Kingsoft Corp Ltd

HKEX:3888

Earnings Call Transcript 2019-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Q1 2019 Kingsoft Corporation Earnings Conference Call. [Operator Instructions] I must advise you that this conference call is being recorded today, the 14th of May, 2019. I would now like to hand the conference over to our speaker today, Ms. Francie Lu. Please go ahead, ma'am.

[Francie Lu, executive]

Thank you. Ladies and gentlemen, good evening and good morning. I would like to welcome everyone to our 2019 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 during 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]

[Interpreted] [ I'll do translation for Mr. Zou. ] We saw steady development momentum across all of our businesses in the first quarter of 2019. We continue to extend the influence of our JX IP and are expecting to launch JX Online III mobile game in the second quarter. Cloud services business expanded its cooperation and service coverage in a continuous and steady way. Meanwhile, we launched WPS Office 2019 for Linux Professional and WPS Office for Mac in March and April, respectively, and we're constantly looking for new and creative ways to improve customer experience in smart offices.

In the first quarter, our total revenue increased by 37% year-on-year to RMB 1,727 million, which shows a positive start to 2019. Cloud service business recorded a year-on-year growth of 100% and office software and services and other businesses grew 35% year-on-year in the first quarter.

Now turning to the call to our CFO. Mr. Francis Ng.

[Yuk Keung Ng, executive]

Good evening, everyone. Our mobile game business achieved a steady performance during the quarter. Gross billing of JX Online I mobile game and Eudemons Online were -- grew steadily quarter-over-quarter, showing the potential for long-term development. We are going to launch JX Online III mobile game in the first -- in the second quarter as we earlier discussed. The number of bookings has reached a historical high of 12 million, and we believe the release of JX Online III mobile will drive the growth of online games business.

Regarding our flagship PC JX Online III, we have set up a professional league club in March this year, indicating its continuous improvement and growing popularity as an e-sport. As a long-term product, we are focusing on the continuous improvement of quality and user experience to achieve long-term stability of JX Online III. Meanwhile, our IP derivative business is growing steadily. There are 3 -- theatrical play JX Online III: Live Fantasy will be on a tour across country this spring and summer, constantly expanding the influence of our classic IP. Cloud service business maintained its leading position in the video cloud section, with further breakthrough in enterprise cloud markets such as government, finance, health care, leading to the rapid growth of the business.

In the video sector, leveraging its strong capabilities and deep understanding of the video industry, cloud services business set out a development strategy incorporating artificial intelligence and edging cloud computing technology to provide its customer with better experience. Regarding the financial cloud, cloud services business continue to provide diversified services across more business scenarios to large banks, namely China Construction Bank and China Merchants Bank. Going forward, cloud service business will continue to promote the all-cloud services, explore integration and innovation with cloud computing, AI with different scenario, accelerate digital transformation of enterprise customers and strive to meets its customers' needs for optimizing cost and better video experiences. With the business upgrade for enterprise market and rapid growth from value-added services, WPS Office achieved a solid year-on-year growth during the first quarter 2019. WPS Office 2019 for Linux Professional was officially launched in March 2019, and it is expected to help our expansion in government departments and enterprises.

In April 2019, the WPS Office for Mac was officially released in Apple App Store, topping the most downloaded free app list on its debut day. During the period, WPS Office continued to push forward its Cloud+Plus AI strategy. After teaming up with Alibaba's DingTalk, WPS provided a customized Web Office for Baidu Wangpan to further expand its cloud office ecosystem. Meanwhile, WPS Office continue to enhance its overall brand recognition and product appeal.

In March 2019, WPS Office teamed up with the Palace Museum and China's Forbidden City Association to hold the first Digital Creative Design Competition for Chinese symbols. WPS Office will continue exploring the integration of technology innovation and traditional Chinese culture to build an efficient and creative office experience for users from home and abroad.

