uCloudlink Group Inc. Q2 FY2021 Earnings Call

Good morning and good evening, ladies and gentlemen. Thank you for standing by and welcome to uCloudlink Group Inc Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a 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 would now like to turn the conference over to your host today, Mr. Bob Shen, Deputy Investor Relations Director of the Company. Please go ahead.

Thanks everyone for joining us for our second quarter 2021 earnings call today. The earnings release is now available on our IR website, as well as via newswire services. I will give a brief introduction to our uCloudlink 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; Yimeng Shi is our Chief Financial Officer; Zhu Tan is our Vice President of Marketing and Sales. Our CEO will begin with an overview of our company and business highlights, which will cover Section 1 of the earnings presentation posted on our IR website. Our CFO, Yimeng Shi, will then discuss our operational highlights and the financial results as presented in Section 2 and Section 3. 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 unaudited GAAP financial information, as well as unaudited non-GAAP financial measures. uCloudlink's press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited 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, Bob. For the Company's overview, perception, there are similar contents as the earnings presentation of the first quarter of year 2021. I will focus on our technology update and recent development. Let's move to Page 6, which shows the coverage and our two major challenges of wireless networks. On the left-hand side, the white coverage circles on the left-hand-side chart represent reliable data connection areas and the shadow areas that weak signals represent unreliable data connection. Even for good coverage, it is easy to have network congestion during peak times. On the right-hand side, you can see Wi-Fi and mobile signals are severely weakened when penetrating walls. This is often the cause of poor indoor coverage. Operators cannot guarantee good indoor coverage while users have a strong demand for high-quality indoor data connection. To improve unbalanced indoor and outdoor coverage for Wi-Fi and mobile data connection, operators need high capital expenditure and cannot solve all data connection problems. Through our technology, we can help operators solve these two major challenges which provide us with great opportunities. Let's now move to Page 7, which shows our solution for such problems. Via our cloud SIM technology through our PaaS and SaaS platform under the HyperConn solution, we can help change unreliable data connection to more reliable data connection. Similar to installing Navigation + Electronic Toll Pass for traffic, Navigation can automatically identify network congestion and actively choose a better route, while the Electronic Toll Pass allows users to avoid long queues when switching between mobile networks, intelligently elevating the user experience with data connectivity. We are able to provide seamless coverage for end users; we solve pain points such as roaming, coverage, and congestion. We improved overall network efficiency and access to all available networks worldwide. By bringing reliable connections to previously unreliable connection areas, we help operators elevate users' mobile broadband and fixed broadband, such as home broadband, data connectivity experience, lowering churn rates and improving overall network efficiency. Let's now move to Page 9. Our Cloud SIM technology has been developed to the HyperConn stage. The definition of hyper-connectivity includes three levels: Level one is the evaluation of connection quality of various wireless-access networks including Wi-Fi and all mobile operators; Level two is network selection and optimization based on cloud SIM technology; and Level three is optimization and acceleration of application routing. After one year's development, HyperConn Products are highly compatible with fast development of 2.0 business, GMI, MBB+FBB, Education, Autopilot, etc. Our hyper-connectivity solution would redefine the mobile network and Wi-Fi user experience while facilitating the data traffic marketplace. User's data connectivity experience is affected by various factors such as signal, interference and routing, bandwidth and delay, and server location. uCloudlink's hyper-connectivity aims to connect cross-networks and technical systems, various SIM form factors such as e-SIM and soft-SIM, and various radio technologies across countries and regions. We plan to achieve this through identification, monitoring, and optimization to further elevate user experience in the data connectivity market. In June 2021, we unveiled our new HyperConn technology and products, such as Numen, the world’s first HyperConn 5G mobile Wi-Fi; and Genie, a HyperConn tablet device at an official virtual product conference during Mobile World Congress Barcelona. Going forward, we will launch more innovative products and services. Let us move to Page 10; uCloudlink 1.0 had a strong track record of high gross margins and profitability with ongoing growth potential. According to the publication of the World Tourism Organization UNWTO in March 2021, international tourism is expected to recover gradually during 2021 compared to 2020. We expect that the recovery of international tourism will benefit our 1.0 business. We intelligently repackage to minimize data traffic unit costs. Data packages of single operator or cross mobile network operators. Mobile virtual operators have large price differences, and we repackage from wholesale to retail. We have the largest SIM card pool and acquire data packages at wholesale local prices from operators to partners. Additionally, we provide high-quality data connection services and elevate the user experience for users and business partners through multi-networks reselection and combination, which highlights our uniqueness. uCloudlink 1.0 business monetization model includes retailing to consumers through rental or selling to end users and wholesale to businesses for business partners. Furthermore, our PaaS and SaaS services include CRM, billing management, device selling and rental management, etc. For wholesale to businesses, we can either be a reseller or provide commission services to our business partners. We enable our business partners to share the data traffic pool through our PaaS and SaaS platform and charge a commission fee. While the COVID-19 pandemic negatively impacted our 1.0 business, it has also created opportunities for potential growth, such as the increased demand for mobile data related to traveling, tracking, vaccination digital passports, and COVID test reports. Moreover, we have observed fewer competitors in the market following the COVID-19 pandemic. We expect the recovery of international travel to benefit our 1.0 business, especially in the U.S. market during the second quarter of 2021. We anticipate that our 1.0 business will not just recover, but grow with new developments fueled by innovative technology and products. Let us move to Page 14. uCloudlink 2.0 business has become a new driver of growth during 2020. Our 2.0 business showed greater resilience with proven high demand and growth potential during the pandemic and experienced less negative impact overall. The monetization model for our 2.0 business is similar to that of our 1.0 business, aiming at a significantly potential local user base. We help operators improve service and solve data connection problems through our PaaS and SaaS platform. During the COVID-19 pandemic, for instance, remote work and learning also require high-quality, reliable data connection services. Through partnerships with more MNOs and mobile handset manufacturers, we aim to embed more GlocalMe Inside, GMI, in smartphones, including 5G smartphones. The arrival of 5G brings us excellent opportunities. We anticipate accelerating the arrival of the 5G cloud era and applications such as AR/VR, cloud computing, and autopilot, among others. High-quality 5G applications for data connection will raise user requirements and awareness of data connectivity quality. Additionally, we have made progress with our hyper-connectivity solution in mobile and fixed broadband businesses across various application scenarios, such as home broadband. We also plan to proactively explore opportunities in new industries and various IoT application scenarios. Despite the continued impact of the COVID-19 pandemic on the global economy, we demonstrated commercial resilience and business vitality in the second quarter of 2021, generating revenue of $19.2 million, above the top end of our guidance range, with revenues primarily from Japan, the U.S., and mainland China markets. In Japan, we successfully launched and began shipping a new tablet targeted at the education industry. This tablet is equipped with cloud SIM technology, enabling it to seamlessly connect to better available mobile broadband and fixed broadband networks at all times. In the U.S. market, we continued to extend and deepen cooperation with online and offline distributors and recorded a new 12-month high for sales via Amazon in the quarter. We also noted a significant year-over-year increase in order demand for international data connectivity services in the U.S. market, compared to the second quarter of 2020. In the Chinese market, we steadily increased our number of mobile broadband and fixed broadband-related product installations through partnerships with a major mobile network operator in Shenzhen. These installations have improved user experience and expanded our potential user base in areas such as home broadband services, providing us with a solid reference case for further business development with mobile network operators across other cities in China. Thank you, everyone. Let us turn to Page 4 of the earnings presentation, which shows our vision and mission. 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. Our technology facilitates carriers and users with a single operator entry point to access all available local and global networks and would enable people to use mobile data traffic freely anytime, anywhere like breathing air. We expect to cover all available networks from operators globally with the recovery of the COVID-19 pandemic and the development of our 2.0 business, ultimately building a fully global marketplace of mobile data traffic. We believe that the trend of moving from connected to better connection is pivotal in the information era, and we are committed to enabling all business partners and users to achieve superior data connectivity. Our innovative technology allows us to establish a leading technological position in our PaaS and SaaS platform at the early stage of 5G, and we are dedicated to promoting better connection for everyone. I will now turn it over to our CFO, Yimeng Shi, who will go through the business and financial highlights sections.

