Earnings Call: Q2 2012

Aug 23, 2012

Thank you for standing by, and welcome to the 2012 Q2 and Interim 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, during which, if you wish to ask a question, you will need to press star one on your telephone. Please be advised that this conference is being recorded today, August 23rd, 2012. I would now like to hand the conference over to Ms. Michelle Harnett. Thank you. Please go ahead. Thank you very much. Ladies and gentlemen, good evening and good morning. I'd like to welcome everyone to our 2012 Q2 and Interim Results Earnings Call. I'm Michelle Harnett, the Company Secretary of Kingsoft. I'd like to start by reminding you that some information provided to you during the earnings call might include forward-looking statements, which may not be relied on in the future for various reasons. These forward-looking statements are based on our own information and on information from other sources we believe to be reliable. Please kindly refer to other public disclosure documents for detailed discussion of risk factors which might affect our business and operations. Having said that, let me introduce our management team who join us today. Ms. Zhang Hongjiang, our Executive Director and CEO. Ms. Frances Ng, our CFO. Now I'm turning the call to our Executive Director and CEO, Mr. Zhang Hongjiang. Thank you, Michelle. Good evening, ladies and gentlemen. Welcome to this session. I would like to start by saying that we are very pleased to report a strong top and bottom-line growth on a quarter-over-quarter basis, and the year-over-year basis for the second quarter of 2012. With the quarterly revenue exceeded over CNY 300 million, we see a solid and healthy growth in revenue from all of our major business lines. Our Kingsoft Internet Security business has reached a new milestone in its monetization capability and has completely transformed from the old software model into the internet free model. Supported by the continually expanded user base of all product lines, the advertising revenue surged to a historical level in our internet security business. This milestone really marks the successful transformation of our internet security business. Also, I'd like to report to you that on June 19, we officially launched our internet browser, codenamed Cheetah. This launch has been welcomed by many users. We also launched a number of mobile applications, such as the China Survival Guide in the past quarter that have gained overwhelmingly positive feedback. In July, Kingsoft Japan, our Japan subsidiary, also launched a market campaign to promote the free model of our Kingsoft Internet Security services in Japan, aiming at expanding our user bases there in the Japan market. Moving to our WPS Office business, we have seen a continued success in this particular business. We have delivered a very strong financial result in the second quarter of 2012. The monthly active user base of WPS Office has expanded over 30 millions. This is our Office for PCs. On July 29, Kingsoft Office mobile version, that is our WPS Office for Android, jumped to the first place in the free business application category in Google Play. For those of you who are not familiar with Google Play, this is the Google Android marketplace. The latest worldwide statistics from Google Play shows that after having gained and retained the first place in seven countries and regions, including Britain, Germany, Australia, and Taiwan, our WPS Office for Android also jumped to the first place in a number of other major markets in July. Most noticeable is United States, France, and Canada, and Singapore, as well as Hong Kong. The outstanding performance here has demonstrated that our WPS strategy, our WPS's strategic transformation to mobile internet and expanding into international market has gained solid ground here. I'd like to move into our other main business, which is the game business, the entertainment business. Our game portfolio has continued to grow and perform well in the second quarter of 2012. In particular, I want to draw your attention to our JX Online 3, and it has reached to a historical record in term of popularity and revenue, thanks to the release of new expansion pack, Light Up Fire, in April. Continue to focus on improving user experience. This part is super important, that will drive the further improvement of this particular game. We are expecting a continued improvement in both user base and in its revenue for the rest of this year and extending into next year. The release of our first summer expansion pack for JX3, Weekend Dragon of High In July, has further consolidated and enhanced the higher popularity of the game. This is the first time we launched an expansion pack in the summer. Also, the JX Online World has demonstrated a steady growth in the second quarter since the release of expansion