Good evening, ladies and gentlemen. Welcome to NetDragon's 2017 First Quarter Earnings Conference C all. 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 time for a Q&A session. But 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 forward-looking statements, which may not be relied upon in the future for various reasons. Non-GAAP data is included as part of this presentation. 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. Thank you for joining us at this call, especially for those of you who are in Hong Kong. For those of you who are not in Hong Kong, we've been raining cats and dogs in Hong Kong the whole day, so I hope that's a good omen. In Hong Kong, we do believe water is good, so I hope that's an indication, not only for Q1, but for the rest of the year.
I think I can sum it up by we are on our way, which is actually, I think that tells a lot about our story. Let me start with that. I'll go into giving you some highlights of what we've seen in Q1, and then Ben will follow by giving you a lot more details in terms of the financials. Then I will come back and give a little bit of the outlook, and of course, we'll open up for question and hopefully some answers.
Let's start with the learning side of the equation. We are stepping up to grow our business. When we look at our business in terms of growth, we look at three different areas. One, of course, is revenue. The other one is actually the contracts that we signed that have not shipped. And the third one will be our pipeline. We are very confident that our business will grow as we expected in the last earnings call. In China, we are seeing traction because we are working with different education authorities in different provinces and cities that will help us to build our community.
One of the things that we talk a lot about, and you also hear about that in the market, is actually One Belt, One Road, which is actually one of our strategies in terms of growth. We are getting a very good traction with the announcement of our partnership with the Moscow government. Our first delivery will be close to 8,000 classrooms, covering about 14,000 teachers. Just case in point, Moscow in total has 27,000 classrooms. You can read between the lines there.
We are doing a lot of work, including pilots, in a lot of the countries along the One Belt, One Road kind of area. We cannot give you the detail right now, but we are very happy with the development, and hopefully in the next call, we can share with you with more detail.
On the product side, is actually we had a very successful showing at BETT in Q1, which I think you all heard about, is one of the premier education trade shows for Europe. We are being recognized as the star of the show. Not only because of the new product that we launched, both hardware, which is the version five of our hardware, and then Classroom 3.0. It is also because of the fact that we integrated a lot of the resources we have within NetDragon, and we show it as one company. We offer a lot more than just a classroom solution. We are getting good traction.
Another area that we are pretty happy about is actually that all the hard work that we have done in rationalizing our cost structure, especially in Promethean, is actually we are seeing a good impact in Q1. Again, Ben will take you through some of those highlights. We continue to build our community in both China and overseas.
Okay, turning over to gaming. It is a record quarter for us. I do not know what else can I say. If you look at the year-over-year growth, actually all the numbers are very impressive. We are very happy with that. It comes in different areas. ARPU increased, the mobile gaming gaining traction, and of course, it really helped on our bottom line. One highlight is our ARPU grew by over 50% year-over-year. That is very, very impressive. Again, this is kind of nothing new for us. If you remember what Ben and I talked about in our last earning call, we kind of predicted this or give you some indication of what we expected.
Also the games are getting some good recognition in the market. One of the game called Heroes Evolved is getting a lot of accolades, and also a game called Tiger Knight is being included in the PlayStation platform, which give us access to the Sony PlayStation users, which is actually very exciting for us.
With that, I am going to turn the call over to Ben, and he will give you some highlights in our financials.
Thank you, Simon. Let's take a look at the overall financial highlights on page 10. I think the highlight of this page is that, as you can see from the headline in our press release, we achieved a positive EBITDA in this quarter. Also, if you look at the non-GAAP operating loss, this figure was narrowed by close to 60% year-over-year at CNY 45.7 million. I think a big part of that is driven by our strong profitability growth of our gaming business. Also, as for the education business, a lot of it is the cost savings that we have achieved over time after our acquisition of Promethean. These are the two main factors that are driving us to achieve a positive EBITDA and a significant reduction in our non-GAAP operating loss.
If you turn to the next page, in page 11. Basically, if you look at the bridge here, a few highlights. As you can see, growth of our gaming business, very robust, contributing to a large part of our improvement in our bottom line. Also, you look at the CNY 13.6 million reduction in the Promethean OpEx. That is a result of a lot of the cost rationalization, a lot of the product rationalization, a lot of the efforts there that we have made over the past few quarters.
