Kingsoft Corp Ltd

HKEX:3888

Earnings Call Transcript 2020-Q2

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Q2 2020 Kingsoft Corporation Earnings Conference Call. [Operator Instructions] Please be advised that today's call is being recorded.

I would now like to hand the conference over to our first speaker today, 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 2020 second quarter and interim 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 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 a 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. Thank you.

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I'll translate for Mr. Zou.

[Interpreted] We saw strong growth in the second quarter, driven by continued demand for subscription and licensing services of Kingsoft Office group, coupled with excellent performance by core online games. Kingsoft Office group focused on product development, product rollout and exploration into complementary verticals to build its core competitiveness. In the online game sector, we continue to improve our ability to develop and offer premium games while extending into new game categories. On May 8, 2020, Kingsoft Cloud Holding Limited was successfully listed on the NASDAQ. As the largest shareholder of Kingsoft Cloud, we have full confidence in its future performance.

Our revenue in the second quarter of 2020 was CNY 1,420 million, up 49% year-on-year and 21% quarter-on-quarter. Our revenue in the first half of 2020, was CNY 2,591 million, up 41% year-on-year. In the second quarter of the year, our online game business reported a year-on-year growth of 53% and office software and services and other businesses grew 43% year-on-year, respectively.

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

Francis?

[Yuk Keung Ng, executive]

Thank you, Francie. Hello, everyone. Let me start with the second quarter of 2020. Kingsoft Office, as a beneficiary of the increased demand in remote working, maintained stable and healthy development. Kingsoft Office group's office software licensing business maintained its rapid growth. We continue to promote a cloud office migration to our leading customer, further strengthening our market leadership in document and information processing.

In the first half of 2020, Kingsoft Office group launched a new addition of WPS office, such as integrated addition, business addition and graphics addition, while establishing an open application program interface with developer partner in our ecosystem.

As of June 2020, we have complete product adaptation with 190 development partners, achieving integration in areas such as work collaboration, input method, mail, voice recognition, handwriting pad and tablet. In addition, over thousands of thousands of micro, small and medium enterprises have used WPS + Cloud office service during the period. Kingsoft Group's personal subscription services continue to show robust growth due to innovative contact, rich features, as well as improved user outreach and experience, via innovative channels such as live streaming sales.

In addition to online document editing, WPS Docs provide collaborative work products such as spreadsheet, calendar, to-do-list and meeting, enabling users to work together seamlessly, via Kingsoft Office group cloud platform. We continue to expand our partnership with brand awareness during this period. Kingsoft Office has become the official supplier of Beijing 2022 Winter Olympics. In addition, Kingsoft entered its strategic cooperation with the international center for higher education, innovation under auspices of United Nation Educational, Scientific and Cultural Organization. Providing WPS office related online courses to this global education resources platform.

Forging ahead, we continue to adhere to our philosophy of technological empowerment, focusing our effort on technological innovation, product optimization and continue to innovate their organization structure and strength from the R&D center.

In the second quarter, revenue from online game achieved significant year-on-year growth. Revenue and average daily active users of our flagship JX Online III PC game, recorded year-on-year growth of 120% and 39%, respectively, reflecting our track record in developing and operating blockbuster online names. In June, we launched a beta test for our JX Online III mobile game and received positive player responses. In the same month, we also started the preregistration for War of the Visions, Final Fantasy Brave Exvius. Meanwhile, the cloud version of JX Online III PC game has officially launched its testing version in July, becoming one of the first cloud game in China. We further strengthened our cooperation with Tencent and launched JX Online tier mobile game on all platform in August, which was branded #1 and in iOS top 3 chart its feedback.

In the coming quarters, we will continue to focus on new product development and operate -- operation optimization. We will celebrate the 11th anniversary of JX Online III PC game and launch a new expansion pack to further strengthen the longevity and vitality of our core IP.

During the year, JX Online I mobile game will be renamed as JX Online I Yuan Qi Wang You with all new games appearances and experience for players. Wo Long Yin 2 will also be launched later this year.

