Good evening, ladies and gentlemen. Welcome to NetDragon's 2017 third quarter earnings conference call. Accompanying this call, we also have a live webcast on our website where you will be able to view the earnings presentation. After the presentation, there will be a time for Q&A. Until the Q&A session, all participants are in listen-only mode. Before the presentation, I would like to remind you all that this call may contain non-GAAP data is not expressly 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 at www.nd.com.cn/ir.
The company's results were released earlier today and are available on our IR website. A webcast replay of the conference call can also be found there following the conclusion of this call. Now, please allow me to introduce our management team who will join us today. Dr. Simon Leung, Vice Chairman and Executive Director of NetDragon, and Mr. Ben Yam, Chief Financial Officer. Simon will begin with a review of recent developments in NetDragon's operating performance, and followed by Ben, who will review the company's financial performance. Following the presentation, they will both be available to answer your questions during the Q&A session.
With that, I would like to turn the call over to Simon. Simon, please go ahead.
Thank you, Joseph. Good afternoon, good evening. Thank you for joining us again. What I'm going to do is actually, I'm going to hit the highlights and have Ben, our CFO, to go into the details. As you can see in our press release, is another good quarter for us. It is actually consecutive profitable quarters, which is something we've been indicated, and also a record achievement in terms of revenue which is actually good news for both businesses. Mobile game continue to contribute to the growth, and also our IP strategy start to bear fruit. Also something that we've been highlighting. Our pipeline is actually stronger than ever, so we're very confident with our business going forward. On the learning side, good news from both the international business and also China. Our growth is actually over 50%, which is very significant.
If you remember, this is actually year-over-year growth, and the year before, is actually we also grew quite significantly. We gained both market share in our existing stronghold and also in the new markets. Good news on China on two fronts. One is actually we have achieved our target in terms of acquiring user base in teachers ahead of schedule, and the other one is actually we have record high sales contract in China. User acquisition already. Contract sales, CNY 150 million in Q3 alone. Our backlog now is actually over CNY 300 million, which is actually 3x more than the previous year. So very, very encouraging. On the international side is actually we are firing from all engines. If you look at the market, we're gaining share, we're growing faster than the market.
Actually, in the U.S., one of our strong market, is actually we grow much faster than the market. The market has grown by a bit already. We are growing faster than the market, that means we gain share. We also expanded our territory, which is actually really exciting. The continual growth in the emerging market is actually give us a great confidence. And also, because of the move towards larger screens and also the flip from the whiteboard to the panels is going to help our revenue on that front. We are going to grow both in the unit side and also on the revenue side. With that, I am going to go into gaming. It sound like a broken record because it seems like we say the same thing last year, but again, another in our mobile strategy.
We sustain the momentum of our growth both in player acquisition and also on monetization. That is why key metrics like ARPU and APA is actually we are growing and also MAU and DAUs. On Eudemons Online, we continue to monetize, and it is actually quite a very sticky business for us, which is good. Our pocket version start to gain momentum, so that is why we start seeing it in September. Our mobile game launch in October with our partner is actually seeing a very high gross billing in the first month, which is quite encouraging. Another key game for us, Heroes Evolved, MAU under this IP has increased 33% quarter-over-quarter and at 141% year-over-year. And then, the pocket version is actually ranked very high in some of the rankings in China.
With that, I am going to turn the microphone over to Ben, and he is going to take you through some of the numbers that you are very interested in. Ben?
Well, thank you, Simon. I am going to go over some of the details in the financials. If you turn to the financial highlights slide, as you can see, we achieved over 50% increase in our overall revenue year-over-year. Last Q3, we have a tremendous increase in profitability. From a loss of close to CNY 90 million last year to CNY 13 million this year, if you look at the non-GAAP operating profit. I should also point out that the profitability on the quarter-by-quarter basis is bound to fluctuate significantly because of operating leverage. And also, finally, on the cash front, our cash balance is very healthy at about CNY 1.9 billion.
If you look at the next page on the bridge, first of all, we're looking at the year-over-year bridge. You can see, basically, we have all around increase, all around pickup of our operating metrics, and that includes growth in the gaming gross profit in this bridge. The increase of the gross profit is offset by several elements, right? One is we have increased the headcount. We have increased the salaries because we have to retain our employees. We also have distributed certain employee bonus, given the great performance of some of our games. I should also point out that in this bridge, we have an item called bonus accrual and reversal at Promethean.
