Kingsoft Corp Ltd

HKEX:3888

Earnings Call Transcript 2018-Q2

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to second quarter 2018 Kingsoft Corporation Earnings Conference Call. [Operator Instructions] I'd like to hand the conference over to your first speaker today, Ms. Francie Lu. Thank you. Please go ahead.

[Francie Lu, executive]

Thank you. Ladies and gentlemen, good evening and good morning. I would like to welcome everyone to our 2018 second quarter and interim result 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 Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[ I will do the translation for Mr. Zou. ] We maintained a steady operation during this quarter and achieved our established goals. We launched YSYY, our new 3D costume-changing mobile game in June, which topped the free game ranking on Apple Store on the day of its release. Kingsoft Cloud delivered a steady growth in all of its business segments performed well on track to meet our strategic targets. WPS Office continued its strong momentum with the global MAU of WPS family reaching 300 million in June.

In the first half of the year we also released several brand new products including WPS Office 2019 and WPS Office for Mac. Our revenue was RMB 1,345 million in the second quarter, up 5% year-on-year and 6% quarter-on-quarter. The revenue of the first half of 2018 was RMB 2,609 million, up 4% year-on-year. In the second quarter revenues from cloud services and the office software and services and other businesses maintained healthy growth, up 54% and 68% year-on-year, respectively. After rapid development in the past few years China's online game market, including the mobile game market, appear to have experienced a relatively sluggish growth in 2018. Basing the increasingly intensive competition in the mobile game market, we decided to push back the release date of our new mobile game JX Online III mobile game so as to align with our strategic deployment plan of our key gaming product. As currently expected that the commercial launch time of JX Online III mobile game will be determined in November after our internal testing results.

Now I will turn the call to our CFO, Mr. Francis Ng.

[Yuk Keung Ng, executive]

Thank you, Francie. Thank you, Tao Zou. Hello, everybody, during the quarter, JX Online I mobile game, which launched in May 2016 continued to enhance the game quality and contents and contributed steady monthly gross billing with outstanding performance and great vitality. Although this quarter brand new mobile game YSYY Yunshangyuyi did not achieve the expected performance financially, it did receive recognition from a wide range of player and ranked at #1 on the free game chart on Apple Store on the day of its release. It reflected our endeavor to developing a game segment and our commitment in achieving more breakthrough to adapt to the rapid changes in the game market. Our first animation Dream Tower premiered online on June 1, and it has been viewed more than 40x million up to now, which has great potential to develop into another core IP.

The theme song for our animation JX Online III make its debut on Bilibili.com and was highly rated by the fans of JX Online III. This helped to sustain the flagship games popularity among users ahead of the upcoming ninth anniversary celebrations. The JX World II mobile game was released on iOS on July 4, which landed #1 on the most frequently searched list and #2 on the chart of free games in Apple Store on the day of its release.

We also plan to launch a series of game products in the coming quarters, including the new expansion pack for JX Online III, JX Online II mobile game and the Chinese Paladin, Xian Jian Qi Xia Zhuan 4.

Kingsoft Cloud maintained a stable growth in the second quarter and each business segment was in line with our strategic planning. Using 3 technologies including AI, artificial intelligence; edge computing and blockchain, Kingsoft Cloud not only helped the video cloud and game cloud clients strengthen their position in the ecosystem but also work on a -- work on smart cities and make breakthrough in the area of government cloud, healthcare cloud and finance cloud.

As one of the first contractor of Beijing government health project, one of the largest government cloud project in China, Kingsoft Cloud has served 42 municipal committee offices, bureaus in Beijing; it also reached a strategic cooperation agreement with Rizhao city to build a smart city together. Kingsoft Cloud launched CloudHIS meaning the healthcare information system, China's first cloud-based medical and healthcare information system and applied in more than a dozen provinces and cities. Driven by new technologies Kingsoft Cloud successfully made breakthrough in technology upgrades upgrading for its video and game clouds.

Looking ahead Kingsoft Cloud will further improve product quality and expand its service -- serving scope. It will also seek opportunities in overseas markets and continue to lead the industry to grow healthily.

