Earnings Call: Q1 2016

May 19, 2016

Earnings release

Ladies and gentlemen, thank you for standing by, and welcome to the 2016 first quarter Kingsoft Corporation results announcement 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 wish 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, 19th of May, 2016. I would now like to hand the conference over to your first speaker today, Ms. Francie Lu. Thank you. Please go ahead. Thank you, operator. Ladies and gentlemen, good evening or good morning. I would like to welcome everyone to our 2016 first quarter earnings call. I am Francie Lu, the IR Director for Kingsoft. I would like to start by reminding you that some information provided during the earnings call may include forward-looking statements which may 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 risks which may affect our business and operations. Having said that, please allow me to introduce our management team who join us today. Dr. Zhang Hongjiang, our Executive Director and CEO, and Mr. Francis Ng, our Executive Director and CFO. Now I am turning the call to Dr. Zhang Hongjiang. Zhang. Thank you, Francie. Good evening, ladies and gentlemen. We have started 2016 with a strong quarter and remain firmly committed to our mobile, global, and cloud focus. In March 2016, Kingsoft group's total mobile MAU reached a new high of 767 million. Cheetah Mobile has been dedicated to expanding its global sales growth by investing in new content product and expanding its direct sales operations. Its mobile and overseas revenue accounted for 75% and 58% of its total revenue, respectively, in the first quarter. We are also very glad to see the strong growth of Kingsoft Cloud, which continues to solidify its leading position in gaming cloud and mobile video cloud services. Looking forward, we are well-positioned to continue strengthening our mobile internet and cloud businesses in the coming quarters. We achieved a total revenue of RMB 1,751.5 million in the first quarter of the year, which represents a 58% annual growth rate. We do experience a slight quarter-over-quarter decrease due to seasonality factors. The sell-off, a 30% quarter-over-quarter decrease is a result of a seasonal impact. The operating profit before the share-based compensation cost increased 32% year-over-year to RMB 255.5 million. Cheetah Mobile has began 2016 on a very solid note with revenue increase of 57% year-over-year to RMB 1,085.1 million in the first quarter. Mobile revenue contributed from 56% of total revenue in the previous year period to 75% in the first quarter of this year. Overseas revenue contribution climbed from 42% of the total revenue in the previous year to 58% in the first quarter of this year. Mobile MAU from Cheetah Mobile increased 47% year-over-year to 651 million in March this year, among which approximately 79% were from overseas markets. Cheetah Mobile is facing some headwinds from advertising sales on some of its third-party advertising platform partners in the international market. To address those headwinds, it has begun to introduce new content product, which will increase our user engagement as well as strengthening its direct sale operation globally. This will help in the accelerating growth for Cheetah Mobile's mobile advertising revenue going forward. While Cheetah Mobile's content product and direct sales initiatives are beginning to take hold, it will take more time for these initiatives to show meaningful results. However, Cheetah Mobile experienced challenges several times in today's rapidly evolving mobile world before, and Cheetah Mobile has successfully evolved and grown with it. With this in mind, we remain confident that Cheetah Mobile's business strategy is on the right track, and we're continuing to aggressively execute on that strategy, managing user acquisition, user engagement, revenue growth, and profitability for the long-term sustainable growth. We are pleased with the solid financial result for the online gaming business in the first quarter of 2016, supported by the continued success of our flagship game, JX Online 3, with four updated versions released in the first quarter. JX Online 3 posted a revenue of RMB 331 million with a 19% quarter-over-quarter increase, far exceeding our expectations. We will continue to cultivate the game's broad and engaged user base and expect to further enhance its popularity following the launch of its expansion packs in the coming quarters. In the first quarter, we entered into an agreement with Tencent in regarding to its mobile game operation, in which we were licensing Tencent to operate two of our JX series mobile games. The first JX Mobile game is currently under testing and is expected to be launched commercially in a few weeks time in the second quarter of this year. Kingsoft Cloud saw a very solid start in 2016 in providing gaming cloud, mobile video cloud, and enterprise cloud services. Mobile live video cloud service has experienced exceptional growth in the first quarter, supported by the technology advantages in its comprehensive video cloud offers. Kingsoft Cloud introduced more than 60 new games in the first quarter, continuing to solidify its leading position in the game cloud market. The healthcare cloud service also made significant progress when Kingsoft Cloud started to form a healthcare cloud ecosystem to continue expanding the collaboration with hospitals and mobile healthcare businesses. With the effort on delivering increasing value-added service, the monetization capabilities of user traffic from the free version of WPS have steadily improved. Despite of the typical seasonality impact for the first quarter, WPS achieved a 65% year-over-year revenue growth. The global MAU of WPS family products reached 205 million in March 2016, with mobile MAU for WPS Office reached nearly 89 million, a 26% increase year-over-year. Our WPS will further explore the great growth potential of enterprise market, improve its user experience through product innovation