If you look at our Promethean, our international education business, across the board, we have achieved cost savings in development, sales and marketing, as well as administrative costs. Across the board in the SG&A, we have achieved a reduction there. Yet we are expecting a robust growth of revenue this year compared to last year. More top line, less cost, more bottom line there.
On this page, another point I want to highlight here is, you can see a decrease in the education gross margin here, CNY 25.6 million here on this page. I want to mention a little bit of details behind this number here. First of all, as you all know, Q1 is a slow season for the international education business. That slow season means less revenue, which also means less gross margin.
The other point that I want to make here is the lower gross margin here in this quarter is also due to a couple of other factors. The first factor here is that in Q1, as you may recall, we had a large tender win in Russia. That tender win entails a lower gross margin because of the sheer scale of that tender. We are happy about it despite its lower margin. This lower margin tender will contribute to a lower overall gross margin for our entire business.
The other factor that I want to mention is that in Q1, we have also been selling down a lot of our so-called end-of-life or discontinued education products in our international education business. The sell-down of such inventory also would reduce in the lower margin.
We turn to the next page. In terms of our segmental financial highlights, I think on this page, a few trends that you can notice here. First of all, very strong growth of our gaming business. Strong growth year-over-year and also quarter-to-quarter. A lot of operating leverage, strong gross margin of our gaming business, 94.7% compared to 92.6% in the last quarter. A lot of growth in the core segmental profit for our gaming business, increasing from CNY 98 million to CNY 168 million. As you can see, because gaming is a business of tremendous operating leverage. As you grow the top line, a lot of that will flow to the bottom line.
As for the education business, you can see that we achieved a good year-over-year growth of our education revenue, despite the fact that the Q1 is a slow season for our international business. But then as you can notice that our core segmental loss for our education business actually remained flat in Q1 versus Q4. A lot of that is despite the reduction in the sequential revenue. You can see that a lot of that is because of the cost savings, again, that we have achieved over time. Again, across the board, you look at R&D and administrative expense, as well as selling and marketing expense, we have achieved a lot of reductions in the cost there for our international education business.
Over to our next page, some financial highlights for our learning business. A little bit of overlap compared to what I just mentioned. Again, looking at Q1, a steady Q1 international revenue performance. This is very much consistent with the historical seasonality that we have been seeing in this market for the last many years.
I want to mention a point on gross margin again. If you look at the gross margin on the previous page for our education segment, it actually reduced quite a bit from 29.6% to 23% year-over-year. I want to say that a lot of it, again, is primarily due to the Russia deal because of the sheer scale of that deal, and also because of the fact that it has a lower margin. Also, if you look at the product rationalization that we have been doing, that has resulted in a lower margin as a result of the inventory management that we have done in Q1.
If you take out the Russia deal factor and also the inventory cleanup factor, the normalized gross margin, so to speak, it is relatively stable at 26.5% in Q1 versus 27.1% in Q4. If I were to mention normalized gross margin for our international education business, that figure is about 28% in Q1 compared to about 29% a year ago, year-over-year. As you can see, normalized gross margin, very stable.
In terms of the cost optimization, as I have mentioned, again, a lot of efforts in the past is starting to pay off. You look at our international education SG&A, a big reduction by 13% in Q1 year-over-year. A little bit of guidance here on Q2 because we are in June already, so we actually have some visibility here in terms of Q2. Actually, by the end of Q1, we have been seeing a lot of actually very strong pipelines going into Q2, and that is why we do expect that Q2 this year is going to be big, especially for our international education business from a revenue standpoint and also from a profitability standpoint. We do expect Q2, we are going to have a substantial profitability for our international education business, and that will be a big turnaround compared to Q1.
In China, we are continuing to focus on user growth. Again, ramping up our user numbers. But financially speaking, we did deliver solid growth in Q1 with over 100% increase in revenue, and also our contracted sales of over CNY 60 million in Q1. Also by the end of Q1, if you look at our backlog, we actually have close to CNY 160 million of sales orders that have been signed but not yet recognized as of end of Q1 because of delivery and also customer validation.
