Kingsoft Corp Ltd

HKEX:3888

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to Q3 2019 Kingsoft Corporation Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded.

I would like to hand the conference over to your first speaker today, Ms. Francie Lu. Thank you. 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 2019 third quarter earnings call. I'm Francie Lu, the IR Director of Kingsoft.

I would like to start by reminding you that some information provided during the earnings call may include forward-looking statements which may not be relied upon in the future for various reasons. These forward-looking statements are based on our own information and information from other sources which we believe to be reliable. Please refer to the other publicly disclosed documents for 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 joined us today. Mr. Zou Tao, our Executive Director and CEO; Mr. Francis Ng, our Executive Director and CFO.

Now I'm turning the call to our Executive Director and CEO, Mr. Zou Tao.

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] Our various business continued to show good momentum in the third quarter of 2019. Our flagship JX Online III PC game and JX Online I mobile game maintained their popularity among users and achieved satisfactory revenue growth quarter-on-quarter.

Our cloud services business achieved record growth, and we officially released a new range of finance cloud solutions to extend our customer portfolio for this segment.

Meanwhile, the revenue from the WPS value-added services maintained strong growth and WPS also strengthened its global presence with the international debut of WPS Office 2020 international suite in August 2019. We're glad to see the listing of Beijing Kingsoft Office Software Inc. on the Science and Technology Innovation Board on the Shanghai Stock Exchange expected to take place on November 18, 2019.

Our revenue for the third quarter was RMB 2,022.9 million, up 32% year-on-year and 8% quarter-on-quarter. Revenue of cloud services continued to grow rapidly year-on-year driven by our competitive advantage in mobile videos and the Internet market, as well as breakthroughs in the enterprise and government market.

Now I'm turning the call to our Executive Director and CFO, Mr. Francis Ng.

[Yuk Keung Ng, executive]

Thank you. Hi, everyone. In the third quarter, revenue from our flagship JX Online III PC game and JX Online I mobile game increased quarter-on-quarter. On 28 August 2019, we celebrated the 10th anniversary of JX Online III PC game in Xi'an and shared with our gamers, with development outlook on technological innovation, user operation and content creation.

Regarding mobile games, we continue to pursue a diversified product strategy and a mobile game Double Life World [Foreign Language] was launched in Japan on September 20, 2019. The domestic version of the game will be released in the very, very near future. In the fourth quarter, we plan to launch a new expansion pack for JX Online III PC game to provide player with new game content and better experience.

Leveraging the company leading infrastructure and technology, Kingsoft video cloud successfully supported the live broadcast of Autohome 818 Global Car Night Gala and the National Day Parade on the PRC's 70th Anniversary Celebration. During the Asia Pacific Content Distribution Network Summit 2019, Kingsoft Cloud won the CDN Leader Award for Top 10 Outstanding Operating Enterprise. In terms of game cloud, together with the China Telecom Corporation Limited and Intel Corporation, Kingsoft Cloud jointly released a cloud gaming solution to achieve a fast cloud streaming from the player end.

In terms of finance cloud development, Kingsoft Cloud has achieved a financial ecosystem from the most basic cloud infrastructure construction by launching full-stack smart cloud solution and Kingsoft Blockchain-as-a-Service. We name it KBaaS commercial blockchain platform. Jinggang Cloud, an industrial cloud platform jointly built by Kingsoft Cloud's government cloud and Angang Steel Corporation Limited, was recognized as one of the top 10 case studies in Cloud Migration in 2019.

The company secured a strategic cooperation with Xiqing district of Tianjin to jointly develop the Xiqing Cloud, and with the government of Chibi City and Shuangliu district of Chengdu to build a big data industrial ecosystem.

Looking in the future, Kingsoft Cloud is committed to empower enterprise client in digital transformation across a variety of industries by leading the integration and innovation of cloud computing, big data, artificial intelligence and other cutting-edge technologies.

Our office software and services business continued to show sustained growth. By providing a complete coverage of office use case scenarios, the performance of personal value-added service of WPS Office maintained -- remained robust. In addition, we launched a new version of WPS Office for Linux which utilizes technology -- technological capability, including knowledge base, AI, data mining. By introducing AI technology into office products, WPS further enhanced user experience and service capability on Linux system. This in turn strengthened our capability to drive our government cloud business.

