GMO Internet Inc

TSE:9449

Earnings Call Transcript 2018-Q1

[Masashi Yasuda, executive]

Here you can see today's agenda. I would like to explain mainly our first quarter results. We changed certain segments in Q1. We added Cryptocurrency segment as a new segment. Cryptocurrency segment has 2 subsegments. 1 is Cryptocurrency exchange business, which offers services under the GMO Coin. The other is Cryptocurrency mining business, which offers services under GMO Internet and the group company in Europe. Mobile Entertainment segment will be merged into other businesses.

This slide shows the business performance of the Q1. Net sales increased by 21.3% to JPY 43.7 billion year-on-year. Operating profit increased by 49% to JPY 5.26 billion year-on-year. Ordinary profit increased by 46.2% to JPY 4.93 billion year-on-year, and net profit increased by 81.3% to JPY 2.08 billion year-on-year. We recorded impressive year-on-year growth as infrastructure saw record-high earnings and the Internet Finance performed favorably. We believe we have made a good start.

This is an executive summary of operating profit covering January to March for each segment. Operating profit increased by JPY 1.73 billion to JPY 5.26 billion compared to this time last year.

Looking at each segment, Internet Infrastructure saw steady growth in each business area, and profit increased by JPY 430 million. Of particular notice is the JPY 2.06 billion increase in profit in Internet Finance segment due to improvement in profitability. However, profit in the Cryptocurrency segment decreased by JPY 710 million year-on-year. Profit in the Cryptocurrency exchange business decreased by JPY 740 million due to one-off loss on valuation and proprietary position, as we were unable to respond to the rapid market fluctuations, though, the profit in the cryptocurrency mining business was JPY 20 million, achieving positive figures. However, we implemented measures to control our position, and figures turned positive in March. We believe that the actual value of quarterly operating profit will soon reach JPY 6 billion as the loss incurred by the cryptocurrency business in Q1 is temporary. Next is the summary of each segment. In Internet Infrastructure, operating profit increased by 20.2% to JPY 2.58 billion year-on-year, achieving a record high. Each business area, including payment, security and provider, performed favorably. In Online Advertising & Media, profit increased by 21.8% to JPY 310 million. A large increase in profit was due to the absence of the previous year's one-off losses. However, the volatile situation continued due to the change in online advertisement market, such as the change in ad network advertisement distribution regulations. We will continue to build up the in-house products, such as ad technology products. Profit in Internet Finance increased significantly by 167% to JPY 3.3 billion. Improvement in FX profitability through an analysis of Big Data is producing good results, and all products performed favorably as opposed to the same period last year.

The new Cryptocurrency segment posted a loss of JPY 730 million. For the Cryptocurrency exchange business, the figures turned negative temporarily, though, the cryptocurrency mining business achieved positive figures. However, the monthly figures turned positive in March. We'll apply our knowledge of FX to expand the market share in the future. For the Cryptocurrency mining business, we are operating the mining machines and the figures are increasing as expected.

As for dividends, we have adopted a quarterly dividend system, but since we will not disclose our guidance, we will also not disclose our dividend forecast. So we will announce the amount of dividend every quarter. The company will pay a dividend of JPY 6 per share for the first quarter based on consolidated net profit. The payout ratio is 33.1%. Next is the summary of first quarter financial results. Shown here are each segment's revenue trends by quarter over the past 5 years. Revenue in infrastructure (sic) [ total revenue ] exceeded JPY 40 billion. Revenue in infrastructure drove the group's net sales, which doubled over the past 5 years. Next is each segment's operating profit. Shown here are each segment's profit trends by quarter over the past 5 years. Profit decreased compared to the previous quarter. Profit in Internet Infrastructure and Internet Finance is continuing to expand.

