uCloudlink Group Inc. Q2 FY2020 Earnings Call

Good morning, and good evening, ladies and gentlemen. Thank you for standing by and welcome to the uCloudlink Group Inc. Second Quarter 2020 Earnings Conference Call. At this time, all participants will be in listen-only mode. After prepared remarks by the management team, there will be a question-and-answer session. Today's conference call is being recorded. I'd now like to turn the call over to your host today Mr. Bob Shen, Senior IR Manager of the Company. Please go ahead.

Thanks everyone for joining us on our second quarter 2020 earnings call today. Our earnings release is now available on our IR website at ir.ucloudlink.com as well as via newswire services. Here I give a brief introduction to our uCloudlink Inc. team. Zhiping Peng, is our Co-Founder and Chairman of the Board of Directors; Chaohui Chen, is our Co-Founder, Director and Chief Executive Officer; Zhigang Du, is our Director and Chief Operating Officer; Yimeng Shi, is our Chief Financial Officer; Zhu Tan, is our Chief Strategy Officer. Our CEO will begin with an introduction of our company overview and the business highlights. This will cover section one and section two of the earnings presentation posted on our IR website. And then our CFO, Yimeng Shi will discuss our financial results in section three. Before we proceed, please note that this call may contain forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and observations that involve known and unknown risks, uncertainties and other factors not under the Company's control, which may cause actual results, performance or achievements of the Company to be materially different from the results. Performance or expectations implied by these forward-looking statements. All forward-looking statements are expressly qualified in their entirety by the cautionary statements, risk factors and the details of the Company's filing with the SEC. The Company does not assume any obligation to revise or update any forward-looking statements as a result of new information, future events, changes in market conditions or otherwise except as required by law. Please also note that uCloudlink's earnings press release and this conference call include discussions of audited GAAP financial information as well as audited and in-depth financial measures. uCloudlink's press release contains a reconciliation of the unaudited non-GAAP measures to the audited most directly comparable GAAP measures. I will now turn the call over to our Co-Founder and CEO, Mr. Chaohui Chen. Please go ahead.

