Kingsoft Corp Ltd

HKEX:3888

Earnings Call Transcript 2019-Q2

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Q2 2019 Kingsoft Corporation Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to your first speaker today, Ms. Francie Lu. Thank you. 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 second quarter and income results 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 be 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]

[Interpreted] [I will do the translation for Mr. Zou.] We maintained a stable performance in the second quarter of 2019. The debut of JX Online III mobile game in June received positive market response, and we're aiming to bring better experiences to attract more gamers in the second half.

As cloud services business experienced robust growth with a significant increase in revenue, we fully expect it to maintain its growth momentum throughout the year. Meanwhile, our value-added services of office software business have been growing quickly, and we will keep improving our product and services to provide better experience for the users.

However, the second quarter of 2019 was also a challenging period for Kingsoft as we had to make provisions for impairment on the carrying value of investment in Cheetah, which directly affect our earnings even though it will not affect our operating profit or cash flows.

We still remain firmly committed to our core businesses and are on track to address the problems we are currently facing.

Our revenue of the second quarter was

RMB 1,874 million, up 39% year-on-year and 9% quarter-on-quarter. Revenue in the first half of 2019 was RMB 3,600 million, up 38% year-on-year.

Building upon the solid momentum achieved in the first quarter, revenue generated from cloud services and office software and services and other businesses maintained a steady growth in the second quarter of the year, up 96% and 31% year-on-year, respectively.

Now I'm turning the call to Francis, our CFO.

[Yuk Keung Ng, executive]

Thank you, Francie. Hi, everybody. Let me talk about the [indiscernible] 2019.

Throughout the quarter, revenue from online games remained stable. JX Online I mobile game launched in 2016 still contribute a steady monthly gross billing. On the June 12, the long-anticipated title, JX Online III mobile game was officially released, and it was ranked as #1 in the iOS downloads charts for games in China on its debut, according to App Annie data.

Meanwhile, we have been fixing technical issues such as improving the facilities of our server and optimizing the game content to meet the demands of our users. Together with Tencent, we will provide large-scale content and features. And we also launched a new season for our flagship JX III PC game on June 20 and will celebrate its 10th anniversary in the third quarter.

In the first half of the year, we are going to launch the Final Fantasy Brave Exvius in China and Double Life World in Japan. We aim to make a breakthrough in different genres.

In the second quarter, the revenue of cloud services business maintained rapid growth. Our game video cloud business focused on innovative technologies such as promoting edge computing; edge node computing platform; smart high definition; and AI, Artificial Intelligence. It helps to push the product bandwidth capability to next level. Meanwhile, our financial cloud business achieved a significant result by launching our 4 solution systems: finance cloud structure; finance cloud intelligence, finance cloud native application and finance cloud value chain.

We make a strategic cooperation with Xiaomi Finance, Nanjing Yang Zi State-owned Investment Group and Nanjing Digital Finance Industry Research Institute to jointly operate the China's first digital financial integrated service platform, helping the Jiangbei New District to become a financial hub.

Our government cloud services achieved rapid growth and helped to develop regional smart city projects, including a cutting-edge security program for the Beijing Belt and Road Summit, World Horticultural Exhibition, et cetera.

According to the International Data Corporation, IDC, Kingsoft Cloud was among the top 10 public cloud IaaS service provider in the world in 2018 and was also featured in Gartner's latest global CDN report, making it one of the world's leading CDN service provider.

Looking ahead, we will continue to leverage our experience and unrivaled expertise in the cloud business, AI, edge computing and CDN field and will work with our partners to create better quality and user-friendly industry solutions, helping accelerate the digital transformation of enterprise customers.

Let me turn to the WPS. Our office software and services and other business maintained its strong momentum in the second quarter. We optimized the membership benefit for WPS and Docer [Foreign Language] and launched the products and services that improved the user experience, which in turn promoted the growth of personal value-added services of WPS Office. We collaborate with China National Offshore Oil Corporation and other key enterprise customers to develop full life platforms of WPS + Office Cloud. We entered into a strategic cooperation with the Shanghai Development Research

Center of Economy and Information and also other government enterprises on the deployment of smart

government technologies.