pack, Heroic-Western Dragon in March. In term of our new release of games, the open beta testing of our new 3D MMO, Legend of the Holy World, was started in July and has been well-received by gamers. I'm quite happy with the result we have seen so far. Legend of Moon is targeted at commercial release in September following the final round of testing in April. In addition, Ma La Jiang Hu, a Q version of 3D role-play game, is scheduled for open beta test later this year. To further extend our game pipeline, several web-based games and our first mobile game are also under development and testing in full swing. One of which is planned for release in the second half of 2012, and maybe we will release one more there. Overall, I would like to say that we see a very solid growth in both of our existing game and our new games in 2012. In particular, we are very pleased with the progress we made on one of our major game, the JX Online 3. The new initiative in Kingsoft, that is the Kingsoft Cloud business. In this, we continue to see the growth of user base of our first service offer, KuaiPan, which is the personal data storage service, resulting from the continued improvement in user experiences and new features we launched. We enter into a strategic partnership with Skyworth TV to provide a cloud storage service to their smart TV users. Also, we have formed the partnership with Xiaomi that have led to the release of personal data storage service on Xiaomi phones, where the initial data already showed that it is going to be a pretty successful partnership. We have also extended, and will continue to push our partnership with application developers who will develop mobile applications and PC-based applications based on the open API of our cloud storage platform. At this moment, I would like to turn the call to Francis, our CFO, to make further comments. Thank you, Dr. Jiang. Good morning, and good evening, everybody. My name is Francis. I am the CFO of the company. I am now going to walk through the Q2 and the first half of 2012 operation and financial results. Now let us start with the Q2 using CNY as a currency. Revenue increased 10% quarter-on-quarter and 23% year-on-year to CNY 323 million. The revenue split was 65% for online games and 35% for application software business. Revenue from our online game increased 9% and 21% quarter-on-quarter and year-on-year respectively to CNY 209 million. The increase was primarily due to the continued popularity of our flagship game, JX Online 3. Here is a key operation data. The daily average PCU, concurrent user, decreased 3% quarter-on-quarter and 6% year-on-year to 600,000. The small decline was primarily due to the adverse impact of online game control policy conducted by the Vietnamese government. The monthly average pay accounts increased 10% quarter-on-quarter and 17% year-on-year to 1.5 million. This increase was primarily reflected the rapid growth of paying accounts for JX3, driven by the release of the expansion pack, Light of the Fire, as mentioned by Dr. Jiang earlier in April 2012. The monthly ARPU held flat quarter-on-quarter and increased 2% year-on-year to CNY 47. Our revenue from our application software business increased 25% quarter-on-quarter and 25% year-on-year to CNY 112 million. The sequential and year-on-year increase was mainly due to the combination of the following two factors. First, the constantly rising advertising revenue from Kingsoft Internet Security, and also the growing sales of WPS Office. Now, we have to pay attention to this important fact that our advertising revenue actually surpassed the fee from our membership. This is very significant milestone for our internet security business. That also evident the successful transformation from a free model to the internet model. The cost of revenue decreased 18% quarter-on-quarter and increased 18% year-on-year to CNY 41 million. The decrease was mainly due to the amortization of capitalized TV production costs based on the progress of the revenue recognized during the first quarter 2012. Our gross profit increased 16% quarter-on-quarter and 23% year-on-year to CNY 282 million. The group's gross profit margin increased four percentage point quarter-on-quarter and half back year-on-year to 87%. Our R&D expenses was flat quarter-on-quarter and increased by 42% year-on-year to CNY 87 million. The year-on-year increase was primarily due to the increase in staff cost, and actually the staff cost account for approximately 80% of our R&D expenditure. The selling and distribution expenses increased 29% quarter-on-quarter and year-on-year to CNY 40 million. This sequential and year-on-year quarterly increases were attributable to the marketing promotion for our release of expansion pack for JX3 and the open beta testing of our new game. Administrative expenses increased 6% quarter on quarter and 41% year-on-year