Earnings Call: Q1 2018

May 23, 2018

Earnings release

Ladies and gentlemen, thank you for standing by and welcome to the Q1 2018 Kingsoft Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question and answer session. At which time, if you would like to ask a question, you will need to press star one on your telephone. I must advise you that this conference is being recorded today. I would now like to hand the conference to your first speaker, Ms. Francie Lu. Thank you. Please go ahead. Thank you. Good morning, ladies and gentlemen. I would like to welcome everyone to our 2018 first quarter earnings call. I am Francie Lu, the IR director of Kingsoft. I would like to start by reminding you that some information provided in 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 join us today. Mr. Zhou Tao, our executive director and CEO, and Mr. Francis Ng, our executive director and CFO. Now I am turning the call to Mr. Zhou Tao. I will do the translation for Mr. Zhou. The first quarter marked a good start to 2018. All of our business are well on their way to achieve the strategic goals of the company. Kingsoft Cloud strengthened its leading position in video cloud sector. The performance of WPS Office remained robust, and the content value-added services saw good momentum by providing a smarter resource sharing platform for our users. As for the online game business, we managed to continue to expand the brand influence of our flagship game, JX Online 3, and also released the first promotion video for one of our key mobile games of the year, "YSYY: Yunshang Yuyi." In the first quarter, our total revenue increased 4% year-on-year to CNY 1,263.7 million, indicating a steady start to the year. Kingsoft Cloud recorded a year-on-year growth of 56%, and office software and services and others grew 66% year-on-year in the first quarter. Our operating profit will be under pressure in the first half of the year as we expect our online game business to pick up its growth momentum in the second half of the year. Thank you. We will turn the call to our CFO, Mr. Francis Ng. Hi. Thank you, Francie. Hi, good morning, everybody. In the first quarter, due to the explosion in the popularity of the PUBG game, some of our user of our flagship PC game, JX Online 3, were temporary occupied, which led to the year-on-year and quarter-on-year decrease in revenue. As a result, the online game business was under pressure, as Mr. Zhou Tao said, in the first quarter. We host the third JX Online 3 expert player competition on March 16, 2018. The number of participants and viewer reach a new record high this year, which helped strengthen the engagement of the core players. With the increasing fierce competition in the mobile game market, we saw the opportunity of new game type and meticulously develop a 3D costume-changing mobile game, "YSYY: Yunshang Yuyi." The first promotion video of the game was released during the 2018 Tencent Neo-Culture Creativity Eco-Conference, and we see great commentary across the market. It lays the solid foundation for our new game type development. We are looking forward to the official launch of the game and expect it to be one of the new driving force of online game business. Kingsoft Cloud maintain a steady growth in the quarter, and the development trend of each business segment is in line with our strategic planning, which we set at the beginning of the year. Video cloud business saw continuous improvement with high-quality services provided for our customers. Through the promotion of high-resolution content delivery network, Kingsoft Cloud managed to strengthen its leading position in the CDN sector and is striving to establish a diversified business structure over time. Game Cloud achieved remarkable results in attracting and retaining strategic clientele, and it continued to explore the artificial intelligence technology and blockchain solutions. Kingsoft Cloud also keeps on expanding its business in government cloud and private cloud sector, and make breakthrough in finance and automobile cloud services. Looking forward, Kingsoft Cloud will continue to provide customer with quality tailor-made services and solution, enhance the business penetration across the market and seek new breakthroughs. WPS Office continued to maintain strong growth for the first quarter of 2018, and with continuous effort in the cloud office services. Both customer and enterprise cloud business sustained decent growth. WPS Government Office Cloud made its debut in the quarter as office solution targeting government and public institutions. Meanwhile, content value-added service have enjoyed good growth momentum, providing users