Sean Shenglong Zou - CEO Tao Thomas Wu - CFO.

Charlie Chai - 86Research.

Good morning and thank you for standing by for Xunlei's Second Quarter 2015 Earnings Conference Call. At this time all participants are in listen-only-mode. After Management's prepared remarks there will be a question-and-answer-session. Today's conference call is being recorded. I would now like to turn the call over to your host today, Ms.

[indiscernible] IR Director of Xunlei..

Thank you, operator. Good morning and good evening. Welcome to Xunlei's second quarter 2015 earnings call. I'm Dani Zhang [ph] Investor Relations Manager at Xunlei. With me today on the call are Mr. Sean Zou, our Chairman and 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 our 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 provisions 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 obligations 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 to GAAP measures in the tables 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, Dani [ph]. Good morning and good evening everyone. Thanks for joining us today for our earnings call for the second quarter of 2015. Let me start by briefly commenting on our financial results for the second quarter of 2015. I'm pleased to report that our revenues were $31.2 million, which were above the high end of our own guidance.

As importantly, the number of our subscribers rose during the second quarter reversing the previous decline since the second half of 2014. We will provide more comments later. Again, like the previous quarter, the results for divestiture [ph] are according to the relevant accounting requirements which do not include the results of Xunlei's Kankan.

Before I talk about our core strategies, let me briefly comment on our subscription business. As I mentioned, the number of our subscribers increased during the second quarter. As of the end of June, our number of subscribers was about 5.06 million compared to 4.88 million at the end of March quarter.

This reversed declining trend which started mid of 2014, most likely as a result of new regulations of Internet content. Although it is too early to [indiscernible] about subscriber base, we are seeing signs of stabilization. I think there are probably a couple reasons for the faster stabilization of our subscriber base.

First, our user base has had almost a year to adjust to government regulations of Internet content and user base strong [ph] consolidation over the half of the year at which our core consumer space. And then secondly, we have been even more focused on customer care efforts as well as built our marketing efforts over the past several quarters.

And then finally, Xunlei Mobile, which is one of Xunlei's mobile app has been increasingly important channel for bringing in new subscribers.

Having said that, changes [ph] remains the number of our [indiscernible] subscribers also increased during the quarter, but we are hopeful that the subscription business are starting to show signs of stabilization reversing the trend of previous declines.

In addition to subscription business, let me share with you the progress that we are making in our Project Crystal. Project Crystal is our ongoing innovation in crowd sourcing idle bandwidth and is potentially large.

It could potentially become a disruptive innovation by improving efficiently providing crowd source bandwidth without actually investing in cloud access. As internet usage continues to grow in China, so will the demand for balance usage. Although it is still in the early stage we achieved meaningful progress and milestones in the second quarter.

In late June, we held an official product launch for Project Crystal in Beijing and Project Crystal was officially launched under the trademark of Xunlei [ph] on the [indiscernible]. The launch was intended to gain greater market awareness and customer acceptance.

It was very well attended by a variety of industry players, including video streaming sites, Xbox and online game companies initiating market interest in product [indiscernible]. I'm pleased to report the customer dialogue and the engagement has been active since the launch, with many of the potential customers approaching to us on their own.

A key customer [indiscernible] iQIYI one of the leading video streaming websites in China dialogue as well as product [indiscernible] was achieved has been ongoing for a while. For the planned partnership we saw with iQIYI which we have announced two weeks ago was a milestone.

The partnership with iQIYI is one of the first company and the most important adopters of our Crystal technology. Project Crystal will provide crowd source bandwidth service to iQIYI.

[indiscernible] would help iQIYI users to enjoy smooth video game experience in their compact network environment and enable iQIYI to increase the stability and security of their service as well as to reduce their operating cost.

The site and a geographical better innovative user base the complexity of iQIYI's video streaming services and in turn adoption of crowd source bandwidth from Project Crystal are a testimony to both Project Crystal's development technology and increasing value propositions.

This was a testimony for Project Crystal in providing product liability, market acceptance as well as its competitive value proposition. The key focus for the next several quarters are, first to continue to build our technology products. As you may know Crystal is an evolving technology.