Thank you everyone. Let me now turn to Page 4 of the earnings presentation, which shows our vision and mission. We are the world's first leading mobile data traffic sharing marketplace with the Cloud SIM technology, which enables consumers to enjoy mobile connections on any available network at any time. We also enable partners to be an over-the-top carrier worldwide to encourage roaming and utilization problems, our innovative Cloud SIM technology is the technological foundation of our marketplace. We are the pioneers of introducing the sharing economic business model into the telecommunications industry, creating a marketplace for mobile data traffic, leveraging our innovative Cloud SIM technology and architecture. We have an innovative solution that is already deploying at scale, enabling the marketplace to be established with our mobile data bottleneck supply and enabling dynamic device data traffic navigation across multi-network connections. We have redefined the mobile data connectivity experience, allowing users to gain access to mobile data traffic allowance shared by network operators on our marketplace. So far, we have everyday mobile data traffic allowance from 220 mobile network operators, which we refer to as MNOs, in 144 countries and regions in our Cloud SIM architecture. Page 5 is a high-level view of the data marketplace that we envision and wish our technology enables. The left-hand side of the slide shows the source of data from the market. With our Cloud SIM technology, we can simply buy SIM cards from carriers or their partners around the world; we refer to this as firsthand mobile data. Our systems can also utilize the unused data from end users; we call this second-hand mobile data. The right-hand side of the slide shows the various users of data in the marketplace. This marketplace is valuable to both users and carriers, as it enables an end user device to connect to any available network at any time and anywhere. It also enables carriers to easily share their network capacity, selling their traffic to worldwide users. They can then act as an over-the-top carrier globally to solve roaming carriage utilization problems and achieve better returns on investment. We have transformed the traditional telecommunications business model and we can do this with packing, distributing, and enabling dynamic allocation recycling, etc. to allow end users to optimize carriage fixed and price with flexibility. Let us move to Page 6 and talk about 5G opportunities for us. As we know, the 5G radiofrequency band is higher, requiring 4 to 5 times the number of base stations to get similar carriage as 4G. In the early stage, 5G coverage and infrastructure are not sufficient to support roaming, and there are significant incremental CapEx requirements related to spectrum, network equipment, and infrastructure. Our 5G ready Cloud SIM platform offers a ready-to-use solution for mobile network operators and smartphone manufacturers, enabling roaming-free inter-carrier 5G network access both domestically and internationally. As network operators start to roll out 5G networks, mobile data traffic sharing between mobile network operators via our Cloud SIM architecture can reduce capital spending and roaming agreements negotiation costs, ensure low network latency for end users, and expand network coverage. We will continue focusing on our R&D investments on service and product development related to 5G, as the advent of 5G brings faster data connectivity speeds and more business opportunities. Our series of 5G products such as MiFi, CPE, and the GMI devices are expected to launch in the near term. We will continue to maintain our leading position and test 5G business opportunities globally. Page 7 shows the evolution of our Cloud SIM business model. At Stage 1, we directly faced end users through a B2C retail model. We have proven that technology and the business model are successful and profitable. It took two to three years, but we are now the largest portable Wi-Fi service provider for international roaming for Chinese outbound travelers in 2018, according to Frost & Sullivan. Stage 2 is the B2B to C wholesale model, where we can work with partners in different countries to use their brand while applying our business model. It incurs far less spending from ourselves and operates at a reduced expense. Stage 3 is what we refer to as a PaaS and SaaS service model. Our business partners can rely on our PaaS and SaaS platform for SIM and data traffic management and focus on sales and marketing. Such specialization enables us and our business partners to operate more efficiently. In addition to 5G, we will continue investing in our R&D efforts towards further development and updates of our PaaS and SaaS platforms, aiming to provide innovative and advanced platform services and functions to our business partners while facilitating our customers globally, contributing to our high potential for growth. Our new and advanced PaaS and SaaS platform can optimize the utilization efficiency of the SIM card pool and improve algorithms for better network quality and enhanced OTT management capabilities. As we migrate from Stage 1 to Stage 3, we are gradually becoming more platform-centric, allowing us to expedite our global expansion by forming a global partner ecosystem. Let’s turn to Page 8 and take a look at Cloud SIM technology. There are four critical advantages of our innovative Cloud SIM technology. Firstly, with Cloud SIM technology, we can create a full marketplace, including both the firsthand and second-hand data traffic with a massive user base. Secondly, with Cloud SIM technology, devices can dynamically connect to different networks by switching to different SIM cards in remote areas. Thirdly, it simplifies the relationship with the carriers through direct SIM card purchases from carriers and their channels. Fourthly, the physical SIM card boasts over 20 years of history, making it secure, reliable, and mature. Our conditions are much easier, with lower risk and barriers in terms of SIM card payments. With these advantages, our Cloud SIM technology facilitates valuable services to both users and carriers, not only connecting but also enabling superior connections. Our Cloud SIM technology-enabled marketplace offers superior connectivity globally and likewise presents great business opportunities. As of June 30, 2020, we have 54 patents approved and 65 patents pending for approval globally. During the second quarter of 2020, we had four new patents approved and two patents pending approval. Page 9 outlines our clear growth strategies. uCloudlink 1.0 is an international data connectivity service focusing on cross-border travelers, maintaining stable growth and high profitability while increasing penetration and market share by launching more channels, expanding into more countries, introducing more GMI GlocalMe Inside services, and providing better service quality, underlined by our technological advancements. uCloudlink 2.0 local data connectivity service focuses on local residents by resolving challenges between carriers. It is beginning to gain faster growth towards a significant volume in user numbers. We are developing the GMI GlocalMe Inside service with handset vendors one by one, establishing low-cost operations successfully with local partners on a country-by-country basis and capturing local mobile applications or IoT GlocalMe Inside opportunities. uCloudlink 3.0 is a full marketplace for data traffic that is in trial and is fundamentally technology-driven.