Here you can see an overview of profit and loss. Gain or loss on valuation of Cryptocurrency inventory is recognized as an operating profit or loss in the consolidated statement. Next, this slide shows the balance sheet. Interest-bearing debt increased compared to the end of 2017 due to the working capital borrowing to meet capital needs, which will arise at the end of 2018 at our FX business. This slide shows consolidated cash flow for Q1. Although, the accounting profit was positive, operating cash flow was minus JPY 17.35 billion mainly due to the increase of customer assets in FX, expansion of the Internet Finance business and payment, and Cryptocurrency mining-related expenses. Financing cash flow increased as interest-bearing debt increased mainly at our FX and cryptocurrency mining businesses. Moving on to the group overview. This slide shows the market cap and equity share of our listed companies.

This diagram shows GMO Internet's 4 segments. The segment sizes are based on the net sales ratio, which between infrastructure, Online Advertising & Media and finance is approximately 5:3:2. Our customer base is expanding across all segments, with growth in infrastructure contracts and customer accounts in FX, securities and Cryptocurrency exchange. At the end of March, the number of partners totaled 5,454 people. 44.2% of our partners are engineers and creators. We will continue to invest in human resources to see the ratio of creators to pass 50%. Next is the summary of each segment. This slide shows the composition of the Internet Infrastructure segment. All products in this segment are #1 in their respective markets. This is net sales in Internet Infrastructure and its breakdown.

Recurring revenue continues to see an upward trend, and the net sales increased 2.5x over the past 5 years. Revenue in provider services was JPY 5.5 billion and is again growing into core products. Shown here are Internet Infrastructure segment's profit trends by quarter over the past 5 years. High-margin products, such as payment and SSL, performed favorably, and operating profit achieved a record high. In Internet Infrastructure, the number of contracts came to a total of 9.1 million, reaching a record high. These contracts are the source of recurring revenue. We expect to see the number of contracts surpass 10 million in the near future. For .shop, the number of customers exceeded 600,000. The average renewal rate from September 2017 to February this year was 49.7%. As a convenient domain and online business, .shop was #9 in new gTLD registration rankings, and we expect that the number of contracts will continue to grow. Next is Online Advertising & Media. This is net sales in Online Advertising & Media and its breakdown. Net sales reached a record high. For online advertising, shown in light blue at the bottom, our in-house ad technology products and the ad agency have performed favorably, resulting in 2-digit growth in their net sales. As for media shown in dark blue, changes in ad network advertisement distribution regulations resulted in year-on-year losses. Shown here are Online Advertising & Media segment's profit trends by quarter over the past 5 years. Our current situation was discussed earlier. While operating profit increased year-on-year, we're struggling to improve the profitability. We will continue to strengthen our in-house products. Moving on to Internet Finance. This slide shows performance trends by quarter. Earnings declined temporarily in Q1 last year but increased steadily through an analysis of Big Data, and both revenue and profit were up in Q1 of this year, as shown on this slide. Shown here are FX trading volume trends by quarter. We've achieved the highest trading volume globally for 6 consecutive years. We were losing share to other competitors temporarily, but it recovered and is now growing again. This slide shows our current alliances in finance and payment services. Developments in each area are continuing to progress steadily. Please look forward to GMO Aozora Net Bank, which will be launched in July. Next, I would like to talk about our global operations. GMO Internet Group has already expanded to 61 locations in 22 countries and includes 1,291 partners. As for our Cryptocurrency mining business, we set up mining centers in 2 countries in Northern Europe with the Swiss office as the regional headquarter.

In overseas sales, in addition to the Internet Infrastructure business in Southeast Asia, which offers services under the Z.com brand and Internet securities, our new Cryptocurrency mining business was added to the portfolio beginning in Q1. In the previous quarter, revenue has grown significantly as the newly incorporated overseas subsidiary has a different fiscal year-end than the parent. Revenue for the first quarter has declined, but net sales continue to see an upward trend. That concludes my part of the presentation. Thank you for listening.

[Unknown Executive]

Kumagai will explain the Cryptocurrency business.