to CNY 37 million. The share-based payment cost also increased 73% quarter on quarter and 281% year-on-year to CNY 40 million. This was in line with our recent MBO and also the award of share option to our senior executive. The operation profit, excluding the impact of ESOP, increased 34% quarter on quarter and 8% year-on-year to CNY 123 million. The operating profit margin, excluding the impact of ESOP, increased seven percentage point quarter on quarter and decreased five percentage point year-on-year to 38%. Our financial income also increased 9% quarter on quarter and 75% year-on-year to CNY 24 million. Income taxes increased 3% quarter on quarter and decreased 1% year-on-year to CNY 15 million. Our effective tax rate, excluding the impact of ESOP, decreased three percentage point quarter on quarter and two percentage point year-on-year to 10%. As a result, our profit to the owner of the parent increased 28% quarter on quarter and 8% year-on-year to CNY 112 million. The profit to our owner of parent, excluding the ESOP impact, increased 13% quarter on quarter and 15% year-on-year to CNY 124 million. The profit margin, excluding the ESOP impact, was 38%, 32%, and 41% respectively for the three-month ended June 30th 2012, March 31st 2011, and June 30th 2011. Let us turn to the result for the figures for the first half 2012. The revenue number increased 24% year-on-year to CNY 615 million. Online game make up 65% of the total revenue, increased 90% year-on-year to CNY 400 million. Application software make up another 33% of the revenue and increased 28% year-on-year to CNY 203 million. Our gross profit margin remain quite stable, decreased by one percentage point to 85%. The profit to owner of the parent increased 70% year-on-year to CNY 199 million. The profit to the owner of our parent, excluding the ESOP impact, increased 20% year-on-year to CNY 290 million, and the profit margin ex ESOP was 36% for the first half 2002 versus 37% for the same period last year. Our statement of financial position, we have cash and time deposit of CNY 2.1 billion as of June 30th, 2012, which represent a cash per share of CNY 1.9. The deferred revenue was CNY 155 million compared to CNY 182 million as of December 31st, 2011. This decrease was primarily due to the sales promotion of prepaid card at the end of 2011. Our net cash from operating expense activity decreased 22% year-on-year to CNY 145 million. These changes were primarily due to the increase in our accounts receivable, which was in turn caused by the increase in KIS advertising receivables. Our capital expenditure decreased 44% year-on-year to CNY 48 million. Going forward to just a little bit ahead to Q3 2012. As a company, we intended to launch a number of new games, so we expected that the advertising expenses in Q3 will increase significantly, which will cause that we expected that the short-term operating margin for Q3 will drop by around 7 to 8 percentage points. This is what I have to report on the financial number movement. Let me pass the floor back to Dr. HongJiang Zhang for the company outlook. Thanks, Francis. Based on what Francis has reported here, I want to add on one thing. That is, maybe you have already noticed the successful transformation of our Internet security business. The value-added services, mostly advertising revenue, has increased tremendously in the last quarter, in the second quarter and in the first year, way past our traditional subscription income for that particular business. I like to provide you a little bit more outlook for the rest of this year and for next quarter. As Francis pointed out, the next quarter, we have a number of new games that will go online and start open testing. That will incur a significant increase in the marketing cost. Overall, with the impressive growth of JX Online 3 and our new game pipeline and the successful transformation and turnaround of our Internet security business and the continued strong sales of WPS Office and its fast expansion into mobile devices, we believe that we have laid a very solid foundation for a successful second half of 2012. We expect all of our business lines will continue to grow in the second half. We are also very determined and confident to deliver sustainable growth and return to the shareholders in the future. On behalf of Kingsoft, I would also like to extend my appreciation to Kingsoft's shareholders, our customers, employees, partners, and all of you for supporting us. We may start our Q&A now. Thank you. Operator, can we start our Q&A, please? At this time, if you would like to ask a question, please press star followed by the number 1 on your telephone keypad. If you wish to cancel your request, please press pound or hash key. Again, ladies and gentlemen, that's star followed by the number 1 for any questions. Your first question comes from Steve Dong with