We obviously achieved a milestone, but we need to move the technology to the next phase. And second, to gain more marquee customers like iQIYI to demonstrate product liability and as well as its value proposition and third, to ramp in terms of our sales scale. Let me now update you on our mobile strategy.

Again our [indiscernible] an anchor for our mobile strategy. Our mobile acceleration [indiscernible] benefit from pre-installation agreement with Xiaomi. All Xiaomi phones will be preinstalled with Xunlei's mobile acceleration software.

Since being officially installed in Xiaomi operating system later last year, we have been executing our strategies to refine our mobile acceleration product in its performance and is consistently to expand install user base and increase the user traffic and to partly be user interface and potentially multiply the user traffic.

Our mobile traffic from Xiaomi phones continue to increase. As of the end of last month our daily active users was about 80 million up from 50 million when I spoke to you last time.

The term by active users means we use Xiaomi's panel functions for apps or gaming centers, also from upgrades which figures Xunlei's embedded acceleration solutions software.

Beyond that, I am also pleased that we have entered into strategic agreements with several other leading smartphone makers in China during the quarter whereby the goal is also to preinstall Xunlei's mobile acceleration software in their phones.

Possibly we are not at liberty to disclose the nature [ph] but this is consistent with our strategy of trying to widen our install base through partnerships with other smartphone makers.

Looking forward, we will continue to execute our core growth strategies through innovation, through Project Crystal, migration to mobile internet and a refocusing our existing product portfolio. [indiscernible] I have articulated before, first to [indiscernible] Xunlei's technology in the platform.

Second, we will need to achieve sustainable profitability. I am excited about Xunlei's future. We have clear strategies and experienced management teams to execute our strategies. We look forward to updating you on our progress in future calls. With that, I am now turning it over to Tom for more detailed financial review.

Tom?.

Thank you, Sean. Good morning and good evening everyone. First of all it was a solid quarter in many ways. We achieved milestone in Project Crystal in its product launch, market awareness and key customer wins.

Secondly, reversing membership decline for our subscription business and the closing of Kankan divestiture shortly after the close of the quarter, which was a part of our growth focus and strategy. Now let me draw your attention to our financial statements.

Again because of Kankan's divestiture, its financial results are reported in discontinued operations according to accounting standards. So all the numbers I'll be sharing with you are on ongoing operations basis including the comparatives which will be on a year-over-year basis unless indicated otherwise.

For the second quarter our revenues were $31.2 million excluding Kankan which as Sean mentioned is above the high end of the guidance range we had provided. Compared to the previous quarter, revenues grew by 3.2%.

Subscription revenues were $21 million, which continued to be the most important segment for us, now representing about 67.4% of our total revenues. On a sequential basis subscription revenues were essentially flat. Number of subscribers at the end of the quarter was 5.06 million, which increased by about 180,000 during the quarter.

Again this is the first increase of our subscriber base since the second half of last year. ARPU was RMB25.8 a decline from RMB26.5 from the previous quarter. As Sean mentioned, challenges remain for the subscription business despite the possible signs of stabilization.

The number of temporary suspension accounts was about 426,000 subscribers up from 390,000 subscribers at the end of the quarter. IVAS revenues were $9.2million for the quarter. This represented 39.4% increase on a year-over-year basis. Growth in web games was the primary reason for growth in our IVAS revenues.

Cost of revenues increased by 18.5% to 14.3% on a quarter-over-quarter basis. Bandwidth cost increased substantially for our subscription services and a larger user base this quarter.

The operating expenses were $19.9 million up 19% on a year-over-year basis primarily driven by an increase in debt compensation expenses including share based compensation. Net income from continuing operations for the quarter was $3.1 million.

Non-GAAP net income from continuing operations was $5.5 million compared with a net income of $6.2 million for the same period last year. Turning to our balance sheet, we ended the quarter with cash, cash equivalent and short-term investments balance of $444.5 million, $10.9 million increase compared to the end of the previous quarter.

Our balance sheet remained strong. Cash value on a per ADS basis is $6.62. Strong balance sheet should continue to allow us to execute our growth strategies that Sean outlined in his section. Guidance for the next quarter, we expect our revenues to be between $29 million to $33 million.

The midpoint of the range represents essentially flat on a sequential basis. With that, let me see if there are any questions we can answer.

