Good evening, ladies and gentlemen. Welcome to NetDragon's fourth quarter and fiscal year 2014 financial results conference call. At this time, all participants are in listen-only mode. The company's results were released earlier today and are available on the company's investor relations website at ir.netdragon.com. Joining us today are Mr. Ben Yam, Chief Financial Officer, and Ms. Maggie Zhou, Senior Director of Investor Relations. Ms. Zhou will discuss NetDragon's business operations and company highlights, followed by Mr. Yam, who will go through the financials. They will both be available to answer your question during the Q&A session that follows. A webcast replay of the conference call will be available on NetDragon's investor relations website following the conclusion of this call.
Before the presentation, I would like to remind you all that this call will contain forward-looking statements, which may include inherent risks and uncertainties that the company may not be able to fulfill due to various possibilities. Non-GAAP data is included as part of this presentation. Non-GAAP data is not explicitly permitted by the Hong Kong Financial Reporting Standards and therefore may not be comparable with other similar indicators. For more details on the non-GAAP financial measures, please refer to the disclosed documents on the company's IR website. It's now my pleasure to introduce Maggie, Senior Director of Investor Relations. Maggie, please go ahead.
Thank you. Good evening to everyone, and thank you for joining us today for NetDragon's fourth quarter and fiscal year 2014 earnings conference call. All monetary figures mentioned in this call will be RMB unless otherwise stated. We experienced healthy growth during the year, with revenue increasing 8.6% to CNY 962.8 million as we further consolidated our position in the global online game space and pushed forward the development of our Online Education business. Our Online Gaming business continued to demonstrate very strong performance during the quarter. Our operational and financial metrics continued to improve across the board, with peak concurrent users reaching 642,000, and the revenues of our online game business increasing 9.8% quarter-over-quarter to CNY 221.5 million in the fourth quarter.
Our Online Games business continued to grow steadily as some of our newest games gained strong user traction. We signed an exclusive China licensing agreement for Calibur of Spirit during the quarter with Tencent and officially launched the game in January 2014. This game achieved a record high monthly active users of 7 million in January and a monthly gross revenue of over CNY 21 million in February. This strong performance during the early days of its life and its selection for the World Cyber Arena last fall leaves us extremely confident that this game will develop into a substantial long-term revenue stream.
Outside of Calibur of Spirit, we launched a number of new expansion packs for our flagship games, including an English version for Conquer Online, which generated an 11-year high monthly revenue in December 2014. We are also excited for Tiger Knight, which will be beta launched later this year. We continue to integrate our Mobile Games business by focusing on extending the life cycle of our existing games portfolio and launching new games. In particular, following its launch at the beginning of 2015, Eudemons Online Pocket Version continues to gain popularity and is expected to register over CNY 10 million in monthly gross revenue this month.
Further, the iOS and Android versions of Blade and Soul continue to move through the various stages of development, and an Arabic version of Wrath of Pirates has remained extremely popular across the Middle East and North Africa, where it is expected to continue to grow as new updates are launched. Moving on to our Online Education business. We continued to make very strong progress during the quarter in our product development, integration of pedagogy, content partnership, sales channel build-out, and M&A.
Our R&D team is in full speed and on track in meeting or exceeding our internal product development milestones with the vision to create a holistic, integrated total solution ecosystem for online and mobile education. I want to emphasize that we are building a software platform with world-class technology architecture that will be highly scalable and expansionable, and this will differentiate us from our competitors, as many solutions in the market today are not built to scale, which becomes very problematic considering the need for reliability and stability in a school venue environment. While our software will be designed to work seamlessly with our proprietary actually, 101 Student Tablet. Our product architecture will provide the flexibility to open up our software to work compatibly with general Android devices.
Our 101 Student Tablet, which has also gone through multiple design interactions, will be commercially launched during the third quarter of 2014. We're expected to make certain announcements in the coming months with details of the product strategy and our value propositions. In addition to moving full speed in R&D, we are continuing to deepen our partnership with Beijing Normal University, China's top education university, to ensure the most effective pedagogy is being developed and integrated into our products. In November, we have signed agreement with Beijing Normal University to jointly research e-classroom design in effect to develop insight into how software and hardware can best be integrated with various teaching models and instructional approaches.
