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Tuesday, March 6, 2012
Giant Interactive's Management Discusses 4Q2011 Results - Earnings Call Transcript
Giant Interactive Group, Inc. (GA) Q4 2011 Earnings Call March 5, 2012
Ms. Jazy Zhang, Chief Financial Officer
Good morning and good evening everyone. First, I would like to read the prepared remarks from our President, Ms. Wei Liu, and then I will walk you through our financial highlights and update you on our game development efforts.
We concluded 2011 with solid fourth-quarter results and delivered another year of consistent growth from both the financial and operational perspective. Our progress throughout 2011 was made possible by our long-term strategy of focusing on developing games with passion and creativity, games that are of the highest quality and games that are fun to play and that engage and broaden paying user base.
ZT Online 2, our new flagship game, has been the main growth driver over the past year, supporting the steady increase in paying accounts and average user -- sorry, average revenue per user. The success of ZT Online 2 has proved the merits of our game segmentation strategy and our strong internal development capability. We’re very proud of ourselves, that even in this increasingly competitive MMORPG market in China, we were able to produce another hit MMO game. We’re highly confident that with its first expansion pack expected to be released in April 2012, ZT Online 2 will continue to grow and achieve greater success in 2012.
With respect to our growth strategy, first, we will continue to focus on MMORPG as we believe it’s still the most profitable segment of the online game market in China, and this is our core competence. Meanwhile, we’re actively working to enter new game genres and new growth areas in China’s online game market. For example, Elsword, our first action casual game which we licensed from South Korea, entered into new open beta testing in December, and our first-person shooter game continues to progress through our development pipeline. Both games represent new genres that are complementary to our core MMORPG competence.
Secondly, as we indicated on our last quarter earnings call, we have a new strategic focus, and this is web game development. As social media and web-based gaming platform usage rapidly expands in China, we are aggressively working to position Giant as a future leader in this segment. We recently hired a senior industry expert in web game development and have allocated significant internal RMB resources to web game development this year and beyond. Given our years of extensive experience in developing and operating MMO games, our deep understanding of web game characteristics and user preferences and our progress made in web game graphics and technology, we believe we are well-positioned to deliver a few hit games in the near future.
Thirdly, we will introduce micro-client versions of our popular games to attract a wider range of players by operating the micro-client versions of our games jointly with various platforms. We believe we will reach out to a much broader user base and bring the additional revenue growth. We’re also targeting some longer-term development opportunities such as the mobile game segment. We are closely monitoring developments in this area and exploring ways in which we either internally or with partners can leverage our experience and capabilities to further expand our game portfolio and game platform.
And finally, we continue to focus on opportunities in game licensing and partnerships in overseas markets. We have already had success with games such as the Golden Land in multiple jurisdictions, and we successfully licensed ZT Online 2 in Taiwan in the first quarter 2012. We have a dedicated internal team focused on international business development opportunities, and our position as a leading game developer and operator in China makes us a compelling choice for international partners.
To maintain the growth momentum and to further bolster our internal development capabilities, we have reorganized our game development teams into various subsidiaries that are 51% owned by Giant and 49% owned by members of the development teams. The game studios will focus on producing and supporting internally developed games and will have a direct stake in the success of those games through a revenue-sharing plan as well as individual P&L responsibilities.
We strongly believe such a reorganization plan will incentivize our game developers, improve productivity, and effectively control expenses. From a financial perspective, our game studio reorganization may cause our net margin to decrease by a few percentage points, but we believe this approach will help increase top-line revenue as well as bottom-line net income growth. We are confident that this strategy will help us success in this competitive market.
Looking to the year ahead, we’re confident in our ability to deliver continued steady growth with many new value-driving events slated for 2012. Our financial position and balance sheet remains strong. And as a result, our Board of Directors has declared a cash dividend of $0.30 per ADS or ordinary share. The total cash payment will be approximately $70.6 million. Our increased dividend payout demonstrates our commitment to maximizing shareholder return and confidence in our business outlook. We will continue to focus on generating positive returns for our investors in the year ahead.
