Kingsoft Corp Ltd

HKEX:3888

Earnings Call Transcript 2021-Q3

[Operator]

Good day, and thank you for standing by. Welcome to the Q3 2021 Kingsoft Corporation Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] 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 2021 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 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 Mr. Zou Tao. Zou Tao?

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] I'll do the translation for Mr. Zou. Our overall business grew steadily during the quarter. Kingsoft Office will focus on addressing user needs to enhance its product and services and continued to pursue a strategy of multiscreen, cloud, content, AI and collaboration. Meanwhile, our online game business adhere to its premium gaming strategy.

The group's business continued to grow in the third quarter, with revenue reaching RMB 1,510 million, up 8% year-on-year. Driven by the continued growth of licensing and subscription service businesses, our office software and service businesses maintained strong growth momentum in the third quarter, with revenue reaching RMB 804 million, up 37% year-on-year.

Now we're turning the call to Francis.

[Yuk Keung Ng, executive]

Thank you, Francie. Good evening, ladies and gentlemen. In the third quarter, the strong year-on-year revenue growth of licensing business was primarily driven by the growing cloud, office and licensing business in the government and enterprise market and the increasing demand for localization.

Kingsoft Office group continued to improve the services, quality of its localization business by joining the trusted computing group where we work with different partners to set up a multidimensional cooperative program. The program focuses on document services to effectively promote the integration of cloud products with digital government and state-owned cloud projects.

Meanwhile, Kingsoft Office group actively participate in the pilot exercise of the newly launched industrial localization business and gain recognition from clients.

The subscription services business continued to maintain a robust year-on-year growth during the quarter. Kingsoft Office group strived to optimize collaboration office scenarios and launched new solution to effectively maintain stable growth in active users and paying users, resulting in transition and paying user habits from casual to long-term needs. As of the end of September 2021, the number of monthly active devices of its key product amount to 521 million, increased 14% year-on-year.

With the increasing demand for cloud and collaboration offices solution, the number of users of WPS Docs in the third quarter already exceeded the peak record during the COVID-19 pandemic.

In order to cater to small and medium-sized enterprise and team's demand for collaboration and convenient office solution, Kingsoft Office group has invested in ActionSoft, a low-code PaaS provider, and aimed at to develop a digital transformation solution to achieve the synergy between office scenarios and business scenarios.

During the quarter, the online game business continued to maintain a stable performance quarter-over-quarter. Revenue from flagship JX Online III PC game and classic JX 2D PC games achieved steady quarter-on-quarter growth, demonstrating the sustainable longevity and vitality of the core IP. In August, we celebrated the 12th anniversary of JX Online III PC game and launches the theme activity with collaboration between traditional and contemporary Chinese culture, which received wide acclaim from young generation gamers.

In October, we launched Bei Tian Yao Zong, the anniversary expansion pack for JX Online III PC game and a new section with the theme of traditional Chinese medicine and upgraded gameplay that has been popular among gamers. In addition, JX I: Gui Lai was released in China in October.

During the third quarter, the domestic games industry adapted to new regulations. We are proactively embracing the new regulatory environment, which we believe should contribute to a more sustainable development path for the industry. Going ahead, we will continue our integration of development and operation of new game genres to create a diversified content ecosystem while strengthening the performance of our core IP products.

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

Revenue increased 8% year-over-year and 2% quarter-over-quarter to CNY 1,510 million. The revenues speed was 47% for our online games and others and 53% for our office software and services. You can see that the contribution from WPS has actually exceeded our gaming business.

Revenue from our online games and other business decreased 13% year-over-year and increased 2% quarter-over-quarter to CNY 706 million. The year-over-year increase was largely due to decreased revenue from existing games, partially offset by the revenue contribution from the newly launched mobile games.

Revenue from office software and services business increased 37% year-over-year and 2% quarter-over-quarter to CNY 804 million. The year-over-year increase was largely due to both strong growth of licensing business and sustainable growth of personal subscription services business of Kingsoft Office Group.

Cost of revenue increased 12% year-over-year and decreased 1% quarter-over-quarter to CNY 269 million. The year-over-year increase was mainly due to: firstly, the greater servers and bandwidth costs in line with the expansion business of Kingsoft Office Group; and secondly, increased personnel-related expenses of operating team of online game business.

Gross profit increased 7% year-over-year and 3% quarter-over-quarter to CNY 1,241 million. Gross profit margin decreased by 1-percentage-point year-over-year and kept flat quarter-over-quarter at 82%.

Research and development costs increased 28% year-over-year and 17% quarter-over-quarter to CNY 621 million. The increases were mainly attributable to the increased headcount as well as personnel-related expenses.

Selling and distribution expenses increased 10% year-over-year and decreased 22% quarter-over-quarter to CNY 243 million. The year-over-year increase was mainly due to higher personnel-related expenses as Kingsoft Office Group continued to increase the sales and marketing efforts to further expand its presence in government and enterprise market, partially offset by decreased marketing and promotional spending of online game business. The quarter-over-quarter decrease was largely due to decreased marketing and promotional spending.

