Xunlei Ltd (XNET) 2015 Q3 法說會逐字稿

Good morning and thank you for standing by for Xunlei's Third Quarter 2015 Earnings Conference Call.

(Operator Instructions)

Today's conference call is being recorded.

I would now like to turn the call over to your host for today, Ms. Danni Zheng, IR Manager of Xunlei. Thank you. Please go ahead.

Thank you, operator. Good morning and good evening. Welcome to Xunlei's third quarter 2015 earnings call. I'm Danni Zheng, Investor Relations Manager at Xunlei. With me today on the call are Mr. Sean Zou, our Chairman and CEO; Mr. Lei Chen, our co-CEO; and Mr. Tom Wu, our CFO.

Today's conference call is being broadcasted, and a replay of the call will be available on our website following the call. Our earnings release was distributed earlier today, and it is now available on the IR section of Xunlei's website as well as newswire service.

Before we get started, please note that the discussion today will contain certain forward-looking statements made under the safe harbor provision of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Please refer to our SEC filings for a more detailed description of the risk factors that may affect our results. We do not assume any obligation to update any forward-looking statements except as required under applicable law.

During this call, we will be referring to both GAAP and non-GAAP financial measures, and the non-GAAP measures are reconciled to the most recent directly comparable GAAP measures in this table attached to our earnings release, which can be found, again, on our IR website. Please note that all numbers are in U.S. dollars unless otherwise stated.

I will now turn the call over to our CEO, Sean. Sean, please.

Thank you, Danni. Good morning and good evening, everyone. Thanks for joining us today for our earnings call for the third quarter of 2015.

Let me start by commenting on our top line. Our total revenues for this quarter were $33.5 million, which exceeded the high end of our guidance range. It also represented 7.5% growth on a sequential basis. Revenue from Project Crystal was a key contributor to the sequential growth.

Let me first comment on Project Crystal, which, as you may know, is one of the most important and innovative products, potentially, for Xunlei. Project Crystal reached a milestone in the third quarter. It started to generate revenues through selling crowd-sourced bandwidth to third parties. We have been using crowd-sourced bandwidth internally for Xunlei's own bandwidth consumption for a while now.

To have external sales does represent a milestone from a product development point of view. It is also an early testimony of market initial acceptance of the product value propositions. The magnitude of Project Crystal revenues is still small, but customers covered this quarter were fairly broad-based from iQIYI, a leading video streaming site, to app store and online game companies, and we are continuing to build the pipeline.

Let me reiterate the core value proposition of Project Crystal. First, the crowd-sourced bandwidth helped enhance user experience for streaming websites and for online game companies in terms of its smoothness because of its architecture. Second, bandwidth from Project Crystal also provides added security features, which is important consideration for content owners. And third, its competitive cost structure. This quarter represents the initial success of market acceptance of this innovative technology and its value propositions.

We are also building up a solid pipeline of potential customers, which are in various stages of product testing and customizations. I would like to point out that Project Crystal is a new technology and a service for each customer who needs to be customized. What that means is that sales cycle tends to be longer, given its technology and architecture, so revenues ramp may take some time. However, once adopted, we see customer stickiness should be strong, and the revenues would almost be recurring in nature.

Going forward, the key priorities for Project Crystal are as follows -- first, to continue to invest on the product and the technology fronts. It is a new technology. We need to be -- we need to refine it and advance it to the new business. Second, to gain more marquee customers like iQIYI. These customers not only have scale but they are thought leaders in their respective industries. Their acceptance is important to Xunlei in terms of product viability and value propositions. And third, to scale and to ramp the business. We will accomplish this through not only adding new customers, but also more wallet share from existing customers. I am delighted to have reached this milestone. I would like to thank the project team for their hard work.

Let me now make some quick comments on our subscription business, which represented over 60% of our total revenues. The number of our paid subscribers was 4.9 million, slightly down from the end of previous quarter. As I've said in the previous quarter, we think the subscriber base has largely stabilized. After all, users have been over a year to adjust Internet content regulations in China.