Thank you, Mr. Chen. Hello everyone. Let us turn to Page 16 for our business highlights. The data for the second quarter of 2021 shows that the impact of COVID-19 is stabilizing. The left-hand side of the slide shows Daily Active Terminals as of June 30, 2021. Our uCloudlink 2.0 service accounted for approximately 68% of total DAT during the second quarter of 2021. Average daily data usage per terminal was 1.90 gigabytes in June 2021. Let us turn to Page 17, which shows global diversification of our business. Mainland China's revenue as a percentage of total revenue increased to 8% during the second quarter of 2021 compared to 6% during the first quarter of 2021. We had 92% of total revenue from outside Mainland China. During the second quarter of 2021, Japan contributed 53% of total revenue and continued to be the single largest market for our business. For other countries' revenue, the U.S. market had the largest contribution to our business. In the second quarter of 2020, we had 8% of total revenue coming from Mainland China, 56% from Japan, and 36% from other countries and regions. Let us turn to Page 19. I will now go through our financial highlights for the second quarter of 2021. Service-related revenue as a percentage of total revenue increased from 46.9% in the second quarter of 2020 to 48.5% during the second quarter of 2021. Revenues from PaaS and SaaS services increased 589.5% from $0.5 million in the second quarter of 2020 to $3.2 million in the second quarter of 2021. This increase was primarily due to a rise in our business partners utilizing our PaaS and SaaS services to provide local data connectivity services. Revenues from PaaS and SaaS as a percentage of total revenue also rose to 16.4% during the second quarter of 2021 compared to 12.9% in the first quarter of 2021. Let us move to Page 20, which shows the revenue breakdown of our two business segments: revenue from services and sales of products. During the second quarter of 2021, revenue from services and sales of products accounted for 48.5% and 51.5% of total revenue, respectively. Our total revenue decreased by 8.5% from $21.0 million in the second quarter of 2020 to $19.2 million in the second quarter of 2021. Revenue from services was $9.3 million, representing a decrease of 5.5% from $9.9 million for the same period of 2020. This decrease was mainly due to lower revenues from international and local data connectivity services, partially offset by an increase in revenues from PaaS and SaaS services. Our total revenue increased by 8.7% compared to $17.7 million in the first quarter of 2021. Let us turn to Page 21 for the gross margin of our business. Our services' gross margin increased to 45.4%, and our overall gross margin increased to 28.1% in the second quarter of 2021, compared to 35.4% and 26.2% during the second quarter of 2020, respectively. The increase in our services' gross margin during the second quarter of 2021 is primarily due to the rise in our PaaS and SaaS revenue, which has a higher gross margin compared to our other business revenue. Let us move to Page 22, which shows the breakdown of our operating expenses, excluding share-based compensation and others. Excluding share-based compensation, operating expenses as a percentage of total revenue dropped from 71% during the first quarter of 2021 to 61% during the second quarter of 2021, and we will continue to improve our operational efficiency. Let us turn to Page 23. Operating cash flow was negative $6.1 million during the second quarter of 2021, compared to negative $2.8 million during the second quarter of 2020. Our cash flow was stable, with sufficient cash and cash equivalents as of June 30, 2021. Our capital expenditures were $0.3 million during the second quarter of 2021, compared to $0.2 million in the same period of 2020. Capital expenditures as a percentage of total revenue rose from 1.0% during the second quarter of 2020 to 1.3% during the second quarter of 2021. Let us move to Page 24. Net income for the second quarter of 2021 was negative $8.2 million, compared to negative $41.6 million during the second quarter of 2020. Adjusted EBITDA was negative $5.5 million during the second quarter of 2021, compared to negative $3.1 million during the same period of 2020. With that, let me conclude today’s presentation. Thank you. Now we will start our Q&A session.