[Masatoshi Kumagai, executive]

Cryptocurrency-related start-ups can be divided into 3 categories. One is Cryptocurrency mining business. Another is Cryptocurrency exchange business. The other is Cryptocurrency payment business. History will decide if Cryptocurrency is gold or a currency. Only time will tell. Personally, I strongly believe that Cryptocurrency is like gold. If so, Cryptocurrency mining and exchange business will be profitable.

It's uncertain whether Cryptocurrency will become a currency. So investing a lot in payment business may pose risks. We'll invest in this business in the future, but right now, we're watching how it develops. Regarding GMO Internet Group's Cryptocurrency business, we focus on mining and exchange. As a Cryptocurrency mining business, we do everything from development, production and sales of the chip to mining. We got into this business with a strategy that is different from other miners. As for the results, we feel more confident every day. Our Cryptocurrency mining business mines cryptocurrencies that continue to develop globally as a new economic value. We're also working on the development and manufacturing of the mining chips and mining machines. The mass production of this next-generation 7-nanometer mining chip is now within reach. So I'll show more about its sales later. Regarding the cloud mining, we will hold information session on June 6 at the Cerulean Tower Tokyo Hotel, Level 2 basement ballroom, for potential customers. We will announce the details separately. Since the launch of business in 2017, we have been supplying the market with cryptocurrencies through GMO Coin. And based on the customers' reaction and transaction volume, we believe that running a business that provides cryptocurrency infrastructure is meaningful. Regarding Cryptocurrency payment, there are various methods available within Japan. Regarding the actual investment to spread Cryptocurrency payment, we believe we need more time to consider. I will explain the current business environment. The chart on the left shows the historical market cap of all types of cryptocurrencies. The cryptocurrency price has declined slightly since the beginning of the year, but it's recently rising again. The chart on the right shows bitcoin's total trading volume. The trading volume is rising when there isn't much fluctuation in the market price of bitcoin. Next, the total hash rate, which is a measure KPI of the cryptocurrency mining business, continues to be on the rise and is now around 30,000 petahash per second. The chart on the right shows the bitcoin price. The price rose at the end of last year and is now around $9,000. Next, the revenue structure of a cryptocurrency mining business is pretty simple as explained in the previous financial results announcement. The newly issued amount is 1,800 bitcoins per day. Revenue is calculated based on the newly issued amount of bitcoin, bitcoin's market value at the time of mining and mining share. Electricity, mining machines and facility comprise the cost.

In consideration of the fact that the Accounting Standards Board of Japan has disclosed the accounting policy for virtual currencies in March. We have summarized our policy as shown on the slide. We will calculate mining earnings at market price, which will be recognized when the cryptocurrencies are mined.

Regarding a gain or loss on sales of cryptocurrencies, the difference between the carrying amounts will be recorded in net sales when the cryptocurrencies are sold. The cryptocurrencies held by the company and its consolidated subsidiaries are recorded in the consolidated balance sheet at the market price value with the difference between the carrying amounts recorded in net sales. The above 3 items will be recognized as an operating profit or loss in the consolidated statement.

Next is the Cryptocurrency exchange business. GMO Coin, which is the consolidated subsidiary of GMO Financial Holdings is at the core of this subsegment. Revenue and profit were affected by bitcoin price fluctuations and dropped compared to the previous quarter but are right now recovering. We posted a valuation loss due to selloff in January but recovered through various strategies, such as the management of proprietary position and optimization of cover deals. This business achieved positive figures in March, and the revenue is growing. This chart shows that the customers' bitcoin balance is increasing steadily.