and designer with a smart platform to share resources. Our flagship product, WPS Office and Kingsoft PowerWord, were both ranked among the top 10 best customer experience APP in the top 100 APP in WeChat, Weibo, and Mobile Office in 2017. WPS Office content ecosystem strategy was announced in the Content Player Plus Conference in Zhuhai. More than 100 content creator participated in the event. The content platform, Docer, 稻壳, was officially upgraded to a strategic content brand at the conference. With the leading office technology and a proven business development model, WPS Office will continue to build an easier office style for global users. I will now discuss the Q1 operational and financial results using CNY as currency. Revenue increased 4% year-over-year and decreased 8% quarter-over-quarter to CNY 1,264 million. The revenue split was 50% for our online games, 33% for cloud services, and 17% for office software and services and others. Revenue from our online game business decreased 23% year-over-year and 16% quarter-over-quarter to CNY 632 million. The decreases mainly reflected decreased revenue from our flagship PC game, JX Online 3, as some of our users were temporarily occupied by the PUBG game, and the natural declines in revenue of JX Online 1 mobile game, which was launched two years ago. Daily average PCU decreased 25% year-over-year and 20% quarter-over-quarter to 700,000. APA for the group online game decreased 22% year-over-year and 17% quarter-over-quarter to 3.3 million. The decreases reflect some players of JX Online 3 were temporarily occupied by PUBG game and the natural decline life cycle of the group existing mobile game. Revenue from cloud services increased 56% year-over-year and 4% quarter-over-quarter to CNY 419 million. The year-on-year increase was mainly driven by the strong customer usage of cloud services from mobile, radio, and internet sector. Revenue from office software and services and others increased 66% year-over-year and decreased 6% quarter-over-quarter to CNY 212 million. The year-over-year increase was largely due to the rapid growth from WPS online marketing services and value-added services of WPS Office Personal Edition. This reflected the strengthened commercialization capability, increased user enhancement, and stickiness driven by continuous product utilization and content enrichment. The quarter-over-quarter decrease was mainly attributable to a seasonal decline in sales and WPS Office, which was partially offset by the revenue growth from WPS online marketing services and value-added services of WPS Office Personal Edition. Cost of revenue increased 27% year-over-year and 6% quarter-over-quarter to CNY 648 million. The increases were primarily due to the higher bandwidth and IDC costs with increased customer usage of cloud services. Gross profit decreased 13% year-over-year and 20% quarter-over-quarter to CNY 616 million. Gross profit margin decreased by 9 percentage point year-over-year and 7 percentage point quarter-over-quarter to 49%. The change in group's gross profit margin is a result of the change in sales mix, reflecting fast growth in cloud services. The cloud services business has relatively lower gross profit margin compared to our games. But the growth of its revenue contribution is much higher than our other business, relying on the massive addressable market prospect and the long-term revenue growth potential in the cloud market. Our R&D costs net increased 18% year-over-year and decreased 5% quarter-over-quarter to CNY 380 million. The year-over-year increase was primarily due to the greater staff-related costs as a result of increase in R&D investments. Selling and distribution expenses increased 56% year-over-year and decreased 27% quarter-over-quarter to CNY 127 million. The year-over-year increase and quarter-over-quarter decreases reflected the change in advertising and promotional spending for our online games business in each of the corresponding quarters. Administrative expenses increased 48% year-over-year and 5% quarter-over-quarter to CNY 183 million. The year-over-year increase was primarily due to the increased staff-related costs. Share-based compensation costs increased 19% year-over-year and 14% quarter-over-quarter to CNY 58 million. The quarter-over-quarter increase was largely due to the new grants of awarded shares and option to selected employees, as well as an increase in fair value of the awarded shares and option of certain subsidiaries. Operating profit before share-based compensation costs decreased 73% year-over-year and 55% year-over-year to CNY 84 million. The margin of operating profit before share-based compensation