As recent as last week, our education subsidiary, Huayu, and Beijing Normal University also announced the establishment of Smart Learning Institute, which will provide a unique platform to integrate the most advanced pedagogy with our technology know-how. In terms of content partnerships, we signed an MOU in November with a subsidiary of Pearson, the renowned global leading education company, and Beijing Normal University to develop a smart education solution.
We're excited to be able to leverage the breadth and depth of Pearson's curated educational content resources. As part of this collaboration, we are also in discussion with numerous major publishers and content partners to enrich the content on our platform. In addition to building our educational business organically, we are also looking actively at M&A opportunities to acquire components to enhance our ecosystem. We are currently in advanced discussion with multiple major acquisition targets and expect M&A to play an important role in our business development in 2014. With that, I'd like to turn the call over to Ben to go over the financials. Ben, please.
Thank you, Maggie. Let's talk about the financials for the fourth quarter. Revenue was $283.9 million, up by 21.6% quarter-over-quarter and 23.5% year-over-year. Revenue from Online Games and other business in China was $229 million, up 19.6% quarter-over-quarter and 11.6% year-over-year, primarily due to the strong performance of Eudemons Online and Calibur of Spirit . ACU and PCU for Online Games reached 301,000 and 642,000 respectively. As Maggie mentioned, these PCU and ACU data included our micro client game, Calibur of Spirit , which we started to collect PCU and ACU data for this game during the quarter. Also, our ARPU for Online Games was $273, which includes gross ARPU of Calibur of Spirit .
Excluding Calibur of Spirit for comparison purpose, the ARPU was $299, which was flat from the previous quarter and up 4.5% quarter-over-quarter. Revenue from Online Games and other businesses generated from overseas markets was $53.9 million, up 46.2% quarter-over-quarter and 126% year-over-year. This increase is due to the growth of overseas games revenue and Cherrypicks mobile technology and mobile marketing business. Gross profits from continuing operations were $245.5 million, up 17.9% quarter-over-quarter and 19.7% year-over-year. Gross profit margin from continuing operations was 87.2%, compared with 89.9% in the previous quarter. The loss for the period from continuing operations was $22.2 million. Non-GAAP operating profit, which excludes certain non-core operational items and hence presents a more accurate profitability picture, was $13.5 million.
We also want to emphasize that our non-GAAP operating profit is a blended figure, which combines our highly profitable Gaming business and our Online Education business, which is currently in product development stage. This figure excludes a net loss on held for trading investments, which tend to fluctuate quarter to quarter, and exchange loss, and also the amortization of intangible assets resulting from the acquisition of Cherrypicks last year. As we continue to invest heavily in the development of educational products, which require significant investments in staff costs, our path to profitability has been reduced in this quarter. However, we believe that these investments represent the best use of our cash and demonstrate our commitment to building an Online Education business that will become another cornerstone for our long-term success.
Lastly, we continue to be in a very strong net cash position as our cash bank balance, bank deposits and liquid investment stood at $3.5 billion as of December 31st. Liquid investments are comprised of predominantly highly liquid fixed income investments, which are used to enhance the return of our overall strong cash position. Operator, are we now ready for questions? Thank you.
Thank you for the presentation. Now we will enter into the Q&A session. Please feel free to raise any questions. To ask the question, please press star one on your telephone keypad. The first question comes from the line of Simon Zhou from First Shanghai. Please ask your question.
Hi. Can you hear me? Hello?
Hello.
Hello?
Yes.
Okay.
Yes.
Yeah. Okay. I got you. My question is about your educational products. First of all, my question is about, as a new product for education area, which kind of the promotion channel or way you are going to promote your new products and also your educational platform to the school and also the consumer market? That is my first question. I got a follow-up question.
Thank you, Simon. Yes, hi. Yes. In terms of the promotional channel, basically, we are going to be following a two-pronged strategy. Essentially, we are going to be going through the B2B and the B2C model. Essentially for B2B, we are talking about going through building a nationwide distributor channel, which is going to involve various regional and local distributors, which we are going to sign agreements with, and they will help us to sell and distribute our products to the schools in various regions. That does not mean that we are just going to leave our customers in their hands. We are actually going to work closely with the schools, together with the distributors and the agents, to serve the schools. That would essentially be the B2B strategy.