Regarding the foreign markets, WPS Office actively expanded its presence overseas. As of June 2019, the MAUs of WPS Office overseas exceeded 80 million. During that period, we continued to push forward the Cloud + AI strategy. At the 2019 Fourth Conference on Machine Translation, our AI LAB team won the English-Chinese translation task on news text. And we will continue to identify global customer needs and transform technological capabilities into products and services to capture more opportunities.

I now turn to the discussion on Q2 and first half of 2019 operational and financial results. Let's start with the Q2 using RMB as currency. Revenue increased 39% year-over-year and 9% quarter-over-quarter to CNY 1,874 million. The revenue split was 30% for online game, 49% for cloud services and 21% for office software and services and others.

Revenue from the online game business decreased 2% year-over-year and 5% quarter-over-quarter to CNY 570 million. Decrease was mainly due to the natural declining of life cycle of certain existing games, partially offset by the revenue contribution from the newly launched mobile games.

Revenue from cloud services increased 96% year-over-year and 9% quarter-over-quarter to CNY 918 million. The increases were mainly driven by the fast-growing demand from the mobile video and internet sectors as well as the increased revenue from enterprise clouds through continuous improvement of our cloud services and further development of our enterprise cloud market.

Revenue from the office software and services increased 31% year-over-year and 34% quarter-over-quarter to CNY 386 million. These healthy increases were largely due to the sustainable growth from the value-added service of WPS Office personal edition and also the sales of its enterprise edition, which was in turn driven by the increased paid users resulting from the continuous improved products and services.

Cost of revenue increased 72% year-over-year and 9% quarter-over-quarter to CNY 1,160 million. The increases were primarily due to a higher bandwidth and IDC cost resulting from the increased customer usage of cloud services.

Our gross profit increased 6% year-over-year and 9% quarter-over-quarter to CNY 714 million. Our Group's gross profit margin decreased by 12 percentage points year-over-year and kept flat quarter-over-quarter at 38%. The decrease of the Group's year-over-year gross profit margin was mainly due to larger revenue contribution from our cloud services, which had a relatively low gross margin and a higher growth potential.

Our research and development expenses increased 16% year-over-year and 3% quarter-over-quarter to CNY 498 million. And the year-over-year increases were primarily attributable to the increased investment on technology innovation and enhancement of products and services.

Selling and distribution expenses increased 53% year-over-year and 54% quarter-over-quarter to CNY 241 million. The increases mainly reflected our further expansion in the enterprise market and more marketing and promotion activities for online games.

Administrative expenses increased 1% year-over-year and decreased 3% quarter-over-quarter to CNY 107 million.

Share-based compensation costs increased 10% year-over-year and 2% quarter-over-quarter to

CNY 57 million. The increases were primarily due to the new grants of awarded shares and options to the selected employees of certain subsidiaries of the company.

Operating loss excluding the impact of ESOP was

CNY 86 million as a result of the combination of above reason compared with the profit of CNY 65 million in the corresponding period last year and the loss of CNY 26 million for the first quarter of 2019.

Net other losses were CNY 1,327 million compared with the loss of CNY 74 million in corresponding period last year and the gain of CNY 25 million in the first quarter of 2019. And the losses in this second quarter, we all know that our refinancing of that was mainly due to the provision of -- for the impairment on carrying value of the investment in Cheetah Mobile.

We recorded share of losses of associates of CNY 58 million compared to a share of profit of CNY 66 million for the second quarter 2018 and a share of losses of CNY 78 million for the first quarter 2019.

Income tax expenses decreased 91% year-over-year and 89% quarter-over-quarter to CNY 5 million.

As a result, the loss contributed -- attributable to the owners of the parent was CNY 1,415 million and a profit of CNY 101 million and the losses of CNY 68 million for the three quarter ended June 30, 2019, June 30, 2018 and March 31, 2019, respectively. Loss to owners of parents excluding the eShop was [ 1,372 million ], a profit of CNY 139 million and loss of CNY 33 million for the 3 months ended June 30, 2019, June 30, 2018 and March 31, 2019, respectively. Net profit and loss margin excluding eShop was negative 73%, 10%, and negative 2% for the 3 months ended June 30, 2019, June 30, 2018 and March 31, 2019, respectively.