costs decreased by 19 percentage point year-over-year and seven percentage point quarter-over-quarter to 7%. Net other gain of CNY 90 million were recorded for the first quarter 2018, compared to net other losses of CNY 92 million for the first quarter 2017, and net other losses of CNY 27 million for the fourth quarter 2017. The losses in the first quarter 2017 were primarily due to the additional provision for impairment on the carrying value of investment in Shengai Limited and 21Vianet, as the further decreases of market valuation in first quarter 2017. Share of profits of associates of CNY 20 million were recorded for the first quarter 2018, compared to share of losses of CNY 2 million for the first quarter 2017, and share of profit of CNY 60 million for the fourth quarter of 2017. Cheetah Mobile has been accounted for as our associate since October 1, 2017, and the quarter-over-quarter decrease was mainly due to a decrease in operating profits of Cheetah Mobile due to the following reason. First, the low seasonality for advertising activity in the first quarter. Second, the decline in the revenue from its mobile utility products and related services business in overseas market. A certain ad format, i.e., the ad on mobile phone lock screen, has been discontinued by its overseas third-party advertising partners. Income tax decreased 7% year-over-year to CNY 43 million, compared to the income tax credit of CNY 5 million for the fourth quarter of 2017. Gain on deemed disposal of a subsidiary, which amount to CNY 2,224 million for the fourth quarter of 2017, represented deemed disposal gain as a result of delegation of the voting right in Cheetah Mobile Inc. Profit for the period from a discontinued operation reflected profit from Cheetah Mobile, which was CNY 102 million for the three month ended March 31, 2017. As a result, our profit to owner of parent, including that from continued operation and a discontinued operation, decreased 50% year-over-year and 95% quarter-over-quarter to CNY 118 million. Profit to owners of parent excluding eShop, including those from the continued operation and a discontinued operation, decreased 45% year-over-year and 94% quarter-over-quarter to CNY 158 million. Our statement of financial position, we have cash and bank deposit of CNY 9.6 billion as of March 31, December 2018. Net cash generated from operating activity, including those from continued operation and a discontinued operation, was CNY 98 million, CNY 613 million, and CNY 149 million for the first month ended March 31, 2018, March 31, 2017, and December 31, 2017, respectively. Capital expenditure was CNY 245 million, CNY 102 million, and CNY 291 million for the three month ended March 31, 2018, March 31, 2017, and December 31, 2017, respectively. We are glad to see this sound overall performance in our business in the first quarter. Kingsoft Cloud and WPS Office sustained stable growth in the first three months, and with the market expansion in increasing sector and customer of different areas. As a commercial launch of Yunshang Yuyi and JX Online 3 mobile game were later than the scheduled timetable, and the performance of JX Online 3 is affected by the market competition in the short term, the company assessed that the operating result of the second quarter 2018 would be still under pressure. Operating profit will possibly be similar to that of the first quarter in 2018. That is, no single digits. But we are confident that will bounce strongly in the second quarter as the new mobile game launch in the second half of 2018. The accrual interest expenses, which is a non-cash item of liability component of redeemable convertible preferred share of around $80 million, will be recorded in the second quarter of 2018. If the exchange rate of the US dollar against RMB rises in the second quarter, we will incur an exchange loss. We expect the performance will improve in the second quarter of the year after the debut of our new mobile games, Yunshang Yuyi and JX Online mobile games. We look forward to bringing more satisfactory results to both our customers and the market with our uneasing effort in product innovation and service optimization. I now hand over the floor to question and answer. Hi, operator. We are ready for the Q&A session. Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you would like to ask a question, please press star one on your telephone and wait for your name to be announced. If you need to cancel that request, please press the pound or hash key. We do request, if possible, please ask your question in both English and Mandarin. Once again, to ask a question, please press star one on your telephone. Our first question comes from Thomas Chong from Credit Suisse. Please go ahead. Maybe I first translate my first question. Thanks, management, for taking my questions. I have a question about the Q2 performance. Given that the operating profit is similar to Q1, should we expect the revenue to be similar to Q1 as well? Given we have the Q2 guidance already, how should we think about the full-year revenue and margin trend if there is any changes from the previous quarters? Then I have a follow-up. Thank you. Okay. Let me answer your question. Thank you for the question, Thomas. First of all, you asked about the guidance for Q2 revenue. The overall Q2 revenue, we expected that it would be on a continuous rise. It will be higher than Q1. We've excepted the online game revenue, because as you see that we have already mentioned that it will take some time for the JX Online 3 to warm up with the further improvement in the optimization of its game. We are expecting that there will be a major mobile game launch in the second market. But in the second quarter, we expected that the game revenue will be slightly lower than the Q1 revenue. But the Cloud business and the WPS Office revenue will continue to increase in Q2 as compared to Q1. Overall, we expected that the Q2 revenue will be higher than the Q1. This is your first question. Yeah. Thank you, Francis. Maybe I translate the questions. Coming mobile games like JX2, as well as the mobile version for JX3, if there's any more concrete timeline, whether it's 3Q or 4Q. The follow-up question is about the impact for PUBG games. Given the fact that we are affected by PUBG in Q1, is there any color that without the impact of PUBG, how our online games in Q1 is going to perform? Any color would be great. Thank you. Hi. Thank you, Thomas, for your question. You talk about the timeline for our new mobile games. As we mentioned, certain of our mobile game launching schedule actually are slightly later than what are internally expected. But I can share with you that one of the major game title, which you refer to as JX3: <foreign language>指尖江湖</foreign language>, launching time will remain unchanged, which will be likely before our 30 anniversary, which is probably at the end of August, beginning of September. Which is the most important mobile game in 2018. Also in the <foreign language>云裳羽衣</foreign language>, you could also see that that has been already debuted in the Tencent game conference, which receive a very good result and popularity among gamers. Which in fact is first six-star ranking game in 2018 after the new Tencent evaluation system was launched. We expected that will be a very major game in 2018 for Kingsoft as well, which you could expect will be likely launched at the end of Q2. That is our 2 major mobile game, which are going to be launched in 2018. Thank you, Francis. On the PUBG impact. The PUBG impact, as we all see that it actually affect the whole market, so to speak. We are not alone. We also experience quite a significant impact by that PUBG game. That is external factor, but I also mentioned that JX Online 3 Mobile revamped version is also a very major revamp addition in 2018. It involve huge effort. We spend huge effort and it also require some of the enhancement in, for example, for the expansion pack, which was very large at the beginning. We are optimizing the size of expansion pack, and we believe that with that will also help the retention in our user. To answer your question, the performance of the JX Online 3 are both affected by the competition in market, namely the PUBG game, and it also requires certain time for our internal enhancement in the revamp pack. Thank you. The team are confident that those enhancement will be made very soon. Thank you, Francis. Once again, if anyone would like to ask a question, please press star one on your telephone. Our next question comes from Liping Zhao from CICC. Please go ahead. Hey, Francis. Francis，早上好。我这边有三个问题。第一个问题是关于我们游戏这边。我看端游咱们剑网3收到这个1Q的时候受到赤翼的影响还是挺大的。我们就是从自己的角度有没有做什么去提高这个玩家的活跃度？如果有的话，我们看在2Q，因为现在已经五月底了，就是2Q前两个月的话，有没有看到一些好转的迹象？另外端游这边今年的拓展包大概是个什么计划？然后手游这边的话，因为刚刚那个Thomas都已经问了，所以这个可以不用问了。然后第二个问题是关于WPS这块。我们可以分开来看WPS它这个2B和2C的增长分别是多少？因为这个季度的话有60%多的增长，我想看主要的驱动力在哪里。第三个问题是关于云这块的，因为现在我想看一下小米，包括Game Cloud和视频云这几个最大头的部分占我们的收入的比例大概是多少？那么云这边的亏损幅度有没有收窄？然后我自己翻译一下吧。 I have three questions for the management. The first one is related to our PC game. Because we saw that JX Online 3 has been impacted by PUBG in the first quarter. What is your strategy to recapture players' engagement? What is your pipeline for the expansion pack this year? My second question is related to the WPS. What is the growth for your 2B and 2C business respectively? The third question is related to Cloud. Do you have a breakdown of the revenue contribution from Xiaomi, gaming and video? Can you see a narrow loss margin for the first quarter? Thank you. 