This concludes the opening remarks from President Liu. And now I will walk you through our financials. Let me now turn to our key operational metrics for the fourth quarter on slide six. The Active Paying Accounts or APA grew 3.9% sequentially and 28% year over year to $2.167 million. Average Revenue Per User or ARPU was RMB221, up 1.8% over last quarter and up 2.8% over the fourth quarter 2010. Average Concurrent Users or ACU was 667,000, a 0.9% sequential increase and a 14.3% increase year over year. Peak Concurrent Users or PCU was up 1.8% sequentially and up 36.5% year over year to 2.339 million.
The increases in our operating metrics were largely driven by the success of ZT Online 2 which has attracted a large and diverse audience who are increasing their in-game spending as they become more accustomed and comfortable with the game and its third-generation in-game economy. Meanwhile, the operating performance of ZT Online 1 remains stable, with the first expansion pack for ZT Online 2 expected in April and continued progress in our development pipeline, we expect to see continued improvement in our operating metrics in the year ahead. The success of ZT Online 2 and the continued stable performance from our other games allowed us to deliver solid financial results for the fourth quarter and full year, as seen starting on slide seven.
Net revenue for the quarter was $78.6 million, an 8.1% increase from the third quarter 2011 and 34.4% increase from the fourth quarter 2010. Our core business, online game revenue grew 5.8% sequentially. For the full year, net revenue was $284.8 million, an increase of 34.5% over the full year 2010.
Gross profit for the fourth quarter 2011 was $67.9 million, representing an 8.3% sequential increase and a 37.3% year-over-year increase. Gross margin of 86.3% was up from 86.2% in the previous quarter and 84.5% in the fourth quarter 2010. Full-year growth profit was $243.9 million, an increase of 34.5% -- 35.4% over 2010. Gross margin for 2011 was 84.6%, up from 85.1% in 2010.
Total operating expenses for the fourth quarter 2011 were $21.3 million, an 18% sequential increase and a 20.3% decrease year over year. The sequential increase was mainly due to higher R&D expenses and sales and marketing expenses in the fourth quarter 2011. For the full year, total operating expenses increased 4.2% year over year to $72.5 million. This increase was mainly due to increased R&D spending, marketing campaigns for new games launched in 2011, and less government financial incentives throughout the year.
R&D expenses increased 41.5% sequentially and 3.9% year over year to $11 million in the fourth quarter. The sequential increase was due to yearend bonuses and expenses related to newly-granted restricted shares. For 2011, R&D expenses were $36.6 million, a year-over-year increase of 23.7%, resulting from the expansion of the R&D department as we developed new products and enhanced our existing games.
Sales and marketing expenses were up 11.3% sequentially and 80.8% year over year in the fourth quarter to $8.8 million. The sequential and year-over-year increases were due to marketing campaigns launched in support of the open beta testing of ZT Online 2 and Elsword during the fourth quarter. Fiscal year sales and marketing expenses were $27 million, an 18.9% increase over 2010, due to new marketing campaigns for new games including ZT Online 2, XT Online and Elsword.
General and administrative expenses increased 9% sequentially and decreased 20.7% from the fourth quarter 2010 to $4.4 million. The sequential increase was mainly due to yearend bonuses, while the year-over-year decrease resulted from an increase in reimbursements related to our ADR program in 2011. For the full year, G&A expenses decreased year over year by 13.2% to $16.5 million due to stricter cost controls and increased reimbursements related to our ADR program.
Net income attributable to the company’s shareholders in the fourth quarter was $39.2 million, a 31.8% sequential decrease and a 6.6% year-over-year quarterly increase. The sequential decrease in net income was due to four factors. First, a sequential decrease in interest income due to our lower cash balance after payment of our one-time special cash dividend of $3 a share or ADS in September 2011. Second, a sequential decrease in other income which mainly included the foreign exchange gains in the third quarter 2011 as we obtained a more favorable exchange rate for the repatriation of cash for the special cash dividends, whereas in the fourth quarter there were no such gains.
Third, the sequential increase in income tax which reflected an income tax benefit in the third quarter 2011 due to the one-time recognition of RMB33 million in deferred tax assets, whereas in the fourth quarter 2011 there was no such one-time adjustment. And finally, a sequential increase in net income attributable to non-controlling interest, which reflected the reorganization of our game development studios as described in our earnings release. Now please allow me to further elaborate the financial impact of this reorganization plan.