Operator?.

Thank you. [Operator Instructions] Our first question comes from the line of Charlie Chai from 86Research. Please go ahead. Mr. Chai, your line is open, please go ahead..

Hi, congratulations on a solid quarter. I think that the company is undergoing some transition and would you please shed some light on the kind of the impact of the Project Crystal? And I have a followup question..

Yes, thank you Charlie, that's a very good question. I think a couple of points that I would reiterate. First of all obviously was a very significant quarter for us as Sean discussed in terms of our product launch as well as key customer wins.

And second, I would also like to reiterate that our strategy going forward which from a technology standpoint is really to moving to the next phase because of rewarding [ph] technologies as well as a ramping our size and improving customer service. Financial impact, revenues were achieved included in the second quarter revenues.

So that was also a major milestone because previously the crowd source bandwidth was only used for our internal purposes. So the second quarter we did achieve third-party sales, this is to a gaming company, not iQIYI, but the magnitude was relatively small.

We do expect revenues from third-party sales which is baked in, in our third quarter revenue guidance. But I would emphasize it's a long steep ramp and we do expect the ramp to take place over the next few quarters. The profitability wise, we're still in investment stage in terms of product development, in terms of sales and marketing.

So we do not expect profit contributions from the Project Crystal over the next several quarters yet. I hope I answered your question..

Okay, thank you very much.

A second question, is there any near-term plan for the cash, I see there is quite some cash sitting on the balance sheet?.

Yes, it's Tom again. That’s a very good question again Charlie. You are absolutely correct. We have a cash balance which translates into $6.60 on a per ADS basis. I think maybe just three things I would mention. Number one, obviously it's important, strategically important for us to have a solid balance sheet to ensure that we can execute our strategies.

And secondly, we are continuing to invest in new products and services, which goes back to your first question, the Project Crystal. And thirdly, it will ensure we have a balance sheet to support our other growth initiatives. So I think those are the key strategic reasons for holding our cash. And finally, we did generate positive cash flow this year.

Some of the cash increase was from free cash flow generation. So we are cautiously optimistic that we can continue to generate cash flow and maintain a strong balance sheet to invest in the future for Xunlei..

Okay, that will make sense. Thank you very much. Congratulations again..

Thank you, Charlie.

Operator, next question please?.

Certainly. The next question comes from the line of Mr. [indiscernible]. Please go ahead..

Good evening Sean and Tom. I've got three questions here. The first one is with the Project Crystal the bandwidth cost is supposed to be reduced.

So why did they increase in this quarter? And the second one will be, why did the average revenue per subscriber decline this year, being the quarter seems the user base increased but the total revenue from subscriptions they are declined? And the third question will be we see you still have a strong quarter for the gaming industry, so why do you think to tie that in the gaming industry? Thank you..

I did not quite catch the third question, but let me answer the first two questions first. It's Tom here. In terms of bandwidth consumption increase, it's primarily because of our subscription service and the user traffic in terms of volume of bandwidth increased significantly quarter-over-quarter. It's a function of two reasons primarily.

Number one is a larger subscriber base which naturally uses more acceleration services and bandwidth and second is the types of acceleration that our user base is increasingly using for.

So what I am saying is that not only the absolute bandwidth is increasing or traffic is increasing, but the video component in terms of types of usage, in terms of percentage is also increasing. So these reasons contributed to increasing in bandwidth consumption which led to bandwidth cost increasing meaningfully on a quarter-over-quarter basis.

Now your question about ARPU, I think a good one, it's really a way how we calculate it. If you recall that the number of suspended accounts increased this quarter to 426,000 over the previous quarter.

So now, when we – let me put it this way, these are the accounts that we do calculate in terms of our total subscriber base because these are customers, but from a revenue recognition standpoint they do not contribute to revenues.

So what I'm saying is that, the denominator when you calculate ARPU in terms of number of subscribers increased partly because of increased India [ph] suspended accounts which led to a decline of ARPU. I am sorry, your third question was about gaming, but I didn’t hear clearly your gaming question..

Yes, thank you, Tom. My third question was, I see there, you've got a really strong game quarter since the line, the other internal value-added service increased like sequentially and year-over-year just because of the game revenues and I also see that Xunlei has intent to divest your client game business.

