Taomi.com's financial report: Taomi's net profit in Q3 2011 was US$4.4 million, down 31% year-on-year

On November 29, 2011, Taomi.com (NYSE:TAOM) released its unaudited financial report for the third quarter of fiscal year 2011 ending September 30. The report showed that Taomi.com's total net revenue in the third quarter was US$12.7 million, up 7.8% from US$11.8 million in the previous quarter and up 23.7% from US$10.3 million in the same period last year, exceeding the company's previous expectations; net profit attributable to common shareholders was US$4.4 million, down 31% from US$6.4 million in the previous quarter and US$4.3 million in the previous quarter.

2011 Third Quarter Financial Report Summary

Net income for the third quarter of 2011 reached a record high of $12.7 million, an increase of 7.8% from $11.8 million in the previous quarter and an increase of 23.7% from $10.3 million in the same period last year.

Gross profit margin for the third quarter of 2011 was 81.2%, down from 85.1% in the previous quarter and 84.9% in the same period last year.

Net income attributable to shareholders for the third quarter of 2011 was $4.4 million, compared with $4.3 million in the previous quarter and $6.4 million in the same period last year.

Basic and diluted earnings per ADS were both $0.12, compared with $0.14 and $0.13, respectively, in the previous quarter and $0.22 and $0.21, respectively, in the same period last year.

Non-GAAP net income attributable to shareholders was $5 million, compared to $4.7 million in the previous quarter and $6.5 million in the same period last year.

Non-GAAP basic and diluted earnings per ADS were $0.14 and $0.13, respectively, compared to $0.15 and $0.14 in the previous quarter and $0.22 in the same period last year.

"We are pleased to announce Taomi's third quarter 2011 results, with record revenue and a record high number of active users of 37.1 million," said Wang Haibing, co-founder, director and CEO of Taomi. "We also launched two movies based on our core games, Sailer and Mole Manor, which ranked among the top 10 domestic animated films in terms of box office revenue."

"The record number of active users is partly due to our strategy of expanding market share, enhancing user stickiness and reducing the charging intensity of online games. The good performance in the third quarter gives us great confidence that we will continue to prioritize expanding market share while expanding our user base and improving user stickiness. The success of the animated film and the triple-digit growth of offline licensing business demonstrate our ability to monetize our brands across platforms while reducing our reliance on online business revenue. On October 28, 2011, we strengthened our competitive position and intensified our efforts to capture market share in the fourth quarter by launching the iOS version of Mole Manor. This entertainment app has been ranked first in the domestic download list since its launch. Looking forward, we are confident that we can seize the opportunity to build Taomi into China's largest and most profitable children's entertainment media company."

2011 Third Quarter Operating Results

The number of active users in mainland China in the third quarter of 2011 was approximately 37.1 million, a 55% increase from 24 million in the previous quarter. The number of active paying users of our games in mainland China decreased from 2.2 million in the second quarter to 2.1 million, compared with 3.1 million in the same period last year. The increase in active users was mainly due to the company's successful attraction of new players through a series of marketing activities in order to expand its market share. The decrease in the number of active paying users was due to the company's decision to weaken the intensity of charging in order to enhance user stickiness.

2011 Third Quarter Financial Results

Net income

Net income for the third quarter of 2011 was $12.7 million, compared to $11.8 million in the previous quarter and $10.3 million in the same period last year.

Online business net income was $10.4 million, compared with $10.7 million in the previous quarter and $9.7 million in the same period last year. The main reason for the quarter-on-quarter decline was that the company actively promoted the strategy of expanding market share and strengthening user stickiness, attracting new users by weakening the charging intensity of online games. The year-on-year increase was mainly due to the contribution of newly released products.

Net income from offline business was $2.3 million, compared to $1.1 million in the previous quarter and $0.6 million in the same period last year. The main reasons for the quarter-on-quarter and year-on-year growth were the growth of offline merchandise sales, book licensing income, and film and television business.

Total service cost

Total service costs were $2.4 million for the third quarter of 2011, compared to $1.8 million in the previous quarter and $1.5 million in the same period last year.

Online business costs were $1.5 million, compared to $1.5 million in the previous quarter and $1.4 million in the same period last year. The main reasons for the quarter-on-quarter and year-on-year increases were the increase in employees and equity incentive expenses.

Offline business costs were $0.9 million, compared to $0.2 million in the previous quarter and $0.2 million in the same period last year. The main reasons for the quarter-on-quarter and year-on-year increases were film production-related expenses, an increase in employees, and an increase in equity incentive expenses.

Gross Profit vs. Gross Margin

Gross profit for the third quarter of 2011 was $10.3 million, compared to $10.0 million in the previous quarter and $8.7 million in the same period last year.