I would now discuss the Q1 operational and financial results using RMB as currency. Revenue increased 37% year-over-year and decreased 2% quarter-over-quarter to CNY 1,727 million. The revenue split was 34% for our online games, 49% for our cloud services and 17% for our office software and others. Revenue from the online game business decreased 5% year-over-year and 9% quarter-over-quarter to CNY 600 million. The slight year-over-year decrease was mainly due to the decreased revenue from existing games, partially offset by the revenue contributed from the expanded game portfolio by introducing several new mobile games. The quarter-over-quarter decrease mainly reflected our natural declining life cycles of the existing games.

Revenue from cloud services increased 100% year-over-year and 16% quarter-over-quarter to CNY 839 million. The increases were primarily due to the strong customer usage of cloud services from mobile, video and internet sectors as well as revenue growth from enterprise cloud through continuous technology innovation and AI applications. Revenue from office software and services and others increased 35% year-over-year and decreased 23% quarter-over-quarter to CNY 288 million. The year-over-year increase were mainly due to the fast growth of the value-added service of WPS Office personal edition and sales of its enterprise edition, demonstrate increases in user and engagement by providing ongoing product function, upgrade and consistent enrichment of content. The quarter-over-quarter decrease was mainly attributable to a seasonal decline in sales of WPS Office enterprise edition, partially offset by the revenue growth from the value-added service of its personal edition.

Cost of revenue increased 65% year-over-year and 6% quarter-over-quarter to CNY 1,069 million. The year-over-year increase was primarily due to a higher bandwidth Internet data center costs associating with fast-growing customer usage of cloud services and increased investment in cloud infrastructure as well. Gross profit increased 7% year-over-year and decreased 13% quarter-over-quarter to CNY 658 million. Gross profit margin decreased by 11 percentage point year-over-year and 5 percentage point quarter-over-quarter to 38%. The decrease in the group's gross profit margin was mainly due to the greater revenue contribution from cloud services, which has relatively lower gross profit margin and higher growth potential.

Our research and development cost, net increased 27% year-over-year and decreased 6% quarter-over-quarter to CNY 483 million. The year-over-year increase were primarily the result of the increased expenditure on product function, enhancement and new technology development. Selling and distribution expenses increased 24% year-over-year and decreased 27% quarter-over-quarter to CNY 158 million. The year-over-year increase mainly reflected greater marketing spending on WPS, cloud services business to capture the opportunities in enterprise market. The quarter-over-quarter decrease reflected less spending on advertising and promotional activities in the first quarter 2019.

Administrative expenses increased 33% year-over-year and decreased 24% quarter-over-quarter to CNY 110 million. The year-over-year increases were primarily due to the increased staff-related costs and professional service fees. The quarter decrease mainly reflected the reduced professional services fees. Share-based compensation costs decreased 3% year-over-year and increased 9% quarter-over-quarter to CNY 56 million. Operating losses before share-based compensation costs were CNY 26 million compared to a profit of CNY 84 million for the first quarter 2018 and a loss of CNY 105 million for the fourth quarter of 2018. Net other gains of CNY 25 million were recorded compared to the net other gain of CNY 19 million for the first quarter 2018 and other losses of CNY 8 million for the fourth quarter of 2018.

Share of loss of associates of CNY 78 million were recorded compared to a share of profit of CNY 20 million for the first quarter 2018 and a share of profit of CNY 261 million for the fourth quarter 2018. The share of profit for the fourth quarter of 2018 was mainly the result of Cheetah Mobile Inc. and its subsidiary disposing shares in certain investee companies. Income tax expense increased 11% year-over-year and 328% to CNY 48 million. As a result, loss attributable to the owners of parent was CNY 68 million compared to a profit of CNY 108 million (sic) [ 118 million ] for the first quarter 2018 and a profit of CNY 229 million for the fourth quarter 2018.