and enhanced WPS Plus as a one-stop cloud office solution service. In January this year, Kingsoft Ciba initiated a strategic collaboration with Systran, a South Korean company seeking collaborations in providing translation services. Given the strong performance of our key business initiatives, we are confident in our revenue growth perspective for the rest of 2016 and beyond. At the same time, our investment in implementing the mobile, global, and all-in cloud strategies will continue. We expect operating profit may be under pressure in the coming quarters, and the operating profit margin for this year may be similar to that for the year of 2015. Now I would like to turn the call to Francis, our CFO, to give you more details on the financial results. Thank you, Dr. Jiang. Hello, everyone. I am now going to discuss the Q1 of 2016 operational and financial results using RMB as the currency. Revenue decreased 1% quarter-over-quarter and increased 58% year-over-year to RMB 1,752 million. The revenue split was 26% for our online game. 62% for quarter-over-quarter increase was mainly due to the healthy growth of our flagship game, JX Online 3, driven by the growing popularity and higher monetization ability, supported by a series of promotional activities. The year-over-year increase was due to our continued effort on improving the quality and user experience of JX Online 3. Daily average PCU kept flat quarter-over-quarter and decreased 19% year-over-year to 500,000. The year-over-year decrease was mainly due to the natural decline life cycle of old licensed games in the overseas market. The APA average paying account increased 1% quarter-over-quarter and decreased 4% year-over-year to 3 million. The year-over-year decrease was due to the natural decrease of our existing game. The monthly ARPU increased 7% quarter-over-quarter and 42% year-over-year to RMB 47. The increases were mainly driven by the improved monetization ability of JX Online 3. Revenue from Cheetah Mobile business decreased 3% quarter-over-quarter and increased 57% year-over-year to RMB 1,085 million. The quarter-over-quarter decrease was primarily due to the seasonality and the lower than expected revenue from Cheetah Mobile's third-party advertising platform partners in the international markets. The year-over-year increase was mainly driven by the Cheetah Mobile's organic business growth, which was attributable to its growing global mobile user base and substantial improvement in the mobile monetization, in particular in the overseas market. The mobile MAU from Cheetah Mobile increased 3% quarter-over-quarter and 47% year-over-year to 651 million in March 2016. Approximately 79% of mobile MAU were from overseas market as compared to approximately 71% in March 2015. Its mobile user installation as of 31st March 2016 has reached. The solid user growth mainly reflected our mission-critical applications continue to gain popularity globally through our effort in market exploration, market expansion, and a continuous improvement of our user experience. Revenue from cloud service, office software, and other business decreased 14% quarter-over-quarter and increased 126% year-over-year to RMB 210 million. The quarter-over-quarter decrease was primarily reflected. Though partially offset by the rapid revenue growth of cloud services driven by the fast-growing user demands, especially from the mobile video industry. The year-over-year increase mainly reflected the following point. Firstly, the exceptional progress of Kingsoft Cloud by extending the cloud service to new customers, especially mobile video and game industry. Secondly, improvement on monetization capability of WPS free user traffic. Cost of revenue increased 4% quarter-over-quarter and 110% year-over-year to CNY 470 million. The increases were primarily due to, firstly, the higher traffic acquisition costs associated with Cheetah Mobile's third-party advertising publishing business on the Cheetah Ad Platform, and also the higher IDC costs, along with the increased user traffic worldwide and data analytics. Secondly, an increase in the bandwidth and equipment depreciation expenses of Kingsoft Cloud as rapid usage growth and continued investment in data center. Gross profit decreased 6% quarter-over-quarter and increased 45% year-over-year to CNY 1,281 million. Gross profit margin decreased by 3 percentage points quarter-over-quarter and 70 percentage points year-over-year. Increased 11% quarter-over-quarter and 38% year-over-year to CNY 406 million. The quarter-over-quarter increase was mainly due to the increased staff costs. The cloud development team, as well as an increase in the salaries. Selling and distribution expenses decreased 17% quarter-over-quarter and increased 17% year-over-year to CNY 493 million. The quarter-over-quarter decrease mainly reflected the reduced promotional activity for the core mobile products of Cheetah Mobile, and also the decreased marketing expenses of online gaming business. The year-over-year increase was primarily due to the increase in expense on promotional activity for Cheetah Mobile's mobile business. Administrative expenses increased 46% quarter-over-quarter and 35% year-over-year to CNY 137 million. The increases were mainly due to the increase in expenses associated with increased headcount and staff costs. Share-based compensation costs increased 1% quarter-over-quarter and 97% year-over-year to CNY 114 million. The year-over-year increases mainly reflected the grant of Cheetah Mobile awarded shares to selected employees in the third quarter 2015. Operating profit before share-based compensation costs decreased 30% quarter-over-quarter and increased 32% year-over-year to CNY 256 million. The margin of operating profit before share-based compensation costs decreased by 5 percentage points quarter-over-quarter and 3 percentage points year-over-year to 15%. Other gains, net recorded a gain of CNY 27 million, which mainly represented the disposal gain of shares of Zhigu