Thank you, Mr. Chen. Hello everyone. Let's now turn to Page 15. The impact of the COVID-19 pandemic continued to rapidly evolve worldwide in the second quarter of 2020. Our total revenue decreased by 41.5% from $35.9 million in the three months ending June 30, 2019, to $21 million in the three months ended June 30, 2020. Revenues from services were $9.9 million, representing a decrease of 53.5% from $21.3 million for the same period in 2019. The decrease was primarily attributable to the decline in our 1.0 international data connectivity service revenue, which was impacted by the prolonged international travel restrictions due to COVID-19. Service-related revenues as a percentage of total revenue decreased to 47% during the second quarter of 2020. On the other hand, our 2.0 local data connectivity service was not impacted by COVID-19, and its revenue increased by approximately 14 times from $0.2 million in the second quarter of 2019 to $3.1 million in the second quarter of 2020, which partially offset the impact on our 1.0 international data connectivity service. So far, we have initiated our 2.0 local data connectivity service in regions like China and Japan, achieving a faster growth rate in the Japanese market. We will continue to expand into more countries and regions such as Asia, the United States, Europe, etc., which offer high growth potential. Revenue from PaaS and SaaS services stood at $0.5 million, representing a decrease of 72.2% from $1.8 million in the same period last year. This decline was primarily due to international travel bans resulting from COVID-19, even though demand for our 2.0 local data connectivity service remained robust. Revenues from product sales were $11.1 million, decreasing by 24% from $14.6 million in the same period last year, primarily due to the decrease in our 1.0 international data connectivity service stemming from COVID-19. Performance and demand for our 2.0 local data connectivity service was strong and remained unaffected by COVID-19. Our total revenue decreased by 10.1% from $60.6 million in the six months ending June 30, 2019, to $54.5 million in the six months ending June 30, 2020. Revenues from services decreased from $41.5 million in the six months ended June 30, 2019, to $27.3 million in the six months ended June 30, 2020. Conversely, revenues from product sales increased by 42.4% from $19.1 million in the six months ended June 30, 2019, to $27.2 million in the six months ended June 30, 2020. Page 16 shows the revenue breakdown by our two business segments, namely revenue from service and sales of products, which exhibit synergy between charges. During the second quarter of 2020, revenues from services and sales of products comprised 47% and 53% of total revenue, respectively. The reduction in service-related revenue was mainly due to the decrease in our 1.0 international data connectivity service revenue. Beyond this, our PaaS and SaaS service generated a portion of revenues from product sales, which was related to our PaaS and SaaS section. We remain focused on our service-related revenue, which is directed towards business development, and we believe that service-related revenue will be a key contributor to our overall revenue with strong growth potential. Let’s now turn to Page 17 for gross margins of our business. Our service gross margins and the overall gross margin decreased to 35% and 26% during the second quarter of 2020 compared to 51% and 35% during the first quarter of 2020, respectively. This decline was primarily due to the reduced revenue from our 1.0 international data connectivity service affected by COVID-19. Furthermore, revenue from certain customers of PaaS/SaaS services, which traditionally had higher gross margins than other segments, also decreased to some extent. To mitigate the impact of COVID-19, we undertook careful scrutiny of our costs during the pandemic; while fixed costs increased, we managed to reduce variable costs to a certain extent. We will continue working on optimizing our cost structure moving forward. We believe that our gross margin and overall gross margins will improve as our 1.0 international data connectivity service recovers. Page 18 outlines the breakdown of our operating expenses. Total operating expenses decreased by 33% from $15.3 million during the second quarter of 2019 to $10.2 million during the second quarter of 2020. We implemented strict controls on our operating expenses to offset the top-line impact from COVID-19. Total operating expenses as a percentage of total revenue grew from 43% in the second quarter of 2019 to 49% in the second quarter of 2020, mainly due to the decline in overall revenue. During the second quarter of 2020, we continued to invest in R&D to maintain our core competitiveness in the long run. You can see from the right-hand side of the slide that our R&D expenses accounted for 24% of total operating expenses during the second quarter of 2020. G&A expenses accounted for 41% of the total operating expenses, which included mitigation fees. Please turn to Page 19. Operating cash flow was negative $2.8 million during the second quarter of 2020 compared to positive $6.3 million during the second quarter of 2019. Our cash flow was stable with sufficient cash and cash equivalents as of June 30, 2020. Our CapEx was $0.2 million during the second quarter of 2020 compared to $0.4 million during the second quarter of 2019. CapEx as a percentage of total revenue decreased from 1.1% during the second quarter of 2019 to 1.0% during the second quarter of 2020, primarily due to a decrease in expenditures related to uCloudlink 1.0. Page 20 highlights the net income during the second quarter of 2020, which was negative $41.6 million compared to positive $0.3 million in the second quarter of 2019. Adjusted EBITDA was negative $3.1 million during the second quarter of 2020 compared to positive $1.2 million in the second quarter of 2019. Looking ahead, we will continue investing in R&D with a focus on innovative technologies and expanding our ecosystem with more partnerships worldwide. The arrival of 5G will unlock further opportunities for both our local and international business. We will continue building and expanding our Cloud SIM ecosystem and provide high-tech innovative products and Cloud SIM technology services to our customers and business partners. With that, I will now turn it over to our CFO, Yimeng Shi, who will go through the financial highlight section.