Loss attributable to owners of parent, excluding ESOP was CNY 33 million compared to a profit of CNY 158 million for the first quarter 2018 and a profit of CNY 262 million for the fourth quarter 2018. In our statement of financial position, we have cash and bank deposit of CYN 9 billion as March 31, 2019. Net cash used in operating activities was CNY 50 million compared to a net cash generated from operating activity of CNY 98 million and CNY 401 million for the 3 months ended March 31, 2018, and December 31, 2018, respectively.

Capital expenditure was CNY 279 million, CNY 245 million and CNY 374 million for the 3 months ended March 31, 2019, March 31, 2018, and December 31, 2018, respectively. The first quarter demonstrate another good performance across all business divisions. To date, we are confident in our strategy and the strength of our business model and our development going forward.

Looking ahead, we intend to bring new flagship mobile games to our user in the coming quarters and continue the strong growth and development of our cloud services and other software and services business. We expect the performance will further improve in the year upon the debut of our new JX Online III mobile game. We will continue to drive long-term growth and are committed to deliver increased value to our shareholders.

Now I return the floor back to questions. Thank you.

[Francie Lu, executive]

Operator, we're ready for the Q&A session. Thank you.

[Operator]

[Operator Instructions] You have the first question coming from the line of Hillman Chan from Citi.

[Hillman Chan, analyst]

So my first question is regarding the cloud business. As we see the revenue growth accelerated in first quarter, so could management share more on the details regarding the strong video space as well as the kind of nice cloud, for example, certain other wins that we have during the quarter, that would be helpful. And then for the 2019 revenue guidance as well as profitability for this particular cloud segment. More color on that would be appreciated. And my second question is on WPS. Noticed that the Q-on-Q revenue declined that was about 23% and I was wondering whether that's mainly because of the low seasonality of other -- or other reasons that you can share as well? And also related to WPS, how should we think about the top line growth and profitability this year?

[Yuk Keung Ng, executive]

Thank you, Hillman. Let me answer your question in Mandarin and Francie translate for Mr. Zou. Is it okay?

[Francie Lu, executive]

Sure.

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] [ Okay. I'll do the translation for Francis. ] So the cloud revenue for the first quarter, of course, is very strong, is better than our expectation. Earlier in the year, we guided the market that the revenue growth for 2019 for cloud will be around 60% and now we may increase our guidance a little bit to 70% or over. The reason behind the strong growth is due to both the strong growth from video cloud business and also the government enterprise businesses. The video cloud is still going very strong and the government enterprise, the growth is even higher because the base for government enterprise was lower. We have strong cooperation with all the major banks in China, for example, the China Construction Bank and also China Merchant Bank and also a few others coming. So we're doing very strong in the cloud business in the first quarter. Not only the revenue growth, also the profit -- profitability improvement is also better than our expectation, and it's due to both economies of scale and also our -- we are improving the efficiency operation for our businesses in order to improve our profitability improvement.

So we are very confident in the performance of cloud in 2019, and it's better than our expectation for both revenue and profitability performance. The second good question regarding WPS. The quarter-on-quarter decline in revenue is quite normal. There are some seasonality impacts for all of our businesses and especially strong for WPS. As you know, a lot of the enterprises, they spend their budget in the -- at the end of the year. So you can notice that the fourth quarter for WPS is always a strong quarter, comparing the first quarter of the year. So we do have a Q-on-Q decline for the first quarter, but you also noticed that we have over 30% year-on-year increase for the WPS business revenue. So it shows that the business is doing quite well. And yes, that's it for the translation. Thank you.

[Operator]

We have our next question coming from the line of Liping Zhao from CICC.