We will now begin the question-and-answer session. The first question comes from Vivian Zhang with Diamond Equity. Please go ahead.

Good evening. This is Vivian from Diamond Equity Research. Thanks for taking my question. So we see the Company just launched a new HyperConn enabled tablet in Japan. So can you update us with more information about this product and its market position? Are there any competitors you believe are in the market for this product? And my second question is regarding your overseas expansion. Can you provide more insights on the recent partnerships you've established in the second quarter? Thank you.

This is Chen speaking here. We have launched our product with HyperConn feature in Japan and also some other countries. We have two products: one is a tablet and the other we call Numen. Numen is a 5G mobile Wi-Fi. Our product is the first to feature this ability, and we do not have any competitors in this domain. Because of our HyperConn, we can connect to any kind of network in the world, whether Wi-Fi or any mobile network, and we may have multiple connections. For instance, one Wi-Fi connection and another mobile network. We can switch from one network to another, whether between the Wi-Fi and mobile network or from one mobile network to another. This unique feature is unmatched by any competitor, enhancing the reliability of connection for our consumers. For example, if our consumers use mobile Wi-Fi for remote learning or video conferencing, we will provide a much better connection than others, even if one base station goes down. With this, we can switch to another network without interruption. Is that clear?

Yes. So, my second question is regarding your overseas expansion. Can you provide more information on the recent partnerships that you established in the quarter?

