Kingsoft Corp Ltd

HKEX:3888

Earnings Call Transcript 2017-Q4

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to Q4 2017 Kingsoft Corporation Earnings Conference Call. [Operator Instructions] Please be advised that this conference is being recorded today, Wednesday, 21st of March 2018.

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. Ladies and gentlemen, good evening and good morning. I would like to welcome everyone to our 2017 Fourth Quarter and Annual Results Conference 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 then, please allow me to introduce our management team who join us today: Mr. Zou Tao, our Executive Director and CEO; and Mr. Francis Ng, our Executive Director and CFO. Now I'm turning the call to Mr. Zou.

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

I would like to translate for Mr. Zou first. The year 2017 has marked a year of great achievements for Kingsoft. Our flagship PC Game, JX Online III continued to outperform the market with revenue up 32% year-over-year. Kingsoft Cloud has further advanced its vertical businesses at a strong pace with total revenue increased 81% year-over-year. The MAU of the WPS Office mobile version continued to grow and exceeded 145 million in December 2017. All these achievements have given us the strength and confidence to keep advancing in the online games, cloud services and other software and service businesses in the future.

Kingsoft recorded stable and healthy growth in 2017. We made a total revenue of RMB 5,180 million, up 35% against the previous year. Operating profit before share-based compensation costs increased 7% year-over-year to RMB 1,049 million. The fast development of all business segments in 2017 has set the stage for Kingsoft to grow its revenue notably and better capture the market potential in the coming years.

Now we would like to turn the call to Mr. Ng.

[Yuk Keung Ng, executive]

Thank you, Francie, and thank you, Zou. Hi, everybody. Before I start, I would like to explain that the comparative figures are restated to reflect the reclassification between the continued operation and the discontinued operation, namely the operation result of the Cheetah Mobile, which has been presented as a discontinued operation for the 9 months ended September 30, 2017. From the 1st October onward, we account our interest in Cheetah Mobile as an associate. That means that we equity accounted for Cheetah Mobile's results.

In 2017, both Kingsoft PC game and mobile games delivered strong performance. The flagship PC game JX Online III has maintained rapid growth for 8 consecutive years, with revenue increased 32% year-over-year in 2017. Such outstanding performance ensures the successful launch of the JX Online III revamped version, laying a solid ground for the long-term development of the great game.

The quality upgrade and the brand-new game features of JX Online III revamped version has attract great attention. Within 24 hours of its launch on 29th December, the total number of user increased 43% and the steady performance of JX Online I mobile games in 2017 created condition for the enhancement and development of other upcoming JX mobile games product, helping maximize the IP value of JX Online.

Together with Tencent, Kingsoft is going to launch 3 major JX series mobile games in 2018, including the YSYY, JX Online II mobile and JX Online III mobile games.

In the fourth quarter of 2017, Kingsoft achieved a breakthrough in licensed mobile games. From the cooperation with NetDragon, the mobile game Eudemons Online was launched on all platform on the 18th of October, and the gross billings exceed CNY 100 million within 90 days (sic) [ 19 days ] of launch. This well-known game IP once again gains widespread acclaim among mobile games players.

Kingsoft Cloud maintained robust growth in 2017, with revenue increased 81% year-over-year. Kingsoft Cloud's performance has been highly acknowledged by the capital market. By March 2018, Kingsoft is expected to complete series D financing, which amount to a total of USD 720 million, with post money valuation reaching USD 2.37 billion.

According to International Data Cooperation's China Semi-annual Public Cloud Services Tracker Report first half 2017, published in November 2017, Kingsoft Cloud was ranked top 3 in the IaaS public cloud service provider in China. Kingsoft Cloud's video cloud business achieved remarkably expansion by applying its video cloud technology and service advantage. Game cloud business reported solid growth in both customer usage and revenue with quantum leaps in multiple fields including CDN, hybrid cloud and network security.

Government cloud and health care cloud business have progressed smoothly with their national footprint expanded during the year.

Kingsoft Cloud also expanded AI technology application in its product services and launched new video technology, rendering video service quality improvement and cost saving for customers.

