Kingsoft Corp Ltd

HKEX:3888

Earnings Call Transcript 2020-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2020 Kingsoft Corporation's Earnings Conference Call.

[Operator Instructions] Please be advised that this conference is being recorded today. I would now 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 2020 third quarter earnings call. I'm Francie Lu, the IR Director of Kingsoft.

I'd 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. 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 Zou, executive]

[Foreign Language]

[Francie Lu, executive]

I'll translate for Mr. Zou. We maintained a steady performance in the third quarter of 2020. Our outstanding results are mainly attributed to the increasing market recognition of Kingsoft Office group as well as our continuous innovation in premium games. Regarding office software, Kings of office both licensing business and subscription services have been growing year-on-year. We continue to explore technology enhancement in the office software industry, optimize our user experience and strengthen our competitive advantages in online collaborative office products. In the online game sector, we will further pursue product innovation and enhance our capabilities in product development and operations so as to extend our game categories. In the third quarter, our total revenue reached RMB 1,397 million, up 34% year-on-year, showing strong resilience despite the impact of the pandemic. Both of our office software and services and other businesses as well as online game business have maintained strong revenue momentum. As they were up 59% and 19% year-on-year, respectively, in the third quarter.

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

[Yuk Keung Ng, executive]

Thank you. Thank you. Hi, everyone. I'm pleased to talk to you again. In the third quarter, we saw significant growth in office software and service and other business. Office software and licensing business from government and enterprise clients maintain its rapid growth. Kingsoft Office Group has further enhanced its service and brand influence in several regional, government and enterprise market as we continue to strengthen our technology capabilities and marketing efforts. We have also established close cooperation with a leading customer in the traditional industry, such as Shaanxi Heavy-duty Motor Company and Jochen Iron and Steel group. Kingsoft Offers Group organized a second office application development conference in the third quarter of 2020 and brought together a diverse group of around 200 developers in the ecosystem. Kingsoft Office group has launched innovative office products such as WPS online preview and WPS document writing during the period. And we fully integrate the Linux version and so grow input method into adopt WPS for Linux addition. Kingsoft Office has also acquired Beijing Suwell Technology company, Beijing Suwell Technology [indiscernible] in the third quarter. Going forward, Kingsoft Office group and Suwell collaboration and technology and product development will drive the fixed layout document format standards for government and enterprise customer. For you, who do not familiar with this fixed layout document, you can refer to the PDF format, similar one.

During the quarter, Kingsoft Office Group's personal subscription services maintained its rapid growth year-on-year. And we continue to explore the innovative channel for marketing such as live streaming e-commerce. By launching new products and services such as PPT design menu, we aim to enrich our platform contact and enriched user reputation for Docer. In addition, WPS Docs has become the official office software supplier for the 31st Summer World University Games. And we launched a WPS Docs education addition. Kingsoft Office also entered into a smart office cooperation framework agreement with Tsinghua University, which further strengthened our presence in the different market segments.

In the third quarter, revenue from online games business reached RMB 788.2 million representing a 19% growth year-on-year, mainly attributable to the continuous growth of the flagship JX Online III PC game. In August 2020, we celebrated 11th anniversary of JX Online III PC game and share with the gamer the latest development of its technological innovation and content creation. In addition, we introduced our development plan in the film and television, music and animation, theatrical plays and e-sport, which will help to further increase its user base and build our long-term growth potential to core IP. In October 2020, we launched Feng Tian Zheng Dao, the anniversary expansion pack for JX III PC game, with a new season and enriched content, which bought players a better gaming experience. In addition, JX Online I mobile game has been renamed as New JX Online I [Foreign Language], with an all-new game appearances and received positive feedbacks from the players.

I will now discuss the Q3 operational and financial results using RMB as a currency.

