Earnings Call: Q1 2012

May 24, 2012

Earnings release

Hi, and welcome to the 2012 first quarter results announcement. 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, May 24, 2012. I would now like to hand the call over to your speaker for today, Ms. Michelle Harnett. Please go ahead. Thank you very much. Ladies and gentlemen, good evening and good morning. I'd like to welcome everyone to our 2012 Q1 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. Mr. Zhang Hongjiang, our Executive Director and CEO. Mr. Eric Wang, our Executive Director and CFO. Now, I'm turning the call to our Executive Director and CEO, Mr. Zhang Hongjiang. Hello. Thank you, Michelle. Hello, everyone. This is Hongjiang, CEO of Kingsoft. I'd like to start by saying that we are very pleased to report to you a very solid first quarter of 2012, with our revenue posted a steady growth of 3% and a year-over-year growth of 27%. Our operating profit margin continued to improve, actually, from 25% in the last quarter and to 29% this quarter. Our quarterly bottom line also recorded a quarter-over-quarter growth of 12% and year-over-year growth of 33%. As you can see from those numbers, this is a very solid quarter for us, and it comes from a number of factors. The first quarter continued to show enhanced performance in our existing games, particularly in our 3D MMO game, JX Online 3 series, which has been ramping up since the launch of The Grand Master expansion pack in November last year. The new expansion pack, Light Up The Fire, was launched in April, actually stimulated the popularity of the game. Also, the expansion pack for the JX Online World was also launched in March to retain the existing gamers and attract former players back. Both of those expansion packs have contributed tremendously to our game business. The new servers of Legend of Moon were opened in April, and the new game title is now under its title, The Last One of Unending Cold beta test. As I mentioned earlier, the game business in the last quarter was extremely good. Also, on our software business, the active users of our Kingsoft Internet Security software and services continue to grow. The advertising revenue from our Kingsoft Internet Security has been gaining momentum in the first quarter. Also, another good news is on May 2, the first internet browser from Kingsoft, Cheetah, was released for beta test. This dual-core internet browser differentiates itself from its competitors not only by speed, but also by security and a very shiny UI design. The user experience so far has been very good, and we have received many positive feedback. The browser integrates both the Chrome and IE core, as you know, one from Google, one from Microsoft. Also for the first time, it introduced the intrusion prevention system supported by our proprietary cloud-based internet security technology. The basic thing is that the user of this browser is kind of guaranteed in term of anti-phishing. This particular browser also has received overwhelmingly positive feedback ever since its beta release, as I mentioned earlier. We believe that the release of the browser later in this quarter will further enrich our product line and will help to cultivate our broader and active user bases and enable us to further improve our monetization capability. As you know, we have moved away from the membership model for our antivirus and security software and introducing the browser, it actually will close our loop in terms of monetizing our user base. Also, in our WPS Office branch, the active user base for the WPS Office continued to expand in the first quarter. Due to the seasonality effect, the top line of our office software reported quarter-over-quarter decreases, but with year-over-year increase of 18% increase to CNY 41 million. This is a very high increase, and this particular increase actually demonstrated the strong momentum of our WPS software benefiting from the improved awareness of copyright protection, our expansion to mobile office, and the continued improvement of WPS product experience itself. As I mentioned before, the user base of WPS expanded tremendously in the past six months and in particular in first quarter as well. Again, I'm very pleased with, as you know, the consumer version of WPS attracted more and more users. Now currently our active users in per month is over 33 million. Also in this past quarter, we have announced the establishment of Kingsoft Cloud. This is a new business division that focuses on providing cloud storage service to consumers and enterprises. This will be a long-term investment, I would like to point out here. I am very pleased to see the users of our service have grown to over 10 million as we continue to improve our product and the user experience and slow down our infrastructure cost. Another thing I'd like to say is that our Kingsoft Japan subsidiary launched a new product, the Android-based Pad in Japanese market. Again, very positive feedback from our users. We believe this move will continue to be received well and will add on our expansion to the Japanese market. That will also help our WPS and other products in that region market. Overall, I like to say again, we have reported a very solid first quarter, both in bottom line and