Macquarie. Hi, and thanks for taking my question. My first question is about your outlook for Q3. You have mentioned that you expect to do a lot of sales and marketing and expect operating margins to drop significantly. Can you talk a little more about what your revenue expectations are if you are investing that much into sales and marketing? Thank you, Steve. For Q3, we are saying that we expected to launch a number of new games. So in terms of revenue, we do expect that there will be a continued growth. But some of those impact will be felt by not only in Q3, but also the rest of the year. So I just wanted to say that we expected that the Q3 will continue to have a steady growth. But some of the investment on the advertising and marketing expenses will benefit not only Q3, and that will be a continued benefit for the quarter going forward. Yeah, Steve, let me add on a few more sentences here. It is just like every time you launch a new game, you put a significant amount of marketing dollars there. But you do it to bring new users, new gamers into your game, your new games. The benefit of that investment is not just for this quarter, it is actually for the rest of this year and enter into 2013. So that- Okay, great. Thank you. Okay. Sure. My second question is related to your browser. Can you talk a little more about what, or how much install base you have for the browser right now? Perhaps, where you are in terms of monthly or daily active users and possibly, the traction you are getting with advertisers to pay for links on your navigation page. Thank you. Well, thanks a lot, Steve. Let me address your question here. We have not started our marketing campaign for our browser yet. All you have seen so far on the browser are the organic growth after we release it to the market. So far, we have not really put any marketing dollar into it yet, but we are going to do that in Q3 and Q4. That is another add-on in term of our marketing cost. All I can say now is the acceptance by our users overwhelmingly exceeded our expectation so far. The advertising from the navigation, from our landing page navigation, has increased tremendously from May to June and continued to July and into August. Basically every year, but every month you see a record new number there. You can see that, to complement what Dr. Jiang just mentioned, that in the internet security business, actually the advertising income has actually surpassed our membership fee. Actually, it was double the membership fee, in Q2 2012. Okay, great. Thank you. Your next question comes from the line of Yanan Ma with Bocom International. Hi, Dr. Jiang, Francis, and Michelle. Thank you for taking my question. My first question is regarding your ad business. Can you please elaborate more on your internet security business? How many of your software revenue came from advertising of your online security services? I have a follow-up. Thanks. Yeah, thank you for the question. This is Hong Zhang. I would like to address the question, a thing that at this moment, we are not dividing further our software business revenue. All I would like to say is that both WPS Office income and our internet security income has reached a historical high on both of them. WPS, thanks to the government to continue push on legalization and our continued improvement of user experience, and in the latest government procurement for office software, we commanded a majority of shares in all the purchases. Also we enter into the enterprise market very successfully. So the WPS part also have seen tremendous growth as well as our internet security business. Okay, thank you. The advertising revenue mainly consists of the revenue sharing of traffic guidance to other websites? Can you give us some light on your advertisers? What are they? What are the top five categories in terms of industry or websites of your online ad revenue? Thanks. Well, thanks for the question. Yes, I can give you some information here. The traffic and advertising revenue mostly come from a search and e-commerce site. Okay. Search and e-commerce. Okay, thank you. Thank you. As a reminder, if you would like to ask a question, please press star followed by the number one on your telephone keypad. Your next question comes to the line of Billy Leung with OSK. Hi, Dr. Jiang. Hi, Francis. Thanks for taking my question and congratulations on the very good results. Just a few questions. The first one is, the software segment is doing quite well right now. You've done a lot with mobile and also search as well. Can you just sort of talk a bit about how you have further plans to monetize on these activities? And also where you think the near-term growth will come from, considering that the free version, the free model will be starting in Japan already. And the second question is to do with margins. Gross margin actually increased, despite a