Revenue increased 34% year-over-year and decreased 2% quarter-over-quarter to CNY 1,397 million. The revenue split was 56% for our online games and 44% for office software and service and others. Revenue from our online game business increased 90% year-over-year and decreased 9% quarter-over-quarter to CNY 788 million. The year-over-year increase were mainly attributable to the robust revenue growth from flagship game JX Online III. As we focus on providing high-quality gaming contact and innovative gameplay for better user experience. The quarter-over-quarter decrease was largely due to the declined revenue from JX Online III as the large-scale expansion pack being successfully launched in the second quarter 2020, which was partially offset by the revenue contribution from the newly released mobile games.

Revenue from office software and services and others increased 59% year-over-year and 11% quarter-over-quarter to CNY 609 million. The year-over-year increase was largely due to the fast growth in both licensing business and subscription services of Kingsoft Office Group. Driven by the increased paid users resulting from a continuously improved product and services. The quarter-over-quarter increase was due to licensing business driven by the solid demand from government and enterprise. Cost of revenue increased 9% year-over-year and 10% quarter-over-quarter to CNY 240 million. The increases were mainly due to higher server and bandwidth service fees associated with the increased user traffic.

Gross profit increased 40% year-over-year and decreased 4% quarter-over-quarter to CNY 1,158 million. GP margin increased by 4 percentage points year-over-year and decreased by 2 percentage points quarter-over-quarter to 83%. The year-over-year increase of the group's gross profit margin was mainly due to the change of sales mix and improve in operating efficiencies.

Net R&D costs increased 25% year-over-year and 24% quarter-over-quarter to CNY 484 million. The year-over-year increase were mainly attributable to the increased headcount as well as personnel-related expenses. This is because we continuously strengthen the development of our new products and services as well as technology updates. The quarter-over-quarter increase was mainly due to increased personnel-related expenses as well as temporary exemption or reduction of our social and medical insurance premium, for large enterprise, which was stopped from implementation from July 220 (sic) [ 2020 ]. Selling and distribution expenses increased 14% year-over-year and 15% quarter-over-quarter to CNY 221 million. And the increase was largely due to the increased channel costs of Kingsoft Office Group, aiming to strengthen the regional technical service capability and brand influence.

Administrative expenses increased 27% year-over-year and 16% quarter-over-quarter to CNY 117 million. The year-over-year increase was primarily due to increased staff-related expenses and professional services fees. To accommodate for the rapid growth of our business, we moved to new office building in Beijing, which led to the increase rental expenses, and the quarter-over-quarter increase was attributable to the increased staff-related expenses.

Share-based compensation costs decreased 12% year-over-year and 15% quarter-over-quarter to CNY 31 million. Operating profit before share-based compensation increased 97% year-over-year and decreased 33% quarter-over-quarter to CNY 393 million. Net other gains were CNY 368 million compared to a gain of CNY 5 million in the corresponding period of last year and the losses of CNY 105 million in the second quarter 2020.

The gain in the third quarter of 2020 were mainly due to debt, we recognized a gain on deemed disposal of Kingsoft Cloud, as a result of the dilution impact of the issue of the new share in this quarter.

The losses in the second quarter of 2020 were primarily due to the loss on deemed disposal of an associate and impairment provisions of certain investee companies.

We recorded share of profit of associate of CNY 12 million compared to share of profit of CNY 128 million for the third quarter of 2019. And the share of losses of CNY 173 million for the second quarter 2020. The profit in the third quarter of 2020 were mainly attributable to the gain recognized in Cheetah Mobile, partially offset by the losses recognized in Kingsoft Cloud. And the profit in the third quarter of 2019 were mainly due to that Cheetah Mobile recognized a gain on disposal of a subsidiary in that quarter. And the losses in the second quarter of 2020 were mainly due to the losses recognized in Kingsoft Cloud, which were also partially offset by the profit recognized in Cheetah Mobile and as it's disposed share in certain investee company in that quarter.

