Kingsoft Corp Ltd

HKEX:3888

Earnings Call Transcript 2019-Q4

[Operator]

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

I would now like to hand the conference over to your first speaker for today, Ms. Francie Lu. Thank you. Please go ahead, ma'am.

[Francie Lu, executive]

Thank you. Ladies and gentlemen, good evening and good morning. I would like to welcome everyone to our 2019 fourth quarter and annual earnings call. I'm Francie Lu, the IR Director of Kingsoft.

I would like to start by reminding you that some information provided during the earnings call may include forward-looking statements, which may not be relied upon in the future for various reasons. These forward-looking statements are based on our own information and information from other sources, which we believe to be reliable. Please refer to the other publicly disclosed documents for detailed discussion on risk factors which may affect our business and operations.

Having said that, please allow me to introduce our management team who joined us today: Mr. 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. [Foreign Language]

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I'll translate for Mr. Zou.

[Interpreted] Our business sustained positive momentum during the quarter. Our online game business delivered stable growth in both PC and mobile segments, while office software and services and cloud services continued to achieve robust revenue growth with accelerated deployment across industries. Meanwhile, we have completed the listing of our office software and services business, Beijing Kingsoft Office Software, Inc. on November 18, 2019, on the Science and Technology Innovation Board of the Shanghai Stock Exchange. Overall, we made solid progress in 2019, and we're confident in the robust operating outlook and sustained growth for 2020.

Our revenue for fourth quarter of 2019 was RMB 2,594.7 million, up 48% year-on-year and 28% quarter-on-quarter. Revenue of 2019 was RMB 8,218.3 million, increasing 39% year-on-year. Our revenue maintained stable growth against the backdrop of a dynamic environment, thanks to our solid market competitiveness and execution capabilities. Meanwhile, annual revenue of cloud services and office software and services and others maintained a strong and rapid growth with a year-on-year growth of 73% and 43%, respectively.

Now I'm turning the call to our CFO, Francis.

[Yuk Keung Ng, executive]

Thank you, Francie. Hello, everyone. Both PC and mobile game recorded stable performance during the year. Our revenue improved year-on-year. We have launched a new expansion pack for our flagship JX Online III PC game in the fourth quarter, which result in a 24% jump in average daily active user, which compared to 30 days prior to that launch and a record high monthly gross billing in December.

Our classic PC JX World achieved year-on-year growth in both the number of gamer and revenue. The continued growth of the JX series demonstrate our resilience and strong capability in developing and operating long-term games and IP values.

For mobile game business, JX Online I continued to perform well during the year with a stable concurrent income. In addition, we have launched a new mobile game, Double Life World, [Foreign Language], which is [Foreign Language] before, in Japan in September, followed by China in November, earning high praises at home and abroad.

The newly launched mobile game was ranked as #1 in the iOS top 3 chart on its debut and subsequently climbed to the top 5 in the top grossing chart. The successful launch of Double Life World has further strengthened our diversified product strategy. We will seize market opportunity and achieve further breakthrough in product diversification. In view of the dynamic market and regulatory environment in China, we will continue to expand our overseas presence to further drive the growth of our game business.

Kingsoft Cloud strengthened its industry-leading position in the Internet and video sector, continued to focus on technology innovation and further promote the integration and implementation of cutting-edge technology, such as edge computing, smart definition and AI, et cetera. As a leading cloud service provider, Kingsoft Cloud made strong progress in terms of government and enterprise services, financial services and AIoT.

The key highlights include the following: Beijing government's cloud project was recognized as one of the most -- one of the outstanding innovation case studies in 2019 Innovation Cases Study of Government Digital Applications. Kingsoft Cloud was awarded the Outstanding Contribution Award for Fintech Product Innovation.

Meanwhile, the company is considering a possible spin-off and separate listing of Kingsoft Cloud Holding Limited. On December 20, 2019, Kingsoft Cloud Limited (sic) [ Kingsoft Cloud Holding Limited ] submitted the confidential filing with SEC. Going forward, Kingsoft Cloud remain committed to strengthening the strategic cooperation with Xiaomi AIoT, increasing the in-depth services of overseas business, leading the integration of cloud computing, big data, AI and other cutting-edge technologies with various industry scenarios, striving for the cost optimization and empowering enterprise client in the digital transformation.