Basically, what happened is, because this year we are having a great year at Promethean, so that's why we decided that we're going to accrue for our annual bonus, and because we have more visibility now. If you look at last year, we actually, the bonus number at Promethean is a lot smaller. This is actually good news for us because we're now seeing the great performance leading to the bonus accrual. Obviously, that is a factor in terms of looking at this bridge.
The other thing that you should look at is bonus reversal, because in Q3 of last year, we actually reversed certain annual bonus because we did not see that the performance as up to our target. Obviously, this year we're having a great year, so that's why we have the effect of having the bonus accrual and also not having the reversal that we had last year. That's why you have a bridge of CNY 17.1 million in the bridge. I just thought I would make a note of that. Finally, if you look at sales commission, CNY 7.4 million. Obviously, this year we're having a much higher sales number compared to last year, so that's why our sales commission is also higher.
In fact, actually, if you look at our fixed SG&A this year in Q3, our fixed SG&A at Promethean is actually lower compared to the Q3 of last year. Turning onto the next page, which is the quarter-over-quarter bridge. Pretty much a similar story, I should say. Again, in this slide, I would just point out that you can I would just make a note of the decrease in the education revenue and gross profits in this bridge. Because as we have noted several times in the past, we have reminded everybody that we have a seasonality issue with our overseas business. Q2 historically is always the highest revenue quarter. Q3 is almost always lower than [Q3] in terms of revenue. That's what the market looks like.
That's why if you look at Q3 versus Q2, we are always going to have a decrease in the education revenue. That is why you're seeing the CNY 48.5 million decrease in education gross profit in this bridge. I should point out that if you look at Q3 education revenue, you should really look at the year-over-year performance. If you look at Q3 year-over-year increase, it's actually a 51.9% increase in our Q3 education revenue on a year-over-year basis. I'm going to turn straight to the financial highlights for learning. I'm going to skip the segmental financial highlights slide because I think you can read by yourself. If you look at the learning financial highlights slide. Again, we had a record quarter. We recorded close to 52% increase in revenue year- over- year. We had all-around strong performance in both international and also in China space.
On the international front, we had a 56% increase in revenue year- over- year. Gross margin, if you take out the Russian tender, is actually 30.2% gross margin. That is actually very consistent with what we have been guiding in the past, is that our gross margin in the overseas market will be around 30%. This is very consistent with our guidance. Again, our international subsidiary, Promethean, achieved consecutive profitable quarters again. Finally, on the SG&A side, as I have mentioned, our SG&A has been going down on a year-over-year basis by 10.2%, if we take out the bonus accrual factor and also the sales commission, which is very much of a variable cost. In China, in Q3, again, we had a record quarter of contracted sales.
It's also pointed out that in terms of validation of our sales, the pattern based on historical track record is that the validation of sales will accelerate in Q4. That's why we would expect that, see the tremendous increase in the contracted sales figure, and that is supported by a large number of tender wins which really validate the quality of our products. And then, in terms of sales backlog, as Simon also mentioned, we have over CNY 340 million, and that backlog represents signed sales order, which is going to be recognized as revenue in the upcoming quarters. Again, in terms of the core segmental loss, we are looking at a steady core segmental loss in Q3 compared to a year before. Again, that is on the back of growing revenue.
We have offsetting factors, in terms of the increase in headcount for the user scaling and product development, sales commission, as I have also mentioned, and also performance-based bonus expense, as I have explained in the bridge. In terms of financial highlights for gaming, another record quarter, over 53% increase year-over-year, CNY 440 million of revenue. Mobile gaming continued to be a star, 19% of our gaming revenue in this quarter. The contribution from mobile revenue is really accelerating, and that is really on the back of very strong performance of both pocket versions of Eudemons and Heroes Evolved. The pocket version of Eudemons, which reached a high monthly gross billing of close to CNY 40 million in September. And also, Heroes Evolved, the pocket version, also ramped up its monetization significantly with about 1.8x increase in revenue over Q2.