Income tax decreased 63% year-over-year and 88% quarter-over-quarter to CNY 10 million. And the loss for a period from a discontinued operation for the first quarter of 2019, reflected losses from Kingsoft Cloud which was loss of CNY 468 million. Profit for the period from a discontinued operation for the second quarter 2020, reflected the combination of the net loss and net gain on deemed disposal from Kingsoft Cloud, which was a profit of CNY 8,927 million. And the net gain on deemed disposal of Kingsoft Cloud was CNY 9,096 million recognized in the second quarter 2020, which was arose from the spin-off and separate listing of Kingsoft Cloud. As a result of the reasons discussed above, profit attributable to the owners of parent, including that from the continuing in operation and a discontinued operation. For the third quarter of 2020 increased 1749% year-over-year and decreased 93% quarter-over-quarter to CNY 667 million.

Profit attributable to the owner of parent, excluding eShop, and including that from a continuing operation and the discontinued operation, increased 749% year-over-year and decreased 93% quarter-over-quarter to CNY 687 million. The net profit margin excludes -- excluding the effect of share-based compensation costs was 49%, 4% and 500% for the 3 months ended September 30, 2020, September 30, 2019, and June 30, 2020, respectively.

Our statement of financial position, we have cash and bank deposit of CNY 15.3 billion, as of September 30, 2020. The net cash generated from the operating activity was CNY 670 million compared to net cash generated from the operating activity of CNY 88 million and CNY 763 million for the third quarter of 2019 and the second quarter of 2020, respectively.

Capital expenditure was CNY 205 million, CNY 480 million and 67 --CNY 76 million for this quarter, the third quarter of 2019 and the second quarter 2020, respectively. In the third quarter, we, once again, demonstrated stable performance across all business divisions amidst a turbulent economic environment and complex international situations. As you can see that we are very resilient to those adverse situation. We are confident in our strategy, business model, operation resilience and our prospects going forward. We will further strengthen our research and development capability, improve the operation efficiency and promote product and service innovation. We strive to provide our customers with the excellent service experience, so as to achieve a sustainable growth in our business and create fruitful returns for our shareholders and business partners.

This conclude my introduction for the Q1 results. Now handing back the floor to your question and answer.

[Francie Lu, executive]

Thank you, Francis. Hi, operator, we're ready for the Q&A session.

[Operator]

[Operator Instructions]

The first question comes from the line of Liping Zhao of CICC.

[Liping Zhao, analyst]

[Foreign Language]

Okay. I'll translate for myself. I have 2 questions here. The first one is about the gaming business. We noticed that the -- can the management share what's the main reason for the Q-o-Q decline of gaming revenue? And how should we expect 4Q and next year's gain growth? And my second question is about Kingsoft Cloud and WPS. So can management elaborate the collaboration between KC and WPS in the coming quarters?

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I'll translate for Mr. Zou. So regarding the question on the slight decline in revenue for quarter-on-quarter for the game business, there are mainly 2 reasons for it. The first one is that, like I said in the past, there's a seasonality -- the pattern for the PC game JX Online III. So usually, for the 4 quarters of the year, the revenue for the fourth quarter is greater than the revenue from the first quarter and then the revenue from the second quarter, lastly, will be the third quarter. So this is our pattern in the past. And for this year, based on our data from the Double Eleven, Double Twelve event, we think that the same pattern will repeat in 2020 as well. And also another reason for the Q-on-Q decline is that the new game that we launched the JX Online II mobile game, [indiscernible], the revenue result is actually less than our expectation, and that's due to very reasons, reasons on our own side and also a reason for our partner and also the market impact. The game that you just mentioned, It's a very successful game just launched, but it's a completely different game than our JX series. So currently, we don't think there's any competition relationship between that game and also our own games. So for the fourth quarter and also the next year outlook, we need to mention that some of the games that we originally planned to launch in the fourth quarter will be delayed to the first quarter of 2021. That include our JX III, FFBE II and also Volomin. The delay may be due to various reasons. For example, the FFBE II may take a longer time to get the license approval as it's IP from overseas from Japan. So it may take longer than expected time to get the license approval. So for the 2021 outlook for the game business, we do have new products, both our PC and mobile games. I mentioned in the past that JX III had a very great performance this year, and there are also new development for the game next year as well. And also some of the other new plans for 2021, we're not ready to disclose yet, but there will be more products for both PC and mobile games. I think it will be better for us to have a more accurate forecast for next year later to the end of this year. We have already started to do the budgeting for -- and plan for next year, starting in mid-November. It will be better for us to wait until the end of this year or early next year to disclose a more accurate plan for 2021.