I'll now discuss the Q2 and first half of 2020 operation and financial results. Let me start with the Q2 using CNY as the currency. Revenue increased 49% year-over-year and 21% quarter-over-quarter to CNY 1,420 million. The revenue split was 61% for our online games and 39% for our office software and services and others. Revenue for our online game business increased 53% year-over-year and 11% quarter-over-quarter to CNY 869 million. The increases were mainly attributable to the impassive robust revenue growth from fresh game, JX Online III, which was resulted from equipment content updates and operational innovation, partially offset by decreased revenue from certain existing mobile game as the natural declining life cycles. Revenue from the office software and services and others increased 43% year-over-year and 41% quarter-over-quarter to CNY 551 million. The increase was largely due to the sustainable growth from subscription services and licensing business of Kingsoft Office Group. Driven by the increased paid user resulting from the continuous improved products and services. Cost of revenue increased 90% year-over-year and 8% year-over-year to CNY 280 million. The increases were mainly due to higher server and bandwidth services fee associated with the increased user traffic as well as greater content costs associated with the increased personnel subscription service of Kingsoft Office Group.

Gross profit increased 55% year-over-year and 24% quarter-over-quarter to CNY 1,202 million. The group's gross profit margin increased by 4 percentage points year-over-year and 2 percentage points quarter-over-quarter to 85%. The increases of the group's gross profit margin were mainly due to the greater revenue contribution from the self-developed games in this quarter, which has relatively high gross -- profit margin as well as improved gross profit margin of subscription service of Kingsoft Office Group.

Our net reserve and development expenses increased 4% year-over-year and 10% quarter-over-quarter to CNY 390 million. The increases were mainly attributable to the increased headcount as well as personnel-related expenses as we consistently focused on improving R&D capability and further developing and enhancing our product and services. Selling and distribution expenses increased 8% year-over-year and 31% quarter-over-quarter to CNY 193 million. The year-over-year increase was largely due to the increased channel cost of Kingsoft Office group, aiming to expand and better serve government and enterprises.

The quarter-over-quarter increase were primarily due to the higher marketing expenses for online games. Administrative expenses increased 35% year-over-year and 9% quarter-over-quarter to CNY 101 million. The year-over-year increase was part -- primarily due to the increased staff-related costs and professional service fee. To accommodate for the rapid growth of our business, we moved into new office building in Beijing, which likely increased rental expenses. Share-based compensation costs increased 5% year-over-year and 18% quarter-over-quarter to CNY 37 million. The increases primarily reflected the new branch of awarded shares to selected employees.

Operating loss, excluding the impact of eShop, increased 193% year-over-year and 41% quarter-over-quarter to CNY 585 million. Finance costs were CNY 28 million compared with a finance cost of CNY 5 million and CNY 6 million for the second quarter of 2019 and first quarter of 2020. The increases were primarily due to new issued convertible bond with the interest rate of the equipment market interest rate for a similar bond in the accounting treatment, which would not result in cash flow instead, which accounted debt asset -- we were accounted the actual yield to maturity.

Net other losses were CNY 105 million compared to loss of CNY 1,288 million in the corresponding period last year and a gain of CNY 3 million in the first quarter of 2020. Losses in the second quarter 2020 were primarily due to a loss of a deemed disposal of an associate and impairment provision of certain investee companies. Losses in the second quarter 2019 was primarily due to the provision for impairment on carrying value of the investment in Cheetah Mobile. We recorded a share of loss of associate of CNY 173 million compared with share of losses of CNY 85 million for the second quarter 2019 and a share of loss of CNY 54 million for the first quarter 2020. The losses in the second quarter 2020, were mainly due to the losses recognized in Kingsoft Cloud as it was changed from subsidiary to the associate and recognize share of profit losses using the equity method since May 8, 2020, which was partially offset by profit recognized in Cheetah Mobile as the disposed shares in certain industry -- company in this quarter. The losses in the second quarter 2019 and the first quarter 2020 were mainly due to loss recognized in the Cheetah Mobile in this quarter.