[Liping Zhao, analyst]

[Interpreted] I'll do the translation by myself. So I have 3 questions for the management. The first one is related to our gaming business. As the management guided last quarter, the JX Mobile III -- JX III Mobile will be launched in the beginning of June, is that the date is still fixed. And we noticed that the game are under beta testing, so hurry through beta testing. And we're still expecting a similar full year gain growth guidance as we mentioned last quarter. And my second question is related to the Kingsoft Cloud. We noticed that the OP margin has improved from last quarter. Is this mainly contributed by the margin expansion of your cloud business? And will this trend continue in the coming quarters? And my third question is related to WPS. Do you have a breakdown for the WPS business and personal edition of this quarter? And what's the growth of these 2 segments? And are you planning to transfer more -- the revenue model to subscription model in the future?

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] [ Okay. I'll do the translation for Mr. Zou. ] So for the game question, for JX Online III mobile game, we have not changed the target launching date. So it's still the beginning of June. And based on the PR2 testing starting from May 18, so far it's around 20 days. The testing result have met our expectations. And during this period, we are doing some minor adjustments to the game. Thank you.

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] [ Okay. I'll do the translation for Francis. ] So for the cloud question, in 2019, both the cloud revenue growth and also its margin improvement is better than our expectation from early on the year. So early in the year, we guided the market that the revenue for cloud will grow about 60% this year, and now we are going to increase that target to 70% and over. We do not disclose the specific margin details on the cloud business, but we could share that there is actually a few percentage improvement in terms of the margin performance for cloud business for the whole year 2019. And for third question on WPS. The value-added services right now accounts for roughly about 75% of the total WPS revenue and the license subscription is roughly about 24% of the total WPS revenue. So we have almost completed the transfer from the license -- license sales to the subscription model, so mainly the revenue for this sector is from the subscription revenue. Thank you.

[Operator]

We have our next question coming from the line of Alex Liu from China Renaissance.

[Alex Liu Zhanxiang, analyst]

[Interpreted] I'll translate myself. Just wondering given that the management already offered I think a full year online game revenue guidance -- a rough guidance in previous calls. Was current implied revenue growth for PC game as well as for the JX II mobile for the entire 2019 and specifically for JX II mobile, what's the current launch time that the management are thinking right now?

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] [ Okay. I'll do the translation. ] So for JX II online mobile game, the launch time, it depends on the launch time for JX III -- JX Online III mobile. So if we launch JX Online III Mobile in early June this year, we plan to launch the JX Online II mobile game at least a quarter apart. So the earliest expectation date for JX Online II mobile launch time is in September. Because both JX Online III and JX Online II mobile games this year, the same distributor, that's the K7 department from Tencent. So when we launched -- so the timing we launched for JX Online II mobile game, they also depends on the launch time for JX Online III and also the workload for JX Online III mobile game distribution.

For the gross billing question, we have not given our detailed guidance to the market because just like JX Online III mobile game, we need to wait until after the PR2 testing to have more data on the retention rate, the ARPU, the user base to give a more precise guidance on the -- our expectation on the JX Online II mobile game after testing. And Francis also added that first, the JX Online II mobile game will launch at least 3 months later than JX Online III mobile game, so the game will be launched more towards the later of the year. And also we don't have the precise data from the PR2 testing -- JX Online II mobile game yet. So in Francis' current budget, he mentioned that he did not put too much expectation on this game, the current budget.

And for the PC game, Mr. Zou explained that because of the natural decline cycle for the PC game, we -- and also our current adjustment to the game, we believe that this year, the overall PC game revenue will be flat from last year. And Francis also added that JX Online III PC game, we are going to also launch the WeGame from Tencent. Expectation is also quite good for this distribution. But overall, we believe that the PC game will be flat from 2000 -- for this year from 2018. Thank you.

[Operator]

The next question comes from Kenneth Fong. Kenneth Fong from Crédit Suisse.

[K. Fong, analyst]

I have a question on the profitability. As we -- the cloud business gradually grow and improve in the scale and profitability, and we also have JX III launching in June, right, higher margin mobile business. How should we think about like the profitability time line over the next few quarters? And also with this investment gain, the cloud business behind us last year and given our strong balance sheet, how should we think about like share buyback or dividend for this year?