In the second quarter of 2018 WPS Office continued its strong momentum launching a series of products and services to create better user experience. In July, WPS Office officially released several brand new products including the WPS Office 2019, WPS Online for Mac, and WPS Documents. Equipped with the cloud and AI technologies these new product provide user smarter office services that fit different working scenarios. For the personal value added service of WPS Office we continue to improve the membership benefits and enhance the content quality for our user. And also initiated the membership promotion, which successfully drove the number of paid membership and the growth of revenues. Furthermore WPS Office participated in the World Intellectual Property Day, showing our commitment in the innovation driven business and proprietary research & development.

We look forward to contributing to proprietary innovation, intellectual property protection and information securities. Users' preference for domestic software will continue to bring more development opportunities to WPS Office.

I will now discuss the Q2 and first half of 2018 operation and financial results. Let me start with the Q2 using RMB as the currency.

Revenue increased 5% year-over-year and 6% quarter-over-quarter to RMB 1,346 million. The revenue splits was 43% for online games, 35% for cloud services and 22% for office software and services and others.

Revenue from our online game business decreased 28% year-over-year and 8% quarter-over-quarter to RMB 582 million. The year-over-year decrease was largely due to the decreased revenue JX Online III and the existing mobile game partially offset by the revenue contribution from our newly launched mobile games. The mild quarter-on-quarter decreases was mainly due to the natural declining lifecycle of the existing mobile game and a slight decrease in revenue from JX Online III.

Daily average PCU decreased 15% year-over-year and increased 14% quarter-over-quarter to RMB 800,000. Monthly average paying account decreased 24% year-over-year and 1% quarter-over-quarter to RMB 3.3 million. And while year-over-year decreases in ADPCU, average daily peak concurrent user, and the average paying account reflected the natural declining lifecycle of the existing games, which was partially offset by the releases of new mobile game.

The quarter-over-quarter increase in ADPCU was mainly due to the newly launched mobile game, resumed growth of JX Online III after the expansion pack launch in the second quarter, which was partially offset by the natural declining lifecycle of the existing mobile games.

Revenue from cloud services increased 54% year-over-year and 12% quarter-over-quarter to RMB 469 million. The strong year-over-year increase was mainly driven by the robust increase of customer usage, from mobile video and Internet sector demonstrating the -- that Kingsoft Cloud further gained competitive advantages in particular industry through improving the quality of products and services by technology innovation.

The steady quarter-over-quarter increase was largely due to the increased revenue from internet and government sectors reflecting our effort on exploring new opportunity by providing high quality cloud services.

Revenue from office software and service and others increased 68% year-over-year and 39% quarter-over-quarter to RMB 295 million. The increases were largely due to the rapid growth from value added service of WPS Office personal edition driven by fast increase of premium member reflecting enhanced popularity of our membership privilege infused with the rich and practical functions and increased sales of WPS Office to enterprise as a result of the increased user engagement driven by consistent product upgrades.

Cost of revenue increased 38% year-over-year and 4% quarter-over-quarter to RMB 765 million (sic) [ 674.5 ]. The year-over-year increase was primarily due to higher bandwidth and IDC cost resulting from increased customer usage of cloud services.

Gross profit decreased 16% year-over-year and increased 9% quarter-over-quarter to RMB 671 million. The group's gross profit margin decreased by 12 percentage points year-over-year and increased by 1 percentage point quarter-over-quarter to 50%.

The decrease of the group's year-over-year gross profit margin is a result of our change in sales mix, reflecting a slight -- significant increase in revenue contribution from cloud services, which has a relatively low gross margin with high -- greater growth potential.

Our research and development expenses increased 17% year-over-year and 13% quarter-over-quarter to RMB 431 million. And the year-over-year and quarter-over-quarter increases were primarily attributable to the increased investments on new products and advanced technology.

Selling and distribution expenses increased 17% year-over-year and 25% quarter-over-quarter to RMB 158 million. The increases were primarily due to the expansion of the channels as well as an increase in marketing and promotional spending for our online games.

Administrative expenses increased 81% year-over-year and 28% quarter-over-quarter to RMB 106 million. The year-over-year and quarter-over-quarter increases were mainly due to an increase in staff-related causes (sic) [ costs ].