Let me go on talk about the first half 2019. Revenue increased 38% year-over-year to CNY 3,601 million. Online game make up 32%, decreased 4% year-over-year to CNY 1,169 million. Cloud services make up the 49%, and increased 98% to CNY 1,758 million. Office softwares and services and others make up the remaining 19% and increased 33% year-over-year to CNY 674 million. Our GP margin decreased 11 percentage points year-over-year to 38%. The all of the above reasons, the loss attributable to the owners of the parent was CNY 1,483 million and profit of CNY 219 million for the 6 months ended June 30, 2019 and June 30, 2018, respectively. Loss attributable to the owner of parent excluding eShop was CNY 1,406 million compared with the profit of CNY 296 million in the prior year period. Net profit margin excluding eShop costs was negative 39% and 11% for the 6 months ended June 30, 2019 and June 30, 2018, respectively.

Now statement of financial position. We have a cash and bank deposit of CNY 9 billion as of June 30, 2019. Net cash from operating activities was CNY 244 million and CNY 363 million for the 6 months ended June 30, 2019 and June 30, 2018, respectively.

And the cash used for capital expenditure was CNY 604 million and CNY 499 million for the 6 months ended June 30, 2019 and June 30, 2018, respectively.

In light of our first half performance, we have outlined our target for the second half of 2019. We expect a solid organic revenue growth on the account of steady growth and development of cloud services business and office software and services business as well as the launch of new mobile games. We are confident in our strategy, the strength of our business model and our development going forward. We remain committed to create long-term value for our shareholders through steady growth and sustainable development.

On behalf of Kingsoft, I would like also to expand our appreciation to Kingsoft customers, shareholders, employees and partners and you for supporting us.

We may now start the Q&A session.

[Francie Lu, executive]

Hi, operator, we are ready for the Q&A session.

[Operator]

[Operator Instructions] The first question comes from the line of Thomas Chong from Jefferies.

[Thomas Chong, analyst]

I have a question about our full year guidance. Can management give us any updates about the full year guidance for games, cloud and WPS given we are already past the first half of the year? Any changes in the guidance that we should expect?

And my second question is about the JX Mobile Online III. Can management give us some color about the monthly grossing and how should we expect it trending in the second half of the year? [Foreign Language]

[Yuk Keung Ng, executive]

Thomas, it is Francis [Foreign Language]

[Francie Lu, executive]

[Interpreted] [ I'll do the translation for Francis first. ] So after the first half of the year, we'll now have an update on the guidance for the -- all 3 businesses.

First for the cloud business. In the beginning of the year, we guided the market that the revenue growth will be 60% and over. And in the first quarter, we already revised upward the guidance to 70%, and now we are confident that we will be able to maintain this guidance. And also the operating profit margin will also improve as we guided earlier, so we're quite confident on this trend.

And with the WPS business, early in the year, we guided the market that the top line growth will be 35% to 40% and the operating profit margin will be 20% plus.

Same with the cloud business, we're confident that we're able to maintain the -- this guidance. And for the revenue guidance, that's for the 35% to 40% range, it may be more close to the upper end of the range. And also we're able to maintain the operating profit margin at 20% over.

So for the game business, we launched the JX Online III mobile game in June. Mr. Zou later will talk about more on the gross billing and the performance of this mobile game. But when it was first launched, we faced some challenges, faced some technical difficulties. So this -- it had an impact on financial performance. And also for the JX III PC game, we also launched that on the new platform. So we'll also have to continue to optimize that game.

So for the JX III mobile game, after the first couple of months of launching, its gross billing have now met our expectations. So it will affect our full year and also the second half of the year game business performance. So we did many things to fix the problems including the team from Seasun and also Tencent. So we will continue to optimize games, and we will have a updated version to be released in the fourth quarter.

So for the game business guidance, now we do need to have a significant downward adjustment. So conceptually speaking, for 2019, the game business will have a year-on-year down 10% comparing to 2018. And for the overall business operating margin, we now give a guidance for a negative 5% to negative 10% for the whole year 2019. So this does not take into consideration if the new JX III to be launched in the fourth quarter. If the gross billing will bounce, it may have a better performance in the second half of the year, but we think that more of the adjustment will have greater impact on the game performance for next year, 2020, because we believe that the update will be released more towards to the end of the year.

So now I turn the call to Mr. Zou.