Income tax expenses for the second quarter 2020 and the second quarter of 2019 and the first quarter 2020 was CNY 83 million, CNY 5 million and CNY 54 million respectively. Profit notes for the period from a discontinued operation reflected the combination of gain on deemed disposal gain and the losses from Kingsoft Cloud, which was the profit of CNY 8,927 million compared to losses of CNY 418 million for the second quarter 2019 and the losses of CNY 481 million for the first quarter of 2020. The gain on deemed disposal of Kingsoft Cloud, was CNY 9,096 million recognized in the second quarter 2020, which arose from the spin-off and separate listing of Kingsoft Cloud. As a result, profit attributable to the shareholders of Parent discontinued operation, was CNY 9,151 million, a loss of CNY 1,450 million and a profit of CNY 6 million for the 3 months ended June 30, 2020, June 30, 2019, and March 31, 2020, respectively.

Over to the owner of [ Parent, ] excluding Asia, including that from the continuing operation and discontinued operation was CNY 9,194 million, a loss of CNY 1,372 million and a profit of CNY 55 million for the 3 months ended June 30, 2020, June 30, 2019, and March 31, 2020, respectively. The net profit and loss margin, excluding eShop, was 500%, negative 73% and 2% for the 3 months ended June 30, 2020, June 30, 2019, and March 31, 2020, respectively.

And now on the first half of 2020. Revenue increased 41% year-over-year to CNY 2,591 million. Online game make up of CNY 64 million -- 64% and increased 64.1% year-over-year to CNY 1,650 million. Office software and services and others make up another 36%, an increase of 4% -- 40% year-over-year and to 90 -- CNY 942 million. Gross profit margin increased by 3 percentage points to -- year-over-year to 84%.

As a result of the reason discussed above, the profit attributable to the owner parent, including that from a continuing operation and discontinued operation was CNY 9,158 million. And a loss of CNY 1,483 million for the 6-month payment ended June 30, 2020, June 30, 2019, respectively. Both are attributable to the governor of parent excluding leisure, including debt on the continuing operation and the discontinued operation, was CNY 9,249 million, compared to a loss of CNY 1,406 million in the previous year period. The net profit margin, excluding issue of costs was 211%, negative 39% for the 6-month period ended June 30, 2020, and June 30, 2019, respectively.

In our statement of financial position, we have a cash and bandwith deposit of CNY 50 billion as at June 30, 2020. Net cash from operating activity was CNY 1,308 million and CNY 244 million for the 6 months ended June 30, 2020 and June 30, 2019, respectively. Cash used for capital expenditure was CNY 404 million and CNY 604 million for the 6 months ended June 30, 2020, and June 30, 2019, respectively. And our results were robust in the first half 2020, despite the impact of COVID-19.

Going forward, we remain confident in the resilience of our business model and the pace of the development. We will continue to focus on optimizing our organization structure, technological innovation and product enhancement so as to provide customer with the best user experiences. We strive to deliver sustainable business growth and bring solid return to our shareholders and partners.

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

And now turning back the floor for question-and-answer. Thank you.

[Francie Lu, executive]

We're ready for the Q&A session. Thank you.

[Operator]

[Operator Instructions] We have the first question coming from the line of Thomas Chong from Jefferies.

[Thomas Chong, analyst]

Congratulations on a very strong set of results. I have 2 questions relating to the gaming and the WPS segments. Given our strong performance for the online games segment, in particular, the PC games, how should we think about the second half outlook? And on WPS, how should we think about the growth momentum in the second half and next year? And also, I would also like to ask about the full year guidance, if there's any revision given the strong first half results? [Foreign Language]

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

I will translate for Francis.