For the fourth quarter of 2019, our office software and services sector makes its debut in the capital market, gaining momentum for further development. On 18 November 2019, Beijing Office Software was listed on the SSE STAR Market, raising RMB 4.459 billion, mainly deployed for the 4 key aspects: development and upgrade of WPS Office software, construction of an AI infrastructure R&D center for office software, Internet cloud services for office products and internationalization of office software.

During the period, we continue to make encouraging progress in working with our key government clients and enter into agreement with leading clients in the field, including energy, finance for comprehensive cooperation in office software. In October 2019, WPS Office's overseas monthly active users exceeded 100 million as we actively seize the opportunity from the Belt and Road Initiative. With the proactive promotion of its cloud service strategy, WPS Office subscription services achieved significant growth during the quarter.

At the beginning of 2020, the demand for cloud office and remote work office by various enterprises has significantly increased, driving the rapid development of online collaboration products like Kingsoft Doc. As at March 2, 2020, the number of MAU of Kingsoft Doc has exceeded 239 million. This trend also further foster user habit and boost market demand, expanding the potential growth in the WPS Office personal and enterprises subscription service in the future.

As for the results, I'm starting the Q4 using RMB as the currency. Revenue increased 48% year-on-year and 28% quarter-over-quarter to CNY 2,595 million. The revenue split was 39 -- 35% for our online game, 43% for cloud services and 22% for office software and services and others. Revenue from our online game business increased 39% year-over-year and 38% quarter-over-quarter to CNY 916 million. The increases were primarily attributable to the impressive performance of our flagship title, JX Online III PC game, and the revenue contributed from the newly launched mobile games.

Revenue from the cloud service increased 53% year-over-year and 14% quarter-over-quarter to CNY 1,113 million. The increases were largely driven by the increased average revenue per major customer as a result of the increasing demand for cloud services, product and solution and also the result in the number of customers due to the cloud services' further penetration in the existing vertical and expansion into more verticals.

Revenue from office software and services and others increased 52% year-over-year and 48% quarter-over-quarter to CNY 566 million. The year-over-year increase were primarily due to the strong revenue growth from WPS Office subscription services and licensing, driven by the expansion of user base and the increased paid conversion rate, reflecting growing demand from personal and enterprises user and enhancement of our user stickiness. The sequential increase was mainly due to the strong revenue growth from WPS Office's licensing and WPS Office online marketing services, resulting from positively seasonality.

Cost of revenue increased 31% year-over-year and 9% quarter-over-quarter to CNY 1,313 million. The year-over-year increase were primarily due to the increase in the IDC cost associated with the significant growth in cloud services business. Gross profit increased 70% year-over-year and increased 56% quarter-over-quarter to CNY 1,282 million. Gross profit margin increased by 6 percentage point year-over-year and 8 percentage point quarter-over-quarter to 49%. The increases of gross profit margins were mainly due to the economy of scale and enhancement operating -- operational efficiency of cloud services business.

Our research and development cost net increase is 11% year-over-year and 7% quarter-over-quarter to CNY 569 million. The year-over-year increase was mainly due to the increase of R&D personnel and their incentive and remuneration as a result of our effort to further improve the internal R&D capability. The quarter-over-quarter increase was primarily due to the accrued year-end bonuses.

Selling and distribution expenses increased 45% year-over-year and 15% quarter-over-quarter to CNY 312 million. The increases mainly reflected the increased investment of office software and services and cloud services business in exploring enterprise and government markets and the construction of sales channel.

Administrative expenses increased 28% year-over-year and 49% quarter-over-quarter to CNY 186 million. The year-over-year increase was largely due to the increased staff-related costs and professional services fee. The quarter-over-quarter increase was mainly attributable to the increased professional services fees.

Share-based compensation costs increased 40% year-over-year and 20% quarter-over-quarter to CNY 72 million. The increases were primarily due to the new grant of awarded shares and option to the selected employee of certain subsidiary of the company.