This orange line graph shows customer account trends. Services began almost a year ago, and the number of customer accounts has reached 140,000. We received many applications, especially at the end of last year. We've been able to target a wider customer base, and the number of customer accounts is equivalent to 50% of securities accounts and 20% of FX accounts. As for trading cryptocurrencies with the leverage, this blue bar graph shows that, despite the drop in cryptocurrency FX trading volume, profitability improved through the management of proprietary position and optimization of cover deals as discussed earlier. Next is the Cryptocurrency mining business. GMO Internet has launched on December 20, 2017, a Cryptocurrency mining business, which has made a good start and achieved positive figures in just 10 days. We're establishing more mining facilities and have obtained a favorable outcome. Initially, we still hold a position in cryptocurrencies which were sold off before accounting standards had been established. We deducted JPY 160 million loss on valuation of our bitcoin inventory from revenue and profit as the cryptocurrency price has declined since the beginning of the year. So net sales and net profit were JPY 600 million and JPY 190 million, respectively. The cost is made up of mainly electricity cost and the depreciation of mining machines as shown on this slide. I have previously founded many businesses. As explained in advance, we're running a profitable business and making for a good start. The next slide shows our computational power and the amount of mined bitcoin over the past 5 months, which are the major KPIs of a cryptocurrency mining business that we're reporting on a monthly basis. Both the hash rate and the amount of mined bitcoin are increasing as planned. These charts show this year's expected hash rate in blue and trends over the last 5 months in red. Our computational capacity saw steady growth. You'll notice that our Cryptocurrency mining business is growing steadily.

Next, I will explain the main reasons for our decision to enter the crypto mining business. We're not just a miner that only mines using existing technologies. In addition to ensuring an advantage in electrical efficiency by utilizing our original next-generation 7-nanometer mining chips, the group will improve the efficiency of the cash flow by selling mine machines and offering cloud mining. We are one of the very few businesses that can do all of this. By fully utilizing our experience and expertise cultivated through Internet Infrastructure and Internet Finance businesses and our web hosting, and by unleashing synergies between existing businesses, volume production can commence rapidly and smoothly, so-called vertical start-up. These are the main reasons for our decision to enter the crypto mining business. We've been working on research and development of next-generation 7-nanometer mining chips with our alliance partner as stated in this slide. We have succeeded in developing 12-nanometer FCC process-based mining chips in December 2017. We will neither mass-produce nor sell the 12 nanometers FCC process-based mining chips. This chip is a significant milestone as it boosts the success rate of the development of 7-nanometer semiconductor chip, which is our goal. The development is a 2-step process with V1 as an initial prototype and V2 as the final product. This will boost the success rate of the development of the world's first 7-nanometer process technologies for mining chips. The explanation just now may have been a bit difficult to understand. 12-nanometer FCC process-based mining chips and V1 are significant milestones as they boost the success rate of the development of V2.

For V1, we have completed manufacturing wafers and are currently assembling mining machines. We will launch mining using the actual V1 at the end of May. 12-nanometer FCC process-based mining chips is the milestone, but we will not sell them. For V1, we will manufacture minimum amounts only, use them in the in-house mining and sell them. We will launch the mass production of V2 in October.

This slide shows the schedule I have explained just now. We will have the completed prototype of V1 at the end of May or in June. After we have confirmed its performance, we will launch the mass production of V1. The tape-out of the V2 will be at the end of May. It will take about 3 months and 10 days to receive V2, then we will assemble the mining machines and sell them. Next, regarding the cloud mining, we decided to hold the information session on June 6. As for the cloud mining, we will launch the services in Q3, earlier than initially planned. We will start accepting applications from potential customers today. For more details, please check our website. These are the photos of our mining centers in Northern Europe. We created large data centers at multiple areas in 2 countries and launched mining.

We're coming to the end of the first quarter presentation. This is the summary of the information we have provided in Q4 last year and Q1 this year.

We will continue to watch the external environment closely, as it is one of the important KPIs. We will not change the total investment. Development status of 7-nanometer semiconductor chip was discussed in detail earlier. In-house mining is progressing as planned. Regarding the sales of mining machines, we have never told specific schedule, but we have announced today when we will start accepting applications and offering mining machines. We have received lots of inquiries. We will announce the details through our website. We will also offer the cloud mining services earlier than initially planned. Speed is the key to win in the internet industry, but in the crypto industry, because players all over the world compete on a level playing field, speed is more important than ever. By responding flexibly to the ever-changing market environment and through a speedy management, which is our strength, we aim to be the #1 in the field of cryptocurrency.

Thank you for your attention today. Internet for Everyone.