In term of overseas expansion, we have released the WPS Office 2020 international suite in New Delhi, India on the 28 August, 2019. As WPS Office's flagship office software suite in overseas market, WPS Office 2020 international suite features a comprehensive suite of functions and services, including the pre-built templates and PDF editing function, et cetera, as well as macOS office support. Looking ahead, we are committed to provide a variety of cutting-edge office products and services, creating the best office user experience for global customers through technology empowerment.

I will now discuss our Q3 operational and financial result using RMB as currency. Revenue increased 32% year-over-year and 8% quarter-over-quarter to RMB 2,023 million. The revenue split was 33% for online game, 48% for our cloud services and 19% for office software and services and others.

Revenue from our online game business decreased 2% year-over-year and increased 16% quarter-over-quarter to RMB 663 million. The year-over-year decrease primarily reflected decreased revenue from existing games, which partially offsetted by revenue contribution from newly released mobile game this year. The quarter-over-quarter increase was mainly due to the revenue growth of our flagship game JX Online III PC game, which are the result of the continuous improvement in our user experience through content -- constant content updates and revenue contribution from our JX Online III mobile game's launch in June 2019.

Revenue from the cloud services increased 62% year-over-year and 6% quarter-over-quarter to RMB 976 million. The rapid year-over-year increases was mainly driven by an increased customer usage from mobile video sector and increased revenue from enterprise cloud. The steady quarter-over-quarter increase was mainly due to the revenue growth of the enterprise cloud which are supported by our progress in expanding into particular industries.

Revenue from office software and services and others increased 15 -- 50% year-over-year and decreased 1% quarter-over-quarter to RMB 383 million. The year-over-year increase was mainly due to the strong growth from value-added services of WPS Personal Edition, driven by enhanced user experience and increased paid users with more practical functions and high quality resources provided. The slight quarter-over-quarter decrease was primarily due to weak seasonality in the first quarter.

Cost of revenue increased 42% year-over-year and 3% quarter-over-quarter to RMB 1,200 million. The year-over-year increase was primarily due to the higher bandwidth and Internet data center cost resulting from the increased customer usage of our cloud services.

Gross profit increased 18% year-over-year and 15% quarter-over-quarter to RMB 823 million. The gross profit margin decreased by 4 percentage points year-over-year and increased by 3 percentage points quarter-over-quarter to 41%. The year-over-year decrease of the gross profit margin was largely due to our change in sales mix. The quarter-over-quarter increase of gross profit margin mainly reflected improved operating efficiency of our cloud business.

Net R&D costs increased 4% year-over-year and decreased 7% quarter-over-quarter to RMB 534 million. The increases were mainly due to an increase in personnel-related expenses, as we engage in developing new value-added products and features, as well as new technology.

Selling and distribution expenses increased 19% year-over-year and 13% quarter-over-quarter to RMB 272 million. The increases were primarily due to the increased spending on channel and promotional marketing.

Administrative expenses increased 9% year-over-year and 16% quarter-over-quarter to RMB 125 million. The increases were mainly due to the increased professional services fees.

Share-based compensation costs increased 18% year-over-year and 5% quarter-over-quarter to RMB 60 million. The increases were primarily due to the new grants of awarded shares and options to selected employees of certain subsidiary of the group.

Operating loss before share-based compensation costs was RMB 72 million compared to a loss of RMB 134 million for the third quarter 2018 and a loss of RMB 86 million for the second quarter 2019.

Net other loss was RMB 87 million compared to net other loss of RMB 83 million for the third quarter 2018 and RMB 1,327 million for the second quarter 2019. As you can remember, the losses in the second quarter of 2019 were mainly due to the provision for impairment on the carrying value of the investments in Cheetah Mobile Inc.

Share of profits of associates of RMB 128 million were recorded compared to a share of profit of RMB 28 million for the third quarter 2018 and a share of losses of RMB 58 million for the second quarter 2019. The increase in the third quarter 2019 was mainly because of the -- because Cheetah Mobile recognized a gain on the deemed disposal of a subsidiary.

Income tax expenses decreased 1% year-over-year and increased RMB 455 million to RMB 29 million.

As a result, profit attributable to owners of the parent was RMB 36 million compared to losses of RMB 59 million for the third quarter 2018 and RMB 1,415 million for the second quarter 2019.

