Kingsoft Corp Ltd

HKEX:3888

Earnings Call Transcript 2022-Q2

[Operator]

Good day, and thank you for standing by. Welcome to the Q2 2022 Kingsoft Corporation Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your first speaker today, Francie Lu. Please go ahead.

[Francie Lu, executive]

Thank you, operator. Ladies and gentlemen, good evening and good morning. I would like to welcome everyone to our 2022 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 detailed discussion on risk factors, which may affect our business and operations.

Having said that, please allow me to introduce our management team who joined us today, Mr. Tao Zou, our Executive Director and CEO; Ms. Yi Li, our Acting CFO.

Now I am turning the call to Mr. Zou.

[Tao Zou, executive]

[Interpreted] Despite the challenges posed by the recurrence of the pandemic, we remain focused on our strategy and achieved satisfactory results in our core businesses. Kingsoft Office Group is committed to empowering the digital transformation of institutional users, while enhancing the cloud office user experience for individual users.

We concentrate on technological empowerment, product innovation, service enhancement, as well as marketing channel and ecosystem expansion. Meanwhile we continue to pursue the product strategy of multi-screen, cloud, content, AI and collaboration and have achieved good operational performance.

Regarding our online game business, we adhere to the strategy of premium games, focusing on technology innovation as well as constant cultural enrichment, and promote further game development.

The Group maintained solid performance in the first half of 2022 with total revenue reaching RMB 3,687 million, increasing by 21% year-on-year, driven by the growth of subscription revenue from individual and institutional businesses. Our office software and services business increased by 15% year-on-year during the first half of 2022.

Our online games and other businesses increased by 28% year-on-year during the first half of 2022, primarily due to the contribution of mobile games launch in the fourth quarter of 2021, such as JX World III and JX I: Gui Lai.

Now I am turning the call to Ms. Li.

[Yi Li, executive]

Thank you, Francie. Good evening, everyone. During the second quarter, individual subscription business sustained the growth momentum. Based on the continuous enhancement of cloud office user experience, Kingsoft Office Group developed and introduced various new functions dedicated to specific scenarios, aiming to drive the actual use of cloud services and continuous increase in paying subscribers. Meanwhile, we remained focusing on attracting more long-term paying users.

In response to the government departments' demand for digital management, end-to-cloud integration and mobile office, our products are highly compatible with government office systems, which assist the government in achieving informatization gradually and realizing centralized document management, effective and efficient file application, collaboration features, security control et cetera.

Facing the soaring demand for digital transformation from enterprises, our core products specialize in uploading documents to the cloud and ensuring file transfer security through continued optimization and the assistance of quality customer services.

Kingsoft Office Group has closely monitored the localization industry trend. As the localization gradually penetrates into local government, we take the initiative to tap those markets. Driven by favorable policies and industry demand, the demand for integrated end-to-cloud products from customers in the industry localization, such as finance, energy and telecommunications, continues to grow, which leads our products penetration in the localization to keep growing.

We have optimized the re-flowable and fixed-layout document format standards of our localization products to provide efficient and integrated user experience, which would further strengthen the competitiveness of our products.

Kingsoft Office Group continued to strategically play down its advertising business by reducing the number of advertising spaces and the frequency of push notifications. Since we strived to improve the quality of clicks and reduce user interference, our advertising business was undergoing a steady and gradual decline.

During the second quarter, our flagship JX Online III PC game remained stable. Upon the launch of long duration test in China, at the end of last year, JX World III maintained an outstanding reputation and a high popularity among gamers. In addition, the game launched in Hong Kong, Macau and Taiwan during the quarter and achieved an excellent performance. In the third quarter, we launched the open beta across all platforms and a new section for JX World III and will celebrate the 13th anniversary of JX Online III PC game.

Through continuous content upgrade and technology innovation, we strive to sustain the vitality of our core IP. Meanwhile, we also uphold our corporate responsibility and continue to explore the social value of our games. Biphase, our initial self-developed charity game which focuses on bipolar disorder, has received multiple awards and acclamation from international gaming authorities upon its debut overseas last year. In addition, the game has also received the license approval in July this year and is scheduled to launch in China.

I will now discuss the second quarter and first half of 2022 operational and financial results and starting from the second quarter using renminbi as the currency. Revenue increased 24% year-over-year and decreased 1% quarter-on-quarter to RMB 1,834 million. Revenue split was 50% for office software and services and 50% for online games and others. Revenue from the office software and services business increased 18% year-over-year and 6% quarter-on-quarter to RMB 925 million. The increases were mainly due to the continued growth of individual and institutional subscription businesses, partially offset by the decreases in institutional licensing and internet advertising business of Kingsoft Office Group.