the top line, and the year-over-year growth have been pretty impressive. At this moment, I would like to turn the microphone to Eric Wang, our CFO, to make further comments. Eric? Good, Hongjia. Hi everybody. This is Eric Wang, the CFO of Kingsoft. In this quarter, I am pleased to announce in the first quarter of this year, we have a sales revenue of CNY 292.5 million. Compared to last quarter end, we have the 3% increase on the top line and compared to a year-over-year with 27% increase. Also in the bottom line, the profit, our total profit in this quarter is CNY 87.5 million compared to last year, the same quarter year-over-year increase by 31%. Even compared to last quarter, we have 11% increase. Let me walk you through more detail about this P&L. In the first quarter, our total revenue composed of CNY 191 million, that is on online game, which is compared to last year, we have a quite significant year-over-year increase. If compared to last quarter, we have CNY 188 million. That increased by 1.5%. On the other hand, the application software, our top line revenue is CNY 90.7 million, which is level off compared to last quarter, also CNY 90.7 million. Also, we have other revenues, about CNY 10.7 million that compared to last quarter is CNY 3.9 million. That CNY 10.7 million is mainly composed of revenue on the TV series, about CNY 8 million. Concerning the gross profit, in this quarter, we have CNY 242.9 million compared to last quarter, CNY 239.9 million. This is also quite an impressive gross profit increase. You may also see that our gross profit margin in this quarter is 83.1% compared to last quarter, 84.6%, which will have a little bit decrease, about 1.5%. This mainly that on the TV series, the revenue that we have also recognized the same cost on our cost of sales. Further down, we look into the R&D expenses. In this quarter, we have CNY 87.3 million, which is about 30% of the total revenue, which compared to last quarter is CNY 88.2 million. I would say there are not much increase or decrease in the R&D. On selling and distribution costs, we have CNY 30.1 million and compared to last quarter, CNY 41.3 million. You can see almost a CNY 10 million decrease. This is mainly due to last year's fourth quarter, we have released quite a couple of expansion packs on the online game that at the same time corresponds to advertising costs also quite amount during the last quarter. This means in the last quarter, we had quite some marketing cost increase. But in this quarter, we have maintained about 11% of our total revenue on the selling and distribution costs. For the administrative expenses, in this quarter, we have CNY 34 million. Compared to last quarter, it is CNY 41.4 million. As well as the last quarter, we have quite a couple of increase in expenses in last quarter, mainly on the bonus and professional fee. In this first quarter, we have still incurred this kind of expenses. So we maintain around 12% of our total revenue on the administrative costs. Further down, you will see that we recognize other income is about $2.2 million compared to last quarter, $8.4 million. In this quarter, we do not recognize too much on the government subsidy, but in the last quarter, we have couple of government subsidy and other income. So it makes up the total operating profit in this quarter is $83.8 million, compared to last quarter, $71 million. So it is quite a significant increase in the operating profit. Concerning the operating profit margin, in this quarter, we recognize about 28.7% in the operating profit percentage compared to last quarter, we have 25%. So there is a quite significance in the operating profit in this quarter, and we expect that the operating profit would still be increasing by maintaining a reasonable expenses on the administration cost and the reasonable expense levels in the selling and distribution. Concerning finance cost, in this quarter, we also recognize $22.2 million compared to last year, almost level off about $21 million finance income. That is mainly the interest income that due to our cash balance. We still maintain about 5% or 6% interest rate recognizing in this quarter. To make up also in the income tax expenses, we still maintain quite a stable effective tax rate around 15% to 14%. To make up the profit for the year is $19 million. Compared to last quarter, $76.7 million. So it increased also quite amount on the bottom line. Overall, I would say this year or this quarter in Q1, in comparing to year-over-year and as well as quarter-over-quarter, we are making progress in terms of the top line, even though normally in quarter 4 we have a peak season, but in the first quarter of the beginning of the year, we are still achieving quite an encouraging top line and encouraging operating profit percentage margin, as well as the bottom line. Talking about some operating highlight on the online game. In this quarter, our PCU maintained at 631,000 compared to last quarter, 661,000. Also the average paying user, we are maintaining at 1.3 million, which also maintain the same as 1.3 million compared to last quarter, and the ARPU is 47. This is the overall financial performance of the company. I would pass the time to any Q&A on this section, and I will pass to Michelle. Thank