In addition, Kingsoft Cloud was the first to obtain authentication of CSA-STAR Tech for both IaaS and PaaS in security enhancement, amplifying (sic) [ exemplifying ] Kingsoft Cloud's leading position in cloud securities construction.

WPS cloud -- WPS Office achieved stable and healthy development in 2017. Both online marketing and license businesses saw steady increase in revenue. Noteworthy here, Kingsoft launched Light Office for individuals user, improving the office experiences for them in all dimension.

In December 2017, the MAU of WPS Office mobile version exceeded 145 million, while the MAU of WPS Office PC version also hit a new record, with the national MAU rose to above 100 million.

In addition, through offering exclusive and high-quality content, the number of premium member at the end of December nearly quadrupled comparing with that at the beginning of 2017. And WPS deeply rooted in office software industry and continued to optimize and develop new feature, aiming to provide users with better customized office experiences.

Therefore, WPS was awarded the 2017 Xiaomi Emmy Award for the Most Scalable APP and the 2017 Next World Award for the Most Popular Office Management APP for the Year in the fourth quarter.

In May 2017, Beijing Kingsoft Office Software, Inc. has officially filed an application to the China Securities Regulatory Commission, CSRC, for an initial public offering and listing on the ChiNext Board of the Shenzhen Stock Exchange, and the application process had been well on track.

As for the financial results, I'm starting from the Q4 using RMB as a currency.

Revenue increased 7% year-over-year and 6% quarter-over-quarter to CNY 1,381 million. The revenue split was 54% for our online game, 29% for our cloud services and 17% for the office software and services and others.

Revenue from our online game business decreased 8% year-over-year and increased 1% quarter-over-quarter to CNY 751 million. The slight year-over-year decreases reflected the mature life cycle of JX Online mobile game -- JX Online I mobile game, partially offset by the revenue growth of JX Online III with constant content and function upgrades.

ADPCU for the group online game decreased 40% (sic) [ 14% ] year-over-year and kept flat quarter-over-quarter at 900,000.

APA for the group online game decreased 12% year-over-year and 2% quarter-over-quarter to 4 million. The decreases reflected the natural declining life cycle of the group's older games, which were partially offset by the launch of new mobile game in the fourth quarter of 2017.

The revenue from cloud services increased 57% year-over-year and 12% quarter-over-quarter to CNY 402 million. The increases were mainly driven by the robust customer usage, especially from the mobile video, mobile game and Internet sectors.

Revenue from office software and services and others increased 4% year-over-year and 15% quarter-over-quarter to CNY 227 million. The increases were largely due to the increased scale of WPS Office to government agencies as a result of the increased user engagement driven by the continuous optimization of products and services.

Cost of revenue increased 43% year-over-year and 10% quarter-over-quarter to CNY 612 million. The year-over-year increases was mainly due to the higher bandwidth and IDC costs, resulting from the increased customer usage of cloud services. And the quarter-over-quarter increase was largely due to greater sharing cost associated with the new launched licensed mobile game as well as higher bandwidth and IDC cost associated with the increased usage of cloud services.

Gross profit decreased 12 -- 11% year-over-year and increased 3% year-over-year -- quarter-over-quarter to CNY 769 million. GP margin decreased by 11 percentage points year-over-year and 1 percentage point quarter-over-quarter to 56%.

Our research and development costs net increased 25% (sic) [ 29% ] year-over-year and 13% quarter-over-quarter to CNY 401 million. The increases were mainly due to the higher staff-related costs.

Selling and distribution expenses increased 64% year-over-year and 13% year-over-year (sic) [ quarter-over-quarter ] to CNY 174 million. The increases were primarily attributed to the increased marketing and advertising activity for online games.

Administrative expenses increased 58% year-over-year and 25% quarter-over-quarter to CNY 79 million. The increases were mainly due to the increase in staff-related costs and higher professional services -- service fees.