Operating profit before share-based compensation cost was CNY 235 million compared to a loss of CNY 105 million in the corresponding periods last year, and a loss of CNY 72 million in the third quarter 2019. Net other gains were CNY 149 million compared to the net other losses of CNY 8 million in the corresponding period last year and net other loss of CNY 87 million in the first (sic) [ third ] quarter 2019. The net other gain in the fourth quarter in 2019 were mainly due to the recognition of foreign exchange gain and a gain on deemed disposal of partial interests in a subsidiary.

We recorded share of losses of associate of CNY 404 million for the fourth quarter of 2019 compared to the share of profit of CNY 261 million for the fourth quarter of 2018 and share of profit of CNY 128 million for the third quarter of 2019. These costs in the fourth quarter of 2019 were mainly due to the losses recognized in Cheetah Mobile during the quarter.

Income tax expenses increased 619% year-over-year and 181% quarter-over-quarter to CNY 80 million. The increases were primarily due to the higher operating profit we recognized in this quarter. As a result of the reasons discussed above, loss attributable to the owner of parent for the fourth quarter 2019 was CNY 99 million compared to a profit of CNY 229 million in the corresponding periods last year and a profit of CNY 36 million in the third quarter 2019.

Losses of owner, excluding ESOP, was CNY 56 million, compared to a profit of CNY 262 million in the corresponding period last year and a profit of CNY 81 million in the third quarter of 2019.

I now turn to the full year 2019. Revenue increased 39% year-over-year to CNY 8,218 million. Online games make up 33%, increased 8% year-over-year to CNY 2,749 million. Cloud services make up 47%, increased 70% (sic) [ 73% ] year-over-year to CNY 3,847 million. And office software and services and other make up the remaining 20% and increased 43% year-over-year to CNY 1,622 million.

GP margin decreased 4 percentage points year-over-year to 42%. Loss to the owners of parent was CNY 1,546 million compared to a profit of CNY 389 million for the year 2019 and 2018, respectively. Again, this is due to the loss we recognized for Cheetah Mobile.

Our balance sheet, we have cash and bank deposit of CNY 13.8 billion at year-end of 2019. Net cash generated from operating activity was CNY 825 million. Capital expenditure was CNY 1,362 million and CNY 1,406 million for the year ended December 31, 2019, and December 30, 2018, respectively.

Amidst the turbulent economic environment, we managed to achieve a satisfactory performance in 2019. Our operating loss has now been narrowed during the year, mainly due to the significant improvement of the operating efficiency of our cloud services business. Beijing Office Software was successfully listed on STAR board market in the Asia. Our game revenue improved last year. Although our investment in the cloud business led to an operating loss in 2019, we recommend a final dividend of HKD 1.10 (sic) [ HKD 0.10 ] per share with an aim to reciprocate our appreciation for our shareholder long-term support. Subsequent to the relief of the global coronavirus 19 pandemic, and the conclusion of the IPO of Kingsoft Cloud Holding Limited, we will further review our dividend policy as and when appropriate.

Going forward, Kingsoft Cloud will be committed to strengthening its market position by leveraging leading technology and promote innovation across various industries. We will work with strategic partner to further expand our ecosystem and make our cloud computing offering more accessible globally.

Office software and services business will focus on its multipronged strategy of cloud, multiscreen, content and AI to solve our users' diverse need and to maintain our competitive advantages. We will continue to provide high-quality content and new game globally.

As we continue to seize opportunity arising from the digital -- enterprise digital transformation, Kingsoft will maintain its competitive edge in the industry. Looking ahead, we will see a clear momentum of growth across all our business segment. Driven by the increasing customer demand, we are confident to meet our performance target in the coming year and create long-term value for our shareholders.

This concludes my briefing. I now hand over the floor back to Francie.

[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 of Jefferies.

[Thomas Chong, analyst]

[Foreign Language] I have 2 questions. The first question is about our 2020 outlook. Can management share about the momentum for gaming, WPS and cloud computing for this year?

And my second question is about the near term business trend. In particular, given the fact that coronavirus affecting all the business across the board in China and we are seeing we are relatively defensive so far, can management comment about the business momentum in Q1 versus Q4, in particular, the gaming business?