you. At this time, if you would like to ask a question, please press star, then the number one on your telephone keypad. Once again, if you would like to ask a question, please press star, then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. You have a question from the line of Jin Yoon of Nomura. Hey, good evening, everyone. Eric, I might have missed or misunderstood what you said regarding administrative expenses. You saw a sequential decline because you saw government subsidies, and you net that out of administrative expenses. Did I hear that correct, or did I misunderstand that? Sorry, you mean the other income on the government subsidy? Okay. Yeah. I am sorry. Let me just start over. The administrative expenses have seen a sharp decline sequentially from CNY 41 million to CNY 34 million. Correct. That's largely due to what again? I'm sorry. I might have missed it. Yeah. The administrative expenses decreased from CNY 41.4 million to CNY 34 million. There's a decrease in the administrative expenses. Due to last quarter, in Q4, we have recognized some bonus expenses. This is the administrative expenses. Furthermore, in the separate line, you can see other income and gains. Yeah In last quarter is CNY 8.4 million. In this quarter, we have CNY 2.2 million. In other expenses and gains that in this quarter, we do not recognize too many or too much of the government subsidy. Got it. But instead, in last quarter, in Q4, we recognized a couple of subsidy from the government authority. So two lines are quite even in nature. Going back to your, it looks like the margins came in a lot stronger than anticipated because you managed to control your sales and marketing costs pretty aggressively. With that being said, you do have a couple expansion packs recently launched. You have new servers for some of your new games rolling out. Have sales and marketing costs for some of these new products, has that already been kind of in the past, or can we see how should we look at sales and marketing costs going forward, knowing that we have some kind of new product rollouts coming out over the next few months? Yeah. If you compare quarter and quarter, in last year, we have CNY 41 million, and compared to this quarter, we have CNY 31 million. You can see that we have CNY 10 million decrease on the selling and distribution cost. The first difference is last quarter, we have couple of expansion pack release on the online game. At the same time, we released couple of, we also run couple of advertising costs for the corresponding expansion pack. This is one reason compared to this quarter, we do not have too many expansion packs released. This is one reason. Looking forward, where are we going to do on this advertising cost? The first point is, we will still maintain doing some online or offline advertising expenses for the game or for the antivirus or for WPS. But one thing we are going to do is, instead of the traditional selling and marketing campaign, we also would do more on the SNS type advertising, like Weibo advertising. This kind of expenses will not be too much. It is close more to the interaction with the gamer or interaction with the user. So in that sense, we are expecting that we will do more on this kind of SNS type of advertising. So we'll say that in the longer run, during the year, we'll maintain about 11%-12% of our total expenses on the selling and distribution. But we are doing more in different ways that we believe that not necessarily to be spending money will do a very good effect result on the advertising. Got it. I'm not sure whether I answered your question, Jin. Yeah. No, absolutely. Finally, just on the top-line aspect, you mentioned on your press release that daily average concurrent users declined 8%, and that's largely due to a slowdown in overseas, especially, I think it was Vietnam. If we assume that the revenues were largely flat quarter-over-quarter, and you saw this level of sequential decline from Vietnam, and yet ARPU remained flat as well, that means contributions from Vietnam was very minimal overall. Can you talk about just pure China business and seeing organically within China what kind of metrics that we would have seen if we excluded all of overseas revenues and key performing metrics? Yeah. Talking in two way. One is the domestic online game. Talking about the overseas, let me talk about more on the overseas online game. Although the PCU is a little bit decreased due to Vietnam, we have a couple of games. One to two game is a little bit PCU decreased, but it didn't change too much on our top line, on our revenue. You can see that our average paying users maintaining compared to last quarter. This is the overseas part. But actually, we have more concentration and more effort on the onshore in China. On the online game, we still, as I mentioned also in last quarter, that this year our target is our existing game. We still see that quite a good momentum, although they have three years time or four year time history. But we still see that these existing games still have a very good momentum. We still have room, provided we have to do more on the expansion pack to be more creative and also to understand where's the gamer, what's the need, and how we going to optimize