Share-based compensation cost increased CNY 672 million (sic) [ 672% ] year-over-year and decreased 31% quarter-over-quarter to CNY 51 million. The year-over-year increase was primarily due to the new grants of awarded shares and options to selected employees as well as an increase in the fair value of awarded shares and option of certain subsidiaries.

Operating profit before share-based compensation costs decreased 54% year-over-year and 16% quarter-over-quarter to CNY 189 million.

The margin of operating profit before share-based compensation cost decreased by 18 percentage points year-over-year and 3 percentage points year-over-year (sic) [ quarter-over-quarter ] to 14%.

Net other loss of CNY 27 million were recorded as compared to net other loss of CNY 141 million for the fourth quarter of 2016 and net other gains of CNY 5 million for the third quarter 2017. The losses in the fourth quarter of 2016 were mainly due to the additional provision for impairment on the carrying value of the investments in XunLei and 21Vianet, as they further decrease the market value in the fourth quarter.

Share of profit associated of CNY 60 million were recorded compared to share of losses of CNY 2 million and CNY 3 million for the fourth quarter 2016 and third quarter 2017, respectively.

Cheetah Mobile has been accounted for as our associate since the 3rd (sic) [ 1st ] October 2017, and its profit increased substantially on year-over-year and quarter-over-quarter basis, primarily resulting from the improved operating profit.

Income tax credit was CNY 5 million compared to income tax expenses of CNY 60 million and CNY 45 million for the fourth quarter 2016 and third quarter 2017, respectively. The significant decreases were primarily attributable to the specific deferred tax asset being recognized in the fourth quarter of 2017.

Gain on deemed disposal of subsidiary of CNY 2,224 million represented deemed disposal gain as a result of the delegation of voting rights in Cheetah Mobile Inc. As a result, our profit to owner of parent increased 847% year-over-year and 938% quarter-over-quarter to CNY 2,475 million.

Profit to owners of parent, excluding ESOP, increased 760% year-over-year and 718% quarter-over-quarter to CNY 2.5 billion.

I'm now going to the full year 2017.

Revenue increased 35% year-over-year to CNY 5,181 million. Online game make up 60%, increased 23% year-over-year to CNY 3,120 million.

Cloud services make up another 26%, increased 81% year-over-year and -- to CNY 1,333 million.

Office software and services and others make up the remaining 14%, and increased 32% year-over-year to CNY 729 million.

GP margin decreased 8 percentage points year-over-year to 58%. Gain on deemed disposal of subsidiary, Cheetah, amounted to CNY 2,224 million. And the profit of owner of parent was CNY 3,202 million and minus CNY 207 million (sic) [ CNY 270 million ] for the year 2017 and 2016, respectively. Of course, the minus CNY 270 million for 2016 is due to the significant provision impairment for XunLei and 21Vianet in 2016.

Our balance sheet, we have cash and bank deposit of CNY 8.5 billion at the end of 2017.

Net cash generated from the operating activity increased 36% year-over-year to CNY 1,890 million.

Capital expenditure was CNY 722 million and CNY 1,023 million for the year ended 2017 and 2016, respectively.

The strong performance of all business segment in 2017 has boosted our confidence in the prospect for the business development and revenue growth in coming years.

Looking ahead, we will continue to maximize the brand value of JX Online and focus on upcoming launches of our major mobile game titles, including YSYY, JX Online II mobile, JX Online III mobile game.

Kingsoft Cloud will a devote greater effort in to developing the AI field, consolidate our leading position in the Internet area and further penetrate into more vertical industry and actively expand into overseas market.

We will also continue to enhance WPS technology and product innovating -- innovation, incorporating the AI features, cloud computing function in order to provide better and more productive solution for its user.

Meanwhile, we will also set our eyes on the global presence, seeking to broaden our international reach by capitalizing on WPS' competitive edge in the mobile area. We believe that we will maintain strong growth momentum and achieve more breakthrough in 2018 and onwards. And we will mark Kingsoft's 30th anniversary with a triumph (sic) [ triumphant ] performance.

This concludes my presentation on the 2017 full year and fourth quarter results. I'm now handing over the -- back to the floor for questions.