Share-based compensation costs decreased 15% year-over-year and 11% quarter-over-quarter to RMB 52 million. Operating profit excluding ESOP decreased 80% year-over-year and 22% quarter-over-quarter to RMB 65 million as a result of the combination of above reasons. The operating profit margin, excluding of the impact of ESOP decreased by 20 percentage point year-over-year and 2 percentage point quarter-over-quarter to 5%. Net other losses were RMB 74 million, compared to losses of RMB 42 million in the corresponding periods last year, and gain of RMB 19 million in the first quarter 2018. The losses in the second quarter 2018 were mainly due to the recognition of foreign exchange loss in this quarter. And the losses in the second quarter 2017 was mainly due to the additional provision for impairment on the investment make in XunLei and 21 Vianet.

We recorded share of profits of associates of RMB 66 million for the second quarter 2018, compared to share of losses of RMB 3 million for the second quarter of 2017 and share of profits of RMB 20 million for the first quarter of 2018. The change was mainly due to that Cheetah Mobile has been accounted for as an associate since October 1, 2017 and its continued profit margin improvements.

Income tax expenses increased 18% year-over-year and 32% quarter-over-quarter to RMB 57 million. As a result our profits to owner of the parents including that from continuing operations and a discontinued operation was RMB 101 million, RMB 250 million and RMB 118 million for the 3 months ended June 30, 2018; June 30, 2017 and March 31, 2018, respectively.

Profit to the owners of parent, excluding ESOP, was RMB 139 million, RMB 306 million and RMB 158 million for the 3 months ended June 30, 2018; June 30, 2017 and March 31, 2018, respectively. And the net profit margin excluding ESOP was 10%, 12%, and 12% for the 3 months ended June 30, 2018; June 30, 2017 and March 31, 2018, respectively.

I now turn to the first half 2018. Revenue increased 4% year-over-year to RMB 2,610 million. Online games make up 47%, and decreased 25% year-over-year to RMB 1,214 million. Cloud services make up another 34%, and increased 55% to RMB 888 million. Office software and services and other services make up 19%, and increased 67% year-over-year to RMB 508 million.

Our gross profit margin decreased by 11 percentage point year-over-year to 49%. As a result, above -- discussed, profit attributable to the owners of parent, including those from continued operation and a discontinued operation, was RMB 219 million, RMB 489 million, for the 6 months ended June 30, 2018 and June 30, 2017, respectively.

Profit attributable to owners of parent, excluding ESOP, was RMB 296 million compared to RMB 592 million in the prior year period, and the net profit margin excluding ESOP was 11% and 12% for the 6 months ended June 30, 2018 and June 30, 2017, respectively.

Our statement of financial position, we have a cash and bank deposit of RMB 10 billion as at June 30, 2018. Net cash from operating activity, including those from continued and discontinued operation, was RMB 363 million, and RMB 1,118 million for the 6 months ended June 30, 2018; June 30, 2017, respectively.

Cash used for capital expenditure was RMB 499 million and RMB 254 million for the 6 months ended June 30, 2018, and June 30, 2017, respectively.

We managed to deliver a steady quarter. Looking ahead, we believe Kingsoft Cloud and WPS Office will continue to expand in revenue and maintain a steady performance. Considering the estimated commercial launch time on the new mobile games, continuous competition in CDN market and the investment in the R&D for office software business, our operating results are expected to remain under pressure for the second half of the year.

Well when we look into 2019, we believe the overall performance will improve on the account of the debut of our new mobile games as well as the steady growth of Kingsoft Cloud and WPS Office.

On behalf of Kingsoft, I would also like to extend our appreciation to Kingsoft's customer, shareholders, employees, partners, and you, for your continuing support.

Now I hand over the floor to question-and-answers

[Francie Lu, executive]

Hi Operator, we are ready to take questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Hillman Chan from Citi.