Administrative expenses increased 14% year-over-year and kept flat quarter-over-quarter to CNY 134 million. The quarter-over-quarter increase was primarily due to increases in personnel-related expenses and depreciation expenses related to new office buildings.

Share-based compensation costs increased 137% year-over-year and 81% quarter-over-quarter to CNY 74 million. The increases primarily reflected the new grants of awarded shares to the selected employees of the group in the third quarter of 2021.

Operating profit before share-based compensation costs decreased 8% year-over-year and increased 33% quarter-over-quarter to CNY 361 million.

Net other gains for the third quarter 2021 were CNY 734 million compared with gains of CNY 368 million in the corresponding period of last year, the gains of CNY 48 million in the second quarter of 2021. The gains in the third quarter 2021 and 2020 were mainly due to that we recognize a gain on deemed disposal of Kingsoft Cloud as a result of the dilution impact of the issue of new shares of -- in this quarter. The gain in the second quarter 2021 were mainly due to fair value gains on financial instruments at fair value through profit or loss.

We recorded share of losses of associates of CNY 286 million for the third quarter of 2021 compared with share of profits of CNY 12 million for the third quarter of 2020 and share of losses of CNY 211 million for the second quarter of 2021.

Income tax expense for the third quarter of 2021 was CNY 97 million compared with the income expenses of CNY 10 million for the third quarter of 2020 and income tax credit of CNY 26 million for the second quarter 2021. The changes were mainly due to the increase in the accrued deferred tax expenses in the third quarter of 2021.

As a result of the reasons discussed above, profit attributable to owners of parent decreased 15% year-over-year and increased 1,061% quarter-over-quarter to CNY 565 million. Profit attributable to owners of parent, excluding eShop, decreased 11% year-over-year and increased 752% quarter-over-quarter to CNY 611 million.

Net profit margin, excluding the effect of share-based compensation costs, were 40%, 49% and 5% for the 3 months ended 30th September 2021, 30th September 2020 and 30th June 2021, respectively.

Our statement of financial position, we have cash resources of CNY 18.8 billion at September 30, 2021. Net cash generated from operating expenses activities was CNY 490 million, CNY 670 million and CNY 631 million for this quarter, the third quarter of 2020 and the second quarter of 2021, respectively.

Capital expenditures was CNY 165 million, CNY 205 million and CNY 46 million for this quarter, the third quarter of 2020 and the second quarter of 2021, respectively.

In the third quarter, our core business continued to expand and contributed solid results to the group.

Looking forward, we will focus on exploring opportunities of the enterprise services and online game market, continue to expand R&D with investment, as well as enhancing our product and services, aiming to provide our users and partner with valuable products and service experience and drive long-term return for our shareholders.

This conclude our brief prepared remarks. And Francie, we are open for question and answers.

[Francie Lu, executive]

Okay. Thanks, Francis. Operator, we're ready for the Q&A session.

[Operator]

[Operator Instructions] The first question comes from the line of [indiscernible] from CICC.

[Unknown Analyst]

[Foreign Language] So I've got 2 questions here. So first of all, can management share some color on guidance for fourth quarter and next year? So my second question is regarding the gaming business. So what's the outlook for next year's pipeline and the regulatory environment?

[Yuk Keung Ng, executive]

[Foreign Language]

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

I'll translate for Francis and Mr. Zou.

[Interpreted] So for the first question, on the revenue guidance for 2021, with the games business, we think that there will be a 10% decline year-on-year. And this is, as Mr. Zou explained earlier, the game business due to the industry regulation, some of our new games were not able to be launched this year, even though JX I performed very well after its launch, but it's not enough to offset the other delayed games -- delayed mobile games. And the game business, it has a big impact on our operating profit performance. So the operating profit for this year, there will also be a 20% decline year-on-year.

And for the Office business, the Kingsoft Office business, we suggest investors to take reference to their own disclosure. They did not give out any exact guidance for the upcoming quarter and also for the full year. But both the group and also Kingsoft Office, we have strong confidence in its overall performance. And we think that the revenue growth will maintain a relatively high growth rate. As the parent company, we are not going to disclose more than the disclosure given by the Kingsoft Office company.

And for next year, I can also give overall general picture for the Kingsoft Office business based on its current user growth performance and also on its products and the performance of our partners and that also the localization trend. We have strong confidence in the performance for Kingsoft Office for next year.

And for the game business, in 2021, we were largely affected by the regulation change in the gaming industry. We have already stated that we are fully supporting the government's regulation restriction. In the short term, there may be some impact on the performance of our profitability. But in the long term, we think that it will be helpful to the overall gaming industry and the market performance. The actual financial impact on our game business is actually quite low.

For minors less than 18 years old, they are actually not allowed to log-on, on our game. And the revenue contribution from minors is roughly just 1% to 2% of our total revenue. In -- for the next year, we are actually conservatively optimistic. We believe that the gaming industry is still an important monetization way for the overall Internet market. So it's not going to be replaced, but we think that the -- it's going to be regulated more effectively going forward. So we think that the 2022 performance will be much better than 2021. The -- we -- once we get the approval license, we're going to launch the new games, including the classic version of JX Online III.