And the second question on the WPS and Cloud collaboration. I want to make it clear that the synergy and the collaboration I mentioned between these 2 businesses is not short term. It's not something that have a short-term impact in one quarter or 2 quarters. It's more a long-term plan that we think there's a lot of collaboration and synergy opportunities between the WPS and cloud businesses. This year, these 2 businesses are actually quite busy on their own. For example, the WPS since the start of the pandemic early this year. They have a lot of development in their products, including online collaboration for example, the Kingsoft Doc product have a very significant increase during the pandemic. And also for Kingsoft Cloud, it's just listed in the second quarter this year and is also developing quickly in its current verticals. So this year, these 2 businesses, they both have a lot of opportunities on their own. And in the long term, we think that these 2 businesses will have a lot of collaboration and synergy opportunities in both the 2B and 2G segments in both the products and also the distribution businesses. Operator, we're ready for the next question.

[Operator]

The next question comes from the line of Thomas Chong of Jefferies.

[Thomas Chong, analyst]

[Foreign Language]

My first question about our use of cash. Can management comment about our M&A strategies as well as how we can return more value to shareholders like dividends? And my second question is about the OpEx trend. Can management comment about the margin outlook for gaming as well as WPS?

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

I'll translate for Francis. For the first -- so the first question on use of cash, so in the past, we have made a plan that we will use most of our cash in our business strategy related areas, in our core opportunities. So other than the M&A option that will most likely to take a conservative approach on our cash management. So during the pandemic period, we have a lot of opportunities in the high-tech development for domestic players. And so there's a lot of opportunities, for example, for the Jingkai project for Kingsoft Office. And we think that this is still the area that we will look and make our M&A strategies and also our R&D developments in. So we'll still have a most of our cash in these areas. So as a prior we'll prioritize our cash -- use of cash plan. So firstly, you will use most of our cash on the related areas in our core business strategy, either M&A opportunities or R&D development. If we have -- still have more cash left over from the M&A or the R&D development, we'll also use our cash into optimize our dividend policy or share repurchase plan to better have -- to better return our shareholders. So even in today, our Board -- we have discussed this in a Board meeting, and then we will disclose our dividend policy or share repurchase plan once we have more confirmed details. And also, we do have a big 5 to 10-year plan. So once we're ready, we'll also disclose that to the market as well. And also we have another development R&D Development Center in Wuhan. So that's also where we're going to invest in the R&D development. So for WPS and also the game margin performance. WPS is already an independent listed company. So you can also approach them directly. We're not going to disclose more details than what they already disclosed to the market. But from a more high-level view on this question, I'm going to discuss it in a short-term also in the mid to long-term for the WPS margin development. In the short term, from the past previous years, especially from 2013, 2018, we were focusing the development of the mobile internet transformation for WPS business. So our operating profit margin was near breakeven level during those past years. Once we started to monetize this business, our margin immediately increased to over 20% in 2019, 2020. And we think that it's going to maintain this healthy level going forward as well. There are still a lot of opportunities in the [indiscernible], also the online collaboration opportunities, so we are still going to keep investing. In 2019, 2020, the number of our R&D headcount actually doubled. But even with that, we are still going to have a high single-digit percentage point improvement for the WPS margin this year. And so we think that for the upcoming 3 years, it's going to maintain a very healthy momentum. And for the long term, we think that there is a lot of opportunities for the WPS business. We have been developed -- many, many years in the software licensing business. So as we increase the number of licenses we sell, we are going to increase our margin performance. Like I said, our number of R&D headcount is doubled in 2019, 2020, but it's not going to double every year. So once the number of licenses increase going forward, that will increase our margin performance for WPS significantly. Also, in the past, we -- this year, we demonstrated a very healthy performance for our MAU and also DAU data for our top products. In March for -- in March and April during the pandemic period, some of products reach -- there MAU and DAU increased significantly. For example, the Kingsoft Doc, it increased its MAU from CNY 60 million to over CNY 200 million in 1 quarter. In June and July, there is a slight decline in some of the products, MAU and DAU. But now in September and October, we noticed that a lot of the MAU and DAU of our products actually reached to their peak level. It's even higher than what we had in back in April or May. So we think that we do have a very strong product line and the performance of these products are very healthy and stable. And we think that there's also a lot of opportunities in the Kingsoft project, especially with the U.S.-China attention. So we think the overall picture as the overall opportunity is massive. We mentioned that for the -- for one of our KPIs for the Kingsoft project what we have given to the market that we want to get 90% of the total Kingsoft project in the market. And based on the performance from the previous 9 months, our market share is actually 93% to 94%. So it's actually even better than our expectations. So we think the long-term margin for WPS actually has a lot -- opportunities. For the game business, we do have a new plan for JX Online III PC game for 2021. For details of this new plan is not ready to disclose. But we think that if the new plans for this game turned out well, there's actually a lot opportunities for this PC game as well. And for this year, the JX Online III PC game is going to reach its historical high in terms of its gross billing. It's even higher than what we had in 2017. This game itself has a very good margin, high margin. So that also help with the total game margin performance as well. And there's also a sales mix change in the game business. We also have a business on the game distribution, but that is still in the early stage. But is that game -- the revenue from the game distribution increase in the future, this may actually dilute our game margin for obvious reasons. Yes. So this is our -- for the game margin. Operator, we're ready for one last question.