the function. This is how going to optimize existing online game. Furthermore, in future, we have further released a couple of new game on MMO, and this is also another revenue driver on the online game. We're expecting a couple of new games coming out. Online game, we're still looking to further on the web game section that we have been doing some R&D since last year. This year we will release online on the web game to test the market. Overall, we will see that our online game on the revenue will still see a consistent growth and a persistent increase on the top line as well as on the PCU. We still find that a couple of existing games have a very good momentum in the first quarter, like the Jianxia 3, that have a very good performance on the PCU. Yeah, that's our outlook of our online game. Yeah. Eric Wang, let me add a couple of comments here. Actually, in the first quarter, due to the release of two expansion packs, one released last November and one released in March for the Jianxia 3 and the Jianxia World, both have created a great effect in our revenue and users. As you may notice that we released another expansion pack for Jianxia 3 in April, and also created a great effect in term of concurrent users and the revenue on that particular game. So we will continue our effort in developing new expansion pack in the rest of 2012, and not just on Jianxia 3 series, but on all existing games to retain our gamers for all those existing games and actually increase the number of gamers and the time and the money they spend on those games. We are pretty confident that this trend will continue. Got it. Perfect. Hey, thanks, guys. Thanks for taking my questions. Thank you. Our next question comes from the line of Yi Zhang of Macquarie. Hi. Thanks, Eric. Thanks, Zhang Dou, for taking my questions. Congratulations on a strong quarter. I have a few questions. Number one, can you talk about the pipeline for your games for the remainder of the year? How is the Legend of Moon progressing in beta testing right now? How about you, Zhang? Eric, you want to say that? Yeah, Zhang, could you answer this? I can- Okay. We have five new games in the pipeline, the five MMO games in the pipeline. They are moving along pretty well. YueYing is in the final testing and improvement stage, and it should be finished in a couple of months. The Ma La Jiang Hu from our Dadi studio is also progressing very well. The HongZhen 3 series is already in the public test, so we are doing the final push. We also have a new game from our Dalian team. The initial testing reality is pretty encouraging. Overall, the five new games are progressing well, and I anticipate they will all release in the next two quarters. We are also going to release the first web game from the Western house and also, I think in later Q2 or maybe early Q3, we will release three mobile games. Overall, I would say the new games are moving along reasonably well and within our plan. Okay, thank you. Going towards the advertising segment. You released a new browser. Yes. Can you talk a little more about how you are monetizing that? I am so sorry, I think I missed the news, but do you have a navigation page right now? How many users do you have for the browser right now? Thanks for this particular question. Actually, the browser was released for beta testing. It is actually a closed test, so basically it is invitation only. We invited about a few thousand testers to test the browser. It is not formally released yet. It is still in the beta testing stage. Overall, the feedback from those who have downloaded and tested the browser has been overwhelmingly positive, both in terms of UI and the visual effect, the speed, and the security features. We are pretty positive about this particular browser. We will release it very soon. Coming back to your question about how do we monetize it. We have walked away from the old fee-based model for our security software and now it is a membership-based model. That revenue has been declining. But on the other hand, the landing page-based advertising and the revenue from there has been increasing tremendously. The browser, if you have spent time looking at the browsers, either on a mobile, on PC, in China, you realize that it is not a typical browser like Chrome or IE, but it is a browser that has many hyperlinks. Those hyperlink places, you have to bid for those places, and that is how you make money. Basically, if for instance, Alibaba places its link on top in the browser, then they have to bid for that. That is how we make money. That is pretty much it, the major reason why we believe browser will actually help us increase our advertising revenue for our security software service. Okay. Sorry, maybe I misunderstood. You say you are already gaining significant revenues from advertising, which means- Yeah, that is from a landing page. Who hosts your landing page right now? Or how do you get people to come to your landing page? It is our own landing page. Our security software and services has a landing page where you have links to our various websites, and those links are advertisements. Okay. How do you get users to So every time they install your security software- Put it this way, every time a user gets an update or a user