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

[Interpreted] Okay. So talking about the 2020 outlook, we just had a Board meeting for the Beijing Office Software business in the morning. For the A-share listed company, they are not allowed to give detail on 2020 revenue growth guidance. So we'll also follow the same policy. So we're not going to mention too much details on the specific number guidance for the Beijing Office Software business.

But overall, we are very confident with the 2020 outlook. For the online game business, we had very good performance from the PC game, JX Online III, in the fourth quarter of 2019. And also the first quarter of 2020, we have very strong growth momentum from this PC game. Not only the revenue grew quite well, but also the number of users increased significantly. So we're very confident in operating this game as a long-life cycle game that's providing us as a cash cow game for our game business.

And so we're confident that the overall game performance in 2020 will be better than 2019. Although 2019 wasn't -- the revenue growth wasn't very satisfactory, mainly because the JX Online III mobile game we launched in 2019, the gross billing didn't meet our expectations, but the PC game performed very well in 2019. And for 2020, we believe that our growth rate will be back to the double-digit growth level for the game revenue.

And for the cloud business, we experienced quite positive impact from the coronavirus situation due to the increased use of online working, online education, the work from home situation. The cloud business performed very well in 2019. The revenue growth was 70% and up, and we are confident that we will maintain similar growth rate in 2020.

We mentioned that we couldn't give detailed revenue growth guidance for the Beijing Office Software business. But this business also benefited from the current situation. The technology adopted for online working, online education, also speed up the performance of WPS.

For example, we had a product called Kingsoft Documents (sic) [ Kingsoft Docs ]. Last year, we only had 6 million users. But in February this year, the number is quadrupled to 240 million. So it has increased significantly. Although the product still, we offered it for free, so it's not going to reflect too much on this financial performance, but this will help the growth of our business and also the -- speed up the digital transformation of the WPS business.

So from the fourth quarter last year to the first quarter of 2020, there's also a slight negative impact that we will also have to mention. That's our 2B business. The licensing business may be impacted -- affected from the current coronavirus situation. But the use of the cloud in our cloud business in WPS and also the game business have improved from the fourth quarter to the first quarter this year. Thank you.

[Operator]

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

[Liping Zhao, analyst]

[Foreign Language] I have 3 questions. The first question is related to games. So can management share the pipeline for this year on gaming sector? And the second question is related to the Kingsoft Cloud. We see a great improvement of operating margin for cloud sector. So what's the margin trend for this year and next year? And when shall we expect the EBITDA margin to breakeven? And the third question is related to the cash. We've noticed that on the balance sheet, we have around RMB 14 billion cash. So what's the plan for the company in the cash position?

[Tao Zou, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I'll translate for Mr. Zou for the first question on the pipeline for 2020.

[Interpreted] As Francis just mentioned, the coronavirus situation actually improved or helped our global game performance. But for the new game time line, this may be affected by the current situation. This is mainly because the -- for the games that we cooperate with Tencent, for example, the JX Online III, it's public launch, and also the [indiscernible] and also [indiscernible] II. So for these 3 games, the launch day may be delayed because employees are not fully back to work for both companies for, Tencent and Kingsoft. So we can't confirm the specific time line yet. The game may be delayed to preliminary schedule not until May to June this year. So we're still talking with Tencent. We may need to wait until April to give a specific time line.

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I'll translate for Francis.

[Interpreted] The cloud margin improved significantly in 2019. We're excited to talk about this. Not only the top line growth of the cloud business exceeding our guidance last year and achieved over 70%, the more exciting thing is that the cloud business operating margin also improved over 10 percentage points in 2019.

Talking about the 2020 outlook, we are very confident in the performance of the cloud business. First, we believe that our top line will keep a similar type of growth rate in 2020. The growth momentum will continue into 2020. And secondly, the market will continue to improve significantly, and maybe the improvement may be close to a double-digit improvement in the OP margin level.