For the B2C model, we are still strategizing a little bit in terms of the proper go-to market for B2C. I think the gist of it is that we are going to be trying to approach B2C in as direct of a model as possible. Essentially, we want to sell directly to the customers and not go through too many channels. I think that is what I can say at the moment in terms of the B2C. In terms of promotions, I think you can assume that we will be going through the usual type of promotional initiatives, including advertising, promotional events, and also PR events as well.
Okay. My second question is about, is there any progress on your educational platform? Say, suppose is there any plans for your future M&A projects about the copyrights or any virtual materials on your Internet platform, on your educational platform? Because you mentioned that you are going to launch some projects, some M&A projects in the foreseeable future to enhance your educational platform. Is there anything you can update with us, Ben?
Yes, I think. Sure. Yeah, I think I can break down your questions into several components, right?
Okay.
If you look at how we develop our educational product, basically, there's two approaches, right? One is we build it ourselves, and the other is to acquire certain products through M&A. Obviously, we have a big team that is developing the products as we speak. We have been doing that for some time, and we've been actually being quite patient in terms of following our product roadmap and making sure that the product is developed in a quality and scalable manner, which is very important if we want to scale the product. The other approach would be M&A. For M&A, basically, we will be looking at several components, right? Basically, those components can be summarized into three categories. One is technology, the second is content, and the third would be pedagogy.
In terms of technology, obviously, we don't think one company can have all the technologies that they want. With our very strong cash positions, we will be able to actually acquire certain technologies that our competitors cannot get a hold of. We are actually in discussion with several targets in this technology area that we aim to close such M&A opportunities in the near future. In terms of content, our content I believe would be acquired more in the form of a partnership rather than M&A. Such kind of partnership could involve, for example, like a joint venture. As a matter of fact, we have been in discussions with several publishers, and we've been exploring JV models whereby we would be contributing money and, of course, our know-how in turning content into digital mobile Internet content.
Our publisher partners would be contributing their content into the platform. We believe that is a very good model, but we're still in discussions, and hopefully we will be able to make announcements very soon with regard to this type of model in terms of content partnerships. I think we are actually very confident that our product, when we launch it into the market, will be very content-rich. Okay, in terms of pedagogy is actually pertaining to the how we integrate teaching models, teaching approaches with technology. With regard to pedagogy, we also are working with Beijing Normal University, a top education university in China, on this initiative. You can see in our press release, and we've also talked about it in the conference call, Maggie has mentioned that also that we have had very encouraging progress in working with Beijing Normal.
We're continuing to see very positive results from this collaboration. Pedagogy is something that we believe is going to form a high barrier to entry for competitors because a lot of competitors actually are very focused in building products that they are not very I guess some of them don't have the resources to actually take the time to work out and to figure out what is the best approach to integrate teaching models with technology. I hope I answered your question properly.
Oh, okay. It is quite detailed. I got a last question about, you have mentioned that you have already contacted some universities and also some school in China area, right? Can you share some information about how many shipments for your educational products up to now? Also, have you ever think about that you may have some difficulties to enter the market, especially in PRC market because the government or also some consensus power maybe force you to You may face a difficulty to enter this kind of market. Have you ever think about it, and what kind of method you are going to face this kind of problem?
Sure.
I think that's my question. Thank you.
Got it. Yeah, in terms of the shipments to date we actually have been deliberately not shipping our products in a big way in the past six months, since we pilot launched our product in, I believe, in September or October of last year. The reason is that this is intended to be a pilot launch, so we don't want to do a full commercial launch because the product essentially is still largely a semi-prototype, if you will. With that, I would say that right now we have about 70 schools in Fuzhou, most in Fuzhou, that are using our products, including our tablets. The purpose of this pilot is basically to understand user behavior, collect data, and as I said, we did not intend to do a very large-scale shipment launch during this phase. So that would be the, I hope that answered your shipment question.
With respect to your question on the difficulties in entering the market, I think you are right. I think you're nail on the head because if you look at the current market landscape there's really no one company that has really been able to crack a code in working very closely with the schools or the government and the educational authorities to penetrate their education products into the markets, into the hands of the consumers in a big way. That is actually precisely why we think with the scale of our resources and our track record and just basically the scale of the company and our mobile Internet technology, that we are actually in a very differentiated and a very unique, strong position against our competitors in approaching the government.
