PlayStation. And since they are running under a closed system and we are using an open platform, so we expect we can be very competitive to them. So you mentioned our Fun Box in future, so it is more like a traditional TV set-top box. But in addition to that, because of its strong hardware power, which is comparable to Xbox and PlayStation, so you can imagine that the users of our Fun Box can enjoy more like the set-top box normal feature. And on top of that, we can also enjoy the gaming experience just like Xbox and PlayStation. And on top of that, the pricing of Fun Box is much lower than PlayStation and also Xbox. So you can imagine the future of Fun Box is very promising in China. So we aim at the Fun Box is home entertainment smart box. So we also emphasize a lot on the game content to be provided by Fun Box. So on this we have accumulated lots of experience in the gaming industry. So all this will be very helpful for us to develop the future Fun Box gaming platform. Thank you. Thomas Chong – BOCI: Thanks. Thanks for the detailed answer. I have a second question. So given the strategic focus right now is on Fun Box, so do you think the future of set-top box is even more brighter than what happens in the mobile games market right now? And my follow-up question is regarding the PC gaming market. How would you see the trend going forward? Do you see the cannibalization from -- between -- for mobile games and set-top box will further slow down the PC gaming growth? And how would you expect Firefall to be launched in China given the slowdown of the PC sector? Thanks.

[Interpreted] So we do not see a big contradiction or competition between the TV game market and also the mobile game PC game market. So for example, for action game, for MMO games, players will be more enjoyable if they play the game on TV instead of mobile [ph]. So for example, like the action games or sports games, so currently the gamers can play on PC or mobile. Especially for mobile game, the players will only play the games in their stress time. So we expect that TV game will have a very significant growth in the China market in the coming one to two years. So we observed a trend that there are thousands of development studios in China. So in the past, most of them have focused their development into client game, and then afterwards the trend went to web game, and then recently went to mobile game. But currently we observed a trend that some of them went back to focus their resources to big game [ph], including like client game. And why did they do that, is they believe that the TV game market in China will go up very soon. And it is relatively easier for them to convert those bigger game [ph], like in the past like those client games into TV games. So this is also another reason why we believe that TV game will grow significantly in China in year 2014 and 2015. So to conclude, we still believe that for mobile games and PC games, there will still be some growth in the coming future. But we believe that TV game will grow at a much faster pace compared with mobile game and PC game. Because Fun Box is in general a home entertainment set-top box, so we will also leverage Qunxing capability to -- for the other contents, including live video and music or other applications. So to conclude, Fun Box is not only the traditional set-top box but we can also play games on the Fun Box. So we welcome all the developers to have their games or apps to put on our Fun Box. So we emphasize a lot on the content and technology. So all this together will make the success of Fun Box. So in the press conference of Fun Box we held several days ago, Jindong [ph] has promised to have a pre-sale of 1 million sets of Fun Box. So this is also another evidence that Fun Box will make success in the China market. So also together with the investment made by Guangdong Guandeng [ph] to ZTE9, so we believe that Guangdong Guandeng [ph] also realize the demand of 30 million users for the value-added services on TV. So this investment made by Guangdong Guandeng [ph] is a proof that the Fun Box will have a very successful market share in the TV set-top box market in China. So Guangdong Guandeng [ph] cooperation is only our first step. So if our first step is successful, we will also talk to different provinces Guandeng [ph] so we will continue to sign different contracts to different Guandeng [ph]. And our ultimate goal is to provide our Fun Box to all the TV users in China. Thank you.

[Operator Instructions] Your next question comes from the line of Allan Zhu [ph] from Zee, Inc. [ph]. Please ask your question.

Yes. I just want to know what's the ownership of my city [ph] in joint venture with Qunxing. Hello?

[Interpreted] So the ownership of The9 and Qunxing at ZTE9 is the same. So Guangdong Guandeng has invested 10% into this joint venture and the other shares are owned by the management of ZTE9.

Thank you. I have a follow-up question, because I know like Perfect World also set up joint venture with Huawei and they're going to release a box probably in upcoming May. So my question is that, how do you see that competition coming along?

[Interpreted] So we believe that competition can lead to improvement of the business.

Thank you. That's all my questions.

Thank you.

[Operator Instructions] There are no further questions at this time. I would now like to hand the conference back to today's presenters. Please continue.

We would like to thank you all for participating in today's call. Please feel free to contact us with any additional questions. Thank you.