In addition to mobile gaming revenue growth, again, we are looking at a very strong performance of our PC version of the Eudemons. In terms of new game launch, we have two new game launches that has happened in the last few months. One is a browser-based game of Eudemons, which was launched in December. We had CNY 27 million of gross billing in that month. And also, last but not least, is the long-awaited Eudemons mobile game, which we launched in partnership with Kingsoft in October. In the first month of launch, we achieved over CNY 100 million of gross billing.
With that, I am actually going to turn back to Simon, who will take us through the outlook.
Okay. Thank you, Ben. I am going to be at high level in terms of our outlook, and then we will take questions and hopefully we will give you some answers. On learning, we see continual growth for our making progress into the emerging markets. As you hear in the market, there is a lot of activities in the One Belt One Road, so we cannot talk, or a sizable tender, we cannot talk in detail. Hopefully, we can talk to you a lot more about how we will be doing in those markets. We will continue to acquire customer. Actually, our pipeline is strong. Two new games under Eudemons Online, and then three under Heroes Evolved that will help to contribute to the growth. We are very confident that the mobile gaming upside will continue to contribute.
We are only at the early stage of how we capitalize our IP. One other thing I want to mention, which is actually what we didn't highlight, because in Q3, but is actually in progress, is actually our integration with JumpStart, which is actually doing very well. Because of the timing of the acquisition, it didn't impact our Q2 that much or at all. However, there is a lot of work going on. The good news is actually we see a lot of leverages between JumpStart and Promethean because JumpStart has a lot of education asset that can be integrated into the Promethean offering that can help us to do even better in terms of the schools or in terms of engaging the teachers and the students.
At the same time, because of that, then we can expose a lot of our customer with our JumpStart game. This is actually one of the main reason that we acquire the company. The other one is actually we continue to expand our IP. Again, we will take you through some of the result at the right time. And then we start to take the JumpStart games to outside of the main market, which is U.S. and Europe. We are doing a lot of preparation to take the games like School of Dragons into Asia, which is all very exciting.
With that, I am going to stop and then hand the microphone back to the operator, and then we open up for Q&A.
Ladies and gentlemen, we will now begin the question- and- answer session. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel the request, please press the hash key. Please also ask your question in English first and translate it in Mandarin afterwards. Your first question comes from the line of Marcus Yang from Macquarie. Please ask.
Hey. Thank you for taking my questions. Congrats for the solid results, I guess especially from this top-line perspective. I got questions on both gaming and education business. For gaming-wise, anything that we can share that entering the second month since the launch of Eudemons Online mobile version, how does the growth look like after the CNY 100 million in the first month?
Secondly, can you give us some updates on the 2018 gaming pipeline? For education-wise, any expectations on the turnaround for the whole education business? I mean, I understand that we set a goal to turn it around in 2018. Are we on track of that goal? Can we consider that bonus and sales commission expense in 3Q this year as a one-off expense? Also, any updates on the projects in Turkey and Malaysia will be appreciated. Thanks.
Actually, that's a loaded question, so I will do it in reverse order. Actually, I do like to use a different word rather than turnaround, because it is like we are building. Our goal is actually is to go to a breakeven scenario in either 2018 or 2019. That is our goal. Really, depending on whether we will decide to make more investment in 2018. If you look at our trend, we are absolutely trending that way. Hopefully that answers your question. In terms of the big project, I cannot disclose anything to you regarding Turkey or Malaysia or Russia. But I can assure you, we are in there. I think that is about all we can say.
Yep. Yes, I guess that is pretty much my questions on education.
Okay. For gaming, I am going to ask Ben to take that question.
Yeah. Sure. In terms of gaming, I think you asked two questions. One is on the performance of Eudemons Online mobile game, the new game, which was launched in October, and the other is the pipeline. In terms of the new mobile game for Eudemons, obviously, we had a great first month with over CNY 100 million of gross billings. Right now, we are strategizing in terms of the upcoming months, how we are really going to continue the revenue flow. But I would like to say that in the next, I guess, after the first month, we have stabilized at a very much of a respectable number. Right now, it is hard for us to really give a very concrete guidance. But we expect that this game will continue, will provide very strong revenue growth for us, for our whole gaming business next year in 2018.
