Kingsoft Corp Ltd

HKEX:3888

Earnings Call Transcript 2018-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Q1 2018 Kingsoft Corporation Earnings Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today.

And I'd now like to hand the conference to your first speaker, Ms. Francie Lu. Thank you. Please go ahead.

[Francie Lu, executive]

Thank you. Good morning, ladies and gentlemen. I would like to welcome everyone to our 2018 first quarter earnings call. I'm Francie Lu, the IR Director of Kingsoft.

I would like to start by reminding you that some information provided in the earnings call may include forward-looking statements which may not be relied upon in the future for various reasons. These forward-looking statements are based on our own information and information from other sources which we believe to be reliable. Please refer to the other publicly disclosed documents for detailed discussion on risk factors which may affect our business and operations.

Having said that, please allow me to introduce our management team who join us today: Mr. Zou Tao, our Executive Director and CEO; and Mr. Francis Ng, our Executive Director and CFO. Now I'm turning the call to Mr. Zou Tao.

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

I'll do the translation for Mr. Zou. The first quarter marked a good start to 2018. All of our business are well underway to achieve the strategic goals of the company. Kingsoft Cloud strengthened its leading position in video cloud sector. The performance of WPS Office remains robust, and the content value-added services saw good momentum by providing a smarter resource-sharing platform for our users.

As for the online game business, we managed to continue to expand the brand influence of our flagship game, JX Online III and also released the first promotion video for one of our key mobile games of the year, YSYY, Yunshangyuyi. In the first quarter, our total revenue increased 4% year-on-year to RMB 1,263.7 million, indicating a steady start to the year. Kingsoft Cloud recorded a year-on-year growth of 56%, and office software and services and others grew 66% year-on-year in the first quarter. Our operating profit will be under pressure in the first half of the year as we expect our online game business to pick up its growth momentum in the second half of the year. Thank you. And we'll turn the call to our [ CFO, Mr. Francis Ng ].

[Yuk Keung Ng, executive]

Hi. Thank you, Francie. Hi. Good morning, everybody. In the first quarter, due to the explosion in the popularity of the PUBG game, some of our user of our flagship PC game, JX Online III, were temporary occupied, which led to the year-on-year and quarter-on-year decrease in revenue. As a result, the online game business was under pressure, as Mr. Zou Tao said, in the first quarter.

We host a third JX Online III expert player competition on March 16, 2018. The number of participant and viewer reach a new record high this year, which helped strengthen the engagement of the core players. With the increasing fierce competition in the mobile game market, we saw the opportunity of new game type and meticulously developed a 3D custom-changing mobile game, Yunshangyuyi. The first promotion video of the game was released during the 2018 Tencent Neo-Culture Creativity Eco-Conference, and we see great commentary across the market.

In light of the solid foundation of our -- for our new game type development, we are looking forward to the official launch of the game and expect it to be one of the new driving force of online game business.

Kingsoft Cloud maintained a steady growth in the quarter, and the development trend of each business segment is in line with our strategic planning, which we said at the beginning of the year.

Video cloud business saw continuous improvement with high-quality services provided for our customers. Through the promotion of high-resolution content delivery network, Kingsoft Cloud managed to strengthen its leading position in the CDN sector and is striving to establish a diversified business structure over time.

Game cloud achieved remarkable results in attracting and retaining strategic clientele, and it continued to explore the artificial intelligence technology and blockchain solutions.

Kingsoft Cloud also keep on expanding its business in government cloud and private cloud sector and make breakthrough in finance and automobile cloud services. Looking forward, Kingsoft Cloud will continue to provide customer with quality, tailor-made services and solution, enhance the business penetration across the market and seek new breakthroughs.

WPS Office continued to maintain strong growth for the first quarter of 2018. And with continuous effort in cloud office services, both consumer and enterprise cloud business sustain the decent growth.

WPS government office cloud made its debut in the quarter as office solution targeting government and public institutions. Meanwhiles, content value-added service have enjoyed good growth momentum, providing users and designers with a smart platform to share resources. Our flagship product, WPS Office and Kingsoft PowerWord were both ranked among the Top 10 Best Customer Experience App in the Top 100 app in WeChat, Weibo and mobile office in 2017.

WPS Office content ecosystem strategy was announced in the [ Content Player Plus Conference ] in Zhuhai. More than 100 content creator participated in the event. The content platform, Docer.com, was official upgraded to a strategic content brand at the conference. With the leading office technology and a proven business development model, WPS Office will continue to build an easier office style for global users.

I will now discuss the Q1 operational and financial results using RMB as currency.