Turning to the next page on gaming. I think Simon has mentioned this quite a bit. Q1, again, robust growth of 40% year-over-year revenue growth on the back of the success of our core games, Eudemons Online and Heroes Evolved. Again, segmental profits, huge growth. The growth rate basically double our revenue growth rate at 79% in Q1. Mobile gaming is particularly encouraging. Again, we double our mobile gaming revenue in Q1 year-over-year.
ARPU, again, increased by over 50%, and a lot of it is a result of our continuous work in terms of coming up with different types of monetization schemes. For example, if you look at Eudemons Online, we have launched a MOBA monetization scheme, leveraging a lot on what we've done in Heroes Evolved, the success of the MOBA scheme, and we are basically migrating that scheme into Eudemons Online, and we are seeing a lot of success. Also, the other thing is for Eudemons Online, we have done quite a bit of activities during the Chinese New Year, so that's also driving the growth in Q1 as well.
Looking forward, if you look at our second half and also the rest of the year, we do have new games that we're expecting to be launched. For example, we have the new mobile version of Eudemons Online. We also have Tiger Knight, the Chinese version, which we're expecting to launch the second half of this year. Also for Heroes Evolved, we've been seeing very robust growth in terms of users. We have DAU of over one million and MAU of over five million, and we're expecting to accelerate the monetization for the rest of the year since we have been working a lot on getting the users and also increasing the stickiness in Q1 .
So that's why, again, for the rest of the year, we expect that we'll continue to accelerate the revenue growth on the back of continuous strength of our core games, Eudemons Online and Heroes Evolved, as well as the revenue contribution from our new games.
With that, I will turn back to Simon with some words on the outlook.
Okay. Thank you, Ben. Let me just do it quickly. It's actually looking out to the rest of the year. If I may remind you, going back to the last earnings call we have made some commitment. Basically, company will be profitable. It's actually, we are continuing to commit to that. We're seeing good traction on that one. Mainly because of, again, what we've kind of anticipated. One is gaming. We have a record quarter one, and we expect the performance will continue on the back of strong monetization, new games like that Ben will talk about, and also the increase in mobile revenue.
On the education side, a combination of our success in the One Belt, One Road initiative, plus in our core market, we're also seeing good growth. So we expect the international business will turn a profit this year. At the same time, the international business will grow even faster than last year. If you remember, we grew 25% last year. We expect to grow even more than 25%. In China, we continue to gain traction. We talk a lot about it, so I am not going to repeat it. Revenue growth will be on track. To summarize, Q1 is actually we are on track, and we are on our way to profitability.
With that, I am going to stop, and then I will hand the call back to the operator for Q&A.
Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. Thank you, Simon and Ben. Now we will begin the Q&A session. Please feel free to ask your questions in English, and please stand by while the operator poses the first question. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. As to be equal to all the participants, please limit your questions to one or two questions at a time. If you have any further questions, please press star one again. The first question comes from the line of Ryan Roberts from MCM Partners. Please ask your question.
Simon and Ben, thank you very much for taking my question. Congratulations on the quarter. I had a couple of questions. First one is on the game side. Could you break out for us how much was mobile and how much was PC? I did not think I caught that. I have a follow-up on education.
Okay. Why do not Ben can give you the breakdown right now?
Yeah, sure. So in Q1, the mobile gaming is 15.7% of the revenue, and the rest is the client-based games.
Oh, great. Thank you for repeating that. Appreciate that. My question on education is just I want to make sure I understand the numbers, the metrics you were disclosing earlier. So your backlog is 60. These are orders that have been received, that are booked, that have not been delivered? Or did you mean that in addition to the Q1 numbers that we have, we have a backlog of 60.
Yeah, 60 is the orders that was signed in Q1. So that would include revenue that has been recognized in Q1 and those that has not been recognized in Q1 because they have not been validated yet.
Okay, so we have a backlog of roughly 28. And just generally speaking, what's the-
I just want to make sure. Sorry, I just want to make sure that number that Ben told you is about China.
Right.
Okay, so it's actually not all education. Sorry if I repeat myself.
I'm sorry. Yeah.
about-
No, yeah, I thought that was kind of the domestic business. Just, could you remind me just briefly, roughly how long does it take? Could we expect that to be recognized, let's say from shipment to revenue recognition? Is that usually a three-month, six-month kind of window? Any kind of color you can provide on that would be wonderful.