And in addition, I would like to emphasize that the -- even though gaming business is a large part of our revenue contribution, but its actual value impact on our SOTP is only a single-digit, so the -- there should not be a big impact on our value -- SOTP value for the overall Kingsoft performance.

And the second question, by Mr. Zou. We first explain the pipeline for this year. We are now able to launch [indiscernible] this year due to the regulation changes. But this year, we already launched the JX I: Gui Lai on October 15. And we have 2 more new mobiles to go for this year. On November 18, we're going to launch [indiscernible] This one already have the license, and then we have already started promotion for the game. By the end of December, we have another self-developed, self-distributed game, JX war III. But this one will be launched towards the end of the year, so it shouldn't have too much impact on the financial performance for 2021.

And regarding the regulation, we have already seen the new regulation launching the -- on September 1st. And this is actually in line with our expectation. Roughly about one week after our second quarter result announcement, the new regulation was officially launched regarding minors. The overall execution for the regulation in the past quarter is quite good, quite smooth. And we think the regulation for next year will be dependent on the result of the regulation on the minors. So based on the past quarter, we think that we actually meet the expectation. And there is some voice in the gaming market that the regulation will be more or less back to normal regarding the approval licenses. In my own opinion, is that the regulation for minors is the very first step. We think that afterwards, it's possible that there are further regulation regarding the content of the game or regarding to the adult gamers. But overall, we are fully supporting and applying -- complying with the new regulation. And we think that it will be beneficial to the overall industry in the long term. Thank you.

[Operator]

The next question comes from the line...

[Francie Lu, executive]

Sorry. Sorry, operator. One more thing to add, for the next year pipeline. We're -- it's already November, we're currently doing the budgeting for 2021 for the pipeline for the games for next year. But so far, we don't have the detailed timeline yet. We're going to discuss that later.

[Operator]

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

[Linlin Yang, analyst]

[Foreign Language] The first question is about the new game. [indiscernible] performed well. Could you share more about the game expectation, about the revenue and the outlook? The second question is about R&D expenses. We saw R&D expenses increased a lot this year. Could you give us some learnings about next year, and the headcount change next year in game and WPS sector?

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

So I'll translate for Francis.

[Interpreted] Regarding the question on R&D investment, R&D capability is always one of our key strengths for Kingsoft. And you have noticed that there is the obvious increase in the R&D expenses for this year. And this is because that we are investing in the Kingsoft Office business due to the localization trend and also the great expectation for the enterprises demand going forward. We are investing in the Wuhan R&D strategic center and also in the development of the new functions for Kingsoft Office. And also for the game business, the salary and bonuses increased in early this year to keep competitive with the market. So there is an increase in the R&D expenses for this year for the gaming business.

Looking forward, we think that R&D is still a key part of our investment. But for the Kingsoft Office business, we are not going to keep the aggressive growth rate at 100% every year. And also for the game business, we are not going to have a large increase in the compensation for the employees every year. And for the -- for next year, for the revenue outlook, we think that Kingsoft Office will maintain a very strong outlook for next year. And for the game business, we think that due to the new games to be launched next year, the profit and revenue will also increase from this year. So as a percentage of revenue, the R&D percentage will decrease compared to this year.

And for the new -- the question on the new games, we launched JX I: Gui Lai this year, and this is actually a small surprise for our game business. We launched it towards the end of the year. But this game actually has a very good performance in the oversea market in Vietnam, which is better than our expectation. And for next year, we are going to have more new games to be launched and also a more contribution from the new games.

[Operator]

The next question comes from the line of Kenneth Chin from HSBC.

[Kenneth Chin, analyst]

[Foreign Language] My first question will be, can we have the revenue contribution coming from the PC based gaming and also the mobile-based gaming? The second question will be the revenue contribution coming from the overseas and the domestic in terms of the gaming industry.

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

I'll translate for Francis.

[Interpreted] We actually don't disclose the specific numbers for the revenue contribution details on the game business. But roughly speaking, the PC game is still takes a heavy percentage contribution for the overall PC -- for the overall game revenue. We have a classic IP, the JX Online III. This PC game alone contributes roughly about 50% of the total revenue. And we also have other classic games like JX I, JX II. They are also good revenue contributors. So the overall PC and -- versus mobile game contribution percentage is roughly about 60% to 40%. PC still takes a greater percentage in terms of the contribution.

For the oversea game business performance, in the past, our key revenue contributor is still from the domestic market. We actually try out the oversea games in Southeast Asia area in small scale. This year, we launched the JX I game in Vietnam. It was quite successful. So in the past year, the revenue contribution from oversea is actually a single-digit percentage point. But this year, due to the good performance from JX I in Vietnam, the oversea contribution is actually a little over 10%, which is a good growth from last year. And the oversea expansion plan, as Mr. Zou stated earlier, that is the -- a direction for our game business. But due to the COVID pandemic and also other factors, we are still developing in the oversea expansion plan.

[Operator]

Thank you. That concludes the conference for today. Thank you for your participation. You may all disconnect your lines now. Thank you.

[Francie Lu, executive]

Thank you.

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