comes to our landing page, our security software landing page- You will see advertisement there. You will also, from time to time, be prompted by a window that will show you advertisement when you use our software. Okay, I see. So right now, the landing page is not for regular users, but only for users who update the software. Is that correct? Yeah. Well, it is for a normal user. Every user of Kingsoft security software and services will update because we have weekly and monthly updates. They just have to have the update then. I see. Okay. The browser fits into that strategy. Okay. All right. In terms of the Kingsoft Cloud, can you talk a little more about where you are in terms of monetization for that business? As I mentioned earlier when we launched the Kingsoft Cloud services, actually we don't have a profitability target for the next couple of years. This is a long-term investment. In particular, the first service we provided now is the personal data storage service. The service itself is very much similar to the Dropbox service. At this moment, the monetization, the major monetization channel is actually through our cooperation with device vendors like smartphone vendors, where they will partner with us to provide a storage service for their users. So they will pay us for the storage space they use. For our direct users at this moment, we give them 15 gig free space, and we have not started charging them yet. But as the demand for more space start to emerge, there will be a charge for that. But at this moment, we have not started that yet. Okay. Have you made any progress with new partners for TV and also mobile instead of- Yes. We have made progress in that front. Actually, we are going to announce another TV collaborator very soon. We are in close collaboration with Xiaomi. Okay, great. One last question. On your gross margin, it fell a little bit this quarter. I guess it seems like one-off events like casual costs and such. How should we look at gross margins going forward? Will it return to the normalized level of maybe 84%-85%? Yeah. I think the gross margin you can see in this quarter decreased by a little bit compared to last quarter. I believe that is only a temporary effect due to our TV series, as I mentioned in the opening explanation. TV series, we recognize CNY 8 million. At the same time, we also recognize CNY 8 million cost. I will say this is temporary in this quarter. But we will see that the margin will be back to our previous level, about 84 something. This is the one point that the TV series effect. In answering your question, longer run, how is our margin, what it look like? In longer run, we believe that the margin will not be changed significantly. That may be because we are doing more in internet operation. We are attracting user, so there may be a broadband expenses or IDC expenses increasing, which is the main component of the cost of revenue. That will increase a little bit. But at the same time, we do not have revenue to cover this part. So there will be just kind of effect that our margin will be increased a little bit in longer run when we have attracting more and more internet user. To concluding up, I think we will maintain this more or less the same level on the margin. Steve? Okay. Thank you, Eric. Thank you, Johnson. Once again, to ask a question, please press star then the number 1 on your telephone keypad. Your next question comes from the line of Billy Long of OSK. Hi, Dr. Zhang. Hi, Eric. Congratulations on the strong quarter. Thanks for taking my question. I just have several questions. I think this one has been touched before, but just on the nearer term, in terms of margins, the marketing expense for the two new expansion packs for April and May were essentially done in the first quarter. I think in the nearer term, would you expect incremental margins going forward in the second or third quarter? The second question before I get back to the line is, what percentage is actually online ad revenue right now? That is all for now, thanks. Concerning the margin, as I mentioned just a while ago, we foresee that the margin will not have a significant change. Although you can see in this quarter we have a little bit decrease. We do not foresee any significant change or decrease in this margin. Sorry, Eric, this is for the operating margins, right? This is the gross profit margin. You mean the operating profit margin, right? Yes. Yeah. The operating profit margin, you can see that in this quarter and compared to last quarter, we have quite an encouraging increase. Yes achieving about 28.7%. Yes. We believe that in this year, in future, that we will still improving on the operating profit. In terms of by light on the expenses, on administrative expenses, we think that we can have further cost reduction on this area. Although it's not significant, but we still see that you have a little bit room on this. But if you look into the R&D part, you will see that we are maintaining quite about 30% of our top line on the R&D. We do not see that will going to decrease. Although we see that R&D is expensive, but we see that from management point, it's just investment. So I would say, R&D costs will maintain quite a steady portion. And in the administrative expenses, it