So I'm looking for the reason why Xunlei is divesting in a strong business?.

Yes. Thanks it is very clear now. That's a very thoughtful question. I think probably three points I will share with you. Number one, what led to a very impressive year-over-year growth in terms of our ADS [ph] was, yes it was gaming business, but it was in web game business that was an excellent quarter for the web game business.

That is not the case however for client game business, okay. So that's the first clarification. And second point is that, we did note in our earnings release that we intend to divest our client game business which is different from the growth business that I mentioned earlier and the reason for that is a couple of things.

I think we'll be trying to part of the strategy that we have laid out for ourselves and the board for 2015 is to refocus our products, to refocus our existing business. And the criteria that we used as Sean actually mentioned in his script, were a couple of things. Number one is the affinity to our technology DNA.

Does it add to the whole technology platform of Xunlei? And as you probably know Xunlei regards itself as intrinsically a technology company. And the second criteria we are using in evaluating our portfolio, existing portfolio is ability to achieve profitability or profit growth.

So if we use those two criteria, it’s the same reason why we decided to divest our video streaming business. It's not quite a technology business, let alone the profit loss that we've been able to generate previously and the same reason for the client game business. It's not a growth business.

And from a profit contribution standpoint it's also a drag in terms of our profits. So it's our intention we're still obviously in the middle of the profits right now, it’s our intention to divest the client game business and it does only represent roughly about 4.2% of our revenue. So it's not a major business for us.

And obviously it will help improve our profitability. And finally, we think that it will help management focus in terms of focusing on what Xunlei does best and allow us to execute our growth strategy. Let me pause and see if there's anything that Sean would like to add on top of the [indiscernible] that I just provided..

I think that's fine.

Operator, next question please?.

Thank you. The next question comes from the line of Jun Wang [ph] from TD Capital [ph]. Please go ahead..

Thanks Sean and Tom, for taking my question. I just had a follow-up question with regards to your iQIYI contract. I understand that early the Project Crystal is doing only [indiscernible] do you mind to give us guidance on when the iQIYI will have the meaningful contribution to the financials and what the magnitude of that contribution? Thanks..

Yes, I'll translate the reply. I think three points. Number one, you're absolutely correct. iQIYI was a milestone for us, because as I mentioned in my prepared remarks the size of its video streaming business, it's one of the largest video streaming sites in China.

The complexity of its business and the diversity of its content, so absolutely it was a marquee customer milestone for us. And secondly, as mentioned very briefly that since the June 24, product launch as I mentioned that response from other potential customers was solid.

Many of them approached us on their own behalf and the variety, the diversity of potential customer base was also wide from other video streaming companies, to gaming companies, to app source. So we are hopeful we can gain further traction as we progress.

Now specifically to your question about impact or financial impact of Project Crystal, I do want to caution that it is still in early stage in many senses of word. In terms of technology as I mentioned, we obviously have achieved a milestone, but we do need to move that into the next phase.

And second, in terms of market acceptance, we are in various stages of testing with different customers, but the sales cycle because it's a new technology, as you may guess, it could be time consuming.

And the specific financial impact from iQIYI we do expect revenues from the third quarter, which we have incorporated in our guidance range for the third quarter.

But I want to emphasize again, it's a long ramp and we hope that market can be patient in terms of this technology and in terms of the magnitude of the revenues that we can generate as we continue to interface with the marketplace.

So having said that, we're obviously very pleased that it was a very solid quarter, especially with iQIYI, but we do expect financial impact at least for the third quarter is fairly minimal at this stage. I hope that answers your question, in terms of your question..

Yes, adequately..

Operator, are there further questions?.

There are no further questions at this time. Please continue..

Why don’t we give the line a few seconds to see if there are any further questions before we wrap it up?.

Certainly. [Operator Instructions].

If not, thank you all for joining our call this morning or this evening. It was a solid quarter for us and we obviously laid out our strategy and we believe it was a very solid quarter in terms of execution for the strategies that we have laid out. Thank you again and we look forward to updating you on our future calls. Good evening..

Thank you ladies and gentlemen. That does conclude our conference for today. Thank you for participating. You may now disconnect your lines..