[Interpreted] So thanks, Thomas, for your question. We are also very excited for the strong performance for the first half of 2020. Under the COVID-19 and also the U.S.-China tension, Kingsoft performed very strong in the first half. Both game and WPS business, and they are not only unaffected by the COVID-19 but both will actually speed up during its digital transformation. And now with the localization of the software and also the online game businesses. We believe that a strong momentum will continue into the second half of 2020, and we are very optimistic about the full year guidance for Kingsoft. We also upgraded our full year guidance from what we gave to the market from the initial -- early initial -- in this year. Early in this year, we gave a conservative guidance on the game's performance due to the unpredictable factors for the game businesses. But based on the strong second quarter performance, we are now upgrading our full year game guidance. Initially, we gave a low-teen guidance for the game business. But now we believe that the full year game will increase over 30% for the top line. And the WPS now that MA yield is CNY 454 million. And also, the accumulated paid user increased 40% from early this year to close to 1,700 -- to close to CNY 17 million. So both these numbers show a strong support for our business growth and also laid a very good -- strong foundation for the long-term growth of WPS going forward. So we believe that the second half of the year, WPS growth will keep the strong momentum from the first half. Although the licensing business are slightly affected by the COVID situation, but we are still very strong about the Xichuan project, which we believe that we will have 90% of the market share And we also encourage you to listen to the WPS earnings call for their detailed information. And for the full year for the WPS, we believe that the top line growth will be 30% and up and also the OP margin will be a few percentage points improved from last year.

[Operator]

We have our next question coming from the line of Elsie Cheng from Goldman Sachs.

[Haiwen Cheng, analyst]

[Foreign Language] And I will quickly translate myself. Congratulations again on a strong quarter. And I have follow-up questions on the gaming side. The first one is on the JX Online III. We have triple-digit growth again for the quarter. And I just want to understand a little bit more in terms of growth driver, apart from the 39% year-on-year growth in DAU, what are you observing in terms of the user time spend or it's more operationally related? And going ahead into next year, for example, can we expect sustained growth? And the second follow-up is really just on the 30% of the updated guidance that you have on the gaming side. I want to ask management, what's your expectation for the mobile game into the second half?

[Tao Zou, executive]

[Foreign Language]

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I will translate for Mr. Zou and Francis.

[Interpreted] So for the JX III performance, we believe that the core driver is due to the strong performance from the expansion pack from last year in the fourth quarter and also the expansion pack we released in May this year. Both expansion packs performed -- exceeded our expectation. And also in the first half of the year, the COVID-19 -- due to the COVID-19, overall gaming industry also performed well. But in the recent 3 to 4 months, while the COVID-19 actually recover in China, we believe that the key gross drivers are still due to the performance of the expansion packs. We think that the overall performance of the JX Online III PC game now is growing momentum -- is similar to what we had before 2018. So the revamped version, the growth of the new revamp version now is back on track to the -- to release strong growth momentum.

And for the mobile games, we usually don't give out specific guidance for each mobile game before they are launched. But what we would like to share is that for the upcoming quarters, basically, every month, we have either a new mobile game or a new expansion pack. So that's something that we're looking forward to. And also, Francis added that although we don't give out specific guidance for the game business for the mobile game, but we do have a new product every month. So the expectation is very good. For example, we have the [ Moyu 2, ] the mobile game to be launched in September. Also, we have a new game for the JX III in October -- as SSE in October. And also, we have [indiscernible] and also JX World III in December. So we have a good expectation for the second half of this year on mobile game.

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I'll translate for Francis.

Francis also added [Interpreted] for the JX III PC game, we launched the revamped version in 2018. So our game had a slight low season in 2018. But for this year, after our strong performance of post expansion pack in the fourth quarter last year and also the -- in May this year, in the second quarter, the independent IT accounts increased 39% year-on-year. And this is very important and that reflected on the year-on-year of 120% revenue growth for JX III PC game. The JX III PC game reached its peak revenue performance in 2017. But in 2020, we believe that our revenue will be higher than what we had in 2017. So this is a very good expectation for the JX III PC game in the long term.

[Operator]

The next question comes from the line of Feiya Zhao from Haitong International.