[Yuk Keung Ng, executive]

[Foreign Language]

[K. Fong, analyst]

[Foreign Language] And...

[Francie Lu, executive]

Go ahead.

[K. Fong, analyst]

Yes. How about dividend as well as the other buyback, please?

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] [ Okay, I'll do the translation for Francis. ] So for the first question on the profitability, we do not give quarterly guidance on the revenue or profitability. Usually, we just give out the whole year annual guidance on revenue growth and also profitability performance. You can notice that in the profitability for the first quarter is better than the previous 2 quarters. The trend -- the improvement trend is actually pretty good from the third quarter 2018, fourth quarter 2018, also the first quarter this year. You could expect that the trend should continue into the second quarter of this year. The second quarter this year, the OP margin could be breakeven or even positive. The third quarter and fourth quarter margin performance will be better than the first and second quarter. So for 2019, the whole year, the profitability should be positive and the second half of the year should be better than the first half of the year.

On the second question on the dividend and also share buyback. We positioned ourselves in the high-growth sector. So our Board decided that we keep a low dividend rate if we're profitable. Last year, we did not give out any dividend because we were at loss last year. So this year, we're going to become profitable, then we're going to continue to give out a dividend. For share buyback, we don't have any specific plan at this moment. It depends on the share price of our stocks. If the chance is good, then we may do share buyback. We don't have any plan at the moment. Thank you.

[K. Fong, analyst]

It is very clear. Congrats on the solid quarter again.

[Francie Lu, executive]

Thank you. Operator, we're ready for last question.

[Operator]

We have the next question coming from the line of Yang Linlin from GF Securities.

[Linlin Yang, analyst]

[Interpreted] I have several questions. The first one is about WPS. What's the number of the type users in the first quarter? And considering about the overall MAU, how should we consider the take rate in the future? The second question is about [indiscernible] I see the loss from [indiscernible] is about CNY 78 million, how to expect it improve in the future? The third question is about the gross margin because in the first quarter, the gross margin declined. Could you give us more details about the gross margin of game and cloud sector, this second?

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] [ Okay. I'll do the translation for Francis. ] So for the WPS, the current number of members is around 4.7 million. The year-on-year growth is roughly about -- at over 100%, it's roughly about 120%. So the growth rate is very strong for the members. The current MAU is over CNY 300 million. So if we take a simple calculation, the members as a percentage for MAU is only less than 2%. So we believe that the growth potential here is still very, very strong. For the second question on Cheetah Mobile, we already gave our voting rights to Cheetah Mobile. So Francis has just -- you could listen to Cheetah Mobile's result announcements, which will be released soon. They will give a more detail on their performance guidance. For the last question on the gross margin performance, it's mainly due to a change in sales mix. All 3 of our business, the revenue is growing quite strong, but the cloud business is -- the revenue is growing the fastest.

Early on this year, we guided the market that the revenue growth was 60% for the year, but the first quarter already delivered 100% year-on-year growth rate for its revenue. So now we increased our guidance for 70% and up for the -- overall this year. And we also believe that the margin performance for the cloud business will also improve in this year, but still the cloud business is not at the breakeven stage yet. It's still at investment stage. So it contributes more into our sales mix. That will have a impact on the gross margin. But all of our business are performing quite well. The WPS, both its gross margin and also operating profit margin are very healthy. The WPS revenue growth is roughly about 40% for 2019. And also, the game business, this year, is doing much better than last year 2018 as we have a very deep margin mobile game to be launched in the second quarter of 2019. Thank you. Operator, we can now conclude our conference call for today.

[Tao Zou, executive]

[Foreign Language]

[Operator]

Ladies and gentlemen, that concludes our conference for today.

[Francie Lu, executive]

Okay. Thank you. [Foreign Language]

[Operator]

To end this conference call, [indiscernible] Thank you.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]