Profit attributable to the owners of parent, excluding the e-shop, was RMB 81 million compared to a losses of RMB 22 million for the third quarter 2018 and RMB 1,372 for the second quarter of 2019.

Our statement of financial position, we have cash and bank deposit of RMB 9 billion as of September 30, 2019.

Net cash generated in operating activities was RMB 87 million compared to a net cash generated from operating activity of RMB 6 million and RMB 294 million for the third quarter 2018 and the second quarter of 2019, respectively.

Capital expenditure was RMB 418 million, RMB 532 million and RMB 325 million for this quarter, the quarter -- the third quarter 2018 and the second quarter of 2019, respectively.

On the whole, we are pleased to achieve a satisfactory performance in the third quarter amidst a challenging environment and we continue to see the convergency of innovation and digital transformation. Kingsoft will maintain its competitive edge in the industry. Looking ahead, we expect our business performance to remain robust, driven by sustained growth of our cloud services business and office software and services business.

We are confident to meet our 2019 target and endeavor to generate long-term value for our shareholders.

Now I -- let the floor back to questions and answer. Thank you.

[Francie Lu, executive]

Hi, operator. We're ready for the Q&A session.

[Operator]

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

[Thomas Chong, analyst]

[Foreign Language]

I have 2 questions from my side. The first one is about 2020 outlook. Can management comment about the strategy for online games, cloud as well as WPS as we go into next year? And my second question is more about WPS. Given the strong growth momentum in Q3, how should we think about the trend in coming quarters as well as the overall group operating profit given that the loss in Q3 is less than what market expected? Should we expect to turn into profit in Q4? Or any visibilities for next year would be great.

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] So thanks, Thomas, for your question. So regarding the 2020 outlook on our online game cloud and WPS businesses, we are currently in the third quarter and we're still doing our budget for 2020. But I can -- we'll give out a more specific guidance in the fourth quarter earnings call, but now I can give you a more general feel for the 2020. Generally speaking, we think that 2020 should be better than 2019 for a few reasons. First, for WPS, WPS will become separately listed on the new Sci-tech Innovation Board next Monday.

Now only mentioning our optimistic outlook on this sale price performance, but we focus more on its fundamentals which are all very strong. In the next 1 or 2 months, we'll also have more color to share with you in the development of the license software business especially in China due to its strong popularity and also for the enterprise demand for domestic software products. And not only for this year 2020, we are quite optimistic about this business segment in the next few years as well. And for the consumer product, the value-added services are still growing very fast especially the non advertisement business.

We are trying to intentionally control the growth of the advertising business, but the non advertising business are growing very fast. In terms of MAU, DAU, the number of paying members are all increased at a fast pace and this will also reflect in our improvement in the operating profit margin performance. Especially in the next few years, the growth in the license software, we have good expectation for this business and the revenue will increase, but the cost will now increase accordingly. So that will also reflect in the improvement in our operating profit margin.

And for the cloud business, we have all-in cloud investing strategy. In the past few years, we have experienced different development periods for the cloud business. We are still in the investment period so the business is still at loss. But this year, the cloud business, including the first 2 quarters and also in the third quarter, the revenue is growing very strong as -- expecting our expectation and not only the revenue, the gross profit margin and also the operating profit margin are also improving, and this momentum will continue in the future.

So our loss level has been improved in this year significantly. And in the very near term, we also have another big plan, big movement for the cloud business to help the business to go to the next level. And all the analysts and investors will see this in the near future. So in 2020, we still expect high growth -- revenue growth momentum for the cloud business, and the loss level will continue to improve.

And lastly, we'll talk about the game business. There have been some satisfactory and also some disappointing moments this year for the game business. For the JX III mobile game, it experienced some difficulties in the beta testing version. But now we are still optimizing the product and we're going to launch the -- its official commercial launch in the next 2 or 3 months. We did a minor update in October, but a big, big update will be released in the next 2 to 3 months. In the -- for the JX III PC game in 2019, we expect this game to remain quite stable. It may -- its revenue may stay flat from 2018. And this momentum is going to continue into 2020, we want to maintain the stability in next year as well. And in 2020, we have our pipeline, it's called 3 plus 3. We have 3 games that are quite ready in terms of development, including the JX Online II mobile game, the more used 3D mobile game and also Volomin. We have another game, it's called Shen Zhi Yi Ji. Its domestic version will also be launched shortly within the week in China. And also, we have good expectations for this game based on its testing data.