[Francie Lu, executive]

Operator, we are now ready to take questions.

[Operator]

[Operator Instructions] Your first question comes from the line of -- from Credit Suisse, from the line of Thomas Chong.

[Yiu Hung Chong, analyst]

I have 3 questions. The first question is about 2018 revenue and margin outlook. Would management provide us with some color about the respective business segments growth rate for this year? And if possible, is there any chance that we can also get a sense of how we should think about the 2019 outlook as well? On that regard, may I also get some color about the timing on release of the 3 mobile games, in particular JS III mobile? And my second question is about WPS. I noticed that I think in this set of results, we talk quite a lot of different achievement for WPS. And is there any color about the stage of listing in mainland? Is it some time this year? And my third question is about the online games market. Given the fact that we see a lot of users going -- playing the PUBG games, how should we think about the mobile games outlook for this year and next year across the industry? [Foreign Language]

[Yuk Keung Ng, executive]

[Foreign Language] I'm going to answer Thomas' question one by one, but -- as I noticed that it related to several, several area. Now first of all, I answer the easier question first. You talk about the WPS listing process, whether it will be launched in 2018. While we actually are in the process, we are not ready to comment on the details of the WPS listing procedures, as you -- as we all know. But I can assure you, I can tell you, I can share with you that they are on track and it's highly likely and it is very highly unlikely that they will not be listed in 2018. So we expect that the listing will be in 2018. And that's anything that beyond our knowledge at this point of time. The second question, you asked about the timing of the JX III game launching. We actually said in the last 2 quarter, and I actually personally talked with you, Thomas, we decided not to comment on the detailed launching time for our mobile game from this year onward because we have been suffering from the expectation gap in the previous year. But I can tell you that the 3 mobile game, including the YSYY, JX II mobile game and JX III mobile game are on track. And you could expect that they will be launched in 2018, but we are not going to comment on the exact detailed timing of the launches of those games. Now you asked about the impact of [ 3G ] on mobile game, I defer that to Tao Zou because he is a game expert. And also you talk about the overall outlook -- now how about I let Mr. Zou to comment about the impact of [ 3G ] on our mobile game and the mobile game trend onward. Zou? [Foreign Language]

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

Okay, I'll do the translation for Mr. Zou. So in the second half of last year, in both the PC and mobile game, the PUBG game became very hot in the market. And they had made an impact for both PC and mobile games, especially taking the players' time away from other type of games on both PC and mobile side. And also, it had an impact on the different genres of gaming, including MMORPG and other types of games. But the level of impact is different for different genres of games. We believe that it has a higher impact on mobile-like type of game. But for the heavy PC games, the impact from PUBG game is relatively lower than the other types. Thank you.

[Yuk Keung Ng, executive]