I would like to share with you that part of the growing segment with in-house subscriber base is users with 50 megabytes bandwidth, which is almost the highest bandwidth available in China. The fact that users with high-speed bandwidth continues to subscribe to our services illustrates Xunlei's basic value proposition, which is to allow users to fully utilize their last-mile connections. And in fact, there are existing structure of bottleneck in the backbones should render our service values for many years to come. In fact, subscribers with 50 MB last-mile connections now represent the highest percentage in our subscriber base.

We are also trying to leverage the subscriber base, which is among the largest of its kind on the Chinese Internet market. We are increasingly thinking through value-added services and cross-selling activities to our subscriber base. This is still relatively in early stage, but part of the revenue growth this quarter was driven by value-added services for subscription business. We will update the marketplace as we formulate coherent strategies on this front in due course.

Let me briefly comment on the mobility program. I would like to highlight Xunlei Mobile, which is Xunlei's in-house mobile app, has been generating significant user traffic in 2015. This app allows users to search, consume and download, all within the same app. It is a strong product, which really takes advantage of Xunlei's substantial downloading and content access capability. But on the mobile end, DAU is approximately 8 million, and we're starting to experiment with possible monetization. Given this substantial user base, importantly, about the app now brings about 40% of new subscribers to our VIP member services, extending our subscription services to the mobile end.

On the other hand, a quick update on our cooperation with Xiaomi. Since being officially part of Xiaomi's operating system since last year. We have been continuing to refine our mobile acceleration product in its performance and its consistency. As of the end of September, our daily active users were about 22 million, which represents roughly 20% of total installed base of our acceleration software, up from 18 million when I spoke to you last. We're continuing to seek the potential monetization of this mobile traffic.

Last but not least, I would like to take this opportunity to close my comments by introducing Chen Lei, our new co-CEO.

Hi, everyone. This is Lei.

As part of our earnings release, we announced that our board has appointed Chen Lei to a new position, co-CEO, effective immediately. Chen Lei joined the company about a year ago as our CTO. He came with a wealth of industry experience in cloud computing, software architecture from his previous roles at Tencent, Google, and Microsoft. Over the last year, I have witnessed personally Chen Lei's impressive tech knowledge and product insight, and prowess. And his energy and leadership skills were critical for the success of Project Crystal this past year. By naming him co-CEO, we hope that Chen Lei will extend his leadership skills to guide Xunlei's tech launch.

With that, I'm now turning it over to Tom for more financial details. Tom?

Thank you, Sean. Good morning, and good evening, everyone. First of all, it was a milestone quarter, as Sean mentioned. That Project Crystal, our innovation in crowd-sourcing added bandwidth, generated revenues for the first time this quarter. Although still in the early stage of ramping, Project Crystal contributed to a total revenue growth which grew by 7.5% on a sequential basis.

Before I dive into the numbers, let me draw your attention to our financial statements. Again, due to the divestiture of Kankan, the video streaming business, all the numbers I'll be sharing with you are operations that are ongoing. This includes their comparatives, which will be on a year-over-year basis, unless indicated otherwise. The financial results of Kankan, whose divestiture was closed this quarter, are reported in discontinued operations in accordance with accounting standards.

For the third quarter, total revenues were $33.5 million, which exceeded the high end of our guidance range. Compared to the previous quarter, revenues grew by 7.5%. Growth in IVAS revenues, which included revenues from Project Crystal, was a key contributor for the sequential growth.

Subscription revenues were $20.4 million. Excluding currency translation loss, subscription revenues were essentially flat. The number of subscribers at the end of the quarter was 4.94 million, down by about 116,000 during the quarter. ARPU was RMB 25.6, a slight decrease from RMB 25.8 in the previous quarter.

IVAS revenues, which includes Project Crystal revenues, were $12.1 million for the quarter. This represented a 32.1% increase from the previous quarter and a 60.1% increase on a year-over-year basis. As Sean mentioned earlier, we reached a milestone for Project Crystal, where we generated revenue from selling crowd-sourced bandwidth for the first quarter, for the first time this quarter to outside parties. Cost of revenues increased by 15.2% to $15.8 million from $13.7 million in the second quarter of 2015. Bandwidth cost increased from $8 million to $9.5 million. The operating expenses were $19.6 million, essentially flat on a sequential basis. While we continued to invest in research and development, the overall operating expenses stayed flat, partly because of benefits from organizational synergies from the recent business restructurings we've undertaken since the beginning of 2015.