I think conservative speaking, it would be roughly about three to six months.
Okay, great.
From the order to getting it recognized.
Got you. Okay. That's very helpful. Thank you very much. I'll get back in the queue.
Thank you. The next question comes from the line of Thomas Chong from Bank of China International. Please ask your question.
Hi. Thanks for taking my questions. I have a quick question about our App Store and content stores initiative, as well as our goal to reach cumulative users of 10 million for the education business in 2017. Any latest updates on that front? Thanks.
Well, let me talk about the App Store and the content store. Actually, you are missing one, but also the social commerce platform. We are looking at launching it in Q3. I mean, we are in June already, and then we expect, so we have the full run in Q4, so we can, how should I say? We can establish the model. We can move into full force in 2018. I think App Store and content store are pretty easy to understand. I think for social commerce platform, it would take quite some time to explain the detail, and we love to do that, by the way.
Maybe with that, maybe I would do a little bit of commercial. We intend to run the event on July 4th. It is actually designed for somebody like yourself, that we have the opportunity. It is a full day event. Half a day is actually for the media. The other half of the day for investors. In the event, our intention is to walk you through the details on how the monetization strategy for the community, rather than doing it in 30 seconds on a call. July 4th, mark the date.
Got it. Thanks.
Thank you. Once again, ladies and gentlemen, 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 your request, please press the pound or the hash key. We have a follow-up question from the line of Ryan Roberts from MCM Partners. Please ask your question.
Hi, guys. Thanks for taking my question again. I just actually had a follow-up on the ARPU. That was really impressive. I am just wondering if you can give us maybe some more detail on how we saw that much growth, and whether or not we think that is sustainable going forward. Just any kind of color you can offer there would be very helpful. Thank you.
Sure. First of all, we believe that ARPU is sustainable if you break it down into games. Second of all, I think as our new games will be launched, I think we are going to have a little bit of a game mix issue here. Because if you look at Calibur of Spirit, as we increase the monetization for our mobile version, I think the ARPU may go down a little bit because Heroes Evolved is a more casual game compared to Eudemons Online, so the ARPU is a little bit lower. If you have a stronger mix from Heroes Evolved, then the overall ARPU is going to go down.
But if you go back to looking at just Eudemons Online, I think this is really an accumulation of a lot of the work that we have done in the past few years. As I mentioned on the call, we have been trying out a lot of the different monetization schemes, and especially if you look at the MOBA monetization scheme that we have been migrating from Heroes Evolved, we have found a lot of success there. Also several other schemes that we have done are just paying off at the moment.
The other thing is, if you look at Eudemons Online pocket version, we have actually seen a lot of growth for that game year-over-year and also sequentially. So that game also, again, because of the growth of that game, and with the monetization schemes being very similar to the PC version, that is also another factor that is contributing to the overall ARPU increase.
If I may, I will add a couple of points here. Actually, I think the ARPU we can maintain, but I will put it in quotes, because one thing very important is actually we are also ramping up the mobile users, so there will be some mix issue going forward. I should not say mix issue. But I think that we can maintain the ARPU, but probably not the growth rate. I want to make sure. I wish we can.
Gotcha. Okay. Thank you. Thank you very much for the color, you guys. Thanks.
Thank you.
Thank you. Once again, ladies and gentlemen, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. We have the next question from the line of Eric Hui from CCBI. Please ask your question.
Hi. Good evening, Simon and Ben. Thank you for taking my question. I have one question regarding the VR application. Could you give me some concrete examples of your VR techniques combined with the education product? When should we expect some really meaningful or significant contribution of revenue or product shipments combined with the VR? Thank you.
You were breaking up. I know you asked a question about VR. Did you say VR in education?
Yes. VR combined with your education product.
Oh, I see. We are at the very beginning of rolling out VR. Essentially, we have a very different strategy. Again, let me try to do it in a very short time, and then I'm sure I can't take you through the whole thing, and then please come to our event on July 4. The way we're going to do it is actually no different from our gaming. We are going to be rolling it out, because the key is actually to have a lot of people using it. Essentially, what we do is actually we are looking at rolling it out as a freemium at the very beginning, so that a lot of people will embrace the product. Then we have monetization strategy going forward.