Okay. Thank you, Francie. Thomas, you asked -- also asked about the 2018 revenue and margin outlook. Let me briefly talk about this question. I understand that you know all the participant in this call are very eager to know about that. As usual, I will not give the exact number, but I give you the trend. Let me talk about the easier part first, the WPS revenue growth. They are on a very solid, solid track. As I mentioned earlier, that they are now already on track on this IPO. So we don't see any headache or fuss in 2017 and 2018. And in fact, we will expect a higher growth further down the road after I complete this IPO process. So in 2018, we will expect that they will continue to -- its track on a very healthy growth. You can expect that, that will be 40% plus for the WPS growth in -- on revenue in 2018. For the Kingsoft Cloud, I also updated the market that after the recent financing, we actually revisit the market situation and our internal strategy on Kingsoft Cloud. Remember that at the earning of 2017, the company actually guided market that we will continue on a high growth, expecting to delivering a triple-digit growth in 2017 and 2018. But actually, in the last 2 quarter, I have already updated that. Since we have been growing on a fast track, investing quite a substantial amount of money in the market for a number of years, and now we also noticed that we went about the top 3 in the cloud market. We are focusing on excel our services quality. We will continue on a high-speed growth, but it will not be 100%. 100% is no longer the target for the team. Instead, they will be improving its quality of services, penetrating in various areas. But in terms of growth, you could also expect that given the cloud market in general is a new -- relatively new market, experiencing high growth as an industry. So you could expect that Kingsoft Cloud will still maintain on a relatively high growth of around 60% in 2018, I would say. And for the game, we expected that, as we discussed earlier, there is a number of major mobile game on the pipeline in 2018. Of course, the overall growth of our gaming revenue depends on the exact timing and popularity of those games. But a few thing. We have very strong confident on the quality and popularity of the pipeline, in particular JX mobile III. And also, judging from the testing data, we also have a very high expectation on the JX II mobile games. And also, we -- also we see very, very good data on YSYY. But as you know from the past experiences, it's really difficult to give a very accurate estimate for gaming revenue, in particular for the mobile game before its launch, even though we have high expectation. But we do not want to put it on an exact number guidance. So in 2017 -- in 2018, we would like to put a relatively prudent growth on the revenue. I would say it will be higher than the growth in 2017. But we now wanted to be a little bit more conservative on the number giving out as a guidance. But the upside is -- could be quite significant. In 2017, as you can see that our overall gaming revenue growth is 23%. We expect that on a prudent basis, it will probably achieve a higher percentage growth on our gaming revenue. So the overall -- having said that, the overall revenue for Kingsoft group, we expect it to be also be on a very good track and higher than the growth rate -- overall growth rate in 2017.

[Yiu Hung Chong, analyst]

Francis, may I ask a quick follow-up question about the margin?

[Yuk Keung Ng, executive]

For the margin? Yes. Start from the easier part for Kingsoft WPS Office. Apart from the very healthy growth on the top line, the operating margin for WPS will also be very solid. Probably, you could expect a slightly increase, but not that -- would not be too much as is -- the management plan to actually actively invest in improving certain area. So you could expect that, that will stay flat with a little bit upside, a little -- slightly higher than 2017, still in the mid-20 mark. For the Kingsoft Cloud, the thing -- the only thing that I can tell you that -- is that the operating margin in 2018 will further improve from 2017. And for the game, as you could see that if we could deliver a higher growth than 2017 in 2018, the margin will also see an improvement. Because you could see that actually, the revenue is actually contribute from 2 sides, right? One is the PC JX Online III, a self-developed and self-published mature game, so it would be high profit margin. And also from the mobile game, the self-developed mobile game, we act as a [ CT ]. We will get the profit sharing from the platform. And an increase in the revenue number will also mean that we will significantly increase the operating margin because the cost will not be significant as the game are being published by the third parties. But of course, there is a small part of revenue, if you remember that we still have a small publishing team, those margin will be seen. And in 2018, we still expected the team are developing and laying the groundwork and we do not expect a high operating margin from the publishing game -- from the [ shell ] publishing game. But the number that -- we are not putting a high number there. So it will not be -- account for a major portion of our total game revenue, it will be a minor portion. So overall, the gaming operating margin will further improve from what we achieved in 2017.

[Operator]

Your next question comes from CICC, from the line of Liping Zhao.

[Liping Zhao, analyst]

I had 2 questions here. One is related to JX IP. We know that you've launched the revamped version of JX Online III, I think in the end of 2017. And also you launched the [ JX ] mobile II in the beginning of this year. So may I know the update about these 2 games, especially what's the gross billing level for these 2 games? And do you have any other initiatives on the JX IP, for example, the TV series or more animation or other kind of like exploration? And my second question is about WPS. I noticed that the revenue growth in the fourth quarter for WPS business division seems slowed down. May I know what's the reason behind? [Foreign Language]

[Tao Zou, executive]

[Foreign Language]

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

I'll do the translation for Mr. Zou for the first

question. So for the JX IP, we do have other initiatives planned for our JX IP, including a TV series, movie, animation. And we do have animation plans that will take place in the coming August of this year. And also we have TV series planned for the second half of this year. And the content for the TV series has been prepared for over 3 years. And for the JX revamped version that was launched by the end of last year, we are currently not disclosing the gross billing information yet. And also for the JX World II mobile game, we are still doing more adjustment to the game. The game has been launched in a small scale, on Xiaomi platform only. So going forward, after we make more adjustment, we will launch the game in the bigger scale on iOS platform as well.