Holding Limited. This 12% year-over-year to CNY 46 million. Income tax expenses decreased 57% quarter-over-quarter and increased 77% year-over-year to CNY 49 million. Our effective tax rate decreased by 26 percentage points quarter-over-quarter and increased 9 percentage points year-over-year to 28%. As a result of the above, our profit to owners of parent increased 18% quarter-over-quarter and 17% year-over-year to CNY 134 million. In our statement of financial position, we have cash and term deposit of March 2016, representing cash per share of RMB 6.5. Net cash from operating activity was CNY 100 million, compared to CNY 860 million last quarter and CNY 14 million the same period last year. Our CapEx, capital expenditure, was CNY 177 million for the first quarter. Now I hand over back to the floor for questions. Thank you. Hi, operator. We are now ready for the question and answer session. Thank you. All right. Ladies and gentlemen, we will now begin a question and answer session. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the pound or hash key. Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. Your first question comes from the line of Evan Zhou from Credit Suisse. Please ask your question. Hi, good evening, management. Thanks for taking my question. This is Dan Zhou calling on behalf of Evan Zhou. I have two questions. The first question is about our mobile games. Can management give some updates on the new mobile titles in our pipeline, and how should we look at the revenue outlook from mobile this year? My second question is about 21Vianet. What is your view on the privatization of 21Vianet so far? As is of more uncertainty due to the likely policy change. Thank you. Let me handle the first question on the mobile game outlook. As mentioned by Dr. Jiang in the presentation, we will be launching our first mobile game in Q2 this year. As we mentioned earlier in a previous call, we have three major mobile game titles using the JX IP. The first one will be launched in a few weeks' time, and the second one probably will launch in end of Q3 or beginning of Q4. The third one will be launching probably in Q1 2017. As we cannot tell too much on the outcome of the mobile game, but we are quite optimistic because we have actually adding all the successful elements, including a very popular JX IP. Also we are partnering with a very powerful distribution platform. The first one we will be partnering with Tencent, and the second one we will be partner with Xiaomi. This is what we can tell about the mobile game outlook. Let's wait and see how it performs in the second half of 2016. The second question, maybe Dr. Jiang could answer on the privatization of 21Vianet. Yeah, on the topic of 21Vianet, its board meeting will take place next week, and I think we should wait after the board meeting to give any more directions on the privatization. At this moment, there is no news to release or to share. Thank you. Okay. Thank you very much. Your next question comes from the line of Thomas Chong from Citigroup. Please ask your question. Hi, thanks, management, for taking my questions. I have two questions. The first question is about the operating profit and the operating margin in 2016 is similar to 2015. Can management elaborate a bit the area of investment and the segment that we see which are under pressure? Because we are just a few months or so ago before the fourth quarter result, what has changed the management view in terms of the financial outlook? My second question is about the online gaming business. Given the JX Online 3, the mobile is going to be launched probably in a couple of weeks time. What is management expectation on this game? Should we expect this game to generate over CNY 100 million revenue? Any particular color that you can share will be great. Thank you. Thank you, Thomas. Let me give you a first cut to your answer, and Dr. Cheng, feel free to jump on. Your first question is about our guidance on operating margin. Probably, Thomas, you will also be listening into the earning call from Cheetah Mobile in 30 minutes time. You probably could hear a direct presentation from Fu Sheng and Andy on the detail of it. However, as you probably know that Cheetah Mobile's revenue account for almost two-third of Kingsoft consolidated revenue. The movement from Cheetah Mobile will directly have a significant impact or result on Kingsoft profit margin and revenue performance. As we have hinted in the presentation that Cheetah Mobile are facing some headwinds from the overseas advertising business. Probably I will not elaborate too much in this call. I urge you to get a direct feel from the Cheetah Mobile management. Since the Cheetah Mobile are facing some headwinds in the operation from mainly the overseas advertising business. Even though they are now actually working very hard on some of the remedial action, including continuous working hard on the content strategy and also compensate some of the losses in the overseas advertising business by adding more effort in the domestic direct sales advertising business. However, it does have a significant impact on the overall Kingsoft group result. What we just mentioned in the call, which is probably quite different from what we reported to all the shareholders in our Q1 profit or revenue guidance, where we say that in 2016, we should be starting to see a rebound in the operating profit while we will be keeping on a very strong top-line growth. The reason I do not repeat it here, the four business are actually quite optimistic in the Q1. In particular, in Cheetah Mobile, they think that even though the Q1 result, at that time, we already know that it's already maybe driven by, impacted by the seasonality. At that time, the management of Cheetah Mobile do expect that there will be some of the rebound in Q2. Unfortunately, that doesn't happen in Q2. So they are now revising the guidance on Q2, and I would expect that they will also have a decline in operating margin as well. So overall, in