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] [Okay. I'll do the translation for Mr. Zou.] So when we first launched JX III Online Mobile game in June, we did face some problems on the technical side. So when the game was first launched, a lot of the gamers would not be able to log in to the mobile game II section, so they had to switch to the WeChat. So it also exposed a lot of problems that we didn't notice in the PR1 and PR2 testing. So together with Tencent, we believe that in the beta testing version, we have stopped our promotion after 2 weeks after we noticed these problems with Tencent together. So the user we were able to attract when we first launched the game were only 55% of the total expectation that we have for JX Online III mobile game. So the -- so that will have impact on the monthly gross billing.

So the initial first monthly gross billing for this game was around RMB 115 million. This had definitely not met our expectation for the game. So in the future, we will continue to optimize the game content, and we will have another official launch of the game in the fourth quarter. And both we and Tencent, we are confident on the optimized version of this game. But we are planning to launch the game after the national holiday, so the game will be launched around the end of October or early November. So that's what Francis meant earlier that this updated version will have more impact on next year's game performance rather than this year. And due to our optimization on JX III and our focus on the optimization, we will not be able to launch JX Online II by the end of this year because both Seasun and Tencent will be more focused on the JX Online III optimization for this year. Thank you.

[Operator]

The next question comes from the line of Hillman from Citi.

[Hillman Chan, analyst]

[Foreign Language] So my first question is to have an update on the latest pipeline for the launches including mobile JX II next year and also Final Fantasy and how we should think about the performance of them.

And then also noticing that the new announcements on the Caribbean title and also Code Break outside of the role play game Swordsman that we are more specialized in, so I just wanted to have a sense on how we are thinking in terms of the strategy and focus of our game development effort going forward.

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] [I'll do the translation for Mr. Zou.] So for the JX Online II mobile game, because like I said earlier that our operating team is very focused on the optimization of JX Online II -- Online III to be launched by end of October or early November, so the JX Online II mobile game will be delayed to next year. I have explained earlier that the JX Online II and JX Online III launch time will be at least 1 quarter apart. So expect the fastest launch time for JX Online II mobile game will be next year March.

For the FFBE game, we will launch the iOS Version later in this month and for the Android version, will be 2 to 3 weeks after the iOS Version. But the launching plan for the FFBE will be quite different as we will focus on the core gamers first and then expand to others. So we will now plan to do aggressive promotion right after the launch of FFBE.

And as you said that we have other titles that you noticed on display in ChinaJoy. So as I explained earlier that our game studio season, we are planning actively to expand to other game types, other IPs. We are not only focusing on the JX IP. So we -- like we have launched Yunshangyuyi the last year, and also we have another game called [ Go Kafikung ], and we -- by our Changyou studio. We are also launching the [ Go Kafikung 2 ] overseeing Japan in the near future. So we are not only doing the JX IP, but we are also actively expanding to other game title and other IPs. We also have other games on our pipeline, and we will start a more comprehensive communication with the Tencent team in early September. So after our communication with Tencent, we will have a more clear picture on our pipeline for next year. Thank you.

[Hillman Chan, analyst]

[Foreign Language] So as cloud revenue maintain fast growth and also margin guidance is improving from last year, how we should think about the competition going into 2020 and also the margin forecast next year?

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] [I'll do the translation for Mr. Zou.] So my view on the overall cloud market has not changed. So as I said earlier in the year that I think that all of the big cloud companies are still able to maintain a high revenue growth rate currently. This is because that the whole cloud market is still in the initial development stage. The market is not mature yet. So all these competitors are developing very fast in different areas. So I am quite confident that this trend will continue for the next couple of years. And -- but this does not mean that in certain network categories that we may face some more aggressive competition. But overall, the whole market is still in the high grossing period, and our OP margin will continue to improve. This is our goal earlier in the year. And after the -- based on the first half of the year performance, our performance is on track. And we have met our expectations, and we will continue to improve our margin in the future.

But as you know that some of the competitors, they are investing heavily in the market, not regarding their profit level. So we do face some pressures here, so we do have to -- some time to think about whether we need to still maintain high growth at the same rate with our competitors or we choose to balance reaching a high growth rate in revenue and also operating profit margin improvement. So the plan of our cloud business may adjust according to different market competition development. But as of now, we are still on track, and we are still growing very fast in revenue, and we are still improving in the operating profit margin. Thank you.

Hi, operator, I think we're ready to end this conference call.

[Operator]

Sure. Thank you, ma'am. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect now. Thank you.

[Francie Lu, executive]

Thank you.

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