Okay. In terms of pipeline, we had in our PowerPoint that we have a very strong pipeline. Right now, we are looking at about three new games under the Eudemons IP, and three more new games under the Heroes Evolved IP. In terms of Eudemons, we would be looking at the interoperable version of our Eudemons PC. It should be a mobile version that interoperates with our PC version. For this version, we expect it to come out in Q1 of next year. Next year, I think the one that we are going to be looking for the most, from a revenue contribution perspective, will be a 3D version, a new mobile 3D game for Eudemons Online. This is a game which we expect to launch in the second half of next year.
This is a game which we are going to be really targeting very much of the young audience. This is a game that we are very much looking forward to. In terms of Heroes Evolved, as I have mentioned in the past, we have a first-person shooting game coming out. This one is going to be coming out, we are doing testing in Q4. This game is likely going to be coming out in Q1 of next year. Then we have a card game as well, which is likely going to come out in the first half of next year. We also have an SLG game. This game, the launch date is not confirmed yet, but it will come out next year.
We do have a very strong pipeline of various games, which, as we said in our press release, I think from a visibility and a quality perspective, and also from a revenue kind of perspective, we believe that our pipeline is stronger than ever.
Sorry. Let me jump back in terms of education. I apologize. Actually, I can share with you on something about Malaysia, because this is public knowledge. The Prime Minister of Malaysia, Najib, is actually in his 2018 budget presentation, actually, to the cabinet and to the public. This is actually, you can get it on the wire. He has committed to roll out 2,000 classrooms next year with a budget of MYR 190 million, roll it out in the next three years, covering the nation. My apologies. I did have something to share on that one.
Thanks. Really helpful.
Okay. Thank you. Next.
Again, for those who wish to ask questions, please press star one and wait for your name to be announced. You may also ask your question in English or in Mandarin. Your next question comes from the line of Hillman Chan from Citigroup. Please ask.
Hi, Simon, Ben, and Maggie. Thank you very much for taking my questions. My first question is regarding your ClassFlow. Could you update us on the growth of the user as well as the progress with the monetization, please? And then, on the gaming part, could you share the grossing split between iOS and Android for mobile Eudemons and also the margin profile if possible? Just now you mentioned for the 3D version of mobile Eudemons in second half next year, who will be the publisher for that title? Thank you.
Okay. Thank you for the question. In terms of ClassFlow, because of the fact that we still have a lot of people using our legacy software called ActivInspire, we spent the last few months working with them and getting them ready to move over to ClassFlow. Strictly from a ClassFlow perspective, it is actually we have the only modest increase, but we expect to see a big surge in ClassFlow users in the beginning of next year on two factors. One is actually the conversion of all the ActivInspire users over to ClassFlow, plus some of the major projects that we have signed throughout the year in the U.S. and also in Europe, plus some of the One Belt One Road activities that we are working on that will help the big increase in next year.
And then, for the 3D version, Ben, why don't you take that question?
Yes. For the 3D version, it's a great question, but unfortunately, we're not able to share that at this point. We're actually in the process of discussing with potential publishers. We will share that as we can.
Okay, thanks.
Okay. Thank you, Simon, Ben and Maggie.
Your next question comes from the line of Susanna Chui from DBS. Please ask.
Simon, Ben, and Maggie, congratulations for the great result. I would like to update about the progress of the content monetization in the international market. How was the progress? Because it would be supposed to be launched in December. The second question is, the international market grew strongly. We know that your China teacher base reached 1 million already, and we would like to update about the teacher base number in the international market as well. Thank you.
Okay, thank you for the question. I did answer the question, I thought, on ClassFlow. The growth is actually in the ActivInspire usage, and then we need to convert it over to ClassFlow so we can take it offline to go into more detail. For monetization, which is actually social commerce, we are getting ready to do the launch. We are looking at whether we should be launching it right now, to be honest, because it is actually Christmas season. We may not launch it in December because of that. But we will definitely launch it very very soon, certainly looking at the content. My apologies is not to have a lot of detail because we are looking at what is the right time to launch.
Okay. Thank you.
Your next question comes from the line of Ryan Roberts from MCM Partners. Please ask.