[Yuk Keung Ng, executive]

[Foreign Language] Okay, let me turn to the second part on the WPS growth. We said that the number is no lower than -- but in fact, I just double checked that the revenue for the WPS is slightly higher than the 2014 -- '16 fourth quarter. So I have no further specific comment on that. But in fact, we had deliberately cut the inventory on the value-added service segment in order to improve the user experience. So we are putting less advertisement in the WPS in 2017 as compared to 2016.

[Operator]

Your next question comes from the line of Joyce Ju of Citibank.

[Joyce Ju, analyst]

[Foreign Language] I will translate my questions. My first question is on the WPS. As WPS previously launched a certain kind of strategy to embed more cloud-based functions. So I wonder what kind of investment goal we should expect for that initiative? And will it impact the overall margins for WPS in 2018 or 2019? And my second question is related to the licensed game that [indiscernible] Seasun's publishing business. Wonder if we have any, like, new games in the pipeline which company can share with us.

[Yuk Keung Ng, executive]

Okay. Now let me answer your question on the investment and initiative of WPS on cloud area. Cloud is definitely a globalization. Cloud and other is the future area for WPS development. But as I mentioned earlier, in 2018, we expected that the margin will stay at the mid-20 with a little bit improvement from 2017. Going onward, we do not expect that it will stay in the low mid-20 area. It's likely that if we work more on the monetization, we could expect that to further improve the margin on our WPS. This is one -- this is your first question.

[Tao Zou, executive]

[Foreign Language]

[Joyce Ju, analyst]

[Foreign Language]

[Francie Lu, executive]

I'll do the translation for Mr. Zou. So since last year we published the Eudemons Online mobile game. This year, we have 2 major areas for the publishing business. The first one is we want to stabilize the revenue from Eudemons Online mobile game. And the second one is that at the same time, we will also publish new game. Now we don't want to disclose too much information because we are still in the detailed discussion with the game's developers. But later, when we are more ready, we will disclose the new publishing game information.

[Operator]

Your next question comes from Macquarie, from the line of Wendy Huang.

[Wendy Huang, analyst]

[Foreign Language] I have 3 questions. Firstly, to follow up on Eudemons. So since Eudemons' launch on October 18, you mentioned that the gross billing actually surpassed RMB 100 million after just 19 days. So what's the current monthly gross billing for this game? And also, what kind of revenue share can Kingsoft get from this game? Second is your cloud business adjusted rate is USD 720 million. So what's the current cash flow rate for your cloud business? And lastly, can you remind us the profit you generate from the WPS in the fourth quarter?

[Yuk Keung Ng, executive]

Wendy, thank you for the questions. Your first question is about the Eudemons numbers, both the revenue and also the profit sharing. First, I can tell you that the game is very successfully -- a successful game. And the revenue is -- meet and exceed our expectation. But I could not tell you about the commercial secret on the profit-sharing ratio and the exact number for a particular game. Second, you asked about after the latest round of financing of the cloud, what is the cash spend rate and how much can we sustain the development? Again, I can also share with you that I already mentioned about our guidance on cloud revenue growth in 2018. It will not be 100%, but it will remain on a relatively high growth of around 60% growth in 2018, we could expect. And also, I also mentioned about that while I did not disclose an exact number, but I can also tell you that the margin, the operating margin is also improvement -- improving. Giving that the cloud business is in very strong financial position at the moment and that's anything that is beyond our anticipation at the moment, the cloud business can run for a relatively long time with this cash on hand. The WPS Office, we didn't disclose the exact profit number. But as I said in 2017, the profit margin for WPS is around -- is mid-20 for 2017, but we did not disclose the quarterly number for the WPS segment.

[Francie Lu, executive]

This will conclude our presentation for the 2017 annual results and the fourth quarter earnings call. Thank you all for your attendance. Thank you.

[Operator]

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

[Francie Lu, executive]

Thank you.