[Feiya Zhao, analyst]

[Foreign Language] I will translate for myself. I have 2 questions. The first is about WPS, we noted very strong growth for the WPS, the Personal business. And I also would like to follow-up on the licensing business. Do you see any recovery of the licensing business? And can you give us some color on the Xichuan project? And secondly, about the strong cash position. And could you please give us some color on the MA progress?

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I'll translate for Francis.

[Interpreted] For the WPS business, for the consumer section, we had a very strong performance in the first half. In the second quarter, our revenue is CNY 313 million, that's 73% year-on-year growth. So this is very strong. And also for the licensing section, we had a low season in the first quarter. And in the second quarter, the licensing business recovered totally but due to the whole COVID-19 situation, the first half performance is slightly slower than our original expectations. But we think that in the second half of this year, the business will be back on track. For the China-U.S. tension, this has been going on and off for the past quarters. We believe that they may not be able to reach certain agreements on the core technological aspects. So we think we are very positive on the Xichuan project. The Xichuan project is not going backwards. And as we see in July and August, they are already the started government purchasing. And in some regions, WPS has gotten 100% of the government contracts. Overall, in China, we believe that WPS will guide 90% and up for the Xichuan project. So this is a very big scale opportunity, like we said in the past and we are going to get a very large market share in this project. So this is also why for the -- the reason behind the strong performance of the Asia market value for WPS, which is around CNY 200 billion for WPS. So we think that we encourage you to have a detailed look on the business.

[Foreign Language]

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I'll translate for Francis.

[Interpreted] For the M&A opportunities, we have a good level of cash on hand and our core use of the cash is still focused on -- in the areas that we think we are focused in. That includes the cloud, AI, and also some of the R&D development. We are still in search for the M&A opportunities. And later tonight, WPS, they will also make some announcements regarding this topic.

Operator, we're ready for the last question, thank you.

[Operator]

We have the last question is coming from Linlin Yang from GF Securities.

[Linlin Yang, analyst]

[Foreign Language] I will translate myself. The first question is about the bonus. Do you consider to have some bonus because we have -- our cash is very sleek. And the second question is about the -- could you give us some guidance about games and WPS and the cloud for this year?

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

Okay, I'll translate for Francis.

[Interpreted] So for the dividend policy, we have been discussing this in the Board meeting. So some of the details will be announced in the future announcements when we have the details ready. We do have a good cash level on hand. And then after the cloud business become prelisted, both WPS and the game business are cash positive. And we also get dividends from Cheetah Mobile. So these were all reflect -- reflected the dividend policy on the group level. And other than the dividend policy and other than the organic growth and also the M&A opportunities, we will also consider share repurchase. And some of these details will also be announced in the future announcements once they're ready.

And for the guidance for each business, the game business, as I said earlier that -- earlier this year, we gave a conservative guidance, which is low teen. And now we believe that the guidance will double, and we believe that there will be a 30% and up revenue growth for the game business in this year. And also the profitability level will also improve higher in the game business. That's also something that we noticed. And also for the WPS business, due to the strong growth for the subscription business, which offset some of the delay on the licensing business. Due to the COVID-19, we believe that the full year growth rate will be over 30%. And also, we encourage you to listen to the WPS earnings call later as well. And we think that the profitability will also improve a few percentage points for WPS business this year from last year.

For the cloud business, we will also have a earnings release later. Based on my discussion with the team is that the top line growth is still very strong, over 60% this year. And also the gross margin already turned positive in last year's third quarter, and we have been remaining -- remained positive for the quarter afterwards. And also the EBITDA performance is still on track. We think that the EBITDA will turn positive by the end of this year, and we're very excited about the performance of the cloud business.

[Operator]

We do not have any other questions at this moment. I would like to hand the conference back to you. Please take over, ma'am.

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

This will conclude the conference call for today. Thank you all for your attendance. Thank you.

[Operator]

Thank you. Ladies and gentlemen, that concludes our conference for today. Thank you all for your participation. You may disconnect your lines now. Thank you.

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