[Hillman Chan, analyst]

My first question is regarding your game pipeline. Could management share with us the timeline of game launches of JX Online II mobile, and also the Chinese Paladin: Sword and Fairy, and what's your expectation on the performance? And my other question is for your JX Online III PC title, what is the current grossing and what is the new feature in the coming expansion pack and the expectations of that as well? [Foreign Language]

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[ Okay. I will translate for Mr. Zou. ] So after our discussion with Tencent, the final launching time for JX Online II mobile game will be in October, but the exact date is not determined yet. And the mobile game Xian Jian 4 will be launched in the fourth quarter this year, either in November or December, roughly about 2 months after the JX Online II launch. And we need to confirm the exact time with Tencent, in the near future. And also for the expansion pack for JX Online III, we will hold a conference for the JX Online III expansion pack game in -- by the end of October, on October 28. And we'll tell you the exact time for the expansion time launch in the conference.

[Hillman Chan, analyst]

Can I have a quick follow-up question? Do we have the required license for monetization from GAPP? [Foreign Language]

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. So Hillman just asked the question on the license information for the JX Online II, JX Online III mobile games, and also Xian Jian 4 mobile game. Mr. Zou explained that we have already got the license for JX Online II and JX Online III mobile earlier. So that's not a problem for JX Online II and JX Online III mobile game. But for Xian Jian 4 mobile game, we haven't got the license yet. So that's why we say the launching -- exact launching time is not determined at this moment. The game itself has been tested for several rounds already, so now the final launching time will depend on when we get the license for the Xian Jian 4 mobile game.

[Operator]

Our next question comes from the line of Thomas Chong from Credit Suisse.

[Yiu Hung Chong, analyst]

I have a couple of questions if I may. First is about the beta testing for the mobile version for JX III, so do we -- are we going to monetize JX III in November, when you start testing? And how long will the testing goes? And if it's very satisfactory and beats our expectation, when is the earliest time that we expect to be launched? And my second question is about the 2018 and 2019 revenue and margin outlook if there's any color? And then I have a follow-up.

[Yuk Keung Ng, executive]

Okay. Do you want to translate in Chinese, first?

[Yiu Hung Chong, analyst]

[Foreign Language]

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[ Okay. I'll do the translation for Mr. Zou, first. ] So we'll start the JX Online III testing in November in big scale and also we'll also test the monetization for JX Online III mobile game. So in October we're going to launch JX Online II mobile game first, so there will be some time in between the JX Online II and JX Online III mobile game to avoid any self-competition. So if the testing result for JX Online III mobile game is good then it's very likely to launch the game in the first quarter of 2019.

[Yuk Keung Ng, executive]

Thomas, thank you for the question, let me answer your second part of your question is regarding the outlook for the 2018 margin. As I said in the earlier announcement that I make on the Monday, we're expected that the second half Q3 include -- will incur a loss due to the delay in launching the mobile games and also the under expectation of the new mobile game launch. And also the loss on -- or the operating loss on the cloud will be slightly higher than the -- or what we originally expected due to the competition in the CDN business. So overall, the first half of 2018, as you see that, we got a very thin margin and we expected that there we will incur a loss in Q3. Q4 from what I could see right now, it will be more or less breakeven in Q4 or maybe with -- depending on the timing of the game, it might incur a slight -- slightly loss in Q4 as well. So the overall the 2018, we're expecting that as we -- what we said in the announcement that likely will be a loss for 2018.

[Yiu Hung Chong, analyst]

And then my follow-up question is about the online games regulatory environments, how would management think about when the licensing approval will get started because for our new game we do expect it to get a license in November or December but is there any color that you can share about how we should think about the regulatory environment. [Foreign Language]

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I'll do the translation for Mr. Zou. Mr. Zou said, the question on the game licensing approval is really beyond our company operation, so it will be better to communicate with the game regulatory department itself, it's hard to -- for us to comment on this question. [ And Mr. Francis Ng also added that ] the other companies also respond to this question in a similar manner but for Kingsoft, as we said that in the second half of this year the major games, major mobile games we're going to launch is JX Online II mobile game and later also JX Online III mobile game. And these 2 games we already got the license approval, so the licensing regulation problem does not affect us on these 2 major mobile games.

[Operator]

Our next question comes from the line of Liping Zhao from CICC.