I will give you an example, in the sense that, most of the regions within China that we have been talking to, and I am talking about the educational authorities. We are actually, well, I would not say surprised, but it was very interesting that despite the fact that our product, it is still not commercialized yet. We are still in product development stage. I guess I should say that in most of the times, we are viewed more favorably by the education decision-makers, the purchase decision-makers in different regions, because we are a very large company, and most of our competitors are startups in the various markets. We have the resources to develop a total solution, and we have hardware, and we are working with Beijing Normal University, and that gave us very strong validation.
Also, our collaboration with Beijing Normal University allows us to actually leverage their resources in terms of getting access to the schools and the teachers that they have strong connections with. Also, the government, and the educational authorities, they know that NetDragon is committed to education over the long run, and we have a lot of cash, a lot of people, and with a very strong vision. So this is actually very unique and very different compared to most, if not all, of our competitors in the market.
Also, the last point that I want to make is most, if not all, of our competitors are developing or selling very much of a single component solution to the schools. There is no competitor in the market that is developing and is marketing a total solution, including hardware, software, social networking, all runs on a robust cloud network. We believe that that is a very compelling value proposition to our users and our target customers.
Okay. Thank you, Ben. So I get to give back to the pool. Thank you.
Yes. Thank you.
The next question comes from [Jesco] from China Merchants. Please ask your question.
Hi, Ben and Maggie. Good evening. I have two questions. First is regarding your Education business. Speaking of the competitive landscape, I am trying to understand who you compete with, and maybe can you give us some example of your competitor, maybe not as an apple-to-apple comparison, probably in some of your areas, for example, hardware, maybe, and content and the software. That could help us to better understand your E ducation business. This is my first question. Thank you.
Thank you, Jes, for your question. I think you present a very good question, which is actually not easy to answer because I will have to talk about competitors. I think to answer the question in a very high-level manner, I guess I would say that we have not seen a direct competitor that is doing exactly the same thing as what we are doing right now. As I mentioned, we are building a total solution. We are building an ecosystem, which is going to cover the entire value chain within the education space, especially in the K-12 space. With that, I guess I can talk a little bit about sections of our competitors, right? I think right now, if you look at the competitive landscape, first of all, most of these companies are startup companies.
Some of these companies, they have obtained a lot of VC funding, if you will, right? For example, if you look at some of the companies out there, for example, you look at companies in the after-class sector. When I talk about after class, I am talking about homework, right? The leading company in this space is probably Yiqi Zuoye, right? They had a very successful VTI recently. I think, Yiqi Zuoye, basically, they target, they are very focused in the after-class segment. Basically, I am not going to talk about their business model, but what I would say is that, they are focused on providing teachers with a way of enabling the teachers to provide homework for students very effectively, and for students to do homework and get graded by the teachers, right? That is their focus, right?
Then if you look at another segment, you look at Interactive classrooms segment. There is actually numerous products in the market, and actually most of these companies are relatively small, private companies. These companies, they would be focused in interaction, in-class solutions enabling teachers and students to communicate within the classroom. I think if you look at our product, basically, we are going to cover in-class, we are going to cover pre-class and after-class. Okay?
The initial version of our product, we are going to be more focused on the in-class, but then we are already developing our after-class version of our product. So I think, to answer your question, it is really the ability and the commitment to create, to develop a total solution, an ecosystem for the end high-value, for the customers that is going to integrate hardware and software together. We do not see any other company right now with the same kind of focus, with the same kind of resources to do this. That is why we like to say that we have a first-mover advantage in building this ecosystem.
Okay, thank you. As a follow-up about your Education business, can you give us some color on the potential financial impact on your financials, maybe in the second half of this year since you are launching your Pad product, in Q3. Probably, what kind of margin are we expecting this year? Thank you.
Yes, okay. I think, right now we are still planning and strategizing on our go-to-market approach. We do not have a defined or concrete specific budget for advertising and marketing this year for our product. I would like to say that we are making no secret that we are hiring a lot of people in the Education business. Right now if you look at our run rates, basically our education staff costs, we are looking at around RMB 10 million per month. That is likely going to be increased gradually over the year as we continue to hire more people and manpower to develop our products. I think with that, we can expect that, I think education is going to be continuing to be a business that will be very much of a business that we are going to continue to invest our manpower, and resources into this business.