Net loss from continuing operations for the quarter was $3.3 million. We continue to invest in a range of new technology and services, including our initiatives in mobility as well as Project Crystal. These investments are still generating losses. Excluding these investments, operating profit was US$6.5 million this quarter, up from $4 million in the previous quarter. Non-GAAP net loss from continuing operations was $0.7 million. Currency translation loss from R&D depreciation was a significant contributor to the loss.

Turning to our balance sheet. We continued to have a strong balance sheet. We ended the quarter with cash, cash equivalents and short-term investments balance of $446.7 million, $2.1 million increase compared to the end of the previous quarter. Cash value on the per ADS basis is $6.62. Strong balance sheet should continue to allow us to execute our growth strategies, as Sean has outlined in his section.

Guidance for the next quarter. We expect our revenues to be between $31 million to $34 million.

With that, Sean, Lei, and myself will be happy to answer any questions that you may have. Operator?

(Operator Instructions) We have a first question from the line of [Eric Zhuang]. Please ask your question.

I would prefer to speak in Mandarin. (Spoken in Mandarin)

(Spoken in Mandarin)

(Spoken in Mandarin)

It's Tom here. I'm going to translate the question first, and Mr. Chen, our co-CEO, will answer the question. First of all, this is from an investor. There are two questions. The first question is how we think about the scale and the ramp of Project Crystal in terms of the revenues going forward. And the second question is more about the widening net loss this quarter, and how we quantify losses generated by Project Crystal.

I'll speak in Chinese. (Spoken in Mandarin)

I'll translate Mr. Chen's comments. You asked it correct, that we accomplished revenues from Project Crystal this quarter, but the magnitude of which is still relatively small. But we are hopeful that the growth trajectory will be steep going forward, but it is fairly early in the ramping stage, and -- but we certainly hope that the growth will continue.

(Spoken in Mandarin)

Sean made some additional comments. Two points. First is Project Crystal is in the to-be services. And as we mentioned in our opening remarks, the nature of the business is that the sales cycle tend to be longer because of architecture and the testing involved. But once we are accepted, not only our stickiness is very good, but we consider revenues are almost recurring in nature.

And the second point is that, just a quick comment in terms of some color of our existing customer base. As we mentioned in our comments, it's a fairly broad range in terms of sectors for the Chinese Internet, both in terms of streaming websites like iQIYI, to online games players as well as app stores. And the actual companies represented in these sectors like iQIYI are leaders in these industries. And they're only getting started in terms of adopting the technology. So we think that, as we go forward, we can continue to gain their wallet share. So the overall comment is that the business model, the revenue model, is really driven by a couple of things -- number one is the number of customers, or new customers, rather, in terms of growth; and the second growth factor is how much wallet share in terms of percentage of business that you can get out of existing business, existing customers.

Let me move on to the second question. Just to refresh everyone's memory, the second question is about the widening loss of the net income, perhaps I will address that, and how we quantify the losses by Project Crystal. Now there are a couple of reasons why loss has increased this quarter. Actually, the main reason is a translation loss of our cash holding. So without getting into too much detail, the cash that we hold offshore, that's denominated not in U.S. dollars because the depreciation of the RMB becomes a translation paper loss. So if you look at sort of apples-to-apples basis compared to last quarter and this quarter, the increased widening loss in terms of net income was almost -- one of the biggest reasons is the FX currency depreciation.

And the second comment I wanted to make there is that, as I pointed out in my section of the opening remarks, the existing businesses, both the subscription business and so forth, actually are becoming more profitable. So we added back the investments that we're making in all the new areas of mobility, including Xunlei Mobile that Sean mentioned, and Project Crystal. If we exclude these investments, the operating profit for our existing businesses, quarter-over-quarter, actually increased by 50%, okay?