Revenue increased 4% year-over-year and decreased 8% quarter-over-quarter to CNY 1,264 million. The revenue split was 50% for our online games, 33% for cloud services and 17 for office software and services and others.

Revenue for our online game business decreased 23% year-over-year and 16% quarter-over-quarter to CNY 632 million. The decreases mainly reflected decreased revenue from our flagship PC game, JX Online III, as some of our user were temporary occupied by the PUBG game and the natural decline in revenue of JX Online I mobile game, which was launched 2 years ago. Daily average PCU decreased 25% year-over-year and 20% quarter-over-quarter to 700,000.

APA for the group online game decreased 22% year-over-year and 17% quarter-over-quarter to CNY 3.3 million. The decreases reflect some players of JX Online III were temporarily occupied by PUBG game and the natural decline life cycle of the group existing mobile game.

Revenue from cloud services increased 56% year-over-year and 4% quarter-over-quarter to CNY 419 million. The year-on-year increase was mainly driven by the strong customer usage of cloud services from mobile, video and Internet sector.

Revenue from office software and services and others increased 66% year-over-year and decreased 6% quarter-over-quarter to CNY 212 million. The year-over-year increase was largely due to the rapid growth on WPS online marketing services and value-added services of WPS Office Personal Edition, reflecting the strengthened commercialization capability, increased user enhancement and stickiness driven by continuous product utilization and content enrichment.

The quarter-over-quarter decrease was mainly attributable to a seasonal decline in sales in WPS Office, which was partially offset by the revenue growth on WPS online marketing services and value-added services of WPS Office Personal Edition.

Cost of revenue increased 27% year-over-year and 6% quarter-over-quarter to CNY 648 million. The increases were primarily due to the higher bandwidth and IDC costs, with increased customer usage of cloud services.

Gross profit decreased 13% year-over-year and 20% quarter-over-quarter to CNY 616 million. Gross profit margin decreased by 9 percentage point year-over-year and 7 percentage point quarter-over-quarter to 49%. The change in group's gross profit margin is a result of the change in sales mix, reflecting fast growth in cloud services. The cloud services business has relatively lower gross profit margin compared to our games. But the growth of its revenue contribution is much higher than our other business, relying on the massive addressable market prospect and the long-term revenue growth potential in the cloud market.

Our R&D costs, net, increased 18% year-over-year and decreased 5% quarter-over-quarter to CNY 380 million. The year-over-year increase was primarily due to a -- the greater staff-related costs as a result of increase in R&D investments.

Selling and distribution expenses increased 56% year-over-year and decreased 27% quarter-over-quarter to CNY 127 million. The year-over-year increase and quarter-over-quarter decreases reflected the change in advertising and promotional spending for our online games business in each of the corresponding quarters.

Administrative expenses increased 48% year-over-year and 5% quarter-over-quarter to CNY 18.3 million. The year-over-year increase was primarily due to the increased staff-related costs.

Share-based compensation cost increased 19% year-over-year and 14% quarter-over-quarter to CNY 58 million. The quarter-over-quarter increase was largely due to the new grants of awarded shares and options to selected employees as well as an increase in fair value of the awarded shares and option of certain subsidiaries.

Operating profit before share-based compensation costs decreased 73% year-over-year and 55% year-over-year (sic) [ quarter-over-quarter ] to CNY 84 million.

The margin of operating profit before share-based compensation costs decreased by 19% -- 19 percentage points year-over-year and 7 percentage point quarter-over-quarter to 7%.

Net other gain of CNY 90 million were recorded for the first quarter 2018 compared to net other losses of CNY 92 million for the first quarter 2017 and net other losses of CNY 27 million for the fourth quarter 2017. The losses in the first quarter 2017 were primarily due to the additional provision for impairment on the carrying value of investment in XunLei Limited and 21Vianet as the further decreases of market valuation in fourth -- first quarter 2017.

Share of profit of associates of CNY 20 million were recorded for the first quarter 2018 compared to share of losses of CNY 2 million for the first quarter 2017 and share of profit of CNY 60 million for the fourth quarter of 2017. Cheetah Mobile has been accounted for as our associate since October 1, 2017, and the quarter-over-quarter decrease was mainly due to a decrease in operating profits of Cheetah Mobile due to the following reason: first, the low seasonality for advertising activity in the first quarter; second, the decline in the revenue from its mobile utility products and related services within the services business in overseas market. A certain ad format, i.e. the add on mobile phone lock screen, has been discontinued by its overseas third-party advertising partners.

Increased tax -- income tax decreased 7% year-over-year to CNY 43 million compared to the income tax credit of CNY 5 million for the fourth quarter of 2017.