The fast growth of individual subscription business was mainly driven by the increase in the accumulated paying subscribers as the continuous enhancement of cloud office user experience and enrichment of value-added functions. The growth of institutional subscription business was largely driven by increasing demand for digital transformation from government and enterprises. The decrease in institutional licensing business was largely due to reduction in new purchase orders on localization solutions, partially offset by increasing demand for domestic office software from government and enterprises. The decrease in internet advertising business was the result of strategic contraction for the purpose of user experience enhancement.

Revenue from the online games and others business increased 31% year-over-year and decreased 7% quarter-on-quarter to RMB 910 million. The year-over-year increase was mainly due to revenue contribution from mobile titles released in the third quarter of 2021, such as JX World III and JX I: Gui Lai. The quarter-on-quarter decrease mainly reflected the high base of aforementioned games in the first quarter of 2022.

Cost of revenue in the quarter increased 35% year-over-year and 5% quarter-on-quarter to RMB 366 million. The year-over-year increase mainly reflected increases in channel costs, as well as server and bandwidth costs of Kingsoft Office Group, and greater channel costs of online games business. The quarter-on-quarter increase mainly reflected greater server and bandwidth costs and purchasing costs of products and services along with the business growth of Kingsoft Office Group.

Gross profit increased 22% year-over-year and decreased 2% quarter-on-quarter to RMB 1,468 million. Gross profit margin decreased by 2 percentage points year-over-year and 1 percentage point quarter-on-quarter to 80%.

Research and Development costs increased 21% year-over-year and 6% quarter-on-quarter to RMB 642 million. The year-over-year increase was mainly attributable to increased headcount as well as personnel-related expenses of Kingsoft Office Group, which reflected our efforts in enhancing core competitiveness of products and services.

Selling and distribution expenses decreased 9% year-over-year and increased 5% quarter-on-quarter to RMB 283 million. The year-over-year decrease and quarter-on-quarter increase mainly reflected changes in marketing spending associated with Kingsoft Office Group in each corresponding quarter.

Administrative expenses increased 15% year-over-year and 4% quarter-on-quarter to RMB 153 million. The increases were mainly due to increased personnel related expenses.

Share-based compensation costs increased 54% year-over-year and decreased 15% quarter-on-quarter to RMB 63 million. The year-over-year increase was mainly due to the grants of awarded shares to the selected employees of certain subsidiaries of the company.

Operating profit before share-based compensation cost increased 78% year-over-year and decreased 16% quarter-on-quarter to RMB 482 million.

Net other gains for the second quarter of 2022 were RMB 6 million, compared with gains of RMB 48 million and RMB 23 million for the second quarter of 2021 and the first quarter of 2022, respectively.

Share of losses of associates of RMB 418 million were recorded for the second quarter of 2022, compared with share of losses of RMB 211 million and RMB 275 million for the second quarter of 2021 and the first quarter of 2022, respectively.

Income tax expense for the second quarter of 2022 was RMB 29 million, compared with income tax credit of RMB 26 million for the second quarter of 2021 and income tax expense of RMB 34 million for the first quarter of 2022.

As a result of the reasons discussed above, loss attributable to owners of the parent was RMB 139 million for the second quarter of 2022 compared with profit of RMB 49 million for the second quarter of 2021 and RMB 99 million for the first quarter of 2022.

Loss attributable to owners of the parent, excluding ESOP was RMB 96 million for the second quarter of 2022, compared with profit of RMB 72 million for the second quarter of 2021 and RMB 143 million for the first quarter of 2022. The net profit/loss margin, excluding ESOP was minus 5%, 5% and 8% for this quarter, the second quarter of 2021 and the first quarter of 2022, respectively.

I will now on the first half of 2022. Revenue increased 21% year-over-year to RMB 3,687 million. Office software and services made up 49% and increased 15% year-over-year to RMB 1,796 million. Online games and others made out 51% and increased 89% year-over-year to RMB 1,891 million. Gross profit margin decreased by 2 percentage points year-over-year to 81%. Operating profit before share based compensation cost increased 30% year-over-year to RMB 1,055 million.

Shares of loss of associates of RMB 692 million and RMB 436 million were recorded for the first half of 2022 and 2021, respectively.