We have, actually, observed that our market share in the United States has increased. I think this market, along with Japan, is currently our focus, and we believe the next significant growth will be in the United States. Additionally, for the Asia Pacific and Europe, we are allocating more human resources for sales in those regions. We anticipate gaining more market share in those areas as well.

Okay, great. Thank you for the additional details, and congratulations on the quarter.

This is Yimeng Shi. I would like to add some points for you. Regarding the HyperConn solution, as you know, we are ready to unveil our HyperConn solution and the related products and services. Apart from the Japanese market, we have also made progress through our Hyper-Connectivity solution with mobile and fixed broadband business in other markets, which we refer to as MBB + FBB. In application scenarios, we received very positive feedback for our 5G and 4G millisecond multi-network reselection technology in the Chinese market for home broadband. Regarding partnerships, we published a press release highlighting our collaborations in Southeast Asia, Europe, and the U.S. market. As point of note, the U.S. and Europe are continuing to develop, and Mainland China remains our major market. Through partnerships, we are innovatively cooperating with MNOs and mobile phone manufacturers, which represents a new business model for us. We believe such cooperation will provide us with more business development potential and help expand our user base via our partnerships and platform. Additionally, we are continually expanding our PaaS and SaaS ecosystem globally. Thank you.

Okay, thank you, Bob.

Yes. I have additional comments. Feedback from the first delivery of HyperConn products, such as the Numen, has been very positive. Regarding your earlier question about expansion, aside from Japan, both the U.S. and China have become fast-growing markets, and our partnerships are expanding into more countries, notwithstanding the COVID-19 impact. We also noticed that PaaS and SaaS revenue is growing much faster than before. That’s some additional information.

The next question comes from Lisa Thompson with Zacks Investment Research. Please go ahead.

Good evening. I have a few questions about your future revenue guidance. I believe you mentioned having some large education contracts for the tablet in Japan. It doesn't appear that this will happen next quarter. Could you provide insight into what happened with that business? Have there been cancellations, is it delayed, or will it occur next year? Can you discuss the circumstances? Hello?

Yes, we can identify several impacts. The first is that the COVID-19 situation has slowed down everything in Japan. Therefore, business progress has been hindered. We believe the demand remains, but it requires more time. That's the first point. The second impact is due to a shortage of chipsets; the supply has become tight and prices have increased. Thirdly, we experienced a slight delay of about one month in delivering our product. All these factors impact our projections for Q3. Nevertheless, we believe the market is present and anticipate receiving orders in the first quarter of next year.

So, you mentioned the first quarter of 2022?

Yes, it's just a delay, not a decrease in demand. We anticipate a growing market, meaning the timeframe is extended due to supply and delivery issues.

Okay. So, you don't believe that being in the middle of the school year will impact you significantly?

We have not missed the entire school year; it's only a minor delay. Demand is still strong and is increasing as we progress. So, we expect to recover effectively.

Do you anticipate that Q4 this year will be similar to Q3?

We will provide Q4 guidance in the next earnings call, and yes, we will share insights at that time. For now, we are focused on the guidance for the third quarter as we have already disclosed.

Can you provide a current update on the status of distributing your 5G products? Where are they currently sold, and when do you expect them to be available in other territories?

We just launched the 5G product, Numen, in August, which was about a month behind our original schedule. We've received positive feedback from users, partners, and channel partners; however, this is a high-end product, designed for enterprise, education, and industrial internet applications. We are targeting high-end markets. Over the coming quarters, we plan to launch additional 5G products, and we are working on reducing prices to become more competitive in the market.

If I wanted to buy a Numen, where could I purchase one? In which countries is it available?

You can purchase it on Amazon, in regions like Japan, Europe, and China, both online and offline. For the United States, due to differing radio frequency regulations, you won't find Numen on Amazon, but we will provide updates once we’re ready with the frequency specifications.

Great, thank you. One last question. I noticed that the gross margin per product has decreased considerably. What’s driving this? Is it related to the startup costs of the 5G products?

Yes, in the second quarter, the gross margin for products did decrease. The main reason is product mix, as we went through a lower gross margin product, the Wi-Fi dongle for Japanese customers. Regardless, we expect to offset this by increasing our PaaS and SaaS services, which have a higher gross margin. Thus, despite lower product margins, we maintain suitable margins overall. Future product mix will determine how we perform in subsequent quarters.

Yes, another impact comes from the rising prices of chipsets.

Okay, great. Thank you for the clarification.

As there are no further questions now, I'd like to hand the call back to management for their closing remarks.

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

This concludes the earnings conference call. You may now disconnect your line. Thank you.