Good evening, Simon, Ben, and Maggie. Thanks for taking my question. I actually wanted to ask about the China business, the education business in China, rather. Could you give us some color on how the margin, how that shaped up from quarter- to- quarter, and also give us a sense, because I understand the revenue recognition is delayed, is pushed into Q4. I am just wondering what kind of impact that is going to have on the margin, because I am not sure if you are recognizing costs first or alternatively how you look at those contracts in terms of revenue versus cost recognition. Any color there would be great. Thanks.
Actually, in general, I will let Ben go into detail. I think from a revenue perspective, once we build up the backlog, I think from a revenue recognition, so you will see.
Yeah, Ryan. In terms of the margin, in China it is really all over the place because our tender is really a combination of hardware, software, and services. The margin can actually go anywhere from single digit to 20%-somewhat . If you look at our Q3 China margin is actually around 27%, which is the gross margin in China. But some of the hardware-oriented tender can go as low as 3%-5%. I think it is really all over the place. And in terms of the margin of the backlog, we are looking at about CNY 350 million.
Actually, Ryan, I think one of your question is actually whether we will recognize the cost first and then the revenue—
Yes.
—we won't. Actually, we match. We're going to match it.
Matches. Got you.
Yeah. We're going to match it.
Okay. Maybe, so that's condition and then some other fixed expenses are higher kind of in the quarter. I'm just kind of curious how we should interpret that. It looks like if you're investing in a headcount and you're investing kind of in the more kind of marketing spend to drive growth, that's a very good thing. I'd just like to get a sense of just kind of from a mechanical standpoint, technical standpoint, how that's going to impact the numbers, I guess now and also kind of as you look out ahead as well.
Yeah, I think from a head standpoint, we add in both areas, right? One is R&D, the other one is SG&A. I think you're really talking about SG&A. I think in SG&A we add in, again, two area. One is actually because, as you know, China is a big market, so we need to cover it. We adding some headcount, so we can cover more kind of territories and all that. The other one is actually we also add the headcounts to go in really revenue generating, because it's all actually more geared towards the engagement piece. The other ones actually are, they are sales-oriented.
Got you. Okay. Thank you very much, guys. And congratulations on some nice top- line growth.
Okay, thank you.
Thank you.
Again, for those who wish to ask question, please press star one on your telephone and wait for your name to be announced. You may ask your question in English or in Mandarin. Your next question comes from the line of Jian Song from Industrial Securities. Please ask.
Good evening, Simon, Ben, Maggie. Congratulations for the good season. I have a question about the gross margin. This is first question. You said that the installation of 101 Education PPT in China is achieving the goal of the whole year. I want to know, what's the DAU or MAU of the 101 PPT? For the game plate, I want to know the proportion of the mobile game and the PC game, and if there is any plan to make a new game in the future. Thank you.
Yeah. Great. Sure. You have several questions. Let me address the gross margin question first. If you look at the gross margin for Promethean, this margin is actually affected largely by the Russian tender. The Russian tender margin is roughly about 12%-13% gross margin. You have to keep in mind that because we have almost no incremental SG&A from the tender. That's why it's all going to the bottom line, right? If you take out the Russian tender, we're looking at about 30.2% gross margin for Promethean, and that is what we have been guiding all along. Going forward, in terms of the gross margin guidance, yes, we expect excluding Russia, our gross margin and potentially other emerging market large tender, we will be looking at roughly about 30% gross margin going forward for Promethean.
In terms of the 1 million teachers, install base of teachers in China, you asked the question about how many active users there are. Basically, our strategy is really have been to get the teachers to install our software and then we follow through to really engage the teachers and get the user activities to pick up, and that will take some time. If you look at the current MAU at the moment, it's roughly about 20% of the 1 million teachers, which is on a monthly active basis. We're not measuring by daily active at the moment because that will take a little bit of effort on user engagement and getting the activities to come up.
A comment on some of the emerging market kind of gross margin situation. To Ben's point, because it's actually by nature, they are big tenders, so they tend to be lower margin, but we will have maintained a higher margin in our key market like U.S. and Europe. There's also a possibility that the whole, I would say the model will change rather than a, in some cases, rather than a buy and sell, we could create a subscription model out of it. That would change the whole structure of the business in some of the countries, which I'm happy to take you guys through offline, not on this call. We are looking at turning our business into more subscription type model, so to make our revenue more predictable.