will increase in the little portion. So, overall in the operating profit, we'll maintain about 28% operating profit. We expect that will be increased in the number one. Okay, thanks. This is the last question. How much of the revenue is currently on the ad base? You mean the advertising, right? Yes. Thanks. I think we do not expect too much on the advertising at this moment, concerning in the online game or application software portion. We are not trying to monetize much on this area, in the expenses of affecting the user experience. This is not our first target to generate advertising income. Instead, our first priority, at least in this year, or even maybe in next year, is to optimize user experience, to service the user, rather than monetizing our resources by mixing revenue top line, monetizing them on advertising. Sure. We do not expect the advertising revenue will be a significant increase. Okay, sure. Thanks. That just flows through to my follow-on question. In terms of the active users, for the WPS Office, is there anything you can disclose in terms of the user base or the user numbers? For WPS and on the anti-viruses, in this quarter, actually since last year, we see increase in the active user. WPS, lately we have reaching 33 million active users on the WPS. I think we see that the direction is correct. Our effort, our emphasis, putting on our WPS and anti-virus is on the trend. Yeah. Okay. Thank you for that. Let me add on one thing to both of your questions. Please hold on. The subscriber you dialed is busy now. Please hold on. Browser will also increase our monetization capability. Thank you. Okay, thanks for that. Your next question comes from the line of Yong Wang of Nomura. Hi. Thanks for taking my question. I have two questions. The first one is regarding your other revenue. You mentioned that the other revenue for this quarter is mainly because of the 8 million revenue from the TV series. I am just wondering if the revenue is more of recurring revenue or more of one-off. Thanks. Sorry. Actually, the TV series, I think is a part of our promotion program instead of our main revenue, core revenue area. Mainly it is a temporary that we did a TV program, and then we released since last year end, and within this year. I think your question is whether this TV series will be an ongoing one, right? Yes. I think it's not going to be a lot of ongoing program that we are going to do. The first thing is we are not reliant on TV series as our business income. Instead, we are using a one-time TV series to test the market, to become a ticket as an advertising program instead. I'm not sure whether I answered your question or not. Got it. Thanks. My second question is regarding the government subsidy. It seems that this item decreased a lot during the quarter. Just wondering if you can give us some color on how should we see this item for the coming quarters of this year? Since the government subsidy will have some seasonality, I think in foreseeing the future that the government subsidy, we're still gaining some government subsidy on high technology or the different kind of subsidy. I think we still have some government subsidy in the future. But one thing I want to show to the investor is that even though in this quarter we do not have a high amount of ad revenue on subsidy, but we still can achieve quite a very promising operating profit. We still can achieve 28.6% revenue profit. This is very critical for the company operation. That means that even though we are not going to operate without any government subsidy, we're still operating in a healthy growth trend. This is more a message to the management. If there's government subsidy, that's good to have. Okay. Thanks very much. Thank you. Once again, to ask a question, please press star then the number one on your telephone keypad. Your next question comes from the line of Connie Xu of DOCOMO International. Hello. Good evening, Dr. Zhang, Ari, and Michelle. Thank you for taking my question. Actually, most of my question has been answered, just a quick question follow-up. The first one, just want to clarify about advertising revenues. Did you say that just more contribution to the advertising revenue to total revenue? You mean the advertising? Yes. Sorry. You mean the advertising, right? Yes. Yes. Advertising revenue. Actually, how much percentage of advertising revenue out of the total revenue in Q1? Yeah. As I answered the question earlier that, first of all, we do not have a priority of urgently to monetize our resources by generating advertising revenue at this moment, at least not in this year. We do not emphasize too much on how much the advertising revenue we are going to have or in the future. I would say advertising revenue is only the result, and the result of we generate a higher number of user base. To answer your question, we do not have a target how much that we are going to generate advertising revenue. Rather, we will concentrate more on how to service the user, the gamer, how to understand the need to optimize our operation. Connie? Okay. Thank you. Also, the second one is for the WPS revenue. WPS contributed CNY 41 million revenue this quarter. For the software revenue, was the result from about CNY 15 million revenue