Obviously, revenue and users will come in the next few years, as we continue to ramp up this business. That was the education. For the Gaming business, we are actually very confident that Calibur of Spirit is going to provide a very growing and a very sizable revenue, cash flow stream to our overall combined P&L. I think if you really look at it is hard to predict or project the final or the combined financial position or the P&L for this coming year, because it will depend on Calibur of Spirit, how quickly we can ramp it up.
Also it will depend on the pace of our hiring in the Education business. For the advertising promotion, right now we do not have a budget at the moment, but we are likely going to spend some money there, but we would have to complete our sales strategy and go-to-market planning first before we can come up with a budget.
Okay. My last question is about your online game business. Can you give us some color on your Mobile Game pipeline this year and your Mobile Game revenue contribution in the fourth quarter and the entire year of 2014? Thank you.
Yes. This year, we are going to launch three to five new mobile games. I think that's consistent with last year. I think the flagship Mobile Game is still going to be the Eudemons Online Pocket version which is expected to exceed a monthly gross revenue of CNY 10 million. In March. Also for the Pirate, which has a very large user base, especially in the Middle East, that is also becoming extremely popular, and we also expect a very stable cash flow there. So overall, we expect five mobile games this year. In terms of the Mobile game contribution in this quarter, give me a second. Yeah. So, our Mobile Game revenue as a percentage of our total games revenue is about 6.3% in Q4. So it actually registered quite healthy growth, and that's mainly because of Eudemons Online Pocket version.
Sir, I didn't get your number. Is that, sorry, 8%?
Oh, sorry. Yeah. So Mobile Games revenue as a percentage of our total games revenue is 6.3% in Q4 of last year.
Okay. That's all from me. Thank you, Ben and Maggie.
Thank you.
Thank you.
The next question comes from Xiang Jiang from Guosen Securities. Please ask your question.
Oh, hi. Hi, Ben. Hi, Maggie. This is Xiang Jiang from Guosen Securities. I want to ask you a question about the ecosystem of our Education business. How many different kind of participant would be in this ecosystem, and how would our ecosystem benefit this participant? As we know, some of the Chinese companies has already set root in this area, like Quantong, and I want to ask, what is the competitive advantage of our ecosystem? Thank you.
Okay. Yeah. Thank you for the question. I think you asked a very broad question. You're asking about the participants, and I believe you're talking about the stakeholders—
Yes.
—in our ecosystem. Yeah. In general, I think that the key stakeholders we're talking about, obviously, the students, the parents, the teachers, and educators r ight? It is hard to talk about it without going into the details. But I think what I can say is that if we narrow it down to the students, we believe that there's no single solution in the market right now, in China or even in the global landscape, that students are able to use in a very repetitive, in a very recurring manner. If you look at the classrooms, if you look at overseas market, if you look at iPads in the U.S. market, there's a lot of schools that buy iPads, and they try to use iPads in the schools.
But the fact of the matter is that there's a lot of iPads that are actually sitting around in schools doing nothing because the teachers actually don't know how to make use of these iPads to teach and to get students to learn. So the issue with that is because there's no one single company to come out and just basically integrate everything together to say, "Okay, I'm going to have a hardware, and I'm going to have a software that's going to have incredibly good content. Then we're going to have applications within the software that will enable students to learn, not just effectively, but also in a fun manner, in a very motivated manner."
So it's very hard to mention it in a few words, but if I'm going to kind of narrow it down to one sentence, I would say that our product is going to enable students to learn both effectively and in a very fun and motivated approach. And that is very difficult to achieve because education, learning in itself is not like playing games, right? And for us, because we are coming in as a gaming company, and we have the expertise to understand user behavior, how they react to different things while they use the mobile Internet products.
This kind of expertise actually allow us to design our product in a way that will make students learn, but also have fun at the same time. I think if you talk about the benefits for the students, that would be it, right? I think we are not talking too much about the parents and teachers, right? Because obviously, if the student learn effectively, parents are happy and educators are happy, teachers are happy.
For the teachers, I think our value proposition for teachers is that we are investing very heavy resources, and probably the heaviest resources out of all our competitors in making sure that teachers are happy. That is because we are working with Jason Ronald personally. We are also working with East China Normal University and also Central China Normal University. These are the top education universities in China that train teachers. By working with universities that train teachers, we make sure that we will be able to take care of teachers' needs when we design our products. That will be a very unique proposition.
