NetDragon Websoft Holdings Limited (777) Earnings Call Transcript & Summary

Good afternoon. I have been [indiscernible] I'm looking at the picture of the 3 of us, we look kind of, all wearing the same jacket. Looks kind of boring. Maybe we should be wearing T-shirt the next time. But anyway, great to be here to share with you on what happened in the first 6 months of the year and talk a little bit about the future, the next 6 months. Today, I'm going to take you through very quickly on highlights and Ben is going to take you through the financials because I think we should kind of dig into the numbers a little bit. And as usual, Lin Chen will be talking about gaming. And because Ben is actually busy today, so I'm going to take over and talk about education, especially our impending spin-off of the company. And then, of course, we touch on the outlook and then we turn into Q&A. So, let's start. Next page, please. The first 6 months is like Charles Dickens story, like that Tale of 2 Cities. So, that goes for the more exciting one. For gaming, we're back on growth, which is actually something very exciting. After COVID in China, people are spending, which is good. So, we grew 8% year-over-year, 16% half-over-half, which is actually very exciting. With all the investments we have made in the last years and we will start to see some of the new games coming out. So, I'm not going to steal the thunder from Lin Chen. He's going to take you through the details, so which is good. So for education, it's really a challenging first 6 months. It's really nothing wrong with mechanics or the operation or the structure of the company, it's really about the market. So I think 2 factors. One is after COVID, is actually, our largest market, U.S. is actually taking a pause to digest all the equipment that they have acquired. So actually, we're seeing a [indiscernible] first 6 months of the year. And the good news is actually the money is still there. I think they're taking a pause. The other one, of course, is Europe. Europe has been slow for us for economic reasons. The upshot of this one is actually a couple of things. We still maintain the #1 market share outside China. That means we didn't lose market share, which is good. And we are also -- actually, we have launched a new product that allows us to expand our addressable market, which is a big part of the, I would call it, the value part of the market, which is the mid- to low-end. We launched the product. We started to ship in June. So, we should be seeing some momentum in the next few months and the years after. Last but not least, actually, we are moving towards making the merger agreement happen. I'll talk a little bit about it later on. So with that, I hope I paint you our overall picture of what we were dealing with in the last m6 months, a lot of encouraging signs. But there's some issues we still need to work on. So with that, I'm going to turn it over to Ben to take you through the numbers.

Thank you, Simon. Okay. First, I'm going to go through our P&L on a high level and then I'll dive into the segmental financials. So here, so you can see that our overall revenue had a negative 13% growth in the first half as a result of a decline in our education revenue, which was really in line with the overall market. And we believe that it is a temporary decline because of the ultra-high growth that we had in the past couple of years because of COVID. And this is something that Simon will go into when he talks about our education business. And then our gaming revenue, on the other hand, was up 8.1% year-over-year and we're really happy with this performance as we see our gaming business clearly back in the growth trajectory. And I'll let Lin Chen go into a lot more details in the next section. On the expense side, we continue to implement disciplined control on our spending and to make sure that we're spending the areas with the proper return. Our admin expense was actually 22.8% higher year-over-year and that's actually because of our expenses -- largely because of expenses related to the spin-off listing transaction for our overseas education business. And if you take out this onetime effect, our admin expense increased by about 10% and that would be due to salary increment as well as more traveling this year compared to last year because of the open up of China from COVID. And in terms of the bottom line, our EBITDA went up by 4.3% and our operating profits and net profits went down by 6.1% and 11.5%, respectively. However, if you add back the onetime nature of the spin-off listing-related expenses, these 2 line items should be largely flat or have a slight increase on an adjusted basis. All right. And the final point that I want to highlight on this slide is that we continue to maintain a strong cash position with a cash and bank balance of RMB 4.2 billion and as well as a net cash balance of approximately RMB 3.2 billion. And with our strong acquisition, we're also happy that we've announced that we've declared a special dividend of HKD 1 per share on top of our regular interim dividend of HKD 0.40 per share. Next slide, please. Okay. On to the segment financials. So, I talked about the revenue in the slide. So here, I'm going to talk about other metrics. But first, on the education business, a couple of things to highlight. Our gross margin was 24.4% in the first half and which was slightly down by 1 percentage point year-over-year. But on a sequential basis, our gross margin actually went up by 8.7% and have gone up for 2 quarters in a row. And that's because we are benefiting from a higher ASP from our ActivPanel 9 that was launched in the middle of last year. And then our core segmental loss for education was higher in the first half at RMB 249 million and that was due to lower revenue and also the fact that our business overhead was largely flat on a year-over-year basis. And then on the gaming, in terms of our gaming business, it's also notable that our gross margin increased by 1% to 96.8% due to more optimized use of our service. And that was the result of our cost management measures carried out last year. And in terms of our overhead expenses for gaming, our R&D expense increased by 16% due to more headcounts that were recruited last year. And as we've mentioned in the past, these headcounts will benefit us as we get to a better position to produce more quality gains in a faster pace. And for the selling and marketing and the G&A costs, we continue to be very disciplined in our spending as these 2 overhead items were largely stable year-over-year. All right. That's what I want to highlight in the financial session, and I'll pass the stage to Lin Chen, who is going to walk us through the performance of the gaming business.