The gross profit margin was 81.2% in the third quarter of 2011, 85.1% in the previous quarter and 84.9% in the same period last year.

The gross profit margin of online business was 85.3%, compared with 86.0% in the previous quarter and 85.6% in the same period last year.

The gross profit margin of offline business was 63.0%, compared with 76.7% in the previous quarter and 72.7% in the same period last year. This quarter, we began to record the revenue and cost of movies and cartoons in the financial statements. The lower profit margin of the movie and cartoon business led to a decline in the average gross profit margin of offline business.

Total operating expenses

Total operating expenses for the third quarter of 2011 were $6.2 million, compared to $5.6 million in the previous quarter and $3.3 million in the same period last year.

Product research and development expenses were $2.9 million, compared to $2.2 million in the previous quarter and $1.4 million in the same period last year. The increase in research and development expenses was mainly due to the increase in the number of research and development personnel, the increase in expenses incurred by the use of the new social welfare system, and the increase in equity incentive expenses.

Sales and marketing expenses were $1.9 million, compared to $1.7 million in the previous quarter and $0.5 million in the same period last year. The increase in sales and marketing expenses was mainly due to the increase in expenses incurred by the company for film promotion, animation production and advertising.

Administrative expenses were $2.3 million, compared to $1.9 million in the previous quarter and $1.4 million in the same period last year. The increase in administrative expenses was mainly due to the increase in share-based compensation expenses and professional service fees paid for listing.

Equity investment income

Equity investment income was $200,000, compared with $300,000 in the previous quarter and $200,000 in the same period last year.

Operating Profit

Operating profit was $4.1 million, compared with $4.4 million in the previous quarter and $5.5 million in the same period last year.

Income tax benefit (expense)

Income tax expense was $0.3 million, compared to $0.5 million in the prior quarter and $0.8 million in the prior year period. The decrease in income tax expense was due to changes in the corporate income tax rates for Shanghai Shengran and Shanghai Taomi in 2011.

Net Profit

Net income attributable to shareholders was $4.4 million, compared with $4.3 million in the previous quarter and $6.4 million in the same period last year.

Non-GAAP net income attributable to shareholders was $5 million, compared to $4.7 million in the previous quarter and $6.5 million in the same period last year.

GAAP basic and diluted earnings per ADS were $0.12 and $0.12, respectively, compared to $0.14 and $0.13, respectively, in the previous quarter and $0.22 and $0.21, respectively, in the same period last year.

Non-GAAP basic and diluted earnings per ADS were $0.14 and $0.13, respectively, compared to $0.15 and $0.14, respectively, in the previous quarter and $0.22 and $0.22, respectively, in the same period last year.

Cash and cash equivalents

As of September 30, 2011, the company had cash and cash equivalents totaling $120.9 million, compared to $119.5 million in the previous quarter.

Latest Business Development

On July 28, 2011, Taomi launched its first animated film "Seer: Searching for the Phoenix".

On August 11, 2011, Taomi launched the second animated film "Mole's World Ice Age" based on the game "Mole's World".

On September 6, 2011, Taomi Chairman Zeng Liqing purchased 216,000 common shares of the company through open market transactions.

On October 28, 2011, Taomi launched the first iOS version of the game "Mole Manor", which was based on Taomi's online children's community of the same name.

On November 22, 2011, Taomi's board of directors approved the company's stock repurchase plan, which is effective immediately. Under the plan, Taomi will have the right to repurchase up to $10 million of its American depositary shares in the open market over the next 12 months, depending on market conditions, stock prices and other factors. The repurchase will be conducted in accordance with the rules and regulations of relevant U.S. securities laws.

Business Outlook for the Fourth Quarter of 2011

In the fourth quarter of 2011, Taomi expects net income to exceed US$8 million, which is lower than the third quarter. The main reason for the quarter-on-quarter decline is seasonal factors, and the company has no plans to launch offline movies in the fourth quarter.

Taomi's users are mainly primary and secondary school students. Compared with the one-month summer vacation in the third quarter, students have almost no vacation in the fourth quarter. Although many students will still log in to the game community in the fourth quarter, their consumption in the community will decrease. Taomi consciously weakened the charging intensity in the third and fourth quarters in order to expand the user base and increase market share and increase user stickiness. Seasonal fluctuations are a normal part of Taomi's business, and management hopes that investors will pay more attention to the long-term development of the company.

Taomi launched two animated films in the third quarter, "Seer: Searching for the Phoenix" and "Mole Manor Ice Age", both of which ranked in the top ten domestic animated films. We expect that the film business will not contribute much revenue in the fourth quarter. The company has no plans to launch new films before the summer of 2012.

Despite the seasonal decline in revenue, Taomi is improving its brand profitability through licensing business and movies, thereby reducing its reliance on online gaming profits.