Okay. Thank you for your answer and—
Do you mind repeating your second question?
No more questions. Thank you for your answer.
Oh, sorry. Okay. Thank you.
The next question comes from Ran Zhu from Guangfa Securities. Please ask your question.
Hi, Ben and Maggie. Thanks for taking my question. My question is about our investment plan. I want to ask, how much we invest in online education in the next two years, and how long our investment cycle in education last before we can take profits? Hi.
Yes, sure. Okay. Yes. Okay. I think the investment into education is going to be a recurring thing. We're not going to stop our investment into education anytime in the next few years. Because we're committed to building our products, and Apple is not stopping their investing and educating in their products, for example. I guess I can talk about the run rate a little bit. Basically, right now, I mentioned earlier in the call that in terms of our staff costs, we're looking at a run rate of around CNY 10 million on a monthly basis. That's the amount of money we spend on our staff, mostly R&D. Actually, a majority of that is R&D staff. If you include outside of the staff cost, you include acquisition of content, you include some outsourcing and some miscellaneous cost.
Right now, we're looking at around CNY 15 million per month expense run rate for the Education business. We expect that this is going to increase over the course of the year as we continue to hire more and more people into this business. I think if you look at this year and next year, our team is definitely going to grow. It's not going to be reduced. It's going to grow. This run rate will continue to increase. As we have mentioned previously, our product, we're expecting to have a launch of our product in the second half of this year. We expect to start getting some revenue this year.
But really, the aim of if you look at our strategy, we are not expecting to really gather a lot of revenue in the initial phase, because really, we believe that the key success factor is really to gain the users, to gain active users in this space. Gaining active users likely is going to involve, is going to entail offering a lot of value to these users at a very low cost to them. Right? Some of it could be a freemium type of model. I think if you really look at it, I think the second half of this year, we're going to have some revenue coming in, right? Because as we sell our hardware, we're not going to sell our hardware for free. Right?
As I've mentioned before, we are going to sell our hardware at least at our cost, or maybe a little bit above our cost. Then, if I look further into next year, revenue will continue to increase as we ramp up our product steps. But it would be hard to very accurately forecast the amount of revenue this year and next year because we're still strategizing at the moment on our go-to-market. We're actually very confident that we're the first mover in this space, and we are in the strongest position to acquire these users. That would actually put us in the best position to monetize at the back end.
Okay. I have a second question to follow up. I noticed that our cash position has declined last year. Could you please tell us how we use that cash in last year?
Okay. Yeah, I think I can talk in terms of on a high-level basis. First of all, we have done a lot of share buybacks last year, so that was a major usage of cash last year. We have also spent some money in building our new headquarters in Changle, which is near the airport in Fuzhou. Building the new headquarters is actually a key initiative for us to retain staff and also to attract talents. I'm looking at a cash movement schedule in front of me right now. If you look at the CapEx in Changle and also other CapEx in 2014, we're looking at around CNY 360 million spent.
Actually, sorry. It's about CNY 550 million spent in CapEx last year, and mostly in Changle. That would be a major usage of cash last year. As I mentioned, stock buybacks last year, and we also distributed dividends twice last year. One is the 2013 final dividend, and then the other is the 2014 interim dividend. I also want to say that we have been making some fixed income investments.
If you look at the cash line or the fixed deposits line, that is not an accurate reflection of our true kind of cash or cash equivalent position because the liquid investments that we're making, for example, the fixed income fund that we bought from Goldman Sachs last year and some of the liquid shares that we bought in the market, these have daily liquidity, and these investments are intended to enhance the return of our cash instead of all sitting in the bank. We've actually been doing that very prudently. As you can see, most of our cash is still in cash or cash deposits. We have a small amount of cash, so-called liquid investments. We should really count those liquid investments together when we look at the cash balance.
Okay, thanks.
Yes. Actually, just one more thing. In 2014, we also paid over CNY 300 million in withholding tax which is a result of our sale of 91.com back in 2013.
Thanks.
That was another major item in the usage of cash. Thank you.
As there are no further questions, we will now conclude today's call. On behalf of the entire NetDragon management team, I would like to thank for your participation in today's conference call. If you have further questions about NetDragon, please feel free to contact the investor relations department. Have a good day or good evening. Thank you and goodbye.