Kingsoft consolidated revenue, we still expected to see a strong growth on the top line. However, on the bottom, on the operating margins side, we will expect that we went back to what we are seeing in the 2015, giving a little bit more time for Cheetah Mobile to find its way to further strengthen its monetization capability. While having said that, we still are optimistic about or we are very confident on the mobile game performance. You mentioned about whether we expected that there will be over CNY 100 million per month. I think probably, Thomas, you referred to. In our plan or in our expectation, the answer is positive. I don't want to give our more exact expectation, but CNY 100 million gross revenue, gross billing, will be what we expected for the three JX Mobile game title. Thank you, Thomas. Thanks, Francis. Your next question comes from the line of Wendy Wang from Macquarie. Please ask your question. Thank you. My question is mainly about your cloud business. Can you give us some update on the number of the customers you have, and also what kind of CapEx you expect for the cloud business? I think other players in the space, AliCloud, they mentioned that they are actually close to the break-even point. Maybe you can give us some update on where you are in terms of the profitability. Thank you. Wendy, thank you. This is Hong Zhang. Let me address your question. On the user business side, we see a continued growth of our customers. One thing I want to remind you is that, unlike many other cloud service providers, Kingsoft has been focused on what we call the heavy customers, basically the big customers. So we are now approaching about 1,000 enterprise customers, and that number continues to grow. Also the spending of each of those customers are also increasing on average. So on the CapEx side, we will continue to invest, and the good news is that we expect the revenue growth will far exceed the CapEx growth. So to your point about profitability, I guess, I don't think that anyone has given a clear guidance they are reaching the profitability point, at same time have over 100% increase in the revenue in this particular space. For us, the Kingsoft Cloud management and board is committed to focus on growth in our customer base and also in our revenue this year. We are going to maintain a 200-plus percent growth in our revenue. We have not, and we will not put a profitability as our target this year. Thank you. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. Your next question comes from the line of Yang Liu from Deutsche Bank. Please ask your question. Good evening, management. Thank you for taking my questions. I have a follow-up question regarding cloud business. Can you please provide either the sales numbers or growth numbers in the cloud business for the Q1? That is my first. I remember in the previous quarter or the annual result presentation, the cloud business profitability is kind of guided to be kind of break even this year. Are you still stick with that guidance, or you kind of fine-tuning that by saying profitability is no longer the top priority for the cloud? Thank you. Let me take this question. As I mentioned earlier, the growth rate of cloud business in the first quarter is more than 200%, and at this moment, we are not breaking down the revenue numbers between WPS and cloud. The one thing I would like to share a little bit more is that the cloud income has overtaken the WPS income in the first quarter, and this is the first time in our history, in Kingsoft's overall income. As I mentioned earlier, the focus of this year is going to be continuing on the growth, on revenue growth, just like all the competitors in this space in China cloud market. You are right, we are not focusing on reaching a profitability point at this moment. Okay. You just mentioned the cloud business growth was over 200% in Q1. I remember for the full year guidance, you were talking about 100%. That means the business momentum. Can I say the business momentum was kind of faster than expected? Yes, the growth is faster than the guidance we originally gave, and we expect that we are going to be faster than 100%, definitely, for the whole year. Let me elaborate a bit further on this point. One is that Dr. Jiang mentioned that our growth for cloud revenue in Q1 is over 200%. Our revised expectation on the cloud for the full year is also over 200%, which is higher than what we gave out in Q1. The second question, I need to comment a bit on your question on achieving the breakeven point. I wanted to reiterate that statement was given by me. I am not telling the public that we will be achieving a breakeven point by end of 2016. What I said in Q1 is that theoretically, given the operating margin or the pricing strategy, if we choose an operating level, and if there is no severe price war happening in 2016, based on simple arithmetic, we should be approaching to breakeven by end of 2016. However, as Dr. Jim mentioned, and I also echo to that, our focus for our cloud business is not to achieving breakeven in the near term, but instead, we wanted to find our position in the competition landscape. We wanted to be growing fast enough to catch up with our competitor, such that we will be viewed as one of the leaders in that space. Okay. All right. Thank you. Let me add a little bit more. We are, at this moment, we look at our Q1 result, and we look at what has been published from other players in this space in China. We are actually growing faster than them in percentage-wise, and we would like to maintain that speed so that we will keep our leading position and keep as a leading player in this particular market. Thank you. Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. There are no further questions at this time. That does conclude our conference for today. Thank you for participating. You may all disconnect. Thank you. Thank you all for attending. This will be the end of our 2016 first quarter earnings call. Have a good night. Thanks.