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Lin Chen, [Foreign Language]. Before I go into education, I'm Christian -- I'm Vin Riera, I'll make a couple of comments. One is actually is content, which is actually very exciting for gaming. Equally exciting is the area of AI because you will see the same theme in education. From a geographical standpoint, both education and for gaming, we find that Middle East/Africa market very exciting going forward. That's going to be a growth engine. So okay, so let me be Vin Riera for the next 2 minutes, even though I'm older and probably as not as good looking. So Okay, next page. Just to give you an idea of how the market has been in the last few years and then the forecast for this year. As you can see, the overall market because a big part that the U.S. needs to digest what they have purchased and the economy in Europe. So, we've seen a negative growth in terms of the total units. And if we look at our peers to Promethean, they're seeing exactly the same challenge. I'm not saying that's right, but it is a market situation that we have to tackle, but we do have the answer to how we'll grow in a down market. Okay. Next page. This is just to give you an idea of how we have been growing compared to the industry. We have been outgrowing the industry for the last couple of years by quite a wide margin. That's why we expect to raise the decline of our first half, so let me kind of take you through some of the next page. The good news for us is actually is if you look at all the operating matrix and metrics, actually, we are very fast. We maintained the #1 market share. We have higher ASP for our new product called AP9, our gross margin improved half-over-half. The revenue decline is actually not 29%. That's partly because of the market decline, but equally kind of important. We dramatize the decline because our last -- first 6 months of last year, we grew 71%. So, if you just take a look at the combination, so it's actually just exaggerate, not a decline. Not any skills, but I just want you to understand the numbers. Okay, next. I did talk about how do we grow in a declining market. This is how we do it. Because for the longest time, we decided to focus on the high-end products because we want to maintain our profitability, our margin and everything because where the market is going, we decided last year, actually not this year, last year to enter this market, which opened up a big market that we never been able to address before with the AP9. So, this is very exciting because the value product is actually -- we can use it to attract the low-end segment of the market. We worked on it last year. We introduced the follow -- early this year, and we started to ship in June. So the impact, we have not seen it yet. So, you will see it in the coming months and years to come. Next, just looking at some of the numbers. So, we have a big opportunity with the new product and it's a huge base of old technology that we can go and replace. We have a very big installed base of our product at 1.7 million. So, it's actually we can open up our market without kind of the actual market growth. So we are looking at a bigger market that we can address after we ship -- after we start shipping KX product. Next, still some of the things that we're doing for the next few months, actually besides launching the product, getting it out and go after the market, we're also moving towards getting more fast revenue coming in. So, we target to roll out our first software subscription by the end of the year. It's actually, if you remember, we acquired a company called Explain Everything. So, we're going to integrate that into our products. So, we're going to launch it in the second half of the year. I think a lot of things that we're doing, we're really aiming to save time and asset for the teachers, which is great. By the way, AI is going to do exactly the same. We're also working on AI, just like Lin Chen talked about in the gaming. We're looking at AI in 2 different areas. One is actually you see a lot of use cases that we use to our teachers. That's down on the efforts in the area of lesser operation, homework, upping the homework and also enable them to teach more effectively in the classroom. So, we're going to put AI into our classroom technology, including our panels. But equally exciting, we're looking at on how to do it. We do believe that we need an education large language model. Not only that, so we need probably education [indiscernible] which model for each country on locality because one of the things about education, you worry about its governance, security, or the local laws and regulation and local culture and all that. So -- and by the way, local curriculum. So, it's not a one-size fit all environment. So that created a lot of good opportunity for us to work with a lot of our customers/countries because you all know we work with countries like Egypt and Ethiopia and all that. So, we believe that we can work with them and really put the AI technology and the large language model technology into countries of districts and all that. So this is actually very, very exciting. That's also related to a SaaS subscription opportunities. Again, so we're very excited about AI and also from a geographical standpoint about the Middle East. Next. So, this is actually something we've been working on very, very hard. Our team in the U.S. has been working day and night to complete this. We had a very final stage of the process, I would say. So, it's going to happen very, very soon. So, as a result of this, we're going to spin off the company on the Education Company Overseas and then we'll be listed on our New York Stock Exchange. As a result, we -- NetDragon will retain the ownership of 70% of the company. Now by the way, we don't have to stay at 70%. I mean we're happy to go down in the percentage as well as the valuation keeps going up. So. we're working on to get there, making sure the NetDragon shareholder is going to share the growth of this particular company going forward. Page, just very quickly, why we want to do that. These are the 3 main reasons to do it. Number one is actually we want to long shareholder value because the sum of all parts probably work better in this particular case. Number 2 will be a separate platform that we can go over and raise money, whether from the properties or from our strategic investors. So, it's very specifically looking at the Education Business Overseas. The third one is actually one to -- and we look at all the geopolitical situation, we are very open about China and U.S. relationships. So, we believe having an education company with a large market in the U.S. being listed in the U.S. is actually a -- strategically is actually much better for us. So because we have deal with the government with a lot of this regulation much more effectively as a separate company. So, we decided to do it. So, this is actually all good for our shareholders. Okay. Next page. What I'm going to do is actually close the session with the outlook. I think I talk quite a bit about it and also Lin Chen talked about it also in this presentation. So, I'm going to be very brief on this one. So on gaming, we are on track. Actually, we're going to be doing well. We'll continue to grow our flagship games plus we are going to work very hard to launch the new games because it's actually that's how we maintain the growth of gaming. In education, very simple, #1 priority is to complete the spin-off, so we can enjoy the valuation of that company. I talk about the LX product. This is how we can grow in a down market because we expand our addressable market. We talk about moving to SaaS. And last but not least, with the spin-off that give us a chance to really look at our cost base in education with what's left in the company and also looking at the China market and see how we react to this part of the business. So, this is what we're going to do in the next 3 months. So, with that, I'm going to stop. Thank you for your patience. Thank you for listening. So operator, I think we're going to be ready for Q&A.