Third reorganization plan is applicable to all of our internally developed games, except for the four games in our ZT Online 1 series. The ongoing development and support work for our other internally developed games will now be conducted by our reorganized game studios that are 51% owned by Giant and 49% owned by members of the relevant development teams. Giant or its designated wholly-owned subsidiary, [Sha], continues to be the sole owner of the game software copyrights for these internally developed games.
From a financial perspective, the company and the reorganized studios have agreed to monthly revenue-sharing plan where the studio receives 24% of its games revenue after deducting channel cost and business taxes. In certain cases, the company agreed to pay an upfront fee to a reorganized studio. From expense perspective, each reorganized studio is responsible for its own costs including game development and support expenses which mainly consist of labor costs.
Giant consolidates its financial results with those of the reorganized studios and then present a net income or loss attributable to the minority shareholders as a separate minority interest line item under the heading Net Income or Loss Attributable to Non-Controlling Interest. The company’s consolidated income attributable to its shareholders is arrived at after deducting the minority interest. Total minority interest related to our reorganized studios was RMB24.7 million and RMB26.4 million for the fourth quarter 2011 and fiscal year 2011 respectively. If games that are supported by our reorganized studios such as ZT Online 2 become more popular and profitable in the future, this minority interest amount will increase, which may result in a lower net income attributable to company shareholders.
The year-over-year increase in net income attributable to the company’s shareholders was due to the increase in game operations throughout 2011. Net margin for the fourth quarter was 49.8% compared to 78.9% in the preceding quarter and 62.8% in the fourth quarter 2010. Full-year net income was $139.8 million, an 8.5% increase over 2010. Net margin for 2011 was 49.1% compared to 60.9% in 2010.
On a non-GAAP basis, excluding non-cash share-based compensation, net income attributable to the company shareholders for the fourth quarter 2011 was $40.9 million, a 9.6% decrease sequentially and a 7% increase year over year. Non-GAAP net margin was 52.1%. For fiscal year 2011, non-GAAP net income attributable to the company’s shareholders was $172.6 million, an increase of 28.6% over 2010. Non-GAAP net margin for fiscal year 2011 was 60.6% compared to 63.4% in 2010.
Basic and diluted earnings per ADS for the fourth quarter 2011 were $0.17 on a GAAP basis and $0.17 on a non-GAAP basis. For fiscal year 2011, basic and diluted earnings per ADS were $0.60 on a GAAP basis and $0.74 and $0.75 respectively on a non-GAAP basis.
Moving on to our balance sheet on slide 10, as of December 31, 2011, cash, cash equivalents and short-term investments totaled $297.1 million compared to $300.2 million as of September 30, 2011. This decrease is mainly due to our $50 million investment in the Yunfeng e-Commerce Funds for the purpose of purchasing shares in Alibaba Group, and repurchases of our ADS according to a share repurchase plan approved by our Board of Directors in September 2011, which authorized the repurchase of up to $50 million worth of ADRs, partially offset by our free cash flow generated in the fourth quarter 2011.
We are pleased with the steady improvement in our financial performance throughout 2011 and we expect to maintain our steady momentum as we enter 2012. We will continue to focus on growing ZT Online 2 while investing in our game pipeline as we work to bring new hit games to the market. In addition, we will continue to focus on cost controls to deliver profitable growth going forward.
Now, let me give you an update on our game development efforts starting on slide 12. As a key element of our strategy, we continue to enhance our games with ongoing upgrades and the addition of new features. For ZT Online 1 series games, in the fourth quarter we launched a new ZT Online expansion pack introducing a new in-game profession, in addition to several customized in-game activities which helped to keep existing players engaged while attracting former players back to the game. We also introduced new game play features to ZT Online Classic Edition and released a new expansion pack for ZT Online Green Edition in the fourth quarter, which received a high level of attention and positive feedback from gamers.
As we have discussed, ZT Online 2 continues to perform well, attracting new users and new paying accounts. During the fourth quarter we launched a special holiday edition of the game for the Chinese New Year.