[Liping Zhao, analyst]

[Foreign Language] I have 2 questions. The first one is related to the gaming sector, my question is what caused the headwinds for mobile games in the first half of this year? And I have also noticed you did some IP initiatives on JX series, do you have any monetization comments on that? And my second question is related to WPS, I notice that the WPS revenue growth is still quite strong. What's the drivers for the strong growth? Do you have a break down for the personal and commercial revenues? And in the personal revenues, do you have a breakdown for the advertisement and also the membership fees growth?

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[ Okay. I'll do the translation for Mr. Zou. So Mr. Tao Zou says that he believed that ] you already notice that the whole gaming market has stayed some plateau in terms of the revenue generation. And in the first quarter, as we already discussed that this has been affected by the popularity of the PUBG game which attracted a lot of the gamers traffic but this type of game has yet to be monetized. Other than the PUBG game impact, we also believe that the revenue was affected by the Baidu app, in the market which offers -- which also has a negative impact on the gaming asset growth. And now regarding the question on the animation for the JX Online IP, we have developed the -- this animation for the JX Online IP to extent the presence of JX Online not only on games but also extent it into animation TV series and even in cartoon features. So it's not only about monetization, it's more about the extending the presence of -- for the JX Online. Thank you.

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

[ Okay. I'll do the translation for Francis. ] So on the question for the WPS second quarter revenue increase component, we said that WPS has always performed very well in the first half of 2018. And in the second quarter, its revenue increase was over 60%. The enterprise revenue increase was close to 60% and the personal, the value added services revenue increase was above 60%. So overall the WPS second quarter increase was around -- was over 60%. And in the personal and value added services sector, we have both value added services and also the advertisement monetization and the main growth is driven by the increase in the number of memberships. In early 2017, our membership was around 500,000 and by early 2018, it was increased to over 2.6 million. So it's more than 5x comparing to the same period in 2017. And also we're -- keep improving on the membership services and we also intentionally control the monetization from advertisement. So the year-on-year increase from the advertisements monetization was around 10% to 20%. But for membership revenue growth, it was over 100% and even near 200%.

[Operator]

Our next question comes from the line of Alex Liu from China Renaissance.

[Alex Liu Zhanxiang, analyst]

[Foreign Language] Well I have finished. I will translate myself. First on the PC game side, for JX III PC versions, we noticed there is a competing titles for that game in the summer. Just wondering how does the management think about the performance of JX III PC version in the summer in light of the competition? For my second question is on the mobile side, for JX III mobile, we are expecting it to be delayed in early 2019. Just wondering, is there any specific reasons or color that we can have on the delay as well as how should we think about the performance of that title given we are already delaying it a few months?

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[ Okay. I'll translate for Mr. Zou. ] So you're talking about the JX Online III PC game, in this summer we'll have a competing title and its impact on the game, so we can only discuss this based on the actual data we have collected at this moment. And at this moment, in terms of the user number including [ DAU ] we see no impact from the competing title on the JX Online III PC game. And for the JX Online III mobile game, the reasons for its delay, we can discuss this both objectively and subjectively. So objectively speaking, we originally planned to launch the game in September or October but now it's already mid-August and we noticed that recently we launched the game YSYY, we think that its performance has been affected by the PUBG game and also the video apps in the market. So it's very difficult for us to acquire [ huge ] traffic and we think that this situation will not improve in September. And subjectively speaking there, we have tested this game -- this mobile game several times already, that the testing result -- the testing data has been very good. But this game JX Online III mobile game, particularly, is very, very important for our season and also for Kingsoft. So we don't only want it to be successful but we want it to be very successful. So considering the gaming environment at this moment and also expectation for this game we believe that it'll be better for us to launch the game at another time at a better timing. So we make this decision even under the current -- the company financial performance pressure. So we hope you understand our decision and the rationale behind this delay for the JX Online III mobile game, thank you. Operator, due to the time limit we want to end the conference call now, thank you.

[Operator]

Ladies and gentlemen, that does conclude the conference for today. Thank you for participating, you may all disconnect.

[Francie Lu, executive]

Thank you. Thank you all for participating, thank you.