Gain on deemed disposal of a subsidiary, which amount to CNY 2,224 million for the fourth quarter of 2017, represented deemed disposal gain as result of delegation of the voting rights in Cheetah Mobile Inc.

Profit for the period from a discontinued operation-reflected profit from Cheetah Mobile, which was CNY 102 million for the 3 months ended March 31, 2017. As a result, our profit to owner of parent, including that from continued operation and a discontinued operation, decreased 50% year-over-year and 95% quarter-over-quarter to CNY 118 million.

Profit to owners of parent, excluding eShop, including those from the continued operation and a discontinued operation, decreased 45% year-over-year and 94% quarter-over-quarter to CNY 158 million.

Our statement of financial position, we have cash and bank deposit of CNY 9.6 billion as of March 31 -- December -- 2018.

Net cash generated from operating activity, including those from continued operation and a discontinued operation, was CNY 98 million, CNY 613 million and CNY 149 million for the first month ended March 31, 2018, March 31, 2017, and December 31, 2017, respectively.

Capital expenditure was CNY 245 million, CNY 102 million and CNY 291 million for the 3 month ended March 31, 2018, March 31, 2017, and December 31, 2017, respectively. We are glad to see the sound overall performance in our business in the first quarter. Kingsoft Cloud and WPS Office sustained stable growth in the first 3 month and with the market expansion in increasing sector and customer of different areas.

As the commercial launch of Yunshangyuyi and [ JX Online II ] mobile game were later than the scheduled timetable, and performance of JX Online III is affected by the market competition in the short term, the company assessed that the operating result of the second quarter 2018 would be still under pressure, and operating profit would possibly be similar to that of the first quarter in 2018, that is a [ low single digit ]. But we are confident that, that will rebound strongly in the second quarter as the new mobile game launch in the second half of 2018.

The accrued interest expenses, which is a non-cash item of liability component of redeemable convertible fee per share of around CNY 80 million, will be recorded in the second quarter 2018. If the exchange rate of the U.S. dollar against RMB rises in the second quarter, we will incur an exchange loss. We expect that the performance will improve the second quarter of the year after the debut of our new mobile games, Yunshangyuyi and JX Online mobile games. We look forward to bring more satisfactory result to both our customers and the market with an -- with our [ uneasing ] asset in the product innovation and service optimization.

I now hand over the floor to question and answer.

[Francie Lu, executive]

Hi, operator. We're ready for the Q&A session.

[Operator]

[Operator Instructions] Our first question comes from Thomas Chong from Crédit Suisse.

[Yiu Hung Chong, analyst]

[Foreign Language] Maybe I first translate my first question. I have a question about the Q2 performance. Given that the operating profit is similar to Q1, should we expect the revenue to be similar to Q1 as well? And given we have the Q2 guidance already, should we expect -- how should we think about the full year revenue and margin trend, if there's any changes on the previous quarters? And then I have a follow-up.

[Yuk Keung Ng, executive]

Let me answer the question. Thank you for the question, Thomas. First of all, you asked about the guidance for Q2 revenue. The overall Q2 revenue, we expected that it will be on a continuous rise, it will be higher than Q1. With respect to the online game revenue because as you see that we have already mentioned that, it would take some time for the JX Online III to ramp up with a further improvement in the optimization of this game. And also, we are expecting that would be a major mobile game launch in the second market. But in the first -- in the second quarter, we were expected that the game revenue will be slightly lower than the Q1 revenue. But the cloud business and the WPS Office's revenue will continue to increase over Q -- in Q2 as compared to Q1. So overall, we expected that the Q2 revenue will be higher than the Q1. This is your first question.

[Yiu Hung Chong, analyst]

[Foreign Language] Maybe I translate the questions. I would like to ask about the pipeline for the upcoming mobile games like JX II as well as the mobile version of JX III, if there's any more concrete time line whether 3Q or 4Q? And then the follow-up question is about the impact for PUBG games. Given the fact that we are affected by PUBG in Q1, is there any color that without the impact of PUBG, how is our online games in Q1 is going to perform? Any color would be great.

[Yuk Keung Ng, executive]

Hi. Thank you, Thomas, for your question. You talk about the timeline for our new mobile games. As we mentioned that the -- certain of our mobile game launching schedule actually are slightly later than what are internally expected. But I can share with you that one of the major, major game title, which you referred to, is JX III, Jian Xia Qing Yuan, launching time will remain unchanged, which will be likely before our 30th anniversary, which is probably at the beginning of -- at the end of August, beginning of September, which is the most important mobile game in 2018. And also in Yunshangyuyi, you could also see that, that has been already [ rebounded ] in the Tencent Game Conference, which receive a very, very good result and popularity among gamers, which in fact is first 6 top ranking game in 2018 after the new Tencent evaluation system was launch. We expected that, that will be a very major game in 2018 for Kingsoft as well, which you could expect it will be -- likely be launch at the end of Q2. That is our 2 major mobile game which are going to be launch in 2018.