Concurrently, a large-scale cross-shard PK tournament attracted a high degree of player interest and involvement. So far in the first quarter 2012, we have licensed ZT Online 2 to the Taiwanese market and are continuously adding new features to keep players engaged. We have begun to prepare for the launch of the micro-client version of the game as well as the first expansion pack scheduled to be release in April 2012. We also released a new expansion pack for Giant Online in the fourth quarter with new equipment upgrading features and increased user [stitchiness]. We are continuing to enhance newly-added functions based on user feedback in the first quarter 2012.
We also released the first expansion pack for XT Online in the fourth quarter since its open beta testing in September 2011, with an emphasis on enhancing core PK-oriented game plays, increasing interaction and competition among players. We intend to roll out a second expansion pack in the current quarter.
Moving on to the Golden Land, which has become our most broadly-licensed international game, we continue to optimize across previously released functions. The Korean version enjoyed great popularity among Korean gamers and remains popular in Taiwan and Japan. The US and European versions entered open beta testing in October 2011 as scheduled. The Spanish version completed closed beta testing in the fourth quarter 2011 and the commercial launch is expected in the first quarter 2012.
Turning to our two licensed games, Elsword and Allods Online. Elsword, a 3D, side-scrolling advanced casual game entered into closed beta testing in November and open beta testing in December, which have received positive feedback from gamers and trying to introduce new characters and release an expansion pack in the first half of 2012. Allods Online, a 3D, free-to-play fantasy MMORPG developed by Mail.Ru is currently under optimization and design customization to align it with local market preferences. We intend to conduct the second engineering testing in April 2012.
In conclusion, we are extremely pleased with our progress throughout 2011. We believe we have generated positive momentum supported by our consistent strategy and strong market response to ZT Online 2. With a robust development pipeline and a strong financial position, we expect to deliver continued sequential top-line growth in the first quarter of 2012.
Facebook Says China Is Biggest Source of Applications Developers in Asia
Facebook Inc. (FB), whose website has been restricted in China since 2009, said it has more application development partners in the country than any other part of Asia.
Developers of software from China make up about 20 percent of Facebook’s partner network in Asia, David Lim, a partner engineer at the company’s mobile developer relations division, said in an interview in Hong Kong today. Chinese app developers are using Facebook (FB) to reach overseas users, Lim said, without providing figures.
Facebook is wooing software firms in China to help bolster its apps lineup for the more than 800 million people worldwide who use its social-networking service. The Menlo Park, California-based company last month said in its filing for a proposed $5 billion initial public offering that it is continuing to evaluate entering China, the world’s biggest Internet market.
“We now have Chinese-language help pages for developers, and we are working on giving them better support,” said Lim. “Developers in mainland China are important to us.”
Facebook’s partners in China include Rekoo.com, a Beijing- based provider of games, Lim said at the World Internet Developers’ Summit conference.
Restrictions in China
China bans pornography, gambling and material critical of the ruling Communist Party on the Internet by requiring local Web companies to self-censor content, and blocking overseas websites including Facebook and Google Inc. (GOOG)’s Youtube. The country had 513 million Internet users at the end of 2011, according to the government-backed China Internet Network Information Center. That’s more than the combined populations of the U.S. and Japan.
“Users are generally restricted from accessing Facebook from China,” the company said in its Feb. 1 regulatory filing for its IPO. “We do not know if we will be able to find an approach to managing content and information that will be acceptable to us and to the Chinese government.”
Shanda Games Ltd. (GAME), China’s third-biggest online games company, is working on titles for Facebook users, Alan Tan, chief executive officer at the Shanghai-based company, said in November.
Facebook plans to expand its mobile advertising business in Asia, Lim said. Advertisers will now be able to insert marketing messages into the news feed feature for people who access Facebook from wireless handsets, Mike Hoefflinger, customer marketing director at Facebook, said Feb. 29.
More than 400 million people, or over half of Facebook’s users, now access the service on mobile devices, Lim said.
Last year, Facebook set up an office in Hong Kong, a special administrative region of China, and said it may win business from Chinese advertisers.
In China, Apple faces its "Nike moment"?
(Reuters) - As Apple Inc, the world's most valuable listed company, braces itself for a report into alleged poor working conditions among its army of low-cost suppliers in China, it could heed the lessons from another big-brand retailer that faced similar issues two decades ago.