And the last part of your question is how we quantify Project Crystal. I will decline to provide the specifics there because it's still in a very sensitive stage, but the gross margin is solid for that business. But on the other hand, we are promoting the product in terms of sales and marketing expenses. So the overall P&L for Project Crystal is being caught in a loss at the bottom line. So we think it's a wise decision, we think that we are making a good investment for the benefits of shareholders in the medium to longer term.

(Spoken in Mandarin)

So, Sean wanted to add an additional comment. The key focus for Project Crystal right now is really twofold. Number one is customer satisfaction. We wanted to make sure companies like iQIYI develop confidence in that product and are happy, not just in terms of cost savings, but also in terms of the user experience of their subscriber base, let alone, security features that we mentioned. So the first focus is customer satisfaction. And the second focus is really, as we mentioned earlier, to ramp and scale the business. So profit, we're going to sacrifice, arguably, short-term profits for the benefit of longer-term leadership in this business and really drive benefits for the shareholders in the longer term.

Operator, can we move to the next question, please?

Thank you, sir. We have our next question from the line of [Sherry Gao]. Please ask your question.

Hi, thank you. So I want to ask four questions. First, I see the subscription revenue has declined this quarter. I want to know the reason behind it. Is it going to be a decline in trend or is it just a fluctuation? Second question, I see the gross margin has declined. So I want to know the reason behind -- I don't know why the cost of revenues have increased. And could you please comment on are we going to keep the cost of revenue, keep it, continue growing? The third question is below the interest income and expenses, the other income, which had changed from positive to negative, largely from last quarter, so I want to know the reason behind it. Fourth, fourth question is I see there's a loss from discontinued operation. Actually, that's income from discontinued operations this quarter. I want to know what the discontinued operations and why it has changed from negative to positive?

That's very good questions. Perhaps I can answer that in reverse order, easier for me to remember that way. Discontinued operation, why it turned out from a loss to a positive. That is the residual part of Kankan, which we divested and was closed this quarter. So the profit that you saw was actually quite small, but it relates to some of the residual accounting from closing of the Kankan transaction.

And again, in a reverse order, the negative income below interest line. Actually, that's partly what I was talking about in terms of foreign exchange loss. We do hold our substantial balance in terms of cash in Chinese RMB. And the RMB that we hold in offshore accounts because of the depreciation of the Chinese RMB, that was the biggest loss coming from the FX loss.

Your first question is about the decline of subscription revenues. Actually, that also has something to do with FX. As I commented on during my opening remarks, if you look at the revenues in the domestic currency, RMB, revenues for subscriptions are almost flat, purely from a subscription basis. And so -- but when you convert that into our reporting currency, in the dollar, because of the depreciation of the currency, you see a 3% decline.

No, as we commented earlier, we think that our subscriber base has essentially stabilized, and the subscribers have had almost a year now to adjust to the current environment. In terms of number of subscribers, we troughed two, I think two quarters ago, and it increased the previous quarter, the second quarter. And right now, it's slightly down from the second quarter. So it's not our expectation that subscription revenues will fluctuate substantially.

And your question on gross margin, the gross margin decline is partly because of additional bandwidth we are applying to both the subscription businesses as well as the bandwidth that we crowd-sourced from our user base for Project Crystal. And I'm not going to give a forecast in terms of our gross profit at this stage, but the absolute gross profit increased, if you look at the third quarter versus the second quarter. And obviously, we're going to be very mindful in terms of managing our profitability here, but there's nothing meaningful in terms of a particular trend going on here. I hope I've answered your questions.

Operator, can you move on to the next question?

Sure, sir. (Operator Instructions) Pardon me, sir, we don't have any more questions from the audio line. Please continue.

That's fine. Thank you for -- if there are no more questions, thank you for your participation and your interest in the company. And I think Sean, Lei, and myself will look forward to interfacing with you in the near future. Thanks again, and have a good evening or good morning.

Thank you very much.

Thank you.

Ladies and gentlemen, that does conclude our conference for today. Thank you all for participating, and you may all disconnect.