As a result of the reasons discussed above, loss attributable to owners with parent was RMB 40 million for the first half of 2022, compared with profit of RMB 165 million in the same period last year. Profit attributable to owners of the parent, excluding ESOP was RMB 47 million compared with profit of RMB 211 million in the prior year period. The net profit margin excluding ESOP was 1% and 7% for the first half of 2022 and 2021, respectively.

Our statement of financial position. We had a cash resources of RMB 19 billion as at 30th June 2022. Net cash from operating activities was RMB 1,053 million and RMB 869 million for the first half of 2022 and 2021, respectively. Cash used for capital expenditures was RMB 197 million and RMB 121 million for the first half of 2022 and 2021, respectively.

In the second quarter, we embraced the change of the complex environment and achieved further development by continuously enhancing our products and services. Looking ahead, the group will adhere to technological empowerment, maintain our investment in research & development and enhance operational efficiency. We will keep focusing on our core strategy, adhere to integrity and innovation to empower our users and partners and create long-term returns for our shareholders.

Thank you. Now I'll turn the call to Francie.

[Francie Lu, executive]

Thank you, Ms. Li. And operator, we're ready for the Q&A session.

[Operator]

[Operator Instructions] First question is from the line of Liping Zhao from CICC.

[Liping Zhao, analyst]

[Foreign Language] I have 2 questions here. The first one is related to the gaming business, because the business segment has achieved very strong growth in the second quarter -- what are the key drivers, and could management share the outlook of this business in the second half of the year? And 2, is about the WPS business segment. The MAU of WPS is Q-on-Q flat, but the revenue achieved solid growth and how should we expect the change of MAU and paying ratio in the coming quarters?

[Tao Zou, executive]

[Interpreted] So for the gaming business, we have a very strong growth in the first half of the year. And there the main driver is because of the launch of several new games in the last -- the fourth quarter of last year 2021, especially JX World III, which we launched by the end of December last year. So the main revenue contribution is recorded in this year. And compared with last year, we didn't have the new games launched. And in the last earnings call, I already mentioned that the actual performance of JX World III actually doubled our original expectation.

And also the JX I: Gui Lai was also launched in the second half of last year, both of its domestic and overseas revenue contribution was quite stable. For the second half of this year and going forward, the revenue growth will depend on the license approval process and also the overall economic and the pandemic situation, because these factors will affect the actual launch date of our new games. According to the current license approval process, we have several games that are actually are waiting in line for the license approval.

And the second question is on Kingsoft Office, the number of users of the MAB is quite flat quarter-on-quarter. So there are several reasons for this. On the PC side, it's still growing quite strong. There's a slight decline on the mobile side. The first reason is that because of the overall sale of mobile devices is actually declining. So this will obviously affect our number of users. We used to have pre-installations in the hardware devices. So the decline in the overall sales of mobile devices will negatively affect our number of users growth. And the second reason is the overall economic condition, also the pandemic situation.

There are 3 aspects of our Office growth strategies: First is the number of users; the second is paying ratio; and lastly is the ARPU growth. According to the meeting we had internally today with the Kingsoft Office management, the paying ratio growth potential is still 70% -- 80% to double the number of paying users growth and ARPU growth potential is also there. And also for the number of users growth, we think that there's still more space. The current overall weak economic situation, also the pandemic situation we think is still temporary. In the long term, we're still optimistic with the growth of the number of users.

Operator, we're ready for the next question.

[Operator]

We'll now take our next question. This is from the line of Yang Liu from Morgan Stanley.

[Yang Liu, analyst]

[Foreign Language] I will do the translation. The first one is a follow-up related with MAU. Does management have any high frequency data to show the trend given the April and May should be the trough of the lockdown and also the mobile device shipment and whether there is any improvement in June and July?

And second question is regarded with the licensing business for Kingsoft Office. Given the second quarter, we still see some decline. And my question is, so whether for the full year, will it be hard to see the positive growth?

[Tao Zou, executive]

[Interpreted] For the first half of this year, the number of mobile devices sales actually declined, which negatively affected our MAU numbers. For the second half of this year, we think that there may be a slight rebound in terms of the situation, but we think that this may still require a longer period, a longer time to recover to the normal rate.

The second question is on localization project. My personal thoughts on this is the pandemic situation and also the upcoming 20th Government Conference are still using up the government resources in terms of their investment in the localization project. So we think that next year will be more optimistic with this situation.

Operator, we're ready for the next question.

[Operator]

So we'll now take the next question. It's from the line of Linlin Yang from GF Securities.