"Apple is facing its 'Nike moment'," said Teresa Cheng, international campaign coordinator for United Students Against Sweatshops (USAS), referring to accusations in the 1990s that suppliers to sportswear retailer Nike Inc mistreated workers.
Such is the California-based iPad and iPhone maker's dominance of the technology sector that its response to the non-profit Fair Labor Association's (FLA) report - expected this week - could affect conditions across China's vast electronics supply chain.
Nike was battered in the media and by public opinion because its suppliers in Asia forced employees to work long hours without breaks, and paid them a pittance without benefits.
The company's response - and what some say are the mistakes it made - could offer a roadmap for Apple, which has faced similar bad press following deaths and reports of suicides at its China supply firms.
Three workers at Foxconn Technology Co Ltd died in a blast last year when dust from polishing iPads ignited, and labor rights groups have said 18 workers at Foxconn sites killed themselves, or tried to, in 2010.
The vast majority of Foxconn's 1.2 million employees are involved in assembling Apple products, according to media reports.
Apple hired teams from the FLA to interview 35,000 workers at three of Foxconn's sprawling factories, which put together iPads and iPhones as well as gadgets for other well-known brands.
The FLA's interim report into Apple's suppliers based on those anonymous interviews over the past three weeks could mirror a number of the issues that Nike faced.
"Trouble in your supply chain can really hurt your reputation globally, extremely rapidly," said Kenneth Lieberthal, director of the Brookings Institution's China center and author of 'Managing the China Challenge: How to Achieve Corporate Success in the People's Republic.'.
"The wisdom in the industry from that (Nike) experience is that you have to do a lot of work to be sure you understand what is happening in your supply chain."
In the early 1990s, when media and activists began reporting on conditions at Nike's suppliers in Asia and central America, the company brought in wide-ranging reforms designed to eradicate worker maltreatment, and later opened those operations to inspection.
It wrote a code of conduct for contractors, requiring them to provide workplaces free of harassment and abuse. Contractors cannot employ underage workers, must pay at least the minimum wage, and provide a clear accounting in writing for every pay period, with no deductions for disciplinary infractions. Rules also govern overtime and days off.
Nike also engaged its critics.
"The most significant shift for Nike was when we began to sit down with the very people who had been critical of us and started to engage not in a denial conversation but in a conversation on how to solve the problems," said Hannah Jones, Nike's vice president of sustainable business and innovation.
But some problems, and criticism, persist.
Last year, one of Nike's contractors in Indonesia agreed to pay more than 4,400 workers $1 million after complaints they were forced to work overtime without payment.
When problems are identified, they are addressed, said Jones. Some problems, however, can slip through.
"We don't have loopholes in our processes, but you're talking about 1,000 or so factories just for Nike, in 52 countries with about 1 million workers in them," Jones said in an interview this week.
TAKING A PAGE FROM NIKE
By hiring the FLA to inspect its factories, Apple is taking a leaf from Nike's book.
Such monitoring, however, should only be a first step, said Richard Locke, head of the political science department at the Massachusetts Institute of Technology, who has researched the supply chains of Nike and Apple rival Hewlett-Packard.
"(Auditing) assumes the problem is (that) there are bad managers who need to be policed more frequently," which is generally not the case, said Locke. Instead, the problem is staff insufficiently trained to run complex operations, and brands and retailers making unreasonable demands of suppliers.
"Where you see suppliers ... working with the brands, you see both improvements on the business side and improvements on the labor side," he said.
"Suddenly, you don't need excess overtime because you're running a good operation. Your margins are higher, and you can afford to pay people a little better."
Foxconn has said it was raising salaries by 16-25 percent, and last month was advertising a basic monthly wage, not including overtime, of 1,800 yuan ($290) in Shenzhen, Guangdong province - where the monthly minimum wage is 1,500 yuan.
Apple stresses its partners are required to adhere to strict global standards.
"We insist our suppliers provide safe working conditions, (and) treat workers with dignity and respect," said spokeswoman Carolyn Wu. "Our suppliers must live up to these requirements if they want to keep doing business with Apple."
But if Nike's experience is any guide, Apple can expect close scrutiny for years to come.
"Unless we hold Apple's feet to the fire, they're going to get away with profiting off the same sweatshop conditions and driving a global race to the bottom while fooling the public and making it look like they're getting better, just like Nike did," Cheng at USAS said in emailed comments.