Thank you, Dr. Leung and management. Now, it is time for our Q&A session. [Operator Instructions] We are now coming to the Q&A session. [Operator Instructions] The first question is from [indiscernible]. Regarding the gaming sector. [Foreign Language]

Okay. [Foreign Language].

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Lin Chen, why don't you pick this one.

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[Interpreted] [Operator Instructions] For the next question, we received a question regarding the capital return initiative of the company. Can the company elaborate on its latest thinking behind its capital return initiative? For example, how much is it prepared to return to shareholders regarding based on its current capital structure?

Ben?

Yes, sure. So in terms of the capital return measures, I think we've been keeping investors updated in the past couple of years. I think if you remember a couple of years ago, we did announced a measure to do up to USD 300 million of stock buyback. Since then, we've actually been carrying out buybacks periodically. And last year, we were not able to do buybacks for the most part because of the compliance issue because we were in a quiet period due to the listing of our education business. I think -- and then after we announced the listing of our education business, we also started to resume our buyback for a few months. And then you guys would also notice that we've also declared a special dividend this time on top of the interim dividend. I think from our -- from a holistic perspective, we want to make sure that we consistently return capital to the shareholders. So, if you look at our announcement or our webcast a couple of years ago, we committed to return a majority of our cash flows or free cash flow to our shareholders by way of a combination of stock buyback and dividends. And I think with the dividends that we have declared yesterday and also a couple of rounds of special dividends that we've declared in the last couple of years, I think we have been kind of living up to that promise. So, I think going forward, I think we would be maintaining current debt commitments. And -- but in the meantime, we also have to be cognizant of kind of the market conditions, right? Because as you can see right now, the stock market is not in a very good condition on a broad basis. So, it's buyback -- is stock buyback and the best approach to return to our shareholders. So, that's something that we should -- we'll continue to think about and we will calibrate. It doesn't mean that we're not going do buyback, but we're going to category between stock buybacks and dividends and overall to make sure that we return the right amount of capital to our shareholders.

May be let me put a caveat around it. What we're going to do is actually we're going to be with review our strategy on a regular basis because we also want to maintain some flexibility in terms of if we intend to do some M&A. So, we have enough capital in the company to go do it. So, that's why we won't commit to kind of a specific plan on how to do it. But history demonstrate we will do the right thing at the right time.

Thank you, Ben and Simon, for your detailed response. [Foreign Language]

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Due to time constraint, we will like to end the 2023 interim results presentation for NetDragon Websoft Holdings. [Foreign Language]. Once again, I would like to thank you all for joining us. If you would like to further communicate with the management, please contact NetDragon's Investor Relations team for meeting arrangements. Thank you, and have a nice day. [Foreign Language]