We will now begin the question-and-answer session. Our question today comes from an analyst with Jefferies. Please go ahead.

Hi, this is Alyssa. Thank you, management, for your presentation. My question is about the revenue mix, specifically the geographic revenue mix. I've noticed that the revenue mix from Mainland China has been decreasing, while Japan and other international markets are on the rise. Could you provide your projections for the future trend of the geographic revenue mix for China? Will it continue to decline? Additionally, I would like to know how the U.S.-China relationship is affecting our overseas business. How do you evaluate the impact of this relationship on our business?

Yes, it's Yimeng Shi. Let me answer your questions. For geographic distribution in the second quarter, the Mainland China contributed 8% of total revenues. The Japanese market contributed 36% of total revenues. This breakdown reflects the performance for the second quarter. We believe the Mainland China market is massive, and its revenue percentage will increase to some extent when COVID-19 recovers and international travel resumes. Therefore, we do not anticipate further decline in the revenue percentage from Mainland China. As for the U.S.-China relationship, we are currently performing well in the U.S. markets, which showed growth in the second quarter. We believe there is significant demand from the U.S. market for both international travel and local mobile broadband services, which is growing and poses higher potential opportunities in the future.

Hi, this is Bob Shen. Let me add some points to your question. First, regarding our percentage for diversifying our business, I would say that it is a positive trend that we are witnessing as our business increasingly expands globally, which aligns with our expectations. For example, a couple of years ago, in 2017, the revenue coming from Mainland China was over 60%, while Japan accounted for only around 12%. The current situation has changed; now, the Mainland China's revenue stands at 8%, whereas Japan has become our single largest market globally. I would say that this reflects our business strategy, as we are a global company, and our operations are internationally diversified, which is beneficial for us. Regarding the U.S.-China relationship, while we cannot predict its trajectory over the next few years, we remain committed to our global focus. We are diversifying our operations beyond the U.S. and expanding into Asia, Europe, and more to mitigate risks, so our strategy remains globally diversified.

Yes, thank you very much. You answered it very well. If I may ask another question, could I receive some guidance on the gross margin for the next few quarters?

We will disclose that when we have clearer explanations regarding the business in the upcoming quarters. So far, we have disclosed the top-line guidance, which for the third quarter will be between $21 million and $22 million.

Sorry, you mean the gross margin, right, gross margin for the next several quarters?

Yes.

Okay. Yes, I think right now our margin for the second quarter 2020 gross margin is around 35%, but this is lower than typical because we are impacted by COVID-19. As our CFO just mentioned, we believe that the gross margin will continue to increase in the next couple of months because: first, we hope that our 1.0 international data connectivity service will recover. Secondly, I think our PaaS and SaaS section will recover well as soon as there is good news regarding developments like vaccines for COVID-19. Thus, we anticipate that our gross margin and service gross margin will continue to increase in the coming months.

And as there are no further questions, I would like to turn the call back over to management for closing remarks.

Thank you, once again for joining us today. If you have further questions, please feel free to contact uCloudlink Investor Relations through the contact information provided on our website over the TPG investor relations.

This concludes the earnings conference call. You may disconnect your lines at this time. Thank you and have a good day.