[Yiu Hung Chong, analyst]

And then on the PUBG impact?

[Yuk Keung Ng, executive]

The PUB III (sic) [ PUBG ] impact, as we all see that, it actually affect all the -- the whole market, so to speak. We are not alone. We also experience a -- quite a significant impact by that PUBG game. That is external factor. But I would also mention that the JX Online Mobile III [indiscernible] version is a very -- also a very major, major with one addition in 2018, involve a huge effort. We spent huge effort, and it also require some of the enhancement in, say, for example, for the [Foreign Language], which was very, very large at the beginning. We are optimizing the size of [Foreign Language], and we believe that, that will also have the retention in our user. So to answer your question, the performance of the JX Online III are both affected by the competition in market -- mainly the PUBG game. And also, it requires certain time for our internal enhancement in the [ ramp-up ]. The team are confident that those enhancement will be made very soon.

[Operator]

[Operator Instructions] Our next question comes from Liping Zhao from CICC.

[Liping Zhao, analyst]

[Foreign Language] I have 3 questions for the management. The first one is related to our PC game. Because we saw that JX Online III has been impacted by PUBG in the first quarter, what's your strategy to recapture players' engagement, and what's your pipeline for the expansion pack this year? And my second question is related to WPS. What's the growth for your 2B and 2C business, respectively? And the third question is related to cloud. Do you have a breakdown of the revenue contribution from Xiaomi, gaming and video, and can you see a narrow lock margin for the first quarter?

[Yuk Keung Ng, executive]

[Foreign Language]

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

Okay, I'll do the translation for Mr. Zou first. So as you know, the whole market is affected by the PUBG game in Q1 in terms of revenue and our -- JX Online III is not an exception. So in terms of the user impact, it's relatively about 10% year-on-year compared with the same period last year. And also, for the revenue, we just launched the revamped version by the end of last year. So there's a complete upgrade on the game, and we are right now still continuing to optimize the game in Q1 and Q2. So these are the both internal and external impact for the game in the first quarter. And now we are continuing to optimize the revamped version based on our user feedbacks. As the time lapse, we believe that this revamped version will definitely have a positive impact in the long run. And in addition to optimizing the revamped version, we are actually actively preparing for the new expansion pack, the new content for the second half of the year. And we believe that with the continuous optimization and also with the launch of the new expansion pack, new content in the second half of the year, we are confident that the growth momentum will pick up for the game in the long run, next 3 to 5 years. Thank you.

[Yuk Keung Ng, executive]

Let me -- Liping Zhao, thank you for ask a question. You asked about -- the other question. Let me answer in Chinese and Francie, please, happy to translate, is that okay?

[Francie Lu, executive]

Yes.

[Yuk Keung Ng, executive]

[Foreign Language]

[Liping Zhao, analyst]

[Foreign Language]

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

Okay, I'll do the translation for Francis. So Liping was asking about the growth momentum for the 2B and 2C business for WPS. So in 2017, our 2C revenue already exceeded the revenue from 2B. Also, this momentum, this trend, continues into 2018. So in the first quarter, our 2C revenue is actually much greater than 2B. Roughly about 75% of the revenue is from the value-added services in the 2C business, so the enterprise and government services revenue is -- accounts for roughly about 25% of the WPS revenue. And as everyone knows that there is seasonality impact for the WPS business, so Q4 was actually a peak season for WPS. So when we talk about the gross rate, it's based on a year-on-year comparison. So the gross rate for the value-added service in the first quarter is very, very high, close to 3 digits. And the enterprise and government gross rate was lower around 10%. And for the Xiaomi revenue contribution in the cloud business, the Xiaomi revenue contribution is much less than 50% of the cloud revenue. It's roughly about 1/4 of the cloud revenue right now. Thank you. Hi, Liping. You could go ahead with your question.

[Liping Zhao, analyst]

Great. [Foreign Language]

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

So I'll do the translation for Francis. The loss as a percentage of revenue for the cloud business has been improving in the past, and this trend is -- it's -- will continue into 2018. Thank you.

[Operator]

[Operator Instructions] As there are no further questions, I will hand back to management for any closing comments.

[Francie Lu, executive]

Okay. Thank you all for attending our conference call for the first quarter 2018 earnings result. Thank you. Thank you for attending.

[Operator]

Thank you so much. Ladies and gentlemen, that does conclude the conference for today. Thank you so much for your attendance. You may all disconnect.