limited set of changes in the product mix. Could you just talk about what the outlook and why the margins were so high this quarter? Thank you. I take the second question. Yeah. Could you repeat the first question a little bit again? I lost. Yeah. Sorry. The first question is simply, in terms of the software segment, in terms of near term, where do you actually see the growth coming from? Which sort of product or which area do you see that coming from? Yeah. Thanks for the question. Yes, we will see a continuing growth in both the Internet security, mostly the advertising and value-added service, and Internet value-added service there. As well as a strong growth in the office software. The momentum of software legalization in China among Chinese government agencies and among the corporations is still very strong. We see continued increase in that revenue. Also, the advertising revenue from Kingsoft Internet Security, we see at least continue at the same growth rate, if not faster, in the rest of the year. We are also exploring the future business model for our large install base for the WPS Office software for the personal consumers, which are free, as you mentioned. As well as the increasing number of users in the mobile Android platform. We are pretty optimistic there that as our user bases grow, we will be able to see some way of monetizing on that user base. Thank you. Thank you, David Jiang. The question on the increase in gross margin. Let me just report that there is a 4 percentage point increase in Q2 2012. The gross margin for Q2 2012 is 87%, versus the Q1 2012, 83%. There is a 4 percentage point increase. Actually, the extra low percent gross profit margin in 2012 Q1 is primarily due to the amortization of the TV production cost, which was not recurred in Q2 2012. Thanks. What you're saying is this level is the standard level we should be expecting going forward as well, right? Yes. The extra high production cost in Q1 is due to the amortization of the TV production cost. Okay. Thanks. Thanks about that. I will get back into the line then. Thank you. Thank you. Again, if you would like to ask a question, please press star, followed by the number one on your telephone keypad. Again, ladies and gentlemen, star followed by the number one for any questions. You do have a follow-up question from the line of Billy Leung with OSK. Hi. Thanks. Just to follow up, I just want to talk about advertising. I was wondering what the collection terms were for the advertising segment right now. Sorry, what is the what? What are the payment and collection terms for the advertising segment, the business? Payment and collection terms. Yes. Our revenue, our account receivable from our advertising customer is usually from 30 to 60 day, the credit terms offered to our advertising customer. Okay, thanks. Is this towards the high end or the low end at this current stage? Pardon? Sorry. Is that towards the higher range of 30 to 60 right now, or is it lower? It's about the middle. Okay, thank you. Thank you. At this time, there are no further questions in queue. Again, if you would like to ask a question, please press star followed by the number one on your telephone keypad. Again, that's star followed by the number one. Okay, and there are no questions in queue. I would now like to turn the call back over to management. I apologize, you do have a follow-up question from the line of Yanan Ma with Bocom International. Hi, just a quick follow-up on the other revenue. We can see that other revenue declines substantially from CNY 11 million to CNY 1.6 million. Can you give some explanation on this? Thanks. The other revenue? Right. Yes. In last quarter it's CNY 11 million, but this quarter it dropped to CNY 1.6 million. Yes. Hold on a second, please. Other revenue. Drop down. Sorry, Ma Yuan, can we call you after the meeting? We need to discuss. Okay, no problem. Thank you. We discuss after this meeting. Thank you. Okay, thank you. And you do have another follow-up question from the line of Billy Leung with OSK. Hi, Dr. Jun. Hi, Francis. Just one more question for the release of Legend of Moon in September. Is that planned to be on early September or late September? Sorry, will you repeat the question one more time? For the release of Legend of Moon, which is scheduled for September, are you aiming for the early September or late September? In the middle. Okay. Exactly middle. Exactly. Okay. Thank you. Thank you. At this time, there are no further questions in queue. I will now turn the call back to management for closing remarks. Ladies and gentlemen, I want to thank you again very much for attending this call. Again, thank you for your continued support and hope to talk to you again in three months' time. Okay, thank you. Good night. Thank you. This does conclude today's 2012 Q2 and interim results announcement conference call.