So next year, we are also quite cautiously optimistic about the game business as well. Thank you.

[Operator]

Your next question comes from the line of Hillman Chan from Citigroup.

[Hillman Chan, analyst]

[Foreign Language] So I would like to have more color on the 3 plus 3 game portfolio and as to which game would be more bigger in size. And also what's the status of game development of these selected title and the timeline as well? How should we think about overseas game expansion strategy in the coming 2 years, and the pipeline for the overseas market?

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] So thanks, Hillman, for the question. We mentioned that next year for the game business, we have a 3 plus 3 strategy. The first 3 is the 3 games that we think they are quite ready for launching in terms of its development and also, they have already got the licenses. So it's very highly likely these 3 games will be launched next year. And the plus 3 are the 3 games that it's possible for them to be launched next year but still based on their development and other factors because these Plus 3 games they are quite innovative. Some include some game categories that didn't have -- never tried in the past. So we'll have more specific launching time or more specific timelines for these games in the fourth quarter by the end of the year. And for the overseas games development, in the past, we have already launched JX series and also the MAT series in Vietnam, Thailand.

And now this year, we also launched the Shen Zhi Yi Ji in Japan as well. So next year, we also have more movement, and we are still planning to -- for the overseas game development next year as well. So we'll have more specific plans to share with you in the fourth quarter, closer to the end of the year. Thank you.

[Operator]

Your next question comes from the line of Linlin Yang from GF Securities.

[Linlin Yang, analyst]

[Foreign Language] The first question is about the WPS business. What about the Op margin of this business? And could you give us some more color about -- more details about the growth of paid users and 2 new business group? The second question is about games, and I want to ask about the change after -- in mobile game and a more color about this game's performance. And the third question is about cloud. As of cloud, which world co industry is the driver of this business? And which year do your management think will breakeven?

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] Okay. So for the WPS operating profit margin, it will -- in 2020, it will be much better than 2019 or 2018. There will be a significant improvement due to the demand from domestic enterprise license sales increase. So this will also drive the improvement in the operating profit performance. In 2019, the operating profit margin is a few percentage points lower than 2018. Like I said earlier in the year that in 2019, our operating profit margin will be 20% plus. In 2018, the operating profit margin was about mid-20. But this is in line with our strategic development because we have a lot of good opportunities for the WPS business. So we had increased our investment in R&D, for example, the number of engineers in 2019 is actually double the number of engineers in 2018. We kept on improving our products' capabilities and also to expand in the overseas market.

So the 2019 Op margin is a few percentage points lower than 2018, but it's still on 20% and up. And in 2020, it will improve significantly due to the strong demand from the enterprise license sales in China.

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] For the number of paying members also going very fast, more than 100% growth -- growth rate, by the end of September, we already have 6.7 million paying members. It's 120% year-on-year growth rate.

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] The cloud business is going very strong. The whole industry is still in the initial development stage, so we have a lot of good opportunities. The industry is growing very fast. We are very strong in the video cloud vertical and the video cloud business is still growing at a very fast pace. And we are even more excited in the new verticals that we expand into, especially the financial cloud, like we mentioned early in the year that we have got a few major contracts from some major banks in China and also the growth in government cloud is also very fast.

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] For the breakeven point, I already answered in the earlier question, that the cloud revenue is growing very strong. But also, more importantly, like the loss is improving. It's -- for this year, the loss margin is proving better than our expectation quarter-over-quarter. So we still keep expecting the loss improvement to continue in the next year. We can't tell you a specific date on the breakeven point. So we could say that it's not going to be too far away.

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] In addition, that we're very happy to say that in the third quarter, the overall gross profit margin is already turned positive. In the past quarters, some verticals in the cloud business, their gross margin have already been positive, but some other verticals are still negative. But in the third quarter, the overall cloud business is gross margin already turned positive.

[Operator]

[Operator Instructions]

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

Hi, operator. I think this will conclude our conference call for today. Thank you.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may all disconnect.

[Francie Lu, executive]

Thank you.

[Tao Zou, executive]

[Foreign Language]

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