We -- if we proceed with this rate, we may be able to achieve or close to achieve the EBITDA breakeven point by the end of this year. The cloud business development depends heavily on 2 things: one is economies of scale and the other thing is market competition. For economies of scale, we performed well, that our top line growth will -- is over 70% growth rate last year and it will also grow at a similar rate in 2020. But for the -- for market competition, we have been in this market for 5 to 6 years in the past. We experienced aggressive market competition in 2018 on the video cloud business. But we thought that in 2019, the pricing competition has been less aggressive compared to 2018. So we think that the market is more stable than the past right now. So if this trend continues going forward, we will hold on to our previous said guidance that both the top line and also the OP margin will continue to improve in 2020.

And talking about the dividend policy. After the IPO of our WPS business, we have RMB 14 billion in cash. We share with the market earlier that after the IPO of the cloud business, the rest of our 2 companies, the game and the WPS business, they have very strong net cash flow. So if we spin off the cloud business, the cash pressure on the Kingsoft Group will be much less, and we will revisit our dividend policy after the IPO of our cloud business.

In the past couple of months, we are -- under the coronavirus situation, there are a lot of changes and opportunities in the market. So in total, we think that the capital market is quite unstable in the past couple of months. So we do think that holding a good level of cash will give more confidence to our investors.

And also, secondly, with this current situation, we see a lot of opportunities. We don't know how the virus situation is going to develop, and we do see they are -- some companies may not be able to survive with the current situation. So we may speed up with some of the opportunities for the WPS or the cloud business. And here, we're talking about emerging acquisition opportunities.

So after the current virus situation and also after the IPO of cloud, we'll definitely revisit our dividend policy. So last year, even though we had a net loss, but we are still giving out HKD 0.10 to our shareholders as dividend for this year, and we will revisit our long-term dividend policy after the IPO of cloud business. Thank you.

[Operator]

Our next question is from the line of Elsie Cheng of Goldman Sachs.

[Haiwen Cheng, analyst]

[Foreign Language] And I would like to follow up on the cloud business and the 3 smaller questions here. The first one is on the gross margin. You mentioned last quarter that the gross margin of the cloud business turned positive. I just wanted to know a little bit more into the fourth quarter what's the trend there. And moving on to 2020, apart from the video vertical, where we definitely have the market-leading position, which are the other verticals you're actually looking to drive the growth for 2020? And then as you just mentioned that maybe into the end of this year, we could look at the positive margin for the cloud business. Then if you look into next 3 to 5 years, what would you think is the normalized margin for the cloud business in the long term?

[Yuk Keung Ng, executive]

[Foreign Language]

[Francie Lu, executive]

Okay. I'll translate for Francis.

[Interpreted] The gross margin for the cloud business in 2019 turned positive. So we believe that unless there's other cut throat competition in 2020, the margin will continue to improve in 2020.

From the fourth quarter of 2019, the gross margin, just for the last 2 quarters of 2019, the gross margin for cloud business just turned positive, so it's more or less close to the breakeven point. We believe that if the trend will -- trend continues, this may be able to close to a double-digit percentage by the end of 2020.

And for the long-term performance outlook for the cloud business, the margin outlook, we can't answer this question as of now. We think that there may be different margin levels for different cloud business. For the IaaS and PaaS business, their margin level may be lower than the SaaS services. So it's hard for us to comment on this margin level as of now. You may take reference to the U.S. market, where I believe the current IaaS level margin is around 20%. Whether this situation will be exactly the same in China, we're not sure, but you may take reference to the U.S. market, which we're in the cloud market 3 to 5 years earlier than China.

And talking about the verticals. Other than the video vertical, we are quite focused in 2019 and 2020. We mentioned that financial cloud vertical is another one that we are very focused, other than the video cloud vertical. And other than financial vertical, we think the government cloud and also health care cloud are also some other verticals with very good potential. Thank you.

[Operator]

That's the end of our Q&A session. I would like to hand the conference back to the presenters. Please continue.

[Francie Lu, executive]

Okay. This will conclude our earnings call for 2019 full year and also the fourth quarter. Thank you for your attendance. Thank you.

[Yuk Keung Ng, executive]

[Foreign Language]

[Tao Zou, executive]

[Foreign Language]

[Operator]

Thank you. Ladies and gentlemen, that concludes our conference for today, and thank you for participating. You may all now disconnect.

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