"The Nike and Apple experiences, although in two different industries, are one and the same."
China's Xiaomi To Invest CNY200 Million To Support Smartphone Customer Service
Chinese smartphone maker Xiaomi has announced plans to invest CNY200 million to strengthen its after-sales system, covering logistics, storage, and maintenance sectors.
Official statistics provided by the company showed that since its formal launch in autumn 2011, the sales of Xiaomi smartphones has reached over one million units. Its latest China Telecom customized version also received an order of 150,000 units. While the sales volume continues to increase, the concern about the after-sales support of this new product has begun to emerge.
Xiaomi therefore announced that it will invest CNY200 million this year to establish its after-sales system, which involves improvements in logistics, storage, and maintenance. Prior to this, Xiaomi already set three major goals for 2012, including the improvement of after-sales quality; the development of the second-generation product; and the process management of its business.
By the end of February 2012, Xiaomi's maintenance sites had covered 163 cities in 26 provinces in China. These 233 maintenance sites provide product testing and maintenance services to users.
For customer service, Xiaomi's hotline currently only provides after-sales services and solutions to users who have booked or purchased the smartphones. Its customer service team now has nearly 200 employees, and the number will increase to 400 during the first quarter of 2012. Meanwhile, Xiaomi said it will accelerate its building of pre-sales service and customer service via microblogs.
Monday, March 5, 2012
Businesses Warned Over Internet Security
When 32-year-old public relations specialist Wang Ning heard that China Software Developer Network, the country's largest programmers' website, had 6 million pieces of its users' personal information stolen days before the end of last year, he decided to change the passwords of all his accounts on the Internet.
"I have to do something to protect my private information because I have put so much personal information online," he said.
However, Internet security experts say changing passwords alone does not guarantee the safety of users' data. They say Internet companies should invest more into keeping users' data safe.
According to an annual report released by Beijing Rising Information Technology Co Ltd, the country's leading Internet security company, nearly 200,000 websites in the nation were hacked last year.
"Our conservative estimation is that at least 10 security breaches can be found on three quarters of the websites whose daily page views exceed 10,000," said Liu Siyu, director of the security research team at Rising.
"That means almost every website in China can be attacked by hackers," he added.
Many Chinese companies' websites have been attacked. More than 50 percent of the hacking was conducted by viruses or Trojan horse programs, said a recent Rising report.
Another Bejing-based Internet security provider, Qihoo 360 Technology Co Ltd, reported last month that more than half of Chinese websites have gaps in their security and as many as 36 percent carry "high-risk vulnerabilities".
Chinese enterprises are vulnerable to hackers because they have failed to take precautions when setting up their websites in the first place, according to Liu. "Most executives in China hesitate to invest in security departments because they do not generate profits for the company."
But this reluctance could leave open a backdoor that rivals with harmful intent could exploit.
In February, an online dating website owner surnamed Le was accused of unfair competition after he allegedly hired hackers to attack baihe.com, China's first dating website, Beijing Times reported.
The attacks caused intermittent paralysis to baihe.com for a month.
"The increasingly vicious competition between Chinese enterprises is turning China's mystery hacker circus into a fresh battle ground," said Liu.
Beijing policemen uncovered more than 2,600 hacking cases in 2011, according to the Rising report.
Experts warned that users' hotel-booking accounts, social networking and online purchasing websites are most at risk of attacks. "These websites usually contain large quantities of personal information including itineraries, contact lists, phone numbers and purchasing habits," said Liu.
"Such information is valuable to many interest groups such as business rivals, salesmen and even swindlers," he added.
However, the most inviting yet poorly-guarded targets for hackers are the websites of education institutions, governments and online games, the report said. More than one third of Trojan attacks were targeted at education institutions.
In addition, the report also found that at least 65 percent of the attacks came from overseas Internet protocol addresses, with the United States, South Korea and Japan being the major sources.
As much as 22 percent of attacks on the country's facilities with relatively high security - such as data centers, terminal controls and automatic industrial control systems - came from the United States.
But Liu pointed out that a large number of hackers in China are using proxy servers to conceal their actual IP address, an action that may disguise the source of the attacks or suggest it came from another country.
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