[Linlin Yang, analyst]

[Foreign Language] I have 2 questions. The first one is about JX III. Could you give us some more detail about the game's performance and the revenue contribution this in the second half year? And the second question is about the subscription business growth this quarter and its growth driver.

[Tao Zou, executive]

[Foreign Language]

[Yi Li, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I'll translate for Mr. Zou and Ms. Li. So for the first game on JX III Origi performance. We did officially promote the game in July. And this is mainly because we are still optimizing the building features for the JX III origin. The original JX III PC game is a time billing plus virtual item billing game. But JX III origin is a free game, it's not time billing. So we have adjusted the billing model for this game. But there is still some major differences between these games. For example, the JX III PC game, the female user percentage is quite large.

At one point, the female user percentage was greater than 60%. So the social demand for this game is quite strong. And the virtual item billing is very popular and contribute over 70% to 80% of the total revenue. But JX III origin is quite different. It's mainly male gamers. So these male gamers are not too much interested in the ritual items or the appearances, accessories for the characters in the game. So we have adjusted the billing model. And based on the data from June, July and August, the adjustment was quite effective, but we still need more time to optimize the billing model for this game. And this is the main reason why we delayed the originally planned July promotion for the game, but operating data for this game have been improving in the past.

The second question is on the Kingsoft Office subscription business. Because that was affected by the localization product due to the pandemic situation, the first half of this year, the growth was mainly contributed by the subscription business from both 2B and the 2C businesses. From the 2B subscription business, the growth was quite strong, but it's still a slightly weaker than our original expense expectation from earlier this year, and this is mainly due to the pandemic situation.

We had a Board meeting with the KSO business. We all agree that IT upgrade and also the digital transformation is the long-term trend. So we think that in the future, we are going to increase our investment in R&D for the IT upgrade and digital transformation for our enterprises and also for the government users, and this will further drive the growth of our 2B subscription business in the long term in the future.

And Ms. Li, added some financial and operating data for the 2B subscription businesses. The overall growth for the KSO business was up 14% in the first half of this year. But the 2C subscription, the growth was 40% and the 2B subscription business was 51%. And also the digital office platform and there are over 1,800 customers using our platform, so that shows a strong growth in the cloud office business for KSO.

[Operator]

Thank you. No other questions at the moment. [Operator Instructions] And we have another question coming through, this is from the line of Linlin Yang from GF Securities.

[Linlin Yang, analyst]

[Foreign Language] Okay. I have more questions about game guidance. And if there are any change about the game guidance, 20% year-on-year growth? And another question is about the guidance of WPS?

[Yi Li, executive]

[Interpreted] So the overall game growth for this year is around 20%, because now it's almost September, we are still applying for new licenses for other games. So it's unlikely that we are going to get new license for the rest of the year. So our overall gaming revenue growth is around 20%. And for the KSO business, like we said before that we're not going to disclose outside of their disclosure. So, so far they haven't give out any financial guidance yet.

[Operator]

We will now take our next question. This is from the line of Ken - Kao Li from Citi.

[Unknown Analyst]

[Foreign Language] In the second quarter, the share of losses of the associates expanded, can you explain the reasons in detail? And what is the expected operating profit margin for the full year?

[Yi Li, executive]

[Interpreted] So there are 2 major associates in our loss of associates item, so that's from the cloud and also from Cheetah Mobile. Because both of these associates have not disclosed their earnings for this quarter yet, so we can't disclose more data at this point. But the losses from these 2 associates in the second quarter are larger than what we had in the first quarter.

And for the operating profit guidance, because of revenue growth for the game business around 20%, so there is also an increase in the operating profit level for the game business. For the KSO business, like we said for the revenue, we can't disclose any financial guidance yet at this point.

[Operator]

We'll now take the last question. This is from the line of Joel Ying from Nomura.

[Joel Ying, analyst]

[Foreign Language] So for the GP margin trend, we see there the decline first quarter, second quarter GP margin for the Group. So is that impact from license business from KO rather than the gaming business?

[Yi Li, executive]

[Interpreted] So regarding the question on gross profit margin, for the KSO business, because the revenue from to 2C subscription business is greater than the revenue from the licensing business, so there is a change in the revenue structure that will affect gross profit margin. And for the game business, because we also have some licensing, so there is some restructure in the internal game revenue structure that will affect our gross profit margin as well.

And operator, this will conclude our presentation for today.

[Operator]

Thank you. This does conclude the conference for today. Thank you for your participation and you may now disconnect.

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