We do believe the rest of the year, we're going to spend a lot of time basically evangelizing, not only just our VR product, it's actually our VR product, also our AR product, also our 101 PPT product and also ClassFlow. We are evangelizing the platform. Then going forward, then we can monetize it with premium content and with other methods to do it. Again, the rest of the year to probably first half of next year is evangelizing, and then we start seeing the revenue coming in from an education standpoint. Thank you.
Okay. Thank you.
Thank you. Once again, ladies and gentlemen, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. We have the next question from the line of Susanna Chui from DBS. Please ask your question.
Hey. Hi, Simon and Ben. Actually, we see that ChangYou launched their TLBB very successful. We, as the investor, also very looking forward to your Eudemons Online mobile. I would like to update that when it will be launched, and I would like to know what is the margin differences between the mobile version and also the PC version. Given that you see the online game profit last year is over a few hundred million CNY, does it mean that if your Eudemons mobile very successful will turn NetDragon back to the profitability sense?
Sorry, Susanna, I think your voice did not come through very clearly, so just let me clarify. Your question is on your Eudemons Online, right?
Yes. The mobile version, which will be published by Kingsoft. Yes.
Okay. Yeah. We expect to launch the Eudemons Online mobile, our second mobile version, in Q3 of this year. We are on track to launch it in Q3.
Okay.
Yeah.
I would like to ask, will your gross profit margin be different from the PC version because you have to share the profit with Kingsoft?
Got it. Yeah. I think you can compare this mobile version with our own pocket version, also the PC version, right? Obviously, PC version, we operate it ourselves. There is no App Store, no mobile platform, so we have over 90% gross margin, right? That is easy. Then you look at our pocket version, we also operate ourselves, but we have to share revenue with the App Store and also the other Android platforms. I think the profit sharing, it is just market practice, market rates. But if you look at Kingsoft, obviously, since the Kingsoft version, obviously, because we are working with Kingsoft, so we have to share a little bit of revenue to Kingsoft in addition to sharing revenue to the mobile, the App Store, and the Android platforms. The ultimate revenue share that we would get would be lower than our Eudemons Online, our own pocket version.
Our cost is lower.
Exactly. Because we do not have to do our own marketing.
Okay.
That is it.
Okay, and I would like to ask you if you think that the Eudemons Online would be very critical factor for leisure and profitability because if the Eudemons mobile can be equally equal to the Eudemons Online, it will contribute a lot to the online game profit, right?
Yeah. Let me put it this way. Because you used the word critical, right? I would say our ability to maintain our growth rate for our gaming business this year, is not going to be too much dependent on the success of our Eudemons Kingsoft mobile version. Let's put it this way. As far as our existing PC and pocket version of our Eudemons Online game, we are confident that we're going to be able to sustain the current level and also maintain the type of year-over-year growth that we're seeing in the first quarter.
Okay.
Well, I think let's put it, Susanna, let's put it into perspective, because that's one of the many games that we're going to launch in the second half of the year. So, it's actually I mean, we want it to perform well, but at the same time, it's actually one of the many games that we're going to be launching. So our risk is actually well spread out. I think that's the key point. We are very bullish about our gaming business for the rest of the year because, again, like Ben said earlier, we are already in June, so we know what's happening.
If you look at Q1, in Q1, we haven't even launched some of the new games. All in all, I don't think we should worry about one versus the other. It's actually our overall growth, our output going up, mobile game ramping up, mobile users ramping up, and then we have more than one mobile game. So it's actually everything is actually working for us in terms of the growth. I think that's the key message I would like to give.
Okay. Thank you.
Okay. Thank you. Thanks, Susanna.
Thank you. Once again, ladies and gentlemen, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. There are no questions at this time. I would like to hand the conference back to the speakers. Over to you, sir.
Okay. Thank you. Well, once again, thank you for joining the call. I hope we answered most of your questions, if not all. Again, let me summarize. We are very bullish about the year. I think we're going to be making our commitments, if not more. Just to do the commercial one more time, mark the date July 4th. We are looking forward to receiving you and taking you through in more detail about our gaming business and also our learning business. Okay. Thank you so much.