By the way, you have a question on mobile games. Do you mind repeating that?
Yes. I want to know the proportion of the mobile game or the PC game revenue.
Yeah. It's about 19% mobile game. Yeah. In terms of the revenue contribution from mobile games in Q3. It is an increasing contribution.
Yes. Do we have any IP to develop in the future?
That's a great question. For now, we're going to be focusing on developing our building on our flagship IPs, which is Eudemons and Heroes. We are working on it. In terms of the other IPs, we are strategizing at the moment, but we cannot really disclose.
Working with Universal, so we can tell you that, because it's actually we are working with them on both Dragon and Madagascar. We are fully expecting also called Neopets, which we have not talked a lot about, because this is Q3 announcement, so it didn't impact Q3. But, in subsequent phone calls, I think Ben will be happy to take you through. In the future, when we think about gaming, we need to think about both JumpStart and also the NetDragon gaming going forward. Okay? Thank you.
Okay. Thank you.
Thanks. Yep.
Your next question comes from the line of Eric Qiu from CCBI. Please ask.
Hi, Eric.
Mr. Qiu, your line is open. You may ask your question.
Hi, can you hear me?
Yes, Eric.
Good evening, Simon, Ben, and Maggie. Congratulations to the very solid result. I have one question regarding your education business in domestic market. How do you think the progress so far, does it match your year beginning expectations in terms of the revenue or in terms of the school and teachers' coverage in 2017? What is the plan in this regard for 2018? Thanks.
Actually, we are tracking in terms of top line. That is why we are quite happy with the record quarter and also with the backlog. In terms of we talked earlier on teacher acquisition, which is actually we achieve it ahead of time, which is actually good news, so we expect this to continue. We are also seeing some very encouraging sign in some of the projects we are working on, which we cannot disclose at this point. We are seeing very solid kind of progress in terms of our business in China. That is why when somebody asks us about our goal to break even in terms of our business, is actually we are looking at 2018 or 2019, depending on whether we want to make additional investment in a certain area that we are looking at.
Unfortunately, we cannot give you the detail, but that is what our expectation will be for 2018.
Okay. Our main products now are still the ClassFlow. Besides that, do you have some other products will come out?
No. It is actually we have a product called 101 PPT, which is actually specially designed for China. Which is actually is our ClassFlow equivalent, if you will, for China. That is our main product for this year. But we are also tracking well in terms of our VR activities. We are seeing good momentum in that one. That is another main product that we are pushing. That is what we have been doing for the last few months.
Okay. I have a follow-up question regarding to the M&A we have made in last one or two years. What is the synergy progress from them? Can you give us some color on that?
A ctually, if you look at our education margin, and we turn around the business, is actually also contributing to the bottom line. We are also using, if you remember, when we did the acquisition of Promethean, we said we are acquiring them because of the user base and also because of the channels that we have all around the world. Because of that and because of some of the additional resources we bring in and also some of the markets starting with Moscow, and we talk about some of the other possibilities. That is going really well.
In terms of other acquisition, for example, the ChiVox, the AI company and big data company that we bought in Suzhou, is actually they are providing a lot of the key technologies that we have in different products that we have been developing and we are developing, that we put on the market. One being a B2C market called English Galaxy, that we have launched just recently in Asia, which has an assessment engine, which is actually based on the technology that we have from ChiVox. They are also working on helping the Chinese government to do English exam assessment. We are making impact in that area.
JumpStart we only acquire about a couple months ago, and I talk about the leverages and synergy between JumpStart and Promethean, and also the synergy of bringing their games into a market in Asia, especially for China. We expect them to contribute not only to the top line and also to the bottom line of our business. Okay?
Okay. Thank you. Very helpful.
Thank you, Eric. Okay. As there is no more questions, we will now conclude the call. On behalf of NetDragon and also the team, thank you for your time, and I will talk to you soon. Thank you.
Ladies and gentlemen, that does conclude our call for today. Thank you for participating. You may all disconnect.