[Operator]

The last question comes from Elsie Cheng of Goldman Sachs. .

[Haiwen Cheng, analyst]

[Foreign Language]

My first question is about the JX III's operating situations after the October expansion pack launch. And as we are also having another one in December, I just want to understand a little bit more in terms of the Q-on-Q trend into 4Q this year. Can we expect a similar kind of Q-on-Q growth versus last year? And second follow-up to that is the differed revenue. We're looking at almost like 4x more deferred revenue for the quarter versus last year? Just want to understand a bit more, breaking down into the gaming and WPS. What's the color over there? And the last question is about operating expenses. In terms of the R&D expenses on the non-gaming -- sorry, non-WPS side, I recognize that we do have some social and medical insurance premium impact. But other than that, are we also investing into more of the game development and in which area, if so?

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

I will transfer for Francis. So for the fourth quarter outlook on the game business. Actually, we launched our last expansion of the year in October 2020, and the result has been quite impressive. The number of IP accounts actually increased after we launched the new expansion pack, roughly about 30%. So the result of expansion pack is actually quite good. For the fourth quarter of the game performance. First, I would like to say that the JX Online III PC game is going to reach its historical high in terms of the total revenue, full year revenue. The full year revenue will be greater than what we had in 2017. So this will be the historical high for the JX Online III PC game. For the fourth quarter, our game team actually is going to -- more to stabilize its performance. We are now going to purely focus on the -- on pursuing the increase of our revenue performance as we already did quite good in the first 3 quarters of this year. And also for the fourth quarter, there -- some of the games that were originally planned to be launched in the fourth quarter will be delayed to 2021 for example, FFBE that will be -- Its launching time will be dependent on its license approval process. As will Volomin and also [indiscernible] 2. These 2 games are likely to be launched in the first quarter of 2021. And also for the R&D expenses increased. We think that the social insurance plan impact will decline. I will confirm with you on the details later. The gross margin, also the op margin of our game business, actually performed very well in the past. But we still have many game studios in-house, and they are developing new games. And we also extend all of the developing expenses before the games are launched. So that's why, like I mentioned in the past, once we have new mobile games launched, margin actually increased significantly because a lot of the R&D expenses are already expensed in the past.

Operator, this will conclude our presentation today. Thank you.

[Operator]

Thank you very much. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect your lines.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]