我来回答第一个问题吧。Q1呢，正如我们所说的，其实整个行业都因为吃鸡这个游戏，在收入上、人数上都受到了一定的影响。剑网3也不例外。但是我们也仔细地研究分析过，人数的影响大概是影响了10%左右，这是同比去年的这个人数。收入的影响呢，也因为我们这次重置版，应该说是一个底层技术的大升级的过程，这个过程当中呢，因为工程量浩大，确实还有一些不完善的地方，我们推出之后也陆续在完善。所以呢，整个Q1的影响，从内外两个因素来讲，主要是这两块。我们自从重置版推出之后，我们也一直是在根据玩家的反馈意见，在不断地修正我们之前的一些设定和修改一些bug。我相信随着时间的推移，整个重置版的这个技术升级，应该说技术升级给未来长远带来的影响呢，我想会表现得越来越明显。刚才问到Q2是否有一些迹象，我也可以很肯定地回答，从事实上看，无论是从收入还是从其他各方面，我们都有比较好的回转。尤其是到了五六月份。然后我们其实也在积极地，应该说上半年除了持续完善我们的重置版的这个技术体系之外，我们也是在应该说积极紧张地、积极努力地在为下半年的新资料片、新门派紧锣密鼓地在工作。我们也有信心，随着重置版底层技术的逐步完善和bug的不断修复，以及下半年的新内容的推出，剑3应该能够重新恢复一个在未来三五年一个比较好的增长的势头。这是关于第一个问题。 Okay, I will do the translation for Mr. Zhou first. As you know, the whole market is affected by the PUBG game in Q1 in terms of revenue, and JX Online 3 is not an exception. In terms of the user impact, it is relatively about 10% year-on-year compared with the same period last year. Also for the revenue, we just launched the revamped version by the end of last year. There is a complete upgrade on the game, and we are right now still continuing to optimize the game in Q1 and Q2. These are the both internal and external impact of the game in the first quarter. Now we are continuing to optimize the revamped version based on our user feedbacks. As the time lapse, we believe that this revamped version will definitely have a positive impact in the long run. In addition to optimizing the revamped version, we are actually actively preparing for the new expansion pack, the new content for the second half of the year. We believe that with the continuous optimization and also with the launch of the new expansion pack, new content in the second half of the year, we are confident that the growth momentum will pick up for the game in the long run in the next 3-5 years. Thank you. Liping, thank you for asking the question. You asked about the other question. Let me answer in Chinese and Francie please help me to translate. Is it okay? Yes. 那立平啊，你问的那个问题的话呢，就是说你问到我们的WPS，就大概那个to C跟to B的那个比例跟增长是吧？对。对的。首先第一个呢，就是说可以跟你介绍呢，我们其实从2017年的时候啊，我们的 To C 的收入其实已经超过了 To B 的收入。这个趋势在 18 年继续延续。所以到 2018 年 Q1 的时候，To C 的收入已经远远超过我们 To B 的收入。而且差不多应该有将近四分之三的收入，现在是由我们的 value-added service 那边过来的。我们 To C、政府的可能降到我们现在大概 25% 或四分之一左右。而且增长的话，当然我讲增长是年对年的增长，因为你知道我们 WPS 有 seasonality，所以 Q1 比 Q4 的话，其实 Q4 是一个 peak season，Q1 是 relatively 是一个 low season，这个大家都非常清楚，你应该也很清楚。但是要是我们讲年对年的增长的话，value-added service 在 Q1 的表现也是特别强劲，它的增长可能接近一个非常高的水平。相对来讲的话，revenue 从 enterprise 跟 government 的话，可能会比较低，大概可能是在 10 几左右。那么 value-added service 年对年的增长，是差不多接近三位数的一个增长。好的。你后面还有一个问题提到我们云方面的话，就是小米占的收入。可以跟你讲，小米占到我们云的收入的话，已经是远低于一半了，现在的水平可能是在大概四分之一左右，整个云的收入。好的。请说一下云的亏损幅度有没有收窄吗？我先让Francis先去翻译一下。 Okay, I will do the translation for Francis. 丽萍 was asking about the growth momentum for the 2B and 2C business for WPS. In 2017, our 2C revenue already exceeded the revenue from 2B. This momentum, this trend continues into 2018. In the first quarter, our 2C revenue is actually much greater than 2B, roughly about 75% of the revenue is from the value-added services in the 2C business. The enterprise and government services revenue accounts for roughly about 25% of the WPS revenue. As everyone knows that there is seasonality impact for the WPS business, so Q4 was actually a peak season for WPS. When we talk about the growth rate, it is based on the year-on-year comparison. The growth rate for the value-added service in the first quarter is very, very high, close to three digits. The enterprise and government growth rate is basically lower, around 10%. For the Xiaomi revenue contribution in the cloud business, the Xiaomi revenue contribution is much less than 50% of the cloud revenue. It is roughly about a quarter of the cloud revenue right now. Thank you. Hi, 丽萍, you could go ahead with your question. 对，就是还想问一下，云这边的亏损的幅度有没有收窄？从数据来看。云的亏损是一起往收窄方面去，这个trend在18年也是比较明显的。 I will do the translation for Francis. The loss as a percentage of revenue for the cloud business has been improving in the past, and this trend will continue into 2018. Thank you. Okay. I have no further questions. Thank you. 谢谢丽萍。 Thank you. Once again, if anyone would like to ask a question, please press star one on your telephone. As there are no further questions, I will hand back to management for any closing comments. Okay, thank you all for attending our conference call for the first quarter 2018 earnings result. Thank you. Thank you for attending. Thank you so much. Ladies and gentlemen, that does conclude the conference for today. Thank you so much for your attendance. You may all disconnect.